Since the credit crunch, the European exchange-traded products market has moved on to a new phase in its development.
In yesterday’s feature article on IU.eu, we reviewed the different options for European investors who want to track the gold price.
One particular theme which emerged from our research into the sector was how product development in European exchange-traded products seems, if anything, to be accelerating. Within the last six months we’ve seen the launch of Julius Baer’s currency-hedged gold ETFs, Lyxor’s ETN range, Source’s new T-ETCs.
The addition of new products has been accompanied by a proliferation of product names, particularly in commodities – we now have ETNs, three varieties of ETCs, Source’s T-ETCs and other debt-based trackers like Xetra-gold.
Lyxor’s decision to have a variable collateral charge within its ETNs – to cover the cost of obtaining ring-fenced backing for the notes – raises a host of questions. If they are telling us that collateral costs so much, why is there no such charge in competing structures? Are the issuers absorbing the cost themselves? Is their collateral not so ring-fenced? There’s no easy way for an investor in exchange-traded products to answer these questions, but they are intriguing ones and we will be exploring them over coming weeks on the site.
It’s worth remembering what has prompted these changes in note design, as well. Eighteen months, or even a year ago, no one was paying much attention to the cost of counterparty exposure, and ETNs and most ETCs were uncollateralised. Then everything changed. Now investors have to perform a much more complicated analysis to try to examine trackers on a like-for-like basis.
Meanwhile, in the European ETF market, where the UCITS stamp at least imposes a certain set of ground rules, there is instability of a different kind. The acquisition of iShares by a private equity firm (assuming that there is no other last-minute bidder) almost guarantees that the world’s largest issuer of exchange-traded funds will be put up for sale again in a few years’ time.
And with banks under pressure to raise money from the sale of non-core divisions, might there not be more corporate finance deals of this kind from other institutions?
This then begs the question of the nature of the relationship between the ETF issuers and their parents. Swap-based ETF issuers typically use their parent bank as the swap provider, and the parent’s financial health has direct implications for the attractiveness of the fund (collateral notwithstanding). ETF issuers using physical replication typically lend out securities, and here the agent lender’s balance sheet strength is important – perhaps one of the reasons why the securities lending operation at Barclays Global Investors didn’t leave with iShares.
All these uncertainties mean that ETF, ETN and ETC product development will continue apace. Big prizes await for the firms that get the product mix right, but there’s always a risk of descending into complexity for its own sake, the ultimate destination of many financial market products.
I’m not complaining – there will be plenty for us at Index Universe to write about, and it’s a fascinating industry to cover. But the exchange-traded products market has now clearly moved on from its initial, rapid phase of development, and now faces the growing pains of adolescence.