ETF Growth Stresses Technology Infrastructure

A divide is growing between what ETF issuers want in technology services and what asset-servicing providers are targeting, according to a report from funds servicing company Calastone. 

London-based Calastone's research shows that much of the technology and servicing networks is at risk of falling behind, as the ETF industry continues to grow well beyond its vanilla-indexed strategies. 

The report comes as the industry has ballooned to over $11 trillion in nearly 12,000 products globally, becoming one of the most popular products among financial advisors. This trend seems likely to continue with a 2023 survey from the accounting powerhouse PwC finding that seven in 10 managers of ETFs believe that these products will reach $15 trillion in assets under management by 2027. The Calastone report, which cited the PwC research, said that this rapid growth "is forcing asset servicers to evolve - and fast."

Creation and Redemption Needs Improvement

One finding, based on surveys of representatives from ETF issuers, fund administrators and authorized participants, shows that 58% of issuers believe the creation and redemption process is the most important factor when measuring the success of their ETF fund administration services.

Further, 41% of issuers said the creation and redemption process was one of the two areas of ETF servicing most in need of improvement.

The gap is illustrated by the fact that just 23% of asset servicers said enhancing the creation and redemption process was one of their two main business priorities, placing it behind fund accounting, transfer agency, technology and operational support, and regulatory compliance and reporting.

“The ETF industry is currently witnessing unprecedented levels of growth and the requirements of fund issuers are becoming increasingly complex,” said David McGuinness, Calastone product director in a statement.

“The creation and redemption process underpins primary market liquidity and is an area that asset servicers must focus on if they are to retain and win business moving forward,” he added. “Asset servicers need to look at how they can upgrade their systems to improve transparency and enhance standardization across their core processes, as this will ultimately benefit the end investor.”

One of the issues, according to the report, is that as asset servicers recognize the pressure to keep pace with the growth of the ETF space, many are investing in ways that only supports legacy technology systems.

Newer ETF service providers are better at keeping pace with the ETF evolution, but they are typically too small to have a significant impact. 

Calastone contends that the growing inefficiencies are resulting in higher costs for ETF investors.

“Underpinning primary market liquidity is the ETF creation and redemption process,” the report states. “The ability to create or redeem ETFs efficiently and at a known cost is a critical prerequisite for market makers, upon whom ETF issuers and investors are so reliant.”