Credit default swap spreads, which serve as a measure of counterparty risk in bilateral transactions, have doubled or trebled this year for the vast majority of banks involved in writing derivatives in the ETF market. This isn’t just a European issue. In fact, some of the banks with the largest percentage rises in CDS spreads this year are US and Asian names: Morgan Stanley, Bank of America, Goldman Sachs, Nomura. For the majority of the banks writing derivatives with European ETFs, it now costs over 3 percent a year to insure against default on senior unsecured debt, a meaningful sum.
For those bank borrowers approved earlier this year by iShares as counterparties in securities lending operations, things are no better. Five of those twelve names—Bank of America, Santander, Goldman Sachs, Morgan Stanley and Unicredit—have senior debt CDS spreads of over 4 percent a year.
Not all European ETFs use derivatives and securities lending, and not all ETFs involved in lending lend out significant proportions of their holdings. Some of the funds involved in lending offer additional safeguards like indemnities. And these questions are not specific to ETFs; they apply to all funds engaging in similar activities.
But—taking Comotto’s point—if you wouldn’t be willing to lend unsecured to the banks involved in repo-like activities with the majority of the ETFs in Europe, should you be buying the ETFs that trade with those counterparties at all?