SEC Commissioner Encourages Dialogue on Exchange-Traded Products

SEC Commissioner Michael Piwowar opened an SEC-NYU conference by describing different types of ETPs: exchange-traded funds (“ETFs”), exchange-traded notes (“ETNs”), and exchange-traded commodity funds (“commodity ETFs”) and by distinguishing between ETPs and other financial products. ETPs “allow investors to invest in a portfolio of assets or in the performance of a benchmark.” Unlike mutual funds, he said, investors can trade ETP shares throughout the day which “allows investors, both retail and institutional, to tailor their portfolios to take advantage of changing market conditions that occur throughout the day.”

The conference, co-sponsored by the SEC Division of Economic and Risk Analysis and the New York University Salomon Center for the Study of Financial Institutions, addressed (i) the effect of ETPs on the efficiency and quality of the financial markets, (ii) implications for investors in a developing market, and (iii) the future of the ETP market, including potential new products and associated “cost-benefit tradeoffs.”

Mr. Piwowar underscored that ETPs are a rapidly expanding asset class, and that significant growth stems from a variety of factors including (i) ease of access, as any investor with a brokerage account can make transactions, and (ii) low trading costs, since ETPs are passive investments that closely track indexes. As such, they are particularly attractive to retail investors. He also said that ETPs are useful for institutional investors due to the ability to lend ETP shares, short sell, and trade on margin. These features are conducive to implementing sophisticated trading strategies.

Mr. Piwowar stated that ETPs also afford investors an opportunity to pursue “unique economic exposures” that are often dependent upon arbitrage trading by institutional investors. Arbitrage trading helps to ensure that ETPs accurately reflect the value of the underlying assets of an ETP, or the benchmark it tracks. Mr. Piwowar explained that certain ETPs, such as those with reference assets which are illiquid or are not traded concurrently with the ETP, are more susceptible to price deviation. Even a brief deviation can result in significant effects to the value of a security. Consequently, ETPs may affect the value of an underlying asset and, in turn, the “overall quality of financial markets.” Mr. Piwowar said that there is some concern that ETPs have negatively impacted capital market efficiency, noting that academic studies of this issue have produced mixed results.

Mr. Piwowar asserted that, as a result of the constantly evolving structure of the ETP market and the relatively recent emergence of ETPs as a prominent asset class, academic study and industry observations are an important tool that can contribute to effective SEC oversight and regulation.