Maintaining Ireland's ETF Supremacy Leaves Little Room for Complacency

With Ireland being a preeminent domicile for ETFs, Ciarán Fitzpatrick, head of ETF Solutions at State Street in Europe, discusses why Ireland has a stronghold in the ETF space, the implications of digitalisation as well as emerging ETF trends.

Since the launch of the first European exchange traded fund (ETF) around 20 years ago, Ireland has proven to be highly adept at spotting and capitalising on emerging global investor interest in ETFs, and it has cemented a commanding lead in Europe that looks almost unassailable.  

ETFs are a type of pooled investment, much like mutual funds, that are listed on stock exchanges, such as Euronext, London Stock Exchange (LSE) and Xetra. Most of them passively track an index, like the Nasdaq or the CAC 40, but more recently there has been  an increased appetite for more actively managed products.

SPDR S&P 500 (SPY), the first ETF to be introduced in the United States and listed on a national stock exchange, made its debut on 22 January 1993. It was developed by State Street to track the S&P 500 and it remains the world's most heavily traded ETF. This groundbreaking ETF revolutionised investor access to a wide array of asset classes and investment strategies1.  

These funds then went on to attract an international investor following as well. Since 2000, when the first ETF launched in Europe2, Ireland has been steadily building up its lead. Ireland domiciled ETFs broke the €1 trillion barrier for assets under management (AUM) for the first time at the end of June this year putting it leagues ahead of second place Luxembourg with €295 billion AUM. This gave Ireland around 68 percent of the European ETF market, according to Morningstar3.   

Comprehensive tax treaties

A key building block of this success is the double taxation treaty Ireland enjoys with the US, which reduces the withholding tax on US dividends to 15 percent from 30 percent. Ireland is the only European jurisdiction to hold such an arrangement for ETFs and given global investor interest in US assets this is a valuable concession. For example, the US comprises 42.5 percent of the global equities markets4, according to the Securities Industry and Financial Markets Association, making it the world leader in this asset class.

In fact, Ireland has one of the most developed tax treaty networks in the world, making it a very attractive jurisdiction for many international investors. According to the Revenue Commissioners, Ireland’s tax authority, the country has comprehensive double taxation agreements with up to 76 countries5. These jurisdictions include Australia, China, Hong Kong, India, Japan, Switzerland, Singapore and the United Kingdom as well as with EU countries.  

But there is more to Ireland's ETF success than tax treaties. It has a supportive regulator and a highly developed ETF ecosystem - covering areas such as administration, custody, legal, tax, accounting and auditing, product development and thought leadership.

Another factor behind Ireland’s success is the establishment of the International Central Securities Depository (ICSD), which provided centralised settlement for all Irish domiciled ETF issuers and, thereby, resulting in reduced fragmentation, boosted liquidity and narrowed spreads. These achievements have, to an extent, been counteracted by the additional costs of complying with the EU’s Central Securities Depositories Regulation (CSDR).   

All these factors have made Ireland an ideal springboard for most asset managers looking to sell ETFs across Europe. 

Emerging ETF Trends

ETFs are evolving rapidly and Ireland is well placed to benefit from these developments. Important trends include the emergence of the “ETF 3.0” model, more US asset managers seeking access to European investors, growth of ESG strategies and the move towards digitalisation. 

ETF 3.0 can be characterised as “actively managed” ETFs. We are seeing a significant number of US asset managers converting their mutual funds into US structures and in Europe a growth in traditional active mutual fund managers seeking to enter the ETF arena with similar active strategies. ETF 1.0 are passive funds tracking an index and version 2.0 are smart beta and thematic products replicating a particular investment strategy be it income, growth, momentum or value. 

This transformation is being driven by investors seeking lower fees associated with ETFs and the ability to receive more regular portfolio updates than typically seen with mutual funds. This could represent an important long-term trend even if only a small proportion of mutual funds make the transition.     

Data from Morningstar shows inflows into active ETFs grew by a net 14 percent during the first half of 20236 while passive ETFs managed a more modest 3 percent increase. Active products account for around 5 percent of the overall ETF universe7.   

