“Only the top four exchange-traded product issuers in Europe are making any money”, a senior employee of one of those firms told me last week. “At some point we have to see consolidation in the market – either mergers or some firms quitting altogether”.
Assets under management in European ETPs are highly concentrated: according to the latest “ETF Landscape – Industry Highlights” from BlackRock, the top three ETF issuers in Europe, iShares, Lyxor and db x-trackers, control a collective 71% of the market, a stranglehold that other firms have made very slow progress in reducing. If you add in ETF Securities’ US$24 billion in exchange-traded commodities and currencies, you get to that top four.
To verify the accuracy of the industry insider’s claim would be good. Unfortunately, measuring the profitability of ETF issuers is very difficult.
First, issuers’ earnings are not confined to the total expense ratios they levy (according to BlackRock, the average European ETF charges 35 basis points a year).
ETF providers can make money from several other areas: securities lending, the way swaps and collateral exposures are managed, and tax-related enhancements of equity dividend income, for example.
You also can’t just look at the aggregate assets under management of an issuer – you have to examine the composition of the fund range as well. Many issuers offer unprofitable, “me-too” versions of certain popular index trackers where they have little hope of encroaching on the assets held in the largest funds of that type, simply because they feel they have to. Others stick confidently to niche areas of the market.
On the cost side of the equation, issuers pay administrative, accounting and custodial expenses out of their funds’ expense ratios. Then they have their own management expenses to cover.
In Europe, there’s an extra layer of costs that derives from the policy of listing funds in different markets, which in turn means extra legal costs and local stock exchange fees, plus the expenditure that goes with translating documents into multiple languages and then trying to sell them locally.
Some issuers we questioned this week about the possible impact of European exchange mergers expressed frustration at the slow pace of the consolidation of individual markets’ trading systems, plus the prospect of possible rises in clearing and settlement costs.
Add into the mix a rise in banks’ funding costs and continuing price competition from new issuers and it certainly seems, reading between the lines, that there’s not a huge amount of fat in the European ETF industry to be trimmed.
The continuing inflows into ETFs are helping raise revenues, of course, as is the rise in equity market levels over the last couple of years.
But could another fall in markets – should that occur in 2011 – act as a trigger for the consolidation that some industry insiders are now talking about openly?