There has been more clamour recently about tightening synthetic ETFs rules worldwide and the topic has been wrestled over by regulators and the regulated. Bloomberg Businessweek reported on Aug 26 on how iShares, a Blackrock’s subsidiary, has been seeking to apply for an exclusive license with the SEC, in order to allow their use of internal indexes as points of reference in possible future synthetic ETF products. Regulators have become more vigilant than ever in limiting counterparty risks in case of their counterparty defaults. Our blog entry earlier mentioned how SFC in Hong Kong had raised collateral limits to 120%; Bank of England was expressing unease about synthetic ETFs as a product class; and SEC intends to solicit public comments on a recent consultation paper on use of derivatives, aiming to enhance disclosures by ETFs in their composition.
As experienced investors are aware, synthetic ETFs help cuts creation costs through the use of swaps. The use of derivatives in place of physical underlyings makes creation much cheaper but this also gives rise to potential counterparty risks. Collateral used in swaps does not always mimic the actual index referenced by the ETF and deviations in performance occur.
Blackrock’s application for tracking an internal iShare index at this time may be more difficult when regulators are looking for ETFs to replicate independent indexes but it will be interesting to see if Blackrock’s proposed control to firewall the tracking process may ease worries about opacity. The suggestion may help distinguish its product offerings.
For those interested in the variation of and views on synthetic ETFs, the working paper 343 from Bank of International Settlements offers some good reviews. The link is attached here.
An article from Interactive Investor can be found here.
A report on iShares SEC Licensing can be found here.
Report World round-up can be found here.