The US ETF market, now valued at around $8 trillion, has experienced remarkable growth over the past five years, with assets more than doubling, over 1,000 new funds launching, and annual trading volumes soaring by approximately $11 trillion. However, this growth hasn’t extended to the number of firms responsible for managing cash flows in and out of these ETFs. These firms, known as authorized participants (APs), are essential for the smooth operation of every ETF in North America. Despite the industry's expansion, the number of active APs has remained largely static, leading to a significant concentration in this sector of the market.
Bloomberg News analyzed filings for over 3,400 funds, revealing that more than half of all US ETF flows are managed by just three firms, and for many funds, more than 90% of all money entering or exiting is handled by three APs or fewer. Hundreds of ETFs reported only one active AP in the latest quarter, indicating a dependency on a single firm for cash flow management. This concentration can lead to mispricing during stress scenarios, creating additional risks and potential costs for investors.
Market Overview:
-The $8 trillion ETF boom hides a stark reality: a handful of firms control the lifeblood of these funds.
-Bloomberg analysis reveals concentration risk, with just three APs dominating fund flows and raising concerns about mispricing in stress scenarios.
-While some argue for a diverse ecosystem, questions linger about potential liquidity crunch and resilience in a downturn.
Key Points:
-Despite explosive growth in the ETF market, the number of authorized participants (APs) handling crucial creation and redemption functions remains remarkably stable.
-Bank of America (BA), Goldman Sachs (GS), and JPMorgan (JPM) reign supreme, collectively handling over half of all US ETF flows.
-Limited AP participation can lead to mispricing in volatile periods, raising concerns for investors and undermining ETF reliability.
-While alternative players like Virtu and Citadel are gaining traction, questions remain about their ability to step up in a crisis if the big banks retreat.
Looking Ahead:
-The ETF market's reliance on a few key players presents a potential vulnerability, particularly in a market downturn.
-Increased transparency and diversification in the AP landscape could mitigate concentration risks and enhance investor confidence.
-Regulatory scrutiny and stress testing are crucial to ensure the resilience of the ETF ecosystem during turbulent times.
The three leading APs in the business are Bank of America, Goldman Sachs, and JPMorgan, with Bank of America leading the market share. This concentration has raised concerns about the efficiency and reliability of the ETF market, especially in times of financial stress. While the typical ETF had 22 APs registered in 2022, the average number of active APs was just 4.3. The industry relies on the assumption that if some APs step back, others will step in when the economics are favorable. However, since APs aren't obligated to perform this arbitrage role, many funds depend on the continued participation of a few firms.
This AP concentration is particularly concerning for commodity ETFs, which show some of the highest levels of concentration. The analysis found that more than 280 ETFs had only a single active AP in the third quarter of 2022, highlighting that even well-established products can rely heavily on just one or a few firms. This raises questions about the market's resilience in the face of future crises and whether other APs will step in to maintain market stability.
