February 22, 2012

The U.S. Securities and Exchange Commission is expanding its probe of exchange-traded funds in a bid to figure out what role they may be playing in an increasingly volatile marketplace, according to a report by Reuters.

The SEC decided to expand its investigation after a sizable trade in a large, liquid ETF failed to settle within four days, Reuters said. The news agency added that regulators in the U.S. and UK are looking into whether so-called settlement fails – when ETF transactions are not completed on time – are making the marketplace more volatile.

The investigation is also an attempt by regulators to pin down what role high-frequency trading may play in such situations. ETFs are securities that trade like stocks on an exchange, but are designed to track indexes, commodities or even baskets of assets like index funds.

From Reuters:

"If you can't figure out what price a stock is at because there are multiple high-frequency traders using ETFs to trade in and out," then when a sudden, unexpected shock occurs in the market, "no one is going to know what caused it," said Joseph Saluzzi, co-founder of Themis Trading, a Chatham, New Jersey brokerage.

The SEC began looking at ETFs following the 2010 "Flash Crash" in which the Dow Jones industrial average plunged 1,000 points in minutes, only to rebound quickly.

The agency again raised concerns about ETFs last October when the U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing on ETFs. An SEC official said a number of the SEC's divisions, including enforcement, were charged with oversight of ETFs.

ABOUT THE AUTHOR
As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced ...