Exchange-Traded Funds, 37332-37411 [2018-14370]
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Federal Register / Vol. 83, No. 147 / Tuesday, July 31, 2018 / Proposed Rules
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Parts 239, 270, and 274
[Release Nos. 33–10515; IC–33140; File No.
S7–15–18]
RIN 3235–AJ60
Exchange-Traded Funds
Securities and Exchange
Commission.
ACTION: Proposed rule.
AGENCY:
The Securities and Exchange
Commission (the ‘‘Commission’’) is
proposing a new rule under the
Investment Company Act of 1940 (the
‘‘Investment Company Act’’ or the
‘‘Act’’) that would permit exchangetraded funds (‘‘ETFs’’) that satisfy
certain conditions to operate without
the expense and delay of obtaining an
exemptive order. In connection with the
proposed exemptive rule, the
Commission proposes to rescind certain
exemptive orders that have been granted
to ETFs and their sponsors. The
Commission also is proposing certain
disclosure amendments to Form N–1A
and Form N–8B–2 to provide investors
who purchase and sell ETF shares on
the secondary market with additional
information regarding ETF trading costs,
regardless of whether such ETFs are
structured as registered open-end
management investment companies
(‘‘open-end funds’’) or unit investment
trusts (‘‘UITs’’). Finally, the Commission
is proposing related amendments to
Form N–CEN. The proposed rule and
form amendments are designed to create
a consistent, transparent, and efficient
regulatory framework for ETFs and to
facilitate greater competition and
innovation among ETFs.
DATES: Comments should be received on
or before October 1, 2018.
ADDRESSES: Comments may be
submitted by any of the following
methods:
SUMMARY:
Electronic Comments
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• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/proposed.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number S7–
15–18 on the subject line.
Paper Comments
• Send paper comments to Brent J.
Fields, Secretary, Securities and
Exchange Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number S7–15–18. This file number
should be included on the subject line
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if email is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s internet website
(https://www.sec.gov/rules/
proposed.shtml). Comments are also
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Persons
submitting comments are cautioned that
we do not redact or edit personal
identifying information from comment
submissions. You should submit only
information that you wish to make
available publicly.
Studies, memoranda, or other
substantive items may be added by the
Commission or staff to the comment file
during this rulemaking. A notification of
the inclusion in the comment file of any
such materials will be made available
on the Commission’s website. To ensure
direct electronic receipt of such
notifications, sign up through the ‘‘Stay
Connected’’ option at www.sec.gov to
receive notifications by email.
FOR FURTHER INFORMATION CONTACT:
Zeena Abdul-Rahman (Senior Counsel),
Joel Cavanaugh (Senior Counsel), John
Foley (Senior Counsel), Jacob D. Krawitz
(Branch Chief), Melissa S. Gainor
(Senior Special Counsel), and Brian
McLaughlin Johnson (Assistant
Director), Investment Company
Regulation Office, at (202) 551–6792,
Sumeera Younis (Branch Chief) and
Christian Sandoe (Assistant Director),
Disclosure Review and Accounting
Office, at (202) 551–6921, Division of
Investment Management, Securities and
Exchange Commission, 100 F Street NE,
Washington, DC 20549.
The
Commission is proposing for public
comment 17 CFR 270.6c–11 (new rule
6c–11) under the Investment Company
Act [15 U.S.C. 80a–1 et seq.];
amendments to Form N–1A [referenced
in 17 CFR 274.11A] under the
Investment Company Act and the
Securities Act of 1933 [15 U.S.C. 77a et
seq.] (‘‘Securities Act’’); and
amendments to Forms N–8B–2
[referenced in 17 CFR 274.12] and N–
CEN [referenced in 17 CFR 274.101]
under the Investment Company Act.1
SUPPLEMENTARY INFORMATION:
1 Unless otherwise noted, all references to
statutory sections are to the Investment Company
Act, and all references to rules under the
Investment Company Act are to title 17, part 270
of the Code of Federal Regulations [17 CFR part
270].
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Table of Contents
I. Introduction
A. Overview of Exchange-Traded Funds
B. Operation of Exchange-Traded Funds
II. Discussion
A. Scope of Proposed Rule 6c–11
1. Organization as Open-End Funds
2. Index-Based ETFs and Actively Managed
ETFs
3. Leveraged ETFs
B. Exemptive Relief Under Proposed Rule
6c–11
1. Treatment of ETF Shares as
‘‘Redeemable Securities’’
2. Trading of ETF Shares at MarketDetermined Prices
3. Affiliated Transactions
4. Additional Time for Delivering
Redemption Proceeds
C. Conditions for Reliance on Proposed
Rule 6c–11
1. Issuance and Redemption of Shares
2. Listing on a National Securities
Exchange
3. Intraday Indicative Value
4. Portfolio Holdings
5. Baskets
6. Website Disclosure
7. Marketing
D. Recordkeeping
E. Share Class ETFs
F. Master-Feeder ETFs
G. Effect of Proposed Rule 6c–11 on Prior
Orders
H. Amendments to Form N–1A
1. Definitions
2. Item 3 of Form N–1A
3. Item 6 of Form N–1A
4. Item 11 of Form N–1A
5. Potential Alternatives to Current ETF
Registration Forms
I. Amendments to Form N–8B–2
J. Amendments to Form N–CEN
III. Economic Analysis
A. Introduction
B. Economic Baseline
1. ETF Industry Growth and Trends
2. Exemptive Order Process
3. Market Participants
4. Secondary Market Trading, Arbitrage,
and ETF Liquidity
C. Benefits and Costs of Proposed Rule
6c–11 and Amendments to Forms N–1A
and N–8B–2
1. Proposed Rule 6c–11
2. Disclosure (Amendments to Forms N–1A
and N–8B–2)
D. Effects on Efficiency, Competition, and
Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Reasonable Alternatives
1. Treatment of Existing Exemptive Relief
2. ETFs Organized as UITs
3. Basket Flexibility
4. Website Disclosure of Every Basket Used
by an ETF
5. The Use of a Structured Format for
Additional Website Disclosures and the
Filing of Additional Website Disclosures
in a Structured Format on EDGAR
6. Treatment of Leveraged ETFs
F. Request for Comments
IV. Paperwork Reduction Act
A. Introduction
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Federal Register / Vol. 83, No. 147 / Tuesday, July 31, 2018 / Proposed Rules
B. Proposed Rule 6c–11
1. Website Disclosures
2. Recordkeeping
3. Policies and Procedures
4. Estimated Total Burden
C. Rule 0–2
D. Form N–1A
E. Disclosure Amendments to Forms
N–8B–2 and S–6
F. Form N–CEN
G. Request for Comments
V. Initial Regulatory Flexibility Analysis
A. Reasons for and Objectives of the
Proposed Actions
B. Legal Basis
C. Small Entities Subject to the Rule
D. Projected Reporting, Recordkeeping, and
Other Compliance Requirements
1. Rule 6c–11
2. Disclosure and Reporting Requirements
E. Duplicative, Overlapping or Conflicting
Federal Rules
F. Significant Alternatives
G. General Request for Comment
VI. Consideration of Impact on the Economy
VII. Statutory Authority
I. Introduction
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The Commission is proposing rule
6c–11 under the Investment Company
Act to permit ETFs that satisfy certain
conditions to operate without the
expense and delay of obtaining an
exemptive order from the Commission
under the Act. This rule would
modernize the regulatory framework for
ETFs to reflect our 26 years of
experience with these investment
products. It is designed to create a
consistent, transparent, and efficient
regulatory framework for ETFs and to
facilitate greater competition and
innovation among ETFs.
The Commission approved the first
ETF in 1992. Since then, ETFs
registered with us have grown to $3.4
trillion in total net assets.2 They now
account for approximately 15% of total
net assets managed by investment
companies,3 and are projected to
continue to grow.4 ETFs currently rely
on exemptive orders, which permit
them to operate as investment
companies under the Act, subject to
representations and conditions that
2 This figure is based on data obtained from
Bloomberg. As of December 2017, there were 1,900
ETFs registered with the Commission. See id.
3 ICI, 2018 Investment Company Fact Book (58th
ed., 2018) (‘‘2018 ICI Fact Book’’), available at
https://www.ici.org/pdf/2018_factbook.pdf, at 96.
When the Commission first proposed a rule for
ETFs in 2008, aggregate ETF assets were less than
7% of total net assets held by mutual funds. See
Exchange-Traded Funds, Investment Company Act
Release No. 28193 (Mar. 11, 2008) [73 FR 14618
(Mar. 18, 2008)] (‘‘2008 ETF Proposing Release’’).
4 See Greg Tusar, The evolution of the ETF
industry, Pension & Investments (Jan. 31, 2017),
available at https://www.pionline.com/article/
20170131/ONLINE/170139973/the-evolution-of-theetf-industry (describing projections that ETF assets
could double to $6 trillion by 2020).
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have evolved over time.5 We have
granted over 300 of these orders over the
last quarter century, resulting in
differences in representations and
conditions that have led to some
variations in the regulatory structure for
existing ETFs.6
Proposed rule 6c–11 would simplify
this regulatory framework by
eliminating conditions included within
our exemptive orders that we no longer
believe are necessary for our exemptive
relief and removing historical
distinctions between actively managed
and index-based ETFs. In connection
with the proposed rule, we also propose
to rescind certain exemptive orders that
have been granted to ETFs and their
sponsors. As a result, proposed rule
6c–11 would level the playing field for
ETFs that are organized as open-end
funds and pursue the same or similar
investment strategies.7 The proposed
rule also would assist the Commission
with regulating ETFs, as funds covered
by the rule would no longer be subject
to the varying provisions of exemptive
orders granted over time, and instead
would be subject to a consistent
regulatory framework. Furthermore,
creating an efficient regulatory
framework for ETFs would allow
Commission staff and industry
resources to focus the exemptive order
process on products that do not fall
within the scope of our proposed rule.
In addition, we are proposing certain
disclosure amendments to provide
additional information to investors who
purchase and sell ETF shares in the
secondary markets, and to provide
investors who purchase UITs with the
5 As the orders are subject to the terms and
conditions set forth in the applications requesting
exemptive relief, references in this release to
‘‘exemptive relief’’ or ‘‘exemptive orders’’ include
the terms and conditions described in the related
application. See, e.g., infra footnote 6.
6 Since 2000, our ETF exemptive orders have
provided relief for future ETFs. See, e.g., Barclays
Global Fund Advisors, Investment Company Act
Release Nos. 24394 (Apr. 17, 2000) [65 FR 21215
(Apr. 20, 2000)] (notice) and 24451 (May 12, 2000)
(order) and related application (‘‘Barclays Global
2000’’). This relief has allowed ETF sponsors to
form ETFs without filing new applications to the
extent that the new ETFs meet the terms and
conditions set forth in the exemptive order.
Applications granted before 2000, unless
subsequently amended, did not include this relief.
7 As discussed below, the scope of proposed rule
6c–11 does not include ETFs that: (i) Are organized
as UITs; (ii) seek to exceed the performance of a
market index by a specified multiple or to provide
returns that have an inverse relationship to the
performance of a market index, over a fixed period
of time (‘‘leveraged ETFs’’); or (iii) are structured as
a share class of a fund that issues multiple classes
of shares representing interests in the same
portfolio (‘‘share class ETFs’’). These ETFs would
continue to operate pursuant to the terms of their
exemptive orders. See infra sections II.A.1 (UIT
ETFs), II.A.3 (leveraged ETFs), and II.E (share class
ETFs).
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same disclosures that we propose to
require of ETFs organized as open-end
funds. The proposed amendments
would include new disclosures
regarding certain unique costs
associated specifically with ETFs, such
as the bid-ask spread and premiums and
discounts from the ETF’s net asset value
(‘‘NAV’’).
Our proposal takes into account the
comments we received in response to
our 2008 ETF proposal, which was
designed to codify the exemptive relief
that had been issued to ETFs at that
time.8 Developments in the ETF
industry since the 2008 proposal and
interim Commission actions also have
informed the parameters of proposed
rule 6c–11 and the related disclosure
amendments that we are proposing.9
A. Overview of Exchange-Traded Funds
ETFs are a type of exchange-traded
product (‘‘ETP’’).10 ETFs possess
characteristics of both mutual funds,
which issue redeemable securities, and
closed-end funds, which generally issue
shares that trade at market-determined
prices on a national securities exchange
and are not redeemable.11 Because ETFs
8 See 2008 ETF Proposing Release, supra footnote
3. Comment letters on the 2008 ETF Proposing
Release are available at https://www.sec.gov/
comments/s7-07-08/s70708.shtml.
9 See, e.g., Request for Comment on ExchangeTraded Products, Exchange Act Release No. 75165
(June 12, 2015) [80 FR 34729 (June 17, 2015)]
(‘‘2015 ETP Request for Comment’’), at section I.A;
Report of the Staffs of the CFTC and SEC to the
Joint Advisory Committee on Emerging Regulatory
Issues, Findings Regarding the Market Events of
May 6, 2010 (Sept. 30, 2010) (‘‘Final May 6
Report’’), available at https://www.sec.gov/news/
studies/2010/marketevents-report.pdf. Comment
letters on the 2015 ETP Request for Comment are
available at https://www.sec.gov/comments/s7-1115/s71115.shtml.
10 ETFs are investment companies registered
under the Investment Company Act. See 15 U.S.C.
80a–3(a)(1). Other types of ETPs are pooled
investment vehicles with shares that trade on a
securities exchange, but they are not ‘‘investment
companies’’ under the Act because they do not
invest primarily in securities. Such ETPs may
invest primarily in assets other than securities, such
as futures, currencies, or physical commodities
(e.g., precious metals). Still other ETPs are not
pooled investment vehicles. For example,
exchange-traded notes are senior, unsecured,
unsubordinated debt securities that are linked to
the performance of a market index and trade on
securities exchanges.
11 The Act defines ‘‘redeemable security’’ as any
security that allows the holder to receive his or her
proportionate share of the issuer’s current net assets
upon presentation to the issuer. 15 U.S.C. 80a–
2(a)(32). While closed-end fund shares are not
redeemable, certain closed-end funds may elect to
repurchase their shares at periodic intervals
pursuant to 17 CFR 270.23c–3 (rule 23c–3) under
the Act (‘‘interval funds’’). Based on staff analysis,
there were 39 interval funds, representing
approximately $21 billion in assets, in 2017. Other
closed-end funds may repurchase their shares in
tender offers pursuant to 17 CFR 240.13e–4 (rule
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have characteristics that distinguish
them from the types of investment
companies contemplated by the Act,
they require exemptions from certain
provisions of the Investment Company
Act in order to operate. The
Commission (and Commission staff
under delegated authority) now
routinely grants exemptive orders
permitting ETFs to operate as
investment companies under the
Investment Company Act, generally
subject to the provisions of the Act
applicable to open-end funds (or
UITs).12 These exemptive orders reflect
our determination that, based on the
factual representations offered by the
applicants and the conditions to which
the applicants have agreed, the
requested relief is necessary or
appropriate in the public interest and
consistent with the protection of
investors and the purposes fairly
intended by the policy and provisions of
the Investment Company Act.13 The
Commission also has approved the
standards of national securities
exchanges, under which ETF shares are
listed and traded.14
As discussed above, ETFs have
become an increasingly popular
investment vehicle over the last 26
years. They also have become a popular
trading tool, making up a significant
portion of secondary market equities
trading. During the first quarter of 2018,
for example, trading in U.S.-listed ETFs
made up approximately 18.75% of U.S.
equity trading by share volume and
28.2% of U.S. equity trading by dollar
volume.15
Investors can buy and hold shares of
ETFs (sometimes as a core component of
13e–4) under the Securities Exchange Act of 1934
(the ‘‘Exchange Act’’).
12 Historically, ETFs have been organized as
open-end funds or UITs. See 15 U.S.C. 80a–5(a)(1)
(defining the term ‘‘open-end company’’) and 15
U.S.C. 80a–4(2) (defining the term ‘‘unit investment
trust’’). Some fund groups have multiple orders
covering different types of ETFs (e.g., one order
covering ETFs organized as UITs and another
covering ETFs organized as open-end funds or one
order covering index-based ETFs and another
covering actively managed ETFs).
13 See 15 U.S.C. 80a–6(c).
14 Additionally, ETFs regularly request relief from
17 CFR 242.101 and 242.102 (rules 101 and 102 of
Regulation M); section 11(d)(1) of the Exchange Act
and 17 CFR 240.11d1–2 (‘‘rule 11d1–2’’ under the
Exchange Act); certain other rules under the
Exchange Act (i.e., 17 CFR 240.10b–10, 240.10b–17,
240.14e–5, 240.15c1–5, and 240.15c1–6 (rules 10b–
10, 10b–17, 14e–5, 15c1–5, and 15c1–6)); and 17
CFR 242.200(g) (rule 200(g) of Regulation SHO). See
2015 ETP Request for Comment, supra footnote 9,
at section I.D.2 (discussing the exemptive and noaction relief granted to ETPs under the Exchange
Act and the listing process for ETP securities for
trading on a national securities exchange).
15 These estimates are based on trade and quote
data from the New York Stock Exchange and Trade
Reporting Facility data from FINRA.
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a portfolio) or trade them frequently as
part of an active trading or hedging
strategy.16 ETF investors can sell ETF
shares short, write options on them, and
set market, limit, and stop-loss orders
on them. Moreover, because certain
costs are either absent in the ETF
structure or are otherwise partially
externalized, many ETFs have lower
operating expenses than mutual
funds.17 ETFs also may offer certain tax
efficiencies compared to other pooled
investment vehicles because
redemptions from ETFs are often made
in kind (that is, by delivering certain
assets from the ETF’s portfolio, rather
than in cash), thereby avoiding the need
for the ETF to sell assets and potentially
realize capital gains that are distributed
to its shareholders.
ETFs today provide investors with a
diverse set of investment options. While
the first ETFs held portfolios of
securities that replicated the component
securities of broad-based domestic stock
market indexes, some ETFs now track
more specialized indexes, including
international equity indexes, fixedincome indexes, or indexes focused on
particular industry sectors such as
telecommunications or healthcare.18
Some ETFs seek to track highly
customized or bespoke indexes, while
others seek to provide a level of
leveraged or inverse exposure to an
index over a fixed period of time.19
Investors also have the ability to invest
in ETFs that do not track a particular
index and are actively managed.20
16 See, e.g., Chris Dieterich, Are You An ETF
‘Trader’ Or An ETF ‘Investor’?, Barrons (Aug. 8,
2017), available at https://www.barrons.com/
articles/are-you-an-etf-trader-or-an-etf-investor1470673638; Greenwich Associates, Institutions
Find New, Increasingly Strategic Uses for ETFs
(May 2012) (‘‘More than one-in-five asset managers
that use [ETFs] report employing ETFs for active
exposures in domestic equities and commodities,
and about 17% note using them for active
exposures in international equities.’’); Joe
Renninson, Institutional Investors Boost Ownership
of ETFs, Financial Times (Apr. 13, 2017), available
at https://www.ft.com/content/c70113ac-ab83-33aca624-d2d874533fb0?mhq5j=e7.
17 For instance, ETFs typically do not bear
distribution or shareholder servicing fees. In
addition, ETFs that transact on an in-kind basis can
execute changes in the ETF’s portfolio without
incurring brokerage costs, leading to transaction
cost savings.
18 The Commission historically has referred to
ETFs that have stated investment objectives of
maintaining returns that correspond to the returns
of a securities index as ‘‘index-based’’ ETFs. See,
e.g., Parker Global Strategies, LLC, et al., Investment
Company Act Release Nos. 32528 (Mar. 10, 2017)
[82 FR 14043 (Mar. 16, 2017)] (notice) and 32595
(Apr. 5, 2017) (order) and related application
(‘‘Parker Global Strategies’’).
19 Inverse ETFs are often marketed as a way for
investors to profit from, or at least hedge their
exposure to, downward moving markets. See infra
section II.A.3.
20 An actively managed ETF’s investment adviser,
like an adviser to any actively managed mutual
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B. Operation of Exchange-Traded Funds
An ETF issues shares that can be
bought or sold throughout the day in the
secondary market at a marketdetermined price. Like other investment
companies, an ETF pools the assets of
multiple investors and invests those
assets according to its investment
objective and principal investment
strategies. Each share of an ETF
represents an undivided interest in the
underlying assets of the ETF. Similar to
mutual funds, ETFs continuously offer
their shares for sale.
Unlike mutual funds, however, ETFs
do not sell or redeem individual shares.
Instead, ‘‘authorized participants’’ that
have contractual arrangements with the
ETF (or its distributor) purchase and
redeem ETF shares directly from the
ETF in blocks called ‘‘creation units.’’ 21
An authorized participant may act as a
principal for its own account when
purchasing or redeeming creation units
from the ETF. Authorized participants
also may act as agent for others, such as
market makers, proprietary trading
firms, hedge funds or other institutional
investors, and receive fees for
processing creation units on their
behalf.22 Market makers, proprietary
trading firms, and hedge funds provide
additional liquidity to the ETF market
through their trading activity.
Institutional investors may engage in
primary market transactions with an
ETF through an authorized participant
as a way to efficiently hedge a portion
of their portfolio or balance sheet or to
fund, generally selects securities consistent with the
ETF’s investment objectives and policies without
trying to track the performance of a corresponding
index. Actively managed ETFs represent
approximately 1.3% of total ETF assets as of
September 2017. Based on data obtained from the
Market Information Data Analytics System
(‘‘MIDAS’’), Bloomberg, and Morningstar Direct.
21 Our exemptive orders typically contain a
representation by the applicant that an authorized
participant will be either: (a) A broker or other
participant in the continuous net settlement system
of the National Securities Clearing Corporation, a
clearing agency registered with the Commission and
affiliated with the Depository Trust Company
(‘‘DTC’’), or (b) a DTC participant, which has
executed a participant agreement with the ETF’s
distributor and transfer agent with respect to the
creation and redemption of creation units. See, e.g.,
Emerging Global Advisors, LLC, et al., Investment
Company Act Release Nos. 30382 (Feb. 13, 2013)
[78 FR 11909 (Feb. 20, 2013)] (notice) and 30423
(Mar. 12, 2013) (order) and related application.
Proposed rule 6c–11(a) would define ‘‘authorized
participant’’ as a member or participant of a
clearing agency registered with the Commission,
which has a written agreement with the ETF or one
of its service providers that allows the authorized
participant to place orders for the purchase and
redemption of creation units.
22 See David J. Abner, The ETF Handbook: How
to Value and Trade Exchange Traded Funds, 2nd
ed. (2016) (‘‘ETF Handbook’’).
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gain exposure to a strategy or asset
class.23
An authorized participant that
purchases a creation unit of ETF shares
directly from the ETF deposits with the
ETF a ‘‘basket’’ of securities and other
assets identified by the ETF that day,
and then receives the creation unit of
ETF shares in return for those assets.24
The basket is generally representative of
the ETF’s portfolio 25 and, together with
a cash balancing amount, equal in value
to the aggregate NAV of the ETF shares
in the creation unit.26 After purchasing
a creation unit, the authorized
participant may hold the individual ETF
shares, or sell some or all of them in
secondary market transactions.27
Investors then purchase individual ETF
shares in the secondary market. The
redemption process is the reverse of the
purchase process: The authorized
participant redeems a creation unit of
ETF shares for a basket of securities and
other assets.
The combination of the creation and
redemption process with secondary
market trading in ETF shares provides
arbitrage opportunities that are designed
to help keep the market price of ETF
shares at or close to the NAV per share
of the ETF.28 For example, if ETF shares
are trading on national securities
exchanges at a ‘‘discount’’ (a price
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23 Id.
24 An ETF may impose fees in connection with
the purchase or redemption of creation units that
are intended to defray operational processing and
brokerage costs to prevent possible shareholder
dilution (‘‘transaction fees’’).
25 The basket might not reflect a pro rata slice of
an ETF’s portfolio holdings. Subject to the terms of
the applicable exemptive relief, an ETF may
substitute other securities or cash in the basket for
some (or all) of the ETF’s portfolio holdings.
Restrictions related to flexibility in baskets have
varied over time. See infra section II.C.5.
26 An open-end fund is required by law to redeem
its securities on demand from shareholders at a
price approximating their proportionate share of the
fund’s NAV at the time of redemption. See 15
U.S.C. 80a–22(d). Title 17 CFR 270.22c–1 (‘‘rule
22c–1’’) generally requires that funds calculate their
NAV per share at least once daily Monday through
Friday. See rule 22c–1(b)(1). Today, most funds
calculate NAV per share as of the time the major
U.S. stock exchanges close (typically at 4:00 p.m.
Eastern Time). Under rule 22c–1, an investor who
submits an order before the 4:00 p.m. pricing time
receives that day’s price, and an investor who
submits an order after the pricing time receives the
next day’s price. See also 17 CFR 270.2a–4 (‘‘rule
2a–4’’) (defining ‘‘current net asset value’’).
27 ETFs register offerings of shares under the
Securities Act, and list their shares for trading
under the Exchange Act. Depending on the facts
and circumstances, authorized participants that
purchase a creation unit and sell the shares may be
deemed to be participants in a distribution, which
could render them statutory underwriters and
subject them to the prospectus delivery and liability
provisions of the Securities Act. See 15 U.S.C.
77b(a)(11) (defining the term ‘‘underwriter’’).
28 To date, the arbitrage mechanism has been
dependent on daily portfolio transparency.
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below the NAV per share of the ETF),
an authorized participant can purchase
ETF shares in secondary market
transactions and, after accumulating
enough shares to compose a creation
unit, redeem them from the ETF in
exchange for the more valuable
securities in the ETF’s redemption
basket. The authorized participant’s
purchase of an ETF’s shares on the
secondary market, combined with the
sale of the ETF’s basket assets, may
create upward pressure on the price of
the ETF shares, downward pressure on
the price of the basket assets, or both,
bringing the market price of ETF shares
and the value of the ETF’s portfolio
holdings closer together.29
Alternatively, if ETF shares are trading
at a ‘‘premium’’ (a price above the NAV
per share of the ETF), the transactions
in the arbitrage process are reversed
and, when arbitrage is working
effectively, keep the market price of the
ETF’s shares close to its NAV.
Market participants also can engage in
arbitrage activity without using the
creation or redemption processes. For
example, if a market participant believes
that an ETF is overvalued relative to its
underlying or reference assets (i.e.,
trading at a premium), the market
participant may sell ETF shares short
and buy the underlying or reference
assets, wait for the trading prices to
move toward parity, and then close out
the positions in both the ETF shares and
the underlying or reference assets to
realize a profit from the relative
movement of their trading prices.
Similarly, a market participant could
buy ETF shares and sell the underlying
or reference assets short in an attempt
to profit when an ETF’s shares are
trading at a discount to the ETF’s
underlying or reference assets. As with
the creation and redemption process,
the trading of an ETF’s shares and the
ETF’s underlying or reference assets
may bring the prices of the ETF’s shares
and its portfolio assets closer together
through market pressure.30
29 As part of this arbitrage process, authorized
participants are likely to hedge their intraday risk.
For example, when ETF shares are trading at a
discount to an estimated intraday NAV per share of
the ETF, an authorized participant may short the
securities composing the ETF’s redemption basket.
After the authorized participant returns a creation
unit of ETF shares to the ETF in exchange for the
ETF’s baskets, the authorized participant can then
use the basket assets to cover its short positions.
30 Some studies have found the majority of all
ETF-related trading activity takes place on the
secondary market. See, e.g., Rochelle Antoniewicz
& Jane Heinrichs, Understanding Exchange-Traded
Funds: How ETFs Work, ICI Research Perspective
20, No. 5 (Sept. 2014) (‘‘Antoniewicz’’), available at
https://www.ici.org/pdf/per20-05.pdf, at 2 (‘‘On
most trading days, the vast majority of ETFs do not
have any primary market activity—that is, they do
not create or redeem shares.’’).
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The arbitrage mechanism is important
because it provides a means to maintain
a close tie between market price and
NAV per share of the ETF, thereby
helping to ensure ETF investors are
treated equitably when buying and
selling fund shares. In granting relief
under section 6(c) of the Act for ETFs
to operate, the Commission has relied
on this close tie between what retail
investors pay (or receive) in the
secondary market and the ETF’s
approximate NAV to find that the
required exemptions are necessary or
appropriate in the public interest and
consistent with the protection of
investors and the purposes fairly
intended by the policy and provisions of
the Act. Investors also have come to
expect that an ETF’s market price will
maintain a close tie to the ETF’s NAV
per share, which may lead some
investors to view ETFs more favorably
than similar closed-end funds.31 On the
other hand, this expectation may lead
investors to view ETFs as a less
attractive investment option or cause
them to sell ETF shares if market price
and NAV per share diverge, particularly
during periods of market stress.32
II. Discussion
Given the growth in the ETF market,
ETFs’ popularity among retail and
institutional investors, and our long
experience regulating this investment
and trading vehicle, we believe that it is
appropriate to propose a rule that would
allow most ETFs to operate without first
obtaining an exemptive order from the
Commission under the Act. We believe
that such a rule would create a
consistent, transparent and efficient
regulatory framework for the regulation
of most ETFs and level the playing field
for these market participants. Proposed
31 Scott W. Barnhart & Stuart Rosenstein,
Exchange-Traded Fund Introductions and ClosedEnd Fund Discounts and Volume, 45 The Financial
Review 4 (Nov. 2010) (within a year of the
introduction of a similar ETF, the average discount
widens significantly and volume falls significantly
in U.S. domestic equity, international equity, and
U.S. bond closed-end funds, which may indicate
that closed-end funds lose some desirability when
a substitute ETF becomes available). As of
December 31, 2017, total net assets of ETFs were
$3.4 trillion compared to $275 billion for closedend funds. See 2018 ICI Fact Book, supra footnote
3.
32 See Staff of the Office of Analytics and
Research, Division of Trading and Markets,
Research Note: Equity Market Volatility on August
24, 2015 (Dec. 2015) (‘‘August 24 Staff Report’’),
available at https://www.sec.gov/marketstructure/
research/equity_market_volatility.pdf (discussing
spikes in ETF trading volume on August 24, 2015
when U.S. equity markets experienced unusual
price volatility). See also infra section II.B.2
(discussing intraday deviations between market
price and NAV as well as contemporaneous
deviations between market price and the intraday
value of the ETF’s portfolio).
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rule 6c–11 includes several conditions
designed to address the concerns
underlying the relevant statutory
provisions and to support a Commission
finding that the exemptions necessary to
allow ETFs to operate are in the public
interest and consistent with the
protection of investors and the purposes
fairly intended by the policy and
provisions of the Act. The proposed
conditions are based upon the existing
exemptive relief for ETFs, which we
believe have served to support an
efficient arbitrage mechanism, but
reflect several modifications based on
our experience regulating this product.
A. Scope of Proposed Rule 6c–11
Proposed rule 6c–11 would define an
ETF as a registered open-end
management investment company that:
(i) Issues (and redeems) creation units to
(and from) authorized participants in
exchange for a basket and a cash
balancing amount (if any); and (ii)
issues shares that are listed on a
national securities exchange and traded
at market-determined prices.33
1. Organization as Open-End Funds
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Proposed rule 6c–11 would be
available only to ETFs that are
organized as open-end funds. The vast
majority of ETFs currently in operation
are organized as open-end funds,
although the earliest ETFs were
organized as UITs (‘‘UIT ETFs’’).34
These early UIT ETFs represent a
significant amount of assets within the
ETF industry.35 For example, two of the
largest ETFs by total net assets and
estimated dollar trading volume (SPDR
S&P 500 ETF Trust (SPY) and
PowerShares QQQ Trust, Series 1
(QQQ)) are organized as UITs.
A UIT is an investment company
organized under a trust indenture or
similar instrument that issues
redeemable securities, each of which
represents an undivided interest in a
33 See proposed rule 6c–11(a) (defining
‘‘exchange-traded fund’’). Under the proposed rule,
the term ‘‘basket’’ would be defined to mean the
securities, assets, or other positions in exchange for
which an ETF issues (or in return for which it
redeems) creation units. The term ‘‘exchange-traded
fund’’ thus would include ETFs that transact on an
in-kind basis, on a cash basis, or both.
34 See, e.g., SPDR Trust, Series 1, Investment
Company Act Release Nos. 18959 (Sept. 17, 1992)
[57 FR 43996 (Sept. 23, 1992)] (notice) and 19055
(Oct. 26, 1992) (order) and related application
(‘‘SPDR’’).
35 As of Dec. 31, 2017, for example, the eight
existing UIT ETFs had total assets of approximately
$379 billion, representing approximately 11.3% of
total assets invested in ETFs (based on data
obtained from MIDAS, Bloomberg, and Morningstar
Direct).
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unit of specified securities.36 By statute,
a UIT is unmanaged and its portfolio is
fixed. Substitution of securities may
take place only under certain predefined circumstances.37 A UIT does
not have a board of directors, corporate
officers, or an investment adviser to
render advice during the life of the trust.
By contrast, ETFs organized as open-end
funds are managed by investment
advisers and, in addition to replicating
an index, can be actively managed or
use a ‘‘sampling’’ strategy to track an
index.38 Unlike an ETF structured as a
UIT, an open-end fund ETF may
participate in securities lending
programs and has greater flexibility to
reinvest dividends from portfolio
securities.39 ETFs structured as openend funds also may invest in
derivatives, which typically require a
degree of management that is not
provided for in the UIT structure.40 As
a result, we understand that most ETF
sponsors now prefer the open-end fund
structure over the UIT structure given
the increased investment flexibility the
open-end structure affords. Indeed, we
have received very few exemptive
applications for new UIT ETFs since
36 See section 4(2) of the Act [15 U.S.C. 80a–4].
A UIT has a fixed life—a termination date for the
trust is established when the trust is created.
37 The exemptive relief granted to UIT ETFs does
not provide relief from the portion of section 4(2)
that requires that UIT securities represent an
undivided interest in a unit of specified securities.
Because a UIT must invest in ‘‘specified securities,’’
the investment strategies that a UIT ETF can pursue
are limited. All UIT ETFs today seek to track the
performance of an index by investing in the
component securities of the index in the same
approximate proportions as in the index (i.e.,
‘‘replicating’’ the index). The trustee of an UIT ETF
may make adjustments to the ETF’s portfolio only
to reflect changes in the composition of the
underlying index. See Actively Managed ExchangeTraded Funds, Investment Company Act Release
No. 25258 (Nov. 8. 2001) [66 FR 57614 (Nov. 15,
2001)] (‘‘2001 Concept Release’’), at n.11.
38 An ETF that uses a sampling strategy includes
assets in its portfolio that are designed, in the
aggregate, to reflect the underlying index’s
capitalization, industry, and fundamental
investment characteristics, and to perform like the
index. The ETF implements the strategy by
acquiring a subset of the underlying index’s
component securities and may invest a portion of
the ETF’s portfolio in securities and other financial
instruments (including derivatives) that are not
included in the corresponding index if the adviser
believes the investment will help the ETF track the
underlying index. See 2008 ETF Proposing Release,
supra footnote 3.
39 UIT dividends are held in a non-interest
bearing account and paid out quarterly. The
inability to reinvest dividends can have a cash drag
on the tracking performance of a UIT ETF. See A.
Seddik Meziani, Exchange-Traded Funds:
Investment Practices and Tactical Approaches
(2016), at 22.
40 See Use of Derivatives by Registered
Investment Companies and Business Development
Companies, Investment Company Act Release No.
31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)]
(‘‘Derivatives Proposing Release’’), at n.139.
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2002 and no new UIT ETFs have come
to market in that time.41
The rule we proposed in 2008 would
not have included UIT ETFs within its
scope.42 Comments on the 2008 ETF
Proposing Release were mixed with
regard to providing relief to UITs, with
two commenters supporting the
exclusion of UITs.43 On the other hand,
two commenters argued that the
Commission should expand the rule to
include UITs, contending that sponsors
in the future may choose the UIT
structure for some reason unforeseen
today.44 Some commenters also stated
that existing UIT ETFs should be able to
rely on the rule, which may provide
broader relief than provided by their
exemptive orders.45
While we acknowledge that excluding
UIT ETFs would result in a segment of
ETF assets that are outside the
regulatory framework of proposed rule
6c–11, we do not believe there is a need
to include ETF UITs within the scope of
the proposed rule given the limited
sponsor interest in developing ETFs
organized as UITs. In addition, even if
we were to include UIT ETFs within the
scope of the rule, we believe that the
unmanaged nature of the UIT structure
would require conditions that differ
from the conditions applicable to ETFs
41 The Commission has received applications for
ETFs structured as a UIT, but with features that are
different from typical UIT-structured ETFs. See
Application of Elkhorn Securities, LLC and Elkhorn
Unit Trust (Mar. 6, 2017) (‘‘Elkhorn Application’’);
Application of Precidian ADRs LLC (Aug. 1, 2014)
(‘‘Precidian ADR Application’’). The Commission
has not taken any action on the Elkhorn
Application, and the Precidian ADR Application
was withdrawn by the applicant. Two orders
modifying relief for existing ETFs organized as UITs
were issued in 2007. See NASDAQ–100 Trust,
Series 1, et al., Investment Company Act Release
Nos. 27740 (Feb. 27, 2007) [72 FR 9594 (Mar. 2,
2007)] (notice) and 27753 (Mar. 20, 2007) (order)
and related application; BLDRS Index Funds Trust,
et al., Investment Company Act Release Nos. 27745
(Feb. 28, 2007) [72 FR 9787 (Mar. 5, 2007)] (notice)
and 27768 (Mar. 21, 2007) (order) and related
application.
42 See 2008 ETF Proposing Release, supra
footnote 3, at text accompanying nn.63–67 (noting
that the Commission had not received an exemptive
application for a new ETF to be organized as a UIT
since 2002 and, as a result, there did not appear to
be a need to include UIT relief in the proposed
rule).
43 See Comment Letter of Xshares Advisors LLC
(May 20, 2008) (‘‘Xshares 2008 Comment Letter’’);
Comment Letter of the Investment Company
Institute (May 19, 2008) (‘‘ICI 2008 Comment
Letter’’).
44 See Comment Letter of Katten Muchin
Rosenman LLP (May 30, 2008) (‘‘Katten 2008
Comment Letter’’); Comment Letter of the Federal
Regulation of Securities Committee, Section of
Business Law, American Bar Association (May 29,
2008) (‘‘ABA 2008 Comment Letter’’).
45 See Comment Letter of State Street Global
Advisors (May 19, 2008) (‘‘SSgA 2008 Comment
Letter’’); Comment Letter of NYSE Arca (May 29,
2008) (‘‘NYSE Arca 2008 Comment Letter’’); Katten
2008 Comment Letter.
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organized as open-end funds, requiring
a regulatory framework that would be
different than our proposed structure for
open-end ETFs. The exemptive relief
that has been granted to UIT ETFs, for
example, provides that the trustee will
make adjustments to the ETF’s portfolio
only pursuant to the specifications set
forth in the trust formation documents
in order to track changes in the ETF’s
underlying indexes.46 The trustee does
not have discretion when making these
portfolio adjustments.47 In most cases,
therefore, a UIT ETF uses baskets that
correspond pro rata to the ETF’s
portfolio holdings.48 The rule we are
proposing would allow ETFs the
flexibility to use baskets that differ from
a pro rata representation of the ETF’s
portfolio if certain conditions are met.49
Because the conditions we are
proposing related to basket flexibility
require ongoing management and board
oversight, we do not believe that
extending such basket flexibility to UIT
ETFs would be appropriate given the
unmanaged nature of a UIT.
Instead, we believe that UIT ETFs
should continue to operate pursuant to
their exemptive orders, which include
terms and conditions that are
appropriately tailored to address the
unique features of a UIT.50 The
exemptive relief granted to UIT ETFs
includes relief from sections of the Act
that govern key aspects of a UIT’s
operations.51 For example, because UITs
are prohibited from paying fees beyond
those necessary to cover the costs of
administrative and bookkeeping
services, UIT ETFs require exemptive
relief from section 26(a)(2)(C) of the Act
to allow the ETF to pay certain
enumerated expenses.52 However,
because UITs are unmanaged and are
not overseen by boards, the exemptive
order for each UIT ETF contains its own
46 See,
e.g., SPDR, supra footnote 34.
id.
48 See id. (permitting baskets accepted by UIT
ETF for purchases of creation units to include the
cash equivalent of a component security of the
underlying index only where: (i) The trustee
determines that the index security is likely to be
unavailable or available in insufficient quantity; or
(ii) a particular investor is restricted from investing
or transacting in such index security).
49 See infra section II.C.5.
50 Unlike the exemptive relief we have granted to
certain ETFs organized as open-end funds (see
supra footnote 6), the relief we have granted to
ETFs organized as UITs does not provide relief for
future ETFs formed pursuant to the same order.
51 See, e.g., SPDR, supra footnote 34.
52 Section 26(a)(2)(C) of the Act requires that the
trust indenture for a UIT prohibit payments to the
depositor or to any affiliated person thereof, except
payments for performing bookkeeping and other
administrative services of a character normally
performed by the trustee or custodian itself. 15
U.S.C. 80a–26(a)(2)(C).
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47 See
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list of permissible capped expenses that
vary among the different UIT ETFs.53
To the extent that ETF sponsors
develop unforeseen, novel UIT ETFs, we
believe that the Commission should
review such products as part of its
exemptive process to determine whether
the relief is necessary or appropriate in
the public interest and consistent with
the protection of investors. We therefore
are not proposing to include ETFs
structured as UITs within the scope of
proposed rule 6c–11.54
We request comment on whether
proposed rule 6c–11 should be available
only to ETFs structured as open-end
funds.
• Should the rule provide exemptive
relief for both ETFs organized as openend funds and ETFs organized as UITs?
Are we correct that ETF sponsors will
likely prefer the open-end structure to
the UIT structure when forming ETFs in
the future? If not, why?
• If UIT ETFs were included in the
scope of the proposed rule, should they
be subject to the same proposed
conditions or should we tailor particular
conditions in light of the unmanaged
nature of a UIT? For example, how
should the proposed rule address basket
composition for UIT ETFs? Should UIT
ETFs only be permitted to replicate their
index, or should we allow them to
engage in representative sampling on a
pro rata basis? Should a UIT ETF only
be permitted to substitute cash (instead
of other securities) for particular basket
assets? Should we allow a UIT ETF to
substitute basket assets only in certain
enumerated circumstances (e.g., only
when the basket asset is not eligible for
trading by an authorized participant or
is not available in sufficient quantity for
delivery to or from the authorized
participant)?
• If UIT ETFs were included within
the scope of the rule, should we
expressly limit the types of indexes that
such ETFs may track given the
unmanaged nature of the UIT structure
and the potential for specialized or
bespoke indexes to be inconsistent with
a fixed portfolio? For example, should
53 See, e.g., NASDAQ–100 Trust, Series 1,
Investment Company Act Release Nos. 23668 (Jan.
27, 1999) [64 FR 5082 (Feb. 2, 1999)] (notice) and
23702 (Feb. 22, 1999) (order) and related
application (exemption from section 26(a)(2)(C) to
permit UIT to reimburse the sponsor up to a
maximum of 20 basis points) (‘‘NASDAQ 100’’);
Midcap SPDR Trust, Series 1, Investment Company
Act Release Nos. 20797 (Dec. 23, 1994) [60 FR 163
(Jan. 3, 1995)] (notice) and 20844 (Jan. 18, 1995)
(order) and related application (30 basis points).
54 While we do not propose to include ETFs
organized as UITs within the scope of proposed rule
6c–11, we are proposing amendments to Form N–
8B–2 to require them to provide certain additional
disclosures regarding trading costs. See infra
section II.I.
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37337
we provide that ETFs structured as UITs
may only track broad-based securities
indexes? Should we limit the
derivatives holdings of UIT ETFs or
restrict them from tracking indexes that
include certain types of derivatives? If
so, what types of derivatives should be
permitted?
• If we were to include UIT ETFs
within the scope of rule 6c–11, should
we provide an exemption from section
26(a)(2)(C), consistent with our
exemptive orders, to permit the
payment of certain expenses associated
with the creation and maintenance of
the ETF? If so, should we limit the
amount of expenses that may be
reimbursed? What should the limit be,
and why? Should we limit the
reimbursement to no more than 20 basis
points of the ETF’s NAV per share on
an annualized basis, consistent with
some of the exemptive orders granted to
UIT ETFs? Should this limit be higher
(e.g., 30 basis points) or lower (e.g., 10
basis points)? Should the rule
enumerate the expenses that may be
reimbursed? For example, should the
rule permit the reimbursement of any or
all of the following: (i) Annual index
licensing fees; (ii) annual federal and
state fees for the registration of newly
issued creation units; and (iii) expenses
of the sponsor relating to the
development, printing, and distribution
of marketing materials? Are there other
expenses that should be permissible
reimbursements under such an
exemption?
• Our exemptive orders for UIT ETFs
also include relief from section 14(a) of
the Act, which provides that no
registered investment company may
make an initial public offering of its
securities unless it has a net worth of at
least $100,000 or is assured, via private
subscriptions, of issuing at least
$100,000 in securities in the offering.55
If UIT ETFs were included within the
scope of the rule, would they need relief
from section 14(a) of the Act consistent
with our prior exemptive relief? If so,
what conditions should we consider as
part of the rule? Alternatively, should
we consider amending rule 14a–3 under
the Act, which provides an exemption
from section 14(a) for UITs that invest
in ‘‘eligible trust securities?’’ 56 If so,
how should we define ‘‘eligible trust
securities’’? For example, should equity
securities be added to the definition of
‘‘eligible trust securities’’? Should we
55 See
NASDAQ 100, supra footnote 53.
trust securities under rule 14a–3
include corporate debt securities (including
nonconvertible preferred stock), government and
municipal securities, and units of a previously
issued series of a UIT. The term does not include
equity securities. See rule 14a–3(b).
56 Eligible
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include other types of securities within
that definition? For example, should we
include FLEX options within the
definition? 57
• Are there any other exemptions we
should consider for UIT ETFs?
• If we were to include UIT ETFs in
rule 6c–11, are there any specific
disclosures that should be required,
other than the ones proposed herein?
• If we do not include UIT ETFs
within the scope of the rule, should we
nonetheless require them to comply
with any of the rule’s requirements for
ETFs organized as open-end funds?
2. Index-Based ETFs and Actively
Managed ETFs
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Proposed rule 6c–11 would provide
exemptions for both index-based ETFs
and actively managed ETFs, but would
not by its terms establish different
requirements based on whether an
ETF’s investment objective is to seek
returns that correspond to the returns of
an index. We believe that index-based
and actively managed ETFs that comply
with the proposed rule’s conditions
function similarly with respect to
operational matters, despite different
investment objectives or strategies, and
do not present significantly different
concerns under the provisions of the
Act from which the proposed rule grants
relief. For example, both index-based
and actively managed ETFs register
under the Act, issue and redeem shares
in creation unit sizes in exchange for
baskets of assets, list on national
securities exchanges, and allow
investors to trade ETF shares throughout
the day at market-determined prices in
the secondary market.
The distinction between index-based
ETFs and actively managed ETFs in our
current exemptive orders is largely a
product of ETFs’ historical evolution.
The Commission did not approve the
first actively managed ETF until nearly
15 years after index-based ETFs were
introduced.58 As discussed in a 2001
57 FLexible EXchange options (‘‘FLEX options’’)
are a type of customized equity or index option
contracts. Some traditional UITs have exemptive
relief from section 14(a) to invest in FLEX options
with expiration dates that coincide with UIT’s
maturity date. See e.g., Olden Lane Securities LLC,
et al., Investment Company Act Release Nos. 32589
(April 3, 2017) [82 FR 17048 (April 7, 2017)]
(notice) and 32619 (May 1, 2017) (order) and related
application.
58 See, e.g., WisdomTree Trust, et al., Investment
Company Act Release Nos. 28147 (Feb. 6, 2008) [73
FR 7776 (Feb. 11, 2008)] (notice) and 28174 (Feb.
27, 2008) (order) and related application (‘‘2008
WisdomTree Trust’’); Barclays Global Fund
Advisors, et al., Investment Company Act Release
Nos. 28146 (Feb. 6, 2008) [73 FR 7771 (Feb. 11,
2008)] (notice) and 28173 (Feb. 27, 2008) (order)
and related application (‘‘Barclays Global 2008’’).
Approximately 100 exemptive orders have been
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21:42 Jul 30, 2018
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concept release on actively managed
ETFs, the Commission was initially
concerned that actively managed ETFs
would not be able (or willing) to provide
portfolio transparency, potentially
hindering the arbitrage mechanism
deemed critical to the operation of an
ETF.59 Actively managed ETFs were
novel at the time of the 2008 ETF
Proposing Release, and the Commission
solicited comment on whether a
proposed ETF rule should specifically
include actively managed ETFs.60 Six
commenters supported this approach,61
while a few commenters questioned
whether it was premature to allow
actively managed ETFs to operate using
the rule.62
The actively managed ETF market has
grown considerably since 2008. There
are now over 200 actively managed
ETFs with approximately $45.8 billion
in assets.63 The Commission has
observed how actively managed ETFs
operate during this time, and has not
identified any operational issues that
suggest additional conditions for
actively managed ETFs are warranted.
As noted below, we believe that the
arbitrage mechanism for existing
actively managed ETFs has worked
effectively with small deviations
between market price and NAV per
share.64
We believe that permitting indexbased and actively managed open-end
ETFs to operate under the proposed rule
subject to the same conditions would
provide a level playing field among
those market participants. Furthermore,
we believe that it would be
unreasonable to create a meaningful
distinction within the rule between
index-based and actively managed ETFs
given the evolution of indexes over the
last decade. The proliferation of highly
customized, often methodologically
complicated, indexes has blurred the
issued since 2008 for actively managed, transparent
ETFs.
59 See 2001 Concept Release, supra footnote 37,
at n.31 and accompanying and following text.
Comment letters to the 2001 Concept Release are
available at https://www.sec.gov/rules/concept/
s72001.shtml.
60 See 2008 ETF Proposing Release, supra
footnote 3, at section III.A.2.
61 See e.g., Comment Letter of the Vanguard
Group, Inc. (June 19, 2008) (‘‘Vanguard 2008
Comment Letter’’); Xshares 2008 Comment Letter;
Comment Letter of Barclays Global Fund Advisors
(May 16, 2008) (‘‘BGFA 2008 Comment Letter’’); ICI
2008 Comment Letter; SSgA 2008 Comment Letter;
Comment Letter of Mutual Fund Directors Forum
(May 21, 2008).
62 See Comment Letter of Brown & Associates LLC
(May 19, 2008); Katten 2008 Comment Letter.
63 These estimates are based on data obtained
from MIDAS, Bloomberg and Morningstar Direct as
of December 31, 2017.
64 See infra section II.B.2.
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distinction between such products.65 At
the same time, ETF industry practices in
areas such as portfolio transparency
have converged between these types of
funds.66 We therefore believe that
eliminating the regulatory distinction
between index-based ETFs and actively
managed ETFs would help to provide a
more consistent and transparent
regulatory framework for ETFs
organized as open-end funds. This
approach also would be consistent with
our regulation of other types of openend funds, which does not distinguish
between actively managed and indexbased strategies.
The rule we proposed in 2008
similarly would not have distinguished
between index-based ETFs and actively
managed ETFs, except in one respect—
it would have permitted an index-based
ETF to disclose daily the composition of
its index in lieu of disclosing its
portfolio holdings.67 However, we
believe that distinguishing between
index-based ETFs and actively managed
ETFs in this manner is no longer
necessary given that all ETFs that could
rely on the proposed rule currently
provide full portfolio transparency.68
We request comment on whether
proposed rule 6c–11 should provide
65 See, e.g., John Waggoner, Smart-beta ETFs Take
in Billions in New Assets, Investment News (Oct.
11, 2017), available at https://
www.investmentnews.com/article/20171011/FREE/
171019982/smart-beta-etfs-take-in-billions-in-newassets); Brendan Conway, New Trend: The
‘‘Bespoke’’ ETF, Barron’s (Jan. 17, 2014), available
at https://www.barrons.com/articles/new-trend-theaposbespokeapos-etf-1389970766.
66 All ETFs that could rely on the proposed rule
currently provide full portfolio transparency as a
matter of market practice, although only actively
managed ETFs and some index-based ETFs with
affiliated index providers are required to do so
pursuant to their exemptive orders. See infra
section II.C.4. See also, e.g., Guggenheim Funds
Investment Advisors, LLC, et al., Investment
Company Act Release Nos. 30560 (June 14, 2013)
[78 FR 37614 (June 21, 2013)] (notice) and 30598
(July 10, 2013) (order) and related application.
Earlier relief granted to ETFs with affiliated index
providers did not require full portfolio
transparency, but included conditions that were
intended to address potential conflicts of interest.
See, e.g., HealthShares Inc., et al., Investment
Company Act Release Nos. 27916 (July 27, 2007)
[72 FR 42447 (Aug. 2, 2007)] (notice) and 27930
(Aug. 20, 2007) (order) and related application;
WisdomTree Investments, Inc., et al., Investment
Company Act Release Nos. 27324 (May 18, 2006)
[71 FR 29995 (May 24, 2006)] (notice) and 27391
(June 12, 2006) (order) and related application
(‘‘2006 WisdomTree Investments’’).
67 For these purposes, an index-based ETF was
defined as an ETF that has a stated investment
objective of obtaining returns that correspond to the
returns of a securities index (whose provider
discloses on its internet website the identities and
weightings of the component securities and other
assets of that index). See 2008 ETF Proposing
Release, supra footnote 3. See also infra section
II.C.4 (discussing proposed condition regarding
portfolio transparency).
68 See 2015 ETP Request for Comment, supra
footnote 9.
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refers to ETFs that seek, directly or
indirectly, to provide returns that
exceed the performance of a market
index by a specified multiple or to
provide returns that have an inverse
relationship to the performance of a
market index, over a fixed period of
time.71 A leveraged ETF seeks to
amplify the returns of its underlying
index or to profit from a decline in the
value of its underlying index. It also
typically seeks to deliver the targeted
return over a short period of time, such
as a day. This means that investors
holding shares over periods longer than
the targeted period may experience
performance that is different, and at
times substantially different, from the
targeted returns. Leveraged ETFs seek to
achieve their targeted returns by using
financial derivatives. These funds are
sometimes referred to as trading tools
because they can be used by investors
to hedge against or profit from shortterm market movements without using
margin.72
The strategy that leveraged ETFs
pursue requires them to rebalance their
portfolios on a daily basis in order to
maintain a constant leverage ratio. This
daily reset, and the effects of
compounding,73 can result in
performance that differs significantly
from some investors’ expectations of
how index investing generally works.74
3. Leveraged ETFs
Although the proposed rule would
not distinguish between actively
managed ETFs and index-based ETFs in
general, it would take a different
approach with respect to leveraged
ETFs, which are a type of index-based
ETF that presents unique
considerations.70 ‘‘Leveraged ETFs’’
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exemptions to index-based ETFs and
actively managed ETFs subject to the
same conditions.
• Should the rule maintain the
historical distinction between indexbased ETFs and actively managed ETFs?
Do investors find this distinction
meaningful?
• If the rule maintains the distinction,
what conditions of the rule should differ
between index-based and actively
managed ETFs? For example, some
applications for index-based ETFs
include a representation that the ETF
will invest at least 80% of its assets,
exclusive of collateral held from
securities lending, in the component
securities of its underlying index.69
Should the rule include a similar
condition?
• Should the proposed rule include
requirements relating to index-based
ETFs with an affiliated index provider?
If so, what requirements and why? For
example, should ETFs with affiliated
index providers be required to adopt
additional policies and procedures
designed to further limit information
sharing between portfolio management
staff and index management staff? How
should we define ‘‘index provider’’ for
these purposes?
• Are there operational differences
between index-based and actively
managed ETFs that should be addressed
in the proposed rule?
that exceed the performance of a market index by
a specified multiple over a period of time) and
inverse strategies (i.e., those that seek to provide
returns that have an inverse relationship to, or
provide returns that are an inverse multiple of, the
performance of a market index over a fixed period
of time). At the end of December 2017, 187 ETFs
employed leveraged or inverse investment
strategies. All of these ETFs are structured as openend funds. In total, these ETFs had total net assets
of $35.26 billion or approximately 1% of all ETF
assets. See infra footnote 427 and following text.
71 See proposed rule 6c–11(c)(4); see also Item
C.3.c. of Form N–CEN (requiring funds to identify
if they seek to achieve performance results that are
a multiple of an index or other benchmark, the
inverse of an index or other benchmark, or a
multiple of the inverse of an index or other
benchmark).
72 See ETF Handbook, supra footnote 22, at 266.
73 For example, as a result of compounding,
leveraged ETFs can outperform a simple multiple
of its index’s returns over several days of
consistently positive returns, or underperform a
simple multiple of its index’s returns over several
days of volatile returns.
74 See Office of Investor Education and Advocacy,
SEC, Leveraged and Inverse ETFs: Specialized
Products with Extra Risks for Buy-and-Hold
Investors Investor Alert and Bulletins (Aug. 1,
2009), available at https://www.sec.gov/investor/
pubs/leveragedetfs-alert.htm; FINRA, NonTraditional ETFs: FINRA Reminds Firms of Sales
Practice Obligations Relating to Leveraged and
Inverse Exchange-Traded Funds, Regulatory Notice
09–31 (June 2009), available at https://
www.finra.org/sites/default/files/NoticeDocument/
p118952.pdf (‘‘FINRA Regulatory Notice 09–31’’)
(providing an example of a four-month period
where a specified index gained 2%, while an ETF
69 There are some variations in this representation
for index-based funds that invest in fixed-income
securities and foreign securities. See, e.g., Destra
Exchange-Traded Fund Trust, et al., Investment
Company Act Release Nos. 33048 (Mar. 14, 2018)
[83 FR 12208 (Mar. 20, 2018)] (notice) and 33071
(Apr. 10, 2018) (order) and related application
(‘‘Each Fund . . . will invest at least 80% of its
assets, exclusive of collateral held from securities
lending, in Component Securities of its respective
Underlying Index, or in the case of Fixed Income
Funds, in the Component Securities of its
respective Underlying Index and [to-be-announced
transactions] representing Component Securities,
and in the case of Foreign Funds, in Component
Securities and depositary receipts representing
foreign securities such as [American Depositary
Receipts and Global Depositary Receipts]
representing such Component Securities (or, in the
case of Foreign Funds tracking Underlying Indexes
for which Depositary Receipts are themselves
Component Securities, underlying stocks in respect
of such Depositary Receipts.’’) (internal footnotes
omitted).
70 We use the term ‘‘leveraged ETFs’’ in this
release to refer to ETFs that pursue leveraged
strategies (i.e., those that seek to provide returns
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This effect can be more pronounced in
volatile markets.75 As a result, buy-andhold investors in a leveraged ETF with
an intermediate or long-term time
horizon—who may not evaluate their
portfolios frequently—may experience
large and unexpected losses.76
Leveraged ETFs, and their use of
derivatives, also may raise issues under
section 18 that we are evaluating as part
of our broader consideration of the use
of derivatives by registered funds and
business development companies.77 In
seeking to deliver twice the daily return of that
index fell 6%, and the related ETF seeking to
deliver twice the inverse of the index’s daily return
fell 26%).
75 See FINRA Regulatory Notice 09–31, supra
footnote 74 (‘‘Using a two-day example, if the index
goes from 100 to close at 101 on the first day and
back down to close at 100 on the next day, the twoday return of an inverse ETF will be different than
if the index had moved up to close at 110 the first
day but then back down to close at 100 on the next
day. In the first case with low volatility, the inverse
ETF loses 0.02 percent; but in the more volatile
scenario the inverse ETF loses 1.82 percent. The
effects of mathematical compounding can grow
significantly over time, leading to scenarios such as
those noted above.’’).
76 See id. (reminding member firms of their sales
practice obligations relating to leveraged ETFs and
noting that leveraged ETFs are typically not suitable
for retail investors who plan to hold these products
for more than one trading session). See also, e.g.,
SEC v. Hallas, No. 1:17-cv-2999 (S.D.N.Y. Sept. 27,
2017); FINRA News Release, FINRA Sanctions
Oppenheimer & Co. $2.9 Million for Unsuitable
Sales of Non-Traditional ETFs and Related
Supervisory Failures (June 8, 2016), available at
https://www.finra.org/newsroom/2016/finrasanctions-oppenheimer-co-29-million-unsuitablesales-non-traditional-etfs. The Commission also
settled an enforcement action against an investment
adviser under section 206(4) of the Investment
Advisers Act of 1940 (the ‘‘Advisers Act’’) and rule
206(4)–7, finding the adviser violated these
provisions by failing to adequately implement
written compliance policies that were designed to
ensure that recommendations of single inverse ETFs
to non-discretionary advisory clients were suitable
for each individual client. See In Re Morgan Stanley
Smith Barney, LLC, Investment Advisers Act
Release No. 4649 (Feb. 14, 2017) (settled action),
available at https://www.sec.gov/litigation/admin/
2017/ia-4649.pdf.
77 The staff has not supported new exemptive
relief for leveraged ETFs since 2009. The orders
issued to current leveraged ETF sponsors prior to
the staff moratorium, as amended over time, relate
to leveraged ETFs that seek investment results of up
to 300% of the return (or inverse of the return) of
the underlying index. Rydex ETF Trust, et al.,
Investment Company Act Release Nos. 27703 (Feb.
20, 2007) [72 FR 8810 (Feb. 27, 2007)] (notice) and
27754 (Mar. 20, 2007) (order) and related
application; Rafferty Asset Management, LLC, et al.,
Investment Company Act Release Nos. 28379 (Sept.
12, 2008) [73 FR 54179 (Sept. 18, 2008)] (notice)
and 28434 (Oct. 6, 2008) (order) and related
application. See also ProShares Trust, et al.,
Investment Company Act Release Nos. 28696 (Apr.
14, 2009) [74 FR 18265 Apr. 21, 2009)] (notice) and
28724 (May 12, 2009) (order) and related
application (amending the applicant’s prior order)
(‘‘ProShares’’); Rafferty Asset Management, LLC, et
al., Investment Company Act Release Nos. 28889
(Aug. 27, 2009) [74 FR 45495 (Sept. 2, 2009)]
(notice) and 28905 (Sept. 22, 2009) (order) and
related application (amending the applicant’s prior
order) (‘‘Rafferty’’).
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2015, for example, we proposed new 17
CFR 270.18f–4 (‘‘rule 18f–4’’ under the
Act). Proposed rule 18f–4 was designed
to address the investor protection
purposes and concerns underlying
section 18 of the Act and to provide an
updated and more comprehensive
approach to the regulation of funds’ use
of derivatives transactions.78
In light of our ongoing consideration,
including the potential staff
recommendation of a re-proposal on
funds’ use of derivatives, we do not
believe it is appropriate to permit
additional leveraged ETF sponsors to
form leveraged ETFs and operate under
our proposed rule at this time.79
Accordingly, we propose to include a
condition that would prevent leveraged
ETFs from relying on proposed rule 6c–
11.80 ETFs that seek to provide returns
that exceed the performance (or inverse
performance) of a market index by a
specified multiple over a fixed period
could not operate under our proposed
rule.
The daily or other periodic reset, and
more particularly the effects of
compounding, are what distinguish a
leveraged ETF strategy from other
strategies pursued by ETFs. The
proposed condition relating to leveraged
ETFs thus includes a temporal element
(i.e., ‘‘over a fixed period of time’’) in
order to specifically capture ETFs that
seek to deliver the leveraged or inverse
return of a market index over a fixed
period of time, daily or otherwise.81 In
addition, the proposed rule’s use of the
term ‘‘multiple’’ includes leverage that
is not evenly divisible by 100, such as
a fund that seeks to provide a return
78 See Derivatives Proposing Release, supra
footnote 40. Section 18 of the Act limits a fund’s
ability to obtain leverage or issue senior securities.
15 U.S.C. 80a–18.
79 See supra footnote 77. As discussed in more
detail in section II.G below, we are not proposing
here to rescind the existing leverage ETF orders.
Existing leveraged ETF sponsors would continue to
operate under their exemptive orders. Existing
leveraged ETFs, however, would be subject to the
proposed amendments to Form N–1A discussed
below.
80 Proposed rule 6c–11(c)(4).
81 The current exemptive orders that allow
leveraged ETFs contemplate a daily reset, because
the orders relate to ETFs that pursue daily
investment objectives. See supra footnote 77. For
example, one application describes its leveraged
ETFs as ‘‘seek[ing] to provide daily investment
results, before fees and expenses, that correspond
to 300% of the daily performance, or 300% of the
inverse (opposite) daily performance, of its
Underlying Index.’’ See Rafferty, supra footnote 77.
Another describes its leveraged ETFs as
‘‘attempt[ing], on a daily basis, to achieve its
investment objective by corresponding to a
specified multiple of the performance (either 125%,
150% or 200%), or the inverse performance, or the
inverse multiple (either 125%, 150% or 200% of
the opposite) of the performance of a particular
securities index.’’ See ProShares, supra footnote 77.
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equal to 150% of the performance of an
index.82 Finally, we believe it is
important to specify that an ETF may
not indirectly seek to provide returns
that exceed the performance of a market
index by a specified multiple or to
provide returns that have an inverse
relationship to the performance of a
market index over a fixed period of time
in order to prevent a fund from
circumventing this condition, such as
by embedding inverse leverage in the
underlying index.
We request comment on excluding
leveraged ETFs from the scope of funds
that may rely on the proposed rule.
• Do commenters agree that it is
appropriate for proposed rule 6c–11 to
include a condition that an ETF may not
seek, directly or indirectly, to provide
returns that exceed the performance of
a market index by a specified multiple,
or to provide returns that have an
inverse relationship to the performance
of a market index, over a fixed period
of time?
• Alternatively, do commenters
believe that the structure and operation
of leveraged ETFs do not raise issues
that warrant our excluding them from a
rule of general applicability related to
the structure and operations of ETFs? If
so, are there any conditions specific to
leveraged ETFs that should be part of
the rule? For example, should we permit
leveraged ETFs to operate in reliance on
the rule but prohibit a leveraged ETF
that exceeds a specific multiple of the
performance, or inverse performance, of
a market index? If so, what multiple
should we use? For example, ETFs
currently may not seek investment
results over 300% of the return (or
inverse of the return) of the underlying
index. Should we maintain the status
quo with respect to the maximum
amount of leveraged market exposure
that leveraged ETFs may obtain (i.e.,
300%)? Should we limit ETFs to a
higher or lower multiplier? If so, what
multiplier and why?
• Does the proposed rule’s use of ‘‘a
fixed period of time’’ effectively
describe the daily reset mechanism in
leveraged ETFs? Are there other
descriptions we should use? Could an
ETF seek to provide returns that are a
multiple, or inverse, of an index without
this limitation? For example, would
such an ETF be able to operate without
the daily (or other periodic) reset?
Would such an ETF raise the same
investor protection issues as the
leveraged ETFs that we are proposing to
82 Similarly, an ‘‘inverse ETF’’ includes both
inverse strategies (i.e., ¥100% of an index’s
performance) and leveraged inverse strategies (e.g.,
¥125% or ¥200% of an index’s performance).
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exclude from relying on proposed rule
6c–11? Would they raise other investor
protection issues? If so, what issues and
why?
• Does the proposed rule prevent an
ETF from circumventing this limitation
by embedding leverage in an index or
through any other means? If not, should
we consider other conditions or
limitations, and if so, what? For
example, should the rule provide that
an ETF may not ‘‘obtain’’ or ‘‘provide’’
leveraged exposure, rather than stating
that an ETF may not ‘‘seek’’ to provide
leveraged exposure as proposed?
Alternatively, should we define
leveraged ETFs as funds currently do in
their applications (i.e., to achieve its
investment objective by corresponding
to a specified multiple of the
performance (either 125%, 150% or
200%), or the inverse performance, or
the inverse multiple (either 125%,
150% or 200% of the opposite) of the
performance of a particular securities
index)? 83
• Proposed rule 6c–11 does not seek
to address any concerns raised under
section 18 of the Act by leveraged ETFs.
Do commenters agree that this is
appropriate? Should we consider
additional conditions in rule 6c–11 for
leveraged ETFs designed to address
concerns raised under section 18 or
other investor protection concerns
raised by their strategies? If so, what
conditions? Should we provide any
relief to these ETFs under section 18 of
the Act?
• What types of investors purchase
shares of leveraged ETFs? What is the
proportion of volume from retail versus
institutional trading? How do these
different types of investors utilize
leveraged ETFs? What is the typical
holding period of leveraged ETFs by
each type of investor?
• What types of intermediaries are
active with leveraged ETF investments?
Are the current suitability requirements
for intermediaries effective with respect
to leveraged ETFs? What specific
methods, if any, are intermediaries
using to meet their suitability
obligations for these products? Should
we propose as part of a future
rulemaking that leveraged ETFs be
subject to additional requirements,
particularly for retail investors? 84
83 See
supra footnote 81.
e.g., NASD, Structured Products: NASD
Provides Guidance Concerning the Sale of
Structured Products, Notice to Members (September
2005), available at https://www.complinet.com/file_
store/pdf/rulebooks/nasd_0559ntm.pdf; see also
FINRA, Complex Products: Heightened Supervision
of Complex Products, Regulatory Notice 12–03
(January 2012), available at https://www.finra.org/
sites/default/files/NoticeDocument/p125397.pdf.
84 See,
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• The Commission understands that
leveraged ETFs typically provide
enhanced disclosure of the risks of
investing in the ETF.85 Do investors
understand leveraged ETFs better today
than they did when Commission staff
and FINRA jointly issued an investor
alert expressing the concern that
individual investors may be confused
about the performance objectives of
leveraged ETFs? 86 For example, are
investors more likely to be aware that
leveraged ETFs are typically designed to
achieve their stated performance
objectives on a periodic basis (e.g.,
daily)? Do investors understand that
leveraged ETFs may not achieve those
performance objectives over the longterm? 87
• Leveraged ETFs typically include
charts in their disclosures that explain
the potential impact of compounding to
an investor’s returns. Should we amend
Form N–1A to require leveraged ETFs to
include such a chart to better explain
the impact of compounding? Are there
other disclosures that we should require
leveraged ETFs to provide? If so, what
are they?
• Should we propose rules governing
leveraged ETF marketing materials to
address concerns that leveraged ETFs
may be marketed to investors that do
not have an appropriate risk tolerance to
invest in these products or that lack
understanding of leveraged ETFs’
strategies and risks? For example,
should we require leveraged ETFs to
include prescribed cautionary
disclosures regarding these strategies
and risks?
B. Exemptive Relief Under Proposed
Rule 6c–11
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Proposed rule 6c–11 would provide
ETFs within the scope of the rule with
exemptions from certain provisions of
the Act that are necessary to allow ETFs
to operate. These exemptions are
generally consistent with the relief we
have given to ETFs under our exemptive
85 This understanding is based on Commission
staff review of registration statements filed with the
Commission and ETF websites.
86 See supra footnote 74.
87 See e.g., Paolo Guasoni and Eberhard
Mayerhofer, Leveraged Funds: Robust Replication
and Performance Evaluation (2017) (‘‘Leveraged and
inverse exchange-traded funds seek daily returns
equal to fixed multiples of indexes’ returns. Trading
costs implied by frequent adjustments of funds’
portfolios create a tension between tracking error,
reflecting short-term correlation with the index, and
excess return, the long-term deviation from the
leveraged index’s performance.’’); Lu Lei, Jun Wang,
and Ge Zhang, Long-term performance of leveraged
ETFs, 21 Financial Services Review 1 (2012)
(‘‘Overall our results caution against the use of
leveraged ETFs as long-term investment substitutes
for long or short positions of the benchmark
indices.’’).
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orders.88 Proposed rule 6c–11 would
permit an ETF that meets the conditions
of the rule to: (i) Redeem shares only in
creation unit aggregations; (ii) permit
ETF shares to be purchased and sold at
market prices rather than at NAV per
share; (iii) engage in in-kind
transactions with certain affiliates; and
(iv) in certain limited circumstances,
pay authorized participants the
proceeds from the redemption of shares
in more than seven days. As discussed
below in section II.C, the exemptions
would be subject to certain conditions
that are designed to address the
concerns underlying the relevant
statutory provisions and to support a
Commission finding that the
exemptions are in the public interest
and consistent with the protection of
investors and the purposes fairly
intended by the policy and provisions of
the Act.89
1. Treatment of ETF Shares as
‘‘Redeemable Securities’’
Under proposed rule 6c–11, an ETF,
as defined in the rule, would be
considered to issue a ‘‘redeemable
security’’ within the meaning of section
2(a)(32) of the Act.90 As discussed
above, ETFs have features that
distinguish them from both traditional
open-end and closed-end funds. A
defining feature of open-end funds is
that they offer redeemable securities,
which allow the holder to receive his or
her proportionate share of the fund’s
NAV per share upon presentation of the
security to the issuer. Although
individual ETF shares cannot be
redeemed, except in limited
circumstances,91 they can be redeemed
in creation unit aggregations.92
Therefore, we believe that ETF shares
are most appropriately classified under
88 Our exemptive orders also provide relief
allowing certain types of funds to invest in ETFs
beyond the limits of section 12(d)(1) of the Act. We
are not addressing this relief at this time. See infra
section II.G. However, we are proposing to rescind
the master-feeder relief that we previously granted
to ETFs that do not rely on the relief as of the date
of this proposal (June 28, 2018). We also propose
to grandfather existing master-feeder arrangements
involving ETF feeder funds, but prevent the
formation of new ones, by amending relevant
exemptive orders. See infra section II.F.
89 See 15 U.S.C. 80a–6(c).
90 Proposed rule 6c–11(b)(1).
91 See infra section II.C.1 (discussing
circumstances where ETF shares can be
individually redeemed).
92 See proposed rule 6c–11(a) (defining an
exchange-traded fund, in part, as a registered openend management company that issues and redeems
its shares in creation units). The proposed rule
would define ‘‘creation unit’’ to mean a specified
number of ETF shares that the ETF will issue to (or
redeem from) an authorized participant in exchange
for the deposit (or delivery) of a basket and a cash
balancing amount (if any). See proposed definition
of ‘‘creation unit’’ in rule 6c–11(a).
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the proposed rule as redeemable
securities within the meaning of section
2(a)(32),93 and that ETFs should be
regulated as open-end funds within the
meaning of section 5(a)(1) of the Act.94
The arbitrage mechanism that is
central to the operation of an ETF (and
the conditions in our relief designed to
facilitate an effective arbitrage
mechanism) serves to keep the market
price of ETF shares at or close to the
ETF’s NAV per share. As a result, even
though only authorized participants
may redeem creation units directly from
the ETF at NAV per share, investors are
able to sell their ETF shares on the
secondary market at or close to NAV,
similar to investors in an open-end fund
that redeem their shares directly from
the fund at NAV per share.95 The shares
of closed-end funds, on the other hand,
generally trade on the secondary market
at a discount or premium to NAV.
Our exemptive orders have provided
exemptions from sections 2(a)(32) and
5(a)(1) of the Act so that ETFs may
register under the Act as open-end
funds while issuing shares redeemable
in creation units only. Unlike our
exemptive orders, however, the
proposed rule would not provide an
exemption from the definition of
‘‘redeemable security’’ in section
2(a)(32) or from the definition ‘‘openend company’’ in section 5(a)(1). We
believe that it is more appropriate for
the proposed rule to address these
questions of status by classifying ETF
shares as ‘‘redeemable securities.’’ Thus,
93 If ETF shares were not classified as redeemable
securities within the meaning of section 2(a)(32) of
the Act, an ETF would be subject to the provisions
of the Act applicable to closed-end funds. See 15
U.S.C. 80a–5(a)(2) (defining a ‘‘closed-end
company’’ as any management company other than
an open-end company).
94 15 U.S.C. 80a–5(a)(1) (defining ‘‘open-end
company’’); 15 U.S.C. 80a–2(a)(32) (defining
‘‘redeemable security’’).
95 See Robert Engle & Debojyoti Sarkar,
Premiums-Discounts and Exchange Traded Funds,
13 Journal of Derivatives 4 (Summer 2006) (‘‘Engle
Article’’) (observing that premiums and discounts
for domestic ETFs are generally small and highly
transient, and that while premiums and discounts
are larger and more persistent in international ETFs,
they are smaller and less persistent than the
premiums and discounts of international closedend funds); but see, e.g., Bradley Kay, Has the ETF
Arbitrage Mechanism Failed?, Morningstar (Mar.
11, 2009), available at https://
news.morningstar.com/articlenet/
article.aspx?id=283302 (stating that market prices
for ETFs may deviate significantly from NAV
during periods of market stress); Chris Dieterich,
Greece ETF Pacing for Record Tumble on Huge
Volume: Here’s What You Need to Know, Barron’s
(June 29, 2015), available at https://
www.barrons.com/articles/greece-etf-pacing-forrecord-tumble-on-huge-volume-heres-what-youneed-to-know-1435597369 (noting that ETFs tied to
Greek and Egyptian stocks traded at significant
discounts to NAV when the exchanges on which
the underlying stocks traded were closed).
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any ETF operating in compliance with
the rule’s conditions and requirements
would meet the definition of open-end
company.96
ETFs operating in reliance on the
proposed rule would be subject to the
requirements imposed under the Act
and our rules that apply to all open-end
funds.97 We note that our approach is
substantially similar to the 2008
proposal, which was generally
supported by commenters.98 In
addition, in our view the rules under
the Exchange Act that apply to
redeemable securities issued by an
open-end fund would apply to ETFs
relying on the proposed rule.99 Thus,
proposed rule 6c–11 would result in
ETFs relying on proposed rule 6c–11
becoming eligible for the ‘‘redeemable
securities’’ exceptions in 12 CFR
242.101(c)(4) and 242.102(d)(4) (‘‘rules
101(c)(4) and 102(d)(4) of Regulation
M’’) and 12 CFR 240.10b–17(c) (‘‘rule
10b–17(c) under the Exchange Act’’) in
connection with secondary market
transactions in ETF shares and the
creation or redemption of creation units.
Similarly, we would view ETFs relying
on rule 6c–11 as within the ‘‘registered
open-end investment company’’
exemption in rule 11d1–2 under the
Exchange Act.100
We request comment on this aspect of
the proposed rule.
• Are there differences between ETFs
and other open-end funds that would
justify not applying certain open-end
fund provisions of the Act or our rules
to ETFs? For example, we adopted
tailored liquidity risk management
program requirements for ETFs under
17 CFR 270.22e–4 (‘‘rule 22e–4’’).101
Should we consider tailored
requirements for ETFs in connection
with other provisions?
• As we discussed above, ETFs
relying on proposed rule 6c–11 would
be able to rely on the ‘‘redeemable
securities’’ exceptions in rules 101(c)(4)
and 102(d)(4) of Regulation M and rule
10b–17(c) under the Exchange Act and
the ‘‘registered open-end investment
company’’ exemption in rule 11d1–2
under the Exchange Act. Should the
Commission exempt ETFs relying on
proposed rule 6c–11 from any other
rules under the Exchange Act? 102 If so,
which rules and why? For example,
ETFs typically request relief from
Exchange Act section 11(d)(1) and rule
11d1–2 thereunder; and 17 CFR
240.10b–10, 240.15c1–5, and
240.15c1–6 (rules 10b–10, 15c1–5, and
15c1–6 under Exchange Act). Should
the Commission provide relief from
these provisions under the Exchange
Act? If so, what conditions should apply
to such relief, if any, and why? For
example, ETFs currently rely on relief
that is conditioned on: minimum
creation unit sizes; 103 dissemination of
the Intraday Indicative Value (‘‘IIV’’); 104
restrictions on the payment of certain
cash compensation or economic
incentives; 105 minimum levels of
diversification in the ETF’s basket; 106
and whether the ETF is managed to
track an index.107 Should we eliminate
or modify any or all of these conditions?
We requested comment on exchange
listing standards for ETFs and other
ETPs in 2015.108 Do commenters have
updated views on those requests for
comment?
2. Trading of ETF Shares at MarketDetermined Prices
Section 22(d) of the Act, among other
things, prohibits investment companies,
their principal underwriters, and
102 See,
e.g., supra footnote 14.
e.g., Letter from James A. Brigagliano,
Deputy Director, Division of Trading and Markets,
to W. John McGuire, Morgan, Lewis & Bockius LLP
re: U.S. One Trust Actively-Managed Exchange
Traded Fund of Exchange Traded Funds, dated May
4, 2010 (conditioning relief under Exchange Act
Section 11(d)(1) on the ETFs continuously
redeeming, at NAV, creation unit aggregations of
50,000 shares valued at a minimum of $1.25
million).
104 Id. (representing that the ETFs would
disseminate the IIV every 15 seconds throughout
the trading day).
105 See, e.g., Letter from Catherine McGuire, Chief
Counsel, Division of Market Regulation to
Securities Industry Association, dated Nov. 21,
2005, at n.3 and accompanying text.
106 Id. (defining, in part, a ‘‘qualifying ETF’’ as
consisting of a basket of twenty or more component
securities with no one component security
constituting more than 25% of the total value of the
ETF).
107 Id.
108 2015 ETP Request for Comment, supra
footnote 9, at n.106 and accompanying and
following text.
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103 See,
96 Section 5(a)(1) defines an ‘‘open-end company’’
as ‘‘a management company which is offering for
sale or has outstanding any redeemable security of
which it is the issuer.’’ 15 U.S.C. 80a–5(a)(1).
97 See, e.g., 15 U.S.C. 80a–22; 17 CFR 270.22c–1.
98 See 2008 ETF Proposing Release, supra
footnote 3. See also ICI 2008 Comment Letter;
Xshares 2008 Comment Letter.
99 See, e.g., 17 CFR 240.15c3–1. See also
Securities Transaction Settlement Cycle, Exchange
Act Release No. 80295 (Mar. 22, 2017) [82 FR 15564
(Mar. 29, 2017)] (‘‘T+2 Adopting Release’’)
(shortening the standard settlement cycle for most
broker-dealer securities transactions to two business
days).
100 Cf. Securities Industry Association, SEC Staff
No-Action Letter (Nov. 21, 2005) (treating certain
equity index-based ETFs as registered open-end
investment companies for purposes of rule 11d1–
2).
101 See Investment Company Liquidity Risk
Management Programs, Investment Company Act
Release No. 32315 (Oct. 13, 2016) [81 FR 82142
(Nov. 18, 2016)] (‘‘LRM Adopting Release’’), at
sections II.A. and II.J.
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dealers from selling a redeemable
security to the public except at a current
public offering price described in the
prospectus.109 Rule 22c–1 generally
requires that a dealer selling, redeeming,
or repurchasing a redeemable security
do so only at a price based on its
NAV.110 Together, section 22(d) and
rule 22c–1 are designed to: (i) Prevent
dilution caused by certain riskless
trading practices of principal
underwriters and dealers; (ii) prevent
unjust discrimination or preferential
treatment among investors purchasing
and redeeming fund shares; and (iii)
preserve an orderly distribution of
investment company shares.111 ETFs
seeking to register under the Act obtain
exemptions from these provisions
because investors may purchase and sell
individual ETF shares from and to
dealers on the secondary market at
market-determined prices (i.e., at prices
other than those described in the
prospectus or based on NAV).
Consistent with our prior exemptive
orders, proposed rule 6c–11 would
provide exemptions from these
provisions.112
As discussed above, only authorized
participants can purchase and redeem
shares directly from an ETF at NAV per
share and only in creation unit
aggregations. Because authorized
participants (and other market
participants transacting through an
authorized participant) can take
advantage of disparities between the
market price of ETF shares and NAV per
share, they may be in a different
position than investors who buy and
sell individual ETF shares only on the
secondary market.113 However, if the
arbitrage mechanism is functioning
effectively, entities taking advantage of
these disparities in market price and
NAV per share move the market price to
a level at or close to the NAV per share
of the ETF. The proposed rule would
provide exemptions from section 22(d)
and rule 22c–1 because we believe this
109 15
U.S.C. 80a–22(d).
17 CFR 270.22c–1.
111 See generally Mutual Fund Distribution Fees;
Confirmations, Investment Company Act Release
No. 29367 (July 21, 2010) [75 FR 47064 (Aug. 4,
2010)] (discussing legislative history of section
22(d)).
112 See proposed rule 6c-11(b)(2). The reference in
the proposed rule to ‘‘repurchases . . . at marketdetermined prices’’ refers to secondary market
transactions with dealers. Thus, the rule would not
allow an ETF to repurchase shares from an investor
at market-determined prices.
113 See, e.g., Comment Letter of Barclays Global
Investors on 2001 Concept Release (Jan. 11, 2002)
(‘‘[D]uring periods of market volatility . . . it is not
unreasonable to assume that some retail investors
would buy or sell ETF shares at secondary market
prices moving in the opposite direction of a fund’s
NAV.’’).
110 See
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arbitrage mechanism—and the
conditions in this rule designed to
promote a properly functioning
arbitrage mechanism—have adequately
addressed, over the significant operating
history of ETFs, the potential concerns
regarding shareholder dilution and
unjust discrimination that these
provisions were designed to address.
We proposed the same exemptions in
2008 and commenters who addressed
this aspect of the 2008 ETF Proposing
Release supported the Commission’s
approach.114 Commenters on the 2015
ETP Request for Comment also
addressed the existing arbitrage
mechanism, generally arguing that it is
effective and efficient in ensuring that
an ETF’s market price does not vary
substantially from its NAV per share.115
On the other hand, one commenter
questioned the efficacy of the arbitrage
mechanism, particularly at the close of
trading when bid-ask spreads tend to
widen.116 One commenter asserted that
the arbitrage mechanism does not work
well for ETFs holding securities that do
not trade during U.S. market hours.117
Another commenter argued that even if
the arbitrage mechanism corrects price
mismatches between market price and
NAV per share, it does so by creating an
unfair windfall for authorized
participants who can capitalize on
information asymmetries and
operational advantages to extract value
from the market.118
The arbitrage mechanism is the
foundation for why retail and other
secondary market investors generally
can buy and sell ETF shares at prices
that are at or close to the prices at which
authorized participants are able to buy
and redeem shares directly from the
ETF at NAV. In the Commission’s
experience, the deviation between the
market price of ETFs and NAV per
share, each calculated as of the close of
trading each day, generally has been
114 See ICI 2008 Comment Letter; Xshares 2008
Comment Letter.
115 See, e.g., Comment Letter of KCG Holdings,
Inc. on 2015 ETP Request for Comment (Aug. 17,
2015); Comment Letter of Vanguard on 2015 ETP
Request for Comment (Aug. 17, 2015); Comment
Letter of Charles Schwab & Co., Inc. and Charles
Schwab Investment Management, Inc. on 2015 ETP
Request for Comment (Aug. 17, 2015) (‘‘Schwab
ETP Comment Letter’’) (noting that it had not
identified any significant systemic differences in
efficiency across various ETF products, regardless
of ETF’s investment strategy).
116 See Comment Letter of ETF Consultants.com,
Inc. on 2015 ETP Request for Comment (Aug. 17,
2015); see also infra section II.H regarding bid-ask
spreads.
117 See Comment Letter of James J. Angel, Ph.D.,
CFA on 2015 ETP Request for Comment (Aug. 17,
2015).
118 See Comment Letter of Occupy the SEC on
2015 ETP Request for Comment (Aug. 21, 2015).
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relatively small.119 For example, during
2016–2017, the closing price of ETFs
based on U.S. equity indexes were
within 1% of NAV for 97.9% of trading
days and within 1% of NAV for actively
managed ETFs investing in U.S. equities
for 98.5% of trading days. The absolute
weighted average of the daily difference
between the NAV and market price
during a six-month period ending in
December 2017 was 0.014% for ETFs
based on U.S. equities indexes and
0.074% for actively managed ETFs
investing in U.S. equities.120
Other types of ETFs have had a
somewhat higher deviation between
NAV per share and market price. During
2016–2017, the closing price for indexbased and actively managed ETFs
investing in international equities, for
example, were within 1% of NAV for
87.4% and 86.8% of trading days,
respectively. Similarly, the absolute
weighted average of the daily difference
between the NAV and market price
during a six-month period ending in
December 2017 for index-based and
actively managed ETFs investing in U.S.
fixed-income securities were 0.067%
and 0.068%, respectively. The absolute
weighted average of daily difference
between NAV per share and market
price during the six-month period
studied was 0.206% for ETFs based on
international equities indexes and
0.390% for actively managed ETFs
investing in international equities.121
These numbers represent only broad
averages with respect to end-of-day
differences, however, and intraday
deviations between market price and
NAV per share may be greater under
certain circumstances. These figures
also do not reflect intraday deviations
between market prices and the
contemporaneous value of the ETF’s
portfolio.122 However, one academic
paper has shown that deviations
119 Figures in this section represent an analysis by
Commission staff of market data obtained from
Bloomberg Professional Services and Morningstar.
In preparing this analysis, staff used the market
price of each ETF as of the close of trading each
day.
120 An ETF can trade at a premium or discount
to its NAV per share on any given day. When taking
an average over many days, premiums (which have
a positive difference) and discounts (which have a
negative difference) may offset each other.
Therefore, to calculate deviation from NAV, we use
the absolute value of premiums and discounts when
calculating weighted average differences to prevent
such offsetting.
121 International equity ETFs can provide
exposure to markets that do not overlap with U.S.
trading hours. In these circumstances, the deviation
between NAV per share and market price may be
attributable in large part to obtaining exposure to
those markets when they are closed.
122 Most funds calculate NAV per share once per
day as of the time the major U.S. stock exchanges
close. See supra footnote 26.
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37343
between intraday market prices and
estimated intraday values for domestic
ETFs also were generally small.123
The Commission and its staff have
observed the operation of the arbitrage
mechanism during periods of market
stress when the deviation between
intraday market prices and the nextcalculated NAV per share significantly
widened for short periods of time.
During periods of extraordinary
volatility in the underlying ETF
holdings, it may be difficult for
authorized participants or market
makers to confidently ascribe precise
values to an ETF’s holdings, thereby
making it more difficult to effectively
hedge their positions.124 These market
participants may widen their quoted
spreads in ETF shares or, in certain
cases, may elect not to transact in or
quote ETF shares, rather than risk
loss.125
Market makers may have already
exhibited this behavior in periods of
extraordinary volatility.126 For example,
123 Engle Article, supra footnote 95. For domestic
ETFs, the study showed intraday average daily
premium of 0.25 basis points with an average
standard deviation of 11.8 basis points. For
international ETFs, the respective figures were 23.7
basis points and an average standard deviation of
64.8 basis points. The intraday premium was
measured every minute as the percentage difference
between: (i) The average of the bid and the ask of
the ETF shares; and (ii) the intraday indicative
value (IIV) of the ETF’s portfolio. See infra sections
II.C.3 and II.C.6 for a discussion of the IIV and the
potential problems associated with using the IIV as
a tool to measure the current value of the ETF’s
portfolio on an ongoing basis.
124 See generally Itzhak Ben-David, et al.,
Exchange Traded Funds (ETFS), National Bureau of
Econ., Working Paper No. 22829 (Nov. 2016),
available at https://www.nber.org/papers/w22829
(‘‘Ben-David’’) (‘‘Because of sparse liquidity in some
exchanges [on the morning of August 24, 2015],
some of the arbitrage programs diagnosed unreliable
price data and withdrew from the market, leading
to a positive feedback loop.’’).
125 See also Milan Borkovec, et al., Liquidity and
Price Discovery in Exchange-Traded Funds: One of
Several Possible Lessons from the Flash Crash, 1
The Journal of Index Investing 2 (2010)
(‘‘Borkovec’’) (reporting that liquidity of ETFs
declined dramatically during the ‘‘Flash Crash,’’
causing spreads to widen significantly).
126 See Ben-David, supra footnote 124 (‘‘ETF
market makers and [authorized participants]
arguably withdrew from the market after a trading
pause in the futures market, which they used to
hedge their exposure in volatile trading sessions.’’)
(internal citations omitted). Many ETFs disclose the
risk that ETF shares will trade at a premium or
discount, particularly during times of market
disruptions, in their prospectuses as part of their
principal risk disclosure. See, e.g., iShares Trust
rule 485(b) Registration Statement (Nov. 1, 2017),
available at https://www.sec.gov/Archives/edgar/
data/1100663/000119312517327588/
d486424d485bpos.htm (‘‘Market Trading Risk: The
Fund faces numerous market trading risks,
including the potential lack of an active market for
Fund shares, losses from trading in secondary
markets, periods of high volatility and disruptions
in the creation/redemption process. ANY OF
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on May 6, 2010, the prices of many U.S.based equity products experienced a
significant decline and recovery, and
many of the securities that experienced
the greatest price changes were equitybased ETFs.127 Significant price
volatility on the morning of August 24,
2015 triggered limit up-limit down
pauses in many equity securities,
including many ETFs.128 In both
instances, certain ETFs saw larger
intraday premiums/discounts and wider
bid-ask spreads for portions of the
trading day.129 Deviations between
market price and NAV per share were
closed after relatively short periods,
however, as the arbitrage mechanism
resumed its effectiveness.130
Accordingly, we recognize that under
certain circumstances, including during
periods of market stress, the arbitrage
mechanism may work less effectively
for a period of time. We also recognize
that secondary market investors who
trade in ETF shares during these periods
may be harmed by trading at a price that
is not close to the NAV per share of the
ETF (or the contemporaneous value of
the ETF’s portfolio). On balance,
however, we believe these investors are
more likely to weigh the potential
benefits of ETFs (e.g., low cost and
intraday trading) against any potential
for market price deviations when
deciding whether to utilize ETFs.131
Further, we believe that the conditions
we are proposing as part of rule 6c–11,
THESE FACTORS, AMONG OTHERS, MAY LEAD
TO THE FUND’S SHARES TRADING AT A
PREMIUM OR DISCOUNT TO NAV.’’).
127 See Final May 6 Report, supra footnote 9, at
n.36 and accompanying text (noting that ETFs
accounted for approximately 70% of all securities
with trades broken pursuant to the clearly
erroneous execution rules on May 6).
128 See August 24 Staff Report, supra footnote 32
(noting that ETFs as a class accounted for almost
all of the 1,279 trading halts on August 24, 2015,
but 80% of ETFs did not experience a single trading
halt).
129 See Borkovec, supra footnote 125; Ben-David,
supra footnote 124.
130 See Borkovec, supra footnote 125, at 40; see
also Ananth Madhavan, Exchange-Traded Funds,
Market Structure, and the Flash Crash, 68 Financial
Analysts Journal 20 (2012) (‘‘Madhavan Article’’).
131 The Commission has taken steps to address
disruptions in the arbitrage mechanism. For
example, the Commission approved changes to the
limit up-limit down rules following the market
events on August 24, 2015. See Self-Regulatory
Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing and Immediate
Effectiveness of a Proposed Rule Change to Clarify
the Operation of the Regulation NMS Plan to
Address Extraordinary Market Volatility, Exchange
Release No. 78435 (July 28, 2016) [81 FR 51239
(Aug. 3, 2016)]; Self-Regulatory Organizations;
Financial Industry Regulatory Authority, Inc.;
Notice of Filing and Immediate Effectiveness of a
Proposed Rule Change to Extend the Effective Date
of SR–FINRA–2016–028, Exchange Release
No.78660 (Aug. 24, 2016) [81 FR 59676 (Aug. 30,
2016)].
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along with other recent actions that are
designed to promote an effective
arbitrage mechanism,132 would continue
to result in a sufficiently close
alignment between an ETF’s market
price and NAV per share in most
circumstances, and provide an
appropriate basis for the exemptive
relief we are proposing. We particularly
find this to be the case given the
benefits ETFs offer investors, as
discussed above.
Furthermore, to the extent that there
are instances where bid-ask spreads
widen, or premiums and discounts
persist, the proposed rule and
disclosure amendments would require
ETFs to disclose certain information on
their website.133 We believe that it is
important for investors to be informed
where costs may increase beyond what
they would reasonably expect. Our
exemptive orders have required ETFs’
websites to disclose, among other
things, the ETF’s NAV per share for the
prior business day, the market closing
price or the midpoint of the bid-ask
spread at the time of the calculation of
NAV, and a calculation of the premium
or discount of the market closing price
or midpoint of the bid-ask spread
against NAV per share.134 However, the
proposed rule and disclosure
amendments would require ETFs to
disclose additional information on their
websites that is not currently required
under our exemptive orders.135
In particular, as discussed in section
II.C.6, we are proposing to require ETFs
to disclose on their websites the median
bid-ask spread for the ETF’s most recent
fiscal year and certain historical
information about the extent and
frequency of an ETF’s premiums and
discounts. This would allow investors
to be more aware of this risk when
deciding whether to invest in ETFs
132 For example, rule 22e–4 under the Act
requires ETFs to consider certain additional factors
that address the relationship between the liquidity
of the ETF’s portfolio and the arbitrage mechanism
in assessing, managing, and periodically reviewing
its liquidity risk. See LRM Adopting Release, supra
footnote 101. We have taken these requirements
into consideration in developing the conditions in
this proposal.
133 See infra section II.C.6.
134 See, e.g., Fidelity Commonwealth Trust,
Investment Company Act Release Nos. 32166 (June
29, 2016) [81 FR 44063 July 6, 2016)] (notice) and
32191 (July 26, 2016) (order) and related
application; Claymore Exchange-Traded Fund
Trust, Investment Company Act Release Nos. 27469
(Aug. 28, 2006) [71 FR 51869 (Aug. 31, 2006)]
(notice) and 27483 (Sept. 18, 2006) (order) and
related application.
135 See infra footnote 278 and accompanying and
following text (noting that, currently, Form N–1A
provides an ETF with the option to omit certain
historical information regarding premiums and
discounts from its prospectus and annual report if
the disclosure is provided on its website).
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generally or in a particular ETF. Our
proposed amendments to Form N–1A
would require additional disclosure
regarding ETF trading information and
related costs, including information
relating to high-end (95th percentile)
spread costs.136 We also request
comment below on whether there are
other ways to calculate premiums and
discounts, or other metrics we should
consider, to better inform investors
about an ETF’s history of deviations
between intraday market prices and (i)
the next-calculated NAV; or (ii) the
contemporaneous value of the ETF’s
portfolio.137
We request comment on the proposed
exemptions from section 22(d) of the
Act and rule 22c–1 thereunder.
• Is the proposed relief sufficient to
facilitate transactions in ETF shares on
the secondary market?
• Will the proposed conditions
(discussed below) promote the arbitrage
mechanism and support the
Commission granting this relief? Are
there other conditions we should
consider?
• Under what circumstances could a
premium or discount for an ETF
develop or persist? For example, when
would a premium or discount develop
due to a break-down in the arbitrage
mechanism? Are there instances where
a premium or discount may develop or
persist because of price discovery, such
as when the underlying markets for the
ETF’s component securities are closed?
Are there instances where a premium or
discount may develop or persist because
of transaction costs relating to the ETF’s
basket securities? How can these
circumstances be distinguished from
one another? Should we consider any
changes to our proposal to account for
these different circumstances?
• Would the arbitrage mechanism
contemplated by the proposed rule keep
ETF market prices at or close to NAV
per share under normal market
conditions? How should this be
measured? For example, is it
appropriate to assess premiums and
discounts solely by comparing ETF
market prices to the ETF’s NAV, which
typically is calculated at the end of the
day? Should intraday calculations play
a larger role when assessing premiums
and discounts? Should we, for example,
assess the efficiency of the arbitrage
mechanism by comparing the mean/
median of the market prices on a given
trading day against the end of day NAV?
Alternatively, should we compare the
mean/median of the market price on a
given trading day against an intraday
136 See
137 See
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infra section II.C.6.
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measure of the value of an ETF’s
portfolio?
3. Affiliated Transactions
Section 17(a) of the Act generally
prohibits an affiliated person of a
registered investment company, or an
affiliated person of such person, from
selling any security or other property to
or purchasing any security from the
company.138 Purchases and
redemptions of ETF creation units are
typically effected in kind, and section
17(a) prohibits these in-kind purchases
and redemptions by affiliated persons of
the ETF. An affiliated person of an ETF
includes, among others: (i) Any person
directly or indirectly owning,
controlling, or holding with power to
vote, 5% or more of the outstanding
voting securities of the ETF; (ii) any
person 5% or more of whose
outstanding voting securities are
directly or indirectly owned, controlled,
or held with power to vote by the ETF;
and (iii) any person directly or
indirectly controlling, controlled by, or
under common control with the ETF.139
ETF applicants have requested, and
we have granted, exemptive relief from
section 17(a) of the Act for: (i) Persons
affiliated with the ETF based on their
ownership of 5% or more of the ETF’s
outstanding securities (‘‘first-tier
affiliates’’); and (ii) affiliated persons of
the first-tier affiliates or persons who
own 5% or more of the outstanding
securities of one or more funds advised
by the ETF’s investment adviser
(‘‘second-tier affiliates’’).140 In seeking
this relief, applicants have stated that
first- and second-tier affiliates are not
treated differently from non-affiliates
when engaging in purchases and
redemptions of creation units.141 All
purchases and redemptions of creation
units are at an ETF’s next-calculated
NAV pursuant to rule 22c–1.
Additionally, the securities deposited or
delivered upon redemption are valued
in the same manner, using the same
standards, as those securities are valued
for purposes of calculating the ETF’s
NAV per share.
Proposed rule 6c–11 similarly would
provide exemptions from sections
17(a)(1) and (a)(2) of the Act with regard
to the deposit and receipt of baskets to
a person who is an affiliated person of
an ETF (or who is an affiliated person
of such a person) solely by reason of: (i)
Holding with the power to vote 5% or
more of an ETF’s shares; or (ii) holding
with the power to vote 5% or more of
any investment company that is an
affiliated person of the ETF.142 We
believe that this relief is necessary to
facilitate the efficient functioning of the
arbitrage mechanism. Without it, an
authorized participant or other market
participant that becomes an affiliated
person of the ETF due to its holdings
would be prevented from engaging in
arbitrage using an in-kind basket. This,
in turn, could have the adverse effect of
limiting the pool of market participants
that could engage in arbitrage.
Ultimately, it could result in the
deviation between market price and
NAV per share widening in cases where
there are very few authorized
participants or other market participants
actively engaged in transactions with
the ETF. The arbitrage mechanism for
newly launched ETFs could be
particularly challenged without this
relief because every purchaser of a
creation unit would be considered an
affiliated person of the ETF so long as
there are fewer than twenty creation
units outstanding. We also believe that
this relief is appropriate because all
purchases and redemptions of creation
units are at an ETF’s next-calculated
NAV, and the securities deposited or
delivered upon redemption would be
valued in the same manner, using the
same standards, as those securities are
valued for purposes of calculating the
ETF’s NAV.
The exemption in proposed rule 6c–
11(b)(3) is similar to the section 17(a)
exemption we proposed in 2008,
although the relief would be subject to
certain additional conditions related to
custom baskets.143 Commenters who
addressed the proposed relief in 2008
supported it.144 Several commenters,
however, requested that the relief be
expanded to cover additional types of
affiliated relationships, such as brokerdealers that are affiliated with the ETF’s
142 See
proposed rule 6c–11(b)(3).
id. To utilize custom baskets, proposed
rule 6c–11(c)(3) would require an ETF to adopt and
implement written policies and procedures that: (i)
Set forth detailed parameters for the construction
and acceptance of custom baskets that are in the
best interests of the ETF and its shareholders,
including the process for any revisions to, or
deviations from, those parameters; and (ii) specify
the titles or roles of the employees of the ETF’s
investment adviser who are required to review each
custom basket for compliance with those
parameters.
144 See, e.g., Comment Letter of Barclays Capital
Inc. (May 8, 2008); ICI 2008 Comment Letter; SSgA
2008 Comment Letter.
143 See
138 15
U.S.C. 80a–17(a).
U.S.C. 80a–2(a)(3)(A), (B) and (C). A control
relationship is presumed when one person owns
more than 25% of another person’s outstanding
voting securities. 15 U.S.C. 80a–2(a)(9).
140 See, e.g., Barclays Global 2000, supra footnote
6 (‘‘Because purchases and redemptions of Creation
Units may be ‘in-kind’ rather than cash
transactions, section 17(a) may prohibit affiliated
persons of an [ETF] from purchasing or redeeming
Creation Units.’’).
141 See e.g., Barclays Global 2008, supra footnote
58.
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adviser.145 These commenters noted
that any Commission concern of undue
influence by the affiliate would be
addressed by the federal securities laws
and regulations that prohibit
manipulative practices and misuse of
nonpublic information, and that ETFs
would benefit from an increase in
entities eligible to transact with the
ETF.146 An increase in the number of
authorized participants could also help
to reduce the potential for an ETF to be
reliant on one or more particular
authorized participants.147
While we acknowledge that an
increase in entities eligible to transact
with an ETF could facilitate the
arbitrage mechanism and reduce
concentration risk, we preliminarily do
not believe that it is appropriate to
expand the scope of affiliated persons
covered by the exemption at the same
time that we are permitting additional
flexibility with respect to custom
baskets. The proposed rule would allow
an ETF to utilize custom baskets if
certain conditions are met, increasing
the possibility that affiliates and nonaffiliates could be treated differently in
connection with an ETF’s receipt or
delivery of baskets.148 We believe that
the conditions related to the issuance or
acceptance of custom baskets in
proposed rule 6c–11 would provide
appropriate protections against
overreaching and similar abusive
practices when an ETF exchanges a
custom basket with an affiliate;
however, limiting the types of affiliates
that are permitted to rely on this
exemption would serve as an additional
protection against potential disparate
treatment in connection with an ETF’s
receipt or delivery of baskets.
We request comment on this aspect of
the proposed rule.
• Without an exemption from section
17(a) of the Act, would ETFs or
authorized participants bear any costs
that they do not incur today?
• As discussed above, the exemptive
relief from section 17(a) of the Act that
we are proposing would apply only to
145 See, e.g., ICI 2008 Comment Letter; BGFA
2008 Comment Letter.
146 See, e.g., ICI 2008 Comment Letter; ABA 2008
Comment Letter.
147 Item E.2.a. of Form N–CEN requires ETFs to
provide certain identifying information regarding
its authorized participants. See Investment
Company Reporting Modernization Adopting
Release, Investment Company Act Release No.
32314 (Oct. 13, 2016) [81 FR 81870 (Nov. 18, 2016)]
(‘‘Reporting Modernization Adopting Release’’)
(‘‘[C]ollecting information concerning these entities
on an annual basis will allow [the Commission] to
understand and better assess the size, capacity, and
concentration of the authorized participant
framework and also inform the public about certain
characteristics of the ETF primary markets.’’).
148 See proposed rule 6c–11(c)(3).
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in-kind purchases and redemptions of
creation units, and only to persons
affiliated with the ETF (or affiliates of
those persons) by reason of holding the
power to vote 5% or more of the ETF’s
shares or holding the power to vote 5%
or more of any investment company that
is affiliated with the ETF. Should the
relief extend to parties that are affiliated
persons of an ETF for other reasons, or
to non-creation unit transactions, such
as portfolio transactions? For example,
should a broker-dealer that is affiliated
with the ETF’s adviser be allowed to
transact in kind with the ETF? If so,
should the proposed rule include any
additional conditions to minimize
potential risks of overreaching for this
type of affiliated person? How would
expanding the scope of the exemption
in this manner interact with the
proposed conditions regarding basket
flexibility?
4. Additional Time for Delivering
Redemption Proceeds
Section 22(e) of the Act generally
prohibits a registered open-end
management investment company from
postponing the date of satisfaction of
redemption requests for more than
seven days after the tender of a security
for redemption.149 This prohibition can
cause operational difficulties for ETFs
that hold foreign investments and
exchange in-kind baskets for creation
units. For example, local market
delivery cycles for transferring foreign
investments to redeeming investors,
together with local market holiday
schedules, can sometimes require a
delivery process in excess of seven days.
These ETFs have previously requested,
and we have granted, relief from section
22(e) so that they may satisfy
redemptions up to a specified maximum
number of days (depending upon the
local markets), as disclosed in the ETF’s
prospectus or statement of additional
information (‘‘SAI’’). Other than in the
disclosed situations, these ETFs satisfy
redemptions within seven days.150
Section 22(e) was designed to prevent
unreasonable delays in the actual
payment of redemption proceeds.151
Proposed rule 6c–11 would provide an
exemption from section 22(e) of the Act
because we believe that the limited
nature of the exemption addresses the
concerns underlying this section of the
Act. As proposed, rule 6c–11 would
149 15
U.S.C. 80a–22(e).
e.g., Parker Global Strategies, supra
footnote 18.
151 See Investment Trusts and Investment
Companies: Hearings on S. 3580 Before a
Subcomm. of the Senate Comm. on Banking and
Currency, 76th Cong., 3d Sess. 291–293 (statements
of David Schenker).
150 See,
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grant relief from section 22(e) to permit
an ETF to delay satisfaction of a
redemption request for more than seven
days if a local market holiday, or series
of consecutive holidays, the extended
delivery cycles for transferring foreign
investments to redeeming authorized
participants, or the combination thereof
prevents timely delivery of the foreign
investment included in the ETF’s
basket.152 To rely on this exemption, an
ETF would be required to deliver
foreign investments as soon as
practicable, but in no event later than 15
days after the tender to the ETF.153 This
proposed exemption thus would permit
a delay in the delivery of foreign
investments only if the foreign
investment is being transferred in kind
as part of the basket.154
The exemption would permit a delay
only to the extent that additional time
for settlement is actually required, when
a local market holiday, or series of
consecutive holidays, or the extended
delivery cycles for transferring foreign
investments to redeeming authorized
participants prevents timely delivery of
the foreign investment included in the
ETF’s basket. To the extent that
settlement times continue to shorten,
the ‘‘as soon as practicable’’ language
embedded in the exemption is designed
to minimize any unnecessary settlement
delays.155 If a foreign investment settles
152 Proposed rule 6c–11(b)(4). This relief from the
requirements of section 22(e) would not affect any
obligations arising under rule 15c6–1 under the
Exchange Act, which requires that most securities
transactions be settled within two business days of
the trade date. 17 CFR 240.15c6–1.
153 Proposed rule 6c–11(b)(4).
154 While mutual funds also may invest in foreign
investments that require a delivery process in
excess of seven days, mutual funds typically deliver
redemption proceeds in cash, rather than in kind.
Mutual funds, ETFs that redeem in cash, and ETFs
that substitute cash in lieu of a particular foreign
investment in a basket do not require an exemption
from section 22(e) of the Act.
155 Austria, Belgium, Bulgaria, Croatia, Cyprus,
the Czech Republic, Denmark, Estonia, Finland,
France, Germany, Greece, Hungary, Iceland, Italy,
Ireland, the Netherlands, Latvia, Lichtenstein,
Lithuania, Luxembourg, Malta, Norway, Poland,
Portugal, Romania, Slovakia, Slovenia, Spain
(certain fixed-income trades only), Sweden,
Switzerland, and the United Kingdom moved to a
T+2 settlement cycle by the end of 2014, while
Australia and New Zealand transitioned to a T+2
settlement cycle in 2016. See Amendments to
Securities Transaction Settlement Cycle, Exchange
Act Release No. 78962 (Sept. 28, 2016) [81 FR
69240 (Oct. 5, 2016)], at n.134. Like the United
States, Mexico, Canada, Peru and Argentina moved
to a T+2 settlement cycle in September 2017. See
T+2 Adopting Release, supra footnote 99. See also
Annie Massa, Your Trades Will Soon Spend Less
Time Stuck in Market’s Plumbing, Bloomberg
Markets (Aug. 31, 2017), available at https://
www.bloomberg.com/news/articles/2017-08-31/
your-trades-will-soon-spend-less-time-stuck-inmarket-s-plumbing. There are many securities that
trade over the counter (OTC) in certain foreign
markets with agreed-upon settlement timeframes
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in less than 15 days, the ETF would be
required to deliver it pursuant to the
standard settlement time of the local
market where the investment trades.
In addition, given the continued
movement toward shorter settlement
times in markets around the world, we
believe that the relief from section 22(e)
in the proposed rule does not need to be
permanent. Accordingly, we propose to
include a sunset provision in the
proposed rule relating to the relief from
section 22(e). Absent further action by
the Commission, the exemption from
section 22(e) for postponement of
delivering redemption proceeds would
expire ten years from the rule’s effective
date. We believe that technological
innovation and changes in market
infrastructures and operations will lead
to further shortening of settlement
cycles, although these developments
may be gradual. Therefore, we believe it
is appropriate for the relief from section
22(e) to be limited in duration to ten
years.156
In 2008, we proposed a similar
exemption for postponement of
delivering redemption proceeds.
However, that exemption would have
allowed up to 12 days to deliver
redemption proceeds without an
offsetting requirement to deliver as soon
as practicable and without a sunset
provision.157 Commenters on the 2008
proposal agreed that the specified delay
in satisfying redemption requests
seemed reasonable because it was for a
limited period of time and disclosed to
investors.158 However, one commenter
suggested increasing the period of time
for settlement beyond 12 days
consistent with the terms of exemptive
orders that had been issued to some
ETFs.159 Since 2012, numerous
applicants for exemptive relief have
indicated that payment or satisfaction of
redemption requests may take as long as
15 days after a redemption request is
received, and we have issued orders
permitting delayed delivery of
settlement proceeds for up to 15
days.160 We believe an extended
between the parties that could extend beyond the
settlement timeframes of central securities
depositories.
156 ETFs that invest in foreign investments from
jurisdictions that continue to require more than
seven days to deliver redemption proceeds would
have the option of redeeming in cash rather than
in-kind once the exemptive relief sunsets. Such
ETFs also could request targeted exemptive relief
from section 22(e) from the Commission.
157 See 2008 ETF Proposing Release, supra
footnote 3.
158 See, e.g., Katten 2008 Comment Letter;
Xshares 2008 Comment Letter.
159 Katten 2008 Comment Letter (recommending
up to 14 days).
160 See, e.g., Legg Mason ETF Trust, Investment
Company Act Release Nos. 30237 (Oct. 22, 2012)
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settlement period in these
circumstances of 15 days, with the
requirement that delivery nevertheless
be made as soon as practicable, is
reasonable in light of the limited nature
and duration of the exemption.
The exemption we proposed in 2008
would have required an ETF to disclose
in its registration statement the foreign
holidays that it expects may prevent
timely delivery of foreign securities, and
the maximum number of days that it
anticipates it will need to deliver the
foreign securities.161 We are not
proposing a similar requirement for
several reasons. First, we do not believe
this disclosure is relevant to investors
who purchase ETF shares on the
secondary market, because the
settlement of these investors’ ETF trades
would be unaffected by the potential
delay. Only authorized participants
engaged in redemption transactions
with the ETF (and market participants
that use the authorized participants as
their agents for transacting with the
ETF) would be affected. We believe that
information regarding these potential
delays is typically covered in the
agreement governing the relationship
between the ETF and the authorized
participant (an ‘‘authorized participant
agreement’’) and would likely be shared
by the authorized participant with other
market participants, as necessary.162
Therefore, authorized participants
already have information regarding
potential delays. Second, given that
these delays are typically covered by the
authorized participant agreement, we do
not believe it is necessary to require
ETFs to provide registration statement
disclosures.
The proposed rule would define
‘‘foreign investment’’ as any security,
asset or other position of the ETF issued
by a foreign issuer (as defined by rule
3b–4 under the Exchange Act) for which
there is no established U.S. public
trading market (as that term is used in
Regulation S–K under the Securities
Act).163 This definition differs from the
one we proposed in 2008 in that it
references rule 3b–4 rather than
enumerating the types of foreign entities
that are considered issuers of foreign
[77 FR 65425 (Oct. 26, 2012)] (notice) and 30265
(Nov. 16, 2012) (order) and related application
(‘‘Legg Mason’’).
161 See 2008 ETF Proposing Release, supra
footnote 3.
162 For example, an authorized participant acting
as an agent typically would share this information
with its customer if it is a necessary part of the
creation or redemption process.
163 See proposed rule 6c–11(a); see also rule
201(a) of Regulation S–K [17 CFR 229.201(a)]
(describing how a registrant should identify its
principal United States market or markets); rule
3b–4 of the Exchange Act [17 CFR 240.3b–4].
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investments.164 We believe this
approach is appropriate because it
creates consistency with a long-accepted
definition under Exchange Act rules.165
The reference to whether the investment
has an ‘‘established U.S. public trading
market’’ is designed to make the relief
unavailable to an ETF that could trade
the investment in its basket on a U.S.
market, thereby avoiding the settlement
delay that is the basis for the relief.166
In addition, this definition is not limited
to ‘‘foreign securities,’’ but also would
include other investments that may not
be considered securities. Although these
other investments may not be securities,
they may present the same challenges
for timely settlement as foreign
securities if they are transferred in kind.
This approach is consistent with the
terms of some recent exemptive orders
that provide relief from section 22(e) for
the delivery of foreign investments that
may not be securities.167
We request comment on this aspect of
the proposed rule.
• Is this relief necessary, particularly
given that many non-U.S. jurisdictions
have shorter settlement periods today
than when we began granting this relief
to ETFs? We specifically request
comment regarding how frequently
ETFs rely on this exemption. Should we
permit the delayed delivery of
settlement proceeds for up to 15 days?
Is this period too long or too short?
Should the rule refer to the applicable
local market’s settlement cycle without
specifying a number of days? Should we
require that the ETF deliver foreign
investments as soon as practicable, as
proposed, in order to minimize
unnecessary settlement delays?
• Should we include a sunset
provision for this relief as proposed? Is
the duration of the proposed sunset
164 The 2008 proposal defined ‘‘foreign security’’
as any security issued by a government or political
subdivision of a foreign country, or corporation or
other organization incorporated or organized under
the laws of any foreign country and for which there
is no established U.S. public trading market. See
2008 ETF Proposing Release, supra footnote 3.
165 Rule 3b-4 under the Exchange Act was
adopted in 1967. See Adoption of Rules Relating to
Foreign Securities, Exchange Act Release No. 8066
(Apr. 28, 1967) [32 FR 7848 (May 30, 1967)].
166 The rule does not rely on registration status
because an unregistered large foreign private issuer
may have an active U.S. market for its securities,
in which case the ETF should be able to meet
redemption requests in a timely manner. See
Termination of a Foreign Private Issuer’s
Registration of a Class of Securities Under Section
12(g) and Duty to File Reports Under Section 13(a)
or 15(d) of the Securities Exchange Act of 1934,
Exchange Act Release No. 55540 (Mar. 27, 2007) [72
FR 16934 (Apr. 5, 2007)].
167 See, e.g., Redwood Investment Management,
LLC, et al., Investment Company Act Release Nos.
33076A (Apr. 26, 2018) [83 FR 19367 (May 2, 2018)]
(notice) and 33100 (May 21, 2018) (order) and
related application.
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provision appropriate? Should it be
longer or shorter?
• Is the proposed definition of
‘‘foreign investment’’ appropriate for
identifying investments that may
routinely settle more than seven days
after a redemption request? For
example, are there circumstances where
a U.S. entity could be subject to delays
due to local market restrictions? Should
we utilize a definition found elsewhere
in rules and regulations set forth under
the Exchange Act, the Investment
Company Act, or other securities laws
(e.g., the definition of ‘‘foreign security’’
set forth in rule 15a–6 under the
Exchange Act, or the definition of
‘‘foreign assets’’ set forth in rule 17f–5
under the Investment Company Act)?
Alternatively, should we utilize the
definition of ‘‘foreign security’’ set forth
in the 2008 ETF Proposing Release, or
utilize an entirely new definition? If
recommending an alternate definition,
please explain the specific types of
investments that would be better
captured or that would be excluded by
that definition.
• Should the rule also provide relief
if an ETF has foreign investments in its
portfolio (and not in a particular
basket)? If so, why? Should the rule
permit the delayed delivery of the entire
basket (instead of the specific foreign
investments in a basket) if the basket is
composed substantially of foreign
investments subject to potential delays
in the delivery of settlement proceeds?
• Are we correct that information
regarding potential delays in the
delivery of settlement proceeds for
foreign investments typically is covered
in the authorized participant agreement?
If so, are we also correct that authorized
participants acting as agents typically
would share this information with their
customers if it is a part of the
redemption process?
• Should the rule require disclosure
in an ETF’s Statement of Additional
Information of the foreign holidays an
ETF expects may prevent timely
delivery of the foreign investments and
the maximum number of days it
anticipates it would need to deliver the
foreign investments as required by
current exemptive orders? For example,
should we require ETFs relying on this
exemption to include a more general
statement in their prospectus or SAI that
the ETF may take up to 15 days to
deliver settlement proceeds for certain
foreign investments affected by foreign
holidays, rather than the more specific
statement of each holiday an ETF
expects may prevent timely delivery of
the investments that is currently
required? Should these disclosures be
included in an ETF’s sales literature or
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on its website? Alternatively, should we
require ETFs to provide a written notice
of the foreign holidays an ETF expects
may prevent timely delivery of the
foreign investments to authorized
participants as a condition to rule
6c–11? If so, how often should this
information be updated?
• Do secondary market investors or
others use information regarding delays
in the delivery of foreign investments?
C. Conditions for Reliance on Proposed
Rule 6c–11
Proposed rule 6c–11 would require
ETFs to comply with certain conditions
that would allow them to operate within
the scope of the Act, and that are
designed to protect investors and to be
consistent with the purposes fairly
intended by the policy and provisions of
the Act. These conditions are generally
consistent with the conditions we have
imposed under our exemptive orders,
which we believe have effectively
accommodated the unique structural
and operational features of ETFs while
maintaining appropriate protections for
ETF investors. The conditions also
reflect certain changes to the conditions
imposed under our exemptive orders
that, based on 26 years of experience
regulating ETFs, we believe will
improve the overall regulatory
framework for these products.
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1. Issuance and Redemption of Shares
Proposed rule 6c–11 would include
several requirements in the paragraph
defining ‘‘exchange-traded fund,’’
including a requirement that the ETF
issue (and redeem) creation units to
(and from) authorized participants in
exchange for baskets and a cash
balancing amount (if any).168 As such,
the proposed rule would seek to
preserve the existing structure, reflected
in our ETF exemptive orders, whereby
only an authorized participant of an
ETF may purchase creation units from
(or sell creation units to) the ETF. This
requirement is designed to preserve an
orderly creation unit issuance and
redemption process between ETFs and
authorized participants. An orderly
creation unit issuance and redemption
process is of central importance to the
arbitrage mechanism, which forms the
basis for several of the proposed rule’s
exemptive provisions.
The proposed rule would define an
authorized participant as a member or
participant of a clearing agency
registered with the Commission, which
has a written agreement with the ETF or
168 See proposed rule 6c–11(a). See also infra
section II.C.5 (discussing definitions of baskets and
cash balancing amount).
