RFQ Platforms Are Key to Optimal ETF Trading in Asia
Institutional investors in the Asia Pacific region are increasingly turning to locally listed ETFs for more cost-efficient trading during Asian market hours, moving away from their traditional reliance on US or European-listed ETFs. Although US and European ETFs continue to benefit from greater scale and liquidity, the gap is narrowing, and the number and variety of Asian ETFs is expanding at a faster pace.
“We’re starting to see in Asia a lot more activity from buy-side clients in ETFs in general, and along with that, more teams are getting engaged with issuers of the funds to understand the due diligence side; looking at not just the fees, but also tracking error, tracking difference, and what the vehicle can give them in terms of performance,” said David Hood, APAC Sales & Trading at Susquehanna International Group.
Hood was speaking on a panel discussing ETF Trading – Creating Better Trading Systems and Trading Tools at the ongoing 2nd annual ETFGI Global ETFs Insights Summit – Asia Pacific. As all the speakers pointed out, the Covid-19 pandemic provided ETFs in Asia an opportunity to shine, acting as a “shock absorber” as Hood described it, during periods of heightened market volatility.
“The ratio of trading in the primary to second market increased and for every six dollars traded on exchange, one dollar was traded on the primary market,” revealed Tom Digby, Head of APAC ETF Capital Markets at Invesco.
“That means you’ve got more buyers and sellers meeting in the secondary market, not affecting the actual underlying. So, they’re willing to use the ETF as a way to discover prices, as a risk transfer mechanism, and not actually acting in the underlying themselves, while a mutual fund might have been suffering large redemptions during that period,” added Digby.
“If you look at some of the troubles in the underlying markets during the Covid period, in fixed incomes you had a lot of bond dealers pulling their inventories out of the market so that we’re not being able to show tradable prices on many credit bonds,” he continued. “But credit ETFs were still trading back and forth on the secondary market.”
As for the liquidity angle, Jean-François Mesnard-Sense, Head of ETF Capital Markets, Asia Pacific at State Street Global Advisors, pointed out that “Investors utilized ETFs as a liquidity vehicle to get in and out of the market when they really need to. ETFs were born from a crisis, and they have shown through the last crisis that they are a very relevant vehicle for investors.
Trading costs in focus
Digby revealed that “the next evolution for the ETF market in Asia is more focus on trading costs and getting as much liquidity and best pricing out of the vehicle as possible.” He explained that while fees are getting lower and performance improving as competition heats up, poorly executed trades are diminishing the value of those gains. “People could be buying and selling ETFs for 10 for 15 basis points because they’re doing it the wrong way, they don’t have the right tools or the right people to access the market. That can be a very inefficient way to get that exposure in, say, an ETF based on the S&P 500 that might only be 5 basis points in management fees.”
Request for quote platforms have become a standard tool for clients seeking to reach out to multiple dealers for the best price via a competitive auction. “This is particularly pertinent to ETFs because the liquidity isn’t necessarily in the screen. It isn’t so much an inventory driven market,” noted Ben Sturgeon, Equity Product Manager at Tradeweb.
“If I have 10,000 shares to buy, I don’t need to go around and find the person with 10,000 shares to sell to me. Effectively, it is the underlying that’s being traded. That gives us this enormous amount of liquidity off the back of the fact that there may be a small number of shares on the bid or offer on the screen, but an issuer can create more of the ETFs because they have purchased the underlyings,” said Sturgeon. “On average, our clients receive three or four basis points improvements on where the touch was, and in some cases they’re trading hundreds if not thousands of times the bid or offer volume on the screen.”
When making trades that are larger than the quantities shown on screen, you can also tap into what Hood refers to as “the liquidity reserve,” which “is sitting on a broker-dealer’s inventory or market maker’s book to help them facilitate their day-to-day market making activities. You can help tap into that activity by working with a capital markets team with an ETF issuer, to identify where those pockets of liquidity may be.”
Such platforms are particularly valuable in markets such as Hong Kong, where “tick size on some ETFs is still very large,” observed Mesnard-Sense. “They don’t trade at one cent. They can trade at two, five and even ten cents. So, there are really a lot of conversations happening with local products, and I would say that reaching out to capital markets teams as well as several market makers is usually a good approach to ensure that trading costs are optimal.”
RFQ platforms also bring the benefits of automation. “I think the biggest advantage is that it can provide scale for ETF clients and traders as well – that ability to do a large number of orders all in one go really streamlines the trading process for clients and pricing providers as well,” said Hood.
“I think the transparency and the competition are really important benefits and components of these platforms. And from my capital markets perspective, I think it’s also very powerful to have this visual to show clients that with this platform, you are able to trade this large notional with these counterparties,” concluded Mesnard-Sense.