In anticipation that Asian ETF trading is poised to rise, Credit Suisse is rolling out a new market-making system for providing on-screen quotes to investors seeking to trade in smaller sizes.
Asia is different to the US, where ETFs predominately trade on-exchange. Some brokers estimate that daily ETF trading volume on-exchange in this region amounts to between $1 billion and $1.5 billion, with average individual trades of less than $500,000.
But secondary trading of ETFs has been lacklustre this year. And with 80% of notional trading in Asian ETFs concentrated in just 20% of funds, many less popular products can go for weeks without trading on exchange.
It means retail investors with small orders often need to try off-exchange avenues – for example, by phoning up a market-maker who is a participating dealer and who can arrange a creation-unit separately with an ETF provider.
The dealer then carves out required units in accordance with the investor’s wishes, although such over-the-counter creation is unlikely to result in the most competitive offer price.
Manuel Schlabbers, head of Asia-Pacific delta one index and ETF trading at Credit Suisse, says his team has completed testing a new on-screen market-making system and recently began signing up as market-maker to some ETFs in Hong Kong.
The goal is to expand the number of on-screen ETF quotations to 60 funds listed across Hong Kong, Singapore and potentially Australia, from about 30 at present.
As such Credit Suisse seems to be moving away from ETF market-making desks at other banks, which have sought to be more selective when it comes to providing liquidity for ETF managers.
But the high cost of running inventories, combined with dwindling ETF transaction volume (down 20-30% year-on-year) have combined to make market-making a thin-margin business.
“While in the past our focus has been largely on providing execution advisory and risk-pricing to institutional clients off-exchange, we feel that now is the time to position for Asia’s ETF market to grow significantly in the next few years,” says Schlabbers.
He bases such optimism on the recent on-screen trading volume of the CSOP FTSE China A50 ETF, which was listed in Hong Kong this August under the renminbi-denominated qualified foreign institutional investor (RQFII) programme.
In the week beginning November 5, this ETF saw average daily trading volume of over $20 million on exchange – a sign that Chinese managers’ RQFII marketing spend is starting to pay off, says Schlabbers.
At the top of the scale, the popular iShares FTSE A50 China Index ETFs, a synthetic ETF traded in Hong Kong, saw daily average trading volume of more than $150 million in the same week.
However, Schlabbers concedes that providing on-screen market-making for Asia-listed ETFs may not be profitable initially as a standalone business.
Ultimately, it will only succeed if trading volume rises across the board and is not limited to a few popular names. But he stresses that Credit Suisse wants to maintain a close relationship with ETF issuers, adding that to grow the ETF market, on-screen volume is important.
The bank’s fresh commitment to its on-screen business has come at a time when proprietary trading firms and specialist market-makers are increasingly eyeing opportunities in Asian ETFs.
Specialist market-makers including Tibra Trading, Optiver, Flow Traders and IMC are currently quoting prices to investors in markets including Hong Kong, Singapore and Australia.
Industry players generally agree their participation has made bid-offer spreads in some Asia-listed ETFs tighter.
Philip York, director of the eTrading Association – an industry advocacy group formed to promote fair and efficient markets – says specialist market-makers tend to be more flexible when it comes to investing in technology than banks, meaning they keep up with market changes.
“A diverse market is a resilient market,” says York. “We do not want just a few big market-makers as we would end up with the moral hazards of a group of organisations becoming too big to fail, as we currently have with the banks.”
The rise of specialist market-makers, which operate with faster execution speeds and are solely dedicated to profiting from pricing anomalies, is leading to subtle changes in the relationship between ETF managers and their market-makers.
(An article on how high-speed ETF market-makers are effecting changes in Asia’s ETF industry will be published in the December issue of AsianInvestor magazine).