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one of its service providers that allows
the authorized participant to place
orders for the purchase and redemption
of creation units.169 This definition
differs from the definition of
‘‘authorized participant’’ we recently
adopted in connection with Form N–
CEN, which, in relevant part, defines
the term as a broker-dealer that is also
a member of a clearing agency registered
with the Commission or a DTC
Participant and has a written agreement
with the ETF or one of its service
providers that allows the authorized
participant to place orders to purchase
and redeem creation units of the ETF.170
Our proposed definition also differs
from the definition of authorized
participant in our ETF exemptive orders
and Form N–CEN, because it does not
include a specific reference to an
authorized participant’s participation in
DTC since DTC is itself a clearing
agency.171 We believe the definition that
we are proposing remains largely
consistent with our existing exemptive
relief, while eliminating unnecessary
terms. As discussed further below, we
are proposing a corresponding
amendment to Form N–CEN.172
The proposed rule would define the
term ‘‘creation unit’’ to mean a specified
number of ETF shares that the ETF will
issue to (or redeem from) an authorized
participant in exchange for the deposit
(or delivery) of a basket and a cash
balancing amount (if any).173 In their
exemptive applications, ETFs have
stated that they would establish a
specific creation unit size (i.e., a
minimum number of shares).174
Creation unit aggregations may differ
among ETFs based on an ETF’s
investment strategy, the type and
availability of the assets in the basket,
and the types of authorized participants
(and other market participants) that are
expected to engage in creation and
redemption transactions with the ETF.
For example, an ETF tracking a
narrowly focused niche strategy may
establish a smaller creation unit size
than an ETF tracking a broad-based
index, such as the S&P 500, in order to
rule 6c–11(a).
Instruction to Item E.2 of Form N–CEN.
See also Reporting Modernization Adopting
Release, supra footnote 147.
171 See, e.g., Legg Mason, supra footnote 160. The
2008 proposal would not have defined the term
‘‘authorized participant’’ because this term was not
used in the definition of an ETF. See 2008 ETF
Proposing Release, supra footnote 3 (defining ETF
to mean, in relevant part, a registered open-end
management company that issues (or redeems)
creation units in exchange for the deposit (or
delivery) of basket assets).
172 See infra section II.J.
173 Proposed rule 6c–11(a).
174 See, e.g., Legg Mason, supra footnote 160.
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170 See
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facilitate arbitrage. Accordingly, we do
not believe it is necessary to mandate a
particular maximum or minimum
creation unit size for all types of ETFs.
This approach is consistent with our
2008 proposal, and commenters who
addressed this aspect of the 2008
proposal generally supported it.175
While we believe that creation unit
sizes are an important component in
effective arbitrage, we do not propose to
expressly require, as we proposed in
2008, that an ETF establish creation unit
sizes reasonably designed to facilitate
arbitrage.176 Commenters on this aspect
of the 2008 proposal generally believed
that the proposed standard was too
vague and that an ETF would not have
an incentive to establish creation unit
sizes that would be too large or too
small to facilitate effective arbitrage.177
Some commenters also questioned the
description of arbitrage embedded
within the 2008 definition of creation
unit on the basis that the definition did
not capture all forms of arbitrage.178
As we noted in the 2008 proposal, a
large creation unit size could reduce the
willingness or ability of authorized
participants (and other market
participants) to engage in creation unit
purchases or redemptions.179 Impeding
the ability of authorized participants to
purchase and redeem ETF shares could
disrupt arbitrage pricing discipline,
which could lead to more frequent
occurrences of premiums or discounts
to NAV per share of the ETF.
Conversely, a small creation unit size
could discourage market making and
render creation units irrelevant because
the ETF could issue and redeem ETF
shares much like a mutual fund.180 We
agree with the view that ETFs are not
likely to have an incentive to set very
large or very small creation unit sizes
that could disrupt the arbitrage
175 See 2008 ETF Proposing Release, supra
footnote 3; see also, e.g., Comment Letter of James
J. Angel (May 16, 2008); Comment Letter of
Chapman and Cutler LLP (May 19, 2008)
(‘‘Chapman 2008 Comment Letter’’).
176 See 2008 ETF Proposing Release, supra
footnote 3 (describing arbitrage, for these purposes,
as ‘‘the purchase (or redemption) of shares from the
ETF with an offsetting sale (or purchase) of shares
on a national securities exchange at as nearly the
same time as practicable for the purpose of taking
advantage of a difference in the Intraday Value and
the [market price] of the shares.’’).
177 See, e.g., Vanguard 2008 Comment Letter;
BGFA 2008 Comment Letter. But see Xshares 2008
Comment Letter (‘‘The proposal to ‘establish
creation unit sizes the number of which is
reasonably designed to facilitate arbitrage’ seems to
describe the process that we apply when
determining the basket size and is appropriate, as
is the definition of arbitrage.’’).
178 See ICI 2008 Comment Letter; Katten 2008
Comment Letter.
179 See 2008 Proposing Release, supra footnote 3.
180 See id.
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mechanism and that an ETF would
establish a size that is appropriate for
market demand given its investment
strategies and objectives. Moreover, we
believe that the conditions in the
proposed rule designed to promote
effective arbitrage are better suited for
that purpose than conditions related to
creation unit size.
An ETF generally would issue and
redeem shares only in creation unit size
aggregations under the proposed rule.
However, the proposed rule would
permit an ETF to sell or redeem
individual shares on the day of
consummation of a reorganization,
merger, conversion or liquidation.181 In
a merger, for example, an acquired ETF
typically transfers substantially all of its
assets to a surviving ETF in exchange
for interests in the surviving ETF. We
understand that, under these limited
circumstances, a surviving ETF may
need to issue shares, not necessarily in
creation unit aggregations, to
shareholders of the acquired ETF
without utilizing authorized
participants. Similarly, an ETF may
need to issue individual shares in
connection with a reorganization,
conversion, or liquidation. We also
understand that the redemptions that
take place in connection with these
transactions are generally intended to
facilitate the transactions themselves
and compensate individual
shareholders that may be exiting the
reorganized, merged, converted or
liquidated ETF—activities likely to
involve small cash amounts and to be
outside the scope of an authorized
participant’s expected role of
transacting in creation units. We believe
that permitting ETFs to conduct
redemptions with investors other than
authorized participants in these limited
circumstances is operationally
necessary to facilitate reorganizations,
mergers, conversions or liquidations.
Permitting ETFs to transact with other
investors in these limited circumstances
also is consistent with prior exemptive
relief, which permits ETF shares to be
individually redeemable in connection
with the termination of an ETF.182
An additional issue related to the
issuance and redemption of ETF shares
is the extent to which an ETF may
directly or indirectly suspend these
processes. An ETF that suspends the
181 See
proposed rule 6c–11(c)(5).
e.g., Application of FFCM, LLC, et al.
(June 12, 2017), at n.23 (‘‘Therefore, in the event of
a termination, the Board in its discretion could
determine to permit the Shares to be individually
redeemable. In such circumstances, the Fund might
elect to pay cash redemptions to all shareholders,
with an ‘in-kind’ election for shareholders owning
in excess of a certain stated minimum amount.’’).
182 See,
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issuance or redemption of creation units
indefinitely could cause a breakdown of
the arbitrage mechanism, resulting in
significant deviations between market
price and NAV per share. Such
deviations may be harmful to investors
that purchase shares at market prices
above NAV per share and/or sell shares
at market prices below NAV per share.
An ETF may suspend the redemption of
creation units only in accordance with
section 22(e) of the Act,183 and an ETF
may charge transaction fees on creation
unit redemptions only in accordance
with 17 CFR 270.22c–2 (‘‘rule 22c–
2’’).184 In addition, we believe an ETF
generally may suspend the issuance of
creation units only for a limited time
and only due to extraordinary
circumstances, such as when the
markets on which the ETF’s portfolio
holdings are traded are closed for a
limited period of time.185 We also
believe that an ETF could not set
transaction fees so high as to effectively
suspend the issuance of creation units.
We request comment on this
requirement.
• Should we require, as proposed,
that an ETF issue (and redeem) creation
units to (and from) authorized
participants in exchange for baskets and
a cash balancing amount if any? Are
there alternative formulations that we
should consider? Does this provision
facilitate the arbitrage mechanism?
• Should we define ‘‘authorized
participant’’ as proposed? Should other
criteria apply? For example, should the
definition require authorized
participants to be registered brokerdealers?
• Instead of amending the definition
of ‘‘authorized participant’’ in Form
N–CEN as proposed below in order to
correspond with proposed rule 6c–11,
183 Section 22(e) of the Act permits open-end
funds to suspend redemptions and postpone
payment for redemptions already tendered for any
period during which the New York Stock Exchange
is closed (other than customary weekend and
holiday closings) and in three additional situations
if the Commission has made certain determinations.
See LRM Adopting Release, supra footnote 101, at
n.36.
184 See supra footnote 24 and accompanying text.
Rule 22c–2 limits redemption fees to no more than
2% of the value of shares redeemed. See rule 22c–
2(a)(1)(i). In other contexts, the Commission has
limited redemption fees paid by redeeming
shareholders, as well as swing pricing NAV
adjustments, to no more than 2%. See Investment
Company Swing Pricing, Investment Company Act
Release No. 32316 (Oct. 13, 2016) [81 FR 82084
(Nov. 18, 2016)] (describing liquidity fees under
rule 2a–7 and the swing factor upper limit under
rule 22c–1).
185 See Comment Letter of BlackRock on 2015
ETP Request for Comment (Aug. 11, 2015) (noting
that suspensions of creations are rare, but an ETF
could suspend creations when it is unable to
increase its exposure to underlying assets, such as
when a non-U.S. market suspends capital inflows).
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should we use the existing Form N–CEN
‘‘authorized participant’’ definition for
rule 6c–11? Should we have the same
definition of ‘‘authorized participant’’
for both rule 6c–11 and Form N–CEN?
Would different definitions cause
confusion or operational difficulties?
• Do commenters agree with our
understanding that ETFs are not likely
to have an incentive to set very large or
very small creation unit sizes that could
disrupt the arbitrage mechanism?
• Should we establish requirements
for creation unit sizes and/or dollar
amounts? Alternatively, should we
establish a standard for how ETFs must
establish creation unit sizes? If so, what
standard should be established? Do
differently sized creation units present
different operational challenges? If so,
please explain these challenges, and
provide data to support such a view.
• Would institutional investors
engage in more create/redeem
transactions with an ETF, through an
authorized participant, if the ETF
established a smaller creation unit size?
If so, what are the costs and benefits of
this result? Would it impact the
efficiency of the ETF’s arbitrage
mechanism? If so, how?
• Should we permit an ETF to sell or
redeem individual shares on the day of
consummation of a reorganization,
merger, conversion or liquidation as
proposed? Should we define any or all
of the terms ‘‘reorganization,’’ ‘‘merger,’’
‘‘conversion’’ and ‘‘liquidation’’ for
purposes of this condition? If so, how
should those terms be defined? For
example, as an alternative, should we
consider the definition for ‘‘merger’’ in
17 CFR 270.17a–8 (‘‘rule 17a–8’’ under
the Act)? 186 Are there other
circumstances or transactions that
should be included within this
provision? For example, should we
specify in this provision that shares may
be issued other than in creation unit
size aggregations as part of a dividend
reinvestment program? Is any additional
relief needed to conduct these
transactions? Should the relief be
limited to the day of consummation of
the transaction, as proposed? Should the
relief be limited in time at all? Should
more time be provided? If so, how much
time?
• Do commenters generally agree that
an ETF may suspend creations only in
limited circumstances? Do commenters
generally agree that an ETF could not
set transaction fees so high as to
effectively suspend the issuance of
186 See rule 17a–8(b)(1) (defining ‘‘merger’’ as the
‘‘merger, consolidation, or purchase or sale of
substantially all of the assets between a registered
investment company (or a series thereof) and
another company’’).
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creation units? Is any additional
guidance needed? Should we consider
including provisions in rule 6c–11 that
would permit ETFs to suspend creations
or redemptions in particular
circumstances?
2. Listing on a National Securities
Exchange
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Proposed rule 6c–11 defines
‘‘exchange-traded fund,’’ in part, to
mean a fund that issues shares that are
listed on a national securities exchange
and traded at market-determined
prices.187 Exchange-listing is one of the
fundamental characteristics that
distinguishes an ETF from other types of
open-end funds (and UITs) and is one
reason that ETFs need certain
exemptions from the Act and the rules
thereunder. The Commission has
premised all of its previous exemptive
orders on an ETF listing its shares for
trading on a national securities
exchange.188 Listing on an exchange
provides an organized and continuous
trading market for the ETF shares at
market-determined prices. Trading on
an exchange also is important to a
functioning arbitrage mechanism. We
proposed a similar condition in 2008
that would have required ETF shares to
be approved for listing and trading on
a national securities exchange.189
Commenters on the 2008 proposal
generally agreed that listing on an
exchange would provide an organized
and continuous trading market for the
ETF shares.190
The proposed definition would
require that the ETF’s shares be traded
at market-determined prices. Like other
exchange-traded equity securities,
however, we understand that there may
be instances where ETF shares simply
may not trade for a given period due to
a lack of market interest.191 This
proposed requirement is not designed to
establish a minimum level of trading
volume for ETFs necessary in order to
rely on the rule, but rather to
distinguish ETFs from other products
that are listed on exchanges, but trade
187 Proposed rule 6c–11(a). For purposes of the
rule, a ‘‘national securities exchange’’ would be
defined as an exchange that is registered with the
Commission under section 6 of the Exchange Act.
188 See, e.g., PowerShares Capital Management
LLC, et al., Investment Company Act Release Nos.
28140 (Feb. 1, 2008) [73 FR 7328 (Feb. 7, 2008)]
(notice) and 28171 (Feb. 27, 2008) (order) and
related application (‘‘PowerShares’’).
189 See 2008 ETF Proposing Release, supra
footnote 3.
190 See, e.g., NYSE Arca 2008 Comment Letter;
SSgA 2008 Comment Letter.
191 Based on staff analysis of data obtained from
Bloomberg, approximately 5% of ETFs do not trade
on the secondary market on a given trading day.
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at NAV-based prices (i.e., exchangetraded managed funds).192
An ETF that is delisted from a
national securities exchange would not
meet the definition of ‘‘exchange-traded
fund,’’ and would no longer be eligible
to rely on the proposed rule. Such a
fund thus would be required to meet
individual redemption requests within
seven days pursuant to section 22(e) of
the Act or liquidate.193 We requested
comment in the 2008 proposal on
whether the rule should include an
exception for ETF shares that are
delisted for a short time or suspended
from listing.194 Commenters generally
did not support such an exception,
asserting that it would be difficult for
the Commission to identify all of the
circumstances in which such an
exception would be appropriate, and
recommended that ETFs seek individual
exemptive relief from the listing
requirement under these
circumstances.195 We are not aware of
any ETF requesting an order that omits
the requirement that its shares be listed
on an exchange. Therefore, we do not
propose to include an exemption for
ETFs whose shares are suspended or
delisted.
We request comment on this
requirement.
• Should the rule make allowance for
shares that are delisted for a short time,
or for halts or suspensions in trading? If
so, how would the arbitrage mechanism
function in these circumstances?
3. Intraday Indicative Value
Exchange listing standards include a
requirement that an intraday estimate of
an ETF’s NAV per share (an ‘‘intraday
indicative value’’ or ‘‘IIV’’) be widely
disseminated at least every 15 seconds
during regular trading hours (60 seconds
for international ETFs).196 Our orders
192 Proposed rule 6c–11 would not apply to
exchange-traded managed funds (ETMFs), which
are not ETFs, but rather hybrids between mutual
funds and ETFs. Unlike ETFs, secondary market
transactions in ETMFs do not occur at a marketdetermined price. Rather, they occur at the nextdetermined NAV plus or minus a marketdetermined premium or discount that may vary
during the trading day. See Eaton Vance
Management, et al., Investment Company Act
Release Nos. 31333 (Nov. 6, 2014) [79 FR 67471
(Nov. 13, 2014)] (notice) and 31362 (Dec. 2, 2014)
(order) and related application.
193 Indeed, an ETF that does not comply with the
provisions of the rule would be required to comply
with the Investment Company Act in all respects
unless it was relying on other relief.
194 See 2008 ETF Proposing Release, supra
footnote 3, at text following n.94.
195 BGFA 2008 Comment Letter; ICI 2008
Comment Letter.
196 See, e.g., NYSE Arca Equities Rule 5.2–E(j)(3),
Commentary .01(c) (stating that the IIV may be
based upon ‘‘current information regarding the
required deposit of securities and cash amount to
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also require the dissemination of the
IIV, and ETFs have stated in their
exemptive applications that an ETF’s
IIV is useful to investors because it
allows them to determine (by comparing
the IIV to the market value of the ETF’s
shares) whether and to what extent the
ETF’s shares are trading at a premium
or discount.197 We are not proposing,
however, to require the dissemination of
an ETF’s IIV as a condition of the
proposed rule. We understand that
market makers today typically calculate
their own intraday value of an ETF’s
portfolio with proprietary algorithms
that use an ETF’s daily portfolio
disclosure and available pricing
information about the assets held in the
ETF’s portfolio.198 We further
understand that they generally use the
IIV, if at all, as a secondary or tertiary
check on the value that their proprietary
algorithms generate.199
We believe that the IIV is no longer
used by market participants when
conducting arbitrage trading. In today’s
fast-moving markets, 15 seconds is
likely too long for purposes of efficient
market making and could result in poor
execution.200 An ETF’s current value
changes every time the value of any
underlying component of the ETF
portfolio changes. Therefore, the IIV for
a more frequently traded component
security might not effectively take into
account the full trading activity for that
security, despite being available every
15 seconds. In particularly volatile
permit creation of new shares of the series or upon
the index value’’); see also supra footnote 14 and
accompanying text. The IIV is also sometimes
referred to as the ‘‘iNAV’’ (indicative net asset
value) or the ‘‘PIV’’ (portfolio indicative value).
197 See, e.g., 2006 WisdomTree Investments,
supra footnote 66.
198 David J. Abner, The ETF Handbook: How to
Value and Trade Exchange Traded Funds (2010), at
90 (‘‘Since stock trading now takes place in
microseconds, a lot can happen between two
separate 15-second quotes. Professional traders are
not using the published IIVs as a basis for trading.
Most, if not all, desks that are trading ETFs are
calculating their own [NAV of the ETF] based on
real time quotes . . . that they are generating within
their own systems.’’).
199 See, e.g., Spruce ETF Trust, et al., Investment
Company Act Release Nos. 31301 (Oct. 21, 2014)
[79 FR 63964 (Oct. 27, 2014)] (notice) and 31337
(Nov. 14, 2017) (order permitting withdrawal of
application) and related application (withdrawn).
200 See, e.g., Gary Gastineau, How to Minimize
Your Cost of Trading ETFs, ETF.com (June 22,
2009), available at https://www.etf.com/
publications/journalofindexes/joi-articles/6042how-to-minimize-your-cost-of-trading-etfs.html, at
Figure 2 and related discussion. See also Comment
Letter of ICI on NASDAQ proposed rule change
relating to iNAV pegged orders for ETFs, File No.
SR–NASDAQ–2012–117 (Nov. 8, 2012), at 4
(‘‘Professional equity traders operate at speeds
calculated in fractions of a second. In such markets,
15 seconds can be an eternity, and establishing an
order price based on data that is nearly 15 seconds
old could result in poor execution.’’).
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markets, the dissemination lag of the IIV
may not reflect the actual value of the
ETF.201
The IIV also may not reflect the actual
value of an ETF that holds securities
that do not trade frequently. For
example, the IIV can be stale or
inaccurate for ETFs with foreign
securities or less liquid debt
instruments. For such ETFs, there may
be a difference in value between the IIV,
which is constructed using the last
available market quotations or stale
prices, and the ETF’s NAV, which uses
fair value when market quotations are
not readily available.202 Moreover,
because there currently are no uniform
methodology requirements, the IIV can
be calculated in different, and
potentially inconsistent, ways.
Several commenters to the 2008 ETF
Proposing Release, which would have
included an IIV dissemination
requirement, agreed that market
professionals no longer rely on the
exchange-published IIV.203 Commenters
on the 2015 ETP Request for Comment
also stated that the IIV is not always
reliable, and in some cases is
misleading, particularly when the
underlying holdings are less liquid, or,
in the case of certain international ETFs,
not traded during the same hours as the
ETF shares.204
201 See Understanding iNAV, ETF.com, available
at https://www.etf.com/etf-education-center/21028understanding-inav.html https://www.etf.com/etfeducation-center/21028-understandinginav.html?nopaging=1; Gary Gastineau, ExchangeTraded Funds Manual, 2nd Ed. (2010), at 200–202.
202 Section 2(a)(41)(B) of the Act defines ‘‘value’’
as: ‘‘(i) with respect to securities for which market
quotations are readily available, the market value of
such securities; and (ii) with respect to other
securities and assets, fair value as determined in
good faith by the board of directors.’’ This
definition also is used in rule 2a–4 under the Act
as the required basis for computing a fund’s current
NAV per share. With daily portfolio disclosure,
market participants can estimate fair value on their
own for the holdings of current ETFs. 15 U.S.C.
80a–2(a)(41)(B).
203 See BGFA 2008 Comment Letter; Xshares 2008
Comment Letter.
204 See Schwab ETP Comment Letter, supra
footnote 115, at 7 (‘‘[A]s the ETF marketplace has
expanded into such markets as fixed income,
precious metals, and foreign securities the
published data points can be potentially misleading
when the reference asset the ETF is covering is not
open for pricing or transactions . . . [t]he
requirement for publication of the IIV every 15
seconds seems antiquated in the evolving electronic
trading world in which we are currently immersed.
Trading now occurs in micro and nano seconds and
the lag between the published IIV value and real
time quoting and trading has essentially made the
calculation of limited worth even when the
reference asset is open for pricing.’’); Comment
Letter of Eaton Vance Corp. to Request for Comment
on Exchange-Traded Products (File No. S7–11–15)
(Aug. 17, 2015) (stating that the IIV is ‘‘frequently
highly misleading’’ as an indicator of current fund
value and investor trading costs); see also John
Spence, ETFs Unfairly Blamed in Recent Market
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As discussed below, we are proposing
that rule 6c–11 condition its relief on
the daily disclosure of portfolio
holdings. We believe that this disclosure
would promote the availability of
information to market participants to
support their ability to calculate an
estimated intraday value of the ETF’s
portfolio holdings using their own
methodologies. Therefore, the proposed
rule would not include a requirement
for IIV dissemination.
We request comment on this aspect of
our proposal.
• Should proposed rule 6c–11
condition relief on dissemination of the
IIV? If so, who should be required to
disseminate the IIV? The national
securities exchange on which the ETF is
listed? Other entities?
• Are we correct in our
understanding that market participants
today typically calculate their own
intraday values of an ETF portfolio by
utilizing proprietary algorithms?
• Do market participants use the
published IIV for any purpose, whether
or not related to its original purpose of
facilitating arbitrage? For example, do
some market participants use the IIV as
a secondary or tertiary check on their
internal calculations of an ETF’s
intraday value?
• Do retail investors use or rely on the
IIV, and if so, how? Do they use the IIV
for international and fixed-income
ETFs, and if so, how? Is there a risk that
this information could be misleading in
certain circumstances? Would omitting
the IIV have a disparate impact on retail
investors as opposed to more
sophisticated market participants?
• Do the published IIVs provide an
accurate indication of the value of ETFs’
underlying holdings? Does the answer
vary depending on the type of the ETF’s
underlying holdings? If we were to
include a requirement to disseminate
the IIV, should and can changes be
made to improve its accuracy? For
example, should we require that the IIV
be disseminated at more frequent
intervals? If so, how frequently (e.g.,
every second, every five seconds)?
Should we require that the IIV be
disseminated for all ETFs or only
specific types of ETFs?
• If we were to include an IIV
requirement, should we establish a
uniform method for calculation of the
IIV for all ETFs relying on the rule? If
so, what should that method take into
Drama, USA Today (June 27, 2013), available at
https://www.usatoday.com/story/money/
personalfinance/2013/06/27/etfs-criticisminvesting/2464741/ (‘‘[I]t’s meaningless to compare
the share price of any international equity ETF with
a stale NAV based on stock prices that are several
hours old.’’).
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account? How should fair valued
securities be treated? Alternatively,
should we prescribe methodologies for
ETFs based on the types of portfolio
holdings?
• If the IIV is no longer required
pursuant to exemptive relief or
regulation, would ETFs continue to
publish this information? If so, should
we require ETFs that voluntarily
disseminate the IIV to follow certain
prescribed methodologies? For example,
should we require that these ETFs
disseminate the IIV more frequently? If
so, how frequently?
4. Portfolio Holdings
As discussed above, since the first
exemptive order for an ETF, the
Commission has relied on the existence
of an arbitrage mechanism to keep the
market prices of ETF shares at or close
to the NAV per share of the ETF.205 One
mechanism that facilitates the arbitrage
mechanism is daily portfolio
transparency. Portfolio transparency
provides authorized participants and
other market participants with an
important tool to facilitate valuing the
ETF’s portfolio on an intraday basis,
which, in turn, would enable them to
assess whether arbitrage opportunities
exist. It also provides information
necessary to hedge the ETF’s portfolio.
The ability to hedge is important
because market makers generally trade
to provide liquidity, balance supply and
demand, and profit from arbitrage
opportunities (without seeking to profit
from taking a directional position in a
security).206 Without the ability to
hedge, market makers may widen
spreads or be reluctant to make markets
because doing so may require taking on
greater market risk than the firm is
willing to bear. For this reason, to
facilitate the ability of market makers to
make markets in ETF shares, our
exemptive orders have historically
required ETFs to provide a certain
degree of daily transparency.207
Furthermore, Commission staff has
observed that all ETFs that could rely on
the proposed rule currently provide full
transparency as a matter of industry
market practice.
205 See
supra section I.B.
Stanislav Dolgopolov, Regulating
Merchants of Liquidity: Market Making From
Crowded Floors to High Frequency Trading, 18 U.
of Penn Journal of Business Law 3 (2016), at 652
(‘‘[T]he distinguishing feature of a market maker is
being ‘pretty well always even.’’’).
207 Exemptive orders for actively managed ETFs
and recent orders for index-based ETFs with an
affiliated index provider have required full portfolio
transparency. Exemptive orders for index-based
ETFs with an unaffiliated index provider have
required publication of the ETF’s baskets.
206 See
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a. Transparency of Portfolio Holdings
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Proposed rule 6c–11 would require an
ETF to disclose prominently on its
website, which is publicly available and
free of charge, the portfolio holdings
that will form the basis for each
calculation of NAV per share.208 The
portfolio holdings disclosure must be
made each business day before the
opening of regular trading on the
primary listing exchange of the ETF’s
shares and before the ETF starts
accepting orders for the purchase or
redemption of creation units.209 For
portfolio transparency to facilitate
effective arbitrage, authorized
participants or other market participants
buying or selling ETF shares, whether
on the secondary market or in a primary
transaction, should have access to
portfolio composition information at the
time of the transaction. The proposed
rule’s timing requirements, therefore,
are designed to prevent an ETF from
disclosing its portfolio holdings only
after the beginning of trading or after the
ETF has begun accepting orders for the
next business day.
In addition, the proposed rule would
require the portfolio holdings that form
the basis for the ETF’s NAV calculation
to be the ETF’s portfolio holdings as of
the close of business on the prior
business day.210 Changes in an ETF’s
holdings of portfolio securities would
therefore be reflected on a T+1 basis.
This condition is consistent with
current ETF practices and enables an
ETF to disclose at the beginning of the
business day the portfolio that will form
the basis for the next NAV calculation,
208 Proposed rule 6c–11(c)(1)(i)(A). See also
proposed rule 6c–11(a) (defining the term ‘‘portfolio
holdings’’ to mean the securities, assets, or other
positions held by the ETF). For purposes of this
proposed requirement, as well as other
requirements to disclose information on a publicly
available website under proposed rule 6c–11, we
believe that an ETF should not establish restrictive
terms of use that would effectively make the
disclosures unavailable to the public or otherwise
difficult to locate. For example, the proposed
required website disclosure should be easily
accessible on the website, presented without
encumbrance by user name, password, or other
access constraints, and should not be subject to
usage restrictions on access, retrieval, distribution
or reuse. We also would encourage ETFs to consider
whether there are technological means to make the
disclosures more accessible. For example, today,
ETFs could include the portfolio holdings
information in a downloadable or machine-readable
format, such as comma-delimited or similar format.
209 For these purposes, ‘‘business day’’ is defined
as any day the ETF is open for business, including
any day when it satisfies redemption requests as
required by section 22(e) of the Act. See proposed
rule 6c–11(a).
210 See proposed rule 6c–11(c)(2). Pursuant to this
condition, an ETF would not be permitted to reflect
portfolio changes on a T+0 basis, notwithstanding
the ability to do so under rule 2a–4 under the Act.
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helping to facilitate the efficient
functioning of the arbitrage process.211
We believe that portfolio transparency
is an effective means to facilitate the
arbitrage mechanism. As noted above in
our discussion of the IIV, authorized
participants and other market
participants today calculate the value of
an ETF’s net assets with proprietary
algorithms that use an ETF’s daily
portfolio disclosure and available
pricing information about the assets
held in the ETF’s portfolio on an
ongoing basis during the course of the
trading day. This information allows
market participants to identify instances
where an arbitrage opportunity exists
and to effectively hedge their positions.
The 2008 proposal would have
required actively managed ETFs to
disclose the identities and weightings of
the portfolio securities and other assets
held by the ETF on the ETF’s website
each business day (i.e. full portfolio
transparency). By contrast, index-based
ETFs would have been required to have
a stated investment objective of
obtaining returns that correspond to the
returns of a securities index, whose
provider discloses on its website the
identities and weightings of the
component securities and other assets of
the index (i.e. index transparency).212
Commenters on that proposal generally
concurred with the importance of
transparency to the arbitrage mechanism
and supported including a transparency
requirement in the proposed rule.213
Some commenters, however, asserted
that index transparency may not be
effective for ETFs whose portfolios
sample an index or include holdings in
proportions that are different from those
in the index.214 These commenters
urged the Commission to consider
alternative approaches, including
permitting index-based ETFs to
disseminate the identities and
weightings of the securities in the
basket, if the basket is a representative
sample of the portfolio.215
211 See, e.g., Morgan Stanley ETF Trust, et al.,
Investment Company Act Release Nos. 32484 (Feb.
21, 2017) [82 FR 11956 (Feb. 27, 2017)] (notice) and
32539 (Mar. 21, 2017) (order) and related
application (‘‘Morgan Stanley’’).
212 In the event the ETF tracks multiple indexes,
the 2008 ETF Proposing Release would have
permitted an ETF to provide full transparency like
actively managed funds. See 2008 ETF Proposing
Release, supra footnote 3.
213 See, e.g., BGFA 2008 Comment Letter.
214 See, e.g., ICI 2008 Comment Letter. See also
Vanguard 2008 Comment Letter (opposing index
transparency (as well as daily portfolio holdings
disclosure) for index-based ETFs, voicing concerns
about front running in the context of index-based
ETFs).
215 Commenters asserted that compliance with the
index transparency requirement we proposed in
2008 would be difficult for ETFs that have licensing
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We are proposing to require full
transparency for all ETFs under this rule
rather than proposing alternative
transparency requirements for indexbased ETFs or actively managed
ETFs.216 We generally agree with
commenters on the 2008 proposal that
portfolio transparency provides more
detailed information than the index
alone when an index-based ETF utilizes
sampling techniques or holds
derivatives or other instruments and, as
noted above, all ETFs that could rely on
the proposed rule already provide full
portfolio transparency as a matter of
market practice. Full portfolio
transparency also may be useful for
investors when they are determining the
efficacy of an index-based ETF tracking
a particular index because performance
of two ETFs tracking the same index can
differ based on sampling practices.217
Similarly, where the primary
information used to support the
arbitrage mechanism is information
about holdings, full portfolio
transparency may be more helpful to
market makers modelling ETFs that seek
to track highly customized or bespoke
indexes.
We seek comment on the portfolio
transparency condition of the proposed
rule.
• Should the rule include other
transparency options? For example,
should we have different transparency
requirements for index-based ETFs and
actively managed ETFs, similar to those
proposed in 2008? Would disclosure of
an index’s constituents alone provide
detailed enough information to allow
market participants to effectively hedge
the ETF’s portfolio when an index-based
ETF utilizes sampling techniques or
holds derivatives or other instruments?
Do index providers make information
about index constituents easily
accessible today? Are there other
alternatives we should consider? For
example, would disclosure of an ETF’s
basket provide a basis for effective
hedging? In setting forth an option,
please explain how your proposed level
of transparency would allow effective
arbitrage.
rights to an index that may preclude them from
publicly disclosing the components of the index.
See, e.g., NYSE Arca 2008 Comment Letter;
Comment Letter of Russell Investments (Aug. 27,
2008). Today, Commission staff, through
conversations with ETF industry participants,
understands the preference for this basket
transparency approach to be significantly lessened.
216 See supra section II.A.2.
217 See, e.g., Ben Johnson, Assessing the Total
Cost of ETF Ownership, Morningstar Advisor (Apr.
12, 2017), available at https://beta.morningstar.com/
articles/802211/assessing-the-total-cost-of-etfownership.html.
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• Are there any circumstances that
would prevent an index-based ETF from
disclosing its portfolio holdings?
• Are we correct that all ETFs that
could rely on the proposed rule
currently provide full transparency as a
matter of market practice?
• Would publicly available website
disclosure of portfolio holdings be an
effective way to convey this
information? If not, what other means of
disclosure should the rule require or
permit? For example, should we allow
ETFs to comply with the transparency
condition by transmitting a portfolio
composition file or ‘‘PCF’’ to a central
clearing facility? Would this method
provide information to enough market
participants to facilitate the arbitrage
mechanism? Would it give fair and
equal access to all market participants?
Should we require ETFs to provide
daily portfolio holdings information to
the Commission through other means,
such as filing on EDGAR?
• Should proposed rule 6c–11 define
‘‘publicly available’’ for purposes of the
website disclosure requirements? If so,
what definition should we use? For
example, should the rule require that all
information publicly posted on a
website pursuant to rule 6c–11 be and
remain freely and persistently available
and easily accessible by the general
public on the ETF’s website and that the
information must be presented in an
easily accessible manner, without
encumbrance, and must not be subject
to any restrictions, including
restrictions on access, retrieval,
distribution and reuse?
• Should we require ETFs to reflect
changes in portfolio holdings no earlier
than a T+1 basis as proposed? Is this
condition necessary?
• Should we define ‘‘business day’’ as
proposed or are there alternative
definitions we should consider? Do
commenters believe that ETFs are likely
to calculate NAV per share more than
once each business day in the future? If
so, would a ‘‘business day’’ standard
cause compliance challenges with the
portfolio holdings disclosure
requirements?
• Should the rule require that
portfolio holdings disclosure be
provided before the opening of regular
trading on the primary listing exchange
of the ETF’s shares and before the ETF
starts accepting orders for the purchase
or redemption of creation units?
Alternatively, should the rule exclude
timing requirements? Are there
operational issues that would make
compliance with the timing
requirements challenging or costly?
• Should we consider exemptions for
ETFs with non-transparent or partially
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transparent portfolios as part of
proposed rule 6c–11? Would a rule of
general applicability be the appropriate
means to provide an exemption for ETFs
using a novel arbitrage mechanism?
b. Disclosure of Securities, Assets or
Other Investment Positions
The proposed rule would require
ETFs to disclose on their websites all
portfolio holdings that will form the
basis for the ETF’s next calculation of
NAV per share. Under the proposed
rule, the term ‘‘portfolio holdings’’ is
defined to mean an ETF’s securities,
assets, or other positions.218 As a result,
an ETF would be required to disclose its
cash holdings, as well as holdings that
are not securities or assets, including
short positions or written options.219
We believe that this approach would
provide more consistent and
comprehensive information regarding
an ETF’s portfolio holdings compared to
other means of disclosure, allowing
market participants to fairly and
effectively value the entirety of the
ETF’s portfolio holdings. We believe
this, in turn, would facilitate the
arbitrage mechanism by allowing
authorized participants and other
market participants to more effectively
hedge their exposure to a particular
ETF.
In order to standardize the manner in
which portfolio holdings are presented
on the ETF’s website, the proposed rule
would require that portfolio holdings
information be presented and contain
information regarding description,
amount, value and/or unrealized gain/
loss (as applicable) in the manner
prescribed within 17 CFR 210.12–12,
210.12–12A, 210.12–13, 210.12–13A,
210.12–13B, 210.12–13C, and 210.12–
13D (‘‘Article 12 of Regulation S–X’’),
which sets forth the form and content of
fund financial statements.220 This
proposed rule 6c–11(a).
the proposed rule, for example, an ETF
would have to disclose that it entered into a written
call option, under which it would sacrifice
potential gains that would result from the price of
the reference asset increasing above the price at
which the call may be exercised (i.e., the strike
price). Unless the ETF discloses the presence of
these and similar liabilities, authorized participants
and other investors may not be able to fully
evaluate the portfolio’s exposure.
220 See 17 CFR 210.12–12, 210.12–12A, 210.12–
13, 210.12–13A, 210.12–13B, 210.12–13C, and
210.12–13D. For investments in securities,
securities sold short, and other investments, this
would include the name of issuer and title of issue
(as prescribed within the S–X schedules including
any related footnotes on the description columns),
balance held at close of period, number of shares,
principal amount of bonds, and value of each item
at close of period. For derivatives, this would
include the description (as prescribed within the S–
X schedules including any related footnotes),
number of contracts, value, expiration date (as
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219 Under
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37353
framework should be efficient for such
disclosure because ETFs already comply
with it for financial reporting purposes
and track the relevant information for
daily NAV calculations. Based on a staff
review of ETF websites, there is
currently little consistency regarding
how portfolio holdings information is
presented, particularly with respect to
derivatives. We believe that this
inconsistency may lead to investor
confusion.221
The proposed rule would not require
disclosure of intraday changes in the
portfolio holdings of the ETF or advance
disclosure of portfolio trades because
changes in holdings would not affect the
composition of the ETF’s portfolio that
serves as a basis for NAV calculation
until the next business day.222 The
selective disclosure of nonpublic
information regarding intraday changes
in portfolio holdings and advance
disclosure of portfolio trades, however,
could result in the front-running of an
ETF’s trades, causing the ETF to pay
more to obtain a security. We have
stated that registered investment
companies’ compliance policies and
procedures required by 17 CFR 38a–1
(‘‘rule 38a–1’’ under the Act) should
address potential misuses of nonpublic
information, including the disclosure to
third parties of material information
about a fund’s portfolio, its trading
strategies, or pending transactions, and
the purchase or sale of fund shares by
advisory personnel based on material,
nonpublic information about the fund’s
portfolio.223 ETFs are also required to
describe their policies and procedures
on portfolio security disclosure in the
Statement of Additional Information
and post such policies and procedures
applicable), unrealized appreciation/depreciation
(as applicable), and amount and description of
currency to be purchased and to be sold (as
applicable).
221 We recognize that the generic listing standards
for actively managed ETFs also currently require
website disclosure of the ticker, CUSIP, description
of the holding, and percentage of net assets for each
portfolio holding. See NYSE Arca Rule 8.600–
E(c)(2); Nasdaq Rule 5735(c)(2); Cboe BZX Rule
14.11(i)(3)(B).
222 See supra footnote 208. None of our exemptive
orders has required advance disclosure of intraday
changes in the portfolio of the ETF or advance
disclosure of portfolio trades. Instead, our orders
have required ETFs to use the prior business day’s
portfolio holdings.
223 Compliance Programs of Investment
Companies and Investment Advisers, Investment
Company Act Release No. 26299 (Dec. 17, 2003) [68
FR 74714 (Dec. 24, 2003)] (‘‘Rule 38a–1 Adopting
Release’’). ETFs typically disclose (and would be
required to disclose pursuant to proposed rule 6c–
11) portfolio holdings information with greater
frequency than other open-end funds, which are
generally required to publicly disclose holdings on
a quarterly basis.
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on their websites.224 As we noted in the
release adopting these disclosures, a
fund or investment adviser that
discloses the fund’s portfolio securities
may only do so consistent with the
antifraud provisions of the federal
securities laws and the adviser’s
fiduciary duties.225 Moreover, divulging
nonpublic portfolio holdings to selected
third parties is permissible only when
the fund has legitimate business
purposes for doing so and the recipients
are subject to a duty of confidentiality,
including a duty not to trade on the
nonpublic information.226
We seek comment on this aspect of
the proposed rule.
• Should we require ETFs to present
the description, amount, value and
unrealized gain/loss in the manner
prescribed within Article 12 of
Regulation S–X? Would such a
presentation be more or less effective in
disclosing portfolio holdings
information than current website
disclosure practices for ETFs? Do
investors use current portfolio holding
disclosures? Do current disclosure
practices regarding portfolio holdings
result in investor confusion? For
example, do investors find the lack of
consistency around the presentation of
derivatives holdings confusing?
• Should we consider excluding any
of the requirements in Article 12 of
Regulation S–X? For example, is
information regarding unrealized gain
and loss useful for all ETFs? Should we
only require that disclosure for ETFs
that transact with authorized
participants on a cash basis? Will
disclosure of non-securities investment
positions and assets permit investors,
particularly authorized participants and
other market participants engaged in
arbitrage activities, to assess the full
scope of the ETF’s portfolio holdings?
• Is there any additional or
alternative holdings information that we
should require ETFs to disclose on their
websites? For example, should we
require daily disclosure regarding the
ticker, CUSIP, or other identifier; subcategories of holdings; and the
percentage of net assets for each
holding?
• Should ETFs be required to disclose
all liabilities as part of their portfolio
holding disclosure? For example, would
224 See Items 9(d) and 16(f) of Form N–1A; see
also Disclosure Regarding Market Timing and
Selective Disclosure of Portfolio Holdings,
Investment Company Act Release No. 26418 (Apr.
20, 2004) [69 FR 22299 (Apr. 23, 2004)]
(‘‘Disclosure of Portfolio Holdings Release’’), at
section II.C.
225 See Disclosure of Portfolio Holdings Release,
supra footnote 224, at section II.C.
226 Id.
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disclosure of bank borrowings allow
authorized participants and other
market participants to evaluate the
impact of leverage from these types of
borrowings on the ETF’s portfolio? How
would the arbitrage mechanism work
without this disclosure?
• Would the presentation
requirements facilitate clear and
uniform disclosure? Are there
alternative presentation requirements
we should consider? If so, what would
those requirements be?
• The proposed rule would not
require disclosure of intraday changes
in the portfolio holdings of the ETF or
advance disclosure of portfolio trades
because changes in holdings would not
affect the composition of the ETF’s
portfolio that serves as a basis for NAV
calculation until the next business day.
Should we require ETFs to disclose
intraday changes in the portfolio or
require advance disclosure of portfolio
trades? Would such disclosure
requirements improve transparency in a
meaningful way? Would such disclosure
requirements be costly to implement?
Would an ETF or its investors suffer any
harm if such information were
disclosed? If so, how?
• Should we require ETFs to maintain
portfolio holdings disclosure on their
websites for periods longer than one
day? If so, for how long (e.g., 30 days)?
• ETFs trade in both portfolio assets
(e.g., when rebalancing) and creation
units (when transacting with authorized
participants). Does this raise any
execution issues for ETFs? For example,
how do ETFs prevent certain
counterparties from receiving
preferential treatment? 227 Are the
policies and procedures noted above
adequate to protect nonpublic
information from misuse by authorized
participants and other market
participants that have access to ETF
sensitive trade data? For example, how
do ETFs ensure that authorized
participants are not trading ahead of
ETF rebalancing trades or other changes
to its portfolio? Are there other
requirements that we should adopt to
protect ETFs and their investors? For
example, should an ETF be required to
maintain communications (including
electronic communications) with its
authorized participants?
• ETFs currently are not subject to
Regulation FD, which prohibits the
selective disclosure of information by
publicly traded companies and other
227 See, e.g., Interpretive Release Concerning the
Scope of Section 28(e) of the Securities Exchange
Act of 1934 and Related Matters, Exchange Act
Release No. 34–23170 (Apr. 28, 1986), at section V
(discussing obligation of money manager to obtain
best execution of client transactions).
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issuers.228 Should we amend Regulation
FD to apply to ETFs given that any
information that is selectively disclosed
may be immediately used to trade ETF
shares (or the ETF’s portfolio holdings)
on the secondary market and given the
proposed relief from section 17(a) for
affiliated transactions? 229
5. Baskets
Proposed rule 6c–11 would require
each ETF relying on the rule to adopt
and implement written policies and
procedures governing the construction
of baskets and the process that would be
used for the acceptance of baskets.230 In
addition, the proposed rule would
provide an ETF with the flexibility to
use ‘‘custom baskets’’ if the ETF has
adopted written policies and procedures
setting forth detailed parameters for the
construction and acceptance of custom
baskets that are in the best interests of
the ETF and its shareholders. The
proposed rule also would require an
ETF to disclose prominently on its
website, which is publicly available and
free of charge, information regarding a
published basket that will apply to
orders for the purchase or redemption of
creation units each business day.231 We
believe that the conditions we are
proposing related to baskets would
provide ETFs with the ability to
customize baskets in circumstances that
would benefit the ETF and its investors,
while at the same time putting in place
protections against the potential for
authorized participants to overreach by
dictating the composition of baskets to
the detriment of other ETF investors.232
228 17
CFR 243.
FD does not apply to investment
companies, other than closed-end funds. The
releases proposing and adopting Regulation FD do
not specifically discuss ETFs. See Selective
Disclosure and Insider Trading, Investment
Company Act Release No. 24209 (Dec. 20, 1999) [64
FR 72590 (Dec. 28, 1999)] (proposing release), at
paragraph preceding n.54 (‘‘Investment companies
that are continually offering their securities to the
public already are required to update their
prospectuses to disclose material changes
subsequent to the effective date of the registration
statement or any post-effective amendment, and are
not permitted to sell, redeem, or repurchase their
securities except at a price based on their securities’
net asset value. While we believe that Regulation
FD would offer little additional protection to
investors in these types of investment companies
and therefore they should be excluded from its
coverage, these considerations do not apply in the
case of closed-end investment companies.’’). See
also Selective Disclosure and Insider Trading,
Investment Company Act Release No. 24599 (Aug.
15, 2000) [65 FR 51716 (Aug. 24, 2000)] (adopting
release).
230 See proposed rule 6c–11(c)(3). The proposed
rule would define ‘‘basket’’ to mean the securities,
assets or other positions in exchange for which an
ETF issues (or in return for which it redeems)
creation units. See proposed rule 6c–11(a).
231 See proposed rule 6c–11(c)(1)(i)(B).
232 See, e.g., proposed rule 6c–11(c)(2).
229 Regulation
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a. Basket Flexibility
Where an ETF uses in-kind creations
and redemptions, the composition of the
basket is an important aspect of the
efficient functioning of the arbitrage
mechanism.233 Basket composition
affects the costs of assembling and
delivering the baskets that will be
exchanged for creation units as well as
the costs of liquidating basket securities
when redeeming creation units. For
example, the number of positions
included in a basket, as well as the
difficulty and cost of trading those
positions, will affect the cost of basket
transactions. A basket with hundreds of
relatively small positions may prove
less efficient than a basket with fewer
positions.
Basket composition also is important
to ETF portfolio management. Each inkind creation or redemption increases or
decreases positions in the ETF’s
portfolio. Managing the composition of
a basket allows the ETF to add certain
instruments to its portfolio during the
creation process (by including those
securities in the basket that it will
accept in exchange for a creation unit),
or, conversely, to remove certain
portfolio holdings during the
redemption process (by including them
in a redemption basket while not
accepting them in the creation unit).
This can be an efficient way for a
portfolio manager to execute changes in
the ETF’s portfolio because the manager
can make the changes without incurring
the additional expenses of trades in the
market. When an ETF does not have
flexibility to manage basket
composition, however, it may result in
undesired changes to the portfolio, such
as the loss of desirable bonds when
paying redemptions in kind.
The exemptive relief we have
provided ETFs relating to baskets has
evolved over time. Our earliest ETF
orders for index-based ETFs organized
as UITs provided that in-kind purchases
of creation units were to be made using
a basket of securities substantially
similar to the composition and
weighting of the ETF’s underlying
index.234 Given the unmanaged nature
of the UIT structure, a UIT ETF’s basket
generally reflected a pro rata
representation of the ETF’s portfolio.235
Early orders for ETFs organized as
open-end funds included few explicit
restrictions on baskets, and these orders
did not expressly limit ETFs’ baskets to
a pro rata representation of the ETF’s
233 See
supra section I.B.
e.g., SPDR, supra footnote 34.
235 See supra section II.A.1. A UIT ETF could
substitute cash for basket assets in certain limited
circumstances. See, e.g., SPDR, supra footnote 34.
234 See,
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portfolio holdings.236 Since
approximately 2006, however, as the
ETF industry grew and the Commission
gained more experience with ETFs, our
exemptive orders have placed tighter
restrictions on ETFs’ composition of
baskets.237 These orders expressly
require that the ETF’s basket generally
correspond pro rata to its portfolio
holdings, while identifying certain
limited circumstances under which an
ETF may use a non-pro rata basket.238
Our recent exemptive orders, for
example, permit ETFs to use baskets
that do not correspond pro rata to the
ETF’s portfolio holdings when it is
impossible to break up bonds beyond
certain minimum sizes needed for
transfer and settlement or where
rounding is necessary to eliminate
fractional shares.239 The orders have
allowed baskets to deviate from a pro
rata representation where the basket
includes positions that cannot be
transferred in kind, such as ‘‘to be
announced’’ transactions (‘‘TBA
transactions’’), short positions, and
derivatives.240 We have also permitted
index-based ETFs to use non-pro rata
baskets where the ETF has determined
to use representative sampling of its
portfolio to create its basket,241 and for
236 See WEBs Index Fund, Inc., et al., Investment
Company Act Release Nos. 23860 (June 7, 1999) [64
FR 31658 (June 11, 1999)] (notice) and 23890 (July
6, 1999) (order) and related application.
237 See, e.g., 2006 WisdomTree Investments,
supra footnote 66; see also infra footnote 245 and
accompanying paragraph.
238 See 2006 WisdomTree Investments, supra
footnote 66 (‘‘[I]n limited circumstances and only
when doing so would be in the best interest of a
Fund as determined by the Advisor or Subadvisor,
each Fund may designate Deposit Securities that
may not be an exact pro rata reflection of such
Fund’s Portfolio Securities. For example, a Fund
might designate a non-pro rata basket of Deposit
Securities if one or more Portfolio Securities were
not readily available, or in order to facilitate or
reduce the costs associated with a rebalancing of a
Fund’s portfolio in response to changes in its
Underlying Index.’’).
239 See, e.g., Nationwide Fund Advisors, et al.,
Investment Company Act Release Nos. 32727 (July
6, 2017) [82 FR 32214 (July 12, 2017)] (notice) and
32771 (Aug. 1, 2017) (order) and related
application.
240 Id. In the TBA market, lenders enter into
forward contracts to sell agency mortgage-backed
securities and agree to deliver such securities on a
settlement date in the future. The specific agency
mortgage-backed securities that will be delivered in
the future may not yet be created at the time the
forward contract is entered into. The purchaser will
contract to acquire a specified dollar amount of
mortgage-backed securities, which may be satisfied
when the seller delivers one or more mortgagebacked securities pools at settlement. See LRM
Adopting Release, supra footnote 101, at n.381.
241 See Morgan Stanley, supra footnote 211. In
this context, representative sampling means that the
ETF’s baskets do not reflect a pro rata
representation of the ETF’s portfolio but contain
assets from the ETF’s portfolio that have been
determined by the ETF to constitute a
representative sample of the portfolio. See id. Our
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temporary periods to replicate changes
in the ETF’s portfolio holdings as a
result of the rebalancing of the ETF’s
securities market index.
Our recent exemptive orders also have
permitted ETFs to specifically substitute
cash for some or all of the securities in
the ETF’s basket in certain limited
circumstances, including where the
basket includes securities that are not
eligible for trading due to local trading
restrictions or are not available in
sufficient quantity for purchases of
creation units.242 In addition, while
most existing ETFs typically engage in
creation and redemption transactions on
an in-kind basis, we have permitted
ETFs to use an all-cash basket.243 Due
to the limited transferability of certain
financial instruments, some ETFs
operate on a cash-only basis under their
exemptive orders.244
The requirement that baskets
correspond pro rata to the ETF’s
portfolio holdings, and the increasingly
limited exceptions to the pro rata
requirement, were designed to address
the risk that an authorized participant
could take advantage of its relationship
with the ETF and pressure the ETF to
construct a basket to be used only for
that authorized participant and that
favors the authorized participant to the
detriment of the ETF’s shareholders. For
example, because ETFs rely on
authorized participants to maintain the
secondary market by promoting an
effective arbitrage mechanism, an
authorized participant holding less
liquid or less desirable securities
potentially could pressure an ETF into
accepting those securities in its basket
in exchange for liquid ETF shares (i.e.,
dumping). An authorized participant
also could pressure the ETF into
including in its basket certain desirable
securities in exchange for ETF shares
tendered for redemption (i.e., cherryexemptive orders have expressly limited the
circumstances under which the ETF may use
representative sampling to select its basket assets:
(i) The sample must be designed to generate
performance that is highly correlated to the
performance of the ETF’s portfolio; (ii) the sample
must consist entirely of instruments that are already
included in the ETF’s portfolio; and (iii) the sample
must be the same for all authorized participants on
a given business day. See id.
242 See, e.g., J.P. Morgan Exchange-Traded Fund
Trust, et al., Investment Company Act Release Nos.
30898 (Jan. 30, 2014) [79 FR 6941 (Feb. 5, 2014)]
(notice) and 30927 (Feb. 25, 2014) (order) and
related application. These orders also generally
require an ETF to use the same basket for both
purchases and redemptions on a particular business
day, subject to certain exceptions. See, e.g., id.
243 See, e.g., 2006 WisdomTree Investments,
supra footnote 66.
244 See, e.g., ProShares Trust, et al., Investment
Company Act Release Nos. 27975 (Sept. 21, 2007)
[72 FR 55257 (Sept. 28, 2007)] (notice) and 28014
(Oct. 17, 2007) (order) and related application.
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picking). In either case, the ETF’s other
investors would be disadvantaged and
would be left holding shares of an ETF
with a less liquid or less desirable
portfolio of securities. These abuses also
could occur when a liquidity provider
or other market participant engages in
primary market transactions with the
ETF by using an authorized participant
as an agent.245
Based on our experience with ETFs,
however, we recognize that there are
many circumstances, in addition to the
specific circumstances enumerated in
our orders, where allowing baskets to
differ from a pro rata representation or
allowing the use of different baskets for
different authorized participants could
benefit the ETF and its shareholders.
For instance, ETFs without basket
flexibility typically are required to
include a greater number of individual
securities within their baskets when
transacting in kind, making it more
difficult and costly for authorized
participants and other market
participants to assemble or liquidate
baskets.246 This could result in wider
bid-ask spreads and potentially less
efficient arbitrage. In such
circumstances, these ETFs may be at a
competitive disadvantage to ETFs with
greater basket flexibility. As a result,
these differing conditions and
requirements for basket composition in
our exemptive orders may have created
a disadvantage for newer ETFs that are
subject to our more recent, stringent
restrictions on baskets.
Moreover, we believe that certain
exceptions to a pro rata basket
requirement may help ETFs operate
more efficiently. For example, a lack of
basket flexibility may cause some ETFs,
particularly fixed-income ETFs, to
satisfy redemption requests entirely in
cash in order to avoid losing hard-tofind securities and to preserve the ETF’s
ability to achieve its investment
objectives.247 ETFs that meet
245 See
supra footnote 22 and accompanying text.
Schwab ETP Comment Letter, supra
footnote 115, at n.10 (‘‘[W]e looked at the daily
National Securities Clearing Corporation Portfolio
Composition Files for three Fixed-Income ETFs that
each seek to track the Barclays U.S. Aggregate Bond
Index. The first ETF is subject to the pro rata
requirement and on the August 7, 2015 trade date
that ETF included 1,486 securities in its creation
basket. The second and third ETFs are not subject
to the pro rata requirement. In striking contrast, on
the same trade date these two ETFs included only
64 and 56 securities in their creation baskets,
respectively.’’).
247 As discussed above, many ETFs, including
fixed-income ETFs, are permitted under their
exemptive orders to satisfy redemptions entirely in
cash where the ETF holds thinly traded securities,
among other circumstances. See, e.g., Pacific
Investment Management Company LLC et al.,
Investment Company Act Release Nos. 28723 (May
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redemptions in cash may be required to
maintain larger cash positions to meet
redemption obligations, potentially
resulting in cash drag on the ETF’s
performance. The use of cash baskets
also may be less tax-efficient than using
in-kind baskets to satisfy redemptions,
and may result in additional transaction
costs for the purchase and sale of
portfolio holdings.248
We believe it is appropriate, therefore,
to provide additional basket flexibility,
subject to conditions designed to
address concerns regarding the potential
risk of overreaching. Additional basket
flexibility potentially could benefit ETF
investors through more efficient
arbitrage and narrower bid-ask spreads,
among other benefits.249 Further, we
believe that permitting the same level of
basket flexibility for all ETFs relying on
the rule would give a consistent
structure to ETFs relying on the rule and
would remove a barrier to entry for new
ETFs.
As proposed, rule 6c–11 would
require all ETFs relying on the rule to
adopt and implement written policies
and procedures that govern the
construction of baskets and the process
that will be used for the acceptance of
baskets.250 These policies and
procedures would be required to cover
the methodology that the ETF would
use to construct baskets. For example,
the policies and procedures should
detail the circumstances when the
basket may omit positions that are not
operationally feasible to transfer in
kind. The policies and procedures
should detail when the ETF would use
representative sampling of its portfolio
to create its basket, and how the ETF
would sample in those
circumstances.251 The policies and
procedures also should detail how the
ETF would replicate changes in the
ETF’s portfolio holdings as a result of
the rebalancing or reconstitution of the
ETF’s securities market index, if
applicable.
11, 2009) [74 FR 22772 (May 14, 2009)] (notice) and
28752 (June 1, 2009) (order) and related application.
248 In-kind redemptions allow ETFs to avoid
taxable events that arise when selling securities for
cash within the ETF.
249 See infra footnote 438 and accompanying
paragraph; see also infra footnote 444 and
accompanying text.
250 See proposed rule 6c–11(c)(3). We note that
ETFs already may have policies and procedures
governing the construction of baskets in order to
comply with the representations and conditions of
their exemptive orders. These policies and
procedures, however, would not have been subject
to the requirements we are proposing for custom
basket policies and procedures, which we discuss
below.
251 See supra footnote 38 for a discussion of
sampling.
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In addition to requiring that ETFs
relying on the proposed rule adopt and
implement policies and procedures
regarding the composition of baskets,
the proposed rule defines two particular
types of baskets as ‘‘custom baskets,’’
which are subject to additional
conditions designed to protect ETF
investors. First, baskets that are
composed of a non-representative
selection of the ETF’s portfolio holdings
would be defined as custom baskets.252
A non-representative selection of the
ETF’s portfolio holdings would include,
but not be limited to, baskets that do not
reflect: (i) A pro rata representation of
the ETF’s portfolio holdings; 253 (ii) a
representative sampling of the ETF’s
portfolio holdings; or (iii) changes due
to a rebalancing or reconstitution of the
ETF’s securities market index, if
applicable.
Second, different baskets used in
transactions on the same business day
are defined as custom baskets under the
proposed rule.254 For example, if an
ETF exchanges a basket with an
authorized participant that reflects a
representative sampling of the ETF’s
portfolio holdings and a different basket
with either the same or another
authorized participant that represents a
different representative sampling, both
baskets would be custom baskets.
Similarly, if an ETF substitutes cash in
lieu of a portion of basket assets for a
single authorized participant, that
basket would be a custom basket.
We believe the use of custom baskets
presents an increased risk that the ETF
may be subject to improper pressure by
an authorized participant to create
specific baskets that favor that
authorized participant. For example,
using a custom basket could give
authorized participants more
opportunities for cherry-picking,
dumping, or other abuses, including the
potential for manipulative trading in the
underlying portfolio securities. The
proposed rule includes heightened
process requirements for ETFs that use
custom baskets as a means to protect
against these risks. We believe that
requiring an ETF that relies on the
proposed rule to adopt basket policies
and procedures that include specified
252 See proposed rule 6c–11(a) (defining ‘‘custom
baskets’’ to include baskets that are composed of a
non-representative selection of the ETF’s portfolio
holdings).
253 A basket that is a pro rata representation of
the ETF’s portfolio holdings, except for minor
deviations when it is not operationally feasible to
include a particular instrument within the basket,
generally would not be considered a ‘‘custom
basket.’’
254 See proposed rule 6c–11(a) (defining ‘‘custom
baskets’’ to include different baskets used in
transactions on the same business day).
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requirements is an appropriately
tailored means to address concerns that
authorized participants may overreach.
Furthermore, we believe that the
consistent implementation of custom
basket policies and procedures would
discipline the basket process and would
act as a safeguard against potential
cherry picking or dumping of unwanted
securities by authorized participants.255
Under the proposed rule, an ETF
using custom baskets must adopt
policies and procedures that: (i) Set
forth detailed parameters for the
construction and acceptance of custom
baskets that are in the best interests of
the ETF and its shareholders, including
the process for any revisions to, or
deviation from, those parameters; and
(ii) specify the titles or roles of the
employees of the ETF’s investment
adviser who are required to review each
custom basket for compliance with
those parameters (‘‘custom basket
policies and procedures’’).256 Effective
custom basket policies and procedures
should provide specific parameters
regarding the methodology and process
that the ETF would use to construct or
accept each custom basket. An ETF’s
custom basket policies and procedures
should describe the ETF’s approach for
testing compliance with the custom
basket policies and procedures and
assessing (including through back
testing or other periodic reviews)
whether the parameters continue to
result in custom baskets that are in the
best interests of the ETF and its
shareholders. The custom basket
policies and procedures should be
consistently applied and must establish
a process that the ETF will adhere to if
it wishes to make any revisions to, or
deviate from, the parameters. In
addition, ETFs should consider
adopting reasonable controls designed
to prevent inappropriate differential
treatment among authorized
participants.
As part of the custom basket policies
and procedures, an ETF must specify
the titles or roles of employees of the
ETF’s investment adviser who are
required to review each custom basket
for compliance with the parameters set
forth in those policies and procedures.
255 In addition, in a highly competitive market,
such as the market for ETFs, low performance or
high tracking error would make ETFs undesirable
for participants in both the primary and secondary
markets. ETFs that do not guard closely against
dumping and cherry-picking could have
diminished performance or higher tracking error
over time, which would likely cause flows out of
the fund.
256 Proposed rule 6c–11(c)(3)(i). We also are
proposing to require ETFs to maintain records
detailing the composition of each custom basket.
See infra section II.D.
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An ETF may want to consider whether
employees outside of portfolio
management should review the
components of custom baskets before
approving a creation or redemption.
Finally, as discussed in more detail
below in section II.D, the ETF would be
required to create a record stating that
each custom basket complies with the
ETF’s custom basket policies and
procedures.257
We believe that the ETF’s investment
adviser is in the best position to design
and administer the custom basket
policies and procedures and to establish
parameters that are in the best interests
of the ETF and its shareholders.258 The
ETF’s adviser (and personnel) would be
familiar with the ETF’s portfolio
holdings and would be able to assess
whether the process and methodology
used to construct or accept a custom
basket would be in the best interests of
the ETF and its shareholders and
whether a particular custom basket
complies with the parameters set forth
in the custom basket policies and
procedures. We believe that these
requirements would allow an ETF to
establish a tailored framework for the
utilization of custom baskets, while also
requiring the ETF to put into place
safeguards against abusive practices
related to basket composition. Custom
basket policies and procedures designed
and utilized in the best interests of an
ETF and its shareholders may help the
ETF manage its portfolio more
efficiently, facilitate the arbitrage
mechanism for the ETF, provide
liquidity in markets for the ETF’s shares
and/or the ETF’s underlying portfolio
holdings, or provide other benefits to
the ETF.
In addition, ETFs currently are
required by rule 38a–1 under the Act to
adopt, implement and periodically
review written policies and procedures
reasonably designed to prevent
violations of the federal securities
laws.259 An ETF’s compliance policies
and procedures should be appropriately
tailored to reflect its particular
compliance risks. An ETF’s basket
policies and procedures (including its
custom basket policies and procedures),
therefore, should be covered by the
ETF’s compliance program and other
proposed rule 6c–11(d)(2)(ii).
investment adviser has a fiduciary duty to
act in the best interests of a fund it advises. See
section 36(a) under the Act. See also, e.g., Rosenfeld
v. Black, 445 F.2d 1337 (2d Cir. 1971); Brown v.
Bullock, 194 F. Supp. 207, 229, 234 (S.D.N.Y.),
aff’d, 294 F.2d 415 (2d Cir. 1961); In re Provident
Management Corp., Securities Act Release No. 5155
(Dec. 1, 1970), at text accompanying n.12; Rule 38a1 Adopting Release, supra footnote 223, at n.68.
259 See Rule 38a–1 Adopting Release, supra
footnote 223.
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258 An
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requirements under rule 38a–1.260 For
example, an ETF would be required to
preserve the basket policies and
procedures pursuant to the
requirements of rule 38a–1(d)(1). We
believe that the ETF’s board of directors’
oversight of the ETF’s compliance
policies and procedures, as well as their
general oversight of the ETF, would
provide an additional layer of protection
for an ETF’s use of custom baskets.
Our 2008 proposal did not expressly
contemplate that an ETF would be
permitted to substitute other securities
in lieu of other basket assets.261 Instead,
the proposal noted that in some
circumstances it may not be practicable,
convenient or operationally possible for
the ETF to operate on an in-kind basis,
and indicated that a fund could
substitute cash for some or all of the
securities in the basket.262 Commenters
on this aspect of the 2008 proposal
agreed with the definition of basket and
did not recommend any
modifications.263
Under proposed rule 6c–11, however,
an ETF would be permitted to construct
baskets using cash, securities, or other
positions, provided that the ETF has
satisfied the appropriate policies and
procedures requirement (i.e., the
standard requirement or the heightened
requirement for custom baskets). As
noted above, the use of in-kind baskets
can result in several advantages to an
ETF and its investors, including tax
efficiencies and transaction cost savings.
We believe that this approach would
provide ETFs with flexibility to cover
operational circumstances that make the
inclusion of certain portfolio securities
and other positions in a basket
operationally difficult (or impossible),
while also facilitating portfolio
management changes in a cost- and taxefficient manner. We believe that an
ETF’s policies and procedures should
include details regarding the
260 For example, rule 38a–1 requires a fund’s
chief compliance officer to provide a written report
to the ETF’s board of directors, no less frequently
than annually, that addresses, among other things,
the operation of the fund’s compliance policies and
procedures and any material changes made to those
policies and procedures since the date of the last
report and any material changes to the policies and
procedures recommended as a result of the annual
review of the policies and procedures. See rule 38a–
1(a)(4)(iii)(A).
261 The 2008 proposal would have defined the
term ‘‘basket assets’’ as the securities or other assets
specified each business day in name and number
by an ETF as the securities or assets in exchange
for which it will issue or in return for which it will
redeem ETF shares. See 2008 ETF Proposing
Release, supra footnote 3.
262 See id., at nn.120–121 (describing the
circumstances in which an ETF may use cash in
lieu of certain securities in the basket).
263 See, e.g., ICI 2008 Comment Letter.
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circumstances in which cash, securities,
or other positions would be substituted.
We seek comment on this aspect of
the proposed rule.
• Is our proposed definition of
‘‘baskets’’ appropriate? Should the term
exclude investments that are not
securities or assets? Should the term
exclude instruments that cannot be
transferred in kind?
• Is our proposed requirement that all
ETFs adopt written policies and
procedures governing basket
construction appropriate? Are there
alternatives we should consider? For
example, should we require only ETFs
that use custom baskets to adopt
policies and procedures? Or, instead of
requiring ETFs to adopt policies and
procedures governing basket
construction generally and custom
basket policies and procedures, should
we adopt a single requirement that all
ETFs adopt policies and procedures
governing the construction of baskets? If
so, what parameters should be placed
on those policies and procedures? What
parameters, if any, should we place on
board oversight of the policies and
procedures governing the construction
of baskets?
• Instead of permitting basket
flexibility as proposed, should we
require baskets to reflect a pro rata
representation of the ETF’s portfolio
holdings? Should we enumerate specific
exemptions to the pro rata
representation requirement? If so, what
should those exemptions include? For
example, should we include an
exemption for an authorized participant
prohibited from transacting in a certain
basket security? Should we require
baskets to be representative of the ETF’s
portfolio holdings according to some
other criteria?
• Should we allow ETFs to utilize
baskets that deviate from a pro rata
representation of the ETF’s portfolio
holdings, but require ETFs to utilize the
same basket for all transactions on a
particular business day? If so, why?
• Do the proposed basket conditions
appropriately address concerns of
overreaching by authorized participants
or other market participants, including
those that are first- or second-tier
affiliates identified in the rule? Should
the proposed rule include any other
conditions to minimize the potential
risks of overreaching or other conflicts
of interest by such affiliates? For
example, should we limit the ability of
an ETF to utilize a custom basket when
an authorized participant or other
market participant is an affiliate covered
by the proposed exemption from section
17(a)?
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• Is our proposed definition of
‘‘custom basket’’ appropriate?
Alternatively, should the term
encompass any basket that deviates
from a pro rata representation of the
identities and quantities of the portfolio
holdings held by the ETF? Should we
provide additional guidance regarding
instances where the basket is composed
of a non-representative selection of the
ETF’s portfolio? Should we include
examples in the definition of ‘‘custom
baskets’’?
• Are there any reasons to prohibit an
ETF from using a custom basket? If so,
what are they?
• Should we provide additional
guidance or include additional
requirements in the rule regarding the
elements of effective custom basket
policies and procedures? For example,
should custom basket policies and
procedures set forth the minimum
number of positions that would be
included in a custom basket? Should the
custom basket policies and procedures
set forth parameters regarding the effect
of the custom basket on the value of the
ETF’s portfolio holdings, its tracking
error (if applicable), and the portfolio’s
risks? Should these policies and
procedures set forth the circumstances
under which the ETF would substitute
cash in lieu of portfolio holdings after
considering the effect cash would have
on performance, trading costs, and if
accepting cash would have tax
consequences? Should they set forth the
parameters in which the ETF will accept
odd-lot securities in a custom basket?
Are there any other considerations that
should be included? Alternatively,
should we eliminate any or all of the
considerations discussed above?
• Should we require an ETF to adopt
policies and procedures that set forth
detailed parameters for the construction
or acceptance of custom baskets that are
in the best interests of the ETF and its
shareholders as proposed? Should we
require the policies and procedures to
include a process for any revisions to or
deviation from the parameters as
proposed? Are there other parameters
we should consider? Should we require
the custom basket policies and
procedures to list the titles or roles of
the employees who review each custom
basket for compliance with the
parameters as proposed? Should we
provide guidance regarding how this
review should be done in cases where
the ETF is sub-advised? Should we
require that this review be done only by
employees outside of portfolio
management? If so, which employees
and why?
• As proposed, rule 6c–11 would
require an ETF to create a record stating
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that each custom basket complies with
the ETF’s custom basket policies and
procedures.264 Should we establish any
other recordkeeping requirements
relating to basket flexibility?
• Should the proposed rule require
the ETF’s investment adviser to review
the basket policies and procedures
(including the custom basket policies
and procedures) on an annual basis or
with such frequency as the ETF’s
adviser deems reasonable and
appropriate? Should the proposed rule
include board reporting requirements?
For example, should the proposed rule
require the adviser to deliver an annual
report to the ETF’s board regarding the
implementation of the basket policies
and procedures?
b. Posting of a Published Basket
We also are proposing to require an
ETF to post on its website information
regarding a published basket at the
beginning of each business day, as well
as the estimated cash balancing amount
if any.265 We believe this disclosure
would contribute to the efficiency of the
arbitrage mechanism by providing
authorized participants and other
market participants with timely
information regarding the contents of a
basket that the ETF will accept for
creations and redemptions each
business day. This, in turn, would allow
market participants to value the
contents of the basket on an intraday
basis to determine whether arbitrage
opportunities exist. This information
also permits market makers to compare
the ETF’s portfolio holdings with the
basket.
In particular, we are proposing to
require that an ETF publish on its
website one basket that it would
exchange for orders to purchase or
redeem creation units to be priced based
on the ETF’s next calculation of NAV
per share each business day.266 This
‘‘published’’ basket must be disclosed
before the opening of trading of the
ETF’s shares and before the ETF begins
accepting orders for the purchase or
redemption of creation units to be
priced based on the ETF’s next
calculation of NAV.267 This requirement
is designed to mitigate possible
inefficiencies in the arbitrage
264 See
proposed rule 6c–11(d)(2)(ii).
proposed rule 6c–11(c)(1)(i)(B) and (C).
Under proposed rule 6c–11(a), the ‘‘cash balancing
amount’’ would be defined as an amount of cash to
account for any differences between the value of a
basket and the NAV of a creation unit. Our ETF
exemptive orders have recognized a cash balancing
amount to reconcile any difference between the
asset value of a creation unit and the value of the
ETF’s basket.
266 See proposed rule 6c–11(c)(1)(i)(B).
267 See id.
265 See
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mechanism that could result from
delaying the publication of an ETF’s
basket.268
Under this requirement, an ETF
would publish a basket that it would
accept if presented by any authorized
participant in exchange for creation
units (or present to an authorized
participant redeeming creation units).269
Accordingly, an ETF that planned to use
only custom baskets on a particular
business day (e.g., a basket reflecting a
non-representative selection of the
ETF’s portfolio holdings), would be
required to post a custom basket as its
‘‘published’’ basket.
Because an ETF would be required to
post only one published basket to
comply with this condition, there may
be occasions where an ETF would not
post the contents of every custom
basket. We considered proposing that
ETFs be required to publish, after the
close of trading on each business day,
information regarding every basket used
by the ETF to serve as an additional
check against overreaching by
authorized participants. However, we
preliminarily believe that this
requirement is an unnecessary
additional burden, resulting in
compliance and other operational costs
for ETFs to review the information
before it is posted. Instead, as discussed
below in section II.D, we are proposing
to require ETFs to maintain records
detailing the composition of baskets,
which would allow our staff to review
an ETF’s baskets as part of an
examination.
The 2008 proposed rule did not
require ETFs to disclose their baskets.
We did note in that proposal, however,
that basket disclosure was a widely
adopted industry practice and
facilitated effective arbitrage activity.270
On this issue, commenters on the 2008
proposal stated that it was not necessary
for the Commission to require ETFs to
disclose their baskets because that
information was available in the
portfolio composition files provided
each business day by ETFs to the
National Securities Clearing Corporation
268 As proposed, an ETF relying on the rule also
would be required to disclose its portfolio holdings
that will form the basis of the next calculation of
NAV per share in this manner. See proposed rule
6c–11(c)(1)(i)(A).
269 Our proposal does not prevent an ETF from
changing the assets in a published basket to
respond to market conditions after the basket is
published.
270 See 2008 ETF Proposing Release, supra
footnote 3, at n.27 and accompanying text. Many
exemptive orders also require ETFs to make basket
information available on a daily basis. See, e.g., Salt
Financial, LLC, et al., Investment Company Act
Release Nos. 32974 (Jan. 23, 2018) [83 FR 4097 (Jan.
29, 2018)] (notice) and 33007 (Feb. 21, 2018) (order)
(‘‘Salt Financial’’).
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(‘‘NSCC’’).271 While this still may be
true, the composition of an ETF’s basket
for a given day may be important
information to not only authorized
participants and large institutional
investors (who, as NSCC members, have
access to the daily portfolio composition
files), but to other market participants as
well. For example, the information
allows investors to compare the ETF’s
baskets for a given day with its portfolio
holdings, assists market participants
who are building their intraday hedge
(we understand that some market
participants primarily look to the
baskets rather than the whole portfolio),
and is important for purposes of
estimating any cash balancing amounts
as it allows market participants to
compare the basket to the whole
portfolio. We also believe that this
proposed basket disclosure requirement
is sufficiently narrow to not impose a
significant burden on ETFs because it
requires only one basket-related
disclosure each trading day, at the
beginning of the day.
We request comment on this proposed
requirement.272
• Are we correct that disclosure of an
ETF’s basket facilitates the arbitrage
mechanism? Is an ETF’s basket
composition useful information to ETF
investors in the secondary market?
• Should we require the posting of a
basket as proposed? Should we provide
additional guidance regarding what
types of basket would constitute a
published basket?
• Would the disclosure of one basket
at the beginning of each business day
provide enough information to all
market participants about an ETF’s
basket composition, particularly for
ETFs using custom baskets? Should we
instead require ETFs to disclose each
basket used on a given business day
after the close of trading on the ETF’s
website? Would these approaches cause
competitive concerns or cause
significant operational challenges? What
costs and benefits would be associated
with a requirement to publish all
baskets used each business day? Would
such an approach allow better policing
of potential overreaching by authorized
participants?
• If an ETF is no longer willing to
accept the basket posted on its website
on a particular business day because of
market events, should the rule require
the ETF to post a replacement basket on
the website that the ETF would accept?
• Our proposal is designed to strike a
balance between process and oversight
e.g., NYSE Arca 2008 Comment Letter.
272 We request comment regarding additional
proposed website disclosures at infra section II.C.6.
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37359
requirements (i.e., policies and
procedures governing basket
construction) and disclosure
requirements. Do commenters agree
with this approach? Would additional
basket transparency lessen the need for
policies and procedures relating to
basket composition? Is there a more
appropriate balance between the two
types of requirements that we should
consider?
• Is our proposed definition of ‘‘cash
balancing amount’’ appropriate?
• Should we require the disclosure of
baskets on an ETF’s website as
proposed? Alternatively, should we
allow ETFs to comply with the basket
transparency condition by sending the
portfolio composition file to a central
clearing facility in accordance with
current practices? What would be the
costs or operational burdens of each
approach? Would the website disclosure
of this information benefit any market
participants (including retail investors)
that may not have access to the portfolio
composition file? If so, how would
market participants use this
information?
6. Website Disclosure
There has been a significant increase
in the use of the internet as a tool for
disseminating information,273 and we
believe that many investors obtain
information regarding ETFs on the
ETFs’ websites. Proposed rule 6c–11
therefore would require ETFs to disclose
certain information on their websites as
a condition to the rule.274 As noted
above, we believe that the arbitrage
mechanism works more efficiently
when certain data is publicly available
to investors each trading day, and are
therefore proposing ETF website
disclosures in order to provide
transparency of portfolio holdings and
baskets.275 In addition, we are
proposing several website disclosure
requirements that are designed to
provide investors with key metrics to
evaluate their investment and trading
decisions in a format that is easily
accessible and frequently updated.
Specifically, the proposed rule would
require disclosure regarding: (i) The
ETF’s NAV per share, market price, and
premium or discount, each as of the end
of the prior business day; (ii) bid-ask
spreads; and (iii) historical information
regarding premiums and discounts.
Some of these conditions are based on
our exemptive relief, which has
required ETFs to disclose on their
273 See, e.g., Reporting Modernization Adopting
Release, supra footnote 147.
274 Proposed rule 6c–11(c)(1).
275 See supra sections II.C.4 and II.C.5.
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websites certain information regarding
their investments and operations,
including quantitative information
regarding discounts or premiums at
which the ETF’s shares trade on the
secondary market.276 Our orders have
required ETFs to publicly disclose on
their websites: (i) The prior business
day’s NAV per share; (ii) the market
closing price or the midpoint of the bidask spread at the time of the calculation
of NAV; and (iii) a calculation of the
premium or discount of the market
closing price or midpoint of the bid-ask
spread against NAV per share.277
Similarly, Form N–1A currently
provides an ETF with the option to omit
certain historical information regarding
premiums and discounts from its
prospectus and annual report if the
disclosure is provided on its website.278
Based on our experience overseeing
ETFs, we are proposing additional
website disclosure requirements that
have not been part of our exemptive
relief or Form N–1A requirements. We
also are requesting comment regarding
ways to better inform investors about
intraday deviations between an ETF’s
market price and: (i) NAV per share; (ii)
the contemporaneous value of its
portfolio; or (iii) both. Each of the
proposed website disclosures is
discussed below.
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a. Daily NAV, Market Price, and
Premiums and Discounts
Proposed rule 6c–11(c)(1)(ii) would
require ETFs to post on their websites,
on each business day, the ETF’s current
NAV per share, market price, and
premium or discount, each as of the end
of the prior business day. This
disclosure provides investors with a
‘‘snapshot’’ view of the difference
between an ETF’s NAV per share and
market price on a daily basis. It is
designed to alert investors to the
relationship between NAV per share
and the market price of the ETF’s shares
and that they may sell or purchase ETF
shares at prices that do not correspond
to NAV of the ETF. It also is designed
to allow investors to compare this
information across ETFs. For example,
an investor using this information likely
would notice that ETFs tracking
emerging markets tend to have greater
premiums or discounts than ETFs
tracking broad-based domestic indexes.
We believe that daily website disclosure
of this information would promote
transparency and help investors better
276 See,
e.g., Barclays Global 2008, supra footnote
58.
277 See
supra footnote 134 and accompanying
text.
278 See
infra section II.H.
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understand the risk that an ETF’s
market price may be higher or lower
than the ETF’s NAV per share. We
further believe that ETF investors use
this information today, as ETFs
currently provide this website
disclosure pursuant to the terms of their
exemptive orders.
This proposed requirement is
consistent with our exemptive orders
and generally consistent with our 2008
proposal, except we have changed the
definition of ‘‘market price’’.279
Proposed rule 6c–11 would define the
term ‘‘market price’’ to mean: (i) The
official closing price of an ETF share; or
(ii) if it more accurately reflects the
market value of an ETF share at the time
as of which the ETF calculates current
NAV per share, the price that is the
midpoint of the national best bid and
national best offer (‘‘NBBO’’), calculated
as of the time NAV per share is
calculated.280
The 2008 proposed rule would have
defined ‘‘market price’’ only as the last
price at which ETF shares trade on their
principal U.S. trading market during a
regular trading session. However, we
believe that using the ‘‘official closing
price,’’ as opposed to the ‘‘closing
market price,’’ is a better measure of an
ETF’s market price, particularly in
situations where the last trade of the day
was not reflective of the actual market
price (e.g., due to an erroneous order).
Exchanges have detailed rules regarding
the determination of the official closing
price of a security.281 For example, if a
listing exchange experiences a systems
disruption and cannot conduct closing
auctions, exchanges use their back-up
procedures to determine the ‘‘official
closing price’’ for the affected securities
(such as relying on a backup exchange’s
closing auction). As a result, we
preliminarily believe that using the
‘‘official closing price’’ provides a more
precise measurement of an ETF’s market
price, including during disruptive
market events.
Commenters on the 2008 ETF
Proposing Release who addressed this
aspect of the proposal opposed the
proposed definition of market price
because of concerns that the last price
at which an ETF trades could be stale
279 See 2008 ETF Proposing Release, supra
footnote 3.
280 See proposed rule 6c–11(a).
281 See, e.g. Self-Regulatory Organizations; New
York Stock Exchange LLC; NYSE MKT LLC; Notice
of Filings of Amendment No. 1, and Order Granting
Accelerated Approval of Proposed Rule Changes, as
Modified by Amendment No. 1, to Provide for How
the Exchanges Would Determine an Official Closing
Price if the Exchanges are Unable to Conduct a
Closing Transaction, Exchange Act Release No.
78015 (June 8, 2016) [81 FR 38747 (June 14, 2016)]
(NYSE backup procedures).
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at the time as of which NAV per share
is calculated.282 These commenters
suggested that ETFs instead be
permitted to use the midpoint between
the highest bid and the lowest offer at
the time as of which the ETF’s NAV is
calculated.283 We generally agree and,
as a result, we are proposing to permit
ETFs to use a price that is the midpoint
of the NBBO as of that time, if it is more
accurate.284 Because security
information processors calculate NBBO
continuously during the trading day,
NBBO has the benefit of being a
verifiable third-party quote. We believe
that this approach provides an
appropriate degree of flexibility to an
ETF when its last reported sales price
may be stale, while at the same time
providing a consistent and verifiable
methodology for how ETFs determine
market price.
As discussed in more detail below,
the proposed definition of market price
also differs from the definition currently
used in Form N–1A.285 Form N–1A
defines ‘‘market price’’ as the last
reported sale price or, if it more
accurately reflects the current market
value of the ETF’s shares, ‘‘a price
within the range of the highest bid and
lowest offer.’’ 286 We believe specifying
that an ETF must use the midpoint of
the NBBO, rather than ‘‘a price within
the range of the highest bid and lowest
offer’’ still provides the ETF with
flexibility in determining a market price
for its shares that accurately reflects the
shares’ market value. At the same time,
requiring ETFs to use the midpoint in
these circumstances would mitigate the
potential for gaming practices that could
inaccurately minimize a deviation
between market price and NAV per
share when showing premiums and
discounts.287 We are proposing to
amend Form N–1A to remove the
definition of market price in that form
282 See, e.g., Chapman 2008 Comment Letter
(noting that shares of some smaller ETFs may not
trade often or at all on a particular day); ICI 2008
Comment Letter (noting that closing price may be
less accurate because the last trade occurred at a
much earlier time than the time as of which NAV
is calculated).
283 See, e.g., Chapman 2008 Comment Letter.
284 See proposed rule 6c–11(a) (defining ‘‘market
price’’); see also rule 600(b)(42) of Regulation NMS
(defining NBBO). [17 CFR 242.600]. The NBBO
represents the highest bid and lowest offer for an
ETF share consolidated across all exchanges.
285 See infra section II.H.1.
286 See General Instruction A to Form N–1A.
287 An ETF would use the market price of an ETF
share in calculating premiums and discounts. See
proposed rule 6c–11(a) (defining ‘‘premium or
discount’’ to mean the positive or negative
difference between the market price of an ETF share
and the ETF’s current NAV per share, expressed as
a percentage of the ETF’s current NAV per share).
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as it would no longer be used in the
same manner.288
We believe that the daily premium/
discount disclosures (and calculation
methodology) we are proposing would
provide investors with useful
information regarding ETFs that
frequently trade at a premium or
discount to NAV per share. For
example, some ETFs have frequent
deviations between closing market price
and NAV per share. These ETFs
typically hold non-U.S. securities and
trade during hours when the markets for
their non-U.S. holdings are closed,
allowing the trading price of ETF shares
to reflect expected changes in the next
opening price of the non-U.S. holdings
(i.e., to help ‘‘discover’’ the price of the
holdings). ETFs also may have greater
premiums and discounts to the extent
that there are greater transaction costs
associated with assembling baskets. In
addition, an ETF with less liquid
portfolio holdings also may show a
deviation between closing market price
and NAV per share,289 and an ETF with
a less efficient arbitrage mechanism may
frequently show this type of end of day
deviation.290
We understand, however, that
proposed premium/discount disclosure
would not provide investors with
information regarding intraday
deviations between market prices and
the next-calculated NAV or the
contemporaneous value of the ETF’s
underlying securities, even if the
deviation is significant. Some
commentators have stated that the lack
of disclosure regarding intraday
deviations could, in some
circumstances, be misleading.291 For
example, some ETFs had relatively large
intraday deviations between market
price and intraday indicative values on
August 24, 2015 that were not reflected
288 See
infra section II.H.1.
LRM Adopting Release, supra footnote
101, at n.33 and accompanying text.
290 See id at text following n.524 (‘‘[S]hares of an
ETF whose underlying securities are relatively less
liquid may not be able to be counted on to provide
liquidity to a fund investing in these shares during
times of stress. In the case of a significant decline
in market liquidity, if authorized participants were
unwilling or unable to trade ETF shares in the
primary market, and the majority of trading took
place among investors in the secondary market, the
ETF’s shares could trade continuously at a premium
or a discount to the value of the ETF’s underlying
portfolio securities.’’).
291 See, e.g., Henry T.C. Hu and John D. Morley,
A Regulatory Framework for Exchange-Traded
Funds, 91 S. Cal. Law Review (forthcoming 2018)
(‘‘Hu and Morley’’) at 53 (‘‘While simplicity and
other reasons help explain the SEC’s decision to
look only at the close and not intra-day
performance, the result was an emphatically
reassuring picture being presented to investors. As
a result, an investor may have a misleading sense
as to the true risks and returns of the ETF.’’).
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289 See
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as a ‘‘premium’’ or ‘‘discount’’ because
market price and NAV per share were
tightly correlated by the end of the
day.292
While we believe that additional
information regarding intraday
deviations could help ETF investors
understand both the potential for
intraday deviations and the
circumstances under which deviations
have occurred in the past, developing an
accurate and cost-effective methodology
to calculate intraday deviations for all
types of ETFs is challenging. For
example, there are many ways to
calculate a market price metric, such as
the average of execution prices on a
business day or the midpoint of the
NBBO measured at specific intervals
during the course of the trading day.
These measures, however, often do not
provide a meaningful picture of intraday
deviations because they can give
outliers either outsized importance (in
the case of averages), particularly for
ETFs with low trading volume, or
insufficient importance (in the case of
medians). In addition, the systems
necessary to calculate and track these
measures can be complex and costly.
Similarly, developing an accurate
measure of the contemporaneous value
of the ETF’s portfolio is complex. As we
noted in our discussion of the IIV,293
calculations of contemporaneous value
can be stale or inaccurate for ETFs with
foreign securities or less liquid debt
instruments for which market
quotations are not readily available. For
such an ETF, a contemporaneous value
calculated using last available market
quotations or stale prices may show a
premium/discount to any ETF share
price that factors in fair valuations of
the ETF’s portfolio holdings. Moreover,
without prescribed uniform
methodology requirements,
contemporaneous values can be
calculated in different, and potentially
inconsistent, ways and lead to noncomparable premium/discount
disclosure. We request comment below
on potential alternative calculations and
disclosure requirements that could
inform investors about intraday
deviations.294
b. Bid-Ask Spread Disclosure
As discussed in more detail below,
our proposed amendments to Form N–
1A would include new requirements for
292 See
supra footnote 128 and accompanying
text.
supra section II.C.3.
ETFs provide qualitative disclosures in
their prospectuses regarding the potential for
periods of market volatility that could lead to
deviations from NAV per share. See, e.g., supra
footnote 126.
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294 Many
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37361
an ETF to disclose information
regarding bid-ask spreads on its website
and in its prospectus.295 Specifically, an
ETF would be required to disclose the
median bid-ask spread for the ETF’s
most recent fiscal year. A bid-ask spread
is the difference between the highest
price a buyer is willing to pay to
purchase shares of the ETF (bid) and the
lowest price a seller is willing to accept
for share of the ETF (ask).296 The
proposed website disclosures are
designed to inform investors that they
may bear bid-ask spread costs when
trading ETFs on the secondary market,
which ultimately could impact the
overall cost of the investment. We are
concerned that investors may not be
aware of the impact trading costs may
have on their investments in ETFs,297
and therefore, propose to require ETFs
to disclose median bid-ask spread
information pursuant to a prescribed
methodology that would be set forth in
Form N–1A. We believe that this
information would provide ETF
investors with greater understanding of
these costs and would allow investors to
compare this information across ETFs.
Spread costs for ETFs can vary
significantly, and disclosure regarding
these costs could aid comparisons of
ETFs pursuing similar investment
strategies. We believe this information
also would allow investors to better
understand the costs of investing in an
ETF.298
We are proposing to require the
disclosure of the bid-ask spread
information on an ETF’s website to
provide trading information that can
help investors make better informed
investment decisions in a format that is
easily accessible and relied upon by a
growing segment of investors. Given the
importance of this information to
understanding the total expenses an
investor may bear when investing in an
ETF, we preliminarily believe that bidask spread information also should be
included in an ETF’s prospectus.
Without this bid-ask spread
information, we preliminarily believe
295 See proposed amendment to Item 3 of Form
N–1A. See also infra section II.H.2. for a discussion
of the bid-ask spread disclosure requirements. We
are also proposing to require ETFs to provide an
interactive calculator that would provide investors
with the ability to customize the hypothetical bidask spread disclosures in Item 3 of Form N–1A to
the investor’s specific investing situation. See id.
296 See proposed amendment to Item 3 of Form
N–1A.
297 See, e.g., Simon Constable, How to Measure
ETF Spreads, The Wall Street Journal (Nov. 5,
2017), available at https://www.wsj.com/articles/
how-to-measure-etf-spreads-1509937200.
298 As discussed in more detail below, mutual
fund investors typically do not incur bid-ask spread
costs in connection with their investment in a
mutual fund. See infra section II.H.2.
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the fee and expense information
provided in a prospectus may not
always provide a complete picture of an
investment’s true costs and/or allow
investors to easily compare prospectus
disclosures across certain investment
options.299
c. Historical Information Regarding
Premiums and Discounts
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We also are proposing to require that
ETFs disclose on their websites
historical information about the extent
and frequency of an ETF’s premiums
and discounts. In particular, proposed
rule 6c–11(c)(1)(iii) and (iv) would
require an ETF to post on its website
both a table and line graph showing the
ETF’s premiums and discounts for the
most recently completed calendar year
and the most recently completed
calendar quarters of the current year.
Alternatively, for new ETFs that do not
yet have this information, the proposed
rule would require the ETF to post this
information for the life of the fund.
Currently, an ETF is required to
disclose historical premium/discount
information in its prospectus by
providing tabular disclosure of the
number of trading days during the most
recently completed calendar year and
quarters since that year ended on which
the market price of the ETF shares was
greater than the ETF’s NAV per share
and the number of days it was less than
the ETF’s NAV per share.300 An ETF
currently may omit the disclosure of
specific premium/discount information
in its prospectus or annual report if the
ETF provides the information on its
website and discloses in the prospectus
or annual report a website address
where investors can locate the
information.301 We believe that
investors may find this tabular
information helpful in understanding
how often an ETF trades at a premium
or discount and the size of such
premiums and discounts and are
proposing to require publication of a
299 Required prospectus disclosures for open-end
funds currently include shareholder fees such as
sales charges and redemption fees, as well as
annual fund operating expenses. See Item 3 of Form
N–1A.
300 Instruction 2 to Item 11(g)(2) of Form N–1A.
ETFs are also required to include a table with
premium/discount information in their annual
reports for the five most-recently completed fiscal
years. Item 27(b)(7)(iv) of Form N–1A.
301 Item 11(g)(2) of Form N–1A; Item 27(b)(7)(iv)
of Form N–1A. Although the time period required
in the disclosure is different in the prospectus and
annual report, ETFs are permitted to omit both
disclosures by providing on their websites only the
premium/discount information required by Item
11(g)(2) (the most recently completed fiscal year
and quarters since that year).
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table on the ETF’s website as part of
proposed rule 6c–11.302
We additionally believe that graphic
disclosure could assist some investors
with understanding how the arbitrage
mechanism performs for an ETF under
various market conditions. Depending
on a variety of factors, an ETF could
have persistent premiums or discounts
(or both) from the ETF’s NAV. For
example, certain classes of ETFs, such
as those that invest in less liquid
securities, like high-yield bonds, and
securities that trade on international
markets, have more persistent
deviations in ETF share prices from the
ETF’s NAV.303 Additionally, for certain
types of ETFs, the disclosure may
inform investors about the pricing of the
ETF’s portfolio holdings. ETFs holding
foreign securities that are traded on
markets that are closed during U.S.
trading hours, for example, may have
persistent premiums or discounts
resulting from this timing differential. In
other cases, a persistent deviation
between market price and NAV per
share could demonstrate inefficiencies
in an ETF’s arbitrage mechanism.304
While past performance cannot
predict how an ETF will trade in the
future, we believe that it is important
that investors, and particularly retail
investors, understand that certain
classes of ETFs could have a larger and
more persistent deviation from NAV,
which could result in a higher cost to
investors and a potential drag on
returns. In addition to alerting
secondary market investors that an
ETF’s NAV per share and market price
may differ, these disclosures would
provide information regarding the
frequency and extent of these
deviations. These disclosures thus
would help investors understand the
value of their investment and could
help shape whether they want to invest
in a particular ETF.
We believe that presenting the data as
both a table and a line graph would
provide investors with useful
information in a variety of formats that
are easy to view and understand,
depending on the investor’s preference.
proposed rule 6c–11(c)(1)(iii).
Hu and Morley, supra footnote 291, at 12
(noting that certain kinds of ETFs have much higher
95% confidence intervals of almost 600 basis
points) (internal citations omitted).
304 See, e.g., Crystal Kim, This Levered Gold
Mining ETF Looks Super Scary, Barrons (Apr. 20,
2017), available at https://www.barrons.com/
articles/this-levered-gold-mining-etf-looks-superscary-1492700892 (linking an ETF trading at a
significant premium to NAV to the ETF’s
suspension of creation units, and in turn, linking
the suspension to the limited availability of certain
investments the ETF needed to make in order to
seek its investment objective).
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302 See
303 See
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For example, investors may find the
proposed tabular disclosure an easy to
understand demonstration of how often
the ETF traded at a premium or
discount. However, the tabular
disclosure does not allow investors to
observe the degree of those deviations,
particularly during periods of market
stress. For example, two ETFs may have
traded at a discount for the same
number of days. One ETF’s daily
deviations could have been small with
little effect on investors trading on those
days, whereas the other ETF could have
had significant discounts. These
distinctions would not be apparent
based on the required tabular
disclosure, but would be observable
with the graphic disclosure we are
proposing. As a result, in order to assist
investors with understanding an ETF’s
premiums and discounts, we are
proposing both tabular and graphical
representations of daily premium and
discounts.305 In order to eliminate
potentially duplicative disclosure
requirements, we are proposing to
eliminate historical premium/discount
disclosure requirements in Item 11(g)(2)
and Item 27(b)(7)(iv) of Form N–1A.306
Proposed rule 6c–11(c)(1)(v) also
would require any ETF whose premium
or discount was greater than 2% for
more than seven consecutive trading
days to post that information on its
website, along with a discussion of the
factors that are reasonably believed to
have materially contributed to the
premium or discount. We propose that
ETFs posting this information be
required to post it on their websites on
the trading day immediately following
the day on which the ETF’s premium or
discount triggered this provision (i.e.,
on the trading day immediately
following the eighth consecutive trading
day on which the ETF had a premium
or discount greater than 2%) and
maintain it on their websites for at least
one year following the first day it was
posted.
We believe that this proposed
disclosure of information about ETFs’
premiums and discounts would
promote transparency regarding the
significance and/or persistency of
deviations between market price and
NAV per share, and thus may permit
investors to make more informed
305 Under the proposal, the historical premium/
discount information would be required for the
most recently completed calendar year and the most
recently completed calendar quarters of the current
year. This period was chosen as it was consistent
with existing requirements in Item 11(g)(2) of Form
N–1A. We believe the time period would allow
investors to readily observe the extent and
frequency of deviations from NAV per share in a
graphic format.
306 See infra section II.H.4.
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investment decisions. This information
also may provide the market (and the
Commission) with information
regarding the efficiency of an ETF’s
arbitrage mechanism. As noted above, in
the Commission’s experience, the
deviation between the market price of
ETFs and NAV per share, averaged
across broad categories of ETF
investment strategies and over time
periods of several months, has been
relatively small.307 Therefore, we
believe that limiting this disclosure to
ETFs that have a premium or discount
of greater than 2% for more than seven
consecutive trading days would serve to
highlight potentially unusual
circumstances when an ETF has a
persistent premium or discount.308
Given the proposed threshold, we do
not believe that many ETFs would be
required to disclose this information.309
However, there could be certain
categories of ETFs that could be
particularly affected. An ETF that
invests in foreign securities, for
example, may be more likely to
experience a persistent deviation
between market price and NAV per
share given that many foreign markets
are closed during the U.S. trading day.
Such deviations may be pronounced if
the market on which the ETF’s
underlying securities trade is closed.310
The proposed rule would require the
disclosure to include a discussion of the
factors that are reasonably believed to
have contributed to the premium or
discount. We believe that this
requirement would provide secondary
market investors with useful context for
the disclosed deviations. In addition, we
believe that requiring ETFs to maintain
it on their website for at least one year
following the first day it was posted
would identify those ETFs that
historically have had such an instance
of persistent deviation between market
price and NAV per share.311
307 See supra footnotes 119–120 and
accompanying text.
308 This belief is based on data obtained from
Morningstar and Bloomberg.
309 See infra footnote 477 and accompanying text.
310 See Tom Lyndon, China A-Shares ETFs
Trading at Steep Discount to NAV, ETF Trends (Jul.
9, 2015), available at https://www.etftrends.com/
2015/07/china-a-shares-etfs-trading-at-steepdiscount-to-nav/ (reporting that U.S.-listed China Ashares ETFs were trading at a steep discount to the
underlying market because of the fact that a
significant number of companies stopped trading on
China’s mainland stock exchanges).
311 We recognize that historical information
relating to these deviations may not be predictive
of future deviations, and request comment below
regarding whether the rule should require ETFs to
include a legend in proximity to the historical
information warning of its limitations.
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We request comment on our proposed
website disclosure requirements for
ETFs.312
• Would the proposed website
disclosures be useful in informing
investors of certain ETF characteristics
and risks? For example, would the
disclosures alert investors to the
relationship between NAV per share
and the market price of the ETF’s
shares? Would they assist investors in
understanding that they may sell or
purchase ETF shares at prices that do
not correspond to NAV per share of the
ETF or that may reflect a premium or
discount to NAV per share that is not in
line with the typical premium or
discount for the same ETF? Would they
assist investors in assessing costs
associated with premiums and
discounts and/or bid-ask spreads?
Would the proposed requirements
promote the goals of enhancing
transparency and encouraging market
discipline on ETFs? Understanding that
ETF investors would be required to
access each ETF’s website, would this
information allow investors to compare
data across ETFs? Should we require
ETFs to present their disclosures in a
structured format on their websites or in
a filing with the Commission in order to
facilitate comparisons among ETFs?
• To what extent would the proposed
website disclosure requirements
increase ETFs’ costs or result in
operational challenges?
• Should we require that information
regarding NAV per share, market price,
and premiums and discounts be posted
on an ETF’s website each business day
as proposed? Should we specify the
time by which such information must be
posted? For example, should we require
that an ETF post the information on its
website before the opening of trading
each business day?
• Should we define ‘‘market price’’ as
proposed? Does the proposed definition
provide ETFs with too much discretion
in determining market price? Should we
define market price using only the
‘‘official closing price’’? Is there an
alternative price that we should require
instead of ‘‘official closing price’’ that
would more accurately reflect the ETF’s
share price at market close? Should we
provide an alternative calculation of
market price, by using the midpoint of
the NBBO, as proposed? Is the midpoint
of the NBBO an appropriate alternative?
If not, what method is appropriate? Do
ETFs and their service providers
currently receive the NBBO for their
our specific requests for comment
regarding an ETF’s daily portfolio and basket
website disclosure, see our discussions of those
subjects, at supra sections II.C.4 and II.C.5,
respectively.
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securities? If not, what are the
additional costs, if any, of receiving a
NBBO quote? Should we require ETFs
to disclose if, for example, they use the
midpoint of the NBBO rather than the
official closing price? Should we define
an alternative closing price? For
example, should we use a definition
similar to the one used by NYSE
ARCA? 313 Alternatively, should we
adopt the definition of ‘‘market price’’
currently used in Form N–1A, which
may provide even more discretion by
not referencing the midpoint? What
definition of market price would
provide the most accurate presentation
of market value? Would there be
investor confusion because of the
proposed change?
• Does calculating premiums and
discounts using market close
information provide investors with
information they would use?
• Should we instead require a
calculation and disclosure of an intraday premium or discount as compared
to the next-calculated NAV? How would
investors use the disclosure of intraday
deviations between market prices and
the next-calculated NAV? Would such
disclosure be costly and/or burdensome
to produce? What calculation
methodology should we require for this
disclosure? For example, should we
require ETFs to disclose information
regarding the difference between: (i) The
mean or median of execution prices on
a business day; and (ii) the nextcalculated NAV per share, in order to
capture situations where deviations
between market price and NAV per
share significantly widened during the
trading day, but were tightly correlated
at the time as of which NAV is
calculated? Alternatively, should we
require ETFs to disclose information
regarding the difference between: (i) The
midpoint of the NBBO calculated every
minute; and (ii) the next-calculated
NAV? If so, should the midpoint of the
NBBO be calculated more or less
frequently? Are there other ways to
calculate intraday market prices that
would provide investors with
meaningful information regarding
intraday deviations between market
price and NAV per share? If we require
this type of disclosure, should it be in
addition to, or an alternative of, current
premium/discount disclosures?
Alternatively, would 5th and/or 95th
percentile data be useful in this context?
How frequently should ETFs disclose
313 See NYSE Arca Rule 1.1(ll) (defining how
official closing price is determined if the exchange
does not conduct a closing auction or if a closing
auction trade is less than a round lot); see also
Securities Exchange Act Release No. 82907 (March
20, 2018) [83 FR 12980 (March 26, 2018)] (order).
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information regarding intraday
deviations between market prices and
the next-calculated NAV? How long
should ETFs be required to maintain
this information on their website?
• Should we instead require
calculation and disclosure of an intraday premium or discount as compared
to the contemporaneous value of the
ETF’s portfolio? How would investors
use the disclosure of intraday deviations
between market price and the
contemporaneous value of the ETF’s
portfolio? Would such disclosure be
costly and/or burdensome to produce?
What calculation methodology should
we require for this disclosure? For
example, despite the limitations of the
IIV in the context of arbitrage activity,
could the IIV be useful for the
measurement and long-term tracking of
an ETF’s intraday market prices? If so,
should we prescribe a uniform
methodology for the calculation of the
IIV? Should we require ETFs to value
their portfolio holdings more frequently
for purposes of assessing any deviations
between market prices and the ETF’s
portfolio holdings, such as hourly or
three times a day? Are there other ways
to value an ETF’s portfolio on an
intraday basis that we should consider?
How frequently should ETFs disclose
information regarding intraday
deviations with the contemporaneous
value of the ETF’s portfolio? How long
should ETFs be required to maintain
this information on their website?
• Alternatively, should we require
ETFs to assess the efficiency of their
arbitrage mechanism pursuant to
internal methodologies and require
ETFs to provide narrative disclosure
regarding intraday deviations between
market price and (i) NAV; (ii) the
contemporaneous value of the ETF’s
portfolio; or (iii) both?
• We are proposing to require ETFs to
disclose the ETF’s median bid-ask
spread for the most recent fiscal year.
How would investors use this
information? Is the median bid-ask
spread an appropriate metric? For
example, the median bid-ask spread
would not capture extreme events and
stress periods. Should we require
additional bid-ask spread metrics, such
as average spread, high-end spread (e.g.,
95th percentile) or effective spread? 314
If so, why is it preferable and how
should it be calculated? Should we
314 For the purposes of this comment request, we
consider the effective spread the ‘‘actual’’ spread
(i.e., the difference between bid and the ask). We
consider the average spread to be the figure that
takes the average bids and asks over a period of
time and finds the difference between them. As
noted in the comment request, we also are soliciting
input on calculation methodology.
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require ETFs to provide the median or
mean spreads for the year?
• Should we require that the bid-ask
spread information be included on both
an ETF’s website and in its prospectus?
Would investors benefit from having
this information in both places? Should
we instead require it only on an ETF’s
website? Should the information be
required to be updated more or less
frequently than proposed? If so, how
frequently? For example, should we
require an ETF to disclose on its website
a trailing average spread over the course
of a year, updated daily? Are there
particular categories of investors that
may not use or have access to the
internet? If so, are there alternative ways
of communicating this information to
them in a cost-effective manner?
• Proposed rule 6c–11(c)(1)(iii) would
require an ETF to post on its website a
table showing the ETF’s premiums and
discounts for the most recently
completed calendar year and the most
recently completed calendar quarters of
the current year. As we discussed above,
this disclosure is a condition in many of
our exemptive orders and required by
Form N–1A. Do investors or their
advisers use this information? Are there
other forms of presenting this data that
would be easier for investors to
understand?
• Proposed rule 6c–11(c)(1)(iv) would
require an ETF to post on its website a
line graph showing the ETF’s premiums
and discounts for the most recently
completed calendar year and the most
recently completed calendar quarters of
the current year. How would investors
and their advisers use a line graph? Are
there other forms of presenting this data
that would be easier for investors to
understand?
• Should ETFs be required to include
intra-day premiums and discounts
(calculated using one of the
methodologies for which we request
comment above) as part of the line
graph? How would this disclosure be
used by investors?
• Should we require ETFs to provide
both forms of disclosure (i.e., table and
line graph)? Would investors use this
information? Should we require more
layered disclosure, such as an
interactive tool where investors can
enter different variables to better
understand historical premiums and
discounts?
• Should the table and line graph
cover the most recently completed
calendar year and the most recently
completed calendar quarters of the
current year as proposed or are there
other periods we should consider?
Should the period be longer or shorter?
Should we consider fiscal year periods
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instead of calendar year periods? If so,
what period and why? How would this
change impact the comparability of the
information across ETFs? In order to
give investors more information on
market dislocations that particularly
affect ETFs, should we also require
tabular and graphic disclosure for major
market events over past five or ten
years?
• Proposed rule 6c–11(c)(1)(v) would
require any ETF whose premium or
discount was greater than 2% for more
than seven consecutive trading days to
post that information on its website,
along with a discussion of the factors
that are reasonably believed to have
materially contributed to the premium
or discount threshold. Should we
require this proposed disclosure? Is 2%
an appropriate premium or discount? If
not, should we consider a higher or
lower threshold for this disclosure (e.g.,
1% or 5%)? If so, why? Should we vary
the premium or discount based on other
factors, such as fund strategy, asset
class, geographic region, or historic
premium/discount for the class? Should
we instead base the reporting threshold
on a different statistic, such as standard
deviation? Should it be based on the
average absolute value of the premium
or discount over a seven-day period? 315
• Is the seven consecutive trading day
requirement appropriate? Should we
require a shorter or longer period of
time? If so, what period and why? Is
there a more appropriate balance
between the magnitude (2%) and length
(seven consecutive trading days) of an
ETF’s premium or discount than we
have proposed (e.g., 10% for one day or
5% for two days)?
• Should we permit ETFs to
determine what percentage premium or
discount threshold is appropriate and
what time period to disclose, based on
the ETF’s particularized circumstances?
• Should we require any additional
measures to trigger the proposed rule
6c–11(c)(1)(v) disclosure requirement?
Should we require a second measure of
non-consecutive days in addition to the
seven trading day requirement? For
example, should we also require a
disclosure of factors if the ETF’s
premium or discount was greater than
2% for seven of the past 30 days?
• We propose that ETFs posting this
information be required to post it by the
end of the trading day immediately
following the day on which the
requirement was triggered. Is this a
reasonable period of time to post this
information? Why or why not? We also
propose that ETFs posting this
315 See supra footnote 120 (describing calculation
of absolute value).
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information be required to maintain it
on their websites for at least one year
following the first day it was posted.
Should these time periods be shorter or
longer?
• As an alternative (or in addition) to
requiring disclosure of this information
on an ETF’s website, should we require
disclosure in an ETF’s prospectus or
shareholder reports? Or should we
require that it be publicly filed on
EDGAR in a different regulatory filing?
• Would this disclosure requirement
disproportionately affect particular
types of ETFs? Would investors use this
information in assessing ETFs, or could
it lead to confusion?
• Should we require a discussion of
the factors that are reasonably believed
to have materially contributed to the
premium or discount? Would this
requirement provide investors with
useful context for deviations between
market price and NAV per share or
would ETFs rely on boilerplate
disclosure?
• Should we provide additional
guidance or impose additional
requirements for cases where a
deviation persists for an extended
period (i.e., much longer than seven
days)?
• In addition to the disclosures
regarding instances where the premium
or discount was greater than 2% for
more than seven consecutive trading
days, should we require that ETFs
disclose other information relating to
premiums and discounts? For example,
should we require ETFs to disclose
rolling average premium and discount
for a prior period? If so, what period?
Should we require ETFs to provide the
greatest premium and/or discount for
the previous month, quarter, or year? If
so, what period would be most useful to
investors and other market participants?
• Should we require ETFs to disclose
index tracking error, if applicable? If so,
how should we define tracking error?
For what period should we require
tracking error? Where should such
disclosure be made and how frequently?
• Should we require ETFs to include
a disclaimer indicating the potential
limitations of historical disclosures on
its website? If so, should the rule
prescribe the legend that should be used
and where the legend should be placed?
Should we require a legend similar to
the current performance-related
disclosure legend in Form N–1A, which
states that ‘‘past performance . . . is not
necessarily an indication of how the
Fund will perform in the future’’? 316
• We are proposing that ETFs provide
certain disclosures on their websites on
316 See
Item 4(b)(2)(i) of Form N–1A.
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a daily basis. Should we require funds
to provide these disclosures less
frequently? Are there other places that
funds should be required to report this
information?
• Should we require this information
to be posted ‘‘prominently’’ on the
ETF’s website? Should we provide any
other instruction as to the presentation
of this information, in order to highlight
the information and/or lead investors
efficiently to the information? For
example, should we require that the
information be posted on the main page
of a particular ETF series? Should the
information be accessible in no more
than two clicks from the ETF complex’s
home page? Should we adopt
presentation requirements that would
aid in the comparability of this
information for different ETFs? In
particular, should we adopt
presentation requirements for the
premium/discount line graph?
• In our discussion of the proposed
amendments to Item 3 of Form N–1A,
we are proposing an exception from the
disclosure requirements of trading
information and related costs for newly
created ETFs with limited trading
history. Should there be a similar
exception for newly created ETFs from
the website disclosure requirements of
the ETF’s NAV per share, market price,
premium or discount, and bid-ask
spreads as of the end of the prior
business day? Should the exception
apply to the requirement to disclose
historical information regarding the
ETF’s premiums and discounts? Why or
why not?
• Should we require ETFs to post the
proposed additional website disclosures
in a structured format and/or to file
them on EDGAR or make them available
in another centralized repository?
7. Marketing
Our exemptive orders and our 2008
proposal included a condition requiring
each ETF to identify itself in any sales
literature as an ETF that does not sell or
redeem individual shares and to explain
that investors may purchase or sell
individual ETF shares through a broker
via a national securities exchange.317
This condition was designed to help
prevent investors, particularly retail
investors, from confusing ETFs with
mutual funds. Given that ETFs have
been available for over 26 years, and the
market has developed a familiarity with
the product, we no longer believe this
317 See 2008 ETF Proposing Release, supra
footnote 3. Commenters who addressed this aspect
of the 2008 proposal generally supported this
condition. See ICI 2008 Comment Letter; Katten
2008 Comment Letter; Xshares 2008 Comment
Letter.
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condition is necessary. We believe that
retail investors generally understand
that, unlike mutual funds, individual
ETF shares may be purchased and sold
only on secondary markets. We further
believe that the website and registration
statement disclosures we are proposing
provide retail investors more useful
information regarding the exchangetraded nature and costs of ETFs.318
Therefore, we are not proposing to
include such a marketing disclosure
requirement in rule 6c–11.
We request comment on this aspect of
our proposal.
• Are we correct that a condition
requiring an ETF to identify itself in any
sales literature as an ETF that does not
sell or redeem individual shares and to
explain that investors may purchase or
sell individual ETF shares through a
broker via secondary markets is no
longer necessary? Do retail investors
understand that individual ETF shares
can be bought and sold only on
secondary markets? If not, should
proposed rule 6c–11 condition relief on
the inclusion of statements in an ETF’s
sales literature regarding the purchase
and sale of ETF shares on secondary
markets? Alternatively, should we
consider adding a disclosure
requirement only to Form N–1A?
• Should we consider other
limitations regarding ETF sales
literature?
• If the rule includes such a
condition, how should we define sales
literature? Should we define sales
literature as we proposed in 2008? 319
Are there other definitions that we
should consider, including by reference
to the definition in 17 CFR 230.156
(‘‘rule 156’’)? 320
318 The proposed website disclosure requirements
are described in section II.C.6 and the proposed
amendments to Form N–1A are described in section
II.H.
319 The 2008 proposed rule, consistent with the
use of the term in section 24(b) of the Act and the
existing definition in rule 34b–1 under the Act,
would have defined the term ‘‘sales literature’’ as
‘‘any advertisement, pamphlet, circular, form letter,
or other sales material addressed to or intended for
distribution to prospective investors other than a
registration statement filed with the Commission
under section 8 of the Act.’’ See 2008 ETF
Proposing Release, supra footnote 3.
320 Rule 156 under the Securities Act defines the
term ‘‘sales literature’’ to include ‘‘any
communication (whether in writing, by radio, or by
television) used by any person to offer to sell or
induce the sale of securities of any investment
company.’’ It also states that communications
between issuers, underwriters and dealers are
included in the definition of sales literature if such
communications, or the information contained
therein, can be reasonably expected to be
communicated to prospective investors in the offer
or sale of securities or are designed to be employed
in either written or oral form in the offer or sale of
securities. See 17 CFR 230.156(c).
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• If the rule included a condition
regarding sales literature, should it also
include an exception to permit an ETF
to disclose to investors that it will issue
or redeem individual shares in order to
consummate a reorganization, merger,
conversion or liquidation?
• To further prevent investors from
confusing ETFs with mutual funds,
should the rule require an ETF to
include the identifier ‘‘ETF’’ in its
name?
• To further prevent investors from
confusing ETFs with mutual funds,
should the rule require an ETF to
explicitly disclose in its sales literature
that shareholders may pay more than
NAV when buying shares and may
receive less than NAV when selling ETF
shares?
• Should the rule impose any
additional conditions or require any
additional disclosures to help investors
distinguish ETFs from other ETPs, such
as exchange-traded notes or commodity
pools that are not subject to the
Investment Company Act? Should the
Commission consider proposing naming
conventions based on these or other
distinctions in a future rulemaking? Are
naming conventions useful to investors?
Should ETFs be required to use a
different identifier (e.g., ‘‘IC’’ for ETFs
that are registered under the Investment
Company Act) before or after ‘‘ETF’’ to
distinguish them from other ETPs?
Should all ETPs be required to have
identifiers (e.g., ETF–N (for exchangetraded notes), ETF–IC (for ETFs that are
not leveraged ETFs), ETF–C (for
exchange-traded commodity pools),
ETF–L (for leveraged ETFs))?
• Alternatively, are there ways we
could address investor confusion by
restricting certain sales practices? For
example, should we consider proposing
restrictions in a future rulemaking on
how intermediaries communicate with
retail investors about ETPs unless they
disclose certain information designed to
clearly differentiate ETPs that are not
registered under the Act from ETFs that
are registered investment companies?
D. Recordkeeping
For the reasons discussed above,
authorized participants play a central
role in the proper functioning of the
ETF marketplace.321 One of the defining
characteristics of authorized
participants under the proposed rule is
that they have a written agreement with
an ETF or one of the ETF’s service
providers whereby the authorized
participant is allowed to purchase or
redeem creation units directly from the
ETF (‘‘authorized participant
321 See
supra section I.
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agreement’’).322 Thus, these agreements
are critical to understanding the
relationship between the authorized
participant and the ETF. While we
believe that most ETFs are currently
preserving copies of their written
authorized participant agreements
pursuant to our current recordkeeping
rules, for avoidance of doubt, we are
proposing to expressly require that ETFs
relying on rule 6c–11 preserve and
maintain copies of all such
agreements.323
This requirement is designed to
provide our examination staff with a
basis to determine whether the
relationship between the ETF and the
authorized participant is in compliance
with the requirements of proposed rule
6c–11 and other provisions of the Act
and rules thereunder, based on the
specific terms of their written
agreement, including, but not limited to,
terms related to postponement of
redemptions and transaction fees. We
did not include a specific preservation
requirement for authorized participant
agreements in the 2008 proposal.324
However, Commission staff’s experience
with the ETF industry since 2008,
including our examination staff’s
experience, has reinforced our belief
that authorized participant agreements
must be preserved.
We are also proposing to require ETFs
to maintain information regarding the
baskets exchanged with authorized
participants. In particular, the proposed
rule would require an ETF to maintain
records setting forth the following
information for each basket exchanged
with an authorized participant: (i) The
names and quantities of the positions
composing the basket; (ii) identification
of the basket as a ‘‘custom basket’’ and
a record stating that the custom basket
complies with the ETF’s custom basket
policies and procedures (if applicable);
(iii) cash balancing amounts (if any);
and (iv) the identity of the authorized
participant conducting the
transaction.325 These records would
provide our examination staff with a
basis to understand how baskets are
being used by ETFs, as well as to
evaluate compliance with the rule and
other provisions of the Act and rules
thereunder. In particular, we believe
these records would allow our
322 Proposed rule 6c–11(a) (defining ‘‘authorized
participant’’).
323 See proposed rule 6c–11(d)(1).
324 See 2008 ETF Proposing Release, supra
footnote 3. Our orders also do not include a specific
preservation requirement. See, e.g., Salt Financial,
supra footnote 270.
325 See proposed rule 6c–11(d)(2).
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examination staff to evaluate whether
the use of custom baskets is appropriate.
ETFs would be required to maintain
these records for at least five years, the
first two years in an easily accessible
place. The retention period is consistent
with the period provided in rules 22e–
4 and 38a–1(d) under the Act. Funds
currently have compliance programrelated recordkeeping procedures in
place that incorporates this type of
retention period, and we preliminarily
believe consistency with that period
would minimize any compliance
burden to funds.
We request comment on these
proposed recordkeeping requirements.
• Are these requirements necessary in
light of the benefits that would result
from Commission examination? Are
there other records that we should
require ETFs to preserve or other
feasible alternatives that would
minimize recordkeeping burdens? What
are the costs associated with
maintaining the proposed recordkeeping
requirements under the rule and what
effects would the proposed
recordkeeping requirements have on an
ETF’s compliance policies and
procedures?
• Do ETFs already preserve their
agreements with authorized participants
under our current recordkeeping
requirements?
• Should we require an ETF to
maintain a record stating that the
custom basket complies with the ETF’s
custom basket policies and procedures?
Is there any additional information that
we should require ETFs to maintain in
connection with their baskets? Should
we require ETFs to record information
regarding any transaction fees assessed
in connection with each basket? Are
there alternatives to this proposed
recordkeeping requirement that would
enable the Commission to examine the
composition of ETFs’ baskets, while
minimizing the recordkeeping burdens
imposed on ETFs?
• Are there other records we should
consider requiring ETFs to maintain
regarding transaction fees? 326 Should
we consider requiring ETFs to disclose
information regarding transaction fees
326 We understand transaction fees are imposed
by ETFs to defray the transaction expenses
associated with the creation or redemption, as
applicable, and prevent possible dilution resulting
from the purchase or redemption of creation units.
For cash baskets, the ETF may assess transaction
fees to offset certain operational, brokerage and
spread costs relating to the ETF’s purchasing or
selling of securities. Transaction fees can impact
secondary market investors in ETF shares because
an authorized participant or other market maker can
cause the spread to widen on ETF shares to recoup
or offset some of the costs from paying the
transaction fees.
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in their registration statement or on
Form N–CEN? For example, should
ETFs be required to describe transaction
fees and the amount of such fees that are
charged in connection with effecting
purchases and redemptions of creation
units? Should there be disclosure about
the aggregate dollar amount or
percentage of transaction fees paid over
particular periods? Should we require
ETFs to disclose the dollar amount (or
percentage) of transaction fees waived
over a particular periods? If so, how
should this information be presented?
