The Central Bank of Ireland has published a discussion paper regarding exchange-traded funds. The regulator is especially keen to look at the expectations of HNW investors, liquidity and the funds' increasing popularity.

On the subject of 'investor expectation,' as it calls it, the regulator wants to know whether HNW investors and others genuinely understand the instruments in which they are investing, or if they simply assume that they do. Because there may be a mismatch of expectation and thereby of risk appetite between the operation of an ETF and the understanding of retail investors, the regulator is also worried that the market price of many an ETF might drift away from the value of underlying assets it holds, leading to problems with liquidity.

Ireland is the largest European centre for ETFs, which are the fastest growing type of investment fund in the world. ETFs have experienced enormous growth since they were first established in 1990 with more than US$4 trillion in assets today. The discussion paper will contribute to the Central Bank’s discussions with its political masters in Brussels on the subject.

Investors have flocked to ETFs because they are easily tradeable, usually associated with passive investment strategies that attract low direct management charges. HNW investors see them as as simple, transparent, diversified, liquid and easy to use. As they increase in popularity they are now offer increasingly "niche exposures." There is evidence to suggest that their growth in use since 2008 has been to the detriment of actively managed investment funds.

Although ETFs are constituted as investment funds (and thereby subject to the full spectrum of investment fund regulation) they are also exchange-traded financial instruments, like equities or bonds, and as such are subject to stock exchange rules and Euro-legislation that applies to publicly traded assets (i.e. MiFID II and the Market Abuse Directive/Regulation). Because of this dual nature, ETFs are subject to overlaps between the UCITS directive and MiFID.