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What happens to ETF if Vanguard/Blackrock Go Bust?

Index tracking funds and ETFs
tlf67482
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What happens to ETF if Vanguard/Blackrock Go Bust?

#228194

Postby tlf67482 » June 9th, 2019, 9:06 pm

Probably a really stupid question but as I am considering moving to ETFs I would like to know what would happen if say the management company (e.g. Vanguard or Blackrock) goes bust/ceases trading what would happen to my investment in their corresponding branded ETFs?

As I am not actually invested in Vanguard/Blackrock itself I assume my investment in their correponding FTSE100 tracker (for example ) would be safe and not be impacted?

Thanks

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228209

Postby vagrantbrain » June 10th, 2019, 12:31 am

Blackrock/Vanguard don't own the assets within the ETF, they manage the ETF while the actual assets are owned by a third party custodian. In the event they went into bankruptcy then the ETF would either be bought over by another provider, or if no-one wanted it then it would be liquidated and the proceeds given back to the shareholders.

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228214

Postby Lootman » June 10th, 2019, 7:39 am

Fund management is not an inherently risky business, since they are not making bets with their own money, nor borrowing or committing much capital. They have few assets - just the talent. What does tend to happen is that smaller or failing fund managers get eaten up by larger managers. The name of the game is assets under management, since fees are typically a percentage of those. Scale matters.

Hedge funds do fail, but they are a different kettle of fish. Perhaps the most notable failure there was Long-Term Capital Management in 1998.

Blackrock and Vanguard are the two biggest fund managers on the planet, with over $11 trillion in assets under management. They are followed by UBS, State Street and Fidelity. It is inconceivable that they would fail but, as noted, their assets are held elsewhere anyway.

Note also that ETFs, although huge, are still only a fraction of their businesses, which also include open-ended retail funds, institutional/pension funds and private/trust/partnership accounts as well.

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228286

Postby Julian » June 10th, 2019, 11:11 am

Maybe not applicable to the Vanguard or Blackrock ETFs but isn't there also the consideration of physical ETFs or synthetic ETFs where the former actually holds (via a third party custodian) the assets relating to whatever it is tracking e.g. the appropriate balance of shares to track a specific share index and the later enters into some contract with a third party to supply some sort of derivative intended to track whatever the ETF is supposed to be tracking (https://www.investopedia.com/terms/s/synthetic-etf.asp)?

Personally I have always been scared of any synthetic ETF since I worry about what would happen if the provider of the tracking instrument(s) were ever to fail and it all feels a bit too exotic to me.

- Julian

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228300

Postby Alaric » June 10th, 2019, 11:34 am

Julian wrote:
Personally I have always been scared of any synthetic ETF since I worry about what would happen if the provider of the tracking instrument(s) were ever to fail


That is the risk to potentially be concerned about. To what extent do the numerous statutory documents disclose it?

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228327

Postby OhNoNotimAgain » June 10th, 2019, 12:55 pm

The risk really lies with the custodian banks that actually hold the securities. All fund managers do is decide what to buy and then keep the score and ensure they know who owns what, but they do not sit on assets other than when they are receive or disburse cash.

In some cases, the fund manager will contract out the ACD function, i.e. fund accounting, to another party as Woodford did with Link.

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228330

Postby Lootman » June 10th, 2019, 1:00 pm

Alaric wrote:
Julian wrote:Personally I have always been scared of any synthetic ETF since I worry about what would happen if the provider of the tracking instrument(s) were ever to fail

That is the risk to potentially be concerned about. To what extent do the numerous statutory documents disclose it?

What I would look at is the stated method of the synthetic methodology. To my mind there are three major classes of artificially replicating an index and they each carry differing levels of risk:

1) A fund may use exchange-traded derivatives to replicate an index. Indeed this may be essential for some asset classes where you cannot hold the underlying physically, such as most commodities. Derivatives that are exchange-listed, like options and futures, carry no more risk than any other exchage-traded security such as a share or bond.

2) A fund may use OTC derivatives, such as swaps and forwards. These carry more risk as there is the settlement/credit risk of the other party to those contracts. However, usually it is the same big IBs involved, and the net exposure is dramatically smaller than the notional exposure. Even Lehmann managed to unwind its OTC obligations, albeit with some difficulty.

