GFX GLOBAL HUB AND SPOKESM SYSTEM
The ETF Application of the GFX Global Hub and SpokeSM System is the next generation solution for ETF sponsors to efficiently operate multiple ETFs with the same investment objective and policies; effectively expand across borders and national market segments; create and operate sub-advisory ETFs for their distribution partners; and employ sophisticated portfolio management techniques to adjust a portfolio’s investment strategy for a specific national market or market segment.
The GFX Global Hub and SpokeSM System is the first that permits an asset management organization to operate a single portfolio with assets from ETFs sold publicly in the U.S. (’40 Act ETFs), Europe (UCITS) and Asia. This System is used for index-based and actively-managed ETFs as well as other exchange traded investment products, including closed-end investment companies and investment trusts.
The GFX Global Hub and SpokeSM System thus results in:
- Efficient and cost effective portfolio operations through a single investment manager, a single safekeeper, a single auditor, single gross investment performance, and a single portfolio compliance platform across fund ranges and across borders for the same investment objective,
- A single, continuous 24-hour global trading market for investors in and market makers for participating ETFs, regardless of their domicile or the exchanges on which their shares are listed, from the opening of the exchanges on the Pacific Rim on a Monday morning until the close of the New York exchanges on a Friday night,
- Enhanced liquidity and tighter spreads for shares of each participating ETF through the ability to convert those shares into shares of each other participating ETF,
- Effective new market entry through the critical mass, performance track record and enhanced liquidity and tighter spreads for new ETFs with the domicile and other components selected independently from other participating ETFs in accordance with the applicable legal/fiscal requirements and market conventions of their intended market segment,
- Efficient and cost effective sub-advisory/private label arrangements between the ETF sponsor and its distribution partners through the creation of new participating ETFs sponsored by the distributor, and
- Customized investment policies through the ability to change, expand or modify the investment strategy of a portfolio for each national market or market segment.
The principals of GFX have developed and operated many innovative fund structures over the past several decades, including the hub and spoke structure. The staff of the U.S. Securities and Exchange Commission reviewed that structure and concluded that “the organization of mutual funds in hub-and-spoke arrangements is an important evolution in the mutual fund industry.”
These development efforts have continued to evolve so that currently GFX is licensing the know-how and software necessary to implement and support the ETF Application of its GFX Global Hub and SpokeSM System.
GFX Global Hub and SpokeSM System
The GFX Global Hub and SpokeSM System is used by two or more index-based or actively-managed ETFs, or other exchange traded investment products, including closed-end investment funds and investment trusts, to invest through a single GFX Portfolio. These ETFs could be U.S., European or Asian.
The GFX Global Hub and SpokeSM System involves the separation of the portfolio components of the ETF from the administration and distribution components. Once separated, other existing or new ETFs can likewise separate their investment components and invest through that same investment portfolio. This single investment portfolio is referred to as a GFX Portfolio and each of the ETFs investing through it are referred to as a participating ETF.
As the portfolio components of an existing traditional ETF are separated from the other components to become a GFX Portfolio, that portfolio retains its performance track record, adjusted for expenses. Thus, in turn, a newly-created participating ETF has that same track record at the time of its organization, adjusted for expenses.
The following diagrams illustrate two parallel traditional ETFs (Fig. 1), and those same two ETFs participating in a GFX Portfolio (Fig. 2).
Fig.1
Fig.2
GFX Portfolio
The GFX Portfolio operates as a single portfolio with a single investment manager, a single custodian, a single auditor, and a single portfolio compliance platform. Likewise, the GFX Portfolio has a single investment objective and a single set of investment policies and restrictions. The GFX Portfolio is tax transparent. The operations taking place through the GFX Portfolio comply with the laws and regulations governing each of the participating ETFs (the “highest common denominator”).
As a result, portfolio management, safekeeping and compliance functions are standardized and centralized across fund ranges and across borders. The GFX Global Hub and SpokeSM System thus results in a more efficient and cost effective operation of multiple ETFs with the same investment.
