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).
The FT highlighted large, recent premium and discount moves in the Market Vectors Russia ETF (NYSEArca: RSX) and the SPDR S&P Russia ETF (NYSEArca: RBL), noting that RSX traded at a 5.8% discount to NAV earlier this month before surging to a 9.5% premium last week. Just this month, RBL has seen both its largest discounts and premiums to NAV, according to the FT.
Recently, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (NYSEArca: ASHR) also traded at a large premium to NAV after Deutsche Asset & Wealth Management, the ETF unit of Deutsche Bank, was forced to limit creations in ASHR because strong demand forced the ETF to bump up against its Renminbi Qualified Foreign Institutional Investor (RQFII) quota, which allows the funds to purchase A-shares equities. [Creation Limit Raised for A-Shares ETF]
DAWM has since announced its RQFII was raised, allowing for increased creations of ASHR.
Still, evidence suggests that some ETFs that hold illiquid assets are able to absorb bouts of volatile trading. For example, in June 2013 the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) experienced its largest trading day to date, but the ETF still saw the average ratio of “average secondary-to-primary ratio for the fixed income ETF category,” according to BlackRock and closed at a mere 81-basis point discount to NAV.
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of HYG.