Written by: Jeff McCarthy | CEO, Exchange Traded Funds, BNY Mellon Asset Servicing
Newton’s first law of motion says an object will remain static or move at the same speed if the forces acting on it remain in balance. Inflows have grown steadily for several years, but a quick assessment of the forces acting on the European exchange-traded fund (ETF) market suggests a marked acceleration over the next 12-18 months. Market structure barriers will reduce, cost and performance pressures on fund manufacturers and distributors will intensify, and awareness of ETFs’ advantages among advisors will increase, driving up demand significantly. No wonder FundForum 2017 is dedicating four sessions to ‘ETF and alpha reinterpreted’ on its opening morning.
Today, the European ETF market stands at around US$620 billion AUM, less than a quarter of the US market (US$2.8 trillion) , where equity ETFs alone have drawn more than US$1 trillion AUM from actively-managed funds in the decade to 2016 . This is a substantially bigger gap than can be explained by the US’s seven-year head start by the time the first European ETF was launched in 2000.
While the appeal of ETFs to investors is universal – low-cost, low-risk, but diverse and flexible passive investment vehicles – cultural and structural factors have slowed their take-up in Europe. From 2018, MiFID II will remove a major barrier by all-but-eliminating commissions from fund manufacturers, thus encouraging distributors and advisors to recommend funds on merit rather than other incentives.
Extending to other EU member states the key principles established in the UK’s 2012 Retail Distribution Review, MiFID II is part of a wider move toward greater transparency in retail investment that is already well-entrenched in the US. Driven partly by the need to regain popular trust post-crisis, the long-term shift from commissions to fee-based financial advice will continue to gather momentum, independent of specific measures such as the Department of Labor’s planned Fiduciary Rule.
This shift obliges advisors to be highly cost-conscious in proposing financial planning solutions to retail investors and has been a key factor in ETFs’ US surge. Under MiFID II, the restrictions on commissions will stimulate the market for independent financial advice in Europe and the awareness among advisors and investors of the strengths of ETFs. This education process will be reinforced as more US firms enter the European market and step up their presence in the region.
While MiFID II is a significant step toward a single European market for financial services, industry initiatives are still required to make market harmonisation meaningful for end-investors. Another factor that has stymied ETFs in Europe has been the need for them to be listed and therefore cleared and settled nationally, thus hiking costs, limiting flexibility and fragmenting liquidity. But innovations can help, such as international central securities depository Euroclear’s ETF settlement service, which effectively collapses the transaction chain, enabling issuers to create single pools of liquidity. Because the underlying securities in an ‘international ETF’ are held centrally, managers have the visibility to manage liquidity more cost-effectively.
Europe will of course continue to differ from the US. European investors have not yet embraced actively managed ETFs, showing a distinct preference for smart beta products. Nevertheless, the potential is almost tangible. BlackRock has predicted that European ETF AUM will reach US$1 trillion by end-2020. That’s going to require faster rate of growth than the 11% achieved in the 12 months to December 2016, but the forces acting on the market are already in motion.
Chief Executive Officer, Exchange Traded Funds
BNY Mellon Asset Servicing
Jeff McCarthy, the Chief Executive Officer of Exchange Traded Funds for BNY Mellon is responsible for leading and executing the long-term strategy to drive growth in BNY Mellon's ETF business. As part of this mandate, he plays a critical role in the successful enterprise-wide delivery of comprehensive ETF solutions to the marketplace, and works to further develop long-lasting partnerships for BNY Mellon in the ETF industry.