A multi-sponsor ETF platform for the 21st Century
In today’s world our retail lives are governed by ease of choice. Whether it’s iTunes to download our favourite artist or Amazon to peruse the latest range of tennis racquets, as consumers it’s never been easier to find what we want.
In November 2013, State Street Global Markets launched Fund Connect, a first-in-class multi-sponsor online ETF platform. The purpose of Fund Connect is to make the lives of Authorised Participants (APs) as straightforward and efficient as possible.
“Nobody wants to log on to five or six different platforms, they want the most efficient method for transacting. That’s what Fund Connect does; it brings together multiple sponsors in one destination. For an AP creating and redeeming units with multiple sponsors, they would like a single destination and that’s exactly what we’re offering,” says Peter McHugh, Head of Fund Connect for Europe, Middle East and Africa.
In other words, Fund Connect is attempting to bring the consolidated benefits of something like iTunes to the ETF marketplace; a single platform where APs can view and interact with multiple sponsors.
This is a big development. Fund Connect is able to speed up the workflow for APs by bringing their archaic reliance on paper-based fax transmissions into the realm of super-efficient electronic trading in a straight-through processing environment. The result is reduced transaction times from potentially hours to minutes.
McHugh notes that whilst Fund Connect first launched in the US in 2008, R&D was needed to refine the platform for the European ETF market; hence the time-gap.
“In developing the Fund Connect platform for Europe, we were able to build out a complex sophisticated rules engine which can be customised at the fund level, for multiple sponsors.
In North America, Fund Connect boasts nine different ETF providers and 30 APs. Already in Europe, the platform has two providers and twelve APs in place, which suggest momentum is building. “For us it underscores just how much a platform like Fund Connect is needed in Europe,” adds McHugh.
By sitting between the ETF sponsors and the APs, Fund Connect is well positioned to understand how the two parties are changing the way they interact as products become more innovative. The key objective here is to make the workflow more automated and efficient. By speeding up the whole creation and redemption process, APs are able to respond more timely to sponsors’ needs, which in turn improves liquidity provision.
“Different sponsors have different workflows, so that’s where we’ve focused in introducing the platform to Europe. A transaction may need to be reviewed by various people, e.g. a portfolio manager before it gets released to the transfer agent, which helps create efficiencies ” says McHugh.
One solution to the next
Just when the Fund Connect team thinks they’ve solved the latest challenge for APs, during the time it has taken to build out that solution a new ETF feature will likely have developed. This constant change presents a challenge for ETF providers who run proprietary AP platforms, especially when one considers the speed with which the European ETF market is evolving.
“What sets us apart with Fund Connect is not only having the ability to support multiple sponsors, but also that we’re committed to continuing to evolve the platform rapidly in response to the feedback from both the AP community and the fund sponsors and their transfer agents,” stresses McHugh.
Even though many ETF platforms might share similar functionality to Fund Connect, the fundamental difference is this: they only offer their own ETFs. Fund Connect can offer ETFs from multiple providers.
“This is generating a lot of interest from the AP community,” says McHugh. “Over time, as the fund sponsors listen to our story and more join the platform, the noise and pressure from the APs will probably increase (for more fund sponsors to come on board). This solution is comparable to how people transact online in the real world in their private lives, we are simply applying those same principles to the institutional marketplace.”
“With Fund Connect, the APs can see all their orders from multiple fund sponsors in a single report and customise it how they wish,” adds McHugh.
Enhanced workflow efficiency
One of the key benefits of the platform, which in turn is helping to reduce the order flow time frame, is that every field for the fund sponsor can be customised and controlled. One ETF sponsor, for example, might have 10 ETFs, each of which settles in a different European jurisdiction. That creates a heavy manual workload for the AP, requiring them to rely upon lots of reference data that need to be checked and verified when using faxes.
“As a result, the AP may inadvertently send information that contains inaccurate settlement locations or the aggregation of all their settlement locations against the actual number of units they need to create may be incorrect,” says McHugh.
“We’ve built systematic checks from start to finish so that before the AP submits an order to the fund sponsor we’ve already carried out a number of checks that historically would have required additional phone calls and follow-ups which act as impediments to getting a trade completed.”
The ability to pass a trade down a life cycle between three or four different parties, and at each part of that process be able to verify and ensure that the trade is correct, in real time: that’s a huge advantage to APs.
Settlement location is a good example that illustrates how Fund Connect is able to 1) deal with the complexity of fragmented markets and 2) support the ever-changing needs of APs.
APs in Europe can settle one basket of securities in multiple locations in Europe. This is not the case in the US.
“For example, one fund might be able to settle in Euroclear in Frankfurt, while another fund might only be able to settle at Euroclear in Brussels, so we’ve built a robust rules engine which is customisable at the fund level. We can support any marketplace or settlement location needed,” confirms McHugh.
The technology expertise of State Street Global Markets allows Fund Connect to adapt to the changing needs of APs.
Focus on your core expertise
As mentioned, there are numerous ETF providers running their own platforms for their own products. Aside from the obvious cost impact, one of the problems of doing this is that ETF providers need to continually develop the technology capabilities of their platforms in order to support their product ranges. They can’t afford not to; growing demand equals more innovative products, which in turn equals more platform functionality.
