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ETF Trading &
Execution in the
European Markets
ETF Trading and Execution in the European Markets
As the European ETF market continues to expand, it is important for investors
to understand the mechanics behind ETF trading and execution. While the
fragmentation of European equity markets has long been a reality for European
equity investors, the impact of this fragmentation on ETF trading is often unclear.
In this paper we highlight the distinctive characteristics of European ETF trading
and how investors can effectively leverage the ETF structure to their advantage.
We also explore the different avenues, common tools, and best practices an
investor can use when buying and selling ETFs.
ETF Market Structure: An Overview
Individual investors buy and sell ETFs in the secondary
market, either through a stock exchange or over-thecounter (OTC) directly with broker-dealers or other
investors. However, the creation and redemption of ETF
units in the primary market underpins this activity.
This process occurs between the ETF manager (known as
the sponsor) and authorised participants (APs), who are
the only parties allowed to transact directly with the ETF.
APs regulate the supply of ETF shares in the secondary
market to meet demand from investors and are therefore
key liquidity providers in the secondary market.
Sometimes an institution needs to trade a larger block of
ETF units than is available in the secondary market. The
overall demand for ETF units could also be greater than
the supply. In these cases, the AP can step in to address
this by submitting a creation order for a block of new
shares in exchange for a basket of the underlying securities
or cash. The process works in reverse if there is a large
seller or an oversupply of ETF units.
Primary Market: The primary market is where securities
are created. In ETF terms, this is where the contract
between the AP and the ETF sponsor to create or redeem
ETF shares takes place.
Secondary Market: The ‘stock market’, i.e. the New York
Stock Exchange (NYSE), the London Stock Exchange
(LSE) and other major stock exchanges around the world,
and the OTC market where investors deal directly with
each other at an agreed price.
ETF Liquidity: Understanding the
True Measure
The staggering growth of the European ETF market has become
hard to ignore. Over the past five years, assets under
management in Europe have almost doubled from $827 billion
at the end of 2009 to $1,486 billion year to date,1 keeping pace
with growth in the more mature US ETF market.
Despite this impressive growth, investors looking to their
domestic exchange expecting to see remarkable trading volumes
are often disappointed with typically low Average Daily Volume
(ADV) figures and at times unattractive bid/ask spreads.
Two factors unique to the European market make this common
gauge of liquidity a misrepresentation: Market fragmentation
through multiple ETF exchange listings (and sometimes
multiple currency listings at each exchange), and the lack of
trade reporting requirements.
Market Fragmentation
ETF post-trade processing and settlement in Europe is
currently a fragmented model. All cross-exchange listed ETFs
in Europe are issued and traded on one or more national stock
exchanges and settle in the central securities depositary (CSD)
of the exchange where the trade is executed (see Section II for
more detail this process).
For example, ETFs with a listing on Borsa Italiana would typically
settle and be held via the Italian domestic CSD — Monte Titoli.
Given this historic domestic bias and the fact that a majority of
European ETFs are cross-listed over multiple exchanges,
liquidity providers often need to transfer or cross-border the
underlying ETF shares from one domestic CSD to another, in
order to re-align their inventory to satisfy client activity.
This post-trade re-alignment creates numerous operational
inefficiencies. Importantly for investors, this cross-border
process can add settlement risk and additional
transactional costs.
1
2
Source: ETFGI.com as at 30 April 2015.
This is just one step towards reducing ETF market
fragmentation in Europe. For example, the ECB’s new securities
settlement platform, T2S, is set to launch in June 2015 and seeks
to provide a “single pan-European platform for securities
settlement in central bank money.”2 Meanwhile, the European
Union’s Markets in Financial Instruments Directive (MiFID)
has made great strides towards harmonising European equity
markets for the benefit of investors and the next version is
keenly awaited.
Solutions, however, are beginning to appear. The first of these
is Euroclear Bank’s new ‘international ETF structure’, which
seeks to provide a centralised, simpler and more efficient
settlement system. In this new structure, Euroclear Bank acts
as an International Central Securities Depository (ICSD). This
means that the underlying ETF shares are centralised in a single
inventory pool held within the ICSD, removing the need for
inventory management across domestic CSDs. By simplifying
the issuance and post-trade structures across Europe, liquidity
providers will be able to service their clients more easily whilst
ultimately reducing overall transactional costs.
Figure 1: Executed Trade Price/Trade Amount
Total Volume in €
Price in €
41.40
11,000,000
41.30
800,000
41.20
600,000
41.10
400,000
41.00
200,000
40.90
0
 On Exchange Volume in €
Trade Price
 OTC Volume in €
It is difficult to use Average Daily Volume (ADV) as the only indicator of an ETF’s
overall liquidity. Given the fragmentation and lack of trade reporting requirements in
Europe, ADV only represents the number of shares traded on exchange in the
secondary market. Investors should also consider the liquidity of the primary market
and understand the intricacies of the European secondary markets.
Lack of ETF Trade Reporting Requirements
Currently ETFs are not subject to the same pre-trade and
post-trade requirements as other exchange traded instruments,
such as equities, and in most markets there is no requirement
for executed trades to be reported.
In terms of pre-trade work, one benefit ETF investors currently
do not have is a consolidated European order book. This means
that investors are not easily able to see aggregate ADV for ETFs
cross-listed on multiple exchanges. It also means that the onus
of on-exchange pre-trade analytical work and finding the best
price is borne by the ETF investor.
For example, an investor is looking to purchase shares of an
ETF on his local exchange. If the ETF is also listed on other
exchanges, there is a possibility that shares are being offered on
another exchange for a better price. There are a wide variety of
reasons why prices vary between exchanges, but it’s important
that investors understand that their exchange of choice might
not show the full picture of an ETF’s on-exchange market from
a spread and volume perspective.
Figure 2: SPDR S&P US Dividend Aristocrat UCITS ETF Consolidated On-Exchange Volume
Ticker
Volume
Bid / Ask
Europe (GBP)
SPYDGBP EU
84.236k
28.836 / 28.761
USDV LN
84.236k
28.692 / 28.805
SPYDUSD EU
107.94k
28.669 / 28.774
UDVD LN
107.94k
28.744 / 28.789
SPYD EU
13.07k
28.740 / 28.775
USDV IM
1.337k
28.740 / 28.775
Europe (USD)
Europe (EUR)
Source: Bloomberg, as of 1 September 2014.
For illustrative purposes only. Information are of date indicated, subject to change and cannot be relied on thereafter.
This information should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security.
2
Source: ECB.com as of 30 September 2014.
State Street Global Advisors | SPDR ETFs
3
ETF Trading and Execution in the European Markets
One useful tool that investors can use to see a fund’s consolidated
ADV and relevant bid/ask spreads is through the quote montage
(QM) function on Bloomberg (see Figure 2). This function
aggregates each exchange listing of a particular ETF and lists the
volume traded on each exchange as well as the relevant bid/ask
spreads in each market. Otherwise, investors can access ETF
listing information via most fund provider’s websites.
Nevertheless, a further consideration is that while there is no
indisputable way to calculate the amount of ETF trading that
goes unreported, industry experts estimate that anywhere
from 50 – 90% of ETF activity occurs over-the-counter (OTC),
one reason why looking at a fund’s ADV as a gauge for liquidity
is flawed. Moreover, the fact that ETFs trade OTC means that
the spreads/depth shown on-exchange may be inferior to those
off screen.
However, it is widely expected that a broadly mandated ETF
post-trade reporting requirement will be included in the next
iteration of MiFID, which has the potential to dramatically
increase visible volumes and potentially improve price
competition. MiFID has a wide scope but in its simplest
form seeks to provide protection to European investors.
Generally speaking, it sets forth rules surrounding the
European pre-trade and post-trade environment in order to
ensure clients are given access to the best available price before
trading and the appropriate transparency regarding
their executions after trading.
But for now, looking beyond the ADV is vital in understanding
the true picture of an ETF’s liquidity. Investors must look at the
available liquidity of the primary market and underlying
securities of the ETF. To get a full picture, investors must first
understand the creation/redemption process, one of the most
fundamental and unique aspects of the exchange traded
fund structure.
ETF Execution: The Mechanics
How are ETFs Created and Redeemed?
Understanding the creation/redemption process is key to
understanding the true extent of an ETF’s overall liquidity.
Creation and redemption take place in the primary market
and is facilitated by Authorised Participants (APs) in order
to regulate supply of ETF shares in the secondary market.
In Europe, APs are regulated investment firms that have
executed dealing agreements in place with the ETF fund
provider as well as the ETF fund administrator (the
counterparty appointed by an ETF provider responsible
for overseeing the operational workflow of creations and
redemptions, among other things). These are the following
steps an AP takes to create ETF shares:
1. On each business day, APs are provided with an
ETF portfolio composition file (PCF) from the ETF
fund provider which contains details of the securities
and/or cash elements that are required for ETF
creation/redemption.
2. APs typically source the underlying PCF constituents
via internal inventory, acquiring them in the market
or borrowing the underlying names from third
party sources.
3. APs then create fund shares in increments that meet
a minimum creation unit size set by the fund provider
— known as creation units (‘units‘ being the minimum
number of shares that can be transacted in the primary
market.) They do this by assembling the underlying
securities of the fund in their appropriate weightings to
reach creation unit size.
4. APs then deliver those securities to the fund provider’s
home CSD in-kind (sometimes used for smaller, liquid
indices) or in cash (which offers greater settlement
flexibility and transactional risk control for both the fund
provider and the AP).
5. In return, the AP receives fund shares which are then
introduced to the secondary market where they are
traded between buyers and sellers through the exchange.
4
PRIMARY MARKET
Figure 3: Creation/Redemption Process
SPDR ETF
Sponsor
Underlying
Securities
ETF
Units
SECONDARY MARKET
Authorised
Participants
(AP)
ETF Shares
Buyers
Stock
Exchange
Sellers
To illustrate the process, let’s walk through a specific example. Suppose an AP
wants to create shares of the SPDR S&P 500 Low Volatility UCITS ETF. First,
the AP would reference a list of the exact securities and their weightings within
the fund using the PCF list from the ETF fund provider. The AP would gather
those same securities in their appropriate weightings into a creation unit. Next,
the AP would transfer the creation unit in-kind or in cash to State Street Global
Advisors in exchange for shares of the SPDR S&P 500 Low Volatility UCITS ETF.
To complete the creation process, the AP would introduce these newly created
ETF shares into the secondary market where they would be traded between
buyers and sellers through the exchange.
When the AP wants to redeem fund shares of the SPDR S&P 500 Low Volatility
UCITS ETF, they would follow the same process in reverse. In the secondary
market, the AP would gather increments of fund shares into a redemption unit.
