ETFs under fire from Bank of England

A panel of industry experts reply to the Bank of England’s recent report into the ETF market

In June the Bank of England published its Financial Stability Report in which it raised concerns about the rapid growth of the ETF market.

It stated: “Financial instrument structures can also amplify and propagate stress across markets... A current example is the rapid growth in exchange-traded funds (ETFs), which have been characterised by increasing complexity, opacity and interconnectedness.”

The Bank also commented that it is working with other authorities “to promote a strengthening of regulatory risk standards applied to ETFs”.

At its Financial Policy Committee Meeting the Bank pledged to “advise the [Financial Services Authority] that its bank supervisors should monitor closely the risks associated with opaque funding structures, such as collateral swaps or similar transactions employed by exchange-traded funds”.

These comments come as part of a spate of regulator warnings on the potential dangers of ETFs, many of which have focused on synthetic (or swap-based) structures.

The Bank of England’s comments are some of the latest although the UK’s Serious Fraud Office has since said it is in talks with the BoE and the Financial Services Authority (FSA) about the potential dangers of ETFs to the financial system.
The European Securities and Markets Authority (Esma) also drew attention to the ETF market in its July discussion paper.

Although no further actions have come from the Bank of England, providers are keen to stress that ETFs are already tightly regulated, while others want the debate to be opened to the whole ETF market rather than honing in on synthetic ETFs.

ETFM asked European providers for their responses to the Bank of England’s comments.

Nizam Hamid, head of ETF strategy at Lyxor ETFs: The report focuses on increased risk and interconnectedness within the financial system and equates ETFs as part of the opaque funding structures that can be a contributory factor to this disguised build-up of risk.

At Lyxor ETF, we would highlight that within swap-based ETFs there are different structures, varying levels of swap exposures, but more importantly real assets held either as collateral against the swap exposure or physical assets owned by the fund.

Complexity has not “begun to creep in” as swap-based ETFs have been around in Europe since 2001.

More importantly swap-based ETFs provide higher levels of transparency than equivalent physical funds that engage in securities lending and it is useful that the report recognises this as a hidden and unreported risk in physical ETFs.