ETF insights: The capital markets view

Behind the scenes of every ETF issuer there is a capital market team taking care of an orderly functioning of the ETF market. We have interviewed Dorcas Phillips, Fidelity Investments, and Jason Xavier, Franklin Templeton Investments, on regulatory changes, opportunities and challenges in the ETF ecosystem.

How was your start into the year?

Jason Xavier: At Franklin Templeton Investments we’ve had a very busy start to our year. Macro issues, including US/China trade tensions, Brexit and the continuing rise of populism in the eurozone, continue to pressure markets globally. Additionally, investors awoke in 2018 to the realisation that synchronised quantitative easing (QE) was no longer a guaranteed fixture. As a result, those investors savvy to the underlying factors driving their returns have aggressively sought alternative weighting schemes like our smart-beta ETF offering, in anticipation of another volatile year.

Dorcas Phillips: Positive. We currently have a small range of smart-beta income products, but we have seen increased interest and understanding of our products leading to decent inflows. Our US Quality Income ETF is the second largest in Europe with assets over USD 700 million.

We are now one year into MiFID II. What impacts has the directive had? Has it improved the ETF ecosystem in your opinion?

Dorcas Phillips: Given the size and scope of our range, we have seen a limited impact on the trading behaviour of our clients. More broadly, we believe there has been significant progress in attempting to increase the transparency and reporting level of ETF trades, however, more work needs to be done.

Jason Xavier: MiFID II has shone a light on the increased transparency of European ETF trading. The directive’s post-trade reporting requirement for all secondary market activity has allowed increased visibility. In particular, it has confirmed that approximately 70% of the European ETF market is still traded over-the-counter (OTC) versus approximately 30% on a regulated exchange.

Has the directive changed this structural make-up? To date, it’s hard to tell. From our evidence we strongly believe many clients still favour request-for-quote (RFQ) platforms as a very efficient path for achieving best execution with reporting requirements. One factor to consider here is the absence of a pan-European consolidated tape to consolidate this newly visible data. In fact, there’s a certain irony in how we now have a lack of transparency of this increased transparency!

Which further developments would you like to see on a regulatory level?

Jason Xavier: From a capital markets point of view we’d like to see wider acceptance of ETFs as collateral. This would allow the development of a European ETF stock-lending market and ultimately increase secondary market liquidity.

The ETF market is becoming increasingly competitive as new players join the market. How are you planning to further attract assets under management (AUM)?

Dorcas Phillips: At Fidelity, we strive to launch differentiated products within the ETF wrapper with the aim of solving client needs. We therefore try to incorporate and position our ETFs within our broader business offering with the hope of cross-fertilising both business areas (funds and ETFs) as we position the entire business as a solutions provider.

Jason Xavier: In Europe, the ETF market is yet to break EUR 1 trillion and is less than 10% the size of European mutual fund assets. Growth and adoption rates continue to maintain strong double-digit numbers. Year-on-year, asset growth continues to trend upwards. The arrival of more entrants into the European ETF market creates more choice and ultimately better value for our end clients. More and more clients are expressing a desire for a broad spectrum of solutions at varying price points, allowing them to allocate risk across active, passive and smart-beta strategies.

Where do you see the highest potential for growth and what are the biggest challenges that lie ahead of the ETF ecosystem?

Jason Xavier: The asset management landscape continues to evolve. The democratisation and disruption that we continuingly see permeating through other industries is still in its infancy for financial services. The ETF wrapper continues to be the vehicle of choice to leverage this disruption. Indeed, ETFs are already democratising many aspects from accessibility to price discovery, and as a result offer clients a new found freedom. Opening the retail channels and platforms in certain parts of Europe will expediate this growth. Indeed, the existing archaic methods for accessing instruments while at present a barrier/challenge to growth will ultimately be the causalities of future disruption.

Dorcas Phillips: Active exchange-traded products are a significant opportunity for growth. However, developing a structure which meets the needs of market participants, issuers, regulators and clients remains a challenge.

Fragmented liquidity across Europe remains an issue. The costs associated for issuers to list across the various exchanges as well as the prices clients obtain when trading is less than optimal.

Commerzbank Disclaimer
The views expressed in this article are those of the author and may differ from the published views of Commerzbank Corporate Clients Research Department, the communication has been prepared separately of such department. No representations, guarantees or warranties are made by Commerzbank with regard to the accuracy, completeness or suitability of the data.