Just past $5.25 trillion and counting: that’s now the startling size of the global exchange-traded funds market. ETF assets have doubled every five years since 1998 – a trend that shows no sign of slowing, fuelled by steadily rising demand from institutional investors.
“The scale of the ETF business is greater than anyone had expected two or three years ago," said Stewart Aldcroft, senior adviser in Citi’s markets and securities services division, and a longtime proponent of ETFs. "It’s now bigger than the entire alternatives market."
"If you ignore that, you do so at your peril,” he added.
So it's perhaps no surprise then that global broker-dealers such as US duo Citi and Goldman Sachs are now looking to build market share in ETF liquidity provision in Asia or in Europe as interest in these instruments and their diversity steadily expand.
Factor-based, leveraged, inverse and other versions are proliferating in both regions, as is the number and use of Ucits ETFs – those that meet the regulatory standards of the European Union.
There are now 7,553 exchange-traded products (the vast bulk being ETFs) from 386 providers, with 14,643 listings on 69 exchanges in 57 countries, according to research house ETFGI.
In previous years banks had generally stepped away from being ETF market-makers due to the commitment needed to be constantly supporting liquidity, Deborah Fuhr, managing partner at ETFGI, told AsianInvestor.
She declined to name any firms, but it's well known that firms such as Deutsche Bank and RBS have fallen away from ETF liquidity provision for various reasons the 2008 global financial crisis. And others, such as Citi and Goldman, had chosen to pull back in the past two or three years.
Aldcroft thinks Citi exited at the wrong time, without saying when it did so. “We looked at a market and decided we couldn’t make money – that there was too much competition and not enough opportunity at the time the decision was taken,” he told AsianInvestor.
Now most ETF market-making is done by specialist trading firms, such as Flow Traders, Jane Street and Susquehanna, according to Fuhr. These companies spend a lot of money on technology and trader headcount to ensure they retain an advantage in the market, she noted.
But the ETF industry is now so large and product-diverse that there is space – and probably the need – for more liquidity providers, Aldcroft said. Despite concerns about the potential risks of this now-vast market,
As institutional demand for ETFs is growing, despite concerns of potential risks in some quarters, so is the number of new players. Names like Legal & General Investment Management, Franklin Templeton and JP Morgan Asset Management are trying to compete with the likes of BlackRock, State Street and Vanguard. Hence, Aldcroft believes, they need more aggressive players in the market-making area.
Accordingly, banks are committing resources with a view to grabbing dealer market share.
Last month Antoine de Saint Vaulry joined Citi as Asia-Pacific head of delta one ETF trading, based in Hong Kong. The US bank has also been aggressively adding similar expertise in New York over the past year, although it lost Dylan Halterlein, Asia-Pacific head of delta one product, earlier in 2018.
Citi has been building out specialist desks in the three key locations of Hong Kong, London and New York for ETF market-making and liquidity provision, Aldcroft said. They work alongside the equity teams and are staffed by recent recruits from some of the firms that have pulled back from this business in recent years, he added.
Meanwhile, Goldman Sachs is targeting a “top-three” position in ETF market-making in Europe, Elizabeth Martin, head of European equity execution services at Goldman, told Bloomberg in April. This pits it directly against dominant players Flow Traders and Jane Street.
On the product manufacturing side also, Peter Thompson, founder of ETF provider Source, rejoined Goldman Sachs Asset Management in June to run the European ETF business.
Goldman Sachs declined to comment when asked by AsianInvestor if it is looking to make similar moves to provide ETF liquidity in Asia.
Marco Montanari, Asia-Pacific head of passive asset management at Deutsche Asset and Wealth Management, agreed that some banks are increasingly looking to impose themselves as the key counterparty for clients looking to trade ETFs.
“It’s not a surprise considering [the market’s] growth and that ETFs represent a larger portion of equity and fixed income trades initiated by institutional investors,” he told AsianInvestor.
This is logical, Montanari said, as ETF fees have fallen substantially in recent years and these products now appeal to investors that previously only focused on index futures and passive mandates.
As a result, he noted, ETFs are more difficult to ignore for banks that can market-make, borrow the securities lent by the ETFs, sell derivatives to the ETFs (if they are synthetic), execute the basket, be the custodian, and so on
Ultimately, it’s decision time for global broker-dealers, remarked Aldcroft: “Banks have to make their mind up about the extent [to which] they want to commit to providing ETF liquidity."
Building a business as a liquidity provider is easier said than done. It requires a lot of resources and the growing size and complexity of the ETF market creates its own new challenges.
However, if you are a bank that is well connected in the institutional market, it can be a natural extension of your business, Aldcroft said.
For more insight on how investors are using ETFs, attend the 'Inside ETFs Asia' forum in Hong Kong on November 7 and 8. For more details, visit this link.