FCA: Ballooning exchange-traded fund sector no threat to financial stability

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FCA: Ballooning exchange-traded fund sector no threat to financial stability
Traders work after the closing bell at the New York Stock Exchange (NYSE) on August 7, 2019 in New York City. - Wall Street stocks finished little changed on August 7, 2019, following a choppy session as a plunge in treasury bond yields early in the day underscored worries about a weakening global economy. (Photo by Johannes EISELE / AFP) (Photo credit should read JOHANNES EISELE/AFP/Getty Images)

Britain’s financial watchdog has said the exchange-traded funds (ETFs) market is not a threat to financial stability and can cope with the sort of liquidity issues that damaged Neil Woodford’s flagship fund.

Read more: New business down at Hargreaves Lansdown as Woodford scandal bites

The wider world of funds has come under scrutiny after Woodford’s open-ended fund was dramatically suspended in June when investors rushed to take their money out.

An ETF is a collection of securities that is listed on an exchange. It tracks an index or a sector and investors can buy shares in it. The market has exploded in recent years. Assets under management in ETFs went from $400m (£330m) in 2007 to $5.3 trillion today.

This has drawn the attention of the UK’s Financial Conduct Authority (FCA), which said today it does “does not detect any initial signs of concern to financial stability” in the market.

The FCA said that unlike in the Woodford case, when the embattled stockpicker could not find buyers for the shares in his fund, the ETF market has plenty of players willing to step in and maintain liquidity at times of stress.

Normal investors buy and sell ETF shares on a secondary market. Only authorised participants (APs) can buy and sell the fundamental units that make up an ETF.

The five largest APs, which are usually investment banks and trading firms, account for about 75 per cent of primary market trading volumes.

Today’s FCA research showed that in times of stress such as the 2016 US presidential election, less active APs would “enter the fray” and buy up the units the bigger APs were seeking to shift.

“While in typical trading periods the primary market is highly concentrated, in times of stress other APs step in to provide alternative liquidity,” the FCA said.

The financial watchdog said its research had “reassuring results”. But it said this “is only the first step in investigating the resilience of ETF markets”.

The research comes as the FCA grapples with the fallout from the Woodford debacle and mulls over rule changes about illiquid assets in open-ended funds.

Read more: Calls for clearer warnings of Woodford-style fund suspension risks

Yet it said in the ETF market there is “evidence for alternative liquidity providers being willing to step in during times of market stress”.