There are more than 2,100 ETFs in the U.S., each one the culmination of a complicated and possibly protracted legal process and multiple parties’ involvement both prior to and after launch.
Here are some of the different groups involved with startup and operations who help make ETFs available to investors.
White-label issuer is a term that is being applied to the ETF industry in a way it was not used with similar open-end mutual fund organizations. The startup process for any mutual fund involves filings with the SEC. A brand new mutual fund or ETF requires going through several additional processes, all of which add time.
The time and resulting expenses can be significantly reduced by partnering with a white-label issuer that already has the exemptive application and other regulatory filings in place.
Firms like Nottingham have gone through these processes numerous times (in Nottingham’s case, several hundred times over a 30-year history).
ETFs involve many moving parts after operations commence. There are ongoing relationships with attorneys, outside auditors, custodians, transfer agents, fund accountants, market makers and authorized participants (“APs”).
Most beneficial is that a while-label issuer has its own exemptive relief – a clearance granted by the SEC to launch ETFs. The legal structure of the series trust allows for multiple funds within the same series trust, using the exemptive order applicable to that trust. The time and cost savings for this attribute alone is many months to well over a year, and a minimum of $50,000 and probably closer to $150,000 in legal and related expenses.
Additional benefits of working with a white label issuer can be found here.
While the term “sponsor” is not a legal term used in any way like other related parties to a fund or ETF, an ETF sponsor is where the idea for an ETF typically originates. This is a company or financial institution that sees a market opportunity for an ETF, vets the idea (usually with a white-label issuer or other consultative source) and decides to undertake the financial and other risks associated with starting a new ETF venture. Nottingham was lucky to find a high-quality wealth management firm in Merlin Asset Management, which decided proprietary ETFs were the way they wanted to provide investment expertise to their client base.
ETF sponsors usually elect the investment strategy and define a fund’s goals and objectives. They also spearhead the marketing and distribution efforts for the ETF.
The authorized participant or “AP” is a broker-dealer that makes a bid-ask market in the ETF shares, and initiates the creation and redemption in ETF shares. APs are charged with maintaining ETF liquidity in the market based on information they receive from the exchange.
Examples of APs in the market today include institutions and banks such as Bank of America Merrill Lynch, Citadel Securities, Morgan Stanley and Goldman Sachs.
Similar to an AP, a market maker makes a bid-ask offer spread in ETF shares on the exchange where the ETF is listed. The difference between the two parties is that the market maker commits to continuously providing a bid-ask offer, whereas an AP can decide it doesn’t want to participate for a period of time.
Cantor Fitzgerald is the lead market maker that Nottingham currently has partnered with.
Custodian/transfer agent/fund accountant
A key difference between ETFs and other types of funds is the “baskets” of securities that are used in creating and redeeming ETF shares. In a creation, the AP will deliver a basket of securities and oftentimes a portion in cash in exchange for ETF shares, to cover shares the AP has sold in the open exchange.
To accept securities in lieu of cash requires special capabilities through the Depository Trust Company system for electronic delivery of securities, available only to DTC participants. Only a limited number of bank custodians offer this capability.
Because the ETF shares are issued in exchange for the securities, the custodian is in the best position to also serve as the transfer agent for the ETF, creating new ETF shares on the ETF books in exchange for a like value of securities.
Nottingham works with BNY Mellon in the capacity of custodian and transfer agent.
ETFs are traded on exchanges just like common stocks and closed-end funds. The role of the exchange is critical in providing the mechanism for making ETF shares available to investors and offering liquidity for investors ready to sell their ETFs. The exchange plays the role of updating the market value of the underlying securities on a continuous basis, providing important information to the AP and market maker for their bid/ask spread in the ETF.
ETF exchanges include BATS, Nasdaq and the New York Stock Exchange. Nottingham is currently enjoying a relationship with the NYSE to serve as its primary exchange.
White-label issuers develop and maintain all of the relationships described above. Developing the relationships alone is a multiyear process, which a white-label issuer is in a unique position to help reduce significantly. There are also attractive economies of scale and pricing of services available to white-label issuers because service providers and other vendors have the opportunity to work with multiple funds under a white-label issuer’s umbrella.
If you want to learn more about how Nottingham has cultivated relationships with the who’s who of the ETF industry and how we can leverage those relationships for your ETF, click here.