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February 10, 2013 6:21 am
BlackRock’s leading position in Europe’s rapidly growing exchange traded funds market has prompted some observers to ask if its iShares ETF business has become too big.
If regulators agree to the deal, iShares will control 42.7 per cent of European ETF market assets, triggering concerns that effective competition is being stifled.
“But who will pick a fight with them?” asks one ex-iShares executive.
Regulators will not comment on deals under review so it is unclear if they will analyse the implications for the ETF market or the larger Ucits fund universe.
The combined iShares and CS ETF platforms will account for around 2.3 per cent of the assets of European Ucits, a level thought unlikely to trigger competition concerns among regulators.
But Shiv Taneja, managing director at Cerulli Associates, a fund consultancy, says iShares’ expansion “definitely stifles competition”.
“It gives iShares purchasing power and scale, but longer term it is not good,” says Mr Taneja, adding that investors do not want an industry where one player has a majority share and the rest are just minor players.
BlackRock declined to comment.
Fund managers that build portfolios from ETFs and index funds have mixed views on the significance of the deal.
ETFs from iShares make up more than half of the trackers used by Evercore Pan-Asset Management. But Christopher Aldous, Pan’s chief executive, says Credit Suisse’s exit is “not a good development” as it reduces competition and choice.
“We need to have more competition in the European ETF market to ensure that average costs falls to around 20 basis points from their current range of 30bp to 40bp,” says Mr Aldous.
Bruno Poulin, chief executive of French ETF boutique Ossiam, agrees: “Price competition is good if you have enough players to compete, but when there is one player that is too big with very strong pricing power, ultimately it is not in clients’ best interests.”
Anthony Christodoulou, founder of WorldTrack, an advisory boutique, takes a different view.
He argues that concerns about the dominance of any single provider are irrelevant because low barriers to entry mean new competitors will enter if costs are held too high by established players.
WorldTrack now regularly uses five or six different providers and up to 20 ETFs to ensure diversification in any one of its portfolios.
“Competition has helped to reduce expenses across our ETF portfolios and also to diversify our counterparty risks to ETF providers that employ derivatives or run securities lending programmes,” says Mr Christodoulou.
He says the effects of competition are also evident in improvements in trading costs because bid and ask spreads have narrowed as trading liquidity has risen.
Mr Christodoulou says ETF providers have one aim: to increase assets so that they can reduce fees for investors and improve margins for themselves.
He points to the US, where charges for S&P 500 ETFs have declined to less than 10 basis points even as the largest providers have increased their market share.
In the US market, BlackRock’s operations account for a comparable share (41.4 per cent) to Europe but it faces much stiffer competition from established rivals such as State Street Global Advisors and Vanguard.
SSgA accounts for almost a quarter (23.6 per cent) of US ETF assets but has only a 1.1 per cent controlling share in Europe.
Market participants have privately expressed surprise that SSgA did not bid more aggressively to buy the Credit Suisse business.
Speaking recently in London, Michael Karpik, head of Europe, the Middle East and Africa, said SSgA’s ETF business would grow organically, suggesting that acquisitions are not part of its strategy to accelerate the development of its European operations.
Meanwhile, Vanguard, which has an 18.1 per cent market share in the US, is only starting to ramp up its European ETF operations.
The current competition for iShares in Europe is fragmented. The number-two player, db-X trackers, the ETF arm of Deutsche Bank, has a market share of 13.7 per cent while Lyxor, the third-largest, accounts for 10.6 per cent
Peter Sleep, portfolio manager at Seven Investment Management, says that “ETF pricing competition [in Europe] seems to have died somewhat”.
He notes that the investment banks that issue derivative-linked “synthetic” ETFs were winning market share before 2011 by offering cheaper products.
Even though European regulators backed away from imposing any restrictions on their products, synthetic providers have struggled to recover momentum since then.
Deutsche Bank and Lyxor, the two largest synthetic providers, have even started to issue “physical” ETFs in an effort to rebuild assets.
The uncertainty created by regulators’ criticisms of synthetic products encouraged investors to switch to physical ETFs. The main beneficiary of the switch was iShares. It has gathered almost two-thirds (64.1 per cent) of the new inflows into European ETFs over the past two years.
BlackRock expects European ETF assets to double over the next three years to around $700bn. Just maintaining its current market share would take iShares’ assets close to $300bn from $140bn at the end of 2012.
But even this might prove conservative if it can continue to attract the lion’s share of new inflows.
Mr Sleep says iShares looks likely to enjoy strong inflows in Europe in future years and “very little” price competition.
“Great for [BlackRock] shareholders, not so great for consumers,” he adds.
Additional reporting by Madison Marriage
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