On Tuesday March 15, following two days of sharp declines in Japan’s stock market, a London-based retail investor placed an order with his online broker to buy Lyxor’s Japan (Topix) exchange-traded fund (LTPX). Noticing later in the day that the order had not been transacted until nearly two and a half hours after the initial trade request, which was entered on the broker’s website at 9am, he queried the delay. ETFs are, after all, supposed to be tradeable instantaneously throughout the day.
It turned out that Société Générale, parent bank of Lyxor and the sole official market maker for the London Stock Exchange’s listing of LTPX, had failed to post bid and offer prices for the fund not only for most of Tuesday morning, but also for the majority of the time since Japan’s earthquake and subsequent tsunami struck in the early morning (European time) of Friday March 11.
Only on Wednesday and Thursday, March 16 and 17, by which time the Japanese equity market had started to recover from its post-earthquake drop of nearly 20%, did LTPX’s market maker return to full-time quoting duty. When doing so, the market maker posted dramatically wider bid-offer spreads on the London Stock Exchange than had prevailed prior to the tsunami. Over those two days, LTPX’s on-exchange bid-offer spread ranged from 150 to 700 basis points, ten to fifty times more than the spread prevailing on 10 March, the last day before the earthquake.
In the charts below, which are based on data supplied to IndexUniverse.eu by an ETF market maker, sourcing price quotes from Bloomberg, average bid-offer spreads from the London Stock Exchange are calculated on a non-time-weighted basis for each minute over the trading day. The charts cover the six (trading) day period from Thursday 10 March to Thursday 17 March, inclusive.
LTPX is a relative minnow in the ETF market – it’s the smallest London-listed exchange-traded fund tracking Japanese equities, with around £10 million in assets. Although it’s an oft-repeated maxim that the liquidity of an ETF reflects the liquidity of its underlying constituents, in practice it’s generally accepted that the size of a fund affects the tightness of spreads in secondary market trading: the bigger the fund, the better the liquidity. So how did the market makers in larger European ETFs cope with the post-tsunami volatility?
According to the Deutsche Bank February 2011 European ETP directory, the iShares MSCI Japan ETF (IJPN LN) and the db x-trackers MSCI Japan TRN Index ETF (XMJP LN) are the largest two funds in the Japan country fund category with London listings. These funds, it turned out, also saw a widening of their bid-offer spreads post-tsunami on the London Stock Exchange, dramatically so when it came to the London listing of XMJP.
It’s worth noting the remarkable complacency of market participants during the European trading day of Friday 11 March. It was only after the weekend, by which time images and accounts showing the full scale of the disaster had emerged, that market prices in Japanese equities – and bid-offer spreads in associated ETFs – reacted.
On Monday and Tuesday 14 and 15 March the London Stock Exchange bid-offer spread for XMJP spiked to near or above 1000 basis points on several occasions. For an investor placing a market order to buy or sell at these points in time, the net result would have been a trading cost equivalent to twenty years’ worth of management fees on the fund (XMJP charges 0.5% per annum).
While iShares’ IJPN (which charges 0.59% a year) didn’t record such high levels of dealing spread in its London listing as XMJP, the fund did record an average bid-offer gap of nearly 3% during individual minutes of the trading day on Tuesday 15 March – again, several years’ worth of fees.
