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ETFs 2019 Operating modelsMinds made for shaping financial services
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1ETFs 2019: operating models |
2 Do operating models hold the key to ETF success
4 The four most valuable areas of potential improvement in ETF operating models
Automation and rationalization
Outsourcingandthirdparties
Partnering
Talentand”workforceofthefuture”
8 Now is the time to develop the ETF operating model of the future
9 Contacts
Contents
DooperatingmodelsholdthekeytoETFsuccess
Facedwithincreasingcompetition,promotersneedanoperatingmodelthat’sfitforthefuture.
2 | ETFs 2019: operating models
Thesuccessofexchange-tradedfunds(ETFs)inassetgatheringovermanyyearsshowslittlesignsofslowing.ButtheETFindustry—likethewholeassetmanagementsector—alsofacesachallengetoreconcilefeeandmarginpressurewithfast-changingdemandsfornewproducts,differentservices,andbetterreporting.
Webelievethatbest-in-classoperatingmodelscouldholdthekeytosuccessinanincreasinglycompetitivemarketandthatfutureoperatingmodelswilllookverydifferentfromthoseoftoday.Thisarticleexaminestheseviewsindetailandsuggestspossibleareasforimprovement.
The ETF industry is growing fast, but faces a continued margin squeezeTherearemanygoodreasons—includingtheshifttopassiveandtheglobalfocusoninvestorprotection—tobelievethatETFscancontinuetheirtrackrecordofglobalexpansion.Evenso,itwouldbewrong to think that ETFs are immune tothegrowingfinancialpressuresfacingallassetmanagers.
Inparticular,EYresearchshowsthat80%ofpromotersexpectETFmanagementfeestodeclineoverthecomingthreeyears,withnearlyaquarteranticipatingafalloffivebasispointsormore.ETFsissuersthereforeurgentlyneedtoreassesstheiroperatingmodelinordertodrivescalabilityandinnovationwhilecontinuingtooffercompetitivepricing.
3ETFs 2019: operating models |
ETF promoters need a step change in capabilities and efficiencyThistoughenvironmentmeansit’svitalforeveryETFpromotertoensureitsproductswillremaincompetitive—againstmutualfundsandotherETFspecialists—wellintothefuture.Thegrowingregulatory focus on value for moneywillonlystrengthentheneedtoreducethecostsofETFownershipateverystageinthevaluechain.
Butfirmsneedtodomorethanpursuesustainablegainsinefficiency.Theyalsoneedtodevelopnewandinnovativecapabilities.Withtechnologyandinvestordemandevolvingfasterthanever,ETFprovidersfacegrowingpressureto:
• Deliver outcomes:forexample,byensuringthatETFscanplayacentralroleasoneofthebuildingblocksofcustomer-orientedinvestmentsolutions.
• Enhance sustainability:mostobviously,byaddressingtheimperativesofenvironmental,socialandgovernance(ESG)investing,whichcouldsoonbecomea“hygiene”factorforETFsandotherinvestmentproducts.
• Distribute digitally:whetheronadirect-to-consumer(D2C)basis,viaonlineplatforms,throughautomatedrobo-advice,oraspartofatraditionaladvisoryorwealthmanagementservice.
• Provide experiences: ETF providers may need to develop theirbranding,reporting,educationanduserinterfacecapabilities,iftheyaretoprovidebest-in-classinvestorexperiences.
Lisa Kealy EMEIA Wealth & Asset Management ETF Leader
As ETFs grow in complexity, there are ever-growing opportunities for asset servicers able to provide tailored support to ETF issuers.
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Thefourmostvaluableareasofpotentialimprovement in ETF operating models
Facedwiththeneedtosimultaneouslyenhancetheirefficiencyandcapabilities,webelieveETFprovidersshouldrespondbytakingacriticallookatexistingoperatingmodelsandbepreparedtomakeradicalchanges.
It’snoexaggerationtosaythatbest-in-classoperatingmodelsdeterminetheindustry’sfuturewinners.
Thegoodnewsisthattherapidevolutionofartificialintelligence(AI),automationanddataanalyticsiscreatingoperationalpossibilitiesthatsimplydidn’texistafewyearsago.Theapplicabilityofthesetoolsisexpandingbeyondthebackoffice,toencompassthewholeETFvaluechain.
ThebreadthanddepthofpartnerorganizationsthatcancontributetoETFoperatingmodelsisalsogrowingfast.ItseemslikelythatthebestfutureETFoperatingmodelswillencompassthecapabilitiesofseveralorganizationsandserviceproviders,notthatinvestorswillbeawareofit.
Inthenextfoursections,webrieflyhighlightwhatweseeassomeofthemostvaluableareasofpotentialimprovementinETFoperatingmodels.
1Automation and rationalization
Leanprocessoptimization(LPO)isanefficiency-focusedmethodologythatchallengesthevalueofindividualprocesses,functionsandactivities.EYexperiencewithclientsshowsthatitcanbeahighlyeffectivewayforETFproviderstoidentifyinefficiencieshiddeninlong-standingprocesses.IssuerscanreviewthelifecycleofanETF,andtheirownprocesses,fromend-to-endtoidentifyopportunitiesforoptimizationorre-engineering.
DevelopmentsinAIarealsoopeninguptherangeoftechnologicaltoolsavailabletoETFissuersandcouldbeusedtoenhancetheefficiencyofincreasinglycomplextaskswithintheETFoperatingmodel.Roboticprocessautomation(RPA)workswithinafirm’sexistingtechnologyarchitecturetoreducecosts,improveservicelevels,enhancedataqualityandreduceoperationalerrors.ExamplesofETFoperationsthatcanbeenhancedbyRPAinclude:
4 | ETFs 2019: operating models
5ETFs 2019: operating models |
2
elementsoftheETFoperatingmodel.Fortheirpart,serviceprovidershaveanopportunitytocollaborateonprovidingintegratedsolutions.Forexample,assetservicerscanpartnerwithFinTechsandRegTechstoofferenhancedETFfocusedoperationalsupport.
Securities servicers:ETFproviders’appetitetooutsourcecoreoperationalprocessesdoesnotmeanthisisastraightforwardopportunityforsecuritiesservicers.AgoodunderstandingoftheETFoperatingmodelisvital.Sotooistheabilitytobuildfastandefficientoperationallinkswithissuers,authorizedparticipants,marketmakers,indexproviders,exchangesandotherplayersintheETFecosystem.Inadditiontoprovidingsettlementandcustodyservices,securitiesservicersalreadyprovideoutsourcedfundaccounting,proxyvoting,valuations,securitieslendingandmanyothertasksforETFpromoters.Theservicerscontinuetoincreasetheircapabilities,addingETFmiddleandfrontofficefunctions,suchasbenchmarkanalysis,post-tradecomplianceandregulatoryreporting.AsETFsgrowincomplexity,thereareevergrowingopportunitiesforassetservicerstoprovidetailoredsupporttoETFissuers.Also,ETFproviderscanleveragethescaleandinvestmentbudgetsofassetservicerstobenefitinvestors.Underquicktakeaways,wetakeamoredetailedlookathowwebelievesecuritiesservicerscanbestsupportETFissuers.
Infrastructure providers:SoftwarevendorscanprovideETFpromoterswithanincreasinglytailored,integratedrangeofservices.AdvancesincloudcomputingmeanthatETFfirmscannowuse”softwareasaservice,”insteadofhostingandmaintainingtheirowntechnology.Functionsthatcanbeperformedbysoftwareprovidersincludeordermanagementinthefrontoffice,processingandreportinginthemiddleoffice,andreconciliations,securitieslending,unitcreationsandredemptionsinthebackoffice.Externalvendorsarealsodevelopingtheirabilitytosupportancillaryfunctions,suchascompliance,financeandHR.
Data providers:ETFpromoterscanworkwitharangeofexternalpartnerstosourceandanalyzeexternaldata,and
• Client onboarding:byincreasingthespeed,consistencyandaccuracyofdatacaptureforinstitutional,highnetworth(HNW)andretailinvestors.
• Back office:byperformingrepetitive,high-volumeprocessesinareas,suchastaxreporting,corporateactions,brokerconfirmations,derivativepricingandbankreconciliations.
• Middle office:bycalculatingcustomizedbenchmarks,andbypullingdatafrommultiplesourcesintoclientandmanagementreports.
RapiddevelopmentsattheotherendoftheAIspectrumarealsocreatingnewwaysforETFproviderstoapplybigdataanalyticstofront-officeactivities.Machinelearningtoolscannowbeappliedtoarangeofportfoliomanagementrelatedtasks,suchaslogisticregressionandotherformsofpredictiveanalysis.
AssetservicersandotherexternalprovidershaveavitalroletoplaywhenitcomestoimprovingtheefficiencyandaccuracyofarangeofETFspecificactivities.Withtheirlargetechnologyinvestmentbudgets,thesethirdpartiescanprovideavaluablerangeofdigitaloperationalenhancements.Examplesincludetheautomationofmanualnetassetvalue(NAV)calculationprocesses,deliveringfasterandmoreaccurateNAVs;andstreamliningthecreationandredemptionofunitsviaawebportalconnectingissuers,exchangesandauthorizedparticipants.
Outsourcing and third partiesEstablishedETFpromotersandnewentrantsalikecanturntoagrowingrangeofexternalpartiestoprovidecore
tointegrateitwithinternaldatatoderivenewinsights.Thisincludesmarketdata,suchasprices,analysis,ratingsandcompanydisclosures;clientdata,suchastransactionsandpersonaldetails;andalternativedata,suchassocialmediachat,websales,apptrafficorgeo-locations.ThegrowingimportanceofESG-themedETFsalsoprovidesanopportunityfortheprovidersofsustainabilityrelateddata—suchascarbonemissionsratings—tosupportthedevelopmentandmanagementofinnovativeETFs.
3Partnering
TherapidevolutionoftechnologywillincreasetheimportanceofpartneringwithintheETFoperatingmodel.Promotershavegrowingopportunitiestoenhancetheirtechnologicalcapabilitiesviacooperationwithexternalpartners.Somepracticalexamplesare:
• WorkingwithFinTechs,professionalservicesfirmsorspecializedproviderstoapplyadvanceddataanalyticsandAItoarangeofdatasources,thusprovidingtailoredsupportforinvestmentdecisionstakenbyactiveETFsportfoliomanagers.Thiscouldincludeprovidingmarketinsightsandtailorednewsfeedstothemanagers of active ETFs;generatingenhancedperformanceattributionanalysisandpeerbenchmarking;processingESG-relatedinformation,suchascarbonfootprints;andusingmachinelearningandnaturallanguageprocessingtofilterinvestmentresearch.
• Workingcloselywithindexproviders,specializeddataprovidersandconsultantstodevelopnewETFs,sharpenproductconcepts,andrefinetheselectionoffactorsandstrategies.Thismightincludeworkingtodevelopnew,tailoredindices;developingissuers’abilitytoself-index;investigatingthecommercialandregulatoryfeaturesofnewgeographicmarkets,suchasChinaorIndia;andintegratingsustainability-relatedfactorsintoindividualETFsoracrossissuers’wholesuiteofoperations.
• PartneringwithFinTechs,robo-advisors,onlinefundplatformsandwealthmanagerstobuildadigitizeddistributionsuitethatincludesarangeofdirectandintermediated,advised,andexecution-onlychannelscateringforinstitutional,HNWandretailinvestors.Externalpartnershavethepotentialtoprovideinsightsintoretailinvestorbehaviorortheneedsofinstitutions.Assetservicersmayalsobeabletoleveragebankingrelationshipsinnewmarkets—suchasAsia—fordistributionpurposes.
• Workingwithassetservicers,technologyvendorsandspecializedregulatorycompliancetechnologytoautomateandenhanceareasasvariedasstresstesting,riskanalysisandthemanagementofcompliancedata.ThirdpartieswithexpertorlocalknowledgecanhelpETFissuerstounderstandandaddresstheregulatoryimplicationsofenteringnewmarkets.Theycanalsohelptoprovidelowcost,automatedregulatoryandtaxreporting,helpingETFproviderstomeettherequirementsofregimes,suchasEuropeanMarketInfrastructureRegulation(EMIR)orForeignAccountTaxComplianceAct(FATCA).
Inourview,itseemsclearthatfindingtherightpartnersiscrucialtoETFissuers’abilitytodeveloptherightoperationalcapabilitiesattherightcost.Inparticular,assetservicershaveakeyroletoplayinhelpingETFproviderstoachieveefficient,capableandflexibleoperatingmodels.
6 | ETFs 2019: operating models
7ETFs 2019: operating models |
4Talent and “workforce of the future”
ThepotentialoftechnologytoautomateandstreamlineprocesseshasimportantimplicationsfortheroleofhumantalentinETFoperatingmodels.AsAI,RPAandothertechnologicaltoolstakeonagrowingrole,ETFproviderswillneedtoadapttheirworkforceaccordingly.Thatisnotjustaboutreducingheadcount,althoughstaffinglevelsarelikelytofallasefficiencygrows.Firmswillneedtorebalancetheirhumantalenttowardvalue-addingactivities.Dataanalysis,inparticular,willbecomeever-moreimportantforrunning,changing,improvingandgrowingETFbusinesses.
