A recent Bloomberg report that banks like Citi and Goldman Sachs might be planning to launch exchange traded funds (ETFs) based on additional tier-1 (AT1) debt has sparked fears in some quarters about an increase in volatility in the asset class. The introduction of a retail investor base, so the argument goes, will bring a very different dynamic to the market.
That sounds plausible, but is it true? And even if it is, does it matter?
Part of the answer depends on how we think about volatility, part depends on the distinction between primary and secondary liquidity (an Important Thing in the context of ETFs) and part depends on who might buy such a product and why.
Before getting into all that, it’s worth remembering the process by which ETF shares are created and redeemed – and the relationship between them and whatever benchmark they are trying to replicate. ETF shares appear and disappear through the actions of authorised participants (APs), financial institutions that enter into contracts with ETF issuers for this purpose.
When new ETF shares need to be created, an AP delivers a basket of relevant underlying securities to the ETF.
