ETF Flash Crash "Impossible" In Europe

Industry experts claim Europe is a very different animal to the U.S., when it comes to ETFs

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Reviewed by: Farah Khalique
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Edited by: Farah Khalique

The workings of the exchange traded fund (ETF) market needs to be thoroughly investigated in light of the so-called U.S. ETF flash crash in August, but European investors can breathe a sigh of relief – a flash crash in Europe is "impossible", say leading ETF experts.

Summer Flash Crash

On 24 August, the U.S.' Dow Jones Industrial Average plummeted over 1,000 points shortly after markets opened, with ETFs following suit. Many fell by as more than 40 percent, far below the value of their component stocks, despite the fact that ETFs are supposed to closely follow their underlying basket of securities.

The event was a wake-up call for the ETF industry, which took the brunt of the blame.

Are ETFs To Blame?

ETFs seem to be blamed for "almost anything that happens", said Fuhr, speaking at an industry event this week in London.

"I'm not sure research that has been done has identified all the challenges, and you have people doing what they call research, with a bias. We've seen papers come out in the U.S. where ETFs have been blamed for things, people have questioned their validity,” she said.

"I think having truly independent people really looking at old issues could be useful to add some clarity and insights; I don't think everything has really been thoroughly investigated,” she added.

The U.S. Securities and Exchange Commission is doing its own investigations – it is poring over data from 24 August to examine the link between ETFs and market volatility, and earlier this year requested public comments on ETFs.

European Flash Crash “Impossible”, Says Lyxor

Market structure in the U.S. ETF world is coming under regulatory scrutiny, but the European landscape is vastly different, insisted market participants.

The flash crash seen in the U.S. would not happen in Europe because European exchanges would cancel trades that moved far away from fair value, said Paolo Giulianini, head of ETF trading and advisory at Unicredit.

 

 

He cited the example of Lyxor's Greek equity UCITS ETF (GRE), which plunged in value earlier this year and was temporarily suspended on most exchanges in Europe amid turmoil in Greece.

But in the U.S., an ETF that tracks the Athens Stock Exchange's 20 biggest companies (GREK) remained open for business, despite the fact that Greece's stock market was closed.

There is a fundamental philosophical difference between what is an ETF in Europe and what is an ETF in the U.S., said Arnaud Llinas, global head of ETFs and indexing at Lyxor Asset Management.

In Europe, ETFs are still considered a derivative of their underlying component securities but in the U.S., they are deemed to be potential substitutes for underlying markets.

Llinas said: "[U.S.] ETF issuers are claiming now that markets are trading more on the ETF than they are trading on the underlying. They have a dream to replace the marketplace...they create pricing discovery in the States through the ETF. I would say this is a very bold and very ambitious belief.

 

"In Europe, you have [market structure] rules that make this kind of event [flash crash] impossible to happen, from a technical point of view,” he said.

ETF: Helps Or Hinders Volatility?

The question remains whether trading of an ETF influences the volatility of its underlying index, said Russ Wermers, professor of finance at the Smith School of Business, University of Maryland.

Academic research shows that the introduction of derivatives can help improve price efficiency, but if there is excessive trading of derivatives then this can ultimately affect their underlying securities.

"An ETF is a derivative, people tend to forget that," said Wermers.