NYSE exec provides update on everything from AMEX’s ‘black box’ technologies for more actively managed ETFs to progress on merging platforms.

Earlier this month, NYSE Euronext completed its acquisition of the American Stock Exchange. With the addition of AMEX’s 416 ETF listings and 13 ETNs, the exchange-traded product listings at NYSE Euronext now number 680, excluding overseas ETFs, and a total of $595 billion in exchange-traded product assets.

IU.com’s Eric Rosenbaum recently spoke with NYSE Euronext Senior Vice President Lisa Dallmer about the specific benefits of the completed acquisition for the ETF industry, and the current outlook for ETFs given the tough markets. 

IndexUniverse (IU): With the Amex deal completed, what are the major benefits to the NYSE as a competitor for ETF listings and ETF servicing business, beyond the bragging rights that are always a part of the battle among exchanges for market share?

Lisa Dallmer (Dallmer): At the broadest level, it’s the bundling of the Amex historical strength in ETF listings, and our stronger technology platform. That allows us to create a best-of-breed approach for exchange-traded products. We’ve made our own strides in the listings business over the past few years, and already listed the biggest names in the ETF business-iShares, Vanguard Group, PowerShares, to name a few. ETFs will now have the largest listings platform aligned with a much better trading platform. This is not only important for the ETFs, either, but for the traders that make markets for ETFs. Firms in order routing and specialist firms, will benefit by the removal of a now redundant trading platform. That AMEX platform has routing costs associated with it, and going forward, those costs will be eliminated. To be frank, the AMEX market share in transactions and order flow has been low, but firms still needed to maintain connections to that platform, and that had a cost.

IU: When will the elimination of the AMEX platform and the movement of all ETFs to the NYSE Arca platform be completed?

Dallmer: As of Dec. 1, we will no longer support the AMEX trading technology for equities and ETFs. On the last day of November, ETFs will all move to NYSE Arca, and on Dec. 1, equities will follow to NYSE Alternext supported by NYSE technology. ETF issuer support has been strong for the migration to NYSE Arca, even before the deal was completed. The Vanguard Group, for example, went ahead with a third quarter migration of ETF listings to NYSE Arca, 10 days prior to the closing of the deal (see story here).

IU: Can you provide a specific example of how the NYSE’s trading platform advantage directly benefits ETFs?

Dallmer: There are some very good statistics, at least initially, in support of the idea that our technology has an immediate, and positive, influence on ETF trading patterns, versus what ETFs experienced when listed on the AMEX. As an ETF issuer, you want to see trading activity take place on the primary exchange where you list. That supports the regulated market aspect of listing with an exchange, among other exchange service functions. Amex may have had the majority of ETF listings, but that did not translate into a dominating position in ETF trading. Amex had struggled with technology and that led to a pattern of competitors chipping away at the trading volume. To see if that might change for ETF issuers with the move to NYSE Arca, we looked at some data since Vanguard moved its ETFs. The Amex numbers for Vanguard ETFs, in particular, were much lower at the open and close.

In the month prior to the transfer, NASDAQ had 57.9% of the open to Amex’s 42.1%. Since Sept. 19, and through Oct. 17, Arca has executed 97.4% of the shares in the opening cross in those issues. NASDAQ’s total volume per day is down from 120,000 to 11,000 in those stocks. Amex was executing 88,000 per day at the open, while Arca is currently at 419,000 at the open (although the gross shares executed may be due to recent high volumes, the share is still astounding). At the close, Amex had still been at about 91% share in these issues. Arca is at 99.8%. However, close volume in these issues totals (across all the ETFs) about 29,000 shares per day (Amex had been 9,700). The lead market maker program that we created in our market structure, and our technology pushed those trading numbers up.

