We recently spoke with Stephan Kraus, Vice President of Institutional Equity at Deutsche Börse, 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 German exchange, and the growth prospects for the European ETF market.
Morningstar: As the leading ETF exchange by market share in Europe, can you outline some of the key factors that have contributed to the Deutsche Börse's success in this category?
Kraus: We believe that three factors have been pivotal to the success of our XTF Exchange Traded Funds segment. First of all, we have been offering a highly attractive market maker programme right from the start of the segment in order to incentivise liquidity provision in ETFs. This has played a crucial role in increasing liquidity to a level where even large institutional orders can be executed cost-effectively with minimal market impact. Secondly, Deutsche Börse has been able to benefit greatly from its vast network of Xetra and Eurex members in terms of developing a truly international trading and distribution platform for ETFs. As a consequence, the majority of order flow in ETFs today originates from outside Germany and our offering comprises the largest number of ETF listings in Europe, which demonstrates the segment’s sustained attractiveness for both investors and issuers. Finally, we have committed ourselves already at an early stage of the market development to ongoing public relations by providing educational material on the advantages of ETFs to both investors and the media. This has certainly helped to increase the awareness and eventually the trading activity in ETFs since our segment was launched.
What steps can be taken to further improve ETF liquidity?
Probably the most rewarding step for an exchange is to further increase the number of investors actually using ETFs. We therefore continue to offer educational publications, host conferences and team up with issuers for road shows and seminars in order to address the growing interest in ETFs from both retail and institutional investors. In addition, we provide the market with various statistical information on ETF trading volumes and liquidity, as many investors require a certain level of [trading] activity before considering an investment. The information provided also includes OTC data, which enables investors to arrive at a more complete picture when evaluating the total trading activity in an ETF.
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 Deutsche Börse?
Deutsche Börse’s electronic trading system Xetra features volatility interruptions as safeguards against potential flash crashes. Volatility interruptions are automatically initiated if the potential execution price of an order lies outside a pre-defined price range around a given reference price. Once a volatility interruption has been initiated, continuous trading is interrupted and a change in trading form to auction is triggered. Market participants are informed of this market situation and may react to it by either adding, modifying or deleting orders and quotes. Continuous trading resumes after a certain minimum duration of the auction. In case of larger price deviations, the auction is extended until the volatility interruption is terminated manually. Given the described circuit breaker mechanism, a scenario similar to May 6 in the US is impossible to happen on Xetra. This is particularly true since the calculation of the DAX is based on Xetra data only, thereby effectively taking into account trading interruptions on Xetra while other platforms may continue to trade.
How much ETF trading is still taking place over the counter in Germany?
Based on data available from Clearstream’s Cascade OTC functionality, we estimate that approximately 60% of total ETF trading takes place over the counter. However, this data also includes creation and redemption transactions of Authorised Participants.
What can be done to attract those trades to the exchange?
The average OTC order size is a multiple of the average on-exchange order size, which gives clear indication of the motivation for trading over the counter: minimising market impact when trading very large orders. In order to attract these transactions to the exchange, ETF liquidity will have to improve further. Given the advantages of trading on regulated markets, such as the existence of a clearing house and supervision by market regulators, and the continuing increase in ETF liquidity over the past few years, we are optimistic that a growing number of ETF transactions will move from OTC to on-exchange in the future.
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.)?
We firmly believe that ETFs will continue to gain popularity among all classes of investors. For example, in the United States, ETFs account for more than 6% of total mutual fund assets. In Europe, however, the ETF share of total mutual fund assets is only 3% and thus hints at the strong growth potential that can be expected from the European market in the future. The advent of fee-based investment advisory services will certainly help to support this growth as an increasing number of individual investors become more and more aware of the advantages offered by ETFs.
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?
From our point of view, increased post-trade transparency would be beneficial for the European ETF market as it would provide investors with full transparency on the total trading activity in ETFs. Greater transparency is also likely to increase on-exchange ETF volumes, as a larger number of investors would be attracted to the product.
