Industry Insights: Entering the European ETF Space

Contributed by Deirdre McIlvenna, Niamh O’Shea and Colm O'Donoghue from Maples Group

Assets in European ETFs have continued to grow over the last two decades and now stand at over $2.1 trillion. They are forecasted to rise 15% annually until 2030, reaching $4.5 trillion in AUM by then. Ireland is the domicile of choice for European ETFs with more than 70% of European ETFs domiciled here. This article explains the most common routes available for managers looking to enter the European ETF space.

The last two decades has seen an explosion in the growth of ETFs across the globe, with global AUM of $2.7 trillion in 2004 growing to over $14.6 trillion in 2024. Assets in European ETFs have grown in line with this trend and now stand at over $2.1 trillion. Assets are forecasted to rise 15% annually until 2030, reaching $4.5 trillion in AUM by that date.

Ireland is the domicile of choice for European ETFs with more than 70% of European ETFs domiciled there. Luxembourg is Europe's next largest market (standing at 21%), with the vast majority of European ETFs domiciled between those two jurisdictions.

The move into ETFs in Europe has largely been driven by investor demand for the funds’ low fee structure, ease of trading and greater liquidity and transparency.

ETFs are an investment product which combine the features of an investment fund with those of an exchange-traded security on the basis that its shares trade on an exchange intra-day using real time pricing. This feature distinguishes it from traditional mutual funds which only provide for direct subscriptions and redemptions of their shares on a periodic basis using the net asset value per share.

European-domiciled ETFs are typically structured as corporate vehicles established under the UCITS Directive, thereby benefitting from the global brand recognition due to the investment rules, investor protections and risk management safeguards provided under the UCITS framework.  Furthermore, UCITS benefit from the principle of mutual recognition within the EEA allowing them to be marketed in other EEA member states under the UCITS 'passport' once authorised in one EEA member state.

Set out below is an overview of the most common routes available for managers looking to enter the European ETF space, namely:

1. Establishing a new standalone ETF umbrella platform;

2. Converting an existing mutual fund into an ETF;

3. Adding an ETF share class to an existing UCITS sub-fund; and

4. Adding a new ETF sub-fund onto an existing UCITS platform.

Establishing a New Standalone ETF Umbrella Platform

There are numerous reasons as to why a promoter may wish to establish a bespoke ETF platform; including retention of control over the manner which the ETF is established (for example exercising its discretion over the selection of the service providers and fund directors), ensuring appropriate brand recognition and/or for tax reasons.

The regulatory process for authorisation of a new fund platform with the Central Bank of Ireland (the "Central Bank") typically takes approximately 16-20 weeks, although this can vary depending on the types of asset classes the funds are seeking exposure to and the strategies it proposes to follow. This involves a detailed review by the Central Bank of the prospectus and supplement for the fund, and the material contracts are subject to certain Central Bank requirements. Once the offering documents have been cleared by the Central Bank of any comments, the material contracts are then filed with the Central Bank for final approval of the new platform.

Once approved, the ETF can then seek to register for marketing throughout the EU and must seek admission to list on at least one recognised stock exchange. This process typically takes between four to six weeks, although it varies depending on the market and the exchange.

Converting an Existing Mutual Fund into an ETF

The conversion of a mutual fund into an ETF has seen significant traction in the United States and is showing signs of evolving in Europe. The ability to carry track record and launch with existing AUM can be a key driver towards converting an existing mutual fund into an ETF. Scale is an important factor in determining success for ETFs and as such, by converting from a mutual fund to an ETF, promoters can potentially launch the ETF with significant AUM.  Additionally, promoters could also bring along the performance history of the fund, which is a big consideration for attracting new investors.

It is important to note that, given shares in an ETF are held by the ICSD, rather than directly by the shareholder in the case of a traditional mutual fund, a mutual fund conversion into an ETF will result in a shift in the ownership arrangements for direct investors, changing the way their shares are held.

In December 2019, the Maples Group successfully advised on the first European mutual fund conversion to an ETF, and as noted above this is a trend that we believe will continue in Europe.