Then in the primary market, the AP would deliver the redemption units to State
Street Global Advisors in-kind or cash in exchange for the underlying securities
in the appropriate weightings equal to that of the redemption unit. Only APs are
able to create or redeem ETF shares in the primary market.
The redemption process is the same, but in reverse. Increments
of fund shares — known as redemption units — are collected in
the secondary market by the AP and then delivered to the fund
provider’s home CSD in-kind or in cash in exchange for the
underlying securities in the appropriate weighting equalling
that redemption unit.
As Europe’s secondary markets mature, ETF fund provider and
APs alike have recognised the need for an efficient and
controlled primary market that provides flexibility to meet
client requirements across multiple exchanges and CSDs. Given
the primary market can act as a main source of liquidity for
client orders (discussed further in Section III), fund provider
have begun to put considerable time and attention into ensuring
that their primary markets function as efficiently as possible.
For example, many fund providers have tried to innovate in the
creation/redemption process, allowing APs to create or redeem
via multiple options – cash, in-specie, or hybrid. From an
investor standpoint, as long as the ETF provider is properly
protecting and managing the fund to its selected benchmark,
flexibility for the AP in the primary market will ultimately
benefit the end investor with more competitive prices and
readily available liquidity.
This ability to introduce additional shares into the marketplace
on a daily basis demonstrates precisely why ETF trading volume
is not an all-encompassing measure of the fund’s overall
liquidity. In order to understand the full liquidity of an ETF,
investors must also consider the liquidity of the
underlying securities.
Central Security Depositories (CSDS)
The creation process is facilitated by different clearing systems.
These depend upon an ETF’s primary CSD and where the AP
would like to settle their transaction (and as we have seen in
Section I, there is now the option of the ICSD). CSDs vary by
exchange, and a fund’s primary CSD typically corresponds with
a fund’s primary exchange listing. For example: Clearstream is
the CSD associated with the Deutsche Börse; Crest is the CSD
associated with the London Stock Exchange; and Euroclear is
the CSD associated with NYSE Euronext.
As ETF administrators have become more sophisticated in
settling shares across systems, this complicated process has
become less onerous than it once was, allowing APs to create
and redeem shares with maximum flexibility of where they
would like their ETF proceeds delivered, in order to align with
client requirements.
For example, an AP looking to create shares via Clearstream has
a unique account in which underlying shares or cash are
exchanged with the fund provider in varying block sizes
depending upon the ETF.
State Street Global Advisors | SPDR ETFs
5
ETF Trading and Execution in the European Markets
In-kind and Cash Dealing Models
In-kind deliveries remain popular for smaller, liquid indices but
the market has seen a huge shift to ’cash‘ creation/redemption
dealing models which offer greater flexibility aligned with the
ever-expanding number of products on offer that cover broader
and more illiquid indices, especially those based upon emerging
market and fixed income benchmarks. Cash dealing models also
offer the ability for delivery versus payment (DVP) settlement,
which gives both the provider and the AP greater risk control
over the transaction. Under both models, the provider is
responsible for delivering the ETF shares to the designated
CSD account indicated by the AP at the time of order placement.
For the in-kind model, this is typically only executed when all
in-kind deliveries have been confirmed as received by the
provider’s custodian.
Premiums/Discounts and Why They Occur
In some cases, a differential between the trading price and fair
value of an ETF may arise. This discrepancy is known as a
premium or discount in the fund. In the example of the ETF
above, one variable that may serve as an impediment to keeping
an ETF’s market price in line with its fair value is high
transaction costs to obtain the underlying securities.
Transaction costs tend to be higher for APs when creating or
redeeming ETFs that represent esoteric, less liquid asset classes.
If an AP needs to spend €5.00 per share to accumulate the
underlying basket for a creation unit in previously mentioned
ETF XYZ, profit margins disappear, thus, there is no longer an
arbitrage incentive for the AP to create. In this case, shares of
XYZ will most likely trade at a €5.00 premium to their fair value
due to the nature of the underlying market.
Why does an AP Create or Redeem ETF Shares?
There are a number of reasons why an AP creates or
redeems ETF shares including arbitrage, inventory
management, customer facilitation, and equity finance/stock
loan. The two reasons most applicable to investors are:
In fast-moving markets where volatility increases, ETFs can
sometimes trade at larger-than-usual premiums or discounts to
their net asset value. This is particularly true where some of the
underlying markets are closed or, as with some segments of the
fixed income market, trade infrequently. Because ETFs need to
price on exchange they act, in effect, as a ‘price discovery‘
mechanism and therefore tend to reflect a more realistic value
for the underlying basket.
Customer Facilitation: APs have the ability to create or
redeem ETF shares for large investors in order to access
additional liquidity beyond what might be shown in the
secondary market. For example, if a pension fund is interested
in acquiring €50 million of ETF XYZ, they may consider
working with an AP to facilitate a creation.
Arbitrage: APs can create or redeem ETF shares in order to
take advantage of arbitrage opportunities in the market. To give
a simple example, if shares of ETF XYZ are trading at €55.00 in
the secondary market and the value of the underlying basket of
securities of the ETF is €50.00 per share, there is an inherent
arbitrage opportunity. In order to realise this opportunity, the
AP would sell ETF shares at €55 per share and hedge their
position by buying the corresponding underlying basket of
securities for €50 per share, thus locking in the €5 per share
profit. The AP then has the ability to create shares of the ETF at
the end of the day with their long position in the corresponding
underlying securities of the ETF. The AP would then close out
their short position in the ETF using these newly created shares.
