How ISE Builds ETF Partnerships

March 08, 2016

Kris Monaco, head of the International Securities Exchanges ETF Ventures, spoke with recently about the options exchange’s expansion into the ETF space, how it’s become a behind-the-scenes participant in some key products and the business plan driving those deals. ISE seems to have a lot of business partners that it works with on ETFs. Can you explain the business plan?

Monaco: When I joined in 2002, the exchange had recently launched and focused on equity options or options on individual stocks and it was going very well. It quickly became the largest equity options exchange in the world, mostly because of its technological edge. It was purely electronic, and the first one to do electronic trading of options.

But when I joined, the goal was to expand the number and types of the listings on the exchange. So I had focused on what I thought was highly adjacent to that space—ETF options and index options.

We started to come up with proprietary indexes. At that point, ISE was the first exchange to be created in almost 30 years, so all of the major headline indexes were exclusively licensed to other exchanges prior to our existence. There was no easy way to break in.

We created our own proprietary indexes, and we came up with first-to-market thematic ideas, like water, homebuilders, homeland security and the SINdex, which covers alcohol, tobacco and gambling.

People were very interested, but they didn't want to trade options, they wanted to trade ETFs. We thought about how to break in to the ETF market, and the way we thought about doing that was to talk to ETF issuers, and to license our indexes to them.

We did that by focusing on very-well-known investment management firms that didn't have an ETF presence yet, like First Trust, for example. They’re fantastic partners of ours, but they weren't getting any love from the S&Ps of the world at that time, and we were there saying, “We will build this for you, we want to work with you.”

We started working with First Trust, Direxion, UBS and other issuers of the day. But we noticed that as soon as they grew, then the index providers would come in and we'd have to now compete with some massive companies.

We thought about, how do we take our high-conviction ideas and bring them to the market? How do we commercialize them, knowing that there's a lot of competition out there for index providers to provide their ideas to issuers?

We thought about providing the startup capital and the backstopping support—basically putting up the money to launch ETFs, but using our proprietary product concepts. The first one was a series of products we did with PureFunds that focused on the mining space—junior miners, junior silver mine suppliers and diamond miners. Was the point—once those ETFs launched—to then launch options on those?
Not at all. That was part of the ecosystem, but the focus was to diversify ISE's revenue to areas that were more than just transaction fees. The way exchanges generate their revenue is from transaction fees. So when two parties trade, there's a transaction, and each party gets assessed a fee.

This was totally different. This was independent of trading activity. It was really about assets under management in the fund. It doesn't have to be a volatile product, it doesn't have to be actively traded by trading firms to be successful. That was very attractive for us.

When we started to talk to issuers about taking our ideas and launching ETFs based on our indexes, it quickly morphed into, “Well, how do we help them launch their ideas that they came up with?”

It evolved to the point where we now have this program that was born out of necessity, where we provide the underlying R&D for the index. We provide the startup capital for launching a fund. We provide the backstopping capital while the assets are low and someone's got to pay the bills to keep the lights on for the fund. We provide the marketing support, a dedicated marketing budget, an internal marketing team that comes with the plan and executes that plan.

We also have active distribution by way of a partnership with one of the private-label issuers called ETF Managers Group, or ETFMG. They hire wholesalers on our behalf, and the wholesalers actively distribute the products. This is about a strategic relationship where we are providing all these other things. Think of it almost like an accelerator, if you will.

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