State Street’s ETF back-office dominance is a ‘potential concern’

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State Street’s dominance in servicing Europe’s exchange traded fund market could be a problem for the sector, industry figures say.

The US bank acts as custodian for more than two-thirds of European ETF assets, totalling over €830bn, figures from Refinitiv Lipper show.

Manooj Mistry, chief operating officer at HANetf, a white-label ETF provider, said “one area of potential concern” was the concentration risk resulting from State Street’s dominance as fund administrator.

Mistry said that if there was an IT or systems failure that caused a delay to the calculation of funds’ net asset values, this could pose problems for the ETFs it services, “which rely on timely NAV dissemination to facilitate efficient secondary market trading”.

“No doubt the large custodians will have contingencies in place to manage such situations, but we have seen disruption in the past,” he added.

State Street is also the largest fund administrator and custodian for Ireland, Luxembourg and the UK fund industries, according to research from Monterey Insight.

The bank provides services for more than one-third of funds in Ireland and more than 20 per cent in each of the other two jurisdictions.

Concerns about service provider concentration are already on the radar of policymakers, according to Sean Tuffy, a financial regulation expert.

“Their dominant global position in the world of custody and, by extension, fund administration is the reason that State Street and BNY Mellon found themselves on the [Financial Stability Board’s post-global financial crisis] list of globally systemic banks,” Tuffy said.

Similar concerns have also been raised by UK and EU regulators, he added.

Concerns about State Street’s size are also understood to have been one of the “major stumbling blocks” preventing its planned acquisition of Brown Brothers Harriman in November, Tuffy added.

However, State Street defended its dominant market share.

Frank Koudelka, senior vice-president and global ETF product specialist at State Street, said: “State Street has a long and deep history of execution and resiliency of our global, proprietary technology platforms.”

In addition to its European dominance, State Street points to the fact that it services 47 per cent of US ETF assets and more than 70 per cent in Canada.

Koudelka said the firm’s market share was “a result of the credibility we’ve amassed from our performance with our clients, the regulators and the market participants related to ETF servicing”.

“Overall, State Street’s growing market share has been a net positive for the ETF market because we continue to invest in further automation, integration and straight-through processing,” he added.

Nizam Hamid, an independent ETF consultant, said the dominance of one firm in custody or administration should not be an issue for investors “to be overly concerned about”.

Hamid said there had previously been delays in calculations of official NAVs, but that these “minor technical glitches” have typically not caused any major disruptions.

“In the case of a delay in official NAV calculations, market makers and authorised participants usually have enough information to calculate an unofficial NAV and price the ETFs on exchange accordingly, and so secondary market liquidity can remain present,” he said.

Hamid added that State Street’s dominance could be attributed to “natural market forces and preferences determined by ETF issuers”.

Tuffy agreed, noting that State Street was BlackRock’s sole service provider. BlackRock’s iShares business accounted for 46 per cent of European ETF assets at the end of 2022, Lipper data shows.

He said that if ETF providers were “truly concerned” about concentration risk they could pick a different service provider.

State Street’s importance within the ETF industry is likely to increase if predictions for the growth of European assets come to fruition.

Assets under management in the European ETF industry will double to more than €2.5tn before the end of 2030, according to Detlef Glow, head of Europe, Middle East and Africa research at Lipper.

Glow expected that “concentration in the custodian space will increase over time”, with some firms forced to merge with others in order to have sufficient scale to cope with increased regulatory requirements and to be able to invest in new technologies, such as blockchain.

*Ignites Europe is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at igniteseurope.com