How Increased Regulation Could Impact ETFs

The exchange traded product business has grown by leaps and bounds over the past several years with the number of ETFs and ETNs trading in the U.S. rising to around 1,500 with about $1.5 trillion in assets under management. On a global basis, the totals are 3,660 funds with over $2.1 trillion in AUM, according to new research published by Credit Suisse.

The Swiss banking giant forecast further growth for the industry, but noted regulation and the size of some ETFs could impact market liquidity.

“While we continue to expect the overall ETF market to grow 5-10% (annualized) over the next five years, we believe regulation (Basel 3, Volcker Rule) and the size of individual ETFs relative to the underlying market could impact ETF trading liquidity (bid-ask spreads and bid-NAV spreads), especially in days of extreme market volatility,” said Credit Suisse in the note.

ETF market liquidity has been a marquee issue for the industry and market participants this year, particularly as liquidity pertains to less-liquid market segments such as emerging markets equities and high-yield bonds. Earlier this year, concerns centered on ETFs tracking less-liquid sectors of the fixed-income market, such as corporate junk bonds and muni bonds. Some of these products traded at discounts to net asset value (NAV) during the May-June volatility. [Digging Deeper Into Bond ETF Liquidity]

Credit Suisse noted that Basel 3 and the Volcker Rule “could limit ETF trading partners in the secondary and primary market, and also limit the inventory that external traders carry.” The bank did note at that even if some ETFs started trading like closed end funds, a scenario Credit Suisse does not view as likely, ETFs are still a low-cost, tax-efficient, highly diversified tool for investors and that ETFs will continue to pilfer share from the actively managed world.

High-yield bond ETFs, such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays Junk Bond ETF (NYSEArca: JNK), were at the epicenter of the May/June liquidity debate.