Abstract
Some of the problems inherent in the structure of Financial Indices, ETFs and Index Funds were discussed in earlier chapters in this book—and the large size of the Global Index Products Market amplifies these problems. Another dimension is that the Social Welfare problems of Indexing can have wide-ranging negative “Multiplier Effects” (on households, companies and government agencies) and which have not been addressed by index sponsors, fund sponsors or regulators. This chapter: (i) discusses the implications of ETFs, Indices and Index Funds for enforcement, Sustainability, Inequality and financial stability; (ii) discusses “path-dependence” and “Lock-ins” and proposes new models of government intervention; and (iii) proposes new sustainability measures that are designed to reduce the wide-ranging adverse effects of Indices, Index Funds and ETFs (such as Destructive Urbanization, Inequality, Pollution and Climate Change, harmful Arbitrage, and Costly Technological Change).
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Notes
- 1.
See Burne, K. (Oct. 1, 2015). Banks Finalize $1.86 Billion Credit-Swaps Settlement—Suit claimed banks conspired to prevent competition. Wall Street Journal. https://www.wsj.com/articles/wall-street-banks-in-credit-swaps-settlement-1443708335
See In re: Credit Default Swaps Antitrust Litigation (U.S. District Court for the Southern District of New York, No. 13-md-02476) (USA lawsuit about manipulation of the credit default swaps market by banks).
See Tomasulo vs. CBOE, et al. (Case No. 18-cv-2025; US District Court For the Northern District Court Of Illinois, USA) (an antitrust Court case in the USA about alleged manipulation of the VIX). http://business.cch.com/srd/TomasuloComplaint.pdf
See Samuel vs. Does (Case number: 18-cv-01593-AT; US District Court For the Southern district Of New York) (a Court case in the USA about alleged manipulation of the VIX).
See Sanduski vs. John Does (Case number: 1:18-cv-02552(AT) (SN); US District Court For The Southern District of New York) (class-action lawsuit in the USA about the manipulation of the VIX). https://www.foley.com/files/uploads/Complaints/NY5.Complaint_Sanduski.pdf
See Atlantic Trading USA, LLC v. Does 1–100 (Case number: 18-cv-01754; U.S. District Court for the Northern District of Illinois) (a Court case in the USA about alleged manipulation of the VIX).
See Bueno vs. CBOE, et al. (U.S. District Court for the Northern District of Illinois) (Complaint in lawsuit against CBOE in the USA about the manipulation of VIX - https://www.rosenlegal.com/media/casestudy/1251_Initial%20Complaint%20_web%20secured_.pdf).
See “It is ‘hard to understand’ why investors are suing Credit Suisse over volatility product, says its CEO”. CNBC. March 19, 2018. https://www.cnbc.com/2018/03/19/credit-suisse-vix-etn-lawsuits-tidjane-thiam-says-bank-not-at-fault.html
See Rennison, J. (September 28, 2015). Investor lawsuits pile up claiming US Treasury market is rigged. http://www.ft.com/cms/s/0/43f0b014-6218-11e5-9846-de406ccb37f2.html
See Dugan, K. (June 9, 2015). Justice Department probes banks for rigging Treasury market. http://www.marketwatch.com/story/justice-department-probes-banks-for-rigging-treasury-market-2015-06-09
See Stempel, J. (May 18, 2016). Five banks sued in U.S. for rigging $9 trillion agency bond market. https://www.reuters.com/article/us-banks-rigging-lawsuit-idUSKCN0Y932L
See Mogel, G. (May 7, 2007). Equity index annuity insurers are facing more lawsuits. http://www.investmentnews.com/article/20070507/free/70507008/equity-index-annuity-insurers-are-facing-more-lawsuits
See Gandel, S. (December 7, 2015). This Lawsuit Could Cost Vanguard Investors Billions. http://fortune.com/2015/12/07/vanguard-billions-taxes/. This article states in part: “The popular mutual fund company is known for its low cost index funds. But a whistleblower suit claims that one of the reasons that its index funds are so cheap [is that it] has allowed the company to avoid tens of billions of dollars in taxes in the past eight years alone. The suit claims that Vanguard owes $35 billion in back taxes, penalties and interest since 2007. Vanguard’s investors would not be liable for those payments. But the suit claims that Vanguard would have to dramatically raise its fees, perhaps by as much as four times, in order to become compliant with tax law. That would collectively increase the fee that Vanguard investors in all of its Mutual Funds pay the company by nearly $20 billion in the past year alone…”
See Levine, M. (April 21, 2014). Lawyers Sue Stock Market for Being Rigged. https://www.bloomberg.com/view/articles/2014-04-21/lawyers-sue-stock-market-for-being-rigged
See Crigger, L. (January 31, 2018). Investors Shoulder ETFMG’s Legal Costs. https://www.etf.com/sections/features-and-news/investors-shoulder-etfmgs-legal-costs
- 2.
