SPECIAL EDITION Brown Brothers Harriman s ETF Newsletter Landmark SEC Decision: ETMF Introduction... 2 Approval of a New Fund Structure... 3 Changing ETP Landscape... 3 Long Term Impact... 4
Welcome to, BBH s ETF Newsletter INTRODUCTION As you may have read, a major milestone was reached on November 7th when the SEC approved Eaton Vance s proposal to create a new fund structure, the Exchange Traded Managed Fund (ETMF). This new fund structure combines characteristics of ETFs and mutual funds, and its approval is likely to have wide ranging implications for the asset management community. In many ways, the approval signals the mainstreaming of an exchange traded product structure as a means of packaging active management. We have consulted with Eaton Vance to develop custody, administration and accounting service solutions for these new product structures and have pulled together this special edition of to provide you with insights on the ETMF, its potential impact on revenue sharing and on the industry overall. If you would like more information on how these products work, or if you are interested in understanding how BBH can support these new structures, please contact us at shawn.mcninch@bbh.com brian.reilly@bbh.com. Shawn McNinch Senior Vice President, Global Head of ETF Services shawn.mcninch@bbh.com +1.617.772.1376 Brian Reilly Vice President, Americas ETF Business Development brian.reilly@bbh.com +1.617.772.1321 2
ACTIVE MANAGERS STAND UP AND TAKE NOTICE A landmark decision by the SEC has cleared the way for a new fund structure, the Exchange Traded Managed Fund (ETMF) offered by Navigate Fund Solutions LLC, to trade on the NASDAQ stock exchange. The decision represents a major milestone in mainstreaming an exchange traded product structure to access active management. While the launch of the first Exchange Traded Managed Fund is thought to be several months away, the asset management community has anticipated the approval of a non-transparent exchange traded fund for a number of years. As a result, myriad asset managers could enter the marketplace and package their actively managed strategies in an ETMF structure. In order to launch branded funds and license their patented processes to other managers, Eaton Vance created a separate entity, Navigate Fund Solutions LLC. The ETMF, filed by NASDAQ on behalf of Eaton Vance, combines the characteristics of ETFs and mutual funds. The ETMF structure seeks to leverage the inherent tax benefits unique to the ETF creation and redemption processes where securities can be delivered in-kind. The ETMF structure also attempts to address concerns of front-running and information leakage by enabling the funds to disclose their holdings with the same frequency as mutual funds (quarterly with a 60 day lag) instead of following the traditional daily ETF disclosure requirements. Purchases and sales of the fund s shares occur throughout the day relative to the fund s next determined Net Asset Value (NAV). The ability to buy and sell an exchange traded product in relation to a fund s NAV, versus the public offering price associated with ETF trading, is a new element to be introduced to the market. And while trades are executed throughout the day, the execution price of any intraday trades is only known once the fund s NAV is calculated and disseminated to the exchange and other market participants. Given these unique aspects of the product s structure, significant education will be required to ensure the future success and adoption of ETMFs across the retail, intermediary, and to a lesser extent, institutional channels. COMPARING ETMFs TO MUTUAL FUNDS AND ETFs Mutual Funds Mostly active strategies Confidential trading Shareholder trades: Directly with fund Priced end of day Based on NAV Cash in and out ETFs Mostly index-based Transparent holdings Shareholder trades: On exchange through broker Priced intraday Arbitrage link to NAV Mostly securities in and out CHANGING ETP LANDSCAPE Adding to the changing landscape of exchange traded products are several competing alternatives to Eaton Vance s solution. A proposal by the NYSE on behalf of Precidian Investments employed a blind trust that protects the fund s holdings from being disclosed to market participants and firms such as Fidelity, T. Rowe Price, and Guggenheim Investments have filed for non-transparent active exchange traded products using their varying methodologies. If approved, active managers could access a range of options to bring non-transparent exchange traded products to market. Yet, with all of the attention levied on this topic, some observers speculate that the next generation of active strategies packaged within an exchange traded wrapper will result in the carryover of many business practices common in the mutual fund marketplace. To date, ETFs are known as lower cost, passive strategies that provide cheap beta to the end investor. While they have evolved into commodity, alternative and a host of other non-cap weighted strategies over the last several years, the revenue sharing discussion has gotten louder given that the platforms on which ETFs are traded and custodied bear much of the transfer agency cost whereas a traditional mutual fund absorbs these costs as part of the fund s built-in expense ratio. The arrival of active ETFs could signal a more overt form of revenue sharing tied to the active strategies. In fact, the practice of revenue sharing in the ETF industry is underway given Schwab s successful ETF OneSource program which offers a selection of commission-free ETFs to its RIA and retail clients, despite the fact that the ETF Sponsor is reportedly levied a basis point and fixed fee to list their products on the Schwab One Source commission free ETF list. 3
LONG TERM IMPACT In addition to revenue sharing, there is speculation that nontransparent active ETFs may also incentivize 401k platforms to update their legacy system architecture to support investment products that are exchange traded. While these are just two examples that asset managers will need to address in the months and years ahead, both would alter the current landscape in which mutual fund and ETF managers compete. Larger firms offering mutual funds and ETFs will likely lead the way and address these challenges in order to maximize these channel and platform opportunities. Recent industry news has begun to confirm this trend with the potential acquisition of smaller ETF firms by large, established asset managers like Janus and Goldman Sachs. These factors, in conjunction with the continued demand for ETFs will likely instill urgency on the part of asset managers to take a closer look at how this new development may allow them to benefit from an ETF like structure while retaining traditional principals of active management such as less frequent disclosure of holdings. Precidian Investments Recently, a competing proposal for an actively managed ETF structure was made by the NYSE on behalf of Bedminster New Jersey s Precidian Investments. Precidian is known in the ETF world as a developer of innovative ETF product concepts and related investment intellectual capital, some of which are patented. Like Eaton Vance s Navigate Fund Solutions LLC, Precidian is said to want to launch its own ETFs and license the processes associated with their non-transparent active ETF concept. Several established asset managers including Blackrock, SSGA, Capital Research Group, Invesco, and Cohen and Steers have filed to launch ETFs using the structure proposed by Precidian. Although the SEC recently rejected Precidian s non-transparent Active ETF proposal, it is widely believed that Precidian will seek to address the SEC s response and file with the SEC anew in the months to come. BBH has consulted with Precidian and Eaton Vance to develop custody, administration and accounting service solutions for these new product structures. If you would like more insights on how these products work or if you want to understand how BBH can support these new structures or ETFs in general, please do not hesitate to reach out to us at shawn.mcninch@bbh.com. 4
TO LEARN MORE ABOUT BBH S GLOBAL ETF SERVICES, PLEASE CONTACT: Global Head of ETF Services: Shawn McNinch +1.617.772.1376 shawn.mcninch@bbh.com Europe: Antonette Kleiser +353.1.603.6465 antonette.kleiser@bbh.com Europe: Andrew Craswell +44-207-614-3992 andrew.craswell@bbh.com Asia: Scott McLaren +852.3756.1620 scott.mclaren@bbh.com Americas: Brian Reilly +1.617.772.1321 brian.reilly@bbh.com 5
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