(Updated to include response from Lyxor)
According to Bloomberg, Laurence Fink, the chief executive of BlackRock, has accused synthetic (swap-based) exchange-traded funds of exposing investors to unnecessary and unadvertised counterparty risks. BlackRock is the world’s largest asset manager and its iShares subsidiary is the largest issuer of ETFs both in the US and Europe. Fink was speaking yesterday at a conference in New York organised by Bank of America Merrill Lynch, Bloomberg reports.
Fink left himself open to claims of misrepresenting synthetic ETF structures, however, by reportedly claiming that “If you buy a Lyxor product, you’re an unsecured creditor of SocGen”. French bank Société Générale (“SocGen”) is Lyxor’s parent company, and provides the derivatives (swap) contracts that guarantee the index returns to Lyxor funds.
Lyxor responded today to Fink’s reported comments.
Laurent Seyer, the firm’s chief executive, said that “Attempting to present Lyxor ETF's investors as Société Générale's unsecured creditors is a wrong and misleading assessment and not allowed under UCITS."
"The facts are clear and transparent, because Lyxor ETFs hold physical assets alongside the swap and these physical assets represent 100% of the fund's NAV,” added Alain Dubois, Lyxor’s chairman. “So the Lyxor ETF holder has zero counterparty risk," Dubois said.
Unlike exchange-traded notes (ETNs), listed certificates and structured notes, which rank equally with senior unsecured debt obligations of the parent bank and where a default of the issuer exposes investors to the potential total loss of their capital, European ETFs that follow the UCITS fund guidelines, including those issued by Lyxor, are structured as funds and are thereby designed not to carry full counterparty risk to the swap provider.
Under UCITS, uncollateralised counterparty risk to a single financial institution is limited to a maximum of 10% of a fund’s net asset value. Since investors started to pay increasing attention to counterparty and collateral risks in fund structures, including ETFs, following the onset of the financial crisis in 2008, many synthetic ETF issuers have moved to collateralise their funds fully, or to overcollateralise them. The mechanism by which investors in synthetic funds can access their funds’ assets or collateral has yet to be tested in a default scenario, however.
The BlackRock CEO’s comments come after months of controversy over risks in exchange-traded funds. The debate, previously carried on largely behind the scenes and amongst industry insiders, burst into the open after a number of global financial regulators spoke out on the subject in the spring.
BlackRock offers a handful of synthetic ETFs as part of its European and Asian fund ranges. However, the vast majority of the firm’s exchange-traded funds use so-called physical (or “in specie”) replication. BlackRock has also been the main beneficiary this year of an apparent shift in European fund flows towards physical ETFs.
According to a recent research report from Deutsche Bank, BlackRock has gained a lion’s share (over 60%) of all net new assets into European ETFs this year, with inflows totalling over €12 billion. Lyxor, meanwhile, has seen outflows of over €5 billion over the same period. Cash flow figures do not suggest a wholesale shift from synthetic replication in Europe, however. Three European ETF issuers that use derivatives to replicate indices--db x-trackers, Amundi and Source--have each acquired over €1 billion in new assets this year.
In recent weeks some synthetic ETF providers have been trying to turn the tables on iShares by refocusing the ETF risk debate on securities lending, a widely followed practice amongst issuers of physical funds. Securities lending also exposes investors to counterparty and collateral risks.
“There is no difference between the risk profile of a synthetic ETF that uses derivatives and the risk profile of a physical ETF that uses securities lending,” said Lyxor’s Dubois at a debate on ETF regulation organised in Brussels two weeks ago by the Centre for European Policy Studies.