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Smaller to mid-size US active ETF issuers face fee challenges from custodian platforms

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US ETF issuers of active ETFs are facing an increase in fees from the big custodian firms, such as Charles Schwab and Fidelity Investments who dominate 85 per cent of the market in the US.

ETF issuers are saying that if they don’t pay the added fees, they don’t appear in searches by Registered Investment Advisers (RIAs). The subject is so contentious, many of those involved will not comment on the record.

One such issuer commented: “More and more investment advisers are setting up on their own and using a custodian, but the custodian firms now want the ETF issuers to pay for the privilege of offering their ETFs.”

Another says: “They are coming to us to ask us to pay for shelf space.”

While some firms have strategic agreements in place, the middle tier is the most hit. 

“You can’t go out and incorporate a newly issued ETF in your practice but as an RIA you have a lot more autonomy because you are independent but if the platform from a custodial perspective is charging you a fee, then there can be frictions.”

The Financial Times quotes the increased fee for the Fidelity Investments platform in the US as USD100 per trade for investors to buy ETFs if the issuers have not agreed to make ‘support payments’. In terms of brokerage, Fidelity is reported by the Financial Times to be asking ETF sponsors to pay 15 per cent of total fund revenue.

One of the ETF issuers affected by this described it as ‘an existential threat’.

From the start, ETFs have been all about low-cost efficiency but the feeling among issuers is that the mutual fund platforms are trying to ruin the wrapper by charging fees which will ultimately cause an increase in expense for the ultimate investor.

There is an understanding that custodians are trying to make the economics of a business work that is increasingly under pressure, and they are seeking to generate additional revenue out of the value of being on their platforms.

“But the reality is the costs aren’t going to be borne by the issuer but by the end investor, which flies in the face of what the ETF wrapper has done over time,” says one issuer.

As ETFs get more active, and those active ETFs capture a large portion of flows there is an increased need for due diligence on the manager, philosophy, process, much like an active mutual fund (MF), leading to increased cost for the platform, industry observers say.

Mechanisms that are unique to the ETF vehicle can cause increased costs for platforms, such as trading, other observers say, such as managing the create/redeem basket; structure; securities lending; liquidity; suitability and stretched resources.

The problem comes as the charging of fees benefits ‘the big guys even more,’ as one issuer puts it, referring to ‘the BlackRock, Vanguard and State Streets of this world who dominate the assets’. 

“If smaller ETF issuers who don’t have the same economics of scale are being forced to pay a fee it makes it even more challenging for those firms,” that firm says.

The Financial Times story is here

And this subject was recently covered by ETF Prime, a podcast from Nate Geraci.

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