The Central Bank of Ireland (CBI) has published a discussion paper to question the potential risks of exchange-traded funds, as the assets in Irish-listed ETFs have grown to €287bn and continue to balloon.
In the paper, the Bank said the Irish ETF industry could grow to €720bn by 2021, and said this growth calls for an industry-wide discussion on the potential unique risks associated with these vehicles.
In particular, the CBI said the key purpose of the paper was to raise questions around potential risks in the primary dealing mechanism of ETFs, and to ensure that these risks are understood by the regulators.
Specifically, it questions whether the “overlapping regulatory frameworks” of UCITS and the MiFID II directive, to both of which ETFs are subject, allow for appropriate regulation of the specific features of ETFs as both exchange-traded financial instruments and investment vehicles.
The Bank has also raised questions about the appropriateness of ETFs for various types of investors, saying the rise in popularity may have made them more attractive to investors who would be better off investing in other types of vehicles.
Additionally, the CBI has addressed the question of liquidity, and the specific liquidity risks to which ETFs are exposed. It notes that the trading of ETFs on the secondary market means their liquidity is linked to the liquidity of the underlying assets, but is not wholly dependent on it. As such, the unique creation/redemption mechanism of ETFs must also be considered when assessing liquidity risks, it said.
The impetus for publishing the paper came primarily from the strong growth in the popularity of the vehicles, which had more than $4trn in assets globally as at the end of April 2017, and are predicted to reach $6trn by 2020, according to the EY Global ETF Survey 2016.
The CBI said: “Because of their recent growth and their likely continued growth in the period ahead, there is every reason to believe that ETFs will be an even more important element of the global funds market.
“Any such locus of innovation requires close regulatory attention to ensure that the benefits of innovation are delivered within a robust, but enabling, regulatory framework.
“Inevitably, this discussion paper focuses on the regulatory challenges which may be raised by the growth of ETFs. Little attention is therefore given to their substantial beneficial effects, although it is important to acknowledge these when considering any issues raised in this paper.”
The central bank has already had discussions with other international regulators, industry bodies and service providers about the ETF industry, and conducted a survey of all Irish authorised ETF providers in 2016 on the products managed by them.
The deadline for responses to the ETF discussion paper is 11 August, after which the Bank will publish the written responses submitted and use these to determine the next stages of its work based on the feedback received.
The full discussion paper can be accessed here.