United States: 2018 Proposed ETF Rulemaking

On June 28, 2018 at an open meeting (the "Open Meeting"), the Securities and Exchange Commission ("SEC") unanimously voted to propose new Rule 6c-11 (the "Proposed Rule") under the Investment Company Act of 1940, as amended ("1940 Act"), which, if adopted, would permit exchange-traded funds ("ETFs") that satisfy certain conditions to organize and operate without the expense and delay of obtaining an exemptive order from the SEC. In addition to several key takeaways from the SEC release describing the proposals1 (the "Release"), we describe the Proposed Rule in detail below and offer insights into how the Proposed Rule may affect ETFs and their sponsors.

KEY TAKEAWAYS

The Proposed Rule seeks to "create a consistent, transparent, and efficient regulatory framework for ETFs and to facilitate greater competition and innovation among ETFs."2 If adopted, the Proposed Rule would significantly ease the regulatory burdens associated with bringing an ETF to market and create a more level playing field for new and existing ETF sponsors. To accomplish this, the SEC proposes to take the following steps:

  • Rescind Prior Exemptive Orders. To help establish a consistent ETF regulatory approach and remove the existing "patchwork" of exemptive orders, the SEC would, except with respect to ETF fund of funds relief described below, rescind exemptive orders previously granted to ETFs eligible to rely on the Proposed Rule. As noted below, certain types of ETFs will not be able to rely on the Proposed Rule and will not have their exemptive orders rescinded under the proposal.
  • Allow Custom Creation and Redemption Baskets. An ETF relying on the Proposed Rule would be permitted to use non-pro rata baskets and/or baskets that differ from other baskets used in transactions on the same business day ("custom baskets").
  • Eliminate the Distinction Between Index-Based and Actively Managed ETFs. All ETFs relying on the Proposed Rule, whether index-based or actively managed, must comply with the same conditions.
  • Implement New Disclosure Requirements. The Proposed Rule and related amendments to Form N-1A (for open-end ETFs) and Form N-8B-2 (for UITs) would require ETFs to disclose certain information on their websites and in their prospectuses, including historical information regarding the ETF's premiums and discounts and bid-ask spreads.

NEW CONDITIONS

The Proposed Rule would provide certain exemptions from the 1940 Act, including most of those currently included in ETF exemptive orders, and also impose many similar conditions. The new conditions in the Proposed Rule include the following:

  • Transparency. Each ETF relying on the Proposed Rule must post its portfolio holdings daily on its website.
  • Custom Basket Policies and Procedures. An ETF relying on the Proposed Rule would be permitted to use custom baskets if the ETF adopts written policies and procedures that set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders and specify the titles or roles of the employees of the ETF's investment adviser who are required to review each custom basket for compliance with those parameters.
  • Website Disclosure. The Proposed Rule and related form amendments would require ETFs to disclose certain information on their websites to increase transparency, including historical information regarding premiums and discounts, bid-ask spread information and information regarding a published creation/redemption basket.

The SEC expects that permitting ETFs to utilize custom baskets will reduce transaction costs, promote efficient portfolio management and lead to a more efficient and effective arbitrage process. In addition, the new disclosure requirements, including full portfolio transparency, should enable the SEC, investors and other market participants to evaluate the functioning of an ETF's arbitrage mechanism.3

SUMMARY OF THE RELEASE

The SEC's proposals aim to level the playing field among existing ETF sponsors, as well as to make it easier for new entrants to break into the ETF business. The SEC hopes the Proposed Rule will "facilitate greater competition and innovation in the ETF marketplace, leading to more choice for investors."4 The proposals in the Release would make substantial progress toward leveling the regulatory landscape for ETF sponsors and promoting the efficient operation of the arbitrage mechanism that supports an ETF's shares trading at a market price approximating the ETF's net asset value per share ("NAV"). In particular, the proposals set forth in the Release would:

  • Codify much of the relief granted on a case-by-case basis to ETF sponsors under the current exemptive order regime, permitting ETFs organized as open-end funds, with some exceptions, to operate without obtaining individual exemptive relief from the SEC.5
  • Rescind exemptive relief previously granted to those ETFs able to rely on the Proposed Rule.6 In addition, the Release proposes rescinding exemptive relief permitting ETFs to operate in a master-feeder structure for all ETFs that do not currently rely on such relief.7
  • Permit an ETF relying on the Proposed Rule to use custom creation and redemption baskets that do not reflect a pro rata representation of the ETF's portfolio and/or that differ from other baskets used in creation or redemption transactions on the same business day.
  • Require ETFs relying on the Proposed Rule to disclose certain information on their websites, including (i) portfolio holdings that will form the basis of the ETF's next NAV calculation; (ii) historical information regarding the ETF's NAV, premiums and discounts, and bid-ask spreads; and (iii) information regarding a basket of securities that the ETF would accept or provide in connection with a creation or redemption, updated at the beginning of each business day.
  • Amend Form N-1A and Form N-8B-2 to require disclosure by all ETFs (not just ETFs eligible to rely on the Proposed Rule) of information relevant to investors who purchase and sell ETF shares in the secondary markets. These new disclosure requirements seek to ensure that ETFs provide more useful, ETF-specific information to investors who purchase ETF shares in the secondary market.

As the SEC noted in the Release, the proposals are based on the SEC's experience in regulating ETFs for more than 25 years, and have been informed by the feedback received in response to the SEC's 2008 Exchange-Traded Funds Rule Proposal8 and the SEC's 2015 Request for Comment on Exchange-Traded Products.9

To read this article in full, please click here.

Footnotes

1. Exchange Traded Funds, Investment Company Act Release No. 28193, available at https://www.sec.gov/rules/proposed/2018/33-10515.pdf.

2. Id. at 6.

3. The Release contains an extensive discussion of the purpose and operation of the ETF arbitrage mechanism. See Release at pp. 41-49 ("The arbitrage mechanism is the foundation for why retail and other secondary market investors generally can buy and sell ETF shares at prices that are at or close to the prices at which authorized participants are able to buy and redeem shares directly from the ETF at NAV.")

4. Securities and Exchange Commission. (2018, June 28). SEC Proposes New Approval Process for Certain Exchange-Traded Funds [Press release]. Available: https://www.sec.gov/news/press-release/2018-118.

5. ETFs organized as unit investment trusts ("UITs"), ETFs structured as a share class of a multi-class fund, and leveraged or inverse ETFs would be unable to rely on the Proposed Rule. At the Open Meeting, however, Commissioner Peirce said that she hoped commenters would weigh in on whether and how the Proposed Rule could accommodate leveraged or inverse ETFs.

6. Note that, with the exception of rescissions related to master-feeder relief discussed herein, the proposed rescissions would be limited to the portions of an ETF's exemptive order that grant relief related to the formation and operation of an ETF. The Staff does not propose to rescind exemptive relief from Section 12(d)(1) and the related relief from Sections 17(a)(1) and (a) (2) of the 1940 Act that permits certain ETF fund of funds arrangements.

7. The proposal would grandfather existing master-feeder arrangements that were in use as of June 28, 2018, but would prevent the formation of new master-feeder arrangements by amending existing exemptive orders.

8. Investment Company Act Release 28193 (March 11, 2008).

9. Securities Exchange Act Release 75165 (June 12, 2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions