September 17, 2008 at 3:00 pm by Heather Hayes
Trading in exchange traded productions known as exchange traded commodities (ETCs) was halted on Tuesday after market makers stopped offering prices in commodity securities backed by matching contracts from American International Group (AIG).
In a statement on their website, ETF Securities says that it is in discussions with market makers and the exchanges to find out when trading can resume. ETF Securities also remains in open dialogue with AIG to ensure a return to orderly and liquid markets.
ETF Securities commodity-based proudcts use financial instruments provided by AIG to track commodity prices, says Gregor Watt for Money Marketing. The ETC provider said AIG was continuing to honor its agreement, and was processing creations and redemptions.
ETF Securities’ agreements with AIG allow the issuer to call for collateral, but only once the credit rating of AIG falls below BBB+ from Standard & Poor’s and Baa1 from Moody’s. Currently, AIG’s long-term credit rating with S&P is A-, while Moody’s has cut it to Aa3.
The downgrades mean that AIG’s trading partners can require the insurer to post an additional $14.5 billion of collateral, reports David Brough for Reuters.
ETF Securities’ products fall into three major brackets, says Matt Hougan for Index Universe. Credit risk from one group doesn’t bleed over into the others. Their precious metal and oil funds are not affected by this.
It begs the question, though: could it happen here? Unlikely, says one industry observer, because of diversification requirements put in place by the Securities and Exchange Commission (SEC).
If it was going to happen here, the observer said, it would have happened already.
Gary Gordon for ETF Expert tells us that, in his opinion, ETFs wouldn’t be prone to this kind of disruption. “The issue comes back to what risks exist in any investment.” ETFs do have some credit risk, he says. If you have an ETF that has invested in a company that goes under (think Lehman or IndyMac), this may affect the ETF’s ability to pay out some of its affected dividends.
“But essentially, credit risk is diversified across a fund’s [ETF] investments,” he says.
Exchange traded notes (ETNs), which do carry credit risk, can be affected by the collapse of these financial insitutions, however. As debt instruments, the investor is taking on the credit of the issuer. If the issuer goes under, as Lehman did, there’s little recourse.
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September 18th, 2008 at 12:30 pm
What would happen if State Street collapses - i.e. if the actual ETF issuer collapses? If I own an ETF such as BWX, what would happen?
September 24th, 2008 at 7:38 am
We’re researching this exact answer and will get back to you!
September 24th, 2008 at 3:20 pm
Thanks, this would be a very interesting question. We seem to know what may happen if an ETN fails. But if something like FXI fails, who knows what happens… Also, what about more complex ETFs like CYB or commodity ETFs or bond ETFs? Are we stuck with futures contracts that we would have to deal with ourselves or do we just eventually get the cash value of the investments? I’m looking forward to your answer.
October 1st, 2008 at 2:31 pm
We stumbled across an article today that addresses this very question. According to Morningstar’s Scott Burns: Investors in ETFs can breathe somewhat easier because shares represent a stake in an investment portfolio. If an ETF sponsor like State Street or Barclays went down, at worst the investors would receive cash or the shares, Burns said.
Sorry for the delayed reply, and I hope this helps!
October 10th, 2008 at 5:17 pm
Some ETFs do not fully replicate the index but take a sampling like Ishare MSCI Singapore. What happens then if Barclays collapses?
Thx Shanker
October 13th, 2008 at 10:52 am
Hi Shanker,
According to Morningstar’s Scott Burns: Investors in ETFs can breathe somewhat easier because shares represent a stake in an investment portfolio. If an ETF sponsor like State Street or Barclays went down, at worst the investors would receive cash or the shares, Burns said.