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Shelly Antoniewicz, ICI

ICI paper details ETF ecosystem providing smooth market functioning and price discovery during March 2020 volatility


Despite unprecedented market volatility in March 2020, the structures for creating, redeeming, and trading shares of ETFs – including ETF issuers, authorised participants (APs), and ETF liquidity providers – proved their resilience, according to a new paper on the Covid-19 market crisis from the Investment Company Institute (ICI) entitled “Experiences of US Exchange-Traded Funds During the Covid-19 Crisis.”

“ETFs and their ecosystem emerged from this real-life ‘stress test’ with distinction,” says Shelly Antoniewicz, (pictured) ICI senior director of industry and financial analysis.

“Throughout this period, APs, market makers, and other liquidity providers remained active and engaged, helping to facilitate high volumes of ETF activity. ETFs also acted as a source of stability and an important source of price discovery in the fixed-income market by providing investors with real-time views on the costs of liquidating the underlying bonds. This evidence should help ease the concerns of policymakers and others about the role ETFs play in our financial system during a crisis.”

The paper draws these conclusions from extensive data, in-depth analysis of ETF trading and flows, and a survey of ICI members to assess the activity of APs during the height of the market turmoil caused by the economic response to the Covid-19 pandemic.

Despite extreme market volatility, the paper finds that ETFs had modest flows in March. Equity ETFs had total net inflows of USD31 billion, or 1.3 per cent of their February assets, and bond ETF outflows totalled USD18 billion or 2.1 per cent of their February assets. Net outflows from bond ETFs were concentrated in investment grade bond ETFs, likely reflecting investors’ desires to shore up their cash positions by selling high-quality assets, the report found.

Most ETF trading takes place in the secondary market and ICI’s paper shows that, during the height of market volatility related to Covid-19, investors turned to ETFs to quickly and efficiently transfer and hedge risks. The paper also demonstrates that registered market makers and other liquidity providers remained active in the secondary market and provided competitive two-sided quotes for ETF shares relative to their underlying securities.

During March, bond ETF prices adjusted quickly in the rapidly changing markets and acted as an important source of price discovery for fixed-income markets, explains ICI. The paper contends that the difference between the ETFs’ price and their net asset values (NAVs) reflects the increased liquidity costs in the underlying market. Bond ETF shares are traded on the secondary market and their market prices are continually updated, incorporating market participants’ real-time, evolving views on the values of the underlying bonds held in ETFs’ portfolios, as well as their estimated transaction costs.

Policymakers and commentators have speculated that ETFs rely too heavily on a limited number of APs that would stop facilitating creations and redemptions during periods of market stress. ICI conducted a survey to determine how well APs served ICI members from 9 to 27 March, 2020 – the height of the Covid-19 market turmoil. The results disprove this theory. When compared with a more ‘normal’ period, from 11 to 19 March, 2019, the results show that rather than pulling back, more APs entered the market to serve a significantly higher volume of ETF creations and redemptions for more ETFs in March 2020 than March 2019.

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