NY Fed Probes ETF Pricing

Amid unusual movements for some exchange traded funds tracking less-than-liquid asset classes, such as high-yield bonds, commodities and emerging markets stocks, the Federal Reserve Bank of New York is launching an ETF pricing probe.

Two authorized participants contacted by the New York Fed said the regulator was concerned by situations where prices of ETFs significantly diverge from those of the assets the funds hold, reports Tracy Alloway for the Financial Times.

ETFs undergo a creation and redemption process in which market makers, authorized participants or large institutional investors swap a basket of securities from the underlying benchmark index for ETF shares, or vice versa.

An authorized participant would borrow shares of stock from an underlying benchmark and put them in a trust to form a so-called creation unit of an ETF. The Trust would provide shares of the ETF that are legal claims on the shares held in the ETF. As such, the authorized participant exchanges the basket of stocks for ETF shares, which are then sold to the public as stocks in the open market. [A Look at How ETF Trades Work]

One authorized participant told the FT that ETFs have been good instruments for price discovery, but there are examples where ETFs, typically those that trade illiquid and hard-to-access assets, trade at large premiums or discounts to their net asset values (NAV).