“Competing for new exchange-traded listings is the only show in town these days,” Ben Johnson, director of global ETF research at Morningstar Inc., said by phone. “There are certainly far fewer options than there were a few years back, so it’s getting heated.”
Industry Optimism
The competition is all the more intense because it pits two companies, Bats and Nasdaq Inc., against one another. They’re trying to break the near-monopoly of a third, Intercontinental Exchange Inc.’s NYSE Arca platform, which lists funds that account for 90 percent of the total market value of ETFs in the U.S. Winning listings is a route to enhanced trading revenue and a host of ancillary advantages, such as building clout with deep-pocketed issuing companies.
“It’s a little bit the fear of missing out,” Balchunas said, “and the optimism of the business potential.”
Few are more optimistic than Chris Concannon, the chief executive officer of Bats, who predicts ETF assets will growth fivefold by 2026 from about $2.7 trillion today. The decade-old exchange operator has made it a priority to lure the funds -- either from underwriters or competitors. Bats, which went public in April, charges nothing to list a fund, and even offers to pay issuers based on volume.
Ulterior Motives
“Just because their product doesn’t trade that much now, doesn’t mean it’s not a fruitful and profitable relationship,” said Bryan Harkins, head of U.S. markets at Bats. Even when a new product is thinly traded, he added, “our natural aspiration will be for those issuers to transfer some of their more liquid products to Bats.”
Other exchanges have tested incentives to promote trading. In 2013, Nasdaq and NYSE Arca both ran pilot programs that allow ETF sponsors to offer payments to market makers, a perk born of concern that lightly traded stocks are less attractive to automated traders. Some long-time critics of market structure say these plans help prop up zombie ETFs.
“Exchanges are the culprits,” said Joe Saluzzi, partner and co-head of equity trading at Themis Trading. “Their model is based on speed and selling data, and the more they can put into their exchange and their data feed, the more valuable it is. It always comes down to that.”
Exchange Benefits
To be sure, because of their expanding assets, ETFs would represent a major growth opportunity for exchanges regardless of whether any new ones were launched. Trading in the fragmented U.S. equity market isn’t tethered to one place, and just by being part of the network, exchanges make money when ETF orders are routed their way.
Still, exchanges do benefit from listing ETFs. Though the securities can trade virtually anywhere, volume returns home at the beginning and end of the day -- bringing in revenue for the listing exchange. Take the SPDR S&P 500 ETF Trust, the most-traded U.S. fund. On Aug. 11, the biggest transactions by far were the opening and closing trades on NYSE Arca, its listing market: 106,258 and 4.3 million shares, respectively. Together, those two accounted for 6.1 percent of total volume for the day.
Moreover, the history of ETFs has been such that as one strain of innovation cools, others heat up. Even if passive industry and asset class funds are finding fewer buyers, securities based on new ideas -- smart beta, multifactor and even actively managed ETFs, which Bats has championed -- have usually arrived to pick up the slack.
A Bigger Equation
The U.S. Securities and Exchange Commission last month approved a rule filing that will speed the listing process for actively managed funds, a victory for the exchanges, which had asked for a streamlined application process last year. In a filing on Thursday, Fidelity Investments said it’s seeking to retrofit closed-end funds -- which issue shares that trade on an exchange but aren’t required to disclose holdings daily -- as ETFs.
To exchange leaders like Nasdaq’s Jeff McCarthy, volume is just one piece of a bigger equation in determining which funds to list or pursue for a listing. Maintaining close contacts with issuers is important, which sometimes means putting up with weak trading in certain funds.
“Looking at the industry, it’s hard to forecast what low-volume product today is going to be a low-volume product tomorrow,” said McCarthy, head of exchange-traded product listings at Nasdaq. “We look at our relationship to issuers holistically.”
In this way, exchanges are playing a long game. History has shown that a slow start isn’t necessarily death for ETFs. The First Trust Enhanced Short Maturity Fund, which invests in short-duration investment-grade securities, traded just 30,000 shares in its first two months after launching in August 2014. In the 22 months since, it has seen more than 177 million units change hands.
“Issuers invest a lot of time, energy and cost into the development and launch of an investment product, but unfortunately there is no magic formula for building one that is highly successful from inception,” said Doug Yones, head of exchange-traded products at NYSE Euronext. “Our role as an exchange is to offer the greatest possible liquidity and tightest spreads, and to give investors the broadest range of products to reflect their investment beliefs.”