ETFs to overcome fragmentation and boost liquidity
There are 51 providers of ETFs in Europe, with their products available on 25 different exchanges. There are primary listings but also numerous secondary listings. For example, there are 288 ETFs that have a primary listing in France, while a further 1,278 can be traded on the Paris Bourse.As indicated by Deborah Fuhr, co-founder and Managing Partner at ETFGI – a leading research and consulting firm on global ETF trends – this mixture represents part of the challenge for trading ETFs.
It can be a lot of effort for a broker or agency lender to search across exchanges to gather a full measure of any ETF’s availability throughout Europe. This fragmentation explains the larger spreads on directional trades of ETFs relative to the US, plus the higher failure rates.
And so, an internationally settled ETF was devised three years ago by Euroclear in conjunction with several leading parties in this field, to overcome the challenge of localism in trading ETFs in Europe. State Street was one of the pioneers in this sphere, transferring 13 of its iTraxx French-listed products to an international listing in Dublin.
Opening up the market
At the Euroclear/Citi iETF conference last month in London, Mark Harris, Vice President-ETF Capital Markets, SPDR, noted it had been a no-brainer to give the market makers this new kind of structure because it fitted what they wanted and the positive effects worked their way downstream.
Matthew James, Prime Brokerage Product Development at Barclays, summed it up succinctly: “This structure will bring more prime brokers, which brings more market makers, which brings prices down. It’s all about critical mass.”
Sander van Nugteren, Director, Capital Markets at iShares, which has launched all new ETFs in Europe since March 2015 in the international structure, confirmed that for both new and transferred ETFs, spreads have either come down or at least stayed the same. He also cautioned a number of factors come into play when looking at spreads.
Van Nugteren warned, however, that more data on international ETFs were necessary to reassure more parties. He noted the importance of securities lending in the ETF ecosystem and how the improved structure of the international ETFs would help the development of that market.
At the end of 2015 there were 90 international ETFs. Mo M’Rabti, Deputy Head of International Capital Markets, Euroclear, told the conference that there would be 200 internationally settled ETFs up and running by the end of 2017.
According to brokers, however, it is not merely a quantity of listings. A Delta One trader on the panel said that the desire for more data and lower spreads would be satisfied when ETFs with greater average turnover were listed in the new structure. He was positive that this would happen and the next stage of information-sharing would take place.
Regarding the appetite for more trading, those involved in the first internationally settled ETFs explained that the more heavily traded ETFs had not been chosen as a precaution in case there were teething difficulties. Ciaran Fitzpatrick at State Street in Dublin, the transfer agency of the first internationally settled ETF, said that it had taken three years’ hard work to realise this project. He then added that the benefits were huge. “This structure can work all over the world. If we have ETFs in Asia settled internationally, that means an extra nine hours’ settling every day. That makes life much easier for my operations team every morning.”
Harris said that education across the whole ETF industry was key to success. He warned other issuers to be prepared for a long effort and lots of discussion. “I did not know so many entities existed. We are grateful to Euroclear who helped facilitate a lot of the conversations.”
Van Nugteren’s advice to other issuers was to make sure that the ETF prospectus was broad enough. iShares had encountered some regulatory concerns regarding beneficial owners, “but most investors are not beneficial owners.” There was also a question as to how the structure impinged on domestic Irish investors. He concluded that the law firms selected had to be familiar with these issues, including the nature of the international central securities depository itself.
Realising the European ETF goal
All panellists were confident that international ETFs’ total market share by assets under management and trading activity will
grow vigorously. According to van Nugteren, one remaining obstacle in Europe is connecting the two big outstanding markets of Italy and Switzerland to the new structure. M’Rabti highlighted that Euroclear is focused on helping the industry realise the mutually beneficial goals the international ETF structure can bring. His aim is to deliver more to the market. More cost efficiency as the international structure becomes a cornerstone of the industry. More liquidity with the growth of ETF securities lending and their use in collateral management.