Flow Traders is calling for a same day creation model to be implemented after warning ETF investors are incurring the cost of wider bid-offer spreads due to inefficiencies in the T+1 creation process.
The Dutch market maker said costs ranging from 1.5-4.5 basis points (bps) were being passed on to investors due to overnight interest rate dynamics, which can benefit certain market participants.
It added members of the ecosystem that have received funds for creation but have not distributed them to purchase the underlying basket of securities can benefit from overnight interest rates, currently at 16-year highs, while authorised participants (APs) incur a cost.
This is particularly true of global funds where T+1 creation is required to synchronise with secondary markets transactions, meaning APs take on these interest rate costs.
As a result, it said those that benefit should pass back the overnight interest rate to the APs in order for the savings to be passed on to the investors, who are "paying the price" for this market inefficiency.
“To better address the allocation of costs, our first recommendation is to partially pass back the overnight interest rates to the AP when the custodian has received funds for a creation but not yet utilised it for purchasing the underlying basket” the liquidity provider said.
"We believe through the industry working together on such a solution it will lead to a more efficient market and a better outcomes for the end investor."
The warning from Flow Traders comes in response to the European Securities Market Authority (ESMA) consultation – which closed in December – on the potential move to a T+1 settlement cycle in Europe.
The securities watchdog said it wanted to assess the viability of moving to a T+1 cycle and comes after the US regulator announced its intention to move to a T+1 settlement cycle by May 2024, while India migrated its markets to a T+1 settlement cycle in January 2023.
T+1 settlement cycles
Despite this, Flow Traders raised concerns about moving to a T+1 settlement cycle while creations also operate on a T+1 basis.
It called for a same-day creation model (T+0) for global funds to “lay the foundation” for T+1 settlement cycles in Europe, with failure to do so “significantly increasing the amount of failed settlements in the market”, increasing the cost to the end investor.
“If same-day creation is not allowed, the earliest settlement for global funds is still T+2 as per current, limiting the possibility of achieving T+1 settlement cycles in European/UK markets,” the group said.
“Through same-day creations, the secondary market transactions are harmonised with the primary market creations, reducing additional funding requirements for APs.”
The proposed model would see same day creations on European and US proportions of the basket, with Asia executing on a T+1 creation cycle, meaning settlement could then occur on a T+1 basis.
“By addressing the issues of overnight interest rate handling and advocating for same-day creation for global funds, the goal is to harmonise interests, reduce costs and pave the way for more streamlined settlement cycles,” Flow Traders said.
As part of the consultation, ESMA also asked market participants to consider the impact of eventually moving to a T+0 settlement cycle.
It is widely thought the move would drive more efficient use of capital across markets by reducing credit, market and liquidity risks.
ESMA said it hopes to publish its final report in Q4 this year.
