International Investing
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Go Big or Go Home Is the Plan for ETF Issuers Eyeing Europe

New MiFID II regulations have the continent on the verge of a boom.

by Rachel Evans
(Bloomberg) --Dan Draper couldn’t get Europe off his mind. 

After working in London for more than a decade, the Virginia-born finance executive understood the local recipe for success in exchange-traded funds as implicitly as British sarcasm and the Gallic shrug. He’d helped build three multibillion-dollar businesses there. Now the 48-year-old’s gut told him it was time for another.

Back in Downers Grove, Illinois, as global head of ETFs at Invesco Ltd.’s PowerShares unit, the fourth-largest issuer of ETFs in the U.S., Draper was thinking the next big thing had to be Europe. He estimated the continent was about seven years behind the $3 trillion American ETF market. But new regulations, just months away, promised to catapult the region into the big time. 

Draper -- not to be confused with Don, his “Mad Men” near-namesake -- wanted a piece of that action.

The rules that had him salivating? A package called MiFID II, the awkward acronym for the equally unwieldy named second version of the Markets in Financial Instruments Directive. It takes effect in January. And it could remake Europe’s ETF industry, creating a new battleground for the world’s biggest players -- including Invesco.

“When you have those opportunities, you’ve really got to go,” Draper said.

MiFID Motivation

For many banks and asset managers, MiFID II is a two-aspirin compliance headache, covering everything from derivatives and high frequency trading to payments for research. But not for ETFs. To them, it’s the linchpin in a series of regulatory overhauls that tilt the playing field to their strengths.

Over the last decade, ETFs have barreled across the U.S., making billions for their creators and giving investors low-cost transparent ways to access equity, debt and commodity strategies.

But they’ve failed to cross the Atlantic, held back by a combination of pay-to-play advisory services that discriminate against commission-free ETFs and fragmented liquidity from the more than 20 European exchanges where ETFs trade.

MiFID II lobs a grenade at those barriers.

“There’s an increased focus on transparency and disclosure of costs, and ETFs really lend themselves to that,” said Andrew Craswell, who’s responsible for ETF business development in Europe at Brown Brothers Harriman.

MiFID II effectively stops financial advisers and portfolio managers from accepting inducements to favor one fund over another. ETFs historically haven’t paid kickbacks, putting them at a disadvantage against the many mutual funds that engage in the practice. In addition, the rules require that ETF traders disclose details including size and price, which will help market participants get a better handle on liquidity.

Coming Home

Craswell said the new rules could encourage some of the estimated $600 billion in foreign money invested in U.S. ETFs to return home. European funds are on track to top 1 trillion euros ($1.2 trillion) by 2020, up from just 550 billion euros as of the end of last year, according to Morningstar Inc.

U.S. ETF issuers’ fascination with Europe isn’t new. In 2009, BlackRock Inc. cannon-balled into the pool with its $15.2 billion acquisition of Barclays Global Investors. With that one leap, it gained a $1.5 trillion operation from Germany to the U.K. and the foundation from which it would create the largest ETF provider in both the U.S. and Europe.

What’s new is the urgency to compete in Europe now that the U.S. market is crowded. In America, more than 2,000 funds compete for investors, with BlackRock, Vanguard Group and State Street Corp. ruling 80 percent of the market. Margins are tight, and while ETFs are on course to take in more money than ever this year, it’s getting harder to turn a profit.

Europe gives issuers a second chance to compete. While BlackRock controls five times the assets of its nearest rival, the battle for second place is much closer. Six firms manage between 20 billion euros and 60 billion euros, while another 15 have more than 1 billion euros of assets, data compiled by Morningstar show.

Running a European business also opens the door to assets from clients who cannot buy U.S. products for tax or regulatory reasons. Asian investors, for example, typically lean toward funds structured in Europe, as do Latin American clients. And then there’s MiFID.

Buying In

All of this was what Draper was seeing as he and his team mapped out how to tackle the continent. He knew Invesco had to be there. The only question was how. And no matter how they sliced the data, gaining scale from scratch would take too long to ride the regulatory tailwind. They had to buy something.

“By coming in and acquiring another manager, firstly they get scale right out the gates but they’re also buying into existing distribution and sales channels,” Brown Brothers Harriman’s Craswell said. “That’s going to continue to drive consolidation.”

Invesco got lucky. Source, a heavyweight in European ETFs, was up for sale at just the right moment. A Top 10 player and regional expert, Source promised to change Invesco’s fortunes in Europe overnight. Invesco agreed to buy the firm in April; the deal closed in August. The combined company is now the seventh-largest ETF issuer in Europe with more than 22 billion euros of assets under management. Meanwhile, in the U.S., Invesco has agreed to buy 79 ETFs from Guggenheim Partners, further expanding its reach.

So Draper’s happy. And for the rest of the ETF industry, a warning has gone out. If you want to be a player Europe you can buy now -- or pay later.

“There’s an underlying current of structural changes that is great for the medium to long term but obviously you don’t want to wait,” said Nik Bienkowski, the co-chief executive of London-based HANetf and former co-head of WisdomTree Investments Inc.’s European operation. “It’s going to be a lot harder to do it in 10 years’ time.”

--With assistance from Elena Popina.To contact the reporter on this story: Rachel Evans in New York at [email protected] To contact the editors responsible for this story: Nikolaj Gammeltoft at ngam[email protected] Eric J. Weiner

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