Where are the best ETF liquidity opportunities in Europe?

One of the major benefits of exchange traded funds (ETFs) is the real-time pricing and intraday liquidity and trading they offer compared with traditional mutual funds, which are only priced once a day.

Investors have the ability to invest in ETFs at any time during the trading day, just like normal shares, which is a significant benefit over mutual funds, especially in volatile environments when markets can experience significant movements intraday.

One important point for investors to understand is that under the Markets in Financial Instruments Directive (MiFID), ETF trades currently do not have to be reported in Europe, meaning investors cannot accurately measure the volume of shares traded.

However, under the second instalment of MiFID, which is on the horizon, it is likely that ETF trades will have to be reported in Europe and there will be a consolidated tape combining the trades that happen on the 20 exchanges in Europe where ETFs are listed.

At the moment, only around 30% of all ETF trades in Europe are reported.

The London Stock Exchange and Swiss Stock Exchange currently require all trades of ETFs to be reported, but other exchanges across Europe do not require this. As a result, around 70% of ETF trades are not reported, so those volumes that you do see only represent the tip of the iceberg.

Not only is there a lack of reporting requirements, but liquidity is also further fragmented by the cross-listing of products on multiple exchanges, as visible trading volumes are not focused in one place. So one ETF can be primarily listed on the London Stock Exchange for example, but it can also be listed on the Borsa Italiana and Xetra.

This means that liquidity is split into smaller pools and the true liquidity is not in whatever you can see, it is in the underlying index the ETF is tracking (below is a table of the top 10 ETPs in terms of assets under management and daily liquidity). 

In terms of the amount of trading done in Europe, reported ETF trades currently account for only 10% of all equity trades, but over the next few years it will start to move more towards the US figure, where ETF trades account for around 25% of all equity trades. 

It is also the case in the US that within the 10 most actively traded stocks, four or five of them are ETFs. Europe will start to move towards this over the next few years.

Liquidity, over the course of the day, is typically higher and more focused when the underlying markets are open. So for an ETF tracking the US, liquidity will tend to be higher in the afternoon when the US markets are open. This means the spreads will be tighter, so it’s easier for brokers to trade.

In terms of the threshold for primary versus secondary trading in the ETF, when a large order is placed that is more than 20% of what the ETF normally trades in a day, this would likely have market impact if done on a secondary a basis – which is why the primary creation mechanism is used.

In a creation, an authorised broker can trade the underlying portfolio and send the securities to the custodian, creating new units of the ETF in the primary market rather than trading existing units on the secondary market, so the ETF gets bigger.