‘synthetic et fs will not rock the global financial system’: bo aml

BofA Merrill Lynch positive about synthetic ETFs, railing against negative regulatory body reports.

|

Its conclusion is simple: “Synthetic ETFs do not pose a risk to global financial stability nor do they present any meaningful risks to ETF investors.”

Jon Maier, an ETF strategist at Bank of America Merrill Lynch, says the reason for some of the misunderstanding about synthetic ETFs is the composition of the collateral behind the swap rather than the product itself.

Collateral

“It is our opinion that the issue of collateral is only relevant in the event of a counterparty default. We would also note the relative benefits of synthetic ETFs compared to ETNs [exchange-traded notes] that are in essence synthetic ETFs that post no collateral. With no collateral, ETNs in our opinion expose investors to much more risk than collateralized synthetic ETFs.”

Maier adds that the size of the synthetically-replicated ETF market needs to be considered, given its relatively small position it has a it holds against the global financial system some of the regulatory bodies are concerned it may bring down. The global ETF market is around $1.5trn when synthetically-replicated ETFs come in at around $195bn.

Another misplaced concern for investors, according to Maier, is the comparison of ETFs being the new collateralised-debt obligations. 

Counterparty

“Precipitating the financial crisis, CDOs that contained low quality assets were put into structures with high quality ratings. What concerns investors about swap based ETFs is the collateral backing the swaps, and the quality of that collateral. It is important to understand the substantial collateral quality and level requirements in evaluating the risks associated with synthetic ETFs,” he wrote.

He admits that the product structures can be complex “but we presently believe that current collateral requirements are sufficient to insulate investors from a counterparty default.”

Maier also warns that if a counterparty does default, there will be other things to worry about, with far greater consideration needed of what is impacting the index the ETF is tracking.