US SEC Seeks Public Comment on the Listing, Trading and Selling of Exchange-Traded Products

The Securities and Exchange Commission (SEC) issued a release (Release) on June 12, 2015 seeking public comment on topics related to the listing and trading of exchange-traded products (ETPs)¹ on national securities exchanges and sales of these products by broker-dealers.² Public comment was specifically requested on: “new, novel, or complex ETPs, including requests by ETPs for exemptive and no-action relief under the [Securities Exchange Act of 1934 (Exchange Act)] and filings by exchanges to adopt listing standards applicable to ETPs;” the ways broker-dealers market ETPs; and “investor understanding of the nature and uses of ETPs, especially by retail investors.” 

According to the Release, as of December 31, 2014, there were 1,664 U.S.-listed ETPs, with an aggregate market capitalization of just over $2 trillion.³ The SEC noted that much of this growth has occurred in recent years, with the total market capitalization of ETPs nearly doubling since December 2009. Growth in market size has also coincided with a greater range of ETP investment strategies since the initial ETP that tracked the S&P 500 (e.g., index ETPs based on fixed income securities or derivatives, actively-managed ETPs, leveraged, inverse and inverse leveraged ETPs, and ETPs employing market volatility, hedging or options-based strategies). Given the potential for continued growth and the emergence of novel and/or complex ETPs, the Release requests that commenters provide their views on issues specifically relating to: (i) arbitrage and market pricing of ETPs; (ii) Exchange Act exemptions and no-action positions with respect to ETPs; (iii) exchange listing standards for ETPs; and (iv) broker-dealer sales practices and investor understanding and use of ETPs. 

Arbitrage and Market Pricing 

The SEC noted its reliance upon representations from sponsors of ETPs “regarding the continuing existence of effective and efficient arbitrage” when considering whether to grant Exchange Act exemptive relief on behalf of a wide range of ETPs. While the SEC noted that, in its experience, deviation between the daily closing prices of ETPs and their net asset values (NAV) “has been relatively small,” the SEC requested comments on “all aspects of the arbitrage mechanism for ETPs, including the nature, extent, and potential causes of premiums and discounts across the wide range of ETP strategies and holdings.” The Release sets forth 18 specific multi-part requests for comments on the ETP arbitrage mechanism. For example, input was requested on the disclosures necessary for the arbitrage mechanism to operate effectively, and whether certain circumstances or strategies (e.g., market stress or less-liquid underlying assets) could hinder effective arbitrage. 

Exemptive and No-Action Relief under the Exchange Act 

Given the increased complexity of ETP investment strategies and the expansion of the types of underlying assets, the SEC requested comments on the application of Rules 101 and 102 under Regulation M of the Exchange Act.⁵ The SEC solicited three specific multi-part requests for comment “on approaches for preventing manipulation of ETP Securities distribution by persons who may have an incentive to do so in light of the nature, variety, and complexity of ETP investment strategies and ETP markets.” In addition, the SEC solicited four specific multi-part requests for comment on the existing conditions pertaining to ETPs’ exemptions from, and the criteria relied on by the SEC staff in no-action positions regarding, Section 11(d)(1) of the Exchange Act and Exchange Act Rules 10b-10, 11d1-2, 14e-5, 15c1-5, and 15c1‑6.⁶ 

Exchange Listing Standards and the Rule 19b-4 Process 

The SEC, through nine specific multi-part requests for comment, invited commenters to provide input on the interplay between national securities exchanges (as self-regulatory organizations) and the SEC in determining listing standards. The SEC specifically requested views on whether the two bodies complement each other and/or whether they overlap each other. Additionally, the SEC, in accordance with the broader theme of the Release, requested views on how increased complexity in ETPs should affect exchange listing standards and what the SEC should consider in evaluating a proposed rule change filing by an exchange to list and trade a specific ETP. For example, the SEC asked whether existing listing standards adequately address the use of derivatives and leverage by ETPs, and what kinds of information the SEC should request to adequately inform itself when dealing with complex strategies or underlying assets. 

Broker-Dealer Sales Practices and Investor Understanding and Use of ETPs 

Finally, the SEC set forth 15 specific multi-part requests for comment regarding how investors use and understand ETPs and how broker-dealers recommend ETPs to investors. For example, the SEC requested comment on the extent to which retail investors are investing in complex ETPs, and whether and how broker-dealers are making recommendations with respect to such ETPs. The SEC also acknowledged the role that investment advisers play in the portfolio management of retail investors, and invited input on how such advisers influence purchases and sales of complex ETPs. 

Other Issues 

The Release follows continued interest in a 2008 rule proposal from the SEC that would codify existing exemptive relief for certain types of ETPs – thereby making it significantly easier for ETP sponsors to launch such ETPs.⁷ Other than noting that the 2008 rule proposal has not been adopted by the SEC, the Release offers no additional guidance on the proposed rule’s status. All comments must be submitted within 60 days after the Release is published in the Federal Register. 

Footnotes 

_{1) While the term “ETP” can encompass a broad range of financial products, the SEC limited its request to: (i) exchange-traded funds; (ii) pooled investment vehicles not registered under the Investment Company Act of 1940; and (iii) exchange-traded notes.
2) Request for Comment on Exchange-Traded Products, Rel. No. 34-75165 (June 12, 2015).
3) Figures were calculated by the SEC staff from subscriptions to Morningstar Direct and Bloomberg Professional Services.
4) The Release also requests input under an “Other” category on items such as: (i) how liquidations of established ETPs affect investors; (ii) how the complexity of investment strategies used by ETPs could develop in the future and the possible effects such developments could have on listing and trading; (iii) the reasons for growth in the ETP market and the outlook for continued growth; and (iv) how commenters have used market structure research provided by the SEC on ETPs.
5) Regulation M is intended to protect the integrity of the securities offering process by proscribing certain potentially manipulative behavior by those with a financial interest to do so. Absent exemptive relief from Rules 101 and 102, ETP creation and redemption transactions would be prohibited under certain circumstances.
6) Similar to Regulation M, because of their inherent structures, ETPs could violate these provisions under the Exchange Act without regulatory relief from the SEC. As noted in the Release, ETPs have generally sought relief from certain of these provisions through class no-action letters. See Release p. 25 (noting class relief granted by the SEC from Rules 101 and 102 of Regulation M, Rules 10a-1, 10b-17 and 14e-5 under the Exchange Act and Rule 200(g) of Regulation SHO).
7) See Exchange-Traded Funds, IC-Rel. No. 28193 (Mar. 11, 2008).}