Should we require ETFs to include
narrative disclosure regarding waivers,
noting for example, that the waiver of
transaction fees may result in additional
costs borne by the ETF?
• Should we require ETFs to maintain
these records for five years, the first two
years in an easily accessible place, as
proposed? Should we use a different
retention period, such as the six-year
retention period under 17 CFR 270.31a–
2 (rule 31a–2 under the Act)?
• Would compliance with these
proposed requirements have any effect
on ETFs’ internal compliance policies
and procedures?
• Should we instead, or additionally,
require that ETFs file their authorized
participant agreements as exhibits to
their registration statements? Why or
why not?
• Are there any additional alternative
recordkeeping requirements we should
consider?
E. Share Class ETFs
The proposed rule does not provide
any relief from sections 18(f)(1) or 18(i)
of the Act or expand the scope of 17
CFR 270.18f–3 (‘‘rule 18f–3’’ under the
Act) (the multiple class rule).327
Sections 18(f) and (i) of the Act were
intended, in large part, to protect
investors from certain abuses associated
with complex investment company
capital structures, including conflicts of
interest among a fund’s share classes.328
These provisions also were designed to
address certain inequitable and
discriminatory shareholder voting
provisions that were associated with
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327 See
15 U.S.C. 80a–18(f)(1) and (i); 17 CFR
270.18f–3. Section 18(f)(1) of the Act generally
prohibits a fund from issuing a class of ‘‘senior
security,’’ which is defined in section 18(g) to
include any stock of a class having priority over any
other class as to distribution of assets or payment
of dividends. See 15 U.S.C. 80a–18(g). Section 18(i)
of the Act provides that all shares of stock issued
by a fund must have equal voting rights.
328 See Exemption for Open-End Management
Investment Companies Issuing Multiple Classes of
Shares, Investment Company Act Release No.19955
(Dec. 15, 1993) [58 FR 68074 (Dec. 23, 1993)]
(proposing release), at nn.20 and 21 and
accompanying text.
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many investment company securities
before the enactment of the Act.329
In 1995, the Commission adopted rule
18f–3 under the Act to create a limited
exemption from sections 18(f)(1) and
18(i) for funds that issue multiple
classes of shares with varying
arrangements for the distribution of
securities and provision of services to
shareholders.330 That rule generally
provides that, notwithstanding sections
18(f)(1) and 18(i) of the Act, a registered
open-end management investment
company or series or class thereof may
issue more than one class of voting
stock, provided that each class, among
other requirements, has in all other
respects the same rights and obligations
as each other class.331
An ETF cannot rely on rule 18f–3 to
operate as a share class within a fund
because the rights and obligations of the
ETF shareholders would differ from
those of investors in the fund’s mutual
fund share classes. For example, ETF
shares would be redeemable only in
creation units, while the investors in the
fund’s mutual fund share classes would
be individually redeemable. Similarly,
ETF shares are tradeable on the
secondary market, whereas mutual fund
shares classes would not be traded.
An ETF structured as a share class of
a fund that issues multiple classes of
shares representing interests in the same
portfolio would not be permitted to rely
on proposed rule 6c–11. We recognize
that the Commission has granted ETFs
exemptive relief from the
aforementioned provisions of section 18
of the Act in the past, subject to various
conditions.332 However, relief from
section 18 raises policy considerations
that are different from those we seek to
address in this rule, which is intended
id.
Exemption for Open-End Management
Investment Companies Issuing Multiple Classes of
Shares, Investment Company Act Release No. 20915
(Feb. 23, 1995) [60 FR 11876 (Mar. 2, 1995)]
(adopting release) (‘‘Multiple Class Adopting
Release’’), at n.8 and accompanying text.
331 See 17 CFR 270.18f–3(a)(4).
332 See Vanguard Index Funds, et al., Investment
Company Act Release Nos. 24680 (Oct. 6, 2000) [65
FR 61005 (Oct. 13, 2000)] (notice) and 24789 (Dec.
12, 2000) (order) and related application; Vanguard
Index Funds, et al., Investment Company Act
Release Nos. 26282 (Dec. 2, 2003) [68 FR 68430
(Dec. 8, 2003)] (notice) and 26317 (Dec. 29, 2003)
(order) and related application; Vanguard
International Equity Index Funds, et al., Investment
Company Act Release Nos. 26246 (Nov. 3, 2003) [68
FR 63135 (Nov. 7, 2003)] (notice) and 26281 (Dec.
1, 2003) (order) and related application; Vanguard
Bond Index Funds, et. al., Investment Company Act
Release Nos. 27750 (Mar. 9, 2007) [72 FR 12227
(Mar. 15, 2007)] (notice) and 27773 (Apr. 25, 2007)
(order) and related application (collectively, the
‘‘Vanguard orders’’).
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330 See
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to address broadly the common type of
relief that most ETFs have sought.
For example, an ETF share class that
transacts with authorized participants
on an in-kind basis and a mutual fund
share class that transacts with
shareholders on a cash basis may give
rise to differing costs to the portfolio. As
a result, while certain of these costs may
result from the features of one share
class or another, all shareholders would
generally bear these portfolio costs.333
At the same time, the share class
structure also can provide benefits to
each share class, including economies of
scale. Given these additional policy
considerations, we believe it is
appropriate for ETFs to continue to
request relief from sections 18(f)(1) and
18(i) of the Act through our exemptive
application process, and for the
Commission to continue to weigh these
policy considerations in the context of
the facts and circumstances of each
particular applicant.
We request comment on this aspect of
the proposal.
• Should proposed rule 6c–11
include exemptions from sections
18(f)(1) or 18(i) of the Act, or should we
expand the scope of rule 18f–3 under
the Act? Why or why not?
• If commenters believe that such
exemptions should be included in the
proposed rule, should the rule include
conditions designed to take into account
the potential costs and benefits of a fund
with both mutual fund and ETF share
classes? If so, what conditions? Are we
correct in our preliminary belief that
combining an ETF share class with
traditional share classes of a mutual
fund may, in certain circumstances,
result in the costs and benefits
described above?
F. Master-Feeder ETFs
Many of our recent ETF orders
contain relief allowing ETFs to operate
as feeder funds in a master-feeder
structure.334 In general, an ETF that
operates as a feeder fund in a masterfeeder structure functions like any other
ETF. An authorized participant deposits
a basket with the ETF and receives a
333 These costs can include brokerage and other
costs associated with buying and selling portfolio
securities in response to mutual fund share class
cash inflows and outflows, cash drag associated
with holding the cash necessary to satisfy mutual
fund share class redemptions, and distributable
capital gains associated with portfolio transactions.
334 See, e.g., T. Rowe Price Associates, Inc., et al.,
Investment Company Act Release Nos. 30299 (Dec.
7, 2012) [77 FR 74237 (Dec. 13, 2012)] (notice) and
30336 (Jan. 2, 2013) (order) and related application;
SSgA Funds Management, Inc., et al., Investment
Company Act Release Nos. 29499 (Nov. 17, 2010)
[75 FR 71753 (Nov. 24, 2010)] (notice) and 29524
(Dec. 13, 2010) (order) and related application
(‘‘SSgA’’).
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creation unit of ETF shares in return for
those assets. Conversely, an authorized
participant that redeems a creation unit
of ETF shares receives a basket from the
ETF. In a master-feeder arrangement,
however, the feeder ETF then also
enters into a corresponding transaction
with its master fund. The ETF may use
the basket assets it receives from an
authorized participant to purchase
additional shares of the master fund, or
it may redeem shares of the master fund
in order to obtain basket assets and
satisfy a redemption request.
Because the feeder ETF may, in the
course of these transactions, temporarily
hold the basket assets, it would not be
able to rely on section 12(d)(1)(E) of the
Act, which requires that a feeder fund
hold no investment securities other than
securities of the master fund.335 To
accommodate these unique operational
characteristics of ETFs, our recent
exemptive orders have allowed a feeder
ETF to rely on section 12(d)(1)(E)
without complying with section
12(d)(1)(E)(ii) of the Act to the extent
that the ETF temporarily holds
investment securities other than the
master fund’s shares for use as basket
assets. These orders also provided the
feeder ETF and its master fund with
relief from sections 17(a)(1) and 17(a)(2)
of the Act, with regard to the deposit by
the feeder ETF with the master fund and
the receipt by the feeder ETF from the
master fund of basket assets in
connection with the issuance or
redemption of creation units,336 and
section 22(e) of the Act if the feeder ETF
includes a foreign security in its basket
assets and a foreign holiday (or a series
of consecutive holidays) prevents timely
delivery of the foreign security.337
The exemptive orders we have
granted to master-feeder ETFs, however,
do not include relief from section 18
under the Act inasmuch as investment
by several feeder funds or by mutual
fund and ETF feeder funds in the same
class of securities issued by a master
fund generally do not involve a senior
335 Section 12(d)(1) of the Act limits the ability of
a fund to invest substantially in shares of another
fund. See sections 12(d)(1)(A)–(C) of the Act; see
also infra footnote 344. Section 12(d)(1)(E) of the
Act allows an investment company to invest all of
its assets in one other fund so that the acquiring
fund is, in effect, a conduit through which investors
may access the acquired fund. See section
12(d)(1)(E)(ii) of the Act.
336 Relief from the affiliated transaction
prohibitions in sections 17(a)(1) and 17(a)(2) of the
Act is necessary because these sections would
otherwise prohibit the feeder ETF and its master
fund from selling to or buying from each other the
basket assets in exchange for securities of the
master fund. See 15 U.S.C. 80a–17(a)(1)–(2).
337 See 15 U.S.C. 80a–22(e) (generally requiring
the satisfaction of redemptions within seven days).
See also supra section III.B.4.
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security subject to section 18. We are
concerned, as discussed above, that if an
ETF feeder fund transacts with a master
fund on an in-kind basis, but non-ETF
feeder funds transact with the master
fund on a cash basis, all feeder fund
shareholders would bear costs
associated with the cash transactions.338
We understand that while many
orders contain this relief, only one fund
complex has established master-feeder
arrangements involving ETF feeder
funds, and each arrangement involves
an ETF as the sole feeder fund.339 Given
the lack of interest in this structure and
our concerns noted above, we are
proposing to rescind the master-feeder
relief granted to ETFs that do not rely
on the relief as of the date of this
proposal (June 28, 2018).340 However,
we also propose to grandfather existing
master-feeder arrangements involving
ETF feeder funds, but prevent the
formation of new ones, by amending
relevant exemptive orders.341 Because
these existing master-feeder ETFs
involve only one feeder fund for each
master fund, we do not believe they
would raise the policy concerns
discussed above so long as they do not
add feeders, and therefore do not
believe it is necessary to require these
structures to change their existing
investment practices.342
We request comment on the lack of
master-feeder relief in proposed rule 6c–
11.
• Are we correct that the market
interest for ETFs using master-feeder
structures, as discussed above, is
limited?
• Should the proposed rule include
master-feeder relief for ETFs, as
provided in certain of our exemptive
orders and discussed above? Why or
why not?
• Should we amend the exemptive
relief relied upon by existing master338 See
supra footnote 333 and accompanying
text.
e.g., SSGA Active Trust Prospectus (Oct.
31, 2017), available at https://us.spdrs.com/public/
SPDR_ACTIVE%20ETF%20TRUST_
PROSPECTUS.pdf.
340 See infra section II.G.
341 Based on staff analysis, we preliminarily
believe that the fund complex currently utilizing
this relief operates nine master-fund arrangements,
each involving only one ETF as the sole feeder
fund. See SSgA, supra footnote 334.
342 Rescinding the relief for existing master-feeder
ETFs would require them to change the manner in
which they invest. For example, transactions
between each of the affected master funds and its
corresponding feeder fund could be transacted in
cash, rather than in-kind, obviating any need for
exemptive relief for the feeder fund to hold
securities other than those issued by the master
fund. Alternatively, the feeder funds could opt to
pursue their investment objectives through direct
investments in securities and/or other financial
instruments, rather than through investments in
master funds.
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feeder arrangements? Alternatively,
should we also rescind the masterfeeder relief relied upon by existing
arrangements? If so, how would these
ETFs be impacted if we also rescinded
their relief?
• If the proposed rule provided
master-feeder relief for master-feeder
structures that include ETF and mutual
fund feeder funds, should the rule
include conditions designed to take into
account the potential costs and benefits
of such structures? If so, what
conditions? For example, should the
proposed rule require a determination
that the investment in a master fund is
in the best interest of the ETF and its
shareholders? If so, who should be
required to make such a determination?
How frequently should such a
determination be made? Alternatively,
should the proposed rule provide
master-feeder relief for master-feeder
structures but allow only ETF feeder
funds? If so, what conditions should
apply?
G. Effect of Proposed Rule 6c–11 on
Prior Orders
The Commission has authority under
the Act to amend or rescind our orders
when necessary or appropriate to the
exercise of the powers conferred
elsewhere in the Act. Pursuant to this
authority, we are proposing to amend
and rescind the exemptive relief we
have issued to ETFs that would be
permitted to rely on the proposed
rule.343 Our proposed rescission of
orders would specifically be limited to
the portions of an ETF’s exemptive
order that grant relief related to the
formation and operation of an ETF and,
with the exception of certain masterfeeder relief discussed above in section
II.F, would not rescind the relief from
section 12(d)(1) 344 and sections 17(a)(1)
and (a)(2) 345 under the Act related to
343 See section 38(a) of the Act, 15 U.S.C. 80a–
37(a).
344 Section 12(d)(1) generally limits the ability of
registered investment companies (including ETFs)
to acquire securities issued by other investment
companies in excess of certain thresholds, and the
ability of registered open-end investment
companies (including ETFs) from knowingly selling
securities to other investment companies in excess
of certain thresholds. The conditions set forth in
ETF exemptive applications for relief necessary to
create a fund of funds structure is generally
designed to prevent the abuses that led Congress to
enact section 12(d)(1), including abuses associated
with undue influence and control by acquiring fund
shareholders, the payment of duplicative or
excessive fees, and the creation of complex
structures. See Salt Financial, supra footnote 270.
We also note that certain standalone exemptive
orders, unrelated to ETF operations, are often
granted to applicants to permit investments in ETFs
beyond the limits in section 12(d)(1) of the Act; we
are not proposing to rescind such exemptive orders.
345 See supra section II.B.3.
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fund of funds arrangements involving
ETFs.346
The terms of the exemptive relief
granted to ETFs have evolved over time
and have resulted in an uneven playing
field among ETF complexes, subjecting
ETFs that pursue the same or similar
investment strategies to different
operational requirements. Moreover,
many ETF complexes have multiple
exemptive orders permitting them to
operate ETFs. Some of those orders
contain different conditions for relief
and different representations by the
applicants regarding how the ETFs
formed pursuant to the order would
operate. Many of those orders also
provide relief for future ETFs created
pursuant to the terms of a particular
exemptive order.347 As a result, ETF
complexes with multiple orders can
effectively choose the exemptive relief
that would be applicable to a new ETF
by selecting what legal entity should
form the new ETF series. Moreover,
differences in the terms of our various
orders have had varying impact on the
structure and costs of an ETF. For
example, shares of an ETF with a less
flexible basket condition in its order
could have wider spreads than a
similarly situated ETF with more
flexible basket compositions. However,
investors may not be able to discern the
difference between these two ETFs’
orders. As we have stated elsewhere in
this release, among our goals in
proposing rule 6c–11 is to create a
consistent, transparent and efficient
regulatory framework for many ETFs.
We do not believe this goal would be
furthered if ETFs that could rely on the
rule continue to rely on those orders.
In addition, we began including a
condition in our ETF exemptive orders
in 2008 stating that the relief permitting
the operation of ETFs would expire on
the effective date of any Commission
rule that provides relief permitting the
operation of ETFs.348 The purpose of
346 ETF exemptive relief typically segregates
exemptive relief from section 17(a) under the Act
necessary to create a fund of funds structure from
section 17(a) exemptive relief necessary for the
operation of the ETFs. This segregation of ‘‘Fund of
Funds Relief’’ and ‘‘ETF Relief’’ appears in
numerous representations and enumerated
conditions set forth in applications for exemptive
relief. See, e.g., Salt Financial, supra footnote 270.
347 See supra footnote 12.
348 See e.g., PowerShares, supra footnote 188;
Javelin Exchange-Traded Trust, Investment
Company Act Release Nos. 28350 (July 31, 2008)
[73 FR 46066 Aug. 7, 2008)] (notice) and 28637
(Aug. 26, 2008) (order) and related application. In
some cases, the automatic expiration condition
applies to the ETF-related relief only, and expressly
does not apply to certain other exemptive relief
requested, such as master-feeder and ‘‘fund of
funds’’ relief under section 12 of the Act. See, e.g.,
Fidelity Merrimack Street Trust, et al., Investment
Company Act Release Nos. 30464 (Apr. 16, 2013)
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this automatic expiration condition was
to better establish equal footing between
ETFs that have received exemptive
relief and ETFs that may rely solely on
a Commission rule, and to reduce
competitive advantages that could
potentially arise out of the conditions
for relief set forth in our earlier
exemptive orders.349 Of the
approximately 300 orders we have
issued that provide ETF exemptive
relief, approximately 200 include this
automatic expiration condition, and
thus the ETF relief would terminate if
and when proposed rule 6c–11 is
adopted and goes into effect. To provide
time for ETFs to transition to rule 6c–
11, however, we propose to amend these
existing orders to provide that the ETF
relief contained in those orders will
terminate one year following the
effective date of any final rule. Absent
this modification or our determining to
delay the effectiveness of any final rule
6c–11, the ETF relief included in orders
with the automatic expiration provision
could expire before ETFs were able to
make any adjustments necessary to rely
on rule 6c–11.
We believe that rescinding ETF
exemptive relief in connection with the
proposed rule (and amending those
orders that require ETF exemptive relief
to automatically expire in order to allow
a transitional period to any final rule)
would result in a more transparent
framework for covered ETFs, as those
ETFs would no longer be subject to
differing and sometimes inconsistent
provisions of their exemptive relief. The
relief and related conditions proposed
under rule 6c–11, moreover, are largely
consistent with our recent orders, and in
some cases, provide ETFs with
additional flexibility. For example,
proposed rule 6c–11 would provide
many ETFs with additional basket
flexibility beyond what is currently
permitted by their exemptive orders.350
We preliminarily believe, therefore, that
the operations of most existing ETFs
would not be significantly negatively
[78 FR 23793 (Apr. 22, 2013)] (notice) and 30513
(May 10, 2013) (order) and related application
(‘‘The requested relief, other than the Fund of
Funds Relief and the Section 17 relief related to a
master-feeder structure, will expire on the effective
date of any Commission rule under the Act that
provides relief permitting the operation of actively
managed exchange traded funds.’’).
349 See 2008 ETF Proposing Release, supra
footnote 3.
350 See proposed rule 6c–11(c)(3); see also supra
section II.C.5. We note that a subset of the ETFs
operating under exemptive relief has basket
flexibility that would not be broadened by the
proposed rule. Under the proposed rule, however,
such ETFs would be required to adopt and
implement written policies and procedures related
to the construction of baskets and the process for
the acceptance of baskets by the ETF.
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affected by the need to comply with the
requirements of rule 6c–11 as opposed
to their exemptive relief. However, in
order to limit any hardship that
revocation of existing exemptive relief
would have on current ETFs with orders
that do not automatically expire, we are
proposing a one-year period after the
effective date before we rescind that
exemptive relief to give those ETFs time
to bring their operations into conformity
with the requirements of proposed rule
6c–11.
We do not propose to rescind the
exemptive relief of ETFs that would not
be permitted to rely on the proposed
rule. Specifically, we do not propose to
rescind the exemptive relief for ETFs
organized as UITs,351 ETFs that are
organized as a share class of a fund,352
or leveraged ETFs.353 We believe it is
appropriate for ETFs seeking to utilize
these structures to continue to request
relief from the Commission through our
exemptive application process, and for
the Commission to continue to make
facts-and-circumstances-based
determinations regarding whether such
relief is appropriate for any particular
applicant.
The Commission does not believe that
it is necessary to give individual
hearings to the holders of the prior
exemptive relief or to any other person.
Proposed rule 6c–11 would be
prospective in effect and is intended to
set forth for covered ETFs the
Commission’s exemptive standards for
ETFs organized as open-end funds.
Recipients of existing exemptive relief
may make their views known in the
context of the comment process that
accompanies this rulemaking, and those
views will be given due consideration.
Finally, investment companies would
be able to request Commission approval
to operate as an ETF under conditions
that differ from those in proposed rule
6c–11.
We request comment on our proposal
to revoke existing ETF and certain
existing master-feeder exemptive relief.
• Should we revoke some or all of the
existing ETF exemptive relief? If not,
why not? Would allowing existing
exemptive relief to continue create an
unequal playing field for ETF market
participants? If not, why not?
• As discussed above, we are
proposing a one year period before
rescinding existing ETF exemptive
relief. Is the one year period appropriate
for ETFs with existing ETF exemptive
351 See discussion of ETFs organized as UITs,
supra section II.A.1.
352 See Vanguard orders, supra footnote 332.
353 See discussion of leveraged ETFs, supra
section II.A.3.
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relief to bring their funds into
compliance with rule 6c–11? If not, how
long should this period last? Why? We
are proposing to implement this one
year period, in part, by amending
existing orders with an automatic
expiration condition to provide that the
ETF exemptive relief contained in these
orders would terminate one year
following the effective date of any final
rule. Should we, instead, delay the
effectiveness of rule 6c–11 for one year?
Are there different approaches we
should consider?
• Should we consider rescinding the
exemptive relief for ETFs organized as
UITs or ETFs organized as a share class
of a fund and instead allow such ETFs
to be covered by rule 6c–11? If so, how
would such ETFs comply with the
requirements of the rule? For example,
would they have to restructure or
liquidate?
• Should we, as proposed, rescind the
exemptive relief that we have
previously granted that allows ETFs to
operate as feeder funds in a masterfeeder structure if they do not rely on
the relief as of the date of this proposal?
Do funds plan to use this relief in the
future? If so, what kind of ETF masterfeeder structures do funds envision
creating? For what purpose?
• We understand that the existing
structures are organized with an ETF as
the sole feeder fund. Is this
understanding correct? Should we
amend the exemptive relief applicable
to these funds as proposed?
• Would our proposal to rescind
certain of our previously issued ETF
exemptive relief, and allow the ETF
exemptive relief contained in the orders
with automatic expiration provisions to
expire one year following the effective
date of rule 6c–11, eliminate any
competitive advantages arising from the
relief we have granted via exemptive
order?
• Would existing ETFs face
significant challenges in complying
with the conditions of rule 6c–11 rather
than exemptive relief?
• Should we consider other
approaches? For example, should we
consider rescinding only ETF exemptive
relief previously granted to ETF
complexes that have multiple exemptive
orders permitting them to operate ETFs?
• Should we consider not rescinding
any of the approximately 100 pre-2008
orders that do not include the automatic
expiration provision? Should we
consider amending the orders that
contain the automatic expiration
provision of the ETF exemptive relief to
remove that provision? Under these
approaches, in which certain ETF
exemptive orders would be left in place,
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ETFs would continue operating under
different sets of conditions. Would
permitting ETFs to operate under
different sets of conditions have an
adverse effect on competition and
capital formation?
• Are there other approaches to the
existing ETF exemptive relief that we
should consider in view of proposed
rule 6c–11?
• Exemptive relief granted prior to
2009 generally includes relief from
section 24(d) of the Act to exempt
broker-dealers selling ETF shares from
the obligation to deliver prospectuses in
most secondary market transactions,
and the rescission of the ETF exemptive
relief from those orders would eliminate
this relief. We understand, however,
that broker-dealers have not relied upon
this relief and, subsequent to the
adoption of amendments to rule 498
under the Securities Act permitting the
delivery of an ETF’s summary
prospectus, most market participants
use the summary prospectus to satisfy
prospectus delivery obligations.354 Are
we correct in our understanding?
Should we provide relief from section
24(d) for ETFs that have this relief in
their exemptive orders if we were to
rescind those orders? If so, why?
H. Amendments to Form N–1A
As discussed above in section II.C.6,
because of the exchange-traded nature
of ETFs, ETF investors may be subject
to different costs than mutual fund
investors. For example, while an ETF
may, in some cases, have a lower
expense ratio than a comparable mutual
fund, an ETF investor will be subject to
certain unique costs associated
specifically with ETFs, such as the bidask spread and premiums and discounts
from the ETF’s NAV. As a result of these
differences, ETF investors may not be
fully aware of the full costs associated
with their investment in an ETF.
We therefore are proposing several
amendments to Form N–1A, the
registration form used by open-end
funds to register under the Act and to
offer their securities under the
Securities Act. The proposed
amendments are designed to provide
investors who purchase ETF shares in
secondary market transactions with
additional information regarding ETFs,
including information regarding costs
associated with an investment in ETFs.
The proposal also would eliminate
certain disclosures that would be
duplicative of the proposed
amendments to Item 3 of Form N–1A
regarding the exchange-traded nature of
354 See rule 498 under the Securities Act [17 CFR
230.498].
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ETFs. Finally, we are requesting
comment on whether we should create
a new ETF-specific registration form.
1. Definitions
We are proposing several
amendments to Form N–1A to reflect
the adoption of proposed rule 6c–11.355
First, we are proposing to amend the
definition of ‘‘Exchange-Traded Fund’’
in Form N–1A to add a specific
reference to proposed rule 6c–11.356
Currently, Form N–1A defines
‘‘Exchange-Traded Fund’’ to include a
fund or class that has formed and
operates in reliance on an exemptive
rule adopted by the Commission.357 We
believe that Form N–1A should make
specific reference to proposed rule 6c–
11, rather than a generic exemptive rule,
and that this change would be
consistent with Form N–1A’s general
approach of referring specifically to
exemptive rules in other defined terms.
Second, we propose to remove the
defined term ‘‘Market Price’’ from the
Definitions section of Form N–1A in
light of our other proposed changes to
Form N–1A. Market Price, as presently
defined in Form N–1A, is used in
several items that we are proposing to
eliminate from the Form.358 The
remaining instances in which ‘‘Market
Price’’ is used do not require the use of
a defined term, as they contemplate a
more general use of the term, such as
the requirement in Item 11 of Form N–
1A that an ETF explain in its prospectus
that the price of its shares is based on
Market Price.359 Accordingly, given our
proposed changes to Form N–1A, we do
not believe it is necessary to include
‘‘Market Price’’ as a defined term, and
propose to remove this definition from
the Form.
We request comment on the proposal
to amend the definition section of Form
N–1A.
• Should we, as proposed, revise the
definition of the term ‘‘Exchange-Traded
355 All of the definitions discussed in this section
would appear in Proposed General Instruction A of
Form N–1A.
356 Specifically, the proposed definition of
‘‘exchange-traded fund’’ would be a fund or class,
the shares of which are listed and traded on a
national securities exchange, and that has formed
and operates under an exemptive order granted by
the Commission or in reliance on rule 6c–11 under
the Act.
357 General Instruction A to Form N–1A.
358 See, e.g., proposed changes to Item 3 of Form
N–1A.
359 Item 11(a)(1) of Form N–1A. Also, in addition
to the defined term ‘‘Market Price,’’ Form N–1A
currently uses the undefined term ‘‘market price’’
in several instances where a more general use of the
term is appropriate. See, e.g., Instruction 3 to Item
11(g) of Form N–1A. Our proposed amendments to
the Form also include the use of the undefined term
‘‘market price.’’ See, e.g., proposed changes to Item
3 of Form N–1A.
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Fund’’ in Form N–1A to make specific
reference to proposed rule 6c–11?
• Should we, as proposed, remove the
defined term ‘‘Market Price’’ from the
Definitions section of the General
Instruction to Form N–1A?
Alternatively, should we replace the
current definition with a reference to
the defined term ‘‘Market price,’’ as
defined in proposed rule 6c–11?
2. Item 3 of Form N–1A
Item 3 of Form N–1A requires funds
to include a table describing the fees
and expenses investors may pay if they
buy and hold shares of the fund. Item
3 does not currently distinguish
between ETFs and mutual funds, and
only requires disclosure of sales loads,
exchange fees, maximum account fees
and redemption fees that funds charge
directly to shareholders.360 We therefore
are proposing several amendments to
this Item to clarify that there are certain
fees that are not reflected in the fee table
for both mutual funds and ETFs and to
require new disclosure requirements
that capture ETF-specific trading
information and costs. Like all
information disclosed in Items 2, 3, or
4 of Form N–1A, the information
disclosed in amended Item 3 would
have to be tagged and submitted in a
structured data format.361
a. Changes That Affect Mutual Funds
and ETFs
First, we are proposing a narrative
disclosure that would clarify that, in
addition to the current disclosures
relating to investors who buy or hold
shares, the fees and expenses reflected
in the Item 3 expense table may be
higher for investors if they sell shares of
the fund.362 This amendment would be
360 Item
361 See
3 of Form N–1A.
General Instruction C.3.g.(i) to Form N–
1A.
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362 Proposed amendments to Item 3 of Form N–
1A. In order to eliminate duplicative disclosures,
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applicable to both mutual funds and
ETFs given that an investor may incur
expenses other than redemption fees
when selling shares of either a mutual
fund or ETF. For example, although less
common than they were in the past, an
investor may incur a back-end sales load
when selling a mutual fund share.
Likewise, an investor may bear costs
associated with bid-ask spreads when
selling ETF shares.
We are also proposing to require a
statement that investors may be subject
to other fees not reflected in the table,
such as brokerage commissions and fees
to financial intermediaries.363 We
believe this is appropriate disclosure for
both ETFs and mutual funds because
brokerage commissions and fees to
financial intermediaries could be
applicable to ETFs and mutual funds
alike.
b. Changes That Affect ETFs
Because ETF shares are exchangetraded, secondary market investors in
ETF shares are subject to trading costs,
such as bid-ask spreads, that are not
currently required to be disclosed under
Item 3. Trading costs, like all costs and
expenses, affect investors’ returns on
we are proposing to amend Instruction 1(e) of Item
3 to eliminate the requirement that ETFs modify the
narrative explanation for the fee table to state that
investors may pay brokerage commissions on their
purchase and sale of ETF shares, which are not
reflected in the example. We are also proposing to
eliminate the instruction that funds may only
exclude fees charged for the purchase and
redemption of the Fund’s creation units if the fund
issues or redeems shares in creation units of net less
than 25,000 shares. Thus, as proposed, an ETF may
exclude from the fee table any fees charged for the
purchase and redemption of the Fund’s creation
units regardless of the number of shares. See
proposed Instruction 1(e)(ii) to Item 3; see also
proposed Instruction 1(e)(ii) to Item 27(d)(1)
(proposing the same modification for the expense
example in an ETF’s annual and semi-annual
reports); see also infra footnote 397 and
accompanying and following text.
363 Proposed amendments to Item 3 of Form N–
1A.
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37371
their investment.364 In addition, some
investors use ETFs more heavily as
trading vehicles compared to mutual
funds, and the extent of the trading
costs borne by an investor depends on
how frequently the investor trades ETF
shares. We believe that investors could
overlook these costs and that additional
disclosure would help them better
understand the total costs of investing
in an ETF. Disclosure would also
facilitate comparisons between different
investment options.365
As a result, we are proposing a new
section in Item 3 that would require
disclosure of certain ETF trading
information and trading costs.366 This
proposed section is formatted as a series
of question and answers (‘‘Q&As’’). We
believe this format would help facilitate
an investor’s understanding of certain
terminology and cost calculations. The
proposed Q&A disclosures would
require information related to the
trading of ETFs on the secondary market
and the costs associated with such
trading. The specific question and
answer disclosures are shown in Figure
1 below.
364 See SEC Office of Investor Education and
Advocacy, Investor Bulletin: How Fees and
Expenses Affect Your Investment Portfolio (Feb.
2014), available at https://www.sec.gov/investor/
alerts/ib_fees_expenses.pdf, at 2 (‘‘As with any fee,
transaction fees will reduce the overall amount of
your investment portfolio.’’); see also Andrea
Coombes, Calculating the Costs of an ETF, The Wall
Street Journal (Oct. 23, 2012), available at https://
www.wsj.com/articles/SB100008723963904440
24204578044293008576204.
365 Alex Bryan & Michael Rawson, The Cost of
Owning ETFs and Index Mutual Funds, Morningstar
Manager Research (Dec. 1, 2014), available at https://
global.morningstar.com/us/documents/pr/Cost-OfOwning-Index-ETF-MFS.pdf, at 15 (‘‘While trading
commissions are the most conspicuous component
of trading costs, indirect trading costs, such as the
bid-ask spread and market impact of trading can
often be more important.’’).
366 Proposed amendments to Item 3 of Form N–
1A.
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Exchange- Traded Fund Trading Information
and Related Costs
What information dn I need to know about how the Exchange-Traded Fund
("ETF'J trades?
Individual shares of an ETF may only be bought and sold in the
secondary market throughabroken~·dealerat a market price. The market
price can change throughout the day due to the supply of and demand
for ETF shares, and changes in the value of the Fund's underlying
investments. among other reasons. Because ETF shares trade at market
prices rather than net asset value, shares may trade at a price greater than
net asset value (premium) or less than net asset value (discount).
Tt'hat costs are associated with trading shares of an ETF?
An investor may incur costs when buying or selling shares on an
exchange that are in addition to the costs described above. Examples
include brokerage commissions, costs attributable to the bid-ask spread,
and costs attributable to premiums and discounts.
What is the bid-ask spread?
111c bid-ask spread is the difference between the highest price a buyer is
willing to pay to purchase shares of the Fund (hid) and the lowest price
seller is willing to acceptl(lr shares ofthe Fund (ask). TI1e bid-ask
spread can change throughout the day due to the supply of or demand
f()r ETF shares, the quantity of shares traded, and the time of day the
trade is executed, among other ±:1ctors. For the ETF' s most recent fiscal
year ended
the median bid-ask spread was
r ].
I XX.XX%.
How does the bid-ask spread impact my retum
011
investment?
111c impact of the bid-ask spread depends on your trading practices. For
example, based on the ETF's ±!seal year-end data, purchasing $10,000
worth of ETF shares and then immediately therealler selling $10,000
worth ofETF shares (i.e., a "round-trip"). your cost, in dollars, would be
as follows:
I•' or a SI:-.IGLE round-trip (each trade being $10,000)
Assuming mid-range spread cost:
s _____
Assuming high-end spread cost:
s _____
But what if1 plan to trade ETF shares frequent{p?
Ba,ed on the ETF's most recent fiscal year-end data, completing 25
round-trips of$1 0,000 each, your cost, in dollars, would be as HJ!lows:
li'or 25 rmmd-trips (each trade being $10,000)
Mid-range spread cost:
s _____
s _____
High-end spread cost:
111e ETF's website at [www.[Series-SpecificLandingPage.com]]
includes recent information on the Fund's net a<;set value, market price,
premiums and discounts, as well as an interactive calculator you can use
to determine how the bid-a-;k spread would impact your specific
investment.
Figure 1
Q&A 1. Currently, Item 6(c) of Form
N–1A requires that ETFs disclose that:
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(i) Shares may only be purchased and
sold on a national securities exchange
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through a broker-dealer; and (ii) the
price of ETF shares is based on market
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Federal Register / Vol. 83, No. 147 / Tuesday, July 31, 2018 / Proposed Rules
price, and since ETFs trade at market
prices rather than at net asset value,
shares may trade at a price greater than
net asset value (premium) or less than
net asset value (discount).367 We are
proposing to move this description from
Item 6 to Q&A 1 in Item 3. We believe
that moving this information to Item 3
would consolidate relevant disclosures
regarding ETF trading costs and provide
the investor with helpful background
information relating to ETF trading.368
We also propose to replace the reference
to ‘‘national securities exchange’’ with a
reference to ‘‘secondary markets’’ to
reflect that ETFs can be bought and sold
over the counter or on an alternative
trading system in addition to their
primary listing exchanges.
Q&A 2. The second Q&A we are
proposing identifies the specific costs
associated with trading shares of an
ETF, such as brokerage commissions,
bid-ask spread costs, and potential costs
attributable to premiums and discounts.
This question clarifies that the costs
being discussed in the questions that
follow should be considered in addition
to the costs previously discussed in the
fee table.
Q&A 3. Proposed Q&A 3 would
include ETF-specific disclosures
relating to the median bid-ask spread for
the ETF’s most recent fiscal year.369
Costs attributable to the bid-ask spread
may increase or decrease when certain
market conditions exist or certain
factors are present. We believe that this
disclosure would inform investors
regarding the potential impact of spread
costs, including for investors who
frequently trade ETF shares. We also
believe that disclosure regarding median
bid-ask spreads would provide a helpful
metric for ETF investors to determine an
ETF’s historic liquidity, since a
narrower bid-ask spread typically
signals higher liquidity and a wider bidask spread generally signals lower
liquidity.370 Investors can use the bid367 Item
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368 See
6(c) of Form N–1A.
proposed amendments to Item 3 of Form
ask spread to assess the ETF’s
tradability in comparison to other
similar ETFs.371
The proposed Q&A would describe
the bid-ask spread as the difference
between the highest price a buyer is
willing to pay to purchase shares of the
ETF (bid) and the lowest price a seller
is willing to accept for share of the ETF
(ask). We are proposing to require this
description because some investors may
not be familiar with the term ‘‘bid-ask
spread,’’ making it difficult for them to
meaningfully analyze the specific bidask spread number that we propose to
include in this Q&A. The proposed Q&A
also would explain that the bid-ask
spread can change throughout the day
due to the supply of or demand for ETF
shares, the quantity of shares traded,
and the time of day the trade is
executed, among other factors.
In addition, we are proposing that an
ETF calculate and disclose its median
bid-ask spread over the most recently
completed fiscal year.372 We propose
that the median bid-ask spread be
calculated by using trading data from
each trading day of the ETF’s prior fiscal
year.373 Each daily bid-ask spread
would be calculated by taking the
average of the intraday bid-ask spreads,
which are measured by using the best
bid and best ask, respectively, at tensecond intervals throughout the trading
day. We understand that this is a widely
accepted method for calculating the bidask spread and believe that using the
best bid and ask would be
administratively easier and less
burdensome than other methods of
calculating the bid and ask price, such
as weighting or averaging bid and ask
prices throughout the trading day. We
propose that the bid-ask spread be
calculated by taking the difference
between the bid and the ask and
dividing that difference by the midpoint
between the bid and the ask. The
median would be expressed as a
N–1A.
369 As discussed above, given the importance of
this information to understanding the total
expenses an investor may bear when investing in
an ETF, we propose that bid-ask spread information
be included in both the ETF’s prospectus and on
the ETF’s website. Proposed Instruction 5(a) to Item
3 of Form N–1A. See also infra section II.C.6.
370 CFA Institute Research Foundation,
Comprehensive Guide to Exchange-Traded Funds
(ETFS) (2015), available at https://
www.cfapubs.org/doi/pdf/10.2470/rf.v2015.n3.1, at
67–8 (‘‘CFA Guide’’). See also Allen B. Atkins &
Edward A. Dyl, Transactions Costs and Holding
Periods for Common Stocks, 52 Journal of Finance
1, 309–325 (1997) (‘‘Additional evidence of an
association between transactions costs and trading
volume can be found in the literature on bid-ask
spreads.’’). Literature also suggests that the bid-ask
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spread could be affected by increased transaction
costs. See Gerald W. Buetow & Brian J. Henderson,
Are Flows Costly to ETF Investors?, 40 Journal of
Portfolio Management 3, 101 (Spring 2014),
available at https://www.bfjlaward.com/pdf/25949/
100-112_Henderson_JPM_0417.pdf (noting that
authorized participants are likely to pass
transaction fees onto shareholders through the
spread).
371 See CFA Guide, supra footnote 370, at 69
(noting that ‘‘for some ETFs, even though the
underlying securities are liquid, bid–ask spreads
may be wide simply because the ETF trades so little
that the chances of an [authorized participant]
rolling up enough volume to use the creation/
redemption process are low’’).
372 Proposed Instruction 5(a) to Item 3 of Form N–
1A.
373 Proposed Instruction 5(b) to Item 3 of Form N–
1A.
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37373
percentage, rounded to the nearest
hundredth percent.
As proposed, an ETF would be
required to use data from the full
trading day without excluding certain
time periods, because we believe the
spread metric should represent the costs
that an actual investor could face at any
time during the day. We note, however,
that costs related to the bid-ask spread
can fluctuate throughout the day. For
example, the bid-ask spread tends to be
higher at the beginning of the trading
day and towards the end of the trading
day.374 At market open, wide spreads
may persist until all underlying stocks
open and start trading. At market close,
market makers may be less willing to
purchase ETF shares because they do
not want to hold the ETF shares
overnight.
We propose to require ETFs to use
one full fiscal year of data because we
believe a full year would capture
spreads during varying market events
throughout the year. Although we
considered requiring ETFs to use a full
calendar year of data for this disclosure
requirement in order to promote greater
comparability among ETFs, we are
concerned that using calendar year data
would necessarily mean that
information in certain ETF prospectuses
would be over a full year old.375 We
preliminarily believe that, to the extent
there are any concerns that using fiscal
year data instead of calendar year data
may undermine comparability of the
spreads of different ETFs when there are
significant market events in a particular
calendar year, such concerns are
mitigated by the relatively low impact of
a single market event to a full year’s
374 Ogden H. Hammond & Michael Lieder, J.P.
Morgan Asset Management, Debunking myths about
ETF liquidity (May 2015), available at https://
am.jpmorgan.com/blob-gim/1383272223898/83456/
1323416812894_Debunking-myths-about-ETFliquidity.pdf, at 6 (noting that certain ETF liquidity
patterns tend to repeat and are well known to
veteran traders, such as limited trading of ETFs
immediately prior to the close). See also Sunil
Wahal, Entry, Exit, Market Makers, and the Bid-Ask
Spread, 10 Rev. Financial Stud 871 (1997),
available at https://www.acsu.buffalo.edu/
∼keechung/MGF743/Readings/H1.pdf (‘‘Large-scale
entry (exit) is associated with substantial declines
(increases) in quoted end-of-day inside spreads,
even after controlling for the effects of changes in
volume and volatility. The spread changes are
larger in magnitude for issues with few market
makers; however, even for issues with a large
number of market makers, substantial changes in
quoted spreads take place.’’).
375 For example, if the ETF’s fiscal year end was
August 31, the annual update would be required to
be filed no later than December 29, which would
include spread cost information from the prior
calendar year for up to one year thereafter, meaning
that the spread cost information could be almost
two years old. By using fiscal year end data, the
information would never be more than 16 months
old.
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Federal Register / Vol. 83, No. 147 / Tuesday, July 31, 2018 / Proposed Rules
median bid-ask spread. Using one full
fiscal year of data also is consistent with
all other requirements for Item 3 of
Form N–1A.376
Under our proposal, an ETF would be
required to disclose median bid-ask
spread instead of average bid-ask spread
because we believe the median spread
better represents the spread that the
average investor would experience,
whereas the average spread better
represents the spread of an average ETF
share in a given transaction. We believe
sorting the spreads across the entire
fiscal year to determine the median—
rather than taking the median spread of
each trading day throughout the fiscal
year first, sorting each day’s median,
and taking the median spread across all
trading days—provides a better
representation of the true median across
the entire fiscal year. Requiring
disclosure of the median bid-ask spread
also avoids the problem of an outlier
skewing the bid-ask spread figure. For
example, if the spread is .05 in nine
instances but 1.00 in one instance, then
the average spread will be 0.145 which
we believe is a less accurate reflection
of the bid-ask spread for that fund.
Q&A 4 and 5. We also propose to
require ETFs to include questions on
how the bid-ask spread impacts the
return on a hypothetical $10,000
investment for both buy-and-hold and
frequent traders.377 These examples are
designed to allow secondary market
investors to see the impact that bid-ask
spreads can have on the investor’s
trading expenses and ultimately the
return on investment. For example, a
hypothetical example of spread costs
can highlight that these costs can be a
drag on returns for someone who trades
frequently in certain types of ETFs. On
a percentage basis, spread costs for a
single trade can equal, if not exceed, the
ETF’s annual operating expenses in
some cases. If an investor trades in and
out of an ETF several times within a
relatively short period of time, the costs
attributable to the bid-ask spread can
increase rapidly. Transparency into
trading costs also may promote greater
comparability among ETFs and other
investment products, such as mutual
funds. For example, two ETFs may have
very similar expense ratios, but one ETF
consistently has higher bid-ask spreads,
which could make the cost of that ETF
significantly higher than the one with a
low bid-ask spread.
The proposed example in Q&A 4
would require disclosure of
376 See
Item 3 of Form N–1A.
proposal uses $10,000 in order to
maintain consistency with the cost example in Item
3 of Form N–1A.
377 The
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hypothetical trading costs attributable
solely to the median bid-ask spread
based on data from the ETF’s prior fiscal
year.378 Specifically, the spread costs
example would demonstrate the
hypothetical impact of the ETF’s bid-ask
spread for one $10,000 ‘‘round-trip’’
trade (i.e., one buy and sell transaction).
The proposed example reflects costs
that are in addition to the annual fund
operating expenses, which are currently
disclosed in Item 3 of N–1A.379 Thus, to
assist investors with comparing the
costs of investing in various ETFs, we
believe that it is appropriate to use the
same hypothetical investment amount,
$10,000, which is used for the current
expense example in Item 3 of Form N–
1A.
To illustrate that more frequent
trading can significantly increase costs,
the proposed example in Q&A 5
demonstrates the costs associated with
25 $10,000 round-trip trades (50 total
trades). This figure represents
approximately two round-trip trades
each month. While the number of trades
that an investor makes during the course
of a year can vary depending on the type
of investor and the type of investment
strategy the ETF pursues, we believe
that an example showing the spread
costs of 50 total trades could provide
useful information for those that trade
frequently.380 As discussed in more
detail below, our proposal also would
allow investors to obtain more tailored
information regarding their costs on the
ETF’s website.381
Pursuant to this requirement, an ETF
would be required to disclose ‘‘midrange spread costs’’ and ‘‘high-end
spread costs.’’ The mid-range spread
costs would be calculated by using the
median spread, divided by two, and
then multiplying the resulting number
by a $10,000 trade size and the number
of transactions. The high-end spread
costs would be calculated by using the
same calculated spread data from the
ETF’s prior fiscal year, except instead of
choosing the median spread, the
disclosure would represent the 95th
percentile spread, after sorting that
378 Proposed
Instruction 5(b) to Item 3 of Form N–
1A.
379 Item 3 of Form N–1A. Item 3 only requires 1and 3-year expense examples for annual fund
operating expenses for ‘‘New Funds.’’
380 We acknowledge the inherent difficulty of
setting a number of trades that reflects an ‘‘average
investor.’’ Based on staff experience, however, we
preliminarily believe that 50 total trades, which
represents approximately 2 round-trip transactions
per month, is a reasonable figure to utilize for the
purposes of demonstrating the costs of trading for
a frequent trader in Q&A 5.
381 See proposed Instruction 5(e) to Item 3 of
Form N–1A.
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year’s data.382 We preliminarily believe
that utilizing the 95th percentile spread
(i.e., the spread representing the
threshold for the highest 5% of spreads)
is appropriate for the purposes of
representing high-end spread costs.
We considered whether to also
include ‘‘low-end spread costs’’ but
determined that the combination of
presenting ‘‘mid-range spread costs’’
and ‘‘high-end spread costs’’ would
provide the most meaningful disclosure
to investors. Many ‘‘low-end spread
costs’’ for ETFs with significant volume
have a penny spread and would
therefore not provide as useful of a
comparison across funds. Furthermore,
some ‘‘mid-range spread costs’’ and
‘‘high-end spread costs’’ could account
for more than 50% of the cost of an
initial investment in an ETF, whereas a
‘‘low-end spread cost’’ might only
account for a small fraction of an
investor’s overall costs. We request
comment on this point below.
An investor could use both the
median bid-ask spread figure from
proposed Q&A 4 and the costs
information in Q&A 5 to better assess
the overall cost impact of the bid-ask
spread. Proposed Q&As 1–5 also would
provide investors with a better
understanding of the basic terminology
needed to understand some frequently
overlooked costs associated with
investing in ETFs, and then provide the
data needed to understand how those
costs materialize for the particular fund
and how those costs compare to other
ETFs.
Q&A 6. Cross-reference to ETF’s
website and Interactive Calculator
Requirement. As discussed above,
proposed rule 6c–11 would require
daily website disclosure of several
items, including the NAV per share,
market price, and premium or discount.
As the disclosures on an ETF’s website
would be updated daily, we believe a
cross-reference in Form N–1A to the
website disclosures would enable
investors to receive timely and granular
information that could assist with
making an investment decision.
382 We are proposing to divide the bid-ask spread
by two on the assumption that the value of an ETF
share is the midpoint between the bid price and the
ask price. Therefore, the ‘‘cost’’ attributable to the
bid-ask spread of executing one trade would be, in
the case of purchasing a share of an ETF, the
difference between the ask price and the midpoint
between the bid and the ask prices—in other words,
this difference would represent the cost above
which the share was valued for this purpose and
not the full ‘‘round-trip’’ cost. Likewise, in the case
of selling an ETF share, the ‘‘cost’’ attributable to
the bid-ask spread of executing one trade would be
the difference between the bid and the midpoint
between the bid and the ask prices. To calculate the
cost of multiple trades, the single trade cost would
be multiplied by the number of transactions.
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Accordingly, we propose to require a
statement in Q&A 6 that would refer
investors to the ETF’s website for more
information.383 Item 11(g) currently
requires an ETF to provide a website
address in its prospectus if the ETF
omits the historical premium/discount
information from the prospectus and
includes this information on its website
instead. As a result, many ETFs already
include a website address in their
prospectus.384
In addition, proposed Instruction 5(e)
to Item 3 would require an ETF to
provide an interactive calculator in a
clear and prominent format on the ETF’s
website. The purpose of the interactive
calculator is to provide investors with
the ability to customize the hypothetical
calculations in Item 3 to their specific
investing situation. For example an
investor with an investment of $2,500
opposed to $10,000 or wishing to trade
10 times opposed to the 25 times
presented in Item 3 could use the
calculator to find more tailored costrelated information. We are sensitive to
the fact that creating a web-based
interactive calculator is not without
cost, especially for smaller fund
complexes. We have tried to mitigate
these costs by limiting the proposed
investor-input to two data points:
Investment amount and number of
trades. We also tried to limit the
complexity of the tool by proposing to
require the interactive calculator to use
the calculations detailed in Instructions
5(a)—(d) to Item 3 to provide the
information required by Q&As 3–5,
which relates to the bid-ask spread.
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c. Exception for ETFs With Limited
Trading History
Trading information and related costs
may not be useful to secondary market
investors in an ETF that has only a
limited amount of trading history since
inception. Therefore, we are proposing
that an ETF that had its initial listing on
a national securities exchange after the
383 Proposed amendments to Item 3 of Form N–
1A would require an ETF to include the following
statement in its prospectus: ‘‘The ETF’s website at
[www.[Series-SpecificLandingPage.com]] includes
recent information on the Fund’s net asset value,
market price, premiums and discounts, as well as
an interactive calculator you can use to determine
how the bid-ask spread would impact your specific
investment.’’ The Commission explained in a 2000
release that filers submitting HTML documents on
EDGAR should take reasonable steps when they
create the document in order to prevent URLs from
being converted into hyperlinks. See Rulemaking
for Edgar System, Securities Act Release No. 33–
7855 (Apr. 24, 2000).
384 As discussed above, we propose to replace the
historical premium/discount information in Item
11(g) with line graph disclosure regarding
premiums and discounts that would be required by
proposed rule 6c–11(c)(1)(iv). See supra section
II.C.6.
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beginning of its most recently
completed fiscal year would not be
required to include the ETF’s median
bid-ask spread or the spread cost
example in its Item 3 disclosure, nor
would the ETF be required to provide
an interactive calculator on its
website.385 We preliminarily believe
this information is most useful when
there is at least one full fiscal year of
data underlying the metrics. Without a
minimum amount of trading data to
calculate this information, the resulting
calculations could be skewed for any
number of reasons. For example, it is
possible that the time of year during
which the ETF was trading or the fact
that an ETF was relatively new to the
market and had not had significant
marketing to gain interest for shares of
the ETF resulted in low trading volume
and higher bid-ask spreads. We propose
to require a newly launched ETF to
provide a brief statement to the effect
that the ETF does not have sufficient
trading history to report trading
information and related costs.386 The
proposed amendment would prohibit a
new ETF from disclosing data based on
very short trading histories, which we
preliminarily believe could be
misleading. This approach would also
be consistent with our treatment of
other disclosure items such as portfolio
turnover data and annual returns.387
We seek comment on our proposed
amendments to Item 3:
• Should we require ETFs and mutual
funds to include a statement that
investors may be subject to other costs
not reflected in the fee table, such as
brokerage commissions and other fees to
financial intermediaries? Would this
disclosure be confusing to individual
investors, particularly those investing in
mutual funds?
• In addition to the statement
regarding brokerage commissions,
should we require quantitative
disclosure of the range of brokerage
commissions for transactions? Should
this disclosure be required of both
mutual funds and ETFs? Where in the
registration statement should such
disclosure be included? Or, would
disclosure of brokerage commissions
raise challenges too great to require
disclosure? For example, would
variations in methods used to collect
and set commissions make such
disclosure too complex? How costly or
difficult would it be to obtain
information about brokerage
commissions?
385 Proposed
Instruction 5(a) to Item 3 of Form N–
1A.
PO 00000
386 Id.
387 See
Items 3 and 4 of Form N–1A.
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• Should other costs be disclosed in
Item 3? If so, which costs and why?
How and where should those other costs
be disclosed? Should Item 3 include
market price range or NAV range? What
other trading information, if any, should
be included in Item 3 and why? For
example, should we require ETFs to
disclose information regarding the
number of days the ETF’s shares traded
on a national securities exchange, the
ETF’s average daily volume, and/or the
ETF’s total number of shares
outstanding? If so, how should we
require these metrics to be calculated
and disclosed?
• Should we include the specific ETF
disclosures in Item 3? Should we
require that those disclosures be made
in a Q&A format? Would investors
understand and find the proposed Q&A
format useful? Are there other formats
we should consider? Should we permit
ETFs to use any format that is designed
to effectively convey the information to
investors?
• Should we replace the reference to
‘‘national securities exchange’’ with
‘‘secondary markets’’ in Q&A 1 as
proposed?
• Should we require ETFs to explain
bid-ask spreads and the factors that
could affect bid-ask spreads in Item 3?
Are there other explanations (or means
to calculate bid-ask spreads) that we
should consider? Are there other factors
that could impact bid-ask spreads that
we should include in this explanation?
• Should the median bid-ask spread
information be included in the
prospectus? Should this information be
included in Item 3 or in a different
section of the registration statement? If
so, where? Alternatively, should we
require disclosure of this information on
an ETF’s website?
• To what extent is historical spread
data predictive of future spread data?
Should we require language indicating
that historical spread data may not be
predictive of future spread data?
• Should the spread calculation
exclude data from the beginning and
end of the trading day? If so, what time
periods should it exclude and why? For
example, should we exclude the first
and last 15 minutes of each trading day?
• Should the spread calculation be
based on data from an ETF’s fiscal-year
end or calendar-year end and why?
Would the use of fiscal-year make
comparability among funds more
difficult since funds have different
fiscal-year ends? Should the spread
calculation be based on data from more
than one year? If so, how many years
and why? Should the spread calculation
be based on data that, in addition to the
fiscal or calendar year, also includes
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data from the most recently completed
fiscal or calendar quarter, respectively?
Should the calculation be done on a
daily basis first and then again across
the entire fiscal year?
• Should the calculation for the bidask spread throughout the trading day
be done more or less frequently than
every ten seconds? If so, how frequently
and why?
• Should the bid and ask be
calculated using a different method,
such as weighting the prices throughout
the book? If so, explain the method and
why it should be used.
• Should a metric other than median
be used for the spread calculation? For
example, should we use average spread
or effective spread? 388 If so, why is it
preferable and how should it be
calculated? Would the use of a different
spread calculation provide more
comprehensive information about
extreme market events? For example,
should we also require disclosure of
additional percentiles towards the
extreme of the distribution, such as the
95th percentile?
• Instead of using the bid-ask spread
as an indicator of trading costs, is there
another method that would better reflect
an ETF’s overall trading costs? If so,
what is that metric, why is it better than
disclosing the bid-ask spread, and how
should it be calculated and disclosed?
• How difficult or costly would it be
for ETFs to obtain the data necessary to
calculate median bid-ask spread as
proposed? Are there any negative
consequences of disclosing the bid-ask
spread? If so, what are they?
• When calculating the spread costs
example, should the bid-ask spread be
divided by two for each transaction
listed or should each transaction reflect
the full round-trip spread cost?
• Should we require disclosure of
costs associated with ‘‘mid-range spread
costs’’ and ‘‘high-end spread costs’’, as
proposed? Should we additionally
include a requirement to disclose ‘‘lowend spread costs’’? Why or why not?
Would the disclosure of this data result
in retail investor confusion?
• Is the $10,000 trade amount used in
the spread costs example reasonable?
Should we consider a lower trade
amount? Alternatively, should the
spread costs example show varying
trade sizes calculated using varying
book depths? If so, what trade sizes and
why should they be used?
• Should the spread example include
a different number of transactions? If so,
how many transactions should be used
for each column and why? Should the
number of transactions vary based on
388 See
supra footnote 314.
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the type of investment strategy the ETF
pursues? If so, how should we
determine the number of transactions
and corresponding ETF types?
• Are there any negative
consequences of disclosing the spread
costs example? If so, what are they?
• Should each ETF be required to
disclose a website address in Item 3 as
proposed? Should we permit an ETF to
comply with this requirement by
including a general web address to an
investment company complex’s website
or should we require a series-specific
landing page for the ETF? Would a
cross-reference to the ETF’s seriesspecific page be useful?
• Should we require ETFs to disclose
information regarding premiums and
discounts in Item 3 of Form N–1A,
either in addition to, or in lieu of, the
disclosures proposed in rule 6c–11? If
so, should the information be based on
data over the entire fiscal year or
calendar year? Do commenters believe
that the reference to the ETF’s website,
where such information may be found,
provides investors with useful
information regarding these potential
costs?
• Would investors find the
information in our proposed
amendments to Item 3 helpful in
comparing between different investment
options?
• Should we require funds, as
proposed, to provide investors with an
interactive calculator on their website?
Would investors find an interactive
calculator helpful to better understand
the costs of investing in ETFs? Are there
data points that we have not discussed
that the interactive calculator should
include? Should the interactive
calculator be required for both mutual
funds and ETFs? For example, should
the interactive calculator be expanded
to include fee table information for both
ETFs and mutual funds? Are there any
challenges to posting an interactive
calculator that we are not considering?
What costs would be associated with
developing this type of calculator?
• Should we require funds to provide
an interactive calculator on their
website for other costs, such as any
costs attributable to premiums or
discounts? If so, what would be the user
inputs and outputs for the calculator?
How would the calculator calculate
such a cost?
• Should there be an exception to the
requirement to disclose trading
information and related costs for newly
launched ETFs as proposed? If not, why
not? Should a newly launched ETF
nevertheless be required to provide an
interactive calculator on its website?
Should the threshold for the exemption
PO 00000
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to include trading information and
related costs disclosure instead be based
on Form N–1A’s definition of ‘‘New
Fund’’ 389 or a different period of time?
If so, why? Should there be an exception
to disclosing trading information and
related costs for any other reason (e.g.,
limited trading book depth, low volume,
or trading only on a percentage of the
days throughout the year)? If so, what
should the threshold be and why?
• In lieu of providing an exception
from the requirement to disclose trading
information and related costs for newly
launched ETFs, should we instead
adopt a requirement for ETFs to disclose
this information once the ETF reaches
or exceeds a specified threshold of
trading volume for a specified period of
time, regardless of how long it has been
in operation? Put differently, should we
base this exception on level of trading
volume rather than the length of an
ETF’s operation? If so, what should such
thresholds be? If not, why not?
3. Item 6 of Form N–1A
Currently, Item 6(c)(i) of Form N–1A
requires an ETF to: (i) Specify the
number of shares it will issue or redeem
in exchange for the deposit or delivery
of baskets; (ii) explain that the
individual shares of the ETF may only
be purchased and sold on a national
securities exchange through a broker or
dealer; and (iii) disclose that the price
of ETF shares is based on the market
price and as a result, shares may trade
at a price greater than NAV (premium)
or less than NAV (discount).390 The
number of shares the ETF issues or
redeems in exchange for the deposit or
delivery of baskets is largely duplicative
of reports required in Form N–CEN.391
We therefore propose to remove this
requirement from Item 6.392 The
remainder of the information required
by Item 6(c)(i) is proposed to be moved
to the Item 3 disclosure.393 In order to
eliminate duplicative disclosure, we
propose to remove these requirements
389 Instruction 6 to Item 3 of Form N–1A defines
a ‘‘New Fund’’ as ‘‘a Fund that does not include in
Form N–1A financial statements reporting operating
results or that includes financial statements for the
Fund’s initial fiscal year reporting operating results
for a period of 6 months or less.’’ The instruction
permits New Funds to estimate ‘‘Other Expenses’’
and to complete only 1- and 3-year portions of the
expense example. Id.
390 Item 6(c)(i) of Form N–1A.
391 See Item E.3.a of Form N–CEN; see also
Reporting Modernization Adopting Release, supra
footnote 147, at n.1100 and accompanying text
(requiring ETFs ‘‘to report the number of ETF shares
required to form a creation unit as of the last
business day of the reporting period.’’).
392 See proposed amendments to Item 6 of Form
N–1A.
393 See proposed amendments to Item 3 of Form
N–1A.
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from Item 6.394 As noted above, moving
this information to Item 3 would
consolidate relevant disclosures
regarding the fees and trading costs that
may be borne by an ETF investor in one
place.
Additionally, Item 6(c)(ii) currently
requires ETFs issuing shares in creation
units of less than 25,000 to disclose the
information required by Items 6(a) and
(b).395 Current Items 6(a) and (b) require
funds to: (i) Disclose their minimum
initial or subsequent investment
requirements; (ii) disclose that the
shares are redeemable; and (iii) describe
the procedures for redeeming shares.
We are proposing to eliminate these
disclosures.396 When we adopted these
requirements, we reasoned that
individual investors may be more likely
to indirectly transact in creation units
through authorized participants if the
creation unit size was less than 25,000
shares.397 Based on staff experience, we
understand that retail investors do not
engage in primary transactions through
authorized participants. Furthermore, to
the extent that authorized participants
act as agents for market makers in
primary transactions with the ETF, we
believe that the flow of information on
how to purchase and redeem shares is
robust given the market maker’s
relationship with an authorized
participant. Therefore, we do not
believe that this disclosure would be
beneficial.
We request comment on the proposed
amendments to Item 6.
• Should we remove the disclosure
regarding creation unit sizes from Form
N–1A, as proposed? Are we correct in
our understanding that this disclosure is
largely duplicative of disclosure
required in Form N–CEN? Are we
correct in our belief that investors do
not find this information useful in the
context of a prospectus? Instead of
removing this disclosure from Form
N–1A entirely, should we move it to the
Statement of Additional Information?
Do retail investors typically use the
information on creation unit size and if
so, for what purpose? Is our belief
correct that this information is more
useful for authorized participants and
market makers and less useful to
investors purchasing individual shares
on an exchange?
394 See proposed amendments to Item 6 of Form
N–1A.
395 Item 6(c)(ii) of Form N–1A.
396 See proposed amendments to Item 6 of Form
N–1A.
397 See Enhanced Disclosure and New Prospectus
Delivery Option for Registered Open-End
Management Investment Companies, Investment
Company Act Release No. 28584 (Jan. 13, 2009) [74
FR 4546 (Jan. 26, 2009)] (‘‘Summary Prospectus
Adopting Release’’), at nn.170–72.
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• Alternatively, should we require
ETFs to disclose information regarding
their creation unit sizes or transaction
fees, or both, on their websites?
• Should ETFs continue to disclose in
Item 6 (or any other Item included
within the summary prospectus
disclosure) information currently
required by Items 6(a) and (b)? If so,
why? Should this disclosure be based
on a numerical threshold, and if so,
what would the appropriate threshold
be and why?
• Should we require ETFs to provide
disclosure regarding transaction fees
associated with the purchase and
redemption of creation units? If so,
where should such disclosure be
provided?
• Are we correct in our
understanding that that the flow of
information on how to purchase and
redeem ETF shares is robust due to the
relationship between market makers and
authorized participants?
4. Item 11 of Form N–1A
Item 11(g)(1) currently specifies that
an ETF may omit information required
by Items 11(a)(2), (b), and (c) if the ETF
issues or redeems shares in creation
units of not less than 25,000 shares
each.398 Similar to the reasoning
discussed above regarding amendments
to Item 6,399 we propose to amend Item
11(g)(1) to permit all ETFs, not just ones
with creation unit sizes of not less than
25,000 shares, to omit the information
required by Items 11(a)(2), (b), and
(c).400
Item 11(a)(2) requires a fund to
disclose when calculations of NAV are
made and that the price at which a
purchase or redemption is effected is
based on the next calculation of NAV
after the order is placed.401 Item 11(b)
and (c) require a fund to describe the
procedures used for purchasing and
redeeming the fund’s shares.402 In our
view, eliminating these disclosure
requirements for all ETFs would not
detract from an understanding of how
authorized participants transact directly
with the ETF in the primary market. As
discussed above, the proposed rule
would define an authorized participant
as a member or participant of a clearing
agency registered with the Commission,
which has a contractual arrangement
with the ETF or one of the ETF’s service
11(g)(1) of Form N–1A.
supra section I.H.3.
400 Proposed Item 11(g)(1) of Form N–1A.
401 Item 11(a)(2) of Form N–1A. Item 11(a)(1)
already requires that ETFs include an explanation
that the price of fund shares is based on market
price. Item 11(a)(1) of Form N–1A.
402 Item 11(b) and (c) of Form N–1A.
PO 00000
398 Item
399 See
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providers.403 Thus, we believe the
parties who purchase or redeem shares
from the ETF directly would either have
the knowledge necessary to do so
without additional procedural
disclosure or the ability to request such
information.
Item 11(g)(2) currently includes a
requirement for an ETF to provide a
table showing the number of days the
market price of the ETF’s shares was
greater than the ETF’s NAV per share for
certain time periods.404 As discussed
above, we propose to require
information about the premium and
discount of the ETF’s shares to their
NAV per share to be included on the
ETF’s website. Thus, we are proposing
to remove the information currently
required by Item 11(g)(2), as more
timely information would be available
on the ETF’s website. For the same
reasons, we are also proposing to
eliminate Item 27(b)(7)(iv) of Form N–
1A, which requires ETFs to include a
table with premium/discount
information in their annual reports for
the five most-recently completed fiscal
years.405
We request comment on the proposal
to remove the requirement to disclose
information required by Items 11(a)(2),
(b), and (c) as well as the proposal to
remove the requirement to disclose the
premium/discount information in the
prospectus and annual report.
• Should we keep this disclosure in
the prospectus? If we were to keep this
disclosure requirement, should we
require ETFs to disclose different
information about the procedures to
purchase and redeem shares directly
with the ETF?
• Do most ETFs provide the
premium/discount information required
by this information on their websites? If
we were to keep the requirement to
disclose the premium/discount
information in the prospectus, should it
mirror the information proposed to be
required on the ETF’s website?
5. Potential Alternatives to Current ETF
Registration Forms
As discussed above, open-end funds,
including ETFs organized as open-end
funds, are required to file Form N–1A to
403 See
proposed rule 6c–11(a).
11(g)(2) of Form N–1A. The item
provides that an ETF may omit the table if it
provides a website address that investors can use
to obtain the premium/discount information
required by the item.
405 Although the time period required by this
disclosure is different than the requirement in Item
11(g)(2), ETFs are permitted to omit both
disclosures by providing on their websites only the
premium/discount information required by Item
11(g)(2) (the most recently completed fiscal year
and quarters since that year).
404 Item
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register under the Act and to offer their
securities under the Securities Act.
UITs, including ETFs organized as UITs,
initially register under the Investment
Company Act on Form N–8B–2 and
register their offerings of securities
under the Securities Act on Form S–
6.406 However, ETFs, regardless of
structure, operate differently than the
other investment companies that
register on Forms N–1A and N–8B–2.
For example, unlike traditional openend funds and UITs, ETFs are exchangetraded and investors rely on the
arbitrage mechanism to ensure that the
ETF’s shares trade at or close to its
NAV.407 As a result of these differences,
in addition to our proposed
amendments to Form N–1A and Form
N–8B–2, we are seeking comment on
whether we should create a new
registration form that is specifically
designed for ETFs or consider other
disclosure formats as part of a future
rulemaking.
• Should we create a new registration
form for ETFs? What types of ETFs
should be required to file reports on
such a form? For example, should we
limit the form to ETFs that would be
subject to proposed rule 6c-11? Or
should all ETFs, including UIT ETFs,
file reports on such a form?
• What type of ETF-specific
information should such a form
include? Should the form require more
disclosure on the effectiveness of the
arbitrage mechanism? 408 Should the
disclosures require qualitative
disclosures that relate specifically to
ETFs, including the performance of the
ETF’s arbitrage mechanism? Should this
disclosure be required as part of an
annual report? 409 Should we require a
discussion of the ETF’s bid-ask spread
or premiums and discounts throughout
the year? Should the form include a
discussion of ETF-specific risk factors?
If so, what risk factors should be
included?
• Should we require ETFs to provide
investors with a short summary
document that provides key information
about the ETF? What type of
information should the document
include? For example, should it include
information related to the ETF’s
strategy, portfolio investments, costs,
risks, or performance? Should we
require it to be in a standardized
format? 410
• As an alternative to a new ETF
form, or in addition to such a form,
should we consider a summary
prospectus targeted specifically at ETFs
and their unique features?
• Should we require ETFs to file
periodic reports, such as on Form 8–K?
Under what circumstances should we
require periodic reports? For example,
should we require ETFs to file periodic
reports after a market event that
adversely affects the arbitrage
mechanism during the trading day?
I. Amendments to Form N–8B–2
Form N–8B–2 is the registration form
under the Investment Company Act for
UITs which are currently issuing
securities and is used for registration of
ETFs organized as UITs.411 For the
reasons discussed above in section
II.A.1, we believe that UIT ETFs should
be regulated pursuant to their exemptive
orders, rather than a rule of general
applicability and are not proposing to
include them within the scope of
proposed rule 6c–11. However, we
believe that it is important for investors
to receive consistent disclosures for ETF
investments, regardless of the ETF’s
form of organization.412 We are
therefore proposing to amend Form N–
8B–2 413 to require UIT ETFs to provide
disclosures that mirror certain of our
proposed disclosure changes in Form
N–1A.414 Below are the proposed Form
N–8B–2 amendments and the
corresponding sections in Form N–1A.
Corresponding
Form N–8B–2
proposed disclosure
Disclosure topic
Proposed Form N–1A
ETF disclosure
Definitions for Exchange-Traded Fund ....................
Information Concerning Fees and Costs .................
Information Concerning Fees and Costs .................
General Instructions Part A .....................................
Item 3. Risk/Return Summary: Fee Table ..............
Item 3. Exchange-Traded Fund Trading Information and Related Costs.
UIT ETFs, like other ETFs, are
exchange-traded. As a result, secondary
market investors in UIT ETFs, like other
ETFs, are subject to costs, such as: bidask spreads; brokerage commissions for
buying and selling shares of a UIT ETF
406 See
infra section II.0.
generally Hu and Morley, supra footnote
291 (proposing a new ETP disclosure regime that
‘‘responds to the significance of the arbitrage
mechanism, model-related complexities and
evolving understandings and conditions’’).
408 See generally id.
409 Id.; see also Item 27(b)(7) of Form N–1A.
410 For example, in 2017, the Canadian Securities
Administrators began requiring ETFs traded on
Canadian exchanges to provide investors with a
document, not to exceed four pages in length, called
‘‘ETF Facts.’’ The ETF Facts document is required
to include certain information about the ETF,
including, among other things, information related
to the ETF’s investments, risks, and performance, as
well as background information about ETFs
generally. See Canadian Securities Administrators,
Mandating a Summary Disclosure Document for
Exchange-Traded Mutual Funds and Its Delivery—
CSA Notice of Amendments to National Instrument
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407 See
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General Instructions Definitions.415
Item I.13(h).
Item I.13(i).
through a broker-dealer; and potential
costs related to purchasing UIT ETF
shares at a premium or discount to NAV
per share. As with investors in ETFs
organized as open-end funds, we believe
that unit holders could overlook these
costs for UIT ETFs. We believe that
additional disclosure would help
investors better understand the total
costs of investing in a UIT ETF.
Accordingly, we are proposing
disclosure requirements in Form N–8B–
41–101 (Dec. 8, 2016), available at https://
www.osc.gov.on.ca/documents/en/SecuritiesCategory4/ni_20161208_41-101_traded-mutualfunds.pdf.
411 While open-end funds register with the
Commission with Form N–1A, UITs must register
with two forms: Form S–6 which is used for
registering the offering of the UITs’ units under the
Securities Act, and Form N–8B–2, which is used for
registration under the Investment Company Act.
Form S–6, which must be filed with the
Commission every 16 months, provides certain
content requirements, mainly by referencing to the
disclosure requirements in Form N–8B–2.
412 See 2008 ETF Proposing Release, supra
footnote 3, at section III.D.1. for a general
discussion of ETF prospectus delivery
requirements. Since UITs issue securities, and not
subject to any of the applicable exemptions, both
sponsors and dealers are required to deliver a
current prospectus to unit holders. See section 5(b)
of the Securities Act (requiring prospectus delivery
with the sale of securities, including units of UITs);
see also section 24(d) of the Act (eliminating the
‘‘dealer exception’’ in section 4(3) of the Securities
Act for transactions in redeemable securities by
UITs); see also supra footnote 27.
413 Because Form S–6 requires UIT prospectuses
to include disclosure required by specified
provisions of Form N–8B–2, the proposed
disclosure amendments to Form N–8B–2 would
also apply to prospectuses on Form S–6.
414 See section II.H.
415 The proposed definition of the term
‘‘exchange-traded fund’’ in Form N–1A covers ETFs
organized as open-end funds and includes ETFs
relying on either exemptive orders or rule 6c–11 to
operate. Form N–8B–2, on the other hand, is for
UITs, which would not be able to rely on rule 6c–
11 to operate. Accordingly, the proposed definition
of ‘‘exchange-traded fund’’ in Form N–8B–2 omits
the reference to rule 6c–11.
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2 that mirror those of Item 3 of Form N–
1A, thus requiring prospectuses on
Form S–6 for UIT ETFs to disclose that
an ETF investor may pay additional
fees, such as brokerage commissions
and other fees to financial
intermediaries, and to provide certain
ETF trading information and related
costs.416
As discussed above, the proposed
instructions to Item 3 would require
median bid-ask spread to be disclosed
on an ETF’s website. UIT ETFs would
be subject to this requirement as well.
We note in this regard that UIT ETFs
currently are not subject to website
disclosure requirements regarding
trading costs or other information.
However, as a matter of practice, UIT
ETFs generally disclose information
regarding market price, NAV per share,
premium and discounts, and spreads on
their websites today.417
We request comment on the proposed
amendments to Form N–8B–2.
• Should we require ETFs organized
as UITs to provide disclosures that are
consistent with Form N–1A in the
manner proposed?
• Do the proposed amendments to
Form N–8B–2 ensure consistency
between ETFs organized as open-end
funds and UIT ETFs? Why or why not?
• Are there additional amendments to
Form N–8B–2 the Commission should
consider? Are there any amendments to
Form S–6 that the Commission should
consider? For example, should we
consider requiring UIT ETFs to provide
disclosure regarding market price, NAV
per share, and premiums and discounts?
Should we consider requiring UIT ETFs
to provide graphic disclosure regarding
the ETF’s historical premiums and
discounts? Should we permit UIT ETFs
to omit such premium/discount in their
registration statement if they include
those disclosures on the ETF’s website?
• Would the proposed trading cost
requirements in Form N–8B–2 Items
I.13(h)–(i) result in UIT ETFs having to
disclose information not currently
disclosed on their websites? If so, what
information would be disclosed that is
not currently disclosed?
416 See proposed Items 13(h) and (i) of Form N–
8B–2. See also supra section II.H.2 describing the
ETF trading information and related costs
disclosure requirements.
417 UIT ETFs also would be required to provide
certain ETF specific information in reports on Form
N–CEN. See Part E of Form N–CEN. Additionally,
a UIT ETF would be required to provide certain
information relating to the index that it tracks,
including the return difference and whether the
index is constructed by an affiliated person or is
exclusive to the UIT. See Item E.4 of Form N–CEN.
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J. Amendments to Form N–CEN
Form N–CEN is a structured form that
requires registered funds to provide
census-type information to the
Commission on an annual basis.418 Item
C.7. of Form N–CEN requires
management companies to report
whether they relied on certain rules
under the Investment Company Act
during the reporting period.419
We are proposing to add to Form N–
CEN a requirement that ETFs report if
they are relying on rule 6c–11.420 While
Form N–CEN already requires funds to
report if they are an ETF,421 we are
proposing to collect specific information
on which funds are relying on rule 6c–
11 in order to better monitor reliance on
rule 6c–11 and to assist us with our
accounting, auditing and oversight
functions, including compliance with
the Paperwork Reduction Act.
As discussed above in section II.C.1,
we are also changing the definition of
‘‘authorized participant’’ in Form N–
CEN to exclude the specific reference to
an authorized participant’s participation
in DTC in order to obviate the need for
future amendments if additional
clearing agencies become registered
with the Commission. Revised Form N–
CEN would define the term as ‘‘a
member or participant of a clearing
agency registered with the Commission,
which has a written agreement with the
Exchange-Traded Fund or ExchangeTraded Managed Fund or one of its
service providers that allows the
authorized participant to place orders
for the purchase and redemption of
creation units.’’ 422
We request comment on our proposed
amendments to Form N–CEN.
• Should we require any additional
information concerning proposed rule
6c-11? If so, what information and
where? For example, should we require
ETFs to provide information to the
Commission on a monthly basis on
Form N–PORT? If so, what information?
• Should we amend the definition of
‘‘authorized participant’’ in Form N–
CEN as proposed or should we retain its
existing definition?
III. Economic Analysis
A. Introduction
ETF sponsors seeking to operate an
ETF currently need to obtain an order
from the Commission that exempts them
from certain provisions of the Act that
418 See Reporting Modernization Adopting
Release, supra footnote 147.
419 Item C.7. of Form N–CEN.
420 Proposed Item C.7.k. of Form N–CEN.
421 See Item C.3.a.i. of Form N–CEN.
422 See proposed amendment to Instruction to
Item E.2 of Form N–CEN.
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otherwise would prohibit several
features essential to the ETF structure.
Obtaining such exemptive relief
typically has resulted in expenses and
delays in forming new ETFs. In
addition, the conditions in the
exemptive orders issued by the
Commission have evolved over time. As
a result, some ETF sponsors may have
a competitive advantage over other
sponsors because some existing
exemptive orders allow the sponsors to
launch new funds under the terms and
conditions of those orders, and because
the terms in some of the existing
exemptive orders may be more flexible
than others.
Proposed rule 6c–11 would allow
ETFs that satisfy certain conditions to
operate without obtaining an exemptive
order from the Commission. As
discussed above, the Commission also
proposes to rescind the exemptive relief
we have issued to ETFs that could rely
on the proposed rule. However, we
anticipate that ETFs whose exemptive
relief would be rescinded under the
proposed rule generally would be able
to rely on the proposed rule without
substantially changing their current
operations, as the conditions for relying
on the proposed rule would be similar
to those contained in existing exemptive
relief, consistent with existing market
practice, or generally more flexible than
those contained within existing
exemptive relief.423 ETFs that wish to
operate in a manner not covered by the
proposed exemptive rule could seek
individual exemptive relief from the
Commission.
We believe that proposed rule 6c–11
would establish a regulatory framework
that: (1) Reduces the expense and delay
currently associated with forming and
operating certain ETFs unable to rely on
existing orders; and (2) creates a level
playing field for ETFs that could rely on
the proposed rule. As such, the
proposed rule would enable increased
product competition among certain ETF
providers, which could lead to lower
fees for investors, encourage financial
innovation, and increase investor choice
in the ETF market.
Furthermore, the amendments to
Forms N–1A and N–8B–2 as well as the
additional website disclosures required
by the proposed rule are intended to
improve the information about ETFs
available to the market and to allow
423 As discussed in more detail below, some
conditions in the proposed rule and the scope of the
relief provided are less flexible than those included
in certain exemptive orders (e.g., the absence in the
proposed rule of master-feeder relief) and others
represent requirements that were not included in
exemptive orders (e.g., basket policies and
procedures and the recordkeeping requirements).
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investors to more readily obtain
information about fund products,
resulting in reduced investor search
costs. To the extent that the proposed
amendments would improve investors’
ability to evaluate the performance and
other characteristics of fund products,
the proposed amendments might result
in better informed investor decisions
and more efficient allocation of investor
capital among fund products, and might
further promote competition among
ETFs and between ETFs and mutual
funds.
The proposed rule and amendments
to Forms N–1A and N–8B–2 also may
impact non-ETF products and market
participants. To the extent that the
proposed rule would lead to lower
investor search costs, lower fees, and
increased product innovation and
investor choice in the ETF market,
investors may shift their investments
towards ETFs and away from funds
similar to ETFs, such as mutual funds.
Such a shift in investor demand also
may affect broker-dealers and
investment advisers, whose customers
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and clients may show increased interest
in and demand for ETFs. Moreover,
because ETF shares are traded on the
secondary market, the proposed rule
also could affect exchanges, alternative
trading systems, facilities for OTC
trading, broker-dealers, and clearing
agencies to the extent that the rule
causes changes in the ETF trading
activity they support.
B. Economic Baseline
1. ETF Industry Growth and Trends
The ETF industry has experienced
extensive growth since the first US ETF
began trading in 1993.424 From 1993 to
2002, an average of 10 new ETFs
registered each year and ETF net assets
increased by an average of $10.7 billion
annually. Industry growth accelerated
from 2003 to 2006, when, on average, 62
new ETFs and $77 billion in net assets
were added to the industry annually.
Since 2007, the industry has seen an
average of 141 new ETF entrants and an
424 For the purpose of this release, we focus
exclusively on ETFs that trade on US exchanges.
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average growth of $272.8 billion
annually. Since 2007, ETF net assets
have grown at an average rate of 18.4%
per year, which compares to 4.2% for
closed-end funds and 9.7% for openend funds over the same period.425
At the end of December 2017, there
were 1,900 registered ETFs that had a
total of $3.4 trillion in net assets,
spanning six broad investment style
categories. ETFs are predominantly
structured as open-end funds; however,
eight funds that together represented
10.9% of ETF total net assets ($372.8
billion) were structured as UITs, and 70
ETFs that together represented 25.1% of
total net assets ($854.9 billion) were
structured as a share class of an openend fund. The chart illustrates growth in
ETF net assets by investment strategy
beginning in 2000 (left-hand side axis).
It also tracks the percentage of net assets
invested in actively managed ETFs
(right-hand side axis).
425 The number and net assets of ETFs are based
on a staff analysis of Bloomberg data. Growth rates
for open- and closed-end funds are based on a staff
analysis of Morningstar data.
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Although indexing is still the most
common ETF strategy, over time ETFs
have evolved to offer, among other
things, active management, leveraged
and inverse investment strategies, and
exposure to various types of foreign
securities. At the end of December 2017,
187 ETFs, structured as open-end funds,
employed leveraged or inverse
investment strategies.426 In total,
leveraged ETFs had total net assets of
$35.26 billion or approximately 1% of
all ETF net assets. None of the eight
registered ETFs structured as UITs
employed leveraged or inverse
investment strategies. Of the remaining
unleveraged ETFs, both index-based and
426 As of the end of December 2017, 1,635 ETFs
were neither organized as a UIT, nor as a share class
of an open-end fund, and do not pursue leveraged
or inverse investment strategies. During 2017, the
number of such funds grew by 124. (In the last five
years, the increase in such funds ranged from 90 in
2013 to 181 in 2015.)
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active, 1,705 funds had combined net
assets of $3 trillion operated as openend funds, while eight funds had $372.8
billion in net assets operated as UITs.427
There were 206 actively managed
ETFs with total net assets of $45.8
billion. The remaining 1,694 funds with
combined $3.36 trillion in net assets
were index-based funds. Of these, 1,686
with total net assets of $2.987 trillion
were structured as open-end funds and
eight with total net assets of $372.8
billion were structured as UITs.
The majority of ETFs, in total 1,456,
held some foreign exposure in their
portfolio according to Morningstar data.
These ETFs had total net assets of
$2.976 trillion. Of these funds, seven
were structured as UITs and had $350.4
billion in net assets. The remaining
1,449 funds and $2.63 trillion in net
427 Bloomberg defines actively managed or indexbased managed funds according to disclosure in the
fund prospectus.
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assets were organized as open-end
funds. On average, these ETFs reported
foreign exposure of 37.75%. This
number was 57.13% for ETFs structured
as UITs and 37.66% for ETFs structured
as open-end funds.428
2. Exemptive Order Process
As discussed above, ETFs seeking to
operate as investment companies
historically have needed exemptive
relief from the Commission. Since the
first exemptive relief was granted in
1992, the Commission has issued
approximately 300 exemptive orders to
428 We estimate funds’ foreign holdings on April
11, 2018 from Morningstar data. For each ETF,
foreign holdings of equity and debt securities are
combined to obtain the approximate percentage of
assets invested in foreign securities. Morningstar
provided foreign holding data for 1,724 ETFs. In
this data, 268 funds, one of which is structured as
a UIT, reported holding no foreign securities and
176 funds from the original 1,900 are missing
foreign holdings data.
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ETFs. The average number of approved
exemptive orders between 1992 and
2006 was approximately 2.5 per year,
which has increased to approximately
25 per year since 2007.
Based on our review of exemptive
orders that granted relief for
unleveraged ETFs between January 2007
and mid-March 2018, the median
processing time from the filing of an
initial application to the issuance of an
order was 221 days, although there was
considerable variation.429 Depending on
the complexity of a fund’s application,
some ETF sponsors received exemptive
relief in a relatively short period of time
(the 10th percentile of the processing
time was 83 days) while others waited
over one year for approval (the 90th
percentile of the processing time was
686 days).
In addition to the processing time
associated with applying for an
exemptive order, Commission staff
estimates that the direct cost of a typical
fund’s application for ETF relief
(associated with, for example, legal fees)
is approximately $100,000, which may
vary considerably depending on the
complexity of the prospective fund.
3. Market Participants
As discussed above, several non-ETF
market participants may be affected by
the proposed rule, including fund
sponsors, authorized participants,
trading venues, and institutional and
retail investors.
Using data from Bloomberg, we find
that there are 83 unique ETF sponsors
with approximately 1,900 ETFs as of
December 31, 2017. The median number
of ETFs per sponsor is eight and the
mean is 23, suggesting that a small
number of sponsors have a large share
of the ETF market (in terms of number
of ETFs). Indeed, the top five sponsors
operate a combined 898 ETFs, whereas
the bottom half of sponsors operate only
a combined 121 ETFs.
An ETF (or one of its service
providers) has contractual arrangements
with a set of authorized participants,
who can place orders for the purchase
or redemption of creation units with the
ETF.430 While we currently lack data on
authorized participants, a 2015 surveybased study of fifteen fund sponsors,
which together offer two-thirds of all
existing ETFs (covering 90% of all ETF
assets), finds that the average ETF has
34 authorized participant agreements.431
The study further reports that creation
and redemption transactions occurred
only on between 10% to 20% of trading
days and that only 10% of the daily
activity in all ETF shares (by volume)
are creations or redemptions.432
ETF shares are mainly traded on
securities exchanges.433 Table 1 lists the
10 exchanges with the largest average
daily ETF trading volume, measured
over the 30 business days ending on
February 12, 2018. The data is from
Bloomberg and shows that NYSE Arca
handles the largest portion of ETF trades
($23.8 billion), followed by Nasdaq
InterMarket ($12.8 billion), and Cboe
BZX Exchange ($11.0 billion).
TABLE 1—ETFS LISTED ON NATIONAL EXCHANGES AND THEIR TRADING VOLUME
Number of
ETFs
Exchange
NYSE Arca ................................................................................................................................................................................................
NASDAQ InterMarket ................................................................................................................................................................................
Cboe BZX Exchange, Inc .........................................................................................................................................................................
Cboe EDGX Exchange, Inc ......................................................................................................................................................................
Cboe BYX Exchange, Inc .........................................................................................................................................................................
NASDAQ Global Market ...........................................................................................................................................................................
Nasdaq BX, Inc .........................................................................................................................................................................................
Chicago Stock Exchange, Inc ...................................................................................................................................................................
Cboe EDGA Exchange, Inc ......................................................................................................................................................................
NASDAQ OMX PSX .................................................................................................................................................................................
1,899
1,537
1,840
1,864
1,816
339
1,801
169
1,781
1,343
Trading
volume
(billion)
$23.8
12.2
11.0
7.4
4.5
3.2
2.7
2.5
2.4
2.2
The table reports the number of ETFs traded at each exchange and the average daily ETF trading volume, measured over the 30 business days ending on February 12, 2018. Trading volume is calculated as trade price multiplied by the number of shares relating to each price by exchange. The figures reflect an analysis by
the Commission staff using data obtained through a subscription to Bloomberg.
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Both institutional and retail investors
participate in the ETF secondary
market. Using combined data from
WRDS SEC Analytics Suite,
Morningstar, and the Center for
Research in Security Prices (CRSP) from
the first quarter of 2014 to the fourth
quarter of 2016, we estimate that
institutions own, on average, 43% of
ETF shares, when calculating the
average using equal weights for all
ETFs, and 55%, when calculating the
average using total net assets (‘‘TNA’’)based weights. The difference between
the equal-weighted and TNA-weighted
average institutional ownership
numbers—43% vs. 55%—suggests that
institutional investors tend to hold
larger shares of ETFs with larger TNA.
The table also shows that the median
ownership by institutional investors is
40%. Additionally, the table shows that
there is considerable variation in
institutional investor holdings, ranging
from an average for the 5th percentile of
6% to an average for the 95th percentile
of 90%.434 However, we observe that the
average institutional holding did not
change considerably over time during
the sample period.
429 The earliest order in our sample was approved
on 1/17/2007 and the latest order was approved on
4/10/2018.
430 Some market makers and other market
participants engage in creation and redemptions
indirectly through authorized participants. See
supra section I.B. The Commission, however, lacks
data on the number of such market participants.
431 See Antoniewicz, supra footnote 30. While we
currently lack data on authorized participants, we
note that, starting July 30, 2018, Form N–CEN Item
E.2 will require a fund to provide certain
information regarding its authorized participants,
including the authorized participant’s name, the
SEC file number, CRD number, and other
information. See Reporting Modernization
Adopting Release, supra footnote 147. This Item,
however, will not provide data about other market
participants that may transact through authorized
participants.
432 NSCC is the sole provider of clearing services
for ETF primary market transactions. Whether a
creation or redemption order is eligible to be
processed through NSCC depends on the eligibility
for NSCC processing of the securities in the ETF’s
basket. See Antoniewicz, supra footnote 30.
433 In the first quarter of 2018, 68% of ETF trading
by dollar volume was executed on exchanges, 23%
over the counter, and 10% using alternative trading
systems (ATSs), based on Trade and Quote (TAQ)
data provided by the New York Stock Exchange,
Trade Reporting Facility (TRF) data provided by
FINRA, and ATS information made publicly
available on the FINRA website.
434 The data we use is from Form 13F filings,
which does not capture all institutional positions
because Form 13F does not require reporting of
short positions (which would lead to an
overstatement of institutional ownership) and
because not all institutional investors are required
to file the form, for example because they exercise
investment discretion in less than $100 million in
Section 13(f) securities (which would lead to an
understatement of institutional ownership).
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TABLE 2—INSTITUTIONAL OWNERSHIP OF ETFS
Equalweighted
average
(%)
Quarter
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
TNAweighted
average
(%)
SD
(%)
P5
(%)
P25
(%)
P50
(%)
P75
(%)
P95
(%)
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
......................................................................................
40
42
41
43
41
42
44
44
44
43
43
44
53
54
55
55
54
55
56
57
57
56
56
57
24
25
24
24
24
25
26
26
26
26
26
25
6
7
7
6
5
6
7
5
5
6
5
6
22
22
23
24
22
23
25
24
24
23
24
24
37
37
38
40
38
40
41
43
42
41
41
42
56
58
59
60
58
60
62
62
62
61
62
61
86
90
88
88
85
91
94
92
92
92
91
91
Average .....................................................................................
43
55
25
6
23
40
60
90
The table reports the quarterly institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided by the total
shares outstanding adjusted for share splits. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. All descriptive stats are equalweighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using data from 2014Q1 to 2016Q4 obtained through a subscription
to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).
Further analysis shows that the
ownership structure varies considerably
by the type of ETF. Using Morningstar
categories, for the fourth quarter of
2016, Table 3 below shows that ETFs’
equal-weighted average institutional
ownership ranges from 23% for
alternative ETFs to 56% for taxable
bond ETFs. We also find that TNAweighted average institutional
ownership is higher than equalweighted average institutional
ownership for international equity,
municipal bond, sector equity, taxable
bond, and U.S. ETFs, suggesting that
institutional investors tend to hold ETFs
with larger TNA within these categories.
The converse is true for allocation,
alternative and commodity ETFs. The
table also shows that there is large
variation within categories.435
TABLE 3—INSTITUTIONAL OWNERSHIP OF ETFS BY MORNINGSTAR CATEGORY FOR 2016: Q4
Equal
weighted
average
(%)
Quarter
Allocation ...................................................................................
Alternative .................................................................................
Commodities .............................................................................
International Equity ...................................................................
Municipal Bond ..........................................................................
Sector Equity .............................................................................
Taxable Bond ............................................................................
U.S. Equity ................................................................................
TNA
weighted
average
(%)
43
23
41
48
48
42
56
45
38
16
38
63
55
57
63
60
SD
(%)
P5
(%)
26
22
20
23
16
22
21
23
P25
(%)
8
2
10
12
15
10
20
11
P50
(%)
23
6
29
31
39
26
41
29
P75
(%)
36
17
39
46
50
40
57
43
P95
(%)
58
33
59
64
59
58
72
59
95
68
71
91
74
83
91
93
The table reports the institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided by the total shares outstanding adjusted for share splits, by Morningstar Category. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. All descriptive
stats are equal-weighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using data for 2016Q4 obtained a through subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).
4. Secondary Market Trading, Arbitrage,
and ETF Liquidity
daltland on DSKBBV9HB2PROD with PROPOSALS4
Unlike shares of open-end funds, ETF
shares are traded in the secondary
market at prices that may deviate from
the ETF’s NAV. As a result, ETF
investors may trade shares at prices that
do not necessarily reflect the intrinsic
value of the underlying ETF assets.436
To reduce the frequency and size of ETF
premiums and discounts, our exemptive
orders have contained several
conditions designed to facilitate an
efficient arbitrage mechanism, help
ensure the proper functioning of the
ETF market, and ultimately protect
investors.
One set of conditions has required
that ETFs be listed on a national stock
exchange and that exchanges publish
the fund’s IIV every 15 seconds for
domestic ETFs and every 60 seconds for
international ETFs. Another condition,
which was designed to support the
effective functioning of the arbitrage
mechanism, is portfolio transparency.
All ETFs in operation today have a
provision in their exemptive order that
requires them to provide some degree of
transparency regarding their portfolio
435 Morningstar category is assigned based on the
underlying securities in each portfolio. Per
Morningstar, funds in allocation categories seek to
provide both income and capital appreciation by
investing in multiple asset classes, including stocks,
bonds, and cash. Funds in alternative strategies
employ investment approaches (similar to those
used by hedge funds) designed to offer returns
different than those of the long-only investments in
the stock, bond, or commodity markets.
International equity portfolios expand their focus to
include stocks domiciled in diverse countries
outside the United States though most invest
primarily in developed markets. Municipal bond
strategies are generally defined by state or national
focus and duration exposure. A fund is considered
state-specific if at least 70% of its assets are
invested in municipal securities issued by the
various government entities of a single state. Sectorspecific equity funds are usually equity funds, in
that they maintain at least 85% exposure to equity.
Fixed Income Taxable bond portfolios invest at
least 80% of assets in securities that provide bond
or cash exposure. U.S. equity portfolios are defined
as maintaining at least 85% exposure to equity and
investing at least 70% of assets in U.S.-domiciled
securities.
436 It is possible for both the ETF’s NAV per share
and its share price to deviate from the intrinsic
value of the ETF’s underlying portfolio. In addition,
there may be cases in which the ETF’s share price
is closer to the intrinsic value of the ETF’s portfolio
than its NAV per share. See, e.g., Madhavan,
Ananth, & Aleksander Sobczyk, Price Discovery and
Liquidity of Exchange-Traded Funds, 14 Journal of
Investment Management 2 (2016).
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holdings. As discussed above, actively
managed ETFs and some ETFs that track
an index from an affiliated index
provider have been required to disclose
their holdings prior to the
commencement of trading each business
day (i.e., full portfolio transparency).
Other index-based ETFs are permitted to
disclose their portfolio holdings
indirectly, by specifying which index
they seek to track, as long as the index
provider lists the constituent securities
on its website (i.e., index transparency)
or by disclosing the components of their
baskets. Based on a staff review of 100
index-based ETFs, randomly selected
from all index-based ETFs, and 50
actively-managed ETFs, randomly
selected from all actively-managed
ETFs, all 150 ETFs maintain a website
and provide the ETF’s complete daily
portfolio holdings. Therefore, we
believe that all index-based and
actively-managed ETFs that could rely
on the proposed rule now, including
those that are not subject to a full
transparency condition in their
exemptive order, currently provide full
portfolio transparency.437
The degree to which ETFs have
flexibility in choosing the composition
of creation and redemption baskets
plays an important role for the effective
functioning of the arbitrage mechanism.
A more flexible basket composition
may, among other considerations
discussed in more detail below, allow
authorized participants to exchange
baskets for ETF shares at a lower cost,
thus increasing arbitrage activity and
efficient functioning of markets.438 The
extent to which our exemptive orders
have allowed ETFs to use creation and
redemption baskets that deviate from a
pro rata representation of the ETF’s
portfolio holdings (i.e., basket
flexibility) has evolved over time. ETFs
that received their exemptive orders in
the early period from 1992–1995 were
mostly structured as UITs and, as a
result, the creation and redemption
baskets were mostly a strict pro rata
representation of the index, plus some
cash balancing amount. From 1996 to
2006, exemptive orders for ETFs, which
then were mostly structured as openend funds, did not expressly limit
437 The samples were randomly drawn from all
index-based ETFs and all actively managed ETFs
currently trading according to Bloomberg. We
recognize that the selection of ETFs examined by
Staff overweights the sample of actively managed
ETFs relative to the entire population of actively
managed ETFs. Our sampling procedure was done
to avoid small sample bias as equally proportioned
sampling would call for a survey of approximately
2 actively managed funds.
438 A more flexible basket composition may create
potential risks such as dumping and cherry-picking,
as discussed in more detail below.
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baskets to a pro rata representation of
the ETF’s portfolio holdings. From 2006
to 2010, the Commission limited basket
flexibility in exemptive orders for ETFs
organized as open-end funds by
requiring baskets to generally represent
a pro rata slice of the fund’s portfolio
holdings and including conditions
limiting the circumstances under which
substitutions would be permitted.
Starting around 2011, the exemptive
orders required baskets to be a strict pro
rata slice of the portfolio holdings and,
in addition, to be the same for all
authorized participants, with minor
exceptions.439
For ETFs that hold foreign
investments in their portfolio, the
redemption process for these securities
may take more than the seven days
specified under section 22(e) of the Act.
The Commission has granted exemptive
relief to certain ETFs who hold foreign
investments, in many instances up to 15
days, to satisfy redemption of a foreign
investment.
Many exemptive orders have required
ETFs to disclose on their website, free
of charge, the previous day’s NAV and
the price of the ETF shares, as well as
the premium or discount associated
with the ETF’s share price at the market
close.440 Based on a staff review of the
websites of 150 randomly selected ETFs,
all of which provided the previous day’s
NAV, price of the ETF shares (one active
ETF provided a price based on the
midpoint between the bid and ask
prices while the remainder of the active
and all index-based ETFs provided
closing prices), as well as the premium
or discount associated with the ETF
share price at the market close, we
believe that all ETFs that could rely on
the proposed rule currently disclose this
information on their website.441
ETFs have also been required to have
contractual agreements with authorized
participants to purchase or redeem ETF
shares in creation unit aggregations in
exchange for a basket of securities and
other assets. Having an accurate
estimate of the current ETF share value
and an opportunity to efficiently create
or redeem ETF shares in creation unit
439 Our exemptive orders have generally included
future funds relief to allow sponsors to form and
operate new ETFs without having to obtain
additional exemptive orders. See supra footnote 5.
As a result, the Commission does not have records
that would allow us to determine the specific
exemptive order under which any particular fund
is operating. We thus do not quantify the number
of funds operating under each of the different
basket flexibility conditions included in our orders.
440 In addition, some funds disclose some
historical information on premiums and discounts
on their website pursuant to the flexibility provided
on Form N–1A. See supra section II.C.6.c.
441 See supra footnote 437.
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sizes allows authorized participants to
engage in arbitrage activity that brings
the market price of ETF shares and the
value of the ETF’s portfolio closer
together. As noted earlier, market
participants can also engage in arbitrage
activity in the secondary market by
taking a long and short position on the
ETF shares and the underlying basket
assets. For example, if the ETF is trading
at a premium relative to the NAV per
share of the ETF’s portfolio, a market
participant can short the ETF and buy
the underlying basket assets in
proportion to the ETF shares.
Alternatively, if the ETF is trading at a
discount relative to NAV per share, a
market participant may buy the ETF and
short the underlying basket assets in
proportion to the ETF shares. Then the
market participant could realize a profit
by closing the position when the gap
between the ETF’s share price and NAV
per share gets closer to zero. This
trading activity could help close the gap
even further.
However, authorized participants,
other market participants, and
arbitrageurs acting in secondary markets
may incur costs and be exposed to risk
when engaging in arbitrage. The costs
include bid-ask spreads and transaction
fees associated with the arbitrage trades.
In addition, during the time it takes
arbitrageurs to execute these trades, they
are exposed to the risk that the prices of
the basket assets and the ETF shares
change. As a consequence, arbitrageurs
may decide to wait for any mispricing
between the market price of ETF shares
and NAV per share to widen until the
expected profit from arbitrage is large
enough to compensate for any
additional costs and risks associated
with engaging in the transaction.
Using data from Bloomberg, we find
that ETFs, on average, trade at a price
slightly higher than the NAV per share
(i.e., at a premium), as shown in Table
4 below. The equal-weighted and TNAweighted average premium/discount
over the last 15 years for all ETFs in the
dataset are, respectively, 0.074% and
0.065%, and the median is 0.024%,
indicating that the prices of ETF shares
are, on average, higher than the NAV
per share. One study finds similar
results and concludes that, on average,
ETF market prices tend to reflect NAV
per share closely. However, consistent
with the study, we find that ETF
premiums/discounts vary
significantly.442 For example, we find
442 Commenters to our 2015 ETP Request for
Comment, supra footnote 9, report qualitatively
similar results. See, e.g., Comment Letter of Eaton
Vance Corp. to Request for Comment on ExchangeTraded Products (File No. S7–11–15) (Aug. 17,
2015).
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that the average premiums/discounts
ranges from 0.03% in 2003 to 0.14% in
2009, and the average standard
deviation of premiums/discounts ranges
from 0.16% in 2017 to 0.60% in 2008.
Moreover, not all ETF shares trade at a
premium. For example, the table shows,
in a given year, at least 25% of ETF
shares trade at a discount, at an average
discount of ¥0.044% between all years
(see the column P25).
TABLE 4—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF PREMIUM/DISCOUNT (%) USING
DAILY DATA
Equal
weighted
average
Year
TNA
weighted
average
SD
P5
P25
P50
P75
P95
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
0.134
0.095
0.058
0.074
0.140
0.087
0.126
0.072
0.035
0.058
0.060
0.046
0.036
0.026
0.069
0.030
0.039
0.078
0.082
0.079
0.100
0.143
0.066
0.068
0.072
0.035
0.038
0.042
0.044
0.058
0.235
0.262
0.276
0.338
0.386
0.603
0.537
0.353
0.412
0.286
0.278
0.216
0.235
0.228
0.159
¥0.215
¥0.259
¥0.221
¥0.344
¥0.389
¥0.785
¥0.557
¥0.436
¥0.550
¥0.309
¥0.352
¥0.245
¥0.25
¥0.222
¥0.085
¥0.061
¥0.060
¥0.038
¥0.042
¥0.060
¥0.142
¥0.079
¥0.046
¥0.040
¥0.019
¥0.025
¥0.013
¥0.015
¥0.015
¥0.008
0.015
0.023
0.036
0.029
0.034
0.055
0.020
0.022
0.021
0.022
0.017
0.016
0.015
0.013
0.015
0.091
0.095
0.111
0.141
0.198
0.343
0.342
0.164
0.170
0.141
0.091
0.082
0.079
0.091
0.094
0.343
0.549
0.617
0.671
0.639
1.054
1.027
0.635
0.766
0.582
0.432
0.351
0.401
0.389
0.332
Average .....................................................................................
0.074
0.065
0.320
¥0.348
¥0.044
0.024
0.149
0.586
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The TNA-Weighted Average is weighted based on an
ETF’s previous month’s total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Fund premiums or discounts are
from daily Bloomberg data covering 1,838 funds for a total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund’s
closing price on the day of the most recent Net Asset Value (NAV) and the NAV of the fund on that day. The data covers the period from 01/03/2003 to 08/31/2017.
Premiums and discounts to NAV per
share also vary considerably by the type
of assets that make up the ETF.443 We
use Morningstar investment categories
to divide ETFs into groups of similar
assets and, in Table 5, report the time-
series averages of cross-sectional
descriptive statistics for premiums/
discounts in the different Morningstar
Investment Categories. We find that the
TNA-weighted average premium/
discount ranges from as low as 0.003%
for alternative to 0.197% for taxable
bond ETFs. The results are qualitatively
similar for equal-weighted average
premium/discounts.
TABLE 5—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF PREMIUM/DISCOUNT (%) BY
MORNINGSTAR INVESTMENT CATEGORY
Equal
weighted
average
Category
Allocation ...................................................................................
Alternative .................................................................................
Commodities .............................................................................
International Equity ...................................................................
Municipal Bond ..........................................................................
Sector Equity .............................................................................
Taxable Bond ............................................................................
U.S. Equity ................................................................................
TNA
weighted
average
0.072
0.007
0.211
0.185
0.086
0.031
0.207
¥0.001
0.083
0.003
0.112
0.193
0.076
0.013
0.197
0.005
SD
0.233
0.345
0.481
0.440
0.314
0.189
0.206
0.079
P5
¥0.119
¥0.404
¥0.545
¥0.482
¥0.358
¥0.243
¥0.068
¥0.104
P25
¥0.039
¥0.126
0.011
¥0.068
¥0.090
¥0.074
0.088
¥0.036
P50
0.047
¥0.004
0.084
0.204
0.061
0.005
0.188
0.008
P75
0.237
0.116
0.158
0.458
0.273
0.085
0.273
0.048
P95
0.295
0.468
1.007
0.833
0.532
0.304
0.539
0.113
daltland on DSKBBV9HB2PROD with PROPOSALS4
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The funds are first divided into groups based on
Morningstar categories. The TNA-Weighted Average is weighted based on an ETF’s previous month’s total net assets. SD refers to standard deviation. Columns P5
to P95 refer to the 5th to 95th percentiles. Fund premiums or discounts are from daily Bloomberg data covering 1,838 funds for a total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund’s closing price on the day of the most recent Net Asset Value (NAV) and the NAV of
the fund on that day. The data covers the period from 01/03/2003 to 08/31/2017.
When the ETF arbitrage mechanism
functions effectively, ETFs also should
trade at smaller bid-ask spreads.444 As
shown in Table 6, the TNA-weighted
average bid-ask spread, as a percentage
of the mid-price, has declined from
0.062% in 2012 to 0.030% in 2017.445
443 See
The table shows a qualitatively similar
decreasing pattern when using equalweighted average bid-ask spreads. The
percentiles of the bid-ask spreads also
follow a decreasing trend. For example,
we observe that the median bid-ask
spread drops from 0.024% in 2012 to
Engle Article, supra footnote 95.
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444 See,
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0.016% in 2017 (see column P50). The
table also shows that the bid-ask spread
varies considerably. For example, the
average standard deviation of the bidask spread (0.081%) is almost twice as
large as its average (0.043%).
445 This analysis starts in 2012 because the
available data begins in that year.
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TABLE 6—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF RELATIVE BID-ASK SPREAD (%)
Equal
weighted
average
Year
2012
2013
2014
2015
2016
2017
TNA
weighted
average
SD
P5
P25
P50
P75
P95
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
..........................................................................................
0.370
0.330
0.273
0.324
0.372
0.349
0.062
0.053
0.038
0.039
0.037
0.030
0.125
0.106
0.061
0.067
0.066
0.063
0.007
0.006
0.005
0.005
0.005
0.004
0.016
0.014
0.012
0.012
0.011
0.009
0.024
0.022
0.020
0.019
0.019
0.016
0.049
0.048
0.045
0.045
0.038
0.030
0.275
0.212
0.114
0.122
0.111
0.086
Average .....................................................................................
0.336
0.043
0.081
0.005
0.012
0.020
0.043
0.153
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The TNA-Weighted Average is weighted based on an
ETF’s previous month’s total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask spreads are from daily
Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is the average of all bid/ask spreads
taken as a percentage of the mid-price. The data covers the period from 01/03/2003 to 08/31/2017.
Table 7 reports bid-ask spreads for
ETF shares by Morningstar category. US
Equity ETFs have the smallest average
bid-ask spread of 0.027%, whereas
allocation ETFs—funds that seek to
provide both income and capital
appreciation by investing in multiple
asset classes, including stocks, bonds,
and cash strategy—have the largest
average bid-ask spread of 0.223%.
TABLE 7—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF RELATIVE BID-ASK SPREAD (%)
BY MORNINGSTAR INVESTMENT
Equal
weighted
average
Category
Allocation ...................................................................................
Alternative .................................................................................
Commodities .............................................................................
International Equity ...................................................................
Municipal Bond ..........................................................................
Sector Equity .............................................................................
Taxable Bond ............................................................................
U.S. Equity ................................................................................
TNA
weighted
average
0.590
0.391
0.353
0.450
0.281
0.285
0.306
0.207
0.223
0.094
0.041
0.072
0.100
0.061
0.043
0.027
SD
0.307
0.162
0.060
0.110
0.111
0.092
0.080
0.041
P5
0.073
0.017
0.009
0.017
0.038
0.015
0.011
0.006
P25
0.084
0.03
0.009
0.024
0.045
0.018
0.014
0.012
P50
0.147
0.047
0.009
0.030
0.064
0.036
0.016
0.014
P75
0.227
0.089
0.061
0.086
0.107
0.062
0.041
0.029
P95
0.642
0.315
0.118
0.212
0.306
0.198
0.159
0.081
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The funds are first divided into groups based on
Morningstar categories. The mean is weighted based on an ETF’s previous month TNA and the data covers the period from 01/03/2012 to 08/31/2017. SD, Min and
Max refer to standard deviation, minimum and maximum. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask spreads are from daily Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is the average of all bid/ask spreads taken as a percentage of
the mid-price.
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The summary statistics presented thus
far in this section suggest that the
arbitrage mechanism generally functions
effectively during normal market
conditions. However, as described
above in section III.B, the Commission
has observed periods of market stress
during which the arbitrage mechanism
has functioned less effectively and
during which there were significant
deviations for some ETFs between
market price and NAV per share and
when bid-ask spreads widened
considerably. We note, however, that
these conditions only persisted for very
short periods of time for the periods of
market stress we have observed,
suggesting that the arbitrage mechanism
recovered quickly.446
C. Benefits and Costs of Proposed Rule
6c–11 and Amendments to Forms N–1A
and N–8B–2
The Commission is sensitive to the
economic effects that could result from
proposed rule 6c–11 and amendments
446 See,
e.g. Madhavan Article, supra footnote
130.
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to Forms N–1A and N–8B–2, including
benefits and costs. However, as
discussed in further detail below, the
Commission is unable to quantify many
of the economic effects, either because
they are inherently difficult to quantify
or because we lack the information
necessary to provide a reasonable
estimate.
1. Proposed Rule 6c–11
Proposed rule 6c–11 would allow new
ETFs to operate in reliance on a rule
rather than individual exemptive orders
if they meet the requirements and
conditions of the rule. In addition, we
propose to rescind all existing ETF
exemptive orders, with the exception of:
(i) The section 12(d)(1) relief included
in those orders; 447 and (ii) orders
relating to ETFs structured as UITs,
leveraged ETFs, and those that are
447 The proposal would however rescind relief
that has been provided to allow master-feeder
arrangements for those ETFs that do not currently
rely on the relief. In addition, we propose to
grandfather existing master-feeder arrangements
involving ETF feeder funds, but prevent the
formation of new ones, by amending relevant
exemptive orders.
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organized as a share class of a mutual
fund.448 This section first evaluates the
general considerations associated with
the proposed rulemaking and then
discusses the effects of the specific
requirements and conditions of the
proposed rule.
a. General Considerations
Proposed rule 6c–11 would grant
exemptive relief from the provisions of
the Act that would otherwise prohibit
several features essential to the ETF
structure. This section evaluates the
overall effect of reducing the expense
and delay of operating certain new ETFs
by granting this exemptive relief as part
of a rule rather than through the
individual exemptive order process.
As the requirements and conditions of
the proposed rule are either similar to
those contained in existing exemptive
orders, consistent with market practice,
or generally provide more flexibility, we
anticipate that the proposed rule and
the related rescission of ETF exemptive
448 ETFs relying on exemptive orders that we
propose to rescind could no longer rely on their
orders to launch additional ETFs.
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daltland on DSKBBV9HB2PROD with PROPOSALS4
relief would not require any existing
ETFs whose exemptive relief would be
rescinded to significantly change the
way they operate. Conversely, some
funds whose exemptive orders contain
conditions that are more restrictive than
those contained in the proposed rule
may decide to change the way they
operate in order to make use of such
increased flexibility.
Relative to the baseline, proposed rule
6c–11 would eliminate the costs
associated with applying to the
Commission for an exemptive order to
form and operate as an ETF for funds
relying on the rule. Specifically, the
process of forming new ETFs in reliance
on the proposed rule would be quicker,
more predictable, less complex, and
therefore less costly than obtaining an
exemptive order as new ETFs are
currently required to do. ETFs that
could not rely on the rule, which
includes those structured as UITs,
leveraged ETFs, and those that are
organized as a share class of a mutual
fund, would continue to be required to
apply for an exemptive order to form
and operate.449
As described above in section IV.B.2,
we estimate that the cost for a typical
ETF of filing for exemptive relief is
$100,000. In addition, based on our
review of exemptive orders that granted
relief for unleveraged ETFs between
January 2007 and mid-March 2018, the
median processing time from the filing
of an initial application to the issuance
of an order was 221 days, although there
was considerable variation. Thus, any
new ETF planning to operate within the
parameters set forth by the proposed
rule would save this expected cost and
avoid this delay. In addition, such ETFs
would avoid the uncertainty about the
length of the delay associated with the
exemptive order process, allowing
sponsors to better control the timetable
for launching a new ETF product in a
way that maximizes benefits to its
business. Conversely, funds that are not
able to comply with the conditions of
the rule would continue to need to
apply for an exemptive order. Assuming
that the number of new ETFs seeking to
form and operate under the proposed
449 As discussed below, some ETFs would incur
additional costs as a result of the rule’s requirement
to adopt and implement written policies and
procedures that govern the construction of basket
assets and the process that will be used for the
acceptance of basket assets, the rule’s additional
website disclosure requirements, and the proposed
amendments to Forms N–1A and N–8B–2. The
operation of such ETFs may therefore become more
costly, on balance, to the extent that these costs are
not offset by the benefits from the other parts of the
proposed rule, such as the increased basket
flexibility and, for new funds, the reduced costs of
forming the fund.
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rule that would otherwise have needed
to apply for exemptive relief is equal to
the average number of ETFs that have
applied for exemptive relief since 2007,
these cost and time savings would
accrue to approximately 25 ETFs per
year.450 Using this assumption, the
annual costs savings to this group of
ETF sponsors would equal $2.5
million.451 We are unable to quantify
the benefit a new ETF would derive
from avoiding the delay and the
uncertainty about the length of the delay
associated with the exemptive order
process as the cost of a delayed
registration for a new ETF is inherently
difficult to measure.
By eliminating the need for ETFs that
can rely on the proposed rule to seek an
exemptive order from the Commission,
the proposed rule would also eliminate
certain indirect costs associated with
the exemptive application process.
Specifically, ETFs that apply for an
order forgo potential market
opportunities until they receive the
order, while others forgo the market
opportunity entirely rather than seek an
exemptive order because they have
concluded that the cost of seeking an
exemptive order would exceed the
anticipated benefit of the market
opportunity.
In addition, we believe that the
proposed rule would make it easier for
some fund complexes to ensure that
each ETF in the complex is in
compliance with regulations.
Specifically, we anticipate that it would
be easier, and thus less costly, for ETF
complexes that today operate funds
under multiple exemptive orders to
ensure compliance with a single set of
requirements and conditions contained
in the proposed rule rather than with
multiple exemptive orders to the extent
that the orders vary in the requirements
and conditions they contain.
We acknowledge that fund complexes
may initially incur costs associated with
assessing the requirements of the
proposed rule. However, we believe that
these costs would be relatively small.452
450 Compared to the baseline, these cost and time
savings would only accrue to such new ETFs whose
sponsors have not received exemptive relief that
would allow such ETFs to operate.
451 This estimate is based on the following
calculation: 25 × $100,000 = $2,500,000.
452 We estimate that assessing the requirements of
the proposed rule would require 5 hours of a
compliance manager ($298 per hour) and 5 hours
of a compliance attorney ($352 per hour), resulting
in a cost of $6,500 (10 × $298 + 10 × $352) per fund.
The total cost for all 1,635 ETFs that could rely on
the proposed rule would thus be $10,627,500 (1,635
× $6,500). The Commission’s estimates of the
relevant wage rates are based on salary information
for the securities industry compiled by the
Securities Industry and Financial Markets
Association’s Office Salaries in the Securities
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37387
In addition, we anticipate that it would
be easier for third-party providers, such
as lawyers and compliance consultants,
to offer services that help ETFs ensure
compliance with the proposed rules,
which will have broad applicability,
than is currently the case with ETFs
relying on exemptive orders with
varying conditions. As a result, third
party service providers may be able to
reduce the price of their services,
compared to the baseline, for ETFs that
could rely on the proposed rule, which
may partially or fully offset the initial
costs of studying the requirements of the
proposed rulemaking that ETFs may
incur.
We expect that the proposed rule also
would benefit ETF investors to the
extent it would remove a possible
disincentive for ETF sponsors to form
and operate new ETFs that provide
investors with additional investment
choices for which these sponsors
currently do not have relief. As noted
above, the direct and indirect costs of
the exemptive application process may
discourage potential sponsors,
particularly sponsors interested in
offering smaller, more narrowly focused
ETFs that may serve the particular
investment needs of certain investors.
By eliminating the need for individual
exemptive relief we anticipate that the
proposed rule would accelerate the rate
at which the ETF industry would
otherwise grow. In those circumstances,
the proposed rule would provide ETF
investors with greater investment
choices.
As we discuss below in section IV.D,
we believe that the proposed rule could
increase competition in the ETF market
as a whole, which could also lead to
lower fees. Any effect of increased
competition on fees would likely be
larger for segments of the ETF market
that currently may be less competitive
(e.g., active ETFs) and smaller for
segments of the market that currently
may be more competitive (e.g., indexbased ETFs tracking major stock
indices).
Additionally, some types of funds
could experience reductions in trading
costs associated with bid-ask spreads or
premiums and discounts to NAV per
share. Specifically, as discussed below
in section IV.C.1.c, the proposed rule’s
increased basket flexibility could reduce
Industry 2013. The estimated wage figures are
modified by Commission staff to account for an
1,800-hour work-year and multiplied by 2.93 to
account for bonuses, firm size, employee benefits,
overhead, and adjusted to account for the effects of
inflation. See Securities Industry and Financial
Markets Association, Report on Management &
Professional Earnings in the Securities Industry
2013 (‘‘SIFMA Report’’).
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the cost of arbitrage for authorized
participants of fixed-income,
international and actively managed
ETFs more than for authorized
participants and other market
participants of other types of ETFs. This
could potentially lead to a reduction in
costs for investors associated with bidask spreads and premiums and
discounts to NAV per share for fixedincome and international ETFs that
could be significantly smaller or
immaterial for other types of ETFs.
As discussed above, by eliminating
the need for individual exemptive relief,
we anticipate that the proposed rule
would, over time, lead to an increase in
ETFs that can meet the requirements
and conditions of the rule and thus
reinforce the current growth trend in the
ETF industry. In addition, the proposed
rule would increase demand for such
ETFs, to the extent that such ETFs lower
their fees to investors and investors are
sensitive to fees.453 To the extent that
some ETFs would experience larger
reductions in trading costs (e.g., fixedincome, international, and active) or
larger increases in competition (e.g.,
actively managed), demand for these
types of ETFs would likely increase
more than for other types of ETFs. The
increased demand would likely be due
in part to investors substituting away
from comparable types of funds, such as
mutual funds, and possibly due to
investors increasing the rate at which
they save.454 Consequently, the
453 There is research to support that fund
investors are sensitive to fees. For instance, one
paper (Erik R. Sirri & Peter Tufano, Costly Search
and Mutual Fund Flows, 53 The Journal of Finance
5 (1998)) finds that ‘‘lower-fee funds and funds that
reduce their fees grow faster’’. However, we
acknowledge that there are studies that suggest that
investors’ sensitivity to fees may be limited. For
instance, one experimental study (James J. Choi,
David Laibson, & Brigitte C. Madrian, Why does the
law of one price fail? An experiment on index
mutual funds, 23 The Review of Financial Studies
4 (2010)) finds that investors may not always pick
the lowest-fee fund when presented with a menu
of otherwise identical funds to choose from. In
addition, other studies (e.g., Michael J. Cooper,
Michael Halling, & Wenhao Yang, The Mutual Fund
Fee Puzzle, Working Paper (2016)) find evidence of
significant fee dispersion among mutual funds,
even after controlling for other observable
differences between funds. While these studies
investigate the sensitivity of investors to fees of
mutual funds rather than ETFs, we believe that
these results are likely hold for ETFs as well. We
are not aware of any studies that specifically study
the sensitivity of ETF investors to fees.
