Letter: Market makers only have a limited amount of capital to risk

You report (“Extreme Market Stress Puts $6.4 Billion ETF Sector Under Acute Pressure”, FTfm, March 23) that even Vanguard’s total $55 billion bond market ETF began to suffer from price dislocation as it moved to a 6.2% discount. March 12.

You quote Sean Tuffy, a regulatory expert at Citigroup, who says, “There has been extraordinary market volatility and we haven’t seen any major issues with ETFs. They continue to function normally. If there are still no major issues, that should help ease some of the concerns among policymakers about any potential risk from ETFs.

To which I would say: well, isn’t it curious that some of the really big fund managers pushed for the markets to be closed for a while?

Ultimately, market makers have limited capital to risk and ETFs have far exceeded their risk appetite in dark times like these. You cannot long factor in the mismatch between market-making ability and the size of the illiquid holdings in the underlying portfolio. You kindly published one of my letters on the 30th anniversary of the crash of 1987 in which I said that ETFs would be at the heart of the next one, and now we are there.

It’s understandable that the Federal Reserve now administers the traditional band-aid of acting as the buyer of last resort, which will save ETFs for now. When the waters calm down, it is essential that governments insist, through their regulators, that there must be no more funds whose underlying holdings are not meaningfully traded daily and sold to investors as being able to trade daily. I would suggest that in future these funds only be opened for trading quarterly.

Stephen Hazell-Smith
Penshurst, Kent, UK

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