U.S. SEC Issues ETF Rule Proposal

The Securities and Exchange Commission on June 28, 2018 proposed Rule 6c-11 under the Investment Company Act of 1940, together with certain form amendments, which would allow most exchange-traded funds to operate without first obtaining exemptive relief and enhance disclosure requirements for ETFs (Proposal). For a comprehensive discussion of the Proposal, as well as background on the operation and regulation of ETFs, please refer to Dechert OnPoint, SEC Proposes Rule to Allow Most ETFs to Operate without Exemptive Relief. Dechert is presenting a webinar on the Proposal on July 25, 2018. 

The following highlights certain significant aspects of the Proposal: 

• Rescission of Existing Exemptive Relief. The SEC proposes to rescind existing exemptive relief for those ETFs that would be eligible to rely on proposed Rule 6c-11. This would eliminate the differing requirements that apply to ETFs based on the evolution of ETF orders over time and subject all eligible ETFs to the same requirements. In addition, the SEC proposes to rescind existing relief to permit the operation of ETFs within a master-feeder structure for those ETFs that did not rely on such relief as of June 28, 2018. ETFs that currently utilize such structure would be grandfathered in, but prohibited from establishing additional feeder funds. 
  
  
• Daily Holdings Disclosure. The Proposal does not distinguish between index-based ETFs (i.e., ETFs that seek to track a particular index) and actively managed ETFs, and would require all ETFs to disclose their portfolio holdings daily on their websites. Under current exemptive relief, an ETF that seeks to track a third-party index is generally not required to disclose its holdings on a daily basis. 
  
  
• Custom Baskets. Proposed Rule 6c-11 would permit ETFs to use custom baskets, which are baskets used for creation and redemption transactions that: (i) reflect a non-representative selection of the ETF’s portfolio holdings; or (ii) differ from baskets used for other transactions on the same day. Although certain older exemptive orders do not restrict the use of custom baskets, more recent exemptive orders generally require ETFs to use baskets that correspond pro rata to their portfolio holdings, with limited exceptions. ETFs using custom baskets would be required to adopt detailed procedures regarding construction and acceptance of custom baskets, and be subject to certain recordkeeping requirements. 
  
  
• Lack of Funds of Funds Relief. Although current exemptive orders also provide exemptions to permit certain funds to invest in ETFs beyond the limits of Section 12(d)(1) of the 1940 Act, the Proposal does not include this relief. Existing Section 12(d)(1) relief would not be rescinded under the Proposal, so ETFs with existing relief could continue to rely on such relief, while other ETFs would need to seek an individual order. 
  
  
• Bid-Ask Spread Disclosure Requirements. The Proposal includes significant changes to the Form N-1A disclosure requirements for ETFs, including addition of detailed summary section disclosure regarding bid-ask spreads and their impact on trading costs. These requirements would apply to all ETFs, not only those relying on proposed Rule 6c-11. 
  
  
• Differences from Current Exemptive Relief. Applicants for exemptive relief generally make various material representations, which impose requirements beyond the explicit conditions to the orders. Many of these requirements would be eliminated under the Proposal, including, among others: disclosure of intraday indicative value (an intraday estimate of an ETF’s net asset value per share) throughout the trading day; and certain disclosure and other requirements that apply where an ETF seeks to track an index for which an affiliate serves as index provider. In certain cases, these requirements would nonetheless continue to apply as a result of exchange listing standards or other factors. 

The SEC is seeking comments on the Proposal, which are due within 60 days after publication in the Federal Register. If adopted, the Proposal would modernize and streamline the regulatory framework governing ETFs, and could permit the SEC staff to focus more resources on exemptive relief for novel products such as non-transparent active ETFs. 

Footnotes 

_{1) See Exchange-Traded Funds, SEC Rel. No. IC-33140 (June 28, 2018).}

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