We’re sure the ETF experts will have a perfectly plausible explanation for the following, but at the moment we don’t know what it is.
Why is it that ETF settlement fails far outweigh any other securities listed on US exchanges, as per the following regulatory threshold figures (via Bloomberg).
Exhibit A - Arca stocks for which sellers failed to deliver 10,000 shares or more in the past five trading days and where the level of “fails” is a minimum of 0.5 per cent of the shares outstanding:
Exhibit B - Nasdaq stocks for which sellers failed to deliver 10,000 shares or more in the past five trading days and where the level of “fails” is a minimum of 0.5 per cent of the shares outstanding (one ETF highlighted):
Exhibit C - NYSE stocks for which sellers failed to deliver 10,000 shares or more in the past five trading days and where the level of “fails” is a minimum of 0.5 per cent of the shares outstanding:
And let’s not neglect the “consecutive days on list” factor for ETFs, which is significantly longer in exchange traded funds and notes than in normal equities. (Note the Direxion products in particular.)
Meanwhile, this letter from James Angel of Georgetown University to the Securities Echange Commission in 2008 would suggest the issue is also a longstanding one.
Furthermore, it also suggests this is a problem which actually encumbers ordinary market participants from shorting ETFs themselves:
As of this writing, over 100 ETFs and ETNs are on the Regulation SHO Threshold List.1 These settlement failures affect some of the largest ETFs as well as the smallest. For example, the iShares Russell 2000 Index (IWM) experienced over 30 trading days in the year 2007 in which over 10 million shares failed. These failures were for over $1 billion worth of shares each day. Similarly, the original SPDR Trust (SPY) experienced at least 10 trading days in 2007 with settlement failures of over a billion dollars per day. Inclusion on the Regulation SHO Threshold List often makes it hard for investors, particularly retail investors, to engage in short sales.
Many brokers will not take the effort to locate shares in order to execute short transactions in Threshold stocks. I have been personally told by my broker that shares were unavailable for shorting some ETFs on the Threshold List. Ease of short selling is one of the attractive features of ETFs, and thus the large settlement failures diminish one of the important features of this important product class.
There is no evidence to suggest this reflects anything sinister at all.
In fact, it is most likely linked to the *robust* creation/redemption tracking mechanisms built into ETF structures. Nevertheless, we for one currently don’t have an answer.
And given the amount of short-selling supposedly going on ETFs — it would be good to know.
Related links:
Can an ETF collapse? – FT Alphaville
The little match problem – FT Alphaville
Hedging and Cross Hedging ETFs - University of Reading