Understanding ETF Trading and Liquidity in Europe

This article describes the market microstructure of the European ETF industry with specific focus on the overall liquidity in this market. While comparing the European and U.S. exchange-traded fund (ETF) markets and analyzing the behavior of its market participants, the article also tries to forecast developments likely to benefit the European marketplace over the years to come. Investor behavior toward ETFs is discussed first, including why investors may prefer over-the-counter trading to on-screen trading. The article describes the different settlement procedures across European markets and discusses how the behavior of different market participants can affect ETFs liquidity—with specific focus on products listed across different venues and in different currencies. Finally, the article highlights the issues faced by market makers with respect to settlement issues, showing how a fragmented market can result in higher fees, penalties, and buy-ins, thus negatively affecting the overall liquidity and spreads of ETFs.