In the past five years U.S. ETF market assets have more than doubled, over 1,000 new funds launched, and annual trading volumes jumped by around $11 trillion. Yet there has been one exception to the explosive growth: The ranks of firms responsible for steering cash in and out of every product.
This cohort—known as authorized participants, or APs—are a type of broker-dealer indispensable to the smooth functioning of every exchange-traded fund in North America. But as the industry has swollen, their numbers have barely changed. In fact, the most active APs have been increasing their market share, strengthening a remarkable concentration in the underbelly of the now-$8 trillion arena.
Bloomberg News analyzed filings for more than 3,400 funds to show that, despite the industry’s breakneck expansion, more than half of all U.S. ETF flows are handled by just three firms. For a majority of funds, more than 90% of all money entering or exiting funnels through three APs or fewer. Hundreds of ETFs reported only one active AP in the latest quarter for which full data is available, meaning they depended on a single firm to keep cash moving.
Funds with fewer active APs are prone to greater mispricing in stress scenarios, research shows. Mispricing—when an ETF trades at a premium or a discount to the value of the assets it holds—creates extra risk and potentially higher costs for investors. It also undermines the reliable functioning of one of Wall Street’s most popular investment vehicles.
“Our message is that investors and retail traders have to be aware of this,” said Taisiya Sikorskaya, a PhD candidate at London Business School who co-authored Two APs Are Better Than One: ETF Mispricing and Primary Market Participation. “This mispricing that we find exists exactly in times when investors would like to rebalance, would like to fly to safety.”
For most retail traders, the mispricing may not be immediately apparent since AP activity and a fund’s deviations from its assets often happen out of most investors’ sight. ETFs have become popular in part because they’re considered low-cost and efficient, yet in a market meltdown these attributes can fade—and a lack of APs exacerbates the problem.
The Big Three
APs close price dislocations by either giving the ETF more assets in exchange for newly created shares, or by buying existing shares in the market and redeeming them in return for assets from the fund.
A trio of major banks have emerged as dominant players in the AP business, Bloomberg’s analysis of Securities and Exchange Commission filings shows. Bank of America Corp. leads the pack, reigning as the most-active AP in every period since the data was first reported. As of the third quarter of 2022—the last for which full data is available—it commanded 24% of the entire market. Goldman Sachs Group Inc. is second with about 17%, while JPMorgan Chase & Co. is in third place with nearly 12%.
“They have the ease and expertise: being able to move cash, being able to settle trades, and getting it all done in a certain amount of time,” said David Graichen, head of capital markets at WisdomTree. “That enables them to continue to thrive in this business.”
Representatives for Goldman Sachs and JPMorgan declined to comment. BofA didn’t respond to requests for comment.
A typical ETF had 22 APs registered as of 2022, while the average number of active APs was just 4.3, the analysis showed. In the entire five-year period, a total of 62 firms registered as APs at one time or another; 28 of them didn’t conduct creations or redemptions at all.
To stay efficient, funds contract multiple APs, and if any step away the assumption is another will take its place when the economics look right. Since APs aren’t obliged to fulfill the arbitrage role, many funds rely on the willingness of just a few firms to keep performing the function.
The filings span a period that featured multiple bull and bear markets, including the Covid crash and the stimulus-fueled recovery. The SEC introduced these annual disclosures a few years ago because it was concerned about limited information regarding ETFs’ reliance on APs. A representative for the SEC declined to comment.
True Depth
The disclosures don’t necessarily present a complete picture of the inner workings of the ETF ecosystem. Major banks often act as prime brokers, meaning they can create and redeem shares on behalf of other liquidity providers like market makers for a fee.
To Samara Cohen of BlackRock Inc., the efficiency of an ETF and how tightly it prices to its underlying assets is a function of the effective arbitrage of these unseen liquidity providers, rather than that of the AP. “We have a much more diverse ecosystem today than we did five years ago as a result of those larger banks really integrating ETF capabilities in their dealing desks,” said Cohen, chief investment officer of ETF and index investments at the world’s largest asset manager.