Industry Updates

Creation-redemption upgrades not priority despite ETF issuer demand

Regulatory pressures mounting

Theo Andrew

Creation-redemption in fixed income ETFs 

Calls for improvements in the creation-redemption process from ETF issuers are not being met by asset servicers, according to research from Calastone.

Almost half of ETF issuers (41.4%) said they would like to see improvements in the area – the highest of all choices – while just 22.8% of asset servicers see it as one of their two main business priorities, behind fund accounting (36.8%) and operational support (33.3%).

ETF issuers also ranked creation-redemption as the most important of the fund administration services they receive, with over half (57.6%) choosing the process alongside timeliness and accuracy of fund NAV calculations (57.7%).

The disconnect highlights how ETF issuer demands are not being met by asset servicers, with creation-redemption a key function underpinning primary market liquidity.

“The ability to create or redeem ETFs efficiently and at a known cost is a critical prerequisite for market makers, upon whom ETF issuers and investors are so reliant,” Calastone said.

“Improving the creation and redemption process is something asset servicers do need to work on if they are to retain and win business moving forward.”

It added service providers will be required to focus more of their resources on upgrading their systems instead of re-investing in legacy technology.

Furthermore, Calastone said incoming regulation was likely to be exacerbating the creation and redemption issue.

The introduction of the Central Securities Depositories Regulation (CSDR) and the move towards T+1 settlement cycles globally are increasing the need for increased standardisation in the process.

Market makers incur cash penalties for settlement fails under CSDR, with regulators threatening the introduction of mandatory buy-ins if fail rates do not improve.

Meanwhile, a T+1 settlement cycle – set to be introduced in the US in May – increases the risks of settlement mismatches due to timing discrepancies between ETF shares and the underlying basket trades.

The differences in settlement timing between the US and other markets could result in an increase in failed trades and wider trading spreads in the secondary market, according to Brown Brothers Harriman.

“CSDR and T+1 could have significant indirect cost implications for ETF investors, especially if the underlying asset servicing function is not properly automated,” Calastone said.

David McGuinness, product director at Calastone, added: “The ETF industry is currently witnessing unprecedented levels of growth and the requirements of fund issuers are becoming increasingly complex.

“Asset servicers need to look at how they can upgrade their systems to improve transparency and enhance standardisation across their core processes, as this will ultimately benefit the end investor.”

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