Regulators should implement a "classification system" to distinguish between ETFs and other ETPs rather than focusing on "misplaced" fears over liquidity and counterparty risks, an industry body has claimed.
The European Fund and Asset Management Association (EFAMA) said investors require "a clearer distinction" between exchange-traded funds (ETFs) - which, in Europe, it said, are "essentially UCITS-licensed products" - and other exchange-traded products (ETPs) in order to assess the risks inherent in each vehicle.
The body suggested introducing a classification system, which would "help investors more readily assess the risks inherent to each type of ETP, as well as aid regulators to better focus their efforts at protecting investors and guarding financial stability".
Currently, regulators and the European Central Bank (ECB) are assessing both liquidity and counterparty risk concerning ETFs and the systemic risk they could pose. But EFAMA said a focus on these factors was "misplaced".
The ECB's semi-annual Financial Stability Review, released in November, warned market "disruptions" that lead to significant redemption pressures across ETFs - and knock-on effects to related markets - could pose a risk to financial stability.
However, in a statement released on Monday, EFAMA said the secondary market for ETFs was "a key, but often overlooked, indicator to appreciate the resilience of ETF liquidity".
"This [secondary market] acts as an additional layer of liquidity when compared to ordinary mutual funds," it said.
"Evidence confirms that both for equity and fixed income ETFs, the secondary market has largely cushioned the impact of sudden market shocks, without affecting investors' ability to redeem their shares, nor that of dealers to trade the underlying securities."
The ECB also warned on the potential for counterparty risk within synthetic ETFs, which use derivatives or engage in securities lending. It said investors in products such as these carried the risk of loss from a default of the counterparty.
But EFAMA said the usage of multi-swap counterparty platforms as an industry 'best practice' for providers of synthetic ETFs should mitigate this risk.
It said "the rigorous selection procedures ETF providers carry out when choosing an eligible counterparty, independently from derivatives or securities lending transactions" would also help alleviate investor concerns.
"We additionally remind regulators of the strict collateral rules under the UCITS (Undertakings for Collective Investment in Transferable Securities) and EMIR (European Market Infrastructure Regulation) regimes as an additional guarantee against the systemic contagion channels often assumed."
EFAMA's statement concluded that "any further regulatory action should be carefully calibrated based on evidence, a clearer understanding of the interaction between ETFs and their broader ecosystem, as well as on existing regulation".
In the respect of the former, it noted MiFID II reforms have had a positive impact on ETFs and their end users by "gradually contributing to greater price transparency and to deeper pools of secondary market liquidity".
Will join IA sectors Q1 2020
Inflows of $99.1bn in Q1
Trading and holding costs
Followed by property
The government will reintroduce the pension schemes bill as part of an “ambitious programme of domestic reform”, the Queen’s Speech confirmed today.
Misuse of audio feed
Should advisers be educating clients to take more risk to reach their objectives or should they encourage a more cautious approach? Claire Tyrrell spoke to couple of advisers and a compliance expert about how they broach the topic of risk with their clients......