Morley Conn: How Canadian ETFs Actually Work | Rational Reminder 413

Why It Matters

Grasping the creation‑redemption and liquidity dynamics of Canadian ETFs reveals why they deliver low‑cost, tax‑efficient exposure and remain resilient during market stress, directly influencing investor returns and market stability.

Key Takeaways

• ETF creation/redemption hinges on authorized participants exchanging baskets for shares
• Market makers provide primary and secondary liquidity, stabilizing NAV deviations
• Canadian ETFs trade less intraday than U.S., yet exceed net inflows
• Capital gains refunds mitigate tax impact, relying on secondary market activity
• ETF liquidity proved crucial during March 2020 fixed‑income market freeze

Summary

The Rational Reminder episode dives deep into the mechanics of Canadian exchange‑traded funds, outlining the roles of issuers, custodians, market makers, and authorized participants that keep the ecosystem running. Morley Conn explains how the creation‑redemption process—either in‑kind basket swaps or cash settlements—allows new ETF units to be issued or retired, aligning market prices with net asset value.

Three tiers of liquidity are highlighted: primary creation/redemption, secondary dealer inventories, and the exchange‑floor trading where market makers post bids and offers. When an ETF’s price drifts from its NAV, authorized participants arbitrage the gap, buying undervalued units and selling overvalued ones, thereby rebalancing the fund’s holdings. The discussion also covers the tax‑efficient capital‑gains‑refund structure unique to Canadian mutual‑fund trusts that underpins ETFs.

Conn references his early exposure to ETF arbitrage on the NYSE floor after 9/11 and cites the March 2020 fixed‑income market freeze as a real‑world stress test where ETFs supplied liquidity while cash markets stalled. He notes that U.S. ETFs see 20‑30 times more secondary trading than primary flows, whereas Canada’s ratio is roughly 6‑10 times, underscoring the importance of secondary market activity.

For investors, these mechanics translate into lower expense ratios, tighter spreads, and tax advantages, while regulators and participants must monitor creation/redemption limits to prevent unintended capital‑gain events. Understanding the Canadian nuances helps advisors and traders optimize execution and risk management in an increasingly ETF‑centric landscape.

Original Description

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In this episode, we are joined by Morley Conn, Director of Sales and Strategy, ETF Services at Scotia Global Banking and Markets, for a deep dive into the mechanics of the ETF ecosystem. With more than 30 years of experience across equities, foreign exchange, and money markets, Morley pulls back the curtain on the creation and redemption process, ETF liquidity, block trading, market making, and the often-overlooked infrastructure that allows ETFs to trade efficiently every day.

We explore how authorized participants and market makers facilitate liquidity, why ETF liquidity is driven by the underlying holdings rather than trading volume, and how large institutional ETF trades are executed. Morley also explains the differences between Canadian and U.S. ETF markets, discusses common misconceptions investors have about ETF trading, and shares practical advice for retail investors seeking better execution. This conversation offers a rare look at the operational machinery behind one of the most important innovations in modern investing.

Timestamps:

0:00:00 Intro

0:05:16 The players involved with creating and managing an ETF

0:08:07 How an ETF is created and redeemed

0:12:32 How the creation and redemption process is related to managing the ETF portfolio

0:13:20 How this is different from mutual fund portfolio management

0:15:41 How secondary market trading affects the ability of ETFs to use the Capital Gains Refund Mechanism

0:18:29 What happens when an ETF's NAV diverges from its market price

0:22:16 How ETF block pricing works when there are illiquid or infrequently priced underlying assets

0;23:47 How the authorized participant manages its risks when the underlying is illiquid or trading on a closed market

0:24:52 What determines how wide the bid-ask spread is on an ETF

0:30:58 How the authorized participant's arbitrage activity affects market depth for people placing large trades

0:35:27 The difference between a NAV trade and an at risk trade, and when each one makes more sense

0:37:57 The involvement market makers have with new ETF products

0:39:58 What retail investors need to be aware of when trading ETF units

0:43:45 When it makes sense to place a block trade order for an ETF

0:45:13 How ETF blocks get priced

0:50:23 What happens to an ETF's assets when the ETF is closed down

0:54:00 The percentage of ETF flows that are retail versus institutional

0:55:27 The types of institutions using ETFs

0:56:29 How retail ETF activity differs from institutional

0:59:51 How the Canadian and U.S. ETF markets differ

1:03:57 How the tax efficiency of ETFs in Canada differs to that of the U.S.

1:05:45 The most common ETF misconceptions

1:10:09 How CRM3 total cost reporting will affect the ETF market

1:13:27 Morley defines success in his life

1:16:22 Disclaimer

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.

Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

Rational Reminder on YouTube — https://www.youtube.com/channel/

Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/