Solving the liquidity and execution challenge in Asia
Keri Neo
Head of Equities, APAC at Tradeweb
This article originally appeared in The Asset here.
Why RFQ and trade automation are set to be game changers in ETF trading
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 (bn), 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 runs a daily average traded value of $15-20bn in the region.
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 felt as the number of ETF tickets and number of counterparties rise in tandem with the number of clients starting to use ETFs more.
The 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’s 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.
What Tradeweb offers
Tradeweb is an electronic marketplace offering RFQ trading, as well as other execution protocols. We started in U.S. Treasuries 25 years ago, in ETFs in 2012, and today serve multiple asset classes. Many of the lessons learned in fixed income were applied to ETFs, one of which was how to develop efficient and effective trade communication and workflows between liquidity providers and liquidity takers. We now transact $100bn-$150bn globally in ETF volumes on a monthly basis.
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 on Tradeweb, we have seen average price improvement compared with on-exchange best bid-offer (BBO) of three basis points.
Further, there is the ability to trade almost round-the-clock (23 hours) with electronic trading. Tradeweb has dealers quoting during Asia hours, enabling Asia buy-side traders to act on news flow with immediacy.
Tradeweb also provides pre-trade information to help clients ensure that each ticket is sent to the right liquidity providers. Additional advanced functionalities include list trading, whereby clients send a full list of ETFs for execution, further improving execution efficiency. Furthermore, through portfolio/conditional list trading — clients are able to move in and out of ETF portfolios into another at competitive package prices.
The 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.
Tradeweb offers an automation solution for ETF trading which we call AiEX, or automated intelligent execution tool. AiEX offers total control over every order, with Tradeweb working with clients to fine-tune pre-defined execution rules for a solution that is fully tailored to each trading strategy. What’s more, there is almost zero technology build involved, allowing the leveraging of the existing FIX set-up for simple and rapid implementation, with no additional set up costs.
How this works for the most prolific AiEX users on our ETF platform is that automation helps them manage a large quantity of orders on a straight-through-processing (STP) 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 2022, the proportion of total European ETF volume traded via Tradeweb’s AiEX tool was 16.8%, up from 5.4% in the same quarter of 2018. In terms of ticket count, approximately 83% of European ETF transactions are completed via AiEX on Tradeweb.
Development of the ETF ecosystem and tools are setting the 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. Tradeweb is at the forefront of this evolution, always working with clients to resolve their challenges and turning their requests around very quickly. We also invest in technological innovation to meet customers’ changing demands, ultimately supporting what we believe will be continued steady growth of ETFs’ status as a key product in Asia’s trading suite.
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