The huge losses incurred by UBS allegedly as a result of unauthorised trades which may have involved ETFs have hurled the funds back into the firing line, just when the furore caused by regulator examinations of the instruments had abated.
ETFs have been accused of being risky and businessman Terry Smith – known for being vocal in his dislike for the instruments – has said that the losses are proof that ETFs are harmful to the financial industry and called for them to be banned.
He has ignored the fact that no ETF investors have lost money as a result of the UBS losses and there have as yet been no knock-on effects on the wider market.
In the race to pin the blame on ETFs, facts have become muddled.
Whatever the extent to which ETFs were involved, those in the ETF industry have all stressed that rogue traders will trade whatever they can get their hands on (click here for more).
Suggestions have been made that because OTC trades in ETFs do not have to be reported under Mifid, trades in fictitious ETFs – which were apparently used to back the unauthorised trades – were able to go undetected.
But those with knowledge of how ETF trading works say that in any client facing business, market makers will do everything on a contract and it will be confirmed under FSA requirements. The same is true under other European authorities.
While no one knows how each bank’s internal activities work, compliance departments usually keep a close eye on business.
Although it is not known what structure of ETF the ‘rogue’ trader used if in fact ETFs were involved at all, the news of what happened at UBS has been used as a means to examine swap-based ETFs. They have been called complex and there are suggestions that using derivatives is somehow hiding something from investors.
Yes, swap-based ETF have counterparty risk but so does any investment and many other funds make use of derivatives, all of which is regulated under Ucits. While many ETF providers agree there could be more transparency around ETFs, most already disclose their holdings at least monthly, many now do it daily.
In the US the SEC’s call for public comment on the use of derivatives in ETFs and other 1940 Act funds noted the example of the Ucits regulations in Europe. The regulator asked whether a similar approach should be adopted in the US.
If the US regulator recognises the benefits that Ucits offers, maybe more attention should be paid in the European market.
Clare Dickinson, Editor
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