Exchange-Traded Funds on European Markets: Has Critical Mass been Reached? Implications for Financial Systems

Abstract

Exchange-traded funds (ETFs) are one of the most rapidly expanding categories of financial products in Europe. One of the key yet still unanswered questions is whether European ETF markets have reached the size at which they could affect the financial systems. In our study, we examine 13 European countries during the period 2004–2017 in order to trace whether the share of ETFs in the total assets of investment funds has reached the ‘critical’ level that makes possible their further growth and can be associated with an influence on the financial system. We use a novel methodological approach that identifies the ‘critical mass’ along diffusion trajectories. Our results show that, in 10 countries, the share of ETFs in assets of investment funds increased. Still, in most countries, the share of ETFs did not exceed 1%. Estimates of the diffusion models indicate that the process of growing shares of ETFs was most dynamic and relatively most stable in Switzerland and United Kingdom. Results of the critical mass analysis imply that its achievement may be forecasted exclusively in these two cases. However, even in such cases there is no substantial evidence for a possible significant influence of ETFs on the local financial systems.