Will Obama's Regulatory Overhaul Include ETFs?

The unveiling of new regulations for the financial services industry on Wednesday is likely to find some very anxious observers among exchange-traded fund investors and sponsors.

At stake for fund companies is a layer of regulations that industry representative say costs extra money -- not just to complete the required paper chase but also to stay one step ahead of slippery supply and demand equations for their investors.

It's a situation which has been heating up for years within the industry. But now, it appears to be bubbling over into the plates of investors. The regulatory issues that many ETF providers (or, more accurately, exchange-traded products sponsors) view as slowing innovation are threatening to directly impact at least one set of fund holders.

As a result, those involved in the latest regulatory snafu should be very interersted in the upcoming disclosure by the Obama administration of its master blueprint for reforming market mechanisms that it says ran amok during the mortgage meltdown.

Along with the millions of other viewers watching President Obama's televised press conference later today, so will a group of money managers in tiny Alameda, Calif.

That's home to fund executives of the United States Commodities Funds, which formerly used to be known as Victoria Bay Asset Management. While refusing to discuss their most recent concerns, they admit it's unlikely that President Obama or any of his cabinet have any idea of the regulatory plight the company is currently going through.

The firm is the subadviser to popular commodities ETFs such as the United States Oil Fund (NYSE Arca: USO). To be more precise, the sort of portfolios USCF put together using futures contracts and derivatives could be more accurately defined as ETPs. (An argument is currently raging on IU.com's blogs about just this topic.)

In any case, the issue that USCF is facing can be viewed as problematic for any fund that could be considered an ETP. The situation came to a head recently when the money manager and fund sponsor was forced to dole out another $75,000 to the Securities & Exchange Commission for a rather mundane piece of paperwork.

Actually, the group that officially got dinged was the trust running the United States Natural Gas Fund (NYSE Arca: UNG). It’s the third such filing fee, in fact, that the United States Natural Gas Fund Ltd. has been forced to pay in its rather short history. (You can read the filing here.)

Since UNG is basically a commodities pool that trades daily on an exchange—commodities pools don’t always do that—the ETF’s trust has to apply to the SEC to issue a certain amount of new shares.

It’s a much different process than mutual funds governed by the Investment Company Act of 1940, including standard equity and fixed-income ETFs.

"This is an issue as a money manager that I'm concerned about," said Rob DeHollander, an adviser in Greenville, S.C. "What if this regulatory situation spreads to other commodity type of funds that deal in futures?"

As a commodities pool, UNG is actually regulated by four different groups. And that's where ETP managers are privately expressing hopes that Obama's new restructuring plan can streamline the paper chase that commodity ETPs are forced to endure.

As a result of current regulations, managers at USCF—which call headquarters a small island pocket community in the San Francisco Bay Area—must constantly try to figure out when demand will outstrip current supply restrictions.

That dynamic can be especially difficult for a heavily traded and liquid commodities pool. Consider with UNG, net assets hit an all-time high after Monday’s close of just over $4.5 billion. At the end of March, UNG had total net assets of $700 million. At the end of May, it was up to $2.2 billion. So in less than two weeks, assets have more than doubled.

UNG’s average daily volume has also increased significantly in the past several weeks. It hit 96 million shares on Friday and is averaging about 19 million shares per day since opening in April 2007. In the past two weeks, volume has jumped to the 50-70 million shares a day range.

So what happens if the SEC doesn’t move quickly on what appears to be a rather routine request?

The last time UNG activity jumped tremendously in March, the product’s managers went through the same drill. As with the most recent filing, they requested a green light to offer new creation units before shares peaked. Still, the SEC dragged its feet and had to file again two months later.

The government finally got around to granting the trust’s requests, but not before a delay of some 48 hours in which the fund wasn’t able to offer new creation units.

It’s a topic that Ian Salisbury first raised in the Wall Street Journal. But it’s also something ETP-types who run portfolios that are based on futures contracts and volatile commodities have been grousing about for years.

It’s a paper chase that gives investors an idea as to why such funds cost more to run—and can cause more agony for advisers and their clients to track.

Of course, there are those who think that products like UNG need increased regulatory scrutiny, not a more streamlined process. (See related items here and here.)

But still, even those within the industry who are supportive of regulators agree that whatever they are or whatever form they take, the SEC's rules and guidelines should be designed to help investors.

It seems clear that with another potential stall in activity of a popular fund such as UNG, more investors are going to find themselves at the center of such a debate.

And undoubtedly, many of those individuals and their advisers will come to the conclusion that, at least at this point, the current regulatory process for ETP products seem like a pointless bump in the road.