ThatmeansthattheETFworkforceofthefuturewillbesmaller,moreskilledandmorebiasedtowardkeydisciplines,suchasmaths,engineeringandtechnology.Thismoreflexible,morefungibleworkforcewillmovebetweendifferentareasofthebusinessasrequired,workingcloselywithtechnologytoenhanceefficiencyandcreatevalue.SecuritiesservicersandotherthirdpartiescancontributetogreaterworkforceefficiencybyensuringthattheirtechnologicalETF-tailoredcapabilitiesaresupportedbydedicatedteamswithin-depthknowledgeandexperienceofETFs.
Takeaway: How asset servicers can strengthen ETF operating modelsWebelievethatassetservicersshouldbeseekingtodevelopasuiteofservicestosupportthefull“lifecycle”ofatypicalETF,including:
1. Productdesign,developmentandregulatoryapproval.
2. Pre-launchsupportandseeding.
3. Partnershipswitharangeofretail,HNWandinstitutionaldistributionchannels.
4. Theprovisionofmarketinsightstoportfoliomanagers.
5. Ongoingservicing,includingNAVcalculations,foreignexchange(FX)handling,unitcreationandredemption,clientreporting,regulatorycompliance,riskmanagement,andperformanceattributionanalysis(PAA).
OtheremergingcapabilitiesthatETFissuersincreasinglyexpecttheirserviceproviderstoofferinclude:
• Collateralmanagementcapabilitiestomonitorthelocationandstatusoffundassets,alongwithsupportforvaluations,margining,transformationmonitoringandtransfers.
• Theabilitytosupportawiderangeofindices,tohelpwiththeconstructionofnewindices,andtocontributetolow-costself-indexing.
Insummary,asETFissuersrequiresupportforafast-wideningrangeoffundsthatgowaybeyondcoreequitytoincludefixedincome,actives,alternatives,smartbetaandotherstrategies,theyincreasinglyrequireassetservicerstoofferanintegratedrangeofETF-tailoredcapabilities.
NowisthetimetodeveloptheETFoperatingmodelofthefuture
Thestrategicchallengeswehaveoutlined—andtheopportunitiesfoundtoimproveoperatingmodels—arenotuniquetoETFs.Giventheirtrackrecordofgrowth,ETFpromotersmayevenfeelunderlesspressurethantraditionalassetmanagerstochangethewaytheyoperate.
However,inourview,thatwouldbetooverlookastrategicopportunity.WebelievethatmanyETFfirms,relativelyunburdenedbyoutdatedtechnology,areideallyplacedtobenefitfromoperationalimprovements.Itholdstruefornicheprovidersseekingtooptimizetheircompetitiveadvantages and for traditional asset managers entering theETFmarket.LargerassetmanagementgroupswithsignificantETFandnon-ETFactivitiescanalsoleverageimprovementsintheirETFmodelsacrossotherbusinessunits—orevenaspiretoafullyintegratedoperatingmodel.
Ofcourse,theindividualcircumstancesofeachETFprovideraredifferent.ButwebelievestreamlinedoperatingmodelswillbecrucialtothesuccessofeveryETFfirmoverthecoming5to10years.Fewfirmsareasefficientastheycouldbeandevenoperatingmodelsthathavedeliveredsuccesstodatemaynotgetfirms”wheretheyneedtogo.”ItiscriticalthatETFoperatingmodelsarereadyforfuturedisruption,change,innovationandpartnering.ETFfirmsshouldinvestintechnologyandefficiencynowtoensuretheyarewellpositionedfora“winner-takes-all”future.
8 | ETFs 2019: operating models
9ETFs 2019: operating models |
ContactsTodiscusshowEYteamscanhelpyourbusinessthriveintheETFspace,pleasecontactoneoftheauthorsoryourlocalEYmemberfirmoffice:
Lisa Kealy EYEMEIAWealth&AssetManagement,ETFLeader T:+35312212848IE:[email protected]
Andrew Melville T:+442070299293IE:[email protected]
Kieran Daly T:+35312212236IE:[email protected]
Bernard Lhoest T:+352421248341IE:[email protected]
Gary Logan T:+447552270908IE:[email protected]
9ETFs 2019: operating models |
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