Turmoil in the eurozone has brought the once fast-growing European ETF market to a standstill.
[This article originally appeared on our sister site, IndexUniverse.eu.]
Last April I described a barrage of regulatory warnings about ETFs as a "game-changer". But it's the intensifying turmoil in the eurozone that's having the greatest impact on the European ETF market's growth prospects.
As you'll see from the chart below, the flurry of ETF-related publications from the IMF, BIS and G20 Financial Stability Board in March and April 2011 had little initial impact on Europe's ETF market. In fact the market registered a record month of inflows just three months later, in July.
Instead, it was the summer deterioration in the eurozone government debt markets that had a direct and negative impact on Europe's ETF market growth.
From August to December last year the market saw outflows of over US$7 billion, following US$26 billion of inflows in the previous seven months.
And 2012 so far gives no indication that Europe's ETF market can return to the strong growth trend of earlier years. As a reminder, European ETF assets grew by a compounded growth rate of 50 percent a year in 2005-2009, followed by a 25 percent jump in 2010.
So far this year we've seen four months of inflows into and one month (April) of outflows from European ETFs. But, according to the latest figures from ETFGI, net new assets entering European ETFs in the first five months of 2012 are a mere 2 percent of the previous year-end's levels, whereas in the US they are a much healthier 6 percent. In fact, since 2010 Europe's ETF market growth rate has switched to lagging that of the US, having previously exceeded it by a substantial margin.
Europe's bankers must be ruing the day they signed up to the Faustian pact of accepting government support. Now, with the fate of banks inextricably linked to those of deteriorating sovereign credits, everyone is being sucked into a vortex of intensifying counterparty risk. The endless cycle of bailouts is also leading to increasing uncertainty over pre-existing contract terms, as new creditors insist on preferential status over older ones. It's unsurprising that asset manager-owned ETF issuers in Europe are doing much better than those under the control of banks.
But threats to the future of Europe's ETF market go beyond questions of ownership and links to the tottering banking system. With rumours spreading about the possible imposition of capital controls in the most beleaguered eurozone member states, there's a wholesale threat to current business models. A typical European ETF is domiciled in one EU member state, managed in another, listed in several more countries, and may have counterparty and custodial relationships in even more jurisdictions. Managing such relationships may become impossible if barriers to capital movements are put up.
Meanwhile, the capital required to support a continuous market-making presence in the multiple listings of Europe's 1300-plus ETFs is becoming ever more expensive, resulting in a worrying widening of bid-offer spreads in many funds.
ETFs, once one of the few bright spots in a shrinking financial sector, now look less and less immune to the turmoil that is sweeping European markets.