According to a Lipper Alpha Insight report, European asset managers held just over €14 trillion in assets at the end of June of this year8. By contrast, ETF managers held €1.4 trillion in assets - suggesting a tantalising growth opportunity for actively managed ETFs.   

Well-established infrastructure

From a custody and administration point of view, turning mutual funds into ETFs in Ireland is relatively straightforward given both are regulated under the EU’s Undertakings for Collective Investment in Transferable Securities (UCITS), albeit not a practice the European market has seen frequently to date. The complexity in this switch is the change in the legal status of the investor from legal shareholder to beneficial owner.

There are some additional operational differences, such as “basket creation,” and as ETFs are exchange-listed, a capital markets team is needed to handle primary and secondary market engagements. Also, investor creations and redemptions in the primary market require detailed reporting to be generated by the service provider, though there are well- established solutions to make these processes run smoothly.  

However, starting 28 May 2024, a challenge arises for European-based ETFs holding US-listed assets. While the US will shift to one day settlement (T+1), Europe will remain on T+2, causing a synchronisation gap. This means US transactions settle on T+1, but European participants will not receive funds or assets in the secondary market until two days later, potentially leading to increased costs. 

Meanwhile, Ireland remains the destination of choice for the latest wave of US asset managers looking to sell products to European investors. Several asset managers, such as the tech-focused ARK Invest, are preparing to launch suites of ETFs into Europe that are to be domiciled in Ireland. As for ESG-themed funds, which are particularly popular with some European investors, Ireland continues to hold its own.   

Digital Risk

A potentially important emerging trend that Ireland should monitor closely involves digitalisation. Financial firms across the world are investigating how to use digitalisation to drive efficiencies and to democratise assets.  

In Europe, for instance, Germany, Luxembourg, and Liechtenstein lead in experimenting and creating regulatory frameworks to support innovation around tokenising assets on blockchains. 

While institutional investors dominate the European ETF landscape, there is some anticipation of increasing retail interest, supported by tokenisation. PwC forecasts a 14 percent annual growth in European retail flows into ETFs until 20279, with Germany driving demand. Therefore, there is a risk of ETFs being established domestically rather than in Ireland should digitalisation become an important trend. 

Nonetheless, Ireland’s position looks secure for now and, given its current momentum, its market share in Europe is likely to keep rising.   

References

1State Street Global Advisors, SPY – the Original S&P 500® ETF https://www.ssga.com/au/en_gb/institutional/etfs/capabilities/spdr-core-equity-etfs/spy-sp-500

2 Irish Funds, WHY IRELAND. The Voice of the Funds & Asset Management Industry in Ireland, May 2023 - https://cdn.irishfunds.ie/x/4b95011afa/2023-05-6709-irish-funds-why-ireland-2023-euro-web.pdf

3 Ignites Europe, Irish ETFs top €1trn – Fund industry increasingly favours ETF investment, July 2023 - https://www.igniteseurope.com/c/4153554/535104

4 SIFMA, Research Quarterly: Equities, July 2023 - https://www.sifma.org/resources/research/research-quarterly-equities/

5 Revenue Commissioners, Double Taxation Treaties, January 2023 - https://www.revenue.ie/en/tax-professionals/tax-agreements/double-taxation-treaties/index.aspx

6 IR magazine, Active ETFs show strong growth in first half of 2023, Aug, 2023 - https://www.irmagazine.com/investor-perspectives/active-etfs-show-strong-growth-first-half-2023

7 IR magazine, Active ETFs show strong growth in first half of 2023, Aug, 2023 - https://www.irmagazine.com/investor-perspectives/active-etfs-show-strong-growth-first-half-2023

8 Lipper Alpha Insight, European Fund Flow Trends Report, June 2023 - https://lipperalpha.refinitiv.com/reports/2023/07/european-fund-flow-trends-report-june-2023/

9 PWC, ETFs 2027: A world of new possibilities, March 2023 - https://www.pwc.com/gx/en/industries/financial-services/publications/future-of-etf-2027-survey.html