February 15, 2013 7:27 pm

Talk of dwindling ETF providers disputed

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The belief that radical change is likely in the European exchange traded funds market on the back of BlackRock’s recent acquisition of Credit Suisse’s ETF business has been disputed by industry commentators.

According to Hector McNeil, co-chief executive of Boost, a new provider of leveraged and inverse exchange traded products, many of the investment banks that have ETF operations will exit the market because of increased regulation and revenue pressures.

He predicts large-scale consolidation in both the number of providers and products.

Mr McNeil argues that BlackRock’s recent purchase is just the start of a consolidation process that is likely to lead to a 30 per cent reduction in the number of ETF providers in Europe as large asset managers take out smaller competing players.

However, State Street Global Advisors, the world’s second-largest ETF manager, has indicated it sees organic growth, not acquisitions, as its preferred strategy in Europe, while Vanguard, the number three player globally, has not historically pursued takeovers to build scale.

Industry observers also say ETF operations remain profitable for bank-owned issuers. In addition to management fees, ETF transactions provide valuable flows for banks’ trading desks as well as opportunities to use ETF holdings in securities lending operations.

But with trading spread across multiple countries and exchanges, the fragmented nature of Europe’s ETF market has led to a proliferation of subscale products. More than 1,200 exchange traded products in Europe have assets of less than $50m, compared with around 700 in the US.

Providers in Europe, however, remain reluctant to shrink product ranges. Just 66 exchange traded products were delisted in Europe last year, compared with 100 in the US.

Michael John Lytle, a director at Source, says that large institutional investors can only deal with a small number of providers in Europe without running into size constraints on their trades.

This helps to create a self-reinforcing circle for managers of larger ETFs as their products are able to absorb big inflows without triggering concerns about concentration risks from their investors.

Last year, the three fastest-growing providers (iShares, Source and ETF Securities) were able to grab almost 80 per cent of new European inflows, illustrating the challenge that smaller providers face in trying to build products of scale that can attract institutional investors.

Investment inflows also show mixed fortunes for bank providers of ETFs.

Commerzbank and BNP Paribas’ ETF operations have suffered two years of net outflows in 2011 and 2012, a trend that continued in January.

But UBS appears to have benefited from Credit Suisse’s exit. It has become the second-largest provider behind BlackRock of “physical” ETFs that buy the constituents of an underlying index, rather than using derivatives to track a benchmark.

Clemens Reuter, head of UBS exchange traded funds, says investors are showing a preference for physical ETFs and want a provider that has established a strong record in managing these vehicles efficiently.

“We are committed to ETFs, which are a fundamentally important business for UBS,” says Mr Reuter, pointing out that UBS completed the largest ETF listings on record in both London and Italy last year.

Deutsche Bank and Société Générale also started to offer physical ETFs alongside derivative linked “synthetic products” last year to compete more effectively with BlackRock.

Both also moved their ETF operations (db-X trackers and Lyxor) from their investment banking arms into their asset management businesses.

These moves prompted talk that the parent banks might consider exiting their ETF operations as part of a retreat from non-core operations.

But executives at db-X trackers and Lyxor insist their moves under the asset management umbrella will strengthen their abilities to provide a broader range of products.

Arnaud Llinas, head of Lyxor’s ETF and index business, says the closer relationship between Lyxor’s ETF and indexing operations will help it become more nimble in reacting to market trends and developing products that meet clients’ needs.

Mr Llinas emphasises that innovation is at the heart of Lyxor’s strategy as it aims to become a “more global actor” in the ETF industry. He anticipates developments in both dividend and volatility linked products and is seeing strong interest in risk-balanced strategies.

Lyxor also recently set up an asset management unit for the UK with a dedicated institutional sales force. Mr Llinas says he is determined that Lyxor should build “a serious presence” in the UK as part of his ambitions to recapture the ranking as number-two ETF provider in Europe from Deutsche Bank.

Another industry analyst says Mr McNeil’s predictions are unlikely because of the strong growth prospects for ETFs in Europe.

“The reality is that the number of providers in Europe is rising,” says Deborah Fuhr, founding partner at ETFGI, a consultancy that analyses ETF trends. Ms Fuhr pointed to the example of First Trust, the US asset manager, which last week announced plans to launch its first ETFs in Europe in the first quarter of the year.

Ms Fuhr said ETFGI has fielded enquiries from asset managers in the US, Asia and Latin America seeking advice about the possibility of setting up in Europe.

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