NEW YORK (TheStreet) -- Commodities ETFs continue to steel themselves against an approaching
army of regulators.
iShares S&P GSCI Commodity Indexed Trust has followed the example of
United States Natural Gas and halted share-creation. As issuers and
regulators prepare to clash, it is a third party, the individual
investor, who stands to lose the most.
ETFs have offered unprecedented access to the commodities markets
through the use of derivatives such as futures contracts and swaps.
Where once only institutions could invest, individuals have gained
access to "pure" commodities vehicles.
Investors rushed in, and
funds like United States Oil
and UNG became bloated with assets.
Regulators such as the Commodities Futures Trading Commission
believe that these futures-based commodity ETFs have become too big for
their britches and are looking to curb the funds with position limits.
The PowerShares DB Commodity Index Tracking Fund
PowerShares DB Agriculture Fund
have already been subject to changing
regulation. On Aug. 20, the CFTC repealed an exemption that previously
exempted these funds from position limits.
By limiting the number of futures contracts that a fund like UNG can
essentially give these fund issuers two choices.
The first and increasingly most popular option is to halt creation.
If a fund can't buy more futures and grow, it can simply stop issuing
new shares. Creation of UNG was halted by force in July and extended by
choice in August. UNG's managers simply decided not to risk
running in the path of a
regulatory freight train.
GSG, the most recent fund to follow in
UNG's footsteps, joins the iPath Dow-Jones-AIG Natural Gas
and the PowerShares DB Crude Oil Double Long ETN (DXO)
The second choice, most likely to be used in conjunction with the first,
is for ETF managers to come up with another strategy. Funds like UNG and
GSG use futures contracts to achieve their investment objectives. If
they can't use futures, they can find something else.
is already combining the first choice with the second and is
selling futures contracts and buying swaps. These swaps are not
regulated in the same way as futures contracts. Other products like GSG
will likely be forced to follow suit if position limits on futures are
put in place.
Neither one of these options, halted creation or on-the-fly
restructuring, is good for investors. Creation plays a defining role in
the ETF process. It is through the creation and redemption processes
that ETFs actually track their underlying indices. A disruption in
either one of these steps will cause a disconnect between the price of
the fund and what it is worth.
Investors will suffer by paying huge premiums to buy shares of funds
like UNG and GSG.
The implicit promise made to each ETF investor by the ETF industry
is that the shares of a fund will track an underlying index. Halting
creation means breaking this promise.
The consequences of on-the-fly restructuring could be even greater.
Other derivatives markets make commodities futures look tame, and
alternative strategies like swaps could put individual investors at even
If regulators are truly worried
about investors getting hurt by
derivatives, they should consider the alternatives that these funds will
use to achieve their objectives.
GSG may be the latest fund to
protect itself from regulation, but it won't be the last. ETF issuers
have been alerted by regulators that the rules could be changed
mid-game. When the music stops, it is investors who will be left
-- Written by Don Dion in Williamstown, Mass.