As the exchange traded fund (ETF) market matures, the Securities and Exchange Commission (SEC) is proposing to harmonize the rules under which all fund sponsors operate.[1] The proposal opens the door for all fund sponsors to review product strategy and consider launching new funds.

In our view, asset managers should also use this occasion to examine the entire lifecycle of their ETF investment operations. The goal? Help ensure their firm does not overlook the chance to embrace emerging industry conventions, adopt new technology and implement efficiencies. As part of this process, it is also critical to assess the evolution and contributions of key service providers.

What the SEC is putting forward

If implemented, the SEC’s proposal aims to level the playing field for most ETF sponsors by supplanting their exemptive relief orders with general rules that apply to all fund sponsors. The key provision permits almost all sponsors to create and redeem custom baskets. Custom baskets can be used as long as comprehensive policies and procedures governing the transactions are adopted by the fund’s board and subjected to continuous oversight by the Chief Compliance Officer. The proposal also formally requires all fund sponsors to publish portfolio holdings on a daily basis and provides additional flexibility on establishing creation unit size.

The proposal’s clearance of custom baskets provides more opportunities in fixed income than equity funds; this is due to the inherent challenges of the bond market: pricing transparency, availability and liquidity. As such, fund sponsors that did not have exemptive relief letters permitting custom baskets could view the proposal as a way to apply their fixed income know-how to the ETF wrapper.

Since the new SEC plan will require policies and procedures for accepting custom baskets in order to protect shareholders of the fund, there is more to consider. For example, portfolio managers likely will need new technology to ensure the acceptance of a creation basket does not cause or exacerbate a tracking error against the fixed income index. Complexity increases, of course, when multiple custom baskets are proposed from multiple market makers or authorized participants throughout the day which must be evaluated on a basket-by-basket basis.

New technology could expedite the process of evaluating the effect on the portfolio of each previously accepted basket, plus the next basket being assessed. This situation, for sure, amounts to a data and technology challenge. And at this moment, many fund sponsors and fintechs are hard at work to resolve it.

Don’t pass up the opportunity

The SEC’s proposal is 25 years in the making. Don’t overlook it as an insignificant milestone. Indeed, we believe that fund sponsors’ ETF operations have reached a certain level of maturity. If your firm’s ETF support processes, technology and service providers haven’t been challenged in a few years, they certainly will be with the adoption of the proposed rule. Now is the time to perform a health check. Focus on processes and partners.

Processes

Benchmark re-balancing, custom basket processing, country/market procedures, dividend funding and approval automation through artificial intelligence are just a few areas where firms may adopt revised processes. Operational procedures are as varied as the number of ETFs – times two.

The SEC’s proposed leveling of the playing field will require taking advantage of every edge at a fund sponsor’s disposal. Cutting costs, reducing capital gains and streamlining operational complexity could be accomplished by performing an end-to-end review and implementing modernized processes that conform to current exemptive relief letters and protect shareholders. This end-to-end assessment of ETF processes also should be viewed as an opportunity. One area to consider is turning certain in-house functions and tasks over to service providers whose capabilities have likely evolved since your ETFs were initially launched.

Vendor relationships

The success of the ETF wrapper would be far different were it not for the significant contribution of the external service provider. I’m talking about data providers, distributors, custodians and even website hosting resources. Each one is essential to the ETF ecosystem by helping to expedite the time-to-market for nearly all fund sponsors. However, fund sponsors should consider these relationships to be dynamic; they need to be evaluated on a continuous basis.

Ensure service providers are adding discernible value and keeping pace with their competitors. In conducting these reviews, fund sponsors should focus on the service provider’s investment in technology, commitment to innovation and the overall quality of service. Of utmost importance is service quality. It cannot be overstated.

Older, better and best

The SEC’s proposed ETF regulations are much more than a requirement. Many asset managers are already seizing upon opportunities embedded in these changes. In a way, the SEC’s proposal means no longer having to ask for permission to innovate. Preparing for the new rules opens the door to streamline operations and innovate on the product side.

As ETFs grow up and no longer need to ask for permission, step up and write the next chapter in your ETF growth story. Contact me if you would like to discuss how Accenture could help.

[1] https://www.sec.gov/rules/proposed/2018/33-10515.pdf

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