A CLOSER LOOK AT THE ETF MARKET MAKING INCENTIVE SCHEME LANDSCAPE AND ITS MARKET IMPACT

Kei Okazaki, Head of ETF Secondary Trading, Manager of Strategic Planning Group, Equities, Tokyo Stock Exchange, Inc.

Transcript

1. Your Exchange of Choice © 2019 Tokyo Stock Exchange, Inc. 11th Annual Japan ETF Conference A CLOSER LOOK AT ETF MARKET MAKING INCENTIVE SCHEME LANDSCAPE & ITS MARKET IMPACT Kei Okazaki Tokyo Stock Exchange April 2, 2019
2. © 2019 Tokyo Stock Exchange, Inc. 2  TSE launched ETF Market Making Scheme in July 2018  Based on the review and some other researches, TSE enhanced its scheme. Present and Future of ETF Market Making Scheme • TSE launched market making scheme in July 2018. • Initially, target of the scheme is retails and small financial institutions. • Better spread and Depth are observed. • AUM & Volume are increased on a few names. • To attract more flow, TSE started “Version 2.0” in April 2019 • New scheme aims mid-bigger size institutional investors. July 2018 Launch of the scheme Evaluation of the impact April 2019 ETF MM Version 2.0
3. © 2019 Tokyo Stock Exchange, Inc. Outline and Impact of ETF MM “Ver. 1”
4. © 2019 Tokyo Stock Exchange, Inc. 4  Nomura Securities  Mitsubishi UFJ Morgan Stanley Securities  Flow Traders (Singapore)  Optiver (Australia)  Vivienne Court Trading (Australia) *Investor can directly request for quote to Market Makers on OTC Market Maker  As of March 2019, 5 Market Makers are providing liquidity to 114 ETFs  In addition to TSE’s, liquidity is provided through Sponsored scheme ETF Market Making Scheme Version 1 Type Issue Maximum Bid-Ask Spread (whichever is larger) Minimum Quantity (one leg) Ａ ETFs tracking Nikkei 225, TOPIX, or JPX Nikkei 400 20 bps OR 2 ticks JPY 30 mil. Ｂ ETFs tracking domestic stocks or REITs 50 bps OR 3 ticks JPY 10 mil. C Foreign index ETFs 50 bps OR 3 ticks JPY 5 mil. Quoting Obligation Sponsored Market Making Scheme Apart from TSE’s incentive/obligation, 5 Asset managers(*) setups own incentive/obligation on 44 ETFs through Sponsored Market Making Scheme for better liquidity and increase of AUM. *Nomura AM, Daiwa AM, AM One, Blackrock and Norinchukin Zenkyoren AM
5. © 2019 Tokyo Stock Exchange, Inc. Example (1) Nikkei 225 ETF  With multiple market makers, depth became better 5 (Value) Sell Buy (Value) 30,666,230 1,427 21,490 81,559,560 3,797 21,480 92,836,280 4,324 21,470 118,974,240 5,544 21,460 278,850 13 21,450 21,440 4,013 86,038,720 21,430 4,514 96,735,020 21,420 3,984 85,337,280 21,410 2,543 54,445,630 21,400 2,750 58,850,000 (Value) Sell Buy (Value) 804,440 34 23,660 260,150 11 23,650 11,890,920 503 23,640 24,906,020 1,054 23,630 23,620 23,610 1,614 38,106,540 23,600 2,095 49,442,000 23,590 1,613 38,050,670 23,580 1,265 29,828,700 23,570 1,390 32,762,300 ＭＸＳ２２５(1346) 10am on May 15, 2018 10am on Feb. 15, 2019 • With Multiple Market Makers, 100 mil. JPY is shown. *Each Market Maker’s obligation is 30 mil. JPY. • Approx. 50 mil. JPY were on order book.
