In an interview with IndexUniverse.eu editor Paul Amery, Ronny Feiereisen, head of the Delta One desk and Quant Portfolio Solutions group at investment bank Nomura, explains how his bank is developing analytical and electronic trading tools to overcome the problem of perceived illiquidity in European ETFs.

IU.eu: Ronny, your desk trades different delta-one instruments: ETFs, swaps, futures and P-notes. What proportion of your trading volumes do ETFs represent and how has this market share been changing?

Feiereisen: ETFs now account for the majority of our trading activity, as many clients have shown a preference for the type of transparent, liquid, listed products that ETFs represent. Swaps are still a significant part of our trading business, but ETFs have been gaining market share at their expense, particularly in equity sector trading, where swaps used to dominate.

Investors are getting used to looking through to the underlying liquidity of ETFs (looking at the trading levels in the underlying index stocks, rather than the reported trading volumes in an ETF itself) and now understand that there is a lot of depth there. Swaps are also operationally more complex for investors to handle, and of course they involve counterparty risk as well.

IU.eu: What trends have you seen in ETF trading costs, both on- and off-exchange?

Feiereisen: In both cases we’ve seen a decline in trading costs, which is a reflection of increased involvement by market participants, both investors and market makers. Ultimately, though, the “impact cost” to an investor of trading ETFs is predominantly a function of the underlying market liquidity, and we’ve worked on developing programmes (such as our “Tradespex” analytical tool) which allow investors to “look through” to the underlying, “shadow” liquidity of an ETF.

So it’s not just a question of headline liquidity, but of investors understanding the true nature of ETFs and how to use them.

IU.eu: Many commentators point to the importance of developing the ETF lending market in Europe in order to improve reported market liquidity. Yet ETF lending seems slow to get going and loan rates are still high. What’s your experience?

Feiereisen: Unfortunately borrow rates for ETFs in Europe haven’t yet declined much. This is largely down to the fact that the majority of ETF trading in Europe is still off-exchange. The more we see trading migrate to the exchanges in Europe, the sooner we will witness an increase in ETF borrowing and lending, with a decline in loan rates.

IU.eu: But don’t recent trends suggest that more trading is actually leaving the exchanges, rather than coming back?

Feiereisen: That’s true, but I think it’s in the interest of all market participants to turn this trend around. In order to attract more retail investors to ETFs, we need to make the market more transparent and more liquid for them.

But until investment banks and other firms step up and commit more capital to back on-exchange market making it will be difficult to attract the segments of the investor market that are currently underrepresented in European ETFs. For our part, Nomura is committed to making ETF markets in Europe more transparent and more efficient and we’re at the forefront of developing on-exchange market making for ETFs.

IU.eu: We’ve just published an article on the importance of receiving as much of the index constituents’ dividends as possible when investing in an ETF. How do ETFs compare with other delta-one products in this regard?

Feiereisen: An ETF’s implied dividend reinvestment rate is primarily a function of where the fund is domiciled. Overall, ETFs’ implied dividend tax treatment is largely in line with that of other delta-one products. However, these rates will vary based on the ETF structure and the index it tracks. We work with clients to help them assess products and determine the best option based on their specific requirements and capabilities.

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