ETF shares are traded on exchange with constant buying and selling in the secondary market. Consequently, the ETF’s price can fluctuation throughout the day and potential diverge from its underlying net asset value, or the fair value of its underlying holdings.
When the ETF’s price diverges from its underlying value, middlemen or market makers like Goldman Sachs or Morgan Stanley can step in by supplying or removing ETF shares from the market to bring ETF prices back inline with the underlying value. The market makers would then profit off the arbitrage opportunity from the price discrepancy between the two markets.
Some observers, including the SEC Commissioner Kara Stein, are worreid that with over 1,750 ETFs on the market, there are not enough market makers to effectively monitor and arbitrage each ETF that diverges from its NAV.
“Do ETFs face a greater risk of market makers stepping back during times of extreme volatility?” Ms. Stein asked in a speech this year.
ETF providers, though, argued that the new requirements will impeded market efficiency.
“Increased transparency…may have detrimental impacts on the vibrant ETF market and individual shareholder investment,” fund sponsor Invesco Advisers Inc. wrote in a letter to the SEC earlier this year. Revealing which market makers play a big role in supporting ETFs “may discourage” market makers “from participating in the ETF market entirely.”
For more information on the ETF industry, visit our current affairs category.