The industry’s response to Tuesday’s warning note on Exchange Traded Funds from the Financial Stability Board has begun predictably with a statement from iShares — the world’s largest provider of ETFs.
And it’s a well thought-out response — one which seemingly seizes on the old Chinese adage that crises can be opportunities too.
After all, Blackrock’s iShares group has always made a point of favouring the pure replication model in the structuring of its ETFs. What’s more, the group has been very vocal about the risks being posed by the rise of synthetic structures in the market — which are at the heart of the FSB’s criticisms.
Here’s their statement (our emphasis):
Following the publication of the Financial Stability Board‘s (FSB) paper on “Potential financial stability issues arising from the recent trends in ETFs”, iShares, the Exchange Traded Funds (ETF) platform of BlackRock, Inc. (NYSE: BLK), is in agreement that a number of recent developments within the ETF industry require closer scrutiny.
iShares welcomes the Board’s call for disclosure, enhanced transparency and in particular disclosure of the frameworks that support collateralisation and securities lending programmes.
Joe Linhares, Head of iShares EMEA commented: “ETFs are one of the most innovative financial products of the last two decades but we believe a number of recent developments within the ETF industry require closer scrutiny. It is encouraging that the FSB calls not just for transparency but also for providers to evidence to investors a demonstrable infrastructure to support transparency.”
In addition, iShares agrees with the concerns arising from potential conflicts of interest where swap-based ETFs and their derivative trading counterparts are within the same group and particularly notes the concern that „risks increase if the bank considers the synthetic structure as a stable and inexpensive source of funding for illiquid securities.‟
Of course, there’s only so far iShares can go with this line of defence since they too have recently started issuing swap-based products.
Their justification, however, is that they — unlike other providers — have been transparent about the additional risks, costs and exposures associated from the get-go.
Or as they put it:
Linhares said: “iShares has long supported the physical replication model but we have recently engineered a leading swap-based ETF platform which is in response to the rapidly growing appetite for exposure to difficult to access markets, combined with a desire for transparency, disclosure and minimised counterparty risk. The iShares swap funds offer non affiliated multiple swap counterparties, are over collateralised and provide investors with full transparency regarding collateral holdings, swap costs and fund exposures.”
With reference to providers and their securities lending programmes, iShares has a very successful securities lending programme that has delivered significant incremental returns to investors, whilst maintaining a low risk profile.
Linhares concluded: “iShares has always been transparent about the revenues generated and the risk framework surrounding the activity, and we are looking to further enhance disclosure where we feel it adds value for our clients. BlackRock’s credit group, which operates independently from our Securities Lending programme, determines counterparty limits and the collateral framework. In BlackRock’s history, our robust framework coupled with the assessment of the suitability of borrowers has protected our clients from any losses resulting from borrower default.”
So there you have it. Swap-based ETFs are bad, but they’re okay if investors can see clearly, with no obstruction, how bad they can be.
We’ll just point out that’s the first we’ve heard of BlackRock’s credit group (our bad) — although we’d be hugely interested to know more about it. Especially what determines their counterparty limits and more details about the collateral framework they operate — or specifically, how much they charge for stock lending.
Proprietary info, we imagine.
Clearing questions for synthetic ETFs – IndexUniverse
ETF anniversary under structured product cloud – FT
Beware your Japan ETF exposure – FT Alphaville
Kauffman: ETFs are the problem, not HFT – FT Alphaville