International ETF Structure Goes Active

Terry Flanagan

Pimco has issued the the first actively managed fixed income exchange-traded fund under the international structure pioneered by Euroclear Bank, the international central securities depositary, in order to reduce ETF trading costs in Europe.

The Pimco Low Duration US Corporate Bond Source UCITS ETF listed yesterday on the London Stock Exchange.

Howard Chan, ETF product manager at Pimco said in a statement: “Pimco is known as an innovator offering value-added ETFs through active and smart beta strategies. This step continues that spirit of innovation to improve European ETF trading dynamics.”

In Europe the the same ETF can be listed on a number of national stock exchanges and settled locally in the national central securities depository of the exchange where the trade is executed.

As a result it is difficult and expensive to trade same ETF across borders i.e buy an ETF listed on one national exchange and sells it a on a different country’s exchange. Market participants need to have accounts with multiple national central securities depositories in order to move ETFs between countries, reconcile their positions and to follow different post-trade market practices in different markets. There is an increased potential for settlement failures, fines, counterparty compensation claims and ETF buy-ins to avoid settlement fails leading to ETFs in Europe trading at much wider spreads than in the US.

Stephan Pouyat, global head of capital markets at Euroclear, told Markets Media in October: “Domestic ETFs experience post-trade fiction as they are held in the local market with settlement dependent on the services offered by the local CSD, opening hours, currency and interoperability limitations. The international structure that we have introduced will greatly reduce this friction and the related costs and risk.”

He said at the time that a conservative estimate of the friction costs in settling European ETFs across borders under the current domestic set up is €200m. “Every week we see new market players adopting the international structure as they realise that trading is much easier than it was previously,” Pouyat added.

Euroclear said in a statement that firms investing in ETFs with an international format will benefit from greater levels of settlement efficiency, afforded through a longer intraday settlement window and the deep pool of international clients that are part of Euroclear’s securities settlement lending programme

“As a result of issuing in this international format, bid/offer spreads are expected to tighten considerably, which should drive greater investor interest in ETFs across Europe and beyond,’ Pouyat said.

In October State Street Global Advisors became the first issuer to migrate exchange-traded funds from a domestic structure to an international structure. SSGA is merging 13 SPDR ETFs, which are listed in different venues around Europe, to an international ETF structure under Irish Law.

In June BlackRock listed an iShares with an international structure on Bats Chi-X Europe in partnership with Euroclear.

Leland Clemons, head of iShares capital markets in EMEA said at the time: “Market infrastructure improvements are imperative to support the rapid growth of the ETF industry and we hope to see this structure adopted by providers across Europe to continue to drive the ETF market evolution.”

Nicholas Colas, chief market strategist at Convergex, a global brokerage company based in New York, said in a note today that assets under management at US listed ETFs are likely to surpass $2 trillion for the first time this month.

Colas said that over the last five years, mutual fund investors have redeemed $411.1bn in assets from US stock funds citing the Investment Company Institute. Over the same period, US equity ETFs received $301.5bn in fresh capital according to www.xtf.com, he said.

“That leaves a shortfall of over $100bn between the two investment types,” Colas added. “The most logical narrative: mutual fund investors are slowly swapping out of mutual funds and into lower-cost exchange traded funds.”

Colas described ETFs as one of the best examples of a “disruptive technology” Wall Street has seen in the last 50 years.

“Mutual funds, by the way, were the same in their day. Both democratized and simplified access to capital markets. They are the Uber of capital markets, pairing low(er) cost and convenience to offer a service previously associated with wealthier consumers,” said Colas.

Featured image via Comugnero Silvana/Dollar Photo Club

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