2025 Outlook: ETFs at the Crossroads of Innovation and Efficiency______

David McGuinness, Product Director

As we step into 2025, the ETF market is set to build on the record-breaking momentum of 2024. Global assets have surged past $14 trillion, with unprecedented inflows underscoring the resilience and versatility of ETFs. These vehicles remain indispensable for modern investors, but the road ahead will be defined by evolving demands, increasing complexity, and regulatory shifts. The challenges and opportunities for the ETF ecosystem are vast, requiring adaptability and innovation across the board.

The Continued Rise of Active ETFs

One of the most significant developments in the ETF space is the rising prominence of active ETFs. Long dominated by passive strategies, the market has experienced a marked shift as asset managers capitalise on the flexibility and efficiency of the ETF structure. High-profile conversions of mutual funds into ETFs by firms like Dimensional and Morgan Stanley have further legitimised this trend.

Active ETFs are expected to gain an even larger share of market inflows in 2025, driven by investors seeking more dynamic, sector-specific, or thematic exposures. Amid ongoing market volatility, active management provides the opportunity for skilled stock selection and risk adjustment, a value proposition that resonates with both institutional and retail investors. Furthermore, the growing breadth of offerings, including ESG-focused and multi-asset strategies, positions active ETFs as a powerful tool for portfolio diversification.

However, the operational demands of active ETFs can place strain on the infrastructure of service providers, particularly as new entrants and product launches expand the scope of servicing requirements. As these products become more bespoke, supporting their unique workflows will challenge the ecosystem to deliver seamless efficiency.

Complexity Drives Innovation and Pressure

The ETF landscape is not just growing—it is evolving in complexity. In 2025, investors can expect an influx of sophisticated products that cater to highly specific investment needs. From options and leveraged ETFs to funds incorporating exposure to alternative assets such as cryptocurrencies, issuers are innovating to meet the appetite for tailored strategies.

While these products offer exciting opportunities, they also demand greater education efforts. Retail and institutional investors alike will require clear insights into the risks and mechanisms underpinning these instruments. At the same time, regulatory bodies are likely to increase scrutiny over such offerings, focusing on liquidity, risk transparency, and investor protections. Issuers and distributors will need to strike a careful balance between innovation and compliance, ensuring that complexity does not come at the expense of market stability.

For the industry as a whole, the servicing of complex ETFs will test operational resilience. Legacy systems, already stretched by traditional workflows, may struggle to handle the nuances of these products. This dynamic will create pressure to modernise, ensuring that operational frameworks can adapt to new demands without compromising scalability.

T+1 Settlement and Operational Readiness

The global transition to T+1 settlement is set to have a profound impact on the ETF market in 2025. Shortening settlement cycles aims to reduce counterparty risk and improve capital efficiency, but the shift introduces significant operational challenges across the value chain.

With T+1, authorised participants (APs), custodians, and issuers face an accelerated timeline for processing trades and managing positions. For ETFs, where creation and redemption mechanisms already involve unique complexities, the margin for error is reduced even further. This requires a robust overhaul of existing processes, with real-time data sharing, seamless communication, and automation becoming critical components of post-trade workflows.

Settlement risks also rise in tandem with shorter cycles. Cross-border transactions, in particular, are vulnerable to delays that could result in costly penalties under frameworks like the Central Securities Depositories Regulation (CSDR). The industry must focus on readiness, with greater collaboration between stakeholders to harmonise processes and reduce operational friction. While the promise of T+1 is clear, its success depends on the ability of the ETF ecosystem to innovate and adapt.

Accessibility Challenges in the Secondary Market

Despite the growing popularity of ETFs, accessibility remains an issue for certain investor groups. Across Europe, many advisers and distributors face obstacles in trading ETFs efficiently, often due to high costs or lack of integration within existing systems. As a result, ETFs are underutilised by some retail investors, despite their potential to offer cost-effective and diversified investment opportunities.

The push to make ETFs more accessible to retail investors will be a defining theme in 2025. Reducing costs associated with trading and settlement is a key priority, as this will help position ETFs as a more competitive alternative to traditional mutual funds. Additionally, improving the connectivity between distributors, custodians, and execution providers is critical to streamlining ETF transactions. By simplifying access, the ETF market can unlock demand from previously underserved investor segments, widening the adoption of these vehicles.

This emphasis on accessibility will likely extend to improving transparency in secondary markets, ensuring that execution quality and cost-efficiency are prioritised. Addressing these challenges could transform ETFs into a truly universal investment tool, fostering greater participation across investor categories.

Standardisation and Scalability in an Expanding Market

As the ETF market grows, so too does the need for standardisation. In an increasingly fragmented ecosystem, the absence of common processes and technology frameworks hampers efficiency and scalability. Moving forward, 2025 will see a concerted push toward harmonisation, particularly in order submission and confirmation in the primary market.

Standardisation offers significant benefits for the ETF ecosystem. By reducing redundancy and aligning operational practices, service providers can handle a growing number of issuers and products with greater efficiency. For issuers, standardisation simplifies market entry, fostering innovation and competition. The scalability achieved through common frameworks ensures that the market can accommodate new participants and adapt to evolving demands without bottlenecks.

Collaboration across the industry will be pivotal in achieving these outcomes. Stakeholders must work together to define a unified roadmap, leveraging technology and shared best practices to lay the foundation for sustainable growth.

Conclusion: A Year of Challenges and Opportunities

In 2025, the ETF industry finds itself at a crossroads. The year promises continued growth, underpinned by active and complex product innovations, but it also brings challenges in the form of regulatory shifts, settlement pressures, and accessibility barriers. The future of ETFs will be defined by the ecosystem’s ability to adapt to these forces, balancing innovation with efficiency.

Amid these changes, technology and collaboration will remain central to overcoming obstacles and unlocking new opportunities. Calastone’s ETF Servicing solution, with its ability to streamline and scale operations, is poised to play a key role in supporting the market’s evolution. As we embrace the year ahead, the ETF market stands ready to continue reshaping the investment landscape for all participants.

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