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October 19, 2011 at 11:59 AM
Eileen Rominger, director of the Securities and Exchange Commission’s Division of Investment Management, told a Senate panel on Wednesday that because of the growth and complexity of exchange traded funds, the commission is reviewing the adequacy of investor disclosure about ETFs, their liquidity and whether they contribute to market volatility.
At a hearing held by Sen. Jack Reed, D-R.I., chairman of the Senate Banking Subcommittee on Securities, Insurance and Investment, Rominger said several divisions and offices at the SEC are “gathering and analyzing detailed information” about specific exchange-traded products.
Commission staff, she said, is assessing the adequacy of “investor disclosure, liquidity levels and transparency of underlying instruments in which ETPs invest, fair valuations, efficiency in the arbitrage process and the relationship between market volatility and ETPs.” Because of the “growth and innovation” in exchange traded products, Rominger said, “the commission has been actively following, and continues to engage in the analysis of, these products.”
But Scott Burns, director of ETF Research at Morningstar, told AdvisorOne on Wednesday that as to whether ETFs affect market volatility, “if the SEC is looking at the same data we are, they won’t find anything.” The majority of the panelists at the hearing agreed that ETFs did not contribute to market volatility, Burns noted.
Eric Noll, executive vice president Transaction Services at NASDAQ OMX, who testified at the hearing, said, “We are seeing no signs that ETFs add to volatility in the market. [There are] other factors in the market that far overwhelm any effect ETFs have” on market volatility.
Reed stated during his opening remarks that ETFs, which now account for about $1 trillion in assets, “are particularly attractive to some investors because you can bet long or short–and you can leverage your bet. And you can hop in and out within the trading day to lock in gains, just as with stocks.”
More and more mainstream investors are purchasing ETFs, Reed said, with about 50% of ETF assets in the United States now being held by retail investors.
However, critics of ETFs, Reed continued, have labeled them as “new weapons of mass destruction that are turning the market into ‘a casino on steroids.’” Others, he said, “believe they are a more efficient, modern, and tax advantaged method of investing.”
Additional innovation in ETFs, Reed said, “has resulted in products that can magnify returns of various indexes by embedding derivatives and other forms of leverage. Theoretically, a leveraged ETF with $1 from investors and $1 from leverage would return 2% for each one-percent movement in the underlying index. Other ETFs, called inverse ETFs, seek to return the inverse of an index, such as providing a 1% return for every 1% decline in the S&P 500.”
