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Margareta Hricova: Welcome to ETF TV – your insight into the role of exchange traded funds, issuers and investments. I am Margareta Hricova and joining me today is Alex Perel, head of ETF Services at Scotiabank, and Deborah Fuhr.
Alex Perel: Thank you very much for having me.
Thank you.
Deborah Fuhr: Alex, it’s great to have you on the show. Many people have been asking what has been the impact of Russia invading Ukraine and the closure of the Russian market on ETFs and other securities?
Alex Perel: There’s a lot of precedent for ETFs trading and country funds trading, even when that local market is not open. And the most prominent example and probably the closest analog would be the Arab Spring situation in Egypt, 2011.
However, the major difference with the situation here is this whole layer of sanctions where the Western world and Russia are imposing sanctions on each other and there’s sanctions and there’s counter-sanctions. So in addition to the Moscow Stock Exchange being closed, one of the things that has happened, and I believe this happened on the 28th of February, the Central Bank of Russia essentially decreed that local custodians cannot settle trades for foreign holders. The effect of that is to make it essentially impossible to have funds taking in assets, delivering assets, any kind of creation/redemption activity, and the ETF structure can’t rely on any sort of primary market activity and arbitrage to the underlying market at all.
Now, even if the stock market in Russia reopens, that sanctions regime might stay on, and it’s created this really unprecedented situation where Russia exposed country funds really don’t know what they have or don’t have. Effectively what it does is it makes them into an almost closed-end funds structure. You know, we can make the assumption that at some point they’ll go back to being full fledged ETFs, but we don’t know when and we don’t know how.
And in this situation, ETFs trade purely on supply and demand from existing holders lying and new investors piling in. And you can have this disconnect between what the underlying market might be worth or what it’s worth and where the ETF is trading.
Now we’ve seen this movie before. We’ve seen it in the Arab Spring, we’ve seen it in certain situations, whether it’s multi-day holidays in some jurisdictions, but we’ve never seen it in a situation where there’s been this much global sanctions overhang, and this much uncertainty around when that would clear. So Russia exposed assets are in a state of limbo.
Deborah Fuhr: Many people think the index providers should be taking a stance as to what the indices should be doing in terms of continuing to hold Russian equities and bonds. What has happened on the index provider landscape?
Alex Perel: It’s an interesting point because the index world is really all about; can you measure the performance of that underlying asset? But also, can it be investable? And when you have a situation where local settlement is impossible, essentially by government decree, index providers will say, ‘well, that’s not an investable asset anymore.’
And what they’ve done, and I think all the majors have done this or are in consultation for doing this, they remove the assets at zero price. So what the index community has said is; ‘the assets we had in the index are now worthless for the purposes of the measurement of performance in that market.’ It’s as though this market no longer exists.
ETFs and funds in general track an index. They don’t replicate an index through magic. They hold assets that are in proportion to index weights. And so what that essentially means is that if you hold those assets and you also value them at zero, you will continue to track. I think the index community has done maybe the only thing that was open to them, because how can you measure index performance when you can’t settle trades and you can’t be sure that the market will reopen? And you also have this company-by-company, and region-by-region sanctions regime, they get super complex.
Margareta Hricova: And we’ve also noticed that some of the exchanges stopped trading outside of Russia. Can you talk a little bit about why that has happened?
Alex Perel: When you have fund managers writing down the assets to essentially zero and you put into that the underlying market can’t be settled, and the index providers also say something is worthless. But then you see assets trading at prices that are very, very far from all of these sort of indications, it becomes a public interest issue.
Does the average investor understand that what they’re buying here is probably not worth what they’ve paid, because the arbitrage mechanism is broken and there is no expectation that it will be back any time soon. So when it comes to regulatory holes like this, you have to pick where you’re going to draw the line between allowing price discovery to happen on when markets reopen, and investor protection for individuals that may not be in a position to have all the information or all of the facts and figures, and might be relying on an arbitrage mechanism that right now frankly does not exist.
Deborah Fuhr: Have you seen the situation impact other types of securities, options, futures and has it impacted commodities?
Alex Perel: The commodity market is in its own state of disarray and fear, uncertainty and doubt, because we’re not really sure economically what will happen to the commodity market globally. And that’s not an ETF discussion. That’s a global, macro-economic discussion. I think the big, open question is; what’s going to happen to options on VanEck Russia country fund RSX, where there’s millions of contracts outstanding or something along those lines.
And it’s not clear whether those options can be exercised and if they do, what happens to the parties, to those options? Because if they can be exercised, someone is going to become a holder of an asset that is potentially worthless and may not trade again for years. Somebody else will become short that asset. I think that’s also unchartered waters. The answers I’ve received are very unsatisfying. I think people don’t quite know what’s going to happen. And I think we’re going to have a lot of precedent coming out of this on how to handle a similar situation like this in the future. And we’re going to be looking at this one for years to come as a case study on just how we can endure a crisis of this magnitude in the ETF industry.
Deborah Fuhr: Yeah, and to be fair, it’s not just for ETFs, right? It’s impacting mutual funds, it’s impacting active funds. So ETF are not alone but I think people are just looking at it, because they’re more transparent and how are they handling it? So thank you so much for joining us today.
Alex Perel: Thank you very much. It was really great to be here.
Margareta Hricova: Debbie, can we talk about some of the other news in the ETF industry?
Deborah Fuhr: March 9th mark the 32nd anniversary of the listing of the first ETF, and that first ETF was listed in Canada, March 9th, 1990, the TIPS ETF. It still exists, although it has been rebranded.
In other news, we did see that we had 20 new ETFs come to market and 47 new cross-listings. And if we look at data for the end of February, we’ve seen 106 billion dollars of net inflows coming into the ETF industry.
When we look at January and February combined, we’ve had 182 billion dollars of net inflows, which is the second highest, first two months of the year inflows, only behind 2021 when it was 2024 billion.
We’ve had 33 months of positive net inflows. The majority of the money is still going into equity-focused ETFs, mostly into the US.
We have also seen, though, that some people are putting money to work back into gold, which, as you will recall at the end of last year, commodity products in general had net outflows.
Margareta Hricova: Thanks so much, Debbie, and thanks again to Alex for joining us today, and to our sponsors, Syntax Advisors, and of course, to all of you for watching.
To watch prior episodes and to see news from the industry, visit us at ETFTV.NET.
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