Could APAC become a global ETF hub?
Is a sleeping ETF giant awakening?
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As highlighted in our chart of the day, global ETF trading activity is currently at record highs. In August 2023, global ETF assets under management (AUM) hit $10.86 trillion, easily surpassing the $10.3 trillion figure reported for the entirety of 2021.
In part, the rapid evolution of ETFs trading has been the driver behind the growth in traded volumes, globally, with Tier I CIBs no longer profiting meagre revenues from on-exchange ETF market making in Europe or in the US. Instead, CIBs are increasingly managing the whole ETF lifecycle, from creation-distribution-listing of client products or an institution’s own products to redemptions and all trading – on-exchange or RFQ.
However, going forward, the US and European ETF marketplaces may no longer be the main drivers of growth in the ETF trading space.
There is a strong argument for Asia-Pacific (APAC) becoming the main growth driver in global ETFs trading. In part, this is due to its unrealised growth potential, and challenges in the US and Europe ETF trading environments.
For example, in the US, ETFs issuers are prohibited from paying a market-maker directly for their services to prevent conflicts of interest in which trading desks profit from a product created within the same institution. Additionally, all US ETF trades must be reported to a public repository, which is normally the exchange venue.
Outside of the US ETFs marketplace, OTC trading of the products through RFQ-centric methods remains the dominant execution paradigm. OTC RFQ trading of ETFs in Europe is estimated at 50% to 70% of all trading activity in the region. However, in 2022, the European ETFs marketplace was characterised by liquidity fragmentation and price opacity; ETFs are typically listed on multiple exchanges, often in more than one currency, institutional investors account for roughly 70% of all trading and liquidity fragmentation is magnified by the absence of a centralised settlement repository in Europe.
Also of significance in the European equities ETFs trading landscape is the fact that, as of 2020, the European Central Securities Depositories Association – an organisation akin to the DTCC NSCC facility in the US – only has 41 members. This means that ETFs redemptions are problematic in the European marketplace because it is costly and time consuming to move inventory from one settlement depository to another, which in turn generates price opacity due to the need for wider on-exchange spreads and a resulting lack of on-screen liquidity. This underlying structure for the European ETFs marketplace drives market-making CIBs to source block-size liquidity away from the leading exchanges such as the SIX Swiss Exchange.
We’d add that, in response to ETF market fragmentation, European policymakers are seeking to implement a consolidated tape for ETF trading data, although no concrete plan is yet in place.
In contrast, APAC, in terms of ETF trading, can be thought of as the “new kid on the block.”
According to Euroclear, over the past five years, APAC has achieved the fastest growth in Exchange Traded Funds (ETFs) AUM of any region in the world, reaching a compound annual growth rate of 18.7% — 5% higher than the worldwide figure of 13.7%. Even so, ETFs still make up only 2.2% of APAC’s equity assets, roughly five times lower than the comparable figure in the US.
One key driver of growth in the region has been market structure enhancements.
For example, one of Asia’s major exchanges, Hong Kong Exchanges and Clearing Limited (HKEX), has made great strides in boosting market liquidity and efficiency, by introducing settlement extensions, a requirement for two-sided quotes and a reduction in minimum price movements. Another driver of growth has been the arrival of new thematic ETF products in APAC, which has stimulated retail interest in particular.
For example, in Singapore, the number of retail accounts has trebled in three years and now make up about 35% of AuM and 25% of trading volumes here.
Additionally, regulatory reforms mean that ETFs are eligible for inclusion in financial products across APAC — including in Korean pensions and Nippon Japanese individual savings accounts.
Collectively, there is an increasing preference for APAC investors to trade products locally rather than look overseas. With improving infrastructure, investors in APAC realise they can trade and access on-exchange prices locally and trade within the comfort of their own time zones.
One roadblock to APAC ETF trading could be the prevalence of retrocession on mutual fund sales. Here, providers of mutual funds such as wealth managers and advisers can charge fees, thereby having more incentive to deal in these products rather than ETFs. However, as Zak Allom, CEO and Co-Founder of B2B digital wealth and asset management platform, BetaSmartz noted:
“We see advisers in Asia and Australia using tens of different platforms and custodians / brokers in order to get their desired fund access, and they have to manage and consolidate data from each of these sources. By switching to ETF model portfolios, this counterparty count can be reduced to only one or two, whilst still achieving similar strategic asset allocation results; a significant efficiency boon”
Nevertheless, the current growth trajectory of APAC ETF trading is one that shouldn’t be ignored. It’s clear that APAC has the necessary ingredients to facilitate a robust ETF trading environment, and make up ground on its European and American counterparts.
In fact, as per our Trends In Equities Trading 2022 report, the growth in APAC ETF trading activity is something that we have foreseen for a while.