BlackRock responds to BIS theory that it bypassed market makers

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BlackRock hit back at suggestions from the Bank for International Settlements that exchange-traded funds may have bypassed market makers during the March 2020 market liquidation.

The BIS document suggested that significant price dislocations opened up last year between bond ETFs and the prices of their underlying securities because ETF managers deliberately handed over baskets of funds to authorized participants. ‘low quality bonds. This would have discouraged the underlying trading and blocked the arbitrage mechanism to bring an ETF’s share price back in line with its net asset value.

But in a report released on Monday, the world’s largest asset manager says the data he compiled proves he didn’t and that those so-called buy-back baskets contained a mix of stocks reflecting faithfully the underlying assets of each ETF.

APs and market makers are the engines of ETFs, not only providing liquidity, but also fulfilling an intermediary role: accepting baskets of securities from the ETF provider and returning them daily to the provider, trading the securities sub- underlying assets of the ETF and control the amount of existing ETF shares by creating and redeeming them. This process is supposed to keep ETF prices close to the underlying NAV of the securities they hold, but in March of last year there was a huge price dislocation.

BlackRock analysis shows that between February 19 and March 12, the worst day of the crisis, 95 percent of the 1,000+ stocks held by the $ 21.8 billion iShares $ iBoxx High Yield Corporate Bond ETF (HYG) appeared in the buyback baskets received by AP at one point.

Similarly, 67% of the roughly 2,000 credits held by the $ 41.6 billion iShares iBoxx Investment Grade Corporate Bond (LQD) ETF were in the baskets. The numbers for a series of five fixed income ETFs domiciled in Europe ranged from 80 to 89%, with the exception of one corporate bond fund which actually saw net inflows during the crisis period.

BlackRock argued that these numbers show that the baskets were very diverse when sold, which left him little wiggle room for filling the repurchase baskets with disproportionately high quality securities, even though he had been inclined to do it.

Unlike those of equity ETFs, bond ETF redemption baskets usually do not contain all securities, as the relatively large minimum trading size of bonds means that it can be impractical to hand a AP a tiny shard of hundreds. even thousands of credits.

The way bond ETFs were traded during the market liquidation caused by Covid in March-April 2020 has come under scrutiny. BlackRock’s Market ETF (BND) and $ 71 billion iShares Core US Aggregate Bond (AGG) ETF closed at haircuts of 6.2% and 4.4% respectively on March 12.

An array of other junk bond, municipal debt, bank loan, and US government bond ETFs have also traded at extraordinary discounts, although ETFs are deliberately designed to closely track the value of their stocks. underlying assets.

Other data from BlackRock on the average duration, bid-offer spread and liquidity of the contents of the buyback basket, compared to ETFs themselves, shows relatively little difference between the two, although in some cases the spreads were a little wider. for the securities in the basket.

“The [BIS] The document suggested that some issuers would try to offer more concentrated baskets. It was actually the opposite, ”said Samara Cohen, co-head of markets and investments at iShares, of a period she described as“ the mother of all stressed bond markets ”.

“In a volatile market with a lot of difficulty around price transparency, the best way to ensure that we are delivering a representative basket was to widen the basket,” Cohen said. “A more diverse basket was also what the market maker community wanted. This relieved them of having to sell concentrated positions. “

In addition, the higher the level of redemptions, the more it is necessary to widen the redemption baskets in order to prevent an ETF from becoming increasingly asymmetrical with respect to its underlying index, has it. she adds.

The BIS analysis covered a longer period than the BlackRock study, with no artificial deadline of March 12. It also looked at a wider range of sub-sectors, including Treasury bond funds, and a wider range of ETF providers.

Contrary to the BIS study, Cohen said it was the discounted price of many bond ETFs that truly reflected the market’s perceptions of fair value during the crisis, and not the prices of the underlying bonds used to calculate. the net asset value of the fund.

BlackRock said, for example, that on March 12 of last year, at the height of the stock market storm, LQD traded nearly 90,000 times, compared to an average of just 37 times each for the five largest holdings. of the ETF.

Throughout March, more than half of LQD’s holdings were traded between zero and five times a day, on average, he added.

“Price formation based on tens of thousands of transactions is likely to be more informative than price formation based on considerably fewer transactions in the underlying bonds,” Cohen said.

“We have never released this data before,” Cohen added. “This is a new dimension of what has become a truly massive body of ETF literature. “

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