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April 1, 2014

Anatomy of an ETF Challenger

By Renee Caruthers

Part of the growth of the U.S. ETF market is because the share of assets invested in ETFs as compared with mutual funds has grown in the U.S. Source expects ETFs have room to gain market share in Europe and predicts overall growth of European assets under management.

In fact, Europe appears to be attracting increasing interest at the moment. Europe's ETF market saw a 20 percent jump in assets in 2013 to $395 billion, according to the Financial Times. In addition to the Warburg Pincus acquisition of Source, U.S.-based ETF provider WisdomTree plans to acquire U.K.-based Boost ETP, and Charles Schwab has admitted to having begun to explore Europe's ETF market. U.S.-based ProShares says it is looking at opportunities outside the U.S. as well.

The European market and U.S. ETF markets operate differently, with U.S. ETF flow driven more by individual investors and the European market more institutionally driven, Lytle says. European investors do significant due diligence before approving ETFs and, as a result, an issuer may have to establish a footprint in the market to attract investment from institutional investors.

 

 

STREAMLINING EUROPEAN ETF TRADING

With the European ETF market attracting increased attention, some firms are bringing technology to market that is aimed at streamlining and increasing the efficiency of European ETF trading.

For authorized participants, who are the traders who trade the underlying stocks or securities that make up ETFs, there remain parts of the trade process in Europe that are fax-based and error prone.

"As demand grows, clearly that is going to give authorized participants more flow, and they will want to execute on that flow in as streamlined and efficient a manner as possible," said Pete McHugh, head of State Street's FundConnect product for EMEA.

FundConnect, which launched in Europe this year, is a platform that uses an online interface to automate communications between fund participants and plan sponsors. While there are other automated single-sponsor platforms in the market, McHugh said FundConnect is the first multi-sponsor platform, meaning authorized participants can use the system to not only to automate communications with State Street, but to automate interactions with other plan sponsors regarding their ETFs as well.

"We are working with various participants in the marketplace to get to the end state where we would have as many sponsors as possible on the platform, whereby the authorized participants could log on to a single destination venue rather than having to log on to single sponsor platforms," McHugh said.

In Europe, the fax-based communications can be particularly problematic because of the variety of settlement locations. In the U.S., all ETFs settle at the Depository Trust & Clearing Corp., but in Europe, a batch of trades could be split with trades settled at different settlement facilities in different counties.

"When doing this over faxes, if not all ETFs are delivered to the same settlement location, it's easy to make errors on behalf of the AP," McHugh said. "Now we have a high degree of control over that sort of information and static data."

Another adjustment made to the European version of the platform is an estimated market price feature that gives authorized participants an estimate of how much the basket of trades being traded are worth.

Meanwhile, the Navesis-ETF platform, a joint venture between interdealer broker Tradition and global investment bank Nomura, which is a leading ETF market maker, helps streamline creation and redemption by enabling authorized participants to cross trades in the secondary market, potentially avoiding the costs and settlement complexity of the primary market for ETFs.

Launched in 2012, Navesis-ETF is the first multilateral a trading facility that facilitates NAV-based trading of ETFs in the secondary market. A fully electronic trading platform, it is used by investors who prefer to trade ETFS based on NAV prices, but it is also used by authorized participants as an alternative to the traditional creation redemption process.

"Rather than trade inventory on the primary market, which can be expensive and complex, it allows market participants to engage in intra-day and auction trading referencing NAV prices in real-time, transparently, and at competitive prices," said Jason Griffin, head of sales for Navesis-ETF.

 

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