454 Investments in ETFs are one of many ways for
investors to save. If investors choose to increase
their investment in ETFs, there can be two sources
for this additional investment: (1) An increase in
overall savings and (2) a decrease in savings
allocated to other investments, such as mutual
funds. These two sources are not mutually
exclusive, so that an increase in ETF investments
can be accompanied by both an increase in overall
savings and a decrease in savings invested
elsewhere, for example in mutual funds.
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proposed rule could increase total assets
of ETFs and could decrease total assets
of other funds, such as mutual funds.
The size of these effects would depend
on the degree to which ETFs would
lower their fees or experience reduced
trading costs, as well as on the
sensitivity of investor demand for ETFs
and other funds to changes in ETF fees
and trading costs. We are unable to
quantify these effects on investor
demand for various types of funds, in
part, because we cannot estimate the
extent to which funds would lower their
fees or experience reduced trading costs
and how lower fees and trading costs
could change investor demand.
Since ETFs are traded in the
secondary market, an increase in total
assets of ETFs would likely coincide
with larger trade volumes for the
exchanges where ETFs are traded, as
well as the clearing agencies and brokerdealers involved in these trades. To the
extent that these market participants are
compensated by volume, the proposed
rule would thus benefit them by leading
to an increase in revenues.
In addition, we expect the proposed
rule to remove applications for more
standard forms of exemptive relief from
consideration, leaving for staff review
only applications for more complex or
novel exemptive relief that falls outside
the parameters of the proposed rule. To
the extent that this speeds up the
processing time for these remaining
applications, the proposal may reduce
the indirect costs of forming and
operating for funds that seek to operate
outside its parameters.
b. Conditions for Reliance on Proposed
Rule
Proposed rule 6c–11 contains several
conditions that are designed to facilitate
an effective arbitrage mechanism,
reduce costs, and inform and protect
investors. Beyond the general impact of
reducing the expense and delay of new
ETFs discussed above, much of the
codification of conditions in proposed
rule 6c–11 does not offer any additional
benefits or costs when measured against
the baseline, as they are generally
codifications of the current regulatory
practice. However, some conditions are
departures from current exemptive
orders or current market practice and
we discuss the effects of these
departures in more detail below.
i. Conditions We Believe May Facilitate
an Effective Arbitrage Mechanism
Arbitrage is the practice of buying and
selling equivalent or similar assets (or
portfolios of assets) in different markets
to take advantage of a price
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difference.455 As a consequence,
arbitrageurs generate price pressure that
works to equalize the prices of these
assets across different markets.
Arbitrage is thus important for investors
as it helps ensure that asset prices
reflect market fundamentals (i.e., are
efficient) irrespective of the market in
which they are traded.
The ETF structure makes use of such
an arbitrage mechanism with the goal of
establishing a close link between the
price of an ETF’s shares and the NAV
per share of the ETF portfolio.
Specifically, as discussed above, the
combination of the creation and
redemption process with the secondary
market trading in ETF shares provides
arbitrage opportunities that, if effective,
help keep the market price of ETF
shares at or close to the NAV per share
of the ETF and also help reduce bid-ask
spreads of ETF shares. Smaller
deviations of ETF prices from the NAV
per share of the ETF benefit investors as
they allow investors to transact in ETF
shares at prices closer to the value of the
ETF’s underlying portfolio of securities.
Similarly, small bid-ask spreads for ETF
shares benefit investors as they reduce
the cost to trading ETF shares.456
There are several factors that are
important for arbitrageurs to determine
the existence of arbitrage opportunities
and execute an arbitrage strategy
effectively. First, when the assets
involved in the arbitrage are similar but
not the same, as is the case for ETFs,
arbitrage will be more effective the more
closely the prices of the two assets track
each other and the more transparency
arbitrageurs have into any factors that
may cause price differences between the
two assets. In addition, arbitrage
requires that arbitrageurs have the
ability to enter into the trades necessary
to execute the arbitrage strategy, and
arbitrage is more effective the smaller
and more predictable the associated
trading costs are. The proposed rule
contains several provisions (many
codifying current exemptive orders) that
take these considerations into account
and are designed to promote the
effective functioning of the arbitrage
mechanism for ETFs.
First, the proposed rule would require
ETFs relying on the rule to adopt and
implement written policies and
procedures that govern the construction
of basket assets and the process that will
be used for the acceptance of basket
assets, including policies and
455 See, e.g., Jonathan B. Berk & Peter DeMarzo,
Corporate Finance, 3rd Ed (2013).
456 For a detailed discussion of the ETF arbitrage
mechanism, see, e.g., CFA Guide, supra footnote
370.
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procedures specific to the creation of
custom baskets.
As discussed in section II.C.5.a, the
proposed additional policies and
procedures requirements for custom
baskets are designed to reduce the
potential for cherry-picking, dumping,
and other potential abuses by
authorized participants. We
acknowledge that this principles-based
approach may not be effective at
preventing all such abuses by
authorized participants. However, as
proposed, ETFs would be required to
maintain records related to the custom
baskets used, which would allow the
Commission to examine for potential
abuses.
As outlined above, current exemptive
orders contain varying provisions for
basket flexibility. However, based on a
staff review of existing orders, we
believe that the existing ETFs that
would operate under the proposed rule
and have their exemptive orders
rescinded would not be required to
change how they construct their baskets,
because the proposed rule would give
ETFs the ability to implement policies
and procedures for basket flexibility,
subject to certain enumerated
requirements for the custom basket
policies and procedures. In addition, we
expect that some existing ETFs that
would operate under the proposed rule
would be able to implement policies
and procedures with respect to basket
flexibility that would give them more
flexibility than what is allowed by their
existing exemptive orders.
We believe that fixed-income,
international, and actively managed
ETFs would particularly benefit from
the increased basket flexibility the rule
would afford compared to existing
exemptive orders. Specifically, the
increased basket flexibility should allow
fixed-income ETFs to avoid losing hardto-find bonds when meeting
redemptions or to use sampling
techniques to construct baskets that are
composed of fewer individual bonds
and thus reduce trading costs for
authorized participants. Similarly,
international ETFs would be able to
tailor their creation and redemption
baskets to accommodate difficulties in
transacting in certain international
securities. In addition, actively managed
ETFs would, in certain instances, be
able to use the increased basket
flexibility to acquire or dispose of
securities by adjusting the composition
of the creation or redemption basket
rather than by directly purchasing or
selling the securities. In these instances,
actively managed funds would be able
to reduce certain transaction costs, such
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as those associated with bid-ask
spreads.
For these reasons we believe the
proposed rule would benefit ETFs that
make use of the increased basket
flexibility the rule affords as well as
their investors to the extent that ETFs
are able to implement procedures that
facilitate the arbitrage mechanism or
reduce costs for the ETFs. Due to a lack
of data, however, we are unable to
quantify the number of ETFs that would
choose to implement policies and
procedures to increase basket flexibility,
and thus the potential benefits arising to
ETFs and their investors.
To the extent that existing ETFs do
not already have policies and
procedures governing basket assets in
place, ETFs would incur a cost
associated with developing and
implementing such policies and
procedures.457 However, such costs may
be partially or totally offset by the
basket flexibility discussed above. As
discussed in section IV.B, we estimate
that an average ETF would incur an
initial cost of $10,268 458 associated
with setting up the process for
documenting the construction and
acceptance of baskets and with
documenting and adopting the custom
basket policies and procedures. In
addition, we estimate that an average
ETF would incur an ongoing cost of
$3,985 459 each year to review and
update its custom basket policies and
procedures as well as its process for
documenting the construction and
acceptance of baskets. We thus estimate
that the total industry cost associated
with the policies and procedures
requirement in the proposed rule for
ETFs that could rely on the rule in the
first year would equal $23,303,655.460
Second, the proposed rule would
require an ETF to disclose prominently
on its website the portfolio holdings that
will form the basis for the next
calculation of NAV per share. We
believe that this requirement supports
the effective functioning of the arbitrage
mechanism as it allows authorized
participants to identify arbitrage
opportunities and chose an appropriate
hedging strategy.
457 While exemptive orders do not require ETFs
to have policies and procedures for basket assets in
place, we believe that some ETFs may currently
have methodologies or compliance policies for
basket assets in place.
458 See infra footnote 553.
459 See infra footnote 554.
460 This estimate is based on the following
calculation: ($10,268 + $3,985) × 1,635 ETFs =
$23,303,655. This estimate may be an over-estimate
in that it assumes that all ETFs, regardless of their
actual use of custom baskets, would implement
policies and procedures for custom basket assets.
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37389
As discussed above in section III.B.4,
the requirements for portfolio
transparency in existing exemptive
orders have varied.461 As also discussed
in section III.B.4, based on a staff review
of ETFs’ websites, we understand that
all ETFs that could rely on the proposed
rule currently provide daily full
portfolio transparency, including all
actively managed ETFs, and thus
already bear ongoing costs associated
with maintaining such disclosures.462
However, we believe that the ETFs that
could rely on the proposed rule would
incur a one-time cost associated with
reviewing whether their current
portfolio disclosure is compliant with
the requirements of proposed rule 6c–11
and, if necessary, make changes to the
information that is presented on their
website.463 We estimate this one-time
cost to be $1,939.50 for the average ETF,
resulting in an aggregate one-time cost
of $3,171,082.50 for all ETFs that could
rely on the proposed rule.464
Finally, the proposed rule also would
require additional disclosure by the ETF
of the median daily bid-ask spread over
the most recent fiscal year on its
website. We believe that this
461 Actively managed ETFs and some ETFs that
track an index from an affiliated index provider
have been required to disclose their holdings prior
to the commencement of trading each business day
(i.e., full portfolio transparency). Other index-based
ETFs are permitted to disclose their portfolio
holdings indirectly, by specifying which index they
seek to track, as long as the index provider lists the
constituent securities on its website (i.e., index
transparency) or by disclosing the components of
their baskets. Some index-based ETFs have been
required to provide full portfolio transparency. See
discussion of portfolio transparency, supra section
II.C.4.a; see also supra footnote 207 and
accompanying text.
462 From a staff review of ETF websites, the
sampled index and actively-managed ETFs already
provide daily portfolio holdings. Extrapolating the
sampled results to the entire universe of ETFs, ETFs
in general should bear no additional costs above the
baseline to collect and maintain on their websites
these holdings. If some ETFs that were not sampled,
however, do not currently maintain on their
websites their daily portfolio holdings, Commission
staff estimates that an ETF each year would spend
approximately 5 hours of professional time to
update the relevant web page daily with this
information at a cost of $1,405.50. See supra note
537. We preliminarily believe that the number of
ETFs that would have to bear these additional costs
would be small due to our experience with the
sampled ETFs.
463 The proposed rule would require that portfolio
holdings information be presented and contain
information regarding description, amount, value
and/or unrealized gain/loss (if applicable) in the
manner prescribed within Article 12 of Regulation
S–X.
464 This estimate is based on the following
calculations: 3 hours (for website development) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319) + 2
hours (for review of current portfolio disclosures)
× $325 (blended rate for a compliance manager
($298) and a compliance attorney ($352)) + $400 for
external website development = $1,939.50. The
industry cost is 1,635 × $1,939.50 = $3,171,082.50.
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requirement would further inform
investors about the expected cost of
trading an ETF and facilitate
comparison of transaction costs across
ETFs. As such, the disclosure of median
bid-ask spreads could reduce investors’
uncertainty about the trading
environment and facilitate the selection
of ETF investments that fit individual
investors’ needs. Currently, disclosure
of median bid-ask spreads by ETFs are
not required by exemptive orders,
although some funds may voluntarily
provide this information on their
websites. For those funds that do not
already disclose this information, they
would have to implement processes and
systems to compute the median bid-ask
spreads and would have to
accommodate a new data point on their
web page to report this information. We
preliminarily do not believe the
incremental cost of such disclosure will
be substantial. The estimated costs for
computing and establishing processes
and systems to update the median bidask spread are $296.50 per fund, while
aggregate costs for computing and
updating the web pages of ETFs to
include the median bid-ask spread
would be $484,777.50.465 We
preliminarily believe that funds will
incorporate the processes of updating
the median bid-ask spread with other
daily processes associated with
updating the web page, such as
reporting the daily portfolio holdings,
and therefore, there will be no
additional daily costs associated with
updating the median bid-ask spread on
the webpage. We also believe that funds
currently maintain a record of historical
prices as a matter of current business
practices which could be used to satisfy
the requirement at a nominal cost, as
discussed above. If a fund does not
maintain a record of historical prices, it
may incur a one-time estimated cost of
$296.50 to satisfy the requirement, or an
upper bound of $484,777.50 in
aggregate, assuming that no ETFs
currently maintain historical price
records.466
465 Commission staff estimate a one-time cost of
computing and implementing processes and
systems for daily updating of the median bid-ask
spread of one burden hour at a per hour cost of
$296.50 (blended rate for a senior systems analyst
($274) and senior programmer ($319)). The onetime cost of updating the web page to include the
median bid-ask spread would be incorporated as
part of the web page development discussed in
section IV.B.1 (see also infra footnote 535). As
median bid-ask spreads are not currently required
to be reported or computed by ETFs, we estimate
that the aggregate costs would be $296.50 × 1,635
ETFs = $484,777.50.
466 Commission staff estimate a one-time cost of
computing and implementing processes and
systems for daily updating of historical prices of
one burden hour at a per hour cost of $296.50
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ii. Omission of Conditions We Believe
May Save Costs for Funds
First, the proposed rule would not
contain a requirement that an ETF’s IIV
be disseminated at least every 15
seconds during regular trading hours (60
seconds for international ETFs), as is
currently required under all exemptive
orders. We believe that many
sophisticated institutional market
participants do not rely on the IIV to
value an ETF’s assets, as discussed
above in section II.C.3.
In some cases, the IIV may not reflect
the actual value of an ETF’s assets (e.g.,
for funds that invest in foreign securities
whose markets are closed during the
ETF’s trading day or funds whose assets
trade infrequently, as is the case for
certain bond funds). In those cases, we
believe that both institutional and retail
market participants would benefit from
the omission of the IIV as a requirement
of the proposed rule by avoiding the
possibility that investors base their
investment decisions on this potentially
misleading information. However, the
IIV may, for certain funds, provide a
reasonably accurate estimate of the
value of an ETF’s assets, including for
those funds whose underlying assets are
very frequently traded during the ETF’s
trading day. Less sophisticated
institutional investors as well as retail
investors relying on the IIV for those
ETFs may thus find the IIV useful and
could see their ability to evaluate ETFs
reduced without this metric.467
Exchange listing standards currently
require the IIV to be disseminated. As
long as exchange listing standards
continue to include this requirement,
the proposed rule’s omission of such a
requirement would not represent a
change from the baseline and would not
result in any costs or benefits to market
participants. Nonetheless, if the listing
standards change, ETFs would not be
subject to the cost of dissemination of
IIV information under the proposed
rule.
Second, under the terms of the
exemptive orders, ETFs are required to
disclose in their registration statement
that redemptions may be postponed for
foreign holidays. The proposed
amendments to Forms N–1A and N–8B–
(blended rate for a senior systems analyst ($274)
and senior programmer ($319)). Although we
preliminarily estimate that funds already maintain
a record of historical prices, an upper bound on
aggregate costs would be estimated at $296.50 ×
1,635 ETFs = $484,777.50.
467 While the IIV may be very accurate for ETFs
whose underlying assets trade frequently (and thus
are liquid as well), such ETFs also tend to have
small premiums/discounts to NAV per share,
reducing the incremental usefulness of the IIV for
investors in these ETFs compared to observing only
the ETF’s share price.
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2 do not contain such a requirement and
would thus eliminate the cost of
preparing and updating this disclosure
for existing ETFs. As discussed above in
section III.B.4, we believe that such a
requirement is not necessary, since this
information is already covered by the
agreement between the ETF and the
authorized participant.468 As discussed
in section III.C.1, we further believe that
such a disclosure would not be relevant
for retail investors, who purchase ETF
shares on the secondary market.
Third, the proposed rule would not
require an ETF to identify itself in any
sales literature as an ETF that does not
sell or redeem individual shares and
explain that investors may purchase or
sell individual ETF shares through a
broker via a national securities
exchange. Although this condition has
been included in our exemptive orders,
we no longer believe that it is necessary
given that markets have become familiar
with ETFs in the multiple decades they
have been available. The omission of
such a requirement could lead to cost
savings for existing and future ETFs
associated with preparing and reviewing
this disclosure for sales literature.469
iii. Website Disclosure Provisions
Proposed rule 6c–11 would require an
ETF to disclose certain information
prominently on its website, which is
publicly accessible and free of
charge.470 The goal of these disclosure
requirements is to provide investors
with key metrics to evaluate their
trading and investment decisions in a
location that is easily accessible and
frequently updated.471 Based on a staff
468 As discussed above, we believe that
authorized participants would share this
information with other market participants as
necessary, for example when a market participant
uses an authorized participant as agent for
transacting with an ETF and this information is a
necessary part of the creation or redemption
process.
469 We estimate that the omission of this
requirement would save 0.25 hours of a compliance
attorney ($352 per hour), resulting in a cost savings
of $88 (0.25 × $352) per fund each year. The total
cost savings for all 1,635 ETFs that could rely on
the proposed rule would thus be $143,880 (1,635
× $88).
470 See supra footnote 208.
471 According to the most recent U.S. census data,
approximately 77.2% of U.S. households had some
form of internet access in their home in 2015 and
86.8% have a computer (e.g., desktop, laptop, tablet
or smartphone). See Camille Ryan & Jamie M.
Lewis, Computer and internet Usage in the United
States: 2015, ACS–37 (Sept. 2017), available at
https://www.census.gov/content/dam/Census/
library/publications/2017/acs/acs-37.pdf; see also
Sarah Holden, Daniel Schrass & Michael Bogdan,
Ownership of Mutual Funds, Shareholder
Sentiment, and Use of the internet, 2017 (Oct.
2017), available at https://www.ici.org/pdf/per2307.pdf (‘‘[i]n mid-2017, 95 percent of households
owning mutual funds had internet access, up from
about two-thirds in 2000’’ and ‘‘86 percent of
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review of ETFs’ websites, we believe
that all ETFs that could rely on the
proposed rule currently have a
website.472 As a consequence, existing
ETFs would generally not incur any
additional cost associated with the
creation and technical maintenance of a
website.
As discussed above, a requirement for
daily website disclosures of NAV,
closing price, and premiums and
discounts—each as of the end of the
prior business day has been included in
substantially all exemptive relief orders
starting from 2008. As discussed in
section III.B.4, based on a staff review of
ETFs’ websites, we believe that all ETFs
that could rely on the proposed rule
currently provide daily website
disclosures of NAV, closing price, and
premiums or discounts.473 As a
consequence, existing ETFs would
generally not incur any additional cost
associated with these website disclosure
requirements.
Our exemptive orders have not
included requirements for line graph
and tabular historical information
regarding premiums and discounts.
However, Form N–1A contains tabular
website disclosures relating historical
premium/discount in Items 11(g)(2) and
27(b)(7)(iv), which we are proposing to
eliminate.474 Nonetheless, we anticipate
that all existing ETFs that fall within the
scope of the proposed rule would incur
some additional costs associated with
these disclosures. We believe that
substantially all ETFs already have the
required data available to them as part
of their regular operations (as it is
required by Form N–1A and also allows
ETFs to monitor the trading behavior of
their shares), as well as have systems
(such as computer equipment, an
internet connection, and a website) in
place that can be used for processing
this data and uploading it to their
websites. However, these ETFs would
still incur the costs associated with
establishing and following (potentially
automated) processes for processing and
uploading this data to their websites.
We estimate that an average ETF would
mutual fund-owning households with a household
head aged 65 or older had internet access in mid2017’’); Andrew Perrin & Maeve Duggan,
Americans’ Internet Access: 2000–2015, Pew
Research Center (June 2015), available at https://
assets.pewresearch.org/wp-content/uploads/sites/
14/2015/06/2015-06-26_internet-usage-acrossdemographics-discover_FINAL.pdf (finding in 2015,
84% of all U.S. adults use the internet). Retail
investors that do not have internet access in their
homes may have access outside their homes, such
as at public libraries.
472 See supra footnote 437.
473 See supra footnote 437.
474 See infra section II.H.4.
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incur a one-time cost of $1,939.5 475 for
implementing this website disclosure
and an ongoing cost of $473.25 476 per
year for updating the relevant web page
with this information. We thus estimate
the total industry cost, in the first year,
to ETFs that could rely on the proposed
rule for providing this website
disclosure, of $3,944,846.35.
Our exemptive orders have not
included a requirement for ETFs to
provide disclosure of the factors that
materially contributed to a premium or
discount, if known, if an ETF’s premium
or discount is greater than 2% for more
than seven consecutive trading days. As
a result, under the proposed rule those
ETFs that experience such a premium or
discount would incur additional costs
associated with determining what
factors contributed to the premiums or
discounts and drafting and uploading a
discussion to their website. Based on a
staff analysis of historical data on ETF
premiums and discounts from 2008 to
2017 using Bloomberg data, we believe
that this disclosure requirement would
be triggered for, on average, 4.7% of
those ETFs that could rely on the
proposed rule per year.477 We estimate
that a fund required to make such a
disclosure in a given year would incur
an average cost of $1,438.50, yielding a
total annual industry cost of
$110,541.53.478
The proposed rule would also require
an ETF to post on its website one
‘‘published’’ basket at the beginning of
475 This estimate is based on the following
calculations: 3 hours (for website development) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (2
hours (for review of website disclosures) × $325
(blended rate for a compliance manager ($298) and
a compliance attorney ($352)) + $400 for an external
website developer to develop the web page =
$1,939.50.
476 This estimate is based on the following
calculations: 0.5 hours (for website updates) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (1
hour (for review of website disclosures) × $325
(blended rate for a compliance manager ($298) and
a compliance attorney ($352) = $473.25.
477 This estimate represents the average of the
percentage of ETFs for which the reporting
requirement was triggered at least once in a given
year, for those ETFs that could rely on the proposed
rule. During the sample period from 2008 to 2017,
the percentage of ETFs for which the reporting
requirement was triggered at least once varied from
1.5% in 2010 to 10% in 2008.
478 We believe that such disclosure would require
4 internal hours (2.5 hours for the compliance
attorney to determine if this requirement has been
triggered and produce a draft of the required
disclosures + 1.5 hours for the webmaster to
include the information on the website), at a time
cost of (2.5 hours × $352 compliance attorney
hourly rate) + (1.5 hours × $239 webmaster hourly
rate) in addition to $200 for external website
development = $1,738.50. The annual cost of this
requirement for those ETFs that could rely on the
proposed rule is calculated as 4.7% × 1,635 ETFs
× $1,738.50 = $110,541.53.
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each business day. While we believe
that authorized participants already
have access to this information in the
daily portfolio composition file
provided to NSCC, many market
participants, such as smaller
institutional investors and retail
investors, are not NSCC members and
do not currently have access to this
information.
Our exemptive orders have not
included requirements for daily website
disclosures of ETF baskets. As a result,
we anticipate that all existing ETFs that
rely on the proposed rule would incur
additional costs associated with this
disclosure.479 Since specifying basket
assets is part of the regular operation of
an ETF, we believe that all ETFs already
have the required data available to
them. In addition, we believe that most
ETFs already have systems (such as
computer equipment, an internet
connection, and a website) in place that
can be used for processing this data and
uploading it to their websites. However,
these ETFs would still incur the costs
associated with establishing and
following (potentially automated)
processes for processing and uploading
this data to their websites. We estimate
that an average ETF would incur a onetime cost of $2,909.25 480 for
implementing this website disclosure
and an ongoing cost of $784 481 per year
for updating the relevant web page daily
with this information. We thus estimate
the total industry cost, in the first year,
to ETFs that could rely on the proposed
rule for providing this website
disclosure, of 6,038,463.75.482
As discussed in section IV.A above,
the proposed disclosures on ETFs’
websites, which are publicly available
and free of charge, would enable
investors to more readily obtain certain
key metrics for individual ETFs,
479 As proposed, the rule would require that
basket information be presented and contain
information regarding description, amount, value
and/or unrealized gain/loss (if applicable) in the
manner prescribed within Article 12 of Regulation
S–X.
480 This estimate is based on the following
calculations: 4.5 hours (for website development) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (3
hours (for review of website disclosures) × $325
(blended rate for a compliance manager ($298) and
a compliance attorney ($352)) + $600 for an external
website developer to develop the web page =
$2,909.25.
481 This estimate is based on the following
calculations: 1 hour (for website updates) × $296.50
per hour (blended rate for a senior systems analyst
($274) and senior programmer ($319)) + (1.5 hours
(for review of website disclosures) × $325 (blended
rate for a compliance manager ($298) and a
compliance attorney ($352) = $784.
482 This estimate is based on the following
calculation: 1,635 ETFs × ($2,909.25 + $784) =
$6,038,463.75.
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potentially resulting in better informed
investment decisions.483 The proposed
conditions standardize certain content
requirements to facilitate investor
analysis of information while allowing
ETFs to select a format for posting
information that the individual ETF
finds most efficient and appropriate for
their website. Because the information
in the proposed disclosures would be
made available on individual websites,
in the format chosen by the ETF, we
acknowledge that an investor’s ability to
efficiently extract information from
website disclosures for purposes of
aggregation, comparison, and analysis
across multiple funds and time periods
may be limited. Investors seeking to
compare multiple ETFs would have to
visit the website of every ETF, navigate
to the relevant section of the website,
and extract the information provided in
the format chosen by the fund.
Depending on the manner in which a
typical fund investor would use the
website disclosures, these
considerations may decrease the
information benefits of the proposed
disclosures. However, we recognize that
investors may rely on third-party
providers that aggregate such
information for all ETFs into a
structured format that investors can
more easily access and process for the
purpose of statistical and comparative
analyses. While investors may incur
costs of obtaining information from
third-party service providers, it would
likely be lower than the cost they would
incur than if they performed the
collection themselves, and the cost of
such services may otherwise be reduced
as a result of competition among service
providers. Overall, we believe that
requiring ETFs to provide this
information on their websites would
ultimately provide an efficient means
for facilitating investor access to
information.
c. Recordkeeping
The proposed rule would require that
ETFs preserve and maintain copies of
all written authorized participant
agreements for at least five years, the
first two years in an easily accessible
place. This requirement would provide
Commission examination staff with a
basis to evaluate whether the authorized
participant agreement is in compliance
with the rule and other provisions of the
Investment Company Act and the rules
thereunder, and would also promote
internal supervision and compliance.484
483 See
supra footnote 208.
already will be required to provide some
information about authorized participants on Form
N–CEN, including the name of each authorized
484 ETFs
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As the agreement forms the contractual
foundation on which authorized
participants engage in arbitrage activity,
compliance of the agreement with the
proposed rule is important for the
arbitrage mechanism to function
properly.
We are also proposing to require ETFs
to maintain information regarding the
baskets exchanged with authorized
participants on each business day the
ETF exchanged creation units, including
a record stating that the custom basket
complies with the ETF’s custom basket
policies and procedures. As discussed
above, we believe that these records
would help our examination staff
understand how baskets are being used
by ETFs, evaluate compliance with the
rule and other provisions of the Act and
rules thereunder, and examine for
potential overreach by ETFs in
connection with the use of custom
baskets or transactions with affiliates.
Existing exemptive orders have not
required ETFs to preserve and maintain
copies of authorized participant
agreements or information about basket
composition. However, we believe that
most ETFs already preserve and
maintain copies of authorized
participant agreements as well as data
on baskets used as a matter of
established business practice. Existing
ETFs that do not already preserve and
maintain copies of these documents and
data, as well as all new ETFs that would
operate under the proposed rule, would
incur maintenance and storage costs
associated with these requirements. As
discussed in section IV.B, we estimate
that an average ETF that does not
currently comply with these
recordkeeping requirements would
incur an annual cost of $380 per year 485
to maintain these records.486 Assuming
that 20% of ETFs would incur this cost,
the total industry cost for ETFs that
could rely on the proposed rule would
be $124,260 per year.487 In addition, the
existing orders have not required that
ETFs prepare and maintain a record
stating that custom baskets comply with
the custom basket policies and
procedures. We anticipate that all ETFs
that could operate under the proposed
participant, additional identifying information, and
the dollar values of the fund shares the authorized
participant purchased and redeemed during the
reporting period. However, this information alone
would not be sufficient for Commission staff to
evaluate whether a fund’s authorized participant
agreements are in compliance with the proposed
rule.
485 See infra footnote 544.
486 An average ETF would have to maintain and
store 34 authorized participant agreements. See
supra footnote 431 and accompanying text.
487 This estimate is based on the following
calculation: 1,635 ETFs × $380 × 20% = $124,260.
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rule will incur additional recordkeeping
costs associated with the requirement
that custom baskets comply with
custom basket policies and procedures.
Assuming that 25% of the total annual
recordkeeping costs can be attributed to
the new requirement for custom baskets,
we estimate a total cost per ETF of $95
per year for the requisite five-year
period and an annual industry cost of
$155,325 for ETFs that could rely on the
rule.488
d. Master-Feeder Relief
The proposed rule would rescind the
master-feeder relief granted to ETFs that
do not rely on the relief as of the date
of this proposal. We are proposing to
rescind such relief because there
generally is a lack of interest in ETF
master-feeder arrangements, and certain
master-feeder arrangements raise policy
concerns discussed above. While there
are currently many exemptive orders
that contain the master-feeder relief, it
is our understanding that only one fund
complex currently relies on this relief to
structure several master-feeder
arrangements with one master and one
feeder fund each.489 As discussed
above, we would also propose to
grandfather existing master-feeder
arrangements involving ETF feeder
funds, but prevent the formation of new
ones, by amending relevant exemptive
orders.490 As a result, we do not expect
that the rescission of the existing
master-feeder relief would impose costs
on ETFs that currently rely on the relief
to structure master-feeder arrangements.
488 This estimate is based on a total record
keeping cost of $380 per ETF over five years, see
infra note 544, 25% × $380 = $95, $95 × 1,635 ETFs
= $155,325.
489 See supra footnote 341.
490 As discussed above, without this relief, the
affected funds could continue operating by effecting
creation and redemption transactions between
authorized participants and the feeder fund (as well
as the transactions between the master and feeder
fund) in cash rather than in kind. As cash creations
and redemptions can be less efficient than in-kind
transactions for certain ETFs, this could impose a
cost on the ETFs that are part of the fund family.
Cash redemptions and creations could also affect
the current relationships that funds have with
authorized participants if the authorized
participants would be unwilling to perform the
arbitrage function when receiving cash instead of
baskets of securities, which could have unintended
spillover effects on the secondary market trading of
these funds’ shares. Alternatively, these feeder
funds may opt to pursue their investment objectives
through direct investments in securities and/or
other financial instruments, rather than through
investments in master funds. Such a restructuring
of the funds involved would also lead to costs
(primarily associated with legal and accounting
work) on the ETFs that are part of the fund family.
As a result, if this change would require portfolio
transactions to occur at the fund, there could be
additional costs such as lower overall total returns
to the fund or that investors may find the fund to
be a less attractive investment.
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At the same time, the rescission of the
relief may benefit investors in
prospective feeder ETFs to the extent
that it protects them from any concerns
associated with feeder ETFs discussed
above.491
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2. Disclosure (Amendments to Forms N–
1A and N–8B–2)
The amendments to Form N–1A and
N–8B–2 are designed to provide
authorized participants and investors
with tailored information regarding the
costs associated with investing in ETFs.
As discussed in section IV.A above, we
expect that the new disclosures would
benefit investors by helping them better
understand and compare specific funds,
potentially resulting in more informed
investment decisions, more efficient
allocation of investor capital, and
greater competition for investor capital
among funds.
As discussed above, we propose to
add a set of Q&As related to fees and
trading information and costs that we
anticipate would help investors better
understand costs specific to ETFs, such
as bid-ask spreads, brokerage
commissions, and purchasing or selling
ETF shares at a premium or discount to
NAV. The answers to the Q&As would
include information about trading costs
specific to an ETF, such as the median
bid-ask spread over the previous year.
In addition, the proposed
amendments to Forms N–1A and N–8B–
2 would require an ETF to provide
information on the ETF’s median bidask spread as well as an interactive
calculator on the ETF’s website that can
be used to determine how the bid-ask
spread would impact the costs
associated with frequent trading of ETF
shares. As discussed above, the purpose
of the interactive calculator is to provide
investors with the ability to customize
the hypothetical calculations in Item 3
of Form N–1A to their specific investing
situation by choosing either the number
or size of the hypothetical round-trip
trades, or both.
While we believe that substantially all
ETFs already have the required data for
these new disclosures on Forms N–1A
and N–8B–2 and for the interactive
calculator as part of their regular
operations, these funds would still incur
costs for processing the data, entering
them into the form, and programming
the interactive calculator.492 We
estimate that each ETF would incur a
491 See
supra section II.F.
discussed in more detail below in section
V.D, the ongoing costs of complying with the
proposed amendments to Form N–8B–2 for all UIT
ETFs as well as the one-time initial costs for
existing UIT ETFs would accrue to Form S–6.
492 As
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one-time cost of $6,710 493 and an
ongoing cost of $3,355 494 per year.495
We thus estimate that the total industry
cost for ETFs in the first year would
equal $19,123,500.496
D. Effects on Efficiency, Competition,
and Capital Formation
This section evaluates the impact of
proposed rule 6c–11 and the
amendments to Forms N–1A and N–8B–
2 on efficiency, competition, and capital
formation. However, as discussed in
further detail below, the Commission is
unable to quantify many of the effects
on efficiency, competition and capital
formation either because they are
inherently difficult to quantify or
because it lacks the information
necessary to provide a reasonable
estimate.
1. Efficiency
The proposed rule would likely
increase total assets of ETFs, as a result
of reducing the expense and delay of
forming and operating new ETFs
organized as open-end funds, reducing
the cost for certain ETFs to monitor
their own compliance with regulations,
and as well increased competition
among ETFs as discussed below. At the
same time, the proposed rule could lead
to a decrease in total assets of other fund
types that investors may regard as
substitutes, such as certain mutual
funds.497 As a result, ETF ownership (as
493 We estimate that each ETF would incur a onetime burden of an additional 20 hours, at a time
cost of an additional $6,710 (10 hours x $335.50
(blended rate for a compliance attorney ($352) and
a senior programmer ($319)) = $6,710) to draft and
finalize the required disclosure, amend its
registration statement, implement the interactive
calculator, and update its website.
494 We estimate that each ETF would incur an
ongoing burden of an additional 10 hours, at a time
cost of an additional $3,355 (10 hours × $335.50
(blended rate for a compliance attorney ($352) and
a senior programmer ($319)) = $3,355) each year to
review and update the proposed disclosures.
495 Like all information disclosed in Items 2, 3, or
4 of Form N–1A, the information disclosed in
amended Item 3 would have to be tagged and
submitted in a structured data format. See supra
footnote 361. We note that we are adopting
amendments to require the use of Inline XBRL
format in a companion release, which would apply
to the information disclosed in amended Item 3
according to the compliance dates of those
amendments. See Inline XBRL Filing of Tagged
Data, Investment Company Act Release No. 33139
(June 28, 2018). Given that filers already have
systems in place to submit the existing information
in Item 3 in a structured format and that filers will
already be required to update those systems to
comply with the Inline XBRL requirement, we
believe that there would not be any significant
additional costs associated with the information in
amended Item 3 being filed in a structured format.
496 This estimate is based on the following
calculation: 1,900 ETFs × ($6,710 + $3,355) =
$19,123,500.
497 The proposed disclosure requirements would
also serve to increase investors’ awareness of the
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a percentage of market capitalization)
for some securities, such as stocks and
bonds, would likely increase, and
ownership by other funds, such as
mutual funds, would likely decrease.
The academic literature that we discuss
in this section suggest that such a shift
in ownership could affect the price
efficiency (the extent to which an asset
price reflects all public information at
any point in time) and liquidity of these
portfolio securities.498
The literature suggests that a shift in
stock ownership towards ETFs may
improve some dimensions of price
efficiency while impeding price
efficiency along other dimensions.
Specifically, the results in one paper
suggest that stock prices incorporate
systematic information more quickly
when they are held in ETF portfolios.499
The evidence in this paper thus
indicates that ETF activity increases
stock market efficiency with regard to
systematic information, i.e., information
relating to market-wide risks. On the
other hand, some studies find that an
increase in ETF ownership may
introduce non-fundamental volatility
into stock prices, i.e., cause temporary
deviations of stock prices from their
fundamental values. For example, one
paper finds that ownership by US equity
index ETFs is associated with higher
volatility among component stocks and
argues that the increased volatility is
non-fundamental.500 Another paper
finds that higher authorized participant
arbitrage activity in US equity ETFs is
trading costs that they can incur when trading
ETFs, which can be substantial in some cases. As
a result, investors who may previously not have
been fully aware of these costs may shift their
demand away from ETFs and towards other types
of funds, such as mutual funds. We believe,
however, that the rulemaking as a whole is likely
to increase demand for ETFs rather than decrease
it.
498 In documenting the impact of ETF arbitrage on
price efficiency and liquidity, the academic
literature does not generally distinguish ETFs that
could rely on the rule from those that could not.
However, these studies investigate a broad range of
ETFs with varying degrees of relief including basket
flexibility. Therefore, we believe that the subsample
of ETFs that could rely on the rule (those organized
as open-end funds that are not leveraged) is
representative of those used in the academic
literature. As a result, we believe that inferences
from the academic research generally apply to ETFs
that can rely on the rule.
499 Lawrence Glosten, Suresh Nallareddy & Yuan
Zou, ETF Trading and Informational Efficiency of
Underlying Securities, Columbia Business School
Research Paper No. 16–71 (2016).
500 See Itzhak Ben-David, Francesco Franzoni &
Rabih Moussawi, Do ETFs Increase Volatility?,
Swiss Finance Institute Research Paper No. 11–66
(2017). This paper also finds that mutual fund
ownership is associated with higher volatility in the
underlying indexes. Thus, to the extent that part of
the increase in ETF assets would be accompanied
by a decrease in mutual fund assets, the net effect
on price efficiency would be unclear.
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associated with a higher correlation of
returns among stocks in the ETF’s
portfolio.501 The authors find evidence
that changes in the prices of these stocks
tend to partially revert over the next
trading day and argue that the increased
co-movement in returns is thus a sign of
excessive price movement due to nonfundamental shocks that ETF trading
helps propagate.
The proposed rule could decrease the
liquidity of stocks held by ETFs, as one
study finds that higher ownership of a
stock by US equity ETFs is associated
with lower liquidity as measured by
market impact.502 Conversely, the
academic literature offers mixed
evidence regarding the impact of ETFs
on bond liquidity. While one paper
finds that increased ETF ownership is
associated with lower bond liquidity for
investment grade bonds,503 another
study finds that bonds included in ETFs
experience improvements in their
liquidity.504
A shift in stock ownership towards
ETFs could also have an effect on the
co-movement of liquidity for stocks held
by ETFs. Specifically, one paper
observes that the liquidity of a stock
with high ETF ownership co-moves
with the liquidity of other stocks that
also have high ETF ownership.505 The
authors argue that this co-movement in
liquidity represents a risk to investors,
as it exposes them to the possibility that
many assets in their portfolio will be
illiquid at the same time.
Since we do not know the degree to
which the proposed rule would increase
ETF ownership of stocks and bonds, we
are unable to quantify the proposed
rule’s effects on price efficiency and
liquidity.
As a result of the proposed rule’s
allowance of increased basket
flexibility, some ETFs that did not
already have this flexibility in their
baskets may choose to increase the
weight of more liquid securities and
501 Zhi Da & Sophie Shive, Exchange Traded
Funds and Asset Return Correlations, Working
Paper, Notre Dame University (2016).
502 See Sophia JW. Hamm, The effect of ETFs on
stock liquidity, Working Paper, Ohio State
University (2014). However, the study also finds the
same relationship for ownership by index mutual
funds. Thus, to the extent that part of the increase
in ETF assets would be accompanied by a decrease
in mutual fund assets, the net effect on price
efficiency would be unclear.
503 Caitlin Dillon Dannhauser, The Impact of
Innovation: Evidence from Corporate Bond ETFs,
Journal of Financial Economics, forthcoming (2016)
(‘‘Dannhauser Article’’).
504 Jayoung Nam, Market Accessibility, Corporate
Bond ETFs, and Liquidity, Working Paper, Indiana
University Bloomington (2017).
505 Vikas Agarwal, Paul Hanouna, et al., Do ETFs
Increase the Commonality in Liquidity of
Underlying Stocks, Working Paper, Villanova
University (2017).
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decrease the weight of less liquid
securities in their baskets compared to
their portfolios.506 During normal
market conditions, this may lead those
ETFs’ shares to trade at smaller bid-ask
spreads, thus benefiting investors. We
note, however, that such a reduction in
bid-ask spreads by over-weighting more
liquid securities may not work during
stressed market conditions, if a large
proportion of such an ETF’s portfolio
securities become less liquid.507 As a
result, the gap between bid-ask spreads
of some ETFs’ shares during normal and
stressed market periods may grow as a
result of the proposed rulemaking,
which some investors may not
anticipate and fail to fully take into
account when making their investment
decisions.508
Finally, the proposed amendments to
Forms N–1A and N–8B–2 as well as the
additional website disclosures required
by proposed rule 6c–11 would allow
investors and other market participants
to better understand and compare ETFs
using more relevant and standardized
disclosure. For example, as discussed
above, the proposed amendments to
Item 3 of Form N–1A would add a
requirement for ETFs to disclose their
median bid-ask spread and include a
statement that ETF investors may be
subject to other expenses that are
specific to ETF trading, including
brokerage commissions and potential
costs related to purchasing ETF shares
at a premium or discount to NAV per
share.509 These costs are not currently
506 This would be the case for those ETFs that
hold less liquid securities in their portfolios.
507 Under rule 22e–4 under the Act, an ETF is
required to consider: (i) The relationship between
portfolio liquidity and the way in which, and the
prices and spreads at which, ETF shares trade,
including, the efficiency of the arbitrage mechanism
and the level of active participation by market
participants (including authorized participants);
and (ii) the effect of the composition of baskets on
the overall liquidity of the ETF’s portfolio as part
of its assessment, management and review of
liquidity risk. See LRM Adopting Release, supra
footnote 101.
508 Conversely, some ETFs may choose to
decrease, rather than increase, the weight of more
liquid securities and increase the weight of less
liquid securities in their basket compared to their
portfolio in order to reduce transaction costs borne
by an ETF’s existing/remaining shareholders when
the ETF must buy and sell portfolio holdings. This
would lead to a reduction in transaction costs for
existing/remaining shareholders and to an increase
in transactions costs for authorized participants
and, ultimately, investors buying and selling ETF
shares. Thus, we believe that most funds would
choose to limit such behavior as they would likely
find it to be in their best interest to balance costs
imposed on remaining and existing/remaining
shareholders.
509 James J. Angel, Todd J. Broms, & Gary L.
Gastineau, ETF Transaction Costs Are Often Higher
Than Investors Realize, 42 The Journal of Portfolio
Management 3, 65–75 (2016) find that the cost of
trading ETF shares depends both on bid-ask spreads
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required to be disclosed by Item 3. Since
these costs are incurred by ETF
investors and not mutual fund investors,
we believe that adding this disclosure
would help investors and other market
participants better assess and compare
fees and expenses between certain funds
and fund types, such as ETFs and
mutual funds. Thus, the proposed rule
could help investors make more
informed investment decisions that are
more suited for their investment
objectives. The degree to which
investors would benefit from the ability
to make more informed investment
decisions is inherently difficult to
quantify, so we are unable to estimate
the size of this benefit.
2. Competition
The proposed rule would likely
increase competition among ETFs that
could rely on the proposed rule. The
first channel through which the
proposed rule would likely foster
competition is by reducing the costs for
ETF sponsors to form new ETFs that
comply with the conditions set by the
proposed rule. This cost reduction
would lower the barriers to entering the
ETF market, which would likely lead to
increased competition among ETFs that
could rely on the proposed rule.
In addition, new ETFs that enter the
market in reliance on the proposed rule
as well as those existing ETFs that
would have their exemptive relief
rescinded and replaced by the proposed
rule, would no longer be subject to
requirements that vary between
exemptive orders. Instead, these ETFs
would operate under uniform
requirements, which would help
promote competition among ETFs that
could rely on the proposed rule.
An increase in competition among
ETFs that could rely on the proposed
rule would likely also lead to an
increase in competition between those
ETFs and ETFs that could not rely on
the proposed rule as well as other types
of funds and products that investors
may perceive to be substitutes for ETFs,
such as certain mutual funds.510
Furthermore, as discussed above, the
proposed website disclosures and
amendments to Forms N–1A and N–8B–
2 would allow investors to compare
ETFs and other open-end investment
companies, which could further foster
as well as premiums and discounts to NAV per
share.
510 The types of funds and products that investors
may consider substitutes for ETFs would depend on
an individual investor’s preferences and investment
objectives. Other types of products that some
investors may consider to be substitutes for ETFs
include closed-end funds and other exchangetraded products, such as exchange-traded notes and
commodity pools.
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competition among open-end
investment companies as well as
between open-end investment
companies and other types of funds that
investors may perceive to be substitutes
for open-end investment companies,
such as closed-end funds and certain
exchange-traded products.
Increased competition would likely
lead to lower fees for investors,
encourage financial innovation, and
increase consumer choice in the markets
for ETFs, open-end investment
companies, and other types of funds
that investors may perceive to be
substitutes.511 Due to the limited
availability of data, however, we are
unable to quantify these effects.
To the extent the proposed rule would
increase the number and total assets of
ETFs, more authorized participants or
other market participants may enter the
market. This could lead to increased
competition among authorized
participants or other market participants
and result in authorized participants or
other market participants exploiting
arbitrage opportunities sooner (i.e.,
when premiums/discounts to NAV per
share are smaller). As a result, bid-ask
spreads may tighten and premiums/
discounts to NAV per share for ETF
shares may decrease. As authorized
participants and some of the other
market participants that engage in ETF
arbitrage are large broker-dealers,
however, we would expect new entries
of authorized participants or other
arbitrageurs as a result of the rule to be
limited and any effects on bid-ask
spreads and premiums/discounts to
NAV per share to be small.
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3. Capital Formation
The proposed rule may lead to
increased capital formation.
Specifically, an increase in the demand
for ETFs, to the extent that it would
increase demand for intermediated
assets as a whole, would likely spill
over into primary markets for equity and
debt securities. As a consequence,
companies may be able to issue new
debt and equity at higher prices in light
of the increased demand for these assets
in secondary markets created by ETFs.
As a consequence, the cost of capital for
firms could fall, facilitating capital
formation.
511 As discussed above, the proposed rule would
likely lead to increased competition both among
ETFs that could rely on the proposed rule as well
as between ETFs that could rely on the rule and
those that could not. While we believe that
increased competition generally is conducive to
innovation, any increased competition in the ETF
market resulting from the proposed rule would be
more likely to involve novel ETFs that would
continue to need to obtain exemptive relief from the
Commission.
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The conclusion that an increase in the
demand for ETFs may lower the firm’s
cost of capital is further supported by a
paper 512 that finds that bonds with a
higher share of ETF ownership have
lower expected returns.513 Due to the
limited availability of data, however, we
are unable to quantify these effects of
the proposed rule on capital formation.
E. Reasonable Alternatives
1. Treatment of Existing Exemptive
Relief
As discussed above, we propose to
rescind the exemptive relief we have
issued to ETFs that would be permitted
to rely on the proposed rule. As an
alternative, we considered allowing
ETFs with existing exemptive relief in
orders that do not contain a selftermination clause to continue operating
under their relief rather than requiring
them to operate in reliance on the rule.
The Commission believes that
allowing ETFs to continue operating
under their existing relief would create
differences in the conditions under
which funds operate. Specifically, some
ETFs that determine they do not need
the additional flexibility (e.g., basket
flexibility) the proposed rule would
provide compared to their existing
exemptive relief could choose to
continue operating under their existing
relief rather than in reliance on the rule.
This could allow these ETFs to
circumvent the other requirements that
are part of the rule (e.g., daily website
disclosure of the basket assets). This
self-selection would create a disparity in
the conditions under which ETFs are
allowed to operate.
Measured against the baseline, the
alternative would thus have smaller
benefits arising from improved
disclosure, including that the alternative
would not level the playing field among
ETFs with regard to these conditions
and thus not be as effective at promoting
product competition as the proposed
rule. In addition, it would be more
difficult for the Commission to evaluate
compliance with regulations under the
alternative compared to the proposed
rule, as some of the ETFs whose
exemptive relief we propose to rescind
Article, supra footnote 503.
acknowledge that there is research (see
Yakov Amihud & Haim Mendelson, Asset Pricing
and the Bid-Ask Spread, 17 Journal of Financial
Economics 2, 223–249 (1986)) that provides
evidence that expected returns of an asset are
positively associated with its liquidity. As
discussed above, the academic literature suggests
that stocks with a higher share of ETF ownership
have lower liquidity (whereas the evidence on the
effect of underlying bonds is mixed). Thus, there
may be an offsetting effect that could weaken the
potential benefits of the rule for capital formation
through new equity issuances by firms.
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513 We
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37395
could choose to continue to operate
under their exemptive relief. The
Commission also believes that the costs
to funds associated with rescinding the
existing exemptive relief would be
minimal, as we anticipate that
substantially all funds whose relief
would be rescinded would be able to
continue operating with only minor
adjustments, other than being required
to comply with the additional website
disclosures and to develop basket asset
policies and procedures.514
2. ETFs Organized as UITs
Proposed rule 6c–11 would be
available only to ETFs that are
organized as open-end funds.515 As an
alternative, we considered including
ETFs organized as UITs in the scope of
the proposed rule. However, as
discussed above in section III.A.1, we
believe that the terms and conditions of
the existing exemptive orders for UITs
are appropriately tailored to address the
unique features of the UIT structure.
In addition, as also discussed above,
ETFs have greater investment flexibility
under the open-end fund structure than
the UIT structure, which leads us to
believe that most new ETFs entering
into the market would prefer to operate
under the open-end fund structure
rather than the UIT structure. No new
UIT ETFs have come to market in recent
years, and we do not think that there
would be significant economic benefits
to including UITs in the scope of the
proposed rule, and thus we propose to
exclude ETFs organized as UITs from
the proposed rule.516
3. Basket Flexibility
Proposed rule 6c–11would require
ETFs relying on the rule to adopt and
implement written policies and
procedures that govern the construction
of basket assets and the process that will
be used for the acceptance of basket
assets. As an alternative, we considered
requiring that an ETF’s basket generally
correspond pro rata to its portfolio
holdings, while identifying certain
limited circumstances under which an
ETF may use a non-pro rata basket, as
514 Some ETFs may change the way they operate
voluntarily by taking advantage of the increased
basket flexibility of the proposed rule.
515 As discussed in above in section IV.B.1, while
the vast majority of ETFs currently in operation are
organized as open-end funds, some early ETFs,
which currently have a significant amount of assets,
are organized as UITs. Examples include SPDR S&P
500 ETF Trust (SPY) and PowerShares QQQ Trust,
Series 1 (QQQ).
516 We note that fund sponsors that plan to
launch a new ETF organized as a UIT would
continue to be able to rely on the exemptive order
process.
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we have done in our exemptive orders
since approximately 2006.517
The requirement included in these
orders was designed to address the risk
that an authorized participant or other
market participant could take advantage
of its relationship with the ETF (i.e.,
engage in cherry picking or dumping).
However, as discussed above, we
believe that the proposed rule’s
additional policies and procedures
requirements for custom baskets would
provide a principles-based approach
that is designed to limit potential abuses
so that they would be unlikely to cause
significant harm to investors. In
addition, as also discussed above in
section III.C.1.b, we believe that the
increased basket flexibility under the
proposed rule would benefit the
effective functioning of the arbitrage
mechanism, particularly benefiting
fixed-income, international, and
actively managed ETFs.518
4. Website Disclosure of Every Basket
Used by an ETF
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Proposed rule 6c–11 would require
ETFs to post, on the ETF’s website at the
beginning of each business day, a
published basket applicable to orders
for the purchase or redemption of
creation units to be priced based on the
ETF’s next calculation of NAV. Because
an ETF would be required to post only
one published basket to comply with
this condition, it would not be required
to post the contents of its other custom
baskets in many instances. As an
alternative, we considered proposing
that ETFs be required to publish
information regarding every basket used
by the ETF after the close of trading on
each business day.
The additional disclosure under this
alternative could reveal whether an
authorized participant has pressured an
ETF into accepting illiquid securities in
exchange for liquid ETF shares (i.e.,
dumping) or into giving an authorized
participant desirable securities in
exchange for ETF shares tendered for
redemption (i.e., cherry-picking) by
comparing an ETF’s portfolio assets and
published basket to the baskets used by
517 ETFs whose orders we are proposing to
rescind and that are operating under exemptive
orders issued before approximately 2006, which
included few explicit restrictions, would have
reduced basket flexibility under the alternative
compared to the baseline.
518 Section III.D discusses the possibility that
some ETFs may use the increased basket flexibility
of the proposed rule to over- or under-weight
securities in their baskets compared to their
portfolios based on the liquidity of these securities.
Such a practice would not be possible under the
alternative that would require an ETF’s basket to
generally correspond pro rata to its portfolio
holdings.
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various authorized participants
throughout the day.
However, the proposed rule contains
additional conditions for basket policies
and procedures, which seek to prevent
overreaching. Moreover, the proposed
rule would require an ETF to maintain
records regarding the baskets used,
which would allow Commission staff to
examine an ETF’s use of basket
flexibility. Consequently, we believe
that the risk for these abusive practices
under the proposed rule would be low
while, at the same time, the rule would
avoid additional operational and
compliance costs for ETFs to post and
review the information, under the
alternative.519
5. The Use of a Structured Format for
Additional Website Disclosures and the
Filing of Additional Website Disclosures
in a Structured Format on EDGAR
As discussed in section II.C.6 above,
we are proposing to require ETFs to post
on their websites certain disclosures to
enable investors to more readily obtain
certain key metrics for individual ETFs.
The proposed rule would allow ETFs to
select a format for posting information
that the individual ETF finds most
efficient and appropriate for the content
management system of their website.
As an alternative, we could require
ETFs to post the disclosures in a
structured format on their websites.
Structured disclosures are made
machine-readable by having reported
disclosure items labeled (tagged) using a
markup language that can be processed
by software for analysis.520 Compared
with each ETF selecting its own layout
and format for the website disclosures,
the resulting standardization under this
alternative would allow for extraction,
aggregation, comparison, and large-scale
analysis of reported information through
significantly more automated means
519 We estimate that, under the alternative, an
average ETF would incur a one-time cost of $3,879
(6 hours (for website development) × $296.50 per
hour (blended rate for a senior systems analyst
($274) and senior programmer ($319)) + (4 hours
(for review of website disclosures) × $325 (blended
rate for a compliance manager ($298) and a
compliance attorney ($352)) + $800 for an external
website developer to develop the web page =
$3,879) for implementing this website disclosure
and an ongoing cost of $1,596.50 (1 hour (for
website updates) × $296.50 per hour (blended rate
for a senior systems analyst ($274) and senior
programmer ($319)) + (4 hours (for review of
website disclosures) × $325 (blended rate for a
compliance manager ($298) and a compliance
attorney ($352)) = $1,596.50) per year for updating
the relevant web page daily with this information.
520 Structured information can be stored, shared
and presented in different systems or platforms.
Standardized markup languages, such as XML or
XBRL, use sets of data element tags for each
required reporting element, referred to as
taxonomies.
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than is possible with unstructured
formats such as HTML. This alternative
would facilitate the extraction and
analysis through automated means of an
individual fund’s disclosures over
time—which would offer the greatest
benefit for higher-frequency ETF
disclosures—and potentially the
comparison of disclosures across a small
number of ETFs. However, requiring a
structured disclosure format would not
lower the collection burden incurred by
the requirement to separately visit each
website to obtain each ETFs disclosure.
The structured data requirement
could impose an incremental cost on
ETFs of tagging the information in a
structured format, particularly to the
extent that ETFs don’t otherwise
structure this data for their own
purposes. Although, if the XML format
is used for the additional disclosure, the
incremental cost of tagging information
in a structured format would likely be
small.521
As another alternative, we could
require ETFs to make the additional
website disclosures available in a
centralized repository in a structured
format, such as by filing them on
EDGAR. Making the information
available in a structured format on
EDGAR would likely improve its
accessibility and the ability of investors,
the Commission, and other data users to
efficiently extract information for
purposes of aggregation, comparison
and analysis of information across
multiple funds and time periods.522 As
stated above, if the XML format is used
for the additional disclosure, the
incremental cost of tagging the
information in a structured format
would likely be small. However, funds
would still incur a cost of filing the
disclosures on EDGAR, which might be
higher than the cost of posting the
disclosures on individual ETF websites.
6. Treatment of Leveraged ETFs
As discussed in section II.A.3. above,
leveraged ETFs would not be able to
521 For example, based on staff experience with
XML filings, the costs of tagging the information in
XML are expected to be minimal given the
technology that will be used to structure the data.
XML is a widely used data format, and based on
the Commission’s understanding of current
practices, most reporting persons and third party
service providers have production systems already
in place to report schedules of investments and
other information. Therefore, we believe systems
should be able to accommodate XML data without
significant costs, and large-scale changes will likely
not be necessary to output structured data files.
522 The Commission has implemented
requirements for the structuring of certain
information disclosed by funds. See, e.g., Release
No. 33–10231 (Oct. 13, 2016) [81 FR 81870]; Release
No. IC–29132 (Feb. 23, 2010) [75 FR 10059]; Release
No. 33–9006 (Feb. 11, 2009) [74 FR 7747].
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rely on proposed rule 6c–11. As an
alternative, we considered permitting
leveraged ETFs to rely on the proposed
rule, while maintaining the status quo of
existing exemptive orders with respect
to the amount of leveraged market
exposure that leveraged ETFs may
obtain (i.e., 300% of the return or
inverse return).523 This alternative
would thus prohibit a leveraged ETF
from seeking a performance result,
directly or indirectly, that exceeds three
times the performance, or inverse
performance, of the specified market
index or benchmark. This alternative
could benefit competition among
leveraged ETFs as compared to the
baseline, as fund sponsors that currently
do not have an exemptive order
permitting them to operate this type of
ETF could enter the market. As a result,
fees for leveraged ETFs would likely
decrease and their assets could increase.
However, as discussed in detail in
section II.A.3., in light of our ongoing
consideration, including the potential
staff recommendation of a re-proposal
on funds’ use of derivatives, we do not
believe it is appropriate to permit
sponsors to form and operate leveraged
ETFs in reliance on our proposed rule.
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F. Request for Comments
The Commission requests comment
on all aspects of this initial economic
analysis, including whether the analysis
has: (1) Identified all benefits and costs,
including all effects on efficiency,
competition, and capital formation; (2)
given due consideration to each benefit
and cost, including each effect on
efficiency, competition, and capital
formation; and (3) identified and
considered reasonable alternatives to
the proposed new rule and disclosure
amendments. We request and encourage
any interested person to submit
comments regarding the proposed rule,
our analysis of the potential effects of
the proposed rule and proposed
amendments, and other matters that
may have an effect on the proposed rule.
We request that commenters identify
sources of data and information as well
as provide data and information to assist
us in analyzing the economic
consequences of the proposed rule and
proposed amendments. We also are
interested in comments on the
qualitative benefits and costs we have
identified and any benefits and costs we
may have overlooked. In addition to our
general request for comment on the
economic analysis associated with the
proposed rule and proposed
amendments, we request specific
523 See
supra footnote 77.
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comment on certain aspects of the
proposal:
• Would the proposed rule require
any existing ETFs whose exemptive
orders would be rescinded to materially
change the way they operate? If so, what
types of funds would have to materially
change the way they operate and it what
ways? Would these funds require any
additional exemptive relief to continue
operating?
• Would the elimination of the direct
costs of obtaining exemptive relief result
in additional benefits to ETFs or their
investors? Are there other costs of the
proposed rule that would offset any cost
savings resulting from not having to file
an exemptive application?
• Would the proposed rule result in
greater product innovation in the ETF
market? Would the proposed rule result
in increased investment options?
• Are we correct to assume that
substantially all ETFs that are currently
not required to make daily website
disclosures of NAV, closing price, and
premiums and discounts would have
the data required to make these
disclosures available to them as part of
their regular operations as well as
systems (such as computer equipment,
an internet connection, and a website)
in place that can be used for processing
this data and uploading it to their
websites? If not, what data or systems
would currently be unavailable, which
ETFs would it be unavailable for, and
what would the cost of acquiring the
unavailable data or systems be?
• Do ETFs already have policies and
procedures in place governing the
composition of baskets? How long
would it take and how much would it
cost to implement such policies and
procedures for funds that do not already
have them in place, particularly the
custom basket policies and procedures?
• Are we correct to assume that
substantially all ETFs would already
have the required data available for
daily website disclosures of bid-ask
spreads and historical information
regarding premiums and discounts as
well as systems (such as computer
equipment, an internet connection, and
a website) in place that can be used for
processing this data and uploading it to
their websites? If not, what data or
systems would currently be unavailable,
which funds would it be unavailable
for, and what would the cost of
acquiring the unavailable data or
systems be?
• Are we correct to assume that
substantially all funds would already
have the required data to complete the
new disclosures required by the
proposed amendments to Forms N–1A
and N–8B–2 available to them as part of
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37397
their regular operations? If not, what
data would currently be unavailable,
which funds would it be unavailable
for, and what would the cost of
acquiring the unavailable data be?
• Is our estimate correct that the cost
to a typical fund for applying for an ETF
exemptive order is approximately
$100,000? If not, what would be a more
accurate estimate?
• How many ETFs (representing how
much in assets) currently are required to
disclose on their website, free of charge,
the previous day’s NAV and the price of
the ETF shares, as well as the premium
or discount associated with the closing
price and information pertaining to the
composition and proportion of
underlying holdings? How many ETFs
(representing how much in assets) are
not required to provide this disclosure
but nevertheless voluntarily provide it?
• Do commenters agree that requiring
ETFs to make the additional website
disclosures available in a structured
format, which is an alternative we
considered, would be associated with
only a small cost of tagging this
information?
• Would the proposed rule lead to
more competition and lower fees in the
leveraged ETF market if leveraged ETFs
were allowed to rely on the rule?
IV. Paperwork Reduction Act
A. Introduction
Proposed rule 6c–11 would result in
new ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’).524 In addition, the proposed
amendments to Form N–1A, Form N–
8B–2, and Form N–CEN would impact
the collection of information burden
under those forms and Form S–6.525
Proposed rule 6c–11 also would impact
the current collection of information
burden of rule 0–2 under the Act.526
The titles for the existing collection of
information are: ‘‘Form N–1A under the
Securities Act of 1933 and under the
Investment Company Act of 1940,
Registration Statement for Open-End
Management Companies’’ (OMB No.
3235–0307); ‘‘Form N–8B–2 under the
Investment Company Act of 1940,
Registration Statement of Unit
Investment Trusts Which are Currently
Issuing Securities’’ (OMB No. 3235–
0186); ‘‘Form S–6 [17 CFR 239.19], for
registration under the Securities Act of
1933 of Unit Investment Trusts
registered on Form N–8B–2’’ (OMB
Control No. 3235–0184); ‘‘Form N–
524 44
U.S.C. 3501–3520.
CFR 274.11A; 17 CFR 274.12; 17 CFR part
101; 17 CFR 239.16.
526 17 CFR 270.0–2.
525 17
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CEN’’ (OMB Control No. 3235–0730);
and ‘‘Rule 0–2 under the Investment
Company Act of 1940, General
Requirements of Papers and
Applications’’ (OMB Control No. 3235–
0636). The title for the new collection of
information would be: ‘‘Rule 6c–11
under the Investment Company Act of
1940, ‘Exchange-traded funds.’ ’’ The
Commission is submitting these
collections of information to the Office
of Management and Budget (‘‘OMB’’) for
review in accordance with 44 U.S.C.
3507(d) and 5 CFR 1320.11. An agency
may not conduct or sponsor, and a
person is not required to respond to, a
collection of information unless it
displays a currently valid control
number.
We published notice soliciting
comments on the collection of
information requirements in the 2008
ETF Proposing Release and submitted
the proposed collections of information
to OMB for review and approval in
accordance with 44 U.S.C. 3507(d) and
5 CFR 1320.11.527 We received no
comments on the collection of
information requirements.
We discuss below the collection of
information burdens associated with
proposed rule 6c–11 and its impact on
rule 0–2 as well as proposed
amendments to Forms N–1A, N–8B–2,
S–6 and N–CEN.
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B. Proposed Rule 6c–11
Proposed rule 6c–11 would permit
ETFs that satisfy certain conditions to
operate without first obtaining an
exemptive order from the Commission.
The rule is designed to create a
consistent, transparent, and efficient
regulatory framework for such ETFs and
facilitate greater competition and
innovation among ETFs. The proposal
attempts to eliminate historical
distinctions and conditions that we no
longer believe are necessary and thus
appropriately level the playing field for
such ETFs that pursue the same or
similar investment strategies.
Proposed rule 6c–11 would require an
ETF to disclose certain information on
its website, to maintain certain records,
and to adopt and implement written
policies and procedures governing their
constructions of baskets, as well as
written policies and procedures that set
forth detailed parameters for the
construction and acceptance of custom
baskets that are in the best interests of
the ETF and its shareholders. These
requirements are collections of
information under the PRA.
527 See 2008 ETF Proposing Release, supra
footnote 3.
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The respondents to proposed rule 6c–
11 would be ETFs registered as openend management investment companies
other than ETFs within multiple-class
funds or leveraged ETFs.528 This
collection would not be mandatory, but
would be necessary for those ETFs
seeking to operate without individual
exemptive orders. We estimate that
1,635 ETFs would likely rely on rule
6c–11.529 Information provided to the
Commission in connection with staff
examinations or investigations would be
kept confidential subject to the
provisions of applicable law.
1. Website Disclosures
Under the proposal, ETFs would be
required to post on their websites: (i)
The ETF’s NAV per share, market price,
and premium or discount; and (ii)
historical information regarding
premiums and discounts. In addition,
proposed rule 6c–11 would require an
ETF to disclose on its website, each
business day, the portfolio holdings that
will form the basis for each calculation
of NAV per share,530 and information
regarding a published basket that will
apply to orders for the purchase or
redemption of creation units each
business day.531 As proposed, the rule
would require that portfolio holdings
and basket information be presented
and contain information regarding
description, amount, value and/or
unrealized gain/loss (if applicable) in
the manner prescribed within Article 12
of Regulation S–X.532 Additionally, the
proposed rule would require an ETF to
disclose on its website a tabular chart
and line graph showing the ETF’s
premiums and discounts for the most
recently completed calendar year and
the most recently completed calendar
quarters of the current year. For new
ETFs that do not yet have this
information, the proposed rule would
require the ETF to post this information
for the life of the fund. As discussed
above, we believe the disclosures
provide useful information to investors
who purchase and sell ETF shares on
national securities exchanges.
Proposed rule 6c–11(c)(1)(v) also
would require any ETF whose premium
or discount was greater than 2% for
more than seven consecutive trading
days to post that information on its
website, along with a discussion of the
factors that are reasonably believed to
528 See proposed rule 6c–11(a) (defining
‘‘exchange-traded fund’’).
529 See supra footnote 425 and accompanying
text. This is estimate does not include UIT ETFs,
share class ETFs, or leveraged ETFs.
530 See proposed rule 6c–11(c)(1)(i)(A).
531 See proposed rule 6c–11(c)(1)(i)(B).
532 See supra footnote 220.
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have materially contributed to the
premium or discount.533 Given the
proposed threshold, we do not believe
that many ETFs would be required to
disclose this information on a routine
basis. For purposes of this PRA, we
assume that all ETFs will be required to
make this disclosure only once in their
lifetime. Therefore, we believe that this
requirement will impose only initial
costs and that there will be no ongoing
costs associated with it.534
For purposes of the PRA analysis, we
estimate that an ETF would incur a onetime average burden of 25 hours
associated with updating the relevant
website disclosures, at a time cost of
$7,697.50.535 The staff estimates the
initial external cost would be $2,000 for
an external website developer to
develop the web page.536 Amortized
over a 3-year period, the hour burden
per ETF would be approximately 8.3
hours, at a time cost of $2,565.8, and an
external cost of approximately $666.65.
Additionally, Commission staff
estimates that an ETF each year would
spend approximately 5 hours of
professional time to update the relevant
web page daily with this information, at
a time cost of $1,405.50.537 Commission
staff does not believe there will be any
ongoing external costs related to the
website disclosure requirements.
Accordingly, we estimate that the total
burden for drafting, reviewing and
uploading the website disclosures
would be 21,745.50 hours,538 at a time
533 This information would be posted on the
trading day immediately following the eighth
consecutive trading day on which the ETF had a
premium or discount greater than 2% and be
maintained on the ETF’s website for at least one
year following the first day it was posted. See supra
at text following footnote 306.
534 For purposes of this analysis, we estimate that
1,635 ETFs would be required to make this
disclosure at least once in their lifetime.
535 This estimate is based on the following
calculations: (15 hours (for website development) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (10
hours (for review of website disclosures) × $325
(blended rate for a compliance manager ($298) and
a compliance attorney ($352)) = $7,697.50).
536 Based on staff experience, the staff estimates
that each ETF initially would spend an additional
$2,000 on external website developers.
537 This estimate is based on the following
calculations: (2 hours (for website updates) ×
$296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (2.5
hours (for review of website disclosures) × $325
(blended rate for a compliance manager ($298) and
a compliance attorney ($352)) = $1,405.50. See
SIFMA Report, supra footnote 452.
538 This estimate is based on the following
calculation: 13.3 hours × 1,635 ETFs = 21,745.50
hours.
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cost of approximately $6,493,075.50,539
and an external cost of $1,089,972.75.540
2. Recordkeeping
The proposed rule requires that ETFs
to preserve and maintain copies of all
written authorized participant
agreements.541 Additionally, we are
proposing to require ETFs to maintain
records setting forth the following
information for each basket exchanged
with an authorized participant: (i) The
names and quantities of the positions
composing the basket; (ii) identification
of the basket as a ‘‘custom basket’’ and
a record stating that the custom basket
complies with the ETF’s custom basket
policies and procedures (if applicable);
(iii) cash balancing amounts (if any);
and (iv) the identity of the authorized
participant conducting the
transaction.542
ETFs would have to maintain these
records for at least five years, the first
two years in an easily accessible
place.543 We estimate that the burden
would be 5 hours per ETF to retain
these records, with 2.5 hours spent by
a general clerk and 2.5 hours spent by
a senior computer operator. We estimate
a time cost per ETF of $380.544 We
estimate the total recordkeeping burden
related to rule 6c–11 would be 8,175
hours, at an aggregate cost of
$621,300.545
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3. Policies and Procedures
As proposed, rule 6c–11 would
require ETFs relying on the proposed
rule to adopt and implement written
policies and procedures that govern the
construction of baskets and the process
that will be used for the acceptance of
basket assets.546 Additionally, to use
custom baskets, an ETF would be
required to adopt and implement
written policies and procedures setting
forth detailed parameters for the
construction and acceptance of custom
baskets that are in the best interests of
the ETF and its shareholders.547 These
policies and procedures also may
include a periodic review requirement
539 This estimate is based on the following
calculation: $3,971.3 × 1,635 ETFs = $6,493,075.50.
540 This estimate is based on the following
calculation: $666.65 × 1,635 ETFs = $1,089,972.75.
541 See proposed rule 6c–11(d).
542 See supra footnote 325 and accompanying
text.
543 Id.
544 This estimate is based on the following
calculations: 2.5 hours × $60 (hourly rate for a
general clerk) = $150; 2.5 hours × $92 (hour rate for
a senior computer operator) = $230. $150 + $230 =
$380.
545 We estimate that 1,635 ETFs would be
required to maintain these records.
546 See proposed rule 6c–11(c)(3).
547 See proposed rule 6c–11(c)(3)(i).
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in order to ensure that the ETF’s custom
basket procedures are being consistently
followed.548 Finally, as discussed above,
such an ETF would be required to
maintain records detailing the
composition of each custom basket.
For purposes of this PRA analysis, we
estimate that an ETF would incur a onetime average burden of 6 hours
associated with setting up the process
for documenting the construction and
acceptance of baskets.549 Accordingly,
we estimate that a total initial burden
associated with setting up the process
for documenting the construction and
acceptance of baskets would be 9,810
hours,550 at a time cost of $4,094,325.551
An ETF utilizing custom baskets would
also incur a one-time average burden of
20 hours associated with documenting
and adopting the custom basket policies
and procedures. Amortized over a 3year period, this would be an annual
burden per ETF of about 2 hours for
documenting the construction and
acceptance of baskets and an annual
burden per ETF of about 6.7 hours for
the custom basket policies and
procedures. Accordingly, we estimate
that a total burden for initial
documentation and review of both the
process for documenting the
construction and acceptance of baskets
as well as an ETF’s custom basket
policies and procedures would be
42,510 hours,552 at a time cost of
$16,788,180.553 Amortizing these costs
over three years, the annual burden of
complying with these requirements
would be 14,170 hours, at a time cost of
$5,596,060. We also estimate that there
supra text accompanying footnote 256.
estimate that all ETFs relying on the rule
will use custom baskets to some extent. Moreover,
we estimate that the cost associated with this
requirement is small because the records detailing
the composition of each custom basket are readily
available.
550 This estimate is based on the following
calculations: 6 hours × 1,635 ETFs = 9,810 hours.
551 This estimate is based on the following
calculations: 3 hours × 317 (hourly rate for a senior
manager) = $951; 2 hours × 511 (hourly rate for
chief compliance officer) = $1,022; 1 hour × $352
(hourly rate for compliance attorney) = $352; $951
+ $1,022 + $352 = $2,325; $2,325 × 1,635 ETFs =
$3,801,375.
552 This estimate is based on the following
calculation: (6 hours + 20 hours) × 1,635 ETFs =
42,510 hours.
553 These estimates are based on the following
calculations: 12 hours × $317 (hourly rate for a
senior portfolio manager) = $3,804; 12 hours × $480
(blended hourly rate for assistant general counsel
($449) and chief compliance officer ($511) = $5,760;
2 hours (for a fund attorney’s time to prepare and
review materials) × $352 (hourly rate for a
compliance attorney) = $704. $3,804 + $5,760 +
$704 = $10,268; $10,268 × 1,635 ETFs =
$16,788,180. See SIFMA Report, supra footnote
452.
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548 See
549 We
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37399
would be no external cost for an ETF
associated with these requirements.
We estimate that each ETF would
incur an ongoing burden of an
additional 10 hours, at a time cost of an
additional $3,985 554 each year to review
and update its custom basket policies
and procedures as well as its process for
documenting the construction and
acceptance of baskets. In aggregate, we
estimate that the total ongoing costs
associated with these requirements are
16,350 hours, at a time cost of
$6,515,475.555 We do not estimate that
there will be any ongoing external costs
associated with these requirements.
Therefore, we estimate that the total
initial and ongoing costs associated with
complying with the policies and
procedures requirements of proposed
rule 6c–11 would be 30,520 556 hours at
a time cost of $12,111,535.557
4. Estimated Total Burden
We estimate that the total hour
burdens and time costs associated with
proposed rule 6c–11, including the
burden associated with: (i) Website
disclosure; (ii) recordkeeping; and (iii)
developing policies and procedures,
would result in an average aggregate
annual burden of 60,440.5 hours 558 and
an average aggregate time cost of
$19,225,910.50.559 We also estimate that
there are $1,089,972.75 external costs
associated with this collection of
information. 560 Therefore, to comply
with rule 6c–11 each ETF would incur
an annual burden of approximately
36.97 561 hours, at an average time cost
of approximately $11,758.97 562, and an
external cost of $666.65.563
554 These estimates are based on the following
calculations: 5 hours × $317 (hourly rate for a senior
portfolio manager) = $1,585; 5 hours × $480
(blended hourly rate for assistant general counsel
($449) and chief compliance officer ($511) = $2,400.
$1,585 + $2,400 = $3,985.
555 This estimate is based on the following
calculation: $3,985 × 1,635 ETFs = $6,515,475.
556 This estimate is based on the following
calculation: 14,170 hours + 16,350 hours = 30,520
hours.
557 This estimate is based on the following
calculation: $5,596,060 + $6,515,475 = $12,111,535.
558 This estimate is based on the following
calculation: 21,745.5 hours + 8,175 hours + 30,520
hours = 60,440.5 hours.
559 This estimate is based on the following
calculation: $6,493,075.50 + $621,300 +
$12,111,535 = $19,225,910.50.
560 See supra footnote 540 and accompanying
text.
561 This estimate is based on the following
calculation: 60,440.5 hours ÷ 1,635 ETFs = 36.97
hours.
562 This estimate is based on the following
calculation: $19,225,910.50 ÷ 1,635 ETFs =
$11,758.97.
563 This estimate is based on the following
calculation: $1,089,972.75 ÷ 1,635 ETFs = $666.65.
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C. Rule 0–2
Section 6(c) of the Act provides the
Commission with authority to
conditionally or unconditionally
exempt persons, securities or
transactions from any provision of the
Act if and to the extent that such
exemption is necessary or appropriate
in the public interest and consistent
with the protection of investors and the
purposes fairly intended by the policy
and provisions of the Act. Rule 0–2
under the Act, entitled ‘‘General
Requirements of Papers and
Applications,’’ prescribes general
instructions for filing an application
seeking exemptive relief with the
Commission.564 We currently estimate
for rule 0–2 a total hour burden of 5,340
hours at an annual time cost of
$2,029,200.60 and the total annual
external cost burden is $14,090,000.565
As discussed above, proposed rule
6c–11 would permit ETFs that satisfy
the conditions of the rule to operate
without the need to obtain an exemptive
order from the Commission under the
Act. Therefore, proposed rule 6c–11
would alleviate some of the burdens
associated with rule 0–2 because it
would reduce the number of entities
that require exemptive relief in order to
operate.566 Based on staff experience,
we estimate that approximately onethird of the annual burdens associated
with rule 0–2 are attributable to ETF
applications. Therefore, we estimate
that proposed rule 6c–11 would result
in a decrease of the annual burden of
rule 0–2 to approximately 3,738 567
hours at an annual time cost of
$1,420,440.42 568 and an annual external
cost of $9,863,000.569
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D. Form N–1A
Form N–1A is the registration form
used by open-end management
564 See Supporting Statement of Rule 0–2 under
the Investment Company Act of 1940, General
Requirements of Paper Applications (Nov. 23,
2016), available at https://www.reginfo.gov/public/
do/PRAViewICR?ref_nbr=201602-3235-008
(summarizing how applications are filed with the
Commission in accordance with the requirements of
rule 0–2).
565 This estimate is based on the last time the
rule’s information collection was submitted for PRA
renewal in 2016.
566 As discussed above, we expect to continue to
receive applications for complex or novel ETF
exemptive relief that are beyond the scope of the
proposed rule. See supra at text following footnote
454.
567 This estimate is based on the following
calculation: 5,340 hours¥(5,340 hours × 0.3) =
3,738 hours.
568 This estimate is based on the following
calculation: $2,029,200.60¥($2,029,200.60 × 0.3) =
$1,420,440.42.
569 This estimate is based on the following
calculation: $14,090,000¥($14,090,000 × 0.3) =
$9,863,000.
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investment companies. The respondents
to the proposed amendments to Form
N–1A are open-end management
investment companies registered or
registering with the Commission.
Compliance with the proposed
disclosure requirements of Form N–1A
is mandatory for open-end funds (to the
extent applicable) including all ETFs
organized as open-end funds. Responses
to the disclosure requirements are not
confidential. We currently estimate for
Form N–1A a total burden hour of
1,579,974 burden hours, with an
estimated internal cost of $129,338,408,
and external cost of $124,820,197.570
We are proposing amendments to
Form N–1A designed to provide
investors who purchase ETF shares in
secondary market transactions with
tailored information regarding ETFs,
including information regarding costs
associated with an investment in
ETFs.571 Specifically, the proposed
amendments to Form N–1A would
require new disclosures regarding fees
and expenses, such as brokerage
commission and financial intermediary
fees, and certain trading costs.572 In
addition, we are proposing to include
instructions in Form N–1A requiring an
ETF to provide bid-ask spread
information on the ETF’s website and an
interactive calculator, in a clear and
prominent format on the ETF’s website,
to allow investors to customize certain
hypothetical calculations to their
specific investing situation.573
We also are proposing amendments to
Form N–1A designed to eliminate
certain disclosures for ETFs that are
duplicative of the new disclosures we
are proposing, discussed above, or are
no longer necessary.574 These proposed
amendments include eliminating certain
disclosures in Item 6(c) of Form N–1A
relating to creation units, secondary
market transactions, premiums and
discounts, as well as certain disclosures
required of ETFs issuing creation units
of less than 25,000 shares. Additionally,
we are proposing to eliminate historical
premium/discount disclosure
requirements in Item 11(g)(2) and Item
27(b)(7)(iv) of Form N–1A.
Form N–1A generally imposes two
types of reporting burdens on
investment companies: (i) The burden of
570 This estimate is based on the last time the
form’s information collection was submitted for
PRA renewal in 2017.
571 See proposed Instruction 5(e) to Item 3 of
Form N–1A.
572 See proposed amendments to Item 3 of Form
N–1A.
573 Proposed Instruction 5(e) to Item 3 of Form N–
1A.
574 See supra footnotes 390–397 and
accompanying text.
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preparing and filing the initial
registration statement; and (ii) the
burden of preparing and filing posteffective amendments to a previously
effective registration statement
(including post-effective amendments
filed pursuant to 17 CFR 230.485(a) or
(b) (rule 485(a) or 485(b) under the
Securities Act), as applicable). We
estimate that each ETF would incur a
one-time burden of an additional 10
hours, at a time cost of an additional
$3,355,575 to draft and finalize the
required disclosure and amend its
registration statement. We further
estimate that an ETF would incur a onetime average burden of 10 hours
associated with implementing the bidask spread disclosures and interactive
calculator on its website, at a time cost
of $3,355,576 as required by proposed
Instruction 5(e) to Item 3. In the
aggregate, we estimate that ETFs would
incur a one-time burden of an additional
20 hours, at a time cost of an additional
$6,710 to comply with the proposed
Form N–1A disclosure requirements for
ETFs. Amortizing the one-time burden
over a three-year period results in an
average annual burden of an additional
6.67 hours at a time cost of an
additional $2,236.67.
We estimate that each ETF would
incur an ongoing burden of an
additional 5 hours, at a time cost of an
additional $1,677.50 577 each year to
review and update the proposed
disclosures.578 We also estimate that
each ETF would incur an ongoing
burden of an additional 5 hours, at a
time cost of an additional $1,677.50,579
relating to the bid-ask spread
disclosures and to maintain the
interactive calculator on its website. In
aggregate, we estimate that each ETF
would incur an annual ongoing burden
of an additional 10 hours, at a time cost
of an additional $3,355, to comply with
the proposed Form N–1A disclosure
requirements. We do not estimate any
change to the external costs associated
with the proposed amendment for Form
N–1A.
In total, we estimate that ETFs, other
than UIT ETFs, would incur an average
575 This estimate is based on the following
calculation: 10 hours × $335.50 (blended rate for a
compliance attorney ($352) and a senior
programmer ($319)) = $3,355.
576 Id.
577 This estimate is based on the following
calculation: 5 hours × $335.50 (blended rate for a
compliance attorney ($352) and a senior
programmer ($319)) = $1,677.50.
578 The estimated burden associated with the
amendments to Form N–1A accounts for the
proposal to remove the information currently
required by Item 11(g)(2) and Item 27(b)(7)(iv) of
Form N–1A.
579 Id.
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annual increased burden of
approximately 31,596.4 hours,580 at a
time cost of approximately
$10,579,307.2,581 to comply with the
proposed Form N–1A disclosure
requirements. We do not estimate any
change to the external costs associated
with the proposed amendment for Form
N–1A.
E. Disclosure Amendments to Forms
N–8B–2 and S–6
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Form N–8B–2 is used by UITs to
initially register under the Investment
Company Act pursuant to section 8
thereof.582 UITs are required to file
Form S–6 in order to register offerings
of securities with the Commission under
the Securities Act.583 As a result, UITs
file Form N–8B–2 only once when the
UIT is initially created and then use
Form S–6 to file all post-effective
amendments to their registration
statements in order to update their
prospectuses.584 We currently estimate
for Form S–6 a total burden of 106,620
hours, with an internal cost burden of
approximately $34,000,000, and an
external cost burden estimate of
$67,359,556.585 Additionally, we
currently estimate for Form N–8B–2 a
total burden of 10 hours, with an
internal cost burden of approximately
$3,360, and an external burden estimate
of $10,000.586
In order to assist investors with better
understanding the total costs of
investing in a UIT ETF, we are
proposing disclosure requirements in
Form N–8B–2 that mirror those
disclosures proposed for Form N–1A.587
All UIT ETFs would be subject to these
disclosure requirements. For existing
UIT ETFs, the one-time and ongoing
costs of complying with the
amendments to Form N–8B–2 would
accrue on Form S–6.588
580 This estimate is based on the following
calculation: (6.7 hours + 10 hours) × 1,892 ETFs =
31,596.4 hours.
581 This estimate is based on the following
calculation: ($2,236.67 + $3,355) × 1,892 ETFs=
$10,579,307.20.
582 See Form N–8B–2 [17 CFR 274.12].
583 See Form S–6 [17 CFR 239.16]. Form S–6 is
used for registration under the Securities Act of
securities of any UIT registered under the Act on
Form N–8B–2.
584 Form S–6 incorporates by reference the
disclosure requirements of Form N–8B–2 and
allows UITs to meet the filing and disclosure
requirements of the Securities Act.
585 This estimate is based on the last time the
form’s information collection was submitted for
PRA renewal in 2014.
586 This estimate is based on the last time the
form’s information collection was submitted for
PRA renewal in 2018.
587 See proposed Items 13(h) and (i) of Form N–
8B–2. See also supra section II.H.5.
588 See supra footnote 583.
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For purposes of the PRA analysis, we
estimate that each UIT ETF would incur
a one-time burden of an additional 20
hours, at a time cost of an additional
$6,710 589 to draft and finalize the
required disclosure and amend its Form
S–6. For each newly created UIT ETF,
these same costs would be incurred on
Form N–8B–2.590 Therefore, in the
aggregate, we estimate that existing UIT
ETFs would incur a one-time burden of
an additional 160 hours,591 at a time
cost of an additional $53,680,592 to
comply with the proposed Form N–8B–
2 disclosure requirements on Form S–6.
Additionally, in the aggregate, we
estimate that newly created UIT ETFs
would incur a one-time burden of an
additional 20 hours, at a time cost of an
additional $6,710, to comply with the
proposed amendments and complete
Form N–8B–2. Amortizing the one-time
burden for both existing and newly
created UIT ETFs over a three-year
period results in an average annual
burden of an additional 6.67 hours, at a
time cost of an additional $2,236.67.
We estimate that each UIT ETF would
incur an ongoing burden of an
additional 10 hours, at a time cost of an
additional $3,355, each year to review
and update the proposed disclosures on
Form S–6. In aggregate, we estimate that
UIT ETFs would incur an annual
burden of an additional 80 hours,593 at
a time cost of an additional $26,840,594
to comply with the proposed Form N–
8B–2 disclosure requirements on Form
S–6.
Additionally, we estimate that newly
created UIT ETFs would also incur an
average annual increased burden of
approximately 10 hours, at a time cost
of an additional $3,355, to complete
Form N–8B–2. We do not estimate any
change to the external costs, on either
Form N–8B–2 or Form S–6, associated
with the proposed amendments to Form
N–8B–2.
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registered funds to provide census-type
information to the Commission on an
annual basis.595 The Commission is
proposing amendments to Form N–CEN
to require ETFs to report if they are
relying on rule 6c–11.596
In the Reporting Modernization
Adopting Release, we estimated that the
Commission would receive an average
of 3,113 reports on Form N–CEN.597 We
estimated that the average annual hour
burden per response for Form N–CEN
for the first year to be 32.37 hours and
12.37 hours in subsequent years.598
Amortizing the burden over three years,
we estimated that the average annual
hour burden per fund per year to be
19.04 hours and the total aggregate
annual hour burden to be 59,272
hours.599 Finally, we estimated that all
applicable funds will incur, in the
aggregate, external annual costs of
$2,088,176 to prepare and file reports on
Form N–CEN.600
Based on Commission staff
experience, we believe that our proposal
to require ETFs to report if they are
relying on rule 6c–11 would increase
the estimated burden hours associated
with Form N–CEN by approximately 0.1
hours, both initially and on an ongoing
basis.601 Therefore, in the aggregate, we
estimate that ETFs will incur an annual
burden of an additional 163.5 hours to
comply with the proposed amendments
to Form N–CEN.602 We estimate that
there are no additional external costs
associated with this collection of
information.
F. Form N–CEN
As discussed above, Form N–CEN is
a structured form that requires
G. Request for Comments
We request comment on whether
these estimates are reasonable. Pursuant
to 44 U.S.C. 3506(c)(2)(B), the
Commission solicits comments in order
to: (i) Evaluate whether the proposed
collections of information are necessary
for the proper performance of the
functions of the Commission, including
whether the information will have
practical utility; (ii) evaluate the
accuracy of the Commission’s estimate
of the burden of the proposed
589 This estimate is based on the following
calculation: 20 hours × $335.50 (blended rate for a
compliance attorney ($352) and a senior
programmer ($319)) = $6,710.
590 Although we noted above that no new UIT
ETFs have come to market since 2002, for purposes
of calculating the time and cost burdens associated
with completing Form N–8B–2, we estimate that 1
UIT ETF will be created annually. See supra
footnote 41 and accompanying text.
591 This estimate is based on the following
calculation: 20 hours × 8 UIT ETFs= 160 hours.
592 This estimate is based on the following
calculation: $6,710 × 8 UIT ETFs = $53,680.
593 This estimate is based on the following
calculation: 10 hours × 8 UIT ETFs = 80 hours.
594 This estimate is based on the following
calculation: $3,355 × 8 UIT ETFs = $26,840.
595 See Reporting Modernization Adopting
Release, supra footnote 147. The compliance date
for Form N–CEN is June 1, 2018.
596 See proposed Item C.7.k. of Form N–CEN.
597 See Reporting Modernization Adopting
Release, supra footnote 147, at text accompanying
n.1524.
598 See id., at text accompanying nn.1531–1532.
599 See id., at text accompanying nn.1533–1534.
600 See Reporting Modernization Adopting
Release, supra footnote 147, at text accompanying
n.1538.
601 This estimate stems from the Commission
staff’s understanding of the time it takes to
complete initially complete and review items on
Form N–CEN.
602 This estimate is based on the following
calculation: 0.1 hours × 1,635 ETFs = 163.5 hours.
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collections of information; (iii)
determine whether there are ways to
enhance the quality, utility, and clarity
of the information to be collected; and
(iv) determine whether there are ways to
minimize the burden of the collections
of information on those who are to
respond, including through the use of
automated collection techniques or
other forms of information technology.
Persons wishing to submit comments
on the collection of information
requirements of the proposed rules and
amendments should direct them to the
OMB, Attention Desk Officer for the
Securities and Exchange Commission,
Office of Information and Regulatory
Affairs, Washington, DC 20503, and
should send a copy to, Brent J. Fields,
Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090, with
reference to File No. S7–15–18. OMB is
required to make a decision concerning
the collections of information between
30 and 60 days after publication of this
release; therefore a comment to OMB is
best assured of having its full effect if
OMB receives it within 30 days after
publication of this release. Requests for
materials submitted to OMB by the
Commission with regard to these
collections of information should be in
writing, refer to File No. S7–15–18, and
be submitted to the Securities and
Exchange Commission, Office of FOIA
Services, 100 F Street NE, Washington,
DC 20549–2736.
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V. Initial Regulatory Flexibility
Analysis
The Commission has prepared the
following Initial Regulatory Flexibility
Analysis (‘‘IRFA’’) in accordance with
section 3 of the Regulatory Flexibility
Act 603 regarding our proposed new rule
6c–11 and proposed amendments to
Form N–1A, Form N–8b–2, and Form
N–CEN.
A. Reasons for and Objectives of the
Proposed Actions
As described more fully above,
proposed rule 6c–11 would allow ETFs
that meet the conditions of the rule to
form and operate without the expense
and delay of obtaining an exemptive
order from the Commission. The
Commission’s objective is to create a
consistent, transparent and efficient
regulatory framework for ETFs and to
facilitate greater competition and
innovation among ETFs. The
Commission also believes the proposed
disclosure amendments would provide
useful information to investors who
purchase and sell ETF shares in
603 See
5 U.S.C. 603(a).
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secondary markets. Finally, the goal of
the proposed amendments to Form N–
CEN is for the Commission to be able to
better monitor reliance on rule 6c–11
and to assist the Commission with its
accounting, auditing and oversight
functions.
B. Legal Basis
The Commission is proposing new
rule 6c–11 pursuant to the authority set
forth in sections 6(c), 22(c), and 38(a) of
the Investment Company Act [15 U.S.C.
80a–6(c), 22(c), and 80a–37(a)]. The
Commission is proposing amendments
to registration Form N–1A under the
authority set forth in sections 6, 7(a), 10
and 19(a) of the Securities Act of 1933
[15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and
sections 8(b), 24(a), and 30 of the
Investment Company Act [15 U.S.C.
80a–8(b), 80a–24(a), and 80a–29]. The
Commission is proposing amendments
to registration Form N–8b–2 under the
authority set forth in section 8(b) and
38(a) of the Investment Company Act
[15 U.S.C. 80a–8(b) and 80a–37(a)]. The
Commission is proposing amendments
to Form N–CEN under the authority set
forth sections 8(b), 30(a), and 38(a) of
the Investment Company Act [15 U.S.C.
80a–8(b), 80a–29(a), and 80a–37(a)].
C. Small Entities Subject to the Rule
An investment company is a small
entity if, together with other investment
companies in the same group of related
investment companies, it has net assets
of $50 million or less as of the end of
its most recent fiscal year.604
Commission staff estimates that, as of
December 2017, there are approximately
8 open-end ETFs that may be
considered small entities.605
Commission staff estimates there are no
UIT ETFs that would be considered
small entities subject to the proposed
disclosures for Form N–8B–2.606
D. Projected Reporting, Recordkeeping,
and Other Compliance Requirements
The proposed amendments would
amend current reporting requirements
for ETFs considered small entities.
1. Rule 6c–11
Proposed rule 6c–11 would require an
ETF to disclose on its website: (i)
Portfolio holding information and
information regarding a published
basket on each business day; (ii) the
ETF’s current NAV per share, market
CFR 270.0–10(a).
estimate is derived from an analysis of
data reported on Form N–1A with the Commission
for the period ending December, 2017.
606 This estimate is derived from an analysis of
data reported on Forms S–6 and N–8B–2 with the
Commission for the period ending December 2017.
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605 This
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price, and premium or discount, each as
of the end of the prior business day; (iii)
if an ETF’s premium or discount is
greater than 2% for more than seven
consecutive trading days, a discussion
of the factors that are reasonably
believed to have materially contributed
to the premium or discount; and (iv) a
table and line graph showing the ETF’s
premiums and discounts.607 We also are
proposing to require that ETFs preserve
and maintain copies of all written
authorized participant agreements, as
well as records setting forth the
following information for each basket
exchanged with an authorized
participant: (i) The names and
quantities of the positions composing
the basket; (ii) identification of the
basket as a ‘‘custom basket’’ and a
record stating that the custom basket
complies with the ETF’s policies and
procedures (if applicable); (iii) cash
balancing amounts (if any); and (iv) the
identity of the authorized participant
conducting the transaction.608 Proposed
rule 6c–11 would also require ETFs
relying on the proposed rule to adopt
and implement written policies and
procedures that govern the construction
of baskets and the process that will be
used for the acceptance of basket
assets.609 ETFs using custom baskets
under the proposed rule must adopt
custom basket policies and procedures
that include certain enumerated
requirements.610
We estimate that approximately 8
ETFs are small entities that would
comply with proposed rule 6c–11, and
we do not believe that their costs would
differ from other ETFs. As discussed
above, we estimate that an ETF would
incur an annual burden of
approximately 36.97 hours, at an
average time cost of approximately
$11,758.97, and an external cost of
$666.65.611
2. Disclosure and Reporting
Requirements
We are proposing amendments to
Form N–1A and Form N–8B–2 designed
to provide investors who purchase ETF
shares in secondary market transactions
with tailored information regarding
ETFs, including information regarding
costs associated with an investment in
ETFs. Specifically, proposed
amendments to Form N–1A would
require new disclosure regarding fees
and expenses, such a brokerage
607 See
proposed rule 6c–11(c)(1)(iii) and (iv).
supra section II.C.5.a.
609 Proposed rule 6c–11(c)(3).
610 Proposed rule 6c–11(c)(3).
611 See supra footnote 561 and accompanying
text.
608 See
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commission and financial intermediary
fees, and additional information on
certain trading costs.612 In addition, we
are proposing to include instructions in
Form N–1A requiring an ETF to provide
bid-ask spread information on the ETF’s
website and an interactive calculator, in
a clear and prominent format on the
ETF’s website, to allow investors to
customize certain hypothetical
calculations to their specific investing
situation.613 Proposed amendments to
Form N–8B–2 mirror proposed
disclosures for Form N–1A. We are also
proposing amendments to Form N–CEN
that would require ETFs to report on
Form N–CEN if they are relying on rule
6c–11. The proposed Form N–CEN
amendments are designed to assist us
with monitoring reliance on rule 6c–11
as well with our accounting, auditing
and oversight functions, including
compliance with the PRA.
All ETFs would be subject to the
proposed disclosure and reporting
requirements, including ETFs that are
small entities. We estimate that 8 ETFs
are small entities that would be required
to comply with the proposed disclosure
and reporting requirements.614
As discussed above, we estimate that
each ETF, including ETFs that are small
entities, would incur a one-time burden
of an additional 10 hours, at a time cost
of an additional $3,355 to draft and
finalize the required disclosure and
amend its registration statement.615 We
further estimate that ETFs, including
ETFs that are small entities, would
incur a one-time average burden of 10
hours associated with implementing the
interactive calculator on its website, at
a time cost of $3,355, as required by
proposed Instruction 5(e) to Item 3. In
the aggregate, we estimate that ETFs,
including ETFs that are small entities,
would incur a one-time burden of an
additional 20 hours, at a time cost of an
additional $6,710, to comply with the
proposed Form N–1A disclosure
requirements for ETFs.616
We also estimate that each ETF,
including ETFs that are small entities,
would incur an ongoing burden of an
additional 5 hours, at a time cost of an
additional $1,677.50, each year to
review and update the proposed
disclosures. We further estimate that
each ETF, including ETFs that are small
entities, would incur an ongoing burden
612 See
supra footnote 572 and accompanying
text.
613 Proposed
Instruction 5(e) to Item 3 of Form N–
1A.
614 See
615 See
supra footnote 605.
supra footnote 576 and accompanying
text.
616 See
of an additional 5 hours, at a time cost
of an additional $1,677.50, to maintain
the interactive calculator on its website.
In aggregate, we estimate that each ETF,
including ETFs that are small entities,
would incur an annual ongoing burden
of an additional 10 hours, at a time cost
of an additional $3,355, to comply with
the proposed Form N–1A disclosure
requirements. We do not estimate any
change to the external costs associated
with the proposed amendments to Form
N–1A.617
As discussed above, because the
amendments made to Form N–8B–2
mirror those made on Form N–1A, we
believe that UIT ETFs, including UIT
ETFs that are small entities, would
incur the same costs as all ETFs
associated with updating their
registration statements. However, none
of the UIT ETFs are small entities.
E. Duplicative, Overlapping or
Conflicting Federal Rules
Commission staff has not identified
any federal rules that duplicate, overlap,
or conflict with the proposed
regulations.
F. Significant Alternatives
The RFA directs the Commission to
consider significant alternatives that
would accomplish our stated objectives,
while minimizing any significant
economic impact on small entities. We
considered the following alternatives for
small entities in relation to the proposed
regulations:
• Exempting ETFs that are small
entities from the proposed disclosure,
reporting or recordkeeping
requirements, to account for resources
available to small entities;
• establishing different disclosure,
reporting or recordkeeping requirements
or different frequency of these
requirements, to account for resources
available to small entities;
• clarifying, consolidating, or
simplifying the compliance
requirements under the amendments for
small entities; and
• using performance rather than
design standards.
We do not believe that exempting any
subset of ETFs, including small entities,
from proposed rule 6c–11 or proposed
form amendments would permit us to
achieve our stated objectives. Nor do we
believe establishing different disclosure,
reporting or recordkeeping requirements
or different frequency of these
requirements for small entities would
permit us to achieve our stated
objectives. Similarly, we do not believe
that we can establish simplified or
supra footnote 576 and accompanying
617 Id.
text.
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37403
consolidated compliance requirements
for small entities under the proposed
rule without compromising our
objectives. As discussed above, the
conditions necessary to rely on
proposed rule 6c–11 and the reporting,
recordkeeping and disclosure
requirements are designed to provide
investor protection benefits, including,
among other things, tailored information
regarding ETFs, including information
regarding costs associated with an
investment in ETFs. These benefits
should apply to investors in smaller
funds as well as investors in larger
funds. Similarly, we do not believe it
would be in the interest of investors to
exempt small ETFs from the proposed
disclosure and reporting requirements
or to exempt small ETFs from the
proposed recordkeeping requirements.
We believe that all ETF investors,
including investors in small ETFs,
would benefit from disclosure and
reporting requirements that permit them
to make investment choices that better
match their risk tolerances. We further
note that the current disclosure
requirements for reports on Form N–1A
and Form N–8B–2 do not distinguish
between small entities and other
funds.618
Finally, we believe that proposed rule
6c–11 and related disclosure and
reporting requirements appropriately
use a combination of performance and
design standards. Proposed rule 6c–11
provides ETFs that satisfy the
requirements of the rule with
exemptions from certain provisions of
the Act necessary for ETFs to operate.
Because the provisions of the Act from
which ETFs would be exempt provide
important investor and market
protections, the conditions of the
proposed rule must be specifically
designed to ensure that these investor
and market protections are maintained.
However, where we believe that
flexibility is beneficial, we proposed
performance-based standards that
provide a regulatory framework, rather
than prescriptive requirements, to give
funds the opportunity to adopt policies
and procedures tailored to their specific
618 See Reporting Modernization Adopting
Release, supra footnote 147, at section V.E (noting
that small entities currently follow the same
requirements that large entities do when filing
reports on Form N–SAR, Form N–CSR, and Form
N–Q, and stating that the Commission believes that
establishing different reporting requirements or
frequency for small entities (including with respect
to proposed Form N–PORT and proposed Form
N–CEN) would not be consistent with the
Commission’s goal of industry oversight and
investor protection).
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needs without raising investor or market
protection concerns.619
G. General Request for Comment
The Commission requests comment
regarding this analysis. We request
comments on the number of small
entities that would be subject to the
proposed ETF regulations and whether
the proposed ETF regulations would
have any effects that have not been
discussed. We request that commenters
describe the nature of any effects on
small entities subject to the proposed
ETF regulations and provide empirical
data to support the nature and extent of
such effects. We also request comment
on the estimated compliance burdens of
the proposed ETF regulations and how
they would affect small entities.
VI. Consideration of Impact on the
Economy
For purposes of the Small Business
Regulatory Enforcement Fairness Act of
1996, or ‘‘SBREFA,’’ 620 the Commission
must advise OMB whether a proposed
regulation constitutes a ‘‘major’’ rule.
Under SBREFA, a rule is considered
‘‘major’’ where, if adopted, it results in
or is likely to result in:
• An annual effect on the economy of
$100 million or more;
• A major increase in costs or prices
for consumers or individual industries;
or
• Significant adverse effects on
competition, investment or innovation.
We request comment on whether our
proposal would be a ‘‘major rule’’ for
purposes of SBREFA. We solicit
comment and empirical data on:
• The potential effect on the U.S.
economy on an annual basis;
• Any potential increase in costs or
prices for consumers or individual
industries; and
• Any potential effect on competition,
investment, or innovation.
Commenters are requested to provide
empirical data and other factual support
for their views to the extent possible.
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VII. Statutory Authority
The Commission is proposing new
rule 6c–11 pursuant to the authority set
forth in sections 6(c), 22(c), and 38(a) of
the Investment Company Act [15 U.S.C.
80a–6(c), 80a–22(c), and 80a–37(a)]. The
Commission is proposing amendments
619 See e.g., supra section II.C.5 (noting that
proposed rule 6c–11 would provide an ETF with
the flexibility to use ‘‘custom baskets’’ if the ETF
has adopted written policies and procedures that
set forth detailed parameters for the construction
and acceptance of custom baskets that are in the
best interests of the ETF and its shareholders).
620 Public Law 104–121, Title II, 110 Stat. 857
(1996) (codified in various sections of 5 U.S.C., 15
U.S.C. and as a note to 5 U.S.C. 601).
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to registration Form N–1A under the
authority set forth in sections 6, 7(a), 10
and 19(a) of the Securities Act of 1933
[15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and
sections 8(b), 24(a), and 30 of the
Investment Company Act [15 U.S.C.
80a–8(b), 80a–24(a), and 80a–29]. The
Commission is proposing amendments
to registration Form N–8B–2 under the
authority set forth in section 8(b) and
38(a) of the Investment Company Act
[15 U.S.C. 80a–8(b) and 80a–37(a)]. The
Commission is proposing amendments
to Form N–CEN under the authority set
forth in sections 8(b), 30(a), and 38(a) of
the Investment Company Act [15 U.S.C.
80a–8(b), 80a–29(a), and 80a–37(a)].
List of Subjects
17 CFR Part 239
Reporting and recordkeeping
requirements, Securities.
17 CFR Parts 270 and 274
Investment companies, Reporting and
recordkeeping requirements, Securities.
Text of Proposed Rules and Form
Amendments
For reasons set out in the preamble,
title 17, chapter II of the Code of Federal
Regulations is proposed to be amended
as follows:
PART 239—FORMS PRESCRIBED
UNDER THE SECURITIES ACT OF 1933
1. The authority citation for part 239
continues to read, in part, as follows:
■
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j,
77s, 77z–2, 77z–3, 77sss, 78c, 78l, 78m, 78n,
78o(d), 78o–7 note, 78u–5, 78w(a), 78ll,
78mm, 80a–2(a), 80a–3, 80a–8, 80a–9, 80a–
10, 80a–13, 80a–24, 80a–26, 80a–29, 80a–30,
and 80a–37; and sec. 107 Pub. L. 112–106,
126 Stat. 312, unless otherwise noted.
*
*
*
*
*
PART 270—RULES AND
REGULATIONS, INVESTMENT
COMPANY ACT OF 1940
2. The authority citation for part 270
continues to read, in part, and is
amended by adding a sectional
authority for § 270.6c–11 to read as
follows:
■
Authority: 15 U.S.C. 80a–1 et seq., 80a–
34(d), 80a–37, 80a–39, and Pub. L. 111–203,
sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
*
*
*
*
*
Section 270.6c–11 is also issued under 15
U.S.C. 80a–6(c) and 80a–37(a).
*
*
*
*
*
■ 3. Section 270.6c–11 is added to read
as follows:
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§ 270.6c–11
Exchange-traded funds.
(a) Definitions. For purposes of this
section:
Authorized participant means a
member or participant of a clearing
agency registered with the Commission,
which has a written agreement with the
exchange-traded fund or one of its
service providers that allows the
authorized participant to place orders
for the purchase and redemption of
creation units.
Basket means the securities, assets or
other positions in exchange for which
an exchange-traded fund issues (or in
return for which it redeems) creation
units.
Business day means any day the
exchange-traded fund is open for
business, including any day when it
satisfies redemption requests as
required by section 22(e) of the Act (15
U.S.C. 80a–22(e)).
Cash balancing amount means an
amount of cash to account for any
difference between the value of the
basket and the net asset value of a
creation unit.
Creation unit means a specified
number of exchange-traded fund shares
that the exchange-traded fund will issue
to (or redeem from) an authorized
participant in exchange for the deposit
(or delivery) of a basket and a cash
balancing amount if any.
Custom basket means:
(i) Baskets that are composed of a
non-representative selection of the
exchange-traded fund’s portfolio
holdings; or
(ii) Different baskets used in
transactions on the same business day.
Exchange-traded fund means a
registered open-end management
company:
(i) That issues (and redeems) creation
units to (and from) authorized
participants in exchange for a basket
and a cash balancing amount if any; and
(ii) Whose shares are listed on a
national securities exchange and traded
at market-determined prices.
Exchange-traded fund share means a
share of stock issued by an exchangetraded fund.
Foreign investment means any
security, asset or other position of the
ETF issued by a foreign issuer as that
term is defined in § 240.3b–4 of this
title, and for which there is no
established United States public trading
market, as that term is used in 17 CFR
227.201 (Item 201 of Regulation S–K
under the Securities Act of 1933).
Market price means:
(i) The official closing price of an
exchange-traded fund share; or
(ii) If it more accurately reflects the
market value of an exchange-traded
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fund share at the time as of which the
exchange-traded fund calculates current
net asset value per share, the price that
is the midpoint between the national
best bid and national best offer as of that
time.
National securities exchange means
an exchange that is registered with the
Commission under section 6 of the
Securities Exchange Act of 1934 (15
U.S.C. 78f).
Portfolio holdings means the
securities, assets or other positions held
by the exchange-traded fund.
Premium or discount means the
positive or negative difference between
the market price of an exchange-traded
fund share at the time as of which the
current net asset value is calculated and
the exchange-traded fund’s current net
asset value per share, expressed as a
percentage of the exchange-traded fund
share’s current net asset value per share.
(b) Application of the Act to
Exchange-Traded Funds. If the
conditions of paragraph (c) of this
section are satisfied:
(1) Redeemable security. An
exchange-traded fund share is
considered a ‘‘redeemable security’’
within the meaning of section 2(a)(32) of
the Act (15 U.S.C. 80a–2(a)(32)).
(2) Pricing. A dealer in exchangetraded fund shares is exempt from
section 22(d) of the Act (15 U.S.C. 80a–
22(d)) and § 270.22c–1(a) with regard to
purchases, sales and repurchases of
exchange-traded fund shares at marketdetermined prices.
(3) Affiliated transactions. (i) A
person who is an affiliated person of an
exchange-traded fund (or who is an
affiliated person of such a person) solely
by reason of the circumstances
described in paragraphs (b)(3)(i)(A) and
(B) of this section is exempt from
sections 17(a)(1) and 17(a)(2) of the Act
(15 U.S.C. 80a–17(a)(1) and (a)(2)) with
regard to the deposit and receipt of
baskets:
(A) Holding with the power to vote
5% or more of the exchange-traded
fund’s shares; or
(B) Holding with the power to vote
5% or more of any investment company
that is an affiliated person of the
exchange-traded fund.
(4) Postponement of redemptions. If
an exchange-traded fund includes a
foreign investment in its basket, and if
a local market holiday, or series of
consecutive holidays, or the extended
delivery cycles for transferring foreign
investments to redeeming authorized
participants prevents timely delivery of
the foreign investment in response to a
redemption request, the exchangetraded fund is exempt, with respect to
the delivery of the foreign investment,
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from the prohibition in section 22(e) of
the Act (15 U.S.C. 80a–22(e)) against
postponing the date of satisfaction upon
redemption for more than seven days
after the tender of a redeemable security
if the exchange-traded fund delivers the
foreign investment as soon as
practicable, but in no event later than 15
days after the tender of the exchangetraded fund shares. The exemption
provided in paragraph (b)(4) of this
section will expire and no longer be
effective on [date ten years from
effective date of rule].
(c) Conditions. (1) Each business day,
an exchange-traded fund must disclose
prominently on its website, which is
publicly available and free of charge:
(i) Before the opening of regular
trading on the primary listing exchange
of the exchange-traded fund shares and
before the exchange-traded fund starts
accepting orders for the purchase or
redemption of creation units:
(A) The portfolio holdings that will
form the basis of the next calculation of
current net asset value per share;
(B) A basket applicable to orders for
the purchase or redemption of creation
units to be priced based on the next
calculation of current net asset value;
and
(C) The estimated cash balancing
amount, if any;
(ii) The exchange-traded fund’s
current net asset value per share, market
price, and premium or discount, each as
of the prior business day;
(iii) A table showing the number of
days the exchange-traded fund’s shares
traded at a premium or discount during
the most recently completed calendar
year and the most recently completed
calendar quarters since that year (or the
life of the exchange-traded fund, if
shorter);
(iv) A line graph showing exchangetraded fund share premiums or
discounts for the most recently
completed calendar year and the most
recently completed calendar quarters
since that year (or the life of the
exchange-traded fund, if shorter); and
(v) If the exchange-traded fund’s
premium or discount is greater than 2%
for more than seven consecutive trading
days, a discussion of the factors that are
reasonably believed to have materially
contributed to the premium or discount,
which must be maintained on the
website for at least one year thereafter;
and
(vi) The exchange-traded fund must
present the description, amount, value
and unrealized gain/loss in the manner
prescribed within 17 CFR 210.12–12,
210.12–12A, 210.12–13, 210.12–13A,
210.12–13B, 210.12–13C, and 210.12–
13D (Article 12 of Regulation S–X) for
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37405
each portfolio holding or basket asset
required to be disclosed pursuant to
paragraphs (c)(1)(i) of this section.
(2) An exchange-traded fund must
reflect changes in the exchange-traded
fund’s portfolio holdings in the first
calculation of net asset value per share
on the first business day following the
trade date.
(3) An exchange-traded fund must
adopt and implement written policies
and procedures that govern the
construction of baskets and the process
that will be used for the acceptance of
baskets; provided, however, if the
exchange-traded fund utilizes a custom
basket:
(i) These written policies and
procedures also must:
(A) Set forth detailed parameters for
the construction and acceptance of
custom baskets that are in the best
interests of the exchange-traded fund
and its shareholders, including the
process for any revisions to, or
deviations from, those parameters; and
(B) Specify the titles or roles of the
employees of the exchange-traded
fund’s investment adviser who are
required to review each custom basket
for compliance with those parameters.
(4) The exchange-traded fund may not
seek, directly or indirectly, to provide
returns that exceed the performance of
a market index by a specified multiple,
or to provide returns that have an
inverse relationship to the performance
of a market index, over a fixed period
of time.
(5) Notwithstanding the definition of
exchange-traded fund in paragraph (a)
of this section, an exchange-traded fund
is not prohibited from selling (or
redeeming) individual shares on the day
of consummation of a reorganization,
merger, conversion or liquidation.
(d) Recordkeeping. The exchangetraded fund must maintain and preserve
for a period of not less than five years,
the first two years in an easily accessible
place:
(1) All written agreements (or copies
thereof) between an authorized
participant and the exchange-traded
fund or one of its service providers that
allows the authorized participant to
place orders for the purchase or
redemption of creation units;
(2) For each basket exchanged with an
authorized participant, records setting
forth:
(i) The names and quantities of the
positions composing the basket
exchanged for creation units;
(ii) If applicable, identification of the
basket as a custom basket and a record
stating that the custom basket complies
with policies and procedures that the
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exchange-traded fund adopted pursuant
to paragraph (c)(3)(i) of this section;
(iii) Cash balancing amount, if any;
and
(iv) Identity of authorized participant
transacting with the exchange-traded
fund.
PART 274—FORMS PRESCRIBED
UNDER THE INVESTMENT COMPANY
ACT OF 1940
4. The general authority citation for
part 274 continues to read, in part, as
follows:
■
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Authority: 15 U.S.C. 77f, 77g, 77h, 77j,
77s, 78c(b), 78l, 78m, 78n, 78o(d), 80a–8,
80a–24, 80a–26, 80a–29, and Pub. L. 111–
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203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
*
*
*
*
*
5. Form N–1A (referenced in
§§ 239.15A and 274.11A) is amended as
follows:
■ a. In General Instruction A revise the
definition of ‘‘Exchange-Traded Fund.’’
■ b. In General Instruction A, remove
the definition of ‘‘Market Price.’’
The additions and revisions read as
follows:
Note: The text of Form N–1A does
not, and this amendment will not,
appear in the Code of Federal
Regulations.
■
Form N–1A
*
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GENERAL INSTRUCTIONS
*
*
*
*
*
A. Definitions
*
*
*
*
*
‘‘Exchange-Traded Fund’’ means a
Fund or Class, the shares of which are
listed and traded on a national
securities exchange, and that has formed
and operates under an exemptive order
granted by the Commission or in
reliance on rule 6c–11 [17 CFR 270.6c–
11] under the Investment Company Act.
*
*
*
*
*
■ 6. Amend Item 3 of Form N–1A to
read as follows:
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37407
Item 3. Risk/Return Summary: Fee Table
Include the following information, in plain English under rule 42l(d) under the Securities Act,
after Item 2:
Fees and Expenses of the Fund
This table describes the fees and expenses that you may pay if you buy, hold and sell
shares of the Fund. You may pay other fees not described below, such as brokerage commissions
and other fees to financial intermediaries, which are not reflected in the tables and examples
below. You may qualify for sales charge discounts if you and your family invest, or agree to
invest in the future, at least $[
] in [name of fund family] funds. More information about
these and other discounts is available from your financial intermediary and in [identify section
heading and page number] of the Fund's prospectus and [identify section heading and page
number] of the Fund's statement of additional information.
Shareholder Fees (fees paid directly from your investment)
Maximum Sales Charge (Load) Imposed on Purchases
(as a percentage of offering price)
Maximum Deferred Sales Charge (Load)
(as a percentage
)
Maximum Sales Charge (Load) Imposed on Reinvested Dividends
- - -%
- - -%
- - -%
[and other Distributions] (as a percentage of_ _ _ _ _ )
Redemption Fee (as a percentage of amount redeemed, if applicable)
Exchange Fee
Maximum Account Fee
- - -%
- - -%
_ _%
Annual Fund Operating Expenses (expenses that you pay each year as a percentage of
the value of your investment)
Management Fees
Distribution [and/or Service] (12b-l) Fees
Other Expenses
- - -%
- - -%
- - -%
- - -%
- - -%
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Total Annual Fund Operating Expenses
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Example
This Example is intended to help you compare the cost of investing in the Fund with the
cost of investing in other mutual funds.
The Example assumes that you invest $10,000 in the Fund for the time periods indicated
and then redeem all ofyour shares at the end of those periods. The Example also assumes that
your investment has a 5% return each year and that the Fund's operating expenses remain the
same.
1 year
You would pay the following expenses if
you did not redeem your shares:
5 years
10 years
$
$
$
$
$
Although your actual costs may be higher
or lower, oased on these assumptions your
costs would be:
3 years
$
$
$
The Example above does not reflect sales charges (loads) on reinvested dividends [and
other distributions]. If these sales charges (loads) were included, your costs would be higher.
Exchange-Traded Fund Trading Information and Related Costs
What information do I need to know about how the Exchange- Traded Fund ("ETF'J
trades?
Individual shares of an ETF may only be bought and sold in the secondary market
through a broker or dealer at a market price. The market price can change throughout the day due
to the supply of and demand for ETF shares, and changes in the value of the Fund's underlying
investments, among other reasons. Because ETF shares trade at market prices rather than net
asset value, shares may trade at a price greater than net asset value (premium) or less than net
asset value (discount).
What costs are associated with trading shares of an ETF?
What is the bid-ask spread?
The bid-ask spread is the difference between the highest price a buyer is willing to pay to
purchase shares of the Fund (bid) and the lowest price a seller is willing to accept for shares of
the Fund (ask). The bid-ask spread can change throughout the day due to the supply of or
demand for ETF shares, the quantity of shares traded, and the time of day the trade is executed,
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An investor may incur costs when buying or selling shares on an exchange that are in
addition to the costs described above. Examples include brokerage commissions, costs
attributable to the bid-ask spread, and costs attributable to premiums and discounts.
BILLING CODE 8011–01–C
*
*
*
*
■ 7. Amend Instruction 1 of Item 3 of
Form N–1A as follows:
*
*
*
*
*
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*
Instructions
1. General
(a) Round all dollar figures to the
nearest dollar and all percentages to the
nearest hundredth of 1%.
(b) Include the narrative explanations
in the order indicated. A Fund may
modify the narrative explanations if the
explanation contains comparable
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information to that shown. The
narrative explanation regarding sales
charge discounts is only required by a
Fund that offers such discounts and
should specify the minimum level of
investment required to qualify for a
discount as disclosed in the table
required by Item 12(a)(1).
(c) Include the caption ‘‘Maximum
Account Fees’’ only if the Fund charges
these fees. A Fund may omit other
captions if the Fund does not charge the
fees or expenses covered by the
captions.
(d)
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37409
(i) If the Fund is a Feeder Fund,
reflect the aggregate expenses of the
Feeder Fund and the Master Fund in a
single fee table using the captions
provided. In a footnote to the fee table,
state that the table and Example reflect
the expenses of both the Feeder and
Master Funds.
(ii) If the prospectus offers more than
one Class of a Multiple Class Fund or
more than one Feeder Fund that invests
in the same Master Fund, provide a
separate response for each Class or
Feeder Fund.
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(e) If the Fund is an Exchange-Traded
Fund, exclude any fees charged for the
purchase and redemption of the Fund’s
creation units.
*
*
*
*
*
■ 8. Amend Instruction 5 of Item 3 of
Form N–1A to read as follows:
*
*
*
*
*
5. Exchange-Traded Fund Trading
Information and Related Costs.
(a) Include the median bid-ask spread
for the Fund’s most recent fiscal year
only if the Fund is an Exchange-Traded
Fund. However, do not include the
median bid-ask spread for any
Exchange-Traded Fund that had its
initial listing on a national securities
exchange after the beginning of the most
recently completed fiscal year. For an
Exchange-Traded Fund that had an
initial listing after the beginning of the
most recently completed fiscal year,
explain that the Exchange-Traded Fund
did not have a sufficient trading history
to report trading information and related
costs. Information should be based on
the most recently completed fiscal year
end. The Fund also must provide
information on the Fund’s website,
which is publicly accessible, free of
charge, that investors can use to obtain
the bid/ask spread information required
in this Item.
(b) Bid-Ask Spread (Median).
Calculate the median bid-ask spread by
dividing the difference between the ask
and the bid by the midpoint of the ask
and the bid for each ten-second interval
throughout each trading day of the
Exchange-Traded Fund’s most recent
fiscal year. Once the bid-ask spread for
each ten-second interval throughout the
fiscal year is determined, sort the
spreads from lowest to highest. If there
is an odd number of spread intervals,
then the median is the middle number.
If there is an even number of spread
intervals, then the median is the average
between the two middle numbers.
Express the spread as a percentage,
rounded to the nearest hundredth
percent.
(c) Determine the mid-range spread
cost for each number of transactions in
the table according to the following
formula:
(SMid/2) * $10,000 * T
Where:
SMid = Median spread as calculated in
Instruction 5(b) during most recently
completed calendar year, expressed as a
percentage;
T = Number of Transactions (1 and 25).
