The threat of increased regulation from the Commodities Futures Trading Commission continues to impact the ETF industry. Increased position limits are designed to reduce the impact that ETFs such as United States Natural Gas (UNG) have on the price of the commodities they are designed to track. The latest chapters in the futures regulation saga are the shuttering of PowerShares DB Crude Oil Double Long ETN (DXO) and the reconfiguration of the PowerShares DB Agriculture (DBA) and PowerShares DB Commodity (DBC) ETFs.
DXO was truly a victim of its own success. This leveraged exchange-traded note became so large that it was subject to limitations placed on its underlying components. Deutsche Bank considered the crackdown a “regulatory event” and redeemed the $407 million in outstanding notes on September 9. Its opposite, the PowerShares DB Crude Oil Double Short ETN (DTO), continues to trade.
Rather than shutting down futures-based DBA and DBC, two other popular commodities ETFs from PowerShares and Deutsche Bank (DB), fund managers decided to restructure the underlying portfolios in order to stay within position limits. The CFTC altered the course of these two funds with new “safety position limits” and the revocation of an exemption that previously governed the fund’s futures-buying capabilities.
The closing of DXO and restructuring of DBA and DBC represent a critical point in the development of the ETF industry. Regulation, not methodology, is shaping the capabilities of these exchange- traded products just as they are reaching new heights of popularity.
Nevertheless, new restrictions on futures-based commodity products will likely not stem the growth of the commodities ETF industry as a whole. While futures-based products are closed or restructured, issuers will continue to introduce new products without limitations.
Physically backed ETFs such as iShares Comex Gold (IAU) could play a greater role in the ETF universe as investor interest in commodities increases and uncertainty hangs over derivatives-based products. ETF Securities, a global ETF issuer, recently launched both the ETFS Silver Trust (SIVR) and ETFS Gold Trust (SGOL) to compete with entrenched competitors like IAU and SPDR Gold Shares (GLD) in the U.S.
Jefferies has also jumped on the commodities ETF bandwagon with the launch of the Thomson Reuters/Jefferies CRB Global Commodity Equity Index Fund (CRBQ). Rather than owning commodities futures or physical stockpiles, this fund invests in a basket of commodities-driven equities. Owning an ETF like CRBQ that tracks companies such as ExxonMobil (XOM) or Potash (POT) will certainly provide indirect exposure to commodities, but it will be less of a pure play on prices than is a futures fund like DBC, and it will offer less diversification to this separate asset class.
For more than a decade, ETFs have offered investors inexpensive access to specific sectors and regions of the global economy that were previously difficult to access. Increased regulation and position limits may be good for investor protection in the long haul, but in the short term these changes are caustic to derivatives-based products. Until definitive regulatory action is taken, investors should stick with physically backed ETFs like IAU or equities-based products like CRBQ.