Laurence D. Fink, chief executive of
BlackRock Inc., stepped up his criticism of some exchange-traded funds such as those provided by Société Générale SA, saying that he doesn't want them to damage the industry.
So-called synthetic ETFs, offered by firms including SocGen's Lyxor Asset Management and
Deutsche Bank AG, introduce a layer of complexity and counterparty risk of which investors may not be aware, Mr. Fink said last week.
Synthetic funds generate returns through derivatives contracts rather than owning underlying securities as traditional ETFs do.
“If you buy a Lyxor product, you're an unsecured creditor of SocGen,” Mr. Fink, who heads the world's largest asset manager, said at a conference held in New York by
Bank of America Merrill Lynch.
Providers of synthetic ETFs should “tell the investor what they actually are. You're getting a swap; you're counterparty to the issuer,” Mr. Fink said.
BlackRock, whose ETFs are almost all backed by the stocks, bonds or commodities that they seek to track, has been campaigning for more disclosure by derivatives-based funds and has urged regulators to ban the use of the term “ETF” for those funds. The effort has drawn counterattacks from competitors in Europe, where derivatives-based products capture about 40% of ETF assets.
Lyxor chairman Alain Dubois said last month that BlackRock's warnings ignored risks associated with securities lending by physical ETFs.
Physical ETFs “expose their holders to undisclosed levels of counterparty risk to typically undisclosed counterparties,” Nizam Hamid, deputy head of Lyxor ETFs, wrote in an e-mailed response to Mr. Fink's comments.
“The unregulated use of securities lending has resulted in meaningful losses in the past,” Mr. Hamid wrote.
BlackRock's iShares unit is the world's largest ETF provider, with $612 billion in assets as of Oct. 31, according to company data. In Europe, Lyxor is the third-biggest, with $40.1 billion, behind
Deutsche Bank AG's $48.5 billion and iShares' $111.1 billion.
POPULARITY FALLS
Synthetic ETFs have lost popularity among investors in Europe this year, reporting $1.86 billion in withdrawals last month, compared with $3.11 billion deposits for physically backed funds.
In a June report, the U.K. Financial Services Authority raised concerns about counterparty risk, and the quality and liquidity of synthetic ETFs' collateral. The International Monetary Fund and the
Bank for International Settlements also have raised concerns about the funds' risks.
“The European market has turned into a street brawl for the soul of exchange-traded products,” said Dave Nadig, director of research at ETF research firm Index Universe.
Although Mr. Fink has a “fair point” to make about synthetic funds, “there's a self-serving component to that because BlackRock's product line happens to match up with the most favorable interpretation of his argument,” he said.
In the United States, synthetic ETFs are largely limited to funds that use leverage to amplify returns or obtain returns that move in the opposite direction of a chosen index.
The Securities and Exchange Commission suspended approvals for new derivatives-based ETFs in March 2010.
Mr. Fink reiterated his criticism of leveraged and inverse ETFs, saying that he was surprised that some were approved by U.S. regulators.
“I do believe we have some responsibility for making sure that the market does not morph itself — the same way when I started in the mortgage market 35 years ago — watching a great market morph into a monster,” he said.
Mr. Fink was a pioneer in the mortgage industry while at First Boston, which was later acquired by
Credit Suisse Group AG. There, he traded bonds in the 1980s, and helped slice and pool mortgage bonds that were then sold to investors as collateralized mortgage obligations.
BlackRock, in an Oct. 5 paper, called for clearer labeling of exchange-traded products. The firm proposed to U.S. lawmakers Oct. 19 that producers be prohibited from labeling derivatives-based products as ETFs.
Mr. Fink's comments about Lyxor refer to the fact that its funds contract with its parent company for the total return swaps that generate their return. If SocGen were to fail, the funds would generate no return.
“There are obviously a lot of stresses with banks in Europe,” Mr. Fink said, adding that he wasn't suggesting that SocGen is an example of such a bank.
To protect investors, European rules require that synthetic funds be collateralized to at least 90% of the value of net assets. Lyxor typically overcollateralizes its funds.
