The United States Securities and Exchange Commission (SEC) has voted to adopt a new rule – dubbed the “ETF Rule” – that is designed to establish a clear and consistent framework for the vast majority of ETFs.
Jay Clayton, Chairman of the SEC.
Most notably, the ETF Rule enhances transparency and allows ETFs to come to market in the U.S. more quickly without the time or expense of applying for individual exemptive relief.
Its adoption is expected to facilitate greater competition and innovation in the ETF marketplace, leading to more choice for investors.
Jay Clayton, Chairman of the SEC, commented, “Since ETFs were first developed over 27 years ago, they have provided investors with a number of benefits, including access to a wide array of investment strategies, in many cases at a low cost.
“As the ETF industry continues to grow in size and importance, particularly to Main Street investors, it is important to have a consistent, transparent, and efficient regulatory framework that eliminates regulatory hurdles while maintaining appropriate investor protections.”
Prior to the adoption of the ETF Rule, prospective ETF issuers were required to apply for exemptive relief from the rules governing funds registered under the Investment Company Act of 1940.
The procedure was a significant financial burden to the issuing firm and could delay an ETF’s launch by several months.
The SEC has issued more than 300 exemptive orders since 1992. As of the end of August 2019, more than 2,000 ETFs have been launched in the US with combined assets surpassing $3.3 trillion.
The ETF Rule streamlines the launch process by dropping the exemptive relief requirement so long as the issuer complies with certain disclosures aimed at boosting transparency. These include publishing daily portfolio holdings as well as historical premiums and discounts (relative to NAV) and bid/ask spreads.
The rule also relaxes the regulations governing how issuers conduct the creation/redemption mechanism that underlies the functioning of the ETF vehicle. Whereas ETFs were previously required to use a proportional representation of portfolio holdings, they will henceforth be permitted to use their own discretionary custom baskets.
The use of custom baskets permits issuers the flexibility to manage their trading more efficiently, especially beneficial for funds undergoing sizable transactions. Issuers using custom baskets will be required to disclose how the process serves investors’ best interests.
The ETF Rule will be effective 60 days after publication in the Federal Register. To help create a consistent ETF regulatory framework, the SEC will rescind exemptive relief previously granted to certain ETFs. These ETFs will have a period of one year to bring themselves in line with the new regulation, starting from the date the ETF Rule becomes effective.
While the ETF Rule applies to most ETFs, there are certain exceptions. ETFs structured as unit investment trusts – most notably the $275bn SPDR S&P 500 ETF Trust (SPY US) – as well as inverse and leveraged ETFs, non-transparent ETFs, and ETFs structured as a share class of a multiclass fund (i.e. Vanguard’s funds) do not fall under its governance.