Perspective: The State Of The ETP Industry From An ETP Provider

by: David Fry

1-16-2013 12-10-20 PM boost logo

Dave Fry interviews Boost CEO, Hector McNeil
January 16, 2013

Q: You have described consolidation of the European market, do you foresee any significant change for U.S. players?

A: I think you will see some of the smaller players disappearing as some of the ideas are very esoteric. For example Faith Shares. I also think you may see some more index provider changes similar to Vanguard moving to FTSE from MSCI. Also you may even see some providers self-indexing, however that appears a big conflict of interest to me.

Q: As you have stated you expect the European ETP market to consolidate, what do you foresee the net effect will be for investors? ie fewer but clearer options? Increase in fees?

A: I think fees will compress in the short term as relatively new entrants try to compete. You will also see retrocessions being paid which I believe is already being aggressively adopted by Source and some of the Swiss providers. In terms of the net effect of long term consolidation I suspect it will leave the larger players with more market share. I suspect that Blackrock may get scrutinized by the competition authorities as they already arguably have a dominant market share.

Q: Will consolidation impact the level of inflows into ETP products? In Europe? The US?

A: I think the market and AUM will continue to grow even with consolidation. ETPs are the vehicle of choice and the demand and awareness is growing. The big potential for Europe is the retail market waking up to the ETP offering. U.K. will probably lead the way due to RDR which is closest to the U.S. model. However it will be slow and take time.

Q: How do you see the ETP market outside of Europe and the US? ie how to you view the Australasian or Latin American markets as representing growth opportunities for core or specialized firms?

A: I think Asian and Australia are relatively minor markets for listing local products but are major ETP buyers. They tend to buy U.S. or European listed products instead. They may grow over time but I think the U.S. & EU will always be significantly larger. China however is the major unknown.

Q: Many ETPs are based on passive strategies, do you believe that Active ETFs will gain significant assets or will they be part of the niche crowd? Ala Pimco or Fidelity's new SelectCo-reputedly to launch actively managed sector ETFs.

A: No I think the ET part of ETP is the most important. They are essentially market access tools at their simplest. Active products will grow as large companies will use ETPs as another distribution mechanism but I can't see this being more than a minor part of the AUM of ETPs. Investors also need to look at the costs of these products, as some can be huge.

Q: Many specialized providers offer exposure to their benchmarks through synthetic portfolios, what risk, if any, do you see to these ETP shops if those in favor of physical replication win any regulatory debate?

A: First of all I think this argument is hugely overplayed and largely misunderstood. ETPs are the gold standard when it comes to product construction. I think perception is 'physical' sounds strong and robust, and 'synthetic' sounds risky. Both are valid and well-practiced replication methods. The main differences are as follows:

- Physical - ETP holds a basket of assets similar to the benchmark being tracked. They are often optimised and hold cash accrued from dividends and interest. This leads to tracking error as a benchmark, it can't be replicated identically. Physical products usually also lend out the underlying assets to third parties typically hedge funds. Collateral is exchanged to cover this risk. The quality of this collateral is at the discretion of the issuer. The revenue from the lending is usually kept by the issuer, however ESMA is proclaiming that the fund should get it as they take the risk. Most issuers indemnify the fund in-case of default. iShares was one of the last to do this. This lending practice is common across all FM products - unit trusts, unlisted, investment trusts etc. ETPs tend to be significantly more transparent though. My view is lending could be phased out over time. Precious metal ETFs such ETFS Physical Gold PHAU doesn't lend out so it can be done.

- Synthetic - ETP buys a swap from a bank(s). The fund's cash is given to the bank and in return the bank gives collateral usually over collateralised e.g 105%. The collateral is governed by UCITS collateral and an example of a collateral schedule can be found here .This is different than physical where collateral is governed by an in-house policy. My preference for synthetic products is that the issuer should be a separate, independent entity than the swap provider. This structure is less independent and has increased conflict of interests where the issuer and swap provider are the same. In the US this is not allowed and I think EU will follow. The major plus of swaps is the tracking is guaranteed and performs usually much better than physical. It also is used in some strategies that can't be replicated physically such as short and leveraged such as Boost FTSE 100 3x Leverage Daily ETP ("3UKL"). Swaps tend to allow more innovation and are just as robust as physical when the issuer is independent, for example ETF Securities and Boost.

Q: What about ETN's and banks. These seemed popular tools for banks, will issuing notes go out of favor if banks pull back from the space?

A: ETNs have been very successful in the US. They tend to be issued of bank balance sheets and are unsecured. They are more akin to structured products and certificates in EU. EU investors are more comfortable with independent, bankruptcy remote issuers with collateral to mitigate counterparty risks.


About Boost:
BOOST is one of the few independent providers of specialised Exchange Traded Products (ETPs) in the European market and will be the first to offer 3x leveraged and short ETPs. Boost is spearheaded by Hector McNeil and Nik Bienkowski who are two veterans of the ETP industry. Both were Managing Partners and major shareholders of ETF Securities (OTC:ETFS) and were pivotal in growing ETFS from start-up to $22bn of assets under management by October 2010.

About Co-CEO Hector McNeil:
Hector is a leading specialist in Exchange Traded Products (ETPs) with over 10 years' experience in the sector. Hector started his career at the London Stock Exchange, completed a short stint at BZW and then moved to Morgan Stanley in the late 90s as Head of New Issue Infrastructure. He went on to work for Jiway Holdings (40% owned by Morgan Stanley) as the COO, Nomura International as Director of Fixed Income and Derivatives Operations, and Susquehanna International Group as Head of Business Development where he spent 3 years building up Susquehanna's ETP market making capabilities. After leaving Susquehanna, Hector worked at ETF Securities as a joint Managing Partner where he headed up Sales and Marketing. He was a key ingredient in the company's growth from 4 members of staff and $50m AUM, to 70 employees globally and $22bn AUM - a growth which led to ETF Securities being arguably the most successful ETP start-up globally. Hector holds a BA in Economics and Social History from the University of Hull, an MBA from Warwick Business School and is a Fellow of the Securities Institute.

Special thanks to Karen Leigh for her contributions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.