Run risks of cash-redeemable ETFs

Abstract

The growing reliance on exchange-traded funds (ETFs), especially for those ETFs which can be redeemed in cash (namely, cash-redeemable ETFs) has raised concerns about their resilience to a market downturn. This study shows that abrupt redemptions of cash-redeemable ETFs are more likely to occur during a market downturn, comparing to other ETFs. In particular, a redemption shock to ETFs that have less cash buffer can lead to fire sales of the ETF assets by the ETF managers. At a large scale, the fire sales can amplify the outflows from the ETFs and the market downturn, posing potential risks to financial stability. Our results underscore potential financial vulnerability of those ETFs in Europe and emerging market economies, where cash redemption mechanism is popularly adopted by ETFs because of taxation regime or asset liquidity. Regulators should carefully scrutinise relevant policies and balance the pros and cons of this ETF redemption mechanism in terms of overall financial stability.