All through the spring, regulators were warning about rapid growth in the ETF space, especially among new and less opaque synthetic products. Back then, I compared the hunger for growth in the space to my son’s naughty antics in the sandbox. Well last week, the ETF industry took its first major hit with a big shovel: a blow that just might knock a few flags off the ETF sandcastle.
The hit came in the form of Kweku Adoboli, a name I’m sure you’re familiar with by now. He’s the 31-year old UBS trader who allegedly went “rogue” between 2008 and 2011 as he tried to cover up mounting losses in the UBS Synthetic Equity department in London. His job was to hedge and balance the trading flows in the group’s ETF business —he lost US$2.3 billion (a number that could grow as regulators seek to untangle this mess).
Adoboli has cooked up some big problems for the ETF industry, which has prided itself of building transparent, liquid and cheap products for investors. HIs actions shed light on a growing issue—the growing opacity and a lack of transparency in some new areas of an industry hungry for innovation. That appetite lead to similar problems in the CDO space in 2007 as Financial Times’ columnist Gillian Tett pointed out last week.
Additional or renewed regulatory scrutiny is a black eye for providers—but it’s also a wakeup call for investors who need to make sure they understand the products they are buying. And for pension funds who are still finding the best ways to use them in their portfolios. While regulators will have a lot to say about what went on at UBS, the entire ETF industry will be on the hook to provide a response to what happened—and to make sure it doesn’t happen again.
ETFs are still a great value proposition for investors—let’s keep it that way.