Many investors are interested in the ETF structure, below we will try to consider the participants in the creation of an ETF exchange-traded fund, and most importantly the very structure of an exchange-traded fund.
The main participants in the ETF and other exchange-traded products market are:
- ETF Providers / Managers
- Stock Index Providers
- Authorized members
- Stock exchanges
- Market makers
- Regulatory and supervisory authorities
Let's consider how market participants interact with each other in the process of creating an exchange-traded fund.
Setting up an exchange-traded fund is similar to setting up a Russian index PIF or a foreign mutual fund. Organizations that meet certain requirements of market regulators (for example, the appropriate amount of equity capital, certain experience and reputation in the financial market) are allowed to the ETF creation process. If an organization meets these requirements, it receives approval and becomes an ETF provider with the right to create exchange-traded funds.
The provider is sometimes also referred to as the ETF issuer (English – issuer). The functions of the provider include the creation (registration) of an exchange-traded fund, control over the process of issuing shares and, in most cases, acting as a fund management company. However, sometimes the ETF provider can transfer the functions of the management company to another organization.
For simplicity, in what follows, the term "ETF management company" will be the main one and will be used synonymously with the terms "ETF provider" and "ETF issuer".
Let us recall that in the industry of Russian mutual investment funds it is precisely the term “management company” that is used, not “provider” or “issuer”. Although the Pifa management company, by analogy with ETF, is at the same time the issuer (or provider) of this fund.
At the beginning of October 2012, there were 195 management companies in the world that issue ETFs and other exchange-traded products.
Consider information about the largest management companies
iShares – an American company engaged in the release of exchange-traded products around the world (USA, Europe, Japan, Australia and other countries). Founded in 1996, today it is the world's largest management company for ETFs and other exchange-traded products. Almost 40% of the money invested in these investment vehicles is managed by iShares.
iShares is owned by BlackRock, one of the world's largest investment asset management firms. It manages about $ 3.67 trillion.
State Street Global Advisors (SSGA) is a division of the large American investment company State Street Corporation, founded in 1978 and engaged in asset management. It manages about $ 2 trillion.
SSGA provides a wide range of investment services, one of which is the issuance of exchange traded products.
It is worth noting that in 1992 SSGA issued the first US exchange-traded fund SPDR S&P 500, which reflects the S&P 500 stock index.Today, the SPDR S&P 500 ETF is the world's largest exchange-traded fund with assets at the beginning of May 2013 of more than 132 billion. $. And State Street Global Advisors (SSGA), in turn, is the world's second-largest asset manager for ETF and other exchange-traded products in terms of assets under management.
New exchange-traded fund
If the management company wishes to issue a new exchange-traded fund, it prepares a set of documents for registering the fund. These documents state the investment goal of the fund, risks, the amount of management fees and other information. The set of documents is submitted to the state bodies that supervise the financial markets. In the USA, for example, this is the SEC – the Securities and Exchange Commission. In the UK – FSA – Financial Conduct Authority. In Russia, this body is the FFMS – the Federal Service for Financial Markets.
Among other information, the documents of the fund indicate on the basis of which underlying assets the fund will be created. If the ETF is indexed, then the management company specifies which index will be tracked in the ETF being created.
Thus, when creating an exchange-traded fund, ETF management companies interact with another participant in the ETF industry – index providers.
Index providers are companies that create new and update existing stock indices. For a fee, the management company of the exchange-traded fund receives the right to use the index as the basis for the composition and structure of the fund's assets, as well as indicate its name in the name of the ETF.
Some exchange-traded fund managers act as index providers themselves. They create their own indices, on the basis of which they then issue new exchange-traded funds themselves. However, market regulators often require that the exchange-traded fund manager and the index creator are not the same person.
According to BlackRock data for 2011, 50% of all existing ETFs are based on indices from 5 index providers.
Looking at index providers by the amount of assets managed by ETFs based on their indexes, the leaders are two providers – S&P and MSCI. Their total share is almost 46% of the total assets in the management of exchange-traded funds. At the same time, the 5 main index providers account for almost 70% of the total assets of all ETFs.
Major index providers of ETFs
Morgan Stanley Capital International (MSCI) is one of the main index providers for ETFs. It is a large American company established in 1998 and is engaged in the production and management of indices, research of financial markets, the creation of analytical reviews, the provision of financial information, etc.
As an index provider, MSCI specializes primarily in stock indices, providing a wide range of global, industry, country and other indices. MSCI stock indices cover more than 70 countries worldwide.
