ETFs passed their Covid-19 test, regulators find

The market disruption and volatility touched off by the Covid-19 pandemic subjected the ETF market to a severe real-world stress test, which it passed with flying colours according to a review by the International Organization of Securities Commissions (IOSCO).

The umbrella group of global securities regulators published a report detailing the results of a review of how well the ETF market operated both during and after the extreme volatility that arose in March 2020.

While certain ETFs “temporarily experienced unusual trading behaviors” — daily turnover of listed ETFs essentially doubled in March, compared with the previous month — the episode did not expose “any major risks or fragilities in the ETF structure,” the report said.

In fact, the review found that the market volatility “shed light on the resilience of most ETFs across various market segments during stressed markets,” which helps “alleviate concerns about possible financial stability risks relating to the ETF structure.”

The review also found that many traders turned to ETFs in the face of intensified volatility, reporting that the share of equity trading attributed to ETFs rose to about 40% in early March from its typical share of between 20% and 30% in normal market conditions.

“Such increase in trading may lend some support to the view that ETFs are convenient and preferred tools for market participants to adjust their exposures in a stressed market,” the report noted.

Additionally, the report suggested that other ETF advantages were revealed by the stress test.

The episode of volatility “deepened the industry’s understanding of fixed income ETFs’ potential role in providing additional pricing information for the underlying bond markets,” it said. “Moreover, it demonstrated the utility of the additional layer of liquidity provided by ETF secondary markets.”

IOSCO noted that it’s continuing a broader analysis of the ETF market this year, and it will consult on possible reform proposals in late 2021 or in the first half of 2022.

“This report is an important milestone as we continue our evaluation work following the Covid-19 induced market stresses. The Covid-19 volatility was a significant stress test for ETF structures and operations,” noted Ashley Alder, chair of the IOSCO board and CEO for Hong Kong’s Securities & Futures Commission.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.