Synthetic ETFs were the target on Wednesday of Laurence D. Fink, CEO of BlackRock, as he criticized the products of Société Générale SA, saying that he didn’t want them to damage the industry.
Some firms, such as SocGen’s Lyxor Asset Management and Deutsche Bank AG, offer synthetic ETFs. These, said Fink, add a layer of complexity and counterparty risk of which investors may not be aware.
Bloomberg reported that Fink, speaking at a New York conference held by Bank of America Merrill Lynch, said of the products, “If you buy a Lyxor product, you’re an unsecured creditor of SocGen.” He added that providers of synthetic ETFs should “tell the investor what they actually are. You’re getting a swap. You’re counterparty to the issuer.”
The criticism has been ongoing; BlackRock has been pushing for more disclosure by funds based on derivatives, and advocates a ban on the name ETF for such products. Its own ETFs are nearly all backed with the actual stocks, bonds, or commodities that they track. However, in Europe, approximately 40% of ETF assets are held by derivative-based products, and their managers have been fighting back. A
Alan Dubois, chairman of Lyxor, said last month that the warnings BlackRock issued about synthetic ETFs ignore the risks associated with securities lending by physical ETFs. Nizam Hamid, deputy head of Lyxor ETFs, said in response to Fink’s Wednesday comments that physical ETFs “expose their holders to undisclosed levels of counterparty risk to typically undisclosed counterparties. The unregulated use of securities lending has resulted in meaningful losses in the past.”
Synthetic ETFs have lost a bit of their luster in Europe this year, however, with $1.86 billion October withdrawals, compared with $3.11 billion deposits for physically backed funds. Not only that, but the U.K. Financial Services Authority warned about counterparty risk in a June report that also questioned the quality and liquidity of synthetic ETFs’ collateral. The International Monetary Fund (IMF) and the Bank for International Settlements have also voiced concern about the funds’ risks.
Dave Nadig, director of research at San Francisco-based ETF research firm Index Universe, was quoted saying, “The European market has turned into a street brawl for the soul of exchange-traded products.” He added that although Fink had a “fair point” on synthetics, “there’s a self-serving component to that because BlackRock’s product line happens to match up with the most favorable interpretation of his argument.”
Fink has criticized leveraged and inverse ETFs and said that he was surprised U.S. regulators approved some. He also compared leveraged ETFs to the created products that brought about the mortgage market collapse, saying, “I do believe we have some responsibility for making sure that the market does not morph itself, the same way when I started in the mortgage market 35 years ago, watching a great market morph into a monster.”