Some Thoughts On The Implementation of an ETF Capability

The attractiveness of diversified, liquid, continuously priced, low-cost instruments to investors has never been greater. The growth in ETF AUM globally from around $1 trillion in 2008 to around $14 trillion at the end of 2023 shows the size of the inroad this asset class has made in a relatively short period. As Investment Managers wrestle with cost pressures across the industry, they are increasingly looking at adding ETFs as a complementary offering. Many of the core requirements for design and managing are common across both funds and ETF’s so it is understandable that IMs consider adding another string to their bow. However, there are some considerations impacting on the operating model which need to be borne in mind in order to ensure the efficient running of both offerings.

ETFs of course require the appointment of Authorised Participants (APs), acting as a buffer between Sponsor and Secondary Market and ensuring that premia and discounts in the ETF price are arbitraged away. This in turn creates a requirement for Investment Managers to have a good internal team to manage the flow of resulting creation and redemption of ETF shares with AP’s. Often this includes Front Office-focused resources, managing the relationship with the AP’s. This skillset may already be present within the existing team but it still requires time some changes to the relevant team members roles if additional resources are not to be added and this needs to be considered.

Sponsors will need to appoint an ETF Administrator. The assumption that the role can be given to a current Administrator may not necessarily stand scrutiny. While many of the Administrator processes are common to both funds and ETF’s, there are others which are very distinct. Serious consideration needs to be given to the impact on the underlying operating model as a result of potentially more regular and unscheduled share creation/redemption, as well as the interfaces – human and automated - and data flows required to support ETF’s. One such example is the requirement for the Administrator to provide a Portfolio Composite File (PCF). The Administrator will need to demonstrate the ability to turn these around quickly and accurately and, in the case of a rebalancing of the ETF to a benchmark, potentially more than once a day. A further complication arises in the management and dissemination of corporate actions data, required for the PCF, which will need to be processed with a high degree of timeliness and accuracy as they will potentially impact the entire creation/redemption chain. The experience and stability of the Administrator’s ETF operations team are, as a result, a major consideration in the selection process.

ETFs are an increasingly valuable tool in the Investment Manager’s armoury. ISC can help smooth the path to setting up a capability, as well as helping to optimise existing operating model processes.