This hypothetical example results in a €5.00 profit per share for
the AP. Arbitrage is important for ETF investors because it
keeps premiums and discounts in check which keeps the ETF’s
market price in line with its underlying components.
6
Bid/Ask Spreads and Depth
What is a Bid/Ask Spread?
The bid is the price at which a buyer is willing to buy ETF
shares, and the ask is the price at which a seller is willing to sell
ETF shares. The difference between the bid and the ask is the
spread, which indicates the overall cost of transacting in any
security (plus any applicable brokerage commission costs).
Theoretically, the difference between the bid/ask spread
midpoint and ask plus commissions is the transaction cost of
buying ETF shares: The difference between the bid/ask spread
midpoint and bid plus commissions is the transaction cost of
selling ETF shares.
When using an exchange website or another data provider (such
as Bloomberg or Reuters) to see the publicly available market in
an ETF, you see what is known as the ‘top of the market’ for that
particular exchange’s listing. This quote consists of the best bid
and best ask available and may come from two different market
makers or other investors. The best bid/best offer is a quote
limited by a specific amount of shares, so understanding the
depth of market is also important. The ‘depth of market’ refers
to the number and size of pending orders on both the bid and ask
quote. Generally, a market is considered ’deep’ if pending orders
are enough to prevent any single order from significantly
moving the price of the ETF. Investors can see the depth of a
particular ETF by examining the full order book. High volume
does not necessarily mean a market is deep and a deep market
does not necessarily mean a market is highly traded. For a
practical example of market depth, see Section III.
Who are the Players?
Many of the terms below are used interchangeably to refer to the different firms that trade ETFs. Although many of the terms are
similar, there are also many key differences.
ETF Fund
Provider
The investment firm that originates and manages the ETF.
Authorised
Participant
APs are regulated investment firms that have fully executed legal documentation which gives them the ability to
create new ETF shares or redeem existing ETF shares. Every ETF providers has different document
requirements and at times providers may have different requirements depending upon the fund.
Market Maker
An all-encompassing term referring to a firm that is willing to provide a price to a buyer or a seller of an ETF. A
market maker may or may not be an Authorised Participant.
On-Exchange
Market Maker
A firm that provides buy and sell prices for ETFs on a stock exchange. This includes market makers who are
providing prices in an official capacity (with signed exchange documentation and certain spread, depth, presence
requirements), as well as market makers who are providing prices unofficially without any exchange-imposed
requirements.
Designated
Sponsor
A firm responsible for providing prices for an ETF on the Deutsche Börse’s Xetra segment. There may be multiple
Designated Sponsors per fund — all are subject to predetermined, exchange-imposed spread/depth requirements.
Liquidity
Provider
One or more firms responsible for providing prices in an ETF on the NYSE Euronext. There may be multiple
liquidity providers (LPs) per fund — all are subject to predetermined, exchange-imposed spread/depth
requirements. Outside of the exchange context, this term can be used broadly to describe any counterparty who
will work with a client to help execute a trade. An LP can also refer to a firm providing liquidity on the Borsa
Italiana without any obligation in terms of minimum quantity and maximum spread.
Specialist
The one firm responsible for providing prices in an ETF on the Borsa Italiana. This firm is subject to spread and
depth requirements.
What does the Bid/Ask Spread Represent?
To better understand what an investor is paying for in a bid/ask
spread, it is helpful to have an understanding of how the trading
firms that specialise in buying and selling ETF shares operate.
Like most businesses, cost to the end consumer is highly
correlated to input costs, plus a profit. In this respect, ETF
trading is no different from any other business. As such, ETF
traders generally need to account for four different categories of
cost when facilitating ETF trades.
Risk: At times, risk can be the highest cost component of
spreads, especially during periods of elevated market volatility.
Most traders who facilitate ETF orders aim to remain market
neutral since they generate their revenues through order
execution, not investment appreciation. What most investors
would call ‘investment exposure’, ETF traders call ‘risk’. In order
to manage this risk, traders will hedge investment exposure with
the use of underlying securities, options, futures contracts, or
even other ETFs. Depending upon the liquidity of the underlying
instruments used to initiate a hedge, it can be costly to maintain
market neutrality when trading ETFs.
This hedging cost will be included in an ETF’s spread and passed
through to any investors that trade the ETF in the secondary
market. Traders are often unable to be completely market neutral
so will pass on any remaining market exposure risk through
wider spreads. Additionally, market makers rely heavily upon the
information provided to them in the daily portfolio composition
files (PCF) provided by PCF calculation agents. As some ETF
providers have PCF files that are less reliable than others, market
makers may widen spreads in light of uncertainty regarding a
fund’s components and thus its true price.
Cost of Buying/Selling Basket Securities: One major
variable cost that ETF traders often encounter is the cost of
gathering the underlying securities in an ETF basket. For less
liquid, esoteric asset classes, such as the high yield or municipal
markets, this cost is greater, thus spreads tend to be wider for
ETFs with more thinly traded underlying markets. In the case
where an AP chooses to exchange cash for ETF shares, it is the
provider’s responsibility to charge the AP any and all execution
costs associated with their creation or redemption in order to
protect the fund from assuming execution costs. This fee
typically includes all relevant taxes, commissions and any other
costs assumed in executing the underlying basket.
State Street Global Advisors | SPDR ETFs
7
ETF Trading and Execution in the European Markets
Business Cost: As the business of ETF trading continues to be
closely tied to rapidly moving markets and the ever-growing
need for lightning-quick technology, trading firms must
constantly reinvest in order to stay competitive. Moreover, the
requirement of multiple exchange memberships and the
associated costs in Europe can quickly add up and these costs
often find their way into the spread of an ETF.
