GLOBAL - The International Monetary Fund has become the latest financial body to express concerns about the growth of the ETF industry.
The IMF's warnings, made in its latest Global Financial Stability paper, centred on the risks involved with synthetic replication and securities lending.
They echo similar concerns expressed recently by the Financial Stability Board and the FSA.
The report acknowledges these "enhancements" reduce costs, but increase counterparty and liquidity risks.
ETFs are as yet a relatively small market in Europe in comparison with the US. However, despite this there are strong signs that pension funds, hedge funds and other investors are beginning to embrace these products.(Global Pensions: 08 December 2010)
Part of the IMF's unease stems from the growing size of the synthetic ETF market in Europe, which it argues increases the potential for contagion.
The report says: "The gross exposures of these funds raises some concerns on whether current restrictions on derivative contracts are sufficient to curtail counterparty risks from becoming systemic under stressed market conditions."
The IMF also alleges that investors are unhappy with current regulation that requires ETF providers to be able to recall lent securities and provide collateralisation.
It reveals: "Participants claim this process currently lacks transparency and that the cash reinvestment guidelines have not been clearly laid out by regulators."
The report also calls into question the ability of ETF issuers to maintain normal creation and redemption mechanisms at times of market stress, and reiterates concerns that heavy ETF trading could disrupt prices in small markets and commodities.
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