The London Stock Exchange (LSE) is gearing up to launch a block trading functionality for exchange-traded funds (ETFs) this month in a move to seize a slice of the trades currently executed over the counter (OTC), and respond to the needs of the buy-side.
Large ETF trades have traditionally been executed in the OTC market and were previously not visible to investors, said Gillian Walmsley (pictured), head of fixed income products at the LSE. “Now we are offering a mechanism to highlight this liquidity on-exchange,” she said.
Investors agreeing ETF block trades will be able to enter into transactions as usual, but then also be able to benefit from printing through exchange execution, providing new ways for investors to execute on exchange and trading using a regulated market, said Walmsley. “Another key element that makes the new functionality attractive to investors is that the new block trade facility allows for large orders to be cleared via central counterparties, eliminating counterparty risk,” she said.
The LSE has a substantial pool of ETF liquidity and has seen significant growth in the last few years, said Walmsley. “The first ETF listed 15 years ago, and we have seen a phenomenal growth of 4,000% in the listed segment over the last ten years, which today covers over 1,000 different products,” she said.
Although well-established in a short period of time, there are still ETF markets that function completely on an OTC basis. “This new development is in response to the current ETF trading landscape, offering more functionality and flexibility for our customers,” she said. “The LSE has the largest market share of ETF trading in Europe, and this latest development is aimed at strengthening its position as a leading liquidity provider. It will also help us to promote and encourage transparency in the ETF segment, as well as bringing more business to the exchange.”
In addition, to block trading, the LSE is also offering cross-trading so investors are not restricted to one choice. The two new functionalities will be fully compliant with the Markets in Financial Instruments Directive (Mifid), said Walmsley. “These trade types are already in place on the Italian exchange and the response from clients has been very encouraging,” said Walmsley. “In Italy, there is a large retail liquidity pool, but we potentially see even more opportunities in London because the block trading facility is well suited to its wider institutional client base.”
The new functionalities are also available on LSE’s ETP segment, but not structured products, as there isn’t demand, according to Walmsley. “The customer base in the structured products segment is smaller than the ETF/ETP, it has more bespoke products, and therefore leads to less liquidity,” she said. “It is something we would be happy to look at, if we felt there was market demand.”
The new LSE functionality has been welcomed by providers, however the head of ETFs at a leading European investment bank said that it is important to take into account the structure of the market and how issuers provide access to the market and support to investors. “We believe exchanges need to do more to protect the real market-makers,” he said. “Exchanges seem to be favouring fast access and high frequency trading (HFT), and that sometimes can be a problem for large market-makers as we do provide pricing for thousands of products.”
Most of the ETF activity in Europe, around 80%, is driven by the OTC market and that is a contradiction because we are talking about ‘exchange-traded’ products, said the banker.
“In some countries, the industry seems to be favouring the OTC market and that is not good for large market-makers because we are exposed to a securities threat and we cannot react as quickly as smaller market-makers which puts us in a disadvantage,” he said. “Requests for quotes on the OTC market always look better than the spread investors or third parties can see on the exchange. That’s why issuers are moving out of the exchange and moving into the OTC market."
“If the real products are going to be traded in the OTC market then we don’t need an exchange, and that could be a problem for exchanges,” he added.
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