Systemic Risk of Etf

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School of Management, Economics, Law, Social Sciences and International Affairs

Systemic Risk of ETFs

Moritz Burckhardt – Master in Banking and Finance – moritz.burckhardt@student.unisg.ch

Jimmy Hui - Guest Student Bachelor Level - siu.hui@student.unisg.ch

Christa Scherrer – Master in Banking and Finance – christa.scherrer@student.unisg.ch

Monika Seppi – Master in Banking and Finance – monika.seppi@student.unisg.ch

Eleonora Vaccari – Master in Banking and Finance – eleonora.vaccari@student.unisg.ch

Abstract

This paper investigates the potential threat of enhanced systemic risk caused by the ETF market. While previous research covers individual risk aspects of ETFs, a combined investigation of this subject has not taken place yet. The authors structure their approach by risk measure and product type in order to achieve a holistic overview of potential threats to the financial market with a main focus on European market developments.  Preliminary results show a low level of prevalent systemic risk, which is mainly caused by external regulation as well as internal market regulation, resulting from previous financial disasters. Nonetheless, it remains of importance to closely monitor future market movements with regards to ETFs.

Table of Contents

List of Illustrations        

List of Abbreviations        

1        Introduction        

2        ETFs: Market Overview        

3        Systemic Risk: Definition and Measurement        

4        Systemic Risk of Physical ETFs        

4.1        Liquidity Risk        

4.2        Counterparty Risk        

4.3        Tracking Error Risk        

5        Systemic Risk of Synthetic ETFs        

5.1        Liquidity Risk        

5.2        Counterparty Risk        

5.2.1        Trading Book Risk and its Commingling with Tracking Error Risk        

5.2.2        Collateral Risk        

6        Event study “the Flash Crash”        

7        Conclusion        

List of References        

Appendix        

List of Illustrations

Illustration  1 – Total assets under management of global ETFs in USD trn (Source: The Economist, 2014)        

Illustration  2 - Physical ETF structure with securities lending (Source: Amnec et al, 2012)        

Illustration  3 - Premiums and discounts compared to NAV of the iShares Russell 2000 ETF (Source: Bloomberg/BlackRock, 2013)        

Illustration  4 – Simplified unfunded swap structure (Source: Amenc et al., 2012)