In the US exchange-traded funds are sold in just one currency, are governed by one set of national regulations and do not have to be listed on multiple exchanges. The situation is very different in Europe where the same ETF can be listed on unconnected national exchanges, in different currencies and have to meet different national regulations. As a result ETF liquidity is fragmented, but it is also hidden as most institutional trading in the region is off-exchange.
Tim Huver, ETF product manager at Vanguard in London, told Markets Media that in the US ETF volumes are 30% of cash equity volumes. “In Europe that is 9% but that figure is seriously understated as most over-the-counter volumes are not reported,” he added.
When the European Markets in Financial Instruments Directive became effective in November 2007 it introduced reporting standards for cash equities to increase transparency and competition, but excluded ETFs. This has been remedied by the proposed MiFID II regulations, which are due to go live at the beginning of 2017. Bats Chi-X Europe, the pan-European exchange, has estimated that between 70% and 80% of ETFs listed in Europe are traded over-the-counter each day.
Grant Davies, director, client execution sales team at BlackRock, said in May at the Markets Media European Trading Network: “Visible liquidity is important and that is not provided in Europe. MiFID II, we hope, will introduce mandatory reporting which will show the additional two-thirds which is currently OTC.”
Keshava Shastry, head of ETP capital markets at Deutsche Asset & Wealth Management, told Markets Media that the asset manager would like investors to be able to assess liquidity in Europe more easily. “We are encouraging regulators, but in the meantime working with brokers and exchanges to voluntarily begin reporting and increasing visibility before the regulations are introduced,” he added.
Shastry said listings in various currencies makes it challenging to consolidate trading volumes for the same ETF. He would like to see single order book and a consolidated tape to make liquidity more visible. He added: “Initiatives such as Bats’ trade reporting, enhancements in market structure, MiFID II and T2S should all help make the market ecosystem more efficient.”
Last October BATS Chi-X Europe launched a service for European ETFs using its BXTR trade reporting platform, to allow participants to report all their ETF trades centrally, rather than to multiple national exchanges or trade data monitors. Shastry welcomed the initiative from Bats, but said it will be more helpful once reporting becomes a requirement. "Even if the door is open, people still have to walk through it,” he added.
T2S, or Target2-Securities, is a project led by the European Central Bank to enable centralised delivery-versus-payment settlement in central bank funds across all securities markets in the region. The first phase went live last month and more CSDs are slated to join over the next two years.
In the ETF market Euroclear Bank, the international central securities depositary, has pioneered an international structure which allows settlement through one central securities depositary. “The pan-European ETF structure decreases the time delay of settling through different CSDs and could lead to decreased costs of trading. It is a relatively new solution so further analysis is needed to assess the full benefits and involvement by wider exchanges/clearing members,” said Shastry.
To help the buy side find liquidity, Bloomberg Tradebook Europe launched its Single counterparty ETF RFQ product last October. The service allows fund managers to send a request-for-quote for large ETF blocks which is then distributed anonymously to several specialist market makers. Lisa Packham, Head of Product Management EMEA at Bloomberg Tradebook Europe Ltd, said that where there is no obligation to print, the agency broker encourages the market-makers to report and is making plans to be able to report all their trades to BTRX.
“Delta One desks at many banks are being eroded as capital constraints have forced them to take on less risk, so this function is shifting flow further to the European market makers,” added Packham.
Bloomberg’s multi-broker ETF platform also allows asset managers who already have many bank relationships to send an electronic request-for-quote to brokers of their choice.
Packham said: “The final MiFID II rules have yet to be finalised but there may be scope to develop new ETF data products once post-trade reporting is obligatory. As the market becomes more transparent it should attract more volumes from end investors.”
Vanguard's Huver warned that if even the European ETF market becomes more transparent, the issue of fragmentation will remain. “Each ETF is listed two and a half times due to the number of local exchanges, and home bias is likely to remain,” he said.
He also warned that average daily volume is not the only measure that should be used in assessing liquidity. Other factors include the depth of the order book and liquidity of the underlying. Huver said: “There are many trades that are multiples of the average daily volume that get better prices than on an exchange.”
Shastry of Deutsche Asset & Wealth Management said issuers’ capital markets teams will remain important due to the growth of the European industry and through initiatives such as analyzing suitable wrappers for clients, execution costs, finding inventory to reduce cost of execution, securities lending and launching derivatives on ETFs.
Shastry said that in the past his capital markets team has helped clients to reduce costs by between 30 and 40 basis points, which is significant in a low-rate environment. Huver agreed that capital markets teams will have a continuing role to play, even after MiFID II.
“We are looking at different methods of clearing and settling as we grow and increase our distribution and range of listings,” added Huver. “Developments such as T2S and using ETFs in securities lending are a focus for the industry and should help prioritise ETFs further.”
In the first six months of 2015, $40 billion of net new assets was gathered by ETFs/ETPs listed in Europe, breaking the previous first-half record of $32 billion from 2014, according to consultancy ETFGI. Total assets in European ETFs/ETPs totaled $499 billion at mid-year.
Davies said that in the past year BlackRock has seen more than $10bn move from futures into ETFs and he expects continued flows into smart beta strategies. “For the first time the lion’s share of our flows have been into fixed income ETFs and we expect that to continue,” added Davies.
Featured image via tostphoto/Dollar Photo Club