Recently, Cohen & Company participated in an ETF Bootcamp event for the investment industry, “Building a Successful ETF Business.” Our panel discussion covered many topics, ranging from reasons to enter the ETF business, including tax benefits of the ETF structure, distribution accessibility, intraday liquidity, trading and transparency; to how the product operates, including cost efficiencies and lower expense ratios without the need for blue sky fees.
However, we focused much of our discussion on three areas critical to foundationally understanding how to launch an ETF, including structures; roles and actors in the ETF ecosystem (that can be of assistance); and mutual fund/separately managed account conversions to ETFs. Below are some of the insights shared throughout the event.
1. ETF Structures
There are various structures to consider before launching an ETF. Some entrants into the space may want to select the “do-it-yourself structure,” which means launching a new trust in which the sponsor will select all service providers, including legal, accounting, transfer agent, custodian, distributor, auditor and independent board. This model offers significant flexibility but requires a longer lead time for research and decision-making in advance of the ETF’s launch.
Another structure to consider is the “series trust” or “shared trust” model, which is typically sponsored by one service provider that has previously selected the complementary roles from across the ecosystem, including the ones mentioned above. However, with this model the sponsor will be sharing costs such as legal and trustee fees with other advisers that have chosen that same series trust.
The final solution is generally referred to as a “white label” provider. This structure is similar to a series trust but has more flexibility and reduces the amount of compliance for the ETF sponsor. The sponsor can leverage all the pre-existing relationships of the white label provider, access distribution and marketing, and choose to act as the adviser, sub-adviser or index provider of the fund.
There are various legal considerations for each model, but exploring options early on will lead the sponsor to the best decision for them.
2. Roles and Actors in the ETF Ecosystem
Our panel also broke down the additional roles and actors in the ETF business that support the success of the products, including listing exchanges, authorized participants, lead market makers/liquidity providers and index providers. While many of these new providers may be intimidating, the expertise and guidance they provide to the ETF sponsor will reduce the sponsor’s burden and help make the product successful.
- Listing exchanges should be one of a sponsor’s first stops in the ETF journey. Learn how these exchanges can list the product and connect sponsors to their ETF ecosystem. They also provide guidance on marketing and distribution.
- As the authorized participant (the party that has an agreement to buy and sell shares directly with the ETF) places orders, they are also tasked with knowing the holdings of the portfolio, selling the shares of the ETF, and then either delivering the securities to the ETF or receiving the portfolio of that ETF in a redemption.
- The lead market makers/liquidity providers are tasked with understanding the ETF’s portfolio on a daily basis and ensuring there is an efficient market to both buy and sell shares of the ETF. Before launching an ETF, it’s important to build a relationship with a lead market maker to ensure the ETF is ready for launch. The lead market maker will also want to understand the demand the fund is expecting and where capital will be sourced to buy the initial shares. Early, pre-launch discussions with the market makers will also help to ensure the liquidity of the constituents of the ETF and a tighter bid/ask spread.
- If the portfolio consists of illiquid positions, the portfolio may not be the best candidate for the ETF structure because the bid/ask spread will be wider due to underlying positions.
- Depending on the strategy of the product, engaging an index provider to build the constructs of the portfolio along with the rules for buying and selling might be an option to operate the product more efficiently.
3. Conversions from Mutual Fund/SMAs to ETFs
Finally, the panel discussed the recent uptick in mutual fund/separately managed account conversions to ETFs. There are several operational considerations in potential conversion scenarios, including an analysis of underlying shareholders. Are those shareholders in tax-advantaged accounts? How many share classes are currently offered? Are there 12b-1 fees and shareholder servicing fees? These are important questions to ask because the answers will help drive the decision on whether converting is the right decision for the fund. There are also legal and tax considerations to weigh regarding outcome for shareholders.
Launching a successful ETF business can be daunting, but knowing there are partners in the industry that are willing to educate, assist, and guide you through the process will help you avoid pitfalls and launch with success.
Contact Brett Eichenberger at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.