ETF industry heavyweights push back on proposed US tax change

BlackRock and State Street have criticised a bill proposed by a senior US lawmaker that might strip exchange traded funds of a key advantage that has helped fuel the industry’s momentous growth.

The draft legislation floated late last week by Democrat Ron Wyden, chair of the Senate committee , would generate billions of dollars in additional tax income for the federal at a time when the Biden administration is looking to fund a huge spending package for social programmes.

Wyden’s bill aims to shut loopholes including one that provides ETFs a tax break over mutual funds. Rising markets and record inflows have enabled the ETF market to just about double in size to $9.7tn, from $4.8tn since the top of 2018, consistent with the info provider ETFGI.

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

State Street, another big player within the ETF industry, echoed this point: “We are against this proposal and have concerns about the negative impact it could wear investors.”.

One of the key ways during which ETFs differ from mutual funds is in how they process investor inflows and outflows. Mutual funds typically buy and sell shares in portfolio companies when clients shift into or out of the fund. The fund incurs taxes on any capital gains made in their portfolio companies.

In comparison, ETFs can answer demand through the creation and redemption of latest units that are sold on the market. Banks and trading groups that employment with ETFs can remove units from the market by trading them reciprocally for a basket of stocks or other assets that matches the composition of the fund. These distributions don’t incur capital gains taxes for the fund, shielding it during a way that’s not available to mutual funds.

The draft legislation would end in ETF investors being required to pay capital gains at the top of every tax year for these investment vehicles.

The US ETF industry is dominated by BlackRock, Vanguard and State Street and therefore the proposed tax change threatens a lucrative area of growth for these titans. Many asset managers are converting mutual funds into ETFs and BlackRock has forecast the worldwide ETF market will swell to $15tn by 2025.

Georgia Bullitt, a partner at the firm Willkie Farr & Gallagher in ny , said but 5 per cent of US-listed ETFs reported taxable gains last year. “This is simply a proposal but it’s by a prominent senator and it might affect the utility of ETFs. The ETF industry is fighting very hard against it.”

Vanguard might be particularly exposed if the legislation goes through because the manager uses a structure that pairs ETFs with mutual funds, allowing both to profit from the advantage .

“This tax treatment change would punish Vanguard’s ETFs and their index open-end fund shareholders,” said Todd Rosenbluth, head of ETF and open-end fund research at CFRA.

Vanguard said the “ability of mutual funds and ETFs to transact securities in-kind may be a longstanding practice that improves outcomes for many investors”. The group said it had been waiting to ascertain how Wyden’s discussion draft progresses, adding it might “reserve comment until additional information on the reconciliation bill is formed available”.

Another outcome is that some investors would increasingly adopt tax-managed accounts, like “direct indexing”. This sector has been gaining ground in recent years among investors as technology has broadened access. within the past year, Morgan Stanley, BlackRock, JPMorgan and Vanguard have made acquisitions to spice up their presence in direct indexing.