French regulator warns ETF boom has threatened liquidity

The AMF warns investors to remain vigilant as ETFs are intrinsically linked to underlying markets.

Exchange-traded fund (ETF) liquidity remains a risk despite the recent boom in activity, as it is tied to underlying securities and relies on the role of market participants, according to the French regulator.

The Autorité des marchés financiers (AMF) explored ETF risks in its latest research report and explained the recent growth in their popularity calls for vigilance regarding the underlying markets associated with ETFs.

“An ETF’s liquidity is ultimately tied to that of its underlying securities and relies heavily on the key role played by the authorised participant. A major event affecting most or all of its underlying market segment can lead to trading halts on both the secondary and primary markets,” the report said.

The AMF warned if investors’ interest in ETFs is supported by low interest rates, “heightened vigilance” is required due to the potential excessive influence of passive management.

“Particularly in stressed markets, when ETF unit prices are likely to show a significant discount and the effects of correlation could further exacerbate volatility on the underlying markets,” the AMF explained.

The report also found the circuit-breaker mechanism in place on Euronext Paris limits the risk of a massive divergence between the traded price of an ETF and the indicative net asset value of the underlying basket.

The ETF market has seen rapid growth over the last few years, with global assets invested increasing annually by 20% over the past four years.

ETFs now account for more than €2,850 billion in assets under management, or 7% of all collective investment assets globally.