The popularity of exchange-traded funds reminds Robert Taylor, the Chair of IOSCO’s investment management division, of the hype around structured products leading up to the global financial crisis.

Taylor, speaking at a Financial Services Council’s event this morning while visiting for the International Organisation of Securities Commission’s annual meeting, said ETFs are “more than just the flavour of the month – they are the flavour of the decade.”

Harking back to his time at Merill Lynch before the GFC, Taylor drew parallels between the mania surrounding structured products – a type of debt obligation investment – in the early 2000s and the hype surrounding ETFs this decade.

“A lot of the people involved with the ETF product are thinking about it the same way that people thought about structured products two decades ago,” Taylor said. “The product has a lot of components that securities market regulators would worry about.”

Taylor’s concern is that, once again, people don’t know the risks inherent in the product they’re investing in. Retail investors love the idea of ETFs, he says, but “they don’t really understand the basic arbitrage function that supports the product.

Liability issues for ETF distributors, he explained, were not out of play.

“Maybe there could just be a client issue at the end of the day where they’re really not certain what they’ve invested in, and if something really goes wrong, how will the industry sort out what its obligation to the client actually is?”

Legitimate questions

IOSCO – who represent the world’s securities regulators including ASIC – are interested in ETFs because they want to understand how to manage the risks associated with them in the event of another significant market downturn.

Taylor calls the prospect of a GFC-type event hitting ETF holdings “haunting”.

He says the regulators “didn’t really pay attention” to structured products, which is something they want to avoid with ETFs. The way regulator’s approach risk has also evolved, he explained, and involves a much more “forward thinking” approach. “We’re constantly dreaming up risks that are out there in the marketplace,” he said.

Taylor said IOSCO wants to know if the market sees the ETF risks they are seeing.

“We just want to understand how the industry looks at them… and how they’re going to react when someone has to pull the emergency brake in a market environment that is tanking to the level it was in 2008, or even worse,” he said. “These are legitimate questions.”

In an earlier address, Financial Services Council chief executive, Sally Loane, echoed Taylor’s sentiment, saying there was “a lot of talk in the US about increasing regulation” of ETFs. This is creating a lot of interest here, Loane said, in the wake of the Hayne royal commission and with our newly “muscled up” regulators.

“[There are] a lot more resources for the regulators to work those laws properly,” she said, before reiterating how high the stakes are for Australian investors.

“As of March this year the [ETF] market cap’ reached $46 billion, which represents 26 per cent growth in the last 12 months,” she said.

Tahn Sharpe is a Sydney-based financial services journalist with a background in financial planning. He writes on advice, superannuation, investment, banking and insurance issues, is a certified SMSF Adviser and holds an Advanced Diploma of Financial Planning.
One comment on “ETF risk a ‘haunting thing’: IOSCO”
  1. Stephan Pfister

    I would like to see more colour to such comments. Are these concerns around the broad structure of ETF’s including those holding highly liquid assets or are we talking specific segments such as EM Credit /underlying illiquid assets?

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