GlobeA pan-European market structure for ETFs might help reduce cost and boost liquidity. Nicholas Pratt examines the latest initiatives to create this model. BlackRock, the largest player in Europe’s ETF market, announced in June that it will pilot a new ETF to be issued through an international issuer model and settled via an international central securities depositary (ICSD), thereby removing the need for costly cross-listings on multiple exchanges and inefficient cross-border trading via regional CSDs. “The ICSD structure will decrease trading costs for end investors in the secondary market by removing the cost of servicing the ETF ecosystem,” says Leland Clemons, managing director, Emea capital markets, iShares. “This should have the effect of attracting new clients and additional volume to the product.” Clemons says that the hope has always been to launch the first ETF before the end of 2013 and according to Stephan Pouyat, head of global reach product management at Euroclear, one of the ICSDs involved in the pilot, this objective will be met. For now the project is in pilot phase and it will take time to put a global framework in place and to make sure each part of the structure and each participant are fully connected, says Pouyat. NEW ASSET CLASS
One helpful aspect is the fact that the ETFs will be based on the existing Eurobond structure – something that is already familiar to the various participants that already use an ICSD for other international asset classes. “It is effectively adding a new asset class to this infrastructure, although because the ETFs are equity-linked instruments, they are more like depositary receipts in terms of behaviour,” says Pouyat. Work is under way with the London Stock Exchange and the London Clearing House which have both announced the new asset class under which the ETFs will be traded. “The segment is defined and we have conducted a series of tests,” he says. For custodians they will need to have membership of an ICSD or else appoint an existing member as their settlement agent. But for ETF investors there will be no operational impact or connectivity work involved and they should benefit from easier access to the market at a more competitive level, says Pouyat. Clearstream is the other ICSD involved in the iShares international settlement model. According to Marc Kieffer, head of issuance and distribution services, the fragmentation of the European ETF model does need to be addressed. But despite its involvement in the international model, Clearstream is not looking to supplant existing models – for example the use of central counterparties for clearing ETFs. “Instead, Cleartsream is focusing on the settlement layer and on making this a more streamlined process,” says Kieffer. In addition to this ICSD issuer model, Clearstream is also working on improving its German CSD issuer model, thereby providing ETF issuers with two options. “We believe in choice and Clearstream can offer two models: the single issuer model for all of Europe through Clearstream Frankfurt; and the ICSD model. Both could be supported by the Central Facility for Funds technique of fund issuance account so that wherever you have listed, the single settlement model can be used.” FACT-FINDING MISSION
Discussions with market participants are ongoing, says Kieffer. “We are working through some limitations. We are all on a fact-finding mission to see how a new structure can be built and the dialogue is very open. “We have been talking about this for more than two years, exploring ways to make the ETF more efficient in Europe and we are working on offering new proposals on this before the end of the year. “In the meantime, our German trading and CCP model is attractive because it offers the highest number of ETFs in Europe.” Meanwhile, the exchange venue Bats Chi-X Europe has launched a pan-European listings business for ETFs which will start in November when BlackRock will be the first ETF provider to issue two of its iShares ETFs – the iShares MSCI Emerging Markets Ucits ETF and the iShares MSCI World Minimum Volatility Ucits ETF as secondary listings. The Bats Chi-X Europe initiative is designed to challenge the vertical model for issuance where the same ETF is listed on multiple exchanges, each with their own post-trade process meaning that each listing is treated as a separate instrument, depriving issuers of any netting ability or to have a fungible position from a clearing and settlement perspective, as in the equities market. “It is time for ETF issuers to consider a pan-European listing,” says its chief executive officer, Mark Hemsley. He says that the initiative is highly complementary to the Euroclear/Clearstream/BlackRock pilot rather than a competing project. Although the company has a pan-European clearing partner in EMCF, the offering is flexible enough to allow issuers to use different CSDs or ICSDs for different products, he adds. TRADE REPORTING
Hemsley sees a pan-European approach to listing and to settlement as all parts of a virtuous circle. “At the moment there is a lack of uniformity in post-trade and this is leading to a lack of pre-trade liquidity and it also leads more firms to trade on an OTC basis where there is no obligation to report trades so that creates less visibility. “Once the Euroclear/ Clearstream pilot demonstrates that the pan-European settlement model can work, more issuers will get involved and this will reduce the cost and increase the operational efficiencies of settlement. This in turn will concentrate liquidity which will increase flow which will make market makers more competitive and benefit investors.” Bats Chi-X has also launched a trade reporting service, which Hemsley hopes will prove popular with the ETF market as well as the equities market. “If we can persuade people that there is a benefit to reporting their ETF trades and creating a more liquid, continuous order book, I think it will lead to more on-exchange trading.” The lack of trade reporting is another limitation of the European ETF market and the success of the ICSD issuance model would be helped by more visibility, says Clemons. “A consolidated pan-European reporting tape of ETF volumes will bring much needed transparency to the ETF industry. It will allow clients a better opportunity to assess prices and volume of the ETF market.” The other development needed to help the ICSD issuance model succeed is the involvement of as many parties as possible. While BlackRock has the exclusive contract to issue the first ETF under the new ICSD model, it will have to be industry-wide to be successful, says Pouyat. “There is limited long-term benefit from working only with BlackRock. The new structure has to involve all stock exchanges, transfer agents and other issuers for it to reach any meaningful level of maturity and to allow issuers to expand beyond Europe.” QUESTIONS REMAIN
Both issuers and asset servicers recognise the potential benefit of an ICSD issuance and settlement model. As Fiona Moore, head of fund administration for Northern Trust’s ETF business in EMEA, says: “Anything that can help to make the ETF market more efficient is definitely to be welcomed. Asset servicers have a key role to play in ensuring that they are continually reviewing the operation of the market and are able to develop suitable solutions.” Lyxor is also looking at improving post-trade processing by allowing some of its ETFs to settle on an ICSD. The wish among many issuers is to have a single ICSD for issuance as well as settlement but there is also a realisation that this development may take longer to materialise due to the legal and administrative issues that come with creating an ETF that will have no country of origin. So questions do remain but if they can be adequately answered, the European ETF market could take a big step forward. ©2013 funds europe

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