Failed ETF trades saw a spike this summer. Experts differ on how big a risk that poses.
James Angel isn'’t shy when he sees something wrong in the markets. “I’m the kind of guy, generally, who complains about serious risk,” the Georgetown University McDonough School of Business finance professor tells Institutional Investor.
"“I warned the SEC five times in writing about high frequency trading before the [May 2010] flash crash. When I see a big risk, I scream about it,"” he says, referring to the many warning letters he sent about the risk of rapid, computer-driven trading to market stability. So it’s unusual to find Angel on the side of the everything’s okay crowd, but that’s precisely where he is in the debate over so-called failed trades in the exchange-traded fund market.
“"Of all the things to worry about in equity market structure,”" Angel says, “"I would put [failed ETF trades] not at the bottom but well down on the list.”"
The issue has raised its head again with the news recently that failed trades — that is, trades that have taken more than the industry standard three days to settle — have spiked dramatically in June. According to data from Boston, Massachusetts–based risk consulting firm Basis Point Group, failed trades for the 30 biggest ETFs hit a daily high of $3.96 billion on June 26.
The surge in failed ETF trades has reignited a debate that was last aired in summer 2011, when a similar spike raised questions about ETFs’ place in the market. Unresolved then was the question — asked in both the Economist and the Financial Times that summer — as to whether those failed trades are a simple by-product of the nature of ETFs or whether they they indicate something bigger and more worrisome.
Fred Sommers, co-founder of Basis Point Group, believes failed trades are a major systemic risk costing investors billions of dollars in lost liquidity. “High frequency trading occurs in nanoseconds,” he says, “So if it takes you three days to find a security in a nanosecond trading environment, what kind of liquidity is there in the market?”
Sommers was one of the authors of a report by the Kansas City, Missouri –based Ewing Marion Kauffman Foundation in 2011 that described failed trades as “canaries in the coalmine,” suggesting they could trigger a broader chain reaction in the markets. As they wrote at the time, “ETF fails account for approximately 60 percent of the nearly $2 billion of daily equity trading fails reported to the [Securities and Exchange Commission], and on some days they account for 90 percent of all exchange-traded fails.”...MUCH MORE
