In recent years, exchange-traded funds (ETFs) have undergone significant evolution, shifting from simple passive investment instruments to more versatile tools that help reinforce a range of strategies. Initially known to track broad market indices, today’s ETFs cover niche sectors and even include thematic investments.
These innovations have attracted a wide range of investors – from institutional to retail – who seek to increase returns and manage risks in an ever-shifting market environment. However, huge disparities exist between trading volumes in the US and Pan-European markets.
Looking at the data, iShares by BlackRock reported that in the first quarter of 2024, trading volumes for US ETFs were at $10.6 trillion. In Europe, ETFs accounted for $782.9 billion in the same period. This can be attributed to differing ways in which active ETFs are adopted, fragmentation in Europe, differing levels of retail engagement, as well as the presence of an established consolidated data source in the US.
A key theme linked to the evolution of ETFs globally has been the increase in scope of products offered to the market. Product type enhancements have led to a wider range of prospective investors. As a result of this increased demand and competition, costs have risen, which have ultimately led to ETFs attracting more attention from investors. Assets under management (AUM) and trading volumes for this asset class have experienced a significant rise over the last few years.
“Consequently, ETF trading techniques have evolved to source new pricing opportunities either via electronic request for quote (RFQ) platforms and/or ETF algos and to take advantage of ETF trading provision at the exchanges themselves,” says Tim Miller, senior trader at Fidelity International. “We have also seen traditional ETF liquidity provision firms moving into forming bilateral relationships with buy-side dealing desks which has further strengthened ETF pricing.”
Active ETFs
Actively managed ETFs have introduced a new dimension to the ETF landscape. The instruments combine traditional active management with the liquidity and transparency of ETFs, while providing access to specific investment processes such as index outperformance and income generation, alongside maintaining the key characteristics of ETF structures.
“Active is a game changer and it’s going to broaden the audience yet again for the product set. It’s going to disrupt the traditional mutual fund market and I truly believe it’s going to position ETFs as the wrapper of choice for managers,” says Chris Gooch, head of ETF/index sales and business development, EMEA at Citi.
“What’s particularly notable is the willingness of big asset managers to launch their latest active strategies in an ETF wrapper. And for me that means that every asset manager is going to need to have a clear strategy of how they’re going to respond.”
The US market is undeniably ahead of Europe in its adoption of active ETFs thanks to the Securities and Exchange Commission’s (SEC) relaxation of its regulation in 2019, which resulted in more discretion in ETFs.
The relaxation meant that ETFs would no longer have to make their holdings public on a daily basis, which became more attractive to active fund managers who view their stock picking abilities as intellectual property. Within Europe, disclosure on portfolio holdings is still required on a daily basis, and has previously stifled adoption in the region. However, with time, adoption of active ETFs is becoming more apparent.
“The impact of there being more acceptance of active ETFs within Europe means that when you look at trading costs like spreads or the creation redemption costs, you’re starting to see them narrow and become more like passive traded ETFs,” notes David Smith, head of ETF sales at SIX Swiss Exchange.
“There’s less difference between the two and we’ve seen the popularity certainly increase in active ETFs. All that being said, active is a small part of the European ETF industry, accounting for approximately 2% of AUM according to ETFGI as of April 2024.”
Active ETFs have been released across different asset classes and have appealed to new and old ETF investors alike as they provide middle ground between passive and active investing, emphasises Miller.
“Through active ETFs, managers are able to offer access to internal intellectual property and house expertise such as bottom-up stock research, allocation weightings etc that not only differentiate their product but can help investors generate alpha for a portfolio alongside core passive holdings,” he says.
Disparities in trading volumes
Despite continued evolution for the asset class in a broader sense across the globe, it can’t be ignored that trading volumes for ETFs in the US far exceed those in Europe and the UK. This reflects a more mature and established market present in the US, with greater investor adoption and noticeable liquidity.