(d) Determine the high-end spread
cost for each number of transactions in
the table according to the following
formula:
(SHigh/2) * $10,000 * T
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Where:
SHigh = High-end spread is calculated by
dividing the difference between the ask
and the bid by the midpoint of the ask
and the bid for each ten-second interval
throughout each trading day of the
Exchange-Traded Fund’s most recently
completed fiscal year. Once the bid-ask
spread for each ten-second interval
throughout the fiscal year is determined,
sort the spreads from lowest to highest.
The high end spread is the number
closest to the 95th percentile, expressed
as a percentage. If two numbers are
equally close to the 95th percentile, use
the average of the two numbers;
T = Number of Transactions (1 and 25).
(e) Provide an interactive calculator in
a clear and prominent format on the
Fund website which uses the
calculations in Instructions 5(a)–(d) to
Item 3 to provide the information
required by Q&As 3, 4 and 5.
*
*
*
*
*
■ 9. Amend Item 6 of Form N–1A as
follows:
*
*
*
*
*
Item 6. Purchase and Sale of Fund
Shares
(a) Purchase of Fund Shares. Disclose
the Fund’s minimum initial or
subsequent investment requirements.
(b) Sale of Fund Shares. Also disclose
that the Fund’s shares are redeemable
and briefly identify the procedures for
redeeming shares (e.g., on any business
day by written request, telephone, or
wire transfer).
(c) Exchange-Traded Funds. If the
Fund is an Exchange-Traded Fund, the
Fund may omit the information required
by this Item.
*
*
*
*
*
■ 10. Amend Items 11(a)(1) and 11(g) of
Form N–1A as follows:
*
*
*
*
*
Item 11. Shareholder Information
(a) Pricing of Fund Shares. Describe
the procedures for pricing the Fund’s
shares, including:
(1) An explanation that the price of
Fund shares is based on the Fund’s net
asset value and the method used to
value Fund shares (market price, fair
value, or amortized cost); except that if
the Fund is an Exchange-Traded Fund,
an explanation that the price of Fund
shares is based on a market price.
*
*
*
*
*
(g) Exchange-Traded Funds. If the
Fund is an Exchange-Traded Fund, the
Fund may omit from the prospectus the
information required by Items 11(a)(2),
(b), and (c).
*
*
*
*
*
■ 11. Remove Item 27(b)(7)(iv) of Form
N–1A and instructions thereto.
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12. Amend Instruction 1(e)(ii) of Item
27(d)(1) of Form N–1A as follows:
*
*
*
*
*
■
Instructions
*
*
*
*
*
1. General.
*
*
*
*
*
(e) If the fund is an Exchange-Traded
Fund:
*
*
*
*
*
(ii) Exclude any fees charged for the
purchase and redemption of the Fund’s
creation units.
*
*
*
*
*
■ 13. Amend Form N–8B–2 (referenced
in §§ 239.16 and 274.12) as follows:
The additions and revisions read as
follows:
Note: The text of Form N–8B–2 does
not, and this amendment will not,
appear in the Code of Federal
Regulations.
Form N–8B–2
*
*
*
*
*
GENERAL INSTRUCTIONS FOR FORM
N–8B–2
*
*
*
*
*
Definitions
*
*
*
*
*
Exchange-Traded Fund (ETF): The
term ‘‘Exchange-Traded Fund’’ or
‘‘ETF’’ means a trust, the shares of
which are listed and traded on a
national securities exchange, and that
has formed and operates under an
exemptive order granted by the
Commission.
*
*
*
*
*
Information Concerning Loads, Fees,
Charges, and Expenses
13.
*
*
*
*
*
(h) If the trust is an Exchange-Traded
Fund, furnish an explanation indicating
that an ETF investor may pay additional
fees not described by any other item in
this form, such as brokerage
commissions and other fees to financial
intermediaries.
(i) If the trust is an Exchange-Traded
Fund, furnish the disclosures and
information set forth in Item 3 of Form
N–1A [referenced in 17 CFR 274.11A],
in the section of that Item titled
‘‘Exchange-Traded Fund Trading
Information and Related Costs.’’ Provide
information specific to the trust as
necessary, utilizing the ETF-specific
methodology set forth in the
Instructions to Form N–1A Item 3.
*
*
*
*
*
■ 14. Amend Items C.7. and E.2. Form
N–CEN (referenced in § 274.101):
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The additions read as follows:
Note: The text of Form N–CEN does
not, and this amendment will not,
appear in the Code of Federal
Regulations.
Item C.7.
FORM N–CEN
Part E. Additional Questions for
Exchange-Traded Funds and ExchangeTraded Managed Funds
ANNUAL REPORT FOR REGISTERED
INVESTMENT COMPANIES
*
*
*
*
*
Part C. Additional Questions for
Management Investment Companies
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*
*
*
VerDate Sep<11>2014
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*
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*
*
*
*
*
k. Rule 6(c)–11 (17 CFR 270.6c–11):
lll
*
*
*
*
*
*
*
*
*
*
Item E.2.
*
*
*
*
*
Instruction. The term ‘‘authorized
participant’’ means a member or
participant of a clearing agency
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37411
registered with the Commission, which
has a written agreement with the
Exchange-Traded Fund or ExchangeTraded Managed Fund or one of its
service providers that allows the
authorized participant to place orders
for the purchase and redemption of
creation units.
*
*
*
*
*
By the Commission.
Dated: June 28, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018–14370 Filed 7–30–18; 8:45 am]
BILLING CODE 8011–01–P
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]]>Agencies
[Federal Register Volume 83, Number 147 (Tuesday, July 31, 2018)]
[Proposed Rules]
[Pages 37332-37411]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-14370]
[[Page 37331]]
Vol. 83
Tuesday,
No. 147
July 31, 2018
Part IV
Securities and Exchange Commission
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17 CFR Parts 239, 270 and 274
Exchange-Traded Funds; Proposed Rule
Federal Register / Vol. 83 , No. 147 / Tuesday, July 31, 2018 /
Proposed Rules
[[Page 37332]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 239, 270, and 274
[Release Nos. 33-10515; IC-33140; File No. S7-15-18]
RIN 3235-AJ60
Exchange-Traded Funds
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing a new rule under the Investment Company Act of 1940 (the
``Investment Company Act'' or the ``Act'') that would permit exchange-
traded funds (``ETFs'') that satisfy certain conditions to operate
without the expense and delay of obtaining an exemptive order. In
connection with the proposed exemptive rule, the Commission proposes to
rescind certain exemptive orders that have been granted to ETFs and
their sponsors. The Commission also is proposing certain disclosure
amendments to Form N-1A and Form N-8B-2 to provide investors who
purchase and sell ETF shares on the secondary market with additional
information regarding ETF trading costs, regardless of whether such
ETFs are structured as registered open-end management investment
companies (``open-end funds'') or unit investment trusts (``UITs'').
Finally, the Commission is proposing related amendments to Form N-CEN.
The proposed rule and form amendments are designed to create a
consistent, transparent, and efficient regulatory framework for ETFs
and to facilitate greater competition and innovation among ETFs.
DATES: Comments should be received on or before October 1, 2018.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-15-18 on the subject line.
Paper Comments
Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-15-18. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
internet website (https://www.sec.gov/rules/proposed.shtml). Comments
are also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street NE, Washington, DC 20549, on
official business days between the hours of 10:00 a.m. and 3:00 p.m.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Zeena Abdul-Rahman (Senior Counsel),
Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), Jacob D.
Krawitz (Branch Chief), Melissa S. Gainor (Senior Special Counsel), and
Brian McLaughlin Johnson (Assistant Director), Investment Company
Regulation Office, at (202) 551-6792, Sumeera Younis (Branch Chief) and
Christian Sandoe (Assistant Director), Disclosure Review and Accounting
Office, at (202) 551-6921, Division of Investment Management,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment 17 CFR 270.6c-11 (new rule 6c-11) under the Investment Company
Act [15 U.S.C. 80a-1 et seq.]; amendments to Form N-1A [referenced in
17 CFR 274.11A] under the Investment Company Act and the Securities Act
of 1933 [15 U.S.C. 77a et seq.] (``Securities Act''); and amendments to
Forms N-8B-2 [referenced in 17 CFR 274.12] and N-CEN [referenced in 17
CFR 274.101] under the Investment Company Act.\1\
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\1\ Unless otherwise noted, all references to statutory sections
are to the Investment Company Act, and all references to rules under
the Investment Company Act are to title 17, part 270 of the Code of
Federal Regulations [17 CFR part 270].
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Table of Contents
I. Introduction
A. Overview of Exchange-Traded Funds
B. Operation of Exchange-Traded Funds
II. Discussion
A. Scope of Proposed Rule 6c-11
1. Organization as Open-End Funds
2. Index-Based ETFs and Actively Managed ETFs
3. Leveraged ETFs
B. Exemptive Relief Under Proposed Rule 6c-11
1. Treatment of ETF Shares as ``Redeemable Securities''
2. Trading of ETF Shares at Market-Determined Prices
3. Affiliated Transactions
4. Additional Time for Delivering Redemption Proceeds
C. Conditions for Reliance on Proposed Rule 6c-11
1. Issuance and Redemption of Shares
2. Listing on a National Securities Exchange
3. Intraday Indicative Value
4. Portfolio Holdings
5. Baskets
6. Website Disclosure
7. Marketing
D. Recordkeeping
E. Share Class ETFs
F. Master-Feeder ETFs
G. Effect of Proposed Rule 6c-11 on Prior Orders
H. Amendments to Form N-1A
1. Definitions
2. Item 3 of Form N-1A
3. Item 6 of Form N-1A
4. Item 11 of Form N-1A
5. Potential Alternatives to Current ETF Registration Forms
I. Amendments to Form N-8B-2
J. Amendments to Form N-CEN
III. Economic Analysis
A. Introduction
B. Economic Baseline
1. ETF Industry Growth and Trends
2. Exemptive Order Process
3. Market Participants
4. Secondary Market Trading, Arbitrage, and ETF Liquidity
C. Benefits and Costs of Proposed Rule 6c-11 and Amendments to
Forms N-1A and N-8B-2
1. Proposed Rule 6c-11
2. Disclosure (Amendments to Forms N-1A and N-8B-2)
D. Effects on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Reasonable Alternatives
1. Treatment of Existing Exemptive Relief
2. ETFs Organized as UITs
3. Basket Flexibility
4. Website Disclosure of Every Basket Used by an ETF
5. The Use of a Structured Format for Additional Website
Disclosures and the Filing of Additional Website Disclosures in a
Structured Format on EDGAR
6. Treatment of Leveraged ETFs
F. Request for Comments
IV. Paperwork Reduction Act
A. Introduction
[[Page 37333]]
B. Proposed Rule 6c-11
1. Website Disclosures
2. Recordkeeping
3. Policies and Procedures
4. Estimated Total Burden
C. Rule 0-2
D. Form N-1A
E. Disclosure Amendments to Forms N-8B-2 and S-6
F. Form N-CEN
G. Request for Comments
V. Initial Regulatory Flexibility Analysis
A. Reasons for and Objectives of the Proposed Actions
B. Legal Basis
C. Small Entities Subject to the Rule
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Rule 6c-11
2. Disclosure and Reporting Requirements
E. Duplicative, Overlapping or Conflicting Federal Rules
F. Significant Alternatives
G. General Request for Comment
VI. Consideration of Impact on the Economy
VII. Statutory Authority
I. Introduction
The Commission is proposing rule 6c-11 under the Investment Company
Act to permit ETFs that satisfy certain conditions to operate without
the expense and delay of obtaining an exemptive order from the
Commission under the Act. This rule would modernize the regulatory
framework for ETFs to reflect our 26 years of experience with these
investment products. It is designed to create a consistent,
transparent, and efficient regulatory framework for ETFs and to
facilitate greater competition and innovation among ETFs.
The Commission approved the first ETF in 1992. Since then, ETFs
registered with us have grown to $3.4 trillion in total net assets.\2\
They now account for approximately 15% of total net assets managed by
investment companies,\3\ and are projected to continue to grow.\4\ ETFs
currently rely on exemptive orders, which permit them to operate as
investment companies under the Act, subject to representations and
conditions that have evolved over time.\5\ We have granted over 300 of
these orders over the last quarter century, resulting in differences in
representations and conditions that have led to some variations in the
regulatory structure for existing ETFs.\6\
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\2\ This figure is based on data obtained from Bloomberg. As of
December 2017, there were 1,900 ETFs registered with the Commission.
See id.
\3\ ICI, 2018 Investment Company Fact Book (58th ed., 2018)
(``2018 ICI Fact Book''), available at https://www.ici.org/pdf/2018_factbook.pdf, at 96. When the Commission first proposed a rule
for ETFs in 2008, aggregate ETF assets were less than 7% of total
net assets held by mutual funds. See Exchange-Traded Funds,
Investment Company Act Release No. 28193 (Mar. 11, 2008) [73 FR
14618 (Mar. 18, 2008)] (``2008 ETF Proposing Release'').
\4\ See Greg Tusar, The evolution of the ETF industry, Pension &
Investments (Jan. 31, 2017), available at https://www.pionline.com/article/20170131/ONLINE/170139973/the-evolution-of-the-etf-industry
(describing projections that ETF assets could double to $6 trillion
by 2020).
\5\ As the orders are subject to the terms and conditions set
forth in the applications requesting exemptive relief, references in
this release to ``exemptive relief'' or ``exemptive orders'' include
the terms and conditions described in the related application. See,
e.g., infra footnote 6.
\6\ Since 2000, our ETF exemptive orders have provided relief
for future ETFs. See, e.g., Barclays Global Fund Advisors,
Investment Company Act Release Nos. 24394 (Apr. 17, 2000) [65 FR
21215 (Apr. 20, 2000)] (notice) and 24451 (May 12, 2000) (order) and
related application (``Barclays Global 2000''). This relief has
allowed ETF sponsors to form ETFs without filing new applications to
the extent that the new ETFs meet the terms and conditions set forth
in the exemptive order. Applications granted before 2000, unless
subsequently amended, did not include this relief.
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Proposed rule 6c-11 would simplify this regulatory framework by
eliminating conditions included within our exemptive orders that we no
longer believe are necessary for our exemptive relief and removing
historical distinctions between actively managed and index-based ETFs.
In connection with the proposed rule, we also propose to rescind
certain exemptive orders that have been granted to ETFs and their
sponsors. As a result, proposed rule 6c-11 would level the playing
field for ETFs that are organized as open-end funds and pursue the same
or similar investment strategies.\7\ The proposed rule also would
assist the Commission with regulating ETFs, as funds covered by the
rule would no longer be subject to the varying provisions of exemptive
orders granted over time, and instead would be subject to a consistent
regulatory framework. Furthermore, creating an efficient regulatory
framework for ETFs would allow Commission staff and industry resources
to focus the exemptive order process on products that do not fall
within the scope of our proposed rule.
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\7\ As discussed below, the scope of proposed rule 6c-11 does
not include ETFs that: (i) Are organized as UITs; (ii) seek to
exceed the performance of a market index by a specified multiple or
to provide returns that have an inverse relationship to the
performance of a market index, over a fixed period of time
(``leveraged ETFs''); or (iii) are structured as a share class of a
fund that issues multiple classes of shares representing interests
in the same portfolio (``share class ETFs''). These ETFs would
continue to operate pursuant to the terms of their exemptive orders.
See infra sections II.A.1 (UIT ETFs), II.A.3 (leveraged ETFs), and
II.E (share class ETFs).
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In addition, we are proposing certain disclosure amendments to
provide additional information to investors who purchase and sell ETF
shares in the secondary markets, and to provide investors who purchase
UITs with the same disclosures that we propose to require of ETFs
organized as open-end funds. The proposed amendments would include new
disclosures regarding certain unique costs associated specifically with
ETFs, such as the bid-ask spread and premiums and discounts from the
ETF's net asset value (``NAV'').
Our proposal takes into account the comments we received in
response to our 2008 ETF proposal, which was designed to codify the
exemptive relief that had been issued to ETFs at that time.\8\
Developments in the ETF industry since the 2008 proposal and interim
Commission actions also have informed the parameters of proposed rule
6c-11 and the related disclosure amendments that we are proposing.\9\
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\8\ See 2008 ETF Proposing Release, supra footnote 3. Comment
letters on the 2008 ETF Proposing Release are available at https://www.sec.gov/comments/s7-07-08/s70708.shtml.
\9\ See, e.g., Request for Comment on Exchange-Traded Products,
Exchange Act Release No. 75165 (June 12, 2015) [80 FR 34729 (June
17, 2015)] (``2015 ETP Request for Comment''), at section I.A;
Report of the Staffs of the CFTC and SEC to the Joint Advisory
Committee on Emerging Regulatory Issues, Findings Regarding the
Market Events of May 6, 2010 (Sept. 30, 2010) (``Final May 6
Report''), available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf. Comment letters on the 2015 ETP Request for
Comment are available at https://www.sec.gov/comments/s7-11-15/s71115.shtml.
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A. Overview of Exchange-Traded Funds
ETFs are a type of exchange-traded product (``ETP'').\10\ ETFs
possess characteristics of both mutual funds, which issue redeemable
securities, and closed-end funds, which generally issue shares that
trade at market-determined prices on a national securities exchange and
are not redeemable.\11\ Because ETFs
[[Page 37334]]
have characteristics that distinguish them from the types of investment
companies contemplated by the Act, they require exemptions from certain
provisions of the Investment Company Act in order to operate. The
Commission (and Commission staff under delegated authority) now
routinely grants exemptive orders permitting ETFs to operate as
investment companies under the Investment Company Act, generally
subject to the provisions of the Act applicable to open-end funds (or
UITs).\12\ These exemptive orders reflect our determination that, based
on the factual representations offered by the applicants and the
conditions to which the applicants have agreed, the requested relief is
necessary or appropriate in the public interest and consistent with the
protection of investors and the purposes fairly intended by the policy
and provisions of the Investment Company Act.\13\ The Commission also
has approved the standards of national securities exchanges, under
which ETF shares are listed and traded.\14\
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\10\ ETFs are investment companies registered under the
Investment Company Act. See 15 U.S.C. 80a-3(a)(1). Other types of
ETPs are pooled investment vehicles with shares that trade on a
securities exchange, but they are not ``investment companies'' under
the Act because they do not invest primarily in securities. Such
ETPs may invest primarily in assets other than securities, such as
futures, currencies, or physical commodities (e.g., precious
metals). Still other ETPs are not pooled investment vehicles. For
example, exchange-traded notes are senior, unsecured, unsubordinated
debt securities that are linked to the performance of a market index
and trade on securities exchanges.
\11\ The Act defines ``redeemable security'' as any security
that allows the holder to receive his or her proportionate share of
the issuer's current net assets upon presentation to the issuer. 15
U.S.C. 80a-2(a)(32). While closed-end fund shares are not
redeemable, certain closed-end funds may elect to repurchase their
shares at periodic intervals pursuant to 17 CFR 270.23c-3 (rule 23c-
3) under the Act (``interval funds''). Based on staff analysis,
there were 39 interval funds, representing approximately $21 billion
in assets, in 2017. Other closed-end funds may repurchase their
shares in tender offers pursuant to 17 CFR 240.13e-4 (rule 13e-4)
under the Securities Exchange Act of 1934 (the ``Exchange Act'').
\12\ Historically, ETFs have been organized as open-end funds or
UITs. See 15 U.S.C. 80a-5(a)(1) (defining the term ``open-end
company'') and 15 U.S.C. 80a-4(2) (defining the term ``unit
investment trust''). Some fund groups have multiple orders covering
different types of ETFs (e.g., one order covering ETFs organized as
UITs and another covering ETFs organized as open-end funds or one
order covering index-based ETFs and another covering actively
managed ETFs).
\13\ See 15 U.S.C. 80a-6(c).
\14\ Additionally, ETFs regularly request relief from 17 CFR
242.101 and 242.102 (rules 101 and 102 of Regulation M); section
11(d)(1) of the Exchange Act and 17 CFR 240.11d1-2 (``rule 11d1-2''
under the Exchange Act); certain other rules under the Exchange Act
(i.e., 17 CFR 240.10b-10, 240.10b-17, 240.14e-5, 240.15c1-5, and
240.15c1-6 (rules 10b-10, 10b-17, 14e-5, 15c1-5, and 15c1-6)); and
17 CFR 242.200(g) (rule 200(g) of Regulation SHO). See 2015 ETP
Request for Comment, supra footnote 9, at section I.D.2 (discussing
the exemptive and no-action relief granted to ETPs under the
Exchange Act and the listing process for ETP securities for trading
on a national securities exchange).
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As discussed above, ETFs have become an increasingly popular
investment vehicle over the last 26 years. They also have become a
popular trading tool, making up a significant portion of secondary
market equities trading. During the first quarter of 2018, for example,
trading in U.S.-listed ETFs made up approximately 18.75% of U.S. equity
trading by share volume and 28.2% of U.S. equity trading by dollar
volume.\15\
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\15\ These estimates are based on trade and quote data from the
New York Stock Exchange and Trade Reporting Facility data from
FINRA.
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Investors can buy and hold shares of ETFs (sometimes as a core
component of a portfolio) or trade them frequently as part of an active
trading or hedging strategy.\16\ ETF investors can sell ETF shares
short, write options on them, and set market, limit, and stop-loss
orders on them. Moreover, because certain costs are either absent in
the ETF structure or are otherwise partially externalized, many ETFs
have lower operating expenses than mutual funds.\17\ ETFs also may
offer certain tax efficiencies compared to other pooled investment
vehicles because redemptions from ETFs are often made in kind (that is,
by delivering certain assets from the ETF's portfolio, rather than in
cash), thereby avoiding the need for the ETF to sell assets and
potentially realize capital gains that are distributed to its
shareholders.
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\16\ See, e.g., Chris Dieterich, Are You An ETF `Trader' Or An
ETF `Investor'?, Barrons (Aug. 8, 2017), available at https://www.barrons.com/articles/are-you-an-etf-trader-or-an-etf-investor-1470673638; Greenwich Associates, Institutions Find New,
Increasingly Strategic Uses for ETFs (May 2012) (``More than one-in-
five asset managers that use [ETFs] report employing ETFs for active
exposures in domestic equities and commodities, and about 17% note
using them for active exposures in international equities.''); Joe
Renninson, Institutional Investors Boost Ownership of ETFs,
Financial Times (Apr. 13, 2017), available at https://www.ft.com/content/c70113ac-ab83-33ac-a624-d2d874533fb0?mhq5j=e7.
\17\ For instance, ETFs typically do not bear distribution or
shareholder servicing fees. In addition, ETFs that transact on an
in-kind basis can execute changes in the ETF's portfolio without
incurring brokerage costs, leading to transaction cost savings.
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ETFs today provide investors with a diverse set of investment
options. While the first ETFs held portfolios of securities that
replicated the component securities of broad-based domestic stock
market indexes, some ETFs now track more specialized indexes, including
international equity indexes, fixed-income indexes, or indexes focused
on particular industry sectors such as telecommunications or
healthcare.\18\ Some ETFs seek to track highly customized or bespoke
indexes, while others seek to provide a level of leveraged or inverse
exposure to an index over a fixed period of time.\19\ Investors also
have the ability to invest in ETFs that do not track a particular index
and are actively managed.\20\
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\18\ The Commission historically has referred to ETFs that have
stated investment objectives of maintaining returns that correspond
to the returns of a securities index as ``index-based'' ETFs. See,
e.g., Parker Global Strategies, LLC, et al., Investment Company Act
Release Nos. 32528 (Mar. 10, 2017) [82 FR 14043 (Mar. 16, 2017)]
(notice) and 32595 (Apr. 5, 2017) (order) and related application
(``Parker Global Strategies'').
\19\ Inverse ETFs are often marketed as a way for investors to
profit from, or at least hedge their exposure to, downward moving
markets. See infra section II.A.3.
\20\ An actively managed ETF's investment adviser, like an
adviser to any actively managed mutual fund, generally selects
securities consistent with the ETF's investment objectives and
policies without trying to track the performance of a corresponding
index. Actively managed ETFs represent approximately 1.3% of total
ETF assets as of September 2017. Based on data obtained from the
Market Information Data Analytics System (``MIDAS''), Bloomberg, and
Morningstar Direct.
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B. Operation of Exchange-Traded Funds
An ETF issues shares that can be bought or sold throughout the day
in the secondary market at a market-determined price. Like other
investment companies, an ETF pools the assets of multiple investors and
invests those assets according to its investment objective and
principal investment strategies. Each share of an ETF represents an
undivided interest in the underlying assets of the ETF. Similar to
mutual funds, ETFs continuously offer their shares for sale.
Unlike mutual funds, however, ETFs do not sell or redeem individual
shares. Instead, ``authorized participants'' that have contractual
arrangements with the ETF (or its distributor) purchase and redeem ETF
shares directly from the ETF in blocks called ``creation units.'' \21\
An authorized participant may act as a principal for its own account
when purchasing or redeeming creation units from the ETF. Authorized
participants also may act as agent for others, such as market makers,
proprietary trading firms, hedge funds or other institutional
investors, and receive fees for processing creation units on their
behalf.\22\ Market makers, proprietary trading firms, and hedge funds
provide additional liquidity to the ETF market through their trading
activity. Institutional investors may engage in primary market
transactions with an ETF through an authorized participant as a way to
efficiently hedge a portion of their portfolio or balance sheet or to
[[Page 37335]]
gain exposure to a strategy or asset class.\23\
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\21\ Our exemptive orders typically contain a representation by
the applicant that an authorized participant will be either: (a) A
broker or other participant in the continuous net settlement system
of the National Securities Clearing Corporation, a clearing agency
registered with the Commission and affiliated with the Depository
Trust Company (``DTC''), or (b) a DTC participant, which has
executed a participant agreement with the ETF's distributor and
transfer agent with respect to the creation and redemption of
creation units. See, e.g., Emerging Global Advisors, LLC, et al.,
Investment Company Act Release Nos. 30382 (Feb. 13, 2013) [78 FR
11909 (Feb. 20, 2013)] (notice) and 30423 (Mar. 12, 2013) (order)
and related application. Proposed rule 6c-11(a) would define
``authorized participant'' as a member or participant of a clearing
agency registered with the Commission, which has a written agreement
with the ETF or one of its service providers that allows the
authorized participant to place orders for the purchase and
redemption of creation units.
\22\ See David J. Abner, The ETF Handbook: How to Value and
Trade Exchange Traded Funds, 2nd ed. (2016) (``ETF Handbook'').
\23\ Id.
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An authorized participant that purchases a creation unit of ETF
shares directly from the ETF deposits with the ETF a ``basket'' of
securities and other assets identified by the ETF that day, and then
receives the creation unit of ETF shares in return for those
assets.\24\ The basket is generally representative of the ETF's
portfolio \25\ and, together with a cash balancing amount, equal in
value to the aggregate NAV of the ETF shares in the creation unit.\26\
After purchasing a creation unit, the authorized participant may hold
the individual ETF shares, or sell some or all of them in secondary
market transactions.\27\ Investors then purchase individual ETF shares
in the secondary market. The redemption process is the reverse of the
purchase process: The authorized participant redeems a creation unit of
ETF shares for a basket of securities and other assets.
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\24\ An ETF may impose fees in connection with the purchase or
redemption of creation units that are intended to defray operational
processing and brokerage costs to prevent possible shareholder
dilution (``transaction fees'').
\25\ The basket might not reflect a pro rata slice of an ETF's
portfolio holdings. Subject to the terms of the applicable exemptive
relief, an ETF may substitute other securities or cash in the basket
for some (or all) of the ETF's portfolio holdings. Restrictions
related to flexibility in baskets have varied over time. See infra
section II.C.5.
\26\ An open-end fund is required by law to redeem its
securities on demand from shareholders at a price approximating
their proportionate share of the fund's NAV at the time of
redemption. See 15 U.S.C. 80a-22(d). Title 17 CFR 270.22c-1 (``rule
22c-1'') generally requires that funds calculate their NAV per share
at least once daily Monday through Friday. See rule 22c-1(b)(1).
Today, most funds calculate NAV per share as of the time the major
U.S. stock exchanges close (typically at 4:00 p.m. Eastern Time).
Under rule 22c-1, an investor who submits an order before the 4:00
p.m. pricing time receives that day's price, and an investor who
submits an order after the pricing time receives the next day's
price. See also 17 CFR 270.2a-4 (``rule 2a-4'') (defining ``current
net asset value'').
\27\ ETFs register offerings of shares under the Securities Act,
and list their shares for trading under the Exchange Act. Depending
on the facts and circumstances, authorized participants that
purchase a creation unit and sell the shares may be deemed to be
participants in a distribution, which could render them statutory
underwriters and subject them to the prospectus delivery and
liability provisions of the Securities Act. See 15 U.S.C. 77b(a)(11)
(defining the term ``underwriter'').
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The combination of the creation and redemption process with
secondary market trading in ETF shares provides arbitrage opportunities
that are designed to help keep the market price of ETF shares at or
close to the NAV per share of the ETF.\28\ For example, if ETF shares
are trading on national securities exchanges at a ``discount'' (a price
below the NAV per share of the ETF), an authorized participant can
purchase ETF shares in secondary market transactions and, after
accumulating enough shares to compose a creation unit, redeem them from
the ETF in exchange for the more valuable securities in the ETF's
redemption basket. The authorized participant's purchase of an ETF's
shares on the secondary market, combined with the sale of the ETF's
basket assets, may create upward pressure on the price of the ETF
shares, downward pressure on the price of the basket assets, or both,
bringing the market price of ETF shares and the value of the ETF's
portfolio holdings closer together.\29\ Alternatively, if ETF shares
are trading at a ``premium'' (a price above the NAV per share of the
ETF), the transactions in the arbitrage process are reversed and, when
arbitrage is working effectively, keep the market price of the ETF's
shares close to its NAV.
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\28\ To date, the arbitrage mechanism has been dependent on
daily portfolio transparency.
\29\ As part of this arbitrage process, authorized participants
are likely to hedge their intraday risk. For example, when ETF
shares are trading at a discount to an estimated intraday NAV per
share of the ETF, an authorized participant may short the securities
composing the ETF's redemption basket. After the authorized
participant returns a creation unit of ETF shares to the ETF in
exchange for the ETF's baskets, the authorized participant can then
use the basket assets to cover its short positions.
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Market participants also can engage in arbitrage activity without
using the creation or redemption processes. For example, if a market
participant believes that an ETF is overvalued relative to its
underlying or reference assets (i.e., trading at a premium), the market
participant may sell ETF shares short and buy the underlying or
reference assets, wait for the trading prices to move toward parity,
and then close out the positions in both the ETF shares and the
underlying or reference assets to realize a profit from the relative
movement of their trading prices. Similarly, a market participant could
buy ETF shares and sell the underlying or reference assets short in an
attempt to profit when an ETF's shares are trading at a discount to the
ETF's underlying or reference assets. As with the creation and
redemption process, the trading of an ETF's shares and the ETF's
underlying or reference assets may bring the prices of the ETF's shares
and its portfolio assets closer together through market pressure.\30\
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\30\ Some studies have found the majority of all ETF-related
trading activity takes place on the secondary market. See, e.g.,
Rochelle Antoniewicz & Jane Heinrichs, Understanding Exchange-Traded
Funds: How ETFs Work, ICI Research Perspective 20, No. 5 (Sept.
2014) (``Antoniewicz''), available at https://www.ici.org/pdf/per20-05.pdf, at 2 (``On most trading days, the vast majority of ETFs do
not have any primary market activity--that is, they do not create or
redeem shares.'').
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The arbitrage mechanism is important because it provides a means to
maintain a close tie between market price and NAV per share of the ETF,
thereby helping to ensure ETF investors are treated equitably when
buying and selling fund shares. In granting relief under section 6(c)
of the Act for ETFs to operate, the Commission has relied on this close
tie between what retail investors pay (or receive) in the secondary
market and the ETF's approximate NAV to find that the required
exemptions are necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Act. Investors also have
come to expect that an ETF's market price will maintain a close tie to
the ETF's NAV per share, which may lead some investors to view ETFs
more favorably than similar closed-end funds.\31\ On the other hand,
this expectation may lead investors to view ETFs as a less attractive
investment option or cause them to sell ETF shares if market price and
NAV per share diverge, particularly during periods of market
stress.\32\
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\31\ Scott W. Barnhart & Stuart Rosenstein, Exchange-Traded Fund
Introductions and Closed-End Fund Discounts and Volume, 45 The
Financial Review 4 (Nov. 2010) (within a year of the introduction of
a similar ETF, the average discount widens significantly and volume
falls significantly in U.S. domestic equity, international equity,
and U.S. bond closed-end funds, which may indicate that closed-end
funds lose some desirability when a substitute ETF becomes
available). As of December 31, 2017, total net assets of ETFs were
$3.4 trillion compared to $275 billion for closed-end funds. See
2018 ICI Fact Book, supra footnote 3.
\32\ See Staff of the Office of Analytics and Research, Division
of Trading and Markets, Research Note: Equity Market Volatility on
August 24, 2015 (Dec. 2015) (``August 24 Staff Report''), available
at https://www.sec.gov/marketstructure/research/equity_market_volatility.pdf (discussing spikes in ETF trading
volume on August 24, 2015 when U.S. equity markets experienced
unusual price volatility). See also infra section II.B.2 (discussing
intraday deviations between market price and NAV as well as
contemporaneous deviations between market price and the intraday
value of the ETF's portfolio).
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II. Discussion
Given the growth in the ETF market, ETFs' popularity among retail
and institutional investors, and our long experience regulating this
investment and trading vehicle, we believe that it is appropriate to
propose a rule that would allow most ETFs to operate without first
obtaining an exemptive order from the Commission under the Act. We
believe that such a rule would create a consistent, transparent and
efficient regulatory framework for the regulation of most ETFs and
level the playing field for these market participants. Proposed
[[Page 37336]]
rule 6c-11 includes several conditions designed to address the concerns
underlying the relevant statutory provisions and to support a
Commission finding that the exemptions necessary to allow ETFs to
operate are in the public interest and consistent with the protection
of investors and the purposes fairly intended by the policy and
provisions of the Act. The proposed conditions are based upon the
existing exemptive relief for ETFs, which we believe have served to
support an efficient arbitrage mechanism, but reflect several
modifications based on our experience regulating this product.
A. Scope of Proposed Rule 6c-11
Proposed rule 6c-11 would define an ETF as a registered open-end
management investment company that: (i) Issues (and redeems) creation
units to (and from) authorized participants in exchange for a basket
and a cash balancing amount (if any); and (ii) issues shares that are
listed on a national securities exchange and traded at market-
determined prices.\33\
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\33\ See proposed rule 6c-11(a) (defining ``exchange-traded
fund''). Under the proposed rule, the term ``basket'' would be
defined to mean the securities, assets, or other positions in
exchange for which an ETF issues (or in return for which it redeems)
creation units. The term ``exchange-traded fund'' thus would include
ETFs that transact on an in-kind basis, on a cash basis, or both.
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1. Organization as Open-End Funds
Proposed rule 6c-11 would be available only to ETFs that are
organized as open-end funds. The vast majority of ETFs currently in
operation are organized as open-end funds, although the earliest ETFs
were organized as UITs (``UIT ETFs'').\34\ These early UIT ETFs
represent a significant amount of assets within the ETF industry.\35\
For example, two of the largest ETFs by total net assets and estimated
dollar trading volume (SPDR S&P 500 ETF Trust (SPY) and PowerShares QQQ
Trust, Series 1 (QQQ)) are organized as UITs.
---------------------------------------------------------------------------
\34\ See, e.g., SPDR Trust, Series 1, Investment Company Act
Release Nos. 18959 (Sept. 17, 1992) [57 FR 43996 (Sept. 23, 1992)]
(notice) and 19055 (Oct. 26, 1992) (order) and related application
(``SPDR'').
\35\ As of Dec. 31, 2017, for example, the eight existing UIT
ETFs had total assets of approximately $379 billion, representing
approximately 11.3% of total assets invested in ETFs (based on data
obtained from MIDAS, Bloomberg, and Morningstar Direct).
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A UIT is an investment company organized under a trust indenture or
similar instrument that issues redeemable securities, each of which
represents an undivided interest in a unit of specified securities.\36\
By statute, a UIT is unmanaged and its portfolio is fixed. Substitution
of securities may take place only under certain pre-defined
circumstances.\37\ A UIT does not have a board of directors, corporate
officers, or an investment adviser to render advice during the life of
the trust. By contrast, ETFs organized as open-end funds are managed by
investment advisers and, in addition to replicating an index, can be
actively managed or use a ``sampling'' strategy to track an index.\38\
Unlike an ETF structured as a UIT, an open-end fund ETF may participate
in securities lending programs and has greater flexibility to reinvest
dividends from portfolio securities.\39\ ETFs structured as open-end
funds also may invest in derivatives, which typically require a degree
of management that is not provided for in the UIT structure.\40\ As a
result, we understand that most ETF sponsors now prefer the open-end
fund structure over the UIT structure given the increased investment
flexibility the open-end structure affords. Indeed, we have received
very few exemptive applications for new UIT ETFs since 2002 and no new
UIT ETFs have come to market in that time.\41\
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\36\ See section 4(2) of the Act [15 U.S.C. 80a-4]. A UIT has a
fixed life--a termination date for the trust is established when the
trust is created.
\37\ The exemptive relief granted to UIT ETFs does not provide
relief from the portion of section 4(2) that requires that UIT
securities represent an undivided interest in a unit of specified
securities. Because a UIT must invest in ``specified securities,''
the investment strategies that a UIT ETF can pursue are limited. All
UIT ETFs today seek to track the performance of an index by
investing in the component securities of the index in the same
approximate proportions as in the index (i.e., ``replicating'' the
index). The trustee of an UIT ETF may make adjustments to the ETF's
portfolio only to reflect changes in the composition of the
underlying index. See Actively Managed Exchange-Traded Funds,
Investment Company Act Release No. 25258 (Nov. 8. 2001) [66 FR 57614
(Nov. 15, 2001)] (``2001 Concept Release''), at n.11.
\38\ An ETF that uses a sampling strategy includes assets in its
portfolio that are designed, in the aggregate, to reflect the
underlying index's capitalization, industry, and fundamental
investment characteristics, and to perform like the index. The ETF
implements the strategy by acquiring a subset of the underlying
index's component securities and may invest a portion of the ETF's
portfolio in securities and other financial instruments (including
derivatives) that are not included in the corresponding index if the
adviser believes the investment will help the ETF track the
underlying index. See 2008 ETF Proposing Release, supra footnote 3.
\39\ UIT dividends are held in a non-interest bearing account
and paid out quarterly. The inability to reinvest dividends can have
a cash drag on the tracking performance of a UIT ETF. See A. Seddik
Meziani, Exchange-Traded Funds: Investment Practices and Tactical
Approaches (2016), at 22.
\40\ See Use of Derivatives by Registered Investment Companies
and Business Development Companies, Investment Company Act Release
No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)]
(``Derivatives Proposing Release''), at n.139.
\41\ The Commission has received applications for ETFs
structured as a UIT, but with features that are different from
typical UIT-structured ETFs. See Application of Elkhorn Securities,
LLC and Elkhorn Unit Trust (Mar. 6, 2017) (``Elkhorn Application'');
Application of Precidian ADRs LLC (Aug. 1, 2014) (``Precidian ADR
Application''). The Commission has not taken any action on the
Elkhorn Application, and the Precidian ADR Application was withdrawn
by the applicant. Two orders modifying relief for existing ETFs
organized as UITs were issued in 2007. See NASDAQ-100 Trust, Series
1, et al., Investment Company Act Release Nos. 27740 (Feb. 27, 2007)
[72 FR 9594 (Mar. 2, 2007)] (notice) and 27753 (Mar. 20, 2007)
(order) and related application; BLDRS Index Funds Trust, et al.,
Investment Company Act Release Nos. 27745 (Feb. 28, 2007) [72 FR
9787 (Mar. 5, 2007)] (notice) and 27768 (Mar. 21, 2007) (order) and
related application.
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The rule we proposed in 2008 would not have included UIT ETFs
within its scope.\42\ Comments on the 2008 ETF Proposing Release were
mixed with regard to providing relief to UITs, with two commenters
supporting the exclusion of UITs.\43\ On the other hand, two commenters
argued that the Commission should expand the rule to include UITs,
contending that sponsors in the future may choose the UIT structure for
some reason unforeseen today.\44\ Some commenters also stated that
existing UIT ETFs should be able to rely on the rule, which may provide
broader relief than provided by their exemptive orders.\45\
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\42\ See 2008 ETF Proposing Release, supra footnote 3, at text
accompanying nn.63-67 (noting that the Commission had not received
an exemptive application for a new ETF to be organized as a UIT
since 2002 and, as a result, there did not appear to be a need to
include UIT relief in the proposed rule).
\43\ See Comment Letter of Xshares Advisors LLC (May 20, 2008)
(``Xshares 2008 Comment Letter''); Comment Letter of the Investment
Company Institute (May 19, 2008) (``ICI 2008 Comment Letter'').
\44\ See Comment Letter of Katten Muchin Rosenman LLP (May 30,
2008) (``Katten 2008 Comment Letter''); Comment Letter of the
Federal Regulation of Securities Committee, Section of Business Law,
American Bar Association (May 29, 2008) (``ABA 2008 Comment
Letter'').
\45\ See Comment Letter of State Street Global Advisors (May 19,
2008) (``SSgA 2008 Comment Letter''); Comment Letter of NYSE Arca
(May 29, 2008) (``NYSE Arca 2008 Comment Letter''); Katten 2008
Comment Letter.
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While we acknowledge that excluding UIT ETFs would result in a
segment of ETF assets that are outside the regulatory framework of
proposed rule 6c-11, we do not believe there is a need to include ETF
UITs within the scope of the proposed rule given the limited sponsor
interest in developing ETFs organized as UITs. In addition, even if we
were to include UIT ETFs within the scope of the rule, we believe that
the unmanaged nature of the UIT structure would require conditions that
differ from the conditions applicable to ETFs
[[Page 37337]]
organized as open-end funds, requiring a regulatory framework that
would be different than our proposed structure for open-end ETFs. The
exemptive relief that has been granted to UIT ETFs, for example,
provides that the trustee will make adjustments to the ETF's portfolio
only pursuant to the specifications set forth in the trust formation
documents in order to track changes in the ETF's underlying
indexes.\46\ The trustee does not have discretion when making these
portfolio adjustments.\47\ In most cases, therefore, a UIT ETF uses
baskets that correspond pro rata to the ETF's portfolio holdings.\48\
The rule we are proposing would allow ETFs the flexibility to use
baskets that differ from a pro rata representation of the ETF's
portfolio if certain conditions are met.\49\ Because the conditions we
are proposing related to basket flexibility require ongoing management
and board oversight, we do not believe that extending such basket
flexibility to UIT ETFs would be appropriate given the unmanaged nature
of a UIT.
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\46\ See, e.g., SPDR, supra footnote 34.
\47\ See id.
\48\ See id. (permitting baskets accepted by UIT ETF for
purchases of creation units to include the cash equivalent of a
component security of the underlying index only where: (i) The
trustee determines that the index security is likely to be
unavailable or available in insufficient quantity; or (ii) a
particular investor is restricted from investing or transacting in
such index security).
\49\ See infra section II.C.5.
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Instead, we believe that UIT ETFs should continue to operate
pursuant to their exemptive orders, which include terms and conditions
that are appropriately tailored to address the unique features of a
UIT.\50\ The exemptive relief granted to UIT ETFs includes relief from
sections of the Act that govern key aspects of a UIT's operations.\51\
For example, because UITs are prohibited from paying fees beyond those
necessary to cover the costs of administrative and bookkeeping
services, UIT ETFs require exemptive relief from section 26(a)(2)(C) of
the Act to allow the ETF to pay certain enumerated expenses.\52\
However, because UITs are unmanaged and are not overseen by boards, the
exemptive order for each UIT ETF contains its own list of permissible
capped expenses that vary among the different UIT ETFs.\53\
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\50\ Unlike the exemptive relief we have granted to certain ETFs
organized as open-end funds (see supra footnote 6), the relief we
have granted to ETFs organized as UITs does not provide relief for
future ETFs formed pursuant to the same order.
\51\ See, e.g., SPDR, supra footnote 34.
\52\ Section 26(a)(2)(C) of the Act requires that the trust
indenture for a UIT prohibit payments to the depositor or to any
affiliated person thereof, except payments for performing
bookkeeping and other administrative services of a character
normally performed by the trustee or custodian itself. 15 U.S.C.
80a-26(a)(2)(C).
\53\ See, e.g., NASDAQ-100 Trust, Series 1, Investment Company
Act Release Nos. 23668 (Jan. 27, 1999) [64 FR 5082 (Feb. 2, 1999)]
(notice) and 23702 (Feb. 22, 1999) (order) and related application
(exemption from section 26(a)(2)(C) to permit UIT to reimburse the
sponsor up to a maximum of 20 basis points) (``NASDAQ 100''); Midcap
SPDR Trust, Series 1, Investment Company Act Release Nos. 20797
(Dec. 23, 1994) [60 FR 163 (Jan. 3, 1995)] (notice) and 20844 (Jan.
18, 1995) (order) and related application (30 basis points).
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To the extent that ETF sponsors develop unforeseen, novel UIT ETFs,
we believe that the Commission should review such products as part of
its exemptive process to determine whether the relief is necessary or
appropriate in the public interest and consistent with the protection
of investors. We therefore are not proposing to include ETFs structured
as UITs within the scope of proposed rule 6c-11.\54\
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\54\ While we do not propose to include ETFs organized as UITs
within the scope of proposed rule 6c-11, we are proposing amendments
to Form N-8B-2 to require them to provide certain additional
disclosures regarding trading costs. See infra section II.I.
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We request comment on whether proposed rule 6c-11 should be
available only to ETFs structured as open-end funds.
Should the rule provide exemptive relief for both ETFs
organized as open-end funds and ETFs organized as UITs? Are we correct
that ETF sponsors will likely prefer the open-end structure to the UIT
structure when forming ETFs in the future? If not, why?
If UIT ETFs were included in the scope of the proposed
rule, should they be subject to the same proposed conditions or should
we tailor particular conditions in light of the unmanaged nature of a
UIT? For example, how should the proposed rule address basket
composition for UIT ETFs? Should UIT ETFs only be permitted to
replicate their index, or should we allow them to engage in
representative sampling on a pro rata basis? Should a UIT ETF only be
permitted to substitute cash (instead of other securities) for
particular basket assets? Should we allow a UIT ETF to substitute
basket assets only in certain enumerated circumstances (e.g., only when
the basket asset is not eligible for trading by an authorized
participant or is not available in sufficient quantity for delivery to
or from the authorized participant)?
If UIT ETFs were included within the scope of the rule,
should we expressly limit the types of indexes that such ETFs may track
given the unmanaged nature of the UIT structure and the potential for
specialized or bespoke indexes to be inconsistent with a fixed
portfolio? For example, should we provide that ETFs structured as UITs
may only track broad-based securities indexes? Should we limit the
derivatives holdings of UIT ETFs or restrict them from tracking indexes
that include certain types of derivatives? If so, what types of
derivatives should be permitted?
If we were to include UIT ETFs within the scope of rule
6c-11, should we provide an exemption from section 26(a)(2)(C),
consistent with our exemptive orders, to permit the payment of certain
expenses associated with the creation and maintenance of the ETF? If
so, should we limit the amount of expenses that may be reimbursed? What
should the limit be, and why? Should we limit the reimbursement to no
more than 20 basis points of the ETF's NAV per share on an annualized
basis, consistent with some of the exemptive orders granted to UIT
ETFs? Should this limit be higher (e.g., 30 basis points) or lower
(e.g., 10 basis points)? Should the rule enumerate the expenses that
may be reimbursed? For example, should the rule permit the
reimbursement of any or all of the following: (i) Annual index
licensing fees; (ii) annual federal and state fees for the registration
of newly issued creation units; and (iii) expenses of the sponsor
relating to the development, printing, and distribution of marketing
materials? Are there other expenses that should be permissible
reimbursements under such an exemption?
Our exemptive orders for UIT ETFs also include relief from
section 14(a) of the Act, which provides that no registered investment
company may make an initial public offering of its securities unless it
has a net worth of at least $100,000 or is assured, via private
subscriptions, of issuing at least $100,000 in securities in the
offering.\55\ If UIT ETFs were included within the scope of the rule,
would they need relief from section 14(a) of the Act consistent with
our prior exemptive relief? If so, what conditions should we consider
as part of the rule? Alternatively, should we consider amending rule
14a-3 under the Act, which provides an exemption from section 14(a) for
UITs that invest in ``eligible trust securities?'' \56\ If so, how
should we define ``eligible trust securities''? For example, should
equity securities be added to the definition of ``eligible trust
securities''? Should we
[[Page 37338]]
include other types of securities within that definition? For example,
should we include FLEX options within the definition? \57\
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\55\ See NASDAQ 100, supra footnote 53.
\56\ Eligible trust securities under rule 14a-3 include
corporate debt securities (including nonconvertible preferred
stock), government and municipal securities, and units of a
previously issued series of a UIT. The term does not include equity
securities. See rule 14a-3(b).
\57\ FLexible EXchange options (``FLEX options'') are a type of
customized equity or index option contracts. Some traditional UITs
have exemptive relief from section 14(a) to invest in FLEX options
with expiration dates that coincide with UIT's maturity date. See
e.g., Olden Lane Securities LLC, et al., Investment Company Act
Release Nos. 32589 (April 3, 2017) [82 FR 17048 (April 7, 2017)]
(notice) and 32619 (May 1, 2017) (order) and related application.
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Are there any other exemptions we should consider for UIT
ETFs?
If we were to include UIT ETFs in rule 6c-11, are there
any specific disclosures that should be required, other than the ones
proposed herein?
If we do not include UIT ETFs within the scope of the
rule, should we nonetheless require them to comply with any of the
rule's requirements for ETFs organized as open-end funds?
2. Index-Based ETFs and Actively Managed ETFs
Proposed rule 6c-11 would provide exemptions for both index-based
ETFs and actively managed ETFs, but would not by its terms establish
different requirements based on whether an ETF's investment objective
is to seek returns that correspond to the returns of an index. We
believe that index-based and actively managed ETFs that comply with the
proposed rule's conditions function similarly with respect to
operational matters, despite different investment objectives or
strategies, and do not present significantly different concerns under
the provisions of the Act from which the proposed rule grants relief.
For example, both index-based and actively managed ETFs register under
the Act, issue and redeem shares in creation unit sizes in exchange for
baskets of assets, list on national securities exchanges, and allow
investors to trade ETF shares throughout the day at market-determined
prices in the secondary market.
The distinction between index-based ETFs and actively managed ETFs
in our current exemptive orders is largely a product of ETFs'
historical evolution. The Commission did not approve the first actively
managed ETF until nearly 15 years after index-based ETFs were
introduced.\58\ As discussed in a 2001 concept release on actively
managed ETFs, the Commission was initially concerned that actively
managed ETFs would not be able (or willing) to provide portfolio
transparency, potentially hindering the arbitrage mechanism deemed
critical to the operation of an ETF.\59\ Actively managed ETFs were
novel at the time of the 2008 ETF Proposing Release, and the Commission
solicited comment on whether a proposed ETF rule should specifically
include actively managed ETFs.\60\ Six commenters supported this
approach,\61\ while a few commenters questioned whether it was
premature to allow actively managed ETFs to operate using the rule.\62\
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\58\ See, e.g., WisdomTree Trust, et al., Investment Company Act
Release Nos. 28147 (Feb. 6, 2008) [73 FR 7776 (Feb. 11, 2008)]
(notice) and 28174 (Feb. 27, 2008) (order) and related application
(``2008 WisdomTree Trust''); Barclays Global Fund Advisors, et al.,
Investment Company Act Release Nos. 28146 (Feb. 6, 2008) [73 FR 7771
(Feb. 11, 2008)] (notice) and 28173 (Feb. 27, 2008) (order) and
related application (``Barclays Global 2008''). Approximately 100
exemptive orders have been issued since 2008 for actively managed,
transparent ETFs.
\59\ See 2001 Concept Release, supra footnote 37, at n.31 and
accompanying and following text. Comment letters to the 2001 Concept
Release are available at https://www.sec.gov/rules/concept/s72001.shtml.
\60\ See 2008 ETF Proposing Release, supra footnote 3, at
section III.A.2.
\61\ See e.g., Comment Letter of the Vanguard Group, Inc. (June
19, 2008) (``Vanguard 2008 Comment Letter''); Xshares 2008 Comment
Letter; Comment Letter of Barclays Global Fund Advisors (May 16,
2008) (``BGFA 2008 Comment Letter''); ICI 2008 Comment Letter; SSgA
2008 Comment Letter; Comment Letter of Mutual Fund Directors Forum
(May 21, 2008).
\62\ See Comment Letter of Brown & Associates LLC (May 19,
2008); Katten 2008 Comment Letter.
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The actively managed ETF market has grown considerably since 2008.
There are now over 200 actively managed ETFs with approximately $45.8
billion in assets.\63\ The Commission has observed how actively managed
ETFs operate during this time, and has not identified any operational
issues that suggest additional conditions for actively managed ETFs are
warranted. As noted below, we believe that the arbitrage mechanism for
existing actively managed ETFs has worked effectively with small
deviations between market price and NAV per share.\64\
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\63\ These estimates are based on data obtained from MIDAS,
Bloomberg and Morningstar Direct as of December 31, 2017.
\64\ See infra section II.B.2.
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We believe that permitting index-based and actively managed open-
end ETFs to operate under the proposed rule subject to the same
conditions would provide a level playing field among those market
participants. Furthermore, we believe that it would be unreasonable to
create a meaningful distinction within the rule between index-based and
actively managed ETFs given the evolution of indexes over the last
decade. The proliferation of highly customized, often methodologically
complicated, indexes has blurred the distinction between such
products.\65\ At the same time, ETF industry practices in areas such as
portfolio transparency have converged between these types of funds.\66\
We therefore believe that eliminating the regulatory distinction
between index-based ETFs and actively managed ETFs would help to
provide a more consistent and transparent regulatory framework for ETFs
organized as open-end funds. This approach also would be consistent
with our regulation of other types of open-end funds, which does not
distinguish between actively managed and index-based strategies.
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\65\ See, e.g., John Waggoner, Smart-beta ETFs Take in Billions
in New Assets, Investment News (Oct. 11, 2017), available at https://www.investmentnews.com/article/20171011/FREE/171019982/smart-beta-etfs-take-in-billions-in-new-assets); Brendan Conway, New Trend: The
``Bespoke'' ETF, Barron's (Jan. 17, 2014), available at https://www.barrons.com/articles/new-trend-the-aposbespokeapos-etf-1389970766.
\66\ All ETFs that could rely on the proposed rule currently
provide full portfolio transparency as a matter of market practice,
although only actively managed ETFs and some index-based ETFs with
affiliated index providers are required to do so pursuant to their
exemptive orders. See infra section II.C.4. See also, e.g.,
Guggenheim Funds Investment Advisors, LLC, et al., Investment
Company Act Release Nos. 30560 (June 14, 2013) [78 FR 37614 (June
21, 2013)] (notice) and 30598 (July 10, 2013) (order) and related
application. Earlier relief granted to ETFs with affiliated index
providers did not require full portfolio transparency, but included
conditions that were intended to address potential conflicts of
interest. See, e.g., HealthShares Inc., et al., Investment Company
Act Release Nos. 27916 (July 27, 2007) [72 FR 42447 (Aug. 2, 2007)]
(notice) and 27930 (Aug. 20, 2007) (order) and related application;
WisdomTree Investments, Inc., et al., Investment Company Act Release
Nos. 27324 (May 18, 2006) [71 FR 29995 (May 24, 2006)] (notice) and
27391 (June 12, 2006) (order) and related application (``2006
WisdomTree Investments'').
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The rule we proposed in 2008 similarly would not have distinguished
between index-based ETFs and actively managed ETFs, except in one
respect--it would have permitted an index-based ETF to disclose daily
the composition of its index in lieu of disclosing its portfolio
holdings.\67\ However, we believe that distinguishing between index-
based ETFs and actively managed ETFs in this manner is no longer
necessary given that all ETFs that could rely on the proposed rule
currently provide full portfolio transparency.\68\
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\67\ For these purposes, an index-based ETF was defined as an
ETF that has a stated investment objective of obtaining returns that
correspond to the returns of a securities index (whose provider
discloses on its internet website the identities and weightings of
the component securities and other assets of that index). See 2008
ETF Proposing Release, supra footnote 3. See also infra section
II.C.4 (discussing proposed condition regarding portfolio
transparency).
\68\ See 2015 ETP Request for Comment, supra footnote 9.
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We request comment on whether proposed rule 6c-11 should provide
[[Page 37339]]
exemptions to index-based ETFs and actively managed ETFs subject to the
same conditions.
Should the rule maintain the historical distinction
between index-based ETFs and actively managed ETFs? Do investors find
this distinction meaningful?
If the rule maintains the distinction, what conditions of
the rule should differ between index-based and actively managed ETFs?
For example, some applications for index-based ETFs include a
representation that the ETF will invest at least 80% of its assets,
exclusive of collateral held from securities lending, in the component
securities of its underlying index.\69\ Should the rule include a
similar condition?
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\69\ There are some variations in this representation for index-
based funds that invest in fixed-income securities and foreign
securities. See, e.g., Destra Exchange-Traded Fund Trust, et al.,
Investment Company Act Release Nos. 33048 (Mar. 14, 2018) [83 FR
12208 (Mar. 20, 2018)] (notice) and 33071 (Apr. 10, 2018) (order)
and related application (``Each Fund . . . will invest at least 80%
of its assets, exclusive of collateral held from securities lending,
in Component Securities of its respective Underlying Index, or in
the case of Fixed Income Funds, in the Component Securities of its
respective Underlying Index and [to-be-announced transactions]
representing Component Securities, and in the case of Foreign Funds,
in Component Securities and depositary receipts representing foreign
securities such as [American Depositary Receipts and Global
Depositary Receipts] representing such Component Securities (or, in
the case of Foreign Funds tracking Underlying Indexes for which
Depositary Receipts are themselves Component Securities, underlying
stocks in respect of such Depositary Receipts.'') (internal
footnotes omitted).
---------------------------------------------------------------------------
Should the proposed rule include requirements relating to
index-based ETFs with an affiliated index provider? If so, what
requirements and why? For example, should ETFs with affiliated index
providers be required to adopt additional policies and procedures
designed to further limit information sharing between portfolio
management staff and index management staff? How should we define
``index provider'' for these purposes?
Are there operational differences between index-based and
actively managed ETFs that should be addressed in the proposed rule?
3. Leveraged ETFs
Although the proposed rule would not distinguish between actively
managed ETFs and index-based ETFs in general, it would take a different
approach with respect to leveraged ETFs, which are a type of index-
based ETF that presents unique considerations.\70\ ``Leveraged ETFs''
refers to ETFs that seek, directly or indirectly, to provide returns
that exceed the performance of a market index by a specified multiple
or to provide returns that have an inverse relationship to the
performance of a market index, over a fixed period of time.\71\ A
leveraged ETF seeks to amplify the returns of its underlying index or
to profit from a decline in the value of its underlying index. It also
typically seeks to deliver the targeted return over a short period of
time, such as a day. This means that investors holding shares over
periods longer than the targeted period may experience performance that
is different, and at times substantially different, from the targeted
returns. Leveraged ETFs seek to achieve their targeted returns by using
financial derivatives. These funds are sometimes referred to as trading
tools because they can be used by investors to hedge against or profit
from short-term market movements without using margin.\72\
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\70\ We use the term ``leveraged ETFs'' in this release to refer
to ETFs that pursue leveraged strategies (i.e., those that seek to
provide returns that exceed the performance of a market index by a
specified multiple over a period of time) and inverse strategies
(i.e., those that seek to provide returns that have an inverse
relationship to, or provide returns that are an inverse multiple of,
the performance of a market index over a fixed period of time). At
the end of December 2017, 187 ETFs employed leveraged or inverse
investment strategies. All of these ETFs are structured as open-end
funds. In total, these ETFs had total net assets of $35.26 billion
or approximately 1% of all ETF assets. See infra footnote 427 and
following text.
\71\ See proposed rule 6c-11(c)(4); see also Item C.3.c. of Form
N-CEN (requiring funds to identify if they seek to achieve
performance results that are a multiple of an index or other
benchmark, the inverse of an index or other benchmark, or a multiple
of the inverse of an index or other benchmark).
\72\ See ETF Handbook, supra footnote 22, at 266.
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The strategy that leveraged ETFs pursue requires them to rebalance
their portfolios on a daily basis in order to maintain a constant
leverage ratio. This daily reset, and the effects of compounding,\73\
can result in performance that differs significantly from some
investors' expectations of how index investing generally works.\74\
This effect can be more pronounced in volatile markets.\75\ As a
result, buy-and-hold investors in a leveraged ETF with an intermediate
or long-term time horizon--who may not evaluate their portfolios
frequently--may experience large and unexpected losses.\76\
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\73\ For example, as a result of compounding, leveraged ETFs can
outperform a simple multiple of its index's returns over several
days of consistently positive returns, or underperform a simple
multiple of its index's returns over several days of volatile
returns.
\74\ See Office of Investor Education and Advocacy, SEC,
Leveraged and Inverse ETFs: Specialized Products with Extra Risks
for Buy-and-Hold Investors Investor Alert and Bulletins (Aug. 1,
2009), available at https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm; FINRA, Non-Traditional ETFs: FINRA Reminds Firms of Sales
Practice Obligations Relating to Leveraged and Inverse Exchange-
Traded Funds, Regulatory Notice 09-31 (June 2009), available at
https://www.finra.org/sites/default/files/NoticeDocument/p118952.pdf
(``FINRA Regulatory Notice 09-31'') (providing an example of a four-
month period where a specified index gained 2%, while an ETF seeking
to deliver twice the daily return of that index fell 6%, and the
related ETF seeking to deliver twice the inverse of the index's
daily return fell 26%).
\75\ See FINRA Regulatory Notice 09-31, supra footnote 74
(``Using a two-day example, if the index goes from 100 to close at
101 on the first day and back down to close at 100 on the next day,
the two-day return of an inverse ETF will be different than if the
index had moved up to close at 110 the first day but then back down
to close at 100 on the next day. In the first case with low
volatility, the inverse ETF loses 0.02 percent; but in the more
volatile scenario the inverse ETF loses 1.82 percent. The effects of
mathematical compounding can grow significantly over time, leading
to scenarios such as those noted above.'').
\76\ See id. (reminding member firms of their sales practice
obligations relating to leveraged ETFs and noting that leveraged
ETFs are typically not suitable for retail investors who plan to
hold these products for more than one trading session). See also,
e.g., SEC v. Hallas, No. 1:17-cv-2999 (S.D.N.Y. Sept. 27, 2017);
FINRA News Release, FINRA Sanctions Oppenheimer & Co. $2.9 Million
for Unsuitable Sales of Non-Traditional ETFs and Related Supervisory
Failures (June 8, 2016), available at https://www.finra.org/newsroom/2016/finra-sanctions-oppenheimer-co-29-million-unsuitable-sales-non-traditional-etfs. The Commission also settled an enforcement action
against an investment adviser under section 206(4) of the Investment
Advisers Act of 1940 (the ``Advisers Act'') and rule 206(4)-7,
finding the adviser violated these provisions by failing to
adequately implement written compliance policies that were designed
to ensure that recommendations of single inverse ETFs to non-
discretionary advisory clients were suitable for each individual
client. See In Re Morgan Stanley Smith Barney, LLC, Investment
Advisers Act Release No. 4649 (Feb. 14, 2017) (settled action),
available at https://www.sec.gov/litigation/admin/2017/ia-4649.pdf.
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Leveraged ETFs, and their use of derivatives, also may raise issues
under section 18 that we are evaluating as part of our broader
consideration of the use of derivatives by registered funds and
business development companies.\77\ In
[[Page 37340]]
2015, for example, we proposed new 17 CFR 270.18f-4 (``rule 18f-4''
under the Act). Proposed rule 18f-4 was designed to address the
investor protection purposes and concerns underlying section 18 of the
Act and to provide an updated and more comprehensive approach to the
regulation of funds' use of derivatives transactions.\78\
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\77\ The staff has not supported new exemptive relief for
leveraged ETFs since 2009. The orders issued to current leveraged
ETF sponsors prior to the staff moratorium, as amended over time,
relate to leveraged ETFs that seek investment results of up to 300%
of the return (or inverse of the return) of the underlying index.
Rydex ETF Trust, et al., Investment Company Act Release Nos. 27703
(Feb. 20, 2007) [72 FR 8810 (Feb. 27, 2007)] (notice) and 27754
(Mar. 20, 2007) (order) and related application; Rafferty Asset
Management, LLC, et al., Investment Company Act Release Nos. 28379
(Sept. 12, 2008) [73 FR 54179 (Sept. 18, 2008)] (notice) and 28434
(Oct. 6, 2008) (order) and related application. See also ProShares
Trust, et al., Investment Company Act Release Nos. 28696 (Apr. 14,
2009) [74 FR 18265 Apr. 21, 2009)] (notice) and 28724 (May 12, 2009)
(order) and related application (amending the applicant's prior
order) (``ProShares''); Rafferty Asset Management, LLC, et al.,
Investment Company Act Release Nos. 28889 (Aug. 27, 2009) [74 FR
45495 (Sept. 2, 2009)] (notice) and 28905 (Sept. 22, 2009) (order)
and related application (amending the applicant's prior order)
(``Rafferty'').
\78\ See Derivatives Proposing Release, supra footnote 40.
Section 18 of the Act limits a fund's ability to obtain leverage or
issue senior securities. 15 U.S.C. 80a-18.
---------------------------------------------------------------------------
In light of our ongoing consideration, including the potential
staff recommendation of a re-proposal on funds' use of derivatives, we
do not believe it is appropriate to permit additional leveraged ETF
sponsors to form leveraged ETFs and operate under our proposed rule at
this time.\79\ Accordingly, we propose to include a condition that
would prevent leveraged ETFs from relying on proposed rule 6c-11.\80\
ETFs that seek to provide returns that exceed the performance (or
inverse performance) of a market index by a specified multiple over a
fixed period could not operate under our proposed rule.
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\79\ See supra footnote 77. As discussed in more detail in
section II.G below, we are not proposing here to rescind the
existing leverage ETF orders. Existing leveraged ETF sponsors would
continue to operate under their exemptive orders. Existing leveraged
ETFs, however, would be subject to the proposed amendments to Form
N-1A discussed below.
\80\ Proposed rule 6c-11(c)(4).
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The daily or other periodic reset, and more particularly the
effects of compounding, are what distinguish a leveraged ETF strategy
from other strategies pursued by ETFs. The proposed condition relating
to leveraged ETFs thus includes a temporal element (i.e., ``over a
fixed period of time'') in order to specifically capture ETFs that seek
to deliver the leveraged or inverse return of a market index over a
fixed period of time, daily or otherwise.\81\ In addition, the proposed
rule's use of the term ``multiple'' includes leverage that is not
evenly divisible by 100, such as a fund that seeks to provide a return
equal to 150% of the performance of an index.\82\ Finally, we believe
it is important to specify that an ETF may not indirectly seek to
provide returns that exceed the performance of a market index by a
specified multiple or to provide returns that have an inverse
relationship to the performance of a market index over a fixed period
of time in order to prevent a fund from circumventing this condition,
such as by embedding inverse leverage in the underlying index.
---------------------------------------------------------------------------
\81\ The current exemptive orders that allow leveraged ETFs
contemplate a daily reset, because the orders relate to ETFs that
pursue daily investment objectives. See supra footnote 77. For
example, one application describes its leveraged ETFs as ``seek[ing]
to provide daily investment results, before fees and expenses, that
correspond to 300% of the daily performance, or 300% of the inverse
(opposite) daily performance, of its Underlying Index.'' See
Rafferty, supra footnote 77. Another describes its leveraged ETFs as
``attempt[ing], on a daily basis, to achieve its investment
objective by corresponding to a specified multiple of the
performance (either 125%, 150% or 200%), or the inverse performance,
or the inverse multiple (either 125%, 150% or 200% of the opposite)
of the performance of a particular securities index.'' See
ProShares, supra footnote 77.
\82\ Similarly, an ``inverse ETF'' includes both inverse
strategies (i.e., -100% of an index's performance) and leveraged
inverse strategies (e.g., -125% or -200% of an index's performance).
---------------------------------------------------------------------------
We request comment on excluding leveraged ETFs from the scope of
funds that may rely on the proposed rule.
Do commenters agree that it is appropriate for proposed
rule 6c-11 to include a condition that an ETF may not seek, directly or
indirectly, to provide returns that exceed the performance of a market
index by a specified multiple, or to provide returns that have an
inverse relationship to the performance of a market index, over a fixed
period of time?
Alternatively, do commenters believe that the structure
and operation of leveraged ETFs do not raise issues that warrant our
excluding them from a rule of general applicability related to the
structure and operations of ETFs? If so, are there any conditions
specific to leveraged ETFs that should be part of the rule? For
example, should we permit leveraged ETFs to operate in reliance on the
rule but prohibit a leveraged ETF that exceeds a specific multiple of
the performance, or inverse performance, of a market index? If so, what
multiple should we use? For example, ETFs currently may not seek
investment results over 300% of the return (or inverse of the return)
of the underlying index. Should we maintain the status quo with respect
to the maximum amount of leveraged market exposure that leveraged ETFs
may obtain (i.e., 300%)? Should we limit ETFs to a higher or lower
multiplier? If so, what multiplier and why?
Does the proposed rule's use of ``a fixed period of time''
effectively describe the daily reset mechanism in leveraged ETFs? Are
there other descriptions we should use? Could an ETF seek to provide
returns that are a multiple, or inverse, of an index without this
limitation? For example, would such an ETF be able to operate without
the daily (or other periodic) reset? Would such an ETF raise the same
investor protection issues as the leveraged ETFs that we are proposing
to exclude from relying on proposed rule 6c-11? Would they raise other
investor protection issues? If so, what issues and why?
Does the proposed rule prevent an ETF from circumventing
this limitation by embedding leverage in an index or through any other
means? If not, should we consider other conditions or limitations, and
if so, what? For example, should the rule provide that an ETF may not
``obtain'' or ``provide'' leveraged exposure, rather than stating that
an ETF may not ``seek'' to provide leveraged exposure as proposed?
Alternatively, should we define leveraged ETFs as funds currently do in
their applications (i.e., to achieve its investment objective by
corresponding to a specified multiple of the performance (either 125%,
150% or 200%), or the inverse performance, or the inverse multiple
(either 125%, 150% or 200% of the opposite) of the performance of a
particular securities index)? \83\
---------------------------------------------------------------------------
\83\ See supra footnote 81.
---------------------------------------------------------------------------
Proposed rule 6c-11 does not seek to address any concerns
raised under section 18 of the Act by leveraged ETFs. Do commenters
agree that this is appropriate? Should we consider additional
conditions in rule 6c-11 for leveraged ETFs designed to address
concerns raised under section 18 or other investor protection concerns
raised by their strategies? If so, what conditions? Should we provide
any relief to these ETFs under section 18 of the Act?
What types of investors purchase shares of leveraged ETFs?
What is the proportion of volume from retail versus institutional
trading? How do these different types of investors utilize leveraged
ETFs? What is the typical holding period of leveraged ETFs by each type
of investor?
What types of intermediaries are active with leveraged ETF
investments? Are the current suitability requirements for
intermediaries effective with respect to leveraged ETFs? What specific
methods, if any, are intermediaries using to meet their suitability
obligations for these products? Should we propose as part of a future
rulemaking that leveraged ETFs be subject to additional requirements,
particularly for retail investors? \84\
---------------------------------------------------------------------------
\84\ See, e.g., NASD, Structured Products: NASD Provides
Guidance Concerning the Sale of Structured Products, Notice to
Members (September 2005), available at https://www.complinet.com/file_store/pdf/rulebooks/nasd_0559ntm.pdf; see also FINRA, Complex
Products: Heightened Supervision of Complex Products, Regulatory
Notice 12-03 (January 2012), available at https://www.finra.org/sites/default/files/NoticeDocument/p125397.pdf.
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[[Page 37341]]
The Commission understands that leveraged ETFs typically
provide enhanced disclosure of the risks of investing in the ETF.\85\
Do investors understand leveraged ETFs better today than they did when
Commission staff and FINRA jointly issued an investor alert expressing
the concern that individual investors may be confused about the
performance objectives of leveraged ETFs? \86\ For example, are
investors more likely to be aware that leveraged ETFs are typically
designed to achieve their stated performance objectives on a periodic
basis (e.g., daily)? Do investors understand that leveraged ETFs may
not achieve those performance objectives over the long-term? \87\
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\85\ This understanding is based on Commission staff review of
registration statements filed with the Commission and ETF websites.
\86\ See supra footnote 74.
\87\ See e.g., Paolo Guasoni and Eberhard Mayerhofer, Leveraged
Funds: Robust Replication and Performance Evaluation (2017)
(``Leveraged and inverse exchange-traded funds seek daily returns
equal to fixed multiples of indexes' returns. Trading costs implied
by frequent adjustments of funds' portfolios create a tension
between tracking error, reflecting short-term correlation with the
index, and excess return, the long-term deviation from the leveraged
index's performance.''); Lu Lei, Jun Wang, and Ge Zhang, Long-term
performance of leveraged ETFs, 21 Financial Services Review 1 (2012)
(``Overall our results caution against the use of leveraged ETFs as
long-term investment substitutes for long or short positions of the
benchmark indices.'').
---------------------------------------------------------------------------
Leveraged ETFs typically include charts in their
disclosures that explain the potential impact of compounding to an
investor's returns. Should we amend Form N-1A to require leveraged ETFs
to include such a chart to better explain the impact of compounding?
Are there other disclosures that we should require leveraged ETFs to
provide? If so, what are they?
Should we propose rules governing leveraged ETF marketing
materials to address concerns that leveraged ETFs may be marketed to
investors that do not have an appropriate risk tolerance to invest in
these products or that lack understanding of leveraged ETFs' strategies
and risks? For example, should we require leveraged ETFs to include
prescribed cautionary disclosures regarding these strategies and risks?
B. Exemptive Relief Under Proposed Rule 6c-11
Proposed rule 6c-11 would provide ETFs within the scope of the rule
with exemptions from certain provisions of the Act that are necessary
to allow ETFs to operate. These exemptions are generally consistent
with the relief we have given to ETFs under our exemptive orders.\88\
Proposed rule 6c-11 would permit an ETF that meets the conditions of
the rule to: (i) Redeem shares only in creation unit aggregations; (ii)
permit ETF shares to be purchased and sold at market prices rather than
at NAV per share; (iii) engage in in-kind transactions with certain
affiliates; and (iv) in certain limited circumstances, pay authorized
participants the proceeds from the redemption of shares in more than
seven days. As discussed below in section II.C, the exemptions would be
subject to certain conditions that are designed to address the concerns
underlying the relevant statutory provisions and to support a
Commission finding that the exemptions are in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Act.\89\
---------------------------------------------------------------------------
\88\ Our exemptive orders also provide relief allowing certain
types of funds to invest in ETFs beyond the limits of section
12(d)(1) of the Act. We are not addressing this relief at this time.
See infra section II.G. However, we are proposing to rescind the
master-feeder relief that we previously granted to ETFs that do not
rely on the relief as of the date of this proposal (June 28, 2018).
We also propose to grandfather existing master-feeder arrangements
involving ETF feeder funds, but prevent the formation of new ones,
by amending relevant exemptive orders. See infra section II.F.
\89\ See 15 U.S.C. 80a-6(c).
---------------------------------------------------------------------------
1. Treatment of ETF Shares as ``Redeemable Securities''
Under proposed rule 6c-11, an ETF, as defined in the rule, would be
considered to issue a ``redeemable security'' within the meaning of
section 2(a)(32) of the Act.\90\ As discussed above, ETFs have features
that distinguish them from both traditional open-end and closed-end
funds. A defining feature of open-end funds is that they offer
redeemable securities, which allow the holder to receive his or her
proportionate share of the fund's NAV per share upon presentation of
the security to the issuer. Although individual ETF shares cannot be
redeemed, except in limited circumstances,\91\ they can be redeemed in
creation unit aggregations.\92\ Therefore, we believe that ETF shares
are most appropriately classified under the proposed rule as redeemable
securities within the meaning of section 2(a)(32),\93\ and that ETFs
should be regulated as open-end funds within the meaning of section
5(a)(1) of the Act.\94\
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\90\ Proposed rule 6c-11(b)(1).
\91\ See infra section II.C.1 (discussing circumstances where
ETF shares can be individually redeemed).
\92\ See proposed rule 6c-11(a) (defining an exchange-traded
fund, in part, as a registered open-end management company that
issues and redeems its shares in creation units). The proposed rule
would define ``creation unit'' to mean a specified number of ETF
shares that the ETF will issue to (or redeem from) an authorized
participant in exchange for the deposit (or delivery) of a basket
and a cash balancing amount (if any). See proposed definition of
``creation unit'' in rule 6c-11(a).
\93\ If ETF shares were not classified as redeemable securities
within the meaning of section 2(a)(32) of the Act, an ETF would be
subject to the provisions of the Act applicable to closed-end funds.
See 15 U.S.C. 80a-5(a)(2) (defining a ``closed-end company'' as any
management company other than an open-end company).
\94\ 15 U.S.C. 80a-5(a)(1) (defining ``open-end company''); 15
U.S.C. 80a-2(a)(32) (defining ``redeemable security'').
---------------------------------------------------------------------------
The arbitrage mechanism that is central to the operation of an ETF
(and the conditions in our relief designed to facilitate an effective
arbitrage mechanism) serves to keep the market price of ETF shares at
or close to the ETF's NAV per share. As a result, even though only
authorized participants may redeem creation units directly from the ETF
at NAV per share, investors are able to sell their ETF shares on the
secondary market at or close to NAV, similar to investors in an open-
end fund that redeem their shares directly from the fund at NAV per
share.\95\ The shares of closed-end funds, on the other hand, generally
trade on the secondary market at a discount or premium to NAV.
---------------------------------------------------------------------------
\95\ See Robert Engle & Debojyoti Sarkar, Premiums-Discounts and
Exchange Traded Funds, 13 Journal of Derivatives 4 (Summer 2006)
(``Engle Article'') (observing that premiums and discounts for
domestic ETFs are generally small and highly transient, and that
while premiums and discounts are larger and more persistent in
international ETFs, they are smaller and less persistent than the
premiums and discounts of international closed-end funds); but see,
e.g., Bradley Kay, Has the ETF Arbitrage Mechanism Failed?,
Morningstar (Mar. 11, 2009), available at https://news.morningstar.com/articlenet/article.aspx?id=283302 (stating that
market prices for ETFs may deviate significantly from NAV during
periods of market stress); Chris Dieterich, Greece ETF Pacing for
Record Tumble on Huge Volume: Here's What You Need to Know, Barron's
(June 29, 2015), available at https://www.barrons.com/articles/greece-etf-pacing-for-record-tumble-on-huge-volume-heres-what-you-need-to-know-1435597369 (noting that ETFs tied to Greek and Egyptian
stocks traded at significant discounts to NAV when the exchanges on
which the underlying stocks traded were closed).
---------------------------------------------------------------------------
Our exemptive orders have provided exemptions from sections
2(a)(32) and 5(a)(1) of the Act so that ETFs may register under the Act
as open-end funds while issuing shares redeemable in creation units
only. Unlike our exemptive orders, however, the proposed rule would not
provide an exemption from the definition of ``redeemable security'' in
section 2(a)(32) or from the definition ``open-end company'' in section
5(a)(1). We believe that it is more appropriate for the proposed rule
to address these questions of status by classifying ETF shares as
``redeemable securities.'' Thus,
[[Page 37342]]
any ETF operating in compliance with the rule's conditions and
requirements would meet the definition of open-end company.\96\
---------------------------------------------------------------------------
\96\ Section 5(a)(1) defines an ``open-end company'' as ``a
management company which is offering for sale or has outstanding any
redeemable security of which it is the issuer.'' 15 U.S.C. 80a-
5(a)(1).
---------------------------------------------------------------------------
ETFs operating in reliance on the proposed rule would be subject to
the requirements imposed under the Act and our rules that apply to all
open-end funds.\97\ We note that our approach is substantially similar
to the 2008 proposal, which was generally supported by commenters.\98\
In addition, in our view the rules under the Exchange Act that apply to
redeemable securities issued by an open-end fund would apply to ETFs
relying on the proposed rule.\99\ Thus, proposed rule 6c-11 would
result in ETFs relying on proposed rule 6c-11 becoming eligible for the
``redeemable securities'' exceptions in 12 CFR 242.101(c)(4) and
242.102(d)(4) (``rules 101(c)(4) and 102(d)(4) of Regulation M'') and
12 CFR 240.10b-17(c) (``rule 10b-17(c) under the Exchange Act'') in
connection with secondary market transactions in ETF shares and the
creation or redemption of creation units. Similarly, we would view ETFs
relying on rule 6c-11 as within the ``registered open-end investment
company'' exemption in rule 11d1-2 under the Exchange Act.\100\
---------------------------------------------------------------------------
\97\ See, e.g., 15 U.S.C. 80a-22; 17 CFR 270.22c-1.
\98\ See 2008 ETF Proposing Release, supra footnote 3. See also
ICI 2008 Comment Letter; Xshares 2008 Comment Letter.
\99\ See, e.g., 17 CFR 240.15c3-1. See also Securities
Transaction Settlement Cycle, Exchange Act Release No. 80295 (Mar.
22, 2017) [82 FR 15564 (Mar. 29, 2017)] (``T+2 Adopting Release'')
(shortening the standard settlement cycle for most broker-dealer
securities transactions to two business days).
\100\ Cf. Securities Industry Association, SEC Staff No-Action
Letter (Nov. 21, 2005) (treating certain equity index-based ETFs as
registered open-end investment companies for purposes of rule 11d1-
2).
---------------------------------------------------------------------------
We request comment on this aspect of the proposed rule.
Are there differences between ETFs and other open-end
funds that would justify not applying certain open-end fund provisions
of the Act or our rules to ETFs? For example, we adopted tailored
liquidity risk management program requirements for ETFs under 17 CFR
270.22e-4 (``rule 22e-4'').\101\ Should we consider tailored
requirements for ETFs in connection with other provisions?
---------------------------------------------------------------------------
\101\ See Investment Company Liquidity Risk Management Programs,
Investment Company Act Release No. 32315 (Oct. 13, 2016) [81 FR
82142 (Nov. 18, 2016)] (``LRM Adopting Release''), at sections II.A.
and II.J.
---------------------------------------------------------------------------
As we discussed above, ETFs relying on proposed rule 6c-11
would be able to rely on the ``redeemable securities'' exceptions in
rules 101(c)(4) and 102(d)(4) of Regulation M and rule 10b-17(c) under
the Exchange Act and the ``registered open-end investment company''
exemption in rule 11d1-2 under the Exchange Act. Should the Commission
exempt ETFs relying on proposed rule 6c-11 from any other rules under
the Exchange Act? \102\ If so, which rules and why? For example, ETFs
typically request relief from Exchange Act section 11(d)(1) and rule
11d1-2 thereunder; and 17 CFR 240.10b-10, 240.15c1-5, and 240.15c1-6
(rules 10b-10, 15c1-5, and 15c1-6 under Exchange Act). Should the
Commission provide relief from these provisions under the Exchange Act?
If so, what conditions should apply to such relief, if any, and why?
For example, ETFs currently rely on relief that is conditioned on:
minimum creation unit sizes; \103\ dissemination of the Intraday
Indicative Value (``IIV''); \104\ restrictions on the payment of
certain cash compensation or economic incentives; \105\ minimum levels
of diversification in the ETF's basket; \106\ and whether the ETF is
managed to track an index.\107\ Should we eliminate or modify any or
all of these conditions? We requested comment on exchange listing
standards for ETFs and other ETPs in 2015.\108\ Do commenters have
updated views on those requests for comment?
---------------------------------------------------------------------------
\102\ See, e.g., supra footnote 14.
\103\ See, e.g., Letter from James A. Brigagliano, Deputy
Director, Division of Trading and Markets, to W. John McGuire,
Morgan, Lewis & Bockius LLP re: U.S. One Trust Actively-Managed
Exchange Traded Fund of Exchange Traded Funds, dated May 4, 2010
(conditioning relief under Exchange Act Section 11(d)(1) on the ETFs
continuously redeeming, at NAV, creation unit aggregations of 50,000
shares valued at a minimum of $1.25 million).
\104\ Id. (representing that the ETFs would disseminate the IIV
every 15 seconds throughout the trading day).
\105\ See, e.g., Letter from Catherine McGuire, Chief Counsel,
Division of Market Regulation to Securities Industry Association,
dated Nov. 21, 2005, at n.3 and accompanying text.
\106\ Id. (defining, in part, a ``qualifying ETF'' as consisting
of a basket of twenty or more component securities with no one
component security constituting more than 25% of the total value of
the ETF).
\107\ Id.
\108\ 2015 ETP Request for Comment, supra footnote 9, at n.106
and accompanying and following text.
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2. Trading of ETF Shares at Market-Determined Prices
Section 22(d) of the Act, among other things, prohibits investment
companies, their principal underwriters, and dealers from selling a
redeemable security to the public except at a current public offering
price described in the prospectus.\109\ Rule 22c-1 generally requires
that a dealer selling, redeeming, or repurchasing a redeemable security
do so only at a price based on its NAV.\110\ Together, section 22(d)
and rule 22c-1 are designed to: (i) Prevent dilution caused by certain
riskless trading practices of principal underwriters and dealers; (ii)
prevent unjust discrimination or preferential treatment among investors
purchasing and redeeming fund shares; and (iii) preserve an orderly
distribution of investment company shares.\111\ ETFs seeking to
register under the Act obtain exemptions from these provisions because
investors may purchase and sell individual ETF shares from and to
dealers on the secondary market at market-determined prices (i.e., at
prices other than those described in the prospectus or based on NAV).
Consistent with our prior exemptive orders, proposed rule 6c-11 would
provide exemptions from these provisions.\112\
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\109\ 15 U.S.C. 80a-22(d).
\110\ See 17 CFR 270.22c-1.
\111\ See generally Mutual Fund Distribution Fees;
Confirmations, Investment Company Act Release No. 29367 (July 21,
2010) [75 FR 47064 (Aug. 4, 2010)] (discussing legislative history
of section 22(d)).
\112\ See proposed rule 6c-11(b)(2). The reference in the
proposed rule to ``repurchases . . . at market-determined prices''
refers to secondary market transactions with dealers. Thus, the rule
would not allow an ETF to repurchase shares from an investor at
market-determined prices.
---------------------------------------------------------------------------
As discussed above, only authorized participants can purchase and
redeem shares directly from an ETF at NAV per share and only in
creation unit aggregations. Because authorized participants (and other
market participants transacting through an authorized participant) can
take advantage of disparities between the market price of ETF shares
and NAV per share, they may be in a different position than investors
who buy and sell individual ETF shares only on the secondary
market.\113\ However, if the arbitrage mechanism is functioning
effectively, entities taking advantage of these disparities in market
price and NAV per share move the market price to a level at or close to
the NAV per share of the ETF. The proposed rule would provide
exemptions from section 22(d) and rule 22c-1 because we believe this
[[Page 37343]]
arbitrage mechanism--and the conditions in this rule designed to
promote a properly functioning arbitrage mechanism--have adequately
addressed, over the significant operating history of ETFs, the
potential concerns regarding shareholder dilution and unjust
discrimination that these provisions were designed to address.
---------------------------------------------------------------------------
\113\ See, e.g., Comment Letter of Barclays Global Investors on
2001 Concept Release (Jan. 11, 2002) (``[D]uring periods of market
volatility . . . it is not unreasonable to assume that some retail
investors would buy or sell ETF shares at secondary market prices
moving in the opposite direction of a fund's NAV.'').
---------------------------------------------------------------------------
We proposed the same exemptions in 2008 and commenters who
addressed this aspect of the 2008 ETF Proposing Release supported the
Commission's approach.\114\ Commenters on the 2015 ETP Request for
Comment also addressed the existing arbitrage mechanism, generally
arguing that it is effective and efficient in ensuring that an ETF's
market price does not vary substantially from its NAV per share.\115\
On the other hand, one commenter questioned the efficacy of the
arbitrage mechanism, particularly at the close of trading when bid-ask
spreads tend to widen.\116\ One commenter asserted that the arbitrage
mechanism does not work well for ETFs holding securities that do not
trade during U.S. market hours.\117\ Another commenter argued that even
if the arbitrage mechanism corrects price mismatches between market
price and NAV per share, it does so by creating an unfair windfall for
authorized participants who can capitalize on information asymmetries
and operational advantages to extract value from the market.\118\
---------------------------------------------------------------------------
\114\ See ICI 2008 Comment Letter; Xshares 2008 Comment Letter.
\115\ See, e.g., Comment Letter of KCG Holdings, Inc. on 2015
ETP Request for Comment (Aug. 17, 2015); Comment Letter of Vanguard
on 2015 ETP Request for Comment (Aug. 17, 2015); Comment Letter of
Charles Schwab & Co., Inc. and Charles Schwab Investment Management,
Inc. on 2015 ETP Request for Comment (Aug. 17, 2015) (``Schwab ETP
Comment Letter'') (noting that it had not identified any significant
systemic differences in efficiency across various ETF products,
regardless of ETF's investment strategy).
\116\ See Comment Letter of ETF Consultants.com, Inc. on 2015
ETP Request for Comment (Aug. 17, 2015); see also infra section II.H
regarding bid-ask spreads.
\117\ See Comment Letter of James J. Angel, Ph.D., CFA on 2015
ETP Request for Comment (Aug. 17, 2015).
\118\ See Comment Letter of Occupy the SEC on 2015 ETP Request
for Comment (Aug. 21, 2015).
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The arbitrage mechanism is the foundation for why retail and other
secondary market investors generally can buy and sell ETF shares at
prices that are at or close to the prices at which authorized
participants are able to buy and redeem shares directly from the ETF at
NAV. In the Commission's experience, the deviation between the market
price of ETFs and NAV per share, each calculated as of the close of
trading each day, generally has been relatively small.\119\ For
example, during 2016-2017, the closing price of ETFs based on U.S.
equity indexes were within 1% of NAV for 97.9% of trading days and
within 1% of NAV for actively managed ETFs investing in U.S. equities
for 98.5% of trading days. The absolute weighted average of the daily
difference between the NAV and market price during a six-month period
ending in December 2017 was 0.014% for ETFs based on U.S. equities
indexes and 0.074% for actively managed ETFs investing in U.S.
equities.\120\
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\119\ Figures in this section represent an analysis by
Commission staff of market data obtained from Bloomberg Professional
Services and Morningstar. In preparing this analysis, staff used the
market price of each ETF as of the close of trading each day.
\120\ An ETF can trade at a premium or discount to its NAV per
share on any given day. When taking an average over many days,
premiums (which have a positive difference) and discounts (which
have a negative difference) may offset each other. Therefore, to
calculate deviation from NAV, we use the absolute value of premiums
and discounts when calculating weighted average differences to
prevent such offsetting.
---------------------------------------------------------------------------
Other types of ETFs have had a somewhat higher deviation between
NAV per share and market price. During 2016-2017, the closing price for
index-based and actively managed ETFs investing in international
equities, for example, were within 1% of NAV for 87.4% and 86.8% of
trading days, respectively. Similarly, the absolute weighted average of
the daily difference between the NAV and market price during a six-
month period ending in December 2017 for index-based and actively
managed ETFs investing in U.S. fixed-income securities were 0.067% and
0.068%, respectively. The absolute weighted average of daily difference
between NAV per share and market price during the six-month period
studied was 0.206% for ETFs based on international equities indexes and
0.390% for actively managed ETFs investing in international
equities.\121\
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\121\ International equity ETFs can provide exposure to markets
that do not overlap with U.S. trading hours. In these circumstances,
the deviation between NAV per share and market price may be
attributable in large part to obtaining exposure to those markets
when they are closed.
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These numbers represent only broad averages with respect to end-of-
day differences, however, and intraday deviations between market price
and NAV per share may be greater under certain circumstances. These
figures also do not reflect intraday deviations between market prices
and the contemporaneous value of the ETF's portfolio.\122\ However, one
academic paper has shown that deviations between intraday market prices
and estimated intraday values for domestic ETFs also were generally
small.\123\
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\122\ Most funds calculate NAV per share once per day as of the
time the major U.S. stock exchanges close. See supra footnote 26.
\123\ Engle Article, supra footnote 95. For domestic ETFs, the
study showed intraday average daily premium of 0.25 basis points
with an average standard deviation of 11.8 basis points. For
international ETFs, the respective figures were 23.7 basis points
and an average standard deviation of 64.8 basis points. The intraday
premium was measured every minute as the percentage difference
between: (i) The average of the bid and the ask of the ETF shares;
and (ii) the intraday indicative value (IIV) of the ETF's portfolio.
See infra sections II.C.3 and II.C.6 for a discussion of the IIV and
the potential problems associated with using the IIV as a tool to
measure the current value of the ETF's portfolio on an ongoing
basis.
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The Commission and its staff have observed the operation of the
arbitrage mechanism during periods of market stress when the deviation
between intraday market prices and the next-calculated NAV per share
significantly widened for short periods of time. During periods of
extraordinary volatility in the underlying ETF holdings, it may be
difficult for authorized participants or market makers to confidently
ascribe precise values to an ETF's holdings, thereby making it more
difficult to effectively hedge their positions.\124\ These market
participants may widen their quoted spreads in ETF shares or, in
certain cases, may elect not to transact in or quote ETF shares, rather
than risk loss.\125\
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\124\ See generally Itzhak Ben-David, et al., Exchange Traded
Funds (ETFS), National Bureau of Econ., Working Paper No. 22829
(Nov. 2016), available at https://www.nber.org/papers/w22829 (``Ben-
David'') (``Because of sparse liquidity in some exchanges [on the
morning of August 24, 2015], some of the arbitrage programs
diagnosed unreliable price data and withdrew from the market,
leading to a positive feedback loop.'').
\125\ See also Milan Borkovec, et al., Liquidity and Price
Discovery in Exchange-Traded Funds: One of Several Possible Lessons
from the Flash Crash, 1 The Journal of Index Investing 2 (2010)
(``Borkovec'') (reporting that liquidity of ETFs declined
dramatically during the ``Flash Crash,'' causing spreads to widen
significantly).
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Market makers may have already exhibited this behavior in periods
of extraordinary volatility.\126\ For example,
[[Page 37344]]
on May 6, 2010, the prices of many U.S.-based equity products
experienced a significant decline and recovery, and many of the
securities that experienced the greatest price changes were equity-
based ETFs.\127\ Significant price volatility on the morning of August
24, 2015 triggered limit up-limit down pauses in many equity
securities, including many ETFs.\128\ In both instances, certain ETFs
saw larger intraday premiums/discounts and wider bid-ask spreads for
portions of the trading day.\129\ Deviations between market price and
NAV per share were closed after relatively short periods, however, as
the arbitrage mechanism resumed its effectiveness.\130\
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\126\ See Ben-David, supra footnote 124 (``ETF market makers and
[authorized participants] arguably withdrew from the market after a
trading pause in the futures market, which they used to hedge their
exposure in volatile trading sessions.'') (internal citations
omitted). Many ETFs disclose the risk that ETF shares will trade at
a premium or discount, particularly during times of market
disruptions, in their prospectuses as part of their principal risk
disclosure. See, e.g., iShares Trust rule 485(b) Registration
Statement (Nov. 1, 2017), available at https://www.sec.gov/Archives/edgar/data/1100663/000119312517327588/d486424d485bpos.htm (``Market
Trading Risk: The Fund faces numerous market trading risks,
including the potential lack of an active market for Fund shares,
losses from trading in secondary markets, periods of high volatility
and disruptions in the creation/redemption process. ANY OF THESE
FACTORS, AMONG OTHERS, MAY LEAD TO THE FUND'S SHARES TRADING AT A
PREMIUM OR DISCOUNT TO NAV.'').
\127\ See Final May 6 Report, supra footnote 9, at n.36 and
accompanying text (noting that ETFs accounted for approximately 70%
of all securities with trades broken pursuant to the clearly
erroneous execution rules on May 6).
\128\ See August 24 Staff Report, supra footnote 32 (noting that
ETFs as a class accounted for almost all of the 1,279 trading halts
on August 24, 2015, but 80% of ETFs did not experience a single
trading halt).
\129\ See Borkovec, supra footnote 125; Ben-David, supra
footnote 124.
\130\ See Borkovec, supra footnote 125, at 40; see also Ananth
Madhavan, Exchange-Traded Funds, Market Structure, and the Flash
Crash, 68 Financial Analysts Journal 20 (2012) (``Madhavan
Article'').
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Accordingly, we recognize that under certain circumstances,
including during periods of market stress, the arbitrage mechanism may
work less effectively for a period of time. We also recognize that
secondary market investors who trade in ETF shares during these periods
may be harmed by trading at a price that is not close to the NAV per
share of the ETF (or the contemporaneous value of the ETF's portfolio).
On balance, however, we believe these investors are more likely to
weigh the potential benefits of ETFs (e.g., low cost and intraday
trading) against any potential for market price deviations when
deciding whether to utilize ETFs.\131\ Further, we believe that the
conditions we are proposing as part of rule 6c-11, along with other
recent actions that are designed to promote an effective arbitrage
mechanism,\132\ would continue to result in a sufficiently close
alignment between an ETF's market price and NAV per share in most
circumstances, and provide an appropriate basis for the exemptive
relief we are proposing. We particularly find this to be the case given
the benefits ETFs offer investors, as discussed above.
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\131\ The Commission has taken steps to address disruptions in
the arbitrage mechanism. For example, the Commission approved
changes to the limit up-limit down rules following the market events
on August 24, 2015. See Self-Regulatory Organizations; Financial
Industry Regulatory Authority, Inc.; Notice of Filing and Immediate
Effectiveness of a Proposed Rule Change to Clarify the Operation of
the Regulation NMS Plan to Address Extraordinary Market Volatility,
Exchange Release No. 78435 (July 28, 2016) [81 FR 51239 (Aug. 3,
2016)]; Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing and Immediate Effectiveness of a
Proposed Rule Change to Extend the Effective Date of SR-FINRA-2016-
028, Exchange Release No.78660 (Aug. 24, 2016) [81 FR 59676 (Aug.
30, 2016)].
\132\ For example, rule 22e-4 under the Act requires ETFs to
consider certain additional factors that address the relationship
between the liquidity of the ETF's portfolio and the arbitrage
mechanism in assessing, managing, and periodically reviewing its
liquidity risk. See LRM Adopting Release, supra footnote 101. We
have taken these requirements into consideration in developing the
conditions in this proposal.
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Furthermore, to the extent that there are instances where bid-ask
spreads widen, or premiums and discounts persist, the proposed rule and
disclosure amendments would require ETFs to disclose certain
information on their website.\133\ We believe that it is important for
investors to be informed where costs may increase beyond what they
would reasonably expect. Our exemptive orders have required ETFs'
websites to disclose, among other things, the ETF's NAV per share for
the prior business day, the market closing price or the midpoint of the
bid-ask spread at the time of the calculation of NAV, and a calculation
of the premium or discount of the market closing price or midpoint of
the bid-ask spread against NAV per share.\134\ However, the proposed
rule and disclosure amendments would require ETFs to disclose
additional information on their websites that is not currently required
under our exemptive orders.\135\
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\133\ See infra section II.C.6.
\134\ See, e.g., Fidelity Commonwealth Trust, Investment Company
Act Release Nos. 32166 (June 29, 2016) [81 FR 44063 July 6, 2016)]
(notice) and 32191 (July 26, 2016) (order) and related application;
Claymore Exchange-Traded Fund Trust, Investment Company Act Release
Nos. 27469 (Aug. 28, 2006) [71 FR 51869 (Aug. 31, 2006)] (notice)
and 27483 (Sept. 18, 2006) (order) and related application.
\135\ See infra footnote 278 and accompanying and following text
(noting that, currently, Form N-1A provides an ETF with the option
to omit certain historical information regarding premiums and
discounts from its prospectus and annual report if the disclosure is
provided on its website).
---------------------------------------------------------------------------
In particular, as discussed in section II.C.6, we are proposing to
require ETFs to disclose on their websites the median bid-ask spread
for the ETF's most recent fiscal year and certain historical
information about the extent and frequency of an ETF's premiums and
discounts. This would allow investors to be more aware of this risk
when deciding whether to invest in ETFs generally or in a particular
ETF. Our proposed amendments to Form N-1A would require additional
disclosure regarding ETF trading information and related costs,
including information relating to high-end (95th percentile) spread
costs.\136\ We also request comment below on whether there are other
ways to calculate premiums and discounts, or other metrics we should
consider, to better inform investors about an ETF's history of
deviations between intraday market prices and (i) the next-calculated
NAV; or (ii) the contemporaneous value of the ETF's portfolio.\137\
---------------------------------------------------------------------------
\136\ See infra section II.H.
\137\ See infra section II.C.6.
---------------------------------------------------------------------------
We request comment on the proposed exemptions from section 22(d) of
the Act and rule 22c-1 thereunder.
Is the proposed relief sufficient to facilitate
transactions in ETF shares on the secondary market?
Will the proposed conditions (discussed below) promote the
arbitrage mechanism and support the Commission granting this relief?
Are there other conditions we should consider?
Under what circumstances could a premium or discount for
an ETF develop or persist? For example, when would a premium or
discount develop due to a break-down in the arbitrage mechanism? Are
there instances where a premium or discount may develop or persist
because of price discovery, such as when the underlying markets for the
ETF's component securities are closed? Are there instances where a
premium or discount may develop or persist because of transaction costs
relating to the ETF's basket securities? How can these circumstances be
distinguished from one another? Should we consider any changes to our
proposal to account for these different circumstances?
Would the arbitrage mechanism contemplated by the proposed
rule keep ETF market prices at or close to NAV per share under normal
market conditions? How should this be measured? For example, is it
appropriate to assess premiums and discounts solely by comparing ETF
market prices to the ETF's NAV, which typically is calculated at the
end of the day? Should intraday calculations play a larger role when
assessing premiums and discounts? Should we, for example, assess the
efficiency of the arbitrage mechanism by comparing the mean/median of
the market prices on a given trading day against the end of day NAV?
Alternatively, should we compare the mean/median of the market price on
a given trading day against an intraday
[[Page 37345]]
measure of the value of an ETF's portfolio?
3. Affiliated Transactions
Section 17(a) of the Act generally prohibits an affiliated person
of a registered investment company, or an affiliated person of such
person, from selling any security or other property to or purchasing
any security from the company.\138\ Purchases and redemptions of ETF
creation units are typically effected in kind, and section 17(a)
prohibits these in-kind purchases and redemptions by affiliated persons
of the ETF. An affiliated person of an ETF includes, among others: (i)
Any person directly or indirectly owning, controlling, or holding with
power to vote, 5% or more of the outstanding voting securities of the
ETF; (ii) any person 5% or more of whose outstanding voting securities
are directly or indirectly owned, controlled, or held with power to
vote by the ETF; and (iii) any person directly or indirectly
controlling, controlled by, or under common control with the ETF.\139\
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\138\ 15 U.S.C. 80a-17(a).
\139\ 15 U.S.C. 80a-2(a)(3)(A), (B) and (C). A control
relationship is presumed when one person owns more than 25% of
another person's outstanding voting securities. 15 U.S.C. 80a-
2(a)(9).
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ETF applicants have requested, and we have granted, exemptive
relief from section 17(a) of the Act for: (i) Persons affiliated with
the ETF based on their ownership of 5% or more of the ETF's outstanding
securities (``first-tier affiliates''); and (ii) affiliated persons of
the first-tier affiliates or persons who own 5% or more of the
outstanding securities of one or more funds advised by the ETF's
investment adviser (``second-tier affiliates'').\140\ In seeking this
relief, applicants have stated that first- and second-tier affiliates
are not treated differently from non-affiliates when engaging in
purchases and redemptions of creation units.\141\ All purchases and
redemptions of creation units are at an ETF's next-calculated NAV
pursuant to rule 22c-1. Additionally, the securities deposited or
delivered upon redemption are valued in the same manner, using the same
standards, as those securities are valued for purposes of calculating
the ETF's NAV per share.
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\140\ See, e.g., Barclays Global 2000, supra footnote 6
(``Because purchases and redemptions of Creation Units may be `in-
kind' rather than cash transactions, section 17(a) may prohibit
affiliated persons of an [ETF] from purchasing or redeeming Creation
Units.'').
\141\ See e.g., Barclays Global 2008, supra footnote 58.
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Proposed rule 6c-11 similarly would provide exemptions from
sections 17(a)(1) and (a)(2) of the Act with regard to the deposit and
receipt of baskets to a person who is an affiliated person of an ETF
(or who is an affiliated person of such a person) solely by reason of:
(i) Holding with the power to vote 5% or more of an ETF's shares; or
(ii) holding with the power to vote 5% or more of any investment
company that is an affiliated person of the ETF.\142\ We believe that
this relief is necessary to facilitate the efficient functioning of the
arbitrage mechanism. Without it, an authorized participant or other
market participant that becomes an affiliated person of the ETF due to
its holdings would be prevented from engaging in arbitrage using an in-
kind basket. This, in turn, could have the adverse effect of limiting
the pool of market participants that could engage in arbitrage.
Ultimately, it could result in the deviation between market price and
NAV per share widening in cases where there are very few authorized
participants or other market participants actively engaged in
transactions with the ETF. The arbitrage mechanism for newly launched
ETFs could be particularly challenged without this relief because every
purchaser of a creation unit would be considered an affiliated person
of the ETF so long as there are fewer than twenty creation units
outstanding. We also believe that this relief is appropriate because
all purchases and redemptions of creation units are at an ETF's next-
calculated NAV, and the securities deposited or delivered upon
redemption would be valued in the same manner, using the same
standards, as those securities are valued for purposes of calculating
the ETF's NAV.
---------------------------------------------------------------------------
\142\ See proposed rule 6c-11(b)(3).
---------------------------------------------------------------------------
The exemption in proposed rule 6c-11(b)(3) is similar to the
section 17(a) exemption we proposed in 2008, although the relief would
be subject to certain additional conditions related to custom
baskets.\143\ Commenters who addressed the proposed relief in 2008
supported it.\144\ Several commenters, however, requested that the
relief be expanded to cover additional types of affiliated
relationships, such as broker-dealers that are affiliated with the
ETF's adviser.\145\ These commenters noted that any Commission concern
of undue influence by the affiliate would be addressed by the federal
securities laws and regulations that prohibit manipulative practices
and misuse of nonpublic information, and that ETFs would benefit from
an increase in entities eligible to transact with the ETF.\146\ An
increase in the number of authorized participants could also help to
reduce the potential for an ETF to be reliant on one or more particular
authorized participants.\147\
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\143\ See id. To utilize custom baskets, proposed rule 6c-
11(c)(3) would require an ETF to adopt and implement written
policies and procedures that: (i) Set forth detailed parameters for
the construction and acceptance of custom baskets that are in the
best interests of the ETF and its shareholders, including the
process for any revisions to, or deviations from, those parameters;
and (ii) specify the titles or roles of the employees of the ETF's
investment adviser who are required to review each custom basket for
compliance with those parameters.
\144\ See, e.g., Comment Letter of Barclays Capital Inc. (May 8,
2008); ICI 2008 Comment Letter; SSgA 2008 Comment Letter.
\145\ See, e.g., ICI 2008 Comment Letter; BGFA 2008 Comment
Letter.
\146\ See, e.g., ICI 2008 Comment Letter; ABA 2008 Comment
Letter.
\147\ Item E.2.a. of Form N-CEN requires ETFs to provide certain
identifying information regarding its authorized participants. See
Investment Company Reporting Modernization Adopting Release,
Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR
81870 (Nov. 18, 2016)] (``Reporting Modernization Adopting
Release'') (``[C]ollecting information concerning these entities on
an annual basis will allow [the Commission] to understand and better
assess the size, capacity, and concentration of the authorized
participant framework and also inform the public about certain
characteristics of the ETF primary markets.'').
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While we acknowledge that an increase in entities eligible to
transact with an ETF could facilitate the arbitrage mechanism and
reduce concentration risk, we preliminarily do not believe that it is
appropriate to expand the scope of affiliated persons covered by the
exemption at the same time that we are permitting additional
flexibility with respect to custom baskets. The proposed rule would
allow an ETF to utilize custom baskets if certain conditions are met,
increasing the possibility that affiliates and non-affiliates could be
treated differently in connection with an ETF's receipt or delivery of
baskets.\148\ We believe that the conditions related to the issuance or
acceptance of custom baskets in proposed rule 6c-11 would provide
appropriate protections against overreaching and similar abusive
practices when an ETF exchanges a custom basket with an affiliate;
however, limiting the types of affiliates that are permitted to rely on
this exemption would serve as an additional protection against
potential disparate treatment in connection with an ETF's receipt or
delivery of baskets.
---------------------------------------------------------------------------
\148\ See proposed rule 6c-11(c)(3).
---------------------------------------------------------------------------
We request comment on this aspect of the proposed rule.
Without an exemption from section 17(a) of the Act, would
ETFs or authorized participants bear any costs that they do not incur
today?
As discussed above, the exemptive relief from section
17(a) of the Act that we are proposing would apply only to
[[Page 37346]]
in-kind purchases and redemptions of creation units, and only to
persons affiliated with the ETF (or affiliates of those persons) by
reason of holding the power to vote 5% or more of the ETF's shares or
holding the power to vote 5% or more of any investment company that is
affiliated with the ETF. Should the relief extend to parties that are
affiliated persons of an ETF for other reasons, or to non-creation unit
transactions, such as portfolio transactions? For example, should a
broker-dealer that is affiliated with the ETF's adviser be allowed to
transact in kind with the ETF? If so, should the proposed rule include
any additional conditions to minimize potential risks of overreaching
for this type of affiliated person? How would expanding the scope of
the exemption in this manner interact with the proposed conditions
regarding basket flexibility?
4. Additional Time for Delivering Redemption Proceeds
Section 22(e) of the Act generally prohibits a registered open-end
management investment company from postponing the date of satisfaction
of redemption requests for more than seven days after the tender of a
security for redemption.\149\ This prohibition can cause operational
difficulties for ETFs that hold foreign investments and exchange in-
kind baskets for creation units. For example, local market delivery
cycles for transferring foreign investments to redeeming investors,
together with local market holiday schedules, can sometimes require a
delivery process in excess of seven days. These ETFs have previously
requested, and we have granted, relief from section 22(e) so that they
may satisfy redemptions up to a specified maximum number of days
(depending upon the local markets), as disclosed in the ETF's
prospectus or statement of additional information (``SAI''). Other than
in the disclosed situations, these ETFs satisfy redemptions within
seven days.\150\
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\149\ 15 U.S.C. 80a-22(e).
\150\ See, e.g., Parker Global Strategies, supra footnote 18.
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Section 22(e) was designed to prevent unreasonable delays in the
actual payment of redemption proceeds.\151\ Proposed rule 6c-11 would
provide an exemption from section 22(e) of the Act because we believe
that the limited nature of the exemption addresses the concerns
underlying this section of the Act. As proposed, rule 6c-11 would grant
relief from section 22(e) to permit an ETF to delay satisfaction of a
redemption request for more than seven days if a local market holiday,
or series of consecutive holidays, the extended delivery cycles for
transferring foreign investments to redeeming authorized participants,
or the combination thereof prevents timely delivery of the foreign
investment included in the ETF's basket.\152\ To rely on this
exemption, an ETF would be required to deliver foreign investments as
soon as practicable, but in no event later than 15 days after the
tender to the ETF.\153\ This proposed exemption thus would permit a
delay in the delivery of foreign investments only if the foreign
investment is being transferred in kind as part of the basket.\154\
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\151\ See Investment Trusts and Investment Companies: Hearings
on S. 3580 Before a Subcomm. of the Senate Comm. on Banking and
Currency, 76th Cong., 3d Sess. 291-293 (statements of David
Schenker).
\152\ Proposed rule 6c-11(b)(4). This relief from the
requirements of section 22(e) would not affect any obligations
arising under rule 15c6-1 under the Exchange Act, which requires
that most securities transactions be settled within two business
days of the trade date. 17 CFR 240.15c6-1.
\153\ Proposed rule 6c-11(b)(4).
\154\ While mutual funds also may invest in foreign investments
that require a delivery process in excess of seven days, mutual
funds typically deliver redemption proceeds in cash, rather than in
kind. Mutual funds, ETFs that redeem in cash, and ETFs that
substitute cash in lieu of a particular foreign investment in a
basket do not require an exemption from section 22(e) of the Act.
---------------------------------------------------------------------------
The exemption would permit a delay only to the extent that
additional time for settlement is actually required, when a local
market holiday, or series of consecutive holidays, or the extended
delivery cycles for transferring foreign investments to redeeming
authorized participants prevents timely delivery of the foreign
investment included in the ETF's basket. To the extent that settlement
times continue to shorten, the ``as soon as practicable'' language
embedded in the exemption is designed to minimize any unnecessary
settlement delays.\155\ If a foreign investment settles in less than 15
days, the ETF would be required to deliver it pursuant to the standard
settlement time of the local market where the investment trades.
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\155\ Austria, Belgium, Bulgaria, Croatia, Cyprus, the Czech
Republic, Denmark, Estonia, Finland, France, Germany, Greece,
Hungary, Iceland, Italy, Ireland, the Netherlands, Latvia,
Lichtenstein, Lithuania, Luxembourg, Malta, Norway, Poland,
Portugal, Romania, Slovakia, Slovenia, Spain (certain fixed-income
trades only), Sweden, Switzerland, and the United Kingdom moved to a
T+2 settlement cycle by the end of 2014, while Australia and New
Zealand transitioned to a T+2 settlement cycle in 2016. See
Amendments to Securities Transaction Settlement Cycle, Exchange Act
Release No. 78962 (Sept. 28, 2016) [81 FR 69240 (Oct. 5, 2016)], at
n.134. Like the United States, Mexico, Canada, Peru and Argentina
moved to a T+2 settlement cycle in September 2017. See T+2 Adopting
Release, supra footnote 99. See also Annie Massa, Your Trades Will
Soon Spend Less Time Stuck in Market's Plumbing, Bloomberg Markets
(Aug. 31, 2017), available at https://www.bloomberg.com/news/articles/2017-08-31/your-trades-will-soon-spend-less-time-stuck-in-market-s-plumbing. There are many securities that trade over the
counter (OTC) in certain foreign markets with agreed-upon settlement
timeframes between the parties that could extend beyond the
settlement timeframes of central securities depositories.
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In addition, given the continued movement toward shorter settlement
times in markets around the world, we believe that the relief from
section 22(e) in the proposed rule does not need to be permanent.
Accordingly, we propose to include a sunset provision in the proposed
rule relating to the relief from section 22(e). Absent further action
by the Commission, the exemption from section 22(e) for postponement of
delivering redemption proceeds would expire ten years from the rule's
effective date. We believe that technological innovation and changes in
market infrastructures and operations will lead to further shortening
of settlement cycles, although these developments may be gradual.
Therefore, we believe it is appropriate for the relief from section
22(e) to be limited in duration to ten years.\156\
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\156\ ETFs that invest in foreign investments from jurisdictions
that continue to require more than seven days to deliver redemption
proceeds would have the option of redeeming in cash rather than in-
kind once the exemptive relief sunsets. Such ETFs also could request
targeted exemptive relief from section 22(e) from the Commission.
---------------------------------------------------------------------------
In 2008, we proposed a similar exemption for postponement of
delivering redemption proceeds. However, that exemption would have
allowed up to 12 days to deliver redemption proceeds without an
offsetting requirement to deliver as soon as practicable and without a
sunset provision.\157\ Commenters on the 2008 proposal agreed that the
specified delay in satisfying redemption requests seemed reasonable
because it was for a limited period of time and disclosed to
investors.\158\ However, one commenter suggested increasing the period
of time for settlement beyond 12 days consistent with the terms of
exemptive orders that had been issued to some ETFs.\159\ Since 2012,
numerous applicants for exemptive relief have indicated that payment or
satisfaction of redemption requests may take as long as 15 days after a
redemption request is received, and we have issued orders permitting
delayed delivery of settlement proceeds for up to 15 days.\160\ We
believe an extended
[[Page 37347]]
settlement period in these circumstances of 15 days, with the
requirement that delivery nevertheless be made as soon as practicable,
is reasonable in light of the limited nature and duration of the
exemption.
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\157\ See 2008 ETF Proposing Release, supra footnote 3.
\158\ See, e.g., Katten 2008 Comment Letter; Xshares 2008
Comment Letter.
\159\ Katten 2008 Comment Letter (recommending up to 14 days).
\160\ See, e.g., Legg Mason ETF Trust, Investment Company Act
Release Nos. 30237 (Oct. 22, 2012) [77 FR 65425 (Oct. 26, 2012)]
(notice) and 30265 (Nov. 16, 2012) (order) and related application
(``Legg Mason'').
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The exemption we proposed in 2008 would have required an ETF to
disclose in its registration statement the foreign holidays that it
expects may prevent timely delivery of foreign securities, and the
maximum number of days that it anticipates it will need to deliver the
foreign securities.\161\ We are not proposing a similar requirement for
several reasons. First, we do not believe this disclosure is relevant
to investors who purchase ETF shares on the secondary market, because
the settlement of these investors' ETF trades would be unaffected by
the potential delay. Only authorized participants engaged in redemption
transactions with the ETF (and market participants that use the
authorized participants as their agents for transacting with the ETF)
would be affected. We believe that information regarding these
potential delays is typically covered in the agreement governing the
relationship between the ETF and the authorized participant (an
``authorized participant agreement'') and would likely be shared by the
authorized participant with other market participants, as
necessary.\162\ Therefore, authorized participants already have
information regarding potential delays. Second, given that these delays
are typically covered by the authorized participant agreement, we do
not believe it is necessary to require ETFs to provide registration
statement disclosures.
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\161\ See 2008 ETF Proposing Release, supra footnote 3.
\162\ For example, an authorized participant acting as an agent
typically would share this information with its customer if it is a
necessary part of the creation or redemption process.
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The proposed rule would define ``foreign investment'' as any
security, asset or other position of the ETF issued by a foreign issuer
(as defined by rule 3b-4 under the Exchange Act) for which there is no
established U.S. public trading market (as that term is used in
Regulation S-K under the Securities Act).\163\ This definition differs
from the one we proposed in 2008 in that it references rule 3b-4 rather
than enumerating the types of foreign entities that are considered
issuers of foreign investments.\164\ We believe this approach is
appropriate because it creates consistency with a long-accepted
definition under Exchange Act rules.\165\ The reference to whether the
investment has an ``established U.S. public trading market'' is
designed to make the relief unavailable to an ETF that could trade the
investment in its basket on a U.S. market, thereby avoiding the
settlement delay that is the basis for the relief.\166\ In addition,
this definition is not limited to ``foreign securities,'' but also
would include other investments that may not be considered securities.
Although these other investments may not be securities, they may
present the same challenges for timely settlement as foreign securities
if they are transferred in kind. This approach is consistent with the
terms of some recent exemptive orders that provide relief from section
22(e) for the delivery of foreign investments that may not be
securities.\167\
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\163\ See proposed rule 6c-11(a); see also rule 201(a) of
Regulation S-K [17 CFR 229.201(a)] (describing how a registrant
should identify its principal United States market or markets); rule
3b-4 of the Exchange Act [17 CFR 240.3b-4].
\164\ The 2008 proposal defined ``foreign security'' as any
security issued by a government or political subdivision of a
foreign country, or corporation or other organization incorporated
or organized under the laws of any foreign country and for which
there is no established U.S. public trading market. See 2008 ETF
Proposing Release, supra footnote 3.
\165\ Rule 3b-4 under the Exchange Act was adopted in 1967. See
Adoption of Rules Relating to Foreign Securities, Exchange Act
Release No. 8066 (Apr. 28, 1967) [32 FR 7848 (May 30, 1967)].
\166\ The rule does not rely on registration status because an
unregistered large foreign private issuer may have an active U.S.
market for its securities, in which case the ETF should be able to
meet redemption requests in a timely manner. See Termination of a
Foreign Private Issuer's Registration of a Class of Securities Under
Section 12(g) and Duty to File Reports Under Section 13(a) or 15(d)
of the Securities Exchange Act of 1934, Exchange Act Release No.
55540 (Mar. 27, 2007) [72 FR 16934 (Apr. 5, 2007)].
\167\ See, e.g., Redwood Investment Management, LLC, et al.,
Investment Company Act Release Nos. 33076A (Apr. 26, 2018) [83 FR
19367 (May 2, 2018)] (notice) and 33100 (May 21, 2018) (order) and
related application.
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We request comment on this aspect of the proposed rule.
Is this relief necessary, particularly given that many
non-U.S. jurisdictions have shorter settlement periods today than when
we began granting this relief to ETFs? We specifically request comment
regarding how frequently ETFs rely on this exemption. Should we permit
the delayed delivery of settlement proceeds for up to 15 days? Is this
period too long or too short? Should the rule refer to the applicable
local market's settlement cycle without specifying a number of days?
Should we require that the ETF deliver foreign investments as soon as
practicable, as proposed, in order to minimize unnecessary settlement
delays?
Should we include a sunset provision for this relief as
proposed? Is the duration of the proposed sunset provision appropriate?
Should it be longer or shorter?
Is the proposed definition of ``foreign investment''
appropriate for identifying investments that may routinely settle more
than seven days after a redemption request? For example, are there
circumstances where a U.S. entity could be subject to delays due to
local market restrictions? Should we utilize a definition found
elsewhere in rules and regulations set forth under the Exchange Act,
the Investment Company Act, or other securities laws (e.g., the
definition of ``foreign security'' set forth in rule 15a-6 under the
Exchange Act, or the definition of ``foreign assets'' set forth in rule
17f-5 under the Investment Company Act)? Alternatively, should we
utilize the definition of ``foreign security'' set forth in the 2008
ETF Proposing Release, or utilize an entirely new definition? If
recommending an alternate definition, please explain the specific types
of investments that would be better captured or that would be excluded
by that definition.
Should the rule also provide relief if an ETF has foreign
investments in its portfolio (and not in a particular basket)? If so,
why? Should the rule permit the delayed delivery of the entire basket
(instead of the specific foreign investments in a basket) if the basket
is composed substantially of foreign investments subject to potential
delays in the delivery of settlement proceeds?
Are we correct that information regarding potential delays
in the delivery of settlement proceeds for foreign investments
typically is covered in the authorized participant agreement? If so,
are we also correct that authorized participants acting as agents
typically would share this information with their customers if it is a
part of the redemption process?
Should the rule require disclosure in an ETF's Statement
of Additional Information of the foreign holidays an ETF expects may
prevent timely delivery of the foreign investments and the maximum
number of days it anticipates it would need to deliver the foreign
investments as required by current exemptive orders? For example,
should we require ETFs relying on this exemption to include a more
general statement in their prospectus or SAI that the ETF may take up
to 15 days to deliver settlement proceeds for certain foreign
investments affected by foreign holidays, rather than the more specific
statement of each holiday an ETF expects may prevent timely delivery of
the investments that is currently required? Should these disclosures be
included in an ETF's sales literature or
[[Page 37348]]
on its website? Alternatively, should we require ETFs to provide a
written notice of the foreign holidays an ETF expects may prevent
timely delivery of the foreign investments to authorized participants
as a condition to rule 6c-11? If so, how often should this information
be updated?
