Dealers fight back amid ETF regulatory scrutiny

Three separate reports from global regulators have warned about the build-up of systemic risk in the exchange-traded funds market, but providers claim supervisors have misunderstood the nature of the market. By Peter Madigan

When three regulatory bodies independently and almost simultaneously reveal concerns about the systemic risks posed by a particular class of product, people sit up and take notice. That is exactly what happened in April, when the Bank for International Settlements (BIS), Financial Stability Board (FSB) and International Monetary Fund (IMF) all published reports highlighting fears about the rapid growth of the exchange-traded fund (ETF) market.

ETF providers are fighting back, though. Faced with a sudden focus on their business, a group of leading European firms is working to set up an ETF industry body. The main driver for the initiative is to rebut some of the fears raised by regulators – and ETF providers reckon they have a good case to make. Regulators, meanwhile, believe they were right to raise concerns.

The ETF industry has seen remarkable growth over the past decade. Global ETF assets under management have grown from $410 million in 2005 to reach $1.31 trillion last year, according to data from asset management firm BlackRock (see figures 1 and 2). By the end of last year, there were 2,500 ETFs offered by around 130 sponsors, traded on more than 40 exchanges.

Systemic risk regulators are worried for a number of reasons – a lack of transparency and growing product complexity, the risk of a liquidity squeeze if investors redeem en masse, and the potential for counterparty risk. The latter point is linked in all three reports to the growth in synthetic ETFs, which now comprise around 45% of the European market, according to data from BlackRock and Bloomberg.

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Dealers fight back amid ETF regulatory scrutiny