US SEC Widens Probe of Exchange-traded Funds

As reported by Reuters, US securities regulators have widened their inquiry into the trillion-dollar market for exchange-traded funds, according to a person familiar with the matter.

Prompted by a delay in a big trade at a popular ETF, the US Securities and Exchange Commission was taking a closer look at a possible connection between high-frequency traders and hedge funds jumping in and out of ETFs, and instances where ETF trades failed to settle on time, this person said.

The SEC’s inquiry is part of a wider probe that began last year and focused on complex ETFs that allow investors to magnify returns or bet against stock indexes.

U.S. and UK regulators are concerned that so-called settlement fails — when trades are not completed on time — could contribute to volatility and systemic risk in financial markets.

The probe’s main focus is on illiquid ETFs, but regulators are now also examining popular ETFs and failed trades, according to the person.

An SEC spokesman confirmed that the agency is looking into failed trades and ETFs, but declined to elaborate.

The SEC’s inquiry comes amid greater scrutiny of the ETF industry, which has surged in popularity since the early 1990s. It is still unclear how settlement delays might affect retail investors in ETFs.

ETFs are baskets of securities that, like mutual funds, give investors exposure to a pool of assets. But unlike mutual funds, they trade throughout the day. Early ETFs were created to mirror benchmarks such as the Standard & Poor’s 500 index. ETF assets have doubled since 2007 to about US$1.3trn, according to Deutsche Bank AG. Some of the most popular ETFs are those that use derivatives to give investors exposure to commodities, high-yield bonds or ETFs that own other ETFs.

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