28 BARRON’S September 30, 2019
Funds
The SEC’s New ETF Rule Evens the Field
BySarahMax
THE $4 TRILLION EXCHANGE-TRADED FUND INDUSTRY HAS FOR
thepast27yearsoperatedviaaquirkinthelaw.Aftersome
dramaticback-and-forththisweek,theSecuritiesandEx-
change Commission has finally changed that.
Themorethan2,200ETFsonthemarkettodayhavees-
sentiallybeencreatedviaaloopholeinthelawthatgoverns
mutualfundsandotherinvestmentproductsforindividual
investors.Themuch-hypedandlong-awaitedETFRulewas
supposedtochangethat,makingiteasierforcompaniesto
create new products. After canceling an open meeting
scheduled for Wednesday to vote on this proposed regula-
tion, the SEC announced on Thursday that it has in fact
adopted the ETF Rule, officially known as Rule 6c-11.
“It is arguably the most important piece of regulatory
actiontohittheETFindustrysince1993,”saysDaveNa-
dig,whoismanagingdirectorofETF.com.“It’sararewin
for both investors and the industry.”
Broadlyspeaking,ETFshavebeenbeholdentothesame
rulesasmutualfunds,viatheInvestmentCompanyActof
1940—butwithamajorasterisk.BecauseETFsarediffer-
ent than mutual funds in myriad ways, issuers have been
requiredtoapplyfor“exemptiverelief”withtheSEC.“It’s
basicallyafancywayofsaying‘gettingpermissiontobreak
the rules,’ ” says Nadig.
Since 1992, the SEC had issued more
than300exemptiveordersallowingETFs
to operate. That additional step drove up
thetimeandcostoflaunchingnewETFs—evenwhenthey
weresimilartofundslaunchedbyotherfirms.“EachETF
was essentially being treated as if it’s a snowflake, where
nothing is the same, and it slows down the process,” says
Todd Rosenbluth, director of fund research at CFRA.
This dynamic also created an environment where some
ETFprovidersweresubjecttomore-stringentregulations
thanothers,basedonthedealseachfirmstruck.“Allhave
slightlydifferentthingsthey’reallowedtodobecausethey
appliedforexemptivereliefatdifferenttimeswithdifferent
commissioners,” says Nadig. The early entrants generally
gotverybroadexemptivereleases,whileprovidersthathave
filed more recently have been held to stricter standards.
The ETF Rule scraps all of that and holds most ETFs
to the same regulatory framework. (There are exceptions
forleveragedandinversefunds.)Oneyearaftertherule’s
effectivedate,theSECwillrescindanyexemptivereliefit
had previously granted. At that point, most ETFs will be
following the same playbook.
This change offers an immediate benefit for existing
ETFsthatweresubjecttomorestringentrulesthantheir
peers.Italsoremovesbarrierstoentryfornewcomersthat
might have been deterred by the additional cost and com-
plexity of filing for exemptive relief.
“Oneofthebiggestpositivesthatwillcomeoutoftherule
will be the availability of custom creation and redemption
basketsforallissuers,”saysJordanFarris,headofETFsat
Nuveen,whichlauncheditsfirstETFsin2016andnowhas
a dozen ETFs, primarily focused on enhanced income and
environmental,social,andgovernance,orESG,factors.“It
will essentially level the playing field between those who
receivedtheirexemptivereliefwithinthepastseveralyears,
versus those who received it 10 or more years ago.”
Investors should ultimately benefit, says Rosenbluth.
While ETF fees are already low, the new ETF Rule could
helpnudgethemlowerstill—byreducingtheupfrontcosts
of launching a fund, opening doors for more competition,
andallowingfundstousecustombasketstominimizetrad-
ingcosts.Italsopotentiallyimprovesmoretransparencyby
requiring issuers to disclose on their websites historical
informationrelatedtobid-askspreads,andpremiumsand
discounts to net asset value.
The biggest sticking point with the previous regula-
tion—or lack thereof—related to whether an ETF can use
custom baskets. ETFs are able to minimize trading costs
andimprovetaxefficiencybycreatingandredeemingshares
throughauthorizedparticipants.Typically,theydothiswith
a basket of securities that mimics the rest of the portfolio,
butthatisn’talwaysfeasible,saysEdBaer,anattorneyin
Ropes&Gray’sassetmanagementgroupinSanFrancisco.
That’swherecustombasketsarekey.Inthecaseofanac-
tivelymanagedfund,forexample,amanagermaywanttosell
aspecificstockandbuyanewone.Afixed-incomemanager
mayfindthatthebondsitneedstobuyaren’tevenavailable.
“It’sverydifficulttooperateafixed-incomefundwithoutthe
ability to engage in custom transactions,” Baer says.
In 2012, the SEC stopped issuing exemptive relief that
permittedcustombaskets.FirmsthathadissuedETFsbe-
fore that have been able to apply their exemptive relief to
newfunds,butmorerecententrantsdidn’thavethatoption.
Now, ETFs can use custom baskets. “This change is a
huge boon for younger firms,” says Nadig, who says this
could open doors for more actively managed ETFs.
With thousands of ETFs already on the market, why
should investors be excited about regulation that opens
doorsforstillmore?“Wedohavetoomanyproducts,”says
Rosenbluth,“but[now]themarket’sgoingtodecidewhat’s
going to be successful, not regulators.”
“It’s arguably the most
important piece of
regulatory action to
hit the ETF industry
since 1993.”
CashTrack,
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