Virtu Sees Human Error Hampering Part of the ETF Market

  • Firm says human error can sneak into create-redeem function
  • Asks regulator to consider risks of popular investment product

Virtu Financial Inc., one of the world’s top electronic traders, said U.S. regulators need to stamp out the risk of human error in a key segment of the stock market.

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The mechanism for creating and turning over shares of exchange-traded funds needs more automation, Virtu told the Securities and Exchange Commission in a letter.

ETFs play an increasingly central role in U.S. stock trading. The haywire session on Aug. 24, 2015, illustrated that when problems crop up with the funds, they can roil the entire market. Since then, exchanges have tightened rules to ward off similar disruptions to the $2 trillion ETF business. The letter from Virtu, one of the biggest ETF traders, suggests more action might be needed.

Traders with the power to create and redeem shares of ETFs run up against the potential for human error in the process, Virtu said. These pitfalls are especially prevalent at the end of the trading day, as U.S. exchanges approach their 4 p.m. close and when an intermediary like Virtu must create or redeem shares of a fund in order to keep up with demand.

But because this system isn’t entirely electronic -- e-mails and phone calls can be involved -- there are unnecessary risks, Venu Palaparthi, Virtu’s senior vice-president for regulatory affairs, wrote in the letter.

“In our experience, this is an area that remains prone to error,” he wrote. “Improvements in these areas are especially important to end users because the resulting lower risk translates to narrower spreads and lower costs.”

Virtu added that the SEC should assess broader operations risks involved with ETFs, saying it’s “an area that deserves a closer look.”

“While the ETF industry has evolved and electronified immensely in the past 3-5 years, the plumbing of the industry has not kept pace with the market,” Virtu CEO Douglas Cifu said in an e-mail. “We encourage all issuers and the commission to examine the entire process of trading, creating and redeeming ETFs to ensure that we as an industry have eliminated as much risk from the system as possible."

Further ETF regulation could hang in the balance amid a looming shake-up to the SEC’s leadership ranks. Chairman Mary Jo White and Division of Trading and Markets Director Steve Luparello both plan to exit when Barack Obama leaves office in January. Meanwhile President-elect Donald Trump’s right-hand man on financial regulation, former SEC Commissioner Paul Atkins, has called for a rethink of some of the fundamental rules underlying how U.S. equities trade.

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