IU: The AMEX had some interesting initiatives in the area of ETF servicing. One, in particular, the so-called “black box” or “scrambler” technology for non-transparent portfolio disclosure of actively managed ETFs, has been an important part of the ongoing efforts to bring actively managed ETFs to market. Where does this initiative stand today, and what are any other initiatives that came out of the Amex’s history in the ETF servicing business, that the NYSE will want to focus on as a combined ETF servicer?

Dallmer: With respect to the “black box project” as you refer to it, we are still working on the technology and with ETF issuers and regulators. There is a proposal in front of the Securities and Exchange Commission now detailing how the service would work to permit listings for a non-transparent actively managed ETF. NYSE Arca has developed strong expertise in the regulatory rule development process behind bringing new products to market. We brought the first commodity trust, SPDR Gold (GLD), and the first ETN to market, and we were early backers of index-linked certificates. We’ve also worked with ETF issuers and the SEC on permitting ETFs of ETFs. I’d also note that one type of product support we can now incrementally offer to AMEX relationships is listings on a global basis. NYSE Euronext is a global marketplace and for ETF clients like iShares, Invesco Powershares, and State Street Global Advisors, there are cross-listing agendas we can fulfill. We already cross-list one ETF into Europe, The Diamonds, and are working on fine- tuning that process so that under appropriate regulatory guidance, there is an easier path for further cross-listing by ETF issuers [Powershares recently listed two versions of ETFs offered in the U.S. in Europe, one on Deutsche Borse's Xetra and one on the London Stock Exchange].

IU: How will new ETF products get to market with seed capital so scarce, and with markets so beaten up?

Dallmer: During a period in which markets are down 4% or more a day, and asset pricing levels down by 20% to 40%, your vetting process for new products changes, with “fourth or fifth fund into a category” typically thrown out. The ETF market has been historically long-only, but already we are seeing the movement to products non-correlated to equities-such as fixed-income, commodities, and currency. Even before the market sell-off there were strong inflows of cash to those ETF categories. Ultimately, I don’t believe ETF success will be about the availability of seed capital or market conditions. It’s about gathering assets. Developing a distribution channel for a fund before it launches has been a strong theme for successful ETF launches in 2008.

IU: How can ETFs with a low level of assets ride out the current market downturn?

Dallmer: To the extent that a fund provider has certain fixed costs, it becomes increasingly difficult to support small asset bases in a down market. There have been some liquidations already, in cases where ETF groups were not finding it cost effective to keep portfolios trading. But the market structure that provides efficiency of trading is the same regardless of asset size, the market rules the same for a $5 billion ETF and a $10 million one. Also, an important difference between ETFs and traditional open-end funds is the lower fixed cost structure for ETFs. There are no transfer agency costs and no shareholder recordkeeping costs. From that perspective, an ETF provider with a low level of assets has less hurdles than a small open-end mutual fund.

No doubt, a very large ETF provider with existing economies of scale to support its fixed costs will more easily be able to add new portfolios, especially in cases where the strategies are more niche and where $100 to $200 million might be a very successful launch. It’s no different than any other business: one revenue stream can’t support multiple pieces. And yet, keep in mind that we’ve had ETF providers like WisdomTree Investments and ProShares grow extensively over a relatively short period of time.

IU: Do you expect that the current market environment will slow the growth of ETFs?

Dallmer: The mass exodus has been from open-end mutual funds. ETFs have not seen those same outflows, and their design has enabled investors to buy into, or exit exposures, intra-day. That has been a valuable feature in this market. When we come to the end of the year, I think comparison of index mutual funds and index ETFs that track the same index will show wide divergence, based on tax-efficiency, in the performance of ETFs versus open-end funds. Heavy turnover creates a situation in which investors using ETFs can really outperform similar open-end fund investors. And remember, all those investors leaving open-end funds in droves, they will eventually go back into the markets to reinvest. Maybe it was 7 to ten years ago that they first invested, and there was not even an ETF available to them. Now those investors are taking their capital gains hits and when they head back into the markets, it may be into ETFs and not back into open-end funds. So that’s a big opportunity for ETF companies.

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