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How ETF service impacts investor TCO Are you happy with your ETF servicing?

How ETF servicing has evolved

The European ETF market has grown and evolved significantly since the first launch 18 years ago. There are now over 60 issuers and 2000 ETFs competing for asset flow from institutional and retail investors alike. But issuers are not the only ones to benefit from this boon. In parallel, the ETF ecosystem has grown and evolved too. Banks, trading houses, exchanges, index providers and asset servicing firms have all invested and developed their businesses to compete for ETF flows and assets.

The ETF space has become increasingly competitive with issuers looking to differentiate themselves through the launch of niche and innovative products, and through the reduction of headline fund fees on core ETF ranges.

The low cost nature of ETFs relative to active mutual funds has been an attractive feature for all types of investors and helped ETFs become one of the most popular investment vehicles.

The headline fee for ETFs, has for many years been the total expense ratio (TER): however, this does not capture the full costs of owning an ETF. In recent years, issuers have promoted the total cost of ownership (TCO) as a measure of the full costs that can drag on an ETF's investment return over time. The TCO includes other fund costs and liquidity costs. Liquidity costs are driven by a number of factors, one of those being the efficiency of the specific ETF range's primary market.

Given the importance of the primary market in driving secondary market liquidity, and by extension, an ETF investor's TCO, we set out to explore how an issuer's choice of asset servicing firm could impact their ETF investors' TCO, and if so, to what extent.

KPMG met with ETF issuers and APs to conduct a survey of current experiences with ETF service providers, and to understand their views on how ETF servicing drives secondary market liquidity and an investor's TCO.

What we asked

We asked key issuers and APs the following core questions:

  • Do you see a link between ETF servicing, secondary market liquidity and an investor's TCO?
  • How well are you supported by your current ETF service provider?
  • What functionality do you consider leading? And do your ETF service providers support it?
  • Do you expect greater regulatory scrutiny to be around the role of the AP?

Our findings

  • Our survey of issuers and APs confirms our hypothesis that the functions asset servicing providers perform do have a meaningful impact on secondary market liquidity and investors TCO.
  • No firm is completely happy with the service it is receiving. Furthermore, the level of satisfaction across the core activities varies markedly, driving a significant spread between the 'best' and the 'worst' service experiences.
  • Our survey and interviews have identified a number of leading features, which are particularly important in reducing ETF liquidity costs. These leading features are not broadly supported by service providers and two, T+0 settlement and auto cash collateral calculation and management, are not supported by any of the providers servicing our respondents.
  • All respondents expect greater regulatory scrutiny around the role of the AP in providing liquidity in the secondary market.

What this means for existing and new ETF issuers

Both existing and new issuers will be well placed to review their asset service arrangements and ensure that they are receiving leading levels of service that can help reduce their investors' ETF TCO. In the same way 'not all ETFs are created equal` - 'not all ETF service providers are the same'. Partnering with the right ETF service provider can make an issuer's ETFs more competitive by reducing the total cost of ownership.

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