A fall in volatility and increased competition have made the trading of exchange-traded funds cheaper in Europe than in the US over the past four quarters according to agency broker ITG.
Data from ITG showed that ETFs in the US were generally cheaper to trade in 2014 but costs have been lower in Europe since the third quarter of last year. The analysis used the ITG Peer Group Database, which contains order-level information from approximately 180 buyside institutions.
Simon Barriball, head of ETP Trading Europe at ITG, told Markets Media that the difference in costs is due to the majority of US ETFs being traded on an exchange while the majority, possibly between 50% and 70%, of European ETFs are traded over-the-counter.
“When volatility is low OTC prices are risk-adjusted,” added Barriball. “The European ETF market has also become more competitive so margins have been squeezed.”
For example, competition has increased as US issuers have entered the market or purchased European firms. US-based WisdomTree acquired Boost ETP and establishing WisdomTree Europe while US private equity firm Warburg Pincus bought a majority stake in Source, another European ETF issuer.
Barriball said MiFID II, the new regulations covering financial markets in the European Union from 2018, will help move some European ETF trading onto exchanges. MiFID II will introduce mandatory ETF reporting and increased transparency should help make liquidity more visible to investors.
“Innovation is just as important as MiFID II,” added Barriball. “Euroclear’s international ETF settlement structure makes it much easier to move line items.”
ITG found that the realized cost of trading an ETF in Europe has significantly wider outcome distribution than in the US where the range of costs is much tighter.
In Europe the same ETF can be listed on a number of national stock exchanges and settled locally in the national central securities depository of the exchange where the trade is executed. At the end of the third quarter of this year, the European ETF/ETP industry had 2,219 ETFs/ETPs, with 6,953 listings from 56 providers listed on 25 exchanges in 21 countries according to ETFGI, the independent research and consultancy firm.
Market participants need to have accounts with multiple national central securities depositories in order to move ETFs between countries, reconcile their positions and to follow different post-trade market practices in different markets. There is an increased potential for settlement failures, fines, counterparty compensation claims and ETF buy-ins to avoid settlement fails which adds to trading costs.
In order to reduce ETF trading costs, Euroclear Bank, the Brussels-based international central securities depositary pioneered an international structure to make it cheaper and easier to trade the same ETF across borders i.e buy an ETF listed on one national exchange and sells it on a different country’s exchange.
For example, In June this year Fullgoal Asset Management, the Hong Kong based fund manager, issued an ETF using the international issuance structure. The ETF was listed and traded in renminbi, US dollars and euros on the London Stock Exchange.
Barriball continued: “ETFs settled through Euroclear can also be used for securities lending. Currently less than 5% of ETFs are used for lending in Europe compared to between 25% and 30% in the US.”
He added that it will take time for on-exchange ETF trading to grow in Europe as this will need the growth of a retail market, such as in the US and Asia, as well as the development of exchange trading facilities, request-for-quote offerings and specialist broker liquidity tools.
ETFs/ETPs listed in Europe reached a new record of $567bn in assets under management at the end of the third quarter of this year. Net flows of $2.98bn in September marked the 25th consecutive month of net inflows, according to preliminary data from ETFGI’s September 2016 global ETF and ETP industry insights report.
“Europe is just at the start of an acceleration in ETF assets under management,” added Barriball. “The lack of on-exchange trading has held back growth and there is a lot more to come.”
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