The changing ETF trading landscape, pressure of fees and the continued explosion of ESG are some of the key themes set to dominate the European ETF ecosystem this year.

ETFs continued their meteoric rise in 2020 posting €102.7bn inflows over the 12 months, according to data from Morningstar, just shy of the record €107bn set in 2019.

Driving these inflows was strong investor demand for ESG ETFs which saw assets increase 137% to €90.4bn while ETF issuers launched 85 strategies in this segment, double the number seen over the past two years combined.

European Union regulation around the ESG data disclosure requirements and definition of standards is set to ensure this trend continues in 2021, according to Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence.

The European Commission’s all-encompassing Sustainable Finance Action Plan, for example, has clarified the duties of institutional investors and asset managers when it come to sustainable investing touching on areas such as the suitability of financial instruments and the need for more transparency on ESG benchmarks.

For Simon Barriball, ETP and portfolio trading, Europe, at Virtu Financial, ETFs will be front and centre of this trend.

With the wide range of options available and the transparency of the wrapper’s rules-based approach, investors are able to select the strategy that suits their needs best.

As Jose Garcia-Zarate, associate director, passive strategies, manager research, Europe, at Morningstar, said: “ESG remains top of the list for product development for most ETF houses, with all considering it a structural trend that will change the way we invest.

“There certainly are good reasons to believe that this can be the case and so we should expect the offering of ESG ETFs to grow strongly.”

European ETF industry review 2020

Another factor driving assets to ESG ETFs is around costs. The average equity ESG ETP in Europe has a total expense ratio (TER) of 0.26% versus 0.34% for a non-ESG ETF, according to data from Bloomberg Intelligence.

Lower fees across the board, Psarofagis stressed, would be a key way for ETF issuers to steal market share from BlackRock this year.

The world’s largest asset manager saw €51.1bn inflows into its European ETF range last year taking its market share to 44.3%.

However, there is plenty of potential to take advantage of the firm’s current fees given that only 12% of its Europe ETFs have fees under 0.10%. The low fee approach worked for Vanguard last year as it saw €6.5bn inflows while Invesco’s cheaper S&P 500 ETFs also attracted flows, Psarofagis highlighted.

ETF liquidity

The way investors access liquidity will be a key topic in 2021 following major developments over the past few years.

In particular, ETF trading flows have migrated to request-for-quote (RFQ) multilateral trading facilities (MTFs) following the introduction of MiFID II.

According to data from Bloomberg, 37.3% of ETF trading in Europe takes place on MTFs while just 29.7% is on exchange while the remaining 33.1% is on other over-the-counter (OTC) venues such as dark pools.

However, Pravin Bagree, head of ETF capital markets at UBS Asset Management, said exchanges are “fighting back aggressively” by implementing their own RFQs.

“We continue to see more clients using RFQ platforms and view the development of exchange RFQs as positive for the ETF trading ecosystem,” Bagree continued.

“RFQ platforms have transformed the order workflow and embedded the concept of competition when executing. Clients will need a compelling reason to change, however, we strongly believe investors require different execution options depending on their benchmark and size of trade.”

This potential shift to more trading through exchanges comes alongside the demand for more automated ETF trading.

Barriball said: “We see faster trading so automated RFQ functionality is of interest to clients and to what extent the exchange RFQs add some additional functionality will be of interest.”

Brexit

Overall, the ETF industry in Europe looks set to cope with the challenges posed by Brexit despite the lack of coverage for the financial services sector in the details of the deal.

As Garcia-Zarate said: “In terms of regulation, the main attention will be on how the lack of coverage of financial services in the EU-UK Brexit deal may impact a truly cross-border investment product like the ETF.”

The Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA) did announce a memorandum of understanding in March 2019.

Ivan Gilmore, head of exchange traded products and global product development at the London Stock Exchange, explained: “Even in the absence of clarity on equivalence, once we knew the memorandum of understanding was agreed between the regulatory bodies we moved to assure the ETF community that trading access would not change in the event of a hard Brexit.”