Axel Lomholt, head of product development for iShares EMEA, talks to Emma Dunkley about launching a new model of ETFs and the drive to enhance transparency
For the last ten years, iShares has been synonymous with physical replication, advocating the merits of simplicity and transparency associated with this fund structure. After iShares became sponsor and investment manager of the first Stoxx 50 and Eurostoxx 50 ETFs listed in Europe, the product provider has consistently offered and endorsed funds that physically hold the underlying index constituents.
However, September marked a sea change as iShares unveiled its inaugural multi-counterparty, swap-based ETF platform, with the launch of the MSCI Russia Capped Swap and S&P CNX Nifty India Swap ETFs. Despite the change in model, iShares says the swap-based funds maintain the same tenets of simplicity and transparency that are central to its core physically replicated ETF offering.
“We had a significant review of the iShares business a couple of years ago and there were two major goals we wanted to achieve,” says Axel Lomholt, head of product development for iShares EMEA. “We wanted to become market leader in fixed income and we wanted to explore options around swap-based ETFs.”
Yet, he says at no point has iShares considered deviating from physically replicated funds as its main offering. “At the same time, we have seen demand for more niche exposures that are hard to physically replicate, such as Russia, India and other emerging markets,” says Lomholt. “So we thought how can we do this in a swap format, in a way that has the same look and feel as the iShares range?”
One of the major focus points for iShares is on transparency and Lomholt says this is the crux of their new prospectuses. “We have put out what is arguably one of the best prospectuses – that’s something we are very proud of. It’s taking prospectuses to a completely different level, in terms of information disclosure, transparency and how we mitigate risk.”
Nevertheless, creating a solution that mimics the simplicity, transparency and liquidity of the physical funds, with support from primary and secondary markets, has not been an easy exercise, says Lomholt. iShares has initially selected three investment banks as counterparties to provide the swap, but seeks to add more to its platform over the coming months. RBS, Credit Suisse and UBS were all chosen at the outset, as they met the minimum credit rating requirements of being at least single A rated.
Competitive pricing is one advantage of the multi-swap model touted by providers. “At the moment we have three counterparties and new creations are allocated to the counterparties based on the prices submitted by the banks,” says Lomholt. As the model develops, he says it will get to a stage where it has around eight to ten counterparties, making it more competitive and therefore more efficient in terms of getting better pricing.
“The usual suspects are interested in joining as counterparties – lots of people want to get involved,” says Lomholt. “Now the products are up and running, other parties are very interested. We had good trading volumes in the first week and that is what potential counterparties want to see.” From inception on 20 September until 14 October, the Russia fund had total volumes, both on exchange and over-the-counter, amount to almost £1.7m. During the same period, the India fund saw total volumes of around £11.2m.
Lomholt says the model is designed to be completely ‘agnostic’ in terms of who the counterparties are on board. “If they follow our credit rating standards and can provide a swap which we believe is competitive, then we do not mind if the counterparty has their own ETF offering, as long as there’s no conflict of interest,” says Lomholt.
One of the major issues for iShares in developing this model was ensuring the products had robust collateral arrangements in place. “We wanted to build a model that was diversified across counterparties and one where the individual swap positions are fully funded and over-collateralised,” says Lomholt. “Our equity ETFs are over-collateralised, with 120% equity collateral, and up to 103% for G10 government bond collateral.”
Other multi-counterparty models in existence launched over a year ago include platforms offered by Source and ETF Securities. Lomholt says each model has its own selling points and nuances, but for iShares, the priority has been to ensure the model is as transparent as possible, serving as an open book for investors to see exactly what goes on within the ETFs. “We haven’t spent time looking at all the models and saying how we can create something better; we’ve sat down and gone how can we create something we call iShares.”
The next phase for the new platform is to list the ETFs on other exchanges across the continent. “Our country managers across Europe will let us know if they’re interested in the product and then we’ll look at cross-listing into different jurisdictions,” says Lomholt.
The flexibility afforded by swaps in accessing particular asset classes also lends itself to iShares expanding into other areas, such as commodities. Lomholt says: “Commodities is of great interest; we will apply exactly the same principles in terms of how can we can come up with some commodity products that we believe would be great for our clients; so it’s definitely an area of interest.”
Axel Lomholt joined iShares in 2006 where he was initially responsible for equity ETF portfolio management and new product development in Europe and Asia ex Japan. Prior to this, Lomholt was head of indexed portfolio management at Gulf International Bank. He was previously head of global indexing at HSBC Asset Management.
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