Global Application
The following diagram (Fig. 3) illustrates the application of the GFX Global Hub and SpokeSM System to create a single portfolio with assets from ETFs domiciled in different global markets and listed on various exchanges with different market makers.
Fig. 3
As a result, and unlike parallel traditional ETFs which have separate and distinct portfolios, the investments of the participating ETFs in a GFX Portfolio are held through the same single portfolio and are thus identical. They are thus normalized, i.e., each participating ETF has the identical gross investment performance as each other participating ETF investing through that same GFX Portfolio. Therefore, an ETF sponsor has the same gross investment performance across its ETF ranges for each investment objective. The net investment performance of participating ETFs varies as the expenses of each ETF vary depending upon its size and market dynamics.
Conversion of ETF Shares
Since each participating ETF holds an interest in the aggregate assets held through the GFX Portfolio, each investor in each participating ETF indirectly holds an interest in those assets. As a result, and unlike parallel traditional ETFs, investments by investors in the ETFs participating in a GFX Portfolio are normalized.
Since the investment of each investor in each ETF participating in a GFX Portfolio can be expressed as an indirect interest in that GFX Portfolio, the investment of each investor in each ETF has an equivalent investment in each of the other participating ETFs. Thus, each investor in each ETF can convert their investment into an absolutely equal investment in any of the other participating ETFs. Since the conversion would take place between valuation points, the cash value of the shares of either participating ETF would not be known. However, since the indirect ownership of each share of each participating ETF would have been determined at the last valuation point and would remain unchanged until the next valuation point, it would be clear that the conversion involved shares of equal, albeit unknown, value. If the investor in a participating ETF converted their investment into shares of another participating ETF, the transaction would be on the secondary market and would have no impact on the GFX Portfolio, or on the activities of the investment manager or custodian of the GFXPortfolio.
After-Hours Trading
The GFX Global Hub and SpokeSM System permits an investor that decides to sell its shares in a participating ETF after the exchange on which they are listed has closed to convert those shares into shares of another participating ETF and then permits those shares to be sold on an exchange which is still open. In the same manner that an investor can convert their shares, market makers can also convert their shares. Thus, market makers have an additional option to the creation/redemption basket process.
As the table below (Fig. 4) indicates throughout each twenty-four hour business day at least one major stock exchange is open. Therefore, the GFX Global Hub and SpokeSM System permits a single, continuous global trading market in ETF shares for investors and market makers from the opening of the exchanges on the Pacific Rim on a Monday morning until the close of the New York exchanges on a Friday night.
Fig. 4
Enhanced Liquidity
As the table above also indicates, for many hours of each business day at least two major stock exchanges are open. Just as an investor can extend the trading day through a conversion of their shares of a participating ETF, during a trading day an investor can convert these shares into shares of another participating ETF which is listed on an exchange with a better spread than the exchange on which the investor’s shares are listed.
Since an investor is now able to sell on a greater number of exchanges, they have greater liquidity. And since market makers on the different exchanges are now in the same market, the bid/ask spreads are expected to tighten permitting the investor to sell at a higher price.
The GFX Global Hub and SpokeSM System therefore creates a single, continuous global trading market with the combined liquidity and tighter spreads that are the result of a larger market.
Effective New Market Entry
The GFX Global Hub and SpokeSM System permits an asset management organization to create new participating ETFs customized for new markets and listed on new exchanges that from creation would have critical mass (through the assets from other participating ETFs being managed through that GFX Portfolio), a performance track record (i.e., the track record of that GFX Portfolio adjusted for expenses), and combined liquidity and tight spreads (through the conversion process into all of the other exchanges and through the enhanced competitive pricing resulting from the conversion process).
Therefore, the GFX Global Hub and SpokeSM System is the most effective means for an ETF sponsor to expand across borders and across national market segments.
