(Ticking time bombs go tic-toc. Are ETFs the canary in the coal mine this time around?)
by on SEPTEMBER 12, 2015
… ETF’s – have grown to the point where any prolonged large scale exit will exceed the funds available to those who control the funds and make the markets. I think they know this and some time ago those market makers and fund controllers began to boost the credit they could draw upon. Problem is the very banks they are agreeing larger credit lines with, are drawn from the same group of financial companies who make the ETF markets.
The ETF market with its promise of easy withdrawal means when there is an event which spooks people and they want out it happens in seconds not days or even hours … . Today it is not a bank run that will amplify some large local event in to a global wave, but a fund run. …
by on MAY 3, 2012
… If I am in any way correct then ETFs will be to the next stage in our on-going state of siege-mentality crisis what CDOs were to the last. … (ETFs) are being seen as the provider of liquidity and risk-controlled ‘exposure to risk’, just as CDOs were, when in fact they are concentrating risk and will, in a moment of panic, cause liquidity and lending to collapse. …
Here is how a paper for the Bank for International Settlements (BIS) describes the rise of the ETF.
…in the low global interest rate environment in 2002–03, structured credit products [CDOs] … offered higher returns to comparably rated plain vanilla assets.
The financial crisis experience, however, dampened investors’ appetite for structured credit products. Yet the low global interest rates (are back, and) financial intermediaries have responded by adding some innovative features to (ETFs). (P.1)
… When interest rates are low banks can’t make much return by simply lending out money. So the desire for a higher return spurs the invention of financial products that promise that special combination of a higher return but without the higher risk that should come with it. Securitization and CDOs promised it. ETFs promise it.
So what is a basic ETF?
An ETF (Exchange Traded Fund) is an investment fund which holds a mix of stocks, bonds or commodities such that it emulates and thus tracks … the particular exchange it is based on … . The ‘product’ is marketed as a way of investing in a basket of stuff so as to spread the risk … . … To me these are the obvious parallels between securities/CDOs and ETFs, on the ‘risk’ side.
There are also parallels on the ‘liquidity’ side. … What makes ETFs different from other kinds of investment funds, like Money Market Funds, is that shares in the ETF can be bought and sold like any other stock or share, on a second by second basis. …
ETFs are also seen as increasing and therefore providing liquidity (for shares on markets like) emerging markets which many investors would not know much about or dare to purchase. …
ETFs were invented back in the 90′s. … In 2005 ETFs held a mere $410 billion in Assets Under Management … and by 2010 ETFs had tripled to $1.3 Trillion … still small, just 5% compared to the much more established Mutual Fund market. But … it is the rate of growth, not its size which seems to me to tell the story. The ETF industry has grown at 40% a year over the past 10 years! The broader market has achieved 5%. …
I want to make it clear that I don’t think ETFs are necessarily a bad thing. But …
Reasons not to be cheerful.
When ETFs began they were what is now referred to as plain vanilla or physical ETFs. Such ETFs replicate (a sector of the) market by simply buying a representative basket of the shares which make up (that) market . The ETF’s creator/Sponsor gives this basket a company name and then creates and sells shares in that name, which people can buy and sell. (So the buying public is not owning the stocks. The public is buying the promise of a Sponsor.)
(While) as of the end of 2010 there were 2500 ETFs offered/sponsored by 130 companies, traded on over 40 exchanges … only 6 companies Sponsor and control 80% of the market. Or to put it another way 80% of the market in ETFs globally, relies on the health and solvency of just 6 companies. … Here is a list of the big 6 ETF sponsors and who owns them.
i Shares = Blackrock … State Street Global Advisors = State Street Bank and Trust. … Vanguard = Specialist ETF company … Lyxor Asset Management = Soc Gen … db x-trackers = Deutsche Bank … Powershares = Invesco…
So of the 6 companies who are most of the ETF market two are drawn from the ranks of the Global banks which have had to be bailed out.
(But there is another layer of concentrated risk, because the Sponsors don’t sell to the public directly. They sell large blocks to “Authorized Participants”.) The ‘primary market’ as its known is populated by ‘Authorized Participants’ which for the vast bulk of ETFs are the small club of global banks and brokers we have all heard so much about in the last few years. They buy or borrow (often from Pension Funds) the stocks and shares which will make up the ‘basket’ which they then put into a Trust. … The Trust then creates what are called ‘Creation Units’, which are blocks of tens of thousand of individual shares in the ETF, which it gives back to the Authorized Participant. The Authorized Participant then either keep these shares as an investment for themselves or sell them on the ordinary , or as they call it, the ‘secondary market’ to ordinary buyers who wants to own an ETF share. …
Sadly, … the Approved Participant are drawn from the same short list of global banks and brokers as are the Sponsors. Here, for example, is a list of APs for an ETF called ‘Greater China’ run by State Street Global Advisors who are the second largest ETF manager in the world.
Merrill Lynch Far East Limited
Citigroup Global Markets Asia Limited*
Credit Suisse Securities (Hong Kong) Limited
Goldman Sachs (Asia) Securities Ltd
Morgan Stanley Hong Kong Securities Ltd
Nomura Securities (Hong Kong) Limited
UBS Securities Hong Kong Ltd
So 80% of the ETF market relies on the solvency of only 6 companies who sponsor and manage them. They rely in turn on the handful of Global banks whose solvency and stability we already know was in a crisis, and still largely is, and remain totally dependant on Tax payer bail outs.
So how much stability do the APs bring to the ETF market? … Just like the Securitized mortgage/CDO market before it, the ETF market is constantly folded back on itself so that … the health, liquidity and operation of the ETF market is tied to the same very small number of very large players. …
(The ‘Flash Crash’ back in May, 2011 was caused by illiquidity in ETF shares. A study) concluded that reason the ETFs froze and in doing so froze the markets was because the Approved Participants (the club of Global Banks and Brokers) froze. … The flash crash clearly demonstrates how fragile and thin their liquidity providing and risk absorbtion actually is.
This theme of how everything is constantly tied back to the same players is what I will return to in part two, because it gets so very much worse. So far all we’ve really looked at are just the general weaknesses of the plain vanilla market.
In the next part we will look at the huge rise in what are called ‘synthetic’ ETFs which (do not hold shares, but hold) derivative swaps contracts. We’ll look at who the counterparties are of all those derivative contracts. I’ll give you one guess.
Then we’ll look at how those risks have been (further) increased by the creation of ‘Leveraged ETFs’ which promise 2 or 3 times the possible returns but at the cost of doubling or tripling the risks as well.
Then, in case anyone thinks that the Vanilla/Physical ETFs, based on owning the underlying shares, are, by comparison with Synthetic ETFs, not really a problem, we’ll look at how the physically-based Vanilla ETFs increasingly lend out the shares they ‘own’ in order to make more money.
(Read ETFs Part 2)