Unveiling the Mysteries of Secondary ETF Trading
In the ever-evolving world of financial markets, a significant shift is underway in Europe, as Exchange-Traded Funds (ETFs) are increasingly being traded off-exchange via Request for Quote (RFQ) and Over-The-Counter (OTC) transactions. This transition, unique to Europe compared to the more on-exchange trading prevalent in the US, is driven by a combination of factors.
The European ETF market, characterized by a complex and decentralized trading ecosystem, has seen a growth in the use of RFQ/OTC venues. These platforms, which electronically connect investors and liquidity providers, offer flexibility and control over the trading process, aligning with the transparency and best execution requirements set out by the MiFID II directive in Europe.
One of the key benefits of RFQ/OTC execution is the direct interaction with authorised participants and market makers, enabling traders to negotiate prices in real-time and tailor execution to their needs. This direct link offers enhanced speed, transparency, and flexibility compared to traditional on-exchange trading.
The operational and technological integration of RFQ platforms into execution systems also improves efficiency, giving investors more control over their trades and facilitating better management of large or complex ETF orders. This integration can help address liquidity challenges posed by global ETF structures and timing differences.
The rise of active and specialized ETFs in Europe has increased demand for more flexible trading mechanisms, with RFQ/OTC execution supporting trading of these more complex ETF strategies. Approximately 71.21% of ETF trades in Europe are off-exchange, underscoring the growing trend.
However, the fragmentation of the European ETF market can create the impression of illiquidity, dispersing liquidity across different exchanges and multilateral trading facilities (MTFs). To mitigate this, the introduction of the Consolidated Tape will help market participants interpret ETF liquidity more accurately by aggregating trading data from multiple venues.
The Consolidated Tape will also provide a unified view of transactions across different markets, improving transparency for investors. It will offer a better pre- and post-trade benchmark, with updated information on transaction prices and volumes.
As the ETF market continues to grow, with forecasts predicting it will reach USD 4.5 trillion in Europe and USD 25 trillion worldwide by 2030, the offering of specialized algorithms for ETFs has significantly expanded. These algorithms allow access to the best liquidity, regardless of the execution location.
The shift towards RFQ/OTC execution formats not only aligns with European regulatory and technological trends aiming to improve transparency and execution efficiency, but it also addresses the challenges related to pricing and order execution in ETF trading that can deter investors from fully utilizing historical exchanges for ETFs.
In conclusion, the shift towards RFQ/OTC execution in Europe's ETF market is a response to the complexities of the market, the need for enhanced control and flexibility, and the operational demands of global and innovative ETF products. This shift, supported by the introduction of the Consolidated Tape, promises to improve transparency and efficiency in ETF trading, making it an attractive proposition for a wide range of clients, from individuals to institutional investors.
[1] EY Global ETF Survey 2020 [2] ETF Securities Whitepaper: The Future of European ETF Trading [3] Cboe Europe Whitepaper: The Evolution of ETF Trading in Europe [4] European Securities and Markets Authority (ESMA) Report on MiFID II and MiFIR Transparency Requirements for ETFs
- As the European ETF market evolves, investing strategies are adapting to the rise of technology, with specialized algorithms avoiding the traditional on-exchange trading routes by executing transactions off-exchange, such as RFQ/OTC, to align with benchmarks set out by regulations like MiFID II.
- In the pursuit of better price negotiation and execution flexibility, the growth in RFQ/OTC transactions for ETFs is not only driven by technological advancements but also regulatory trends, as these platforms provide a means to address financing requirements and liquidity challenges associated with global ETF structures, contributing to the market's overall efficiency and transparency.
