An IOSCO study has helped to “alleviate concerns” about possible financial stability risks or fragilities relating to the ETF structure.
IOSCO (International Organization of Securities Commissions) has published a report revealing the findings of a study into the behaviour of ETFs during the Covid-19 related market stress during the first half of 2020.
The study found that the ETF structure was “relatively resilient” during March and April 2020, despite heightened volatility and significant stresses in financial markets during the period.
In March 2020, the price dislocations were observed, but they were generally short-lived in most markets. By April 2020, these pricing differences were largely eliminated, following the actions taken by various central banks to help restore liquidity, pricing transparency, and market confidence to underlying bond markets.
“Overall, available evidence has not indicated any significant risks or fragilities in the ETF structure, although a subset of ETFs temporarily experienced unusual trading behaviors,” the report said. In particular, certain futures-based oil ETPs/ETFs and leveraged/inverse ETFs (L&I ETFs) experienced difficulties during the Covid-19 volatility.
Nevertheless, IOSCO says the pandemic presented a real-world test for the ETF structure in an environment of significant market stress, and that the study has helped to “alleviate concerns” about possible financial stability risks relating to the ETF structure.
The study also found that many traders turned to ETFs in the face of intensified volatility, with the share of equity trading attributed to ETFs increasing to about 40 percent in early March from its typical share of between 20 percent and 30 percent in normal market conditions. “Such increase in trading may lend some support to the view that ETFs are convenient and preferred tools for market participants to adjust their exposures in a stressed market,” the report said.
The study also helped to deepen the industry’s understanding of fixed income ETFs’ potential role in providing additional pricing information for the underlying bond markets, and demonstrated the utility of the additional layer of liquidity provided by ETF secondary markets.
For certain derivatives-based ETPs/ETFs that were impacted by extreme market circumstances, IOSCO says further consideration related to product structuring and contingency planning is warranted.
As part of its 2021-2022 Work Programme, IOSCO will continue its broader analysis of the ETF market in 2021 and consult on ETF policy proposals in late 2021/H1 2022.