We recently spoke with Gillian Walmsley at the London Stock Exchange about the exchange’s success in attracting ETF trading volume, the measures being undertaken to further increase on-exchange liquidity, the potential for a “flash crash” on the London exchange, and the growth prospects for the UK retail market.
Morningstar: As one of the leading ETF exchanges by market share in Europe, can you outline some of the key factors that have contributed to the London Stock Exchange’s success in this category?
Gillian Walmsley: Although London has had an ETF sector since 2000, development of the market was held back by the UK tax regime, in particular the application of stamp duty to UK-listed ETFs. Following amendments to the stamp duty regime on ETFs in 2007, we saw a dramatic increase in new listings, as European issuers could list in the UK. Our merger with Borsa Italiana has created a very successful group for ETFs with each exchange offering its own strengths: Italy has a strong retail investor base while the UK is largely institutional. With over 700 ETFs trading on one platform across London and Milan, and a greater trading volume than any other operator, we believe we have a diverse and comprehensive offering: the best in Europe.
Morningstar: What measures does the exchange have in place to prevent a “flash crash” like the one witnessed on May 6 in the US? Specifically, are there presently "circuit breakers" in place that would bring a halt to trading under a similar scenario? Are market makers obliged to actively quote bid and offer prices under these extreme circumstances? Are there any additional measures that can be put in place to prevent a similar market disruption on the London Stock Exchange?
Walmsley: We've had our own version of so-called 'circuit breakers' in place at the Exchange for many years, as have other European exchanges. If an ETF price breaches a certain percentage threshold in its variance from the last traded price and the previous day's close, the Exchange's system will prevent this order from executing and the ETF will go into auction mode before resuming continuous trading. Market makers are obliged under Exchange rules to supply continuous two-way prices in a specified minimum quote size and maximum bid/offer spread width throughout the trading session. A market maker may withdraw quotes when hit on an order but this is only for a maximum of ninety seconds to allow quotes to be refreshed and after this short period continuous quoting must be resumed. The causes of the market event in New York are still being debated, so we would hesitate to say something similar could never happen here. But we take the operation of an orderly market very seriously, and continually review the measures we have in place to minimise the risk of that orderly operation being disrupted.
Morningstar: How much ETF trading is still taking place over the counter in the UK?
Walmsley: There is an active OTC market in ETFs and because these transactions are not transparent to the wider market, many investors do not see the full scale of liquidity in these instruments. It is certainly our aim to encourage greater transparency in ETFs so that investors can gain the full picture with respect to turnover in this market.
Morningstar: What can be done to attract those trades to the exchange?
Walmsley: It is important that the benefits of greater transparency and of central counterparties are fully promoted to users of ETFs. For our part we need to offer an attractive service, which we do: we have a huge range of ETF issuers and products, and a highly liquid order book for them to trade on. As investors continue to see the benefits on transparent, secure, on-exchange trading in the current environment, we expect volumes to grow further. The London Stock Exchange's rules require that all on-exchange trades must be reported to the Exchange or to a venue of greater or equivalent transparency, this is not the case for other European venues who do not require all off-book transactions to be reported. We also offer a voluntary OTC trade reporting facility for a number of non-London listed ETFs to allow customers to print details of transactions in these European ETFs if they so wish.
Morningstar: What do you see as the largest potential growth opportunity for the ETF category? (increased use by hedge funds, insurance companies, private banks, individuals, etc.)
Walmsley: ETFs are a fantastic growth story across the board and I think there's scope for considerable further growth in usage among all market participants. At the moment however, we are making a particular effort to open up the ETF market in the UK to the retail investment community. Promoting the advantages of ETFs to private investors, and educating them on their characteristics is important and we actively support initiatives which do so, as well as leading our own. In the UK, the FSA's Retail Distribution Review (RDR) which specifically highlights ETFs as a product appropriate for private investors, is expected to stimulate wider retail participation in ETFs.
Morningatar: How might prospective changes to MiFID affect your ETF volumes? Would the promise of improved pre-trade transparency, best execution, and clearing attract more ETF volumes onto the exchange?
Walmsley: We need to wait to see what changes will arise from the MiFID review before commenting on them. But any measures which improve the ETF experience for participants accessing our markets are welcome. We'll be looking out for proposals which maintain and enhance the benefits ETFs are well known for: transparency, diversity, simplicity and cost effectiveness for the end investor.
