February 23rd, 2012
Econintersect: The CES (Securities and Exchange Commission) is expanding its examination of possible manipulation of ETFs (electronically traded funds). Last year the SEC started an investigation of leveraged ETFs that allow investors to take positions that are nominally 2x or 3x a reference index, both positively (long) and negatively (short). The question at that time was whether the frequent trading of these vehicles was contributing to excessive market volatility. At the time a number of knowledgeable investment people were of the opinion that the likelihood that there was much effect when the leveraged products accounted for only 2-3% of all the money invested in all ETFs. (See Tom Lydon review, ETF Trends.) Click on cartoon for larger image.
Follow up:The new aspects of the probe are focused on possible abuses of settlement time requirements for trades involving high-frequency traders and hedge funds jumping in and out of ETFs. From Securities Technology Monitor :
U.S. and UK regulators are concerned that so-called settlement fails - when trades are not completed on time - could contribute to volatility and systemic risk in financial markets.
The probe's main focus is on illiquid ETFs, but regulators are now also examining popular ETFs and failed trades, according to the person.
An SEC spokesman confirmed that the agency is looking into failed trades and ETFs, but declined to elaborate.
There appears to be some confusion about how failure to settle is defined. Most trades must settle in three days and clear in four. However, market makers have seven days to clear trades and the data does not account for those trades when counting settlement fails, according to Securities Technology Monitor. Also, the market should be little effected by the “fails” anyway because the NSCC (National Securities Clearing Corp, a trade processing subsidiary of the Depository Trust & Clearing Corp.) guarantees the delivery of all shares.
Another concern that the SEC is looking into is insider trading could be masked through the use of complex moves involving ETFs. The Financial Times reports that FBI and SEC investigations have resulted in criminal charges being brought against hedge funds, company insiders and consultants for insider trading in which ETFs were used.
- Do Leveraged ETFs Really Move the Market? (Tom Lydon, ETF Trends, 07 September 2011)
- SEC Widens Probe of ETFs (Securities Technology Monitor from Reuters, 21 February 2012)
- SEC Investigates ETF use in insider trading (Kara Scannell, Financial Times, 10 February 2012)