Exchange-traded fund issuers have welcomed the initiative to make it easier to pledge ETFs as collateral as it will allow market makers to use their balance sheets more efficiently and pass cost savings onto end clients.
Markit has compiled collateral schedules, which can be used by tri-party agents, by applying quantitative criteria to assess ETFs on a fund-by-fund basis. The financial information provider estimated that in Europe less than 5% of ETFs available for lending are currently on loan, compared to four times this amount in the US over the last five years.
Andrew Jamieson, global head of broker dealer relationships for iShares, BlackRock’s ETF business, told Markets Media: “The opportunity to use ETFs as collateral may be greater in Europe than in the US as there is a broader institutional customer base and an increasing sophistication in how they use ETFs.”
The equity ETFs on the new collateral schedules represent approximately $480bn in assets under management from 61 funds and 17 issuers. The fixed income ETFs represent $35bn in assets under management from 22 funds and 7 issuers.
These initial lists are expected to evolve to include a broader universe as their use becomes more widespread.
Keshava Shastry, head of ETP capital markets at Deutsche Asset & Wealth Management, told Markets Media: “They could expand the domicile to other markets such as Asia, to other asset classes or to meet different users criteria for collateral.”
Shastry said being able to post ETFs as collateral will reduce balance sheet pressure for market makers and brokers as their inventory can be used for other purposes. He added: “This could lower fees charged for balance sheet usage and make them more supportive of owning and seeding ETFs.”
Jamieson said fixed income investors have increasingly been using ETFs for the first time as they can offer greater transparency and liquidity than the underlying market. “One of their key criteria in expressing macro views is the ability to go short as well as long and hence the need to borrow ETFs,” he added.
ETFs are also increasingly being used instead of futures by both equity and fixed income investors and so the ability to pledge as collateral will increase.
“The use of ETFs as collateral could accelerate the growth of assets under management for ETFs as investors do more and more deals in larger size to replace their futures positions,” added Jamieson. “Lenders would also gain an additional revenue stream and with assets moving more quickly around the system, market makers can perform more efficiently and pass these cost savings onto the end customers.”
Tim Huver, ETF product manager at Vanguard in London, said clients did not bring up the topic of using ETFs as collateral. However he agreed that the increased ability to borrow ETFs will enhance the ability of market makers to manage their inventory and promote liquidity.
Huver warned that securities lending is not a panacea to overcoming the perceptions of the lack of liquidity in the European ETF market.
“Lending is one more move to help promote liquidity in a fragmented European market alongside central settlement and increased transparency from reporting of OTC volume under MiFID II,” Huver 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.
Last year BATS Chi-X Europe launched a voluntary service for reporting European ETF volumes using its BXTR platform, rather than having to report trades to multiple national exchanges or trade data monitors.
Shastry said: “In Europe there will be an evolution in the post-trade environment for ETFs with MiFID II reporting requirements also increasing visible liquidity. As all the moving parts come together, the ETF market will grow further and attract more market participants.”