Creation/Redemption Fee: Otherwise known as third party
administrator (TPA) charges, or custody charges, this is a fee
passed on by the ETF administrator that represents the cost of
settling the underlying stock of an ETF on a line by line basis.
These costs tend to be higher for more esoteric, thinly traded
securities in emerging markets. Since this charge is per line of
stock regardless of creation or redemption size, costs diminish
(in percentage terms) as order sizes increase.
If any of these four cost categories rise, this is reflected in an
ETF’s spread, meaning investors transacting in an ETF pay
higher fees to participate. Much like a farmer who raises prices
after an increase in the price of fertiliser, water or equipment,
an ETF trader will widen spreads if any of his/her costs or
risks rise.
What is the Difference Between an AP and a Market Maker?
APs have the ability to create or redeem ETF shares for the funds
with which they have the properly executed legal documentation.
If a client were to contact an AP and inquire about trading an
ETF, the AP would be able to make a market in that specific ETF
for the client. There is a distinct and important difference
between making a market when asked, as the AP in this example
has done, and being an exchange market maker with publicly
available prices posted. Most times (though not always) market
makers are also APs.
Throughout most exchanges in Europe, an ETF must have at
least one market maker who is required by the exchange to
provide prices at all times throughout the trading day.
Typically called an official market maker, designated sponsor,
specialist or lead market maker (nomenclature varies by
exchange), these particular market makers are different from
market makers who make prices whenever and at whatever
spread/size they deem appropriate. The spread and depth of
the official market maker’s quotes are subject to the exchange
imposed and often defined maximum spread/size
requirements by the ETF provider.
Please contact your local SPDR ETF representative for further
details on the different APs/Market Markers/Official Market
Makers for each SPDR ETF.
8
How does the Spread of an ETF Change Over Time?
Although there are certainly a number of factors that contribute
to the spread of an ETF, studies have shown there is one main
factor that tends to compress spreads: secondary market trading
volume. Over time, as secondary market trading volumes
increase, this leads to more efficient trading and lower costs for
liquidity providers, which can lead to tighter bid/ask spreads (as
demonstrated in Figure 4 below). As volume in an ETF rises,
competition and economies of scale lower spreads and allow
investors to transact in a more cost-efficient manner in the
secondary market. Often, significant secondary market trading
volume can trump the other costs. This means that at a certain
point an ETF may hit a tipping point where it becomes more
liquid than the underlying securities that compose it.
Figure 4: Spreads and Trading Volumes
($ million)
%
150
0.48
125
0.40
100
0.32
75
0.24
50
0.16
25
0.08
0
Mar
2012
Sep
2012
n $ Value Traded
Mar
2012
Sep
2013
Mar
2015
Sep
2014
0
1M Average Spreads
Source: Bloomberg, as of 1 September 2014, in USD. Example above shows the SPDR
S&P US Dividend Aristocrat UCITS ETF (UDVD LN).
Buying and Selling an ETF: Getting
Best Execution
Now that we have discussed the mechanics of the ETF structure
and the parties involved in providing liquidity, let’s discuss how
investors can efficiently buy and sell ETFs. There are two layers
of liquidity with an ETF: the first is available liquidity in the
secondary market, the second is the liquidity of the underlying
securities. In order to access all available liquidity of an ETF,
investors must understand and evaluate the various ways they
can buy and sell ETFs.
On Exchange
On stock exchanges, participants post bids and offers at price
levels they are willing to buy or sell a particular number of shares
of a given ETF. There are a number of different order types which
can be used to introduce ETF orders in the secondary market.
The most appropriate order type for ETF orders may be the
marketable limit order. A marketable limit order is a limit order to
buy or sell at or below/above the consolidated best offer/bid for
the security. In order to get a better sense of why investors should
utilise limit orders when buying or selling an ETF, let’s look at the
quote below for the hypothetical ETF (XYZ). (If your systems do
not provide access to the full order book, we recommend speaking
with your dealing desk to get a full picture of the depth of quote
for a given ETF.)
XYZ bid
XYZ ask
Shares
Price
Shares
Price
1,000
€36.11
1,000
€36.25
1,000
€36.10
3,000
€36.30
10,000
€35.96
12,000
€36.35
3,000
€35.95
4,000
€36.39
Let’s consider the impact of a market order versus a limit order
for an investor who wants to purchase 20,000 shares of XYZ.
The average execution price for a 20,000 share market order
would be €36.35 or €.10 from the best offer available. This is
because only 1,000 shares are offered at the best offer price of
€36.25. The remainder of the trade is then executed at
subsequent price levels until it has been fully executed. As a
result, a market order for 20,000 shares would sweep through
the available liquidity, in this case, at all four levels shown. In
order to maintain greater control over the execution price, the
investor could place a marketable limit order at the national
best offer of €36.25, which would immediately execute
1,000 shares at that price. The market maker would then
have the chance to post additional shares at this price level.
This example highlights why market orders should generally be
avoided with ETFs, especially with those that are more thinly
traded. Although market orders provide faster execution of the
entire order, the lack of control over the price can lead to
unintended trading slippage. With limit orders, the trade-off is
less immediate execution, but greater control over price. One
risk with limit orders is that the entire trade will not be filled.
In order to increase the probability that the entire trade will be
filled, investors can enter more aggressive limit orders, for
instance at a price which is higher than the national best offer
available when buying.
