Do ETFs Reflect Stock Prices—or Help Shape Them?

Beyond the “High-Risk Product” Debate

Beyond the Risk Inside the Product

In JAMP Perspective No. 326: “ETFs Create Markets,” distributed on March 29, 2026, I argued that ETFs link indices to investment capital: they are financial products, but also part of the market infrastructure through which capital is allocated and markets are shaped. Recent developments have led me to reconsider my own phrase, “ETFs create markets,” and to think about another meaning it may carry.

On August 27, Japan’s Financial Services Agency (FSA) stated that it would be inappropriate from a public-interest standpoint for Financial Instruments Business Operators and other firms in Japan to offer or otherwise handle overseas-domiciled single-stock leveraged ETFs referencing Japanese equities. At first glance, the measure can look primarily like an attempt to prevent high-risk products referencing Japanese stocks—products of a kind not permitted on domestic exchanges—from reaching Japanese investors through overseas markets.

Certainly, a single-stock leveraged ETF seeking twice the daily return of one stock involves significant risks. In addition to concentration risk in a single security, investors who hold the product for more than one day may receive a return materially different from simply twice the underlying stock’s cumulative return. Daily returns compound, and the outcome depends on the path of the stock price, volatility, and the holding period. These features require investors to understand risks that differ materially from those of conventional ETFs and raise important investor-protection concerns.

But the FSA’s published explanation placed particular emphasis on something beyond the investor’s own risk of loss: the possibility that such products could amplify fluctuations in Japanese stocks and materially affect price formation in Japan’s financial markets. The question, in other words, is not only the risk that remains “inside” the product. It is also the risk that may extend “outside” the product and into the underlying market.

When Product Rules Mechanically Generate the Next Trade

The prospectus filed with the U.S. Securities and Exchange Commission for the T-REX 2X Long Kioxia Daily Target ETF describes a strategy seeking 200% of the daily performance of Kioxia Holdings Corporation common stock listed on the Tokyo Stock Exchange, with exposure obtained through instruments including swaps and rebalanced daily.

Consider a simplified example. Suppose a 2x leveraged product has net assets of 100 and equity exposure of 200. If the underlying stock rises by 10%, net assets become 120 while the existing exposure becomes 220. To restore exposure to twice the new net asset value—240—the product must add 20 of exposure. If the stock falls by 10%, the adjustment works in the opposite direction and exposure must be reduced. Even without any new investment decision by an investor, a price movement can mechanically generate the next trade through the rules of the product. This is a form of positive feedback.

Of course, this does not necessarily mean that the ETF itself buys or sells the underlying shares directly. A swap counterparty may retain the risk on its own balance sheet, offset it against other client flows, or hedge it using the underlying shares or related derivatives. But changing the form of the exposure does not make the economic exposure disappear. It remains somewhere on a balance sheet or appears as a hedge in one market or another.

There is also a cross-market timing issue. The current prospectus identifies Kioxia shares traded on the Tokyo Stock Exchange as the reference asset while the ETF is structured for listing in the United States. Because U.S. and Tokyo cash-equity trading hours do not overlap, the market impact can differ depending on whether a counterparty carries the risk during U.S. hours, uses another asset as a proxy hedge, or adjusts the position in Tokyo on the following trading day. The gap between the time used for daily rebalancing and the trading hours of the underlying market can therefore change where, and when, the risk is expressed.

Nor should we assume that leveraged and inverse products automatically offset each other when both exist in the market. In theory, daily adjustments required to restore target exposure can cause both types of products to generate buying pressure after an increase in the underlying price and selling pressure after a decline. At that point, an ETF is no longer merely a mirror reflecting a stock price. Through its rebalancing mechanics and the actions of its manager and derivatives counterparties, an ETF can itself become a mechanism that generates trades. 

Product Type Alone Does Not Determine Market Impact

None of this means that a single product with these characteristics will necessarily distort price formation. If the product is small and the underlying stock is highly liquid, the market may absorb the flows. The outcome can also depend on market-maker and derivatives-counterparty inventories, how execution is distributed over time, and whether the flows are offset by other trading.

If the price impact is temporary and is quickly absorbed by market participants taking the other side of the trade or by arbitrage activity, it may remain within the normal process of supply-and-demand adjustment. Even among ETFs that use derivatives, daily leveraged strategies, covered-call strategies, and buffer strategies designed to limit losses within a defined range can produce very different hedging directions and concentrations in time. Product category alone therefore tells us little about the scale of potential market impact.

The harder question is who should measure and manage a product’s “market footprint”—the amount of mechanical trading it could generate in the underlying market. What matters is not the label attached to the product, but the estimated rebalancing flow implied by its net assets, target leverage, and assumed movement in the underlying asset, considered relative to trading value, free float, and order-book depth in the underlying market. The concentration of hedging entities and execution times also matters.

Product sponsors earn management fees. Exchanges and securities firms earn trading-related revenues. Derivatives counterparties are compensated for providing funding, balance-sheet capacity, and hedging. Yet the price impact created by these transactions does not appear as an explicit product expense and may affect participants in the cash market who do not own the ETF at all.

Where the product is established overseas but the hedge ultimately reaches the Japanese market, several things can become geographically separated: the place where revenues are earned and the place where externalities are felt, as well as the regulator supervising the product and the regulator responsible for the integrity of the underlying market.

How Far Should Product Governance Extend?

What follows from this is not a need to classify products as uniformly dangerous based on product characteristics alone. Rather, it suggests a need for governance proportionate to market footprint.

There is a reasonable basis for the FSA to restrict the domestic handling of overseas single-stock leveraged ETFs referencing Japanese equities. But that step alone does not eliminate demand from overseas investors or hedging by overseas counterparties. The next question may therefore be whether product review should consider not only disclosures to investors and suitability considerations at launch, but also the expected hedging channels and where risk ultimately resides, how much rebalancing demand could arise and when, and how stressed rebalancing flows would compare with the capacity of the underlying market.

It may also be necessary to monitor changes in assets and underlying-market liquidity over time. Other questions include whether limits on assets or adjustments to exposure should be considered once a product exceeds a certain market footprint, and how the necessary data and responsibilities should be connected among sponsors, counterparties, market makers, exchanges, and regulators in both the product’s home jurisdiction and the jurisdiction of the underlying asset.

From the perspective of the JAMP Group, whose ETF-related businesses include product-development and operating support provided through JAMP Fund Management, innovation should not be measured simply by the number of products brought to market. Sustainable market development requires a framework that considers the benefits of a product and the effects its design may create in the market within the same analytical framework.

Do ETFs reflect stock prices, or do they help shape them? When privately designed product mechanics such as daily rebalancing begin to influence price formation in public markets, should responsibility for product governance end at the boundary of the product itself?  As Japan’s ETF market becomes more diverse, this is a question that may become increasingly difficult to avoid.

Author: Keiichi Ohara, President & CEO, JAMP Corporation
About This Article
This article is an adapted English edition of JAMP Perspective No. 350, originally written in Japanese by Keiichi Ohara and distributed on  September 16. It has been edited and supplemented where necessary to make the discussion and its Japan-specific context clearer to readers outside Japan. It is therefore not a direct translation of the original Japanese newsletter.
This article is provided for informational purposes only and does not constitute investment advice or a recommendation regarding any financial product.