Extraordinary financial market volatility in the late summer has prompted the Securities and Exchange Commission to look into how exchange-traded products are sold and priced.
SEC Chairwoman Mary Jo White said Thursday that the agency is using data from Aug. 24 — when the markets opened sharply lower and lost more than 3% — to examine how ETPs, such as exchanged-traded funds, behaved.
Trading was halted in more than 1,000 ETFs that day as mechanisms kicked in that limit how much they can rise or fall in volatile conditions.
The SEC also is assessing how ETP prices align with the value of the underlying assets that comprise the products.
On Aug. 24, many ETPs traded at a sharp discount from their net asset value.
“These two issues — the operation of the limit up/limit down mechanism and the quality of ETP pricing in secondary markets — have been and continue to be of great interest to the commission,” Ms. White told a meeting of the SEC Investor Advisory Committee.
Prior to Aug. 24, the SEC was already looking into exchange-traded products. Over the summer, the
agency collected public comments on how they are listed, priced and marketed to retail investors.
Exchanged-traded products are similar to open-ended mutual funds, but they can be bought and sold throughout the trading day based on market prices, rather than net asset value. The vehicles provide exposure across many asset classes to a wide range of financial instruments, benchmarks and strategies.
Demand for ETPs, which include ETFs, pooled investments and exchange-traded notes, has spiked in recent years. From 2006-13, the number of ETPs listed and traded rose by an average of 160 annually. There were 1,664 ETPs listed on U.S. exchanges with a market value of a little more than $2 trillion at the end of 2014, according to the SEC.
Financial firms have been designing complex ETFs — often based on derivatives and other hedging strategies — that they tout as a way to generate higher portfolio returns.
SEC member Kara Stein said at the advisory committee meeting that the spike in volatility on Aug. 24 highlights the vulnerability of retail investors, who are increasingly putting retirement funds into ETFs. She said the agency should look closely at how ETF trading differs from trading in traditional mutual funds.
“This is an excellent time to examine the SEC's investor protection mandate,” Ms. Stein said.
Another SEC member, Luis Aguilar, also endorsed paying attention to ETFs.
“It seems fairly certain that the explosive growth of ETFs in recent years poses a challenge that isn't going away and may well become even more acute,” Mr. Aguilar told the comittee in a statement read by an aide. Mr. Aguilar did not attend the meeting.
An industry official cautioned regulators not to overreact to the events of Aug. 24, when the markets hit their second-highest trading level in history.
“Many things did work that day, even though the opening was problematic,” Samara Cohen, U.S. head of iShares Capital Markets at BlackRock Inc., told the committee members.
Ms. Cohen recommended “a holistic approach to volatility and order imbalance” that encompasses harmonizing trading rules for futures, options, individual stocks and ETPs, recalibrating limit up/down rules, revising marketwide circuit breakers and educating investors.
The committee was created by the Dodd-Frank financial reform law to represent the concerns of retail investors before the agency.
