The London Stock Exchange is aiming to launch clearing for exchange-trade funds next year to ease balance sheet pressures for market makers and to encourage a shift to trading ETFs on an exchange.

Brian Schwieger, global head of equites and co-head equity, funds and fixed income, secondary markets at London Stock Exchange Group, told Markets Media the the firm has been successful with a request for quote and clearing functionality for ETFs in its Italian market. Feedback from market makers had led to plans to launch this functionality in London in the spring of next year.

Schwieger told Markets Media: “This is an important step as the CCP gets ETFs off a market maker’s balance sheet. The biggest trend over next two years for infrastructure providers will be to help clients use their balance sheet more efficiently.”

In addition once ETFs are cleared, clients and eligible members will benefit from portfolio margining opportunities. There may be margin offsets between listed products and cleared over-the counter products in the same CCP. For example, the UK exchange owns clearing house LCH but has an open access model.

Schwieger  continued that RFQs will also be more compatible with market makers’ liquidity seeking algos. Instead of sending RFQs bilaterally, clearing members will send their RFQs to the LSE, thus removing counterparty risk. All ETFs listed in London will be eligible for the new service and Schwieger added that others are under review.

The RFQ platform will run alongside the existing order book structure providing a mechanism whereby traders can privately negotiate and carry out large trades with market makers outside of the normal order book

In Europe it is estimated that approximately 70% of ETF trading is over-the-counter so the RFQ could encourage a shift to more trading on exchange. In addition, MiFID II, the new regulations covering European Union financial markets from January 2018, will introduce new pre and post-trade transparency requirements for ETFs.

“The RFQ platform could be very different a year from now,” Schwieger added. “This is just the first step under MiFID II as we do not know how the regulations will affect liquidity, especially in fixed income.”

Detlef Glow, head of EMEA research at date provider Lipper, said in a note this morning that ETFs have been a success story in Europe over the past 15 years and the market does not yet seem to be oversaturated. Instead, new players have entered the market, despite high competition, although not all of them may be profitable.

Glow said: ‘There is a sweet spot (the “smart beta segment”) where the competition is not that high and the pressure on management fees is quite low. Fund promoters can differentiate themselves there by using particular factors or by the way they structure the underlying indices for their ETFs.”

He noted that ETF boutiques such as Wisdom Tree and First Trust offer ETFs based on indices they have developed while Candriam, Fidelity and Franklin Templeton have all entered the European market through offering active ETFs.

In September US asset manager Franklin Templeton Investments launched its first range of smart beta ETFs in Europe and the four funds were listed on Deutsche Börse and the London Stock Exchange. Smart beta ETFs do not track indexes just based on market capitalisation but instead track indexes based on other characteristics such as dividends or low volatility.

At the time the London Stock Exchange said it had 27 dedicated active ETP issuers. In the first half of this year there was more than £163bn ($214bn) of on-exchange trading in ETPs on the exchange.

“During the summer we learned that JP Morgan is going to launch in Europe later this year a suite of ETFs based on hedge fund strategies, while Amundi (a well-established ETF promoter in Europe) launched on Euronext Paris at the beginning of this month an ETF with a market-neutral strategy,” Glow added.