Should regulators be concerned by ETFs?

Joanne Young asks a panel of experts to explain the risks and how the industry can respond to these anxieties

Deborah Fuhr, BlackRock global head of ETF research and implementation strategy

I strongly support the efforts of the Financial Stability Board, the Bank for International Settlements and the International Monetary Fund to increase understanding of ETFs and exchange-traded products, including notes, partnerships, grantor trusts, commodity pools and other non-fund structures.

The move to synthetic ETFs has meant many different models are being offered by various providers. This has changed the understanding and transparency on costs, because the commission and annual financing costs of swaps are not part of synthetic ETFs’ annual total expense ratio.

Transparency on the underlying portfolio in some products is no longer daily and the number of brokers who are authorised to create and redeem the swap is typically much lower than physically-backed ETFs.

Greater transparency on trades is also needed. ETF trade reporting is not required for most trades under the markets in financial instruments directive (Mifid). Mifid II should require all ETF trades to be reported and provide for a consolidated tape. This will enable a greater level of price discovery, tighter spreads and give all investors better transparency on the real secondary liquidity in ETFs.

Overall the thrust of these reports points to significant concern around systemic risk posed especially by synthetic ETFs of the ‘in house’ model and to a lesser extent securities lending.



A source at a leading swap-based ETP provider

Inevitably when something grows rapidly there are going to be questions and maybe clarifications required. What I would point out is that some of the issues raised are not just relevant to ETFs, but pertain to the whole fund industry. 

When a bank is acting as both issuer and swap-provider, all the fund fiduciary aspects are done by independent parties.  The parent bank is an arm’s length swap counterpart, so I do not understand why there would be any conflict of interest there.  Moreover, the issuance vehicles for the funds are typically umbrella investment companies. These are standalone; they have independent auditors and are subject to audit every year. So I think the FSB has misunderstood that point.

As for the issues of maintaining redemptions, one of the features of the ETF market is that selling takes place on the secondary market, so there are market-makers who can soak up a lot of that. What we normally see during periods of market volatility is that ETF market-makers adjust by slightly widening their spreads, but they are still providing liquidity, so people are able to sell.

If you were in an actively-managed fund and everyone tried to redeem on the same day, you would probably struggle more. What we have actually seen is when there have been volatile situations and heightened activity, such as the end of 2008 and beginning of 2009, the ETF market has adapted very well.