A little transparency could mean a lot of cash for Europe’s burgeoning ETF industry.
In Europe’s opaque ETF market, where 70% of securities are traded over-the-counter, firms will soon be required to report details of transactions, such as price and trade volume, under Europe’s MiFID II rules.
The change, which kicks in on Jan. 3., will appeal to investors and likely push European fund assets from $725 billion to $1 trillion within two years, said Juergen Blumberg, head of capital markets at ETF provider Source.
“Investors in Europe still think ETFs are not liquid,’’ said Blumberg, based in London. “In the future, each trade must be reported, which will lead to more visibility of liquidity and attract more money. This could add 5% to 10% on top of the usual annual growth.’’
The European Union’s Markets in Financial Instruments Directive regulations also encourage more transparency around fees across the whole asset-management industry for products that weren’t previously required to reveal such information. Increased availability of details about the commission-based advisory model will make the “true cost” of active funds more visible, according to Morningstar.
MiFID II is redefining the way markets operate in everything from research to dark pools. ETFs are expected to be one of the rule’s big beneficiaries. The boost comes at a time when global ETF assets are at a record, with the U.S. accounting for more than $3 trillion of the $4.5 trillion pie. However, the European market for the funds has lagged in growth.
EUROPEAN FRAGMENTATION
In the U.S., ETF providers must report transaction data, and the majority of trading takes place on exchanges, making it clear where liquidity lies. The market has one central clearing repository, the Depository Trust & Clearing, or DTCC, in contrast to multiple clearing and settlement systems in Europe, according to a May discussion paper by the Central Bank of Ireland.
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The fragmentation of the European ETF market, which operates on about 21 exchanges and has 1,500 funds with multiple listings, has hampered the market’s development, said Thomas Meyer zu Drewer, global head of ComStage ETFs, part of Commerzbank. He also expects Europe’s ETF market will exceed $1 trillion, but by 2020-2021. The growth will be driven in part by cost-conscious retail investors lured by MiFID — currently, individuals make up 15% to 20% of the market, he said.
“Now you will be able to compare an insurance contract and an ETF,” zu Drewer said. “You can see what the costs are, such as rebates or kickbacks, as all of a sudden financial advisers have to inform their clients that they are getting a commission for the insurance product.’’
Fee disclosure means ETFs are “perfectly positioned” according to Clarisse Djabbari, deputy head of Lyxor ETF. “This plays to the low cost and transparent nature of ETFs,’’ which will result in increased use, she said.
There wasn’t a lot of diversification among the top funds as technology has dominated the market gains in recent years.
ETFs in Europe saw $28 billion of net inflows in the second quarter through June to reach $725 billion, according to Morningstar. Eyeing Europe’s growth potential, Atlanta-based Invesco, which operates the PowerShares brand of ETFs, bought Source in April.
Still, not everyone believes the new rules will be an overnight game-changer. Tom Bartolacci, head of European ETF capital markets at Vanguard Group, said it will take time for investors to digest the newly reported information and act on it.
“It’s premature to say that MiFID II is going to be an extreme catalyst for further ETF flows,’’ he said. “Maybe it’s not a meaningful spike in trading volume or inflows in January, but that’s a step to building a foundation for an ETF industry that will serve all investors.’’
