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Franklin Templeton is moving four of its ETFs – worth about $1-billion – to the NEO Exchange starting March 4, 2021.

Louie Palu/The Globe and Mail

Asset management giant Franklin Templeton is moving approximately $1-billion worth of exchange-traded funds from the Toronto Stock Exchange to the NEO Exchange, citing a new pricing mechanism on the NEO that it believes will better reflect the underlying value of its ETFs.

The company received conditional approval from the NEO this week to exclusively list four broad-based ETFs – Franklin FTSE U.S. Index ETF, Franklin FTSE Canada All Cap Index, Franklin FTSE Japan Index ETF and Franklin FTSE Europe ex U.K. Index ETF – starting March 4.

“The new closing price methodology offered by the NEO Exchange is a good starting point for our partnership and an opportunity to move a suite of our ETFs to NEO that would benefit investors,” company spokesperson Sarah Kingdon said in a statement to The Globe and Mail.

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At the heart of the matter is a pricing technicality involving less-actively traded ETFs. These investment vehicles can sometimes go days without trading, even though the value of the underlying securities and the net asset value of the ETFs could have changed. But the TSX, in accordance with rules set out by the Investment Industry Regulatory Organization of Canada (IIROC), defines the closing price of an ETF as the last price it traded at on its exchange, a method some ETF manufacturers say distorts the valuation.

Under the NEO’s new pricing methodology, if no trading takes place on an ETF within the last 30 minutes of the day, a price is calculated based on the midpoint of the last bid and ask.

“We spoke with ETF manufacturers and brokers and all of them concluded that that price is a much better representation of the value of an ETF,” said Jos Schmitt, the NEO Exchange’s chief executive.

Steve Hawkins, the CEO of Horizons ETFs, one of Canada’s largest ETF providers, calls the old pricing system “antiquated” and “a problem that ETF manufacturers have been struggling with for years.” Horizons ETFs lists most of its products on the TSX, with the exception of a cannabis ETF and a newly launched psychedelics ETF that trade on the NEO.

But Mr. Hawkins does not believe the NEO’s new pricing methodology really solves the underlying issue with valuating thinly traded ETFs. “Yes, they have a new process which records a different closing price, which they publish to their system. But it doesn’t change what goes into the month-end broker system or what shows up on a client’s statement,” he said.

Only the IIROC, Mr. Hawkins said, has the authority to implement a different pricing method for these ETFs across the board that will ultimately be reflected in monthly broker statements and what retail investors see in their own investment accounts.

The broader impact of this pricing distortion to the average retail investor is minimal, though it occasionally causes confusion among those who actively analyze the day-to-day movements of their ETFs, he added. ”We simply want retail investors to get the most accurate information to avoid doubt and anxiety. We have gotten calls asking us about a pricing problem … for example, why there’s a discrepancy between what’s printed in the newspaper and the bid-ask of the ETF that can be seen online.”

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Franklin Templeton’s decision to migrate some of its ETFs to the NEO has perhaps more of an impact on the NEO than on the TSX. The latter remains the leading listing platform for ETFs, generating 99.5 per cent of Canadian ETF volumes.

Graham MacKenzie, the head of exchange-traded products at the TMX Group Ltd., the parent company of the TSX, said the exchange has in fact been actively lobbying regulators to change the rules used to calculate the value of less actively traded ETFs. Its pricing solution differs from the NEO’s in terms of how it is calculated, but the fundamental intention is similar: to ensure the values of all ETFs are accurately reflected in their prices, regardless of how often they trade.

“We want to improve the user experience and make things better for investors. We approached IIROC [about this issue], but I’m not sure where it sits on the priority list for them,” Mr. MacKenzie said.

Still, Mr. Schmitt believes the pace of innovation offered by his exchange is only going to incentivize other investment managers to move their ETF products to the NEO. “This is a big deal for us,” he said, referring to Franklin Templeton’s move. “We’ve moved fast on this, and it’s meaningful to many.”

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