Are ETFs Getting Too Complicated? Not Necessarily, But Complexity Has a Cost

Are ETFs Getting Too Complicated?

The ETF industry has never been short on innovation.

What started primarily as a way to track broad equity indexes has expanded into fixed income, commodities, international markets, options strategies, leveraged and inverse exposures, crypto, buffered products and, more recently, increasingly complex structured strategies.

The SEC has taken notice. This summer, it formally requested public comment on what it calls “Novel ETFs”—funds investing in innovative asset classes or pursuing novel investment strategies.

The SEC framed the discussion around facilitating innovation while protecting investors and maintaining fair and efficient markets. U.S. ETF assets had grown from roughly $4 trillion in 2019 to more than $12 trillion at the end of 2025.

So, are ETFs getting too complicated?

From a capital-markets perspective, my answer is mostly no.

But complexity isn't free.

Market Makers Have Been Handling Complexity for Decades

A traditional domestic equity ETF is generally straightforward to price.

The securities are transparent, the markets are open at the same time and there are numerous ways for a market maker to hedge its exposure.

International equity and fixed-income ETFs are more complicated, but neither is new.

Market makers have spent decades developing the systems, experience and risk-management capabilities necessary to price and trade them.

Many of today's newer products are simply another progression.

Buffer and covered-call ETFs can be priced effectively, but they require options expertise.

Single-stock leveraged ETFs may have a relatively simple underlying exposure, but the trader needs to understand the leverage, daily rebalance and resulting hedge requirements.

None of those things make the ETF wrapper unsuitable.

They simply change the skill set required to make the market.

The Real Problem May Be a Market-Making Bottleneck

This is where I think the industry should be paying more attention.

Issuers aren't just launching more ETFs; they're launching products that increasingly require specialized knowledge and infrastructure to price and hedge.

Autocallable ETFs are a good current example.

An autocallable payoff is more complicated to value than a basket of domestic equities. Pricing and hedging it can require additional modeling, expertise, technology and trader time.

A market maker can do that.

The more important question is: Why should they?

Market makers don't work for free.

Every new ETF competes for a firm's technology, traders, capital and risk appetite.

As the product becomes more specialized, the number of firms that are both capable of supporting it and interested in doing so can shrink.

There is also the cost of managing residual inventory.

Positions that don't naturally recycle can consume capital and require ongoing hedging, financing and risk management. In a specialized ETF with limited secondary-market activity, those costs can become meaningful.

In some corners of the market, ETF innovation may be occurring faster than specialized market-making capacity is expanding to support it.

And that doesn't necessarily show up as an inability to price an ETF. It can show up much earlier, when an issuer calls market makers before launch and discovers that relatively few firms want the assignment.

Where Are the Banks?

ETF assets have grown tremendously, trading volumes have grown and products have become more sophisticated.

Banks certainly aren't absent from ETFs.

Many play important roles as authorized participants, institutional trading counterparties, derivatives dealers and liquidity providers.

But there is a difference between participating in the ETF ecosystem and committing resources to competitively quote ETFs every day.

Much of that responsibility, particularly for newer or specialized products, remains concentrated among a relatively small group of sophisticated trading firms with deep expertise in derivatives, hedging and principal risk-taking.

As ETF products become more specialized, it is fair to ask why more banks haven't made ETF market making a larger strategic priority.

Additional competition would be healthy for issuers, investors and the ETF ecosystem, and could help expand the pool of firms available to support increasingly specialized products.

Getting a Market Maker's Attention Has a Cost

Historically, there have been several ways for an asset manager to make an ETF relationship economically worthwhile to a market maker.

The ETF itself may generate enough trading activity. Or the asset manager may have a broader relationship involving institutional trading, options, derivatives or other business.

But what about an ETF issuer that doesn't have those businesses?

A newer issuer may have plenty of capital available to support its ETF franchise but little commission flow or ancillary trading business to direct to a market maker.

That doesn't mean its ETF is a bad product.

It means the traditional relationship economics may not exist.

Exchange-sponsored liquidity programs can help bridge that gap by creating explicit economics for firms willing to take on enhanced quoting responsibilities. And there is an important regulatory reason those arrangements operate through formal exchange frameworks.

FINRA Rule 5250 generally prohibits member firms from accepting payment from an issuer for acting as a market maker or publishing quotations, while providing an exception for payments expressly provided for under the rules of a national securities exchange.

The rationale is understandable: issuer payments shouldn't compromise a market maker's independence or the integrity of displayed quotations.

This isn't an entirely new debate.

In 2020, FINRA considered industry requests to permit ETP issuers to pay market makers directly outside an exchange-administered program. Proponents argued that the derivative nature of ETPs and their arbitrage mechanism reduced some of the concerns Rule 5250 was designed to address. FINRA ultimately decided against creating the exception, citing investor-protection and other regulatory considerations.

Other markets provide a useful comparison. In parts of Europe, ETF issuers can compensate market makers under formal liquidity arrangements. On Germany's Xetra market, for example, ETF issuers engage Designated Sponsors under agreements that can provide compensation in exchange for defined market-making responsibilities.

The European experience doesn't necessarily provide a blueprint for the U.S. market, but it demonstrates that compensated market-making arrangements can operate within a regulated framework that includes quoting obligations, transparency and investor protections.

But the ETF market has changed considerably since then. Assets have roughly tripled since 2019, the number of ETFs has more than doubled, and the products themselves continue to become more specialized.

That makes the question worth revisiting.

An ETF is different from a traditional operating-company stock. It represents an investment portfolio with an underlying value that market participants can generally observe or estimate, supported by a creation/redemption mechanism designed to facilitate arbitrage between the ETF and its portfolio.

Making a market in an increasingly complex ETF can therefore require specialized technology, capital, modeling and hedging expertise. The issuer isn't paying a market maker to establish an artificial value for its securities; rather, the potential compensation would be for committing additional resources to provide liquidity around a portfolio with an independently observable or estimable underlying value.

That distinction raises a market-structure question worth discussing:

Should there eventually be a more direct and transparent mechanism for ETF issuers to compensate market makers for enhanced market-making services?

Any such framework would need appropriate safeguards around transparency, conflicts, market-maker independence, quoting obligations and investor protection. The answer isn't simply to remove existing protections.

But as ETFs become more specialized, the economics ultimately have to support the resources required to make markets in them.

Sometimes organic trading revenue will do it.

Sometimes a broader commercial relationship will do it.

Sometimes an exchange incentive will do it.

The question is whether those should always be the only options.

Complexity Isn't the Enemy

I don't think ETFs are getting too complicated.

The ETF structure has demonstrated an extraordinary ability to adapt. The industry has successfully incorporated asset classes and strategies that would have seemed unusual inside an ETF twenty years ago.

The bigger challenge may be making sure the ecosystem surrounding the ETF evolves as quickly as the products inside it.

We need enough experienced firms willing to price and hedge increasingly specialized exposures.

We need competition among those firms.

And we need an economic structure that makes committing those resources worthwhile.

The next stage of ETF innovation may therefore require innovation outside the ETF wrapper as well.

Before an issuer designs the next groundbreaking ETF, there is one very practical question worth asking:

Who is going to make the market—and why is it economically worthwhile for them to do it?

Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.