10.05.2016
By Rob Daly

ETFs May Offer OTC Pricing Insights

As demand for exchange-traded funds continues to heat up, a debate continue over whether market participants can use ETF pricing as a useful price-discovery tool for the instrument’s less-liquid components.

“There has been a record investment in ETFs over the last few years, and an increasing number of institutions are trading these securities,” said Adam Gould, head of US equity derivatives at Tradeweb.

Since launching its US ETF market in the first quarter of this year, Tradeweb has seen 18 market makers and more than 135 participants trade more than $12 billion of notional volume on its electronic request-for-quote platform.

However, Gould sees clients using the platform to move in and out of positions to support their investing strategies but not as a price discovery mechanism for their underlying components. “There’s significant liquidity in corporate bond ETFs, and clients use Tradeweb to access the liquidity they need.”

On the other hand, Rick Redding, CEO of the industry advocacy group Index Industry Association, sees investors benefiting from the broader participation in ETF trading on the exchanges and other trading venues.

“I think that is what is happening de facto is that people are looking to those because of the market prices ETFs in real-time,” he said. “There’s a reason for a price to be quoted to the broader public. It’s not the fact that there’s an ETF. It is that the ETF is focusing people’s attention on that price.”

Bond dealers know where the bond market is trading and not trading, he added. “Now more people can see the ETF quotes quicker than Trace trade updates, and that is why I’m saying that ETFs are almost becoming a price discovery mechanism for people.”

Redding admits that it relying on ETF pricing would be an imperfect tool since there is only so much “equitization” that can be applied to the corporate bond and other over-the-counter markets.

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