May 5, 2015 / 4:38 PM / 3 years ago

Bank of Canada cautions on ETFs, outlines liquidity proposals

MONTREAL (Reuters) - Some exchange-traded funds (ETFs) and mutual funds might face liquidity problems if a large number of investors were to run for the exits at the same time, Bank of Canada Senior Deputy Governor Carolyn Wilkins warned on Tuesday.

A man walks past the Bank of Canada office in Ottawa March 4, 2015. REUTERS/Chris Wattie

She raised the red flag cautiously in a speech in which she outlined central bank proposals to insure markets remain sufficiently liquid under strained conditions. “Should another major bout of liquidity turmoil arise, we will be ready,” she promised.

Wilkins also said regulatory reforms and other initiatives such as central bank bond-buying programs might be unintentionally reducing liquidity in secondary bond markets.

And she said a risk worth watching is whether funds such as mutual funds and some ETFs, which investors can sell on short notice, have enough liquidity.

“It’s far from clear all investors and savers appreciate the liquidity and redemption risks involved in some funds,” Wilkins said in the prepared text of a speech to a Montreal business audience. “I‘m not trying to tar all these funds with the same brush, but I would say everyone should be aware of all the risks involved in investing, including liquidity risks.”

Among changes the Bank of Canada is proposing, Wilkins listed:

- Reducing the amount of benchmark government bonds the Bank of Canada buys at government bond auctions for its balance sheet, thereby increasing the amount available to other buyers

- Making changes to the bank’s securities-lending program to assist primary dealers that need to borrow securities

- Setting up a regular program of term repo operations that will provide timely insights on liquidity conditions in short-term funding markets

- Setting up a Contingent Term Repo Facility that the bank can activate at its discretion to deal with extraordinary market-wide stress

- Agreeing to accept mortgages as collateral as a last resort for emergency loans under the bank’s Emergency Lending Assistance (ELA) program.

Wilkins emphasized ELA is used extremely rarely, noting that the bank has not activated it for 30 years. She also said that nothing about the bank’s current or future monetary policy stance should be inferred from these proposals.

Reporting by Allison Lampert in Montreal, and Randall Palmer and Leah Schnurr in Ottawa; Editing by Peter Galloway

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