How has the trading of ETFs evolved and what role are market structure changes having in this evolution?
Market structure changes, particularly regulatory reforms like Mifid I and, more specifically for ETFs, Mifid II, have significantly reshaped the European ETF trading landscape. Mifid II disrupted the dominance of traditional stock exchanges by opening the door for alternative trading venues, increasing competition, and expanding investor choice. However, this democratisation has also led to market fragmentation, with ETF trading now spread across multiple platforms and exchanges.
In Europe, multilateral trading facilities (MTFs) have emerged as key players. These MTFs can make execution quicker, potentially more efficient, and transparent, giving liquidity providers access to streamlined trading and offering clients pre-trade pricing transparency. At the same time, the emphasis on ‘best execution’ has driven more complex and fragmented market structures, with many algorithms now ready to help capture fair value trading via all lit, dark exchange executing venues. All aiming to ensure investors fully leverage the ETF wrapper’s trading characteristics for better trading outcomes wherever they choose to execute.
What’s next for the ETF landscape, particularly in fixed income?
The ETF market continues to expand at a rapid rate, and there are some exciting trends shaping its future. One of the most significant growth areas is within fixed income. For me this is where the ETF wrapper has created real structural change. Unlike stock markets, which have well-known centralised exchanges (e.g., LSE, NYSE, NASDAQ, etc.), the bond market operates differently. There is no single centralised exchange for bonds. Instead, bond trading occurs primarily in decentralised, over the counter (OTC) markets.
ETFs have indirectly evolved this market structure, taking an opaque over the counter market and successfully placing this on the same well-known exchanges around the world. ETFs’ success in evolving this market structure has created more price discovery within the fixed income asset class that has become evident after recent stressed market periods. This price discovery and execution transparency for fund assets is something only possible with the ETF wrapper. For this and more we believe the ETF wrapper will become mainstream for both passive and active fixed income pooled investment.
How does ETF activity differ between the US and the UK, and how do they interact?
In the US, about 70% of ETF trading happens on exchanges, while 30% is over the counter. In Europe, including the UK, it’s the opposite: 70% of trading is OTC, and only 30% is on exchanges. The US is the global leader in ETFs, with around 4,000 ETFs and about $10 trillion in assets, making up 70% of the global total. Europe, including the UK, has about 3,800 ETFs with $2.4 trillion in assets, which accounts for 16% of the global total. The US dominates ETF trading volume, handling over 80% of total global ETF trades, while Europe accounts for just 6%.
However, European ETFs grew faster than the US market in 2024, with a 33% increase in assets under management compared to a slower growth rate in the US. Despite this, ETFs still make up a smaller part of the retail investment market in Europe compared to the US, where retail investors play a more active role in ETF trading.
What are the nuances of how ETFs are, and will be, traded?
There are a few different strategies for trading ETFs, each with its own pros and cons. You’ve got NAV trading, risk trading, and agency/algorithmic trading. Some key tips for trading ETFs include knowing the best time to trade, considering your trade objective, choosing the right order type, and making sure ETF is trading close to its fair value.
ETFs can be traded on various venues, directly with brokers, or OTC via the MTFs mentioned earlier. This trading and liquidity flexibility is again a key catalyst for further investor ETF adoption, as many traders and investors continue to look for differentiating approaches to portfolio construction, execution and risk management.
How does ETF liquidity perform during times of market stress?
During periods of market stress, ETF liquidity can be a critical lifeline for investors. The structure of ETFs, which allows for continuous trading and relies on market makers to maintain liquidity, enables them to function even when underlying markets face pressure.
A prime example of this occurred during the pandemic in March 2020, when global markets experienced significant turmoil. While underlying bond markets became illiquid, fixed-income ETFs continued to trade actively on secondary markets, despite trading at record discounts to their net asset values (NAVs). This demonstrated the resilience of ETFs, as they provided investors with access to liquidity and price discovery when traditional markets froze.
The role of market makers and the ability of ETFs to aggregate liquidity across a basket of securities were key factors in their ability to remain functional during the crisis, solidifying their importance as a reliable tool for navigating market uncertainty.