Do secondary market investors or others use information
regarding delays in the delivery of foreign investments?
C. Conditions for Reliance on Proposed Rule 6c-11
Proposed rule 6c-11 would require ETFs to comply with certain
conditions that would allow them to operate within the scope of the
Act, and that are designed to protect investors and to be consistent
with the purposes fairly intended by the policy and provisions of the
Act. These conditions are generally consistent with the conditions we
have imposed under our exemptive orders, which we believe have
effectively accommodated the unique structural and operational features
of ETFs while maintaining appropriate protections for ETF investors.
The conditions also reflect certain changes to the conditions imposed
under our exemptive orders that, based on 26 years of experience
regulating ETFs, we believe will improve the overall regulatory
framework for these products.
1. Issuance and Redemption of Shares
Proposed rule 6c-11 would include several requirements in the
paragraph defining ``exchange-traded fund,'' including a requirement
that the ETF issue (and redeem) creation units to (and from) authorized
participants in exchange for baskets and a cash balancing amount (if
any).\168\ As such, the proposed rule would seek to preserve the
existing structure, reflected in our ETF exemptive orders, whereby only
an authorized participant of an ETF may purchase creation units from
(or sell creation units to) the ETF. This requirement is designed to
preserve an orderly creation unit issuance and redemption process
between ETFs and authorized participants. An orderly creation unit
issuance and redemption process is of central importance to the
arbitrage mechanism, which forms the basis for several of the proposed
rule's exemptive provisions.
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\168\ See proposed rule 6c-11(a). See also infra section II.C.5
(discussing definitions of baskets and cash balancing amount).
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The proposed rule would define an authorized participant as a
member or participant of a clearing agency registered with the
Commission, which has a written agreement with the ETF or one of its
service providers that allows the authorized participant to place
orders for the purchase and redemption of creation units.\169\ This
definition differs from the definition of ``authorized participant'' we
recently adopted in connection with Form N-CEN, which, in relevant
part, defines the term as a broker-dealer that is also a member of a
clearing agency registered with the Commission or a DTC Participant and
has a written agreement with the ETF or one of its service providers
that allows the authorized participant to place orders to purchase and
redeem creation units of the ETF.\170\ Our proposed definition also
differs from the definition of authorized participant in our ETF
exemptive orders and Form N-CEN, because it does not include a specific
reference to an authorized participant's participation in DTC since DTC
is itself a clearing agency.\171\ We believe the definition that we are
proposing remains largely consistent with our existing exemptive
relief, while eliminating unnecessary terms. As discussed further
below, we are proposing a corresponding amendment to Form N-CEN.\172\
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\169\ Proposed rule 6c-11(a).
\170\ See Instruction to Item E.2 of Form N-CEN. See also
Reporting Modernization Adopting Release, supra footnote 147.
\171\ See, e.g., Legg Mason, supra footnote 160. The 2008
proposal would not have defined the term ``authorized participant''
because this term was not used in the definition of an ETF. See 2008
ETF Proposing Release, supra footnote 3 (defining ETF to mean, in
relevant part, a registered open-end management company that issues
(or redeems) creation units in exchange for the deposit (or
delivery) of basket assets).
\172\ See infra section II.J.
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The proposed rule would define the term ``creation unit'' to mean a
specified number of ETF shares that the ETF will issue to (or redeem
from) an authorized participant in exchange for the deposit (or
delivery) of a basket and a cash balancing amount (if any).\173\ In
their exemptive applications, ETFs have stated that they would
establish a specific creation unit size (i.e., a minimum number of
shares).\174\ Creation unit aggregations may differ among ETFs based on
an ETF's investment strategy, the type and availability of the assets
in the basket, and the types of authorized participants (and other
market participants) that are expected to engage in creation and
redemption transactions with the ETF. For example, an ETF tracking a
narrowly focused niche strategy may establish a smaller creation unit
size than an ETF tracking a broad-based index, such as the S&P 500, in
order to facilitate arbitrage. Accordingly, we do not believe it is
necessary to mandate a particular maximum or minimum creation unit size
for all types of ETFs. This approach is consistent with our 2008
proposal, and commenters who addressed this aspect of the 2008 proposal
generally supported it.\175\
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\173\ Proposed rule 6c-11(a).
\174\ See, e.g., Legg Mason, supra footnote 160.
\175\ See 2008 ETF Proposing Release, supra footnote 3; see
also, e.g., Comment Letter of James J. Angel (May 16, 2008); Comment
Letter of Chapman and Cutler LLP (May 19, 2008) (``Chapman 2008
Comment Letter'').
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While we believe that creation unit sizes are an important
component in effective arbitrage, we do not propose to expressly
require, as we proposed in 2008, that an ETF establish creation unit
sizes reasonably designed to facilitate arbitrage.\176\ Commenters on
this aspect of the 2008 proposal generally believed that the proposed
standard was too vague and that an ETF would not have an incentive to
establish creation unit sizes that would be too large or too small to
facilitate effective arbitrage.\177\ Some commenters also questioned
the description of arbitrage embedded within the 2008 definition of
creation unit on the basis that the definition did not capture all
forms of arbitrage.\178\
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\176\ See 2008 ETF Proposing Release, supra footnote 3
(describing arbitrage, for these purposes, as ``the purchase (or
redemption) of shares from the ETF with an offsetting sale (or
purchase) of shares on a national securities exchange at as nearly
the same time as practicable for the purpose of taking advantage of
a difference in the Intraday Value and the [market price] of the
shares.'').
\177\ See, e.g., Vanguard 2008 Comment Letter; BGFA 2008 Comment
Letter. But see Xshares 2008 Comment Letter (``The proposal to
`establish creation unit sizes the number of which is reasonably
designed to facilitate arbitrage' seems to describe the process that
we apply when determining the basket size and is appropriate, as is
the definition of arbitrage.'').
\178\ See ICI 2008 Comment Letter; Katten 2008 Comment Letter.
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As we noted in the 2008 proposal, a large creation unit size could
reduce the willingness or ability of authorized participants (and other
market participants) to engage in creation unit purchases or
redemptions.\179\ Impeding the ability of authorized participants to
purchase and redeem ETF shares could disrupt arbitrage pricing
discipline, which could lead to more frequent occurrences of premiums
or discounts to NAV per share of the ETF. Conversely, a small creation
unit size could discourage market making and render creation units
irrelevant because the ETF could issue and redeem ETF shares much like
a mutual fund.\180\ We agree with the view that ETFs are not likely to
have an incentive to set very large or very small creation unit sizes
that could disrupt the arbitrage
[[Page 37349]]
mechanism and that an ETF would establish a size that is appropriate
for market demand given its investment strategies and objectives.
Moreover, we believe that the conditions in the proposed rule designed
to promote effective arbitrage are better suited for that purpose than
conditions related to creation unit size.
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\179\ See 2008 Proposing Release, supra footnote 3.
\180\ See id.
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An ETF generally would issue and redeem shares only in creation
unit size aggregations under the proposed rule. However, the proposed
rule would permit an ETF to sell or redeem individual shares on the day
of consummation of a reorganization, merger, conversion or
liquidation.\181\ In a merger, for example, an acquired ETF typically
transfers substantially all of its assets to a surviving ETF in
exchange for interests in the surviving ETF. We understand that, under
these limited circumstances, a surviving ETF may need to issue shares,
not necessarily in creation unit aggregations, to shareholders of the
acquired ETF without utilizing authorized participants. Similarly, an
ETF may need to issue individual shares in connection with a
reorganization, conversion, or liquidation. We also understand that the
redemptions that take place in connection with these transactions are
generally intended to facilitate the transactions themselves and
compensate individual shareholders that may be exiting the reorganized,
merged, converted or liquidated ETF--activities likely to involve small
cash amounts and to be outside the scope of an authorized participant's
expected role of transacting in creation units. We believe that
permitting ETFs to conduct redemptions with investors other than
authorized participants in these limited circumstances is operationally
necessary to facilitate reorganizations, mergers, conversions or
liquidations. Permitting ETFs to transact with other investors in these
limited circumstances also is consistent with prior exemptive relief,
which permits ETF shares to be individually redeemable in connection
with the termination of an ETF.\182\
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\181\ See proposed rule 6c-11(c)(5).
\182\ See, e.g., Application of FFCM, LLC, et al. (June 12,
2017), at n.23 (``Therefore, in the event of a termination, the
Board in its discretion could determine to permit the Shares to be
individually redeemable. In such circumstances, the Fund might elect
to pay cash redemptions to all shareholders, with an `in-kind'
election for shareholders owning in excess of a certain stated
minimum amount.'').
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An additional issue related to the issuance and redemption of ETF
shares is the extent to which an ETF may directly or indirectly suspend
these processes. An ETF that suspends the issuance or redemption of
creation units indefinitely could cause a breakdown of the arbitrage
mechanism, resulting in significant deviations between market price and
NAV per share. Such deviations may be harmful to investors that
purchase shares at market prices above NAV per share and/or sell shares
at market prices below NAV per share. An ETF may suspend the redemption
of creation units only in accordance with section 22(e) of the
Act,\183\ and an ETF may charge transaction fees on creation unit
redemptions only in accordance with 17 CFR 270.22c-2 (``rule 22c-
2'').\184\ In addition, we believe an ETF generally may suspend the
issuance of creation units only for a limited time and only due to
extraordinary circumstances, such as when the markets on which the
ETF's portfolio holdings are traded are closed for a limited period of
time.\185\ We also believe that an ETF could not set transaction fees
so high as to effectively suspend the issuance of creation units.
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\183\ Section 22(e) of the Act permits open-end funds to suspend
redemptions and postpone payment for redemptions already tendered
for any period during which the New York Stock Exchange is closed
(other than customary weekend and holiday closings) and in three
additional situations if the Commission has made certain
determinations. See LRM Adopting Release, supra footnote 101, at
n.36.
\184\ See supra footnote 24 and accompanying text. Rule 22c-2
limits redemption fees to no more than 2% of the value of shares
redeemed. See rule 22c-2(a)(1)(i). In other contexts, the Commission
has limited redemption fees paid by redeeming shareholders, as well
as swing pricing NAV adjustments, to no more than 2%. See Investment
Company Swing Pricing, Investment Company Act Release No. 32316
(Oct. 13, 2016) [81 FR 82084 (Nov. 18, 2016)] (describing liquidity
fees under rule 2a-7 and the swing factor upper limit under rule
22c-1).
\185\ See Comment Letter of BlackRock on 2015 ETP Request for
Comment (Aug. 11, 2015) (noting that suspensions of creations are
rare, but an ETF could suspend creations when it is unable to
increase its exposure to underlying assets, such as when a non-U.S.
market suspends capital inflows).
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We request comment on this requirement.
Should we require, as proposed, that an ETF issue (and
redeem) creation units to (and from) authorized participants in
exchange for baskets and a cash balancing amount if any? Are there
alternative formulations that we should consider? Does this provision
facilitate the arbitrage mechanism?
Should we define ``authorized participant'' as proposed?
Should other criteria apply? For example, should the definition require
authorized participants to be registered broker-dealers?
Instead of amending the definition of ``authorized
participant'' in Form N-CEN as proposed below in order to correspond
with proposed rule 6c-11, should we use the existing Form N-CEN
``authorized participant'' definition for rule 6c-11? Should we have
the same definition of ``authorized participant'' for both rule 6c-11
and Form N-CEN? Would different definitions cause confusion or
operational difficulties?
Do commenters agree with our understanding that ETFs are
not likely to have an incentive to set very large or very small
creation unit sizes that could disrupt the arbitrage mechanism?
Should we establish requirements for creation unit sizes
and/or dollar amounts? Alternatively, should we establish a standard
for how ETFs must establish creation unit sizes? If so, what standard
should be established? Do differently sized creation units present
different operational challenges? If so, please explain these
challenges, and provide data to support such a view.
Would institutional investors engage in more create/redeem
transactions with an ETF, through an authorized participant, if the ETF
established a smaller creation unit size? If so, what are the costs and
benefits of this result? Would it impact the efficiency of the ETF's
arbitrage mechanism? If so, how?
Should we permit an ETF to sell or redeem individual
shares on the day of consummation of a reorganization, merger,
conversion or liquidation as proposed? Should we define any or all of
the terms ``reorganization,'' ``merger,'' ``conversion'' and
``liquidation'' for purposes of this condition? If so, how should those
terms be defined? For example, as an alternative, should we consider
the definition for ``merger'' in 17 CFR 270.17a-8 (``rule 17a-8'' under
the Act)? \186\ Are there other circumstances or transactions that
should be included within this provision? For example, should we
specify in this provision that shares may be issued other than in
creation unit size aggregations as part of a dividend reinvestment
program? Is any additional relief needed to conduct these transactions?
Should the relief be limited to the day of consummation of the
transaction, as proposed? Should the relief be limited in time at all?
Should more time be provided? If so, how much time?
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\186\ See rule 17a-8(b)(1) (defining ``merger'' as the ``merger,
consolidation, or purchase or sale of substantially all of the
assets between a registered investment company (or a series thereof)
and another company'').
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Do commenters generally agree that an ETF may suspend
creations only in limited circumstances? Do commenters generally agree
that an ETF could not set transaction fees so high as to effectively
suspend the issuance of
[[Page 37350]]
creation units? Is any additional guidance needed? Should we consider
including provisions in rule 6c-11 that would permit ETFs to suspend
creations or redemptions in particular circumstances?
2. Listing on a National Securities Exchange
Proposed rule 6c-11 defines ``exchange-traded fund,'' in part, to
mean a fund that issues shares that are listed on a national securities
exchange and traded at market-determined prices.\187\ Exchange-listing
is one of the fundamental characteristics that distinguishes an ETF
from other types of open-end funds (and UITs) and is one reason that
ETFs need certain exemptions from the Act and the rules thereunder. The
Commission has premised all of its previous exemptive orders on an ETF
listing its shares for trading on a national securities exchange.\188\
Listing on an exchange provides an organized and continuous trading
market for the ETF shares at market-determined prices. Trading on an
exchange also is important to a functioning arbitrage mechanism. We
proposed a similar condition in 2008 that would have required ETF
shares to be approved for listing and trading on a national securities
exchange.\189\ Commenters on the 2008 proposal generally agreed that
listing on an exchange would provide an organized and continuous
trading market for the ETF shares.\190\
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\187\ Proposed rule 6c-11(a). For purposes of the rule, a
``national securities exchange'' would be defined as an exchange
that is registered with the Commission under section 6 of the
Exchange Act.
\188\ See, e.g., PowerShares Capital Management LLC, et al.,
Investment Company Act Release Nos. 28140 (Feb. 1, 2008) [73 FR 7328
(Feb. 7, 2008)] (notice) and 28171 (Feb. 27, 2008) (order) and
related application (``PowerShares'').
\189\ See 2008 ETF Proposing Release, supra footnote 3.
\190\ See, e.g., NYSE Arca 2008 Comment Letter; SSgA 2008
Comment Letter.
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The proposed definition would require that the ETF's shares be
traded at market-determined prices. Like other exchange-traded equity
securities, however, we understand that there may be instances where
ETF shares simply may not trade for a given period due to a lack of
market interest.\191\ This proposed requirement is not designed to
establish a minimum level of trading volume for ETFs necessary in order
to rely on the rule, but rather to distinguish ETFs from other products
that are listed on exchanges, but trade at NAV-based prices (i.e.,
exchange-traded managed funds).\192\
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\191\ Based on staff analysis of data obtained from Bloomberg,
approximately 5% of ETFs do not trade on the secondary market on a
given trading day.
\192\ Proposed rule 6c-11 would not apply to exchange-traded
managed funds (ETMFs), which are not ETFs, but rather hybrids
between mutual funds and ETFs. Unlike ETFs, secondary market
transactions in ETMFs do not occur at a market-determined price.
Rather, they occur at the next-determined NAV plus or minus a
market-determined premium or discount that may vary during the
trading day. See Eaton Vance Management, et al., Investment Company
Act Release Nos. 31333 (Nov. 6, 2014) [79 FR 67471 (Nov. 13, 2014)]
(notice) and 31362 (Dec. 2, 2014) (order) and related application.
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An ETF that is delisted from a national securities exchange would
not meet the definition of ``exchange-traded fund,'' and would no
longer be eligible to rely on the proposed rule. Such a fund thus would
be required to meet individual redemption requests within seven days
pursuant to section 22(e) of the Act or liquidate.\193\ We requested
comment in the 2008 proposal on whether the rule should include an
exception for ETF shares that are delisted for a short time or
suspended from listing.\194\ Commenters generally did not support such
an exception, asserting that it would be difficult for the Commission
to identify all of the circumstances in which such an exception would
be appropriate, and recommended that ETFs seek individual exemptive
relief from the listing requirement under these circumstances.\195\ We
are not aware of any ETF requesting an order that omits the requirement
that its shares be listed on an exchange. Therefore, we do not propose
to include an exemption for ETFs whose shares are suspended or
delisted.
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\193\ Indeed, an ETF that does not comply with the provisions of
the rule would be required to comply with the Investment Company Act
in all respects unless it was relying on other relief.
\194\ See 2008 ETF Proposing Release, supra footnote 3, at text
following n.94.
\195\ BGFA 2008 Comment Letter; ICI 2008 Comment Letter.
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We request comment on this requirement.
Should the rule make allowance for shares that are
delisted for a short time, or for halts or suspensions in trading? If
so, how would the arbitrage mechanism function in these circumstances?
3. Intraday Indicative Value
Exchange listing standards include a requirement that an intraday
estimate of an ETF's NAV per share (an ``intraday indicative value'' or
``IIV'') be widely disseminated at least every 15 seconds during
regular trading hours (60 seconds for international ETFs).\196\ Our
orders also require the dissemination of the IIV, and ETFs have stated
in their exemptive applications that an ETF's IIV is useful to
investors because it allows them to determine (by comparing the IIV to
the market value of the ETF's shares) whether and to what extent the
ETF's shares are trading at a premium or discount.\197\ We are not
proposing, however, to require the dissemination of an ETF's IIV as a
condition of the proposed rule. We understand that market makers today
typically calculate their own intraday value of an ETF's portfolio with
proprietary algorithms that use an ETF's daily portfolio disclosure and
available pricing information about the assets held in the ETF's
portfolio.\198\ We further understand that they generally use the IIV,
if at all, as a secondary or tertiary check on the value that their
proprietary algorithms generate.\199\
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\196\ See, e.g., NYSE Arca Equities Rule 5.2-E(j)(3), Commentary
.01(c) (stating that the IIV may be based upon ``current information
regarding the required deposit of securities and cash amount to
permit creation of new shares of the series or upon the index
value''); see also supra footnote 14 and accompanying text. The IIV
is also sometimes referred to as the ``iNAV'' (indicative net asset
value) or the ``PIV'' (portfolio indicative value).
\197\ See, e.g., 2006 WisdomTree Investments, supra footnote 66.
\198\ David J. Abner, The ETF Handbook: How to Value and Trade
Exchange Traded Funds (2010), at 90 (``Since stock trading now takes
place in microseconds, a lot can happen between two separate 15-
second quotes. Professional traders are not using the published IIVs
as a basis for trading. Most, if not all, desks that are trading
ETFs are calculating their own [NAV of the ETF] based on real time
quotes . . . that they are generating within their own systems.'').
\199\ See, e.g., Spruce ETF Trust, et al., Investment Company
Act Release Nos. 31301 (Oct. 21, 2014) [79 FR 63964 (Oct. 27, 2014)]
(notice) and 31337 (Nov. 14, 2017) (order permitting withdrawal of
application) and related application (withdrawn).
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We believe that the IIV is no longer used by market participants
when conducting arbitrage trading. In today's fast-moving markets, 15
seconds is likely too long for purposes of efficient market making and
could result in poor execution.\200\ An ETF's current value changes
every time the value of any underlying component of the ETF portfolio
changes. Therefore, the IIV for a more frequently traded component
security might not effectively take into account the full trading
activity for that security, despite being available every 15 seconds.
In particularly volatile
[[Page 37351]]
markets, the dissemination lag of the IIV may not reflect the actual
value of the ETF.\201\
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\200\ See, e.g., Gary Gastineau, How to Minimize Your Cost of
Trading ETFs, ETF.com (June 22, 2009), available at https://www.etf.com/publications/journalofindexes/joi-articles/6042-how-to-minimize-your-cost-of-trading-etfs.html, at Figure 2 and related
discussion. See also Comment Letter of ICI on NASDAQ proposed rule
change relating to iNAV pegged orders for ETFs, File No. SR-NASDAQ-
2012-117 (Nov. 8, 2012), at 4 (``Professional equity traders operate
at speeds calculated in fractions of a second. In such markets, 15
seconds can be an eternity, and establishing an order price based on
data that is nearly 15 seconds old could result in poor
execution.'').
\201\ See Understanding iNAV, ETF.com, available at https://www.etf.com/etf-education-center/21028-understanding-inav.html
https://www.etf.com/etf-education-center/21028-understanding-inav.html?nopaging=1; Gary Gastineau, Exchange-Traded Funds Manual,
2nd Ed. (2010), at 200-202.
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The IIV also may not reflect the actual value of an ETF that holds
securities that do not trade frequently. For example, the IIV can be
stale or inaccurate for ETFs with foreign securities or less liquid
debt instruments. For such ETFs, there may be a difference in value
between the IIV, which is constructed using the last available market
quotations or stale prices, and the ETF's NAV, which uses fair value
when market quotations are not readily available.\202\ Moreover,
because there currently are no uniform methodology requirements, the
IIV can be calculated in different, and potentially inconsistent, ways.
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\202\ Section 2(a)(41)(B) of the Act defines ``value'' as: ``(i)
with respect to securities for which market quotations are readily
available, the market value of such securities; and (ii) with
respect to other securities and assets, fair value as determined in
good faith by the board of directors.'' This definition also is used
in rule 2a-4 under the Act as the required basis for computing a
fund's current NAV per share. With daily portfolio disclosure,
market participants can estimate fair value on their own for the
holdings of current ETFs. 15 U.S.C. 80a-2(a)(41)(B).
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Several commenters to the 2008 ETF Proposing Release, which would
have included an IIV dissemination requirement, agreed that market
professionals no longer rely on the exchange-published IIV.\203\
Commenters on the 2015 ETP Request for Comment also stated that the IIV
is not always reliable, and in some cases is misleading, particularly
when the underlying holdings are less liquid, or, in the case of
certain international ETFs, not traded during the same hours as the ETF
shares.\204\
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\203\ See BGFA 2008 Comment Letter; Xshares 2008 Comment Letter.
\204\ See Schwab ETP Comment Letter, supra footnote 115, at 7
(``[A]s the ETF marketplace has expanded into such markets as fixed
income, precious metals, and foreign securities the published data
points can be potentially misleading when the reference asset the
ETF is covering is not open for pricing or transactions . . . [t]he
requirement for publication of the IIV every 15 seconds seems
antiquated in the evolving electronic trading world in which we are
currently immersed. Trading now occurs in micro and nano seconds and
the lag between the published IIV value and real time quoting and
trading has essentially made the calculation of limited worth even
when the reference asset is open for pricing.''); Comment Letter of
Eaton Vance Corp. to Request for Comment on Exchange-Traded Products
(File No. S7-11-15) (Aug. 17, 2015) (stating that the IIV is
``frequently highly misleading'' as an indicator of current fund
value and investor trading costs); see also John Spence, ETFs
Unfairly Blamed in Recent Market Drama, USA Today (June 27, 2013),
available at https://www.usatoday.com/story/money/personalfinance/2013/06/27/etfs-criticism-investing/2464741/ (``[I]t's meaningless
to compare the share price of any international equity ETF with a
stale NAV based on stock prices that are several hours old.'').
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As discussed below, we are proposing that rule 6c-11 condition its
relief on the daily disclosure of portfolio holdings. We believe that
this disclosure would promote the availability of information to market
participants to support their ability to calculate an estimated
intraday value of the ETF's portfolio holdings using their own
methodologies. Therefore, the proposed rule would not include a
requirement for IIV dissemination.
We request comment on this aspect of our proposal.
Should proposed rule 6c-11 condition relief on
dissemination of the IIV? If so, who should be required to disseminate
the IIV? The national securities exchange on which the ETF is listed?
Other entities?
Are we correct in our understanding that market
participants today typically calculate their own intraday values of an
ETF portfolio by utilizing proprietary algorithms?
Do market participants use the published IIV for any
purpose, whether or not related to its original purpose of facilitating
arbitrage? For example, do some market participants use the IIV as a
secondary or tertiary check on their internal calculations of an ETF's
intraday value?
Do retail investors use or rely on the IIV, and if so,
how? Do they use the IIV for international and fixed-income ETFs, and
if so, how? Is there a risk that this information could be misleading
in certain circumstances? Would omitting the IIV have a disparate
impact on retail investors as opposed to more sophisticated market
participants?
Do the published IIVs provide an accurate indication of
the value of ETFs' underlying holdings? Does the answer vary depending
on the type of the ETF's underlying holdings? If we were to include a
requirement to disseminate the IIV, should and can changes be made to
improve its accuracy? For example, should we require that the IIV be
disseminated at more frequent intervals? If so, how frequently (e.g.,
every second, every five seconds)? Should we require that the IIV be
disseminated for all ETFs or only specific types of ETFs?
If we were to include an IIV requirement, should we
establish a uniform method for calculation of the IIV for all ETFs
relying on the rule? If so, what should that method take into account?
How should fair valued securities be treated? Alternatively, should we
prescribe methodologies for ETFs based on the types of portfolio
holdings?
If the IIV is no longer required pursuant to exemptive
relief or regulation, would ETFs continue to publish this information?
If so, should we require ETFs that voluntarily disseminate the IIV to
follow certain prescribed methodologies? For example, should we require
that these ETFs disseminate the IIV more frequently? If so, how
frequently?
4. Portfolio Holdings
As discussed above, since the first exemptive order for an ETF, the
Commission has relied on the existence of an arbitrage mechanism to
keep the market prices of ETF shares at or close to the NAV per share
of the ETF.\205\ One mechanism that facilitates the arbitrage mechanism
is daily portfolio transparency. Portfolio transparency provides
authorized participants and other market participants with an important
tool to facilitate valuing the ETF's portfolio on an intraday basis,
which, in turn, would enable them to assess whether arbitrage
opportunities exist. It also provides information necessary to hedge
the ETF's portfolio. The ability to hedge is important because market
makers generally trade to provide liquidity, balance supply and demand,
and profit from arbitrage opportunities (without seeking to profit from
taking a directional position in a security).\206\ Without the ability
to hedge, market makers may widen spreads or be reluctant to make
markets because doing so may require taking on greater market risk than
the firm is willing to bear. For this reason, to facilitate the ability
of market makers to make markets in ETF shares, our exemptive orders
have historically required ETFs to provide a certain degree of daily
transparency.\207\ Furthermore, Commission staff has observed that all
ETFs that could rely on the proposed rule currently provide full
transparency as a matter of industry market practice.
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\205\ See supra section I.B.
\206\ See Stanislav Dolgopolov, Regulating Merchants of
Liquidity: Market Making From Crowded Floors to High Frequency
Trading, 18 U. of Penn Journal of Business Law 3 (2016), at 652
(``[T]he distinguishing feature of a market maker is being `pretty
well always even.''').
\207\ Exemptive orders for actively managed ETFs and recent
orders for index-based ETFs with an affiliated index provider have
required full portfolio transparency. Exemptive orders for index-
based ETFs with an unaffiliated index provider have required
publication of the ETF's baskets.
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[[Page 37352]]
a. Transparency of Portfolio Holdings
Proposed rule 6c-11 would require an ETF to disclose prominently on
its website, which is publicly available and free of charge, the
portfolio holdings that will form the basis for each calculation of NAV
per share.\208\ The portfolio holdings disclosure must be made each
business day before the opening of regular trading on the primary
listing exchange of the ETF's shares and before the ETF starts
accepting orders for the purchase or redemption of creation units.\209\
For portfolio transparency to facilitate effective arbitrage,
authorized participants or other market participants buying or selling
ETF shares, whether on the secondary market or in a primary
transaction, should have access to portfolio composition information at
the time of the transaction. The proposed rule's timing requirements,
therefore, are designed to prevent an ETF from disclosing its portfolio
holdings only after the beginning of trading or after the ETF has begun
accepting orders for the next business day.
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\208\ Proposed rule 6c-11(c)(1)(i)(A). See also proposed rule
6c-11(a) (defining the term ``portfolio holdings'' to mean the
securities, assets, or other positions held by the ETF). For
purposes of this proposed requirement, as well as other requirements
to disclose information on a publicly available website under
proposed rule 6c-11, we believe that an ETF should not establish
restrictive terms of use that would effectively make the disclosures
unavailable to the public or otherwise difficult to locate. For
example, the proposed required website disclosure should be easily
accessible on the website, presented without encumbrance by user
name, password, or other access constraints, and should not be
subject to usage restrictions on access, retrieval, distribution or
reuse. We also would encourage ETFs to consider whether there are
technological means to make the disclosures more accessible. For
example, today, ETFs could include the portfolio holdings
information in a downloadable or machine-readable format, such as
comma-delimited or similar format.
\209\ For these purposes, ``business day'' is defined as any day
the ETF is open for business, including any day when it satisfies
redemption requests as required by section 22(e) of the Act. See
proposed rule 6c-11(a).
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In addition, the proposed rule would require the portfolio holdings
that form the basis for the ETF's NAV calculation to be the ETF's
portfolio holdings as of the close of business on the prior business
day.\210\ Changes in an ETF's holdings of portfolio securities would
therefore be reflected on a T+1 basis. This condition is consistent
with current ETF practices and enables an ETF to disclose at the
beginning of the business day the portfolio that will form the basis
for the next NAV calculation, helping to facilitate the efficient
functioning of the arbitrage process.\211\
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\210\ See proposed rule 6c-11(c)(2). Pursuant to this condition,
an ETF would not be permitted to reflect portfolio changes on a T+0
basis, notwithstanding the ability to do so under rule 2a-4 under
the Act.
\211\ See, e.g., Morgan Stanley ETF Trust, et al., Investment
Company Act Release Nos. 32484 (Feb. 21, 2017) [82 FR 11956 (Feb.
27, 2017)] (notice) and 32539 (Mar. 21, 2017) (order) and related
application (``Morgan Stanley'').
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We believe that portfolio transparency is an effective means to
facilitate the arbitrage mechanism. As noted above in our discussion of
the IIV, authorized participants and other market participants today
calculate the value of an ETF's net assets with proprietary algorithms
that use an ETF's daily portfolio disclosure and available pricing
information about the assets held in the ETF's portfolio on an ongoing
basis during the course of the trading day. This information allows
market participants to identify instances where an arbitrage
opportunity exists and to effectively hedge their positions.
The 2008 proposal would have required actively managed ETFs to
disclose the identities and weightings of the portfolio securities and
other assets held by the ETF on the ETF's website each business day
(i.e. full portfolio transparency). By contrast, index-based ETFs would
have been required to have a stated investment objective of obtaining
returns that correspond to the returns of a securities index, whose
provider discloses on its website the identities and weightings of the
component securities and other assets of the index (i.e. index
transparency).\212\ Commenters on that proposal generally concurred
with the importance of transparency to the arbitrage mechanism and
supported including a transparency requirement in the proposed
rule.\213\ Some commenters, however, asserted that index transparency
may not be effective for ETFs whose portfolios sample an index or
include holdings in proportions that are different from those in the
index.\214\ These commenters urged the Commission to consider
alternative approaches, including permitting index-based ETFs to
disseminate the identities and weightings of the securities in the
basket, if the basket is a representative sample of the portfolio.\215\
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\212\ In the event the ETF tracks multiple indexes, the 2008 ETF
Proposing Release would have permitted an ETF to provide full
transparency like actively managed funds. See 2008 ETF Proposing
Release, supra footnote 3.
\213\ See, e.g., BGFA 2008 Comment Letter.
\214\ See, e.g., ICI 2008 Comment Letter. See also Vanguard 2008
Comment Letter (opposing index transparency (as well as daily
portfolio holdings disclosure) for index-based ETFs, voicing
concerns about front running in the context of index-based ETFs).
\215\ Commenters asserted that compliance with the index
transparency requirement we proposed in 2008 would be difficult for
ETFs that have licensing rights to an index that may preclude them
from publicly disclosing the components of the index. See, e.g.,
NYSE Arca 2008 Comment Letter; Comment Letter of Russell Investments
(Aug. 27, 2008). Today, Commission staff, through conversations with
ETF industry participants, understands the preference for this
basket transparency approach to be significantly lessened.
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We are proposing to require full transparency for all ETFs under
this rule rather than proposing alternative transparency requirements
for index-based ETFs or actively managed ETFs.\216\ We generally agree
with commenters on the 2008 proposal that portfolio transparency
provides more detailed information than the index alone when an index-
based ETF utilizes sampling techniques or holds derivatives or other
instruments and, as noted above, all ETFs that could rely on the
proposed rule already provide full portfolio transparency as a matter
of market practice. Full portfolio transparency also may be useful for
investors when they are determining the efficacy of an index-based ETF
tracking a particular index because performance of two ETFs tracking
the same index can differ based on sampling practices.\217\ Similarly,
where the primary information used to support the arbitrage mechanism
is information about holdings, full portfolio transparency may be more
helpful to market makers modelling ETFs that seek to track highly
customized or bespoke indexes.
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\216\ See supra section II.A.2.
\217\ See, e.g., Ben Johnson, Assessing the Total Cost of ETF
Ownership, Morningstar Advisor (Apr. 12, 2017), available at https://beta.morningstar.com/articles/802211/assessing-the-total-cost-of-etf-ownership.html.
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We seek comment on the portfolio transparency condition of the
proposed rule.
Should the rule include other transparency options? For
example, should we have different transparency requirements for index-
based ETFs and actively managed ETFs, similar to those proposed in
2008? Would disclosure of an index's constituents alone provide
detailed enough information to allow market participants to effectively
hedge the ETF's portfolio when an index-based ETF utilizes sampling
techniques or holds derivatives or other instruments? Do index
providers make information about index constituents easily accessible
today? Are there other alternatives we should consider? For example,
would disclosure of an ETF's basket provide a basis for effective
hedging? In setting forth an option, please explain how your proposed
level of transparency would allow effective arbitrage.
[[Page 37353]]
Are there any circumstances that would prevent an index-
based ETF from disclosing its portfolio holdings?
Are we correct that all ETFs that could rely on the
proposed rule currently provide full transparency as a matter of market
practice?
Would publicly available website disclosure of portfolio
holdings be an effective way to convey this information? If not, what
other means of disclosure should the rule require or permit? For
example, should we allow ETFs to comply with the transparency condition
by transmitting a portfolio composition file or ``PCF'' to a central
clearing facility? Would this method provide information to enough
market participants to facilitate the arbitrage mechanism? Would it
give fair and equal access to all market participants? Should we
require ETFs to provide daily portfolio holdings information to the
Commission through other means, such as filing on EDGAR?
Should proposed rule 6c-11 define ``publicly available''
for purposes of the website disclosure requirements? If so, what
definition should we use? For example, should the rule require that all
information publicly posted on a website pursuant to rule 6c-11 be and
remain freely and persistently available and easily accessible by the
general public on the ETF's website and that the information must be
presented in an easily accessible manner, without encumbrance, and must
not be subject to any restrictions, including restrictions on access,
retrieval, distribution and reuse?
Should we require ETFs to reflect changes in portfolio
holdings no earlier than a T+1 basis as proposed? Is this condition
necessary?
Should we define ``business day'' as proposed or are there
alternative definitions we should consider? Do commenters believe that
ETFs are likely to calculate NAV per share more than once each business
day in the future? If so, would a ``business day'' standard cause
compliance challenges with the portfolio holdings disclosure
requirements?
Should the rule require that portfolio holdings disclosure
be provided before the opening of regular trading on the primary
listing exchange of the ETF's shares and before the ETF starts
accepting orders for the purchase or redemption of creation units?
Alternatively, should the rule exclude timing requirements? Are there
operational issues that would make compliance with the timing
requirements challenging or costly?
Should we consider exemptions for ETFs with non-
transparent or partially transparent portfolios as part of proposed
rule 6c-11? Would a rule of general applicability be the appropriate
means to provide an exemption for ETFs using a novel arbitrage
mechanism?
b. Disclosure of Securities, Assets or Other Investment Positions
The proposed rule would require ETFs to disclose on their websites
all portfolio holdings that will form the basis for the ETF's next
calculation of NAV per share. Under the proposed rule, the term
``portfolio holdings'' is defined to mean an ETF's securities, assets,
or other positions.\218\ As a result, an ETF would be required to
disclose its cash holdings, as well as holdings that are not securities
or assets, including short positions or written options.\219\ We
believe that this approach would provide more consistent and
comprehensive information regarding an ETF's portfolio holdings
compared to other means of disclosure, allowing market participants to
fairly and effectively value the entirety of the ETF's portfolio
holdings. We believe this, in turn, would facilitate the arbitrage
mechanism by allowing authorized participants and other market
participants to more effectively hedge their exposure to a particular
ETF.
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\218\ See proposed rule 6c-11(a).
\219\ Under the proposed rule, for example, an ETF would have to
disclose that it entered into a written call option, under which it
would sacrifice potential gains that would result from the price of
the reference asset increasing above the price at which the call may
be exercised (i.e., the strike price). Unless the ETF discloses the
presence of these and similar liabilities, authorized participants
and other investors may not be able to fully evaluate the
portfolio's exposure.
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In order to standardize the manner in which portfolio holdings are
presented on the ETF's website, the proposed rule would require that
portfolio holdings information be presented and contain information
regarding description, amount, value and/or unrealized gain/loss (as
applicable) in the manner prescribed within 17 CFR 210.12-12, 210.12-
12A, 210.12-13, 210.12-13A, 210.12-13B, 210.12-13C, and 210.12-13D
(``Article 12 of Regulation S-X''), which sets forth the form and
content of fund financial statements.\220\ This framework should be
efficient for such disclosure because ETFs already comply with it for
financial reporting purposes and track the relevant information for
daily NAV calculations. Based on a staff review of ETF websites, there
is currently little consistency regarding how portfolio holdings
information is presented, particularly with respect to derivatives. We
believe that this inconsistency may lead to investor confusion.\221\
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\220\ See 17 CFR 210.12-12, 210.12-12A, 210.12-13, 210.12-13A,
210.12-13B, 210.12-13C, and 210.12-13D. For investments in
securities, securities sold short, and other investments, this would
include the name of issuer and title of issue (as prescribed within
the S-X schedules including any related footnotes on the description
columns), balance held at close of period, number of shares,
principal amount of bonds, and value of each item at close of
period. For derivatives, this would include the description (as
prescribed within the S-X schedules including any related
footnotes), number of contracts, value, expiration date (as
applicable), unrealized appreciation/depreciation (as applicable),
and amount and description of currency to be purchased and to be
sold (as applicable).
\221\ We recognize that the generic listing standards for
actively managed ETFs also currently require website disclosure of
the ticker, CUSIP, description of the holding, and percentage of net
assets for each portfolio holding. See NYSE Arca Rule 8.600-E(c)(2);
Nasdaq Rule 5735(c)(2); Cboe BZX Rule 14.11(i)(3)(B).
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The proposed rule would not require disclosure of intraday changes
in the portfolio holdings of the ETF or advance disclosure of portfolio
trades because changes in holdings would not affect the composition of
the ETF's portfolio that serves as a basis for NAV calculation until
the next business day.\222\ The selective disclosure of nonpublic
information regarding intraday changes in portfolio holdings and
advance disclosure of portfolio trades, however, could result in the
front-running of an ETF's trades, causing the ETF to pay more to obtain
a security. We have stated that registered investment companies'
compliance policies and procedures required by 17 CFR 38a-1 (``rule
38a-1'' under the Act) should address potential misuses of nonpublic
information, including the disclosure to third parties of material
information about a fund's portfolio, its trading strategies, or
pending transactions, and the purchase or sale of fund shares by
advisory personnel based on material, nonpublic information about the
fund's portfolio.\223\ ETFs are also required to describe their
policies and procedures on portfolio security disclosure in the
Statement of Additional Information and post such policies and
procedures
[[Page 37354]]
on their websites.\224\ As we noted in the release adopting these
disclosures, a fund or investment adviser that discloses the fund's
portfolio securities may only do so consistent with the antifraud
provisions of the federal securities laws and the adviser's fiduciary
duties.\225\ Moreover, divulging nonpublic portfolio holdings to
selected third parties is permissible only when the fund has legitimate
business purposes for doing so and the recipients are subject to a duty
of confidentiality, including a duty not to trade on the nonpublic
information.\226\
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\222\ See supra footnote 208. None of our exemptive orders has
required advance disclosure of intraday changes in the portfolio of
the ETF or advance disclosure of portfolio trades. Instead, our
orders have required ETFs to use the prior business day's portfolio
holdings.
\223\ Compliance Programs of Investment Companies and Investment
Advisers, Investment Company Act Release No. 26299 (Dec. 17, 2003)
[68 FR 74714 (Dec. 24, 2003)] (``Rule 38a-1 Adopting Release'').
ETFs typically disclose (and would be required to disclose pursuant
to proposed rule 6c-11) portfolio holdings information with greater
frequency than other open-end funds, which are generally required to
publicly disclose holdings on a quarterly basis.
\224\ See Items 9(d) and 16(f) of Form N-1A; see also Disclosure
Regarding Market Timing and Selective Disclosure of Portfolio
Holdings, Investment Company Act Release No. 26418 (Apr. 20, 2004)
[69 FR 22299 (Apr. 23, 2004)] (``Disclosure of Portfolio Holdings
Release''), at section II.C.
\225\ See Disclosure of Portfolio Holdings Release, supra
footnote 224, at section II.C.
\226\ Id.
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We seek comment on this aspect of the proposed rule.
Should we require ETFs to present the description, amount,
value and unrealized gain/loss in the manner prescribed within Article
12 of Regulation S-X? Would such a presentation be more or less
effective in disclosing portfolio holdings information than current
website disclosure practices for ETFs? Do investors use current
portfolio holding disclosures? Do current disclosure practices
regarding portfolio holdings result in investor confusion? For example,
do investors find the lack of consistency around the presentation of
derivatives holdings confusing?
Should we consider excluding any of the requirements in
Article 12 of Regulation S-X? For example, is information regarding
unrealized gain and loss useful for all ETFs? Should we only require
that disclosure for ETFs that transact with authorized participants on
a cash basis? Will disclosure of non-securities investment positions
and assets permit investors, particularly authorized participants and
other market participants engaged in arbitrage activities, to assess
the full scope of the ETF's portfolio holdings?
Is there any additional or alternative holdings
information that we should require ETFs to disclose on their websites?
For example, should we require daily disclosure regarding the ticker,
CUSIP, or other identifier; sub-categories of holdings; and the
percentage of net assets for each holding?
Should ETFs be required to disclose all liabilities as
part of their portfolio holding disclosure? For example, would
disclosure of bank borrowings allow authorized participants and other
market participants to evaluate the impact of leverage from these types
of borrowings on the ETF's portfolio? How would the arbitrage mechanism
work without this disclosure?
Would the presentation requirements facilitate clear and
uniform disclosure? Are there alternative presentation requirements we
should consider? If so, what would those requirements be?
The proposed rule would not require disclosure of intraday
changes in the portfolio holdings of the ETF or advance disclosure of
portfolio trades because changes in holdings would not affect the
composition of the ETF's portfolio that serves as a basis for NAV
calculation until the next business day. Should we require ETFs to
disclose intraday changes in the portfolio or require advance
disclosure of portfolio trades? Would such disclosure requirements
improve transparency in a meaningful way? Would such disclosure
requirements be costly to implement? Would an ETF or its investors
suffer any harm if such information were disclosed? If so, how?
Should we require ETFs to maintain portfolio holdings
disclosure on their websites for periods longer than one day? If so,
for how long (e.g., 30 days)?
ETFs trade in both portfolio assets (e.g., when
rebalancing) and creation units (when transacting with authorized
participants). Does this raise any execution issues for ETFs? For
example, how do ETFs prevent certain counterparties from receiving
preferential treatment? \227\ Are the policies and procedures noted
above adequate to protect nonpublic information from misuse by
authorized participants and other market participants that have access
to ETF sensitive trade data? For example, how do ETFs ensure that
authorized participants are not trading ahead of ETF rebalancing trades
or other changes to its portfolio? Are there other requirements that we
should adopt to protect ETFs and their investors? For example, should
an ETF be required to maintain communications (including electronic
communications) with its authorized participants?
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\227\ See, e.g., Interpretive Release Concerning the Scope of
Section 28(e) of the Securities Exchange Act of 1934 and Related
Matters, Exchange Act Release No. 34-23170 (Apr. 28, 1986), at
section V (discussing obligation of money manager to obtain best
execution of client transactions).
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ETFs currently are not subject to Regulation FD, which
prohibits the selective disclosure of information by publicly traded
companies and other issuers.\228\ Should we amend Regulation FD to
apply to ETFs given that any information that is selectively disclosed
may be immediately used to trade ETF shares (or the ETF's portfolio
holdings) on the secondary market and given the proposed relief from
section 17(a) for affiliated transactions? \229\
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\228\ 17 CFR 243.
\229\ Regulation FD does not apply to investment companies,
other than closed-end funds. The releases proposing and adopting
Regulation FD do not specifically discuss ETFs. See Selective
Disclosure and Insider Trading, Investment Company Act Release No.
24209 (Dec. 20, 1999) [64 FR 72590 (Dec. 28, 1999)] (proposing
release), at paragraph preceding n.54 (``Investment companies that
are continually offering their securities to the public already are
required to update their prospectuses to disclose material changes
subsequent to the effective date of the registration statement or
any post-effective amendment, and are not permitted to sell, redeem,
or repurchase their securities except at a price based on their
securities' net asset value. While we believe that Regulation FD
would offer little additional protection to investors in these types
of investment companies and therefore they should be excluded from
its coverage, these considerations do not apply in the case of
closed-end investment companies.''). See also Selective Disclosure
and Insider Trading, Investment Company Act Release No. 24599 (Aug.
15, 2000) [65 FR 51716 (Aug. 24, 2000)] (adopting release).
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5. Baskets
Proposed rule 6c-11 would require each ETF relying on the rule to
adopt and implement written policies and procedures governing the
construction of baskets and the process that would be used for the
acceptance of baskets.\230\ In addition, the proposed rule would
provide an ETF with the flexibility to use ``custom baskets'' if the
ETF has adopted written policies and procedures setting forth detailed
parameters for the construction and acceptance of custom baskets that
are in the best interests of the ETF and its shareholders. The proposed
rule also would require an ETF to disclose prominently on its website,
which is publicly available and free of charge, information regarding a
published basket that will apply to orders for the purchase or
redemption of creation units each business day.\231\ We believe that
the conditions we are proposing related to baskets would provide ETFs
with the ability to customize baskets in circumstances that would
benefit the ETF and its investors, while at the same time putting in
place protections against the potential for authorized participants to
overreach by dictating the composition of baskets to the detriment of
other ETF investors.\232\
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\230\ See proposed rule 6c-11(c)(3). The proposed rule would
define ``basket'' to mean the securities, assets or other positions
in exchange for which an ETF issues (or in return for which it
redeems) creation units. See proposed rule 6c-11(a).
\231\ See proposed rule 6c-11(c)(1)(i)(B).
\232\ See, e.g., proposed rule 6c-11(c)(2).
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[[Page 37355]]
a. Basket Flexibility
Where an ETF uses in-kind creations and redemptions, the
composition of the basket is an important aspect of the efficient
functioning of the arbitrage mechanism.\233\ Basket composition affects
the costs of assembling and delivering the baskets that will be
exchanged for creation units as well as the costs of liquidating basket
securities when redeeming creation units. For example, the number of
positions included in a basket, as well as the difficulty and cost of
trading those positions, will affect the cost of basket transactions. A
basket with hundreds of relatively small positions may prove less
efficient than a basket with fewer positions.
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\233\ See supra section I.B.
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Basket composition also is important to ETF portfolio management.
Each in-kind creation or redemption increases or decreases positions in
the ETF's portfolio. Managing the composition of a basket allows the
ETF to add certain instruments to its portfolio during the creation
process (by including those securities in the basket that it will
accept in exchange for a creation unit), or, conversely, to remove
certain portfolio holdings during the redemption process (by including
them in a redemption basket while not accepting them in the creation
unit). This can be an efficient way for a portfolio manager to execute
changes in the ETF's portfolio because the manager can make the changes
without incurring the additional expenses of trades in the market. When
an ETF does not have flexibility to manage basket composition, however,
it may result in undesired changes to the portfolio, such as the loss
of desirable bonds when paying redemptions in kind.
The exemptive relief we have provided ETFs relating to baskets has
evolved over time. Our earliest ETF orders for index-based ETFs
organized as UITs provided that in-kind purchases of creation units
were to be made using a basket of securities substantially similar to
the composition and weighting of the ETF's underlying index.\234\ Given
the unmanaged nature of the UIT structure, a UIT ETF's basket generally
reflected a pro rata representation of the ETF's portfolio.\235\
---------------------------------------------------------------------------
\234\ See, e.g., SPDR, supra footnote 34.
\235\ See supra section II.A.1. A UIT ETF could substitute cash
for basket assets in certain limited circumstances. See, e.g., SPDR,
supra footnote 34.
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Early orders for ETFs organized as open-end funds included few
explicit restrictions on baskets, and these orders did not expressly
limit ETFs' baskets to a pro rata representation of the ETF's portfolio
holdings.\236\ Since approximately 2006, however, as the ETF industry
grew and the Commission gained more experience with ETFs, our exemptive
orders have placed tighter restrictions on ETFs' composition of
baskets.\237\ These orders expressly require that the ETF's basket
generally correspond pro rata to its portfolio holdings, while
identifying certain limited circumstances under which an ETF may use a
non-pro rata basket.\238\ Our recent exemptive orders, for example,
permit ETFs to use baskets that do not correspond pro rata to the ETF's
portfolio holdings when it is impossible to break up bonds beyond
certain minimum sizes needed for transfer and settlement or where
rounding is necessary to eliminate fractional shares.\239\ The orders
have allowed baskets to deviate from a pro rata representation where
the basket includes positions that cannot be transferred in kind, such
as ``to be announced'' transactions (``TBA transactions''), short
positions, and derivatives.\240\ We have also permitted index-based
ETFs to use non-pro rata baskets where the ETF has determined to use
representative sampling of its portfolio to create its basket,\241\ and
for temporary periods to replicate changes in the ETF's portfolio
holdings as a result of the rebalancing of the ETF's securities market
index.
---------------------------------------------------------------------------
\236\ See WEBs Index Fund, Inc., et al., Investment Company Act
Release Nos. 23860 (June 7, 1999) [64 FR 31658 (June 11, 1999)]
(notice) and 23890 (July 6, 1999) (order) and related application.
\237\ See, e.g., 2006 WisdomTree Investments, supra footnote 66;
see also infra footnote 245 and accompanying paragraph.
\238\ See 2006 WisdomTree Investments, supra footnote 66 (``[I]n
limited circumstances and only when doing so would be in the best
interest of a Fund as determined by the Advisor or Subadvisor, each
Fund may designate Deposit Securities that may not be an exact pro
rata reflection of such Fund's Portfolio Securities. For example, a
Fund might designate a non-pro rata basket of Deposit Securities if
one or more Portfolio Securities were not readily available, or in
order to facilitate or reduce the costs associated with a
rebalancing of a Fund's portfolio in response to changes in its
Underlying Index.'').
\239\ See, e.g., Nationwide Fund Advisors, et al., Investment
Company Act Release Nos. 32727 (July 6, 2017) [82 FR 32214 (July 12,
2017)] (notice) and 32771 (Aug. 1, 2017) (order) and related
application.
\240\ Id. In the TBA market, lenders enter into forward
contracts to sell agency mortgage-backed securities and agree to
deliver such securities on a settlement date in the future. The
specific agency mortgage-backed securities that will be delivered in
the future may not yet be created at the time the forward contract
is entered into. The purchaser will contract to acquire a specified
dollar amount of mortgage-backed securities, which may be satisfied
when the seller delivers one or more mortgage-backed securities
pools at settlement. See LRM Adopting Release, supra footnote 101,
at n.381.
\241\ See Morgan Stanley, supra footnote 211. In this context,
representative sampling means that the ETF's baskets do not reflect
a pro rata representation of the ETF's portfolio but contain assets
from the ETF's portfolio that have been determined by the ETF to
constitute a representative sample of the portfolio. See id. Our
exemptive orders have expressly limited the circumstances under
which the ETF may use representative sampling to select its basket
assets: (i) The sample must be designed to generate performance that
is highly correlated to the performance of the ETF's portfolio; (ii)
the sample must consist entirely of instruments that are already
included in the ETF's portfolio; and (iii) the sample must be the
same for all authorized participants on a given business day. See
id.
---------------------------------------------------------------------------
Our recent exemptive orders also have permitted ETFs to
specifically substitute cash for some or all of the securities in the
ETF's basket in certain limited circumstances, including where the
basket includes securities that are not eligible for trading due to
local trading restrictions or are not available in sufficient quantity
for purchases of creation units.\242\ In addition, while most existing
ETFs typically engage in creation and redemption transactions on an in-
kind basis, we have permitted ETFs to use an all-cash basket.\243\ Due
to the limited transferability of certain financial instruments, some
ETFs operate on a cash-only basis under their exemptive orders.\244\
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\242\ See, e.g., J.P. Morgan Exchange-Traded Fund Trust, et al.,
Investment Company Act Release Nos. 30898 (Jan. 30, 2014) [79 FR
6941 (Feb. 5, 2014)] (notice) and 30927 (Feb. 25, 2014) (order) and
related application. These orders also generally require an ETF to
use the same basket for both purchases and redemptions on a
particular business day, subject to certain exceptions. See, e.g.,
id.
\243\ See, e.g., 2006 WisdomTree Investments, supra footnote 66.
\244\ See, e.g., ProShares Trust, et al., Investment Company Act
Release Nos. 27975 (Sept. 21, 2007) [72 FR 55257 (Sept. 28, 2007)]
(notice) and 28014 (Oct. 17, 2007) (order) and related application.
---------------------------------------------------------------------------
The requirement that baskets correspond pro rata to the ETF's
portfolio holdings, and the increasingly limited exceptions to the pro
rata requirement, were designed to address the risk that an authorized
participant could take advantage of its relationship with the ETF and
pressure the ETF to construct a basket to be used only for that
authorized participant and that favors the authorized participant to
the detriment of the ETF's shareholders. For example, because ETFs rely
on authorized participants to maintain the secondary market by
promoting an effective arbitrage mechanism, an authorized participant
holding less liquid or less desirable securities potentially could
pressure an ETF into accepting those securities in its basket in
exchange for liquid ETF shares (i.e., dumping). An authorized
participant also could pressure the ETF into including in its basket
certain desirable securities in exchange for ETF shares tendered for
redemption (i.e., cherry-
[[Page 37356]]
picking). In either case, the ETF's other investors would be
disadvantaged and would be left holding shares of an ETF with a less
liquid or less desirable portfolio of securities. These abuses also
could occur when a liquidity provider or other market participant
engages in primary market transactions with the ETF by using an
authorized participant as an agent.\245\
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\245\ See supra footnote 22 and accompanying text.
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Based on our experience with ETFs, however, we recognize that there
are many circumstances, in addition to the specific circumstances
enumerated in our orders, where allowing baskets to differ from a pro
rata representation or allowing the use of different baskets for
different authorized participants could benefit the ETF and its
shareholders. For instance, ETFs without basket flexibility typically
are required to include a greater number of individual securities
within their baskets when transacting in kind, making it more difficult
and costly for authorized participants and other market participants to
assemble or liquidate baskets.\246\ This could result in wider bid-ask
spreads and potentially less efficient arbitrage. In such
circumstances, these ETFs may be at a competitive disadvantage to ETFs
with greater basket flexibility. As a result, these differing
conditions and requirements for basket composition in our exemptive
orders may have created a disadvantage for newer ETFs that are subject
to our more recent, stringent restrictions on baskets.
---------------------------------------------------------------------------
\246\ See Schwab ETP Comment Letter, supra footnote 115, at n.10
(``[W]e looked at the daily National Securities Clearing Corporation
Portfolio Composition Files for three Fixed-Income ETFs that each
seek to track the Barclays U.S. Aggregate Bond Index. The first ETF
is subject to the pro rata requirement and on the August 7, 2015
trade date that ETF included 1,486 securities in its creation
basket. The second and third ETFs are not subject to the pro rata
requirement. In striking contrast, on the same trade date these two
ETFs included only 64 and 56 securities in their creation baskets,
respectively.'').
---------------------------------------------------------------------------
Moreover, we believe that certain exceptions to a pro rata basket
requirement may help ETFs operate more efficiently. For example, a lack
of basket flexibility may cause some ETFs, particularly fixed-income
ETFs, to satisfy redemption requests entirely in cash in order to avoid
losing hard-to-find securities and to preserve the ETF's ability to
achieve its investment objectives.\247\ ETFs that meet redemptions in
cash may be required to maintain larger cash positions to meet
redemption obligations, potentially resulting in cash drag on the ETF's
performance. The use of cash baskets also may be less tax-efficient
than using in-kind baskets to satisfy redemptions, and may result in
additional transaction costs for the purchase and sale of portfolio
holdings.\248\
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\247\ As discussed above, many ETFs, including fixed-income
ETFs, are permitted under their exemptive orders to satisfy
redemptions entirely in cash where the ETF holds thinly traded
securities, among other circumstances. See, e.g., Pacific Investment
Management Company LLC et al., Investment Company Act Release Nos.
28723 (May 11, 2009) [74 FR 22772 (May 14, 2009)] (notice) and 28752
(June 1, 2009) (order) and related application.
\248\ In-kind redemptions allow ETFs to avoid taxable events
that arise when selling securities for cash within the ETF.
---------------------------------------------------------------------------
We believe it is appropriate, therefore, to provide additional
basket flexibility, subject to conditions designed to address concerns
regarding the potential risk of overreaching. Additional basket
flexibility potentially could benefit ETF investors through more
efficient arbitrage and narrower bid-ask spreads, among other
benefits.\249\ Further, we believe that permitting the same level of
basket flexibility for all ETFs relying on the rule would give a
consistent structure to ETFs relying on the rule and would remove a
barrier to entry for new ETFs.
---------------------------------------------------------------------------
\249\ See infra footnote 438 and accompanying paragraph; see
also infra footnote 444 and accompanying text.
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As proposed, rule 6c-11 would require all ETFs relying on the rule
to adopt and implement written policies and procedures that govern the
construction of baskets and the process that will be used for the
acceptance of baskets.\250\ These policies and procedures would be
required to cover the methodology that the ETF would use to construct
baskets. For example, the policies and procedures should detail the
circumstances when the basket may omit positions that are not
operationally feasible to transfer in kind. The policies and procedures
should detail when the ETF would use representative sampling of its
portfolio to create its basket, and how the ETF would sample in those
circumstances.\251\ The policies and procedures also should detail how
the ETF would replicate changes in the ETF's portfolio holdings as a
result of the rebalancing or reconstitution of the ETF's securities
market index, if applicable.
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\250\ See proposed rule 6c-11(c)(3). We note that ETFs already
may have policies and procedures governing the construction of
baskets in order to comply with the representations and conditions
of their exemptive orders. These policies and procedures, however,
would not have been subject to the requirements we are proposing for
custom basket policies and procedures, which we discuss below.
\251\ See supra footnote 38 for a discussion of sampling.
---------------------------------------------------------------------------
In addition to requiring that ETFs relying on the proposed rule
adopt and implement policies and procedures regarding the composition
of baskets, the proposed rule defines two particular types of baskets
as ``custom baskets,'' which are subject to additional conditions
designed to protect ETF investors. First, baskets that are composed of
a non-representative selection of the ETF's portfolio holdings would be
defined as custom baskets.\252\ A non-representative selection of the
ETF's portfolio holdings would include, but not be limited to, baskets
that do not reflect: (i) A pro rata representation of the ETF's
portfolio holdings; \253\ (ii) a representative sampling of the ETF's
portfolio holdings; or (iii) changes due to a rebalancing or
reconstitution of the ETF's securities market index, if applicable.
---------------------------------------------------------------------------
\252\ See proposed rule 6c-11(a) (defining ``custom baskets'' to
include baskets that are composed of a non-representative selection
of the ETF's portfolio holdings).
\253\ A basket that is a pro rata representation of the ETF's
portfolio holdings, except for minor deviations when it is not
operationally feasible to include a particular instrument within the
basket, generally would not be considered a ``custom basket.''
---------------------------------------------------------------------------
Second, different baskets used in transactions on the same business
day are defined as custom baskets under the proposed rule.\254\ For
example, if an ETF exchanges a basket with an authorized participant
that reflects a representative sampling of the ETF's portfolio holdings
and a different basket with either the same or another authorized
participant that represents a different representative sampling, both
baskets would be custom baskets. Similarly, if an ETF substitutes cash
in lieu of a portion of basket assets for a single authorized
participant, that basket would be a custom basket.
---------------------------------------------------------------------------
\254\ See proposed rule 6c-11(a) (defining ``custom baskets'' to
include different baskets used in transactions on the same business
day).
---------------------------------------------------------------------------
We believe the use of custom baskets presents an increased risk
that the ETF may be subject to improper pressure by an authorized
participant to create specific baskets that favor that authorized
participant. For example, using a custom basket could give authorized
participants more opportunities for cherry-picking, dumping, or other
abuses, including the potential for manipulative trading in the
underlying portfolio securities. The proposed rule includes heightened
process requirements for ETFs that use custom baskets as a means to
protect against these risks. We believe that requiring an ETF that
relies on the proposed rule to adopt basket policies and procedures
that include specified
[[Page 37357]]
requirements is an appropriately tailored means to address concerns
that authorized participants may overreach. Furthermore, we believe
that the consistent implementation of custom basket policies and
procedures would discipline the basket process and would act as a
safeguard against potential cherry picking or dumping of unwanted
securities by authorized participants.\255\
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\255\ In addition, in a highly competitive market, such as the
market for ETFs, low performance or high tracking error would make
ETFs undesirable for participants in both the primary and secondary
markets. ETFs that do not guard closely against dumping and cherry-
picking could have diminished performance or higher tracking error
over time, which would likely cause flows out of the fund.
---------------------------------------------------------------------------
Under the proposed rule, an ETF using custom baskets must adopt
policies and procedures that: (i) Set forth detailed parameters for the
construction and acceptance of custom baskets that are in the best
interests of the ETF and its shareholders, including the process for
any revisions to, or deviation from, those parameters; and (ii) specify
the titles or roles of the employees of the ETF's investment adviser
who are required to review each custom basket for compliance with those
parameters (``custom basket policies and procedures'').\256\ Effective
custom basket policies and procedures should provide specific
parameters regarding the methodology and process that the ETF would use
to construct or accept each custom basket. An ETF's custom basket
policies and procedures should describe the ETF's approach for testing
compliance with the custom basket policies and procedures and assessing
(including through back testing or other periodic reviews) whether the
parameters continue to result in custom baskets that are in the best
interests of the ETF and its shareholders. The custom basket policies
and procedures should be consistently applied and must establish a
process that the ETF will adhere to if it wishes to make any revisions
to, or deviate from, the parameters. In addition, ETFs should consider
adopting reasonable controls designed to prevent inappropriate
differential treatment among authorized participants.
---------------------------------------------------------------------------
\256\ Proposed rule 6c-11(c)(3)(i). We also are proposing to
require ETFs to maintain records detailing the composition of each
custom basket. See infra section II.D.
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As part of the custom basket policies and procedures, an ETF must
specify the titles or roles of employees of the ETF's investment
adviser who are required to review each custom basket for compliance
with the parameters set forth in those policies and procedures. An ETF
may want to consider whether employees outside of portfolio management
should review the components of custom baskets before approving a
creation or redemption. Finally, as discussed in more detail below in
section II.D, the ETF would be required to create a record stating that
each custom basket complies with the ETF's custom basket policies and
procedures.\257\
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\257\ See proposed rule 6c-11(d)(2)(ii).
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We believe that the ETF's investment adviser is in the best
position to design and administer the custom basket policies and
procedures and to establish parameters that are in the best interests
of the ETF and its shareholders.\258\ The ETF's adviser (and personnel)
would be familiar with the ETF's portfolio holdings and would be able
to assess whether the process and methodology used to construct or
accept a custom basket would be in the best interests of the ETF and
its shareholders and whether a particular custom basket complies with
the parameters set forth in the custom basket policies and procedures.
We believe that these requirements would allow an ETF to establish a
tailored framework for the utilization of custom baskets, while also
requiring the ETF to put into place safeguards against abusive
practices related to basket composition. Custom basket policies and
procedures designed and utilized in the best interests of an ETF and
its shareholders may help the ETF manage its portfolio more
efficiently, facilitate the arbitrage mechanism for the ETF, provide
liquidity in markets for the ETF's shares and/or the ETF's underlying
portfolio holdings, or provide other benefits to the ETF.
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\258\ An investment adviser has a fiduciary duty to act in the
best interests of a fund it advises. See section 36(a) under the
Act. See also, e.g., Rosenfeld v. Black, 445 F.2d 1337 (2d Cir.
1971); Brown v. Bullock, 194 F. Supp. 207, 229, 234 (S.D.N.Y.),
aff'd, 294 F.2d 415 (2d Cir. 1961); In re Provident Management
Corp., Securities Act Release No. 5155 (Dec. 1, 1970), at text
accompanying n.12; Rule 38a-1 Adopting Release, supra footnote 223,
at n.68.
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In addition, ETFs currently are required by rule 38a-1 under the
Act to adopt, implement and periodically review written policies and
procedures reasonably designed to prevent violations of the federal
securities laws.\259\ An ETF's compliance policies and procedures
should be appropriately tailored to reflect its particular compliance
risks. An ETF's basket policies and procedures (including its custom
basket policies and procedures), therefore, should be covered by the
ETF's compliance program and other requirements under rule 38a-1.\260\
For example, an ETF would be required to preserve the basket policies
and procedures pursuant to the requirements of rule 38a-1(d)(1). We
believe that the ETF's board of directors' oversight of the ETF's
compliance policies and procedures, as well as their general oversight
of the ETF, would provide an additional layer of protection for an
ETF's use of custom baskets.
---------------------------------------------------------------------------
\259\ See Rule 38a-1 Adopting Release, supra footnote 223.
\260\ For example, rule 38a-1 requires a fund's chief compliance
officer to provide a written report to the ETF's board of directors,
no less frequently than annually, that addresses, among other
things, the operation of the fund's compliance policies and
procedures and any material changes made to those policies and
procedures since the date of the last report and any material
changes to the policies and procedures recommended as a result of
the annual review of the policies and procedures. See rule 38a-
1(a)(4)(iii)(A).
---------------------------------------------------------------------------
Our 2008 proposal did not expressly contemplate that an ETF would
be permitted to substitute other securities in lieu of other basket
assets.\261\ Instead, the proposal noted that in some circumstances it
may not be practicable, convenient or operationally possible for the
ETF to operate on an in-kind basis, and indicated that a fund could
substitute cash for some or all of the securities in the basket.\262\
Commenters on this aspect of the 2008 proposal agreed with the
definition of basket and did not recommend any modifications.\263\
---------------------------------------------------------------------------
\261\ The 2008 proposal would have defined the term ``basket
assets'' as the securities or other assets specified each business
day in name and number by an ETF as the securities or assets in
exchange for which it will issue or in return for which it will
redeem ETF shares. See 2008 ETF Proposing Release, supra footnote 3.
\262\ See id., at nn.120-121 (describing the circumstances in
which an ETF may use cash in lieu of certain securities in the
basket).
\263\ See, e.g., ICI 2008 Comment Letter.
---------------------------------------------------------------------------
Under proposed rule 6c-11, however, an ETF would be permitted to
construct baskets using cash, securities, or other positions, provided
that the ETF has satisfied the appropriate policies and procedures
requirement (i.e., the standard requirement or the heightened
requirement for custom baskets). As noted above, the use of in-kind
baskets can result in several advantages to an ETF and its investors,
including tax efficiencies and transaction cost savings. We believe
that this approach would provide ETFs with flexibility to cover
operational circumstances that make the inclusion of certain portfolio
securities and other positions in a basket operationally difficult (or
impossible), while also facilitating portfolio management changes in a
cost- and tax-efficient manner. We believe that an ETF's policies and
procedures should include details regarding the
[[Page 37358]]
circumstances in which cash, securities, or other positions would be
substituted.
We seek comment on this aspect of the proposed rule.
Is our proposed definition of ``baskets'' appropriate?
Should the term exclude investments that are not securities or assets?
Should the term exclude instruments that cannot be transferred in kind?
Is our proposed requirement that all ETFs adopt written
policies and procedures governing basket construction appropriate? Are
there alternatives we should consider? For example, should we require
only ETFs that use custom baskets to adopt policies and procedures? Or,
instead of requiring ETFs to adopt policies and procedures governing
basket construction generally and custom basket policies and
procedures, should we adopt a single requirement that all ETFs adopt
policies and procedures governing the construction of baskets? If so,
what parameters should be placed on those policies and procedures? What
parameters, if any, should we place on board oversight of the policies
and procedures governing the construction of baskets?
Instead of permitting basket flexibility as proposed,
should we require baskets to reflect a pro rata representation of the
ETF's portfolio holdings? Should we enumerate specific exemptions to
the pro rata representation requirement? If so, what should those
exemptions include? For example, should we include an exemption for an
authorized participant prohibited from transacting in a certain basket
security? Should we require baskets to be representative of the ETF's
portfolio holdings according to some other criteria?
Should we allow ETFs to utilize baskets that deviate from
a pro rata representation of the ETF's portfolio holdings, but require
ETFs to utilize the same basket for all transactions on a particular
business day? If so, why?
Do the proposed basket conditions appropriately address
concerns of overreaching by authorized participants or other market
participants, including those that are first- or second-tier affiliates
identified in the rule? Should the proposed rule include any other
conditions to minimize the potential risks of overreaching or other
conflicts of interest by such affiliates? For example, should we limit
the ability of an ETF to utilize a custom basket when an authorized
participant or other market participant is an affiliate covered by the
proposed exemption from section 17(a)?
Is our proposed definition of ``custom basket''
appropriate? Alternatively, should the term encompass any basket that
deviates from a pro rata representation of the identities and
quantities of the portfolio holdings held by the ETF? Should we provide
additional guidance regarding instances where the basket is composed of
a non-representative selection of the ETF's portfolio? Should we
include examples in the definition of ``custom baskets''?
Are there any reasons to prohibit an ETF from using a
custom basket? If so, what are they?
Should we provide additional guidance or include
additional requirements in the rule regarding the elements of effective
custom basket policies and procedures? For example, should custom
basket policies and procedures set forth the minimum number of
positions that would be included in a custom basket? Should the custom
basket policies and procedures set forth parameters regarding the
effect of the custom basket on the value of the ETF's portfolio
holdings, its tracking error (if applicable), and the portfolio's
risks? Should these policies and procedures set forth the circumstances
under which the ETF would substitute cash in lieu of portfolio holdings
after considering the effect cash would have on performance, trading
costs, and if accepting cash would have tax consequences? Should they
set forth the parameters in which the ETF will accept odd-lot
securities in a custom basket? Are there any other considerations that
should be included? Alternatively, should we eliminate any or all of
the considerations discussed above?
Should we require an ETF to adopt policies and procedures
that set forth detailed parameters for the construction or acceptance
of custom baskets that are in the best interests of the ETF and its
shareholders as proposed? Should we require the policies and procedures
to include a process for any revisions to or deviation from the
parameters as proposed? Are there other parameters we should consider?
Should we require the custom basket policies and procedures to list the
titles or roles of the employees who review each custom basket for
compliance with the parameters as proposed? Should we provide guidance
regarding how this review should be done in cases where the ETF is sub-
advised? Should we require that this review be done only by employees
outside of portfolio management? If so, which employees and why?
As proposed, rule 6c-11 would require an ETF to create a
record stating that each custom basket complies with the ETF's custom
basket policies and procedures.\264\ Should we establish any other
recordkeeping requirements relating to basket flexibility?
---------------------------------------------------------------------------
\264\ See proposed rule 6c-11(d)(2)(ii).
---------------------------------------------------------------------------
Should the proposed rule require the ETF's investment
adviser to review the basket policies and procedures (including the
custom basket policies and procedures) on an annual basis or with such
frequency as the ETF's adviser deems reasonable and appropriate? Should
the proposed rule include board reporting requirements? For example,
should the proposed rule require the adviser to deliver an annual
report to the ETF's board regarding the implementation of the basket
policies and procedures?
b. Posting of a Published Basket
We also are proposing to require an ETF to post on its website
information regarding a published basket at the beginning of each
business day, as well as the estimated cash balancing amount if
any.\265\ We believe this disclosure would contribute to the efficiency
of the arbitrage mechanism by providing authorized participants and
other market participants with timely information regarding the
contents of a basket that the ETF will accept for creations and
redemptions each business day. This, in turn, would allow market
participants to value the contents of the basket on an intraday basis
to determine whether arbitrage opportunities exist. This information
also permits market makers to compare the ETF's portfolio holdings with
the basket.
---------------------------------------------------------------------------
\265\ See proposed rule 6c-11(c)(1)(i)(B) and (C). Under
proposed rule 6c-11(a), the ``cash balancing amount'' would be
defined as an amount of cash to account for any differences between
the value of a basket and the NAV of a creation unit. Our ETF
exemptive orders have recognized a cash balancing amount to
reconcile any difference between the asset value of a creation unit
and the value of the ETF's basket.
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In particular, we are proposing to require that an ETF publish on
its website one basket that it would exchange for orders to purchase or
redeem creation units to be priced based on the ETF's next calculation
of NAV per share each business day.\266\ This ``published'' basket must
be disclosed before the opening of trading of the ETF's shares and
before the ETF begins accepting orders for the purchase or redemption
of creation units to be priced based on the ETF's next calculation of
NAV.\267\ This requirement is designed to mitigate possible
inefficiencies in the arbitrage
[[Page 37359]]
mechanism that could result from delaying the publication of an ETF's
basket.\268\
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\266\ See proposed rule 6c-11(c)(1)(i)(B).
\267\ See id.
\268\ As proposed, an ETF relying on the rule also would be
required to disclose its portfolio holdings that will form the basis
of the next calculation of NAV per share in this manner. See
proposed rule 6c-11(c)(1)(i)(A).
---------------------------------------------------------------------------
Under this requirement, an ETF would publish a basket that it would
accept if presented by any authorized participant in exchange for
creation units (or present to an authorized participant redeeming
creation units).\269\ Accordingly, an ETF that planned to use only
custom baskets on a particular business day (e.g., a basket reflecting
a non-representative selection of the ETF's portfolio holdings), would
be required to post a custom basket as its ``published'' basket.
---------------------------------------------------------------------------
\269\ Our proposal does not prevent an ETF from changing the
assets in a published basket to respond to market conditions after
the basket is published.
---------------------------------------------------------------------------
Because an ETF would be required to post only one published basket
to comply with this condition, there may be occasions where an ETF
would not post the contents of every custom basket. We considered
proposing that ETFs be required to publish, after the close of trading
on each business day, information regarding every basket used by the
ETF to serve as an additional check against overreaching by authorized
participants. However, we preliminarily believe that this requirement
is an unnecessary additional burden, resulting in compliance and other
operational costs for ETFs to review the information before it is
posted. Instead, as discussed below in section II.D, we are proposing
to require ETFs to maintain records detailing the composition of
baskets, which would allow our staff to review an ETF's baskets as part
of an examination.
The 2008 proposed rule did not require ETFs to disclose their
baskets. We did note in that proposal, however, that basket disclosure
was a widely adopted industry practice and facilitated effective
arbitrage activity.\270\ On this issue, commenters on the 2008 proposal
stated that it was not necessary for the Commission to require ETFs to
disclose their baskets because that information was available in the
portfolio composition files provided each business day by ETFs to the
National Securities Clearing Corporation (``NSCC'').\271\ While this
still may be true, the composition of an ETF's basket for a given day
may be important information to not only authorized participants and
large institutional investors (who, as NSCC members, have access to the
daily portfolio composition files), but to other market participants as
well. For example, the information allows investors to compare the
ETF's baskets for a given day with its portfolio holdings, assists
market participants who are building their intraday hedge (we
understand that some market participants primarily look to the baskets
rather than the whole portfolio), and is important for purposes of
estimating any cash balancing amounts as it allows market participants
to compare the basket to the whole portfolio. We also believe that this
proposed basket disclosure requirement is sufficiently narrow to not
impose a significant burden on ETFs because it requires only one
basket-related disclosure each trading day, at the beginning of the
day.
---------------------------------------------------------------------------
\270\ See 2008 ETF Proposing Release, supra footnote 3, at n.27
and accompanying text. Many exemptive orders also require ETFs to
make basket information available on a daily basis. See, e.g., Salt
Financial, LLC, et al., Investment Company Act Release Nos. 32974
(Jan. 23, 2018) [83 FR 4097 (Jan. 29, 2018)] (notice) and 33007
(Feb. 21, 2018) (order) (``Salt Financial'').
\271\ See, e.g., NYSE Arca 2008 Comment Letter.
---------------------------------------------------------------------------
We request comment on this proposed requirement.\272\
---------------------------------------------------------------------------
\272\ We request comment regarding additional proposed website
disclosures at infra section II.C.6.
---------------------------------------------------------------------------
Are we correct that disclosure of an ETF's basket
facilitates the arbitrage mechanism? Is an ETF's basket composition
useful information to ETF investors in the secondary market?
Should we require the posting of a basket as proposed?
Should we provide additional guidance regarding what types of basket
would constitute a published basket?
Would the disclosure of one basket at the beginning of
each business day provide enough information to all market participants
about an ETF's basket composition, particularly for ETFs using custom
baskets? Should we instead require ETFs to disclose each basket used on
a given business day after the close of trading on the ETF's website?
Would these approaches cause competitive concerns or cause significant
operational challenges? What costs and benefits would be associated
with a requirement to publish all baskets used each business day? Would
such an approach allow better policing of potential overreaching by
authorized participants?
If an ETF is no longer willing to accept the basket posted
on its website on a particular business day because of market events,
should the rule require the ETF to post a replacement basket on the
website that the ETF would accept?
Our proposal is designed to strike a balance between
process and oversight requirements (i.e., policies and procedures
governing basket construction) and disclosure requirements. Do
commenters agree with this approach? Would additional basket
transparency lessen the need for policies and procedures relating to
basket composition? Is there a more appropriate balance between the two
types of requirements that we should consider?
Is our proposed definition of ``cash balancing amount''
appropriate?
Should we require the disclosure of baskets on an ETF's
website as proposed? Alternatively, should we allow ETFs to comply with
the basket transparency condition by sending the portfolio composition
file to a central clearing facility in accordance with current
practices? What would be the costs or operational burdens of each
approach? Would the website disclosure of this information benefit any
market participants (including retail investors) that may not have
access to the portfolio composition file? If so, how would market
participants use this information?
6. Website Disclosure
There has been a significant increase in the use of the internet as
a tool for disseminating information,\273\ and we believe that many
investors obtain information regarding ETFs on the ETFs' websites.
Proposed rule 6c-11 therefore would require ETFs to disclose certain
information on their websites as a condition to the rule.\274\ As noted
above, we believe that the arbitrage mechanism works more efficiently
when certain data is publicly available to investors each trading day,
and are therefore proposing ETF website disclosures in order to provide
transparency of portfolio holdings and baskets.\275\ In addition, we
are proposing several website disclosure requirements that are designed
to provide investors with key metrics to evaluate their investment and
trading decisions in a format that is easily accessible and frequently
updated. Specifically, the proposed rule would require disclosure
regarding: (i) The ETF's NAV per share, market price, and premium or
discount, each as of the end of the prior business day; (ii) bid-ask
spreads; and (iii) historical information regarding premiums and
discounts.
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\273\ See, e.g., Reporting Modernization Adopting Release, supra
footnote 147.
\274\ Proposed rule 6c-11(c)(1).
\275\ See supra sections II.C.4 and II.C.5.
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Some of these conditions are based on our exemptive relief, which
has required ETFs to disclose on their
[[Page 37360]]
websites certain information regarding their investments and
operations, including quantitative information regarding discounts or
premiums at which the ETF's shares trade on the secondary market.\276\
Our orders have required ETFs to publicly disclose on their websites:
(i) The prior business day's NAV per share; (ii) the market closing
price or the midpoint of the bid-ask spread at the time of the
calculation of NAV; and (iii) a calculation of the premium or discount
of the market closing price or midpoint of the bid-ask spread against
NAV per share.\277\ Similarly, Form N-1A currently provides an ETF with
the option to omit certain historical information regarding premiums
and discounts from its prospectus and annual report if the disclosure
is provided on its website.\278\ Based on our experience overseeing
ETFs, we are proposing additional website disclosure requirements that
have not been part of our exemptive relief or Form N-1A requirements.
We also are requesting comment regarding ways to better inform
investors about intraday deviations between an ETF's market price and:
(i) NAV per share; (ii) the contemporaneous value of its portfolio; or
(iii) both. Each of the proposed website disclosures is discussed
below.
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\276\ See, e.g., Barclays Global 2008, supra footnote 58.
\277\ See supra footnote 134 and accompanying text.
\278\ See infra section II.H.
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a. Daily NAV, Market Price, and Premiums and Discounts
Proposed rule 6c-11(c)(1)(ii) would require ETFs to post on their
websites, on each business day, the ETF's current NAV per share, market
price, and premium or discount, each as of the end of the prior
business day. This disclosure provides investors with a ``snapshot''
view of the difference between an ETF's NAV per share and market price
on a daily basis. It is designed to alert investors to the relationship
between NAV per share and the market price of the ETF's shares and that
they may sell or purchase ETF shares at prices that do not correspond
to NAV of the ETF. It also is designed to allow investors to compare
this information across ETFs. For example, an investor using this
information likely would notice that ETFs tracking emerging markets
tend to have greater premiums or discounts than ETFs tracking broad-
based domestic indexes. We believe that daily website disclosure of
this information would promote transparency and help investors better
understand the risk that an ETF's market price may be higher or lower
than the ETF's NAV per share. We further believe that ETF investors use
this information today, as ETFs currently provide this website
disclosure pursuant to the terms of their exemptive orders.
This proposed requirement is consistent with our exemptive orders
and generally consistent with our 2008 proposal, except we have changed
the definition of ``market price''.\279\ Proposed rule 6c-11 would
define the term ``market price'' to mean: (i) The official closing
price of an ETF share; or (ii) if it more accurately reflects the
market value of an ETF share at the time as of which the ETF calculates
current NAV per share, the price that is the midpoint of the national
best bid and national best offer (``NBBO''), calculated as of the time
NAV per share is calculated.\280\
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\279\ See 2008 ETF Proposing Release, supra footnote 3.
\280\ See proposed rule 6c-11(a).
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The 2008 proposed rule would have defined ``market price'' only as
the last price at which ETF shares trade on their principal U.S.
trading market during a regular trading session. However, we believe
that using the ``official closing price,'' as opposed to the ``closing
market price,'' is a better measure of an ETF's market price,
particularly in situations where the last trade of the day was not
reflective of the actual market price (e.g., due to an erroneous
order). Exchanges have detailed rules regarding the determination of
the official closing price of a security.\281\ For example, if a
listing exchange experiences a systems disruption and cannot conduct
closing auctions, exchanges use their back-up procedures to determine
the ``official closing price'' for the affected securities (such as
relying on a backup exchange's closing auction). As a result, we
preliminarily believe that using the ``official closing price''
provides a more precise measurement of an ETF's market price, including
during disruptive market events.
---------------------------------------------------------------------------
\281\ See, e.g. Self-Regulatory Organizations; New York Stock
Exchange LLC; NYSE MKT LLC; Notice of Filings of Amendment No. 1,
and Order Granting Accelerated Approval of Proposed Rule Changes, as
Modified by Amendment No. 1, to Provide for How the Exchanges Would
Determine an Official Closing Price if the Exchanges are Unable to
Conduct a Closing Transaction, Exchange Act Release No. 78015 (June
8, 2016) [81 FR 38747 (June 14, 2016)] (NYSE backup procedures).
---------------------------------------------------------------------------
Commenters on the 2008 ETF Proposing Release who addressed this
aspect of the proposal opposed the proposed definition of market price
because of concerns that the last price at which an ETF trades could be
stale at the time as of which NAV per share is calculated.\282\ These
commenters suggested that ETFs instead be permitted to use the midpoint
between the highest bid and the lowest offer at the time as of which
the ETF's NAV is calculated.\283\ We generally agree and, as a result,
we are proposing to permit ETFs to use a price that is the midpoint of
the NBBO as of that time, if it is more accurate.\284\ Because security
information processors calculate NBBO continuously during the trading
day, NBBO has the benefit of being a verifiable third-party quote. We
believe that this approach provides an appropriate degree of
flexibility to an ETF when its last reported sales price may be stale,
while at the same time providing a consistent and verifiable
methodology for how ETFs determine market price.
---------------------------------------------------------------------------
\282\ See, e.g., Chapman 2008 Comment Letter (noting that shares
of some smaller ETFs may not trade often or at all on a particular
day); ICI 2008 Comment Letter (noting that closing price may be less
accurate because the last trade occurred at a much earlier time than
the time as of which NAV is calculated).
\283\ See, e.g., Chapman 2008 Comment Letter.
\284\ See proposed rule 6c-11(a) (defining ``market price'');
see also rule 600(b)(42) of Regulation NMS (defining NBBO). [17 CFR
242.600]. The NBBO represents the highest bid and lowest offer for
an ETF share consolidated across all exchanges.
---------------------------------------------------------------------------
As discussed in more detail below, the proposed definition of
market price also differs from the definition currently used in Form N-
1A.\285\ Form N-1A defines ``market price'' as the last reported sale
price or, if it more accurately reflects the current market value of
the ETF's shares, ``a price within the range of the highest bid and
lowest offer.'' \286\ We believe specifying that an ETF must use the
midpoint of the NBBO, rather than ``a price within the range of the
highest bid and lowest offer'' still provides the ETF with flexibility
in determining a market price for its shares that accurately reflects
the shares' market value. At the same time, requiring ETFs to use the
midpoint in these circumstances would mitigate the potential for gaming
practices that could inaccurately minimize a deviation between market
price and NAV per share when showing premiums and discounts.\287\ We
are proposing to amend Form N-1A to remove the definition of market
price in that form
[[Page 37361]]
as it would no longer be used in the same manner.\288\
---------------------------------------------------------------------------
\285\ See infra section II.H.1.
\286\ See General Instruction A to Form N-1A.
\287\ An ETF would use the market price of an ETF share in
calculating premiums and discounts. See proposed rule 6c-11(a)
(defining ``premium or discount'' to mean the positive or negative
difference between the market price of an ETF share and the ETF's
current NAV per share, expressed as a percentage of the ETF's
current NAV per share).
\288\ See infra section II.H.1.
---------------------------------------------------------------------------
We believe that the daily premium/discount disclosures (and
calculation methodology) we are proposing would provide investors with
useful information regarding ETFs that frequently trade at a premium or
discount to NAV per share. For example, some ETFs have frequent
deviations between closing market price and NAV per share. These ETFs
typically hold non-U.S. securities and trade during hours when the
markets for their non-U.S. holdings are closed, allowing the trading
price of ETF shares to reflect expected changes in the next opening
price of the non-U.S. holdings (i.e., to help ``discover'' the price of
the holdings). ETFs also may have greater premiums and discounts to the
extent that there are greater transaction costs associated with
assembling baskets. In addition, an ETF with less liquid portfolio
holdings also may show a deviation between closing market price and NAV
per share,\289\ and an ETF with a less efficient arbitrage mechanism
may frequently show this type of end of day deviation.\290\
---------------------------------------------------------------------------
\289\ See LRM Adopting Release, supra footnote 101, at n.33 and
accompanying text.
\290\ See id at text following n.524 (``[S]hares of an ETF whose
underlying securities are relatively less liquid may not be able to
be counted on to provide liquidity to a fund investing in these
shares during times of stress. In the case of a significant decline
in market liquidity, if authorized participants were unwilling or
unable to trade ETF shares in the primary market, and the majority
of trading took place among investors in the secondary market, the
ETF's shares could trade continuously at a premium or a discount to
the value of the ETF's underlying portfolio securities.'').
---------------------------------------------------------------------------
We understand, however, that proposed premium/discount disclosure
would not provide investors with information regarding intraday
deviations between market prices and the next-calculated NAV or the
contemporaneous value of the ETF's underlying securities, even if the
deviation is significant. Some commentators have stated that the lack
of disclosure regarding intraday deviations could, in some
circumstances, be misleading.\291\ For example, some ETFs had
relatively large intraday deviations between market price and intraday
indicative values on August 24, 2015 that were not reflected as a
``premium'' or ``discount'' because market price and NAV per share were
tightly correlated by the end of the day.\292\
---------------------------------------------------------------------------
\291\ See, e.g., Henry T.C. Hu and John D. Morley, A Regulatory
Framework for Exchange-Traded Funds, 91 S. Cal. Law Review
(forthcoming 2018) (``Hu and Morley'') at 53 (``While simplicity and
other reasons help explain the SEC's decision to look only at the
close and not intra-day performance, the result was an emphatically
reassuring picture being presented to investors. As a result, an
investor may have a misleading sense as to the true risks and
returns of the ETF.'').
\292\ See supra footnote 128 and accompanying text.
---------------------------------------------------------------------------
While we believe that additional information regarding intraday
deviations could help ETF investors understand both the potential for
intraday deviations and the circumstances under which deviations have
occurred in the past, developing an accurate and cost-effective
methodology to calculate intraday deviations for all types of ETFs is
challenging. For example, there are many ways to calculate a market
price metric, such as the average of execution prices on a business day
or the midpoint of the NBBO measured at specific intervals during the
course of the trading day. These measures, however, often do not
provide a meaningful picture of intraday deviations because they can
give outliers either outsized importance (in the case of averages),
particularly for ETFs with low trading volume, or insufficient
importance (in the case of medians). In addition, the systems necessary
to calculate and track these measures can be complex and costly.
Similarly, developing an accurate measure of the contemporaneous
value of the ETF's portfolio is complex. As we noted in our discussion
of the IIV,\293\ calculations of contemporaneous value can be stale or
inaccurate for ETFs with foreign securities or less liquid debt
instruments for which market quotations are not readily available. For
such an ETF, a contemporaneous value calculated using last available
market quotations or stale prices may show a premium/discount to any
ETF share price that factors in fair valuations of the ETF's portfolio
holdings. Moreover, without prescribed uniform methodology
requirements, contemporaneous values can be calculated in different,
and potentially inconsistent, ways and lead to non-comparable premium/
discount disclosure. We request comment below on potential alternative
calculations and disclosure requirements that could inform investors
about intraday deviations.\294\
---------------------------------------------------------------------------
\293\ See supra section II.C.3.
\294\ Many ETFs provide qualitative disclosures in their
prospectuses regarding the potential for periods of market
volatility that could lead to deviations from NAV per share. See,
e.g., supra footnote 126.
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b. Bid-Ask Spread Disclosure
As discussed in more detail below, our proposed amendments to Form
N-1A would include new requirements for an ETF to disclose information
regarding bid-ask spreads on its website and in its prospectus.\295\
Specifically, an ETF would be required to disclose the median bid-ask
spread for the ETF's most recent fiscal year. A bid-ask spread is the
difference between the highest price a buyer is willing to pay to
purchase shares of the ETF (bid) and the lowest price a seller is
willing to accept for share of the ETF (ask).\296\ The proposed website
disclosures are designed to inform investors that they may bear bid-ask
spread costs when trading ETFs on the secondary market, which
ultimately could impact the overall cost of the investment. We are
concerned that investors may not be aware of the impact trading costs
may have on their investments in ETFs,\297\ and therefore, propose to
require ETFs to disclose median bid-ask spread information pursuant to
a prescribed methodology that would be set forth in Form N-1A. We
believe that this information would provide ETF investors with greater
understanding of these costs and would allow investors to compare this
information across ETFs. Spread costs for ETFs can vary significantly,
and disclosure regarding these costs could aid comparisons of ETFs
pursuing similar investment strategies. We believe this information
also would allow investors to better understand the costs of investing
in an ETF.\298\
---------------------------------------------------------------------------
\295\ See proposed amendment to Item 3 of Form N-1A. See also
infra section II.H.2. for a discussion of the bid-ask spread
disclosure requirements. We are also proposing to require ETFs to
provide an interactive calculator that would provide investors with
the ability to customize the hypothetical bid-ask spread disclosures
in Item 3 of Form N-1A to the investor's specific investing
situation. See id.
\296\ See proposed amendment to Item 3 of Form N-1A.
\297\ See, e.g., Simon Constable, How to Measure ETF Spreads,
The Wall Street Journal (Nov. 5, 2017), available at https://www.wsj.com/articles/how-to-measure-etf-spreads-1509937200.
\298\ As discussed in more detail below, mutual fund investors
typically do not incur bid-ask spread costs in connection with their
investment in a mutual fund. See infra section II.H.2.
---------------------------------------------------------------------------
We are proposing to require the disclosure of the bid-ask spread
information on an ETF's website to provide trading information that can
help investors make better informed investment decisions in a format
that is easily accessible and relied upon by a growing segment of
investors. Given the importance of this information to understanding
the total expenses an investor may bear when investing in an ETF, we
preliminarily believe that bid-ask spread information also should be
included in an ETF's prospectus. Without this bid-ask spread
information, we preliminarily believe
[[Page 37362]]
the fee and expense information provided in a prospectus may not always
provide a complete picture of an investment's true costs and/or allow
investors to easily compare prospectus disclosures across certain
investment options.\299\
---------------------------------------------------------------------------
\299\ Required prospectus disclosures for open-end funds
currently include shareholder fees such as sales charges and
redemption fees, as well as annual fund operating expenses. See Item
3 of Form N-1A.
---------------------------------------------------------------------------
c. Historical Information Regarding Premiums and Discounts
We also are proposing to require that ETFs disclose on their
websites historical information about the extent and frequency of an
ETF's premiums and discounts. In particular, proposed rule 6c-
11(c)(1)(iii) and (iv) would require an ETF to post on its website both
a table and line graph showing the ETF's premiums and discounts for the
most recently completed calendar year and the most recently completed
calendar quarters of the current year. Alternatively, for new ETFs that
do not yet have this information, the proposed rule would require the
ETF to post this information for the life of the fund.
Currently, an ETF is required to disclose historical premium/
discount information in its prospectus by providing tabular disclosure
of the number of trading days during the most recently completed
calendar year and quarters since that year ended on which the market
price of the ETF shares was greater than the ETF's NAV per share and
the number of days it was less than the ETF's NAV per share.\300\ An
ETF currently may omit the disclosure of specific premium/discount
information in its prospectus or annual report if the ETF provides the
information on its website and discloses in the prospectus or annual
report a website address where investors can locate the
information.\301\ We believe that investors may find this tabular
information helpful in understanding how often an ETF trades at a
premium or discount and the size of such premiums and discounts and are
proposing to require publication of a table on the ETF's website as
part of proposed rule 6c-11.\302\
---------------------------------------------------------------------------
\300\ Instruction 2 to Item 11(g)(2) of Form N-1A. ETFs are also
required to include a table with premium/discount information in
their annual reports for the five most-recently completed fiscal
years. Item 27(b)(7)(iv) of Form N-1A.
\301\ Item 11(g)(2) of Form N-1A; Item 27(b)(7)(iv) of Form N-
1A. Although the time period required in the disclosure is different
in the prospectus and annual report, ETFs are permitted to omit both
disclosures by providing on their websites only the premium/discount
information required by Item 11(g)(2) (the most recently completed
fiscal year and quarters since that year).
\302\ See proposed rule 6c-11(c)(1)(iii).
---------------------------------------------------------------------------
We additionally believe that graphic disclosure could assist some
investors with understanding how the arbitrage mechanism performs for
an ETF under various market conditions. Depending on a variety of
factors, an ETF could have persistent premiums or discounts (or both)
from the ETF's NAV. For example, certain classes of ETFs, such as those
that invest in less liquid securities, like high-yield bonds, and
securities that trade on international markets, have more persistent
deviations in ETF share prices from the ETF's NAV.\303\ Additionally,
for certain types of ETFs, the disclosure may inform investors about
the pricing of the ETF's portfolio holdings. ETFs holding foreign
securities that are traded on markets that are closed during U.S.
trading hours, for example, may have persistent premiums or discounts
resulting from this timing differential. In other cases, a persistent
deviation between market price and NAV per share could demonstrate
inefficiencies in an ETF's arbitrage mechanism.\304\
---------------------------------------------------------------------------
\303\ See Hu and Morley, supra footnote 291, at 12 (noting that
certain kinds of ETFs have much higher 95% confidence intervals of
almost 600 basis points) (internal citations omitted).
\304\ See, e.g., Crystal Kim, This Levered Gold Mining ETF Looks
Super Scary, Barrons (Apr. 20, 2017), available at https://www.barrons.com/articles/this-levered-gold-mining-etf-looks-super-scary-1492700892 (linking an ETF trading at a significant premium to
NAV to the ETF's suspension of creation units, and in turn, linking
the suspension to the limited availability of certain investments
the ETF needed to make in order to seek its investment objective).
---------------------------------------------------------------------------
While past performance cannot predict how an ETF will trade in the
future, we believe that it is important that investors, and
particularly retail investors, understand that certain classes of ETFs
could have a larger and more persistent deviation from NAV, which could
result in a higher cost to investors and a potential drag on returns.
In addition to alerting secondary market investors that an ETF's NAV
per share and market price may differ, these disclosures would provide
information regarding the frequency and extent of these deviations.
These disclosures thus would help investors understand the value of
their investment and could help shape whether they want to invest in a
particular ETF.
We believe that presenting the data as both a table and a line
graph would provide investors with useful information in a variety of
formats that are easy to view and understand, depending on the
investor's preference. For example, investors may find the proposed
tabular disclosure an easy to understand demonstration of how often the
ETF traded at a premium or discount. However, the tabular disclosure
does not allow investors to observe the degree of those deviations,
particularly during periods of market stress. For example, two ETFs may
have traded at a discount for the same number of days. One ETF's daily
deviations could have been small with little effect on investors
trading on those days, whereas the other ETF could have had significant
discounts. These distinctions would not be apparent based on the
required tabular disclosure, but would be observable with the graphic
disclosure we are proposing. As a result, in order to assist investors
with understanding an ETF's premiums and discounts, we are proposing
both tabular and graphical representations of daily premium and
discounts.\305\ In order to eliminate potentially duplicative
disclosure requirements, we are proposing to eliminate historical
premium/discount disclosure requirements in Item 11(g)(2) and Item
27(b)(7)(iv) of Form N-1A.\306\
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\305\ Under the proposal, the historical premium/discount
information would be required for the most recently completed
calendar year and the most recently completed calendar quarters of
the current year. This period was chosen as it was consistent with
existing requirements in Item 11(g)(2) of Form N-1A. We believe the
time period would allow investors to readily observe the extent and
frequency of deviations from NAV per share in a graphic format.
\306\ See infra section II.H.4.
---------------------------------------------------------------------------
Proposed rule 6c-11(c)(1)(v) also would require any ETF whose
premium or discount was greater than 2% for more than seven consecutive
trading days to post that information on its website, along with a
discussion of the factors that are reasonably believed to have
materially contributed to the premium or discount. We propose that ETFs
posting this information be required to post it on their websites on
the trading day immediately following the day on which the ETF's
premium or discount triggered this provision (i.e., on the trading day
immediately following the eighth consecutive trading day on which the
ETF had a premium or discount greater than 2%) and maintain it on their
websites for at least one year following the first day it was posted.
We believe that this proposed disclosure of information about ETFs'
premiums and discounts would promote transparency regarding the
significance and/or persistency of deviations between market price and
NAV per share, and thus may permit investors to make more informed
[[Page 37363]]
investment decisions. This information also may provide the market (and
the Commission) with information regarding the efficiency of an ETF's
arbitrage mechanism. As noted above, in the Commission's experience,
the deviation between the market price of ETFs and NAV per share,
averaged across broad categories of ETF investment strategies and over
time periods of several months, has been relatively small.\307\
Therefore, we believe that limiting this disclosure to ETFs that have a
premium or discount of greater than 2% for more than seven consecutive
trading days would serve to highlight potentially unusual circumstances
when an ETF has a persistent premium or discount.\308\
---------------------------------------------------------------------------
\307\ See supra footnotes 119-120 and accompanying text.
\308\ This belief is based on data obtained from Morningstar and
Bloomberg.
---------------------------------------------------------------------------
Given the proposed threshold, we do not believe that many ETFs
would be required to disclose this information.\309\ However, there
could be certain categories of ETFs that could be particularly
affected. An ETF that invests in foreign securities, for example, may
be more likely to experience a persistent deviation between market
price and NAV per share given that many foreign markets are closed
during the U.S. trading day. Such deviations may be pronounced if the
market on which the ETF's underlying securities trade is closed.\310\
---------------------------------------------------------------------------
\309\ See infra footnote 477 and accompanying text.
\310\ See Tom Lyndon, China A-Shares ETFs Trading at Steep
Discount to NAV, ETF Trends (Jul. 9, 2015), available at https://www.etftrends.com/2015/07/china-a-shares-etfs-trading-at-steep-discount-to-nav/ (reporting that U.S.-listed China A-shares ETFs
were trading at a steep discount to the underlying market because of
the fact that a significant number of companies stopped trading on
China's mainland stock exchanges).
---------------------------------------------------------------------------
The proposed rule would require the disclosure to include a
discussion of the factors that are reasonably believed to have
contributed to the premium or discount. We believe that this
requirement would provide secondary market investors with useful
context for the disclosed deviations. In addition, we believe that
requiring ETFs to maintain it on their website for at least one year
following the first day it was posted would identify those ETFs that
historically have had such an instance of persistent deviation between
market price and NAV per share.\311\
---------------------------------------------------------------------------
\311\ We recognize that historical information relating to these
deviations may not be predictive of future deviations, and request
comment below regarding whether the rule should require ETFs to
include a legend in proximity to the historical information warning
of its limitations.
---------------------------------------------------------------------------
We request comment on our proposed website disclosure requirements
for ETFs.\312\
---------------------------------------------------------------------------
\312\ For our specific requests for comment regarding an ETF's
daily portfolio and basket website disclosure, see our discussions
of those subjects, at supra sections II.C.4 and II.C.5,
respectively.
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Would the proposed website disclosures be useful in
informing investors of certain ETF characteristics and risks? For
example, would the disclosures alert investors to the relationship
between NAV per share and the market price of the ETF's shares? Would
they assist investors in understanding that they may sell or purchase
ETF shares at prices that do not correspond to NAV per share of the ETF
or that may reflect a premium or discount to NAV per share that is not
in line with the typical premium or discount for the same ETF? Would
they assist investors in assessing costs associated with premiums and
discounts and/or bid-ask spreads? Would the proposed requirements
promote the goals of enhancing transparency and encouraging market
discipline on ETFs? Understanding that ETF investors would be required
to access each ETF's website, would this information allow investors to
compare data across ETFs? Should we require ETFs to present their
disclosures in a structured format on their websites or in a filing
with the Commission in order to facilitate comparisons among ETFs?
To what extent would the proposed website disclosure
requirements increase ETFs' costs or result in operational challenges?
Should we require that information regarding NAV per
share, market price, and premiums and discounts be posted on an ETF's
website each business day as proposed? Should we specify the time by
which such information must be posted? For example, should we require
that an ETF post the information on its website before the opening of
trading each business day?
Should we define ``market price'' as proposed? Does the
proposed definition provide ETFs with too much discretion in
determining market price? Should we define market price using only the
``official closing price''? Is there an alternative price that we
should require instead of ``official closing price'' that would more
accurately reflect the ETF's share price at market close? Should we
provide an alternative calculation of market price, by using the
midpoint of the NBBO, as proposed? Is the midpoint of the NBBO an
appropriate alternative? If not, what method is appropriate? Do ETFs
and their service providers currently receive the NBBO for their
securities? If not, what are the additional costs, if any, of receiving
a NBBO quote? Should we require ETFs to disclose if, for example, they
use the midpoint of the NBBO rather than the official closing price?
Should we define an alternative closing price? For example, should we
use a definition similar to the one used by NYSE ARCA? \313\
Alternatively, should we adopt the definition of ``market price''
currently used in Form N-1A, which may provide even more discretion by
not referencing the midpoint? What definition of market price would
provide the most accurate presentation of market value? Would there be
investor confusion because of the proposed change?
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\313\ See NYSE Arca Rule 1.1(ll) (defining how official closing
price is determined if the exchange does not conduct a closing
auction or if a closing auction trade is less than a round lot); see
also Securities Exchange Act Release No. 82907 (March 20, 2018) [83
FR 12980 (March 26, 2018)] (order).
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Does calculating premiums and discounts using market close
information provide investors with information they would use?
Should we instead require a calculation and disclosure of
an intra-day premium or discount as compared to the next-calculated
NAV? How would investors use the disclosure of intraday deviations
between market prices and the next-calculated NAV? Would such
disclosure be costly and/or burdensome to produce? What calculation
methodology should we require for this disclosure? For example, should
we require ETFs to disclose information regarding the difference
between: (i) The mean or median of execution prices on a business day;
and (ii) the next-calculated NAV per share, in order to capture
situations where deviations between market price and NAV per share
significantly widened during the trading day, but were tightly
correlated at the time as of which NAV is calculated? Alternatively,
should we require ETFs to disclose information regarding the difference
between: (i) The midpoint of the NBBO calculated every minute; and (ii)
the next-calculated NAV? If so, should the midpoint of the NBBO be
calculated more or less frequently? Are there other ways to calculate
intraday market prices that would provide investors with meaningful
information regarding intraday deviations between market price and NAV
per share? If we require this type of disclosure, should it be in
addition to, or an alternative of, current premium/discount
disclosures? Alternatively, would 5th and/or 95th percentile data be
useful in this context? How frequently should ETFs disclose
[[Page 37364]]
information regarding intraday deviations between market prices and the
next-calculated NAV? How long should ETFs be required to maintain this
information on their website?
Should we instead require calculation and disclosure of an
intra-day premium or discount as compared to the contemporaneous value
of the ETF's portfolio? How would investors use the disclosure of
intraday deviations between market price and the contemporaneous value
of the ETF's portfolio? Would such disclosure be costly and/or
burdensome to produce? What calculation methodology should we require
for this disclosure? For example, despite the limitations of the IIV in
the context of arbitrage activity, could the IIV be useful for the
measurement and long-term tracking of an ETF's intraday market prices?
If so, should we prescribe a uniform methodology for the calculation of
the IIV? Should we require ETFs to value their portfolio holdings more
frequently for purposes of assessing any deviations between market
prices and the ETF's portfolio holdings, such as hourly or three times
a day? Are there other ways to value an ETF's portfolio on an intraday
basis that we should consider? How frequently should ETFs disclose
information regarding intraday deviations with the contemporaneous
value of the ETF's portfolio? How long should ETFs be required to
maintain this information on their website?
Alternatively, should we require ETFs to assess the
efficiency of their arbitrage mechanism pursuant to internal
methodologies and require ETFs to provide narrative disclosure
regarding intraday deviations between market price and (i) NAV; (ii)
the contemporaneous value of the ETF's portfolio; or (iii) both?
We are proposing to require ETFs to disclose the ETF's
median bid-ask spread for the most recent fiscal year. How would
investors use this information? Is the median bid-ask spread an
appropriate metric? For example, the median bid-ask spread would not
capture extreme events and stress periods. Should we require additional
bid-ask spread metrics, such as average spread, high-end spread (e.g.,
95th percentile) or effective spread? \314\ If so, why is it preferable
and how should it be calculated? Should we require ETFs to provide the
median or mean spreads for the year?
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\314\ For the purposes of this comment request, we consider the
effective spread the ``actual'' spread (i.e., the difference between
bid and the ask). We consider the average spread to be the figure
that takes the average bids and asks over a period of time and finds
the difference between them. As noted in the comment request, we
also are soliciting input on calculation methodology.
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Should we require that the bid-ask spread information be
included on both an ETF's website and in its prospectus? Would
investors benefit from having this information in both places? Should
we instead require it only on an ETF's website? Should the information
be required to be updated more or less frequently than proposed? If so,
how frequently? For example, should we require an ETF to disclose on
its website a trailing average spread over the course of a year,
updated daily? Are there particular categories of investors that may
not use or have access to the internet? If so, are there alternative
ways of communicating this information to them in a cost-effective
manner?
Proposed rule 6c-11(c)(1)(iii) would require an ETF to
post on its website a table showing the ETF's premiums and discounts
for the most recently completed calendar year and the most recently
completed calendar quarters of the current year. As we discussed above,
this disclosure is a condition in many of our exemptive orders and
required by Form N-1A. Do investors or their advisers use this
information? Are there other forms of presenting this data that would
be easier for investors to understand?
Proposed rule 6c-11(c)(1)(iv) would require an ETF to post
on its website a line graph showing the ETF's premiums and discounts
for the most recently completed calendar year and the most recently
completed calendar quarters of the current year. How would investors
and their advisers use a line graph? Are there other forms of
presenting this data that would be easier for investors to understand?
Should ETFs be required to include intra-day premiums and
discounts (calculated using one of the methodologies for which we
request comment above) as part of the line graph? How would this
disclosure be used by investors?
Should we require ETFs to provide both forms of disclosure
(i.e., table and line graph)? Would investors use this information?
Should we require more layered disclosure, such as an interactive tool
where investors can enter different variables to better understand
historical premiums and discounts?
Should the table and line graph cover the most recently
completed calendar year and the most recently completed calendar
quarters of the current year as proposed or are there other periods we
should consider? Should the period be longer or shorter? Should we
consider fiscal year periods instead of calendar year periods? If so,
what period and why? How would this change impact the comparability of
the information across ETFs? In order to give investors more
information on market dislocations that particularly affect ETFs,
should we also require tabular and graphic disclosure for major market
events over past five or ten years?
Proposed rule 6c-11(c)(1)(v) would require any ETF whose
premium or discount was greater than 2% for more than seven consecutive
trading days to post that information on its website, along with a
discussion of the factors that are reasonably believed to have
materially contributed to the premium or discount threshold. Should we
require this proposed disclosure? Is 2% an appropriate premium or
discount? If not, should we consider a higher or lower threshold for
this disclosure (e.g., 1% or 5%)? If so, why? Should we vary the
premium or discount based on other factors, such as fund strategy,
asset class, geographic region, or historic premium/discount for the
class? Should we instead base the reporting threshold on a different
statistic, such as standard deviation? Should it be based on the
average absolute value of the premium or discount over a seven-day
period? \315\
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\315\ See supra footnote 120 (describing calculation of absolute
value).
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Is the seven consecutive trading day requirement
appropriate? Should we require a shorter or longer period of time? If
so, what period and why? Is there a more appropriate balance between
the magnitude (2%) and length (seven consecutive trading days) of an
ETF's premium or discount than we have proposed (e.g., 10% for one day
or 5% for two days)?
Should we permit ETFs to determine what percentage premium
or discount threshold is appropriate and what time period to disclose,
based on the ETF's particularized circumstances?
Should we require any additional measures to trigger the
proposed rule 6c-11(c)(1)(v) disclosure requirement? Should we require
a second measure of non-consecutive days in addition to the seven
trading day requirement? For example, should we also require a
disclosure of factors if the ETF's premium or discount was greater than
2% for seven of the past 30 days?
We propose that ETFs posting this information be required
to post it by the end of the trading day immediately following the day
on which the requirement was triggered. Is this a reasonable period of
time to post this information? Why or why not? We also propose that
ETFs posting this
[[Page 37365]]
information be required to maintain it on their websites for at least
one year following the first day it was posted. Should these time
periods be shorter or longer?
As an alternative (or in addition) to requiring disclosure
of this information on an ETF's website, should we require disclosure
in an ETF's prospectus or shareholder reports? Or should we require
that it be publicly filed on EDGAR in a different regulatory filing?
Would this disclosure requirement disproportionately
affect particular types of ETFs? Would investors use this information
in assessing ETFs, or could it lead to confusion?
Should we require a discussion of the factors that are
reasonably believed to have materially contributed to the premium or
discount? Would this requirement provide investors with useful context
for deviations between market price and NAV per share or would ETFs
rely on boilerplate disclosure?
Should we provide additional guidance or impose additional
requirements for cases where a deviation persists for an extended
period (i.e., much longer than seven days)?
In addition to the disclosures regarding instances where
the premium or discount was greater than 2% for more than seven
consecutive trading days, should we require that ETFs disclose other
information relating to premiums and discounts? For example, should we
require ETFs to disclose rolling average premium and discount for a
prior period? If so, what period? Should we require ETFs to provide the
greatest premium and/or discount for the previous month, quarter, or
year? If so, what period would be most useful to investors and other
market participants?
Should we require ETFs to disclose index tracking error,
if applicable? If so, how should we define tracking error? For what
period should we require tracking error? Where should such disclosure
be made and how frequently?
Should we require ETFs to include a disclaimer indicating
the potential limitations of historical disclosures on its website? If
so, should the rule prescribe the legend that should be used and where
the legend should be placed? Should we require a legend similar to the
current performance-related disclosure legend in Form N-1A, which
states that ``past performance . . . is not necessarily an indication
of how the Fund will perform in the future''? \316\
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\316\ See Item 4(b)(2)(i) of Form N-1A.
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We are proposing that ETFs provide certain disclosures on
their websites on a daily basis. Should we require funds to provide
these disclosures less frequently? Are there other places that funds
should be required to report this information?
Should we require this information to be posted
``prominently'' on the ETF's website? Should we provide any other
instruction as to the presentation of this information, in order to
highlight the information and/or lead investors efficiently to the
information? For example, should we require that the information be
posted on the main page of a particular ETF series? Should the
information be accessible in no more than two clicks from the ETF
complex's home page? Should we adopt presentation requirements that
would aid in the comparability of this information for different ETFs?
In particular, should we adopt presentation requirements for the
premium/discount line graph?
In our discussion of the proposed amendments to Item 3 of
Form N-1A, we are proposing an exception from the disclosure
requirements of trading information and related costs for newly created
ETFs with limited trading history. Should there be a similar exception
for newly created ETFs from the website disclosure requirements of the
ETF's NAV per share, market price, premium or discount, and bid-ask
spreads as of the end of the prior business day? Should the exception
apply to the requirement to disclose historical information regarding
the ETF's premiums and discounts? Why or why not?
Should we require ETFs to post the proposed additional
website disclosures in a structured format and/or to file them on EDGAR
or make them available in another centralized repository?
7. Marketing
Our exemptive orders and our 2008 proposal included a condition
requiring each ETF to identify itself in any sales literature as an ETF
that does not sell or redeem individual shares and to explain that
investors may purchase or sell individual ETF shares through a broker
via a national securities exchange.\317\ This condition was designed to
help prevent investors, particularly retail investors, from confusing
ETFs with mutual funds. Given that ETFs have been available for over 26
years, and the market has developed a familiarity with the product, we
no longer believe this condition is necessary. We believe that retail
investors generally understand that, unlike mutual funds, individual
ETF shares may be purchased and sold only on secondary markets. We
further believe that the website and registration statement disclosures
we are proposing provide retail investors more useful information
regarding the exchange-traded nature and costs of ETFs.\318\ Therefore,
we are not proposing to include such a marketing disclosure requirement
in rule 6c-11.
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\317\ See 2008 ETF Proposing Release, supra footnote 3.
Commenters who addressed this aspect of the 2008 proposal generally
supported this condition. See ICI 2008 Comment Letter; Katten 2008
Comment Letter; Xshares 2008 Comment Letter.
\318\ The proposed website disclosure requirements are described
in section II.C.6 and the proposed amendments to Form N-1A are
described in section II.H.
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We request comment on this aspect of our proposal.
Are we correct that a condition requiring an ETF to
identify itself in any sales literature as an ETF that does not sell or
redeem individual shares and to explain that investors may purchase or
sell individual ETF shares through a broker via secondary markets is no
longer necessary? Do retail investors understand that individual ETF
shares can be bought and sold only on secondary markets? If not, should
proposed rule 6c-11 condition relief on the inclusion of statements in
an ETF's sales literature regarding the purchase and sale of ETF shares
on secondary markets? Alternatively, should we consider adding a
disclosure requirement only to Form N-1A?
Should we consider other limitations regarding ETF sales
literature?
If the rule includes such a condition, how should we
define sales literature? Should we define sales literature as we
proposed in 2008? \319\ Are there other definitions that we should
consider, including by reference to the definition in 17 CFR 230.156
(``rule 156'')? \320\
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\319\ The 2008 proposed rule, consistent with the use of the
term in section 24(b) of the Act and the existing definition in rule
34b-1 under the Act, would have defined the term ``sales
literature'' as ``any advertisement, pamphlet, circular, form
letter, or other sales material addressed to or intended for
distribution to prospective investors other than a registration
statement filed with the Commission under section 8 of the Act.''
See 2008 ETF Proposing Release, supra footnote 3.
\320\ Rule 156 under the Securities Act defines the term ``sales
literature'' to include ``any communication (whether in writing, by
radio, or by television) used by any person to offer to sell or
induce the sale of securities of any investment company.'' It also
states that communications between issuers, underwriters and dealers
are included in the definition of sales literature if such
communications, or the information contained therein, can be
reasonably expected to be communicated to prospective investors in
the offer or sale of securities or are designed to be employed in
either written or oral form in the offer or sale of securities. See
17 CFR 230.156(c).
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[[Page 37366]]
If the rule included a condition regarding sales
literature, should it also include an exception to permit an ETF to
disclose to investors that it will issue or redeem individual shares in
order to consummate a reorganization, merger, conversion or
liquidation?
To further prevent investors from confusing ETFs with
mutual funds, should the rule require an ETF to include the identifier
``ETF'' in its name?
To further prevent investors from confusing ETFs with
mutual funds, should the rule require an ETF to explicitly disclose in
its sales literature that shareholders may pay more than NAV when
buying shares and may receive less than NAV when selling ETF shares?
Should the rule impose any additional conditions or
require any additional disclosures to help investors distinguish ETFs
from other ETPs, such as exchange-traded notes or commodity pools that
are not subject to the Investment Company Act? Should the Commission
consider proposing naming conventions based on these or other
distinctions in a future rulemaking? Are naming conventions useful to
investors? Should ETFs be required to use a different identifier (e.g.,
``IC'' for ETFs that are registered under the Investment Company Act)
before or after ``ETF'' to distinguish them from other ETPs? Should all
ETPs be required to have identifiers (e.g., ETF-N (for exchange-traded
notes), ETF-IC (for ETFs that are not leveraged ETFs), ETF-C (for
exchange-traded commodity pools), ETF-L (for leveraged ETFs))?
Alternatively, are there ways we could address investor
confusion by restricting certain sales practices? For example, should
we consider proposing restrictions in a future rulemaking on how
intermediaries communicate with retail investors about ETPs unless they
disclose certain information designed to clearly differentiate ETPs
that are not registered under the Act from ETFs that are registered
investment companies?
D. Recordkeeping
For the reasons discussed above, authorized participants play a
central role in the proper functioning of the ETF marketplace.\321\ One
of the defining characteristics of authorized participants under the
proposed rule is that they have a written agreement with an ETF or one
of the ETF's service providers whereby the authorized participant is
allowed to purchase or redeem creation units directly from the ETF
(``authorized participant agreement'').\322\ Thus, these agreements are
critical to understanding the relationship between the authorized
participant and the ETF. While we believe that most ETFs are currently
preserving copies of their written authorized participant agreements
pursuant to our current recordkeeping rules, for avoidance of doubt, we
are proposing to expressly require that ETFs relying on rule 6c-11
preserve and maintain copies of all such agreements.\323\
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\321\ See supra section I.
\322\ Proposed rule 6c-11(a) (defining ``authorized
participant'').
\323\ See proposed rule 6c-11(d)(1).
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This requirement is designed to provide our examination staff with
a basis to determine whether the relationship between the ETF and the
authorized participant is in compliance with the requirements of
proposed rule 6c-11 and other provisions of the Act and rules
thereunder, based on the specific terms of their written agreement,
including, but not limited to, terms related to postponement of
redemptions and transaction fees. We did not include a specific
preservation requirement for authorized participant agreements in the
2008 proposal.\324\ However, Commission staff's experience with the ETF
industry since 2008, including our examination staff's experience, has
reinforced our belief that authorized participant agreements must be
preserved.
---------------------------------------------------------------------------
\324\ See 2008 ETF Proposing Release, supra footnote 3. Our
orders also do not include a specific preservation requirement. See,
e.g., Salt Financial, supra footnote 270.
---------------------------------------------------------------------------
We are also proposing to require ETFs to maintain information
regarding the baskets exchanged with authorized participants. In
particular, the proposed rule would require an ETF to maintain records
setting forth the following information for each basket exchanged with
an authorized participant: (i) The names and quantities of the
positions composing the basket; (ii) identification of the basket as a
``custom basket'' and a record stating that the custom basket complies
with the ETF's custom basket policies and procedures (if applicable);
(iii) cash balancing amounts (if any); and (iv) the identity of the
authorized participant conducting the transaction.\325\ These records
would provide our examination staff with a basis to understand how
baskets are being used by ETFs, as well as to evaluate compliance with
the rule and other provisions of the Act and rules thereunder. In
particular, we believe these records would allow our examination staff
to evaluate whether the use of custom baskets is appropriate.
---------------------------------------------------------------------------
\325\ See proposed rule 6c-11(d)(2).
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ETFs would be required to maintain these records for at least five
years, the first two years in an easily accessible place. The retention
period is consistent with the period provided in rules 22e-4 and 38a-
1(d) under the Act. Funds currently have compliance program-related
recordkeeping procedures in place that incorporates this type of
retention period, and we preliminarily believe consistency with that
period would minimize any compliance burden to funds.
We request comment on these proposed recordkeeping requirements.
Are these requirements necessary in light of the benefits
that would result from Commission examination? Are there other records
that we should require ETFs to preserve or other feasible alternatives
that would minimize recordkeeping burdens? What are the costs
associated with maintaining the proposed recordkeeping requirements
under the rule and what effects would the proposed recordkeeping
requirements have on an ETF's compliance policies and procedures?
Do ETFs already preserve their agreements with authorized
participants under our current recordkeeping requirements?
Should we require an ETF to maintain a record stating that
the custom basket complies with the ETF's custom basket policies and
procedures? Is there any additional information that we should require
ETFs to maintain in connection with their baskets? Should we require
ETFs to record information regarding any transaction fees assessed in
connection with each basket? Are there alternatives to this proposed
recordkeeping requirement that would enable the Commission to examine
the composition of ETFs' baskets, while minimizing the recordkeeping
burdens imposed on ETFs?