6. © 2019 Tokyo Stock Exchange, Inc. Example (2) REIT ETF  Even on REIT ETFs, Size on order book became dramatically bigger 6 (Value) Sell Buy (Value) 22,365,090 1,189 1,881 23,612,800 1,256 1,880 48,102,400 2,560 1,879 19,906,800 1,060 1,878 1,144,970 61 1,877 1,875 71 1,331,250 1,874 60 1,124,400 1,873 2,327 43,584,710 1,872 3,856 72,184,320 1,871 1,883 35,230,930 Daiwa ETF TSE REIT(1488) 10am on May 15, 2018 10am on Feb. 15, 2019 • With multiple market makers, several 10 mil. JPY can be executed immediately. • Approx. 10 mil. JPY were on order book. (Value) Sell Buy (Value) 2,030,340 114 1,781 11,018,200 619 1,780 10,798,530 607 1,779 11,201,400 630 1,778 1,776,000 100 1,776 1,770 510 9,027,000 1,769 500 8,845,000 1,768 501 8,857,680 1,766 1 17,660 1,765 130 2,294,500
7. © 2019 Tokyo Stock Exchange, Inc. Ref. What if orders on order book are executed ?  Although orders on order book are swept, with market makers, orders are supplied in just a sec.  By splitting orders, certain amount of orders can be executed 7 JPY 10 thou. Sell Qty. Buy Qty. JPY 10 thou. 17,149 95,270 1800 14,280 79,380 1799 5,773 32,110 1798 1797 50,920 9,150 1796 142,120 25,525 1795 85,000 15,258 JPY 10 thou. Sell Qty. Buy Qty. JPY 10 thou. 17,149 95,270 1800 14,280 79,380 1799 1,823 10,140 1798 1797 50,920 9,150 1796 142,120 25,525 1795 85,000 15,258 JPY 10 thou. Sell Qty. Buy Qty. JPY 10 thou. 17,149 95,270 1800 14,280 79,380 1799 5,063 28,160 1798 1797 50,920 9,150 1796 142,120 25,525 1795 85,000 15,258 • Execution approx. 40 mil. JPY happens TOPIX ETF(1306) July 31, 2018 9:14:39.785 9:14:39.786 9:14:39.797 JPY 10 thou. Sell Qty. Buy Qty. JPY 10 thou. 17,149 95,270 1800 14,280 79,380 1799 7,221 40,160 1798 1797 53,440 9,603 1796 141,010 25,325 1795 85,000 15,258 9:14:41.498 • Order is supplied in 10 msec • More is sent in 1.5 sec
8. © 2019 Tokyo Stock Exchange, Inc. 0 50 100 150 200 250 300 0 50 100 150 200 250 300 Sponsored Market Maker No Market Maker Improvement in Bid-Ask Spread  Spreads decreased in 69 of 103 ETFs with Market Maker(s) After: Average of Jul. - Dec. 2018(bps) Before: Average of May. 2018 8 ETFs with narrower spreads ETFs with wider spreads
9. © 2019 Tokyo Stock Exchange, Inc. 10 100 1,000 10,000 100,000 1,000,000 10,000,000 10 100 1,000 10,000 100,000 1,000,000 10,000,000 Sponsored Market Maker No Market Maker 9 Increase in Trading Value  Ttrading value of 68 of 103 ETFs has in fact increased After: Average daily trading value in Jul. - Dec. 2018 (JPY ‘000) *Logarithmic scale Before: Average daily trading value in Jan.-Jun. 2018 (JPY ‘000) *Logarithmic scale Average daily trading value (JPY)
10. © 2019 Tokyo Stock Exchange, Inc. 10 Increase in AUM  The AUM of ETFs, especially with Sponsor or/and Market Maker has increased. ※Source: Bloomberg AUM as of June 29 (JPY 100 million) * Logarithmic scale AUM growth rate as of December 30 -20% -15% -10% -5% 0% 5% 10% 15% 20% 1 10 100 1,000 10,000 100,000 Sponsored Market Maker No Market Maker Nikkei 225, TPX and JNX400
11. © 2019 Tokyo Stock Exchange, Inc. Study Before Version 2
12. © 2019 Tokyo Stock Exchange, Inc. Percentage of ETF Usage 12  Currently, approximately 80% of Japanese Financial Institutions have been investing through ETFs  This percentage is higher by 20% compared to same survey in 2017 ※N=281, Targets are all of the regional financial institutions. Survey in 2017 was by Nikkin. N=542. In 2018 is by Nikkei Research Feb. 2017 Nov. 2018 Percentage of ETF Usage among Japanese Financial Institutions Using ETFs, 59.96% Not using ETFs, 40.04% Using ETFs, 79.72% Not using ETFs, 20.28%