See the comments in UNIDO (2015), Smulders (1998), Wu and Li (2017), Elbahnasawy et al. (2016), Turnovsky (2015), Meszaros (2018), Broecke et al. (2017), Halvarsson et al. (2018), US Federal Trade Commission (2016), Koopman et al. (2015), Edelman and Geradin (2016), Hartmann et al. (2017), Elbahnasawy et al. (2016) and Mühleisen (2018).
- 3.
More specifically, the models and theories in the Paul Romer and Willian Nordhaus lines of research and related approaches are inaccurate and misspecified, as can be seen in Nordhaus (1969a, b, 2002, 2005, 2009, 2014, 2015), Nordhaus and Van Der Heyden (1983), Romer (1983, 1990, 2007, 2011), Romer and Jones (2010), Easterly (2002), Helpman (2004), and Acemoglu (2009), etc.
- 4.
See Clemente, J. (Oct. 1, 2015). “Cap-And-Trade Is Fraught With Fraud”. Forbes. https://www.forbes.com/sites/judeclemente/2015/10/01/cap-and-trade-green-climate-fund-are-fraught-with-fraud/#5efb15f54940
See Haley, B. (March 13, 2017). “Political Manipulation Could Derail Nova Scotia’s Cap-and-Trade System”. Halifax Examiner (Canadian newspaper). https://www.halifaxexaminer.ca/environment/political-manipulation-could-derail-nova-scotias-cap-and-trade-system/
See Goldstein, L. (July 23, 2016). “Call it Cap-And-Fraud”. Toronto Sun (Canadian newspaper). https://torontosun.com/2016/07/23/call-it-cap-and-fraud/wcm/7635fae3-866b-430c-97b9-24b212458188. This article stated in part: “A carbon credit entitles the bearer to emit one tonne of industrial carbon dioxide or equivalent, on the theory another emitter didn’t. Since CO2 is a colourless, odourless gas, it’s relatively easy to commit fraud. Interpol noted this can include: ‘Fraudulent manipulation of measurements to claim more carbon credits from a project than were actually obtained; sale of carbon credits that either do not exist or belong to someone else; false or misleading claims with respect to the environmental or financial benefits of carbon market investments; exploitation of weak regulations in the carbon market to commit financial crimes, such as money laundering, securities fraud or tax fraud; computer hacking/phishing to steal carbon credits and personal information.’ The Stockholm Environment Institute reported last year that almost 75% (seventy five percent) of carbon credits generated by Russia and Ukraine could be fraudulent. There have been similar findings with regard to China, India and elsewhere. The public pays the cost because carbon pricing increases the price of most goods and service, since most are made using fossil fuel energy. And if a carbon credit is fraudulent, there’s no lowering of emissions because of it…”
- 5.
See the comments in Helm (2009), Tanuro (2008), Vlachou and Pantelias (2017), Zeng et al. (2018), Antimiani et al. (2013), Sijm et al. (2006), Frondel et al. (2012), Grubb et al. (2015), Goulder and Stavins (2011), Monjon and Quirion (2011), Weishaar (2014), Pang and Duan (2016), Schneider et al. (2015), Tynkkynen (2014), Wang et al. (2017), Berthe and Elie (2015), Furceri et al. (2018) and Kerr and Duscha (2014).
- 6.
More specifically, the models and theories in the Paul Romer and Willian Nordhaus lines of research and related approaches are inaccurate and misspecified, including in Nordhaus (1974, 1977, 1980, 1981, 1994, 1995, 1998, 2006a, b, c, 2007a, b, c, 2013, 2016), Nordhaus and Moffat (2017), Nordhaus and Boyer (1999).
- 7.
See the comments in Scott (Zurich Insurance Group) (2015), Trivedi et al. (2008), Rukmana (2013), Aliyu and Amadu (2017), World Economic Forum (2018), Bampinas et al. (2017), Bove and Elia (2017), Hare (2016), Yamada (2012), Perkins et al. (2011), Elbahnasawy et al. (2016) and Miller and Neanidis (2015).
- 8.
