I know exchange-traded funds aren’t guaranteed, but I wonder if the issuer of an exchange-traded fund goes bankrupt… what would happen to our money?
Jacques Larose
One can legitimately wonder, indeed. The answer, however, is quite short.
“The assets must be held with a securities custodian, so they would not be affected in the event of bankruptcy,” succinctly asserts Jean-Philippe Tarte, lecturer at HEC Montreal.
Remember that an exchange-traded fund (ETF) is a fund whose securities are traded like shares on the stock exchange. The best known, index ETFs, reproduce a benchmark index, for example a stock market index, by holding an equivalent proportion of the securities that make up this index.
“In fact, a bit like for mutual funds, the assets of an ETF are with the securities depositary,” continues our expert. If I invest $1,000 in an ETF, that $1,000 goes into a dedicated fund with what you might call a securities custodian, in a specific account. The custodian must by law be an independent entity. »
The securities of the ETF are therefore not held by the manager or the issuer of the fund.
These assets belong to the unitholders. This means that if the company goes bankrupt, these assets are not on the company’s balance sheet and are not involved in the bankruptcy.
Jean-Philippe Tarte, lecturer at HEC Montreal
The principle also applies to large foreign asset management companies such as BlackRock.
“The laws apply in Canada as they should apply, insists the teacher. They must follow local laws. »
The real risk: fraud
Apart from a stock market crash that would affect the entire portfolio, the danger comes less from bankruptcy than from fraud, in which case the assets are outright stolen.
“Embezzlement is always possible, formulates our expert. Maybe you have seen the movie norbourg ? In this film, we see by what mechanism they managed to thwart the government surveillance agency in order to divert the assets which were precisely supposed to be held in dedicated accounts. But since then, regulatory agencies have dramatically tightened regulation and oversight, making that scenario now much less likely. »
The exception of ETNs
While ETFs are protected in the event of the issuer’s bankruptcy, “the same cannot be said for ETNs” (Exchange Traded Notes), argues Jean-Philippe Tarte.
Little known, Exchange Traded Notes – a term that could be translated as “notes traded on the stock exchange” – are issued directly by the promoter of the security, in order to reduce intermediaries and follow with a minimum of lag the index they are tracing.
PHOTO OLIVIER PONTBRIAND, LA PRESSE ARCHIVES
Jean-Philippe Tarte, lecturer at HEC Montreal
“There, we are exposed to credit risk. Because unlike the ETF, the note has no funds at the custodian. The funds go directly to the sponsor in exchange for the payment of returns corresponding to the index, which is essentially equivalent to a debt security. The holders of these securities become creditors in the event of the issuer’s bankruptcy. »
These products are more present in the United States, he explains, where they offer investors specific risk management tools at reduced cost and complexity for the issuer.
However, they are extremely rare in Canada. A few were offered on Canadian stock exchanges, but most were retired in the mid-2010s.
In this regard, Jean-Philippe Tarte recalls that if investors wish to exchange ETFs, exchange-traded notes or any other security in US currency, “it is important to do so in an account registered in this currency so as not to suffer hidden exchange fees on each transaction, as well as on dividend payments or share distributions”.