“At the broadest level, the US ETF market benefits from having launched the first funds around 10 years ahead of Europe and therefore is much more embedded in the investment psyche, particularly among retail investors,” highlights Miller.
“Although the US ETF market is undoubtedly larger than Europe, the top 100 US-listed ETFs account for around two-thirds of both the entire US ETF assets and trading volumes, demonstrating that the US is characterised by a relatively small number of mega AUM ETFs and mega-liquid ETFs. Outside of the top 100 or so it starts to look a lot more like Europe.”
Several factors exist which contribute towards greater ETF volumes in the US. Europe and the UK have noticeably less AUM linked to the segment, but also, various jurisdictions, venues and clearing houses which contribute to the disparities in trading volumes.
“In Europe, there are about 11,000 different trading lines of ETFs. That liquidity can be spread across the different countries and different listings,” highlights Smith. “There’s multiple listings of the same ETF, whereas the US doesn’t face that same problem and that can mean that liquidity is more concentrated in a fewer number of ETFs.”
ETFs in the US typically experience more favourable liquidity compared to their European counterparts, resulting in narrower bid-ask spreads and more efficient trading. Contrastingly, European ETFs often experience lower trading volumes, which can lead to wider spreads and less favourable execution for investors.
“The US has many immensely liquid, mega-sized ETFs that trade colossal amounts. Europe just doesn’t have the liquidity that the US does,” emphasises Simon Barriball, ETP and portfolio trading Europe at Virtu Financial. “We don’t have ETFs with that scale of AUM in them or anything like the daily turnover on screen in the US and that’s a huge differentiator.”
Fragmentation
With ETFs increasingly becoming more popular in Europe, fragmentation and regulation have been pegged as two key pain points that need to be addressed going forward to boost growth in the region – a viewpoint that has been echoed at various panels at conferences in recent months.
“The most obvious impact of fragmentation has been on the perception of an absence of secondary-market liquidity,” highlights Miller. “This has mostly likely held back some adoption of ETFs from investors but has also led to increased innovation from all market participants to source, aggregate and efficiently price ETFs.”
Echoing this sentiment, Citi’s Gooch notes that European fragmentation makes it hard for investors to get a true representation of what the actual liquidity is for ETFs in the European market.
“That [fragmentation] has led to the perception, I would argue incorrectly, that the European market is not liquid,” argues Gooch. “This has stopped new clients adopting ETFs and has led some clients to trade ETFs listed in the US, rather than ETFs listed in Europe, even with the structural benefits that European ETFs can present to certain investors.”
Fragmentation does, however, provide some benefits, in the sense that it gives investors increased choice when considering their different objectives, where to trade and settle, as well as the types of currency they would like to execute in. It is, nevertheless, more complicated to navigate a fragmented environment, especially if liquidity does not always appear to be there across the different lines of ETFs.
“The fragmentation in Europe extends to the fragmentation of how orders are executed. Probably only about 20% of trading is on exchange, 50% of trading is in RFQs and the remaining 30% are over SIs and other MTF type venues,” notes Barriball. “There’s also the fragmentation of trading and I think that in itself, affects the perception of liquidity as well, because you need to have a broker who can help you find where the liquidity is.”
Retail
Another key driver that leads to the disparities in trading volumes when comparing the US with the UK and Europe is the region’s differing levels of retail participation – with retail activity making up 5-7% of total trading in Europe compared to over 25% in the US . As a historically more passive instrument, ETFs have proved popular with retail investors who don’t want to take on too much risk.
“Already, it’s a bigger market, but the split of that market is much more evenly institutional and retail,” says Gooch. “There’s much more of a trading mindset in how they’re using the products, whereas the institutional client base, particularly in Europe, is much more around strategic asset allocation and tactical asset allocation, which doesn’t have the same trading velocity.”
