MiFID II – the EU directive that came into force in January 2018 – is affecting how industry players view the role of ETFs. In particular, the directive is highlighting a renewed focus on value, trade transparency and liquidity – and driving awareness about ETFs as a way to invest across asset classes and geographies.
Headlines
MiFID II helps investors with broker and trading venue selection, which can mean tighter pricing.
- Increased trading on venues, combined with increased MiFID transparency, means that investors can find the most competitive pricing.
- Increased transparency of ETF trading volumes under MiFID is helping investors become comfortable that the industry is big and liquid enough to be an efficient way to invest.
- While there is some debate around the value of intra-day trading of ETFs, the attraction, especially for those trading larger ticket items, is the flexibility, speed and ease of trading it offers.
Key themes
The evolution of ETFs can be loosely compared to that of the music industry: going from vinyl to tape to CD to Spotify – you are still listening to the same tune / track, yet the channel via which it is accessed has evolved; this is analogous with ETFs.
A common misconception about ETFs is that they are synonymous with passive. This is outdated and not strictly true. Another is that the ETF industry is too big.
ETFs offers more liquidity and assists with price discovery and transparency – both of which are in the spirit of MiFID II. By adopting the RFQ hub – a direct result of MiFID’s (unbundling the costs of research, trading, dealing directive), dealers are executing on best price pre- and post- trade.
Studies have also shown that if the market drops, instead of ETFs suffering, the volume in trading actually increases; and times of volatility and stress can inject much needed liquidity.
Yet some delegates argued that MiFID II changed little for them and their clients because they were competitive to begin with:
“Not much has changed for us internally. Our fee structure is transparent and we don’t feel like we need to open up or change, pursue smart beta etc.”
So what role do ETFs play in portfolio construction among those who are exposed?
“It’s unlikely to be driven by price point. Though some players are more predisposed to it than others… it depends where you’re coming from (size, scale of firm and so on)”.
There is a debate around intraday liquidity and why some professionals are so focused on it.
“Times you need to trade intraday are very few. It’s not rational to place so much emphasis on it. We spend our life convincing clients they should be investing for the future, have a three-to-five-year investment outlook, yet here we are, debating the importance of intraday liquidity.”
Given the ongoing worries around ETFs, especially the synthetic ones, investors need to ensure they understand how to trade them responsibly.
“Is what you’re getting actually what you’re getting? What exposures are you getting? Derivatives bought without advice move you away from what you originally thought you were initially buying.”
So, as MiFID dictates, we should continue to ensure best outcomes for our clients and think about the next steps in the evolution of the fund range.
Conclusions
ETFs suffer from an image problem – some of which is historic i.e. how they performed in the financial crisis. And while there has been progress (with greater expertise, price discovery, transparency), many in the room remain reticent to embrace them fully. The logical next step is therefore to learn from the past, know the product and act in an informed way on that knowledge.
Expert: John Adu, JP Morgan
