How The ETF Sausage Gets Made

Brown Brothers Harriman's head of ETF services peels back the curtain on thematic ETFs.

Reviewed by: Lara Crigger
Edited by: Lara Crigger

Ryan SullivanAn ETF isn't just the product of its issuer. It requires the involvement of dozens of people, most of whom work tirelessly behind the scenes to make sure everything from daily trading to the creation of new shares keeps humming along smoothly.

Recently, chatted with Brown Brothers Harriman’s  Ryan Sullivan, vice president of global ETF services for one of the largest ETF custodian banks worldwide, to gain insight on these often-overlooked and misunderstood roles—as well as to better understand what trends he sees impacting the ETF industry moving forward. What role does Brown Brothers Harriman play in helping ETFs come to light?

Ryan Sullivan: We really perform the nuts and bolts for ETFs. We can act as transfer agent; we can work directly with authorized participants on creation/redemption activity. We're also a global custodian, meaning we provide safekeeping, trade processing and settlement, corporate action projections and so on.

We're also fund accountants and administrators. So we're striking the NAV, reconciling custody activity, pricing securities. And for ETFs, in particular, we're creating a basket every night for the PCF [editor's note: "portfolio composition file," or what APs and issuers use to build creation/redemption baskets]. We settle that with the NSCC [National Securities Clearing Corporation] and the APs.

But we also offer ETF consulting capabilities. We arm ourselves with a team of ETF experts from sponsors and trading desks, so we can have conversations around product development, ETF 101 education and the costs associated with launching an ETF business.

That expertise allows us to consult with sponsors very early on in their process, sometimes even years in advance of an actual fund launch. Do ETF issuers usually opt for an all-in-one service provider? Or do they often go with one firm for custodian, one firm for transfer agent, and so on?

Sullivan: Well, we like to offer the all-in-one package, and it's often the first conversation we have. There are certainly operating benefits to having all those functions under one umbrella. But we do have models where we're the custodian and transfer agent, but the issuer might work with a third-party administrator and accountant. So maybe the third party builds the creation/redemption basket, and we transmit it once it's approved by the manager, and send if off to the NSCC. But that's a secondary model next to our full-service offering.

In the ETF world, the custody and the transfer agency functions are really tied together. It's different compared to the mutual fund world, where a transfer agent can sit on its own, and there are a handful of large transfer agents for thousands of accounts that mutual funds can have. For the ETF world, it makes more sense for them to be closely aligned. What would you say is the most misunderstood thing about what you do?

Sullivan: That we’re not an ETF sponsor! A lot of folks who are maybe newer to the asset management space, particularly organizations launching ETFs who don't have other investment products, often look at banks like ours and say, "OK, they must offer products too." But we don't. We don't compete with ETF sponsors against their products. How long does it normally take a new fund to set up the machinery of creation/redemption? Is it faster or slower than it used to be, say, 10 years ago?

Sullivan: It's definitely faster. The advances we've made in technology have accelerated how quickly we can get everything in place. There's a tremendous amount of efficiency and scale we've built out, through investing in ETF-dedicated technology—not just for creation/redemption and order-taking, but through all the accounting responsibilities and even helping calculate iNAV intraday, and so on.

We've seen funds launch inside of three months, from the first conversation when we were hired to the final, live product. When firms are ready, we can move very quickly. People are always saying that the ETF industry has run out of ideas. Do you believe that’s the case?

Sullivan: I definitely don't think our industry or our clients are out of ideas. We're still very much in the early days of the ETF revolution.

Consider that some of these products were originally built for an institutional audience, some hedge funds and pension plans. Then they proliferated and have been adopted by the retail channels. Now we're seeing a pivot back to institutions, in the form of custom-built products, thematic ETFs built for longer-term investment horizons that are chasing fundamental shifts in demographics. It's early days, definitely. Every corner of the market—even thematic ETFs—is experiencing fee pressure. Does launching a super-narrow thematic ETF present an opportunity for issuers to stand out from the crowd?

Sullivan: For the firms that have captive distributions—asset managers affiliated with broker-dealers or insurers, where they can put a product back into a financial advisory network or into a general account—that allows them far more levers to pull when it comes to fees.

You can start bottom-up, like Fidelity and their zero-fee funds. Or you could start top-down, and use a model that's sold through your advisory network for free, as we've seen some do in the robo space; or at a significantly reduced cost. You may still be able to maintain your profit margins, but the investor is also seeing benefit. Some themes have a lot of interest among investors, but haven't seen too much uptake in ETFs yet: bitcoin, marijuana and so on. There aren't any bitcoin ETFs yet, and there's only one marijuana ETF, which came to be under pretty unusual circumstances. From a custodian's perspective, why haven't we seen more products on these themes? What needs to change for us to see more?

Sullivan: To us, the biggest roadblock for both of those assets is the regulatory front. We don't have a clear path forward with the SEC or the CFTC, as it relates to the crypto assets. Without that, it leaves a lot of uncertainty about the ability to successfully design, implement and manage a product in that regulatory vacuum.

We know the SEC has been interested. It’s been very clear on its concerns around these crypto assets. Until that irons itself out, or until the SEC takes action and works with the industry to come up with an approach, we don't see a tremendous amount of growth in this product set.

The same holds true on the marijuana side. Until we get more clarity and, quite frankly, legalization [of marijuana] at the federal level, that’s going to impact the ability to design a product, and make it very difficult for the banks to step in. If and when legalization happens, do you predict there will be flood of competitors joining the one marijuana ETF currently on the market, the ETFMG Alternative Harvest ETF (MJ)?

Sullivan: Whether it’s this administration or future administrations, if they decide to enact or seek legislation that would effectively legalize marijuana in some fashion, and then we see improvements in how banks could offer services around it, there is likely to be an influx of product. I think that would help stabilize that market; maybe bring it more in line with guidelines around other investment products.

But right now, the legal status means many firms are limited in the services they can offer. Bitcoin, marijuana or maybe something else—what do you see as one of the most promising investment themes?

Sullivan: I'm not a portfolio manager, I'm not designing investment strategies, but I think some of the interesting products are ones targeting insurance firms in particular, whether it's their general accounts or their variable annuity business.

The idea of managed volatility and managed-risk ETFs at attractive price points is something to watch. As we see an uptick in adoption by insurance channels, that may open more doors, especially with larger pension groups. You could see cross-pollination across the institutional channels, if those are successful.

Contact Lara Crigger at [email protected]

Lara Crigger is a former staff writer for and ETF Report.