The race for ETF innovation: new structures and strategies

The popularity of Exchange Traded Funds (ETFs) has surged in recent years, from $700bn before 2008 to more than $6trn by the end of 2019[1]. ETFs began with passive equity indices based on broad market indices, dominated by US managers and equity-based strategies. But in recent years, the ETF sector has broadened out, with a growing presence in Europe.

Two countries have been key to this European growth. About 40% of total trading in European ETFs is on the London Stock Exchange, where more than 1,100 ETFs are listed[2]. However, Ireland is the domicile for more than half of European ETFs, accounting for about €430 billion in assets[3]. BNP Paribas services over 150 ETFs accounting for over EUR40bn AUC in Continental Europe and is a leading securities services provider in both the UK and Ireland.

With the recent coronavirus pandemic sparking record outflows from ETFs[4], we are starting to see the initial effects of a bear market. Only time will tell whether investors will return to ETFs in the long-term, and the potential impact on the popularity of strategies such as actively-managed ETFs, which provide managers with more flexibility to re-tilt portfolios when indices show a downward trend. 

ETFs are certainly a product that have responded to changing market conditions through constant innovation. In this article we explore three new innovations in the ETF market, as providers experiment with new structures and strategies. Will recent developments first seen in the US take hold in Europe? And how can servicers support ETF managers in harnessing new innovations?

Innovation one: Semi-transparent ETFs

American Century Investments made history in 2019 when it became the first manager to gain clearance from the US Securities and Exchange Commission for a ‘semi-transparent’ ETF. This was far from a one-off case; Precidian Investments has licensed its semi-transparent framework to several other investment managers in addition to American Century[5].

Under this semi-transparent model, managers are not required to report exact holdings every day, but must disclose a sample basket of investments – enough to give investors a rough idea

A key question is who requires transparency reporting, and for what purpose.

“If a method can be found to protect fund managers’ intellectual property, but also maintain a level of transparency acceptable to investors, semi-transparent ETFs could represent a significant opportunity. It could enable fund managers to deliver the benefits of their active management strategies in an efficient and cost effective product wrapper, which includes the advantages that the ETF secondary market can also offer”,

says Phil Jones, EMEA Fund Solutions Manager at BNP Paribas Securities Services.

Innovation two: Niche ETFs

The US has seen the proliferation of niche ETFs in recent years, which may be further bolstered by the arrival of semi-transparent ETFs. Recent ETFs have capitalised on social and investment trends, such as the rapid adoption of ESG and sustainability practices, digital innovation or growing sectors such as e-sports. Other ETFs have been launched in reaction to geo-political or economic events, such as the Invesco MSCI Kuwait ETF, which was launched in response to MSCI’s move to include Kuwait in its Emerging Markets Index from June 2020[6].

However, ETF providers need to balance the desire for differentiation with commercial realities. Although the margins for niche products may be higher, their volumes will inevitably be smaller and size is vital for promoters and investors to realise the benefits of economies of scale. For this reason, many niche ETFs may prove commercially unviable in the long run.

Innovation three: Fractional shares and ETF share classes

In January 2020 Fidelity Investments launched fractional trading of ETFs and other stocks in the US, three months after the chairman of Charles Schwab had announced that he planned to do the same[7].

In recent months, BNP Paribas Securities Services has seen increased interest by European fund managers investigating whether to add ETF share classes to existing ranges, instead of converting whole funds. This could potentially open up new distribution channels and offer a more cost effective launch for managers, as well as lowering the barriers to investment for investors.

Despite regulatory reforms intended to level the distribution playing field, such as the Retail Distribution Review in the UK and MiFID II across the EU, retail take-up of ETFs in Europe has remained low compared to the USA. One potential benefit of fractional shares is that they could boost retail take-up of ETFs, opening the door further to younger retail investors making small-value investments.

There are still practical concerns that need to be addressed in order to fully capture the retail market. For example, a retail investor transferring to a new platform cannot transfer their fractional shares and must cash them in, which may cause unwanted tax implications. In the absence of a market wide solution, however an increasing number of platforms are making fractional shares available on their platforms as they move to new systems that can support better access.

The race for innovation: how can your service provider help?

As ETF managers race to innovate, they are looking to service providers to develop a consistent and seamless experience, whatever the asset class, structure, or jurisdiction.

“While the ETF market globally is growing, the development is inconsistent; Europe is certainly not at the same stage as the US market. But that does not mean managers should accept inconsistency of service”

says Jeffrey Baccash, Global Head of ETF Solutions at BNP Paribas Securities Services.

BNP Paribas Securities Services currently services more than 200 ETFs registered in four different domiciles across the Americas, Europe and Asia. The consistency of our next-generation ETF platform is the result of extensive collaboration with asset managers, third party consultants, technology providers and other members of the ETF ecosystem.

Another important consideration is the service provider’s digital offering. If structures such as semi-transparent ETFs and fractional shares become commonplace beyond the USA, there are many implications for investor reporting, fund administration and connectivity with different distribution platforms. Key to this is access to, and reliability of data from different sources. BNP Paribas Securities Services is investing in a new digital portal, where asset managers globally can access consistent data on their ETF products and flows, regardless of their domicile.

“Our new digital platform will benefit from the application programming interfaces (APIs) that we’ve already developed across our fund administration business”, says Baccash. “APIs are just one way we intend to increase the flow of information to the ETF client so they have greater transparency around our service offering.”

As ETFs continue to grow their share of assets in Europe in the coming years, we will support clients as they continue to innovate with new ETF strategies and structures.


[1] Source: Assets held in exchange traded funds surge to record $6tn, Financial Times, December 2019

[2] Source: Exchange Traded Funds, London Stock Exchange, April 2020

[3] Source: Assets in Irish domiciled funds reach all-time high, Irish Funds, May 2019

[4] Source: Record Outflows from ETFs in Market Panic, Morningstar, March 2020

[5] Source: SEC Officially Signs Off on New Wave of Semi-Transparent ETFs, ETF trends, December 2019

[6] Source: MSCI announces the results of the 2019 annual market classification review, MSCI, June 2019

[7] Source: Fidelity beats Schwab to market with free fractional share trading, RIABiz, February 2020