FMVA Certification

Counterparty and liquidity risks in exchange-traded funds Prepared by Michael Grill, Claudia Lambert, Philipp Marquardt, Gibran Watfe and Christian Weistroffer Published as part of the Financial Stability Review November 2018. Over the last decade, exchange-traded funds (ETFs) have grown at a fast pace both globally and in the euro area. ETFs typically offer low-cost diversified investment opportunities for investors. ETF shares can be bought and sold at short notice, making them efficient and flexible instruments for trading and hedging purposes. At the same time, the wider use of ETFs may also come with a growing potential for transmission and amplification of risks in the financial system. This special feature focuses on two such channels arising from (i) liquidity risk in ETF primary and secondary markets and (ii) counterparty risk in ETFs using derivatives and those engaging in securities lending. While ETFs still only account for a small fraction of investment fund asset holdings, their growth has been strong, suggesting a need for close monitoring from a financial stability and regulatory perspective, including prospective interactions with other parts of the financial system. 1 Introduction Over the last decade, ETFs in the euro area have seen double-digit annual growth rates in assets under management, while accounting for sizeable shares of trading volumes on exchanges. Amid a broader shift from active to passive investing, total assets of euro area-domiciled ETFs have doubled in the past four years and amount to approximately €660 billion or 16% of the global market (see Chart C.1).1 ETFs account for approximately 10% of equities and about 5% of bonds held by euro area investment funds, while the share of ETF trading in equity trading is likely to be more significant.2 ETF shares are also increasingly used as collateral and in securities lending transactions, as well as by some institutional investors for liquidity management purposes.3

Chart C.1 Strong growth of euro area-domiciled ETFs since 2009