Exchange traded funds (ETFs) continue to experience extraordinary growth, now comprising more than 4,800 different securities and over $3.5 trillion in assets under management as of January 2017, according toETFGI research.
Historically, the record levels of inflows have been significantly driven by retail investment; lately though, we are beginning to see increasing interest from institutional investors seeking new ways of accessing liquidity in the ETF marketplace.
A variety of factors are driving a heightened institutional focus in ETFs, ranging from equitizing cash to different hedging strategies.In particular, we believe the introduction of disclosed, request-based trading has helped expand ETF opportunities for investors.
RFQ: A new way to trade ETFs
For many years, institutional investors have leveraged request-for-quote (RFQ) protocols to execute larger size transactions in various fixed income instruments. Firms like Tradeweb have adapted this technology for ETFs to provide market participants with a different approach to obtain competitive pricing, and access to liquidity with immediacy in execution.
When an investor sends an RFQ for either block or NAV ETF trades to a specific group of liquidity providers, they can execute much larger size than what may be shown on an exchange, and with market makers in competition.
This allows traders to execute larger ETF orders in just one RFQ trade, and helps improve access to liquidity across a broader spectrum of ETF securities that may not generally trade as frequently.
Unlocking U.S. ETF Liquidity
To demonstrate the different levels of liquidity available via RFQ, Tradeweb analyzed top-of-book liquidity in U.S. ETF securities listed on exchange (NBBO) v. trades executed via RFQ on the Tradeweb U.S. ETF platform in 2016.
By mirroring all trades executed on the Tradeweb U.S. ETF platform with the liquidity available on exchange in each security, we see significantly larger amounts of executable liquidity in each of these categories via RFQ – assuming traders are able to execute 70% of their order at these top-of-book levels on exchange:
Less Liquid: >260%
Rarely traded: >3033%
*Liquid: >10mm average daily shares traded (ADST); Less Liquid: 5mm-10mm ADST; Illiquid: 1mm-5mm ADST; Rarely Trades: <1mm ADST
The data shows that RFQ trading offers greater immediacy to significantly larger amounts of liquidity, and ETFs that were previously considered illiquid on exchange can be traded effectively via RFQ.
The Rise of RFQ Trading
Institutional investors are capitalizing on these benefits, and the adoption of RFQ trading for ETFs is accelerating.
Since launching in Q1 2016, more than $30 billion notional volume has traded on the Tradeweb RFQ platform for U.S. ETFs. Quarterly volume doubled in Q3 from Q2, and nearly again in Q4 – with average trade size increasing to more than 135,000 shares.
RFQ trading for better access to liquidity, more competitive and transparent pricing has become a valuable execution tool for institutional investors who trade in size and/or ETF securities where the liquidity they need is not met by exchange levels.
We believe it represents an evolutionary step for the ETF market, and affords investors a transparent and operationally efficient workflow. And as more institutional investors begin to trade ETFs, RFQ trading will continue to enable them with greater flexibility and immediacy to access the scope and scale of liquidity they need.