3) ETNs and ETCs, which are really loan insruments issued by an institution. These are credit instruments whose payout replicates an index. The good news is that you get exactly the index return with no costs. The bad news is that if the issuer goes bust, you are an unsecured creditor.

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228869

Postby UncleEbenezer » June 12th, 2019, 10:01 am

Lootman wrote:Derivatives that are exchange-listed, like options and futures, carry no more risk than any other exchage-traded security such as a share or bond.

Are you sure?

A risk there is counterparty risk. I've heard reported that the total volume of derivatives in popular markets exceeds that of the underlying assets by big multiples. So in effect the counterparty risk is highly geared. Yes, the risk would be there if you buy a share in a company with £10 borrowings for every £1 assets, but that is at least visible in the accounts.

Or if not, of what stick have I got the wrong end?

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#228959

Postby Lootman » June 12th, 2019, 3:26 pm

UncleEbenezer wrote:
Lootman wrote:Derivatives that are exchange-listed, like options and futures, carry no more risk than any other exchage-traded security such as a share or bond.

Are you sure?

A risk there is counterparty risk. I've heard reported that the total volume of derivatives in popular markets exceeds that of the underlying assets by big multiples. So in effect the counterparty risk is highly geared. Yes, the risk would be there if you buy a share in a company with £10 borrowings for every £1 assets, but that is at least visible in the accounts.

Or if not, of what stick have I got the wrong end?

When you trade via an exchange then your counterparty is the exchange, and not the entity that took the other side of the trade. So your only settlement risk is with the exchange and they have impeccable credit due to the fact that they hold margin and collateral from all the exchange members.

I can't recall an exchange going backrupt, although I vaguely recall a metals exchange going bust a few decades ago.

It's true that the outstanding liabilities for derivatives can exceed the value of the underlying, but that is the gross value. The net value is a small fraction of that.

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Re: What happens to ETF if Vanguard/Blackrock Go Bust?

#229027

Postby WorkShy » June 12th, 2019, 7:26 pm

UncleEbenezer wrote:Are you sure?
A risk there is counterparty risk. I've heard reported that the total volume of derivatives in popular markets exceeds that of the underlying assets by big multiples. So in effect the counterparty risk is highly geared. Yes, the risk would be there if you buy a share in a company with £10 borrowings for every £1 assets, but that is at least visible in the accounts.
Or if not, of what stick have I got the wrong end?

As @ Lootman has noted exchange traded derivatives will be cleared by a clearing house. The exchange members who you trade with will generally own the clearing house and have members' accounts with margin and collateral. As a result, positions are overcollateralized.

Moreover, since 2008 most OTC (over-the-counter) derivatives are now also cleared through clearing houses such as LCH (London Clearing House). Rather than say Blackrock facing JPMorgan bilaterally on a dervatives transaction, what now occurs is that the clearing house steps-in such that Blackrock faces the LCH and LCH faces JPMorgan. Again all the major banks, large assets managers and even corporations may have accounts with clearing houses (and if they don't, they will use a clearing agent who does). The end result is that the OTC derivative effectively becomes very much like an exchange-traded derivative since the counterparty exposure is again to a clearing house which is overcollateralized.

The idea that derivative transactions are going to destroy the world tends to stem from many misunderstandings. The biggest derivative positions held globally are fx swaps and interest rates swaps. Notionally there are tens of trillions of these. The important word there is "notionally". On an interest rate swap, the notionals are never exchanged between counterparties. The notional is purely used to calculate cashflows.

For example lets say we do £1billion of a 10-year interest rate swap (a swap between a fixed rate coupon and a floating rate, 3m LIBOR). The fixed rate is 1.06%, 3m LIBOR is 0.79%. So each year a net cashflow of 0.27% will be exchanged, which is £2.7m. That is far smaller than £1 billion. The clearing house will ask for initial margin from each of the counterparties to collateralize the swap. They will require variation margin each day to account for mark-to-market movements. Basically, that £1bn 10 year transaction will be turned into a position that effectively only has overnight credit risk. If any side fails to post margin, there is a break clause allowing the clearing house to unwind it. Once all these gross positions are netted, the actual credit risk becomes even smaller.


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