Brown Brothers Harriman: A Quiet Force In ETFs

Ryan Sullivan
Senior Vice President of ETF Services
Brown Brothers Harriman

As Brown Brothers Harriman (BBH) prepares to release the results of its seventh annual Global ETF Investor Survey in late January, Senior Vice President of Global ETF Services Ryan Sullivan looks back over the major developments in the ETF space during 2019. As a global custodian and fund administrator, BBH supports the day-to-day operations of ETFs. But with its deep bench of ETF experts, BBH goes further and extends its ETF operational, product and distribution expertise to help its clients navigate the constantly evolving ETF market, helping new players become “ETF ready.”

The BBH survey polls ETF investors—mainly advisors—across the U.S., Europe and Greater China on how they use ETFs and what they want to see available in the future.

Would you give an overview of what BBH does in the ETF space and who your clients are?
Broadly speaking, BBH, through our investor services business line, is a global custodian and fund administrator. We support the back and middle office of various investment products like mutual funds and alternative investments across the globe.

Our ETF support model is built upon this foundation and includes ETF-specific technology and a team of subject matter experts across operations, client service and ETF product strategy teams. We support ETFs and their managers across three regions—the U.S., Europe and Asia. On a day-to-day basis, we provide various solutions as a custodian and administrator in terms of safekeeping assets, booking trades and reconciling to accounting. We strike the funds’ NAVs, and create the ETF baskets and the PCF files. We’re also an ETF order-taker and transfer agent for the funds. In this capacity, we interact daily with our clients and other constituents in the ETF ecosystem, such as authorized participants, market makers and the listing exchanges.

While our day-to-day focus is facilitating core operational requirements for ETFs, we’ve assembled a deep bench of ETF experts that affords us ability to consult with clients. We really seek to help inform their ETF operating model, technology requirements as well as their product and sales leaders as they build out their ETF strategies. This includes elements like helping them build business cases, assess the ETF market and latest product trends, align their sales teams, and identify new roles and responsibilities across operations and capital markets. We really try to help them put all the parts of the puzzle together so they can execute on their ETF strategies.

2019 has been a very busy year for the ETF market. Would you talk about what some of the big changes are?
I think “busy” is an understatement. Suffice it to say, when we look back at 2019, it will be seen as a historic year for ETFs. We had the Securities and Exchange Commission enshrining ETFs into their own permanent regulatory structure, moving out of this environment where every ETF issuer needed an exemptive relief or an exemptive order from the 1940 Act Mutual Fund regime before they could launch product. Essentially, the regulators recognized ETFs as a vital investment tool for the U.S. financial services industry and standardized the regulations on them through the so-called ETF Rule (6c-11).

Then we had movement and approval, in two phases, to bring periodically disclosed products—also known as nontransparent or semitransparent active ETFs—to market. First, we had a patent that was managed and owned by the folks at Precidian for their ActiveShares ETFs, and that moved through the SEC back in the spring. Most recently, we’ve had another batch of approvals for T. Rowe Price, Fidelity, Blue Tractor and the New York Stock Exchange, all with unique offerings and disclosure methodologies intending to protect active managers’ investment strategy. All of these structures are part of a movement to bring more actively managed ETFs to market.

These structures seek to change the disclosure policies from what in the traditional ETF world is a daily view into the funds’ holdings and trading decisions. These new structures seek to change the frequency of that disclosure, moving it to a monthly or a quarterly basis that is similar to the mutual fund industry. This could add a whole new element of growth and product offering in the market, as well as a new wave of managers bringing ETFs to market for the first time.

What is BBH doing with its clients to help them make these transitions?
It’s an interesting inflection point for us as we look at what these changes mean. Even the most seasoned ETF managers are going to be impacted by some of these regulatory changes, such as the ETF Rule and trying to become compliant with that new rule—what they might do, for example, to support custom baskets on a more frequent basis than what they were otherwise able to do.

