10 August, 2020
Exchange Traded Funds (ETFs) have grown consistently as an investment vehicle since their introduction over 25 years ago. The collective value of European ETFs hit an all-time high of $974 billion in December 2019. The COVID-19 crisis hit market valuations but ETFs have proved resilient and their value has now rebounded to $928 billion as at the end of June 2020.
While assets under management in Europe are expected to continue to grow in the coming years, certain aspects of the European market remain fragmented, particularly when compared to the US market.
For ETFs to flourish in Europe, pragmatic solutions are needed to address some of this fragmentation and its impact on the smooth execution of ETF trading. These proposed solutions should provide further transparency, reduce costs and enhance the investment experience of investors.
We believe there are four key areas, set out below, where the European trading infrastructure and trading environment could be enhanced. These changes could bring increased efficiencies and even greater transparency to the industry. This would be beneficial for all stakeholders.
MiFID II has already had a significant positive impact on the transparency of the trading volumes of the European ETF market which provides investors with a better insight in relation to liquidity. There is potential for more enhancements which would further support the growth of the industry such as enhanced availability, quality and consistency of data about ETF trading activity, particularly trading volumes across jurisdictions.
European investors have several choices of ETF trading venues which has been a contributor to the growth of the market as many of the trading venues can offer different benefits to investors. However, the broad variety of venues can sometimes result in higher bid or ask spreads and trading costs for investors. One notable observation is the lack of a consistent set of rules or absence of a common "rule book" across different venues, different jurisdictions that support the ETF industry. Standardisation and consistency of certain aspects of trading across Europe could increase investor protection, lower costs and promote ease of access for more types of investors.
In the post-trade environment, ETFs have historically been captured within the rules for either single securities or for UCITS vehicles. As ETFs have unique features compared to either a stock or a traditional UCITS fund structure, these unique features need to be catered for in Regulations. The industry has made good progress on clearing and settlement with developments such as the Target 2 Securities (T2S) settlement platform and the move by most of the European ETF market to the international settlement (ISCD) model. As we look ahead to future Regulations such as the European Central Securities Depository Regulation (CSDR) as an example, while this Regulation is intended to harmonise the different rules applying to CSDs across Europe, the Regulations do need to take account of the unique features of how the primary and secondary markets operate to facilitate ETF trading if they are to achieve their intended objective of an integrated market in the context of the ETF industry.
The acceptability of ETFs as a form of collateral has increased, enhancing options for the broader capital markets. For ETFs to reach the next frontier, they need to be even more widely acceptable as a form of collateral for lending, recognising that they have unique features that are of value to investors and they enhance options for the broader capital markets.
Similarly, the lending of ETFs is increasing. Broader access to this lending market has the potential to enhance price stability by reducing spreads. This could lead to greater efficiencies and investor choice.
ETFs are emerging as a core product for many investors in Europe. As the market continues to mature, it is important that the industry infrastructure continues to evolve to support the growth and evolution of this industry.