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Solving liquidity-and-execution challenge in Asia
Why RFQ, trade automation set to be game-changers in ETF trading
Keri Neo 7 Dec 2022

In the hunt for liquidity in exchange-traded funds (ETFs), Asia offers opportunity and challenge at the same time.

Opportunity, because the region is witnessing impressive growth in investor trading appetite, with ETF assets in Asia-Pacific, ex-Japan, having tripled in the three years to the end of 2021. Assets under management hit US$560 billion, according to ETFGI, a London-based consultancy. 

The number of ETFs offered grew from 1,200 to 2,046 in the same period, meaning the region accounts for 22% of the global total of available ETFs. Trading activity in the asset class in the region runs a daily average traded value of US$15 billion to US$20 billion.

However – and this is where the challenge comes in - the top 20 ETFs account for 47% of that value. This means the remaining approximately 2,000 ETFs tend to suffer a long tail of relatively low on-screen volumes.

This begs a question that’s on the minds of many traders in the region: how can I ensure I have access to the best liquidity and have the confidence to execute at the best possible price, in the timeframes that meet my best execution criteria?

Exchange-based trading is only part of the answer. Asian ETF markets are highly fragmented and have differing market structures, forcing investors to navigate a degree of complexity that’s familiar to those in Europe. For starters, there are 21 different exchanges in the Asia Pacific region, compared with the 27 in Europe. About two-thirds of ETF volumes in Europe are traded off-exchange – about the same as in Asia. 

Yet liquidity providers need to generate and update bids and offers for each listing simultaneously (or as close to it as possible). To reduce cost of capital, and to contain the risk of the market moving before they have had time to adjust all their quotes, liquidity providers typically limit the size in which they make public markets in ETFs.

Voice execution, conducted by phone or chat, is inefficient and time consuming, especially as the number of ETF tickets and number of counterparties rise in tandem with the number of clients starting to use ETFs more.

Advantages of RFQ trading

The good news is that trading ETFs via the request-for-quote (RFQ) protocol offers much deeper layers of liquidity beyond the exchange order book, and it does so across trade sizes in a single system.

Trading electronically via RFQ also provides investors with a single trading approach that uncovers an ETF’s multiple layers of liquidity that is not available on-exchange. The first layer is on-screen, the second layer is non-displayed liquidity that market-makers are able to price but not displaying, while the third is primary market liquidity.

The primary market liquidity refers to the fact that ETFs can be created or redeemed, and hence ultimately can afford as much liquidity as the constituents’ basket that underlies the ETF.

We see a clear trend now of traders embracing the efficiencies that come from trading electronically, as well as the price benefits of putting liquidity providers in competition in an RFQ system.

By putting dealers in competition with one another, there is noticeable price improvement in comparison with the on-exchange environment. As an example, in non-automated European ETF trades, we have seen average price improvement compared with on-exchange best bid offer of three basis points.

Further, there is the ability to trade almost round-the-clock (23 hours) with electronic trading. Dealers quoting during Asia hours enable Asia buy-side traders to act on news flow with immediacy.

Next era of electronification: automation

In Asia we see that as traders explore moving away from voice and manual processes, full automation can be very valuable once they get comfortable with RFQ. For the most prolific users, automation helps them manage a large quantity of orders on a straight-through-processing basis, while being able to access potential price improvement via an RFQ.  

With automation, there are also features like time release. Traders are able to choose to put an order in the market when it’s most beneficial or convenient for them, without having to wait around to process the order, for example, trading the open or the close.

In Europe, the results already speak for themselves. In the third quarter of this year, the proportion of our total European ETF volume we saw being traded was 16.8%, up from 5.4% in the same quarter of 2018. In terms of ticket count, we see approximately 83% of our European ETF transactions being completed via an automated system.

Development of ETF ecosystem, tools setting next evolutionary stage

Asia is a rapidly evolving trading ecosystem, with increasing numbers of institutional traders enjoying the efficiencies of electronic execution and automation. This is helping to address market fragmentation, lack of transparency and perceptions of illiquidity, which should in turn help the ETF market fulfil its potential as daily flow and volumes increase.

RFQ platforms are key to optimizing ETF trading in Asia, helping to uncover liquidity and to improve price discovery and, ultimately, supporting what we believe will be continued steady growth of ETFs’ status as a key product in Asia’s trading suite.

Keri Neo is the head of equities for Asia-Pacific at Tradeweb.

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