ETFs under scrutiny over liquidity risk

Secondary market trading in funds could freeze up in times of stress, supervisors fear

It is an unwritten rule of financial markets that any security experiencing breakneck growth will attract a proportional increase in regulatory attention. The market for exchange-traded funds, or ETFs, has proved no exception.

Of particular concern is the tracking error that can occur in ETFs covering less liquid underlying markets. Another concern, also liquidity related, centres on the creation and redemption of ETF shares, particularly in stressed market conditions.

Both areas of scrutiny

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There is nothing new about the dynamics behind the ALM banking crisis of earlier this year: maturity transformation, liquidity risk and interest rate risk are at the heart of the traditional banking business model. But these old threats have been given…

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