13. © 2019 Tokyo Stock Exchange, Inc. 13 Who has ETF?  Beside BOJ, Banks are the biggest holder of ETFs ※ETF Beneficiary Survey (July 2018) https://www.jpx.co.jp/english/markets/statistics-equities/examination/02.html Banks Life Insurance Non-Life Insurance Other Fin. Inst. Brokers Corporations Foreign companies Retails and Others Others 59 21 0 96 7 11 36 83 Leverage/Inverse 312 0 2 332 1,142 457 844 3,464 Commodity 8 0 0 23 42 188 47 737 REIT 4,980 210 29 3,634 181 548 128 365 Fixed Income 134 0 0 105 11 106 56 204 Foreign Equity 55 0 0 199 64 14 45 621 Japanese Equity 21,749 5,481 89 13,014 4,448 1,206 10,734 3,509 0 5,000 10,000 15,000 20,000 25,000 30,000 (100mil. JPY) Net Assets Held by Linked-Category on Investor Type Basis
14. © 2019 Tokyo Stock Exchange, Inc. 0% 50% 100% Other No Insider Regulation Transparency of Portfolio Cheap Management Cost Easiness of Diversified Investment Swift Trading is available Advantages of ETF Feb. 2016 Nov. 2018 14 Survey Targeting Banks 1  TSE conducted survey among Japanese Financial Institutions  Compared to same survey in 2 years, “Advantage of ETF is Swift Trading” & “Biggest needs on TPX/225/JNX400” have not changed  At the same time, changes including increased interest on Foreign product are observed 0% 20% 40% 60% 80% 100% Active ETF Leverage/Inverse ETF Foreign Bond ETF Foreign Equity/REIT ETF Multi Asset ETF Domestic Bond ETF Smart beta ETF Domestic REIT ETF Other Domestic Equity ETF TOPIX/NKY225/JNX400 ETF would like to use in Future Feb. 2016 Nov. 2018
15. © 2019 Tokyo Stock Exchange, Inc. 15 Survey Targeting Banks 2  ETF is as popular as Domestic Equity  Most of the usage is still on Domestic Equity ETF and REIT ETF 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% ETFs Currently Investing 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% Domestic Equity ETF Listed REIT Listed Infra Fund Products Currently Investing
16. © 2019 Tokyo Stock Exchange, Inc. 16 Survey Targeting Banks 3  On choosing ETF, easiness of index and liquidity are considered  The biggest demand is improvement of liquidity  Are just “TPX/NKY/JNX400” enough for market? 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% Other Volatility Tracking Error Spread/Depth of Order Book Performance Management Fee AUM Dividend Yield Liquidity (ADV) Easiness of Index Points to put high importance on choosing ETF
17. © 2019 Tokyo Stock Exchange, Inc. 17 Situation in United States  Fixed income accounts for approx. 20%  Foreign Products also hold 20-25% of AUM/ADV (Mil. USD) US Other Total Alternative 652 2,900 3,552 Commodity 6,361 63,846 70,207 Equity 2,106,411 790,862 2,897,273 Fixed Income 607,652 81,536 689,188 Mixed Allocation 7,577 3,890 11,467 Money Market 14 0 14 Specialty 2,586 1,603 4,189 Total 2,731,253 944,638 3,675,890 (Mil. USD) US Other Total Alternative 7 23 30 Commodity 1,072 1,669 2,741 Equity 74,037 20,213 94,251 Fixed Income 9,862 1,039 10,901 Mixed Allocation 57 25 82 Money Market 0 0 0 Specialty 1,465 61 1,526 Total 86,501 23,030 109,531 Alternative 0% Commodity 2% Equity 79% Fixed Income 19% Mixed Allocation 0% Money Market 0% Specialty 0% AUM by Asset Class Alternative 0% Commodity 3% Equity 86% Fixed Income 10% Mixed Allocation 0% Money Market 0% Specialty 1% ADV by Asset Class ※Source: Bloomberg. As of Feb. 13, 2019. ADV is 6 month average. VIX is included to specialty
