JP Morgan Asset Management case study

ETFs Weighing the risks

Published by : JP Morgan Asset Management

The dramatic growth in exchange traded funds (ETFs) has led regulators to consider more carefully the systemic risks ETFs may pose. Several organisations have published papers recently highlighting their concerns and calling for further study. We offer here a summary of these reports.

The reason for the increased attention given to ETFs is the parallels some see with the development of the mortgage-backed security (MBS) market and the fallout of the global financial crisis. Mortgage-backed securities were initially relatively simple. A bank could take a group of mortgages that were being held on its balance sheet, amalgamate the regular payments the borrower made, and sell the bundle as a security. This allowed the bank to free up its balance sheet to pursue fresh lending, while offering the investors who bought the MBS a new, diversified source of income. Regulators viewed MBS benignly as the products seemed to spread risk more broadly across the financial system. Over the years, however, innovation led banks to securitise new sources of revenue (commercial mortgages, credit cards, student loans, etc.), and to structure the payments in ever more complex ways. This led to the plethora of securitised acronyms: MBS, ABS, CMBS, CMO, CDO, CLO, etc. In retrospect, the risk was only being spread across interconnected players, while also being magnified through layers of leverage, so that when house prices finally fell it almost brought down the entire global financial system instead of just the banks that had originally made the loans1. Regulators now want to be sure that the increasing complexity and popularity of ETFs is not similarly generating unappreciated risk in the financial system.

Published:01 July 2012

Business Area: ETF

Type: Portable Document Format (.pdf)

Rating: 2 people found this useful


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