Q&A: ETF bankruptcy

Question: What happens if ETF providers (BlackRock, Claymore, BMO, Horizon, Invesco, etc.) go bankrupt? Would it be wise to spread investments between providers? What is the maximum percentage of a portfolio that should be placed with one ETF company? In Canada we are limited by the number of companies. Most sample portfolios use only one or two companies.

Should I use more than one on-line broker to reduce a similar risk? – George T.

Gordon Pape answers: For starters, there is very little probability of an ETF distributor going bankrupt. Most are very wealthy international companies (e.g. Blackrock, Claymore, Invesco) or operated by a Canadian bank (BMO, RBC). But in the unlikely event it did happen, your assets would be safe. ETFs, like mutual funds, invest in a portfolio of securities. Those portfolios do not belong to the sponsoring company but are held in trust on behalf of the investors. If a company went belly-up, the ETFs would not form part of the corporate assets and would not be subject to creditor claims. This differentiates ETFs from stocks, which represent equity in a company and therefore could potentially lose all their value if that firm goes under.

However, there is one situation in which an ETF can go belly-up. That can happen in the case of leveraged ETFs (those that pay double or triple the return of the target index). These ETFs use derivatives provided by what are called “counter parties” to insure themselves against heavy losses. If the counter party goes under, the ETF is left exposed and could be wiped out. This actually happened to a few U.S. ETFs after Lehman Brothers, which was their counter party, collapsed in 2008.

Brokerage accounts are protected against bankruptcy by the Canadian Investor Protection Fund (CIPF). For details go to www.cipf.ca.

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