Equity Trading Desks Grapple ETF Execution Challenges

ETF trading volume has grown over the past three years, fostering new challenges for trading venues.

Exchange-traded-funds (ETFs) have seen a growth in popularity in recent years in the United States, though this has not come without challenges, namely for equity trading desks.

This includes which execution channel to utilize for ETFs. Overall, a wide range of factors collectively influence this concern, including liquidity attributes of the ETFs, liquidity in the underlying securities, and other elements.

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According to Shane Swanson, Senior Analyst for Greenwich Associates Market Structure and Technology, “The decision over which execution channel to use will be based in large part on the liquidity characteristics of the ETFs, which in turn can depend on different factors, including liquidity in the underlying securities, spread, quoted depth of market, and others.”

New data points to increasing ETF adoption

New light can be shone on this dilemma, from recently released data from Greenwich Associates, which delves into specific ETF trends in the US.

The data found that ETFs are indeed comprising a growing share of the volume on institutional equity trading desks.

This is driven by institutional investors, who have increasingly embraced ETFs as a low-cost and efficient path to market beta, sectors, factors, and other investment exposures.

Over the last three years alone, ETF notional trading volume increased from 6.4% of buy-side equity trading desk total volume to 10.4% per data from Greenwich Associates.

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Most of this volume is derived from equity ETFs, as well as ETFs representing credit indices to a lesser extent.

Moreover, ETF trading volume rose to 14.4% from 8.9% over the same period, when factoring out the 30% of buy-side firms that do not currently trade these instruments.

According to the data, market-wide ETF volume are likely higher than these recorded figures, indicating even greater adoption among retail and registered investment advisor segments.

“Given the growing demand for ETFs and the SEC’s new ‘ETF rule’ that makes it easier for issuers to launch new ETFs and improve liquidity, we expect to see a steady stream of new products and strategies that help buy-side traders analyze and execute ETF orders,” reiterated Mr. Swanson.

ETF execution trends

Upwards of 55% of institutional ETF flow is currently being executed via sell-side equity trading desks through standard channels, including to a firm’s regular high-touch sales trader or via a standard execution algorithm.

However, only 41% of ETF flow is currently executed via more specialist channels. These include a request for quote platforms that aggregates liquidity from multiple dealers and specialist ETF desks.

Due to these rises in ETF flows, the data found that 57% of traders are actively interested in using an execution algorithm that is calibrated specifically for these types of securities.

This includes utilizing execution tools specifically calibrated for ETFs. It will be interesting to see if this trend increases in 2020, given the methodic growth in ETFs over the past three years.

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