Unlike the U.S. exchange traded fund industry, the European market is dominated by so-called synthetic products. Deutsche Asset and Wealth Management, though, will change strategies as the provider switches into physical ETFs.

Deutsche will convert 18 synthetic equity ETFs, with €9.5 billion, or $13 billion, in assets, to physical funds, reports Chris Flood for Financial Times.

Reinhard Bellet, DeAWM’s head of passive asset management, said the funds are undergoing changes due to rising demand for physical ETFs for tracking mainstream equity indicis like Dax and Euro Stoxx 50.

“There is no doubt that the future is ‘physical’ for replicating mainstream equity indices,” Bellet said in the article.

Synthetic ETFs utilize swaps and derivatives to replicate the performance of the market, including leveraged/inverse funds or Undertakings for Collective Investments in Transferable Securities (UCITS) in Europe. A swap is a promise from a counterparty, usually an investment bank, to replicate the performance of the market or index. Investors have grown increasingly concerned with synthetic ETFs due to greater awareness in counterparty risks raised by their securities lending activities.

While not a pressing subject in the U.S., international regulators have voiced concerns that the lending practices could hurt investors and the financial systems. Most critics contend that the practice poses counterparty risk where a default of the security’s borrower could leave the ETF provider in a short squeeze. [Global Regulators Plan Standardized ETF Rules]

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