We’re spending a lot of time working with our clients and helping educate them around the nuances of these regulations: What are the impacts to their day-to-day operating environment? What are the impacts to their compliance procedures? What are the potential impacts to their board reporting? We want to help them navigate and better understand from a best practices perspective how the rest of the industry might be thinking about these changes and give them some of that context that can help inform some of their own decision-making.

For managers that are not in the ETF market but are looking at some of these new structures as a potential path forward, it’s about getting them “ETF ready.” These firms bring an investment strategy, they bring an operational business, they bring distribution, but the ETF wrapper is new for them. So questions and considerations exist around things like: What are the added operational requirements the ETFs will need? What does it mean, and how is it going to impact their sales team to sell ETFs in addition to mutual funds or collective investment trusts or managed accounts? What is the role of ETF capital markets, and how are firms solving for that?

When we go in to some of our mutual fund clients who already have very robust product and operational lines of business, we’re focusing on those new, unique ETF- specific components and helping them make sure they’re ETF-ready to inform their ETF business case and support a product launch.

Do you expect to see a lot of movement into the periodically disclosed ETF market? Has there been a lot of interest from your clients in that area?
We’ve spoken with just about every one of our U.S.-based clients, either ETF issuers that are curious what these mean, or our mutual fund clients who are looking for a path forward in the market. We certainly see the interest there, and we do think there’s going to be a lot of demand from the management community to get behind some of these products and patents, and some are even considering more than one structure.

The biggest question then becomes. what’s the appetite in the market for these from the investor perspective? That was actually something we worked in to our forthcoming 2020 Global ETF Investor survey.

One of the biggest things that jumped out at us this year was in the active space. Of U.S. respondents, 62% said they plan to increase their allocations to actively managed ETFs in the next 12 months. When we posed another question around what types of new products they would like to see more of, active ETFs was the highest-rated category. This may present a real opportunity for managers who can promote alpha or offer a product that might have some downside protection in volatile periods through an active management strategy. We think there is going to be investor demand there.

The survey is a good example of how we try to come to the table with information like this to help our clients prep their business case, to execute on their business case, and get the buy-in and executive commitments they need to successfully enter this market.

Stay tuned to see the rest of the survey results. We’re planning to publish the survey just before the Inside ETFs conference in Florida, Jan. 26-29.

Where do you see the biggest gaps in ETF education?
I think the education efforts that most shops have undertaken over the years have been successful. When we look at our own survey, each year there are nuances to where investors want to see more focus, and that suggests they’re becoming comfortable with the wrapper—including it in their broader portfolio, understanding the trading dynamics, and the total cost of ETF ownership. It’s going beyond just the fund expense ratio and factoring in their time horizon for the investment: How liquid is it going to be? Can they get more of it when they want it? Can they get out of it when they need to make a change? Those education efforts undertaken by ETF issuers appear to be paying off.

I think what we’re seeing now is a shift in that education to more of an outcomes-oriented view. It’s no longer just using the ETF as sort of a tactical tool, but more strategically: How is that going to drive better tax outcomes for an advisor’s end investor? How are they going to use ETFs to help solve for the need for income, especially for portfolios that may be moving into a retirement footing, may be looking more at withdrawals? How can they use ETFs to help solve for some of those income needs?

And then there’s hedging. How can these ETFs be used to either offset certain volatility in the market? How can strategies within an ETF be used as a counter to market head winds when they arise?

It’s really about managers thinking through their product offering and how they can create a narrative as part of a “master class” in ETFs for their end investors. It’s about helping advisors create these types of outcomes that they are seeking to deliver for their clients.

The opinions expressed are a reflection of Brown Brothers Harriman’s (“BBH”) best judgment at the time this interview was conducted and any obligation to update or alter our views as a result of new information, future events or otherwise is disclaimed. Neither BBH nor its affiliates provide legal or tax advice. Nothing contained herein is intended as a recommendation to buy or sell any security, or to invest in any particular country, sector or asset class.