Are there other records we should consider requiring ETFs
to maintain regarding transaction fees? \326\ Should we consider
requiring ETFs to disclose information regarding transaction fees
[[Page 37367]]
in their registration statement or on Form N-CEN? For example, should
ETFs be required to describe transaction fees and the amount of such
fees that are charged in connection with effecting purchases and
redemptions of creation units? Should there be disclosure about the
aggregate dollar amount or percentage of transaction fees paid over
particular periods? Should we require ETFs to disclose the dollar
amount (or percentage) of transaction fees waived over a particular
periods? If so, how should this information be presented? Should we
require ETFs to include narrative disclosure regarding waivers, noting
for example, that the waiver of transaction fees may result in
additional costs borne by the ETF?
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\326\ We understand transaction fees are imposed by ETFs to
defray the transaction expenses associated with the creation or
redemption, as applicable, and prevent possible dilution resulting
from the purchase or redemption of creation units. For cash baskets,
the ETF may assess transaction fees to offset certain operational,
brokerage and spread costs relating to the ETF's purchasing or
selling of securities. Transaction fees can impact secondary market
investors in ETF shares because an authorized participant or other
market maker can cause the spread to widen on ETF shares to recoup
or offset some of the costs from paying the transaction fees.
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Should we require ETFs to maintain these records for five
years, the first two years in an easily accessible place, as proposed?
Should we use a different retention period, such as the six-year
retention period under 17 CFR 270.31a-2 (rule 31a-2 under the Act)?
Would compliance with these proposed requirements have any
effect on ETFs' internal compliance policies and procedures?
Should we instead, or additionally, require that ETFs file
their authorized participant agreements as exhibits to their
registration statements? Why or why not?
Are there any additional alternative recordkeeping
requirements we should consider?
E. Share Class ETFs
The proposed rule does not provide any relief from sections
18(f)(1) or 18(i) of the Act or expand the scope of 17 CFR 270.18f-3
(``rule 18f-3'' under the Act) (the multiple class rule).\327\ Sections
18(f) and (i) of the Act were intended, in large part, to protect
investors from certain abuses associated with complex investment
company capital structures, including conflicts of interest among a
fund's share classes.\328\ These provisions also were designed to
address certain inequitable and discriminatory shareholder voting
provisions that were associated with many investment company securities
before the enactment of the Act.\329\
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\327\ See 15 U.S.C. 80a-18(f)(1) and (i); 17 CFR 270.18f-3.
Section 18(f)(1) of the Act generally prohibits a fund from issuing
a class of ``senior security,'' which is defined in section 18(g) to
include any stock of a class having priority over any other class as
to distribution of assets or payment of dividends. See 15 U.S.C.
80a-18(g). Section 18(i) of the Act provides that all shares of
stock issued by a fund must have equal voting rights.
\328\ See Exemption for Open-End Management Investment Companies
Issuing Multiple Classes of Shares, Investment Company Act Release
No.19955 (Dec. 15, 1993) [58 FR 68074 (Dec. 23, 1993)] (proposing
release), at nn.20 and 21 and accompanying text.
\329\ See id.
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In 1995, the Commission adopted rule 18f-3 under the Act to create
a limited exemption from sections 18(f)(1) and 18(i) for funds that
issue multiple classes of shares with varying arrangements for the
distribution of securities and provision of services to
shareholders.\330\ That rule generally provides that, notwithstanding
sections 18(f)(1) and 18(i) of the Act, a registered open-end
management investment company or series or class thereof may issue more
than one class of voting stock, provided that each class, among other
requirements, has in all other respects the same rights and obligations
as each other class.\331\
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\330\ See Exemption for Open-End Management Investment Companies
Issuing Multiple Classes of Shares, Investment Company Act Release
No. 20915 (Feb. 23, 1995) [60 FR 11876 (Mar. 2, 1995)] (adopting
release) (``Multiple Class Adopting Release''), at n.8 and
accompanying text.
\331\ See 17 CFR 270.18f-3(a)(4).
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An ETF cannot rely on rule 18f-3 to operate as a share class within
a fund because the rights and obligations of the ETF shareholders would
differ from those of investors in the fund's mutual fund share classes.
For example, ETF shares would be redeemable only in creation units,
while the investors in the fund's mutual fund share classes would be
individually redeemable. Similarly, ETF shares are tradeable on the
secondary market, whereas mutual fund shares classes would not be
traded.
An ETF structured as a share class of a fund that issues multiple
classes of shares representing interests in the same portfolio would
not be permitted to rely on proposed rule 6c-11. We recognize that the
Commission has granted ETFs exemptive relief from the aforementioned
provisions of section 18 of the Act in the past, subject to various
conditions.\332\ However, relief from section 18 raises policy
considerations that are different from those we seek to address in this
rule, which is intended to address broadly the common type of relief
that most ETFs have sought.
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\332\ See Vanguard Index Funds, et al., Investment Company Act
Release Nos. 24680 (Oct. 6, 2000) [65 FR 61005 (Oct. 13, 2000)]
(notice) and 24789 (Dec. 12, 2000) (order) and related application;
Vanguard Index Funds, et al., Investment Company Act Release Nos.
26282 (Dec. 2, 2003) [68 FR 68430 (Dec. 8, 2003)] (notice) and 26317
(Dec. 29, 2003) (order) and related application; Vanguard
International Equity Index Funds, et al., Investment Company Act
Release Nos. 26246 (Nov. 3, 2003) [68 FR 63135 (Nov. 7, 2003)]
(notice) and 26281 (Dec. 1, 2003) (order) and related application;
Vanguard Bond Index Funds, et. al., Investment Company Act Release
Nos. 27750 (Mar. 9, 2007) [72 FR 12227 (Mar. 15, 2007)] (notice) and
27773 (Apr. 25, 2007) (order) and related application (collectively,
the ``Vanguard orders'').
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For example, an ETF share class that transacts with authorized
participants on an in-kind basis and a mutual fund share class that
transacts with shareholders on a cash basis may give rise to differing
costs to the portfolio. As a result, while certain of these costs may
result from the features of one share class or another, all
shareholders would generally bear these portfolio costs.\333\ At the
same time, the share class structure also can provide benefits to each
share class, including economies of scale. Given these additional
policy considerations, we believe it is appropriate for ETFs to
continue to request relief from sections 18(f)(1) and 18(i) of the Act
through our exemptive application process, and for the Commission to
continue to weigh these policy considerations in the context of the
facts and circumstances of each particular applicant.
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\333\ These costs can include brokerage and other costs
associated with buying and selling portfolio securities in response
to mutual fund share class cash inflows and outflows, cash drag
associated with holding the cash necessary to satisfy mutual fund
share class redemptions, and distributable capital gains associated
with portfolio transactions.
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We request comment on this aspect of the proposal.
Should proposed rule 6c-11 include exemptions from
sections 18(f)(1) or 18(i) of the Act, or should we expand the scope of
rule 18f-3 under the Act? Why or why not?
If commenters believe that such exemptions should be
included in the proposed rule, should the rule include conditions
designed to take into account the potential costs and benefits of a
fund with both mutual fund and ETF share classes? If so, what
conditions? Are we correct in our preliminary belief that combining an
ETF share class with traditional share classes of a mutual fund may, in
certain circumstances, result in the costs and benefits described
above?
F. Master-Feeder ETFs
Many of our recent ETF orders contain relief allowing ETFs to
operate as feeder funds in a master-feeder structure.\334\ In general,
an ETF that operates as a feeder fund in a master-feeder structure
functions like any other ETF. An authorized participant deposits a
basket with the ETF and receives a
[[Page 37368]]
creation unit of ETF shares in return for those assets. Conversely, an
authorized participant that redeems a creation unit of ETF shares
receives a basket from the ETF. In a master-feeder arrangement,
however, the feeder ETF then also enters into a corresponding
transaction with its master fund. The ETF may use the basket assets it
receives from an authorized participant to purchase additional shares
of the master fund, or it may redeem shares of the master fund in order
to obtain basket assets and satisfy a redemption request.
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\334\ See, e.g., T. Rowe Price Associates, Inc., et al.,
Investment Company Act Release Nos. 30299 (Dec. 7, 2012) [77 FR
74237 (Dec. 13, 2012)] (notice) and 30336 (Jan. 2, 2013) (order) and
related application; SSgA Funds Management, Inc., et al., Investment
Company Act Release Nos. 29499 (Nov. 17, 2010) [75 FR 71753 (Nov.
24, 2010)] (notice) and 29524 (Dec. 13, 2010) (order) and related
application (``SSgA'').
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Because the feeder ETF may, in the course of these transactions,
temporarily hold the basket assets, it would not be able to rely on
section 12(d)(1)(E) of the Act, which requires that a feeder fund hold
no investment securities other than securities of the master fund.\335\
To accommodate these unique operational characteristics of ETFs, our
recent exemptive orders have allowed a feeder ETF to rely on section
12(d)(1)(E) without complying with section 12(d)(1)(E)(ii) of the Act
to the extent that the ETF temporarily holds investment securities
other than the master fund's shares for use as basket assets. These
orders also provided the feeder ETF and its master fund with relief
from sections 17(a)(1) and 17(a)(2) of the Act, with regard to the
deposit by the feeder ETF with the master fund and the receipt by the
feeder ETF from the master fund of basket assets in connection with the
issuance or redemption of creation units,\336\ and section 22(e) of the
Act if the feeder ETF includes a foreign security in its basket assets
and a foreign holiday (or a series of consecutive holidays) prevents
timely delivery of the foreign security.\337\
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\335\ Section 12(d)(1) of the Act limits the ability of a fund
to invest substantially in shares of another fund. See sections
12(d)(1)(A)-(C) of the Act; see also infra footnote 344. Section
12(d)(1)(E) of the Act allows an investment company to invest all of
its assets in one other fund so that the acquiring fund is, in
effect, a conduit through which investors may access the acquired
fund. See section 12(d)(1)(E)(ii) of the Act.
\336\ Relief from the affiliated transaction prohibitions in
sections 17(a)(1) and 17(a)(2) of the Act is necessary because these
sections would otherwise prohibit the feeder ETF and its master fund
from selling to or buying from each other the basket assets in
exchange for securities of the master fund. See 15 U.S.C. 80a-
17(a)(1)-(2).
\337\ See 15 U.S.C. 80a-22(e) (generally requiring the
satisfaction of redemptions within seven days). See also supra
section III.B.4.
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The exemptive orders we have granted to master-feeder ETFs,
however, do not include relief from section 18 under the Act inasmuch
as investment by several feeder funds or by mutual fund and ETF feeder
funds in the same class of securities issued by a master fund generally
do not involve a senior security subject to section 18. We are
concerned, as discussed above, that if an ETF feeder fund transacts
with a master fund on an in-kind basis, but non-ETF feeder funds
transact with the master fund on a cash basis, all feeder fund
shareholders would bear costs associated with the cash
transactions.\338\
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\338\ See supra footnote 333 and accompanying text.
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We understand that while many orders contain this relief, only one
fund complex has established master-feeder arrangements involving ETF
feeder funds, and each arrangement involves an ETF as the sole feeder
fund.\339\ Given the lack of interest in this structure and our
concerns noted above, we are proposing to rescind the master-feeder
relief granted to ETFs that do not rely on the relief as of the date of
this proposal (June 28, 2018).\340\ However, we also propose to
grandfather existing master-feeder arrangements involving ETF feeder
funds, but prevent the formation of new ones, by amending relevant
exemptive orders.\341\ Because these existing master-feeder ETFs
involve only one feeder fund for each master fund, we do not believe
they would raise the policy concerns discussed above so long as they do
not add feeders, and therefore do not believe it is necessary to
require these structures to change their existing investment
practices.\342\
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\339\ See, e.g., SSGA Active Trust Prospectus (Oct. 31, 2017),
available at https://us.spdrs.com/public/SPDR_ACTIVE%20ETF%20TRUST_PROSPECTUS.pdf.
\340\ See infra section II.G.
\341\ Based on staff analysis, we preliminarily believe that the
fund complex currently utilizing this relief operates nine master-
fund arrangements, each involving only one ETF as the sole feeder
fund. See SSgA, supra footnote 334.
\342\ Rescinding the relief for existing master-feeder ETFs
would require them to change the manner in which they invest. For
example, transactions between each of the affected master funds and
its corresponding feeder fund could be transacted in cash, rather
than in-kind, obviating any need for exemptive relief for the feeder
fund to hold securities other than those issued by the master fund.
Alternatively, the feeder funds could opt to pursue their investment
objectives through direct investments in securities and/or other
financial instruments, rather than through investments in master
funds.
---------------------------------------------------------------------------
We request comment on the lack of master-feeder relief in proposed
rule 6c-11.
Are we correct that the market interest for ETFs using
master-feeder structures, as discussed above, is limited?
Should the proposed rule include master-feeder relief for
ETFs, as provided in certain of our exemptive orders and discussed
above? Why or why not?
Should we amend the exemptive relief relied upon by
existing master-feeder arrangements? Alternatively, should we also
rescind the master-feeder relief relied upon by existing arrangements?
If so, how would these ETFs be impacted if we also rescinded their
relief?
If the proposed rule provided master-feeder relief for
master-feeder structures that include ETF and mutual fund feeder funds,
should the rule include conditions designed to take into account the
potential costs and benefits of such structures? If so, what
conditions? For example, should the proposed rule require a
determination that the investment in a master fund is in the best
interest of the ETF and its shareholders? If so, who should be required
to make such a determination? How frequently should such a
determination be made? Alternatively, should the proposed rule provide
master-feeder relief for master-feeder structures but allow only ETF
feeder funds? If so, what conditions should apply?
G. Effect of Proposed Rule 6c-11 on Prior Orders
The Commission has authority under the Act to amend or rescind our
orders when necessary or appropriate to the exercise of the powers
conferred elsewhere in the Act. Pursuant to this authority, we are
proposing to amend and rescind the exemptive relief we have issued to
ETFs that would be permitted to rely on the proposed rule.\343\ Our
proposed rescission of orders would specifically be limited to the
portions of an ETF's exemptive order that grant relief related to the
formation and operation of an ETF and, with the exception of certain
master-feeder relief discussed above in section II.F, would not rescind
the relief from section 12(d)(1) \344\ and sections 17(a)(1) and (a)(2)
\345\ under the Act related to
[[Page 37369]]
fund of funds arrangements involving ETFs.\346\
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\343\ See section 38(a) of the Act, 15 U.S.C. 80a-37(a).
\344\ Section 12(d)(1) generally limits the ability of
registered investment companies (including ETFs) to acquire
securities issued by other investment companies in excess of certain
thresholds, and the ability of registered open-end investment
companies (including ETFs) from knowingly selling securities to
other investment companies in excess of certain thresholds. The
conditions set forth in ETF exemptive applications for relief
necessary to create a fund of funds structure is generally designed
to prevent the abuses that led Congress to enact section 12(d)(1),
including abuses associated with undue influence and control by
acquiring fund shareholders, the payment of duplicative or excessive
fees, and the creation of complex structures. See Salt Financial,
supra footnote 270. We also note that certain standalone exemptive
orders, unrelated to ETF operations, are often granted to applicants
to permit investments in ETFs beyond the limits in section 12(d)(1)
of the Act; we are not proposing to rescind such exemptive orders.
\345\ See supra section II.B.3.
\346\ ETF exemptive relief typically segregates exemptive relief
from section 17(a) under the Act necessary to create a fund of funds
structure from section 17(a) exemptive relief necessary for the
operation of the ETFs. This segregation of ``Fund of Funds Relief''
and ``ETF Relief'' appears in numerous representations and
enumerated conditions set forth in applications for exemptive
relief. See, e.g., Salt Financial, supra footnote 270.
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The terms of the exemptive relief granted to ETFs have evolved over
time and have resulted in an uneven playing field among ETF complexes,
subjecting ETFs that pursue the same or similar investment strategies
to different operational requirements. Moreover, many ETF complexes
have multiple exemptive orders permitting them to operate ETFs. Some of
those orders contain different conditions for relief and different
representations by the applicants regarding how the ETFs formed
pursuant to the order would operate. Many of those orders also provide
relief for future ETFs created pursuant to the terms of a particular
exemptive order.\347\ As a result, ETF complexes with multiple orders
can effectively choose the exemptive relief that would be applicable to
a new ETF by selecting what legal entity should form the new ETF
series. Moreover, differences in the terms of our various orders have
had varying impact on the structure and costs of an ETF. For example,
shares of an ETF with a less flexible basket condition in its order
could have wider spreads than a similarly situated ETF with more
flexible basket compositions. However, investors may not be able to
discern the difference between these two ETFs' orders. As we have
stated elsewhere in this release, among our goals in proposing rule 6c-
11 is to create a consistent, transparent and efficient regulatory
framework for many ETFs. We do not believe this goal would be furthered
if ETFs that could rely on the rule continue to rely on those orders.
---------------------------------------------------------------------------
\347\ See supra footnote 12.
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In addition, we began including a condition in our ETF exemptive
orders in 2008 stating that the relief permitting the operation of ETFs
would expire on the effective date of any Commission rule that provides
relief permitting the operation of ETFs.\348\ The purpose of this
automatic expiration condition was to better establish equal footing
between ETFs that have received exemptive relief and ETFs that may rely
solely on a Commission rule, and to reduce competitive advantages that
could potentially arise out of the conditions for relief set forth in
our earlier exemptive orders.\349\ Of the approximately 300 orders we
have issued that provide ETF exemptive relief, approximately 200
include this automatic expiration condition, and thus the ETF relief
would terminate if and when proposed rule 6c-11 is adopted and goes
into effect. To provide time for ETFs to transition to rule 6c-11,
however, we propose to amend these existing orders to provide that the
ETF relief contained in those orders will terminate one year following
the effective date of any final rule. Absent this modification or our
determining to delay the effectiveness of any final rule 6c-11, the ETF
relief included in orders with the automatic expiration provision could
expire before ETFs were able to make any adjustments necessary to rely
on rule 6c-11.
---------------------------------------------------------------------------
\348\ See e.g., PowerShares, supra footnote 188; Javelin
Exchange-Traded Trust, Investment Company Act Release Nos. 28350
(July 31, 2008) [73 FR 46066 Aug. 7, 2008)] (notice) and 28637 (Aug.
26, 2008) (order) and related application. In some cases, the
automatic expiration condition applies to the ETF-related relief
only, and expressly does not apply to certain other exemptive relief
requested, such as master-feeder and ``fund of funds'' relief under
section 12 of the Act. See, e.g., Fidelity Merrimack Street Trust,
et al., Investment Company Act Release Nos. 30464 (Apr. 16, 2013)
[78 FR 23793 (Apr. 22, 2013)] (notice) and 30513 (May 10, 2013)
(order) and related application (``The requested relief, other than
the Fund of Funds Relief and the Section 17 relief related to a
master-feeder structure, will expire on the effective date of any
Commission rule under the Act that provides relief permitting the
operation of actively managed exchange traded funds.'').
\349\ See 2008 ETF Proposing Release, supra footnote 3.
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We believe that rescinding ETF exemptive relief in connection with
the proposed rule (and amending those orders that require ETF exemptive
relief to automatically expire in order to allow a transitional period
to any final rule) would result in a more transparent framework for
covered ETFs, as those ETFs would no longer be subject to differing and
sometimes inconsistent provisions of their exemptive relief. The relief
and related conditions proposed under rule 6c-11, moreover, are largely
consistent with our recent orders, and in some cases, provide ETFs with
additional flexibility. For example, proposed rule 6c-11 would provide
many ETFs with additional basket flexibility beyond what is currently
permitted by their exemptive orders.\350\ We preliminarily believe,
therefore, that the operations of most existing ETFs would not be
significantly negatively affected by the need to comply with the
requirements of rule 6c-11 as opposed to their exemptive relief.
However, in order to limit any hardship that revocation of existing
exemptive relief would have on current ETFs with orders that do not
automatically expire, we are proposing a one-year period after the
effective date before we rescind that exemptive relief to give those
ETFs time to bring their operations into conformity with the
requirements of proposed rule 6c-11.
---------------------------------------------------------------------------
\350\ See proposed rule 6c-11(c)(3); see also supra section
II.C.5. We note that a subset of the ETFs operating under exemptive
relief has basket flexibility that would not be broadened by the
proposed rule. Under the proposed rule, however, such ETFs would be
required to adopt and implement written policies and procedures
related to the construction of baskets and the process for the
acceptance of baskets by the ETF.
---------------------------------------------------------------------------
We do not propose to rescind the exemptive relief of ETFs that
would not be permitted to rely on the proposed rule. Specifically, we
do not propose to rescind the exemptive relief for ETFs organized as
UITs,\351\ ETFs that are organized as a share class of a fund,\352\ or
leveraged ETFs.\353\ We believe it is appropriate for ETFs seeking to
utilize these structures to continue to request relief from the
Commission through our exemptive application process, and for the
Commission to continue to make facts-and-circumstances-based
determinations regarding whether such relief is appropriate for any
particular applicant.
---------------------------------------------------------------------------
\351\ See discussion of ETFs organized as UITs, supra section
II.A.1.
\352\ See Vanguard orders, supra footnote 332.
\353\ See discussion of leveraged ETFs, supra section II.A.3.
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The Commission does not believe that it is necessary to give
individual hearings to the holders of the prior exemptive relief or to
any other person. Proposed rule 6c-11 would be prospective in effect
and is intended to set forth for covered ETFs the Commission's
exemptive standards for ETFs organized as open-end funds. Recipients of
existing exemptive relief may make their views known in the context of
the comment process that accompanies this rulemaking, and those views
will be given due consideration. Finally, investment companies would be
able to request Commission approval to operate as an ETF under
conditions that differ from those in proposed rule 6c-11.
We request comment on our proposal to revoke existing ETF and
certain existing master-feeder exemptive relief.
Should we revoke some or all of the existing ETF exemptive
relief? If not, why not? Would allowing existing exemptive relief to
continue create an unequal playing field for ETF market participants?
If not, why not?
As discussed above, we are proposing a one year period
before rescinding existing ETF exemptive relief. Is the one year period
appropriate for ETFs with existing ETF exemptive
[[Page 37370]]
relief to bring their funds into compliance with rule 6c-11? If not,
how long should this period last? Why? We are proposing to implement
this one year period, in part, by amending existing orders with an
automatic expiration condition to provide that the ETF exemptive relief
contained in these orders would terminate one year following the
effective date of any final rule. Should we, instead, delay the
effectiveness of rule 6c-11 for one year? Are there different
approaches we should consider?
Should we consider rescinding the exemptive relief for
ETFs organized as UITs or ETFs organized as a share class of a fund and
instead allow such ETFs to be covered by rule 6c-11? If so, how would
such ETFs comply with the requirements of the rule? For example, would
they have to restructure or liquidate?
Should we, as proposed, rescind the exemptive relief that
we have previously granted that allows ETFs to operate as feeder funds
in a master-feeder structure if they do not rely on the relief as of
the date of this proposal? Do funds plan to use this relief in the
future? If so, what kind of ETF master-feeder structures do funds
envision creating? For what purpose?
We understand that the existing structures are organized
with an ETF as the sole feeder fund. Is this understanding correct?
Should we amend the exemptive relief applicable to these funds as
proposed?
Would our proposal to rescind certain of our previously
issued ETF exemptive relief, and allow the ETF exemptive relief
contained in the orders with automatic expiration provisions to expire
one year following the effective date of rule 6c-11, eliminate any
competitive advantages arising from the relief we have granted via
exemptive order?
Would existing ETFs face significant challenges in
complying with the conditions of rule 6c-11 rather than exemptive
relief?
Should we consider other approaches? For example, should
we consider rescinding only ETF exemptive relief previously granted to
ETF complexes that have multiple exemptive orders permitting them to
operate ETFs?
Should we consider not rescinding any of the approximately
100 pre-2008 orders that do not include the automatic expiration
provision? Should we consider amending the orders that contain the
automatic expiration provision of the ETF exemptive relief to remove
that provision? Under these approaches, in which certain ETF exemptive
orders would be left in place, ETFs would continue operating under
different sets of conditions. Would permitting ETFs to operate under
different sets of conditions have an adverse effect on competition and
capital formation?
Are there other approaches to the existing ETF exemptive
relief that we should consider in view of proposed rule 6c-11?
Exemptive relief granted prior to 2009 generally includes
relief from section 24(d) of the Act to exempt broker-dealers selling
ETF shares from the obligation to deliver prospectuses in most
secondary market transactions, and the rescission of the ETF exemptive
relief from those orders would eliminate this relief. We understand,
however, that broker-dealers have not relied upon this relief and,
subsequent to the adoption of amendments to rule 498 under the
Securities Act permitting the delivery of an ETF's summary prospectus,
most market participants use the summary prospectus to satisfy
prospectus delivery obligations.\354\ Are we correct in our
understanding? Should we provide relief from section 24(d) for ETFs
that have this relief in their exemptive orders if we were to rescind
those orders? If so, why?
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\354\ See rule 498 under the Securities Act [17 CFR 230.498].
---------------------------------------------------------------------------
H. Amendments to Form N-1A
As discussed above in section II.C.6, because of the exchange-
traded nature of ETFs, ETF investors may be subject to different costs
than mutual fund investors. For example, while an ETF may, in some
cases, have a lower expense ratio than a comparable mutual fund, an ETF
investor will be subject to certain unique costs associated
specifically with ETFs, such as the bid-ask spread and premiums and
discounts from the ETF's NAV. As a result of these differences, ETF
investors may not be fully aware of the full costs associated with
their investment in an ETF.
We therefore are proposing several amendments to Form N-1A, the
registration form used by open-end funds to register under the Act and
to offer their securities under the Securities Act. The proposed
amendments are designed to provide investors who purchase ETF shares in
secondary market transactions with additional information regarding
ETFs, including information regarding costs associated with an
investment in ETFs. The proposal also would eliminate certain
disclosures that would be duplicative of the proposed amendments to
Item 3 of Form N-1A regarding the exchange-traded nature of ETFs.
Finally, we are requesting comment on whether we should create a new
ETF-specific registration form.
1. Definitions
We are proposing several amendments to Form N-1A to reflect the
adoption of proposed rule 6c-11.\355\ First, we are proposing to amend
the definition of ``Exchange-Traded Fund'' in Form N-1A to add a
specific reference to proposed rule 6c-11.\356\ Currently, Form N-1A
defines ``Exchange-Traded Fund'' to include a fund or class that has
formed and operates in reliance on an exemptive rule adopted by the
Commission.\357\ We believe that Form N-1A should make specific
reference to proposed rule 6c-11, rather than a generic exemptive rule,
and that this change would be consistent with Form N-1A's general
approach of referring specifically to exemptive rules in other defined
terms.
---------------------------------------------------------------------------
\355\ All of the definitions discussed in this section would
appear in Proposed General Instruction A of Form N-1A.
\356\ Specifically, the proposed definition of ``exchange-traded
fund'' would be a fund or class, the shares of which are listed and
traded on a national securities exchange, and that has formed and
operates under an exemptive order granted by the Commission or in
reliance on rule 6c-11 under the Act.
\357\ General Instruction A to Form N-1A.
---------------------------------------------------------------------------
Second, we propose to remove the defined term ``Market Price'' from
the Definitions section of Form N-1A in light of our other proposed
changes to Form N-1A. Market Price, as presently defined in Form N-1A,
is used in several items that we are proposing to eliminate from the
Form.\358\ The remaining instances in which ``Market Price'' is used do
not require the use of a defined term, as they contemplate a more
general use of the term, such as the requirement in Item 11 of Form N-
1A that an ETF explain in its prospectus that the price of its shares
is based on Market Price.\359\ Accordingly, given our proposed changes
to Form N-1A, we do not believe it is necessary to include ``Market
Price'' as a defined term, and propose to remove this definition from
the Form.
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\358\ See, e.g., proposed changes to Item 3 of Form N-1A.
\359\ Item 11(a)(1) of Form N-1A. Also, in addition to the
defined term ``Market Price,'' Form N-1A currently uses the
undefined term ``market price'' in several instances where a more
general use of the term is appropriate. See, e.g., Instruction 3 to
Item 11(g) of Form N-1A. Our proposed amendments to the Form also
include the use of the undefined term ``market price.'' See, e.g.,
proposed changes to Item 3 of Form N-1A.
---------------------------------------------------------------------------
We request comment on the proposal to amend the definition section
of Form N-1A.
Should we, as proposed, revise the definition of the term
``Exchange-Traded
[[Page 37371]]
Fund'' in Form N-1A to make specific reference to proposed rule 6c-11?
Should we, as proposed, remove the defined term ``Market
Price'' from the Definitions section of the General Instruction to Form
N-1A? Alternatively, should we replace the current definition with a
reference to the defined term ``Market price,'' as defined in proposed
rule 6c-11?
2. Item 3 of Form N-1A
Item 3 of Form N-1A requires funds to include a table describing
the fees and expenses investors may pay if they buy and hold shares of
the fund. Item 3 does not currently distinguish between ETFs and mutual
funds, and only requires disclosure of sales loads, exchange fees,
maximum account fees and redemption fees that funds charge directly to
shareholders.\360\ We therefore are proposing several amendments to
this Item to clarify that there are certain fees that are not reflected
in the fee table for both mutual funds and ETFs and to require new
disclosure requirements that capture ETF-specific trading information
and costs. Like all information disclosed in Items 2, 3, or 4 of Form
N-1A, the information disclosed in amended Item 3 would have to be
tagged and submitted in a structured data format.\361\
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\360\ Item 3 of Form N-1A.
\361\ See General Instruction C.3.g.(i) to Form N-1A.
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a. Changes That Affect Mutual Funds and ETFs
First, we are proposing a narrative disclosure that would clarify
that, in addition to the current disclosures relating to investors who
buy or hold shares, the fees and expenses reflected in the Item 3
expense table may be higher for investors if they sell shares of the
fund.\362\ This amendment would be applicable to both mutual funds and
ETFs given that an investor may incur expenses other than redemption
fees when selling shares of either a mutual fund or ETF. For example,
although less common than they were in the past, an investor may incur
a back-end sales load when selling a mutual fund share. Likewise, an
investor may bear costs associated with bid-ask spreads when selling
ETF shares.
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\362\ Proposed amendments to Item 3 of Form N-1A. In order to
eliminate duplicative disclosures, we are proposing to amend
Instruction 1(e) of Item 3 to eliminate the requirement that ETFs
modify the narrative explanation for the fee table to state that
investors may pay brokerage commissions on their purchase and sale
of ETF shares, which are not reflected in the example. We are also
proposing to eliminate the instruction that funds may only exclude
fees charged for the purchase and redemption of the Fund's creation
units if the fund issues or redeems shares in creation units of net
less than 25,000 shares. Thus, as proposed, an ETF may exclude from
the fee table any fees charged for the purchase and redemption of
the Fund's creation units regardless of the number of shares. See
proposed Instruction 1(e)(ii) to Item 3; see also proposed
Instruction 1(e)(ii) to Item 27(d)(1) (proposing the same
modification for the expense example in an ETF's annual and semi-
annual reports); see also infra footnote 397 and accompanying and
following text.
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We are also proposing to require a statement that investors may be
subject to other fees not reflected in the table, such as brokerage
commissions and fees to financial intermediaries.\363\ We believe this
is appropriate disclosure for both ETFs and mutual funds because
brokerage commissions and fees to financial intermediaries could be
applicable to ETFs and mutual funds alike.
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\363\ Proposed amendments to Item 3 of Form N-1A.
---------------------------------------------------------------------------
b. Changes That Affect ETFs
Because ETF shares are exchange-traded, secondary market investors
in ETF shares are subject to trading costs, such as bid-ask spreads,
that are not currently required to be disclosed under Item 3. Trading
costs, like all costs and expenses, affect investors' returns on their
investment.\364\ In addition, some investors use ETFs more heavily as
trading vehicles compared to mutual funds, and the extent of the
trading costs borne by an investor depends on how frequently the
investor trades ETF shares. We believe that investors could overlook
these costs and that additional disclosure would help them better
understand the total costs of investing in an ETF. Disclosure would
also facilitate comparisons between different investment options.\365\
---------------------------------------------------------------------------
\364\ See SEC Office of Investor Education and Advocacy,
Investor Bulletin: How Fees and Expenses Affect Your Investment
Portfolio (Feb. 2014), available at https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf, at 2 (``As with any fee, transaction
fees will reduce the overall amount of your investment
portfolio.''); see also Andrea Coombes, Calculating the Costs of an
ETF, The Wall Street Journal (Oct. 23, 2012), available at https://www.wsj.com/articles/SB10000872396390444024204578044293008576204.
\365\ Alex Bryan & Michael Rawson, The Cost of Owning ETFs and
Index Mutual Funds, Morningstar Manager Research (Dec. 1, 2014),
available at https://global.morningstar.com/us/documents/pr/Cost-Of-Owning-Index-ETF-MFS.pdf, at 15 (``While trading commissions are the
most conspicuous component of trading costs, indirect trading costs,
such as the bid-ask spread and market impact of trading can often be
more important.'').
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As a result, we are proposing a new section in Item 3 that would
require disclosure of certain ETF trading information and trading
costs.\366\ This proposed section is formatted as a series of question
and answers (``Q&As''). We believe this format would help facilitate an
investor's understanding of certain terminology and cost calculations.
The proposed Q&A disclosures would require information related to the
trading of ETFs on the secondary market and the costs associated with
such trading. The specific question and answer disclosures are shown in
Figure 1 below.
---------------------------------------------------------------------------
\366\ Proposed amendments to Item 3 of Form N-1A.
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[[Page 37372]]
[GRAPHIC] [TIFF OMITTED] TP31JY18.016
Q&A 1. Currently, Item 6(c) of Form N-1A requires that ETFs
disclose that: (i) Shares may only be purchased and sold on a national
securities exchange through a broker-dealer; and (ii) the price of ETF
shares is based on market
[[Page 37373]]
price, and since ETFs trade at market prices rather than at net asset
value, shares may trade at a price greater than net asset value
(premium) or less than net asset value (discount).\367\ We are
proposing to move this description from Item 6 to Q&A 1 in Item 3. We
believe that moving this information to Item 3 would consolidate
relevant disclosures regarding ETF trading costs and provide the
investor with helpful background information relating to ETF
trading.\368\ We also propose to replace the reference to ``national
securities exchange'' with a reference to ``secondary markets'' to
reflect that ETFs can be bought and sold over the counter or on an
alternative trading system in addition to their primary listing
exchanges.
---------------------------------------------------------------------------
\367\ Item 6(c) of Form N-1A.
\368\ See proposed amendments to Item 3 of Form N-1A.
---------------------------------------------------------------------------
Q&A 2. The second Q&A we are proposing identifies the specific
costs associated with trading shares of an ETF, such as brokerage
commissions, bid-ask spread costs, and potential costs attributable to
premiums and discounts. This question clarifies that the costs being
discussed in the questions that follow should be considered in addition
to the costs previously discussed in the fee table.
Q&A 3. Proposed Q&A 3 would include ETF-specific disclosures
relating to the median bid-ask spread for the ETF's most recent fiscal
year.\369\ Costs attributable to the bid-ask spread may increase or
decrease when certain market conditions exist or certain factors are
present. We believe that this disclosure would inform investors
regarding the potential impact of spread costs, including for investors
who frequently trade ETF shares. We also believe that disclosure
regarding median bid-ask spreads would provide a helpful metric for ETF
investors to determine an ETF's historic liquidity, since a narrower
bid-ask spread typically signals higher liquidity and a wider bid-ask
spread generally signals lower liquidity.\370\ Investors can use the
bid-ask spread to assess the ETF's tradability in comparison to other
similar ETFs.\371\
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\369\ As discussed above, given the importance of this
information to understanding the total expenses an investor may bear
when investing in an ETF, we propose that bid-ask spread information
be included in both the ETF's prospectus and on the ETF's website.
Proposed Instruction 5(a) to Item 3 of Form N-1A. See also infra
section II.C.6.
\370\ CFA Institute Research Foundation, Comprehensive Guide to
Exchange-Traded Funds (ETFS) (2015), available at https://www.cfapubs.org/doi/pdf/10.2470/rf.v2015.n3.1, at 67-8 (``CFA
Guide''). See also Allen B. Atkins & Edward A. Dyl, Transactions
Costs and Holding Periods for Common Stocks, 52 Journal of Finance
1, 309-325 (1997) (``Additional evidence of an association between
transactions costs and trading volume can be found in the literature
on bid-ask spreads.''). Literature also suggests that the bid-ask
spread could be affected by increased transaction costs. See Gerald
W. Buetow & Brian J. Henderson, Are Flows Costly to ETF Investors?,
40 Journal of Portfolio Management 3, 101 (Spring 2014), available
at https://www.bfjlaward.com/pdf/25949/100-112_Henderson_JPM_0417.pdf
(noting that authorized participants are likely to pass transaction
fees onto shareholders through the spread).
\371\ See CFA Guide, supra footnote 370, at 69 (noting that
``for some ETFs, even though the underlying securities are liquid,
bid-ask spreads may be wide simply because the ETF trades so little
that the chances of an [authorized participant] rolling up enough
volume to use the creation/redemption process are low'').
---------------------------------------------------------------------------
The proposed Q&A would describe the bid-ask spread as the
difference between the highest price a buyer is willing to pay to
purchase shares of the ETF (bid) and the lowest price a seller is
willing to accept for share of the ETF (ask). We are proposing to
require this description because some investors may not be familiar
with the term ``bid-ask spread,'' making it difficult for them to
meaningfully analyze the specific bid-ask spread number that we propose
to include in this Q&A. The proposed Q&A also would explain that the
bid-ask spread can change throughout the day due to the supply of or
demand for ETF shares, the quantity of shares traded, and the time of
day the trade is executed, among other factors.
In addition, we are proposing that an ETF calculate and disclose
its median bid-ask spread over the most recently completed fiscal
year.\372\ We propose that the median bid-ask spread be calculated by
using trading data from each trading day of the ETF's prior fiscal
year.\373\ Each daily bid-ask spread would be calculated by taking the
average of the intraday bid-ask spreads, which are measured by using
the best bid and best ask, respectively, at ten-second intervals
throughout the trading day. We understand that this is a widely
accepted method for calculating the bid-ask spread and believe that
using the best bid and ask would be administratively easier and less
burdensome than other methods of calculating the bid and ask price,
such as weighting or averaging bid and ask prices throughout the
trading day. We propose that the bid-ask spread be calculated by taking
the difference between the bid and the ask and dividing that difference
by the midpoint between the bid and the ask. The median would be
expressed as a percentage, rounded to the nearest hundredth percent.
---------------------------------------------------------------------------
\372\ Proposed Instruction 5(a) to Item 3 of Form N-1A.
\373\ Proposed Instruction 5(b) to Item 3 of Form N-1A.
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As proposed, an ETF would be required to use data from the full
trading day without excluding certain time periods, because we believe
the spread metric should represent the costs that an actual investor
could face at any time during the day. We note, however, that costs
related to the bid-ask spread can fluctuate throughout the day. For
example, the bid-ask spread tends to be higher at the beginning of the
trading day and towards the end of the trading day.\374\ At market
open, wide spreads may persist until all underlying stocks open and
start trading. At market close, market makers may be less willing to
purchase ETF shares because they do not want to hold the ETF shares
overnight.
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\374\ Ogden H. Hammond & Michael Lieder, J.P. Morgan Asset
Management, Debunking myths about ETF liquidity (May 2015),
available at https://am.jpmorgan.com/blob-gim/1383272223898/83456/1323416812894_Debunking-myths-about-ETF-liquidity.pdf, at 6 (noting
that certain ETF liquidity patterns tend to repeat and are well
known to veteran traders, such as limited trading of ETFs
immediately prior to the close). See also Sunil Wahal, Entry, Exit,
Market Makers, and the Bid-Ask Spread, 10 Rev. Financial Stud 871
(1997), available at https://www.acsu.buffalo.edu/~keechung/MGF743/
Readings/H1.pdf (``Large-scale entry (exit) is associated with
substantial declines (increases) in quoted end-of-day inside
spreads, even after controlling for the effects of changes in volume
and volatility. The spread changes are larger in magnitude for
issues with few market makers; however, even for issues with a large
number of market makers, substantial changes in quoted spreads take
place.'').
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We propose to require ETFs to use one full fiscal year of data
because we believe a full year would capture spreads during varying
market events throughout the year. Although we considered requiring
ETFs to use a full calendar year of data for this disclosure
requirement in order to promote greater comparability among ETFs, we
are concerned that using calendar year data would necessarily mean that
information in certain ETF prospectuses would be over a full year
old.\375\ We preliminarily believe that, to the extent there are any
concerns that using fiscal year data instead of calendar year data may
undermine comparability of the spreads of different ETFs when there are
significant market events in a particular calendar year, such concerns
are mitigated by the relatively low impact of a single market event to
a full year's
[[Page 37374]]
median bid-ask spread. Using one full fiscal year of data also is
consistent with all other requirements for Item 3 of Form N-1A.\376\
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\375\ For example, if the ETF's fiscal year end was August 31,
the annual update would be required to be filed no later than
December 29, which would include spread cost information from the
prior calendar year for up to one year thereafter, meaning that the
spread cost information could be almost two years old. By using
fiscal year end data, the information would never be more than 16
months old.
\376\ See Item 3 of Form N-1A.
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Under our proposal, an ETF would be required to disclose median
bid-ask spread instead of average bid-ask spread because we believe the
median spread better represents the spread that the average investor
would experience, whereas the average spread better represents the
spread of an average ETF share in a given transaction. We believe
sorting the spreads across the entire fiscal year to determine the
median--rather than taking the median spread of each trading day
throughout the fiscal year first, sorting each day's median, and taking
the median spread across all trading days--provides a better
representation of the true median across the entire fiscal year.
Requiring disclosure of the median bid-ask spread also avoids the
problem of an outlier skewing the bid-ask spread figure. For example,
if the spread is .05 in nine instances but 1.00 in one instance, then
the average spread will be 0.145 which we believe is a less accurate
reflection of the bid-ask spread for that fund.
Q&A 4 and 5. We also propose to require ETFs to include questions
on how the bid-ask spread impacts the return on a hypothetical $10,000
investment for both buy-and-hold and frequent traders.\377\ These
examples are designed to allow secondary market investors to see the
impact that bid-ask spreads can have on the investor's trading expenses
and ultimately the return on investment. For example, a hypothetical
example of spread costs can highlight that these costs can be a drag on
returns for someone who trades frequently in certain types of ETFs. On
a percentage basis, spread costs for a single trade can equal, if not
exceed, the ETF's annual operating expenses in some cases. If an
investor trades in and out of an ETF several times within a relatively
short period of time, the costs attributable to the bid-ask spread can
increase rapidly. Transparency into trading costs also may promote
greater comparability among ETFs and other investment products, such as
mutual funds. For example, two ETFs may have very similar expense
ratios, but one ETF consistently has higher bid-ask spreads, which
could make the cost of that ETF significantly higher than the one with
a low bid-ask spread.
---------------------------------------------------------------------------
\377\ The proposal uses $10,000 in order to maintain consistency
with the cost example in Item 3 of Form N-1A.
---------------------------------------------------------------------------
The proposed example in Q&A 4 would require disclosure of
hypothetical trading costs attributable solely to the median bid-ask
spread based on data from the ETF's prior fiscal year.\378\
Specifically, the spread costs example would demonstrate the
hypothetical impact of the ETF's bid-ask spread for one $10,000
``round-trip'' trade (i.e., one buy and sell transaction). The proposed
example reflects costs that are in addition to the annual fund
operating expenses, which are currently disclosed in Item 3 of N-
1A.\379\ Thus, to assist investors with comparing the costs of
investing in various ETFs, we believe that it is appropriate to use the
same hypothetical investment amount, $10,000, which is used for the
current expense example in Item 3 of Form N-1A.
---------------------------------------------------------------------------
\378\ Proposed Instruction 5(b) to Item 3 of Form N-1A.
\379\ Item 3 of Form N-1A. Item 3 only requires 1- and 3-year
expense examples for annual fund operating expenses for ``New
Funds.''
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To illustrate that more frequent trading can significantly increase
costs, the proposed example in Q&A 5 demonstrates the costs associated
with 25 $10,000 round-trip trades (50 total trades). This figure
represents approximately two round-trip trades each month. While the
number of trades that an investor makes during the course of a year can
vary depending on the type of investor and the type of investment
strategy the ETF pursues, we believe that an example showing the spread
costs of 50 total trades could provide useful information for those
that trade frequently.\380\ As discussed in more detail below, our
proposal also would allow investors to obtain more tailored information
regarding their costs on the ETF's website.\381\
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\380\ We acknowledge the inherent difficulty of setting a number
of trades that reflects an ``average investor.'' Based on staff
experience, however, we preliminarily believe that 50 total trades,
which represents approximately 2 round-trip transactions per month,
is a reasonable figure to utilize for the purposes of demonstrating
the costs of trading for a frequent trader in Q&A 5.
\381\ See proposed Instruction 5(e) to Item 3 of Form N-1A.
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Pursuant to this requirement, an ETF would be required to disclose
``mid-range spread costs'' and ``high-end spread costs.'' The mid-range
spread costs would be calculated by using the median spread, divided by
two, and then multiplying the resulting number by a $10,000 trade size
and the number of transactions. The high-end spread costs would be
calculated by using the same calculated spread data from the ETF's
prior fiscal year, except instead of choosing the median spread, the
disclosure would represent the 95th percentile spread, after sorting
that year's data.\382\ We preliminarily believe that utilizing the 95th
percentile spread (i.e., the spread representing the threshold for the
highest 5% of spreads) is appropriate for the purposes of representing
high-end spread costs.
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\382\ We are proposing to divide the bid-ask spread by two on
the assumption that the value of an ETF share is the midpoint
between the bid price and the ask price. Therefore, the ``cost''
attributable to the bid-ask spread of executing one trade would be,
in the case of purchasing a share of an ETF, the difference between
the ask price and the midpoint between the bid and the ask prices--
in other words, this difference would represent the cost above which
the share was valued for this purpose and not the full ``round-
trip'' cost. Likewise, in the case of selling an ETF share, the
``cost'' attributable to the bid-ask spread of executing one trade
would be the difference between the bid and the midpoint between the
bid and the ask prices. To calculate the cost of multiple trades,
the single trade cost would be multiplied by the number of
transactions.
---------------------------------------------------------------------------
We considered whether to also include ``low-end spread costs'' but
determined that the combination of presenting ``mid-range spread
costs'' and ``high-end spread costs'' would provide the most meaningful
disclosure to investors. Many ``low-end spread costs'' for ETFs with
significant volume have a penny spread and would therefore not provide
as useful of a comparison across funds. Furthermore, some ``mid-range
spread costs'' and ``high-end spread costs'' could account for more
than 50% of the cost of an initial investment in an ETF, whereas a
``low-end spread cost'' might only account for a small fraction of an
investor's overall costs. We request comment on this point below.
An investor could use both the median bid-ask spread figure from
proposed Q&A 4 and the costs information in Q&A 5 to better assess the
overall cost impact of the bid-ask spread. Proposed Q&As 1-5 also would
provide investors with a better understanding of the basic terminology
needed to understand some frequently overlooked costs associated with
investing in ETFs, and then provide the data needed to understand how
those costs materialize for the particular fund and how those costs
compare to other ETFs.
Q&A 6. Cross-reference to ETF's website and Interactive Calculator
Requirement. As discussed above, proposed rule 6c-11 would require
daily website disclosure of several items, including the NAV per share,
market price, and premium or discount. As the disclosures on an ETF's
website would be updated daily, we believe a cross-reference in Form N-
1A to the website disclosures would enable investors to receive timely
and granular information that could assist with making an investment
decision.
[[Page 37375]]
Accordingly, we propose to require a statement in Q&A 6 that would
refer investors to the ETF's website for more information.\383\ Item
11(g) currently requires an ETF to provide a website address in its
prospectus if the ETF omits the historical premium/discount information
from the prospectus and includes this information on its website
instead. As a result, many ETFs already include a website address in
their prospectus.\384\
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\383\ Proposed amendments to Item 3 of Form N-1A would require
an ETF to include the following statement in its prospectus: ``The
ETF's website at [www.[Series-SpecificLandingPage.com]] includes
recent information on the Fund's net asset value, market price,
premiums and discounts, as well as an interactive calculator you can
use to determine how the bid-ask spread would impact your specific
investment.'' The Commission explained in a 2000 release that filers
submitting HTML documents on EDGAR should take reasonable steps when
they create the document in order to prevent URLs from being
converted into hyperlinks. See Rulemaking for Edgar System,
Securities Act Release No. 33-7855 (Apr. 24, 2000).
\384\ As discussed above, we propose to replace the historical
premium/discount information in Item 11(g) with line graph
disclosure regarding premiums and discounts that would be required
by proposed rule 6c-11(c)(1)(iv). See supra section II.C.6.
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In addition, proposed Instruction 5(e) to Item 3 would require an
ETF to provide an interactive calculator in a clear and prominent
format on the ETF's website. The purpose of the interactive calculator
is to provide investors with the ability to customize the hypothetical
calculations in Item 3 to their specific investing situation. For
example an investor with an investment of $2,500 opposed to $10,000 or
wishing to trade 10 times opposed to the 25 times presented in Item 3
could use the calculator to find more tailored cost-related
information. We are sensitive to the fact that creating a web-based
interactive calculator is not without cost, especially for smaller fund
complexes. We have tried to mitigate these costs by limiting the
proposed investor-input to two data points: Investment amount and
number of trades. We also tried to limit the complexity of the tool by
proposing to require the interactive calculator to use the calculations
detailed in Instructions 5(a)--(d) to Item 3 to provide the information
required by Q&As 3-5, which relates to the bid-ask spread.
c. Exception for ETFs With Limited Trading History
Trading information and related costs may not be useful to
secondary market investors in an ETF that has only a limited amount of
trading history since inception. Therefore, we are proposing that an
ETF that had its initial listing on a national securities exchange
after the beginning of its most recently completed fiscal year would
not be required to include the ETF's median bid-ask spread or the
spread cost example in its Item 3 disclosure, nor would the ETF be
required to provide an interactive calculator on its website.\385\ We
preliminarily believe this information is most useful when there is at
least one full fiscal year of data underlying the metrics. Without a
minimum amount of trading data to calculate this information, the
resulting calculations could be skewed for any number of reasons. For
example, it is possible that the time of year during which the ETF was
trading or the fact that an ETF was relatively new to the market and
had not had significant marketing to gain interest for shares of the
ETF resulted in low trading volume and higher bid-ask spreads. We
propose to require a newly launched ETF to provide a brief statement to
the effect that the ETF does not have sufficient trading history to
report trading information and related costs.\386\ The proposed
amendment would prohibit a new ETF from disclosing data based on very
short trading histories, which we preliminarily believe could be
misleading. This approach would also be consistent with our treatment
of other disclosure items such as portfolio turnover data and annual
returns.\387\
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\385\ Proposed Instruction 5(a) to Item 3 of Form N-1A.
\386\ Id.
\387\ See Items 3 and 4 of Form N-1A.
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We seek comment on our proposed amendments to Item 3:
Should we require ETFs and mutual funds to include a
statement that investors may be subject to other costs not reflected in
the fee table, such as brokerage commissions and other fees to
financial intermediaries? Would this disclosure be confusing to
individual investors, particularly those investing in mutual funds?
In addition to the statement regarding brokerage
commissions, should we require quantitative disclosure of the range of
brokerage commissions for transactions? Should this disclosure be
required of both mutual funds and ETFs? Where in the registration
statement should such disclosure be included? Or, would disclosure of
brokerage commissions raise challenges too great to require disclosure?
For example, would variations in methods used to collect and set
commissions make such disclosure too complex? How costly or difficult
would it be to obtain information about brokerage commissions?
Should other costs be disclosed in Item 3? If so, which
costs and why? How and where should those other costs be disclosed?
Should Item 3 include market price range or NAV range? What other
trading information, if any, should be included in Item 3 and why? For
example, should we require ETFs to disclose information regarding the
number of days the ETF's shares traded on a national securities
exchange, the ETF's average daily volume, and/or the ETF's total number
of shares outstanding? If so, how should we require these metrics to be
calculated and disclosed?
Should we include the specific ETF disclosures in Item 3?
Should we require that those disclosures be made in a Q&A format? Would
investors understand and find the proposed Q&A format useful? Are there
other formats we should consider? Should we permit ETFs to use any
format that is designed to effectively convey the information to
investors?
Should we replace the reference to ``national securities
exchange'' with ``secondary markets'' in Q&A 1 as proposed?
Should we require ETFs to explain bid-ask spreads and the
factors that could affect bid-ask spreads in Item 3? Are there other
explanations (or means to calculate bid-ask spreads) that we should
consider? Are there other factors that could impact bid-ask spreads
that we should include in this explanation?
Should the median bid-ask spread information be included
in the prospectus? Should this information be included in Item 3 or in
a different section of the registration statement? If so, where?
Alternatively, should we require disclosure of this information on an
ETF's website?
To what extent is historical spread data predictive of
future spread data? Should we require language indicating that
historical spread data may not be predictive of future spread data?
Should the spread calculation exclude data from the
beginning and end of the trading day? If so, what time periods should
it exclude and why? For example, should we exclude the first and last
15 minutes of each trading day?
Should the spread calculation be based on data from an
ETF's fiscal-year end or calendar-year end and why? Would the use of
fiscal-year make comparability among funds more difficult since funds
have different fiscal-year ends? Should the spread calculation be based
on data from more than one year? If so, how many years and why? Should
the spread calculation be based on data that, in addition to the fiscal
or calendar year, also includes
[[Page 37376]]
data from the most recently completed fiscal or calendar quarter,
respectively? Should the calculation be done on a daily basis first and
then again across the entire fiscal year?
Should the calculation for the bid-ask spread throughout
the trading day be done more or less frequently than every ten seconds?
If so, how frequently and why?
Should the bid and ask be calculated using a different
method, such as weighting the prices throughout the book? If so,
explain the method and why it should be used.
Should a metric other than median be used for the spread
calculation? For example, should we use average spread or effective
spread? \388\ If so, why is it preferable and how should it be
calculated? Would the use of a different spread calculation provide
more comprehensive information about extreme market events? For
example, should we also require disclosure of additional percentiles
towards the extreme of the distribution, such as the 95th percentile?
---------------------------------------------------------------------------
\388\ See supra footnote 314.
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Instead of using the bid-ask spread as an indicator of
trading costs, is there another method that would better reflect an
ETF's overall trading costs? If so, what is that metric, why is it
better than disclosing the bid-ask spread, and how should it be
calculated and disclosed?
How difficult or costly would it be for ETFs to obtain the
data necessary to calculate median bid-ask spread as proposed? Are
there any negative consequences of disclosing the bid-ask spread? If
so, what are they?
When calculating the spread costs example, should the bid-
ask spread be divided by two for each transaction listed or should each
transaction reflect the full round-trip spread cost?
Should we require disclosure of costs associated with
``mid-range spread costs'' and ``high-end spread costs'', as proposed?
Should we additionally include a requirement to disclose ``low-end
spread costs''? Why or why not? Would the disclosure of this data
result in retail investor confusion?
Is the $10,000 trade amount used in the spread costs
example reasonable? Should we consider a lower trade amount?
Alternatively, should the spread costs example show varying trade sizes
calculated using varying book depths? If so, what trade sizes and why
should they be used?
Should the spread example include a different number of
transactions? If so, how many transactions should be used for each
column and why? Should the number of transactions vary based on the
type of investment strategy the ETF pursues? If so, how should we
determine the number of transactions and corresponding ETF types?
Are there any negative consequences of disclosing the
spread costs example? If so, what are they?
Should each ETF be required to disclose a website address
in Item 3 as proposed? Should we permit an ETF to comply with this
requirement by including a general web address to an investment company
complex's website or should we require a series-specific landing page
for the ETF? Would a cross-reference to the ETF's series-specific page
be useful?
Should we require ETFs to disclose information regarding
premiums and discounts in Item 3 of Form N-1A, either in addition to,
or in lieu of, the disclosures proposed in rule 6c-11? If so, should
the information be based on data over the entire fiscal year or
calendar year? Do commenters believe that the reference to the ETF's
website, where such information may be found, provides investors with
useful information regarding these potential costs?
Would investors find the information in our proposed
amendments to Item 3 helpful in comparing between different investment
options?
Should we require funds, as proposed, to provide investors
with an interactive calculator on their website? Would investors find
an interactive calculator helpful to better understand the costs of
investing in ETFs? Are there data points that we have not discussed
that the interactive calculator should include? Should the interactive
calculator be required for both mutual funds and ETFs? For example,
should the interactive calculator be expanded to include fee table
information for both ETFs and mutual funds? Are there any challenges to
posting an interactive calculator that we are not considering? What
costs would be associated with developing this type of calculator?
Should we require funds to provide an interactive
calculator on their website for other costs, such as any costs
attributable to premiums or discounts? If so, what would be the user
inputs and outputs for the calculator? How would the calculator
calculate such a cost?
Should there be an exception to the requirement to
disclose trading information and related costs for newly launched ETFs
as proposed? If not, why not? Should a newly launched ETF nevertheless
be required to provide an interactive calculator on its website? Should
the threshold for the exemption to include trading information and
related costs disclosure instead be based on Form N-1A's definition of
``New Fund'' \389\ or a different period of time? If so, why? Should
there be an exception to disclosing trading information and related
costs for any other reason (e.g., limited trading book depth, low
volume, or trading only on a percentage of the days throughout the
year)? If so, what should the threshold be and why?
---------------------------------------------------------------------------
\389\ Instruction 6 to Item 3 of Form N-1A defines a ``New
Fund'' as ``a Fund that does not include in Form N-1A financial
statements reporting operating results or that includes financial
statements for the Fund's initial fiscal year reporting operating
results for a period of 6 months or less.'' The instruction permits
New Funds to estimate ``Other Expenses'' and to complete only 1- and
3-year portions of the expense example. Id.
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In lieu of providing an exception from the requirement to
disclose trading information and related costs for newly launched ETFs,
should we instead adopt a requirement for ETFs to disclose this
information once the ETF reaches or exceeds a specified threshold of
trading volume for a specified period of time, regardless of how long
it has been in operation? Put differently, should we base this
exception on level of trading volume rather than the length of an ETF's
operation? If so, what should such thresholds be? If not, why not?
3. Item 6 of Form N-1A
Currently, Item 6(c)(i) of Form N-1A requires an ETF to: (i)
Specify the number of shares it will issue or redeem in exchange for
the deposit or delivery of baskets; (ii) explain that the individual
shares of the ETF may only be purchased and sold on a national
securities exchange through a broker or dealer; and (iii) disclose that
the price of ETF shares is based on the market price and as a result,
shares may trade at a price greater than NAV (premium) or less than NAV
(discount).\390\ The number of shares the ETF issues or redeems in
exchange for the deposit or delivery of baskets is largely duplicative
of reports required in Form N-CEN.\391\ We therefore propose to remove
this requirement from Item 6.\392\ The remainder of the information
required by Item 6(c)(i) is proposed to be moved to the Item 3
disclosure.\393\ In order to eliminate duplicative disclosure, we
propose to remove these requirements
[[Page 37377]]
from Item 6.\394\ As noted above, moving this information to Item 3
would consolidate relevant disclosures regarding the fees and trading
costs that may be borne by an ETF investor in one place.
---------------------------------------------------------------------------
\390\ Item 6(c)(i) of Form N-1A.
\391\ See Item E.3.a of Form N-CEN; see also Reporting
Modernization Adopting Release, supra footnote 147, at n.1100 and
accompanying text (requiring ETFs ``to report the number of ETF
shares required to form a creation unit as of the last business day
of the reporting period.'').
\392\ See proposed amendments to Item 6 of Form N-1A.
\393\ See proposed amendments to Item 3 of Form N-1A.
\394\ See proposed amendments to Item 6 of Form N-1A.
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Additionally, Item 6(c)(ii) currently requires ETFs issuing shares
in creation units of less than 25,000 to disclose the information
required by Items 6(a) and (b).\395\ Current Items 6(a) and (b) require
funds to: (i) Disclose their minimum initial or subsequent investment
requirements; (ii) disclose that the shares are redeemable; and (iii)
describe the procedures for redeeming shares. We are proposing to
eliminate these disclosures.\396\ When we adopted these requirements,
we reasoned that individual investors may be more likely to indirectly
transact in creation units through authorized participants if the
creation unit size was less than 25,000 shares.\397\ Based on staff
experience, we understand that retail investors do not engage in
primary transactions through authorized participants. Furthermore, to
the extent that authorized participants act as agents for market makers
in primary transactions with the ETF, we believe that the flow of
information on how to purchase and redeem shares is robust given the
market maker's relationship with an authorized participant. Therefore,
we do not believe that this disclosure would be beneficial.
---------------------------------------------------------------------------
\395\ Item 6(c)(ii) of Form N-1A.
\396\ See proposed amendments to Item 6 of Form N-1A.
\397\ See Enhanced Disclosure and New Prospectus Delivery Option
for Registered Open-End Management Investment Companies, Investment
Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26,
2009)] (``Summary Prospectus Adopting Release''), at nn.170-72.
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We request comment on the proposed amendments to Item 6.
Should we remove the disclosure regarding creation unit
sizes from Form N-1A, as proposed? Are we correct in our understanding
that this disclosure is largely duplicative of disclosure required in
Form N-CEN? Are we correct in our belief that investors do not find
this information useful in the context of a prospectus? Instead of
removing this disclosure from Form N-1A entirely, should we move it to
the Statement of Additional Information? Do retail investors typically
use the information on creation unit size and if so, for what purpose?
Is our belief correct that this information is more useful for
authorized participants and market makers and less useful to investors
purchasing individual shares on an exchange?
Alternatively, should we require ETFs to disclose
information regarding their creation unit sizes or transaction fees, or
both, on their websites?
Should ETFs continue to disclose in Item 6 (or any other
Item included within the summary prospectus disclosure) information
currently required by Items 6(a) and (b)? If so, why? Should this
disclosure be based on a numerical threshold, and if so, what would the
appropriate threshold be and why?
Should we require ETFs to provide disclosure regarding
transaction fees associated with the purchase and redemption of
creation units? If so, where should such disclosure be provided?
Are we correct in our understanding that that the flow of
information on how to purchase and redeem ETF shares is robust due to
the relationship between market makers and authorized participants?
4. Item 11 of Form N-1A
Item 11(g)(1) currently specifies that an ETF may omit information
required by Items 11(a)(2), (b), and (c) if the ETF issues or redeems
shares in creation units of not less than 25,000 shares each.\398\
Similar to the reasoning discussed above regarding amendments to Item
6,\399\ we propose to amend Item 11(g)(1) to permit all ETFs, not just
ones with creation unit sizes of not less than 25,000 shares, to omit
the information required by Items 11(a)(2), (b), and (c).\400\
---------------------------------------------------------------------------
\398\ Item 11(g)(1) of Form N-1A.
\399\ See supra section I.H.3.
\400\ Proposed Item 11(g)(1) of Form N-1A.
---------------------------------------------------------------------------
Item 11(a)(2) requires a fund to disclose when calculations of NAV
are made and that the price at which a purchase or redemption is
effected is based on the next calculation of NAV after the order is
placed.\401\ Item 11(b) and (c) require a fund to describe the
procedures used for purchasing and redeeming the fund's shares.\402\ In
our view, eliminating these disclosure requirements for all ETFs would
not detract from an understanding of how authorized participants
transact directly with the ETF in the primary market. As discussed
above, the proposed rule would define an authorized participant as a
member or participant of a clearing agency registered with the
Commission, which has a contractual arrangement with the ETF or one of
the ETF's service providers.\403\ Thus, we believe the parties who
purchase or redeem shares from the ETF directly would either have the
knowledge necessary to do so without additional procedural disclosure
or the ability to request such information.
---------------------------------------------------------------------------
\401\ Item 11(a)(2) of Form N-1A. Item 11(a)(1) already requires
that ETFs include an explanation that the price of fund shares is
based on market price. Item 11(a)(1) of Form N-1A.
\402\ Item 11(b) and (c) of Form N-1A.
\403\ See proposed rule 6c-11(a).
---------------------------------------------------------------------------
Item 11(g)(2) currently includes a requirement for an ETF to
provide a table showing the number of days the market price of the
ETF's shares was greater than the ETF's NAV per share for certain time
periods.\404\ As discussed above, we propose to require information
about the premium and discount of the ETF's shares to their NAV per
share to be included on the ETF's website. Thus, we are proposing to
remove the information currently required by Item 11(g)(2), as more
timely information would be available on the ETF's website. For the
same reasons, we are also proposing to eliminate Item 27(b)(7)(iv) of
Form N-1A, which requires ETFs to include a table with premium/discount
information in their annual reports for the five most-recently
completed fiscal years.\405\
---------------------------------------------------------------------------
\404\ Item 11(g)(2) of Form N-1A. The item provides that an ETF
may omit the table if it provides a website address that investors
can use to obtain the premium/discount information required by the
item.
\405\ Although the time period required by this disclosure is
different than the requirement in Item 11(g)(2), ETFs are permitted
to omit both disclosures by providing on their websites only the
premium/discount information required by Item 11(g)(2) (the most
recently completed fiscal year and quarters since that year).
---------------------------------------------------------------------------
We request comment on the proposal to remove the requirement to
disclose information required by Items 11(a)(2), (b), and (c) as well
as the proposal to remove the requirement to disclose the premium/
discount information in the prospectus and annual report.
Should we keep this disclosure in the prospectus? If we
were to keep this disclosure requirement, should we require ETFs to
disclose different information about the procedures to purchase and
redeem shares directly with the ETF?
Do most ETFs provide the premium/discount information
required by this information on their websites? If we were to keep the
requirement to disclose the premium/discount information in the
prospectus, should it mirror the information proposed to be required on
the ETF's website?
5. Potential Alternatives to Current ETF Registration Forms
As discussed above, open-end funds, including ETFs organized as
open-end funds, are required to file Form N-1A to
[[Page 37378]]
register under the Act and to offer their securities under the
Securities Act. UITs, including ETFs organized as UITs, initially
register under the Investment Company Act on Form N-8B-2 and register
their offerings of securities under the Securities Act on Form S-
6.\406\ However, ETFs, regardless of structure, operate differently
than the other investment companies that register on Forms N-1A and N-
8B-2. For example, unlike traditional open-end funds and UITs, ETFs are
exchange-traded and investors rely on the arbitrage mechanism to ensure
that the ETF's shares trade at or close to its NAV.\407\ As a result of
these differences, in addition to our proposed amendments to Form N-1A
and Form N-8B-2, we are seeking comment on whether we should create a
new registration form that is specifically designed for ETFs or
consider other disclosure formats as part of a future rulemaking.
---------------------------------------------------------------------------
\406\ See infra section II.0.
\407\ See generally Hu and Morley, supra footnote 291 (proposing
a new ETP disclosure regime that ``responds to the significance of
the arbitrage mechanism, model-related complexities and evolving
understandings and conditions'').
---------------------------------------------------------------------------
Should we create a new registration form for ETFs? What
types of ETFs should be required to file reports on such a form? For
example, should we limit the form to ETFs that would be subject to
proposed rule 6c-11? Or should all ETFs, including UIT ETFs, file
reports on such a form?
What type of ETF-specific information should such a form
include? Should the form require more disclosure on the effectiveness
of the arbitrage mechanism? \408\ Should the disclosures require
qualitative disclosures that relate specifically to ETFs, including the
performance of the ETF's arbitrage mechanism? Should this disclosure be
required as part of an annual report? \409\ Should we require a
discussion of the ETF's bid-ask spread or premiums and discounts
throughout the year? Should the form include a discussion of ETF-
specific risk factors? If so, what risk factors should be included?
---------------------------------------------------------------------------
\408\ See generally id.
\409\ Id.; see also Item 27(b)(7) of Form N-1A.
---------------------------------------------------------------------------
Should we require ETFs to provide investors with a short
summary document that provides key information about the ETF? What type
of information should the document include? For example, should it
include information related to the ETF's strategy, portfolio
investments, costs, risks, or performance? Should we require it to be
in a standardized format? \410\
---------------------------------------------------------------------------
\410\ For example, in 2017, the Canadian Securities
Administrators began requiring ETFs traded on Canadian exchanges to
provide investors with a document, not to exceed four pages in
length, called ``ETF Facts.'' The ETF Facts document is required to
include certain information about the ETF, including, among other
things, information related to the ETF's investments, risks, and
performance, as well as background information about ETFs generally.
See Canadian Securities Administrators, Mandating a Summary
Disclosure Document for Exchange-Traded Mutual Funds and Its
Delivery--CSA Notice of Amendments to National Instrument 41-101
(Dec. 8, 2016), available at https://www.osc.gov.on.ca/documents/en/Securities-Category4/ni_20161208_41-101_traded-mutual-funds.pdf.
---------------------------------------------------------------------------
As an alternative to a new ETF form, or in addition to
such a form, should we consider a summary prospectus targeted
specifically at ETFs and their unique features?
Should we require ETFs to file periodic reports, such as
on Form 8-K? Under what circumstances should we require periodic
reports? For example, should we require ETFs to file periodic reports
after a market event that adversely affects the arbitrage mechanism
during the trading day?
I. Amendments to Form N-8B-2
Form N-8B-2 is the registration form under the Investment Company
Act for UITs which are currently issuing securities and is used for
registration of ETFs organized as UITs.\411\ For the reasons discussed
above in section II.A.1, we believe that UIT ETFs should be regulated
pursuant to their exemptive orders, rather than a rule of general
applicability and are not proposing to include them within the scope of
proposed rule 6c-11. However, we believe that it is important for
investors to receive consistent disclosures for ETF investments,
regardless of the ETF's form of organization.\412\ We are therefore
proposing to amend Form N-8B-2 \413\ to require UIT ETFs to provide
disclosures that mirror certain of our proposed disclosure changes in
Form N-1A.\414\ Below are the proposed Form N-8B-2 amendments and the
corresponding sections in Form N-1A.
---------------------------------------------------------------------------
\411\ While open-end funds register with the Commission with
Form N-1A, UITs must register with two forms: Form S-6 which is used
for registering the offering of the UITs' units under the Securities
Act, and Form N-8B-2, which is used for registration under the
Investment Company Act. Form S-6, which must be filed with the
Commission every 16 months, provides certain content requirements,
mainly by referencing to the disclosure requirements in Form N-8B-2.
\412\ See 2008 ETF Proposing Release, supra footnote 3, at
section III.D.1. for a general discussion of ETF prospectus delivery
requirements. Since UITs issue securities, and not subject to any of
the applicable exemptions, both sponsors and dealers are required to
deliver a current prospectus to unit holders. See section 5(b) of
the Securities Act (requiring prospectus delivery with the sale of
securities, including units of UITs); see also section 24(d) of the
Act (eliminating the ``dealer exception'' in section 4(3) of the
Securities Act for transactions in redeemable securities by UITs);
see also supra footnote 27.
\413\ Because Form S-6 requires UIT prospectuses to include
disclosure required by specified provisions of Form N-8B-2, the
proposed disclosure amendments to Form N-8B-2 would also apply to
prospectuses on Form S-6.
\414\ See section II.H.
\415\ The proposed definition of the term ``exchange-traded
fund'' in Form N-1A covers ETFs organized as open-end funds and
includes ETFs relying on either exemptive orders or rule 6c-11 to
operate. Form N-8B-2, on the other hand, is for UITs, which would
not be able to rely on rule 6c-11 to operate. Accordingly, the
proposed definition of ``exchange-traded fund'' in Form N-8B-2 omits
the reference to rule 6c-11.
------------------------------------------------------------------------
Corresponding
Proposed Form N-1A ETF Form N-8B-2
Disclosure topic disclosure proposed
disclosure
------------------------------------------------------------------------
Definitions for Exchange- General Instructions General
Traded Fund. Part A. Instructions
Definitions.\41
5\
Information Concerning Fees Item 3. Risk/Return Item I.13(h).
and Costs. Summary: Fee Table.
Information Concerning Fees Item 3. Exchange- Item I.13(i).
and Costs. Traded Fund Trading
Information and
Related Costs.
------------------------------------------------------------------------
UIT ETFs, like other ETFs, are exchange-traded. As a result,
secondary market investors in UIT ETFs, like other ETFs, are subject to
costs, such as: bid-ask spreads; brokerage commissions for buying and
selling shares of a UIT ETF through a broker-dealer; and potential
costs related to purchasing UIT ETF shares at a premium or discount to
NAV per share. As with investors in ETFs organized as open-end funds,
we believe that unit holders could overlook these costs for UIT ETFs.
We believe that additional disclosure would help investors better
understand the total costs of investing in a UIT ETF. Accordingly, we
are proposing disclosure requirements in Form N-8B-
[[Page 37379]]
2 that mirror those of Item 3 of Form N-1A, thus requiring prospectuses
on Form S-6 for UIT ETFs to disclose that an ETF investor may pay
additional fees, such as brokerage commissions and other fees to
financial intermediaries, and to provide certain ETF trading
information and related costs.\416\
---------------------------------------------------------------------------
\416\ See proposed Items 13(h) and (i) of Form N-8B-2. See also
supra section II.H.2 describing the ETF trading information and
related costs disclosure requirements.
---------------------------------------------------------------------------
As discussed above, the proposed instructions to Item 3 would
require median bid-ask spread to be disclosed on an ETF's website. UIT
ETFs would be subject to this requirement as well. We note in this
regard that UIT ETFs currently are not subject to website disclosure
requirements regarding trading costs or other information. However, as
a matter of practice, UIT ETFs generally disclose information regarding
market price, NAV per share, premium and discounts, and spreads on
their websites today.\417\
---------------------------------------------------------------------------
\417\ UIT ETFs also would be required to provide certain ETF
specific information in reports on Form N-CEN. See Part E of Form N-
CEN. Additionally, a UIT ETF would be required to provide certain
information relating to the index that it tracks, including the
return difference and whether the index is constructed by an
affiliated person or is exclusive to the UIT. See Item E.4 of Form
N-CEN.
---------------------------------------------------------------------------
We request comment on the proposed amendments to Form N-8B-2.
Should we require ETFs organized as UITs to provide
disclosures that are consistent with Form N-1A in the manner proposed?
Do the proposed amendments to Form N-8B-2 ensure
consistency between ETFs organized as open-end funds and UIT ETFs? Why
or why not?
Are there additional amendments to Form N-8B-2 the
Commission should consider? Are there any amendments to Form S-6 that
the Commission should consider? For example, should we consider
requiring UIT ETFs to provide disclosure regarding market price, NAV
per share, and premiums and discounts? Should we consider requiring UIT
ETFs to provide graphic disclosure regarding the ETF's historical
premiums and discounts? Should we permit UIT ETFs to omit such premium/
discount in their registration statement if they include those
disclosures on the ETF's website?
Would the proposed trading cost requirements in Form N-8B-
2 Items I.13(h)-(i) result in UIT ETFs having to disclose information
not currently disclosed on their websites? If so, what information
would be disclosed that is not currently disclosed?
J. Amendments to Form N-CEN
Form N-CEN is a structured form that requires registered funds to
provide census-type information to the Commission on an annual
basis.\418\ Item C.7. of Form N-CEN requires management companies to
report whether they relied on certain rules under the Investment
Company Act during the reporting period.\419\
---------------------------------------------------------------------------
\418\ See Reporting Modernization Adopting Release, supra
footnote 147.
\419\ Item C.7. of Form N-CEN.
---------------------------------------------------------------------------
We are proposing to add to Form N-CEN a requirement that ETFs
report if they are relying on rule 6c-11.\420\ While Form N-CEN already
requires funds to report if they are an ETF,\421\ we are proposing to
collect specific information on which funds are relying on rule 6c-11
in order to better monitor reliance on rule 6c-11 and to assist us with
our accounting, auditing and oversight functions, including compliance
with the Paperwork Reduction Act.
---------------------------------------------------------------------------
\420\ Proposed Item C.7.k. of Form N-CEN.
\421\ See Item C.3.a.i. of Form N-CEN.
---------------------------------------------------------------------------
As discussed above in section II.C.1, we are also changing the
definition of ``authorized participant'' in Form N-CEN to exclude the
specific reference to an authorized participant's participation in DTC
in order to obviate the need for future amendments if additional
clearing agencies become registered with the Commission. Revised Form
N-CEN would define the term as ``a member or participant of a clearing
agency registered with the Commission, which has a written agreement
with the Exchange-Traded Fund or Exchange-Traded Managed Fund or one of
its service providers that allows the authorized participant to place
orders for the purchase and redemption of creation units.'' \422\
---------------------------------------------------------------------------
\422\ See proposed amendment to Instruction to Item E.2 of Form
N-CEN.
---------------------------------------------------------------------------
We request comment on our proposed amendments to Form N-CEN.
Should we require any additional information concerning
proposed rule 6c-11? If so, what information and where? For example,
should we require ETFs to provide information to the Commission on a
monthly basis on Form N-PORT? If so, what information?
Should we amend the definition of ``authorized
participant'' in Form N-CEN as proposed or should we retain its
existing definition?
III. Economic Analysis
A. Introduction
ETF sponsors seeking to operate an ETF currently need to obtain an
order from the Commission that exempts them from certain provisions of
the Act that otherwise would prohibit several features essential to the
ETF structure. Obtaining such exemptive relief typically has resulted
in expenses and delays in forming new ETFs. In addition, the conditions
in the exemptive orders issued by the Commission have evolved over
time. As a result, some ETF sponsors may have a competitive advantage
over other sponsors because some existing exemptive orders allow the
sponsors to launch new funds under the terms and conditions of those
orders, and because the terms in some of the existing exemptive orders
may be more flexible than others.
Proposed rule 6c-11 would allow ETFs that satisfy certain
conditions to operate without obtaining an exemptive order from the
Commission. As discussed above, the Commission also proposes to rescind
the exemptive relief we have issued to ETFs that could rely on the
proposed rule. However, we anticipate that ETFs whose exemptive relief
would be rescinded under the proposed rule generally would be able to
rely on the proposed rule without substantially changing their current
operations, as the conditions for relying on the proposed rule would be
similar to those contained in existing exemptive relief, consistent
with existing market practice, or generally more flexible than those
contained within existing exemptive relief.\423\ ETFs that wish to
operate in a manner not covered by the proposed exemptive rule could
seek individual exemptive relief from the Commission.
---------------------------------------------------------------------------
\423\ As discussed in more detail below, some conditions in the
proposed rule and the scope of the relief provided are less flexible
than those included in certain exemptive orders (e.g., the absence
in the proposed rule of master-feeder relief) and others represent
requirements that were not included in exemptive orders (e.g.,
basket policies and procedures and the recordkeeping requirements).
---------------------------------------------------------------------------
We believe that proposed rule 6c-11 would establish a regulatory
framework that: (1) Reduces the expense and delay currently associated
with forming and operating certain ETFs unable to rely on existing
orders; and (2) creates a level playing field for ETFs that could rely
on the proposed rule. As such, the proposed rule would enable increased
product competition among certain ETF providers, which could lead to
lower fees for investors, encourage financial innovation, and increase
investor choice in the ETF market.
Furthermore, the amendments to Forms N-1A and N-8B-2 as well as the
additional website disclosures required by the proposed rule are
intended to improve the information about ETFs available to the market
and to allow
[[Page 37380]]
investors to more readily obtain information about fund products,
resulting in reduced investor search costs. To the extent that the
proposed amendments would improve investors' ability to evaluate the
performance and other characteristics of fund products, the proposed
amendments might result in better informed investor decisions and more
efficient allocation of investor capital among fund products, and might
further promote competition among ETFs and between ETFs and mutual
funds.
The proposed rule and amendments to Forms N-1A and N-8B-2 also may
impact non-ETF products and market participants. To the extent that the
proposed rule would lead to lower investor search costs, lower fees,
and increased product innovation and investor choice in the ETF market,
investors may shift their investments towards ETFs and away from funds
similar to ETFs, such as mutual funds. Such a shift in investor demand
also may affect broker-dealers and investment advisers, whose customers
and clients may show increased interest in and demand for ETFs.
Moreover, because ETF shares are traded on the secondary market, the
proposed rule also could affect exchanges, alternative trading systems,
facilities for OTC trading, broker-dealers, and clearing agencies to
the extent that the rule causes changes in the ETF trading activity
they support.
B. Economic Baseline
1. ETF Industry Growth and Trends
The ETF industry has experienced extensive growth since the first
US ETF began trading in 1993.\424\ From 1993 to 2002, an average of 10
new ETFs registered each year and ETF net assets increased by an
average of $10.7 billion annually. Industry growth accelerated from
2003 to 2006, when, on average, 62 new ETFs and $77 billion in net
assets were added to the industry annually. Since 2007, the industry
has seen an average of 141 new ETF entrants and an average growth of
$272.8 billion annually. Since 2007, ETF net assets have grown at an
average rate of 18.4% per year, which compares to 4.2% for closed-end
funds and 9.7% for open-end funds over the same period.\425\
---------------------------------------------------------------------------
\424\ For the purpose of this release, we focus exclusively on
ETFs that trade on US exchanges.
\425\ The number and net assets of ETFs are based on a staff
analysis of Bloomberg data. Growth rates for open- and closed-end
funds are based on a staff analysis of Morningstar data.
---------------------------------------------------------------------------
At the end of December 2017, there were 1,900 registered ETFs that
had a total of $3.4 trillion in net assets, spanning six broad
investment style categories. ETFs are predominantly structured as open-
end funds; however, eight funds that together represented 10.9% of ETF
total net assets ($372.8 billion) were structured as UITs, and 70 ETFs
that together represented 25.1% of total net assets ($854.9 billion)
were structured as a share class of an open-end fund. The chart
illustrates growth in ETF net assets by investment strategy beginning
in 2000 (left-hand side axis). It also tracks the percentage of net
assets invested in actively managed ETFs (right-hand side axis).
[[Page 37381]]
[GRAPHIC] [TIFF OMITTED] TP31JY18.017
Although indexing is still the most common ETF strategy, over time
ETFs have evolved to offer, among other things, active management,
leveraged and inverse investment strategies, and exposure to various
types of foreign securities. At the end of December 2017, 187 ETFs,
structured as open-end funds, employed leveraged or inverse investment
strategies.\426\ In total, leveraged ETFs had total net assets of
$35.26 billion or approximately 1% of all ETF net assets. None of the
eight registered ETFs structured as UITs employed leveraged or inverse
investment strategies. Of the remaining unleveraged ETFs, both index-
based and active, 1,705 funds had combined net assets of $3 trillion
operated as open-end funds, while eight funds had $372.8 billion in net
assets operated as UITs.\427\
---------------------------------------------------------------------------
\426\ As of the end of December 2017, 1,635 ETFs were neither
organized as a UIT, nor as a share class of an open-end fund, and do
not pursue leveraged or inverse investment strategies. During 2017,
the number of such funds grew by 124. (In the last five years, the
increase in such funds ranged from 90 in 2013 to 181 in 2015.)
\427\ Bloomberg defines actively managed or index-based managed
funds according to disclosure in the fund prospectus.
---------------------------------------------------------------------------
There were 206 actively managed ETFs with total net assets of $45.8
billion. The remaining 1,694 funds with combined $3.36 trillion in net
assets were index-based funds. Of these, 1,686 with total net assets of
$2.987 trillion were structured as open-end funds and eight with total
net assets of $372.8 billion were structured as UITs.
The majority of ETFs, in total 1,456, held some foreign exposure in
their portfolio according to Morningstar data. These ETFs had total net
assets of $2.976 trillion. Of these funds, seven were structured as
UITs and had $350.4 billion in net assets. The remaining 1,449 funds
and $2.63 trillion in net assets were organized as open-end funds. On
average, these ETFs reported foreign exposure of 37.75%. This number
was 57.13% for ETFs structured as UITs and 37.66% for ETFs structured
as open-end funds.\428\
---------------------------------------------------------------------------
\428\ We estimate funds' foreign holdings on April 11, 2018 from
Morningstar data. For each ETF, foreign holdings of equity and debt
securities are combined to obtain the approximate percentage of
assets invested in foreign securities. Morningstar provided foreign
holding data for 1,724 ETFs. In this data, 268 funds, one of which
is structured as a UIT, reported holding no foreign securities and
176 funds from the original 1,900 are missing foreign holdings data.
---------------------------------------------------------------------------
2. Exemptive Order Process
As discussed above, ETFs seeking to operate as investment companies
historically have needed exemptive relief from the Commission. Since
the first exemptive relief was granted in 1992, the Commission has
issued approximately 300 exemptive orders to
[[Page 37382]]
ETFs. The average number of approved exemptive orders between 1992 and
2006 was approximately 2.5 per year, which has increased to
approximately 25 per year since 2007.
Based on our review of exemptive orders that granted relief for
unleveraged ETFs between January 2007 and mid-March 2018, the median
processing time from the filing of an initial application to the
issuance of an order was 221 days, although there was considerable
variation.\429\ Depending on the complexity of a fund's application,
some ETF sponsors received exemptive relief in a relatively short
period of time (the 10th percentile of the processing time was 83 days)
while others waited over one year for approval (the 90th percentile of
the processing time was 686 days).
---------------------------------------------------------------------------
\429\ The earliest order in our sample was approved on 1/17/2007
and the latest order was approved on 4/10/2018.
---------------------------------------------------------------------------
In addition to the processing time associated with applying for an
exemptive order, Commission staff estimates that the direct cost of a
typical fund's application for ETF relief (associated with, for
example, legal fees) is approximately $100,000, which may vary
considerably depending on the complexity of the prospective fund.
3. Market Participants
As discussed above, several non-ETF market participants may be
affected by the proposed rule, including fund sponsors, authorized
participants, trading venues, and institutional and retail investors.
Using data from Bloomberg, we find that there are 83 unique ETF
sponsors with approximately 1,900 ETFs as of December 31, 2017. The
median number of ETFs per sponsor is eight and the mean is 23,
suggesting that a small number of sponsors have a large share of the
ETF market (in terms of number of ETFs). Indeed, the top five sponsors
operate a combined 898 ETFs, whereas the bottom half of sponsors
operate only a combined 121 ETFs.
An ETF (or one of its service providers) has contractual
arrangements with a set of authorized participants, who can place
orders for the purchase or redemption of creation units with the
ETF.\430\ While we currently lack data on authorized participants, a
2015 survey-based study of fifteen fund sponsors, which together offer
two-thirds of all existing ETFs (covering 90% of all ETF assets), finds
that the average ETF has 34 authorized participant agreements.\431\ The
study further reports that creation and redemption transactions
occurred only on between 10% to 20% of trading days and that only 10%
of the daily activity in all ETF shares (by volume) are creations or
redemptions.\432\
---------------------------------------------------------------------------
\430\ Some market makers and other market participants engage in
creation and redemptions indirectly through authorized participants.
See supra section I.B. The Commission, however, lacks data on the
number of such market participants.
\431\ See Antoniewicz, supra footnote 30. While we currently
lack data on authorized participants, we note that, starting July
30, 2018, Form N-CEN Item E.2 will require a fund to provide certain
information regarding its authorized participants, including the
authorized participant's name, the SEC file number, CRD number, and
other information. See Reporting Modernization Adopting Release,
supra footnote 147. This Item, however, will not provide data about
other market participants that may transact through authorized
participants.
\432\ NSCC is the sole provider of clearing services for ETF
primary market transactions. Whether a creation or redemption order
is eligible to be processed through NSCC depends on the eligibility
for NSCC processing of the securities in the ETF's basket. See
Antoniewicz, supra footnote 30.
---------------------------------------------------------------------------
ETF shares are mainly traded on securities exchanges.\433\ Table 1
lists the 10 exchanges with the largest average daily ETF trading
volume, measured over the 30 business days ending on February 12, 2018.
The data is from Bloomberg and shows that NYSE Arca handles the largest
portion of ETF trades ($23.8 billion), followed by Nasdaq InterMarket
($12.8 billion), and Cboe BZX Exchange ($11.0 billion).
---------------------------------------------------------------------------
\433\ In the first quarter of 2018, 68% of ETF trading by dollar
volume was executed on exchanges, 23% over the counter, and 10%
using alternative trading systems (ATSs), based on Trade and Quote
(TAQ) data provided by the New York Stock Exchange, Trade Reporting
Facility (TRF) data provided by FINRA, and ATS information made
publicly available on the FINRA website.
Table 1--ETFs Listed on National Exchanges and Their Trading Volume
------------------------------------------------------------------------
Trading volume
Exchange Number of ETFs (billion)
------------------------------------------------------------------------
NYSE Arca............................... 1,899 $23.8
NASDAQ InterMarket...................... 1,537 12.2
Cboe BZX Exchange, Inc.................. 1,840 11.0
Cboe EDGX Exchange, Inc................. 1,864 7.4
Cboe BYX Exchange, Inc.................. 1,816 4.5
NASDAQ Global Market.................... 339 3.2
Nasdaq BX, Inc.......................... 1,801 2.7
Chicago Stock Exchange, Inc............. 169 2.5
Cboe EDGA Exchange, Inc................. 1,781 2.4
NASDAQ OMX PSX.......................... 1,343 2.2
------------------------------------------------------------------------
The table reports the number of ETFs traded at each exchange and the
average daily ETF trading volume, measured over the 30 business days
ending on February 12, 2018. Trading volume is calculated as trade
price multiplied by the number of shares relating to each price by
exchange. The figures reflect an analysis by the Commission staff
using data obtained through a subscription to Bloomberg.
Both institutional and retail investors participate in the ETF
secondary market. Using combined data from WRDS SEC Analytics Suite,
Morningstar, and the Center for Research in Security Prices (CRSP) from
the first quarter of 2014 to the fourth quarter of 2016, we estimate
that institutions own, on average, 43% of ETF shares, when calculating
the average using equal weights for all ETFs, and 55%, when calculating
the average using total net assets (``TNA'')-based weights. The
difference between the equal-weighted and TNA-weighted average
institutional ownership numbers--43% vs. 55%--suggests that
institutional investors tend to hold larger shares of ETFs with larger
TNA. The table also shows that the median ownership by institutional
investors is 40%. Additionally, the table shows that there is
considerable variation in institutional investor holdings, ranging from
an average for the 5th percentile of 6% to an average for the 95th
percentile of 90%.\434\ However, we observe that the average
institutional holding did not change considerably over time during the
sample period.
---------------------------------------------------------------------------
\434\ The data we use is from Form 13F filings, which does not
capture all institutional positions because Form 13F does not
require reporting of short positions (which would lead to an
overstatement of institutional ownership) and because not all
institutional investors are required to file the form, for example
because they exercise investment discretion in less than $100
million in Section 13(f) securities (which would lead to an
understatement of institutional ownership).
[[Page 37383]]
Table 2--Institutional Ownership of ETFs
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal- TNA-
Quarter weighted weighted SD (%) P5 (%) P25 (%) P50 (%) P75 (%) P95 (%)
average (%) average (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
2014Q1...................................................... 40 53 24 6 22 37 56 86
2014Q2...................................................... 42 54 25 7 22 37 58 90
2014Q3...................................................... 41 55 24 7 23 38 59 88
2014Q4...................................................... 43 55 24 6 24 40 60 88
2015Q1...................................................... 41 54 24 5 22 38 58 85
2015Q2...................................................... 42 55 25 6 23 40 60 91
2015Q3...................................................... 44 56 26 7 25 41 62 94
2015Q4...................................................... 44 57 26 5 24 43 62 92
2016Q1...................................................... 44 57 26 5 24 42 62 92
2016Q2...................................................... 43 56 26 6 23 41 61 92
2016Q3...................................................... 43 56 26 5 24 41 62 91
2016Q4...................................................... 44 57 25 6 24 42 61 91
-------------------------------------------------------------------------------------------
Average..................................................... 43 55 25 6 23 40 60 90
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports the quarterly institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided
by the total shares outstanding adjusted for share splits. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles.
All descriptive stats are equal-weighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using data from 2014Q1
to 2016Q4 obtained through a subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).
Further analysis shows that the ownership structure varies
considerably by the type of ETF. Using Morningstar categories, for the
fourth quarter of 2016, Table 3 below shows that ETFs' equal-weighted
average institutional ownership ranges from 23% for alternative ETFs to
56% for taxable bond ETFs. We also find that TNA-weighted average
institutional ownership is higher than equal-weighted average
institutional ownership for international equity, municipal bond,
sector equity, taxable bond, and U.S. ETFs, suggesting that
institutional investors tend to hold ETFs with larger TNA within these
categories. The converse is true for allocation, alternative and
commodity ETFs. The table also shows that there is large variation
within categories.\435\
---------------------------------------------------------------------------
\435\ Morningstar category is assigned based on the underlying
securities in each portfolio. Per Morningstar, funds in allocation
categories seek to provide both income and capital appreciation by
investing in multiple asset classes, including stocks, bonds, and
cash. Funds in alternative strategies employ investment approaches
(similar to those used by hedge funds) designed to offer returns
different than those of the long-only investments in the stock,
bond, or commodity markets. International equity portfolios expand
their focus to include stocks domiciled in diverse countries outside
the United States though most invest primarily in developed markets.
Municipal bond strategies are generally defined by state or national
focus and duration exposure. A fund is considered state-specific if
at least 70% of its assets are invested in municipal securities
issued by the various government entities of a single state. Sector-
specific equity funds are usually equity funds, in that they
maintain at least 85% exposure to equity. Fixed Income Taxable bond
portfolios invest at least 80% of assets in securities that provide
bond or cash exposure. U.S. equity portfolios are defined as
maintaining at least 85% exposure to equity and investing at least
70% of assets in U.S.-domiciled securities.
Table 3--Institutional Ownership of ETFs by Morningstar Category for 2016: Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal TNA
Quarter weighted weighted SD (%) P5 (%) P25 (%) P50 (%) P75 (%) P95 (%)
average (%) average (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation.................................................. 43 38 26 8 23 36 58 95
Alternative................................................. 23 16 22 2 6 17 33 68
Commodities................................................. 41 38 20 10 29 39 59 71
International Equity........................................ 48 63 23 12 31 46 64 91
Municipal Bond.............................................. 48 55 16 15 39 50 59 74
Sector Equity............................................... 42 57 22 10 26 40 58 83
Taxable Bond................................................ 56 63 21 20 41 57 72 91
U.S. Equity................................................. 45 60 23 11 29 43 59 93
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports the institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided by the
total shares outstanding adjusted for share splits, by Morningstar Category. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to
95th percentiles. All descriptive stats are equal-weighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using
data for 2016Q4 obtained a through subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).
4. Secondary Market Trading, Arbitrage, and ETF Liquidity
Unlike shares of open-end funds, ETF shares are traded in the
secondary market at prices that may deviate from the ETF's NAV. As a
result, ETF investors may trade shares at prices that do not
necessarily reflect the intrinsic value of the underlying ETF
assets.\436\ To reduce the frequency and size of ETF premiums and
discounts, our exemptive orders have contained several conditions
designed to facilitate an efficient arbitrage mechanism, help ensure
the proper functioning of the ETF market, and ultimately protect
investors.
---------------------------------------------------------------------------
\436\ It is possible for both the ETF's NAV per share and its
share price to deviate from the intrinsic value of the ETF's
underlying portfolio. In addition, there may be cases in which the
ETF's share price is closer to the intrinsic value of the ETF's
portfolio than its NAV per share. See, e.g., Madhavan, Ananth, &
Aleksander Sobczyk, Price Discovery and Liquidity of Exchange-Traded
Funds, 14 Journal of Investment Management 2 (2016).
---------------------------------------------------------------------------
One set of conditions has required that ETFs be listed on a
national stock exchange and that exchanges publish the fund's IIV every
15 seconds for domestic ETFs and every 60 seconds for international
ETFs. Another condition, which was designed to support the effective
functioning of the arbitrage mechanism, is portfolio transparency. All
ETFs in operation today have a provision in their exemptive order that
requires them to provide some degree of transparency regarding their
portfolio
[[Page 37384]]
holdings. As discussed above, actively managed ETFs and some ETFs that
track an index from an affiliated index provider have been required to
disclose their holdings prior to the commencement of trading each
business day (i.e., full portfolio transparency). Other index-based
ETFs are permitted to disclose their portfolio holdings indirectly, by
specifying which index they seek to track, as long as the index
provider lists the constituent securities on its website (i.e., index
transparency) or by disclosing the components of their baskets. Based
on a staff review of 100 index-based ETFs, randomly selected from all
index-based ETFs, and 50 actively-managed ETFs, randomly selected from
all actively-managed ETFs, all 150 ETFs maintain a website and provide
the ETF's complete daily portfolio holdings. Therefore, we believe that
all index-based and actively-managed ETFs that could rely on the
proposed rule now, including those that are not subject to a full
transparency condition in their exemptive order, currently provide full
portfolio transparency.\437\
---------------------------------------------------------------------------
\437\ The samples were randomly drawn from all index-based ETFs
and all actively managed ETFs currently trading according to
Bloomberg. We recognize that the selection of ETFs examined by Staff
overweights the sample of actively managed ETFs relative to the
entire population of actively managed ETFs. Our sampling procedure
was done to avoid small sample bias as equally proportioned sampling
would call for a survey of approximately 2 actively managed funds.
---------------------------------------------------------------------------
The degree to which ETFs have flexibility in choosing the
composition of creation and redemption baskets plays an important role
for the effective functioning of the arbitrage mechanism. A more
flexible basket composition may, among other considerations discussed
in more detail below, allow authorized participants to exchange baskets
for ETF shares at a lower cost, thus increasing arbitrage activity and
efficient functioning of markets.\438\ The extent to which our
exemptive orders have allowed ETFs to use creation and redemption
baskets that deviate from a pro rata representation of the ETF's
portfolio holdings (i.e., basket flexibility) has evolved over time.
ETFs that received their exemptive orders in the early period from
1992-1995 were mostly structured as UITs and, as a result, the creation
and redemption baskets were mostly a strict pro rata representation of
the index, plus some cash balancing amount. From 1996 to 2006,
exemptive orders for ETFs, which then were mostly structured as open-
end funds, did not expressly limit baskets to a pro rata representation
of the ETF's portfolio holdings. From 2006 to 2010, the Commission
limited basket flexibility in exemptive orders for ETFs organized as
open-end funds by requiring baskets to generally represent a pro rata
slice of the fund's portfolio holdings and including conditions
limiting the circumstances under which substitutions would be
permitted. Starting around 2011, the exemptive orders required baskets
to be a strict pro rata slice of the portfolio holdings and, in
addition, to be the same for all authorized participants, with minor
exceptions.\439\
---------------------------------------------------------------------------
\438\ A more flexible basket composition may create potential
risks such as dumping and cherry-picking, as discussed in more
detail below.
\439\ Our exemptive orders have generally included future funds
relief to allow sponsors to form and operate new ETFs without having
to obtain additional exemptive orders. See supra footnote 5. As a
result, the Commission does not have records that would allow us to
determine the specific exemptive order under which any particular
fund is operating. We thus do not quantify the number of funds
operating under each of the different basket flexibility conditions
included in our orders.
---------------------------------------------------------------------------
For ETFs that hold foreign investments in their portfolio, the
redemption process for these securities may take more than the seven
days specified under section 22(e) of the Act. The Commission has
granted exemptive relief to certain ETFs who hold foreign investments,
in many instances up to 15 days, to satisfy redemption of a foreign
investment.
Many exemptive orders have required ETFs to disclose on their
website, free of charge, the previous day's NAV and the price of the
ETF shares, as well as the premium or discount associated with the
ETF's share price at the market close.\440\ Based on a staff review of
the websites of 150 randomly selected ETFs, all of which provided the
previous day's NAV, price of the ETF shares (one active ETF provided a
price based on the midpoint between the bid and ask prices while the
remainder of the active and all index-based ETFs provided closing
prices), as well as the premium or discount associated with the ETF
share price at the market close, we believe that all ETFs that could
rely on the proposed rule currently disclose this information on their
website.\441\
---------------------------------------------------------------------------
\440\ In addition, some funds disclose some historical
information on premiums and discounts on their website pursuant to
the flexibility provided on Form N-1A. See supra section II.C.6.c.
\441\ See supra footnote 437.
---------------------------------------------------------------------------
ETFs have also been required to have contractual agreements with
authorized participants to purchase or redeem ETF shares in creation
unit aggregations in exchange for a basket of securities and other
assets. Having an accurate estimate of the current ETF share value and
an opportunity to efficiently create or redeem ETF shares in creation
unit sizes allows authorized participants to engage in arbitrage
activity that brings the market price of ETF shares and the value of
the ETF's portfolio closer together. As noted earlier, market
participants can also engage in arbitrage activity in the secondary
market by taking a long and short position on the ETF shares and the
underlying basket assets. For example, if the ETF is trading at a
premium relative to the NAV per share of the ETF's portfolio, a market
participant can short the ETF and buy the underlying basket assets in
proportion to the ETF shares. Alternatively, if the ETF is trading at a
discount relative to NAV per share, a market participant may buy the
ETF and short the underlying basket assets in proportion to the ETF
shares. Then the market participant could realize a profit by closing
the position when the gap between the ETF's share price and NAV per
share gets closer to zero. This trading activity could help close the
gap even further.
However, authorized participants, other market participants, and
arbitrageurs acting in secondary markets may incur costs and be exposed
to risk when engaging in arbitrage. The costs include bid-ask spreads
and transaction fees associated with the arbitrage trades. In addition,
during the time it takes arbitrageurs to execute these trades, they are
exposed to the risk that the prices of the basket assets and the ETF
shares change. As a consequence, arbitrageurs may decide to wait for
any mispricing between the market price of ETF shares and NAV per share
to widen until the expected profit from arbitrage is large enough to
compensate for any additional costs and risks associated with engaging
in the transaction.
Using data from Bloomberg, we find that ETFs, on average, trade at
a price slightly higher than the NAV per share (i.e., at a premium), as
shown in Table 4 below. The equal-weighted and TNA-weighted average
premium/discount over the last 15 years for all ETFs in the dataset
are, respectively, 0.074% and 0.065%, and the median is 0.024%,
indicating that the prices of ETF shares are, on average, higher than
the NAV per share. One study finds similar results and concludes that,
on average, ETF market prices tend to reflect NAV per share closely.
However, consistent with the study, we find that ETF premiums/discounts
vary significantly.\442\ For example, we find
[[Page 37385]]
that the average premiums/discounts ranges from 0.03% in 2003 to 0.14%
in 2009, and the average standard deviation of premiums/discounts
ranges from 0.16% in 2017 to 0.60% in 2008. Moreover, not all ETF
shares trade at a premium. For example, the table shows, in a given
year, at least 25% of ETF shares trade at a discount, at an average
discount of -0.044% between all years (see the column P25).
---------------------------------------------------------------------------
\442\ Commenters to our 2015 ETP Request for Comment, supra
footnote 9, report qualitatively similar results. See, e.g., Comment
Letter of Eaton Vance Corp. to Request for Comment on Exchange-
Traded Products (File No. S7-11-15) (Aug. 17, 2015).
Table 4--Time-Series Averages of Cross-Sectional Descriptive Statistics of Premium/Discount (%) Using Daily Data
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal TNA
Year weighted weighted SD P5 P25 P50 P75 P95
average average
--------------------------------------------------------------------------------------------------------------------------------------------------------
2003........................................................ 0.134 0.030 0.235 -0.215 -0.061 0.015 0.091 0.343
2004........................................................ 0.095 0.039 0.262 -0.259 -0.060 0.023 0.095 0.549
2005........................................................ 0.058 0.078 0.276 -0.221 -0.038 0.036 0.111 0.617
2006........................................................ 0.074 0.082 0.338 -0.344 -0.042 0.029 0.141 0.671
2007........................................................ 0.140 0.079 0.386 -0.389 -0.060 0.034 0.198 0.639
2008........................................................ 0.087 0.100 0.603 -0.785 -0.142 0.055 0.343 1.054
2009........................................................ 0.126 0.143 0.537 -0.557 -0.079 0.020 0.342 1.027
2010........................................................ 0.072 0.066 0.353 -0.436 -0.046 0.022 0.164 0.635
2011........................................................ 0.035 0.068 0.412 -0.550 -0.040 0.021 0.170 0.766
2012........................................................ 0.058 0.072 0.286 -0.309 -0.019 0.022 0.141 0.582
2013........................................................ 0.060 0.035 0.278 -0.352 -0.025 0.017 0.091 0.432
2014........................................................ 0.046 0.038 0.216 -0.245 -0.013 0.016 0.082 0.351
2015........................................................ 0.036 0.042 0.235 -0.25 -0.015 0.015 0.079 0.401
2016........................................................ 0.026 0.044 0.228 -0.222 -0.015 0.013 0.091 0.389
2017........................................................ 0.069 0.058 0.159 -0.085 -0.008 0.015 0.094 0.332
-------------------------------------------------------------------------------------------
Average..................................................... 0.074 0.065 0.320 -0.348 -0.044 0.024 0.149 0.586
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The TNA-Weighted Average is weighted based
on an ETF's previous month's total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Fund premiums
or discounts are from daily Bloomberg data covering 1,838 funds for a total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is
the difference between the fund's closing price on the day of the most recent Net Asset Value (NAV) and the NAV of the fund on that day. The data
covers the period from 01/03/2003 to 08/31/2017.
Premiums and discounts to NAV per share also vary considerably by
the type of assets that make up the ETF.\443\ We use Morningstar
investment categories to divide ETFs into groups of similar assets and,
in Table 5, report the time-series averages of cross-sectional
descriptive statistics for premiums/discounts in the different
Morningstar Investment Categories. We find that the TNA-weighted
average premium/discount ranges from as low as 0.003% for alternative
to 0.197% for taxable bond ETFs. The results are qualitatively similar
for equal-weighted average premium/discounts.
---------------------------------------------------------------------------
\443\ See Engle Article, supra footnote 95.
Table 5--Time-Series Averages of Cross-Sectional Descriptive Statistics of Premium/Discount (%) by Morningstar Investment Category
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal TNA
Category weighted weighted SD P5 P25 P50 P75 P95
average average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation.................................................. 0.072 0.083 0.233 -0.119 -0.039 0.047 0.237 0.295
Alternative................................................. 0.007 0.003 0.345 -0.404 -0.126 -0.004 0.116 0.468
Commodities................................................. 0.211 0.112 0.481 -0.545 0.011 0.084 0.158 1.007
International Equity........................................ 0.185 0.193 0.440 -0.482 -0.068 0.204 0.458 0.833
Municipal Bond.............................................. 0.086 0.076 0.314 -0.358 -0.090 0.061 0.273 0.532
Sector Equity............................................... 0.031 0.013 0.189 -0.243 -0.074 0.005 0.085 0.304
Taxable Bond................................................ 0.207 0.197 0.206 -0.068 0.088 0.188 0.273 0.539
U.S. Equity................................................. -0.001 0.005 0.079 -0.104 -0.036 0.008 0.048 0.113
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The funds are first divided into groups
based on Morningstar categories. The TNA-Weighted Average is weighted based on an ETF's previous month's total net assets. SD refers to standard
deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Fund premiums or discounts are from daily Bloomberg data covering 1,838 funds for a
total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund's closing price on the day of the most
recent Net Asset Value (NAV) and the NAV of the fund on that day. The data covers the period from 01/03/2003 to 08/31/2017.
When the ETF arbitrage mechanism functions effectively, ETFs also
should trade at smaller bid-ask spreads.\444\ As shown in Table 6, the
TNA-weighted average bid-ask spread, as a percentage of the mid-price,
has declined from 0.062% in 2012 to 0.030% in 2017.\445\ The table
shows a qualitatively similar decreasing pattern when using equal-
weighted average bid-ask spreads. The percentiles of the bid-ask
spreads also follow a decreasing trend. For example, we observe that
the median bid-ask spread drops from 0.024% in 2012 to 0.016% in 2017
(see column P50). The table also shows that the bid-ask spread varies
considerably. For example, the average standard deviation of the bid-
ask spread (0.081%) is almost twice as large as its average (0.043%).
---------------------------------------------------------------------------
\444\ See, e.g., CFA Guide, supra footnote 370.
\445\ This analysis starts in 2012 because the available data
begins in that year.
[[Page 37386]]
Table 6--Time-Series Averages of Cross-Sectional Descriptive Statistics of Relative Bid-Ask Spread (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal TNA
Year weighted weighted SD P5 P25 P50 P75 P95
average average
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012........................................................ 0.370 0.062 0.125 0.007 0.016 0.024 0.049 0.275
2013........................................................ 0.330 0.053 0.106 0.006 0.014 0.022 0.048 0.212
2014........................................................ 0.273 0.038 0.061 0.005 0.012 0.020 0.045 0.114
2015........................................................ 0.324 0.039 0.067 0.005 0.012 0.019 0.045 0.122
2016........................................................ 0.372 0.037 0.066 0.005 0.011 0.019 0.038 0.111
2017........................................................ 0.349 0.030 0.063 0.004 0.009 0.016 0.030 0.086
-------------------------------------------------------------------------------------------
Average..................................................... 0.336 0.043 0.081 0.005 0.012 0.020 0.043 0.153
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The TNA-Weighted Average is weighted
based on an ETF's previous month's total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask
spreads are from daily Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is
the average of all bid/ask spreads taken as a percentage of the mid-price. The data covers the period from 01/03/2003 to 08/31/2017.
Table 7 reports bid-ask spreads for ETF shares by Morningstar
category. US Equity ETFs have the smallest average bid-ask spread of
0.027%, whereas allocation ETFs--funds that seek to provide both income
and capital appreciation by investing in multiple asset classes,
including stocks, bonds, and cash strategy--have the largest average
bid-ask spread of 0.223%.
Table 7--Time-Series Averages of Cross-Sectional Descriptive Statistics of Relative Bid-Ask Spread (%) by Morningstar Investment
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal TNA
Category weighted weighted SD P5 P25 P50 P75 P95
average average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation.................................................. 0.590 0.223 0.307 0.073 0.084 0.147 0.227 0.642
Alternative................................................. 0.391 0.094 0.162 0.017 0.03 0.047 0.089 0.315
Commodities................................................. 0.353 0.041 0.060 0.009 0.009 0.009 0.061 0.118
International Equity....................................... 0.450 0.072 0.110 0.017 0.024 0.030 0.086 0.212
Municipal Bond.............................................. 0.281 0.100 0.111 0.038 0.045 0.064 0.107 0.306
Sector Equity............................................... 0.285 0.061 0.092 0.015 0.018 0.036 0.062 0.198
Taxable Bond................................................ 0.306 0.043 0.080 0.011 0.014 0.016 0.041 0.159
U.S. Equity................................................. 0.207 0.027 0.041 0.006 0.012 0.014 0.029 0.081
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The funds are first divided into
groups based on Morningstar categories. The mean is weighted based on an ETF's previous month TNA and the data covers the period from 01/03/2012 to 08/
31/2017. SD, Min and Max refer to standard deviation, minimum and maximum. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask spreads are
from daily Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is the average of
all bid/ask spreads taken as a percentage of the mid-price.
The summary statistics presented thus far in this section suggest
that the arbitrage mechanism generally functions effectively during
normal market conditions. However, as described above in section III.B,
the Commission has observed periods of market stress during which the
arbitrage mechanism has functioned less effectively and during which
there were significant deviations for some ETFs between market price
and NAV per share and when bid-ask spreads widened considerably. We
note, however, that these conditions only persisted for very short
periods of time for the periods of market stress we have observed,
suggesting that the arbitrage mechanism recovered quickly.\446\
---------------------------------------------------------------------------
\446\ See, e.g. Madhavan Article, supra footnote 130.
---------------------------------------------------------------------------
C. Benefits and Costs of Proposed Rule 6c-11 and Amendments to Forms N-
1A and N-8B-2
The Commission is sensitive to the economic effects that could
result from proposed rule 6c-11 and amendments to Forms N-1A and N-8B-
2, including benefits and costs. However, as discussed in further
detail below, the Commission is unable to quantify many of the economic
effects, either because they are inherently difficult to quantify or
because we lack the information necessary to provide a reasonable
estimate.
1. Proposed Rule 6c-11
Proposed rule 6c-11 would allow new ETFs to operate in reliance on
a rule rather than individual exemptive orders if they meet the
requirements and conditions of the rule. In addition, we propose to
rescind all existing ETF exemptive orders, with the exception of: (i)
The section 12(d)(1) relief included in those orders; \447\ and (ii)
orders relating to ETFs structured as UITs, leveraged ETFs, and those
that are organized as a share class of a mutual fund.\448\ This section
first evaluates the general considerations associated with the proposed
rulemaking and then discusses the effects of the specific requirements
and conditions of the proposed rule.
---------------------------------------------------------------------------
\447\ The proposal would however rescind relief that has been
provided to allow master-feeder arrangements for those ETFs that do
not currently rely on the relief. In addition, we propose to
grandfather existing master-feeder arrangements involving ETF feeder
funds, but prevent the formation of new ones, by amending relevant
exemptive orders.
\448\ ETFs relying on exemptive orders that we propose to
rescind could no longer rely on their orders to launch additional
ETFs.
---------------------------------------------------------------------------
a. General Considerations
Proposed rule 6c-11 would grant exemptive relief from the
provisions of the Act that would otherwise prohibit several features
essential to the ETF structure. This section evaluates the overall
effect of reducing the expense and delay of operating certain new ETFs
by granting this exemptive relief as part of a rule rather than through
the individual exemptive order process.
As the requirements and conditions of the proposed rule are either
similar to those contained in existing exemptive orders, consistent
with market practice, or generally provide more flexibility, we
anticipate that the proposed rule and the related rescission of ETF
exemptive
[[Page 37387]]
relief would not require any existing ETFs whose exemptive relief would
be rescinded to significantly change the way they operate. Conversely,
some funds whose exemptive orders contain conditions that are more
restrictive than those contained in the proposed rule may decide to
change the way they operate in order to make use of such increased
flexibility.
Relative to the baseline, proposed rule 6c-11 would eliminate the
costs associated with applying to the Commission for an exemptive order
to form and operate as an ETF for funds relying on the rule.
Specifically, the process of forming new ETFs in reliance on the
proposed rule would be quicker, more predictable, less complex, and
therefore less costly than obtaining an exemptive order as new ETFs are
currently required to do. ETFs that could not rely on the rule, which
includes those structured as UITs, leveraged ETFs, and those that are
organized as a share class of a mutual fund, would continue to be
required to apply for an exemptive order to form and operate.\449\
---------------------------------------------------------------------------
\449\ As discussed below, some ETFs would incur additional costs
as a result of the rule's requirement to adopt and implement written
policies and procedures that govern the construction of basket
assets and the process that will be used for the acceptance of
basket assets, the rule's additional website disclosure
requirements, and the proposed amendments to Forms N-1A and N-8B-2.
The operation of such ETFs may therefore become more costly, on
balance, to the extent that these costs are not offset by the
benefits from the other parts of the proposed rule, such as the
increased basket flexibility and, for new funds, the reduced costs
of forming the fund.
---------------------------------------------------------------------------
As described above in section IV.B.2, we estimate that the cost for
a typical ETF of filing for exemptive relief is $100,000. In addition,
based on our review of exemptive orders that granted relief for
unleveraged ETFs between January 2007 and mid-March 2018, the median
processing time from the filing of an initial application to the
issuance of an order was 221 days, although there was considerable
variation. Thus, any new ETF planning to operate within the parameters
set forth by the proposed rule would save this expected cost and avoid
this delay. In addition, such ETFs would avoid the uncertainty about
the length of the delay associated with the exemptive order process,
allowing sponsors to better control the timetable for launching a new
ETF product in a way that maximizes benefits to its business.
Conversely, funds that are not able to comply with the conditions of
the rule would continue to need to apply for an exemptive order.
Assuming that the number of new ETFs seeking to form and operate under
the proposed rule that would otherwise have needed to apply for
exemptive relief is equal to the average number of ETFs that have
applied for exemptive relief since 2007, these cost and time savings
would accrue to approximately 25 ETFs per year.\450\ Using this
assumption, the annual costs savings to this group of ETF sponsors
would equal $2.5 million.\451\ We are unable to quantify the benefit a
new ETF would derive from avoiding the delay and the uncertainty about
the length of the delay associated with the exemptive order process as
the cost of a delayed registration for a new ETF is inherently
difficult to measure.
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\450\ Compared to the baseline, these cost and time savings
would only accrue to such new ETFs whose sponsors have not received
exemptive relief that would allow such ETFs to operate.
\451\ This estimate is based on the following calculation: 25 x
$100,000 = $2,500,000.
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By eliminating the need for ETFs that can rely on the proposed rule
to seek an exemptive order from the Commission, the proposed rule would
also eliminate certain indirect costs associated with the exemptive
application process. Specifically, ETFs that apply for an order forgo
potential market opportunities until they receive the order, while
others forgo the market opportunity entirely rather than seek an
exemptive order because they have concluded that the cost of seeking an
exemptive order would exceed the anticipated benefit of the market
opportunity.
In addition, we believe that the proposed rule would make it easier
for some fund complexes to ensure that each ETF in the complex is in
compliance with regulations. Specifically, we anticipate that it would
be easier, and thus less costly, for ETF complexes that today operate
funds under multiple exemptive orders to ensure compliance with a
single set of requirements and conditions contained in the proposed
rule rather than with multiple exemptive orders to the extent that the
orders vary in the requirements and conditions they contain.
We acknowledge that fund complexes may initially incur costs
associated with assessing the requirements of the proposed rule.
However, we believe that these costs would be relatively small.\452\ In
addition, we anticipate that it would be easier for third-party
providers, such as lawyers and compliance consultants, to offer
services that help ETFs ensure compliance with the proposed rules,
which will have broad applicability, than is currently the case with
ETFs relying on exemptive orders with varying conditions. As a result,
third party service providers may be able to reduce the price of their
services, compared to the baseline, for ETFs that could rely on the
proposed rule, which may partially or fully offset the initial costs of
studying the requirements of the proposed rulemaking that ETFs may
incur.
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\452\ We estimate that assessing the requirements of the
proposed rule would require 5 hours of a compliance manager ($298
per hour) and 5 hours of a compliance attorney ($352 per hour),
resulting in a cost of $6,500 (10 x $298 + 10 x $352) per fund. The
total cost for all 1,635 ETFs that could rely on the proposed rule
would thus be $10,627,500 (1,635 x $6,500). The Commission's
estimates of the relevant wage rates are based on salary information
for the securities industry compiled by the Securities Industry and
Financial Markets Association's Office Salaries in the Securities
Industry 2013. The estimated wage figures are modified by Commission
staff to account for an 1,800-hour work-year and multiplied by 2.93
to account for bonuses, firm size, employee benefits, overhead, and
adjusted to account for the effects of inflation. See Securities
Industry and Financial Markets Association, Report on Management &
Professional Earnings in the Securities Industry 2013 (``SIFMA
Report'').
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We expect that the proposed rule also would benefit ETF investors
to the extent it would remove a possible disincentive for ETF sponsors
to form and operate new ETFs that provide investors with additional
investment choices for which these sponsors currently do not have
relief. As noted above, the direct and indirect costs of the exemptive
application process may discourage potential sponsors, particularly
sponsors interested in offering smaller, more narrowly focused ETFs
that may serve the particular investment needs of certain investors. By
eliminating the need for individual exemptive relief we anticipate that
the proposed rule would accelerate the rate at which the ETF industry
would otherwise grow. In those circumstances, the proposed rule would
provide ETF investors with greater investment choices.
As we discuss below in section IV.D, we believe that the proposed
rule could increase competition in the ETF market as a whole, which
could also lead to lower fees. Any effect of increased competition on
fees would likely be larger for segments of the ETF market that
currently may be less competitive (e.g., active ETFs) and smaller for
segments of the market that currently may be more competitive (e.g.,
index-based ETFs tracking major stock indices).
Additionally, some types of funds could experience reductions in
trading costs associated with bid-ask spreads or premiums and discounts
to NAV per share. Specifically, as discussed below in section IV.C.1.c,
the proposed rule's increased basket flexibility could reduce
[[Page 37388]]
the cost of arbitrage for authorized participants of fixed-income,
international and actively managed ETFs more than for authorized
participants and other market participants of other types of ETFs. This
could potentially lead to a reduction in costs for investors associated
with bid-ask spreads and premiums and discounts to NAV per share for
fixed-income and international ETFs that could be significantly smaller
or immaterial for other types of ETFs.
As discussed above, by eliminating the need for individual
exemptive relief, we anticipate that the proposed rule would, over
time, lead to an increase in ETFs that can meet the requirements and
conditions of the rule and thus reinforce the current growth trend in
the ETF industry. In addition, the proposed rule would increase demand
for such ETFs, to the extent that such ETFs lower their fees to
investors and investors are sensitive to fees.\453\ To the extent that
some ETFs would experience larger reductions in trading costs (e.g.,
fixed-income, international, and active) or larger increases in
competition (e.g., actively managed), demand for these types of ETFs
would likely increase more than for other types of ETFs. The increased
demand would likely be due in part to investors substituting away from
comparable types of funds, such as mutual funds, and possibly due to
investors increasing the rate at which they save.\454\ Consequently,
the proposed rule could increase total assets of ETFs and could
decrease total assets of other funds, such as mutual funds. The size of
these effects would depend on the degree to which ETFs would lower
their fees or experience reduced trading costs, as well as on the
sensitivity of investor demand for ETFs and other funds to changes in
ETF fees and trading costs. We are unable to quantify these effects on
investor demand for various types of funds, in part, because we cannot
estimate the extent to which funds would lower their fees or experience
reduced trading costs and how lower fees and trading costs could change
investor demand.
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\453\ There is research to support that fund investors are
sensitive to fees. For instance, one paper (Erik R. Sirri & Peter
Tufano, Costly Search and Mutual Fund Flows, 53 The Journal of
Finance 5 (1998)) finds that ``lower-fee funds and funds that reduce
their fees grow faster''. However, we acknowledge that there are
studies that suggest that investors' sensitivity to fees may be
limited. For instance, one experimental study (James J. Choi, David
Laibson, & Brigitte C. Madrian, Why does the law of one price fail?
An experiment on index mutual funds, 23 The Review of Financial
Studies 4 (2010)) finds that investors may not always pick the
lowest-fee fund when presented with a menu of otherwise identical
funds to choose from. In addition, other studies (e.g., Michael J.
Cooper, Michael Halling, & Wenhao Yang, The Mutual Fund Fee Puzzle,
Working Paper (2016)) find evidence of significant fee dispersion
among mutual funds, even after controlling for other observable
differences between funds. While these studies investigate the
sensitivity of investors to fees of mutual funds rather than ETFs,
we believe that these results are likely hold for ETFs as well. We
are not aware of any studies that specifically study the sensitivity
of ETF investors to fees.
\454\ Investments in ETFs are one of many ways for investors to
save. If investors choose to increase their investment in ETFs,
there can be two sources for this additional investment: (1) An
increase in overall savings and (2) a decrease in savings allocated
to other investments, such as mutual funds. These two sources are
not mutually exclusive, so that an increase in ETF investments can
be accompanied by both an increase in overall savings and a decrease
in savings invested elsewhere, for example in mutual funds.
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Since ETFs are traded in the secondary market, an increase in total
assets of ETFs would likely coincide with larger trade volumes for the
exchanges where ETFs are traded, as well as the clearing agencies and
broker-dealers involved in these trades. To the extent that these
market participants are compensated by volume, the proposed rule would
thus benefit them by leading to an increase in revenues.
In addition, we expect the proposed rule to remove applications for
more standard forms of exemptive relief from consideration, leaving for
staff review only applications for more complex or novel exemptive
relief that falls outside the parameters of the proposed rule. To the
extent that this speeds up the processing time for these remaining
applications, the proposal may reduce the indirect costs of forming and
operating for funds that seek to operate outside its parameters.
b. Conditions for Reliance on Proposed Rule
Proposed rule 6c-11 contains several conditions that are designed
to facilitate an effective arbitrage mechanism, reduce costs, and
inform and protect investors. Beyond the general impact of reducing the
expense and delay of new ETFs discussed above, much of the codification
of conditions in proposed rule 6c-11 does not offer any additional
benefits or costs when measured against the baseline, as they are
generally codifications of the current regulatory practice. However,
some conditions are departures from current exemptive orders or current
market practice and we discuss the effects of these departures in more
detail below.
i. Conditions We Believe May Facilitate an Effective Arbitrage
Mechanism
Arbitrage is the practice of buying and selling equivalent or
similar assets (or portfolios of assets) in different markets to take
advantage of a price difference.\455\ As a consequence, arbitrageurs
generate price pressure that works to equalize the prices of these
assets across different markets. Arbitrage is thus important for
investors as it helps ensure that asset prices reflect market
fundamentals (i.e., are efficient) irrespective of the market in which
they are traded.
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\455\ See, e.g., Jonathan B. Berk & Peter DeMarzo, Corporate
Finance, 3rd Ed (2013).
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The ETF structure makes use of such an arbitrage mechanism with the
goal of establishing a close link between the price of an ETF's shares
and the NAV per share of the ETF portfolio. Specifically, as discussed
above, the combination of the creation and redemption process with the
secondary market trading in ETF shares provides arbitrage opportunities
that, if effective, help keep the market price of ETF shares at or
close to the NAV per share of the ETF and also help reduce bid-ask
spreads of ETF shares. Smaller deviations of ETF prices from the NAV
per share of the ETF benefit investors as they allow investors to
transact in ETF shares at prices closer to the value of the ETF's
underlying portfolio of securities. Similarly, small bid-ask spreads
for ETF shares benefit investors as they reduce the cost to trading ETF
shares.\456\
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\456\ For a detailed discussion of the ETF arbitrage mechanism,
see, e.g., CFA Guide, supra footnote 370.
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There are several factors that are important for arbitrageurs to
determine the existence of arbitrage opportunities and execute an
arbitrage strategy effectively. First, when the assets involved in the
arbitrage are similar but not the same, as is the case for ETFs,
arbitrage will be more effective the more closely the prices of the two
assets track each other and the more transparency arbitrageurs have
into any factors that may cause price differences between the two
assets. In addition, arbitrage requires that arbitrageurs have the
ability to enter into the trades necessary to execute the arbitrage
strategy, and arbitrage is more effective the smaller and more
predictable the associated trading costs are. The proposed rule
contains several provisions (many codifying current exemptive orders)
that take these considerations into account and are designed to promote
the effective functioning of the arbitrage mechanism for ETFs.
First, the proposed rule would require ETFs relying on the rule to
adopt and implement written policies and procedures that govern the
construction of basket assets and the process that will be used for the
acceptance of basket assets, including policies and
[[Page 37389]]
procedures specific to the creation of custom baskets.
As discussed in section II.C.5.a, the proposed additional policies
and procedures requirements for custom baskets are designed to reduce
the potential for cherry-picking, dumping, and other potential abuses
by authorized participants. We acknowledge that this principles-based
approach may not be effective at preventing all such abuses by
authorized participants. However, as proposed, ETFs would be required
to maintain records related to the custom baskets used, which would
allow the Commission to examine for potential abuses.
As outlined above, current exemptive orders contain varying
provisions for basket flexibility. However, based on a staff review of
existing orders, we believe that the existing ETFs that would operate
under the proposed rule and have their exemptive orders rescinded would
not be required to change how they construct their baskets, because the
proposed rule would give ETFs the ability to implement policies and
procedures for basket flexibility, subject to certain enumerated
requirements for the custom basket policies and procedures. In
addition, we expect that some existing ETFs that would operate under
the proposed rule would be able to implement policies and procedures
with respect to basket flexibility that would give them more
flexibility than what is allowed by their existing exemptive orders.
We believe that fixed-income, international, and actively managed
ETFs would particularly benefit from the increased basket flexibility
the rule would afford compared to existing exemptive orders.
Specifically, the increased basket flexibility should allow fixed-
income ETFs to avoid losing hard-to-find bonds when meeting redemptions
or to use sampling techniques to construct baskets that are composed of
fewer individual bonds and thus reduce trading costs for authorized
participants. Similarly, international ETFs would be able to tailor
their creation and redemption baskets to accommodate difficulties in
transacting in certain international securities. In addition, actively
managed ETFs would, in certain instances, be able to use the increased
basket flexibility to acquire or dispose of securities by adjusting the
composition of the creation or redemption basket rather than by
directly purchasing or selling the securities. In these instances,
actively managed funds would be able to reduce certain transaction
costs, such as those associated with bid-ask spreads.
For these reasons we believe the proposed rule would benefit ETFs
that make use of the increased basket flexibility the rule affords as
well as their investors to the extent that ETFs are able to implement
procedures that facilitate the arbitrage mechanism or reduce costs for
the ETFs. Due to a lack of data, however, we are unable to quantify the
number of ETFs that would choose to implement policies and procedures
to increase basket flexibility, and thus the potential benefits arising
to ETFs and their investors.
To the extent that existing ETFs do not already have policies and
procedures governing basket assets in place, ETFs would incur a cost
associated with developing and implementing such policies and
procedures.\457\ However, such costs may be partially or totally offset
by the basket flexibility discussed above. As discussed in section
IV.B, we estimate that an average ETF would incur an initial cost of
$10,268 \458\ associated with setting up the process for documenting
the construction and acceptance of baskets and with documenting and
adopting the custom basket policies and procedures. In addition, we
estimate that an average ETF would incur an ongoing cost of $3,985
\459\ each year to review and update its custom basket policies and
procedures as well as its process for documenting the construction and
acceptance of baskets. We thus estimate that the total industry cost
associated with the policies and procedures requirement in the proposed
rule for ETFs that could rely on the rule in the first year would equal
$23,303,655.\460\
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\457\ While exemptive orders do not require ETFs to have
policies and procedures for basket assets in place, we believe that
some ETFs may currently have methodologies or compliance policies
for basket assets in place.
\458\ See infra footnote 553.
\459\ See infra footnote 554.
\460\ This estimate is based on the following calculation:
($10,268 + $3,985) x 1,635 ETFs = $23,303,655. This estimate may be
an over-estimate in that it assumes that all ETFs, regardless of
their actual use of custom baskets, would implement policies and
procedures for custom basket assets.
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Second, the proposed rule would require an ETF to disclose
prominently on its website the portfolio holdings that will form the
basis for the next calculation of NAV per share. We believe that this
requirement supports the effective functioning of the arbitrage
mechanism as it allows authorized participants to identify arbitrage
opportunities and chose an appropriate hedging strategy.
As discussed above in section III.B.4, the requirements for
portfolio transparency in existing exemptive orders have varied.\461\
As also discussed in section III.B.4, based on a staff review of ETFs'
websites, we understand that all ETFs that could rely on the proposed
rule currently provide daily full portfolio transparency, including all
actively managed ETFs, and thus already bear ongoing costs associated
with maintaining such disclosures.\462\ However, we believe that the
ETFs that could rely on the proposed rule would incur a one-time cost
associated with reviewing whether their current portfolio disclosure is
compliant with the requirements of proposed rule 6c-11 and, if
necessary, make changes to the information that is presented on their
website.\463\ We estimate this one-time cost to be $1,939.50 for the
average ETF, resulting in an aggregate one-time cost of $3,171,082.50
for all ETFs that could rely on the proposed rule.\464\
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\461\ Actively managed ETFs and some ETFs that track an index
from an affiliated index provider have been required to disclose
their holdings prior to the commencement of trading each business
day (i.e., full portfolio transparency). Other index-based ETFs are
permitted to disclose their portfolio holdings indirectly, by
specifying which index they seek to track, as long as the index
provider lists the constituent securities on its website (i.e.,
index transparency) or by disclosing the components of their
baskets. Some index-based ETFs have been required to provide full
portfolio transparency. See discussion of portfolio transparency,
supra section II.C.4.a; see also supra footnote 207 and accompanying
text.
\462\ From a staff review of ETF websites, the sampled index and
actively-managed ETFs already provide daily portfolio holdings.
Extrapolating the sampled results to the entire universe of ETFs,
ETFs in general should bear no additional costs above the baseline
to collect and maintain on their websites these holdings. If some
ETFs that were not sampled, however, do not currently maintain on
their websites their daily portfolio holdings, Commission staff
estimates that an ETF each year would spend approximately 5 hours of
professional time to update the relevant web page daily with this
information at a cost of $1,405.50. See supra note 537. We
preliminarily believe that the number of ETFs that would have to
bear these additional costs would be small due to our experience
with the sampled ETFs.
\463\ The proposed rule would require that portfolio holdings
information be presented and contain information regarding
description, amount, value and/or unrealized gain/loss (if
applicable) in the manner prescribed within Article 12 of Regulation
S-X.
\464\ This estimate is based on the following calculations: 3
hours (for website development) x $296.50 per hour (blended rate for
a senior systems analyst ($274) and senior programmer ($319) + 2
hours (for review of current portfolio disclosures) x $325 (blended
rate for a compliance manager ($298) and a compliance attorney
($352)) + $400 for external website development = $1,939.50. The
industry cost is 1,635 x $1,939.50 = $3,171,082.50.
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Finally, the proposed rule also would require additional disclosure
by the ETF of the median daily bid-ask spread over the most recent
fiscal year on its website. We believe that this
[[Page 37390]]
requirement would further inform investors about the expected cost of
trading an ETF and facilitate comparison of transaction costs across
ETFs. As such, the disclosure of median bid-ask spreads could reduce
investors' uncertainty about the trading environment and facilitate the
selection of ETF investments that fit individual investors' needs.
Currently, disclosure of median bid-ask spreads by ETFs are not
required by exemptive orders, although some funds may voluntarily
provide this information on their websites. For those funds that do not
already disclose this information, they would have to implement
processes and systems to compute the median bid-ask spreads and would
have to accommodate a new data point on their web page to report this
information. We preliminarily do not believe the incremental cost of
such disclosure will be substantial. The estimated costs for computing
and establishing processes and systems to update the median bid-ask
spread are $296.50 per fund, while aggregate costs for computing and
updating the web pages of ETFs to include the median bid-ask spread
would be $484,777.50.\465\ We preliminarily believe that funds will
incorporate the processes of updating the median bid-ask spread with
other daily processes associated with updating the web page, such as
reporting the daily portfolio holdings, and therefore, there will be no
additional daily costs associated with updating the median bid-ask
spread on the webpage. We also believe that funds currently maintain a
record of historical prices as a matter of current business practices
which could be used to satisfy the requirement at a nominal cost, as
discussed above. If a fund does not maintain a record of historical
prices, it may incur a one-time estimated cost of $296.50 to satisfy
the requirement, or an upper bound of $484,777.50 in aggregate,
assuming that no ETFs currently maintain historical price records.\466\
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\465\ Commission staff estimate a one-time cost of computing and
implementing processes and systems for daily updating of the median
bid-ask spread of one burden hour at a per hour cost of $296.50
(blended rate for a senior systems analyst ($274) and senior
programmer ($319)). The one-time cost of updating the web page to
include the median bid-ask spread would be incorporated as part of
the web page development discussed in section IV.B.1 (see also infra
footnote 535). As median bid-ask spreads are not currently required
to be reported or computed by ETFs, we estimate that the aggregate
costs would be $296.50 x 1,635 ETFs = $484,777.50.
\466\ Commission staff estimate a one-time cost of computing and
implementing processes and systems for daily updating of historical
prices of one burden hour at a per hour cost of $296.50 (blended
rate for a senior systems analyst ($274) and senior programmer
($319)). Although we preliminarily estimate that funds already
maintain a record of historical prices, an upper bound on aggregate
costs would be estimated at $296.50 x 1,635 ETFs = $484,777.50.
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ii. Omission of Conditions We Believe May Save Costs for Funds
First, the proposed rule would not contain a requirement that an
ETF's IIV be disseminated at least every 15 seconds during regular
trading hours (60 seconds for international ETFs), as is currently
required under all exemptive orders. We believe that many sophisticated
institutional market participants do not rely on the IIV to value an
ETF's assets, as discussed above in section II.C.3.
In some cases, the IIV may not reflect the actual value of an ETF's
assets (e.g., for funds that invest in foreign securities whose markets
are closed during the ETF's trading day or funds whose assets trade
infrequently, as is the case for certain bond funds). In those cases,
we believe that both institutional and retail market participants would
benefit from the omission of the IIV as a requirement of the proposed
rule by avoiding the possibility that investors base their investment
decisions on this potentially misleading information. However, the IIV
may, for certain funds, provide a reasonably accurate estimate of the
value of an ETF's assets, including for those funds whose underlying
assets are very frequently traded during the ETF's trading day. Less
sophisticated institutional investors as well as retail investors
relying on the IIV for those ETFs may thus find the IIV useful and
could see their ability to evaluate ETFs reduced without this
metric.\467\
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\467\ While the IIV may be very accurate for ETFs whose
underlying assets trade frequently (and thus are liquid as well),
such ETFs also tend to have small premiums/discounts to NAV per
share, reducing the incremental usefulness of the IIV for investors
in these ETFs compared to observing only the ETF's share price.
---------------------------------------------------------------------------
Exchange listing standards currently require the IIV to be
disseminated. As long as exchange listing standards continue to include
this requirement, the proposed rule's omission of such a requirement
would not represent a change from the baseline and would not result in
any costs or benefits to market participants. Nonetheless, if the
listing standards change, ETFs would not be subject to the cost of
dissemination of IIV information under the proposed rule.
Second, under the terms of the exemptive orders, ETFs are required
to disclose in their registration statement that redemptions may be
postponed for foreign holidays. The proposed amendments to Forms N-1A
and N-8B-2 do not contain such a requirement and would thus eliminate
the cost of preparing and updating this disclosure for existing ETFs.
As discussed above in section III.B.4, we believe that such a
requirement is not necessary, since this information is already covered
by the agreement between the ETF and the authorized participant.\468\
As discussed in section III.C.1, we further believe that such a
disclosure would not be relevant for retail investors, who purchase ETF
shares on the secondary market.
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\468\ As discussed above, we believe that authorized
participants would share this information with other market
participants as necessary, for example when a market participant
uses an authorized participant as agent for transacting with an ETF
and this information is a necessary part of the creation or
redemption process.
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Third, the proposed rule would not require an ETF to identify
itself in any sales literature as an ETF that does not sell or redeem
individual shares and explain that investors may purchase or sell
individual ETF shares through a broker via a national securities
exchange. Although this condition has been included in our exemptive
orders, we no longer believe that it is necessary given that markets
have become familiar with ETFs in the multiple decades they have been
available. The omission of such a requirement could lead to cost
savings for existing and future ETFs associated with preparing and
reviewing this disclosure for sales literature.\469\
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\469\ We estimate that the omission of this requirement would
save 0.25 hours of a compliance attorney ($352 per hour), resulting
in a cost savings of $88 (0.25 x $352) per fund each year. The total
cost savings for all 1,635 ETFs that could rely on the proposed rule
would thus be $143,880 (1,635 x $88).
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iii. Website Disclosure Provisions
Proposed rule 6c-11 would require an ETF to disclose certain
information prominently on its website, which is publicly accessible
and free of charge.\470\ The goal of these disclosure requirements is
to provide investors with key metrics to evaluate their trading and
investment decisions in a location that is easily accessible and
frequently updated.\471\ Based on a staff
[[Page 37391]]
review of ETFs' websites, we believe that all ETFs that could rely on
the proposed rule currently have a website.\472\ As a consequence,
existing ETFs would generally not incur any additional cost associated
with the creation and technical maintenance of a website.
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\470\ See supra footnote 208.
\471\ According to the most recent U.S. census data,
approximately 77.2% of U.S. households had some form of internet
access in their home in 2015 and 86.8% have a computer (e.g.,
desktop, laptop, tablet or smartphone). See Camille Ryan & Jamie M.
Lewis, Computer and internet Usage in the United States: 2015, ACS-
37 (Sept. 2017), available at https://www.census.gov/content/dam/Census/library/publications/2017/acs/acs-37.pdf; see also Sarah
Holden, Daniel Schrass & Michael Bogdan, Ownership of Mutual Funds,
Shareholder Sentiment, and Use of the internet, 2017 (Oct. 2017),
available at https://www.ici.org/pdf/per23-07.pdf (``[i]n mid-2017,
95 percent of households owning mutual funds had internet access, up
from about two-thirds in 2000'' and ``86 percent of mutual fund-
owning households with a household head aged 65 or older had
internet access in mid-2017''); Andrew Perrin & Maeve Duggan,
Americans' Internet Access: 2000-2015, Pew Research Center (June
2015), available at https://assets.pewresearch.org/wp-content/uploads/sites/14/2015/06/2015-06-26_internet-usage-across-demographics-discover_FINAL.pdf (finding in 2015, 84% of all U.S.
adults use the internet). Retail investors that do not have internet
access in their homes may have access outside their homes, such as
at public libraries.
\472\ See supra footnote 437.
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As discussed above, a requirement for daily website disclosures of
NAV, closing price, and premiums and discounts--each as of the end of
the prior business day has been included in substantially all exemptive
relief orders starting from 2008. As discussed in section III.B.4,
based on a staff review of ETFs' websites, we believe that all ETFs
that could rely on the proposed rule currently provide daily website
disclosures of NAV, closing price, and premiums or discounts.\473\ As a
consequence, existing ETFs would generally not incur any additional
cost associated with these website disclosure requirements.
---------------------------------------------------------------------------
\473\ See supra footnote 437.
---------------------------------------------------------------------------
Our exemptive orders have not included requirements for line graph
and tabular historical information regarding premiums and discounts.
However, Form N-1A contains tabular website disclosures relating
historical premium/discount in Items 11(g)(2) and 27(b)(7)(iv), which
we are proposing to eliminate.\474\ Nonetheless, we anticipate that all
existing ETFs that fall within the scope of the proposed rule would
incur some additional costs associated with these disclosures. We
believe that substantially all ETFs already have the required data
available to them as part of their regular operations (as it is
required by Form N-1A and also allows ETFs to monitor the trading
behavior of their shares), as well as have systems (such as computer
equipment, an internet connection, and a website) in place that can be
used for processing this data and uploading it to their websites.
However, these ETFs would still incur the costs associated with
establishing and following (potentially automated) processes for
processing and uploading this data to their websites. We estimate that
an average ETF would incur a one-time cost of $1,939.5 \475\ for
implementing this website disclosure and an ongoing cost of $473.25
\476\ per year for updating the relevant web page with this
information. We thus estimate the total industry cost, in the first
year, to ETFs that could rely on the proposed rule for providing this
website disclosure, of $3,944,846.35.
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\474\ See infra section II.H.4.
\475\ This estimate is based on the following calculations: 3
hours (for website development) x $296.50 per hour (blended rate for
a senior systems analyst ($274) and senior programmer ($319)) + (2
hours (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352)) + $400
for an external website developer to develop the web page =
$1,939.50.
\476\ This estimate is based on the following calculations: 0.5
hours (for website updates) x $296.50 per hour (blended rate for a
senior systems analyst ($274) and senior programmer ($319)) + (1
hour (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352) =
$473.25.
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Our exemptive orders have not included a requirement for ETFs to
provide disclosure of the factors that materially contributed to a
premium or discount, if known, if an ETF's premium or discount is
greater than 2% for more than seven consecutive trading days. As a
result, under the proposed rule those ETFs that experience such a
premium or discount would incur additional costs associated with
determining what factors contributed to the premiums or discounts and
drafting and uploading a discussion to their website. Based on a staff
analysis of historical data on ETF premiums and discounts from 2008 to
2017 using Bloomberg data, we believe that this disclosure requirement
would be triggered for, on average, 4.7% of those ETFs that could rely
on the proposed rule per year.\477\ We estimate that a fund required to
make such a disclosure in a given year would incur an average cost of
$1,438.50, yielding a total annual industry cost of $110,541.53.\478\
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\477\ This estimate represents the average of the percentage of
ETFs for which the reporting requirement was triggered at least once
in a given year, for those ETFs that could rely on the proposed
rule. During the sample period from 2008 to 2017, the percentage of
ETFs for which the reporting requirement was triggered at least once
varied from 1.5% in 2010 to 10% in 2008.
\478\ We believe that such disclosure would require 4 internal
hours (2.5 hours for the compliance attorney to determine if this
requirement has been triggered and produce a draft of the required
disclosures + 1.5 hours for the webmaster to include the information
on the website), at a time cost of (2.5 hours x $352 compliance
attorney hourly rate) + (1.5 hours x $239 webmaster hourly rate) in
addition to $200 for external website development = $1,738.50. The
annual cost of this requirement for those ETFs that could rely on
the proposed rule is calculated as 4.7% x 1,635 ETFs x $1,738.50 =
$110,541.53.
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The proposed rule would also require an ETF to post on its website
one ``published'' basket at the beginning of each business day. While
we believe that authorized participants already have access to this
information in the daily portfolio composition file provided to NSCC,
many market participants, such as smaller institutional investors and
retail investors, are not NSCC members and do not currently have access
to this information.
Our exemptive orders have not included requirements for daily
website disclosures of ETF baskets. As a result, we anticipate that all
existing ETFs that rely on the proposed rule would incur additional
costs associated with this disclosure.\479\ Since specifying basket
assets is part of the regular operation of an ETF, we believe that all
ETFs already have the required data available to them. In addition, we
believe that most ETFs already have systems (such as computer
equipment, an internet connection, and a website) in place that can be
used for processing this data and uploading it to their websites.
However, these ETFs would still incur the costs associated with
establishing and following (potentially automated) processes for
processing and uploading this data to their websites. We estimate that
an average ETF would incur a one-time cost of $2,909.25 \480\ for
implementing this website disclosure and an ongoing cost of $784 \481\
per year for updating the relevant web page daily with this
information. We thus estimate the total industry cost, in the first
year, to ETFs that could rely on the proposed rule for providing this
website disclosure, of 6,038,463.75.\482\
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\479\ As proposed, the rule would require that basket
information be presented and contain information regarding
description, amount, value and/or unrealized gain/loss (if
applicable) in the manner prescribed within Article 12 of Regulation
S-X.
\480\ This estimate is based on the following calculations: 4.5
hours (for website development) x $296.50 per hour (blended rate for
a senior systems analyst ($274) and senior programmer ($319)) + (3
hours (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352)) + $600
for an external website developer to develop the web page =
$2,909.25.
\481\ This estimate is based on the following calculations: 1
hour (for website updates) x $296.50 per hour (blended rate for a
senior systems analyst ($274) and senior programmer ($319)) + (1.5
hours (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352) = $784.
\482\ This estimate is based on the following calculation: 1,635
ETFs x ($2,909.25 + $784) = $6,038,463.75.
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As discussed in section IV.A above, the proposed disclosures on
ETFs' websites, which are publicly available and free of charge, would
enable investors to more readily obtain certain key metrics for
individual ETFs,
[[Page 37392]]
potentially resulting in better informed investment decisions.\483\ The
proposed conditions standardize certain content requirements to
facilitate investor analysis of information while allowing ETFs to
select a format for posting information that the individual ETF finds
most efficient and appropriate for their website. Because the
information in the proposed disclosures would be made available on
individual websites, in the format chosen by the ETF, we acknowledge
that an investor's ability to efficiently extract information from
website disclosures for purposes of aggregation, comparison, and
analysis across multiple funds and time periods may be limited.
Investors seeking to compare multiple ETFs would have to visit the
website of every ETF, navigate to the relevant section of the website,
and extract the information provided in the format chosen by the fund.
Depending on the manner in which a typical fund investor would use the
website disclosures, these considerations may decrease the information
benefits of the proposed disclosures. However, we recognize that
investors may rely on third-party providers that aggregate such
information for all ETFs into a structured format that investors can
more easily access and process for the purpose of statistical and
comparative analyses. While investors may incur costs of obtaining
information from third-party service providers, it would likely be
lower than the cost they would incur than if they performed the
collection themselves, and the cost of such services may otherwise be
reduced as a result of competition among service providers. Overall, we
believe that requiring ETFs to provide this information on their
websites would ultimately provide an efficient means for facilitating
investor access to information.
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\483\ See supra footnote 208.
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c. Recordkeeping
The proposed rule would require that ETFs preserve and maintain
copies of all written authorized participant agreements for at least
five years, the first two years in an easily accessible place. This
requirement would provide Commission examination staff with a basis to
evaluate whether the authorized participant agreement is in compliance
with the rule and other provisions of the Investment Company Act and
the rules thereunder, and would also promote internal supervision and
compliance.\484\ As the agreement forms the contractual foundation on
which authorized participants engage in arbitrage activity, compliance
of the agreement with the proposed rule is important for the arbitrage
mechanism to function properly.
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\484\ ETFs already will be required to provide some information
about authorized participants on Form N-CEN, including the name of
each authorized participant, additional identifying information, and
the dollar values of the fund shares the authorized participant
purchased and redeemed during the reporting period. However, this
information alone would not be sufficient for Commission staff to
evaluate whether a fund's authorized participant agreements are in
compliance with the proposed rule.
---------------------------------------------------------------------------
We are also proposing to require ETFs to maintain information
regarding the baskets exchanged with authorized participants on each
business day the ETF exchanged creation units, including a record
stating that the custom basket complies with the ETF's custom basket
policies and procedures. As discussed above, we believe that these
records would help our examination staff understand how baskets are
being used by ETFs, evaluate compliance with the rule and other
provisions of the Act and rules thereunder, and examine for potential
overreach by ETFs in connection with the use of custom baskets or
transactions with affiliates.
Existing exemptive orders have not required ETFs to preserve and
maintain copies of authorized participant agreements or information
about basket composition. However, we believe that most ETFs already
preserve and maintain copies of authorized participant agreements as
well as data on baskets used as a matter of established business
practice. Existing ETFs that do not already preserve and maintain
copies of these documents and data, as well as all new ETFs that would
operate under the proposed rule, would incur maintenance and storage
costs associated with these requirements. As discussed in section IV.B,
we estimate that an average ETF that does not currently comply with
these recordkeeping requirements would incur an annual cost of $380 per
year \485\ to maintain these records.\486\ Assuming that 20% of ETFs
would incur this cost, the total industry cost for ETFs that could rely
on the proposed rule would be $124,260 per year.\487\ In addition, the
existing orders have not required that ETFs prepare and maintain a
record stating that custom baskets comply with the custom basket
policies and procedures. We anticipate that all ETFs that could operate
under the proposed rule will incur additional recordkeeping costs
associated with the requirement that custom baskets comply with custom
basket policies and procedures. Assuming that 25% of the total annual
recordkeeping costs can be attributed to the new requirement for custom
baskets, we estimate a total cost per ETF of $95 per year for the
requisite five-year period and an annual industry cost of $155,325 for
ETFs that could rely on the rule.\488\
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\485\ See infra footnote 544.
\486\ An average ETF would have to maintain and store 34
authorized participant agreements. See supra footnote 431 and
accompanying text.
\487\ This estimate is based on the following calculation: 1,635
ETFs x $380 x 20% = $124,260.
\488\ This estimate is based on a total record keeping cost of
$380 per ETF over five years, see infra note 544, 25% x $380 = $95,
$95 x 1,635 ETFs = $155,325.
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d. Master-Feeder Relief
The proposed rule would rescind the master-feeder relief granted to
ETFs that do not rely on the relief as of the date of this proposal. We
are proposing to rescind such relief because there generally is a lack
of interest in ETF master-feeder arrangements, and certain master-
feeder arrangements raise policy concerns discussed above. While there
are currently many exemptive orders that contain the master-feeder
relief, it is our understanding that only one fund complex currently
relies on this relief to structure several master-feeder arrangements
with one master and one feeder fund each.\489\ As discussed above, we
would also propose to grandfather existing master-feeder arrangements
involving ETF feeder funds, but prevent the formation of new ones, by
amending relevant exemptive orders.\490\ As a result, we do not expect
that the rescission of the existing master-feeder relief would impose
costs on ETFs that currently rely on the relief to structure master-
feeder arrangements.
[[Page 37393]]
At the same time, the rescission of the relief may benefit investors in
prospective feeder ETFs to the extent that it protects them from any
concerns associated with feeder ETFs discussed above.\491\
---------------------------------------------------------------------------
\489\ See supra footnote 341.
\490\ As discussed above, without this relief, the affected
funds could continue operating by effecting creation and redemption
transactions between authorized participants and the feeder fund (as
well as the transactions between the master and feeder fund) in cash
rather than in kind. As cash creations and redemptions can be less
efficient than in-kind transactions for certain ETFs, this could
impose a cost on the ETFs that are part of the fund family. Cash
redemptions and creations could also affect the current
relationships that funds have with authorized participants if the
authorized participants would be unwilling to perform the arbitrage
function when receiving cash instead of baskets of securities, which
could have unintended spillover effects on the secondary market
trading of these funds' shares. Alternatively, these feeder funds
may opt to pursue their investment objectives through direct
investments in securities and/or other financial instruments, rather
than through investments in master funds. Such a restructuring of
the funds involved would also lead to costs (primarily associated
with legal and accounting work) on the ETFs that are part of the
fund family. As a result, if this change would require portfolio
transactions to occur at the fund, there could be additional costs
such as lower overall total returns to the fund or that investors
may find the fund to be a less attractive investment.
\491\ See supra section II.F.
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2. Disclosure (Amendments to Forms N-1A and N-8B-2)
The amendments to Form N-1A and N-8B-2 are designed to provide
authorized participants and investors with tailored information
regarding the costs associated with investing in ETFs. As discussed in
section IV.A above, we expect that the new disclosures would benefit
investors by helping them better understand and compare specific funds,
potentially resulting in more informed investment decisions, more
efficient allocation of investor capital, and greater competition for
investor capital among funds.
As discussed above, we propose to add a set of Q&As related to fees
and trading information and costs that we anticipate would help
investors better understand costs specific to ETFs, such as bid-ask
spreads, brokerage commissions, and purchasing or selling ETF shares at
a premium or discount to NAV. The answers to the Q&As would include
information about trading costs specific to an ETF, such as the median
bid-ask spread over the previous year.
In addition, the proposed amendments to Forms N-1A and N-8B-2 would
require an ETF to provide information on the ETF's median bid-ask
spread as well as an interactive calculator on the ETF's website that
can be used to determine how the bid-ask spread would impact the costs
associated with frequent trading of ETF shares. As discussed above, the
purpose of the interactive calculator is to provide investors with the
ability to customize the hypothetical calculations in Item 3 of Form N-
1A to their specific investing situation by choosing either the number
or size of the hypothetical round-trip trades, or both.
While we believe that substantially all ETFs already have the
required data for these new disclosures on Forms N-1A and N-8B-2 and
for the interactive calculator as part of their regular operations,
these funds would still incur costs for processing the data, entering
them into the form, and programming the interactive calculator.\492\ We
estimate that each ETF would incur a one-time cost of $6,710 \493\ and
an ongoing cost of $3,355 \494\ per year.\495\ We thus estimate that
the total industry cost for ETFs in the first year would equal
$19,123,500.\496\
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\492\ As discussed in more detail below in section V.D, the
ongoing costs of complying with the proposed amendments to Form N-
8B-2 for all UIT ETFs as well as the one-time initial costs for
existing UIT ETFs would accrue to Form S-6.
\493\ We estimate that each ETF would incur a one-time burden of
an additional 20 hours, at a time cost of an additional $6,710 (10
hours x $335.50 (blended rate for a compliance attorney ($352) and a
senior programmer ($319)) = $6,710) to draft and finalize the
required disclosure, amend its registration statement, implement the
interactive calculator, and update its website.
\494\ We estimate that each ETF would incur an ongoing burden of
an additional 10 hours, at a time cost of an additional $3,355 (10
hours x $335.50 (blended rate for a compliance attorney ($352) and a
senior programmer ($319)) = $3,355) each year to review and update
the proposed disclosures.
\495\ Like all information disclosed in Items 2, 3, or 4 of Form
N-1A, the information disclosed in amended Item 3 would have to be
tagged and submitted in a structured data format. See supra footnote
361. We note that we are adopting amendments to require the use of
Inline XBRL format in a companion release, which would apply to the
information disclosed in amended Item 3 according to the compliance
dates of those amendments. See Inline XBRL Filing of Tagged Data,
Investment Company Act Release No. 33139 (June 28, 2018). Given that
filers already have systems in place to submit the existing
information in Item 3 in a structured format and that filers will
already be required to update those systems to comply with the
Inline XBRL requirement, we believe that there would not be any
significant additional costs associated with the information in
amended Item 3 being filed in a structured format.
\496\ This estimate is based on the following calculation: 1,900
ETFs x ($6,710 + $3,355) = $19,123,500.
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D. Effects on Efficiency, Competition, and Capital Formation
This section evaluates the impact of proposed rule 6c-11 and the
amendments to Forms N-1A and N-8B-2 on efficiency, competition, and
capital formation. However, as discussed in further detail below, the
Commission is unable to quantify many of the effects on efficiency,
competition and capital formation either because they are inherently
difficult to quantify or because it lacks the information necessary to
provide a reasonable estimate.
1. Efficiency
The proposed rule would likely increase total assets of ETFs, as a
result of reducing the expense and delay of forming and operating new
ETFs organized as open-end funds, reducing the cost for certain ETFs to
monitor their own compliance with regulations, and as well increased
competition among ETFs as discussed below. At the same time, the
proposed rule could lead to a decrease in total assets of other fund
types that investors may regard as substitutes, such as certain mutual
funds.\497\ As a result, ETF ownership (as a percentage of market
capitalization) for some securities, such as stocks and bonds, would
likely increase, and ownership by other funds, such as mutual funds,
would likely decrease. The academic literature that we discuss in this
section suggest that such a shift in ownership could affect the price
efficiency (the extent to which an asset price reflects all public
information at any point in time) and liquidity of these portfolio
securities.\498\
---------------------------------------------------------------------------
\497\ The proposed disclosure requirements would also serve to
increase investors' awareness of the trading costs that they can
incur when trading ETFs, which can be substantial in some cases. As
a result, investors who may previously not have been fully aware of
these costs may shift their demand away from ETFs and towards other
types of funds, such as mutual funds. We believe, however, that the
rulemaking as a whole is likely to increase demand for ETFs rather
than decrease it.
\498\ In documenting the impact of ETF arbitrage on price
efficiency and liquidity, the academic literature does not generally
distinguish ETFs that could rely on the rule from those that could
not. However, these studies investigate a broad range of ETFs with
varying degrees of relief including basket flexibility. Therefore,
we believe that the subsample of ETFs that could rely on the rule
(those organized as open-end funds that are not leveraged) is
representative of those used in the academic literature. As a
result, we believe that inferences from the academic research
generally apply to ETFs that can rely on the rule.
---------------------------------------------------------------------------
The literature suggests that a shift in stock ownership towards
ETFs may improve some dimensions of price efficiency while impeding
price efficiency along other dimensions. Specifically, the results in
one paper suggest that stock prices incorporate systematic information
more quickly when they are held in ETF portfolios.\499\ The evidence in
this paper thus indicates that ETF activity increases stock market
efficiency with regard to systematic information, i.e., information
relating to market-wide risks. On the other hand, some studies find
that an increase in ETF ownership may introduce non-fundamental
volatility into stock prices, i.e., cause temporary deviations of stock
prices from their fundamental values. For example, one paper finds that
ownership by US equity index ETFs is associated with higher volatility
among component stocks and argues that the increased volatility is non-
fundamental.\500\ Another paper finds that higher authorized
participant arbitrage activity in US equity ETFs is
[[Page 37394]]
associated with a higher correlation of returns among stocks in the
ETF's portfolio.\501\ The authors find evidence that changes in the
prices of these stocks tend to partially revert over the next trading
day and argue that the increased co-movement in returns is thus a sign
of excessive price movement due to non-fundamental shocks that ETF
trading helps propagate.
---------------------------------------------------------------------------
\499\ Lawrence Glosten, Suresh Nallareddy & Yuan Zou, ETF
Trading and Informational Efficiency of Underlying Securities,
Columbia Business School Research Paper No. 16-71 (2016).
\500\ See Itzhak Ben-David, Francesco Franzoni & Rabih Moussawi,
Do ETFs Increase Volatility?, Swiss Finance Institute Research Paper
No. 11-66 (2017). This paper also finds that mutual fund ownership
is associated with higher volatility in the underlying indexes.
Thus, to the extent that part of the increase in ETF assets would be
accompanied by a decrease in mutual fund assets, the net effect on
price efficiency would be unclear.
\501\ Zhi Da & Sophie Shive, Exchange Traded Funds and Asset
Return Correlations, Working Paper, Notre Dame University (2016).
---------------------------------------------------------------------------
The proposed rule could decrease the liquidity of stocks held by
ETFs, as one study finds that higher ownership of a stock by US equity
ETFs is associated with lower liquidity as measured by market
impact.\502\ Conversely, the academic literature offers mixed evidence
regarding the impact of ETFs on bond liquidity. While one paper finds
that increased ETF ownership is associated with lower bond liquidity
for investment grade bonds,\503\ another study finds that bonds
included in ETFs experience improvements in their liquidity.\504\
---------------------------------------------------------------------------
\502\ See Sophia JW. Hamm, The effect of ETFs on stock
liquidity, Working Paper, Ohio State University (2014). However, the
study also finds the same relationship for ownership by index mutual
funds. Thus, to the extent that part of the increase in ETF assets
would be accompanied by a decrease in mutual fund assets, the net
effect on price efficiency would be unclear.
\503\ Caitlin Dillon Dannhauser, The Impact of Innovation:
Evidence from Corporate Bond ETFs, Journal of Financial Economics,
forthcoming (2016) (``Dannhauser Article'').
\504\ Jayoung Nam, Market Accessibility, Corporate Bond ETFs,
and Liquidity, Working Paper, Indiana University Bloomington (2017).
---------------------------------------------------------------------------
A shift in stock ownership towards ETFs could also have an effect
on the co-movement of liquidity for stocks held by ETFs. Specifically,
one paper observes that the liquidity of a stock with high ETF
ownership co-moves with the liquidity of other stocks that also have
high ETF ownership.\505\ The authors argue that this co-movement in
liquidity represents a risk to investors, as it exposes them to the
possibility that many assets in their portfolio will be illiquid at the
same time.
---------------------------------------------------------------------------
\505\ Vikas Agarwal, Paul Hanouna, et al., Do ETFs Increase the
Commonality in Liquidity of Underlying Stocks, Working Paper,
Villanova University (2017).
---------------------------------------------------------------------------
Since we do not know the degree to which the proposed rule would
increase ETF ownership of stocks and bonds, we are unable to quantify
the proposed rule's effects on price efficiency and liquidity.
As a result of the proposed rule's allowance of increased basket
flexibility, some ETFs that did not already have this flexibility in
their baskets may choose to increase the weight of more liquid
securities and decrease the weight of less liquid securities in their
baskets compared to their portfolios.\506\ During normal market
conditions, this may lead those ETFs' shares to trade at smaller bid-
ask spreads, thus benefiting investors. We note, however, that such a
reduction in bid-ask spreads by over-weighting more liquid securities
may not work during stressed market conditions, if a large proportion
of such an ETF's portfolio securities become less liquid.\507\ As a
result, the gap between bid-ask spreads of some ETFs' shares during
normal and stressed market periods may grow as a result of the proposed
rulemaking, which some investors may not anticipate and fail to fully
take into account when making their investment decisions.\508\
---------------------------------------------------------------------------
\506\ This would be the case for those ETFs that hold less
liquid securities in their portfolios.
\507\ Under rule 22e-4 under the Act, an ETF is required to
consider: (i) The relationship between portfolio liquidity and the
way in which, and the prices and spreads at which, ETF shares trade,
including, the efficiency of the arbitrage mechanism and the level
of active participation by market participants (including authorized
participants); and (ii) the effect of the composition of baskets on
the overall liquidity of the ETF's portfolio as part of its
assessment, management and review of liquidity risk. See LRM
Adopting Release, supra footnote 101.
\508\ Conversely, some ETFs may choose to decrease, rather than
increase, the weight of more liquid securities and increase the
weight of less liquid securities in their basket compared to their
portfolio in order to reduce transaction costs borne by an ETF's
existing/remaining shareholders when the ETF must buy and sell
portfolio holdings. This would lead to a reduction in transaction
costs for existing/remaining shareholders and to an increase in
transactions costs for authorized participants and, ultimately,
investors buying and selling ETF shares. Thus, we believe that most
funds would choose to limit such behavior as they would likely find
it to be in their best interest to balance costs imposed on
remaining and existing/remaining shareholders.
---------------------------------------------------------------------------
Finally, the proposed amendments to Forms N-1A and N-8B-2 as well
as the additional website disclosures required by proposed rule 6c-11
would allow investors and other market participants to better
understand and compare ETFs using more relevant and standardized
disclosure. For example, as discussed above, the proposed amendments to
Item 3 of Form N-1A would add a requirement for ETFs to disclose their
median bid-ask spread and include a statement that ETF investors may be
subject to other expenses that are specific to ETF trading, including
brokerage commissions and potential costs related to purchasing ETF
shares at a premium or discount to NAV per share.\509\ These costs are
not currently required to be disclosed by Item 3. Since these costs are
incurred by ETF investors and not mutual fund investors, we believe
that adding this disclosure would help investors and other market
participants better assess and compare fees and expenses between
certain funds and fund types, such as ETFs and mutual funds. Thus, the
proposed rule could help investors make more informed investment
decisions that are more suited for their investment objectives. The
degree to which investors would benefit from the ability to make more
informed investment decisions is inherently difficult to quantify, so
we are unable to estimate the size of this benefit.
---------------------------------------------------------------------------
\509\ James J. Angel, Todd J. Broms, & Gary L. Gastineau, ETF
Transaction Costs Are Often Higher Than Investors Realize, 42 The
Journal of Portfolio Management 3, 65-75 (2016) find that the cost
of trading ETF shares depends both on bid-ask spreads as well as
premiums and discounts to NAV per share.
---------------------------------------------------------------------------
2. Competition
The proposed rule would likely increase competition among ETFs that
could rely on the proposed rule. The first channel through which the
proposed rule would likely foster competition is by reducing the costs
for ETF sponsors to form new ETFs that comply with the conditions set
by the proposed rule. This cost reduction would lower the barriers to
entering the ETF market, which would likely lead to increased
competition among ETFs that could rely on the proposed rule.
In addition, new ETFs that enter the market in reliance on the
proposed rule as well as those existing ETFs that would have their
exemptive relief rescinded and replaced by the proposed rule, would no
longer be subject to requirements that vary between exemptive orders.
Instead, these ETFs would operate under uniform requirements, which
would help promote competition among ETFs that could rely on the
proposed rule.
An increase in competition among ETFs that could rely on the
proposed rule would likely also lead to an increase in competition
between those ETFs and ETFs that could not rely on the proposed rule as
well as other types of funds and products that investors may perceive
to be substitutes for ETFs, such as certain mutual funds.\510\
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\510\ The types of funds and products that investors may
consider substitutes for ETFs would depend on an individual
investor's preferences and investment objectives. Other types of
products that some investors may consider to be substitutes for ETFs
include closed-end funds and other exchange-traded products, such as
exchange-traded notes and commodity pools.
---------------------------------------------------------------------------
Furthermore, as discussed above, the proposed website disclosures
and amendments to Forms N-1A and N-8B-2 would allow investors to
compare ETFs and other open-end investment companies, which could
further foster
[[Page 37395]]
competition among open-end investment companies as well as between
open-end investment companies and other types of funds that investors
may perceive to be substitutes for open-end investment companies, such
as closed-end funds and certain exchange-traded products.
Increased competition would likely lead to lower fees for
investors, encourage financial innovation, and increase consumer choice
in the markets for ETFs, open-end investment companies, and other types
of funds that investors may perceive to be substitutes.\511\ Due to the
limited availability of data, however, we are unable to quantify these
effects.
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\511\ As discussed above, the proposed rule would likely lead to
increased competition both among ETFs that could rely on the
proposed rule as well as between ETFs that could rely on the rule
and those that could not. While we believe that increased
competition generally is conducive to innovation, any increased
competition in the ETF market resulting from the proposed rule would
be more likely to involve novel ETFs that would continue to need to
obtain exemptive relief from the Commission.
---------------------------------------------------------------------------
To the extent the proposed rule would increase the number and total
assets of ETFs, more authorized participants or other market
participants may enter the market. This could lead to increased
competition among authorized participants or other market participants
and result in authorized participants or other market participants
exploiting arbitrage opportunities sooner (i.e., when premiums/
discounts to NAV per share are smaller). As a result, bid-ask spreads
may tighten and premiums/discounts to NAV per share for ETF shares may
decrease. As authorized participants and some of the other market
participants that engage in ETF arbitrage are large broker-dealers,
however, we would expect new entries of authorized participants or
other arbitrageurs as a result of the rule to be limited and any
effects on bid-ask spreads and premiums/discounts to NAV per share to
be small.
3. Capital Formation
The proposed rule may lead to increased capital formation.
Specifically, an increase in the demand for ETFs, to the extent that it
would increase demand for intermediated assets as a whole, would likely
spill over into primary markets for equity and debt securities. As a
consequence, companies may be able to issue new debt and equity at
higher prices in light of the increased demand for these assets in
secondary markets created by ETFs. As a consequence, the cost of
capital for firms could fall, facilitating capital formation.
The conclusion that an increase in the demand for ETFs may lower
the firm's cost of capital is further supported by a paper \512\ that
finds that bonds with a higher share of ETF ownership have lower
expected returns.\513\ Due to the limited availability of data,
however, we are unable to quantify these effects of the proposed rule
on capital formation.
---------------------------------------------------------------------------
\512\ Dannhauser Article, supra footnote 503.
\513\ We acknowledge that there is research (see Yakov Amihud &
Haim Mendelson, Asset Pricing and the Bid-Ask Spread, 17 Journal of
Financial Economics 2, 223-249 (1986)) that provides evidence that
expected returns of an asset are positively associated with its
liquidity. As discussed above, the academic literature suggests that
stocks with a higher share of ETF ownership have lower liquidity
(whereas the evidence on the effect of underlying bonds is mixed).
Thus, there may be an offsetting effect that could weaken the
potential benefits of the rule for capital formation through new
equity issuances by firms.
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E. Reasonable Alternatives
1. Treatment of Existing Exemptive Relief
As discussed above, we propose to rescind the exemptive relief we
have issued to ETFs that would be permitted to rely on the proposed
rule. As an alternative, we considered allowing ETFs with existing
exemptive relief in orders that do not contain a self-termination
clause to continue operating under their relief rather than requiring
them to operate in reliance on the rule.
The Commission believes that allowing ETFs to continue operating
under their existing relief would create differences in the conditions
under which funds operate. Specifically, some ETFs that determine they
do not need the additional flexibility (e.g., basket flexibility) the
proposed rule would provide compared to their existing exemptive relief
could choose to continue operating under their existing relief rather
than in reliance on the rule. This could allow these ETFs to circumvent
the other requirements that are part of the rule (e.g., daily website
disclosure of the basket assets). This self-selection would create a
disparity in the conditions under which ETFs are allowed to operate.
Measured against the baseline, the alternative would thus have
smaller benefits arising from improved disclosure, including that the
alternative would not level the playing field among ETFs with regard to
these conditions and thus not be as effective at promoting product
competition as the proposed rule. In addition, it would be more
difficult for the Commission to evaluate compliance with regulations
under the alternative compared to the proposed rule, as some of the
ETFs whose exemptive relief we propose to rescind could choose to
continue to operate under their exemptive relief. The Commission also
believes that the costs to funds associated with rescinding the
existing exemptive relief would be minimal, as we anticipate that
substantially all funds whose relief would be rescinded would be able
to continue operating with only minor adjustments, other than being
required to comply with the additional website disclosures and to
develop basket asset policies and procedures.\514\
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\514\ Some ETFs may change the way they operate voluntarily by
taking advantage of the increased basket flexibility of the proposed
rule.
---------------------------------------------------------------------------
2. ETFs Organized as UITs
Proposed rule 6c-11 would be available only to ETFs that are
organized as open-end funds.\515\ As an alternative, we considered
including ETFs organized as UITs in the scope of the proposed rule.
However, as discussed above in section III.A.1, we believe that the
terms and conditions of the existing exemptive orders for UITs are
appropriately tailored to address the unique features of the UIT
structure.
---------------------------------------------------------------------------
\515\ As discussed in above in section IV.B.1, while the vast
majority of ETFs currently in operation are organized as open-end
funds, some early ETFs, which currently have a significant amount of
assets, are organized as UITs. Examples include SPDR S&P 500 ETF
Trust (SPY) and PowerShares QQQ Trust, Series 1 (QQQ).
---------------------------------------------------------------------------
In addition, as also discussed above, ETFs have greater investment
flexibility under the open-end fund structure than the UIT structure,
which leads us to believe that most new ETFs entering into the market
would prefer to operate under the open-end fund structure rather than
the UIT structure. No new UIT ETFs have come to market in recent years,
and we do not think that there would be significant economic benefits
to including UITs in the scope of the proposed rule, and thus we
propose to exclude ETFs organized as UITs from the proposed rule.\516\
---------------------------------------------------------------------------
\516\ We note that fund sponsors that plan to launch a new ETF
organized as a UIT would continue to be able to rely on the
exemptive order process.
---------------------------------------------------------------------------
3. Basket Flexibility
Proposed rule 6c-11would require ETFs relying on the rule to adopt
and implement written policies and procedures that govern the
construction of basket assets and the process that will be used for the
acceptance of basket assets. As an alternative, we considered requiring
that an ETF's basket generally correspond pro rata to its portfolio
holdings, while identifying certain limited circumstances under which
an ETF may use a non-pro rata basket, as
[[Page 37396]]
we have done in our exemptive orders since approximately 2006.\517\
---------------------------------------------------------------------------
\517\ ETFs whose orders we are proposing to rescind and that are
operating under exemptive orders issued before approximately 2006,
which included few explicit restrictions, would have reduced basket
flexibility under the alternative compared to the baseline.
---------------------------------------------------------------------------
The requirement included in these orders was designed to address
the risk that an authorized participant or other market participant
could take advantage of its relationship with the ETF (i.e., engage in
cherry picking or dumping). However, as discussed above, we believe
that the proposed rule's additional policies and procedures
requirements for custom baskets would provide a principles-based
approach that is designed to limit potential abuses so that they would
be unlikely to cause significant harm to investors. In addition, as
also discussed above in section III.C.1.b, we believe that the
increased basket flexibility under the proposed rule would benefit the
effective functioning of the arbitrage mechanism, particularly
benefiting fixed-income, international, and actively managed ETFs.\518\
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\518\ Section III.D discusses the possibility that some ETFs may
use the increased basket flexibility of the proposed rule to over-
or under-weight securities in their baskets compared to their
portfolios based on the liquidity of these securities. Such a
practice would not be possible under the alternative that would
require an ETF's basket to generally correspond pro rata to its
portfolio holdings.
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4. Website Disclosure of Every Basket Used by an ETF
Proposed rule 6c-11 would require ETFs to post, on the ETF's
website at the beginning of each business day, a published basket
applicable to orders for the purchase or redemption of creation units
to be priced based on the ETF's next calculation of NAV. Because an ETF
would be required to post only one published basket to comply with this
condition, it would not be required to post the contents of its other
custom baskets in many instances. As an alternative, we considered
proposing that ETFs be required to publish information regarding every
basket used by the ETF after the close of trading on each business day.
The additional disclosure under this alternative could reveal
whether an authorized participant has pressured an ETF into accepting
illiquid securities in exchange for liquid ETF shares (i.e., dumping)
or into giving an authorized participant desirable securities in
exchange for ETF shares tendered for redemption (i.e., cherry-picking)
by comparing an ETF's portfolio assets and published basket to the
baskets used by various authorized participants throughout the day.
However, the proposed rule contains additional conditions for
basket policies and procedures, which seek to prevent overreaching.
Moreover, the proposed rule would require an ETF to maintain records
regarding the baskets used, which would allow Commission staff to
examine an ETF's use of basket flexibility. Consequently, we believe
that the risk for these abusive practices under the proposed rule would
be low while, at the same time, the rule would avoid additional
operational and compliance costs for ETFs to post and review the
information, under the alternative.\519\
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\519\ We estimate that, under the alternative, an average ETF
would incur a one-time cost of $3,879 (6 hours (for website
development) x $296.50 per hour (blended rate for a senior systems
analyst ($274) and senior programmer ($319)) + (4 hours (for review
of website disclosures) x $325 (blended rate for a compliance
manager ($298) and a compliance attorney ($352)) + $800 for an
external website developer to develop the web page = $3,879) for
implementing this website disclosure and an ongoing cost of
$1,596.50 (1 hour (for website updates) x $296.50 per hour (blended
rate for a senior systems analyst ($274) and senior programmer
($319)) + (4 hours (for review of website disclosures) x $325
(blended rate for a compliance manager ($298) and a compliance
attorney ($352)) = $1,596.50) per year for updating the relevant web
page daily with this information.
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5. The Use of a Structured Format for Additional Website Disclosures
and the Filing of Additional Website Disclosures in a Structured Format
on EDGAR
As discussed in section II.C.6 above, we are proposing to require
ETFs to post on their websites certain disclosures to enable investors
to more readily obtain certain key metrics for individual ETFs. The
proposed rule would allow ETFs to select a format for posting
information that the individual ETF finds most efficient and
appropriate for the content management system of their website.
As an alternative, we could require ETFs to post the disclosures in
a structured format on their websites. Structured disclosures are made
machine-readable by having reported disclosure items labeled (tagged)
using a markup language that can be processed by software for
analysis.\520\ Compared with each ETF selecting its own layout and
format for the website disclosures, the resulting standardization under
this alternative would allow for extraction, aggregation, comparison,
and large-scale analysis of reported information through significantly
more automated means than is possible with unstructured formats such as
HTML. This alternative would facilitate the extraction and analysis
through automated means of an individual fund's disclosures over time--
which would offer the greatest benefit for higher-frequency ETF
disclosures--and potentially the comparison of disclosures across a
small number of ETFs. However, requiring a structured disclosure format
would not lower the collection burden incurred by the requirement to
separately visit each website to obtain each ETFs disclosure.
---------------------------------------------------------------------------
\520\ Structured information can be stored, shared and presented
in different systems or platforms. Standardized markup languages,
such as XML or XBRL, use sets of data element tags for each required
reporting element, referred to as taxonomies.
---------------------------------------------------------------------------
The structured data requirement could impose an incremental cost on
ETFs of tagging the information in a structured format, particularly to
the extent that ETFs don't otherwise structure this data for their own
purposes. Although, if the XML format is used for the additional
disclosure, the incremental cost of tagging information in a structured
format would likely be small.\521\
---------------------------------------------------------------------------
\521\ For example, based on staff experience with XML filings,
the costs of tagging the information in XML are expected to be
minimal given the technology that will be used to structure the
data. XML is a widely used data format, and based on the
Commission's understanding of current practices, most reporting
persons and third party service providers have production systems
already in place to report schedules of investments and other
information. Therefore, we believe systems should be able to
accommodate XML data without significant costs, and large-scale
changes will likely not be necessary to output structured data
files.
---------------------------------------------------------------------------
As another alternative, we could require ETFs to make the
additional website disclosures available in a centralized repository in
a structured format, such as by filing them on EDGAR. Making the
information available in a structured format on EDGAR would likely
improve its accessibility and the ability of investors, the Commission,
and other data users to efficiently extract information for purposes of
aggregation, comparison and analysis of information across multiple
funds and time periods.\522\ As stated above, if the XML format is used
for the additional disclosure, the incremental cost of tagging the
information in a structured format would likely be small. However,
funds would still incur a cost of filing the disclosures on EDGAR,
which might be higher than the cost of posting the disclosures on
individual ETF websites.
---------------------------------------------------------------------------
\522\ The Commission has implemented requirements for the
structuring of certain information disclosed by funds. See, e.g.,
Release No. 33-10231 (Oct. 13, 2016) [81 FR 81870]; Release No. IC-
29132 (Feb. 23, 2010) [75 FR 10059]; Release No. 33-9006 (Feb. 11,
2009) [74 FR 7747].
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6. Treatment of Leveraged ETFs
As discussed in section II.A.3. above, leveraged ETFs would not be
able to
[[Page 37397]]
rely on proposed rule 6c-11. As an alternative, we considered
permitting leveraged ETFs to rely on the proposed rule, while
maintaining the status quo of existing exemptive orders with respect to
the amount of leveraged market exposure that leveraged ETFs may obtain
(i.e., 300% of the return or inverse return).\523\ This alternative
would thus prohibit a leveraged ETF from seeking a performance result,
directly or indirectly, that exceeds three times the performance, or
inverse performance, of the specified market index or benchmark. This
alternative could benefit competition among leveraged ETFs as compared
to the baseline, as fund sponsors that currently do not have an
exemptive order permitting them to operate this type of ETF could enter
the market. As a result, fees for leveraged ETFs would likely decrease
and their assets could increase. However, as discussed in detail in
section II.A.3., in light of our ongoing consideration, including the
potential staff recommendation of a re-proposal on funds' use of
derivatives, we do not believe it is appropriate to permit sponsors to
form and operate leveraged ETFs in reliance on our proposed rule.
---------------------------------------------------------------------------
\523\ See supra footnote 77.
---------------------------------------------------------------------------
F. Request for Comments
The Commission requests comment on all aspects of this initial
economic analysis, including whether the analysis has: (1) Identified
all benefits and costs, including all effects on efficiency,
competition, and capital formation; (2) given due consideration to each
benefit and cost, including each effect on efficiency, competition, and
capital formation; and (3) identified and considered reasonable
alternatives to the proposed new rule and disclosure amendments. We
request and encourage any interested person to submit comments
regarding the proposed rule, our analysis of the potential effects of
the proposed rule and proposed amendments, and other matters that may
have an effect on the proposed rule. We request that commenters
identify sources of data and information as well as provide data and
information to assist us in analyzing the economic consequences of the
proposed rule and proposed amendments. We also are interested in
comments on the qualitative benefits and costs we have identified and
any benefits and costs we may have overlooked. In addition to our
general request for comment on the economic analysis associated with
the proposed rule and proposed amendments, we request specific comment
on certain aspects of the proposal:
Would the proposed rule require any existing ETFs whose
exemptive orders would be rescinded to materially change the way they
operate? If so, what types of funds would have to materially change the
way they operate and it what ways? Would these funds require any
additional exemptive relief to continue operating?
Would the elimination of the direct costs of obtaining
exemptive relief result in additional benefits to ETFs or their
investors? Are there other costs of the proposed rule that would offset
any cost savings resulting from not having to file an exemptive
application?
Would the proposed rule result in greater product
innovation in the ETF market? Would the proposed rule result in
increased investment options?
Are we correct to assume that substantially all ETFs that
are currently not required to make daily website disclosures of NAV,
closing price, and premiums and discounts would have the data required
to make these disclosures available to them as part of their regular
operations as well as systems (such as computer equipment, an internet
connection, and a website) in place that can be used for processing
this data and uploading it to their websites? If not, what data or
systems would currently be unavailable, which ETFs would it be
unavailable for, and what would the cost of acquiring the unavailable
data or systems be?
Do ETFs already have policies and procedures in place
governing the composition of baskets? How long would it take and how
much would it cost to implement such policies and procedures for funds
that do not already have them in place, particularly the custom basket
policies and procedures?
Are we correct to assume that substantially all ETFs would
already have the required data available for daily website disclosures
of bid-ask spreads and historical information regarding premiums and
discounts as well as systems (such as computer equipment, an internet
connection, and a website) in place that can be used for processing
this data and uploading it to their websites? If not, what data or
systems would currently be unavailable, which funds would it be
unavailable for, and what would the cost of acquiring the unavailable
data or systems be?
Are we correct to assume that substantially all funds
would already have the required data to complete the new disclosures
required by the proposed amendments to Forms N-1A and N-8B-2 available
to them as part of their regular operations? If not, what data would
currently be unavailable, which funds would it be unavailable for, and
what would the cost of acquiring the unavailable data be?
Is our estimate correct that the cost to a typical fund
for applying for an ETF exemptive order is approximately $100,000? If
not, what would be a more accurate estimate?
How many ETFs (representing how much in assets) currently
are required to disclose on their website, free of charge, the previous
day's NAV and the price of the ETF shares, as well as the premium or
discount associated with the closing price and information pertaining
to the composition and proportion of underlying holdings? How many ETFs
(representing how much in assets) are not required to provide this
disclosure but nevertheless voluntarily provide it?
Do commenters agree that requiring ETFs to make the
additional website disclosures available in a structured format, which
is an alternative we considered, would be associated with only a small
cost of tagging this information?
Would the proposed rule lead to more competition and lower
fees in the leveraged ETF market if leveraged ETFs were allowed to rely
on the rule?
IV. Paperwork Reduction Act
A. Introduction
Proposed rule 6c-11 would result in new ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\524\ In addition, the proposed
amendments to Form N-1A, Form N-8B-2, and Form N-CEN would impact the
collection of information burden under those forms and Form S-6.\525\
Proposed rule 6c-11 also would impact the current collection of
information burden of rule 0-2 under the Act.\526\
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\524\ 44 U.S.C. 3501-3520.
\525\ 17 CFR 274.11A; 17 CFR 274.12; 17 CFR part 101; 17 CFR
239.16.
\526\ 17 CFR 270.0-2.
---------------------------------------------------------------------------
The titles for the existing collection of information are: ``Form
N-1A under the Securities Act of 1933 and under the Investment Company
Act of 1940, Registration Statement for Open-End Management Companies''
(OMB No. 3235-0307); ``Form N-8B-2 under the Investment Company Act of
1940, Registration Statement of Unit Investment Trusts Which are
Currently Issuing Securities'' (OMB No. 3235-0186); ``Form S-6 [17 CFR
239.19], for registration under the Securities Act of 1933 of Unit
Investment Trusts registered on Form N-8B-2'' (OMB Control No. 3235-
0184); ``Form N-
[[Page 37398]]
CEN'' (OMB Control No. 3235-0730); and ``Rule 0-2 under the Investment
Company Act of 1940, General Requirements of Papers and Applications''
(OMB Control No. 3235-0636). The title for the new collection of
information would be: ``Rule 6c-11 under the Investment Company Act of
1940, `Exchange-traded funds.' '' The Commission is submitting these
collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number.
We published notice soliciting comments on the collection of
information requirements in the 2008 ETF Proposing Release and
submitted the proposed collections of information to OMB for review and
approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.\527\
We received no comments on the collection of information requirements.
---------------------------------------------------------------------------
\527\ See 2008 ETF Proposing Release, supra footnote 3.
---------------------------------------------------------------------------
We discuss below the collection of information burdens associated
with proposed rule 6c-11 and its impact on rule 0-2 as well as proposed
amendments to Forms N-1A, N-8B-2, S-6 and N-CEN.
B. Proposed Rule 6c-11
Proposed rule 6c-11 would permit ETFs that satisfy certain
conditions to operate without first obtaining an exemptive order from
the Commission. The rule is designed to create a consistent,
transparent, and efficient regulatory framework for such ETFs and
facilitate greater competition and innovation among ETFs. The proposal
attempts to eliminate historical distinctions and conditions that we no
longer believe are necessary and thus appropriately level the playing
field for such ETFs that pursue the same or similar investment
strategies.
Proposed rule 6c-11 would require an ETF to disclose certain
information on its website, to maintain certain records, and to adopt
and implement written policies and procedures governing their
constructions of baskets, as well as written policies and procedures
that set forth detailed parameters for the construction and acceptance
of custom baskets that are in the best interests of the ETF and its
shareholders. These requirements are collections of information under
the PRA.
The respondents to proposed rule 6c-11 would be ETFs registered as
open-end management investment companies other than ETFs within
multiple-class funds or leveraged ETFs.\528\ This collection would not
be mandatory, but would be necessary for those ETFs seeking to operate
without individual exemptive orders. We estimate that 1,635 ETFs would
likely rely on rule 6c-11.\529\ Information provided to the Commission
in connection with staff examinations or investigations would be kept
confidential subject to the provisions of applicable law.
---------------------------------------------------------------------------
\528\ See proposed rule 6c-11(a) (defining ``exchange-traded
fund'').
\529\ See supra footnote 425 and accompanying text. This is
estimate does not include UIT ETFs, share class ETFs, or leveraged
ETFs.
---------------------------------------------------------------------------
1. Website Disclosures
Under the proposal, ETFs would be required to post on their
websites: (i) The ETF's NAV per share, market price, and premium or
discount; and (ii) historical information regarding premiums and
discounts. In addition, proposed rule 6c-11 would require an ETF to
disclose on its website, each business day, the portfolio holdings that
will form the basis for each calculation of NAV per share,\530\ and
information regarding a published basket that will apply to orders for
the purchase or redemption of creation units each business day.\531\ As
proposed, the rule would require that portfolio holdings and basket
information be presented and contain information regarding description,
amount, value and/or unrealized gain/loss (if applicable) in the manner
prescribed within Article 12 of Regulation S-X.\532\ Additionally, the
proposed rule would require an ETF to disclose on its website a tabular
chart and line graph showing the ETF's premiums and discounts for the
most recently completed calendar year and the most recently completed
calendar quarters of the current year. For new ETFs that do not yet
have this information, the proposed rule would require the ETF to post
this information for the life of the fund. As discussed above, we
believe the disclosures provide useful information to investors who
purchase and sell ETF shares on national securities exchanges.
---------------------------------------------------------------------------
\530\ See proposed rule 6c-11(c)(1)(i)(A).
\531\ See proposed rule 6c-11(c)(1)(i)(B).
\532\ See supra footnote 220.
---------------------------------------------------------------------------
Proposed rule 6c-11(c)(1)(v) also would require any ETF whose
premium or discount was greater than 2% for more than seven consecutive
trading days to post that information on its website, along with a
discussion of the factors that are reasonably believed to have
materially contributed to the premium or discount.\533\ Given the
proposed threshold, we do not believe that many ETFs would be required
to disclose this information on a routine basis. For purposes of this
PRA, we assume that all ETFs will be required to make this disclosure
only once in their lifetime. Therefore, we believe that this
requirement will impose only initial costs and that there will be no
ongoing costs associated with it.\534\
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\533\ This information would be posted on the trading day
immediately following the eighth consecutive trading day on which
the ETF had a premium or discount greater than 2% and be maintained
on the ETF's website for at least one year following the first day
it was posted. See supra at text following footnote 306.
\534\ For purposes of this analysis, we estimate that 1,635 ETFs
would be required to make this disclosure at least once in their
lifetime.
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For purposes of the PRA analysis, we estimate that an ETF would
incur a one-time average burden of 25 hours associated with updating
the relevant website disclosures, at a time cost of $7,697.50.\535\ The
staff estimates the initial external cost would be $2,000 for an
external website developer to develop the web page.\536\ Amortized over
a 3-year period, the hour burden per ETF would be approximately 8.3
hours, at a time cost of $2,565.8, and an external cost of
approximately $666.65. Additionally, Commission staff estimates that an
ETF each year would spend approximately 5 hours of professional time to
update the relevant web page daily with this information, at a time
cost of $1,405.50.\537\ Commission staff does not believe there will be
any ongoing external costs related to the website disclosure
requirements. Accordingly, we estimate that the total burden for
drafting, reviewing and uploading the website disclosures would be
21,745.50 hours,\538\ at a time
[[Page 37399]]
cost of approximately $6,493,075.50,\539\ and an external cost of
$1,089,972.75.\540\
---------------------------------------------------------------------------
\535\ This estimate is based on the following calculations: (15
hours (for website development) x $296.50 per hour (blended rate for
a senior systems analyst ($274) and senior programmer ($319)) + (10
hours (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352)) =
$7,697.50).
\536\ Based on staff experience, the staff estimates that each
ETF initially would spend an additional $2,000 on external website
developers.
\537\ This estimate is based on the following calculations: (2
hours (for website updates) x $296.50 per hour (blended rate for a
senior systems analyst ($274) and senior programmer ($319)) + (2.5
hours (for review of website disclosures) x $325 (blended rate for a
compliance manager ($298) and a compliance attorney ($352)) =
$1,405.50. See SIFMA Report, supra footnote 452.
\538\ This estimate is based on the following calculation: 13.3
hours x 1,635 ETFs = 21,745.50 hours.
\539\ This estimate is based on the following calculation:
$3,971.3 x 1,635 ETFs = $6,493,075.50.
\540\ This estimate is based on the following calculation:
$666.65 x 1,635 ETFs = $1,089,972.75.
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2. Recordkeeping
The proposed rule requires that ETFs to preserve and maintain
copies of all written authorized participant agreements.\541\
Additionally, we are proposing to require ETFs to maintain records
setting forth the following information for each basket exchanged with
an authorized participant: (i) The names and quantities of the
positions composing the basket; (ii) identification of the basket as a
``custom basket'' and a record stating that the custom basket complies
with the ETF's custom basket policies and procedures (if applicable);
(iii) cash balancing amounts (if any); and (iv) the identity of the
authorized participant conducting the transaction.\542\
---------------------------------------------------------------------------
\541\ See proposed rule 6c-11(d).
\542\ See supra footnote 325 and accompanying text.
---------------------------------------------------------------------------
ETFs would have to maintain these records for at least five years,
the first two years in an easily accessible place.\543\ We estimate
that the burden would be 5 hours per ETF to retain these records, with
2.5 hours spent by a general clerk and 2.5 hours spent by a senior
computer operator. We estimate a time cost per ETF of $380.\544\ We
estimate the total recordkeeping burden related to rule 6c-11 would be
8,175 hours, at an aggregate cost of $621,300.\545\
---------------------------------------------------------------------------
\543\ Id.
\544\ This estimate is based on the following calculations: 2.5
hours x $60 (hourly rate for a general clerk) = $150; 2.5 hours x
$92 (hour rate for a senior computer operator) = $230. $150 + $230 =
$380.
\545\ We estimate that 1,635 ETFs would be required to maintain
these records.
---------------------------------------------------------------------------
3. Policies and Procedures
As proposed, rule 6c-11 would require ETFs relying on the proposed
rule to adopt and implement written policies and procedures that govern
the construction of baskets and the process that will be used for the
acceptance of basket assets.\546\ Additionally, to use custom baskets,
an ETF would be required to adopt and implement written policies and
procedures setting forth detailed parameters for the construction and
acceptance of custom baskets that are in the best interests of the ETF
and its shareholders.\547\ These policies and procedures also may
include a periodic review requirement in order to ensure that the ETF's
custom basket procedures are being consistently followed.\548\ Finally,
as discussed above, such an ETF would be required to maintain records
detailing the composition of each custom basket.
---------------------------------------------------------------------------
\546\ See proposed rule 6c-11(c)(3).
\547\ See proposed rule 6c-11(c)(3)(i).
\548\ See supra text accompanying footnote 256.
---------------------------------------------------------------------------
For purposes of this PRA analysis, we estimate that an ETF would
incur a one-time average burden of 6 hours associated with setting up
the process for documenting the construction and acceptance of
baskets.\549\ Accordingly, we estimate that a total initial burden
associated with setting up the process for documenting the construction
and acceptance of baskets would be 9,810 hours,\550\ at a time cost of
$4,094,325.\551\ An ETF utilizing custom baskets would also incur a
one-time average burden of 20 hours associated with documenting and
adopting the custom basket policies and procedures. Amortized over a 3-
year period, this would be an annual burden per ETF of about 2 hours
for documenting the construction and acceptance of baskets and an
annual burden per ETF of about 6.7 hours for the custom basket policies
and procedures. Accordingly, we estimate that a total burden for
initial documentation and review of both the process for documenting
the construction and acceptance of baskets as well as an ETF's custom
basket policies and procedures would be 42,510 hours,\552\ at a time
cost of $16,788,180.\553\ Amortizing these costs over three years, the
annual burden of complying with these requirements would be 14,170
hours, at a time cost of $5,596,060. We also estimate that there would
be no external cost for an ETF associated with these requirements.
---------------------------------------------------------------------------
\549\ We estimate that all ETFs relying on the rule will use
custom baskets to some extent. Moreover, we estimate that the cost
associated with this requirement is small because the records
detailing the composition of each custom basket are readily
available.
\550\ This estimate is based on the following calculations: 6
hours x 1,635 ETFs = 9,810 hours.
\551\ This estimate is based on the following calculations: 3
hours x 317 (hourly rate for a senior manager) = $951; 2 hours x 511
(hourly rate for chief compliance officer) = $1,022; 1 hour x $352
(hourly rate for compliance attorney) = $352; $951 + $1,022 + $352 =
$2,325; $2,325 x 1,635 ETFs = $3,801,375.
\552\ This estimate is based on the following calculation: (6
hours + 20 hours) x 1,635 ETFs = 42,510 hours.
\553\ These estimates are based on the following calculations:
12 hours x $317 (hourly rate for a senior portfolio manager) =
$3,804; 12 hours x $480 (blended hourly rate for assistant general
counsel ($449) and chief compliance officer ($511) = $5,760; 2 hours
(for a fund attorney's time to prepare and review materials) x $352
(hourly rate for a compliance attorney) = $704. $3,804 + $5,760 +
$704 = $10,268; $10,268 x 1,635 ETFs = $16,788,180. See SIFMA
Report, supra footnote 452.
---------------------------------------------------------------------------
We estimate that each ETF would incur an ongoing burden of an
additional 10 hours, at a time cost of an additional $3,985 \554\ each
year to review and update its custom basket policies and procedures as
well as its process for documenting the construction and acceptance of
baskets. In aggregate, we estimate that the total ongoing costs
associated with these requirements are 16,350 hours, at a time cost of
$6,515,475.\555\ We do not estimate that there will be any ongoing
external costs associated with these requirements. Therefore, we
estimate that the total initial and ongoing costs associated with
complying with the policies and procedures requirements of proposed
rule 6c-11 would be 30,520 \556\ hours at a time cost of
$12,111,535.\557\
---------------------------------------------------------------------------
\554\ These estimates are based on the following calculations: 5
hours x $317 (hourly rate for a senior portfolio manager) = $1,585;
5 hours x $480 (blended hourly rate for assistant general counsel
($449) and chief compliance officer ($511) = $2,400. $1,585 + $2,400
= $3,985.
\555\ This estimate is based on the following calculation:
$3,985 x 1,635 ETFs = $6,515,475.
\556\ This estimate is based on the following calculation:
14,170 hours + 16,350 hours = 30,520 hours.
\557\ This estimate is based on the following calculation:
$5,596,060 + $6,515,475 = $12,111,535.
---------------------------------------------------------------------------
4. Estimated Total Burden
We estimate that the total hour burdens and time costs associated
with proposed rule 6c-11, including the burden associated with: (i)
Website disclosure; (ii) recordkeeping; and (iii) developing policies
and procedures, would result in an average aggregate annual burden of
60,440.5 hours \558\ and an average aggregate time cost of
$19,225,910.50.\559\ We also estimate that there are $1,089,972.75
external costs associated with this collection of information. \560\
Therefore, to comply with rule 6c-11 each ETF would incur an annual
burden of approximately 36.97 \561\ hours, at an average time cost of
approximately $11,758.97 \562\, and an external cost of $666.65.\563\
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\558\ This estimate is based on the following calculation:
21,745.5 hours + 8,175 hours + 30,520 hours = 60,440.5 hours.
\559\ This estimate is based on the following calculation:
$6,493,075.50 + $621,300 + $12,111,535 = $19,225,910.50.
\560\ See supra footnote 540 and accompanying text.
\561\ This estimate is based on the following calculation:
60,440.5 hours / 1,635 ETFs = 36.97 hours.
\562\ This estimate is based on the following calculation:
$19,225,910.50 / 1,635 ETFs = $11,758.97.
\563\ This estimate is based on the following calculation:
$1,089,972.75 / 1,635 ETFs = $666.65.
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[[Page 37400]]
C. Rule 0-2
Section 6(c) of the Act provides the Commission with authority to
conditionally or unconditionally exempt persons, securities or
transactions from any provision of the Act if and to the extent that
such exemption is necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Act. Rule 0-2 under the
Act, entitled ``General Requirements of Papers and Applications,''
prescribes general instructions for filing an application seeking
exemptive relief with the Commission.\564\ We currently estimate for
rule 0-2 a total hour burden of 5,340 hours at an annual time cost of
$2,029,200.60 and the total annual external cost burden is
$14,090,000.\565\
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\564\ See Supporting Statement of Rule 0-2 under the Investment
Company Act of 1940, General Requirements of Paper Applications
(Nov. 23, 2016), available at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201602-3235-008 (summarizing how applications are
filed with the Commission in accordance with the requirements of
rule 0-2).
\565\ This estimate is based on the last time the rule's
information collection was submitted for PRA renewal in 2016.
---------------------------------------------------------------------------
As discussed above, proposed rule 6c-11 would permit ETFs that
satisfy the conditions of the rule to operate without the need to
obtain an exemptive order from the Commission under the Act. Therefore,
proposed rule 6c-11 would alleviate some of the burdens associated with
rule 0-2 because it would reduce the number of entities that require
exemptive relief in order to operate.\566\ Based on staff experience,
we estimate that approximately one-third of the annual burdens
associated with rule 0-2 are attributable to ETF applications.
Therefore, we estimate that proposed rule 6c-11 would result in a
decrease of the annual burden of rule 0-2 to approximately 3,738 \567\
hours at an annual time cost of $1,420,440.42 \568\ and an annual
external cost of $9,863,000.\569\
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\566\ As discussed above, we expect to continue to receive
applications for complex or novel ETF exemptive relief that are
beyond the scope of the proposed rule. See supra at text following
footnote 454.
\567\ This estimate is based on the following calculation: 5,340
hours-(5,340 hours x 0.3) = 3,738 hours.
\568\ This estimate is based on the following calculation:
$2,029,200.60-($2,029,200.60 x 0.3) = $1,420,440.42.
\569\ This estimate is based on the following calculation:
$14,090,000-($14,090,000 x 0.3) = $9,863,000.
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D. Form N-1A
Form N-1A is the registration form used by open-end management
investment companies. The respondents to the proposed amendments to
Form N-1A are open-end management investment companies registered or
registering with the Commission. Compliance with the proposed
disclosure requirements of Form N-1A is mandatory for open-end funds
(to the extent applicable) including all ETFs organized as open-end
funds. Responses to the disclosure requirements are not confidential.
We currently estimate for Form N-1A a total burden hour of 1,579,974
burden hours, with an estimated internal cost of $129,338,408, and
external cost of $124,820,197.\570\
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\570\ This estimate is based on the last time the form's
information collection was submitted for PRA renewal in 2017.
---------------------------------------------------------------------------
We are proposing amendments to Form N-1A designed to provide
investors who purchase ETF shares in secondary market transactions with
tailored information regarding ETFs, including information regarding
costs associated with an investment in ETFs.\571\ Specifically, the
proposed amendments to Form N-1A would require new disclosures
regarding fees and expenses, such as brokerage commission and financial
intermediary fees, and certain trading costs.\572\ In addition, we are
proposing to include instructions in Form N-1A requiring an ETF to
provide bid-ask spread information on the ETF's website and an
interactive calculator, in a clear and prominent format on the ETF's
website, to allow investors to customize certain hypothetical
calculations to their specific investing situation.\573\
---------------------------------------------------------------------------
\571\ See proposed Instruction 5(e) to Item 3 of Form N-1A.
\572\ See proposed amendments to Item 3 of Form N-1A.
\573\ Proposed Instruction 5(e) to Item 3 of Form N-1A.
---------------------------------------------------------------------------
We also are proposing amendments to Form N-1A designed to eliminate
certain disclosures for ETFs that are duplicative of the new
disclosures we are proposing, discussed above, or are no longer
necessary.\574\ These proposed amendments include eliminating certain
disclosures in Item 6(c) of Form N-1A relating to creation units,
secondary market transactions, premiums and discounts, as well as
certain disclosures required of ETFs issuing creation units of less
than 25,000 shares. Additionally, we are proposing to eliminate
historical premium/discount disclosure requirements in Item 11(g)(2)
and Item 27(b)(7)(iv) of Form N-1A.
---------------------------------------------------------------------------
\574\ See supra footnotes 390-397 and accompanying text.
---------------------------------------------------------------------------
Form N-1A generally imposes two types of reporting burdens on
investment companies: (i) The burden of preparing and filing the
initial registration statement; and (ii) the burden of preparing and
filing post-effective amendments to a previously effective registration
statement (including post-effective amendments filed pursuant to 17 CFR
230.485(a) or (b) (rule 485(a) or 485(b) under the Securities Act), as
applicable). We estimate that each ETF would incur a one-time burden of
an additional 10 hours, at a time cost of an additional $3,355,\575\ to
draft and finalize the required disclosure and amend its registration
statement. We further estimate that an ETF would incur a one-time
average burden of 10 hours associated with implementing the bid-ask
spread disclosures and interactive calculator on its website, at a time
cost of $3,355,\576\ as required by proposed Instruction 5(e) to Item
3. In the aggregate, we estimate that ETFs would incur a one-time
burden of an additional 20 hours, at a time cost of an additional
$6,710 to comply with the proposed Form N-1A disclosure requirements
for ETFs. Amortizing the one-time burden over a three-year period
results in an average annual burden of an additional 6.67 hours at a
time cost of an additional $2,236.67.
---------------------------------------------------------------------------
\575\ This estimate is based on the following calculation: 10
hours x $335.50 (blended rate for a compliance attorney ($352) and a
senior programmer ($319)) = $3,355.
\576\ Id.
---------------------------------------------------------------------------
We estimate that each ETF would incur an ongoing burden of an
additional 5 hours, at a time cost of an additional $1,677.50 \577\
each year to review and update the proposed disclosures.\578\ We also
estimate that each ETF would incur an ongoing burden of an additional 5
hours, at a time cost of an additional $1,677.50,\579\ relating to the
bid-ask spread disclosures and to maintain the interactive calculator
on its website. In aggregate, we estimate that each ETF would incur an
annual ongoing burden of an additional 10 hours, at a time cost of an
additional $3,355, to comply with the proposed Form N-1A disclosure
requirements. We do not estimate any change to the external costs
associated with the proposed amendment for Form N-1A.
---------------------------------------------------------------------------
\577\ This estimate is based on the following calculation: 5
hours x $335.50 (blended rate for a compliance attorney ($352) and a
senior programmer ($319)) = $1,677.50.
\578\ The estimated burden associated with the amendments to
Form N-1A accounts for the proposal to remove the information
currently required by Item 11(g)(2) and Item 27(b)(7)(iv) of Form N-
1A.
\579\ Id.
---------------------------------------------------------------------------
In total, we estimate that ETFs, other than UIT ETFs, would incur
an average
[[Page 37401]]
annual increased burden of approximately 31,596.4 hours,\580\ at a time
cost of approximately $10,579,307.2,\581\ to comply with the proposed
Form N-1A disclosure requirements. We do not estimate any change to the
external costs associated with the proposed amendment for Form N-1A.
---------------------------------------------------------------------------
\580\ This estimate is based on the following calculation: (6.7
hours + 10 hours) x 1,892 ETFs = 31,596.4 hours.
\581\ This estimate is based on the following calculation:
($2,236.67 + $3,355) x 1,892 ETFs= $10,579,307.20.
---------------------------------------------------------------------------
E. Disclosure Amendments to Forms N-8B-2 and S-6
Form N-8B-2 is used by UITs to initially register under the
Investment Company Act pursuant to section 8 thereof.\582\ UITs are
required to file Form S-6 in order to register offerings of securities
with the Commission under the Securities Act.\583\ As a result, UITs
file Form N-8B-2 only once when the UIT is initially created and then
use Form S-6 to file all post-effective amendments to their
registration statements in order to update their prospectuses.\584\ We
currently estimate for Form S-6 a total burden of 106,620 hours, with
an internal cost burden of approximately $34,000,000, and an external
cost burden estimate of $67,359,556.\585\ Additionally, we currently
estimate for Form N-8B-2 a total burden of 10 hours, with an internal
cost burden of approximately $3,360, and an external burden estimate of
$10,000.\586\
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\582\ See Form N-8B-2 [17 CFR 274.12].
\583\ See Form S-6 [17 CFR 239.16]. Form S-6 is used for
registration under the Securities Act of securities of any UIT
registered under the Act on Form N-8B-2.
\584\ Form S-6 incorporates by reference the disclosure
requirements of Form N-8B-2 and allows UITs to meet the filing and
disclosure requirements of the Securities Act.
\585\ This estimate is based on the last time the form's
information collection was submitted for PRA renewal in 2014.
\586\ This estimate is based on the last time the form's
information collection was submitted for PRA renewal in 2018.
---------------------------------------------------------------------------
In order to assist investors with better understanding the total
costs of investing in a UIT ETF, we are proposing disclosure
requirements in Form N-8B-2 that mirror those disclosures proposed for
Form N-1A.\587\ All UIT ETFs would be subject to these disclosure
requirements. For existing UIT ETFs, the one-time and ongoing costs of
complying with the amendments to Form N-8B-2 would accrue on Form S-
6.\588\
---------------------------------------------------------------------------
\587\ See proposed Items 13(h) and (i) of Form N-8B-2. See also
supra section II.H.5.
\588\ See supra footnote 583.
---------------------------------------------------------------------------
For purposes of the PRA analysis, we estimate that each UIT ETF
would incur a one-time burden of an additional 20 hours, at a time cost
of an additional $6,710 \589\ to draft and finalize the required
disclosure and amend its Form S-6. For each newly created UIT ETF,
these same costs would be incurred on Form N-8B-2.\590\ Therefore, in
the aggregate, we estimate that existing UIT ETFs would incur a one-
time burden of an additional 160 hours,\591\ at a time cost of an
additional $53,680,\592\ to comply with the proposed Form N-8B-2
disclosure requirements on Form S-6. Additionally, in the aggregate, we
estimate that newly created UIT ETFs would incur a one-time burden of
an additional 20 hours, at a time cost of an additional $6,710, to
comply with the proposed amendments and complete Form N-8B-2.
Amortizing the one-time burden for both existing and newly created UIT
ETFs over a three-year period results in an average annual burden of an
additional 6.67 hours, at a time cost of an additional $2,236.67.
---------------------------------------------------------------------------
\589\ This estimate is based on the following calculation: 20
hours x $335.50 (blended rate for a compliance attorney ($352) and a
senior programmer ($319)) = $6,710.
\590\ Although we noted above that no new UIT ETFs have come to
market since 2002, for purposes of calculating the time and cost
burdens associated with completing Form N-8B-2, we estimate that 1
UIT ETF will be created annually. See supra footnote 41 and
accompanying text.
\591\ This estimate is based on the following calculation: 20
hours x 8 UIT ETFs= 160 hours.
\592\ This estimate is based on the following calculation:
$6,710 x 8 UIT ETFs = $53,680.
---------------------------------------------------------------------------
We estimate that each UIT ETF would incur an ongoing burden of an
additional 10 hours, at a time cost of an additional $3,355, each year
to review and update the proposed disclosures on Form S-6. In
aggregate, we estimate that UIT ETFs would incur an annual burden of an
additional 80 hours,\593\ at a time cost of an additional $26,840,\594\
to comply with the proposed Form N-8B-2 disclosure requirements on Form
S-6.
---------------------------------------------------------------------------
\593\ This estimate is based on the following calculation: 10
hours x 8 UIT ETFs = 80 hours.
\594\ This estimate is based on the following calculation:
$3,355 x 8 UIT ETFs = $26,840.
---------------------------------------------------------------------------
Additionally, we estimate that newly created UIT ETFs would also
incur an average annual increased burden of approximately 10 hours, at
a time cost of an additional $3,355, to complete Form N-8B-2. We do not
estimate any change to the external costs, on either Form N-8B-2 or
Form S-6, associated with the proposed amendments to Form N-8B-2.
F. Form N-CEN
As discussed above, Form N-CEN is a structured form that requires
registered funds to provide census-type information to the Commission
on an annual basis.\595\ The Commission is proposing amendments to Form
N-CEN to require ETFs to report if they are relying on rule 6c-11.\596\
---------------------------------------------------------------------------
\595\ See Reporting Modernization Adopting Release, supra
footnote 147. The compliance date for Form N-CEN is June 1, 2018.
\596\ See proposed Item C.7.k. of Form N-CEN.
---------------------------------------------------------------------------
In the Reporting Modernization Adopting Release, we estimated that
the Commission would receive an average of 3,113 reports on Form N-
CEN.\597\ We estimated that the average annual hour burden per response
for Form N-CEN for the first year to be 32.37 hours and 12.37 hours in
subsequent years.\598\ Amortizing the burden over three years, we
estimated that the average annual hour burden per fund per year to be
19.04 hours and the total aggregate annual hour burden to be 59,272
hours.\599\ Finally, we estimated that all applicable funds will incur,
in the aggregate, external annual costs of $2,088,176 to prepare and
file reports on Form N-CEN.\600\
---------------------------------------------------------------------------
\597\ See Reporting Modernization Adopting Release, supra
footnote 147, at text accompanying n.1524.
\598\ See id., at text accompanying nn.1531-1532.
\599\ See id., at text accompanying nn.1533-1534.
\600\ See Reporting Modernization Adopting Release, supra
footnote 147, at text accompanying n.1538.
---------------------------------------------------------------------------
Based on Commission staff experience, we believe that our proposal
to require ETFs to report if they are relying on rule 6c-11 would
increase the estimated burden hours associated with Form N-CEN by
approximately 0.1 hours, both initially and on an ongoing basis.\601\
Therefore, in the aggregate, we estimate that ETFs will incur an annual
burden of an additional 163.5 hours to comply with the proposed
amendments to Form N-CEN.\602\ We estimate that there are no additional
external costs associated with this collection of information.
---------------------------------------------------------------------------
\601\ This estimate stems from the Commission staff's
understanding of the time it takes to complete initially complete
and review items on Form N-CEN.
\602\ This estimate is based on the following calculation: 0.1
hours x 1,635 ETFs = 163.5 hours.
---------------------------------------------------------------------------
G. Request for Comments
We request comment on whether these estimates are reasonable.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments
in order to: (i) Evaluate whether the proposed collections of
information are necessary for the proper performance of the functions
of the Commission, including whether the information will have
practical utility; (ii) evaluate the accuracy of the Commission's
estimate of the burden of the proposed
[[Page 37402]]
collections of information; (iii) determine whether there are ways to
enhance the quality, utility, and clarity of the information to be
collected; and (iv) determine whether there are ways to minimize the
burden of the collections of information on those who are to respond,
including through the use of automated collection techniques or other
forms of information technology.
Persons wishing to submit comments on the collection of information
requirements of the proposed rules and amendments should direct them to
the OMB, Attention Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
DC 20503, and should send a copy to, Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090, with reference to File No. S7-15-18. OMB is required to
make a decision concerning the collections of information between 30
and 60 days after publication of this release; therefore a comment to
OMB is best assured of having its full effect if OMB receives it within
30 days after publication of this release. Requests for materials
submitted to OMB by the Commission with regard to these collections of
information should be in writing, refer to File No. S7-15-18, and be
submitted to the Securities and Exchange Commission, Office of FOIA
Services, 100 F Street NE, Washington, DC 20549-2736.
V. Initial Regulatory Flexibility Analysis
The Commission has prepared the following Initial Regulatory
Flexibility Analysis (``IRFA'') in accordance with section 3 of the
Regulatory Flexibility Act \603\ regarding our proposed new rule 6c-11
and proposed amendments to Form N-1A, Form N-8b-2, and Form N-CEN.
---------------------------------------------------------------------------
\603\ See 5 U.S.C. 603(a).
---------------------------------------------------------------------------
A. Reasons for and Objectives of the Proposed Actions
As described more fully above, proposed rule 6c-11 would allow ETFs
that meet the conditions of the rule to form and operate without the
expense and delay of obtaining an exemptive order from the Commission.
The Commission's objective is to create a consistent, transparent and
efficient regulatory framework for ETFs and to facilitate greater
competition and innovation among ETFs. The Commission also believes the
proposed disclosure amendments would provide useful information to
investors who purchase and sell ETF shares in secondary markets.
Finally, the goal of the proposed amendments to Form N-CEN is for the
Commission to be able to better monitor reliance on rule 6c-11 and to
assist the Commission with its accounting, auditing and oversight
functions.
B. Legal Basis
The Commission is proposing new rule 6c-11 pursuant to the
authority set forth in sections 6(c), 22(c), and 38(a) of the
Investment Company Act [15 U.S.C. 80a-6(c), 22(c), and 80a-37(a)]. The
Commission is proposing amendments to registration Form N-1A under the
authority set forth in sections 6, 7(a), 10 and 19(a) of the Securities
Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and sections 8(b),
24(a), and 30 of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-
24(a), and 80a-29]. The Commission is proposing amendments to
registration Form N-8b-2 under the authority set forth in section 8(b)
and 38(a) of the Investment Company Act [15 U.S.C. 80a-8(b) and 80a-
37(a)]. The Commission is proposing amendments to Form N-CEN under the
authority set forth sections 8(b), 30(a), and 38(a) of the Investment
Company Act [15 U.S.C. 80a-8(b), 80a-29(a), and 80a-37(a)].
C. Small Entities Subject to the Rule
An investment company is a small entity if, together with other
investment companies in the same group of related investment companies,
it has net assets of $50 million or less as of the end of its most
recent fiscal year.\604\ Commission staff estimates that, as of
December 2017, there are approximately 8 open-end ETFs that may be
considered small entities.\605\ Commission staff estimates there are no
UIT ETFs that would be considered small entities subject to the
proposed disclosures for Form N-8B-2.\606\
---------------------------------------------------------------------------
\604\ 17 CFR 270.0-10(a).
\605\ This estimate is derived from an analysis of data reported
on Form N-1A with the Commission for the period ending December,
2017.
\606\ This estimate is derived from an analysis of data reported
on Forms S-6 and N-8B-2 with the Commission for the period ending
December 2017.
---------------------------------------------------------------------------
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The proposed amendments would amend current reporting requirements
for ETFs considered small entities.
1. Rule 6c-11
Proposed rule 6c-11 would require an ETF to disclose on its
website: (i) Portfolio holding information and information regarding a
published basket on each business day; (ii) the ETF's current NAV per
share, market price, and premium or discount, each as of the end of the
prior business day; (iii) if an ETF's premium or discount is greater
than 2% for more than seven consecutive trading days, a discussion of
the factors that are reasonably believed to have materially contributed
to the premium or discount; and (iv) a table and line graph showing the
ETF's premiums and discounts.\607\ We also are proposing to require
that ETFs preserve and maintain copies of all written authorized
participant agreements, as well as records setting forth the following
information for each basket exchanged with an authorized participant:
(i) The names and quantities of the positions composing the basket;
(ii) identification of the basket as a ``custom basket'' and a record
stating that the custom basket complies with the ETF's policies and
procedures (if applicable); (iii) cash balancing amounts (if any); and
(iv) the identity of the authorized participant conducting the
transaction.\608\ Proposed rule 6c-11 would also require ETFs relying
on the proposed rule to adopt and implement written policies and
procedures that govern the construction of baskets and the process that
will be used for the acceptance of basket assets.\609\ ETFs using
custom baskets under the proposed rule must adopt custom basket
policies and procedures that include certain enumerated
requirements.\610\
---------------------------------------------------------------------------
\607\ See proposed rule 6c-11(c)(1)(iii) and (iv).
\608\ See supra section II.C.5.a.
\609\ Proposed rule 6c-11(c)(3).
\610\ Proposed rule 6c-11(c)(3).
---------------------------------------------------------------------------
We estimate that approximately 8 ETFs are small entities that would
comply with proposed rule 6c-11, and we do not believe that their costs
would differ from other ETFs. As discussed above, we estimate that an
ETF would incur an annual burden of approximately 36.97 hours, at an
average time cost of approximately $11,758.97, and an external cost of
$666.65.\611\
---------------------------------------------------------------------------
\611\ See supra footnote 561 and accompanying text.
---------------------------------------------------------------------------
2. Disclosure and Reporting Requirements
We are proposing amendments to Form N-1A and Form N-8B-2 designed
to provide investors who purchase ETF shares in secondary market
transactions with tailored information regarding ETFs, including
information regarding costs associated with an investment in ETFs.
Specifically, proposed amendments to Form N-1A would require new
disclosure regarding fees and expenses, such a brokerage
[[Page 37403]]
commission and financial intermediary fees, and additional information
on certain trading costs.\612\ In addition, we are proposing to include
instructions in Form N-1A requiring an ETF to provide bid-ask spread
information on the ETF's website and an interactive calculator, in a
clear and prominent format on the ETF's website, to allow investors to
customize certain hypothetical calculations to their specific investing
situation.\613\ Proposed amendments to Form N-8B-2 mirror proposed
disclosures for Form N-1A. We are also proposing amendments to Form N-
CEN that would require ETFs to report on Form N-CEN if they are relying
on rule 6c-11. The proposed Form N-CEN amendments are designed to
assist us with monitoring reliance on rule 6c-11 as well with our
accounting, auditing and oversight functions, including compliance with
the PRA.
---------------------------------------------------------------------------
\612\ See supra footnote 572 and accompanying text.
\613\ Proposed Instruction 5(e) to Item 3 of Form N-1A.
---------------------------------------------------------------------------
All ETFs would be subject to the proposed disclosure and reporting
requirements, including ETFs that are small entities. We estimate that
8 ETFs are small entities that would be required to comply with the
proposed disclosure and reporting requirements.\614\
---------------------------------------------------------------------------
\614\ See supra footnote 605.
---------------------------------------------------------------------------
As discussed above, we estimate that each ETF, including ETFs that
are small entities, would incur a one-time burden of an additional 10
hours, at a time cost of an additional $3,355 to draft and finalize the
required disclosure and amend its registration statement.\615\ We
further estimate that ETFs, including ETFs that are small entities,
would incur a one-time average burden of 10 hours associated with
implementing the interactive calculator on its website, at a time cost
of $3,355, as required by proposed Instruction 5(e) to Item 3. In the
aggregate, we estimate that ETFs, including ETFs that are small
entities, would incur a one-time burden of an additional 20 hours, at a
time cost of an additional $6,710, to comply with the proposed Form N-
1A disclosure requirements for ETFs.\616\
---------------------------------------------------------------------------
\615\ See supra footnote 576 and accompanying text.
\616\ See supra footnote 576 and accompanying text.
---------------------------------------------------------------------------
We also estimate that each ETF, including ETFs that are small
entities, would incur an ongoing burden of an additional 5 hours, at a
time cost of an additional $1,677.50, each year to review and update
the proposed disclosures. We further estimate that each ETF, including
ETFs that are small entities, would incur an ongoing burden of an
additional 5 hours, at a time cost of an additional $1,677.50, to
maintain the interactive calculator on its website. In aggregate, we
estimate that each ETF, including ETFs that are small entities, would
incur an annual ongoing burden of an additional 10 hours, at a time
cost of an additional $3,355, to comply with the proposed Form N-1A
disclosure requirements. We do not estimate any change to the external
costs associated with the proposed amendments to Form N-1A.\617\
---------------------------------------------------------------------------
\617\ Id.
---------------------------------------------------------------------------
As discussed above, because the amendments made to Form N-8B-2
mirror those made on Form N-1A, we believe that UIT ETFs, including UIT
ETFs that are small entities, would incur the same costs as all ETFs
associated with updating their registration statements. However, none
of the UIT ETFs are small entities.
E. Duplicative, Overlapping or Conflicting Federal Rules
Commission staff has not identified any federal rules that
duplicate, overlap, or conflict with the proposed regulations.
F. Significant Alternatives
The RFA directs the Commission to consider significant alternatives
that would accomplish our stated objectives, while minimizing any
significant economic impact on small entities. We considered the
following alternatives for small entities in relation to the proposed
regulations:
Exempting ETFs that are small entities from the proposed
disclosure, reporting or recordkeeping requirements, to account for
resources available to small entities;
establishing different disclosure, reporting or
recordkeeping requirements or different frequency of these
requirements, to account for resources available to small entities;
clarifying, consolidating, or simplifying the compliance
requirements under the amendments for small entities; and
using performance rather than design standards.
We do not believe that exempting any subset of ETFs, including
small entities, from proposed rule 6c-11 or proposed form amendments
would permit us to achieve our stated objectives. Nor do we believe
establishing different disclosure, reporting or recordkeeping
requirements or different frequency of these requirements for small
entities would permit us to achieve our stated objectives. Similarly,
we do not believe that we can establish simplified or consolidated
compliance requirements for small entities under the proposed rule
without compromising our objectives. As discussed above, the conditions
necessary to rely on proposed rule 6c-11 and the reporting,
recordkeeping and disclosure requirements are designed to provide
investor protection benefits, including, among other things, tailored
information regarding ETFs, including information regarding costs
associated with an investment in ETFs. These benefits should apply to
investors in smaller funds as well as investors in larger funds.
Similarly, we do not believe it would be in the interest of investors
to exempt small ETFs from the proposed disclosure and reporting
requirements or to exempt small ETFs from the proposed recordkeeping
requirements. We believe that all ETF investors, including investors in
small ETFs, would benefit from disclosure and reporting requirements
that permit them to make investment choices that better match their
risk tolerances. We further note that the current disclosure
requirements for reports on Form N-1A and Form N-8B-2 do not
distinguish between small entities and other funds.\618\
---------------------------------------------------------------------------
\618\ See Reporting Modernization Adopting Release, supra
footnote 147, at section V.E (noting that small entities currently
follow the same requirements that large entities do when filing
reports on Form N-SAR, Form N-CSR, and Form N-Q, and stating that
the Commission believes that establishing different reporting
requirements or frequency for small entities (including with respect
to proposed Form N-PORT and proposed Form N-CEN) would not be
consistent with the Commission's goal of industry oversight and
investor protection).
---------------------------------------------------------------------------
Finally, we believe that proposed rule 6c-11 and related disclosure
and reporting requirements appropriately use a combination of
performance and design standards. Proposed rule 6c-11 provides ETFs
that satisfy the requirements of the rule with exemptions from certain
provisions of the Act necessary for ETFs to operate. Because the
provisions of the Act from which ETFs would be exempt provide important
investor and market protections, the conditions of the proposed rule
must be specifically designed to ensure that these investor and market
protections are maintained. However, where we believe that flexibility
is beneficial, we proposed performance-based standards that provide a
regulatory framework, rather than prescriptive requirements, to give
funds the opportunity to adopt policies and procedures tailored to
their specific
[[Page 37404]]
needs without raising investor or market protection concerns.\619\
---------------------------------------------------------------------------
\619\ See e.g., supra section II.C.5 (noting that proposed rule
6c-11 would provide an ETF with the flexibility to use ``custom
baskets'' if the ETF has adopted written policies and procedures
that set forth detailed parameters for the construction and
acceptance of custom baskets that are in the best interests of the
ETF and its shareholders).
---------------------------------------------------------------------------
G. General Request for Comment
The Commission requests comment regarding this analysis. We request
comments on the number of small entities that would be subject to the
proposed ETF regulations and whether the proposed ETF regulations would
have any effects that have not been discussed. We request that
commenters describe the nature of any effects on small entities subject
to the proposed ETF regulations and provide empirical data to support
the nature and extent of such effects. We also request comment on the
estimated compliance burdens of the proposed ETF regulations and how
they would affect small entities.
VI. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \620\ the Commission must advise OMB
whether a proposed regulation constitutes a ``major'' rule. Under
SBREFA, a rule is considered ``major'' where, if adopted, it results in
or is likely to result in:
---------------------------------------------------------------------------
\620\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------
An annual effect on the economy of $100 million or more;
A major increase in costs or prices for consumers or
individual industries; or
Significant adverse effects on competition, investment or
innovation.
We request comment on whether our proposal would be a ``major
rule'' for purposes of SBREFA. We solicit comment and empirical data
on:
The potential effect on the U.S. economy on an annual
basis;
Any potential increase in costs or prices for consumers or
individual industries; and
Any potential effect on competition, investment, or
innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
VII. Statutory Authority
The Commission is proposing new rule 6c-11 pursuant to the
authority set forth in sections 6(c), 22(c), and 38(a) of the
Investment Company Act [15 U.S.C. 80a-6(c), 80a-22(c), and 80a-37(a)].
The Commission is proposing amendments to registration Form N-1A under
the authority set forth in sections 6, 7(a), 10 and 19(a) of the
Securities Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and
sections 8(b), 24(a), and 30 of the Investment Company Act [15 U.S.C.
80a-8(b), 80a-24(a), and 80a-29]. The Commission is proposing
amendments to registration Form N-8B-2 under the authority set forth in
section 8(b) and 38(a) of the Investment Company Act [15 U.S.C. 80a-
8(b) and 80a-37(a)]. The Commission is proposing amendments to Form N-
CEN under the authority set forth in sections 8(b), 30(a), and 38(a) of
the Investment Company Act [15 U.S.C. 80a-8(b), 80a-29(a), and 80a-
37(a)].
List of Subjects
17 CFR Part 239
Reporting and recordkeeping requirements, Securities.
17 CFR Parts 270 and 274
Investment companies, Reporting and recordkeeping requirements,
Securities.
Text of Proposed Rules and Form Amendments
For reasons set out in the preamble, title 17, chapter II of the
Code of Federal Regulations is proposed to be amended as follows:
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
0
1. The authority citation for part 239 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78ll,
78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26,
80a-29, 80a-30, and 80a-37; and sec. 107 Pub. L. 112-106, 126 Stat.
312, unless otherwise noted.
* * * * *
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
0
2. The authority citation for part 270 continues to read, in part, and
is amended by adding a sectional authority for Sec. 270.6c-11 to read
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
* * * * *
Section 270.6c-11 is also issued under 15 U.S.C. 80a-6(c) and
80a-37(a).
* * * * *
0
3. Section 270.6c-11 is added to read as follows:
Sec. 270.6c-11 Exchange-traded funds.
(a) Definitions. For purposes of this section:
Authorized participant means a member or participant of a clearing
agency registered with the Commission, which has a written agreement
with the exchange-traded fund or one of its service providers that
allows the authorized participant to place orders for the purchase and
redemption of creation units.
Basket means the securities, assets or other positions in exchange
for which an exchange-traded fund issues (or in return for which it
redeems) creation units.
Business day means any day the exchange-traded fund is open for
business, including any day when it satisfies redemption requests as
required by section 22(e) of the Act (15 U.S.C. 80a-22(e)).
Cash balancing amount means an amount of cash to account for any
difference between the value of the basket and the net asset value of a
creation unit.
Creation unit means a specified number of exchange-traded fund
shares that the exchange-traded fund will issue to (or redeem from) an
authorized participant in exchange for the deposit (or delivery) of a
basket and a cash balancing amount if any.
Custom basket means:
(i) Baskets that are composed of a non-representative selection of
the exchange-traded fund's portfolio holdings; or
(ii) Different baskets used in transactions on the same business
day.
Exchange-traded fund means a registered open-end management
company:
(i) That issues (and redeems) creation units to (and from)
authorized participants in exchange for a basket and a cash balancing
amount if any; and
(ii) Whose shares are listed on a national securities exchange and
traded at market-determined prices.
Exchange-traded fund share means a share of stock issued by an
exchange-traded fund.
Foreign investment means any security, asset or other position of
the ETF issued by a foreign issuer as that term is defined in Sec.
240.3b-4 of this title, and for which there is no established United
States public trading market, as that term is used in 17 CFR 227.201
(Item 201 of Regulation S-K under the Securities Act of 1933).
Market price means:
(i) The official closing price of an exchange-traded fund share; or
(ii) If it more accurately reflects the market value of an
exchange-traded
[[Page 37405]]
fund share at the time as of which the exchange-traded fund calculates
current net asset value per share, the price that is the midpoint
between the national best bid and national best offer as of that time.
National securities exchange means an exchange that is registered
with the Commission under section 6 of the Securities Exchange Act of
1934 (15 U.S.C. 78f).
Portfolio holdings means the securities, assets or other positions
held by the exchange-traded fund.
Premium or discount means the positive or negative difference
between the market price of an exchange-traded fund share at the time
as of which the current net asset value is calculated and the exchange-
traded fund's current net asset value per share, expressed as a
percentage of the exchange-traded fund share's current net asset value
per share.
(b) Application of the Act to Exchange-Traded Funds. If the
conditions of paragraph (c) of this section are satisfied:
(1) Redeemable security. An exchange-traded fund share is
considered a ``redeemable security'' within the meaning of section
2(a)(32) of the Act (15 U.S.C. 80a-2(a)(32)).
(2) Pricing. A dealer in exchange-traded fund shares is exempt from
section 22(d) of the Act (15 U.S.C. 80a-22(d)) and Sec. 270.22c-1(a)
with regard to purchases, sales and repurchases of exchange-traded fund
shares at market-determined prices.
(3) Affiliated transactions. (i) A person who is an affiliated
person of an exchange-traded fund (or who is an affiliated person of
such a person) solely by reason of the circumstances described in
paragraphs (b)(3)(i)(A) and (B) of this section is exempt from sections
17(a)(1) and 17(a)(2) of the Act (15 U.S.C. 80a-17(a)(1) and (a)(2))
with regard to the deposit and receipt of baskets:
(A) Holding with the power to vote 5% or more of the exchange-
traded fund's shares; or
(B) Holding with the power to vote 5% or more of any investment
company that is an affiliated person of the exchange-traded fund.
(4) Postponement of redemptions. If an exchange-traded fund
includes a foreign investment in its basket, and if a local market
holiday, or series of consecutive holidays, or the extended delivery
cycles for transferring foreign investments to redeeming authorized
participants prevents timely delivery of the foreign investment in
response to a redemption request, the exchange-traded fund is exempt,
with respect to the delivery of the foreign investment, from the
prohibition in section 22(e) of the Act (15 U.S.C. 80a-22(e)) against
postponing the date of satisfaction upon redemption for more than seven
days after the tender of a redeemable security if the exchange-traded
fund delivers the foreign investment as soon as practicable, but in no
event later than 15 days after the tender of the exchange-traded fund
shares. The exemption provided in paragraph (b)(4) of this section will
expire and no longer be effective on [date ten years from effective
date of rule].
(c) Conditions. (1) Each business day, an exchange-traded fund must
disclose prominently on its website, which is publicly available and
free of charge:
(i) Before the opening of regular trading on the primary listing
exchange of the exchange-traded fund shares and before the exchange-
traded fund starts accepting orders for the purchase or redemption of
creation units:
(A) The portfolio holdings that will form the basis of the next
calculation of current net asset value per share;
(B) A basket applicable to orders for the purchase or redemption of
creation units to be priced based on the next calculation of current
net asset value; and
(C) The estimated cash balancing amount, if any;
(ii) The exchange-traded fund's current net asset value per share,
market price, and premium or discount, each as of the prior business
day;
(iii) A table showing the number of days the exchange-traded fund's
shares traded at a premium or discount during the most recently
completed calendar year and the most recently completed calendar
quarters since that year (or the life of the exchange-traded fund, if
shorter);
(iv) A line graph showing exchange-traded fund share premiums or
discounts for the most recently completed calendar year and the most
recently completed calendar quarters since that year (or the life of
the exchange-traded fund, if shorter); and
(v) If the exchange-traded fund's premium or discount is greater
than 2% for more than seven consecutive trading days, a discussion of
the factors that are reasonably believed to have materially contributed
to the premium or discount, which must be maintained on the website for
at least one year thereafter; and
(vi) The exchange-traded fund must present the description, amount,
value and unrealized gain/loss in the manner prescribed within 17 CFR
210.12-12, 210.12-12A, 210.12-13, 210.12-13A, 210.12-13B, 210.12-13C,
and 210.12-13D (Article 12 of Regulation S-X) for each portfolio
holding or basket asset required to be disclosed pursuant to paragraphs
(c)(1)(i) of this section.
(2) An exchange-traded fund must reflect changes in the exchange-
traded fund's portfolio holdings in the first calculation of net asset
value per share on the first business day following the trade date.
(3) An exchange-traded fund must adopt and implement written
policies and procedures that govern the construction of baskets and the
process that will be used for the acceptance of baskets; provided,
however, if the exchange-traded fund utilizes a custom basket:
(i) These written policies and procedures also must:
(A) Set forth detailed parameters for the construction and
acceptance of custom baskets that are in the best interests of the
exchange-traded fund and its shareholders, including the process for
any revisions to, or deviations from, those parameters; and
(B) Specify the titles or roles of the employees of the exchange-
traded fund's investment adviser who are required to review each custom
basket for compliance with those parameters.
(4) The exchange-traded fund may not seek, directly or indirectly,
to provide returns that exceed the performance of a market index by a
specified multiple, or to provide returns that have an inverse
relationship to the performance of a market index, over a fixed period
of time.
(5) Notwithstanding the definition of exchange-traded fund in
paragraph (a) of this section, an exchange-traded fund is not
prohibited from selling (or redeeming) individual shares on the day of
consummation of a reorganization, merger, conversion or liquidation.
(d) Recordkeeping. The exchange-traded fund must maintain and
preserve for a period of not less than five years, the first two years
in an easily accessible place:
(1) All written agreements (or copies thereof) between an
authorized participant and the exchange-traded fund or one of its
service providers that allows the authorized participant to place
orders for the purchase or redemption of creation units;
(2) For each basket exchanged with an authorized participant,
records setting forth:
(i) The names and quantities of the positions composing the basket
exchanged for creation units;
(ii) If applicable, identification of the basket as a custom basket
and a record stating that the custom basket complies with policies and
procedures that the
[[Page 37406]]
exchange-traded fund adopted pursuant to paragraph (c)(3)(i) of this
section;
(iii) Cash balancing amount, if any; and
(iv) Identity of authorized participant transacting with the
exchange-traded fund.
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
4. The general authority citation for part 274 continues to read, in
part, as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203,
sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *
0
5. Form N-1A (referenced in Sec. Sec. 239.15A and 274.11A) is amended
as follows:
0
a. In General Instruction A revise the definition of ``Exchange-Traded
Fund.''
0
b. In General Instruction A, remove the definition of ``Market Price.''
The additions and revisions read as follows:
Note: The text of Form N-1A does not, and this amendment will not,
appear in the Code of Federal Regulations.
Form N-1A
* * * * *
GENERAL INSTRUCTIONS
* * * * *
A. Definitions
* * * * *
``Exchange-Traded Fund'' means a Fund or Class, the shares of which
are listed and traded on a national securities exchange, and that has
formed and operates under an exemptive order granted by the Commission
or in reliance on rule 6c-11 [17 CFR 270.6c-11] under the Investment
Company Act.
* * * * *
0
6. Amend Item 3 of Form N-1A to read as follows:
BILLING CODE 8011-01-P
[[Page 37407]]
[GRAPHIC] [TIFF OMITTED] TP31JY18.018
[[Page 37408]]
[GRAPHIC] [TIFF OMITTED] TP31JY18.019
[[Page 37409]]
[GRAPHIC] [TIFF OMITTED] TP31JY18.020
BILLING CODE 8011-01-C
* * * * *
0
7. Amend Instruction 1 of Item 3 of Form N-1A as follows:
* * * * *
Instructions
1. General
(a) Round all dollar figures to the nearest dollar and all
percentages to the nearest hundredth of 1%.
(b) Include the narrative explanations in the order indicated. A
Fund may modify the narrative explanations if the explanation contains
comparable information to that shown. The narrative explanation
regarding sales charge discounts is only required by a Fund that offers
such discounts and should specify the minimum level of investment
required to qualify for a discount as disclosed in the table required
by Item 12(a)(1).
(c) Include the caption ``Maximum Account Fees'' only if the Fund
charges these fees. A Fund may omit other captions if the Fund does not
charge the fees or expenses covered by the captions.
(d)
(i) If the Fund is a Feeder Fund, reflect the aggregate expenses of
the Feeder Fund and the Master Fund in a single fee table using the
captions provided. In a footnote to the fee table, state that the table
and Example reflect the expenses of both the Feeder and Master Funds.
(ii) If the prospectus offers more than one Class of a Multiple
Class Fund or more than one Feeder Fund that invests in the same Master
Fund, provide a separate response for each Class or Feeder Fund.
[[Page 37410]]
(e) If the Fund is an Exchange-Traded Fund, exclude any fees
charged for the purchase and redemption of the Fund's creation units.
* * * * *
0
8. Amend Instruction 5 of Item 3 of Form N-1A to read as follows:
* * * * *
5. Exchange-Traded Fund Trading Information and Related Costs.
(a) Include the median bid-ask spread for the Fund's most recent
fiscal year only if the Fund is an Exchange-Traded Fund. However, do
not include the median bid-ask spread for any Exchange-Traded Fund that
had its initial listing on a national securities exchange after the
beginning of the most recently completed fiscal year. For an Exchange-
Traded Fund that had an initial listing after the beginning of the most
recently completed fiscal year, explain that the Exchange-Traded Fund
did not have a sufficient trading history to report trading information
and related costs. Information should be based on the most recently
completed fiscal year end. The Fund also must provide information on
the Fund's website, which is publicly accessible, free of charge, that
investors can use to obtain the bid/ask spread information required in
this Item.
(b) Bid-Ask Spread (Median). Calculate the median bid-ask spread by
dividing the difference between the ask and the bid by the midpoint of
the ask and the bid for each ten-second interval throughout each
trading day of the Exchange-Traded Fund's most recent fiscal year. Once
the bid-ask spread for each ten-second interval throughout the fiscal
year is determined, sort the spreads from lowest to highest. If there
is an odd number of spread intervals, then the median is the middle
number. If there is an even number of spread intervals, then the median
is the average between the two middle numbers. Express the spread as a
percentage, rounded to the nearest hundredth percent.
(c) Determine the mid-range spread cost for each number of
transactions in the table according to the following formula:
(SMid/2) * $10,000 * T
Where:
SMid = Median spread as calculated in Instruction 5(b)
during most recently completed calendar year, expressed as a
percentage;
T = Number of Transactions (1 and 25).
(d) Determine the high-end spread cost for each number of
transactions in the table according to the following formula:
(SHigh/2) * $10,000 * T
Where:
SHigh = High-end spread is calculated by dividing the
difference between the ask and the bid by the midpoint of the ask
and the bid for each ten-second interval throughout each trading day
of the Exchange-Traded Fund's most recently completed fiscal year.
Once the bid-ask spread for each ten-second interval throughout the
fiscal year is determined, sort the spreads from lowest to highest.
The high end spread is the number closest to the 95th percentile,
expressed as a percentage. If two numbers are equally close to the
95th percentile, use the average of the two numbers;
T = Number of Transactions (1 and 25).
(e) Provide an interactive calculator in a clear and prominent
format on the Fund website which uses the calculations in Instructions
5(a)-(d) to Item 3 to provide the information required by Q&As 3, 4 and
5.
* * * * *
0
9. Amend Item 6 of Form N-1A as follows:
* * * * *
Item 6. Purchase and Sale of Fund Shares
(a) Purchase of Fund Shares. Disclose the Fund's minimum initial or
subsequent investment requirements.
(b) Sale of Fund Shares. Also disclose that the Fund's shares are
redeemable and briefly identify the procedures for redeeming shares
(e.g., on any business day by written request, telephone, or wire
transfer).
(c) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund,
the Fund may omit the information required by this Item.
* * * * *
0
10. Amend Items 11(a)(1) and 11(g) of Form N-1A as follows:
* * * * *
Item 11. Shareholder Information
(a) Pricing of Fund Shares. Describe the procedures for pricing the
Fund's shares, including:
(1) An explanation that the price of Fund shares is based on the
Fund's net asset value and the method used to value Fund shares (market
price, fair value, or amortized cost); except that if the Fund is an
Exchange-Traded Fund, an explanation that the price of Fund shares is
based on a market price.
* * * * *
(g) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund,
the Fund may omit from the prospectus the information required by Items
11(a)(2), (b), and (c).
* * * * *
0
11. Remove Item 27(b)(7)(iv) of Form N-1A and instructions thereto.
0
12. Amend Instruction 1(e)(ii) of Item 27(d)(1) of Form N-1A as
follows:
* * * * *
Instructions
* * * * *
1. General.
* * * * *
(e) If the fund is an Exchange-Traded Fund:
* * * * *
(ii) Exclude any fees charged for the purchase and redemption of
the Fund's creation units.
* * * * *
0
13. Amend Form N-8B-2 (referenced in Sec. Sec. 239.16 and 274.12) as
follows:
The additions and revisions read as follows:
Note: The text of Form N-8B-2 does not, and this amendment will
not, appear in the Code of Federal Regulations.
Form N-8B-2
* * * * *
GENERAL INSTRUCTIONS FOR FORM N-8B-2
* * * * *
Definitions
* * * * *
Exchange-Traded Fund (ETF): The term ``Exchange-Traded Fund'' or
``ETF'' means a trust, the shares of which are listed and traded on a
national securities exchange, and that has formed and operates under an
exemptive order granted by the Commission.
* * * * *
Information Concerning Loads, Fees, Charges, and Expenses
13.
* * * * *
(h) If the trust is an Exchange-Traded Fund, furnish an explanation
indicating that an ETF investor may pay additional fees not described
by any other item in this form, such as brokerage commissions and other
fees to financial intermediaries.
(i) If the trust is an Exchange-Traded Fund, furnish the
disclosures and information set forth in Item 3 of Form N-1A
[referenced in 17 CFR 274.11A], in the section of that Item titled
``Exchange-Traded Fund Trading Information and Related Costs.'' Provide
information specific to the trust as necessary, utilizing the ETF-
specific methodology set forth in the Instructions to Form N-1A Item 3.
* * * * *
0
14. Amend Items C.7. and E.2. Form N-CEN (referenced in Sec. 274.101):
[[Page 37411]]
The additions read as follows:
Note: The text of Form N-CEN does not, and this amendment will not,
appear in the Code of Federal Regulations.
FORM N-CEN
ANNUAL REPORT FOR REGISTERED INVESTMENT COMPANIES
* * * * *
Part C. Additional Questions for Management Investment Companies
* * * * *
Item C.7.
* * * * *
k. Rule 6(c)-11 (17 CFR 270.6c-11): ___
* * * * *
Part E. Additional Questions for Exchange-Traded Funds and Exchange-
Traded Managed Funds
* * * * *
Item E.2.
* * * * *
Instruction. The term ``authorized participant'' means a member or
participant of a clearing agency registered with the Commission, which
has a written agreement with the Exchange-Traded Fund or Exchange-
Traded Managed Fund or one of its service providers that allows the
authorized participant to place orders for the purchase and redemption
of creation units.
* * * * *
By the Commission.
Dated: June 28, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-14370 Filed 7-30-18; 8:45 am]
BILLING CODE 8011-01-P
