The wealth industry is undergoing a profound transformation, driven by evolving investor demographics, growing demand for financial democratization, and the increased desire to access a broader set of asset classes. This evolving environment presents new pressures – and opportunities – for wealth and investment management firms.
One of the most remarkable illustrations of this shift has been the tremendous growth of exchange-traded funds over recent years. In the US alone, there are over $10 trillion US-listed ETF assets under management, with the potential to add an additional $10 trillion by the end of the decade, according to research from Citigroup.
With this anticipated growth, it is not surprising that over 80 traditional asset managers have applied for exemptive relief from the Securities and Exchange Commission to offer a dual-share-class model. A dual-share-class model could provide increased flexibility, tax efficiency and a lower cost structure than ETFs provide for asset managers today.
However, as regulatory approvals advance, the industry faces an operational implementation challenge: how to effectively support a mutual fund investor requesting to convert to an ETF share class – which can be heavily manual, complex, labor-intensive and risky given there is currently no established system to facilitate the efficient exchange of a mutual fund to an ETF share class.
Today, different assets types are typically managed in separate, siloed systems that individually process activity, adding complexities and inefficiencies. For ETFs specifically, asset managers must manually process bilateral conversions between broker-dealers and fund managers. This can take up to five days, introducing not only financial, operational, and market risk but also higher costs and unsatisfactory shareholder experience.
Investors are generally not exposed to the complexities of operating the financial system. But in this case, the lack of a fit for purpose solution could cause real risk — not only financial or operational — but also cause an inadequate client experience. Since the introduction of ETFs in the early 1990s, market infrastructure innovation has always been a core component of delivering new products. As asset managers prepare for regulatory approvals, many need a standardized, automated solution that provides automatic conversions and significantly improves inefficiencies, scalability, exchange process timelines and the overall user experience.
In the current ecosystem, firms typically manage ETF and mutual fund operations separately and uniquely, with distinct operational structures, teams, and divergent trade share approaches. These differences create increased challenges when considering how to operationally support a dual share class structure. The proposal of implementing a comprehensive approach to managing the operations for ETFs and mutual funds is increasingly desired by asset managers as it allows for a more comprehensive framework rather than individual components to further improve decision-making, efficiency, and outcomes across both funds. This is another example of the convergence we’re seeing across domains in our industry.
The Investment Company Institute’s (ICI’s) recent paper, ETF Share Class Operational Considerations, highlights the industry’s continued efforts to enhance operational efficiencies and support seamless connectivity through automation. This supports the observation that, when compared to a mutual fund, ETFs are attractive to certain investors, even though there are important structural differences between these fund types due to their intraday liquidity, increased transparency of holdings, tax efficiency, and relatively low cost. More specifically, the paper advocates the need to leverage an industry-defined solution as a major next step in capitalizing on this advancement.
To address these challenges, DTCC, in partnership with the industry’s leading asset managers, broker dealers, and ETF agents, is proactively enhancing its Fund/SERV offering to solve the exchange of a mutual fund to an ETF share class to facilitate smoother interactions for ETF agents and improve operational efficiency. This builds on the nearly four decades of collaborative innovation the funds industry has advanced together to deliver benefits for underlying and institutional investors. To make the future vision a reality, the industry must continue to work in partnership to define and implement an optimal solution that will meet the needs of a rapidly evolving market.
Ultimately, the growth of ETFs and advancement of new product types for funds and beyond must be underpinned by robust, holistic solutions that are agreed upon frameworks and led by a sound infrastructure. The industry has been here before, and it’s an exciting time to do it again, together.
Talia Klein is managing director, head of wealth & investment solutions at DTCC.
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