ETFs in fashion
The exchange-traded funds (ETFs) market and its growth prospects are increasingly fashionable as objects of attention and discussion. This reflects the underlying growth of interest in an asset class that now boasts a history stretching back a quarter century and more. The recent announcement from Euronext that it plans to launch a single trading platform for European ETFs – Euronext1 ETF Europe – adds interestingly to the mix of options available.
Forecasts by accounting and consultancy firm EY2 estimate 15% annual growth for the global ETF market. They say that by 2030 it will reach USD 4.5 trillion in assets under management (AuM) in Europe and USD 25 trillion worldwide.
Nearly 90% of fund managers who do not yet offer ETFs are considering doing so within the next three to four years, according to a survey3 from third-party management company Carne Group.
Across the spectrum
Clients placing orders for ETFs vary. The demand set includes individuals, wealth managers, family offices and institutional investors. Each of these profiles may have specific investment needs and objectives that influence their execution requirements. Regarding execution channels, there are no specific demands, but there are expectations regarding price benchmarks. Clients seek executions at competitive prices, valuing transparency and speed. Understanding the individual needs of each client and providing tailored solutions in terms of price, liquidity, and transparency is essential.
RFQ/OTC vs Exchange
According to Big-XYT4, approximately 71.21% of ETF trades in Europe are off-exchange, executed on Request for Quote (RFQ) venues, or in other over-the-counter (OTC) transactions. By contrast, in the US, most ETFs are traded on-exchange.
An RFQ is a price request used in financial markets to obtain prices for financial instruments. Investors send RFQs to market makers, such as brokers or banks, to get competitive prices for buying or selling assets. This method is common in OTC trading and has gained importance with the MiFID II directive on ETF execution. RFQs are typically executed via dedicated electronic trading platforms, which facilitate the rapid and efficient transmission of requests and responses from market makers. These electronic channels ensure quick and transparent execution, improving the efficiency of the trading process.
There are two main reasons for using this type of execution rather than going via traditional stock markets. Firstly, the direct integration into our execution systems provides greater control over the trading process, thereby enhancing efficiency and flexibility. Secondly, the direct relationship with liquidity providers (authorised participants) allows us to access real-time quotes and negotiate directly with counterparties. This is inherently advantageous for the speed and transparency of transactions.
Choice criteria
Investors choose the market for executing ETFs based on several criteria. For retail investors, accessibility through their bank or broker is crucial, as it may be limited. In contrast, institutional investors generally face fewer barriers and focus on achieving the best possible execution. The price gap between buying and selling ETFs in Europe on RFQ platforms (the spread) can be more than double the spread seen in transactions via traditional stock exchanges, a recent study by specialist trading data and analytics provider Big-XYT5 found. The difference is most significant for smaller trades (less than €500,000), and the spread variation is ETF-specific.
Several factors can limit the attractiveness of historical exchanges for ETFs. The fragmentation of the European market can create the impression that ETFs are illiquid, dispersing liquidity across different exchanges and multilateral trading facilities (MTFs). Additionally, there has historically been a lack of tools to effectively access ETFs on traditional exchanges for institutional investors, there are gaps in trading infrastructure and there are challenges related to pricing and order execution. These obstacles can deter investors from fully utilising historical exchanges for ETFs.
Accessibility, liquidity, efficiency
The barriers are not insurmountable but represent challenges to be addressed to improve accessibility, liquidity, and efficiency of ETFs. Initiatives aimed at enhancing transparency and accessibility can help overcome these obstacles and strengthen the appeal of exchanges.
From the perspective of institutional investors, we observe a shift towards more sophisticated execution methods for ETFs. Initially, this type of order was processed at net asset value (NAV). Increased confidence in the intra-day liquidity of ETFs has led to a transition toward risk transactions via RFQ, as alluded to earlier.
Expansion and innovation
The offering of specialised algorithms for ETFs has significantly expanded and continues to innovate, allowing access to the best liquidity, regardless of the execution location. These short-term developments should increase trading volumes on stock markets for institutional investors. The growing impact of specialised algorithms will increasingly merit specialist attention.
One of the main challenges in ETF trading is the lack of complete visibility into trading activity. This should be mitigated with the establishment of the Consolidated Tape, which will provide a unified view of transactions across different markets, thereby improving transparency for investors. The Consolidated Tape will help market participants interpret ETF liquidity more accurately by aggregating trading data from multiple venues. Additionally, it will provide a better pre- and post-trade benchmark, with updated information on transaction prices and volumes.
In summary
ETF trading poses challenges in terms of visibility and transparency. But these instruments offer significant advantages in terms of access to liquidity and exposure to specific markets, thus enhancing their attractiveness for investors.
View more articles by Societe Generale here.
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1Euronext considers ETF listing consolidation on Amsterdam exchange – reports – Source ETF Stream : “Euronext is considering shifting all exchange-traded products (ETPs) listed on its seven European exchanges to Amsterdam in a bid to tackle the fragmentation of its ETP listings”
2 European ETF market forecast to grow 15% annually over next 5 years, reaching $4.5trn by 2030 | EY – Ireland – Source EY : “European ETF market forecast to grow 15% annually over next 5 years, reaching $4.5trn by 2030”
3 Almost 90% of fund managers yet to offer ETFs expect to do so – Source ETF Stream : “Almost 90% of fund managers not currently offering ETFs expect to begin using the wrapper within the next three to four years, according to a survey from Carne Group, a third-party management company.”
4ETF Trading Strategies: Evolving Execution Methods in a Growing Market – Source Big-XYT : “Approximately 71.21% of ETF trades in Europe are off-exchange, executed on Request for Quote (RFQ) venues, or in other over-the-counter (OTC) transactions.”
5 Assessing ETF Liquidity: What RFQ Spreads Reveal About the European Market – Source Big-XYT : “The price gap between buying and selling ETFs in Europe on RFQ platforms (the spread) can be more than double the spread seen in transactions via traditional stock exchanges.”