January 9, 2015 / 7:25 PM / 5 years ago

U.S. SEC economists to write paper on risky ETFs and market volatility

WASHINGTON (Reuters) - U.S. Securities and Exchange Commission economists have begun scrutinizing riskier types of exchange-traded funds as part of an effort to determine whether they may inflame already rocky market conditions.

The seal of the U.S. Securities and Exchange Commission hangs on the wall at SEC headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst

SEC Chief Economist Mark Flannery said he and colleagues had started working on a white paper about the extent to which ETFs “exacerbate financial volatility.”

“What we are going to try to do is take apart the various possibilities,” he told reporters on the sidelines of an event held Friday at the Brookings Institution.

Flannery’s comments came after he spoke on a panel with other regulators about asset managers and whether certain activities or products may pose systemic risks to the marketplace.

The U.S. Financial Stability Oversight Council, a group of regulators created by the Dodd-Frank Wall Street reform law to monitor emerging threats to the markets, has been especially focused on the issue.

The FSOC, which is led by Treasury Secretary Jack Lew and counts SEC Chair Mary Jo White among its members, is soliciting comments from the industry about potential risks, but has not yet decided what, if any, action should be taken.

Asset managers have fiercely lobbied against the FSOC amid fears it might try to designate certain large industry members as systemic - a tag that imposes tougher capital and oversight by the Federal Reserve.

The industry has urged the FSOC to let the SEC, the primary regulator for the sector, take the reins and adopt its own policies to address systemic risks.

Last month, White announced the SEC was drafting reforms to improve how the market watchdog monitors risk in asset managers, including efforts to collect more data, mandate better risk controls for mutual funds and ETFs, and require firms come up with a plan to unwind if they are in trouble.

Flannery said he is devoting 10 staffers to working on the white paper, which will cover primarily leveraged and synthetic ETFs.

Leveraged ETFs use derivatives and debt to amplify daily index returns, while synthetic ETFs mimic other similar products using different underlying structures, such as swaps.

Such ETFs have been debated hotly for the past few years, at the SEC and beyond.

In May, BlackRock (BLK.N) CEO Larry Fink criticized leveraged ETFs, saying their various structural flaws could “blow up” the entire sector.

Flannery said he hopes to have a rough draft written in a few months.

Reporting by Sarah N. Lynch; Editing by Christian Plumb

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