Customized Participating ETFs
After investing through a GFX Portfolio each participating ETF can continue to have, for example, a different: (1) sponsor, (2) domicile, (3) name, (4) legal regime (e.g., investment fund, insurance, banking), (5) legal structure (e.g., SICAV, OEIC, unit trust), (6) pricing structure (e.g., total expense ratio, commissions, asset-based distribution fees), (7) valuation structure, (8) classes of shares, (9) currency of denomination, (10) distribution policy (e.g., roll-up, distributing), (11) fiduciary (e.g., depositary bank, individual directors), (12) group of authorized participants, and (13) exchange listing(s).
Each participating ETF customizes each of these administration and distribution components for its market, regardless of the options other participating ETFs use to customize these components for their markets. Therefore, existing traditional ETFs which have been customized for a particular market do not have to modify their components in order to participate in a GFX Portfolio. Also, newly-created participating ETFs can select whatever options are best suited for their intended markets and participate in a GFX Portfolio.
Each participating ETF may also change, expand or modify the investment strategy of a GFX Portfolio for its national market or market segment. A participating ETF does this by holding additional securities at the ETF level, by entering into derivative contracts at the ETF level, or by investing a portion of its assets through another GFX Portfolio.
Efficient Sub-advisory / Private Label Arrangements
A more efficient and cost effective sub-advisory or private label arrangement can be created and operated through the GFX Global Hub and SpokeSM System since the sponsor of a participating ETF and the investment manager of the GFX Portfolio can be unaffiliated. As with a traditional sub-advisory or private label arrangement, the sponsor of a participating ETF can select its domicile, name, legal regime, legal structure, pricing structure, valuation structure, classes of shares, currency of denomination, distribution policy, fiduciary, group of authorized participants and exchange listing(s).
As a result, the participating ETF would function as a seamless part of the sponsor’s ETF range, in the same manner as would be the case with a traditional sub-advised or private label ETF.
However, unlike a traditional sub-advisory or private label arrangement, the participating ETF would commence operations with a critical mass of assets, a performance record, twenty-four hour trading, and enhanced liquidity and tighter spreads. Likewise, the investment manager would continue to have only a single large portfolio to manage, instead of two (one of which would be quite small) as would be the case with a traditional sub-advisory or private label arrangement.
Customized Investment Strategy
The sponsor of a participating ETF can employ sophisticated portfolio management techniques to change, expand or modify the investment strategy of a portfolio for its national market or market segment.
In addition to its investments in fixed income securities through a GFXPortfolio, the sponsor of a participating ETF could use derivative instruments at the ETF level to change the duration of its investments.
As a result, a single fixed income GFX Portfolio could have one participating ETF with a long duration, another with an intermediate duration, and a third with a short/intermediate duration.
Also, in addition to its investments in equity securities through a GFX Portfolio, the sponsor of a participating ETF could use derivative instruments at the ETF level to offset the exposure of the portfolio to specific national or industry segments, or to specific issuers or other groups of issuers.
Regulatory Status
The general legal, fiscal and regulatory issues underlying the GFX Global Hub and SpokeSM System were presented to the relevant authorities in the U.S., UK, Luxembourg and Ireland. The authorities in the UK, Luxembourg and Ireland confirmed that funds organized in those jurisdictions and operating as UCITS could participate in the structure. GFX believes that the issues raised in the U.S. have also been adequately addressed. However, as with other fund structures – including traditional ones – no assurance can be given that, in the context of any specific application or filing, additional issues may not arise which would lead the applicable regulatory or fiscal authority to deny, reject or significantly modify that application or filing.
More Information
Global Fund Connections LLC (GFX) is a multi-disciplinary FinTech firm that has developed the know-how and software for this innovative GFX Global Hub and SpokeSM System. For more information concerning the GFX Global Hub and SpokeSM System, including its use by traditional funds and the composite of traditional funds and ETFs, or GFX’s know-how and software licensing program to implement and support it, or to be added to our mailing list, please contact us at info@GlobalFundConnections.com.
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