|
Features
|
Written by Paul Amery
- June 09, 2009 09:38 AM
|
Related ETFs:
LQD
|
|
Page 2 of 3
When Is Best To Trade?
An ETF’s liquidity is in many cases directly related to that of the underlying asset market. As a result, it often makes the most sense to place orders for the ETF itself when the underlying market is open for trading.
For example, Asian stock exchanges shut early in the morning in European time, but it’s still better to place a trade in a Hong Kong equity ETF at 09.30 CET, when the market has just closed, than later in the European day, said Hodenius of Flow Traders. US equity ETFs are clearly likely to be better priced in European trading after US exchanges open at 15.30 CET. And in some commodity markets, exchanges have odd hours on a European clock – Chicago wheat futures, for example, are open until 13.00 CET, then close until 16.30, then reopen with the best liquidity of the day.
ETFs still trade outside the opening times of the underlying asset markets, but for market makers, pricing them ETFs may be more of an art than a science. Often, there may be “offshore” markets, such as those for ADRs and GDRs, to help establish trading levels in the underlying equities when home markets are shut. Otherwise, proprietary correlation models can be used to work out what a fund’s price should be. Market makers are cagy about revealing precisely how they do this, as it goes to the heart of how they operate. Other things being equal, though, buying or selling an ETF that’s priced in this way will be subject to slightly higher bid-offer spreads.
Where To Trade?
According to the market-making firms IndexUniverse.com spoke to, 50-70% of European ETF trading still takes place off-exchange or over-the-counter (“OTC”). Institutions wishing to trade in ETFs can therefore survey the prices quoted on different European exchanges and the new multilateral trading facilities (“MTFs”), as well as calling the market makers directly, before choosing the best option.
Retail investors in ETFs are much more constrained, since they typically have no choice other than to buy or sell their locally listed funds, which may mean that they do not necessarily achieve “best execution” from a Europe-wide perspective.
Bart Lijnse, managing director at Dutch trading firm Nyenburgh, explained that market makers’ obligation to maintain screen quotes across different European exchanges necessarily tends to fragment liquidity, and the recent appearance of trading venues like Turquoise and Chi-X has added to the process of dispersion. Lijnse added that, from his firm’s experience, trading liquidity tends to converge to an ETF’s primary listing location.
Market makers had varying opinions about the ideal business plan for issuers, which have historically tried to cross-list popular funds across the region and on several exchanges. Source ETF, by contrast, has broken with the traditional cross-listing model in an attempt to concentrate trading liquidity in one venue, on the German exchange. One trader said he saw Source’s move as a way of testing the water with its funds, to be followed by further listings in due course, but another said he saw merit in the new issuer’s strategy.
While further consolidation of European exchanges might help in reducing the number of trading venues, John Keogh, managing director at Susquehanna in Dublin, expressed a view that the creation of a single European depositary was more important, since the existence of multiple settlement systems makes it difficult for a trading firm to net off positions created in different markets in the same ETF. This is important, because if a market maker cannot automatically match a long position in an ETF in one European settlement system with a short position in another, the trader’s capital limits will be taken up and the prices he quotes will inevitably be less competitive.
However, on the same subject, Nyenburgh’s Lijnse pointed out that there is already an EU initiative in place to harmonise settlement systems across the region, called Target 2 Securities, but few people he had spoken to expected the project to result in substantive change by the initial target date of 2012, he added.
Laurent Kssis, head of ETF sales trading at Labranche Structured Products in London, argued that European ETF market liquidity trends are the opposite of those in the US. In the US, he said, most secondary market ETF quotes are retail investor-driven. The limit orders that US retail investors typically place with broking firms create transparency and a significant depth to liquidity, Kssis explained, and the existence of rules such as the SEC’s Regulation NMS also ensures that OTC orders are reported on-exchange. In Europe, by contrast, secondary market trading activities are much less transparent, and market makers have so far proved reluctant to pay exchanges to report the trades they conduct elsewhere.
|
Latest comments on this feature
|
|
RSS
