Debbie Fuhr is one of the best-known figures in the exchange-traded fund industry at the global level. Until recently, she was the managing director heading Morgan Stanley's Investment Strategies group, based in London. Her reports on ETFs have been widely read throughout the ETF industry. She parted ways with Morgan Stanley in May, and IndexUniverse.com's European correspondent, Paul Amery, recently caught up with her at the Terrapinn ETF & Indexing Investments conference in London on June 25 for her first interview since leaving her post. Although she was unable to discuss her departure, she did turn her attention to some of the bigggest issues facing ETFs in Europe and abroad, including liquidity, actively managed ETFs and the UCITS III structure.
 

Paul Amery (IU): Debbie, in a recent research report Raimar Dieckmann of Deutsche Bank argued that the European ETF market enjoys a structural advantage over the U.S. market because of UCITS III and the ability of European ETFs to use swaps. Would you agree with this assessment?

Debbie Fuhr (Fuhr): In terms of structuring new products, I think the UCITS framework does add a flexibility that is not available under the 1940 Investment Act in the U.S. But I think that the U.S. does have other advantages, in that there is more of an equity culture on the retail side. And so we have seen retail investors embrace ETFs to a much greater extent than here in Europe. Also, in Europe, the IFA model is a hindrance. Though they are called independent financial advisers, they are not so independent in reality. So both sides of the Atlantic have their pros and cons as far as ETFs are concerned.

IU: What other impact has UCITS III had, as a regulatory framework, on the European ETF market?

Fuhr: I think there are a number of things worth mentioning. First, the ability of funds to use ETFs was capped at 5% of assets under the previous version of UCITS. Under UCITS III, a fund can now invest up to 20% in any one other UCITS fund and up to 100% in total, as long as the funds meet certain regulatory criteria. So UCITS has opened up new opportunities for people to use ETFs, as well as offered more flexibility on the structuring side when designing new products, which you referred to in your first question.

Also, UCITS allows you to go synthetically long and short. This is an area that a lot of firms are looking at. This has been like opening up a Pandora's box for some asset managers; particularly those who are used to the long-only world and who have not been using derivatives. The challenge for some investment managers in using swaps-which, by their nature, are OTC and do not have ISINs or SEDOLs-is that their middle and back offices find it harder to track and account for these instruments. As a result, we see that a lot of asset management firms are stopping short of getting involved with swaps and are sticking with using futures, certificates and ETFs.

IU: Talk of swaps brings us to the topic of counterparty risk, something that has been of increasing concern to investors with the ongoing problems in the credit market. How would you evaluate the choice between ETFs and ETCs/ETNs with their note-type structure? And should swap-based ETFs be a concern to investors, when compared with ETFs holding the underlying securities in specie?

Fuhr: When comparing an ETF to an ETC note or certificate (which are effectively the same thing), clearly you have specific counterparty exposure when holding the latter. For some investors this has been a concern. For example, I've seen some pension plans in Europe decide that they no longer wanted to hold any certificates or notes based upon concern about counterparty issues. From a regulatory perspective, there may well be constraints anyway for some fund managers, limiting holdings in notes to 10% of assets.

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