There are clear benefits of trade reporting for European ETFs and all the major market players have expressed their support. Why then, asks Nicholas Pratt, is the market nowhere close to having such a facility?
It is clear the vast majority of participants believe that more transparency would help to grow the European ETF market. After all, they all say as much in a letter to the European Securities Market Authority (Esma) in April this year. The list of signatories includes ETF providers (iShares, Deutsche Bank, State Street and Vanguard), execution venues (Bats Chi-X), brokers (UBS, Nomura) and investment managers (HSBC Asset Management, Lombard Odier).
The letter addresses changes to Europe’s market structure as a result of forthcoming regulation and called for ETFs to be included within the scope of the Markets in Financial Instruments Directive (MiFID) II and its requirement for all trades, over-the-counter (OTC) and exchange-based, to be reported. It is estimated that almost 70% of Europe’s ETF market is transacted on an OTC basis, much is not reported.
Consequently, it is hard for participants to get a true picture of the liquidity for an ETF. “It is, therefore, critical that ETFs are included in the requirement to publish and report all transacted volumes,” says the letter. Not only do the market participants want the trades reported, they also want them to be published on a consolidated basis so that they can be easily viewed in an industry-wide context – otherwise known as a consolidated tape.
However, attempts to establish a consolidated tape for the equities market have failed due to the lack of a regulatory requirement and commercial conflicts among market participants. The sell-side believes that trade reporting will increase the risk around execution and has focused on abolishing market data fees as recompense. The exchanges and market data vendors have sought to resist any price regulation.
Others say these commercial conflicts are a smokescreen to avoid making the changes that a consolidated tape would bring. The hope is that the desire within the ETF market to grow assets under management should supercede the obstacles impeding progress. There has been no formal reply from Esma, says Keshava Shastry, head of ETP capital markets at Deutsche Bank, but there is a dialogue between various market participants about ways to grow the ETF market, including how to encourage voluntary trade reporting.
However, says Shastry, unless MiFID II makes it mandatory, reporting will not be as prevalent as it could be. “There are both pre- and post-trade benefits to a consolidated tape – price discovery and evidence of the liquidity in a specific product,” says Shastry. “Market participants see these benefits, but without the regulatory requirement it will not be as high on everyone’s agenda to solve all the open points.”
This is not to say that trade reporting for OTC trades in the ETF market does not take place. In 2012, iShares, the ETF arm of BlackRock, and Bloomberg collaborated on a consolidated tape that aggregated all the reported data for iShares ETFs on 22 of the venues they are traded on. Elsewhere, venues such as the London Stock Exchange, have made trade reporting a feature of their rulebook.
And in September, Bats Chi-X Europe, the pan-European equities trading platform, extended its trade reporting service BXTR to cover European ETFs. “We are looking to persuade market makers, liquidity providers and brokers in the ETF market to report their OTC trades voluntarily ahead of MiFID II,” says Bats Chi-X chief executive Mark Hemsley. “We believe that more transparency would bring more certainty about market volume, more confidence in the market, tighter spreads and more liquidity."
MiFID II intends to introduce a tighter regime for trade reporting by authorising trade reporting vehicles that meet certain standards and Bats Chi-X hopes to be one of these vehicles. “We are saying to the market, report your ETF trades to us because you will have to do so anyway, so why not do it now to the benefit of the market and with a vehicle that is widely adopted and will be authorised under MiFID II,” comments Hemsley.
BXTR has also worked with industry players to develop a delayed reporting schedule that meets Esma’s stipulations which are designed to limit any possible market impact from making large ETF trades public. This means that a delay will be placed on a reporting of a trade, dependent on its size and inherent the risk of market impact.
Bats Chi-X Europe also hopes that it will be able to persuade not just those firms trading and reporting on its own venues but third parties trading reporting elsewhere to use BXTR as their single reporting resource solution for all pan-European trading. “Most of the European exchanges all have a trade reporting facility but our advantage is that we are pan-European.”
Bats Chi-X Europe is trying to position itself ahead of any announcement from Esma on a consolidated tape project. In addition to its pan-European model, it also hopes that its existing hold in the equities space can be translated to the ETF market by extending its focus and connectivity from the equity trading desks to the delta one desks where most OTC ETF activity emanates.
Bats Chi-X offers a facility that aggregates market-wide trading data and not just its own is the price of obtaining market data from other exchanges. “Our strategy is to have a low-cost service so we want to keep the cost of market data down and get a far wider dialogue. But to produce a truly industry-wide consolidated tape, you have to make sure that the data from other venues comes at a reasonable cost,” says Hemsley.
While it is easy to criticise the exchanges for onerous market data fees, the reality is their fees have little to do with the commercial model required to support a consolidated tape, says Mark Schaedel, co-founder of the Coba Project, a UK company that tried to establish a consolidated tape for Europe’s equity markets but was wound up in 2013 citing a lack of industry support. The collective costs of Europe’s exchange market data (approximately €480 per month per user) are often cited in comparison to the US ($100 per user), relying on a flawed comparison between the 50-plus exchange feeds to the US Consolidated Tape System rather than the equivalent costs related to the 14 US exchange feeds, which exceeds $500 per user.
These exchange feeds were neither priced nor designed for consolidation, making them unsuitable as the basis for a consolidated tape, says Schaedel, who is now managing director of the information division at market data provider Markit.
A price has to be established for the European tape and it has to be within reason, but the real work is about applying standards and rules, says Schaedel.
“If data is standardised, it can be consolidated. If there are clear rules which require trades to be reported and procedures for doing so, the consolidated data will be accurate and comprehensive.”
Whether there is one tape or many tapes, these rules and standards need appling. Yet the focus is on the wrong issues, says Schaedel. “The discussions are being overwhelmed by commercial smokescreens. The pace and manner of rulemaking is not allowing for consideration of the interdependencies and the opportunities for a properly designed solution. Instead, we need to understand how OTC trades will be reported and counted only once.
“We need to understand how this data will be combined with exchange data so that investors will be able to see the total liquidity across all markets.”
The US is commonly cited as an example of a market with a fully functioning consolidated tape and one where the size of the ETF market is much larger than in Europe. However, Schaedel believes that any consolidated tape in Europe should seek to avoid some of the limitations of the US market.
For example, the revenues that would be collected for the European tape should be allocated to those who contribute as in the US where tape revenue allocation has proven to be a powerful force which influences market behaviour and market structure. However, that revenue is restricted to exchanges in the US and Schaedel believes there is an opportunity to democratise the tape revenue allocation here in Europe to all markets thereby supporting innovation.
“These revenues could be allocated as a means of providing commercial incentives for desired behaviors rather than having to rely solely on regulatory monitoring and complex rules. For example, rather than complex rules and thresholds on dark pools, why not reward displayed markets for the information value they represent,” says Schaedel.
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