8011 a mixed bag from kauffman year 2011 month 10 start 1


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A Mixed Bag From Kauffman

Written by Paul Amery

October 25, 2011

ETFs deserve tighter circuit breakers than individual stocks

I agree with this argument in principle, since ETFs, by virtue of being diversified, are supposed to be less volatile than individual stocks. Calibrating ETF-specific circuit breaker levels will be hard, though.

My colleague Dave Nadig points out that it’s important not to leave loopholes where trading in the ETF (for example) is stopped, but that in most of the underlying stocks can carry on. On the other hand one could argue that the reverse currently applies: if ETF and single stock circuit breaker limits are set at the same level, it’s likely that in a market decline trading in many index stocks will be halted before the ETF hits its limit.

5/10 for this suggestion: good idea but hard to implement in practice.

ETFs need a new regulatory framework

It’s hard to argue with this one either, given that most US ETFs are defined by blanket exemptions from a 1940 law designed for mutual funds.

Approving ETF issuance via so-called exemptive relief allows for the unsatisfactory state of affairs we’ve seen in the US over the last couple of years, where new derivatives-based funds can’t come to market but the ones listed earlier are left untouched.

Such a review of ETFs is now ongoing, anyway, in the US, while an equivalent exercise is taking place in Europe under the European Securities and Markets Authority.

ETF regulation cannot be looked at independently from that of derivatives, market making, and secured finance, to name just three related areas. But there’s an obvious need for the ETF rules to be re-examined.

8/10 by calling for a broad inquiry into the subject.

Market maker exemptions should be removed and settlement practices improved

I’m with Bradley’s and Litan’s March 2011 co-author, Fred Sommers, on this one. Allowing traders leeway to settle ETF trades late on the basis of the exemptions currently allowed to market makers under the US Securities and Exchange Commission’s Regulation SHO introduces unnecessary systemic risks.

Sommers has done a dogged job asking pointed questions about who’s benefiting from delayed settlements, whether there are new risks in the system, focused at custodial banks, and whether lax settlement practices might combine with high levels of short interest in certain ETFs to create liquidity problems.

In Europe, ETF settlement practices appear even more chaotic, suggesting the need for regulatory action this side of the Atlantic, too.

9/10 to the Kauffman authors for requesting improved practices in this area.





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