Counting the full cost of ETF servicing______

Simon Keefe, Head of Market Solutions

Funds Europe talks to Simon Keefe, Calastone, about the importance of asset servicer technology in reducing costs for ETF Investors.

ETFs are an established part of global financial markets, the first being launched 30 years ago – the growth story continues. According to ETFGI, global ETF Assets Under Management (AUM) reached a new high of $10.99 trillion in November 2023, supported by YTD inflows of $803 billion, the second-highest YTD inflows on record.

With nearly 12,000 ETFs issued globally, the ETF market is hugely competitive and set to become even more so as active managers embrace the ETF structure and enter the market at pace. In this highly competitive environment, ETF issuers are increasingly focused on reducing costs for investors.

An ETF’s total expense ratio (TER) is normally considered the key metric when assessing the cost of investing in an ETF. However, it does not capture the full cost paid by investors. The total cost of ownership (TCO) of an ETF is a metric that investors can use to determine the full cost of investing through an ETF. It can compare similar ETF exposures across issuers and ETFs against mutual funds.

An ETF’s TCO has three components – the TER, liquidity costs and tracking error. Liquidity costs relate to the bid/offer spread and the premium and discount of the ETF’s tradable price to the value of its underlying assets.

ETF service providers play an important role in facilitating liquidity in the primary market process through their roles as transfer agent, fund accountant and custodian. By increasing efficiency and removing risk from the primary market process, ETF servicers can better support authorised participants (APs) in their role as liquidity providers and arbitrageurs, ultimately reducing liquidity costs and the TCO for ETF investors.

“To be competitive, ETF issuers are working with their service providers to remove friction from the primary market process. In an increasingly complex environment, this will be achieved through advances in technology that supports the process,” says Simon Keefe, Head of Market Solutions at Calastone. “Given the challenges faced by APs through regulation like CSDR and a move towards T+1 settlement, it has never been more important that APs have confidence in the asset servicers’ process and technology.”

The ability to create or redeem ETFs efficiently and at a known cost is critical to market makers, upon whom ETF issuers and investors are so reliant. With a mutual fund, the subscription and redemption process is relatively straightforward. ETFs require an enhanced TA and ETF servicing process that supports the intricacies and timings of the creation and redemption process and the demands of the APs.

The findings from our recent survey of ETF Issuers support this message, says Keefe. “Supporting market-making and liquidity provision is one of the top two most important ETF fund servicing tasks for ETF issuers, second only to fund accounting, as cited by more than a third of respondents to the survey.  More than half (51.9%) nominated it as one of the two most important areas of ETF servicing when it comes to choosing a provider.”

It is not just ETF issuers aware of the importance of market-making and liquidity provision. In Ireland, which is home to the majority of ETFs domiciled in Europe, the Central Bank has issued guidance on the importance of the market-making process.

This was after the International Organisation of Securities Commissions (IOSCO) issued its ETF Good Practices to regulators like the Central Bank. IOSCO called for greater due diligence on the role of APs and market-makers in ensuring efficient trading. The effectiveness of liquidity provision “is largely dependent on the robust participation of APs and market makers”.

The efficient and accurate handling of the creation and redemptions process was a key driver of success, according to 58% of the survey respondents. Interestingly, the creation and redemption process was also highlighted by the survey respondents as the area most in need of improvement, chosen by 41%. However, the creation and redemption process was only fifth in the list of priority areas that asset servicers are looking to make improvements in.

This is where you see some variation in the quality of asset servicer’s offerings, says Keefe. “Some have invested in technology to keep pace with the complexity and growth of the market. Others have not, resulting in inefficiency and risk, which presents itself to the end investors as liquidity cost,” he says.

Earlier this year, Calastone announced its partnership with HSBC on the development of an ETF asset servicing platform which includes real-time processing, monitoring, and cash calculation capabilities to APs and ETF issuers throughout the creation and redemption cycle.  Calastone ETF Servicing is the firm’s first entrance into the ETF market and comes at a time when the asset servicer’s role in the ETF market has become increasingly important and under greater scrutiny from regulators, issuers, and APs.

Technology will be crucial to the future success of ETF servicers, says Keefe. “To be competitive, asset servicers need to provide an efficient, timely and robust service that is scalable to support the continued growth of the industry both in terms of AUM and number of issuers and products.”

(First published Funds Europe 2024:

Simon Keefe, Head of Market Solutions

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