18. © 2019 Tokyo Stock Exchange, Inc. 18 Situation in US (Sorted by ADV)  Very liquid on major ETFs  ETFs investing various asset classes are with good liquidity ＃ Name Ticker Asset Class Cost （%） Avg. Trading Value （Mil. USD)↓ AUM （Mil. USD) Spread(%) 1 SPDR S&P 500 ETF TRUST SPY Domestic Equity (Market) 0.0945 27,699 254,936 0.0038 2 INVESCO QQQ TRUST SERIES 1 QQQ Domestic Equity (Market) 0.20 8,856 65,511 0.0061 3 ISHARES RUSSELL 2000 ETF IWM Domestic Equity (Market) 0.20 3,766 42,891 0.0070 4 ISHARES MSCI EMERGING MARKET EEM Foreign Equity 0.69 3,543 34,015 0.0236 5 ISHARES MSCI EAFE ETF EFA Foreign Equity 0.32 2,281 64,535 0.0160 6 ISHARES IBOXX HIGH YLD CORP HYG Domestic Bond 0.49 1,815 15,011 0.0118 7 FINANCIAL SELECT SECTOR SPDR XLF Domestic Equity (Sector) 0.13 1,694 23,645 0.0387 8 ISHARES CHINA LARGE-CAP ETF FXI Foreign Equity 0.73 1,408 6,080 0.0235 9 ISHARES CORE S&P 500 ETF IVV Domestic Equity (Market) 0.04 1,403 156,666 0.0077 10 SPDR DJIA TRUST DIA Domestic Equity (Market) 0.17 1,255 20,590 0.0087 11 ISHARES MSCI BRAZIL ETF EWZ Foreign Equity 0.62 1,184 9,081 0.0232 12 TECHNOLOGY SELECT SECT SPDR XLK Domestic Equity (Sector) 0.13 1,157 18,279 0.0147 13 ENERGY SELECT SECTOR SPDR XLE Domestic Equity (Sector) 0.13 1,134 13,171 0.0158 14 INDUSTRIAL SELECT SECT SPDR XLI Domestic Equity (Sector) 0.13 1,083 10,274 0.0137 15 ISHARES 20+ YEAR TREASURY BO TLT Domestic Bond 0.15 1,063 10,879 0.0083 16 UTILITIES SELECT SECTOR SPDR XLU Domestic Equity (Sector) 0.13 1,044 8,755 0.0181 17 HEALTH CARE SELECT SECTOR XLV Domestic Equity (Sector) 0.13 1,003 19,183 0.0112 18 ISHARES CORE MSCI EMERGING IEMG Foreign Equity 0.14 978 58,025 0.0197 19 VANECK VECTORS GOLD MINERS E GDX Domestic Equity (Theme) 0.53 977 10,477 0.0450 20 CONSUMER STAPLES SPDR XLP Domestic Equity (Sector) 0.13 977 10,352 0.0187 ※Source: Bloomberg. As of Feb. 13, 2019. ADV is 6 month average. Spread is 5-days average.
19. © 2019 Tokyo Stock Exchange, Inc. 19 Wrap up of Consideration • Usage of ETF among Financial Institutions become popular • Mobility or Easiness of ETF is highly admired, however, there is still big demand for improving liquidity • Only domestic equity ETFs are widely used • Main Indices & REITs are products investor would like to invest in future • In US, Fixed Income & Foreign Products have good liquidity • There is ETF like SPY which has super high liquidity • Further Improvement of Liquidity on TPX/NKY225 • Providing “Institutional Size” Liquidity on Foreign Equity/Foreign Bond ETFs Now Future Version 2
20. © 2019 Tokyo Stock Exchange, Inc. Market Making Scheme Version 2
21. © 2019 Tokyo Stock Exchange, Inc. Index Obligation Code name Management Company Nikkei 225 1Bil. JPY/20bps ★Japanese SPY *Showing 1 Bil. JPY in 20 bps which are difference of bid/ask 1321 Nikkei 225 Exchange Traded Fund Nomura AM TOPIX 1305 Daiwa ETF-TOPIX Daiwa AM 1306 TOPIX Exchange Traded Fund Nomura AM 1473 One ETF TOPIX AM One S&P500/Unhedged 100mil. JPY/20bps 1547 Listed Index Fund US Equity (S&P500) Nikko AM S&P500/Hedged 2521 Listed Index Fund US Equity (S&P500) Currency Hedge Nikko AM MSCI KOKUSAI/Unhedged 2513 NEXT FUNDS International Equity MSCI-KOKUSAI (Unhedged) Nomura AM MSCI KOKUSAI/Hedged 2514 NEXT FUNDS International Equity MSCI-KOKUSAI (Yen-Hedged) Nomura AM MSCI Emerging/Unhedged 100mil. JPY/40bps 2520 NEXT FUNDS Emerging Market Equity MSCI-EM (Unhedged) Nomura AM US Bond/Hedged 500mil. JPY/20bps 1487 Listed Index Fund US Bond (Currency Hedge) Nikko AM FTSE WGBI/Unhedged 100 mil. JPY/40bps 2511 NEXT FUNDS International Bond FTSE World Government Bond Index (ex Japan Unhedged) Nomura AM FTSE WGBI/Hedged 2512 NEXT FUNDS International Bond FTSE World Government Bond Index (ex Japan Yen-Hedged) Nomura AM Markit iBoxx USD Liquid Investment Grade/Hedged 1496 iShares USD Investment Grade Corporate Bond JPY Hedged ETF Blackrock Japan ETF Market Making Scheme Version2.0 <1>  Start from the beginning of April 2019  Sufficient amount of liquidity for institutional investor is set additionally as Japanese SPY and Star ETFs 21 【Version 2.0 ETFs】
22. © 2019 Tokyo Stock Exchange, Inc. 22 ETF Market Making Scheme Version2.0 <2>  Change number of ETF obligation to “10 Low Liquid ETFs”  Improvement of sponsor incentive/obligation Reduction of Number of ETF (During Acclimation Period) 10 Low Liquid ETFs + 10 ETFs 10 Low Liquid ETFs Extension of Acclimation Period June 2019 OR 6 month from Signup March 2020 OR 6 month from Signup Shortening of lead time to setup sponsor incentive/obligation One month Two Weeks Multiple Conditions as sponsor incentive/obligation Single condition per ETF Multiple conditions per ETF * Nikkei 225, TOPIX including ex-financial and risk control and JNX 400 are not counted as illiquid * During acclimation period, in addition to lower number of ETFs obligation, equivalent amount of 2 virtual servers are provided. * Improvements of statistics are also planned
23. © 2019 Tokyo Stock Exchange, Inc. 23 Start of Email RFQ Service Investor TSE Market Maker Market Maker Market Maker ①Sending Email with Issue Code, Buy/Sell and No. of Units (Time) ②By sending emails to market makers, TSE requests showing quote on order book *TSE sends emails only to registered market makers. Name of investor is not disclosed. *Response by market maker is not obligation, but best-effort.  When an investor needs bigger size on order book, by sending email to TSE, they can request showing desirable size of quote to market makers. ③Market Maker(s) shows quote on order book within the realms of possibility
24. © 2019 Tokyo Stock Exchange, Inc. 24 Example of usage of Mail RFQ (Value) Sell Buy (Value) 26,936,650 14,290 1,885 35,871,360 19,040 1,884 28,301,490 15,030 1,883 56,460 30 1,882 1,881 1,880 60 112,800 1,879 5,000 9,395,000 1,878 14,100 26,479,800 1,877 20,480 38,440,960 1,876 13,630 25,569,880 MAXIS J-REIT ETF (1597) (Value) Sell Buy (Value) 26,936,650 14,290 1,885 12,980,760 6,890 1,884 187,546,800 99,600 1,883 146,852,460 78,030 1,882 1,881 1,880 40 75,200 1,879 5,000 9,395,000 1,878 14,100 26,479,800 1,877 20,480 38,440,960 1,876 13,630 25,569,880 • To respond RFQ mail, Market Makers Show bigger size temporarily (Value) Sell Buy (Value) 26,936,650 14,290 1,885 12,980,760 6,890 1,884 187,546,800 99,600 1,883 146,852,460 78,030 1,882 1,881 78,000 146,718,000 1,880 40 75,200 1,879 5,000 9,395,000 1,878 14,100 26,479,800 1,877 20,480 38,440,960 1,876 13,630 25,569,880 • Normally, 2-30 mil. JPY are shown • Investor sends order slightly lower (Value) Sell Buy (Value) 26,936,650 14,290 1,885 12,980,760 6,890 1,884 187,546,800 99,600 1,883 146,852,460 78,030 1,882 146,718,000 78,000 1,881 78,000 146,718,000 1,880 40 75,200 1,879 5,000 9,395,000 1,878 14,100 26,479,800 1,877 20,480 38,440,960 1,876 13,630 25,569,880 • Market Maker takes that order