CFTC moves to rein in small ETF investors: report

Sat Aug 22, 2009 12:18pm EDT

CHICAGO (Reuters) – Exchange-traded funds or ETFs have become a top target in U.S. regulators’ efforts to rein in excessive speculation in oil and other commodity markets, The Wall Street Journal reported on Saturday.

Commodity ETFs, which came into existence in 2003, offer one of the few avenues for small investors to gain direct exposure to commodity markets. The funds pool money from investors to make one-way bets, usually on rising prices.

Some say this causes excessive buying that artificially inflates prices for oil, natural gas and gold.

Commodity ETFs have ballooned to hold $59.3 billion in assets as of July, according to the National Stock Exchange, which tracks ETF data.

The Commodity Futures Trading Commission has said it seeks to protect end users of commodities, and that cutting out individual investors is not the goal.

“The Commission has never said, ‘You aren’t tall enough to ride,'” CFTC Commissioner Bart Chilton was quoted as saying in the WSJ article. “I don’t want to limit liquidity, but above all else, I want to ensure that prices for consumers are fair and that there is no manipulation — intentional or otherwise.”

Limiting the size of ETFs will result in higher costs for investors, the WSJ reported, because legal and operational costs have to be spread out over a fewer number of shares. Investors range from individuals to banks and hedge funds with multimillion-dollar positions.

The CFTC is currently considering a host of measures to curb excessive speculation, including position limits in U.S. futures markets. Many U.S. lawmakers called for greater regulation of some commodity markets after a price surge last year sent crude oil to a record high of $147 a barrel in July 2008.

(Reporting by Matthew Lewis; Editing by Toni Reinhold)

Hidden Credit Risks of ETFs

Friday September 19, 2:00 pm ET
By John Gabriel
Morningstar.com

Most exchange-traded products are index investments, backed by the actual portfolio of equities or bonds. Although an investor may be taking on the underlying risks of those portfolio holdings, they are not exposed to any risk from the issuer’s financial state. For example, if State Street (STT) were to go bankrupt (unlikely, even in these tumultuous times), investors in the SPDRs ETF (SPY) would be made whole by their claims on the underlying stock investments held by the unit trust.

However, not all exchange-traded products have this safety. Exchange-traded notes, or ETNs, are actually promissory notes with no claim on an underlying portfolio, so they are only as trustworthy as the debt of their backing bank. Morningstar’s director of ETF analysis, Scott Burns, recently wrote an article on ETNs and the credit risk that they face.

Besides ETNs’ inherent credit risk, some ETFs also posses a certain amount of credit risk. Some ETFs cannot invest directly in their underlying assets, relying on swaps, futures, or other derivatives to match the return on their index. These derivatives open those ETFs to counterparty risk, the risk that the institution on the other side of their trade will default, which could leave a fund with no return on its assets or even a loss. The ETFs vulnerable to counterparty risk fall into two major categories: leveraged funds and commodities funds.