Sanctions Throw ETF Custody Into New Territory

February 28, 2022

The latest sanctions from the U.S. Treasury Department froze assets from the Russian central bank and its ministry of finance, a move that may pose an unprecedented challenge to the plumbing that underlies several billion-dollar ETFs. 

The new penalties introduced Monday “effectively immobilizes any assets of the Central Bank of the Russian Federation,” the Russian Ministry of Finance or the country’s sovereign wealth fund in the U.S., according to a statement from the Treasury Department. 

While investors can continue to trade the shares of ETFs and pooled investment vehicles holding Russian assets on U.S. markets, the movement of Russian bonds in creation and redemption baskets has been abruptly halted. 

“Trading in these funds, by the funds and with other institutions as counterparties would also be restricted, because the whole point is not to be able to move these Russian [assets] ultimately back into Russia,” said Eric Young, a senior managing director at compliance consultancy Guidepost Solutions. 

Nearly $932 million of assets are in Russian sovereign debt or corporate debt issued by companies hit in last week’s sanctions, according to FactSet data. 

 

Ticker Fund AUM ($M) Exposure To Russia
ELD WisdomTree Emerging Markets Local Debt Fund 117.30 5.90%
BSCE Invesco BulletShares 2023 USD Emerging Markets Debt ETF 35.62 4.87%
EMLC VanEck J. P. Morgan EM Local Currency Bond ETF 3,559.40 4.12%
LEMB iShares J.P. Morgan EM Local Currency Bond ETF 603.51 4.10%
EBND SPDR Bloomberg Emerging Markets Local Bond ETF 1,264.66 4.10%
ESEB Xtrackers J.P. Morgan ESG Emerging Markets Sovereign ETF 27.69 3.50%
GEMD Goldman Sachs Access Emerging Markets USD Bond ETF 49.27 3.48%
EMHC SPDR Bloomberg Emerging Markets USD Bond ETF 175.55 3.31%
EMB iShares JP Morgan USD Emerging Markets Bond ETF 17,063.95 3.13%
VWOB Vanguard Emerging Markets Government Bond ETF 3,157.28 2.82%
PCY Invesco Emerging Markets Sovereign Debt ETF 2,337.99 2.45%
BSBE Invesco BulletShares 2022 USD Emerging Markets Debt ETF 45.67 2.30%
AEMB American Century Emerging Markets Bond ETF 27.33 2.23%
JPMB JPMorgan USD Emerging Markets Sovereign Bond ETF 72.53 2.16%
EMSH ProShares Short Term USD Emerging Markets Bond ETF 10.48 2.00%
EMBD Global X Emerging Markets Bond ETF 134.65 0.86%
BSDE Invesco BulletShares 2024 USD Emerging Markets Debt ETF 25.33 0.81%
EMCB WisdomTree Emerging Markets Corporate Bond Fund 63.22 0.61%
HYEM VanEck Emerging Markets High Yield Bond ETF 1,261.30 0.33%
EMHY iShares J.P. Morgan EM High Yield Bond ETF 474.63 0.20%
CEMB iShares J.P. Morgan EM Corporate Bond ETF 517.08 0.13%

Note: Includes debt issued by the government of Russia and companies located in Russia. Sources: FactSet/Bloomberg

 

This poses a conundrum for ETF custodians, financial groups that hold an ETF’s underlying assets and act as an integral part of the creation/redemption process that allows ETFs to trade intraday. 

Representatives from Brown Brothers Harriman, U.S. Bank and BNY Mellon declined to comment, citing the rapidly evolving nature of the situation. 

Foreside declined to make a representative available for an interview, but in a statement said it is monitoring changes to the SWIFT payments system made in the past few days to restrict the flow of assets in and out of Russia. 

“We are hearing from certain global custodians that the SWIFT sanctions which have been announced will take time to be implemented and information on how the sanctions will be enacted is dependent on SWIFT. When these sanctions are implemented, SWIFT will likely remove sanctioned entities from the platform,” the firm said. 

While ETFs have had to deal with disruptions in pricing before, such as when Van Eck Global halted creations for the VanEck Egypt Index ETF (EGPT) for nearly two months during the country’s revolution and subsequent stock market closure in 2011, this may be the first time that a specific group of securities held by ETFs have been frozen. 

Active ETF managers may have been able to dump their positions in the past few weeks, but index-based funds have had to maintain their positions. That will likely incur higher-than-normal tracking error between a fund’s price and its net asset value. 

Some funds may have to hold onto this tracking error for the rest of the month. ICE Indexes announced on Monday it would remove all sanctioned debt from its indexes on its March 31 rebalancing

“I think this will make it harder to run the fund, and harder for the fund to be able to trade in line with its net asset value,” said Todd Rosenbluth, director of ETF and mutual fund research at CFRA. “How much harder? I don't know.” 

The path forward for these funds is uncertain, but there may be some hints in their prospectuses listing potential risks, said Kip Meadows, CEO of fund advisory group Nottingham. 

For example, the $17 billion iShares JP Morgan USD Emerging Markets Bond ETF (EMB) is allowed to halt in-kind transactions and instead use cash, but such a move would increase transaction costs for shareholders. 

A spokesperson for iShares was unable to provide a response before publication time when asked by ETF.com if the firm was planning to halt in-kind transactions for funds with sanctioned assets.

 
Contact Dan Mika at [email protected], and follow him on Twitter

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