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Earlier this week, Paul Amery, editor of IndexUniverse.eu, spoke to Keshava Shastry, head of markets at iShares Europe, about various aspects of the ETF secondary market, including the impact of exchange proliferation, the development of the market for ETF lending and what can be done to increase the secondary market’s liquidity and transparency for investors.
IU.eu: Keshava, ETF issuers don’t actually trade in the secondary market, so what does the markets team at iShares do?
Shastry: We are a central hub between the end-clients who hold our assets and the brokers and market makers who interact with the fund to create and redeem ETFs. As you know, an investor cannot come straight to us to buy an ETF – they have to go through an intermediary broker or market maker and often via an exchange, platform or MTF (multilateral trading facility) – and so we look after the intermediaries.
For example, we can recommend a broker to the end-investor for trading in a particular ETF, we work with the iShares sales team to educate investors on secondary market trading in ETFs, we provide a number of analytical reports that are relevant to trade execution, and we offer pre-trade analysis to clients, often comparing ETFs to other delta-one products such as swaps or futures.
We work actively with the exchanges and MTFs to enhance the secondary market trading structure and with a number of the new platforms for retail investor trading to increase the visibility of iShares and ETFs in general.
We also operate a free inter-dealer broker service to market intermediaries, helping them to match off demand and supply and save creation and redemption costs – something that should lead to savings for the end-investor as well.
IU.eu: Why does so much European ETF trading take place away from the official exchanges and what can be done to improve the visibility of this activity?
Shastry: The volumes of ETF trading conducted on-exchange are growing year-on-year but liquidity is still fragmented in Europe; there are many exchanges and MTFs, for example, and many different currency lines, so clients don’t receive a single consolidated view. When end-investors look at the average daily volume figures on a particular exchange they often then decide to ask for an over-the-counter (OTC) price for their large-sized trades, since they think that there isn’t sufficient liquidity to execute their transaction in one venue. Such OTC trades are often “invisible” since neither the investor nor the dealer cares particularly if they are reported publicly.
However, OTC flows could be made visible if brokers were willing to report their trading activity to regulated trade reporting venues. Some of these venues are affiliated to the traditional exchanges – the London stock exchange has one, for example – but there are also specialised OTC printing facilities like Markit BOAT. Trades reported at these venues are anonymous but they can then become visible to the public through information vendors like Bloomberg or Reuters.
In fact, many brokers are already reporting OTC trades in this way and we are working with the exchanges and regulators to improve post-trade transparency in the ETF market. As you may know, post-trade reporting of ETFs was not made compulsory in the first MiFID directive, which came into effect in late 2007, but we are hoping that this will change in the next version of MiFID, which is due to come into force next year.
It would help buy-side clients if they were to insist that brokers print their OTC ETF trades. As more trade printing happens, more confidence builds in the liquidity of a particular product. Liquidity begets liquidity, in that sense.
IU.eu: But will more trading move on-exchange as well?
Shastry: On-exchange trading volumes are increasing. They did last year, for example, even though index levels and markets went down. We think that there will be a tipping point when there will be enough average daily volume on the exchanges for larger end-investors to move there. There are clear benefits to trading on-exchange; for example, you have a central counterparty in an environment where people are still worried about counterparty risk. There’s also a larger overall pool of liquidity with tighter spreads and perhaps a deeper book. In fact, we’re seeing a big increase in demand from our clients for cross trades on-exchange rather than trading OTC. Many brokers are receptive to this idea too, and we feel that over the next 18 months we’ll see a significant increase in exchange-based ETF trading volumes in Europe.
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