Mifid II and ETF

MiFID II brings with it positive developments for ETFs. Currently ETFs are not MiFID instruments and there are no legal requirements to make trading volumes public.

The introduction of MiFID II means that it will be easier to see the demand and liquidity within the European ETF market. MiFID II will require reporting of ETF trades for the first time. ETF issuers are one, of some might say, a small group of promoters who are looking forward to the implementation of the new post-trade disclosure rules. At the moment it is very hard to see the liquidity in European ETFs because the trading is done over the counter and trades do not hit the consolidated tape. The consolidated tape is an electronic program which will provide real-time data on volume and prices for exchange traded securities. This gives an incomplete picture of the demand and liquidity in the European ETF market. Once MiFID II is implemented, ETFs will be in scope of the new reporting obligations. It is anticipated that investors will be able to see the true depth of liquidity in European ETFs, which, based on current publicly available information, looks less liquid than the US market. ETFs trades do not currently have one home. MiFID II will enable investors to see all trading activity across the whole ETF market.

MiFID II’s general transparency requirements include pre-trade and post-trade disclosures of the details of orders submitted to and transactions conducted on a trading venue. Trading venues can be a regulated market (RM), a multilateral trading facility (MTF) or an organised trading facility (OTF)). The transaction reporting requirements means that the competent authority will have to be notified of the trade. The impact for ETFs will be the mandatory trade reporting for OTC trades and a consolidated tape. Across Europe there are 25 exchanges and ETFs are cross-listed over multiple exchanges. This means that shares on one exchange might be priced differently and it could difficult to see the total trading volume across the exchanges.

This new window into the liquidity in the ETF market will give investors a clearer picture of the market. As the liquidity of ETFs and the transparency requirements both become clearer, it is we believe very likely that ETFs will be used in a greater capacity by the securities lending market.

In the UK, the Retail Distribution Review (RDR) requirements ban payment of commission to intermediaries and supports the development of new and innovative ETFs which do not pay commission. RDR removes the incentive for an independent financial advisor to choses a financial product that pays commission. Like RDR the proposed ban on inducements under MiFID II could help considerably with the expansion of the ETF European market.

While MiFID II does bring with it positive development for ETFs it will of course bring challenges. Distributors will have stricter compliance obligations, they will have to complete target market suitability assessments and there will be increased requirements regarding the disclosure of costs.

As knowledge of ETFs increases we will see innovative products developed taking into account regulatory developments, the changing demographic of investors and their evolving risk appetite. We believe investors will become more familiar and comfortable with ETFs due to the MiFID II requirements. At the moment ETFs are used sparingly in securities lending and with the implementation of MiFID II there should be more borrowing of ETFs by the market as investors see the potential for extra income. This increased availability of non-cash collateral may be seen as an option for some investors willing to take on higher risk investments.