The ETP Ecosystem: Explaining It To Clients

The ETP ecosystem is a symphony of firms each pursuing their own self-interest but united by a common goal to harmonise the ETP investment experience.

These entities surrounding the ETP issuer include the exchange the ETP lists on, the ETP’s primary advisors and subadvisors, a custodian, an administrator, perhaps a distributor or marketing agent, an auditor, providers of initial seed capital, and of course, the authorised participants (APs) and market makers who engage in ETF trading and arbitrage every day.

For the sake of clarity, let’s briefly take a look at each of these entities:

Exchange Of ETP Listing: The regulated and standardised marketplace where ETPs are listed and traded. Exchanges have different listing requirements, so ETP issuers need to initially work with exchanges to determine which exchange(s) to list their shares on (see "Exchanges and ETPs"). It’s not uncommon for one ETP to be listed on multiple exchanges.

Primary Adviser: The primary adviser is in charge of the day-to-day operations of the ETP. Often, the primary adviser is the fund manager that determines which securities the fund will hold and which securities should constitute the creation and redemption baskets. Sometimes the primary adviser will defer daily investment decisions to a subadviser who is overseen by the primary adviser.

Subadviser: Similar to the primary adviser, sometimes the subadviser will be in charge of an ETP’s day-to-day operations. Not all ETPs have a subadviser.

Custodian: The custodian is a third-party firm that is responsible for holding the ETP’s assets—you can think of them as the “bank” where the vault holding all your investments is. By having a third party as the holder of assets, away from the fund manager and advisors, it helps to build an extra layer of risk mitigation. For example, for swap-based ETPs with substitute baskets that act as collateral, those securities are held in a separate account with the custodian. Custodians often provide trade settlement and clearing services.

Administrator: The administrator is a third-party firm that provides various noninvesting services, including the calculation of the product’s net asset value, regulatory and compliance services, financial reporting and that sometimes even acts as the transfer agent of the ETP, keeping track of the shareholders of record.

Distributor/Marketing Agent: The distributor is often a third-party firm that acts as a liaison between the ETF issuer and other pertinent players in the ecosystem. It also provides administrative duties, including sales and marketing, compliance reviews, record maintenance, technological assistance and even underwriting services.

Auditor: A third-party firm that reviews the ETP’s accounting materials to make sure the product’s books and records are complete, accurate and comply with regulations.

Seeding Agents: The agent that originally seeds the new product with capital. The capital is then used to buy underlying shares of the ETP, which is submitted to the issuer for the initial creation unit (usually 50,000 shares), which gets floated on the exchange. Note: The seeding agent can sometimes be the market maker and the AP all in one.

Authorised Participants: APs are involved in the creation and redemption mechanism for the ETP. They are authorised to buy or sell the underlying shares in the ETP, and they can deliver the shares to the issuer for an ETP creation unit, or they can deliver the ETP creation unit to the issuer in exchange for the shares in the case they want to redeem shares (see "Authorised Participants").

Market Makers: Market makers are in the business of maintaining an orderly market for ETP trading. They aim to provide liquidity in the markets, and offer up bid/ask spreads. Some prominent market makers in Europe include Susquehanna, Flow Traders, Optiver, UniCredit and IMC. It’s not unusual to see the lead market maker of an ETP also acting as the AP.

Tying It All Together

An issuer that wants to launch an ETP has several steps to go through, and must work with a wide network of related firms to bring an ETP to market.

Once the issuer selects an index to track, it will determine the party in charge of the day-to-day operations of the fund (the primary adviser or subadviser) and the party that will hold the assets (the custodian).

The issuer then selects a firm to act as the transfer agent and manage its financial documents (administrator). A distributor may also be hired to market the ETP and provide other administrative functions. Then an auditor is chosen to review the ETP’s financial books.

When it’s time to list the product, the issuer will need to select the exchanges on which to list the product and will need to find a seeding agent as well as assign APs and market makers.

This complex web of third-party firms, each focusing on its own distinct responsibilities and providing its own specialty services, comprises the entire ETP ecosystem. It’s a well-oiled machine that has delivered efficient and transparent investment vehicles.