Standard & Poor's, along with MSCI, is one of the two major index providers in the ETF industry. The company has a rich history dating back to 1860.
The main activities of the company are investment analytics, market research, assignment of credit ratings, creation and management of stock indices.
Standard & Poor's offers a wide range of indices, including global, regional, industry stock indices, as well as commodity indices, fixed income securities indices, etc.
Barclays Capital is the investment arm of the British financial group Barclays. Today Barclays is one of the largest banks in the UK and in the world, providing its clients with a wide range of banking, investment and other financial services around the world.
Barclays Capital was founded in 1986 with the aim of developing the investment services business. One of the company's activities is the creation of stock indices.
Today Barclays Capital specializes in fixed income indexes and is the world's leading provider of this type of index. Barclays Capital indices cover all kinds of existing fixed income assets (high yield, municipal, government bonds, etc.), both of individual countries and entire regions.
Depositaries for safekeeping of securities
One participant in the ETF market is organizations that hold securities (or commodities such as gold) that are the underlying asset of ETFs and other exchange-traded products.
These are depositories – specialized institutions that carry out storage, operations of acceptance / issue of securities and keep records for each security (asset unit) that comes and goes from the fund.
The custodian also controls that all ETF units issued into circulation are fully backed by assets in the management company's account, which is opened with the depositary.
All changes that are made in the assets of the fund are rechecked by the depositary, which verifies the correctness of the operations performed. The management company of the exchange-traded fund enters into an agreement with the depositary. For the provision of his services, he receives a certain fee.
In addition, when creating an exchange-traded fund, the management company enters into an agreement with organizations that are called authorized participants within the ETF industry.
Eligible Participants are usually large financial institutions. For example, in the US, the authorized participants are investment banks Goldman Sachs, Smith Barney, Merrill Lynch.
In Europe – Commerzbank, Credit Suisse, UniCredit Bank, Banca IMI, etc.
Such organizations have a special role. Only authorized participants have the right to interact directly with the fund manager in the event of the creation of new and redemption of existing ETF units.
Investors, unlike mutual funds and PIFs, are completely withdrawn from this process. Only authorized participants receive new shares of the exchange-traded fund from the management company, which are then sold to investors.
Selling ETF Units
ETF units are sold only on stock exchanges. Therefore, the ETF management company, before launching a new exchange-traded fund, selects the stock exchange on which the fund's shares will be traded.
According to Blackrock, at the end of 2011, ETFs were listed on 51 stock exchanges in 41 countries.
It should be noted that exchange-traded funds can be listed on several stock exchanges at once. This, for example, often happens in Europe. The management company wants to attract more investors from different European countries and issues shares of the fund for circulation on several exchanges in different countries.
For example, the HSBC MSCI WORLD ETF, which invests in stocks of companies in the MSCI World Index (the index includes shares of more than 1600 large companies from 24 developed countries of the world), is listed on the London Stock Exchange in the UK. the Swiss exchange SIX Swiss Exchange and the French NYSE Euronext. American ETFs are less likely to be traded simultaneously on an exchange in the United States and on an exchange in another country, but such cases also occur.
At the end of 2011, the existing 3,011 ETFs had 6,612 placements on exchanges. Due to the simultaneous circulation of the same funds on several exchanges at once, the number of placements is more than 2 times higher than the number of ETFs created.
For each of the stock exchanges, a separate count is kept of the number of ETFs first issued in circulation and on this particular exchange, as well as the number of ETFs traded on the exchange as a whole (i.e., taking into account ETFs that were originally issued on other exchanges, but subsequently received additional placement on a new exchange).
Exchanges are leaders in ETF trading
The main exchanges on which ETFs are traded are the American NYSE Arca (the undoubted leader in all indicators), the German Deutsche Börse and the British London Stock Exchange.
For the placement of ETF units on the exchange, the management company prepares a certain set of documents, which may differ for different exchanges.
Before placing shares on the exchange, the ETF management company additionally concludes agreements with market makers, i.e. large financial institutions that will provide liquidity for ETF units traded on the exchange.
Market makers are constantly placing orders to buy / sell shares, thereby ensuring the necessary turnover of the shares so that investors can buy or sell ETF shares at fair value at any time. Often, large market participants can be both authorized participants and market makers of an exchange-traded fund.
After the ETF management company concludes agreements with the index provider, the depositary, authorized fund participants, market makers, the fund obtains permission from the regulatory authorities to create the ETF, and the necessary documents are submitted to the stock exchange, exchange-traded fund ready to launch… For this, shares of an exchange-traded fund are created, which are then acquired by investors on the stock exchange.