RFQ platforms and the institutional ETF trading revolution
Head of Equities, Tradeweb
This article originally appeared on IPE here.
What do ETFs, RFQ and ESG all have in common? Aside from being some of the most popular acronyms in the history of financial services, the three-letter abbreviations for exchange- traded funds (ETF), electronic request-for-quote (RFQ) trading, and environmental, social and governance (ESG) driven investing, have all come together at the centre of a revolution in asset management.
Fuelled by a combination of pandemic-induced shifts, industry consolidation, macro- economic conditions and evolving investor priorities, ETF trading volumes on electronic RFQ platforms have been skyrocketing, while the portion of that activity concentrated in ESG- themed products has been increasing consistently.
On Tradeweb’s European ETF platform alone, average daily volumes of €2.8bn were up by 34% year-over-year in July. ESG products accounted for 19.4% of all monthly activity, up from 7.6% in August 2021.
It’s not just the current spate of market volatility that’s causing the influx into ETFs; the trend has continued steadily over the course of the past decade and several economic cycles. Asset managers have come to recognise the power of ETFs to deliver instant exposure to a broad range of securities with lower transaction costs and, in some cases, better overall liquidity than the underlying securities themselves.
ETFs become go-to solution for every economic cycle
In the mid to late 2010s, for example, when volatility was relatively low and asset managers were laser-focused on efficiency, transparency and reducing trading costs, ETF volume on Tradeweb doubled annually for five years in a row. Then, in March 2020, as the COVID-19 crisis gripped global markets and volatility surged, US ETFs and European ETFs on the platform saw volumes increase year-over-year by 242% and 204% respectively. The trend was driven primarily by trading in fixed income ETFs, which continued to deliver liquidity, even as the underlying bond markets were challenged. It was official: ETFs had passed the test, delivering value throughout a period of extreme market stress.
As rising inflation, a weakening economy and steadily growing interest in sustainable investing have come to define the market, ETFs are still the go-to asset class. Much of that comes down to efficiency. One innovation that has been driving the steady growth of ETF adoption in the asset management community is the evolution of the RFQ trading protocol, which has applied lessons learned in institutional fixed income markets to the ETF market.
RFQ rises from its roots in fixed income
Developed initially to support electronic trading in fixed income markets, Tradeweb launched the first RFQ for Treasuries in 1998. Its combination of seamless integration into the trading workflow, flexibility, and access to the entire institutional marketplace of liquidity providers resulted in better pricing, increased efficiency and immediate execution for traders.
Over time, workflow enhancements were added, allowing things like straight-through processing, automated execution, and list and portfolio trading capabilities, which set the stage for expansion into the institutional ETF marketplace. In 2018, Tradeweb launched its first RFQ cash equities platform in Europe.
The reduction of manual touch points and the automation of ETF trades made possible major strategic gains. The liquidity of the ETF market combined with solutions that can be customised to optimise trading based on an asset manager’s unique needs, suddenly made it possible to move large volumes with virtually no manual intervention.
This capability has become increasingly important as the universe of ETFs has continued to grow. According to specialist data provider ETFGI, more than $1trn in European ETFs and other exchange-traded products are now active in the marketplace, meaning it’s becoming critical for asset managers to automate in order to maximise liquidity opportunities for their clients. Accordingly in Q2 2022, the proportion of total European ETF volume traded via Tradeweb’s automated trading tool, AiEX, was 18.4%, up from 5.9% in Q2 2018. That growth speaks to the streamlined nature of electronic ETF trading in the current environment and highlights the high degree of flexibility asset managers have in building their automated trading strategies to maximise the impact of each trade.
Other advantages to trading ETFs on RFQ venues include granular pre-trade price transparency, whereby historical dealer statistics, axes and streams, as well as live exchange data, are visible directly within each trade ticket to help asset managers select the best liquidity provider and the best price for each trade. Furthermore, because these trades are occurring electronically, audit trails are automatically logged throughout the trading workflow. These advantages are particularly important in Europe, where ETFs are traded in several currencies and across multiple exchanges, creating a high degree of frag- mentation in on-exchange liquidity. By trading in an electronic RFQ environment – as opposed to exchange-based trading – asset managers avoid that fragmented approach.
It is against this backdrop of higher efficiency, steadily rising volumes and growing reliance on automation that ESG-themed ETFs have burst on to the scene in a big way. Last year, 51% of inflows to the European ETF market were directed towards ESG products, putting the total amount managed by ESG-themed ETFs at roughly €244bn, according to Morningstar. This compares with 40% in 2020 and 10% in 2019. A total of 96 new ESG-oriented ETFs were launched over the course of the year and in July 2022 there were three ESG products among the top 10 by traded notional volume listed on the Tradeweb European ETF platform.
Ultimately, what’s happening in the ETF marketplace is the result of a confluence of variables coming together to make it easy for asset managers to express a view. Clients can diversify and modify their risk exposure and investment sensibility without having to spend days tailoring a portfolio and executing dozens or hundreds of bespoke trades.
The efficiency gains that come with that approach allow market participants to scale their operations considerably without increasing their cost structure.
As the technology continues to improve, those efficiencies of scale will only grow. For example, new developments currently in the pipeline include notional- based trading capabilities, which would allow asset managers to adjust their allocations based on a specific amount of investable capital, as opposed to a share- based approach. The industry is also taking significant steps forward in reducing settlement costs by netting trades with a central counterparty.
Together, these continued advances in trading technology and infrastructure, particularly on electronic RFQ platforms, along with the steady growth of the underlying marketplace will help support ETFs’ burgeoning status as the asset class of choice for the asset management industry.