Leveraged ETFs May 'Blow Up' Industry

BlackRock CEO warns of structural market risks created by funds with embedded leverage.

BlackRock Inc.’s Laurence D. Fink, who oversees the world’s biggest exchange-traded fund (ETF) lineup, said leveraged ETFs are a structural problem and have the potential to “blow up” the industry.

“BlackRock would never do a leveraged ETF,” Fink said in a question-and-answer session with Deutsche Bank AG co-chairman Anshu Jain today in New York. Fink said he doesn’t understand why the U.S. Securities and Exchange Commission (SEC) allows them to operate.

ETFs, which have turned into one of the most popular investing vehicles over the past decade, have become increasingly complex as firms try to appeal to a more diverse base of investors. While the majority of ETFs mimic indexes, leveraged versions use swaps or derivatives to try to amplify daily index returns. Leveraged and inverse ETFs have came under scrutiny over several issues since 2009, the year the SEC warned brokers and investors that the vehicles weren’t appropriate for long-term investors.

Fink said today that products with embedded leverage should be supervised. Regulators should focus their efforts on products, instead of the amount of assets managed, when seeking to reduce risk in the financial system, he said. BlackRock is among large money managers that has been lobbying regulators and lawmakers to avoid being labeled a systemically important financial institution, or SIFI.

“We still need a safer and sounder market,” Fink said.

The SEC examined whether ETFs contributed to equity-market volatility in 2010 and the 8.6 percent intraday plunge in the Standard & Poor’s 500 stock index on May 6, 2010, known as the “flash crash.” The International Monetary Fund has said that European ETFs that generate returns through derivatives, “synthetic” ETFs, add a layer of complexity and risk to financial markets.

BlackRock, which owns the iShares family of exchange-traded products, has proposed that regulators enforce a new categorization regime with clearer labeling and risk disclosures to help individual investors. In 2011, Fink compared the development of hard-to-understand ETFs to financial engineering in the mortgage-backed securities market, which played a key role in the 2008 financial crisis.

BlackRock is the world’s biggest investment firm, with $4.4 trillion under management in everything from open-end mutual funds to private hedge funds.

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