A Work-Around or an End-Around?

Yesterday morning, a reporter reached out about yet another filing for a pair of single-stock ETFs.  Quite frankly, I don’t see the point in these products.  But yesterday’s filing by Roundhill appears to fill a void.  If approved, they will allow US investors to gain access to Samsung and Aramco, two well-known, enormous companies that don’t trade in the US – either as ordinary shares or ADRs.  The key word here is “if”.

First, let me explain my dislike of single-stock ETFs.  If you want exposure to a single stock, go ahead and buy or sell it.   For those want leveraged exposure, experienced and risk-tolerant traders can utilize margin or options to achieve that goal[i].   If you’re not comfortable using margin or options, then you probably shouldn’t be using leveraged ETF’s anyway.  Besides the management fee, any leveraged ETF must utilize derivatives to achieve their goal, and those involve hidden fees that detract from performance.  Options decay, futures need to be rolled, and they all need to be rebalanced daily.  The prospectuses for leveraged ETFs clearly state that they tend to underperform their benchmarks if held for more than a day, yet people persist in using them as investments.  None of this is optimal, though to be fair, they can be useful for short-term traders.

I fully understand the commercial logic in a sponsor trying to offer ways for individual investors to gain exposure to Samsung and Aramco.  I have numerous Samsung products in my home, and Aramco is the 500-pound gorilla of the energy markets.  These ETFs are potentially a clever way to offer these well-known foreign companies to US investors.  If they offered ADRs, they would undoubtedly be popular.

But there is a reason why they don’t offer ADRs in these companies – they choose not to follow US reporting standards.  It’s entirely within their rights to do so, by the way.  That said, an ETF that contains single-stock exposure to companies that don’t meet US accounting standards would seem to open a Pandora’s Box. 

The SEC is taking a hard line on a wide range of Chinese companies for not meeting auditing requirements.  What would prevent an ETF sponsor from offering single-stock ETFs on delisted Chinese shares?  It would seem logical for someone to turn around and offer an ETF on, say, PetroChina (PTR), after it is delisted at the end of this month. 

Furthermore, if the SEC won’t permit a bitcoin ETF because it holds unregulated financial instruments (as opposed to bitcoin futures ETFs), why would it be eager to allow US listings of ETFs that hold stocks that aren’t registered in the US? 

Frankly, I can’t see how the SEC would be eager to allow US listings of ETFs that are clearly trying to exploit a regulatory loophole.  I understand the sponsor’s rationale and admire their cleverness.  But I would be shocked if the SEC says “yes”.  It would be inconsistent at best, and a potentially terrible regulatory precedent.

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[i] Both margin and options investing can be risky and require special disclosures.