While the ETF industry has been advancing impressively all over the world, it is not a homogeneous space. One just needs to look at the US and European markets, which a report from the Financial Times
notes are distinguishable based on several characteristics.
Citing data from consultancy firm ETFGI, the report notes that the European ETF industry’s third-quarter record of US$567 billion is dwarfed by its US counterpart’s record of $2.4 trillion. The disparity is attributed to two major differences: Europe’s considerable off-exchange ETF business, and the significant retail base in the US.
In the US, share trading on exchanges is done under a regulation called Reg NMS, which requires brokers to route share or ETF trades to the exchange that has the most competitive buy and sell price; if two or more exchanges are tied, the broker can choose. Furthermore, all US trades have to be reported to a publicly available source.
On the other hand, Europe’s 2007 Mifid regulation, under which European share trading is done, did not recognize ETFs as an asset class, making reports non-mandatory. Because of this, most European ETFs are traded over-the-counter: the ratio of on-versus-off exchange trading in the US is 70:30, while many estimate the ratio to be reversed for Europe.
report says that European ETFs are not really traded on exchanges, which suits many large institutional investors who prefer to trade in large blocks via off-exchange transactions. “[In the EU market], only 11 per cent of households own funds compared to over 40 per cent in the US. So it’s not surprising that European ETFs are largely the domain of institutional investors,” said Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman.
Investors in European ETFs, especially ETFs outside the UK, typically buy them through banks and not specialist brokers. “The banks are more likely to sell banking products than fund products,” Tuffy said. In addition, a broker in Europe may have to move collateral between central securities depositories – the European Central Securities Depositories Association has 41 members, compared to the Depository Trust and Clearing Corporation that exclusively serves the US) – making ETF redemptions problematic.
Another concern is financial incentives. US issuers are forbidden from paying a market-maker directly for their services; this prevents conflicts of interest wherein trading desks profit from a product created in the same institution. In Europe, no such prohibition exists, so issuers and market makers can have direct agreements.
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