Trading ETFs on the London Stock Exchange

INTERVIEW: The UK market is leading the way in improving liquidity and transparency around ETF trading in Europe, explains Gillian Walmsley of the London Stock Exchange

Hortense Bioy, CFA 1 May, 2013 | 7:00AM
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We recently spoke with Gillian Walmsley, Head of Listed Products at London Stock Exchange (LSE) about the exchange’s success in attracting ETF trading volume, the measures being undertaken to improve transparency around ETF liquidity, and the continuous need for investor education.

Morningstar: 2012 wasn’t a good year for overall trading activity, and European ETP trading was no exception. ETP turnover fell significantly across all European exchanges, except on the London Stock Exchange. How did the LSE manage to maintain its ETP trading activity, and thus increase its market share in Europe?

Gillian Walmsley: Last year was certainly one of challenging market conditions and we did see a relatively small drop in trading volumes (value turnover for ETFs on our London market was down by 0.2% on the previous year) but despite this, a number of factors indicate that our ETF market continues to go from strength to strength. London Stock Exchange’s market share of ETF trading across Europe grew in 2012 and now accounts for 22% of all pan-European on-exchange ETF trading.

There was also considerable growth in trading fixed income ETFs, where turnover increased by 61% year on year. This was driven by wider market conditions, the current interest environment and the demand for yield, but it also indicated that investors are increasingly using ETFs to access particular asset classes. We saw higher turnover particularly in ETFs that provide exposure to Euro High Yield, Global Corporates and Emerging Markets local bond markets.

We also saw strong listing activity last year with 179 new ETFs issued and 34 ETPs coming to market, up 37% on the previous year. The LSE welcomed UBS, Vanguard and Boost as new ETF and ETP issuers to its market.

Morningstar: Total ETP trading volume and liquidity in Europe are still hard to gauge because, unlike equities, there are no requirements to report trades in ETFs and ETCs. The bulk of ETP trades continue to take place over the counter (OTC). What is LSE doing to change that and improve transparency?

Gillian Walmsley: It is very important that investors in ETFs are able to gain as full a picture as possible of the true extent of liquidity in ETFs. Naturally, there are different trading models to meet the needs of different types of customers, and while offering this flexibility, London Stock Exchange Group continues to be an active proponent of transparency and already imposes additional reporting requirements on ETFs that are admitted to trading on our London market. The Rules of LSE requires that even when trades are executed away from the electronic order book, if at least one of the parties is a member firm of LSE, the trade has to be reported. This allows investors to gain a broader view of the ETF liquidity available on our market and our reporting requirements mean that they are not limited to only seeing electronic liquidity. We also offer a voluntary OTC trade reporting facility so that customers can print trades in ETFs which are not listed on our market.

Morningstar: Do you have a sense of what OTC trades represent in the total ETP trading activity in the UK?

Gillian Walmsley: There are various estimates on what the proportion of OTC activity is in the European ETF markets but because this is not on-exchange business it is difficult to arrive at accurate numbers. ETF market participants estimate that around 60% of the trades are still executed OTC but we definitely see member firms showing increasing interest in reporting off-book ETF trades and directing more flows to the order-book for price discovery.  We are also looking at new ways to support execution of larger size trades on the order book and are developing new trading functionality to support block trades.

The reporting requirements of London Stock Exchange show that we are aiming to make as large a proportion of trades transparent as possible. London is currently one of the only markets in Europe to do this.

Morningstar: Many market participants see liquidity as one of the biggest challenges that the European ETP industry faces today. What can ETP providers and stock exchanges like the LSE do to improve liquidity in their own products for the benefit of investors?

Gillian Walmsley: Liquidity is an important feature of ETF markets and our London market has established itself as one of the key centres for ETF liquidity in Europe. Theliquidity of an ETF depends on a number of factors, including liquidity in the underlying securities making up the ETF and other factors such as the level of competition among market makers. London is well supported by a broad range of liquidity providers, including market makers and brokers.

Every ETF/ETP admitted to London Stock Exchange must have at least one registered market maker obliged to provide bid and ask prices within the applicable maximum spread and the minimum quote size for at least 90% of trading day. However, most of ETFs have multiple market makers and other liquidity providers, meaning greater price competition and enhanced liquidity.

Morningstar: With the RDR now a reality, what is the LSE doing to promote ETFs and other ETPs to advisers and the retail community?

Gillian Walmsley: As with all financial products, having educational materials for investors to make informed decisions is vital. We have seen growing appetite from financial advisors for information on ETFs and to respond to this we have developed a range of dedicated IFA resources on our website. We’ve also started to run CPD-qualifying educational events which explore the mechanics of ETFs and their uses in a portfolio. The impact of RDR is one which we explored in an expert roundtable session with key market participants: How the Retail Distribution Review will affect the ETF/ETC market, details of which are available on our website.

Morningstar: As the number of ETPs grows, providers are increasingly launching products with complex strategies embedded into them. I am referring here to leverage and inverse 3x ETPs, volatility, and alternatively-weighted ETPs. Do you feel the LSE has a role to play in ensuring these products are well-understood and adequately-used by retail investors?

Gillian Walmsley: One of key attractions of ETFs and other ETPs is the diverse range of markets and underlying asset classes to which they offer access.  As the universe of products expands and more complex structures are introduced, it is absolutely essential that investors have all the information they need to make informed investment choices. The ETF and ETP industry has been very proactive in making a wide range of educational resources available and for promoting transparency on product structures.  We are continually working with product issuers to see how we can support clear categorisation and product identification across the ETF and ETP product range.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Hortense Bioy, CFA

Hortense Bioy, CFA  is global head of sustainability research at Morningstar