International ETFs: Transforming how we work together
The international ETF structure is a new and growing brand of Exchange-Traded Funds that settle in one place. Together we are simplifying the European ETF post-trade industry.
This should be a ‘win-win’ situation for an industry looking to:
- increase liquidity
- grow distribution opportunities
- improve transparency via the searchability of stock
Stocks that can be easily located are more readily borrowed. This is vital for ETF securities lending and will help bring down spreads for all ETF trades ultimately.
Today, over 250 ETFs in the new international structure operate on European stock exchanges. This article explains how they were created and how other ETFs can, and are, migrating to the international structure.
Many of the new ETFs were not created from scratch. The majority of those already up and running have been converted from other jurisdictions. While essential legal changes have to be made and communicated, the branding and look of these ETFs remain the same as before conversion.
Not only do they look the same but there is no disruption in buying and selling the ETF. The conversion process takes place overnight so that trading in the stock is not affected. “With three successful migrations we have enough experience to say that the entire market is convertible,” says Mohamed M’Rabti, Deputy Head, International Capital Markets, Euroclear.
An international ETF in 24 hours
Step 1 – Managing the legalities…
The first international ETF was created in 2014. The journey to 2016 has been vital for the securities industry to find a streamlined approach that works.
“In the beginning, we needed to conduct due diligence on two fronts because the
first migrations were different projects,” explains M’Rabti. The first was a merger of funds for SPDRs. Here 13 ETFs under domestic French law and another 13 under Irish law merged to form 13 international ETFs.
The second was a change of issuance structure for iShares, where the ETF transferred from domestic Irish law to international Irish law.
Both required a mandatory corporate action, which has to be done with lawyers. Then the issuers prepared the resolution and documentation for an Extraordinary General Meeting (EGM) where shareholders endorsed the corporate action.
Step 2 – Collaborating to implement
Then begins the implementation, which necessitates working with many different entities to make sure all the links in the chain are going to operate smoothly on the days in and around the weekend of the transfer.
Registrars, transfer agents and common securities depositories are the three groups crucial to the actual migration. Prior to the first migration, Euroclear hosted numerous workshops around Europe with these entities and other links in the chain to help them prepare.
Practical steps include ensuring the old registrar is informed of the change to come and the new registrar is in place. Issuance has to be marked down in the former when markets close and marked up the next day in time for market opening. Any error or omission at this stage will have a domino effect so collaboration is vital.
Wherever a migration from one jurisdiction to another occurs, the ISIN will change. If there is no jurisdictional change, then the same ISIN is retained.
This potential change matters greatly because a stock’s Sedol number is unique to each exchange it is listed on. If the ISIN number changes too, then traders must be informed.
Step 3 – Seamless trading environment
It is no use migrating a stock unless traders and market-makers are aware of what is going on.
Euroclear spent five months in preparation touring Europe to ensure that the main market-makers and stock exchanges knew the ETFs were going to migrate from domestic to international issuance. This is a category change that matters greatly to market-makers.
“Our aim with these parties is always to keep liquidity and trading levels the same on either side of the move” says M’Rabti. “We ensure the majority of the liquidity providers are in place and visibility of iETFs is high.”
This view is endorsed by major marketmakers. “The biggest impact of these transitions were purely operational,” says Jeroen Scherbeijn, Global Head of mid-office and SBL at Flow Traders in Amsterdam.
“For example, we had to make sure internal and external trading routings to our account still worked and that all positions got migrated. We also had to update our standard settlement instructions on dealings in these ICSDETFs to ensure that settlements would not be hindered” Looking back on past migrations, he reckons everything went smoothly because of intensive contact between the exchanges and Flow Traders’ clearing members.
Scherbeijn lists four advantages of international ETFs for market-makers:
- falling financing costs - lower borrowing costs, but also netted positions
- better expectations regarding corporate actions cashflows such as FX-elections
- lower risk of failing settlements and eventually lower buy-in risk because of the central depository for multiple markets
- more expected availability in the Securities-Based Lending market because the fragmentation of the ETF-holder depots is decreasing
Step 4 – Clearing the way
Other crucial links in the chain were those supporting the market-makers: prime brokers and clearers. As Scherbeijn observes, the key Central Clearing Parties had to make sure that new flows were settled to the right account of their client in Euroclear Bank, the international Central Securities Depository for international ETFs.
Education and communication played their part here. Euroclear made sure that CCPs were ready in advance, not just on the day. The prime brokers had to move their positions from the local market to Euroclear Bank to settle any stock exchange or OTC activity.
Onno Porskamp, global ETF manager at ABN Amro Clearing, says that its final preparation for a position migration generally takes off two weeks in advance, with a dedicated team of six people taking care of required conversions and depot switches the day before the actual move.
On education and communication around the international ETF, Porskamp states
that Euroclear provided all the support and information required and acted as a
perfect partner in the process.
Porskamp reckons the new international structure is also simpler than the old national vehicles and thus easier to explain to clients. The settlement process is also easier to track. Both ABN Amro and Flow Traders envisage costs for clients coming down as bid-offer spreads shrink, making Europe more like the US market: deeper and cheaper.
Are there any disadvantages to international ETFs? Porskamp reckons multiple intermediate settlements between CCPs will become redundant, which should lead to a higher number of
This could have a negative effect on the overall income of a clearer. However, he believes the introduction of the international ETF structure will also reduce the operational risk.
“When frictional costs go down, it also means the arbitrage opportunities for our clients may increase. Therefore in the end the possible negative may turn out to be a positive when looking at the overall transaction volume.”
Francois Cadario, Director, Exchanges & Infrastructures at LCH confirmed that when market participants were setting up an International ETF structure, then the clearing and settlement were STP, based upon existing infrastructures.
The future is bright
Smaller vehicles were chosen for the initial migrations so that the experiment could be handled comfortably. There was no point taking the risk of transferring a flagship product in an operation that had never been conducted before. Now, after three major migrations and a lot of shared experience, all parties are more
comfortable that these actions can occur seamlessly, without disruption to investors either side of the migratory weekend.
The potential exists for the entire market to be settled internationally, with all the attendant benefits for liquidity and cost-saving. BlackRock, the market-leader globally and in Europe, now issues all new ETFs in Europe in the international ETF structure.
M’Rabti concludes that the market is not there yet but some of Europe’s most liquid ETFs have been migrated without any problems, so the journey has begun.
Having migrated the flagship ETFs for iShares, Euroclear now has the confidence and experience to do this for every other issuer. The number of issuers is expected to double by the end of 2016.