It’s an endless cycle. The danger here is that ETF sponsors start to take their eye off the ball.
“Our platform is highly scalable. We know it’s challenging for sponsors to build their own platforms. That’s where we feel we are really able to add value, by applying this scalable approach to constantly develop new solutions for market participants. Where we do it for one, we do it for all,” says McHugh.
It’s an attractive proposition. Why build out their own platform piecemeal when ETF sponsors can outsource all the technology heavy lifting to someone who can do it on an industrial scale?
“The core expertise of an ETF sponsor is in the provision of ETF solutions and looking at the evolution of that market and growing with it. Our expertise is in technology solutions. Sometimes sponsors almost get drawn in to becoming a tech shop rather than an ETF shop as the technology side of things starts to take up more of their time.
“We are in the technology space to facilitate ETF sponsors; they can focus on the product whilst we can take care of the technology solution,” states McHugh.
Fund Connect is the kind of platform, then, that the AP community has been waiting for. They want to be able to log in to one location with one password and trade with each and every ETF provider they do business with. They are driving the discussion forward and whilst still reluctant to a degree – particularly those that are running their own proprietary platforms – ETF sponsors are beginning to listen.
“The reason sponsors want their own platforms is because they have a unique feature they want to protect. Information, however, travels so fast now (as do people) that the fear of giving away the secret sauce of how they do things is somewhat unfounded in this day and age,” suggests McHugh.
A burgeoning European ETF market
The European ETF market is at a tipping point right now. Investors increasingly recognise the attractiveness of low-cost passive tracking strategies relative to the higher fees and unspectacular performance of actively managed funds. Factor in RDR in the UK and more broadly across Europe and the ETF market is set to burgeon.
Within that context, what is it that ETF sponsors are trying to achieve?
“It goes back to my earlier point,” adds McHugh. “Are you an ETF sponsor who wants to ride the crest of that wave and continue to develop innovative products or do you want to spend your whole day dealing with technology issues?
That APs still rely on faxes to complete transactions underscores precisely why consolidated platforms like Fund Connect are so necessary. It is bringing the creation and redemption process firmly into the 21st Century and is better able to deal with the complex ways in which APs interact with sponsors. This is especially true when one considers the growing trend in actively managed ETFs, where index weightings are tweaked and altered during the trading day.
“As fund providers and APs figure out how they are going to interact with those new types of assets, we will be right there in conversation with them understanding how it will impact the creation/redemption process; what do we need to do to help them facilitate that transaction? If the weights of index components are moving around intraday do they need us to maintain those weights? How often do the APs need that information?” confirms McHugh.
As McHugh concludes: “We are ready to evolve in whichever way the ETF industry chooses to evolve, We deal with both sides of the party so that makes it easier to ensure that Fund Connect evolves in the right direction. It creates more efficiency for both sides.”
Fund Connect report: An AP's perspective
“We use Fund Connect as one comprehensive solution for the SPDR ETF products to create and redeem units online. We’ve been using the platform for over six months,” confirms Frank Mohr, Head of ETF Sales-Trading at Commerzbank AG in Frankfurt.
Commerzbank is one of twelve authorised participants (APs) now using Fund Connect since the platform launched in Europe. Although still early days in terms of adoption amongst ETF sponsors the degree to which APs have bought in to the idea of leveraging such a solution has been significant.
As Mohr says: “As a market maker it’s necessary to have such an online connection as it makes things much more straightforward. It is making our lives a lot easier.”
This is partly due to a clear reduction in time that an electronic automated platform can offer. “It removes the burden of manual intervention. Before we used to send faxes but those days are now surely over; sending faxes is hardly a state-of-the-art solution. It’s a very easy platform to use. We can halve our time by not having to send faxes and it helps reduce manual risk,” says Mohr.
Another benefit is the improved workflow processes that the Commerzbank traders are able to implement within the platform. Creating and redeeming units has become a far more streamlined exercise taking 10 to 20 minutes. In Mohr’s words, “The Fund Connect platform has proved crucial to automating workflows. We’ve had no issues whatsoever using it. There have been no complaints from the traders. They use it on a daily basis and so far it has worked fine.”
The ability to see different settlement locations for different ETF products and sponsors is a feature that APs will appreciate as more ETF sponsors join Fund Connect.
For Commerzbank, however, they currently only use the platform for SPDR products. Nevertheless, Mohr agrees that “for the AP community it will make things much easier to have one platform for all. We are always looking to improve things. We speak with different ETF sponsors and say ‘Listen, we need a better process to create and redeem units’. They hear our concerns.”
One of those concerns is the fact that this is very much a low margin business. This is where Fund Connect comes into its own. By helping to improve and smooth workflows for APs it reduces both time and cost and brings a level of operational efficiency that can make all the difference when operating margins are so slim.
“Of course, it would be ideal for an AP to have one system where they can create and redeem everything (for multiple ETF sponsors). There are approximately 20 different ETF issuers in Europe and most of them have their own operation, their own platform.”
This increases the complexity of operations for APs, especially as the way they interact with ETF sponsors becomes evermore sophisticated.
“As a market maker Fund Connect is a very useful addition to the marketplace. Anything that can reduce our workflow processes is welcome. We’re happy to be using the platform,” concludes Mohr.
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Fund Connect report: An AP’s perspective