How will growth in the ETF landscape impact trading behaviours?
The rapid growth in the ETF industry has been well documented and expectations suggest this will continue – both in assets and product types. Increased ETF usage among both institutional and retail investors has led to some interesting changes in trading behavior as dealers are able to take advantage of new liquidity sources and trading infrastructure developments. Increasing adoption of ETFs from the retail community, combined with improved connectivity from platforms to exchanges creates opportunities for buy-side dealers to interact with these improved volumes on exchange, as professional and retail volumes create a better dynamic for orderbook trading. Traders now have more optionality around how and when to trade whether they require immediacy via request for quote (RFQ) platforms or working anonymously over a longer intra-day timeframe via dedicated ETF execution algorithms. Fixed income ETFs have seen significant growth as investors have been drawn to the liquidity benefits of the ETF wrapper versus the underlying bond markets. For most buy-side desks, all ETF trading irrespective of asset class is undertaken by equity-specialist traders who have upskilled their understanding of the market forces and dynamics within other asset classes.
What innovation are you seeing in this space?
The ETF industry has been one of continuous innovation and that remains the case today. At the product level, we are seeing a rise in active ETFs, which not only offer more choice for current ETF users but should create opportunities for new investors to invest into ETFs and subsequently new trading opportunities for buy-side desks. We are also seeing solutions from the exchanges themselves such as exchange-based RFQs that utilise straight-through processing (STP) protocols all the way through to settlement, which improves efficiency and ultimately cost in the trading process. Alongside these developments at the exchange level, more dedicated ETF trading algorithms have been launched which empowers dealers with the ability to access this wider range of liquidity pools at differing urgency settings which alter the child-order placement logic, often within fair-value frameworks. Finally, there is also innovation at RFQ platforms with the automation of ETF execution via trader-customisable rules that allow quick and efficient trading of smaller tickets leaving the trader to concentrate on orders where they can add most value.
How are traders and market makers currently addressing liquidity fragmentation?
Traders are increasingly using the wider range of trading options within their toolkit as well as pushing for further ETF algo technology to bring together cross order book liquidity on an ETF and other proxy assets to provide liquidity on any single target listing. Alongside this, trading desks have been more open to adding new market makers to their risk-provision panels which leads to greater pricing competition and ultimately, improved trading outcomes. Market makers constantly search to improve efficiencies within their processes to better utilise their balance sheets to offer tighter pricing and/or greater liquidity. Market makers would also look to benefit from any harmonisation of trading venues and order books to bring their liquidity to a single point of execution. Additionally, making the post-trade fragmentation (central counterparty clearing and central securities depositories) more streamlined would allow market makers to commit more cash into the market, rather than having it tied up to satisfy post-trade provisions.
What new offerings are being developed to enhance liquidity and execution quality?
Aside from the developments mentioned previously, there are moves within the retail space to increase/improve the ability of platforms to offer more ETF trading to their clients. Technology firms are looking to help platform providers streamline the ETF process, reducing complexity where platforms may currently struggle due to legacy systems. There has also been an increase in ETF post-trade analytic capabilities for traders – either developed inhouse and/or utilising third party solutions that can offer detailed breakdowns of not only each trade itself but can provide information on changes of liquidity during the trading process such as price movement, reversion, or the widening of spreads. Finally, an efficient and well-implemented consolidated tape could help to complete the circle allowing greater transparency at the pre- and post-trade level generating greater confidence in ETF trading for all users of ETFs.