Tradeweb’s Pace: Secondary market ETF volumes improving in Europe

Ratio of secondary to primary market ETF trading higher in the US

Tom Eckett

a man in a suit and tie

Adriano Pace, head of equities, Europe, at Tradeweb, has said the growing ratio of secondary to primary market ETF trading in Europe will benefit the wrapper during periods of heightened volatility.

Speaking at ETF Stream’s Big Call: Fixed Income event on 4 November, Pace (pictured) said the continent’s ETF ecosystem remained around seven years behind the US which has a higher ratio of trading on the secondary market.

When trading takes place on the secondary market, authorised participants (APs) do not have to enter the creation-redemption process in the primary market which can cause frictions between an ETF and its underlying holdings, particularly during periods of market stress.

As the ecosystem in Europe progresses, however, Pace predicted the secondary market would begin to resemble the picture in the US where there is less of an overreliance of trading in the primary market.

The ETF wrapper was put to the test during the March volatility when liquidity from the corporate bond market vanished.

Discounts on fixed income ETFs blew out as a result with as many as 80% of investment-grade corporate bond ETFs trading at all-time high discounts, according to a research note from Citi.

Although Pace noted there was an overreliance on two or three liquidity providers during this period, he added ETFs acted as the reference point for price discovery compared to the stale NAVs which were not reflecting the true price of the underlying bonds.

“An ETF’s NAV is trying to reflect what the basket of underlying securities are indicating,” he continued. “However, there was a problem with the way NAVs were calculated during the volatility whether that be because the underlying bonds were not trading or because they did not reflect the risk premium embedded.

“The analysis we have done would indicate whoever is providing the NAVs for these ETFs was not fully reflecting the price where investors genuinely would have been able to sell.”

What happens when the lights go out? An analysis of ETFs when liquidity vanishes

At the other end of the spectrum, Pace, who was named in ETF Stream’s Industry 30 2020, said APs were doing the right job by factoring how difficult it would be to sell the underlying securities and how long a holding period they would need before offloading the positions.

If calculations remain behind and NAVs are stale, Pace warned wide discounts on ETFs would happen again as the ETF is reflecting the true mark at where the underlying bonds are priced.

“The ETF was the best reference point [during the March volatility] but NAVs are subject to improvement over time,” he added.

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