U.S. ETF Rule: Are You Ready for Custom Baskets?

U.S. ETF Rule: Are You Ready for Custom Baskets?

U.S. ETF Rule: Are You Ready for Custom Baskets?

February 2019

Flipping the calendar to 2019 brings us much closer to the vision of many in the ETF industry of an ETF rule. With commentary from ETF participants generally agreeing that custom baskets should be allowed, we thought now would be a good time to touch upon custom baskets and key considerations in preparation for go live.

 

In preparation for the implementation of custom baskets, BNY Mellon has authored a series of documents, with this being the first, to help ETF issuers maximize their use of this old for some but new capability for many. As the playing field becomes level with respect to custom basket capabilities, ETF issuers that historically have been left out and who for the first time will have the same capabilities as others using custom baskets need to be prepared for the added benefits and competition focused on the same pool of liquidity. BNY Mellon’s experience servicing issuers with custom basket capabilities has provided us with a few areas we believe should be a focus.

 

While the SEC final ruling has yet to be released, here are a few things for issuers to consider:

 

  • Custom basket flexibility
    While impactful for equities, custom baskets can have an even larger impact in the fixed income space. Specifically, using custom baskets can potentially reduce trading costs by allowing for the delivery of different but similar securities from market makers and AP’s which may lead to tighter spreads and reduced premiums and discounts.
  • Custom basket policies and procedures if adopted as part of the rule
    Do you have written policies and procedures that detail the custom process? Who will have oversight within the firm? Portfolio Managers, Fund Treasurers, Capital Markets specialists, or a combination of all?
  • Public disclosures
    Is your firm’s technology ready to disseminate all custom create/redeem baskets to the public?
  • Have you considered impacts to your people, process, and technology?
    People – who will be involved in reviewing and analyzing custom proposals?
    Process – how will custom inventory be received, in what format?
    Technology – will you use technology to analyze inventory?
  • Additional regulatory changes and impacts to custom baskets for Fixed Income ETFs
    Is there a potential for asymmetrical advantages with the proposed FIMSAC rule that would allow 48 hours to pass before reporting corporate fixed income trades that exceed a certain dollar threshold? Would this have an impact to sourcing corporate fixed income securities for custom create/redeem proposals?
 

In summary, when market makers have confidence that inventory can easily and efficiently be managed through the primary market via a custom negotiated basket, competition will increase – competition typically begets better prices/tighter bid-ask spreads, which is a win for investors. The increase in competition while good for investors will require that ETF issuers be prepared to support this capability ensuring that they have a seat at the table with liquidity providers when negotiating baskets.

 

BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally. Products and services may be provided under various brand names and in various countries by subsidiaries, affiliates, and joint ventures of The Bank of New York Mellon Corporation where authorized and regulated as required within each jurisdiction. The material contained in this document, which may be considered advertising, is for general information and reference purposes only and is not intended to provide or construed as legal, tax, accounting, investment, financial or other professional advice on any matter, and is not to be used as such. This document, and the statements contained herein, are not an offer or solicitation to buy or sell any products (including financial products) or services or to participate in any particular strategy mentioned and should not be construed as such. The views expressed within this article are those of the authors only and not those of BNY Mellon or any of its subsidiaries or affiliates.

 

© 2019 The Bank of New York Mellon Corporation. All rights reserved.

 

Ready to grow

your business?

Speak to our team.

Ready to grow your business? Speak to our team.