• Thu
  • Nov 20, 2014
  • Updated: 11:09am

Old format, new market

PUBLISHED : Monday, 05 December, 2011, 12:00am
UPDATED : Monday, 05 December, 2011, 12:00am
 

While they have been around for nearly three decades, Exchange Traded Funds (ETFs) are still often considered the new investment kids on the block and more recently blamed for destabilising financial markets.

ETFs, which are said by providers to offer investors diversification and liquidity at a low cost, have exploded in popularity in recent years and now represent a US$1 trillion global market. A Greenwich Associates survey found that more than 60 per cent of pension fund respondents expected to increase their ETF holdings during the year ahead.

But with fast growth has come rising concerns from regulators and investment experts about the complexity and the way ETFs are traded. According to a number of analysts the impact of new ETF innovations on market liquidity and financial institutions is not yet fully understood by market participants, especially during episodes of acute market stress.

Jack Bogle, the legendary client-owned investment management company founder, says that speculation with ETFs 'is on the edge of insanity'.

'They've destabilised the market,' says the author of Common Sense on Mutual Funds.

The way ETFs are used also came under the spotlight when Kweku Adoboli, the UBS trader charged with unauthorised trading that resulted in US$2.3 billion in losses, was arrested. Adoboli allegedly established phantom positions in ETFs as a way to offset actual trades.

Lisa Wang, State Street Global Advisors regional head of ETF marketing, says any suggestion that ETFs are destabilising the markets is misleading. 'While ETFs are often portrayed as a new investment product, ETFs (including State Street's family of SPDR ETFs), have track records spanning nearly two decades,' says Wang.

'Our ETFs have efficiently handled significant inflows and outflows and consistently delivered index-tracking performance.'

State Street Global Advisors does not believe that ETFs pose unique systemic risks, but welcomes the important questions that have been raised and the call for increased disclosure, greater transparency, and improved investor education. 'The increased scrutiny of exchange traded funds is evidence of the industry's greatest opportunity and challenge - promoting a better understanding of the structures and safeguards that span a rapidly growing industry,' says Wang.

State Street also points out that instances of unauthorised or 'rogue' trading activity involving the use of ETFs, does not suggest that ETFs compromise the trading markets. 'Any suggestion that ETFs cause or facilitate insider trading represents a gross misunderstanding of the product and its structure,' says Wang.

Instead, Wang says these are trading desk compliance issues, not having to do with the ETF structure. 'Any misinformation suggesting that ETFs cause or facilitate rogue trading underscores the need for ensuring investors and third parties to better understand the product and its structure,' she says.

Once an ETF is created and becomes a publicly traded security, it trades like any single stock. 'ETF providers do not have any purview over secondary market, over-the-counter transactions or how these trades are reported by market participants,' says Wang.

Marco Montanari, head of Deutsche Bank's ETF business, branded as db X-trackers, in Asia says it is the role of the authorities to analyse the impact of the ETF market in the financial industry. 'When we contextualise the size of the ETF market it is interesting to observe that even if ETFs grew more than 30 per cent a year in the past 10 years, they still represent less than 10 per cent of the total assets under management managed by funds around the world,' says Montanari.

He says it is also important to recognise the function of ETFs is simply to give access to a predefined market that in the end investors could generally access anyway by directly buying the stocks listed in that specific market.

Montanari says it is also important to remember that ETFs are funds and not mini-bonds or bonds.

Being funds they are regulated by stricter rules in terms of counterparty risk and diversification even before the recent tighter rules imposed by Hong Kong Securities and Futures Commission (SFC).

'We are pleased with the new SFC policy which establishes collateral obligations that have been implemented by Deutsche Bank for more than a year,' says Montanari. 'When we set the collateral standard in 2009 - the first among all Hong Kong listed ETFs - we had the ultimate objective of protecting investors' interests by applying more stringent collateral rules than the then prevailing regulation,' says Montanari.

He says the level of the collateral is only one part of the equation. 'Transparency is also key so we publish the full collateral composition on a daily basis on our website. We think investors are appreciating and rewarding our efforts for more transparency.'

According to Reuters, on the year to date, the total ETFs market turnover in Hong Kong is similar to last year, with Deutsche Bank having gained more than 4 per cent market share, up from less than 12 per cent to 16 per cent.

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