CROWDED HOUSE.
Europe’s exchange-traded fund (ETF) landscape has certainly become more crowded following BATS Chi-X Europe’s launch of a new pan-European platform late last year. Can the market stomach another and what’s the prognosis for 2014? Roger Aitken reports.
Opaque and illiquid. That’s how some have described the European ETF market. However, things are changing and there are high hopes for 2014. The evolution though is likely to differ from the US where it all began in 1993 largely for the retail segment.
Essentially ETFs are a hybrid blending the investment characteristics of an index mutual fund with the trading characteristics of equities. Today one of the most frequently traded in the US is State Street’s SPDR S&P 500, which has seen over 100m shares traded daily. Between 2001 and 2012 the number of ETFs listed in the country increased from 102 to 1,194 with total net assets of more than $1.3trn and 36 product providers as of November 2012.
Highly fragmented market
Europe has some way to go before it catches up. It is far more fragmented, with some 24 stock exchanges listing ETF products versus three for the US. Between them the London Stock Exchange Group, Deutsche Börse and NYSE Euronext account for over 80% of on-exchange ETF trading, and one might rightly ask if any more entrants can be absorbed.
This is particularly so if one considers that around 70% of ETF trading in the region is transacted over-the-counter (OTC) according to industry estimates and confirmed by data from Deutsche Börse’s Cascade OTC platform operated by Clearstream.
Wallace Wormley, managing director, OSPARA Ltd, a wealth management advisory firm, says: “With so much fragmentation already in the European exchanges space and platforms that handle ETFs, it is difficult to expect this type of growth to continue. More likely to happen is consolidation, with M&A activity occurring amongst existing players as well as new entrants from Asia and the Americas looking to muscle into the business.”
On the ETF provider front, Europe had 41 players as at the end of November 2013 according to a Deutsche Bank ETF market review published at the end of the year. The trend is up over 2012, with five new entrants. However, FinEx Fund Plc, the highest ranked of the new crop had assets under management (AUM) of E34m and is dwarfed by BlackRock, the top ranked ETF provider in Europe, with 263 ETF products and E145,538m AUM. This represents a 22% increase since the end of 2012 and it accounts for 48% of the entire European market, totalling E303,061m which is up 8% from end 2012. The firm’s acquisition of Credit Suisse’s ETF business has helped i-Shares (BlackRock owned) capture more market share and it accounts for about 75% of all physical ETF-only assets.
Deutsche Bank ranked second with E37,632m (12.41% share) followed by Lyxor Asset Management with E31,905m (10.52%). Of other notable players, Vanguard, a leader in the US, has put extra efforts into Europe. Ranked fifteenth and offering nine ETFs, it has seen a stellar 1133% AUM rise to E2,594m from E210m a year earlier. UBS in seventh place saw a 16% rise in AUM to E10,758m across 114 ETFs. State Street Global Advisers, another top US provider, ranked ninth in Europe, saw a 93% jump in AUM to E6,140m inside one year.
Physical versus synthetic
Deborah Fuhr, managing partner at ETFGI, an independent research and consultancy to the global ETF and exchange traded product (ETP) industry, notes in terms of the European landscape there has been an increasing preference for physical replication of late.
“Ever since the bankruptcy of Lehman Brothers we have seen clients display a preference for ETFs that hold underlying securities as opposed to those that use synthetic replication. This is not related to concerns over counterparty issuer risk, but quite often due to the fact that it is easier and simpler to understand. Some players also do not like derivatives.” An example could be a FTSE 100 ETF that buys stocks in the index rather than something synthetic that might hold Eurozone securities and a swap.
Fuhr adds, “Over the past year Lyxor and Deutsche Bank moved their [ETF] business from being in their investment bank to being in their asset management arms. They also started to offer physical products. In Lyxor’s case they converted some products and launched a few new physicals. Deutsche Bank were initially launching some physical products based on the same benchmarks as their synthetic, but more recently have been converting some synthetic products to physical.”
Highlighting the trend BlackRock has almost 100% of its European ETF product (254 ETFs) in physical replication and five in synthetic form as at the end of November 2013, while the split for UBS was 75% physical / 25% synthetic and Vanguard’s nine products were entirely physical.
“We have also seen generally that firms are putting a greater focus on Europe and additionally dedicating resources to the region,” notes Fuhr. UBS, for example, has expanded significantly and adjusted fees downwards to their offering. “Previously it [UBS] had an institutional share class that was lower in price than their retail offering, but now the fee has been aligned such that they are all at the lower fee.” The bank has also expanded its market team and has a consortia model whereby they are partnering with firms like Legal & General, PIMCO and Nomura to bring products to the market.
Adriano Pace, Tradeweb’s director of equity derivatives and product manager for the firm’s multi-dealer European-listed ETF platform, commenting on OTC versus on-exchange ETF trading says: “The nature of the European market means that there is clearly a role for both on-exchange and OTC trading. The OTC market allows market participants to execute very large and significant orders – without any market impact or slippage – however, there were some limitations trading larger orders via voice or chat.”
To address the issue of facilitating larger-size ETF trades, Tradeweb launched a multi-dealer European-listed ETF platform in October 2012. Pace explains: “We built the platform directly in response to some of our biggest asset manager clients in Europe telling us that there was a fundamental gap in the market for trading ETFs.”
He adds: “Smaller trades were happening on exchange while many of the bigger trades had to be executed OTC. There was no structured way to ask for prices or indeed to get multiple dealers to compete with each other for pricing. And there was no easy way to record that auction process in a way that would be compliant with what the regulators want to see, and which would provide a fuller picture of the depth of the market.”
Starting out with eleven dealers, Tradeweb today has eighteen dealers signed up – including some of the biggest global investment banks – who benefit from the platform’s functionality and heightened efficiencies. This includes aspects such as integrated trade processing, direction locking and identifier matching to reduce the risk of trading errors.
Stephan Kraus, responsible for the development of the XTF-segment at Deutsche Börse, comments: “Although bilateral trading certainly has its value when trading large blocks of shares, most investors will find the continuously growing on-exchange liquidity in ETFs nowadays ample enough to conveniently execute even larger-sized orders with next to zero market impact.”
He argues: “Taking the on-exchange path is therefore not only more transparent, but often proves to be more efficient when considering all costs involved in the decision making and order execution process. This is particularly true when counterparty risk is of concern to investors, given that on-exchange ETF trades are cleared by a central counterparty, thus effectively mitigating counterparty risk.”
Fuhr contends that a lot of “positive winds” are pushing the ETF market along and Europe should prosper going forward – barring a major disaster. She believes too that the introduction in the UK of the Retail Distribution Review (RDR), new rules introduced in January 2013 by the UK’s Financial Conduct Authority, should help boost ETF interest among retail investors as independent financial advisers have to review the whole market for products. Equally an upcoming version of RDR in the Netherlands should do no harm either.
That said, stopping European investors buying ETFs in the US where larger volumes can be sourced may be more challenging. As will addressing post-trade issues in Europe and resulting higher costs associated from investors buying the same ETFs on the same exchange but choosing to settle in different venues.
©Best Execution 2014
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