In market-structure development supporting ETF growth, Nasdaq sees a model for SEC’s stock-trading overhaul


this article was Originally published by Kuratia,

A simple rule change in 2019 opened the floodgates for ETF growth by easing the way for new fund launches. Since then, organic market-structure development has nurtured a flourishing ETF ecosystem — a trend set to continue as liquidity-risk management augmented by tick-sized reform, market-wide changes such as mutual-fund conversions. Meets the trends.

The iterative approach provides a blueprint for the SEC’s proposed overhaul of U.S. stock trading, Jiang Bui, Nasdaq head of U.S. exchange-traded products, explained at the Securities Traders Association’s Washington, D.C. Spring Update.

thriving ecosystem

Allowing ETF issuers to bring new strategies to market while bypassing long regulatory approval queues, the 2019 ETF rule opened an era of unprecedented ETF growth thanks to the retail-trading boom.

That growth has proven resilient even amid recent market volatility, senior experts from Nasdaq, Invesco and Flow Traders dissected in an insightful discussion on ETFs at STA’s Washington, D.C. event. spring update in mid-April.

The US ETF landscape saw 91 new launches and $81B inflows in Q1. Two-thirds of the inflows went to fixed-income funds. Actively managed ETFs also attracted significant interest as the uncertainty of a recession prompted investors to adopt defensive strategies.

The market influence of ETFs has grown in a similar way. While ETFs accounted for 32% of US equity trading in 2022, their share increased by 40% Volatility increased due to the banking crisis in March.

At the same time, ETF proliferation in various categories from crypto to commodity has created strong competition for inflows. As a result, 57 ETFs were liquidated in Q1 – a 200% YoY increase, contributing to the overall health of the ETF ecosystem as liquidity pools in successful funds.

“Even as recent developments have lowered issuers’ barriers to entry, they have also raised the bar for success,” said Eric Polyakov, Invesco Global Head of ETF Capital Markets and panel moderator.

According to the panellists, the evolution of organic market-structure has been a significant contributor to increasing the effectiveness of ETFs. For example, the Nasdaq has developed a strong framework liquidity stimulus For market makers in newly launched and thinly traded ETFs.

Investor education has similarly worked to address the cause of ETFs by dispelling the perception that ETFs dilute the liquidity in their underlying securities. In fact, for every $9 traded in US ETFs in the first quarter, only $1 resulted in business activity in their underlying securities.

The ETF demonstrated strong growth in bull and bear markets alike, with panel participants agreeing that the future looks even brighter. Seven out of 10 respondents have a pwc survey published in March that they thought global ETF assets would grow from around $10T now $15T or more by mid-2027. Experts predict that active and fixed income ETFs will lead the charge. Mutual-fund conversions can also prove to be a significant source of ETF asset growth.

freeze reforms

Regulation figures are important in determining the growth arc of an ETF. While the previous reforms eased the way for launching ETFs, the present rule changes are aimed at ensuring stable functioning of ETF markets.

Many of the changes to stock-trading mechanics that rulemakers issued in their proposed overhaul of U.S. stock trading will apply to ETFs in equal measure. Panelists highlighted the potential for tick-sized reform, for example, to reduce trading costs, but also jeopardize liquidity if taken too far – a concern that has led the industry to push for half-penny tick increments. inspired to.

“What we have seen based on our research is that too many ticks within a spread can cause wider spreads, increase message traffic, reduce the resting time of quotes,” Ms. Bui said.

“So that’s something we’re looking at. And as Nasdaq wrote in our comment paper, just adding a tick under a penny would be tremendously beneficial to support tick-constrained stocks. So half a penny Tick ​​is probably a more appropriate way to go about it.

In the case of tick-size correction, trial and error may be required to find the sweet spot that minimizes trading costs without impacting liquidity, especially since that sweet spot likely varies from one security to another.

Such dilemmas have prompted many industry participants to stump for a more incremental approach to the overhaul, with regulators holding back more of the proposed rule changes.

“How can we be sure we’re making adjustments without impacting the quality of the market, the technology and the increased cost of operations?” Ms. Bui asked. “We need to make incremental changes over time to help our markets become best-in-class.”

Other regulatory reforms aim to ensure that funds maintain sufficient liquidity to endure troubled market conditions — a strength of ETFs that could accelerate mutual-fund conversions.

Amendments to the SEC’s Liquidity Rule Proposed In November mutual funds and most ETFs will be required to keep at least 10% of net assets highly liquid. They will also mandate swing pricing and a tighter daily closing time for mutual funds, as well as more frequent and detailed disclosures about liquidity risk management.

rule making template

Despite the importance of those reforms to the stable functioning of ETF markets, their rollout has been isolated and could take years. Nasdaq says the iterative approach, which lets regulators independently observe the effects of each reform and adjust rules as needed, could serve as a blueprint for the SEC’s proposed US stock-trading overhaul.

“There is no doubt the markets will evolve with the times, and regulation will have to evolve with it,” said Nasdaq’s head of strategy for North American Trading Services. SIFMA Equity Market Structure Roundtable, “And ‘grow’ is a really important word. Growth is iterative over a long period of time. That’s why we need to see that. We need to see growth.

Nowhere is organic market growth more evident than in the conversion of mutual funds, the industry’s prevailing fund structure, to their more liquid successors—apparently in ETFs.

While ETF assets account for just one-third of mutual-fund assets today, ETFs are generating inflows at five times the rate of mutual funds, reflecting investors’ growing affinity for ETFs. Furthermore, Bloomberg senior ETF analyst Eric Balchunas estimated last year that issuers would convert $1T From mutual funds to ETFs over the next decade.

Several factors are conspiring to make that estimate increasingly realistic, according to the panel’s participants. Active fund managers are getting more comfortable with the transparency of ETFs. Organic market solutions including services to reduce conversion friction and efforts to educate portfolio managers on the mechanics of the ETF-type transfer are also encouraging conversion.

“ETFs have always been a game-changer for their liquidity and tax benefits,” Ms. Bui said after the panel discussion. “To make mutual-fund conversions worthwhile, however, both investors and PMs had to better understand ETF mechanics. As this happens, conversions are likely to accelerate. My guess is that we’ll see an increase in conversions over the next decade.” Will cross $1T.”

The evolution of organic solutions, from vendor services to education efforts that emphasize collaboration among market participants, is another reason to adopt an iterative approach to regulatory reform.

“The thoughtful development of regulation in collaboration with the industry has encouraged innovation and lowered barriers to entry for new participants in the ETF space,” Mr. Mack told us. Use a healthy process for industry-regulatory cooperation to create a healthy framework for furthering competition.

This could help regulators do more with less – and build trust with industry at the same time.

The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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