Retail adoption of ETFs in the US is more prevalent than in Europe largely because of a more widespread investment culture among individuals, backed by more favourable regulatory conditions. The US also has a larger variety of ETFs available and when paired with better investor education and greater access, this encourages more participation from retail investors.
“Increasing adoption of ETFs from the retail community combined with improved connectivity from platforms to exchanges creates opportunities for buy-side dealers to interact with these improved volumes on exchange as professional and retail volumes create a better dynamic for orderbook trading,” notes Miller.
Technology firms, in this context, are able to help platform providers simplify ETF procedures, ultimately removing complexity linked to legacy systems, to enable clients to have improved ETF trading experiences on said platforms.
Elsewhere, looking forward, Citi’s Gooch suggests that the EU’s retail investment strategy also has potential to help boost ETF participation in the region. “Some of this was watered down from what many in the ETF industry were hoping for, but it is, at the heart of it, pushing for retail investors to be treated much more fairly,” he says. “The ETF as a cost-efficient vehicle can only win from that statement of intent.”
Consolidated tape
Looking at potential innovations to boost ETF adoption in the UK and Europe, it comes as no surprise that one of the first things that comes to mind is a consolidated tape. A consolidated tape in Europe will enhance transparency and price discovery in the ETF market, simplifying investors’ access to real-time data across different venues.
As a result, the improved visibility could lead to a boost in market liquidity and efficiency, which would be beneficial for all market participants. It could also lead to a boost in retail volumes if individual investors had access to a clearer view of the market, alongside more participation from institutions.
“If you understand what the aggregate volume is and the true volume, it’s a real benefit to issuers trying to get people to invest in ETFs in the first place, because you realise just how liquid they are in aggregate. The absence of that information means you have to go looking for it – and many people don’t,” argues Barriball. “A consolidated tape would have huge benefits to ETF issuers trying to get more money into ETFs, improving people’s understanding of aggregate liquidity and also for making meaningful pre- and post-trade calculations.”
Such benefits have already been observed in the US, which has had an established consolidated data source in place for years. This creates enhanced market transparency by providing real-time, consolidated trade and quote data across all major exchanges, helping improve price discovery, market efficiency, and investor confidence through the presentation of key market information.
“In the US, where we do have a consolidated tape, that has allowed for the asset class to grow at a much bigger rate from a distribution standpoint when liquidity is easily accessible, easily visible and the execution quality that comes on the back of that is just better. It’s allowed many different firms to launch ETFs and grow AUM by going out to the investor community and selling those ETFs confidently,” says Brian Gilman, ETF & FI liquidity sales at Virtu Financial.
“In the States, you’re already starting with this head start of investor confidence because of execution quality and the consolidated tape. From a distribution standpoint it’s an easier arena for sure.”
Regulators within Europe and the UK appear to be geared towards ensuring greater transparency, which is manifesting itself through a consolidated tape. However, how this will materialise when considering ETFs specifically has not yet been finalised. Regardless, it’s expected that it will help with frustrations associated with fragmentation as discussed before.
Lessons from the US
When comparing these two regions, it’s worth considering what could be learned from the US and translated into European markets to help improve the ETF landscape. The US has a handful of very dominant exchanges, one dominant clearer and a key currency. However, such characteristics cannot directly be translated into a European context.
“There is a lot around the US that simply are structural advantages of that market which we cannot emulate,” emphasises Gooch. “However, we’ve got the innovation that’s currently happening around retail and is appealing to the next generation of investors, which is great because that’s where there’s going to be this huge passing of wealth.”
Moving forward, there are number of things that can be adopted from across the pond to help boost trading volumes within the UK and Europe. Namely, boosting active ETFs through the relaxation of regulations linked to disclosures, a promotion of retail engagement, and greater transparency in the form of a consolidated market data source, which will ultimately contribute to more liquidity. Can Europe eventually match or compete with the US when considering trading volumes for this specific asset class? Only time will tell – following in the US’ footsteps might not be such a bad idea.