Understanding the ETF ecosystem 

Despite the rapid growth of Canada’s ETF market, it’s never a bad idea to go back and revisit the basics of how the sector functions.  

Indeed, advisors often raise questions about ETFs, regarding their liquidity, the role played by market makers and the finer points of actively managed ETFs. 

ETF issuers and designated brokers  

A defining feature of ETFs is the involvement of designated brokers, often referred to as market makers. Their job is to ensure continuous liquidity. ETF issuers collaborate with these brokers to create and redeem units, a process that keeps the ETF’s price aligned with its net asset value.  

Market makers play a critical role in supporting efficient trading by quoting prices and maintaining tight bid-ask spreads, which benefits investors.  

In Canada, ETF issuers typically choose partners based on their ability to manage inventory, their expertise in specific asset classes and their capacity to maintain competitive spreads. This contributes to a smooth trading experience, even during periods of market volatility.   

Liquidity considerations for actively managed ETFs  

Unfortunately, not all actively managed ETFs are fully transparent about their holdings. Unlike index-based ETFs, which disclose their portfolios daily, some actively managed ETFs limit transparency to protect proprietary strategies.  

While this is becoming more common in the U.S., there are regulatory frameworks in Canada that emphasize investor protection and transparency.  

What’s unclear is whether fewer market makers for such ETFs could impact liquidity or tradability. While it’s true that our smaller pool of market makers could widen bid-ask spreads, the Canadian market mitigates these risks through robust regulations.  

The Canadian Investment Regulatory Organization (CIRO) ensures that market participants adhere to rules that prioritize fair pricing and market stability.  

Does less market maker activity affect fair value?  

It’s natural for concerns about trading efficiency to come up when an ETF has fewer market makers actively quoting prices. Canadian ETFs do benefit from sophisticated trading mechanisms.  

And in addition to CIRO’s efforts, Canadian exchanges require ETFs’ registered traders to adhere to standards for quoting and pricing.  

Furthermore, there’s more to liquidity than simply the number of market makers. It’s the fund’s underlying securities that often drive an ETF’s tradability. Consider metrics such as bid-ask spreads and average daily trading volume.