Europe’s bond market is modernising

By Brett Olson, EMEA Head of iShares Fixed Income ETFs, BlackRock

The European bond market is modernising at a rapid pace – and fixed income exchange-traded funds (ETFs) have become the vehicle of choice for this modernisation. This reflects their liquidity, transparency and increasing versatility. Over the past five years, the European corporate bond market has grown by 56% to €2.8 trillion in debt outstanding [Source: Bloomberg Barclays, ICE benchmark indices, as at 30 Jun 2020].   

Trading is increasingly done electronically. One driver is the EU’s MiFID II directive, which came into force in 2018. A key objective was to move trading onto regulated venues. It also imposed new obligations for regulatory trade reporting, trade transparency and best execution. This is all much easier to do via electronic markets. Fixed income ETFs have grown rapidly too. The US$284 billion European UCITS-listed ETF market has shown a compound annual growth rate of 21% over the past five years [Source: BlackRock, GBI, 30 Jun 2020].  European fixed income ETFs are increasingly accepted by institutional investors.

Fixed income ETFs pass the Covid-19 test

The Covid-19 crisis was a big test of European fixed income ETFs’ ability to remain open to institutional investors. During the March 2020 volatility in financial markets, ETFs proved their resilience, trading efficiently and offering liquidity, flexibility, and price transparency. They continued to track their benchmarks closely.  UCITS fixed income ETFs traded an average of US$5.3 billion a day in March, almost twice the 2019 daily average of US$2.9 billion [Source: BlackRock, Bloomberg, as at 30 June 2020]. Moreover, while secondary trading volumes fell in the European fixed income market as a whole in the months that followed, European ETFs kept setting new records.

As the ETF market grows, so too does its ecosystem. We see this in practice through the growth of lending and options markets.  Recent years have seen an increase in lending of fixed income ETFs – the balance of EMEA-listed fixed income ETFs on loan has more than quadrupled in the three years to June 2020 [Source: IHS Markit. Data as at 30 June 2020]. Looking to the future, another key driver of growth will come from investors’ increasing transition to sustainable investing. As ESG adoption increases, we expect ESG ETFs to become the flagship funds.

ETFs are becoming the tool of choice for fixed income investors

Continued adoption of fixed income ETFs and other bond index tools, growth in electronic trading, algorithmic pricing capabilities and dramatic improvements in technology are revolutionising the way investors access European corporate bond markets. The recent Covid-19 selloff proved to be a catalyst for further adoption of fixed income ETFs, particularly by institutional investors, as well as further improvement in algorithmic trading capabilities.

Investors are increasingly managing their fixed income exposure through a portfolio lens, using a broader toolkit to access European corporate debt. The largest and most liquid ETFs are increasingly becoming the macro and scalable risk transfer tools of choice for investors. ETFs also offer a standardised index-based tool that allows for ESG integration. Market transparency is expected to continue to improve and positively feed into the liquidity of the underlying bond markets. This change is to the benefit of investors. However, given the still opaque nature of the underlying cash bond market, coupled with the lack of a timely, unified picture of bond trades and pricing (a consolidated tape), we believe ETFs play an integral role for investors looking to access euro corporate bond exposure, whether investment grade or high yield. Investors who embrace fixed income ETFs and other index exposures may benefit from improved transparency, liquidity, and efficiency.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.