Fragmentation impairing Europe’s ETF expansion, but MiFID II bodes well for growth

Nov 1st, 2016 | By | Category: ETF and Index News

Global research and consulting firm Cerulli Associates has released commentary on how upcoming regulation MiFID II may boost Europe’s exchange-traded funds market by promoting the use of ETFs by financial advisors.

Cerulli Associates: Fragmentation impairing growth, but MiFID II bodes well for ETFs

Barbara Wall, Europe managing director at Cerulli.

The Markets in Financial Instruments Directive (MiFID) is the framework of European Union legislation for investment intermediaries that provide services to clients around shares, bonds, units in collective investment schemes and derivatives. MiFID was applied in the UK from November 2007, but is now being revised to improve the functioning of financial markets in light of the financial crisis and to strengthen investor protection. The changes are currently set to take effect from 3 January 2018, with the new legislation being known as MiFID II.

Cerulli’s report cites fragmentation, and the dominance of banks and tied-agents’ networks in countries such as Italy, France, and Spain, as current inhibitors to ETFs gaining further ground on the continent.

Barbara Wall, Europe managing director at Cerulli, commented: “Distribution of financial products in southern Europe is firmly in the hands of banks and tied-agents’ networks–intermediaries with little interest in promoting ETFs. The ban on commissions for independent financial advisors, which is due to be introduced by MiFID II in 2018, is likely to encourage them to make greater use of ETFs.”

While boosts to demand for ETFs in the US has historically been strongly correlated with reductions in fund fees, Cerulli believes this will not be the case in Europe, at least in the short term.

“In the US, low prices drew in investors and economies of scale, in turn, compressed fees further, attracting more investors, thereby establishing a virtuous circle,” said Wall. “One of the reasons Europe has not followed suit, is that operating on the continent involves dealing with different regulators in different languages and through various marketing strategies. In other words, inflows may be on the rise but distribution among more than 20 exchanges and sometimes in multiple exchanges inevitably entails more expenses.”

One area where MiFID II may further benefit the European market however is by increasing fund liquidity, a factor that has previously been inhibited due to most ETF trades being conducted over-the-counter, and thereby not subject to trade reporting requirements. Wall notes: “…MiFID II will require ETFs to report their trades. This is expected to result in more transparency on trade volumes and pricing dynamics and to bring more trades on exchange, thereby improving liquidity.”

Cerulli believes fixed income and commodity ETFs have the largest potential for growth on the continent, with fixed income products benefiting from opportunities across the whole range of developed and emerging sovereign debt, investment grade corporate debt, and high yield bonds. Smart beta products are also predicted to gain in popularity among protection-seeking investors averse to paying over the odds.

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