See: Patterson, S. (Sept. 7, 2011). “SEC Looks into Effect of ETFs on Market.” The Wall Street Journal, September 7, 2011. http://www.wsj.com/articles/SB10001424053111903648204576554770203689108
See: Weinberg, A. (Feb. 7, 2016). “SEC Raises Concerns About Bond ETFs – The SEC is concerned about funds and ETFs with too many harder-to-sell securities”. The Wall Street Journal. http://www.wsj.com/articles/sec-raises-concerns-about-bond-etfs-1454900904
See: Authers, J. (December 28, 2015). “ETFs to play main role in the next crisis – Liquidity fears in indexed products have caused jitters this year”. Financial Times (London). https://www.ft.com/content/53b5b728-a9ae-11e5-9700-2b669a5aeb83. This article states in part: “The next financial crisis will be played out in indexes and exchange traded funds. That is inevitable given the huge share that ETFs now take of investor fund flows, and their popularity as hedge fund trading vehicles. What is less clear, and deeply controversial, is whether the structure of ETFs will itself contribute to the next crisis, or even cause it. Regulators, worried by past incidents when untested financial innovations helped exacerbate financial crises, are worried that it could. ETF providers indignantly counter that they make the market more liquid, and less prone to sudden stops. Indeed, they complain that well-intentioned regulations exacerbate a problem they were meant to cure. The scale of the ETF industry is not in question. They now hold more than $3 trillion in assets. But this raises the question of whether they have come to lead the market rather than follow it. This operates at two levels. First, there is a concern that the power of the indexes distorts markets over time, and second, there is the possibility that the structure of ETFs and index funds worsens market shocks when they happen…”
See: Maverick, T. (Jan. 25, 2016). “The Real Financial Crisis Will Be Caused by ETFs”. Wall Street Daily. http://www.wallstreetdaily.com/2016/01/25/financial-crisis-etfs/. This article states in part: “But even without the derivatives factor, the SEC is right to be worried, based on what we saw in 2015. Even regular ETFs caused headaches. And in this case, the size is larger in magnitude. The overall ETF industry now has $3 trillion in assets. Overall, ETFs globally attracted $372 billion in net inflows in 2015. And in 2015, roughly $70 trillion worth of ETFs changed hands. During the August swoon/flash crash, supposedly safe ETFs (more than 1000) had circuit breakers implemented on them more than 600 times! And even though the stocks inside the ETFs were down 10% or so, some ETFs plummeted by as much as 35%. And those were the lucky ones – many ETFs didn’t price at all for many hours. The Wall Street Journal looked into what happened after circuit breakers were initiated on many stocks. And here is the low-down: ‘...Many ETF market makers were unable to accurately calculate the value of the underlying holdings or properly hedge their trades. That caused them to lowball their buy offers and overprice their sell orders to ensure they didn’t take on too much risk. This sent ETF market values tumbling and caused disruptions in the trading of other assets…’ The disruption in trading of other assets is really concerning. And whatever happened to all that much-advertised liquidity? It seemed to disappear quicker than a wisp of fog…”
- 9.
See US Securities & Exchange Commission (2015) which stated in part: “The data shows many ETPs along with their underlying assets are illiquid….In many respects, ETPs today resemble the over-leveraged risks that have created the past significant financial crises….Just since the May 2010 Flash Crash when 27% of the 838 ETPs existing at that time imploded in price or became unhinged from their underlying securities pricing, the number of registered U.S. Exchange Traded Products (ETPs) has nearly doubled from 838 to 1663 as of December 31, 2014, which includes Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs). Adding new ETPs that are mostly illiquid appears to have no benefit to the marketplace or investors. Moreover, using the same blue chip securities underlying many important ETFs for additional illiquid ETF products appears to only increase systemic risk to the very same ETFs and their underlying securities. As of December 31, 2014, there were more than three hundred ETPs based on U.S. large capitalization stocks. Of these, 85% have an average daily volume less than one million shares. In other words, most of these products are relatively illiquid and the newest do not appear to be filling a product void/desire-to-trade and thus questions arise if the new products are ‘necessary or appropriate’…”
See US Securities & Exchange Commission (2015) which stated in part: “We examined thirty-one new State Street ETFs approved for trading since September 2012. They are all potentially illiquid in price and execution quality. Of the thirty-one State Street ETFs, the top two have an average daily volume of one-hundred-and-eight and forty-three thousand shares (respectively) and the other twenty-nine trade less than ten thousand shares each day. Table-1 shows seventeen example ETFs based on U.S. equities that were launched in 2014. Each of these seventeen ETFs are based on total market or large capitalization stocks; i.e. they contain the same blue chip stocks that are already underlying the largest and most significant ETFs. These seventeen new ETFs in 2014 are illiquid, trading seventy-five thousand shares or less on average each day over the prior three months ending December 31, 2014…”
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Nwogugu, M.I.C. (2018). Implications for Decision Theory, Enforcement, Financial Stability and Systemic Risk. In: Indices, Index Funds And ETFs. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-44701-2_13
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