Sylvain Thieullent, CEO of Horizon Trading Solutions, explains how market makers are underpinning European ETF growth and why increasingly complex products demand more sophisticated pricing and hedging capabilities to sustain liquidity.
Not a day goes by without a news story highlighting the growth of ETF inflows or the launch of new ETF products. The announcements lead with the asset managers who issue the new products and the investors channelling capital into them. However, those making ETF markets play a critical and often unseen role. Their participation is made more challenging in the current landscape as a result of growing product complexity and demand for these products. This requires a reconsideration of the technology and infrastructure that underpins this activity.
As the ETF universe expands, that hidden layer of market infrastructure becomes more important. Investors may see a simple listed product and an on-screen price, but providing that liquidity requires increasingly sophisticated decisions around valuations and hedging.
Part of the reason is that market makers are no longer simply quoting ETFs tied to equities or one basic theme. Increasingly, they’re making markets across ETF products spanning multiple asset classes, currencies, venues and time zones.
That means supporting products whose underlying components may behave very differently by trading on different venues or operating in different market hours. The complexity of the product is increasingly reflected in the complexity of the market-making process behind it.
The growth of active ETF strategies, thematic ETFs and demand for crypto asset exposure has significantly changed the range of ETFs market makers are being asked to price. The innovation that has helped fuel the ETF market’s success is also broadening the range of risks and increasing the complexity of workflows that liquidity providers must manage.
As issuers continue to expand into new strategies and exposures, the ability of liquidity providers to support those products efficiently becomes an important part of whether innovation can translate into sustainable secondary-market liquidity.
The price visible on-screen is just the ‘tip of the iceberg.’ Before an ETF can be quoted, liquidity providers must model underlying baskets and calculate a continuously updated theoretical price, combining live market data, pricing logic and basket modelling. That theoretical value informs quoting and dynamic hedging decisions across multiple instruments. Firms increasingly have to think in four interconnected stages: building baskets, pricing them as accurately as possible, quoting efficiently and, finally, hedging dynamically.
Each stage feeds directly into the next. A weakness in basket construction or pricing can affect quote quality, while delays or inefficiencies in hedging can increase the risk attached to providing that liquidity.
This matters beyond the market makers themselves. The ability to price and manage the risk of an ETF with confidence and accuracy influences how readily liquidity can be provided to the wider market. As the market continues to grow in both size and complexity, better technology infrastructure can therefore play a vital role in keeping ETF trading liquid and resilient.
For investors and issuers, that ultimately affects the quality and availability of liquidity. The more confidently risk can be understood and managed, the more readily firms can compete to provide prices across a broader range of products.
The rollout of the EU equities consolidated tape, and plans for a UK equivalent, should improve access to market data and transparency across fragmented markets. But greater visibility of market activity doesn’t automatically translate into better ETF pricing or liquidity.
The value of improved market data will depend on how effectively firms can incorporate it into basket pricing, valuation and hedging workflows. Greater transparency is useful, but it still needs to be translated into actionable pricing decisions.
For years, electronic ETF trading has been defined by speed and low latency. While execution performance clearly remains essential, competitive advantage today increasingly depends on the intelligence underpinning pricing and risk management, rather than latency alone.
That shifts more emphasis onto the quality of the models and infrastructure sitting behind execution. As products become more complex, firms need to know not only how quickly they can quote, but how accurately they can assess fair value and manage the resulting exposure.
Larger market makers may benefit from their ability to invest more heavily in automation across a wider ETF range, but this scale doesn’t guarantee an advantage. The ability to accurately calculate fair value, automate hedging decisions and scale these capabilities across a growing universe of ETFs can enable smaller or specialist providers to compete efficiently in markets that would previously have been harder to support. In short, integrating a smarter approach to technology creates an opportunity to capitalise on continued ETF growth.
This could also broaden competition in liquidity provision, particularly where specialist firms can combine strong pricing expertise with automation that allows them to support more products efficiently.
By enabling a broader range of firms to compete for ETF liquidity provision and price risk effectively, better market-making infrastructure has the potential to support deeper liquidity and more resilient trading across today’s dynamic, increasingly sophisticated ETF market.