Pros
Cons
Market Order
Order is usually filled quickly
No control over execution price
Limit Order
Control over execution price
Chance order will not be filled
One way that investors determine the prices at which to enter
their limit orders is based upon the iNAV — the intraday net
asset value of the basket of securities which underlies the ETF.
The iNAV is disseminated every 15 seconds by a third party data
provider who has been selected by the fund provider. Since the
iNAV is calculated based on the underlying securities, it is an
accurate measure for domestic equities; however, it is less
accurate for markets that are closed during domestic hours as
well as markets which are not as transparent, such as fixed
income. It is also worth noting that the iNAV does not take into
account any of the costs associated with buying or selling an
ETF’s underlying basket or the other costs associated with
trading an ETF as highlighted in Section II. Consider speaking
with your dealing desk or ETF provider about how to most
efficiently enter an ETF order if you are unsure.
OTC Trading
The fact that investors have the ability to trade ETFs over-thecounter (OTC) introduces an entirely new and unique venue by
which to implement trades. Despite the transparency of the
secondary market, investors may face certain situations where
the size, intricacy, or sensitivity of a trade might not make the
most sense to execute directly via exchange. In these
circumstances, it may make sense to execute trades via a
liquidity provider. Liquidity providers for ETFs are most often
APs as they are able to seamlessly create or redeem shares of the
ETF. Liquidity providers who are not APs do tend to have
relationships with firms that are APs and can create or redeem
on their behalf. Below are two common ways to execute large
ETF trades with a liquidity provider.
Risk Trade
One way investors can interact with a liquidity provider is
through a risk trade. With a risk trade, a liquidity provider will
quote a market for a given ETF at a given size. For example, if a
client is looking to buy 125,000 shares of ETF XYZ, the
liquidity provider will calculate its risk and offer the client a
price at which they are willing to sell the 125,000 shares to the
client. If the client finds the price agreeable, then the trade is
executed OTC.
The reason this is referred to as a risk trade is because once the
trade is executed, the liquidity provider assumes the market
risk of the position and will work to hedge their position in
order to limit their risk. In the event the trade is large enough,
the liquidity provider may create or redeem shares to complete
the trade. This is of little concern to the client as their trade
has been executed at a pre-determined price regardless of how
the shares are obtained. For instance, a liquidity provider may
have existing inventory in a fund, could go to an exchange to
gather shares, or might be in contact with another AP who has
existing inventory they are willing to pass along at a mutually
agreeable price. In Europe, this broker-to-broker network is
quite active, and is something ETF providers can help to
facilitate where appropriate.
State Street Global Advisors | SPDR ETFs
9
ETF Trading and Execution in the European Markets
Nav + Trade
Another way that investors can interact with a liquidity
provider is through a NAV + transaction, also known as a
creation or redemption. The majority of these transactions take
place between clients and liquidity providers who are set up as
APs in the specific funds they are looking to trade. In this
scenario, an investor arranges to create or redeem shares with
an AP. The end price the client pays or receives for the shares is
based on the closing NAV as well as any implicit costs which the
AP incurs in the process of creating or redeeming the shares. As
previously discussed, these costs include many of the trading
costs outlined in Section II. Given the nature of a NAV + trade,
market risk is accepted by the client until an order’s NAV is
determined. Since any market risk is taken on by the client, this
tends to be the more cost-efficient way of transacting in a fund.
It is extremely important to note, however, that any market risk
assumed by a client in a NAV+ trade, although difficult to
quantify, can translate into significant unintended market
movement costs. For example, certain ETFs are unable to
confirm NAV until one day after an order has been accepted.
This tends to happen with ETFs tracking global benchmarks
that might have securities in the underlying basket that are
closed for trading at the time an order is received. As such,
the market can potentially move significantly (either positively
or negatively) between the time a client places an order in their
ETF of choice and the NAV is confirmed the next day. For clients
with a shorter term, more tactical view on their ETF choices,
this market risk tends to be less than ideal given the nature of
their investment goals.
Each of the above scenarios allows investors to access deeper
pools of liquidity than offered by the ETF itself in the secondary
market. The main difference between the two is that the
investor transfers market risk to the AP and receives an
immediate price and execution in a risk trade while maintaining
market risk until the NAV is confirmed for a NAV + trade. The
reason for using one over the other is based on the investor’s
goals. If you are unsure how to access liquidity providers, speak
with your dealing desk or ETF provider.
10
How Do I Know if I Got ‘Good’ OTC Execution?
Print your Trade
Just because a trade is facilitated OTC does not mean that it can’t
be printed to an exchange. Asking your liquidity provider to print
your ETF order on exchange is a transparent way to benchmark
your trade relative to any other orders at that time. It is important
to note that there is a difference between ‘reporting’ a trade
(typically at the end of day and is less helpful for benchmarking
your execution) and ‘printing’ a trade (real time).
iNAV
You can use the iNAV as a rough estimate for the real time value of
the ETF you are purchasing. It is important to note that this is only
a rough estimate as iNAVs do not include any sort of transaction
cost embedded in them. Moreover, iNAVs become less reliable in
more opaque, thinly traded (and sometimes closed) markets.
Engage your Liquidity Provider
There are a number of highly talented ETF liquidity providers
throughout Europe who pride themselves on attention to detail and
transparency with clients. As the ETF market continues to evolve,
many trading firms have developed analytical tools as well as the
proper expertise to clearly demonstrate an ETF’s underlying
market liquidity. If asked, an ETF trader should be able to elaborate
on market liquidity in the context of an ETF order and the related
costs of execution. We highly recommend engaging with multiple
liquidity providers in order to understand your ETF executions.
