Exchange Traded Funds (ETFs)

ETF Market Participants

The ETF market is made up of a primary and secondary market.

Primary Market

The primary ETF market is made up of three participants:

• Issuers of ETFs
• Authorised Participants
• Market Makers

Secondary Market

The secondary market is made up of buyers and sellers of ETF securities on a securities exchange. Different parties include:

• Securities Exchange (for example the ASX)
• Financial Advisers and Brokers
• Investors
• Share registrars

The issuer of an ETF is the fund manager who manages the ETF and its underlying securities (for example Vanguard is the issuer of Vanguard ETFs). The issuer publishes a basket of securities for delivery each trading day to Authorised Participants and swaps this basket when delivered for ETF units.

Authorised Participants or APs are authorised trading participants with the ASX that have an agreement in place with the issuer to create and redeem units in an ETF off market to meet supply and demand. APs are typically large institutional broking organisations.

A market maker’s role is slightly different. They provide liquidity to the market by quoting buy and sell prices throughout the trading day.

Market makers seek to provide continuous liquidity to the market. The process begins with the issuer distributing the current fund composition to the market every morning, allowing market makers to price the basket of securities underlying the ETF. Market makers place a buy/sell spread around the true value of the ETF and send these prices to the stock exchange as orders. These orders are published to market, and investors can either ‘hit’ orders to trade with the market maker or send their own orders to the exchange and wait for someone else to ‘hit’ them.

Market maker orders are updated continuously throughout the day to reflect price changes in the underlying securities. Often, participants in the market can fulfil both the market making and authorised participant roles.

ETF – Fact or fiction?

An ETF can collapse in the event of a large redemption – FICTION

1. An AP can only redeem with settled ETF securities, meaning they must have the ETF securities in their possession. This also requires those securities to be released from any stock lending agreement.
2. No one AP can enter an order to redeem the entire amount of ETF securities outstanding.

The security exchange’s primary role is to provide buyers and sellers a platform (or marketplace) to trade ETF securities. The ASX conducts a formal review process of each ETF issuer and product before new ETFs can be quoted on the exchange. Having products that trade on the ASX also means that ETF issuers are subject to ASX market supervision rules.

In Australia, ETFs are quoted for trading on the ASX AQUA platform. This dedicated market service was launched in 2007 to provide managed funds, ETFs, and structured products with a tailored trading platform and access to a back-office clearing and settlement service offered by the ASX.

Financial advisers and brokers can trade ETFs on behalf of their clients through two types of brokerage services: non-advisory brokers - which include direct orders through an administration platform or online broker, and, full service brokers who can offer advice and guide an investor or their adviser through the ETF transaction process.

Investors can trade ETF securities directly via their financial adviser or broker.

As ETFs are quoted investments, a share registrar manages the administration for investors such as paying distributions, providing distribution and tax information and allowing investors to elect and change their tax file number status and distribution reinvestment plan elections. Computershare is the share registrar for Vanguard ETFs.

ETF spreads

The spread is the difference between the bid price and offer price. A market maker’s role is to provide liquidity in trading volume and quote within agreed spreads.