Do ETFs create harmful market volatility? It’s a question being considered by the U.S. Securities and Exchange Commission as they study and review ETF transparency and the overall impact of ETFs on market volatility (not to mention the growing use of leverage in some funds).
Of course the timing could be better. Right now, it’s hard to put all of the blame for volatile markets on ETFs given what’s happening in Europe, the U.S. …. in fact the entire global economy. At the same time, regulatory scrutiny of the ETF industry has left investors sharply divided, with high profile critics emerging like Vanguard founder John Bogle who says they have no “social value”.
But whatever you think of ETFs and their merits, it’s about time regulators came to grips with them. After all they’ve become a mainstay of global market activity, generating 35% to 35% of exchange trading volume every day according to Morningstar.
If capital markets regulators can’t handle the growth, then we’re all in trouble.
To me, the most interesting outcome of all this will be how the SEC decides to handle the role of derivatives in the ETF space. Sure, untamed, leverage in ETFs can present a danger to markets. But some experts don’t think it’s to blame for market volatility: at least not yet. For one thing, the use of derivatives in new ETFs has been on hold since 2010. In addition, there really isn’t enough money invested in them to cause huge market swings like the ones we saw this past August. As Morningstar ETF researcher Scott Burns told the Wall Street Journal only 13% of total ETF trading volume in August came from leveraged ETFs.
But they could quickly grow into a problem, which is why it’s nice to see a rare instance of regulators stepping in before disaster strikes.
I hope the SEC’s review provides meaningful data and conclusions on the role that ETFs now play in global markets. The big question for me will be what they choose to do with it.