The NYSE: Where An ETF’s Life Begins

How do exchange traded funds (ETFs) actually wind up on their exchanges? It’s probably not something to which you’ve given much thought – you see an ETF you like and you buy it. But an ETF’s life can start years before it ever begins trading, and Lisa Dallmer is one of the people who makes it all happen.

Dallmer, the executive vice president at NYSE Euronext, monitors exchange traded products (ETPs) and the index business around the world. She’s involved in nearly all aspects of an ETF’s life: linking up those who design and create indexes that will serve as benchmarks for ETFs to those who have ideas for ETFs. She also works to ensure that ETFs meet all the regulatory requirements for listing, and ensures that the funds’ trading operate as they should after they IPO. (Watch Tom Lydon and Lisa Dallmer discuss the basics of ETFs).

A Global Business Streamlined

Dallmer’s work has her traveling back and forth between the United States and Europe, ensuring that the approach to listing ETFs is as streamlined as possible in both markets. She points out that clients of NYSE are primarily ETF providers with products on both continents: State Street, Invesco PowerShares and iShares all have robust ETF businesses not only in the United States, but in Europe, as well.

The process of creating an ETF first has to begin with a good idea. “It ultimately has to begin with an idea that is appealing to investors,” whether it’s fixed income, international equity or a China-focused fund. Sometimes, the issuer will have an index in mind. Other times, the product is merely an idea. Either way, Dallmer’s team steps in to make it all happen.

NYSE put the product business next to the index business, Dallmer says, “because the product reflects the returns of a particular index.” Often, the index team and the issuer team are getting together and talking to a specific asset manager. (More on indexing).

Dallmer’s team has seen its fair share of ETF ideas come and go, so their opinions are often sought at some point in the creation process. But they’re not going to offer unsolicited advice if an idea doesn’t seem like a workable one. “We don’t really engage in a merit review process where we say this is interesting or not,” she says.

“People do come to us, and we provide anecdotal evidence. But if it’s a sixth to market product, it’s not my job to say five is enough.”

The Listing Process

Once an ETF idea is in place and an index has been put together, a prospectus is drafted and the Securities and Exchange Commission (SEC) is brought in for regulatory review.

There are two ways products are submitted to the exchange for listing:

• Generic listing standards: This often applies to products for which there’s already a broad-based mold in place. For example, if a product consists of domestic equities and there are already a number of those listed, it means the generic listing standard will apply.
• The “other” category: This is the category under which all other products that don’t fit the generic listing standards go, and it then has to be taken to the SEC. At that point, the SEC looks at the product, the prospectus and the exchange explains why they think it’s a reasonable product for investors to trade and why it’s justified under the exchange rules. (Creation and redemption explained).

Dallmer points out that actively managed ETFs have no generic listing standard, so every product that comes out is a unique filing. Once rules on a particular category of funds have been established, the generic listing standard is in place.

Keeping ETFs on Track

After an ETF is up and running on the exchange, it’s a matter of keeping things running smoothly. Dallmer says what is primarily being looked at is whether an ETF’s NAV (net asset value) is being provided each day and that the basket of holdings as stated in the prospectus is being transparently provided. The exchange also looks at how the ETF is structured under the terms of the 40 Act. (Why ETFs beat mutual funds).

If there is a failure on the transparency front, the exchange reaches out to the issuer, and in some cases ceases secondary trading until the issue is resolved.

“We’re not managing the portfolio management process, but we monitor the interaction with respect to what’s articulated on transparent data for the purposes of trading,” Dallmer says.

For other would-be ETF issuers out there, Dallmer has a few ideas for success because, as she puts it, “We’re at a point where the marketplace is becoming more mature than it used to be.”

The first step is knowing your audience. “It’s very important for issuers to understand what investors want. Do they know what types of investors they’re targeting? Do they have the expertise to reach that investor?”

It’s also important, she says, to consider the current landscape and how they can best distinguish their message from that of their competitors.

Looking to the Future

In 2010, Dallmer foresees more ETFs aimed at closing gaps in exposure. “We’re moving to a level where we’re packaging a whole investment idea – equities and fixed income – in a packaged solution. We’ll see more of that in Europe and the U.S.”

Dallmer, who first worked in fixed income and credit derivatives, is happy to be at the forefront of the evolution of ETFs. “I enjoy watching the growth of our business. I value the interactions with our issuers, index partners and participating in the packaging of so many creative investment ideas.”

For more educational articles on ETF investing, visit our education page.