From FT Alphaville:
Why ETF baskets are worth paying attention to
An obscure but tweak-able mechanism within the ETF structure plays an important role in shock absorbing market volatility, argues a BIS paper. The question is, to what degree does it displace risk elsewhere?
The FT’s Steve Johnson had a good write up on Wednesday of a new BIS paper that takes a closer look at the arbitrage mechanics behind bond ETFs. The paper also delves deeper into the potential role played by authorised participants (APs) in supporting liquidity to ETFs.
APs are liquidity-providing intermediary traders -- often big broker-dealer or market-making HFT names -- who are exclusively able to redeem and create ETF baskets thanks to the contracts they sign with fund sponsors.One might think such baskets faithfully represent a fund’s underlying holdings. But the big insight in the BIS paper is, actually, that they don’t.
That shouldn’t come as a surprise to FT Alphaville readers. We’ve long noted the composition of baskets can be tweaked to suit daily trading objectives. In theory these changes are transparent. In practice, the wider market is not always au fait with the processes, so they’re not necessarily scrutinised in real time....
....MUCH MORE
