At least the Bank’s new Financial Stability Report recognises the central role of ETFs in the current market structure, and lays out a number of areas where regulators should be on guard.
Most importantly, it reminds the industry that it is being watched. And let’s be honest: the ETF industry could occasionally do with some watching.
The specialist in your blog cites the example of ETF Securities’ AIG-backed ETCs, which almost imploded during the financial crisis. That could have been a real black eye for the industry, and it occurred because those exchange-traded commodities were not soundly structured.
ETF Securities still offers a handful of uncollateralised ETCs: several of its oil-based products are backed by the credit of a single company, Royal Dutch Shell. While ETF Securities is very up-front about this – its fact sheet notes: “In the event Shell were to go bankrupt, the ETFs would become an unsecured credit of Shell” – you have to wonder if most investors truly understand the credit risk they are taking.
Would a new issuer now structure an ETC in that way? After Lehman (or, to focus on the energy patch, BP), probably not. And if they did structure it with unsecured credit exposure, they would call it an exchange-traded note.
The ETF Securities ETCs are water under the bridge; they are what they are, and they were designed prior to the financial crisis.
The problem for regulators is that the industry has left them behind. Yes, we do need regulators, but – more importantly – we need good, well-informed, up-to-date regulators.
Take the Bank of England report. Writing about leveraged funds, for example, the authors note that the funds accounted “for around 20% of daily turnover according to contacts” [emphasis added].
According to contacts? That wouldn’t pass muster in most news rooms, and that’s the best the mighty Bank of England can do regarding trading volume?
If regulators really want to catch up and do some good in the ETF space today, they should start with some basic fundamentals, like transparency.
In your blog, Paul, you cite Eddy Wymeersch, chairman of the Committee of European Securities Regulators (CESR), calling for more transparency in ETFs. But the way he calls for that transparency is toothless. You paraphrase Wymeersch as saying it is “the industry’s responsibility to improve transparency, rather than the regulator’s to impose rules.”
Are you kidding me? Haven’t we learned anything from the past few years?
Step one in sound regulation would be to get trading data into the open, so that everyone can see how ETFs trade, what the spreads are, and whether investors are getting pushed around by unsound prices. I know efforts are being made in that direction with Mifid II, but they should be hammered out and fast-tracked as quickly as possible.
Step two would be to force complete disclosure of counterparty risk, fund tracking performance and fund holdings on a day-to-day basis.
Step three…well, we can get to step three later.