IMF warns of concentration of liquidity providers in Irish ETF market

The International Monetary Fund has warned that Irish ETFs, which make up the majority of European ETFs, should look towards using a greater range of liquidity providers.

The dominant player in the Irish ETF market is BlackRock, which controls 61% of ETF AUM in the country. However, just two liquidity providers make up to 90% of activity for certain ETFs from BlackRock.

Ireland is the domicile for 60% of European ETFs by assets under management, with ETFs accounting for 23% of Irish fund AUM.

The AUM of ETFs has more than doubled since 2017, totalling €878bn by 30 September 2021. The vast majority (97%) are passively managed, with 70% of ETF AUM in equities. For bond ETFs, the sector is split evenly between government and corporate debt.

The IMF highlighted various specific characteristics of ETFs that give rise to certain risks.

These included: pricing discount risk, where there is a disparity in pricing between the market price of the ETF and its NAV; settlement risk, where settlement delays can have a knock-on effect on market participants; and direct redemption risk, where investors redeem directly at the level of the ETF provider.

Liquidity providers were also identified as a key risk, where only authorised participants have direct access to the ETF for subscription and redemption activities, while market makers can step away from providing liquidity.

This is where the risk comes from for BlackRock, as the IMF said while there was no evidence of market makers stepping away during the market stress in the coronavirus pandemic, "this remains an area that requires close monitoring".

The IMF added: "The relevant central bank supervision teams should engage with ETF providers to ensure their arrangements with APs and MMs are robust and promote the smooth functioning of the sector, including in times of market stress.

"There should also be closer cooperation between supervisors of IFs and the colleagues supervising APs and MMs."

As for the other risks identified, the IMF noted that the pricing discount risk did materialise during the pandemic, causing differences between some fixed income ETF shares and their assets to reach up to 17%. However, the Central Bank of Ireland reported that these discounts generally disappeared within a week.