Exchange Traded Fund Updates

BlackRock and State Street criticized a bill proposed by a top US lawmaker that would deprive exchange-traded funds of a key tax advantage that has helped fuel the industry’s considerable growth.

The bill introduced late last week by Democrat Ron Wyden, chairman of the Senate Finance Committee, would generate billions of dollars in additional tax revenue for the federal government at a time when the Biden administration seeks to fund a massive spending program for social programs. .

by Wyden tax bill aims to close loopholes, including one that gives ETFs a tax advantage over mutual funds. Rising markets and record inflows allowed the ETF market to nearly double to $ 9.7 billion, from $ 4.8 billion since late 2018, according to data provider ETFGI.

“We would be concerned about policies that would increase costs and reduce returns for long-term investors and retirement savers,” said BlackRock, the world’s largest asset manager.

State Street, another big player in the ETF industry, echoed this point: “We are opposed to this proposal and have concerns about the negative impact it could have on investors.

One of the main differences between ETFs and mutual funds is how they handle the inflows and outflows of investors. Mutual funds typically buy and sell shares of portfolio companies when clients enter or exit the fund. The fund pays taxes on capital gains realized in the companies in its portfolio.

In comparison, ETFs can meet demand by creating and redeeming new shares that are sold in the market. Banks and trading groups that work with ETFs can withdraw market share by trading them in exchange for a basket of stocks or other assets that match the makeup of the fund. These distributions do not result in capital gains tax for the fund, protecting it in a way that is not available for mutual funds.

The bill would require ETF investors to pay capital gains at the end of each tax year for these investment vehicles.

The US ETF industry is dominated by BlackRock, Vanguard and State Street and the proposed tax change threatens a lucrative area of ​​growth for these titans. Many asset managers have converted mutual funds to ETFs and BlackRock has forecast the global ETF market to reach $ 15 billion by 2025.

Georgia Bullitt, a partner at Willkie Farr & Gallagher law firm in New York City, said less than 5% of U.S.-listed ETFs reported taxable gains last year. “This is only a proposal, but it is made by a distinguished senator and it would affect the usefulness of ETFs. The ETF industry is fighting very hard against this.

Vanguard could be particularly exposed if the legislation is passed as the manager uses a structure that combines ETFs with mutual funds, allowing both to benefit from the tax advantage.

“This change in tax treatment would punish Vanguard ETFs and their index mutual fund shareholders,” said Todd Rosenbluth, head of ETF and mutual fund research at CFRA.

Vanguard said that “the ability of mutual funds and ETFs to conduct in-kind securities transactions is a long-standing practice that improves results for millions of investors.” The group said it was waiting to see how Wyden’s draft discussion progressed, adding that it would “reserve comments until more information on the reconciliation bill becomes available.”

Another result is that some investors would increasingly adopt tax-managed accounts, such as “direct indexation”. This sector has gained ground in recent years among investors as technology has broadened access. Over the past year, Morgan Stanley, BlackRock, JPMorgan and Vanguard have made acquisitions to strengthen their presence in direct indexing.

Additional reporting by Emma Boyde

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