Shipping ETP required novel approach
ETF Express reported news of the launch of the Breakwave Dry Bulk Shipping ETF (NYSE ARCA: BDRY) in March. This is the first and only freight futures ETP focusing exclusively on dry bulk shipping.
The law firm behind the innovative structure is Sullivan & Worcester, who advised ETF Managers Group on the launch of the product.
John Hunt is the partner who worked on the product along with associate Eric Simanek (pictured), who provided counsel to ETFMG throughout the development process.
Development of the fund is notable not only for being the first of its kind, but also for the lengthy process and rules change needed to achieve Securities and Exchange Commission and New York Stock Exchange [ARCA] (NYSE ARCA) approval.
The fund was created to provide investors with a cost-effective and convenient way to gain exposure to daily changes in the price of ocean freight futures.
Sullivan & Worcester’s Simanek says: “We work with ETF Managers Group who provide a platform for anyone who wants to get into the ETF business.
“They get called constantly with different idea for ETFs and started working with John Kartsonas, Founder and Managing Partner of Breakwave Advisors, who has had a long career in shipping. He had an idea for a fund that invested in futures contracts on the price of shipping dry bulk freight around the world and the challenge was turning that general idea into a structure that complied with the regulatory rules.”
Simanek says that the challenge was meeting exchange listing requirements. “Pooled investment vehicles are regulated by the Investment Company Act [of 1940],” Simanek explains. Most ETFs are registered under the 1940 Act but because this product would be based on futures, it fell outside of that regulation.
“So, we worked with Breakwave Advisors to turn Kartsonas’s idea into a benchmark portfolio consisting of the futures contracts that he wanted the fund to hold but that fit within the requirements for passive funds.”
Sullian & Worcester partner, Hunt, explains that Simanek and Breakwave and ETFMG didn’t have anyone else to look to for inspiration. “It required a lot of novel thinking because the second issue was that the key to an ETF is transparency.”
The customised benchmark on which the ETF is based is itself based on three different futures contracts. Hunt says: “Ultimately, after a lengthy review process and a rule change, the SEC and the New York Stock Exchange concluded that there was sufficient transparency and approved the client’s proposed benchmark. We needed to work creatively to stay within the exchange’s rules.”
Over the nearly year-long process, the Sullivan & Worcester team worked with ETFMG through all pertinent regulatory bodies, including the National Futures Association (NFA) and NYSE ARCA, and the SEC.
Simanek says: “Because these futures are traded off exchange there was a concern that there was adequate information about the prices of the underlying instruments. Both the fund and the benchmark have to publish intra-day prices so we had to talk to the client about what kind of information would be available on which these prices would be based.”
The resulting ETF is designed to be a hedge that shippers can invest in against the volatile price of shipping.
Simanek says: “It’s also a way to get exposure to global trade and the Chinese economy because a lot of shipping is to and from China.”
This ETF fits within the ranges of niche products coming from smaller managers at the moment, and there may be more on the way.
Hunt says: “Looking forward you might see more futures-based ETFs using this route with more novel indices and more specialist products.”