PlatformsMay 24 2017

The tech challenges ahead for ETPs

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The tech challenges ahead for ETPs

Traditionally, wrap platforms and, by extension, the technology and processes they employ, have been almost exclusively focused around mutual funds. However, the recent and rapid growth in the exchange traded product (ETP) industry has presented a new set of challenges.

According to the research and consultancy firm ETFGI, there is now around US$3.5 trillion invested in over 6,625 ETPs worldwide.

Despite record inflows and year-on-year growth, the lack of access to ETPs on IFA platforms has slowed the adoption of ETPs among retail investors in the UK significantly. So, what are the challenges of ETP inclusion faced by existing platforms, and how are they working to overcome them?

Cost is often cited as the most important contributing factor to the increase in popularity of passive investments across the UK.

However, when comparing ETPs and tracker funds on IFA platforms, research has shown that ETPs are often at a disadvantage, with some ETP-based model portfolios turning out to be 50 per cent more expensive than their tracker fund equivalents.

Nevertheless, it seems there is potential for the current status quo to change. Most platforms have already begun to look at ways to make access to ETPs more efficient, and the evidence seems to suggest that this will in turn lead to lower prices in the long run as more IFA platforms adopt new technology and adapt their infrastructure to the evolving investment landscape. 

One of the key benefits of ETPs is the ability to trade their securities throughout the course of the day on a regulated exchange. This has created a problem for some platforms, as their core systems were not originally designed with intra-day trading in mind. 

As the demand for ETPs and the various exposures they offer continues to rise, platforms such as Ascentric, Transact and AJ Bell have invested heavily in the technology and knowledge required to bring ETP trading capabilities in-house. Other platforms have opted to look externally for solutions by outsourcing to brokers experienced in ETP trading. 

Fractional share dealing is also a major consideration, and is a barrier which has yet to be fully broken down. While mutual fund units are often split and subsequently bought and sold as fractions, the same cannot be said for ETPs. 

ETPs must trade as complete shares. This causes a potential problem when rebalancing model portfolios because, as previously mentioned, the changes required to adapt the traditional systems that are currently in place are considerable.

Despite this, robo-adviser firm Nutmeg became the first online platform to launch fractional share dealing in ETPs in 2016. Developed as part of their own internal system, the online investment manager now has the ability to purchase and sell fractions of ETPs, while the full shares are held in a client account at State Street in accordance with the FCA’s client money and assets rules.

In search of an industry-wide solution, EU market-making firm Winterflood Securities was first out of the gate with a ‘plug and play’ add-on system, which aims to work alongside the existing core technology currently employed by platforms. According to Winterflood, the service offers trading and custody of fractional shares, and allows ETP trading at four decimal places.

Although progress has been made in terms of the ability of platforms to trade ETPs efficiently, lack of understanding regarding the structure of ETPs is still a major barrier which needs to be addressed with IFAs and platforms alike. Without the internal policies in place and end-consumer confidence in the vehicle itself, the efforts of platforms to accommodate ETPs might not be met with the rush of activity they might expect. To this end, ETP issuers must increasingly focus on client education. 

IFA platforms are also beginning to create internal due diligence processes for the approval of ETPs. These focus predominantly on the replication method of the product (physical or synthetic), and whether the product in question is considered to be complex. Due to a lack of clear guidance from regulators regarding this last point, it is often down to the platform to decide which products are deemed to be complex, and which are not. 

While there is a clear preference for physical replication among wealth managers and IFAs, there are many instances where physical replication is not possible, for example, when gaining exposure to the price of perishable commodities, and where synthetic replication is the only viable option. This has led to careful consideration being given not only to the motive behind the replication methodology, but to what realistic alternatives, if any, there might be to that particular exposure. 

In spite of these hurdles, the global uptake of ETPs seems set to continue, with industry assets under management set to reach US$6 trillion by the end of 2020.  Their acceptance and widespread use by UK retail investors, however, ultimately depends upon the implementation of new processes and systems by online platforms, and quality educational material being provided to all parts of the supply chain. 

Liz Wright is head of UK wealth and intermediary distribution of ETF Securities

 

Key points

The lack of access to ETPs on IFA platforms has slowed the adoption of ETPs among retail investors in the UK.

Fractional share dealing is a barrier which has yet to be fully broken down.

IFA platforms are also beginning to create internal due diligence processes for the approval of ETPs.