Unintended consequences of Mifid II could undermine the broader benefits that the ETF market stands to gain from increased transparency around trading and costs, according to Simon Barriball, head of ETP Trading in Europe for ITG.
The technology company for some time has been assessing the practical implications of Mifid II on trading, given its history of enabling trading through the Posit and Posit Alert solutions used in markets globally. ITG’s technology addresses liquidity, execution, analytics and workflow on trading desks.
“ETFs are becoming more than just passives,” notes Barriball, outlining how the role of exchange traded products is evolving from just being a matter of passive versus active choice. Increasingly it is about cost issues per se, whether the investment is being actively or passively managed.
“The cost justification will drive more money into ETFs, particularly as they move away from the core passive based investments. There will be more options for clients to consider,” Barriball says.
In terms of the impact of Mifid II and uptake of ETFs, he says that “As things stand now, with lack of on screen trading and reporting, people struggle to have same level of pre and post level transparency as they get from trading directly into equities.”
This, as well as the sometimes lack of deep understanding of the costs of trading ETPs may be acting as barriers to more interaction with such products, but “a lot of that will be dealt with by Mifid II”, for example through the trading reporting requirements. These mean more visibility of trading volume, and should lead to improved understanding of what it costs to trade on an exchange and compare that with OTC traded instruments.
“That element of it is very positive,” Barriball stresses.
Improved transparency around the product, improved understanding of pre and post trading costs, should contribute to a boost in the takeup of ETFs, he says. The improved transaction costs in particular should remove what has been a stumbling block for institutional investors, he further argues. That said, the change will not come overnight, but will take some time, he adds
One reason for this is, for example, that it will take time to build up the volume of data around pre- and post-trading data.
“A couple of months isn’t enough to make decisions, but as analytics catches up and more data is available and longer time lines available, then there is more information to make decisions.”
Barriball says that although he strongly agrees with the general view that Mifid II is positive for ETFs, there is also potential for unintended consequences, including behavioural changes.
He notes that ETP trading in Europe is relatively illiquid, with the bulk of trading done over the counter. What Mifid II and enhanced trading requirements is likely to result in is a push towards RFQ (request for quote) platforms.
These serve an important purpose in terms of accessing liquidity, but what Barriball and ITG have noted in the past is that when trading desks take on RFQ facilitites it can change user behaviour.
“They become very reliant on it. That could lead to some detrimental impact. More people taking up RFQ means more trading away from primary exchanges. And issuers and traders across desks might see that as a slightly negative outcome.”
ETFs in Europe might garner more support if they traded more on primary exchanges, Barriball suggests. The unintended consequences therefore are linked to perceptions of liquidity. It might not necessarily be reality, but as a factor it may be acting as a barrier to greater takeup of ETFs. As the market evolves post Mifid II, it may result in an uptick in volumes away from primary markets.
What that in turn means for ITG and other analytics firms giving clients access to the data for making better trading and execution choices is that they need to ensure they can provide interaction with all liquidity sources. That means being able to look at on exchange liquidity and the costs of on exchange trading versus OTC.
What cannot be said is that there is a one-size-fits-all solution.
“Best execution, like selecting the ETF in the first place, is very selective and relates to the individual products,” Barriball says.
“You need to look not just at TER, but also tracking, the tradeability of product and other issues.”
The money being invested in some illiquid products may justify RFQ, whereas for others it may be more suitable to use on exchange liquidity. Ultimately, he says: “It means having tools to hand to choose right execution methodology.”