Flow Traders is calling for a same day creation model to be implemented after warning ETF investors are incurring the cost of wider bid-offer spreads due to inefficiencies in the T+1 creation process.
The Dutch market maker said costs ranging from 1.5-4.5 basis points (bps) were being passed on to investors due to overnight interest rate dynamics, which currently benefit issuers and their custodians.
Issuers that have received funds for creation but have not distributed them to purchase the underlying basket of securities can benefit from overnight interest rates, currently at 16-year highs, while authorised participants (APs) incur a cost.
This is particularly true of global funds where T+1 creation is required to synchronise with secondary markets transactions, leading overnight long positions for issuers.
It said issuers should pass back the overnight interest rate to the APs so the savings can be passed on to the investors.
“This would ensure a fair distribution of costs and revenues, preventing issuers and custodians from solely benefiting from overnight long positions and indirectly increasing the costs for the end investor,” the liquidity provider said.
The warning from Flow Traders comes in response to the European Securities Market Authority (ESMA) consultation – which closed in December – on the potential move to a T+1 settlement cycle in Europe.
The securities watchdog said it wanted to assess the viability of moving to a T+1 cycle and comes after the US regulator announced its intention to move to a T+1 settlement cycle by May 2024, while India migrated its markets to a T+1 settlement cycle in January 2023.
T+1 settlement cycles
Despite this, Flow Traders raised concerns about moving to a T+1 settlement cycle while creations also operate on a T+1 basis.
It called for a same-day creation model (T+0) for global funds to “lay the foundation” for T+1 settlement cycles in Europe, with failure to do so “significantly increasing the amount of failed settlements in the market”, increasing the cost to the end investor.
“If same-day creation is not allowed, the earliest settlement for global funds is still T+2 as per current, limiting the possibility of achieving T+1 settlement cycles in European/UK markets,” the group said.
“Through same-day creations, the secondary market transactions are harmonised with the primary market creations, reducing additional funding requirements for APs.”
The proposed model would see same day creations on European and US proportions of the basket, with Asia executing on a T+1 creation cycle, meaning settlement could then occur on a T+1 basis.
“By addressing the issues of overnight interest rate handling and advocating for same-day creation for global funds, the goal is to harmonise interests, reduce costs and pave the way for more streamlined settlement cycles,” Flow Traders said.
As part of the consultation, ESMA also asked market participants to consider the impact of eventually moving to a T+0 settlement cycle.
It is widely thought the move would drive more efficient use of capital across markets by reducing credit, market and liquidity risks.
ESMA said it hopes to publish its final report in Q4 this year.
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Investors 'paying the price' for T+1 creation inefficiencies - ETF Stream
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