ETF Share Class: ICI Highlights Key Operational Considerations

Key Takeaways

• The Investment Company Institute recently published a white paper detailing operational, governance, and disclosure considerations for industry stakeholders in implementing a structure offering an ETF share class within an existing mutual fund.
• The key considerations include intermediary considerations, reporting requirements, operational mechanics for interclass exchange privileges, technology and systems considerations, and investor experience considerations. 
• The white paper emphasizes the importance of proactive engagement and collaboration among asset managers, intermediaries, and service providers in order to assess and address the challenges with launching and operating a dual share class structure and to ensure positive investor experience with this product structure.
• In addition to the considerations that ICI addressed in the white paper, Exchange Act relief and changes to exchange listing rules will also need to be in place before ETF share classes can be launched.

Recently, the Investment Company Institute (ICI) published a white paper outlining key operational, governance, and disclosure considerations for the industry in launching and operating an ETF share class within an existing mutual fund (dual share class structure).¹ The White Paper reflects the work of various ICI working groups composed of asset managers, intermediaries, service providers, and the Depository Trust and Clearing Corporation (DTCC). The White Paper focuses on key areas that include intermediary considerations, reporting requirements, operational mechanics for interclass exchange privileges, technology and systems considerations, and investor experience considerations. 

Background

Starting in 2000, the U.S. Securities and Exchange Commission (SEC) issued several exemptive orders to permit an ETF share class alongside mutual fund share class(es) (ETF Share Class Relief), but the SEC Staff subsequently declined to advance additional applications for this relief. More recently, at least 80 applications have been filed with the SEC for ETF Share Class Relief. On September 29, 2025, the SEC indicated its intent to grant ETF Share Class Relief by issuing a notice of application for an order that would permit a dual share class structure.² The expected relief will provide investors with access to a fund's investment strategy through either a mutual fund share class or an ETF share class (multi-class fund). The White Paper shortly followed the SEC's issuance of the notice of application and assumes that any ETF Share Class Relief will generally align with this notice of application. 

Initial Considerations Prior to Launching an ETF Share Class

The White Paper outlines various areas of consideration for asset managers prior to launching an ETF share class:

• First, asset managers should take into account the exemptive application process and its potentially variable timeline, as well as the initial board approval process, which may have significant impacts on the product launch timeline.
• Second, asset managers should consider the appropriateness of a particular mutual fund strategy for the dual share class structure in light of: (i) the daily portfolio holdings disclosure requirement of Rule 6c-11 under the Investment Company Act of 1940 (as a condition for ETF Share Class Relief); (ii) potential capacity constraints (as ETF share classes will generally be unable to close to new creations); and (iii) potential differences in the dividend schedules of a mutual fund share class and ETF share class.
• Third, asset managers should consider the operational model of operating a dual share class structure, particularly in terms of selection and integration of fund service providers and capital markets personnel. 
• Fourth, asset managers should consider engagement with intermediaries in advance to evaluate their operational support readiness and resolve any necessary modifications to existing distribution arrangements.
• Fifth, asset managers should assess the composition of a fund's shareholder base and the potential impacts to different categories of shareholders arising from the introduction of an ETF share class.

Intermediary Considerations

The White Paper identifies three broad areas where intermediaries may be most impacted by the introduction of a dual share class structure and emphasizes the importance of bilateral discussions between asset managers and intermediaries to address these impacts. First, the White Paper indicates that intermediaries will be required to consider changes in systems, policies and procedures, and staff training resulting from their current disparate systems for servicing mutual funds and ETFs. In addition, such operational changes will be necessary to accommodate the interclass exchange feature (i.e., a shareholder exchanging their mutual fund shares for ETF shares of the same fund) and potential changes to privileges currently extended only to mutual fund shareholders, such as rights of accumulation, letters of intent, and automatic investment and withdrawal provisions. Second, the White Paper notes that the introduction of a dual share class structure may introduce challenges and complexities for broker-dealers in making the determination that investing in a particular share class is in the best interest of a customer under Regulation Best Interest, thereby potentially increasing their operating costs and regulatory risk. Third, the White Paper suggests that intermediaries should consider impacts to their revenues and business models as a result of migration of mutual fund shareholders to ETF share classes and technology and system uplifts. 

Reporting Requirements and Considerations

The White Paper notes that funds will need to implement policies and procedures and the necessary framework to produce the initial adviser report, the ongoing adviser report, and the ongoing monitoring process for certain metrics relevant for the board's oversight, which are the proposed conditions for ETF Share Class Relief. The production of these reports and the ongoing monitoring process will likely focus on assessing three potential sources of “cross-subsidization” between a fund's mutual fund share class(es) and ETF share class: (i) trading costs (i.e., costs resulting from brokerage and other costs related to portfolio transactions); (ii) tax drag (i.e., performance impacts resulting from distributable capital gains generated by portfolio transactions); and (iii) cash drag (i.e., performance impacts resulting from the need to hold cash to satisfy mutual fund share class redemptions), as well as assessing the potential cost savings of the dual share class structure due to greater economies of scale.

With respect to trading costs, the White Paper observes that disparate impacts of trading costs on the mutual fund share class(es) and ETF share class may result from differences in how mutual funds and ETFs traditionally adjust their portfolios in response to asset flows, as well as in pursuit of their investment strategies. While mutual funds typically buy and sell portfolio holdings and incur trading costs in the process, ETFs generally can utilize the in-kind creation and redemption process to make adjustments to their portfolios and thereby minimize trading costs. In a dual share class structure, cross-subsidization may primarily come from portfolio adjustments resulting from asset flows in and out of the mutual fund share class(es) that are effected using in-kind creations and redemptions of the ETF share class. The White Paper suggests that the impacts of trading costs can be estimated by using information on fund flows, portfolio holdings, and the trading costs of the underlying securities, and provides an example for calculating trading cost impacts under various hypothetical fund structures.

With respect to tax drag, the White Paper notes that ETFs typically enjoy greater tax efficiency relative to mutual funds due to in-kind creation/redemption transactions that reduce the realization of capital gains/losses. As such, cross-subsidization may arise where portfolio transactions by a mutual fund share class may have tax impacts on the ETF share class or vice versa. The White Paper suggests that such impacts can be estimated by comparing taxable distributions of a multi-class fund to those of a comparable standalone ETF.

Similarly, with respect to cash drag, cross-subsidization may arise from the need of a multi-class fund to hold cash necessary to satisfy mutual fund share class redemptions, which could result in performance impacts to the ETF share class. The White Paper suggests that such impacts can be estimated by comparing the cash holding of a multi-class fund to that of a comparable standalone ETF and assessing the disparate performance impact resulting therefrom, which can be positive or negative depending on the market environment.

In addition to the assessment of these sources of cross-subsidization, the White Paper also focuses on the assessment of cost savings through potentially greater economies of scale under a dual share class structure. The White Paper suggests that cost savings can be estimated by comparing the expense ratio of an ETF share class to that of a similar standalone ETF.

Interclass Exchange Privilege Considerations

The White Paper observes that asset managers offering funds with a dual share class structure may consider offering an interclass exchange privilege from the mutual fund share class(es) into the ETF share class of the same fund. It notes that because of the current separate systems and service infrastructure for mutual funds and ETFs, the introduction of an interclass exchange privilege poses unique operational challenges for the industry. The White Paper observes that individual interclass exchange calculations (as opposed to a uniform conversion ratio used for all interclass exchanges on a given day) are likely needed to determine the number of ETF shares a mutual fund investor will receive in exchange for their mutual fund shares, which will take into account the respective net asset values (NAVs) of the mutual fund and ETF share classes, as well as potential fractional shares remaining after the exchange (as ETFs generally do not issue fractional shares). The White Paper also provides a sample manual workflow to effect an interclass exchange developed by the ICI and various industry stakeholders, which outlines step-by-step the roles and responsibilities of the intermediary, adviser, transfer agents, and fund accounting service provider. The White Paper also identifies other considerations in operating interclass exchange privileges, such as the treatment of fractional shares post-exchange, disclosure enhancements, and potential exchange “blackout” periods.

Technology and Systems Considerations

The White Paper identifies several areas of technology and system uplifts necessary to operate a dual share class structure, with a particular focus on automating interclass exchanges. While the sample manual workflow described in the White Paper would allow interclass exchanges to be implemented as soon as ETF Share Class Relief is granted, the industry generally acknowledges that such a manual process is unlikely to offer a sustainable “at scale” solution for operating interclass exchanges. The White Paper thus describes a process developed by DTCC, the ICI, asset managers, intermediaries, and fund service providers, to automate interclass exchanges. The automated process, which is expected to be available in 2026, would involve expanding and enhancing the existing NSCC Fund/SERV^®  functionality.³ The White Paper highlights certain considerations for asset managers, intermediaries, and service providers ahead of the implementation of the automated process:

• All parties who are not members of NSCC Fund/SERV^® would need to become members of Fund/SERV^® in order to take advantage of the automated solution.
• As the determination to offer interclass exchange privileges is optional, asset managers should consider developing processes and procedures for communication of availability, as well as technology for rejecting any exchange requests received through NSCC Fund/SERV^®  when not available.
• Intermediaries, mutual fund transfer agents, and ETF agents should consider upgrades to their own systems to effectively integrate the automated process.

Investor Experience Considerations

The White Paper observes that potential impacts on individual investors of introducing an ETF share class to a mutual fund will likely be addressed through updates to the fund's prospectus disclosures. The potential disclosure updates considered include:

• Language that describes the mechanics of the interclass exchange privilege, as well as addressing certain nuances such as eligibility, “black out” windows, and documentation requirements.
• Impacts to existing dividend reinvestment programs and mutual fund shareholder privileges, such as rights of accumulation, letters of intent, and automatic investment and withdrawal plans.
• Changes to certain shareholder communications, such as trade confirmations, account statements, and tax documentation.
• Differences in the level of support for interclass exchanges among intermediaries.

In addition, the White Paper also discusses certain unique considerations for asset managers with shareholders that hold mutual fund accounts directly with the fund's transfer agent. When these shareholders seek to purchase or exchange into the ETF share class, they will need to do so through an ETF-eligible brokerage account. This will require efforts from asset managers and intermediaries to ensure shareholders are informed of the necessary steps to open a brokerage account or utilize an existing brokerage account that is ETF-eligible.

Other areas for consideration by asset managers identified in the White Paper for ensuring a positive investor experience under a dual share class structure include: (i) a review of the current shareholder servicing model, including retraining and/or integrating different servicing teams for mutual funds and ETFs; and (ii) investor education, including developing new marketing and training materials for both investors and intermediaries that engage directly with investors.

Additional Considerations

The White Paper notes that the introduction of an ETF share class to an existing mutual fund also raises the question of whether state notice filing and registration fees (which currently only apply to mutual funds) would apply to the ETF share class. The ICI so far is not aware of any state regulators providing guidance and advises asset managers to consider these potential additional costs.

The White Paper also considers the impacts of mutual fund share class activities and interclass exchanges on daily basket and holdings dissemination for the ETF share class. In particular, the White Paper notes that information on mutual fund share class flows and interclass exchanges may not be available in sufficient time for ETF servicers to facilitate same-day basket and holdings reporting. A potential solution developed by the relevant ICI working group involves publishing further information on a fund's website (in addition to fund-level holdings), including:

• ETF share class pricing basket: the projection of the proportional allocation of fund holdings to the ETF share class as of the start of the next day. The pricing basket may be used as a transparency tool for market making.
• ETF share class trading basket: the portfolio of securities to be used for the creation and redemption processes.

Exchange Act Relief, Listing Rules and Authorized Participant Agreements

While the White Paper primarily focuses on the operational considerations of the dual share class structure, relevant industry stakeholders should keep in mind that changes to exchange listing rules and SEC no-action relief from certain provisions under the Securities Exchange Act of 1934 are also needed to operate ETF share classes. In 2019, in connection with the adoption of Rule 6c-11, the SEC granted relief from Section 11(d)(1) of and Rules 10b-10, 15c1-5, 15c1-6, and 14e-5 under the Exchange Act to broker-dealers and certain other persons engaging in transactions in ETF shares. Because multi-class funds would not meet the definition of an “exchange-traded fund” under Rule 6c-11, the current Exchange Act relief would not cover broker-dealers and certain other persons engaging in transactions in shares of an ETF share class within a multi-class fund. Accordingly, separate Exchange Act relief would be needed to operate ETF share classes.

Furthermore, fund sponsors, distributors, and ETF authorized participants should proactively consider whether changes need to be made to existing and future authorized participant agreements in order to accommodate the dual share class structure.

Conclusions

While the dual share class structure is a significant development in the asset management industry and presents an opportunity for expanding choices for investors, existing structural differences between mutual funds and ETFs can give rise to operational, governance, and disclosure challenges. Industry stakeholders, including asset managers, intermediaries, and service providers, should continue their engagement to assess and address these challenges in order to ensure operational efficiency and positive investor experience when bringing this type of product to market.

Footnotes

1.  ETF Share Class Operational Considerations, Investment Company Institute (October 6, 2025) (White Paper). Although most of the exemptive applications seek to permit both an ETF share class of a mutual fund and one or more mutual fund share classes of an ETF, the White Paper was prepared from the perspective of adding an ETF share class to an existing mutual fund.

2. See  SEC Issues Notice of Intent to Grant ETF Share Class Relief, Dechert OnPoint (September 29, 2025).

3. NSCC Fund/SERV® functionality currently serves as the industry standard for processing and settling mutual fund, bank collective fund, and other pooled investment product transactions between fund companies and distributors.

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