We are in a new world today for ETFs. After 4,213 days, the time it would take to send a rocket to Pluto, the Securities and Exchange Commission (“SEC”) has adopted Rule 6c-11 (the “ETF Rule”) bringing regulations in line with market demand. In March 2008, the SEC’s investment management division first published for comment a proposal to create an ETF rule, which would allow new entrants to enter the market more quickly. For a refresher on the original proposal, see our previous analysis.
While market response to the 2008 proposal was positive, the financial crisis kicked into high gear ultimately pushing any regulations for ETFs to the side.
Meanwhile ETF demand experienced strong growth in the United States as reflected by assets under management (AUM) increasing at a 20% CAGR during this period with total AUM surpassing $3.5 trillion. (Exhibit 1). However, ETF AUM remains small relative to the mutual fund space in the United States, which stands at $16.8 trillion1.
Source: ETFGI.com “August 2019 US landscape”
Now let’s jump into what is included and what was left out.
The key items in the final rule include:
A big positive for the ETF market is that the theme of transparency remains in the website requirements, which will benefit both end investors and manufacturers. The new requirements are set to improve operating models by removing bespoke processes and data dissemination requirements.
Not included in the final rule is the need to publish a basket to the website daily.
Custom baskets were expected to be included in any form of a rule. This inclusion in the final rule should help level the playing field for large and small. For those looking to utilize custom baskets for the first time, we recently provided insights on key considerations as firms begin to access this new tool.
When looking to implement custom baskets, the SEC has included specific requirements that users must adhere to.
First, the definition of a custom basket is now a list that contains a non-representative selection of the ETF’s portfolio holdings.
Second, to implement custom baskets, the SEC will now require additional information, including:
Regulatory considerations include:
In a welcomed move, liquidations, reorgs, mergers or conversions will not require an ETF to sell or redeem individual shares solely with Authorized Participants. Instead the SEC has agreed in the final rule that in these instances ETFs can conduct redemptions with investors directly.
Given the differences in website data structuring, and operating models for issuers today, we are prepared to work with issuers in upgrading their operating models to comply with these new rules, while providing best practices for first time entrants.
IOPVs, which were on the chopping block, will no longer be required as part of the ETF Rule. This change reflects the recognition of changes in market structure from when IOPVs were first introduced in 1993. While not required by the ETF Rule, a question remains of whether or not the exchanges will modify their listing rules to account for this change. As of today, listing rules still require an IOPV every fifteen seconds.
Certain Details in Website Disclosures
The expectation that the rule would have a one-year implementation timeline was confirmed. The ETF Rule will be effective 60 days from the effective date of September 26, 2019. As such, firms with ETFs that fall within the scope of the ETF Rule will have one year to come into compliance with the requirements of the ETF Rule.
“It is an exciting day for the ETF industry and asset management industry as a whole. As a key contributor to the global ETF industry, we are pleased to see the SEC streamline the regulatory landscape for ETFs in the U.S, allowing for more innovation and investor access to Exchange Traded Funds.”— Jeff McCarthy, Global Head of Exchange Traded Funds
Exemptive relief obtained for UIT ETFs, leveraged/inverse ETFs, share class ETFs, commodity ETPs, or non-transparent ETFs will not be affected. Those products will continue to rely on existing exemptive relief. Additionally, Fund of Fund arrangements for ETFs will not be rescinded. For those products which have received exemption from Section 12(d)(1) and Sections 17(a)(1) and (a)(2) of the 40 Act.
We certainly believe it will. Earlier this year the SEC provided updates that the average cost for exemptive relief required to launch an ETF was $100K and could run between 6 and 9 months2. Now the ability to utilize a standardized exemptive relief will provide all a faster route to market. Quicker market access is but one benefit of the ETF Rule.
Jeff McCarthy, Global Head of Exchange Traded Funds, commented on the final rule, saying: “It is an exciting day for the ETF industry and asset management industry as a whole. As a key contributor to the global ETF industry, we are pleased to see the SEC streamline the regulatory landscape for ETFs in the U.S, allowing for more innovation and investor access to Exchange Traded Funds.”
As the market begins to digest the new rule, we will continue to provide further guidance to our issuers on the best approaches to compliance by the implementation date. We stand ready to help you navigate this new and exciting world for ETFs.
Whether you are looking to enter the ETF space for the first time, expand your offering across strategies, or use new capabilities we have the depth and breadth of experience to help you navigate.
For further discussions and insights please reach out to the ETFProduct@BNYMellon.com or your current relationship manager.
1 ICI.org (August 2019). “Trends in Mutual Fund Investing July 2019”. Note: Total Net Assets represent total long-term strategies as defined by ICI.org.
2 ETF Global Markets Roundtable 2019, Panel: “Examining the Impact of Regulatory Developments on ETFs and the ETF Capital Markets”
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