Conclusion
ETF use continues to accelerate as investors increasingly
appreciate the inherent benefits of ETFs such as low cost,
liquidity, and transparency. Understanding the unique
structure of these vehicles will allow investors to buy and
sell ETFs more efficiently and with greater confidence. We
strongly encourage all investors to undertake the proper
due diligence in order to understand all of the execution
solutions available to them in the rapidly developing
European ETF capital markets.
Further reading: ‘How ETFs are Created and Redeemed’ and ‘The International ETF Structure:
Centralised Settlement for Europe’, available on spdrseurope.com
For more Information
The SPDR ETF Capital Markets Group (CMG) supports an open architecture liquidity platform,
engaging with various market participants including Authorised Participants, market making
firms and exchanges in order to ensure liquidity and competitive pricing for SPDR ETFs. The
group also works directly with both institutional and intermediary clients to provide guidance on
best practices for ETF trading and execution.
For more information on SPDR ETF liquidity providers, and help navigating the nuances of ETF
trading, please contact the SPDR Capital Markets Group at [email protected] or
+44 (0)20 3395 6888.
State Street Global Advisors | SPDR ETFs
11
ssga.com | spdrseurope.com
For investment professional use only.
Not for use with the public.
SSGA SPDR ETFs Europe II plc (“the Company”) issue SPDR ETFs, and is an open-ended investment company
with variable capital having segregated liability between its sub-funds. The Company is organised as an
Undertaking for Collective Investments in Transferable Securities (UCITS) under the laws of Ireland and
authorised as a UCITS by the Central Bank of Ireland.
For Investors in Finland: The offering of funds by the Company has been notified to the Financial
Supervision Authority in accordance with Section 127 of the Act on Common Funds (29.1.1999/48) and by
virtue of confirmation from the Financial Supervision Authority the Company may publicly distribute its
Shares in Finland. Certain information and documents that the Company must publish in Ireland pursuant to
applicable Irish law are translated into Finnish and are available for Finnish investors by contacting State
Street Custodial Services (Ireland) Limited, 78 Sir John Rogerson’s Quay, Dublin 2, Ireland.
This document is not, and under no circumstances is to be construed as, an offer or any other step in
furtherance of a public offering in the United States, Canada or any province or territory thereof, where
the Company is not authorised or registered for distribution and where the Company’s Prospectus have not
been filed with any securities commission or regulatory authority. Neither this document nor any copy hereof
should be taken, transmitted or distributed (directly or indirectly) into the United States. The Company has
not and will not be registered under the Investment Company Act of 1940 or qualified under any applicable
state securities statutes.
For Investors in France: This document does not constitute an offer or request to purchase shares in
the Company. Any subscription for shares shall be made in accordance with the terms and conditions
specified in the complete Prospectus, the KIIDs, the addenda as well as the Company’s Supplements. These
documents are available from the Company’s centralizing correspondent: State Street Banque S.A., 23-25
rue Delariviere- Lefoullon, 92064 Paris La Defense Cedex or on the French part of the site www.spdrseurope.
com. The Company is an undertaking for collective investment in transferable securities (UCITS) governed by
Irish law and accredited by the Central Bank of Ireland as a UCITS in accordance with European Regulations.
European Directive no. 2009/65/CE dated 13 July 2009 on UCITS, as amended, established common rules
pursuant to the cross-border marketing of UCITS with which they duly comply. This common base does not
exclude differentiated implementation. This is why a European UCITS can be sold in France even though its
activity does not comply with rules identical to those governing the approval of this type of product in France.
The offering of these compartments has been notified to the Autorité des Marchés Financiers (AMF) in
accordance with article L214-2-2 of the French Monetary and Financial Code.
For Investors in Germany: The offering of SPDR ETFs by the Company has been notified to the
Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in accordance with section 132 of the German
Investment Act. Prospective investors may obtain the current sales Prospectus, the articles of incorporation,
the KIIDs as well as the latest annual and semi-annual report free of charge from State Street Global
Advisors GmbH, Brienner Strasse 59, D-80333 Munich. Telephone +49 (0)89-55878-400. Facsimile +49
(0)89-55878-440.
For Investors in Luxembourg: The Company has been notified to the Commission de Surveillance du
Secteur Financier in Luxembourg in order to market its shares for sale to the public in Luxembourg and the
Company is a notified Undertaking in Collective Investment for Transferable Securities (UCITS).
For Investors in the Netherlands: This communication is directed at qualified investors within the
meaning of Section 2:72 of the Dutch Financial Markets Supervision Act (Wet op het financieel toezicht) as
amended. The products and services to which this communication relates are only available to such persons
and persons of any other description should not rely on this communication. Distribution of this document
does not trigger a licence requirement for the Company or SSGA in the Netherlands and consequently no
prudential and conduct of business supervision will be exercised over the Company or SSGA by the Dutch
Central Bank (De Nederlandsche Bank N.V.) and the Dutch Authority for the Financial Markets (Stichting
Autoriteit Financiële Markten). The Company has completed its notification to the Authority Financial
Markets in the Netherlands in order to market its shares for sale to the public in the Netherlands and the
Company is, accordingly, an investment institution (beleggingsinstellingen) according to Section 2:72 Dutch
Financial Markets Supervision Act of Investment Institutions.
For Investors in Norway: The offering of SPDR ETFs by the Company has been notified to the Financial
Supervisory Authority of Norway (Kredittilsynet) in accordance with applicable Norwegian Securities Funds
legislation. By virtue of a confirmation letter from the Financial Supervisory Authority dated 16 October 2013
the Company may market and sell its shares in Norway.
For Investors in Spain: SSGA SPDR ETFs Europe II plc has been authorised for public distribution in Spain
and is registered with the Spanish Securities Market Commission (Comisión Nacional del Mercado de
Valores) under no.1242. A copy of the Prospectus and Key Investor Information Documents, the Marketing
Memoranda, the fund rules or instruments of incorporation as well as the annual and semi-annual reports
of SSGA SPDR ETFs Europe II plc may be obtained from the Spanish distributors. The complete lists of the
authorised Spanish distributors of SSGA SPDR ETFs Europe II plc is available on the website of the Securities
Market Commission (Comisión Nacional del Mercado de Valores).
For Investors in Switzerland: This document is directed at qualified investors only, as defined by Article
10(3) of the Swiss Act on Collective Investment Schemes (CISA) and Article 6 of the Swiss Ordinance on
Collective Investment Schemes (CISO). Certain of the funds are not registered with the Swiss Financial
Market Supervisory Authority (FINMA) which acts as supervisory authority in investment fund matters.
Certain of the funds referenced herein have not been authorised by the FINMA as a foreign Collective
Investment Scheme under Article 120 of the Collective Investment Schemes Act of June 23, 2006.
Accordingly, the shares of these funds may not be offered to the public in or from Switzerland unless they
are placed without public solicitation as such term is defined by FINMA from time to time. In relation to those
funds which are registered with FINMA, prospective investors may obtain the current sales Prospectuses,
the articles of incorporation, the KIIDs as well as the latest annual and semi-annual reports free of charge
from the Swiss representative, State Street Fund Management Ltd., Beethovenstrasse 19, 8027 Zurich, from
the Swiss paying agent, State Street Bank GmbH Munich, Zurich Branch, Beethovenstrasse 19, 8027 Zurich
as well as from the main distributor in Switzerland, State Street Global Advisors AG , Beethovenstrasse 19,
8027 Zurich. Before investing please read the Prospectuses and KIIDs, copies of which can be obtained from
the Swiss representative, or at www.spdrseurope.com.
For Investors in the UK: The Company is a recognised schemes under Section 264 of the Financial Services
and Markets Act 2000 (“the Act”) and is directed at ‘professional clients’ in the UK (within the meaning of the
rules of the Act) who are deemed both knowledgeable and experienced in matters relating to investments.
The products and services to which this communication relates are only available to such persons and
persons of any other description should not rely on this communication. Many of the protections provided
by the UK regulatory system do not apply to the operation of the Company, and compensation will not be
available under the UK Financial Services Compensation Scheme.
Important Information This document has been issued by State Street Global Advisors Limited (“SSGA”).
Authorised and regulated by the Financial Conduct Registered No. 2509928. VAT No. 5776591 81. Registered
office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. Telephone: 020 3395 6000. Facsimile: 020 3395
6350 Web: ssga.com
The information provided does not constitute investment advice as such term is defined under
the Markets in Financial Instruments Directive (2004/39/EC) and it should not be relied on as
such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into
account any investor’s or potential investor’s particular investment objectives, strategies, tax status, risk
appetite or investment horizon. If you require investment advice you should consult your tax and financial or
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Exchange traded funds (ETFs) trade like stocks, are subject to investment risk and will fluctuate in market
value. The value of the investment can go down as well as up and the return upon the investment will
therefore be variable. Changes in exchange rates may have an adverse effect on the value, price or income of
an investment. Further, there is no guarantee an ETF will achieve its investment objective.
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate,
precious metals and natural resources. Investments can be significantly affected by events relating to
these industries.
Diversification does not ensure a profit or guarantee against loss.
There can be no assurance that a liquid market will be maintained for ETF shares.
Frequent trading of ETF’s could significantly increase commissions and other costs such that they may offset
any savings from low fees or costs.
Investments in asset backed and mortgage backed securities are subject to prepayment risk which can limit
the potential for gain during a declining interest rate environment and increases the potential for loss in a
rising interest rate environment.
All the index performance results referred to are provided exclusively for comparison purposes only. It should
not be assumed that they represent the performance of any particular investment.
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The views expressed in this material are the views of the Intermediary Business Group through the period
ended 31 March 2015 and are subject to change based on market and other conditions. TThe information
provided does not constitute investment advice as such term is defined under the Markets in Financial
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solicitation to buy or an offer to sell any investment. It does not take into account any investor’s or potential
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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability
for, decisions based on such information and it should not be relied on as such.
Investing involves risk including the risk of loss of principal.
Risks associated with equity investing include stock values which may fluctuate in response to the activities
of individual companies and general market and economic conditions.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as
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You should obtain and read the Company’s Prospectus prior to investing. Prospective investors
may obtain the current Prospectus, the articles of incorporation, the Key Investor Information
Documents (KIIDs) as well as the latest annual and semi-annual reports free of charge from State
Street Global Advisors, or from spdrseurope.com
SPDR ETFs is the exchange traded funds (“ETF”) platform of State Street Global Advisors and is comprised
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© 2015 State Street Corporation. All Rights Reserved.
ID4110-IBGE-1620 0615 Exp. Date: 31/12/2015