Adding an ETF Share Class to an Existing UCITS Sub-Fund 

A further option to enter the ETF space would to be launch a listed (ETF) share class on an existing mutual fund.

From a speed-to-market perspective, there is no need to onboard service providers or directors, and applications for approval will benefit from the sub-fund supplement having previously been approved by the Central Bank and so is likely to benefit from a more streamlined review process. However, it will be necessary to ensure all aspects of the ETF ecosystem are appropriately built into the fund documentation. For example, setting out the manner in which share can be traded on the primary and secondary market, as well as negotiating with Authorised Participants, Market Makers and iNAV Calculation Agents.

This is an option for promoters who want to quickly offer investors access to their funds via an exchange traded product.

Adding a New ETF Sub-Fund onto an Existing UCITS Platform

It is possible to co-mingle unlisted, traditional mutual funds and ETF sub-funds on the same platform. Where a promoter has an existing UCITS platform in place, they can look to establish a new sub-fund on the platform, provided the necessary ETF ecosystem is put in place for those funds intended to be managed as ETFs. This option may be suitable for promoters looking to convert some existing mutual funds while also launching new strategies, while benefitting from the existing contractual framework of an already established fund. While service provider agreements may need to be reviewed to ensure that the services required by an ETF are considered, promoters will not need to go through the same lengthy onboarding and due diligence process of service providers as in establishing an entirely new platform as detailed above.

Similar considerations would be in play where a promoter looks to partner with a 'white label' solution, which allows a provider access to all the pre-existing contractual documentation in place for a white label provider. In those circumstances, the promoter has limited or no ability to have input on the service providers and directors of the existing platform and there may be some constraints in terms of the form of offering documents to be prepared for the fund.

General Requirements

Regardless of the option taken by promoters, there are a number of requirements and points which are required to be considered in the context of the establishment of an ETF.

Disclosure Requirements

ETFs are required to include 'UCITS ETF' in the name of the product. The UCITS ETF reference can be included at the level of the sub-fund or the share class, thereby allowing managers the flexibility to have ETF and non-ETF share classes under the same sub-fund allowing for greater distribution options.

Portfolio Transparency

Currently, most ETFs are required to publish their portfolio holdings daily which includes the identities and quantities of portfolio holdings. The initial tranche of ETFs were established as passive index tracking funds where this was non-controversial. However, with the recent growth of active strategies, the publication of holdings can be a sensitive subject for promoters who fear giving away the 'secret sauce' of their strategies. While 'semi-transparent' ETFs have been approved in the US, to date many European regulators continue to require a 'gold standard' of daily portfolio publication.  The requirement to publish the holdings daily is something that is being considered further in Europe, and in particular by the Central Bank.

Taxation

As with any investment fund structure, detailed tax advice should be obtained before electing any of the options detailed above, and each different option will have different considerations with which promoters will need to grapple.

Registration and Listing

European ETFs structured as UCITS benefit from the UCITS marketing passport, and promoters will need to consider the jurisdictions they want to be registered in for sale. Unlike the US, Europe has a much more disparate network of exchanges.  As a result, ETFs are required to make applications for listing on each of the exchanges that they identify for listing their sub-funds. Again, promoters will need to pay close attention to the listing requirements of the various exchanges and consider in detail the exchanges on which they wish to list their product.

The Growth of Active ETFs – A Recent Trend

As noted above, while initial ETFs had traditionally been established as passive index tracking products, the past number of years has seen an increase in the number of active products being approved on both sides of the Atlantic. To date these products still make up a small portion of the overall ETF market, however it is anticipated that active products will be a significant source of growth for the industry. There are numerous reasons as to why an active manager may consider entering the ETF space – in addition to responding to investor demand, promoters have seen the operational benefits of ETFs and as such, have sought to put their actively managed strategies into the ETF wrapper. From an investor perspective, the ability to avail of the advantages of an ETF is a significant factor - being able to access a diversified product which offers them greater transparency than would typically be the case with a normal mutual fund is beneficial.