Capital Markets

What is NAV trading?

NAV trading is used to target the official NAV of an ETF and is most used by investors who are benchmarked to ETF NAV.

It is appropriate for investors who want a cost effective method of execution without time sensitivity. Brokers provide investors with fixed prices for execution, usually shown in reference to a basis point cost versus the official NAV publication e.g. NAV -2bps / +2bps. This means the broker is willing to buy the ETF at the reference NAV minus two basis points and sell the ETF at NAV plus two basis points.

What is OTC risk trading?

Some of the largest facilitation trades in the ETF market are conducted with the use of a broker via OTC risk trading. This involves investors asking brokers for a live price of the ETF in which they wish to trade.

Once the investor has executed their trade, the risk is then fully transferred to the broker who will need to hedge the position. Trading desks will charge a risk premium for this commitment to capital. Generally, the price shown on a risk trade will take into consideration: market impact and slippage, financing of the ETF position and implied creation redemption costs.

The diagram below illustrates how OTC risk trading would work:

What is exchange trading?

Investors can also choose to trade ETFs on the global exchanges with the use of algorithms. During the course of European trading hours, designated market makers provide exchange bid and offer prices to provide liquidity to ETFs.

Investors are able to enter and exit trades at any point during the trading day.

One of the key differences between exchange and OTC risk execution is the process of achieving the final fill price. When an investor asks a broker for an OTC risk price, it is the final price they will achieve.

In the case of exchange execution the investor has various options in which they can achieve their execution but they will not know their final price at the outset.

The order book example below demonstrates the number of shares on the bid and offer of the respective prices for an ETF. Currently there are 76 shares on the offer at a price of 131.94 EUR. However, if an investor wanted to trade 100,000 shares of this product, they may not achieve all of the execution at this price. The investor’s final fill would be the weighted average of all the executions:

What is Agency OTC trading?

An agency order involves an investor giving an order to a broker with the agreement that the broker will execute the order and pass the execution fills back to the investor. The broker acts as an agent, simply executing the order for the client on a best efforts basis.

In order to provide this service, the broker may charge the client a commission for the execution services. There are multiple ways in which an agency order can be executed, all of which are appropriate accordingly to the underlying market conditions.

The diagram below highlights the advantages and disadvantages of agency execution: