Exchange-Traded Funds, 57162-57238 [2019-21250]

Download as PDF 57162 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 210, 232, 239, 270, and 274 [Release Nos. 33–10695; IC–33646; File No. S7–15–18] RIN 3235–AJ60 Exchange-Traded Funds Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (the ‘‘Commission’’) is adopting a new rule under the Investment Company Act of 1940 (the ‘‘Investment Company Act’’ or the ‘‘Act’’) that will 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 final rule, the Commission will rescind certain exemptive relief that has been granted to ETFs and their sponsors. The Commission also is adopting 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 and associated 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 adopting related amendments to Form N–CEN. The final rule and form amendments are designed to create a consistent, transparent, and efficient regulatory framework for ETFs that are organized as open-end funds and to facilitate greater competition and innovation among ETFs. The Commission also is adopting technical amendments to Form N–CSR, Form N– 1A, Form N–8B–2, Form N–PORT, and Regulation S–X. DATES: Effective Date: This rule is effective December 23, 2019. Compliance Dates: The applicable compliance dates are discussed in section II.L. of this final rule. FOR FURTHER INFORMATION CONTACT: Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), J. Matthew DeLesDernier (Senior Counsel), Jacob D. Krawitz (Branch Chief), Melissa S. Gainor (Assistant Director), and Brian McLaughlin Johnson (Assistant Director), Investment Company Regulation Office, at (202) 551–6792, Kay-Mario Vobis (Senior Counsel), Daniele Marchesani (Assistant Chief khammond on DSKJM1Z7X2PROD with RULES2 SUMMARY: VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 I. Introduction A. Overview of Exchange-Traded Funds B. Operation of Exchange-Traded Funds II. Discussion A. Scope of Rule 6c–11 1. Organization as Open-End Funds 2. Index-Based ETFs and Actively Managed ETFs 3. Leveraged/Inverse ETFs B. Exemptive Relief Under 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 Rule 6c–11 1. Issuance and Redemption of Shares 2. Listing on a National Securities Exchange 3. Intraday Indicative Value (‘‘IIV’’) 4. Portfolio Holdings Disclosure 5. Baskets 6. Website Disclosure 7. Marketing 8. ETF and ETP Nomenclature D. Recordkeeping E. Share Class ETFs F. Master-Feeder ETFs G. Effect of Rule 6c–11 on Prior Orders H. Amendments to Form N–1A 1. Fee Disclosures for Mutual Funds and ETFs (Item 3) 2. Disclosures Regarding ETF Trading and Associated Costs (Item 6) 3. Eliminated Disclosures I. Amendments to Form N–8B–2 J. Amendments to Form N–CEN K. Technical and Conforming Amendments to Form N–1A, Form N–8B–2, Form N– CSR, Form N–PORT, and Regulation S– X L. Compliance Dates III. Other Matters IV. Economic Analysis A. Introduction B. Economic Baseline 1. ETF Industry Growth and Trends 2. Exemptive Order Process and Certain Conditions Under Existing Orders 3. Market Participants 4. Secondary Market Trading, Arbitrage, and ETF Liquidity C. Benefits and Costs of Rule 6c–11 and Form Amendments 1. Rule 6c–11 2. Amendments to Forms N–1A, N–8B–2, and N–CEN D. Effects on Efficiency, Competition, and Capital Formation 1. Efficiency 2. Competition 3. Capital Formation E. Reasonable Alternatives 1. Website Disclosure of Basket Information 2. Disclosure of ETF Premiums or Discounts Greater than 2% 3. Website and Prospectus Disclosure of the Median Bid-Ask Spread Calculated Over the Most Recent 1-Year Period 4. Additional Disclosures Showing the Impact of Bid-Ask Spreads 5. Website Disclosure of a Modified IIV 6. The Use of a Structured Format for Additional Website Disclosures and the Filing of Additional Website Disclosures in a Structured Format on EDGAR 7. Pro Rata Baskets 8. Treatment of Existing Exemptive Relief 9. ETFs Organized as UITs 10. Treatment of Leveraged/Inverse ETFs V. Paperwork Reduction Act A. Introduction B. 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. Forms N–8B–2 and S–6 F. Form N–CEN VI. Final Regulatory Flexibility Analysis A. Need for and Objectives of the Rule and Form Amendments B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Rule D. Projected Reporting, Recordkeeping, and Other Compliance Requirements 1. Rule 6c–11 2. Other Disclosure and Reporting Requirements E. Agency Action To Minimize Effect on Small Entities VII. Statutory Authority 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]. I. Introduction The Commission is adopting rule 6c– 11 under the Investment Company Act to permit ETFs that satisfy certain conditions to operate without the Counsel), Chief Counsel’s Office, at (202) 551–6825, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: The Commission is adopting 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 The Commission also is adopting technical amendments to Form N–CSR [referenced in § 274.128], Form N–1A, Form N–8B–2, and Form N–PORT [referenced in § 274.150] under the Investment Company Act, and 17 CFR 210.12–01 through 210.12–29 (Article 12 of Regulation S–X). Table of Contents PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 expense and delay of obtaining an exemptive order from the Commission under the Act. This rule will modernize the regulatory framework for ETFs to reflect our more than two decades of experience with these investment products. The rule is designed to further important Commission objectives, including establishing a consistent, transparent, and efficient regulatory framework for ETFs and facilitating greater competition and innovation among ETFs. The Commission approved the first ETF in 1992. Since then, ETFs registered with the Commission have grown to $3.32 trillion in total net assets.2 They now account for approximately 16% 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 On June 28, 2018, we proposed new rule 6c–11 under the Investment Company Act, which would simplify this regulatory framework by eliminating conditions included within our exemptive orders that we no longer 2 This figure is based on data obtained from Bloomberg. As of December 2018, there were approximately 2,000 ETFs registered with the Commission. 3 ICI, 2019 Investment Company Fact Book (59th ed., 2019) (‘‘2019 ICI Fact Book’’), available at https://www.ici.org/pdf/2019_factbook.pdf, at 93. 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 reach $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., 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. 6 In addition, since 2000, our ETF exemptive orders have provided relief for future ETFs. See id. 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. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 believe are necessary for our exemptive relief and removing historical distinctions between actively managed and index-based ETFs.7 We also proposed to rescind certain exemptive orders that have been granted to ETFs and their sponsors in order to level the playing field for ETFs that are organized as open-end funds and pursue the same or similar investment strategies.8 In addition, the Commission proposed certain disclosure amendments to Form N–1A and Form N–8B–2 to provide investors additional information regarding ETF trading and associated costs, regardless of whether ETFs are organized as open-end funds or UITs. Finally, the Commission proposed related amendments to Form N–CEN. We received more than 85 comment letters on the proposal.9 As discussed in greater detail below, commenters were supportive of the adoption of an ETF rule and generally supported rule 6c–11 as proposed. Commenters did, however, recommend modifications or clarifications to certain aspects of the rule. For example, several commenters suggested expanding the scope of ETFs covered by the rule or the scope of certain exemptions.10 Many commenters recommended modifications to the proposed rule’s 7 See Exchange-Traded Funds, Investment Company Act Release No. 33140 (June 28, 2018) [83 FR 37332 (July 31, 2018)] (‘‘2018 ETF Proposing Release’’). 8 Proposed rule 6c–11 did 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; 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’’). Under the proposal, these ETFs would continue to operate pursuant to the terms of their exemptive orders. Since that time, we have granted an exemptive order permitting certain ETFs that are actively managed to operate without being subject to the daily portfolio transparency condition included in other actively managed ETF orders (‘‘non-transparent ETFs’’). See Precidian ETFs Trust, et al., Investment Company Act Release Nos. 33440 (Apr. 8, 2019) [84 FR 14690 (Apr. 11, 2019)] (notice) and 33477 (May 20, 2019) (order) and related application (‘‘2019 Precidian’’). Because these non-transparent ETFs do not provide daily portfolio transparency, they would not meet the conditions of rule 6c–11. We use the term ‘‘actively managed ETFs’’ in this release to refer to actively managed ETFs that provide daily portfolio transparency and ‘‘non-transparent ETFs’’ to refer to actively managed ETFs that do not. 9 The comment letters on the 2018 ETF Proposing Release (File No. S7–15–18) are available at https:// www.sec.gov/comments/s7-15-18/s71518.htm. 10 See, e.g., Comment Letter of BNY Mellon (Sept. 27, 2018) (‘‘BNY Mellon Comment Letter’’) (suggesting the rule should cover all ETFs registered under the Investment Company Act); Comment Letter of Dechert LLP (Sept. 28, 2018) (‘‘Dechert Comment Letter’’) (suggesting that the Commission should provide ETFs with uniform exemptive relief from certain provisions of the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’)). PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 57163 conditions, particularly relating to the timing and presentation of portfolio holdings information, the requirements related to custom baskets, the publication of basket information, and the availability of an intraday indicative value.11 In addition, although commenters were largely supportive of our efforts to improve the information that ETFs disclose to investors about the trading costs of investing in ETFs, several commenters objected to the bidask spread disclosure requirements and the related interactive calculator.12 Others recommended alternatives to the proposed format and placement of the trading cost disclosures.13 Finally, commenters were largely supportive of our proposal to rescind certain exemptive orders that have been granted to ETFs and their sponsors and to replace such relief with rule 6c–11.14 After consideration of the comments we received, we are adopting rule 6c– 11 and the proposed form amendments with several modifications that are designed to reduce the operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful information regarding ETFs. As proposed, we also are rescinding the exemptive relief that we have issued to ETFs that fall within the scope of rule 6c–11, while retaining the exemptive relief granted to ETFs outside the scope of the rule. In addition, we are retaining the exemptive relief allowing ETFs to enter into fund of funds arrangements. We believe that the resulting regulatory framework will level the playing field 11 See, e.g., Comment Letter of the Asset Management Group of the Securities Industry and Financial Markets Association (Sept. 28, 2018) (‘‘SIFMA AMG Comment Letter I’’) (relating to the timing and presentation of portfolio holdings and basket information); Comment Letter of the Investment Company Institute (Sept. 21, 2018) (‘‘ICI Comment Letter’’) (relating to custom baskets); Comment Letter of Professor James G. Angel, Georgetown University (Oct. 1, 2018) (‘‘Angel Comment Letter’’) (relating to intraday indicative values). 12 See, e.g., Comment Letter of Independent Directors Council (Sept. 27, 2018) (‘‘IDC Comment Letter’’); Comment Letter of State Street Global Advisors (Oct. 1, 2018) (‘‘SSGA Comment Letter I’’). 13 See e.g., Comment Letter of The Vanguard Group, Inc. (Sept. 28, 2018) (‘‘Vanguard Comment Letter’’); Comment Letter of BlackRock, Inc. (Sept. 26, 2018) (‘‘BlackRock Comment Letter’’); IDC Comment Letter; Comment Letter of Fidelity Investments (Sept. 28, 2018) (‘‘Fidelity Comment Letter’’). 14 See, e.g., Comment Letter of Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Oct. 11, 2018) (‘‘ABA Comment Letter’’); ICI Comment Letter; Comment Letter of Invesco Ltd. (Sept. 26, 2018) (‘‘Invesco Comment Letter’’). Exemptive orders granted to ETFs and their sponsors often include relief allowing funds to invest in other funds in excess of statutory limits. We did not propose to rescind that relief. See infra section II.G. E:\FR\FM\24OCR2.SGM 24OCR2 57164 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations for ETFs that are organized as open-end funds and pursue the same or similar investment strategies.15 The rule also will assist the Commission with regulating ETFs, as funds covered by the rule will no longer be subject to the varying provisions of exemptive orders granted over time. Furthermore, rule 6c– 11 will allow Commission staff, as well as funds and advisers seeking exemptions, to focus exemptive relief on products that do not fall within the rule’s scope. The Commission will continue to monitor this large, diverse and important market. We welcome continued engagement with ETF sponsors, investors and other market participants on matters related to the ETF market, including with regard to ETFs that do not fall within the scope of rule 6c–11 and ETFs that may not function in a manner consistent with the expectations embodied in our regulatory framework. khammond on DSKJM1Z7X2PROD with RULES2 A. Overview of Exchange-Traded Funds ETFs are a type of exchange-traded product (‘‘ETP’’).16 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.17 Because ETFs have characteristics that distinguish them from the types of investment companies contemplated by the Act, 15 Additionally, as discussed below in section II.B, the Commission is issuing an order granting an exemption from certain provisions of the Exchange Act and the rules thereunder for certain transactions in securities of ETFs that can rely on rule 6c–11. See Order Granting a Conditional Exemption from Exchange Act Section 11(d)(1) and Exchange Act Rules 10b–10; 15c1–5; 15c1–6; and 14e–5 for Certain Exchange Traded Funds, Release No. 34–87110 (September 25, 2019) (‘‘ETF Exchange Act Order’’). 16 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. 17 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 rule 23c–3 under the Act. Other closedend funds may repurchase their shares in tender offers pursuant to rule 13e–4 under the Exchange Act. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 they require exemptions from certain provisions of the Investment Company Act in order to operate. The Commission 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).18 The Commission also has approved the listing standards of national securities exchanges under which ETF shares are listed and traded.19 As discussed above, ETFs have become an increasingly popular investment vehicle over the last 27 years, providing investors with a diverse set of investment options.20 They also have become a popular trading tool, making up a significant portion of secondary market equities trading. During the first quarter of 2019, for example, trading in U.S.-listed ETFs made up approximately 18.3% of U.S. equity trading by share volume and 27.2% of U.S. equity trading by dollar volume.21 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 18 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’’). 19 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); and 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)). See 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.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). 20 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. 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 predetermined period of time. 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. Investors also have the ability to invest in ETFs that do not track a particular index and are actively managed. See 2018 ETF Proposing Release, supra footnote 7, at nn.18–20. 21 These estimates are based on trade and quote data from the New York Stock Exchange and Trade Reporting Facility data from FINRA. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 strategy.22 Because certain costs are either absent in the ETF structure or are otherwise partially externalized, many ETFs have lower operating expenses than mutual funds.23 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. 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.’’ 24 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.25 Market makers, proprietary 22 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-etfinvestor1470673638; Greenwich Associates, Institutions Find New, Increasingly Strategic Uses for ETFs (May 2012). ETF investors also can sell ETF shares short, write options on them, and set market, limit, and stop-loss orders on them. 23 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. 24 As discussed below, rule 6c–11(a)(1) defines ‘‘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. 25 See David J. Abner, The ETF Handbook: How to Value and Trade Exchange Traded Funds, 2nd ed. (2016) (‘‘ETF Handbook’’). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 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 gain exposure to a strategy or asset class.26 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.27 The basket is generally representative of the ETF’s portfolio,28 and together with a cash balancing amount, it is equal in value to the aggregate net asset value (‘‘NAV’’) of the ETF shares in the creation unit.29 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.30 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 khammond on DSKJM1Z7X2PROD with RULES2 26 Id. 27 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’’). 28 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.4.c. 29 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). 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’’). 30 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’’). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 market trading in ETF shares and underlying securities 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.31 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 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.32 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 31 The arbitrage mechanism for ETFs that would be subject to rule 6c–11 has been dependent on daily portfolio transparency. 32 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 basket assets, the authorized participant can then use the basket assets to cover its short positions. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 57165 may bring the prices of the ETF’s shares and its portfolio assets closer together through market pressure.33 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.34 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 or some types of ETFs more favorably than similar closed-end funds.35 On the other hand, if the expectation of a close tie to NAV per share is not met, investors may sell or refrain from purchasing ETF shares.36 II. Discussion Given the growth in the ETF market, ETFs’ popularity among retail and institutional investors, and our long experience regulating this investment vehicle, we believe that it is appropriate to adopt a rule that will allow most ETFs to operate without first obtaining 33 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 I’’), 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.’’); 2019 ICI Factbook, supra footnote 3 (‘‘On average, 90 percent of the total daily activity in ETFs occurs on the secondary market.’’). 34 See 15 U.S.C. 80a–6(c). 35 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, 2018, total net assets of ETFs were $3.4 trillion compared to $250 billion for closedend funds. See 2019 ICI Fact Book, supra footnote 3. 36 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. E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 57166 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations an exemptive order from the Commission under the Act. We believe, and commenters on proposed rule 6c– 11 generally agreed, that such a rule will help create a consistent, transparent, and efficient regulatory framework for the regulation of most ETFs and help level the playing field for these market participants.37 As adopted, rule 6c–11 will exempt ETFs organized as open-end funds from certain provisions of the Act and our rules. The exemptions will permit an ETF to: (i) Redeem shares only in creation unit aggregations; (ii) permit ETF shares to be purchased and sold at market prices, rather than NAV; (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. These exemptions are subject to 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 conditions are based upon existing exemptive relief for ETFs, which we believe has served to support an efficient arbitrage mechanism, but reflect several modifications based on our experience regulating this product and commenters’ input on the proposed rule. • First, rule 6c–11 will require an ETF to disclose portfolio holdings each business day on its website before the opening of trading on the ETF’s primary listing exchange in a standardized manner. The rule also will require daily website disclosure of the ETF’s NAV, market price, premium or discount, and the extent and frequency of an ETF’s premiums and discounts. These disclosures are designed to promote an effective arbitrage mechanism and inform investors about the risks of deviation between market price and NAV when deciding whether to invest in ETFs generally or in a particular ETF. • In addition, the rule will require daily website disclosure of the ETF’s median bid-ask spread over the last thirty calendar days. This requirement is designed to provide investors with additional information regarding 37 See, e.g., BlackRock Comment Letter; IDC Comment Letter; Fidelity Comment Letter; Angel Comment Letter; Comment Letter of Nasdaq, Inc. (Sept. 28, 2018) (‘‘Nasdaq Comment Letter’’). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 potential costs associated with buying and selling ETF shares. • With respect to baskets, the rule will require an ETF 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. The rule will allow ETFs to use ‘‘custom baskets’’ if their basket policies and procedures: (i) Set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interest 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. As discussed below, these conditions will provide ETFs with additional basket flexibility, which we believe could benefit investors through more efficient arbitrage and narrower bid-ask spreads, subject to protections designed to address the risks that such flexibility may present. • Rule 6c–11 also will include a condition that excludes an ETF that seeks, directly or indirectly, to provide investment returns over a predetermined period of time that: (i) Correspond to the performance of a market index by a specified multiple; or (ii) have an inverse relationship to the performance of a market index (including by an inverse multiple) (‘‘leveraged/inverse ETFs’’).38 • An ETF also must retain certain records under rule 6c–11, including information regarding each basket exchanged with an authorized participant. In order to harmonize the regulation of most ETFs, we are rescinding, one year after the effective date of rule 6c– 11, those portions of our prior ETF exemptive orders that grant relief related to the formation and operation of an ETF, including certain master-feeder relief.39 We are not rescinding the exemptive relief of UIT ETFs, leveraged/ inverse ETFs, share class ETFs, and non-transparent ETFs, however, which are outside the scope of rule 6c–11. In addition, we are not rescinding the portions of our prior ETF exemptive orders allowing funds to invest in ETFs in excess of statutory limits in connection with this rulemaking and we 38 See infra section II.A.3. infra sections II.F. and II.G. We are also amending approximately 200 ETF exemptive orders that automatically expire on the effective date of a rule permitting the operation of ETFs to give them time to make any adjustments necessary to rely on rule 6c–11. 39 See PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 are providing relief to allow newly formed ETFs to enter into certain fund of funds arrangements.40 Finally, we are adopting amendments to Forms N–1A and N–8B–2 to eliminate certain disclosures that we believe are no longer necessary and to require ETFs that do not rely on rule 6c– 11 to provide secondary market investors with disclosures regarding certain ETF trading and associated costs. For example, the form amendments will require such an ETF to provide median bid-ask spread information either on its website or in its prospectus. We believe these amendments will provide investors who purchase ETF shares in secondary market transactions with information to better understand the total costs of investing in an ETF. A. Scope of Rule 6c–11 1. Organization as Open-End Funds As proposed, rule 6c–11 will 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.41 ETFs organized as UITs (‘‘UIT ETFs’’) will continue operating pursuant to their exemptive orders, which include terms and conditions more appropriately tailored to address the unique features of a UIT.42 Additionally, as proposed, 40 See infra section II.G. In December 2018, we proposed new 17 CFR 270.12d1–4 (rule 12d1–4 under the Act) to streamline and enhance the regulatory framework applicable to fund of funds arrangements. See Fund of Funds Arrangements, Investment Company Act Release No. 33329 (Dec. 19, 2018) [84 FR 1286 (Feb. 1, 2019)] (proposing release) (‘‘FOF Proposing Release’’). In connection with proposed rule 12d1–4, we also proposed to rescind the exemptive orders granting relief for certain fund of funds arrangements, including the relief from sections 12(d)(1)(A) and (B) that has been included in our ETF exemptive orders. See id. at nn.236–237 and accompanying text. 41 See rule 6c–11(a)(1). Under the rule, the term ‘‘basket’’ will 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 will include ETFs that transact on an in-kind basis, on a cash basis, or both. 42 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. See section 4(2) of the Act [15 U.S.C. 80a–4]. By statute, a UIT is unmanaged and its portfolio is fixed. Substitution of securities may take place only under certain pre-defined circumstances. A UIT does not have a board of directors, corporate officers, or an investment adviser to render advice during the life of the trust. See 2018 ETF Proposing Release, supra footnote 7, at section II.A.1. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 our form amendments will require UIT ETFs to provide disclosures similar to those provided by other ETFs that are subject to the Investment Company Act. We understand that most ETF sponsors prefer the open-end fund structure over the UIT structure given the increased investment flexibility the open-end structure affords.43 For example, ETFs organized as open-end funds can be actively managed or use a ‘‘sampling’’ strategy to track an index.44 An open-end ETF also may participate in securities lending programs, has greater flexibility to reinvest dividends, and may invest in derivatives, which typically require a degree of management that is not provided for in the UIT structure.45 Commenters addressing this aspect of the proposal generally supported excluding UIT ETFs from the scope of rule 6c–11. These commenters stated that the structural and operational nuances associated with UIT ETFs would make their inclusion in rule 6c– 11 impractical.46 These commenters also generally agreed that existing UIT ETFs should continue to rely on their individual exemptive orders, and that the Commission should review new UIT ETFs as part of the exemptive order process. One commenter suggested, however, that the Commission consider potential updates to UIT ETFs’ exemptive orders to account for certain sponsor services that were not 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. 43 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. See 2018 ETF Proposing Release, supra footnote 7, at section II.A.1. 44 UIT ETFs seek to track the performance of an index by investing in the component securities of an index in the same approximate proportions as in the index (i.e., ‘‘replicating’’ the index) rather than acquiring a subset of the underlying index’s component securities or other financial instruments that the ETF’s adviser believes will help the ETF track the underlying index (i.e., ‘‘sampling’’ the index). In addition, because the exemptive relief granted to UIT ETFs does not provide relief from the portion of section 4(2) that requires UIT securities to represent an undivided interest in a unit of ‘‘specified securities,’’ the investment strategies that a UIT ETF can pursue are limited. See id. at n.37. 45 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. 46 See, e.g., Invesco Comment Letter; SSGA Comment Letter I; Comment Letter of CFA Institute (Nov. 15, 2018) (‘‘CFA Institute Comment Letter’’); Comment Letter of Cboe Global Markets, Inc. (Oct. 1, 2018) (‘‘Cboe Comment Letter’’) (stating that the ‘‘unique issue set applicable to UITs as compared to non-UIT ETFs warrant the disparate treatment between UITs and other ETFs.’’). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 contemplated at the time the orders were granted.47 After considering comments, we continue to believe that rule 6c–11 should apply only to ETFs organized as open-end funds, while UIT ETFs should continue to rely on their existing exemptive orders.48 We acknowledge that excluding UIT ETFs will result in a segment of ETF assets outside the regulatory framework of rule 6c–11. However, we do not believe there is a need to include UIT ETFs within the scope of the 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, the unique structural and operational aspects of UIT ETFs noted by commenters would necessitate a regulatory framework that differs from the structure we are adopting for openend ETFs. We believe that the unmanaged nature of the UIT structure, in particular, would require conditions that differ from the conditions applicable to open-end ETFs. For example, rule 6c–11 will 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 such conditions require ongoing management and board oversight, we do not believe that extending such basket flexibility to UIT ETFs would be appropriate.50 The relief granted to UIT ETFs also includes relief from sections of the Act that govern key aspects of a UIT’s operations, which differ from the relief we are providing under rule 6c–11.51 In short, we believe including UIT ETFs within the scope of rule 6c–11 would complicate the rule significantly and would continue to result in a regulatory framework where 47 Invesco Comment Letter (stating that these services include chief compliance officer services and ongoing trading services). UIT ETFs have obtained exemptive relief from section 26(a)(2)(C) of the Act to allow the ETF to pay certain enumerated expenses. See 2018 ETF Proposing Release, supra footnote 7, at n.52 and accompanying text. 48 The vast majority of ETFs currently in operation are organized as open-end funds, though the earliest ETFs were organized as UIT ETFs, and these early UIT ETFs represent a significant portion of the assets within the ETF industry. As of Dec. 31, 2018, 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). 49 See infra section II.C.4.c. 50 See 2018 ETF Proposing Release, supra footnote 7, at nn.46–48 and accompanying text. 51 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’’). PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 57167 the relief and conditions applicable to UIT ETFs and open-end ETFs differ. To the extent that ETF sponsors develop 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 also believe that the Commission’s exemptive process is well-suited to handle requests to modify existing UIT ETF exemptive relief. Consistent with the proposal, we are not rescinding existing exemptive orders that allow UIT ETFs to operate. Two commenters addressing the exclusion of UIT ETFs from the rule urged the Commission to clarify that UIT ETFs operating pursuant to their exemptive orders can nevertheless continue marketing themselves as ‘‘ETFs.’’ 52 As discussed below, the Commission is not limiting use of the term ‘‘ETF’’ or ‘‘exchange-traded fund’’ to funds relying on rule 6c–11. UIT ETFs therefore may continue to use these terms in their marketing materials and otherwise hold themselves out as ‘‘ETFs.’’ Further, while UIT ETFs are excluded from the scope of rule 6c–11, we are adopting amendments to Form N–8B–2 that will require them to provide certain additional disclosures regarding ETF trading costs.53 2. Index-Based ETFs and Actively Managed ETFs Consistent with the proposal, rule 6c– 11 will provide exemptions for both index-based ETFs and actively managed ETFs, but will 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. Index-based and actively managed ETFs that comply with the rule’s conditions function similarly with respect to operational matters, despite different investment objectives or strategies. For example, both indexbased 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. 52 See SSGA Comment Letter I; SIFMA AMG Comment Letter I. 53 See Form N–8B–2 disclosure requirements infra section II.I. E:\FR\FM\24OCR2.SGM 24OCR2 57168 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 The Commission did not approve the first actively managed ETF until nearly 15 years after index-based ETFs were introduced.54 Since 2008, however, the actively managed ETF market has grown considerably.55 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. Commenters that addressed this aspect of the proposal supported the rule’s elimination of the historical distinction between index-based and actively managed ETFs.56 Specifically, commenters agreed that ETFs operate similarly irrespective of whether they are index-based or actively managed, and stated that there are no operational issues that warrant additional conditions for actively managed ETFs.57 In addition, one commenter stated that, in its experience, deviations between market price and NAV per share are more variable across asset classes 54 See 2018 ETF Proposing Release, supra footnote 7, at n.58. Approximately 100 exemptive orders have been issued since 2008 for actively managed, transparent ETFs. 55 Based on data obtained from MIDAS, Bloomberg and Morningstar Direct as of December 31, 2018, we estimate that there are now over 270 actively managed ETFs with approximately $72 billion in assets. 56 See, e.g., ICI Comment Letter; Invesco Comment Letter; Comment Letter of the Index Industry Association (Sept. 30, 2018); Comment Letter of the Fixed Income Market Structure Advisory Committee (Oct. 29, 2018) (‘‘FIMSAC Comment Letter’’); Comment Letter of NYSE Arca, Inc. (Oct. 10, 2018) (‘‘NYSE Arca Comment Letter’’); CFA Institute Comment Letter; Comment Letter of J.P. Morgan Asset Management (Oct. 1, 2018) (‘‘JPMAM Comment Letter’’). 57 See, e.g., NYSE Arca Comment Letter; Comment Letter of WisdomTree Asset Management, Inc. (Oct. 1, 2018) (‘‘WisdomTree Comment Letter’’). As discussed in section II.C.4. infra, however, some commenters opposed, or suggested alternatives to, full portfolio transparency for actively managed ETFs. We also received 43 comment letters requesting that the Commission approve an ETP with an investment objective that seeks results that correspond to the performance of bitcoins or other digital assets. See, e.g., Comment Letter of Charles Brown (July 12, 2018); Comment Letter of Lars Hoffman (July 14, 2018). Rule 6c–11, however, is based on existing relief for ETFs relating to the formation and operation of ETFs under the Investment Company Act and does not relate to specific strategies. See Letter from Dalia Blass, Director of Investment Management, to Paul Schott Stevens, President and CEO, Investment Company Institute and Timothy W. Cameron, Asset Management Group—Head, Securities Industry and Financial Markets Association (Jan. 18, 2018), available at https://www.sec.gov/divisions/ investment/noaction/2018/cryptocurrency011818.htm (noting that in the staff’s view ETFs and other funds that hold substantial amounts of cryptocurrencies and related products raise significant questions regarding how they would satisfy certain other requirements of the Investment Company Act and its rules). The Commission continues to welcome engagement with the public on issues related to cryptocurrency ETPs. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 underlying ETFs than between indexbased and actively managed ETFs investing in the same asset class.58 We continue to believe that indexbased and actively managed ETFs do not present significantly different concerns under the provisions of the Act from which the rule grants relief because they function similarly with respect to operational matters. As noted below, the arbitrage mechanism for existing actively managed ETFs has worked effectively with small deviations between market price and NAV per share.59 Permitting indexbased and actively managed open-end ETFs to operate under the rule subject to the same conditions also will 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 proliferation of highly customized, often methodologically complicated indexes. Commenters agreed that the proliferation of these indexes has blurred the distinction between index-based and actively managed ETFs, while ETF industry practices in areas such as portfolio transparency generally do not vary between these types of funds.60 We therefore believe that eliminating the regulatory distinction between indexbased ETFs and actively managed ETFs for purposes of exemptive relief under the Act will help to provide a more consistent and transparent regulatory framework for ETFs organized as openend funds. This approach is consistent with our regulation of other types of open-end funds, which does not distinguish between actively managed and index-based strategies. In addition, consistent with our proposal, rule 6c–11 does not include additional conditions relating to indexbased ETFs with affiliated index providers (‘‘self-indexed ETFs’’). Commenters generally agreed with the proposal’s approach to self-indexed ETFs, indicating that existing securities laws adequately address any special 58 See JPMAM Comment Letter (‘‘[O]ur active ETFs trade with similar, and at times lower, deviations than our index ETFs; all of them typically trade within 50 basis points of their NAVs.’’). 59 See supra section II.B.2. 60 See FIMSAC Comment Letter (‘‘[I]ndustry participants note that distinctions between active and passive products . . . are increasingly blurred with the advent of ‘smart beta’ or factor products, or of index products with active elements . . . .); JPMAM Comment Letter (‘‘[A]s the proposal notes, practices around portfolio transparency have converged across index-based and actively managed ETFs.’’). PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 concerns presented by these ETFs.61 One commenter, however, noted that the concerns that were expressed by the Commission when it granted individualized exemptive relief for selfindexed ETFs remain important.62 This commenter stated that the Commission should permit self-indexed ETFs only ‘‘on the condition that [an information] firewall between the index provider and the asset manager exists.’’ 63 We agree with the commenters who stated that the existing federal securities laws adequately address any special concerns that self-indexed ETFs present, including the potential ability of an affiliated index provider to manipulate an underlying index to the benefit or detriment of a self-indexed ETF.64 For 61 See Invesco Comment Letter; BlackRock Comment Letter; IIA Comment Letter; JPMAM Comment Letter; SSGA Comment Letter (‘‘[C]urrent regulatory requirements . . . effectively require a heightened set of requirements associated with affiliated index providers . . .’’); WisdomTree Comment Letter (‘‘Advisers are already required to adopt policies designed to prevent portfolio information from being misappropriated.’’). 62 See Morningstar Comment Letter. See also 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 (‘‘Guggenheim Funds’’) (discussing concerns regarding the ability of an affiliated index provider to manipulate an underlying index to the benefit or detriment of a self-indexed ETF and the potential for conflicts that may arise with respect to the personal trading activity of an affiliated index provider’s personnel). Guggenheim Funds permitted a self-indexed ETF to address these concerns through full portfolio transparency, instead of certain policies and procedures that had been required in earlier exemptive orders for self-indexed ETFs. But 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. 63 See Morningstar Comment Letter. 64 See 17 CFR 270.38a–1 (rule 38a–1 under the Act) (requiring funds to adopt policies and procedures reasonably designed to prevent violation of federal securities laws); 17 CFR 270.17j–1(c)(1) (rule 17j–1(c)(1) under the Investment Company Act) (requiring funds to adopt a code of ethics containing provisions designed to prevent certain fund personnel (‘‘access persons’’) from misusing information regarding fund transactions); section 204A of the Investment Advisers Act of 1940 (‘‘Advisers Act’’) (15 U.S.C. 80b–204A) (requiring an adviser to adopt policies and procedures that are reasonably designed, taking into account the nature of its business, to prevent the misuse of material, non-public information by the adviser or any associated person, in violation of the Advisers Act or the Exchange Act, or the rules or regulations thereunder); section 15(g) of the Exchange Act (15 U.S.C. 78o(f)) (requiring a registered broker or dealer to adopt policies and procedures reasonably designed, taking into account the nature of the broker’s or dealer’s business, to prevent the misuse of material, nonpublic information by the broker or dealer or any person associated with the broker or dealer, in violation of the Exchange Act or the rules or regulations thereunder). Cf., e.g., Rule Commentary .02(b)(i) of NYSE American Rule 1000A (requiring a ‘‘fire wall’’ between an ETF and an affiliated index provider). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations example, ETF sponsors are likely to be in a position to understand the potential circumstances and relationships that could give rise to the misuse of nonpublic information, and can develop appropriate measures to address them. Therefore, we continue to believe that portfolio transparency combined with existing requirements should be sufficient to protect against the abuses addressed in exemptive applications of ETF sponsors that either use affiliated index providers or create their own indexes.65 khammond on DSKJM1Z7X2PROD with RULES2 3. Leveraged/Inverse ETFs As proposed, rule 6c–11 includes a condition that excludes leveraged/ inverse ETFs.66 These ETFs may not rely on the rule, and will instead continue to operate pursuant to their exemptive orders.67 Broadly speaking, leveraged/inverse ETFs seek to amplify the returns of an underlying index by a specified multiple or to profit from a decline in the value of an underlying index over a predetermined period of time using financial derivatives. Leveraged/inverse ETFs also rebalance their portfolios on a daily or other periodic basis in order to maintain a constant leverage ratio.68 These funds’ use of leverage together with this periodic rebalancing (or ‘‘reset’’), and the resulting effects of compounding, can result in performance that differs significantly from some investors’ expectations of how index investing generally works. For example, as a result of compounding, a leveraged/inverse ETF 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.69 Investors holding 65 See infra section II.C.4. (discussing requirements in rule 6c–11 regarding portfolio transparency). 66 See rule 6c–11(c)(4). 67 As of December 2018, 167 ETFs employed leveraged or inverse investment strategies. These ETFs had total net assets of $29.64 billion or approximately 1% of all ETF assets. 68 See 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 II’’) (providing a description of maintaining a stated ratio to an underlying index as a daily investment objective). 69 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 shares over periods longer than the time period targeted by the ETF’s investment objective may experience performance that is different, and at times substantially different, from the returns of the targeted index over the same investment period. Buy-and-hold investors with an intermediate or longterm time horizon that invest in a leveraged/inverse ETF—who may not evaluate their portfolios frequently— may experience large and unexpected losses or otherwise experience returns that are different from what they anticipated.70 As a result, leveraged/ inverse ETFs are complex products that serve a markedly different investment purpose than most other ETFs.71 Leveraged/inverse ETFs’ use of derivatives also raises issues under section 18 of the Act, which limits a fund’s ability to obtain leverage.72 The Commission has been evaluating these section 18 issues as part of a broader consideration of derivatives use by registered funds and business development companies (‘‘BDCs’’).73 We therefore proposed to exclude 09–31 (June 2009), available at https:// www.finra.org/sites/default/files/NoticeDocument/ p118952.pdf (‘‘FINRA Regulatory Notice 09–31’’). 70 See FINRA Regulatory Notice 09–31, supra footnote 69 (reminding member firms of their sales practice obligations relating to leveraged/inverse ETFs and noting that leveraged/inverse ETFs are typically not suitable for retail investors who plan to hold these products for more than one trading session). 71 See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)] at n.39 and accompanying text (‘‘[I]nverse or leveraged exchange-traded products that are designed primarily as short-term trading tools for sophisticated investors may not be in the best interest of a retail client absent an identified, shortterm, client-specific trading objective and, to the extent that such products are in the best interest of a retail client initially, they would require daily monitoring by the adviser’’). See also Regulation Best Interest, Exchange Act Release No. 86031 (June 5, 2019) [84 FR 33318 (July 12, 2019)] at text accompanying n.596 (stating that broker-dealers recommending leveraged or inverse exchangetraded products with a daily reset should understand that such products may not be suitable for, and as a consequence also not in the best interest of, retail customers who plan to hold them for longer than one trading session, particularly in volatile markets); Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 2, to Amend Nasdaq Rules 5705 and 5710 to Adopt a Disclosure Requirement for Certain Securities, Exchange Act Release No. 85362 (Mar. 19, 2019) [84 FR 11148 (Mar. 25, 2019)] (adopting certain disclosure requirements for leveraged/ inverse ETFs). 72 15 U.S.C. 80a–18. 73 See Derivatives Proposing Release, supra footnote 45 (proposing new rule 18f–4 under the Act, which 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’ (including leveraged/inverse ETFs’) use of derivatives transactions). PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 57169 leveraged/inverse ETFs from the scope of rule 6c–11 so that the Commission could consider these concerns in a comprehensive manner with other funds that use leverage.74 We also proposed to allow leveraged/inverse ETFs and their sponsors to continue to rely on their existing exemptive relief in order to preserve the status quo.75 Most commenters who addressed this aspect of the proposal agreed that leveraged/inverse ETFs present issues and concerns that should be addressed outside the context of rule 6c–11.76 One such commenter stated that leveraged/ inverse ETFs present ‘‘highly specific and accentuated risks’’ and stated that the Commission should regulate these products under tailored exemptive orders.77 Other commenters urged the Commission to consider additional investor protection requirements for leveraged/inverse ETFs, such as requiring marketing materials to notify retail investors about the risks of investing in these instruments or other enhanced disclosure requirements.78 Some commenters stated that the Commission should not permit 74 Proposed rule 6c–11 would have provided that an ETF relying on the rule ‘‘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.’’ See proposed rule 6c– 11(c)(4). 75 The staff has not supported new exemptive relief for leveraged/inverse ETFs since 2009. The orders issued to current leveraged/inverse ETF sponsors, as amended over time, relate to leveraged/ inverse ETFs that seek daily 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 (‘‘Rafferty I’’). 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 II, supra footnote 68. 76 See BlackRock Comment Letter; Invesco Comment Letter; SSGA Comment Letter I; Comment Letter of ICE Data Services (Oct. 1, 2018) (‘‘IDS Comment Letter’’); FIMSAC Comment Letter; CFA Institute Comment Letter; see also Cboe Comment Letter (indicating that these ETFs should be ‘‘treated differently’’ but not specifically stating whether such ETFs should be excluded from the scope of the rule). 77 See Invesco Comment Letter. 78 See CFA Institute Comment Letter; Nasdaq Comment Letter (stating that there is significant investor confusion regarding existing leveraged/ inverse ETFs’ daily investment horizon). See also Comment Letter of Rafferty Asset Management, LLC (Oct. 1, 2018) (‘‘Direxion Comment Letter’’) (supporting enhanced disclosure requirements for leveraged/inverse ETFs if reliance on rule 6c–11 is allowed for the operation of leveraged/inverse ETFs). E:\FR\FM\24OCR2.SGM 24OCR2 57170 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 leveraged/inverse ETFs to use the terms ‘‘ETF’’ or ‘‘exchange-traded fund’’ in their names, because investors might mistakenly assume that all products referred to as ETFs are structured and regulated like ‘‘traditional’’ ETFs.79 Other commenters were less specific as to whether the Commission should regulate leveraged/inverse ETFs under exemptive orders or through a separate rule, but stated that leveraged/inverse ETFs should be regulated by means other than rule 6c–11.80 One commenter agreed that leveraged/inverse ETFs ‘‘raise important disclosure and investor protection issues,’’ but strongly encouraged the Commission to ‘‘initiate proceedings, whether as part of its consideration of derivative usage or otherwise, to determine what its future approach’’ to leveraged/inverse ETFs will be.81 Sponsors of leveraged/inverse ETFs, however, advocated that the rule should not exclude leveraged/inverse ETFs. They asserted that leveraged/inverse ETF investors understand the special concerns related to these products, accept the products’ risks, and utilize the products appropriately.82 One of these commenters stated that the rule’s exemptive relief targets ETFs’ structural and operational characteristics, and that leveraged/inverse ETFs are structured and operated in the same manner as other ETFs within the rule’s scope.83 Among other similarities, the commenter noted that leveraged/inverse ETFs are structured as open-end funds, provide full portfolio transparency, and accept creation and redemption baskets using the same operating mechanisms as other ETFs. The commenter also opined that leveraged/inverse ETFs should not be excluded from the scope of the rule because other ETFs that utilize leverage 79 See BlackRock Comment Letter; FIMSAC Comment Letter. 80 See SSGA Comment Letter I (‘‘Leveraged ETFs . . . present issues which are appropriately addressed through means other than the Proposed ETF Rule.’’); IDS Comment Letter (‘‘IDS believes that leveraged and inverse ETFs strategies carry significantly different risk profiles than index-based ETFs. For that reason we agree that they should be excluded from the scope of funds that may rely on the proposed rule.’’). 81 Comment Letter of the Mutual Fund Directors Forum (Oct. 1, 2018) (‘‘MFDF Comment Letter’’). 82 See Direxion Comment Letter (‘‘Given [certain data findings and educational efforts by regulators, brokerage firms, and the ETFs themselves] we believe it would be hard for investors not to understand that our leveraged ETFs are complex products that are ‘different’ from other ETFs, and we have not seen any recent empirical data or other evidence to the contrary.’’); Comment Letter of ProShare Advisors LLC (Oct. 1, 2018) (‘‘ProShares Comment Letter’’). 83 See ProShares Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 in their investment strategies are not excluded from the scope of the rule. Another commenter did not object to excluding leveraged/inverse ETFs from rule 6c–11, but opined that the proposed rule’s condition excluding leveraged/inverse ETFs was overly broad, potentially capturing ETFs that have an inverse relationship to the performance of a market index or ETFs that use other hedging strategies to reduce risk.84 This commenter also asked the Commission to confirm that the exclusion would not, in effect, apply to every ETF that seeks to track an index that includes derivatives. Additionally, several commenters did not specifically address leveraged/inverse ETFs, but generally stated that rule 6c–11 should apply across all ETFs registered under the Investment Company Act to create an even playing field.85 After considering these comments, we have determined to include a condition that prevents leveraged/inverse ETFs from relying on the rule.86 Although leveraged/inverse ETFs are structurally and operationally similar to other types of ETFs within the scope of rule 6c–11, we believe it is premature to permit sponsors to form and operate leveraged/ inverse ETFs in reliance on the rule without first addressing the investor protection purposes and concerns underlying section 18 of the Act. We therefore believe that the Commission should complete its broader consideration of the use of derivatives by registered funds before considering allowing leveraged/inverse ETFs to rely on the rule. Given that rule 6c–11 is intended to help create a consistent regulatory framework for ETFs and a level playing field among ETF sponsors, we acknowledge that excluding leveraged/ inverse ETFs from the rule’s scope and permitting existing leveraged/inverse ETFs to continue to operate pursuant to their exemptive orders at this time delays, in part, achieving those goals. However, because leveraged/inverse ETFs raise policy considerations that are different from those we seek to address in the rule, we believe rule 6c–11 should exclude leveraged/inverse ETFs. As adopted, rule 6c–11 will exclude ETFs that seek to provide leveraged or inverse investment returns over a predetermined period of time. The periodic reset that such strategies necessitate distinguish leveraged/ 84 See Cboe Comment Letter (stating that the exclusion should cover only those inverse ETFs that seek to provide returns that exceed the performance of a market index by a ‘‘specified inverse multiple’’). 85 See, e.g., BNY Mellon Comment Letter. 86 See Rule 6c–11(c)(4). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 inverse ETFs from other types of ETFs that may use leverage. In the proposal we did not specify the period of time over which an ETF had to seek to deliver a leveraged or inverse return of an index to be covered by the proposed rule’s leveraged/inverse ETF exclusion, and we similarly decline to specify a period of time here.87 However, the condition relating to leveraged/inverse ETFs continues to include a temporal element (i.e., ‘‘over a predetermined period of time’’) in order to specifically capture ETFs that seek to deliver the leveraged or inverse return of a market index over a set period of time, daily or otherwise.88 In addition, while the rule uses the term ‘‘multiple,’’ leveraged/inverse ETFs with strategies that seek directionally leveraged or inverse returns of an index present the investor protection concerns discussed above regardless of whether the amplification factor or inverse factor is evenly divisible by 100 (e.g., a fund that seeks to provide a daily investment return equal to 150% of the performance of an index). Thus, to clarify the rule’s use of the term ‘‘multiple,’’ leveraged/inverse ETFs are excluded from the scope of the rule regardless of whether the returns they seek over a predetermined time period are evenly divisible by 100.89 The exclusion also includes strategies that pursue a specified range of a multiple or inverse multiple of an index’s performance (e.g., 200% to 300% of an index’s performance or ¥200% to ¥300% of an index’s performance). This approach is consistent with our existing exemptive orders and will capture those ETFs that have historically been considered ‘‘leveraged/inverse ETFs’’ in the marketplace. 87 See 2018 ETF Proposing Release, supra footnote 7, at section II.A.3. 88 See rule 6c–11(c)(4). The current exemptive orders that allow leveraged/inverse ETFs contemplate a daily reset, because the orders relate to ETFs that pursue daily investment objectives. See 2018 ETF Proposing Release, supra footnote 7 at n.77 and related discussion. Proposed rule 6c–11 used the term ‘‘fixed period of time’’ to prevent both these ETFs and leveraged/inverse ETFs contemplating non-daily resets (e.g., weekly or monthly resets) from relying on the rule. See proposed rule 6c–11(c)(4). Rule 6c–11 as adopted uses the term ‘‘predetermined period of time’’ to clarify that leveraged/inverse ETFs contemplating predetermined but variable resets (e.g., leveraged/ inverse ETFs that contemplate a range of daily-toweekly resets) are similarly prohibited from relying on the rule. 89 Additionally, though a strict mathematical interpretation of the term ‘‘multiple’’ may include a multiple of 100%, an ETF that simply seeks to track the performance of an index is not considered ‘‘leveraged’’ for these purposes and may rely on the rule. But see infra footnotes 90–91 and accompanying text. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations We also continue to believe that it is important to specify that an ETF relying on the rule may not indirectly seek to provide investment returns that correspond to 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 predetermined period of time in order to prevent a fund from circumventing this condition, such as by embedding leverage in the underlying index.90 For example, an ETF could not circumvent the rule’s conditions and rely on the rule to track an index if the index itself tracks 300% or ¥100% of the performance of the S&P 500.91 In response to commenter concerns discussed above, however, this does not mean that the exclusion would apply to every ETF that tracks an index with constituents that are derivatives.92 Whether a particular index is ‘‘leveraged’’ would depend on the economic characteristics of the index’s constituents, and not just on whether some or all of the constituents are derivatives. Finally, we are not adopting enhanced website or other disclosure requirements for leveraged/inverse ETFs at this time as some commenters had recommended. We believe all registered funds that pursue leveraged or inverse strategies raise similar disclosure issues. We therefore believe that the Commission should address any such potential disclosure issues separately for all leveraged/inverse registered funds. khammond on DSKJM1Z7X2PROD with RULES2 B. Exemptive Relief Under Rule 6c–11 Rule 6c–11 will provide ETFs that fall within the scope of the rule exemptive relief from certain provisions of the Act that are necessary to allow ETFs to operate. These exemptions are consistent with the relief we have given to ETFs under our exemptive orders.93 As discussed below in section II.C., the exemptions will be subject to conditions that are designed to address the 90 Rule 6c–11(c)(4) (emphasis added). See also 2018 ETF Proposing Release, supra footnote 7, at text following n.82. 91 The exemptive orders that we have issued to sponsors of leveraged/inverse ETFs do not provide relief to ETFs described as seeking investment returns that correspond to the performance of a leveraged or inverse leveraged market index over a predetermined period of time. See supra footnote 75. 92 See supra footnote 84 and following text. 93 See 2018 ETF Proposing Release, supra footnote 7, at n.88 and related discussion. 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. See infra section II.F. (discussing our treatment of masterfeeder relief) and section II.G. (discussing our treatment of other relief for fund investments in ETFs). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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.94 1. Treatment of ETF Shares as ‘‘Redeemable Securities’’ Consistent with our proposal, ETFs relying on rule 6c–11 will be considered to issue a ‘‘redeemable security’’ within the meaning of section 2(a)(32) of the Act.95 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, they can be redeemed in creation unit aggregations.96 Therefore, we believe that ETF shares are most appropriately classified under the final rule as redeemable securities within the meaning of section 2(a)(32), and that ETFs should be regulated as open-end funds within the meaning of section 5(a)(1) of the Act.97 Unlike our exemptive orders, which have provided exemptions from the definitions of ‘‘redeemable security’’ in section 2(a)(32) and ‘‘open-end company’’ in section 5(a)(1), rule 6c–11 will not provide exemptions from these definitions. Instead, we believe that it is more appropriate for the rule to address these questions of status by classifying ETF shares as ‘‘redeemable securities.’’ Thus, any ETF that relies on the rule’s conditions and requirements will be 94 See 15 U.S.C. 80a–6(c). 95 Rule 6c–11(b)(1). 96 See rule 6c–11(a)(1) (defining an exchangetraded fund, in part, as a registered open-end management company that issues and redeems its shares in creation units). The rule defines ‘‘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 rule 6c–11(a)(1). See also infra section II.C.1. (discussing circumstances where ETF shares can be individually redeemed). 97 15 U.S.C. 80a–2(a)(32) (defining ‘‘redeemable security’’); 15 U.S.C. 80a–5(a)(1) (defining ‘‘openend company’’ as ‘‘a management company which is offering for sale or has outstanding any redeemable security of which it is the issuer’’). If ETF shares were not classified as redeemable securities within the meaning of section 2(a)(32) of the Act, an ETF that is a management company (as defined under the Act) 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). PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 57171 subject to requirements imposed under the Act and our rules that apply to open-end funds.98 In addition, the rules under the Exchange Act that apply to transactions in redeemable securities issued by an open-end fund will apply to ETFs relying on rule 6c–11.99 Shares issued by ETFs relying on rule 6c–11 therefore are eligible for 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 in connection with secondary market transactions in ETF shares and the creation or redemption of creation units. ETFs relying on rule 6c–11 similarly will qualify for the ‘‘registered open-end investment company’’ exemption in rule 11d1–2 under the Exchange Act. Many commenters supported our proposed classification of ETF shares as ‘‘redeemable securities.’’ 100 Commenters also supported our view that the arbitrage mechanism that is central to the operation of an ETF (and the conditions in the final rule 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.101 As a result, even though only authorized participants may redeem creation units at NAV per share, commenters agreed that 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 at NAV per share.102 Commenters also supported the resulting eligibility for the redeemable securities exceptions and the registered open-end investment company exemption under the Exchange Act 98 See, e.g., 15 U.S.C. 80a–22; 17 CFR 270.22c–1. ETFs that are management companies and operate in reliance on rule 6c–11 and those that operate in reliance on an exemptive order would equally be subject to the Act and our rules as open-end funds. 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)] (shortening the standard settlement cycle for most broker-dealer securities transactions to two business days). 100 See, e.g., ICI Comment Letter; Fidelity Comment Letter; Comment Letter of the Asset Management Group of the Securities Industry and Financial Markets Association (Feb. 22, 2019) (‘‘SIFMA AMG Comment Letter II’’); Vanguard Comment Letter; SSGA Comment Letter; Comment Letter of Virtu Financial, Inc. (Oct. 3, 2018) (Virtu Comment Letter’’); Comment Letter of Eaton Vance Corp. (Oct. 4, 2018) (‘‘Eaton Vance Comment Letter’’); ABA Comment Letter. 101 See, e.g., ICI Comment Letter. See also 2018 ETF Proposing Release, supra footnote 7, at n.95 and related discussion. 102 See, e.g., ICI Comment Letter; Virtu Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 57172 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations rules discussed above.103 Commenters stated that such treatment would reduce regulatory complexity and eliminate potential inconsistencies between rule 6c–11 and this Exchange Act relief.104 Several commenters recommended extending the ‘‘redeemable security’’ classification to ETFs that are not eligible to rely on rule 6c–11, such as UIT ETFs or share class ETFs, to make them similarly eligible for the exceptions under the Exchange Act that apply to redeemable securities issued by an open-end fund.105 After considering comments, we are clarifying that we view securities of all ETFs, including those that do not rely on rule 6c–11, as eligible for 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 in connection with secondary market transactions in ETF shares and the creation or redemption of creation units and the exemption in rule 11d1–2 under the Exchange Act for securities issued by a registered openend investment company or unit investment trust. We believe that securities issued by ETFs that are exempt from the definitions of ‘‘redeemable security’’ in section 2(a)(32) and ‘‘open-end company’’ in section 5(a)(1) of the Investment Company Act pursuant to their orders do not raise different concerns with respect to these Exchange Act provisions than those issued by ETFs relying on rule 6c–11. Several commenters recommended further harmonization between rule 6c– 11 and certain other Exchange Act relief that ETFs must currently seek in order to operate.106 Commenters expressed concern that this Exchange Act relief is duplicative or, in some cases, inconsistent with other requirements applicable to ETFs.107 In particular, khammond on DSKJM1Z7X2PROD with RULES2 103 See, e.g., Dechert Comment Letter; BlackRock Comment Letter; Invesco Comment Letter I; ABA Letter. 104 See, e.g., Vanguard Comment Letter; Dechert Comment Letter; WisdomTree Comment Letter; ABA Comment Letter; SIFMA AMG Comment Letter I. 105 See ICI Comment Letter; Dechert Comment Letter; SIFMA AMG Comment Letter I; Vanguard Comment Letter; SSGA Comment Letter I; ABA Comment Letter; BlackRock Comment Letter. 106 See, e.g., BlackRock Comment Letter; ICI Comment Letter; Fidelity Comment Letter; SIFMA AMG Comment Letter I; Comment Letter of John Hancock Investments (Oct. 1, 2018) (‘‘John Hancock Comment Letter’’); Comment Letter of Flow Traders US LLP (Oct. 1, 2018) (‘‘Flow Traders Comment Letter’’). 107 See, e.g., BlackRock Comment Letter. See also, e.g., ICI Comment Letter (‘‘Currently, ETFs often must satisfy multiple and sometimes conflicting requirements from different divisions within the SEC.’’). Commenters also expressed concerns about the administrative delay in obtaining these VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 commenters noted that rule 6c–11 as proposed would not address relief for ETFs from section 11(d)(l) of the Exchange Act as well as rules 10b–10, 15c1–5, 15c1–6, and 14e–5 thereunder.108 Commenters also recommended that the ETF generic listing standards of national securities exchanges be broadened and harmonized with any final ETF rule.109 We agree that complementary exemptive relief under the Exchange Act could further reduce regulatory complexity, administrative delay, and eliminate potential inconsistencies between rule 6c–11 and the related Exchange Act relief that ETFs must obtain to operate. Accordingly, the Commission is issuing an order granting exemptive relief to ETFs operating in reliance on rule 6c–11 from the requirements of section 11(d)(1) of the Exchange Act and rules 10b–10, 15c1– 5, 15c1–6, and 14e–5 under the Exchange Act for ETFs, where certain conditions are met.110 Finally, commenters asked that we exempt ETF insiders and large shareholders from certain section 13(d) and section 16 reporting requirements under the Exchange Act beyond the conditions in several staff no-action letters.111 The staff no-action letters stated that the staff would not recommend enforcement action to the Commission if certain insiders and large shareholders of ETFs seeking to track the performance of a benchmark index through a replication strategy did not file reports under section 13(d) and section 16(a) based on certain facts and circumstances, including that there is no material deviation between the ETF’s secondary market price and NAV.112 Commenters stated that the portfolio transparency requirements in rule 6c–11 would address the concerns underlying additional approvals. See, e.g., SIFMA AMG Comment Letter I. 108 See, e.g., Dechert Comment Letter; see also 2015 ETP Request for Comment, supra footnote 19. 109 See, e.g., Cboe Comment Letter (‘‘Cboe encourages the Commission to evaluate exchange proposals to broaden their generic listing standards . . . in order to achieve efficiencies with exchange listing processes in a manner very similar to those which [rule 6c–11] is designed to accomplish.’’). See also, e.g., ABA Comment Letter, Nasdaq Comment Letter. 110 See ETF Exchange Act Order, supra footnote 15. ETFs that do not operate in reliance on rule 6c– 11 and currently have relief from the Exchange Act provisions discussed above may continue to rely on such relief. 111 See, e.g., Fidelity Comment Letter; Comment Letter of Thompson Hine LLP (Oct. 1, 2018) (‘‘Thompson Hine Comment Letter’’). 112 See PDR Services Corporation, SEC Staff NoAction Letter (pub. avail. December 14, 1998) (‘‘PDR Services Letter’’); Select Sector SPDR Trust, SEC Staff No-Action Letter (pub. avail. May 6, 1999) (‘‘Select Sector SPDR Trust Letter’’). PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 section 13(d) and section 16 without conditioning relief on there being no material deviation between the ETF’s market price and NAV per share.113 As discussed above, the exemptions we are providing today under rule 6c– 11 are based on the existence of a close tie between market price and NAV per share. Expanding on the existing staff no-action letters by providing exemptions from the reporting requirements in sections 13(d) and 16 even when there is a material deviation between market price and NAV would be inconsistent with the exemptions in rule 6c–11. We therefore refrain from taking additional action concerning the conditions outlined in our existing staff no-action letters. 2. Trading of ETF Shares at MarketDetermined Prices Rule 6c–11 will provide exemptions from section 22(d) and rule 22c–1 to permit secondary market trading of ETF shares at market-determined prices as proposed. 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.114 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.115 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.116 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, rule 6c–11 will provide exemptions from these provisions.117 113 See, e.g., Thompson Hine Comment Letter. U.S.C. 80a–22(d). 115 See 17 CFR 270.22c–1. 116 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)). 117 See rule 6c–11(b)(2). The reference in the rule to ‘‘repurchases . . . at market-determined prices’’ refers to secondary market transactions with dealers. Thus, the rule will not allow an ETF to 114 15 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 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.118 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 final rule will provide exemptions from section 22(d) and rule 22c–1 because we believe this 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. 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 has generally been relatively small.119 However, we recognize that under certain circumstances, including during periods of market stress, the arbitrage mechanism may work less effectively.120 We also recognize that repurchase shares from an investor at marketdetermined prices. 118 See 2018 ETF Proposing Release, supra footnote 7, at n.113 and accompanying discussion. 119 In an analysis of various asset classes during 2017–2018, end-of-day deviations between closing price of ETFs and NAV were relatively rare and generally not persistent. See also id., at nn.119–123 and accompanying text (discussing similar staff analysis for 2016–2017 period). 120 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. 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. See 2018 ETF Proposing Release, supra footnote 7, at nn.124–130 and accompanying text. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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 continue to 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.121 Further, we believe that the conditions we are adopting as part of rule 6c–11, along with other recent actions that are designed to promote an effective arbitrage mechanism, will 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 granting.122 We particularly find this to be the case given the benefits ETFs offer investors as discussed above. Moreover, to the extent that there are instances where bid-ask spreads widen, or premiums and discounts persist, the final rule and disclosure amendments will require ETFs to disclose certain information on their website.123 These disclosure requirements are designed to increase investor awareness of these risks. We continue to believe that it is important for investors to be informed where costs may increase beyond what they would reasonably expect. Commenters generally agreed that rule 6c–11 should provide the proposed exemptions from section 22(d) and rule 121 See id., at n.131 and accompanying text. The Commission also 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 Act 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 Act Release No.78660 (Aug. 24, 2016) [81 FR 59676 (Aug. 30, 2016)]. 122 For example, 17 CFR 270.22e–4 (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 Investment Company Liquidity Risk Management Programs, Investment Company Act Release No. 32315 (Oct. 13, 2016) [81 FR 82142 (Nov. 18, 2016)] (‘‘LRM Adopting Release’’). We have taken these requirements into consideration in adopting the conditions in rule 6c–11. 123 See infra section II.C.6. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 57173 22c–1.124 These commenters highlighted the ability of investors to transact in ETF shares intraday at market-determined prices as one of the primary benefits of the ETF structure. Commenters also agreed with our observation that the arbitrage mechanism generally has kept the deviation between the ETF market price and NAV per share relatively small, and that an efficient arbitrage mechanism adequately addresses potential concerns under section 22(d) and rule 22c–1.125 One commenter agreed that, on balance, given the historically insignificant and short duration of unusual ETF premiums and discounts, and the relatively low risks presented to investors as a result, ETF investors are likely to weigh the potential benefits of ETFs against any potential for market price deviations when selecting an investment in ETFs.126 3. Affiliated Transactions As proposed, rule 6c–11 will provide exemptions from sections 17(a)(1) and (a)(2) of the Act with regard to the deposit and receipt of baskets by 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.127 The relief from section 17(a) in rule 6c–11 is consistent with the exemptive relief that we have granted to ETF applicants.128 Section 17(a) of the Act generally prohibits an affiliated person of a registered investment company, or an affiliated person of such person, from knowingly selling any security or other 124 See, e.g., ICI Comment Letter; SSGA Comment Letter I; Invesco Comment Letter. 125 See, e.g., ICI Comment Letter; Invesco Comment Letter. 126 See Invesco Comment Letter. 127 See rule 6c–11(b)(3). 128 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’’). 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. 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. See 2018 ETF Proposing Release, supra footnote 7, at nn.140–141 and accompanying discussion. E:\FR\FM\24OCR2.SGM 24OCR2 57174 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations property to or purchasing any security from the company.129 Purchases and redemptions of ETF creation units are typically effected in kind, and section 17(a) would prohibit 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.130 Commenters expressed support for our proposed exemptions from sections 17(a)(1) and (a)(2), concurring with our view that this relief is necessary to facilitate the efficient functioning of the arbitrage mechanism.131 Commenters noted that, without this relief, 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, which, in turn, could have the adverse effect of limiting the pool of market participants that could engage in arbitrage.132 Ultimately, this 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. Commenters also stated that in-kind purchases and redemptions of ETF creation units between an ETF and authorized participants, which may be affiliated persons, or affiliated persons of affiliated persons, as a result of such transactions are not the types of potentially harmful transactions that section 17(a) is designed to prevent.133 129 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). 131 See e.g., Thompson Hine Comment Letter; ICI Comment Letter; JPMAM Comment Letter; SSGA Comment Letter I; Fidelity Comment Letter; SIFMA AMG Comment Letter I. 132 See, e.g., ICI Comment Letter. Newly launched ETFs could face particular challenges 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. 133 See, e.g., Thompson Hine Comment Letter; see also 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’’) (‘‘To prevent self-dealing and khammond on DSKJM1Z7X2PROD with RULES2 130 15 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 We continue to believe that this relief is appropriate to facilitate the efficient functioning of the arbitrage mechanism after considering comments. As noted above, all purchases and redemptions of creation units with such an affiliated person are at an ETF’s next-calculated NAV, and an ETF would value the securities deposited or delivered upon redemption in the same manner, using the same standards, as the ETF values those securities for purposes of calculating the ETF’s NAV. We do not believe that these transactions will give rise to the policy concerns that section 17(a) is designed to prevent. Several commenters asked us to confirm that the section 17(a) relief in rule 6c–11 would extend to entities that are affiliated with the ETF by virtue of holding more than 25% of the ETF’s shares or more than 25% of any investment company that is an affiliated person of the ETF (‘‘25% holders’’), consistent with the terms of our existing exemptive orders.134 Our proposal was designed to provide relief from section 17(a) similar to our orders.135 We do not believe that an express reference to 25% holders in rule 6c–11(b)(3) is necessary, however, because the rule text will capture entities that are affiliated with the ETF by virtue of share ownership greater than 5%. We confirm that 25% holders are within the scope of this exemption. A number of commenters also recommended expanding the relief to cover additional types of affiliated relationships, such as exempting brokerdealers that are affiliated with the ETF’s adviser,136 or permitting an ETF’s adviser or its affiliates to transact with the ETF to provide in-kind seed capital to the ETF.137 These commenters noted that increasing the entities eligible to overreaching by persons in a position to take advantage of the fund, the Investment Company Act prohibits funds from entering into certain transactions with affiliated persons.’’) (internal citations omitted). 134 See e.g., SIFMA Comment Letter I. The related exemptive application to our orders usually includes an express reference to holders of 25% or more of the ETF’s shares or 25% or more of an investment company that is an affiliated person of the ETF. See, e.g., Pacer Funds, et al., Investment Company Act Release Nos. 33374 (Feb. 13, 2019) [84 FR 5125 (Feb. 20, 2019)] (notice) and 33397 (March 12, 2019) (order). 135 Our 2008 proposal expressly included section 17(a) relief for 25% holders. See 2008 ETF Proposing Release, supra footnote 3. One commenter on that proposal stated that the reference to 25% holders was superfluous in light of the reference to 5% holders. See Comment Letter of Stradley Ronan Stevens & Young, LLP (May 19, 2008). 136 See ICI Comment Letter; JPMAM Comment Letter; SSGA Comment Letter I. 137 See Fidelity Comment Letter; SIFMA AMG Comment Letter I. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 transact with an ETF could further help facilitate the arbitrage mechanism, reduce concentration risk, and lower transaction costs. These commenters also noted that a fund’s policies and procedures on baskets and custom baskets, as well as the federal securities laws and regulations that prohibit manipulative practices and misuse of nonpublic information, would address potential concerns regarding overreaching and similar abusive practices by these affiliated entities. While permitting additional types of affiliated entities to transact with the ETF could provide additional benefits to an ETF, expanding the scope of affiliated persons covered by the exemption would constitute novel section 17(a) relief. To date, our exemptive orders have been narrowly tailored to permit in-kind purchases and redemptions between an ETF and certain affiliates to facilitate efficient arbitrage. Expanding this relief would raise novel affiliation issues that would require a careful consideration of whether the current protections embedded in our relief sufficiently address any risks posed by such transactions with additional categories of affiliates. This would be especially the case if the exemption were expanded to include affiliated entities such as the ETF’s sponsor and other service providers that typically have greater ability to influence an ETF. Given that rule 6c–11 is generally intended to codify existing relief for ETFs, we therefore do not believe that it is appropriate to expand the scope of affiliated persons covered by the exemption as part of this rulemaking, although such exemptions may be considered within our regular exemptive applications process. 4. Additional Time for Delivering Redemption Proceeds We are adopting, largely as proposed, an exemption from section 22(e) to permit an ETF to delay satisfaction of a redemption request in the case of certain foreign investments for which a local market holiday or the extended delivery cycles of another jurisdiction make timely delivery unfeasible. 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.138 This prohibition can cause operational difficulties for ETFs that hold foreign investments and exchange in-kind baskets for creation 138 15 E:\FR\FM\24OCR2.SGM U.S.C. 80a–22(e). 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 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.139 Section 22(e) was designed to prevent unreasonable delays in the actual payment of redemption proceeds.140 Rule 6c–11 will 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. Rule 6c–11 will 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, or 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.141 Under this exemption, an ETF must deliver foreign investments as soon as practicable, but in no event later than 15 days after the tender to the ETF. The exemption therefore will 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.142 If a foreign investment settles in less than 15 days, the rule will require an ETF to deliver it pursuant to 139 ETFs that hold foreign investments 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. 140 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). 141 Rule 6c–11(b)(4). The relief from section 22(e) does not affect any obligations arising under rule 15c6–1 under the Exchange Act, which requires that most securities transactions settle within two business days of the trade date. 17 CFR 240.15c6– 1. 142 This exemption permits a delay in the delivery of foreign investments only if the foreign investment is being transferred in kind as part of the basket. 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. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 the standard settlement time of the local market where the investment trades. 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.143 Commenters generally supported our proposed exemption from section 22(e).144 Commenters stated that the relief would provide additional assurance that an ETF could postpone payment of redemption proceeds in certain circumstances outside of its control.145 One commenter observed that a period of 15 days, accompanied by a requirement that delivery be made as soon as practicable, is appropriate and reasonable.146 Another commenter agreed that it was appropriate to limit the exemption to the particular foreign investment and not the entire basket.147 Proposed rule 6c–11 would have included a ten-year sunset provision in light of the continued movement toward shorter settlement times in markets around the world.148 Commenters generally objected to the proposed sunset provision, citing a number of reasons for why the section 22(e) relief would likely remain necessary beyond the sunset period. Although we continue to believe that technological innovation and changes in market infrastructures and operations should lead to further shortening of settlement cycles, we recognize commenters’ concerns that these developments may be gradual and difficult to predict.149 Moreover, given that certain local market holidays may last for up to seven business days, we agree with commenters that settlement within seven days may continue to pose challenges even in light of continued technological progress and changes in market operations.150 We therefore are 143 See 2018 ETF Proposing Release, supra footnote 7, at n.155 (discussing settlement cycles for various foreign markets). 144 See, e.g., ICI Comment Letter; Fidelity Comment Letter; Comment Letter of Charles Schwab Investment Management (Oct. 1, 2018) (‘‘CSIM Comment Letter’’); John Hancock Comment Letter. 145 See John Hancock Comment Letter; ICI Comment Letter. 146 See CSIM Comment Letter. 147 See ICI Comment Letter. 148 See 2018 ETF Proposing Release, supra footnote 7, at n.156 and accompanying text (proposing that the exemption from section 22(e) for postponement of delivering redemption proceeds expire ten years from the rule’s effective date). 149 See, e.g., Dechert Comment Letter; CSIM Comment Letter; ICI Comment Letter; Invesco Comment Letter; Fidelity Comment Letter; WisdomTree Comment Letter; ABA Comment Letter. 150 See, e.g., Invesco Comment Letter (citing Taiwan market holidays); CSIM Comment Letter; PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 57175 not adopting a sunset provision to limit the relief from section 22(e) to ten years from the rule’s effective date. The rule will 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), and that is traded on a trading market outside of the U.S.151 As under the proposal, this definition is not limited to ‘‘foreign securities,’’ but also includes 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.152 We received no comments on this aspect of the definition of ‘‘foreign investment.’’ Unlike our proposal, we are not defining ‘‘foreign investment’’ as an investment for which there is no ‘‘established U.S. public trading market.’’ 153 A number of commenters recommended that we modify or eliminate this aspect of the definition.154 These commenters expressed concern that this requirement could make the exemption from section 22(e) unavailable whenever a foreign issuer has issued a security in the U.S. Commenters stated that ETFs investing in certain foreign markets typically hold the security that is traded in the foreign issuer’s local trading market (‘‘foreigntraded security’’) rather than its U.S.traded equivalent.155 These commenters explained that this is particularly true for ETFs tracking certain international indexes because those indexes often include foreign-traded securities, which Fidelity Comment Letter; ICI Comment Letter; John Hancock Comment Letter. 151 See rule 6c–11(a)(1). We believe this approach is appropriate because it creates consistency with a long-accepted definition under Exchange Act rules. 152 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. 153 See 2018 ETF Proposing Release, supra footnote 7, at n.166 and accompanying text (proposing to 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)). 154 See ICI Comment letter; SIFMA AMG Comment Letter I; SSGA Comment Letter I; BlackRock Comment Letter; Invesco Comment Letter. 155 See, e.g., ICI Comment Letter; SIFMA Comment Letter I. E:\FR\FM\24OCR2.SGM 24OCR2 57176 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 generally have greater liquidity and trading volume than their U.S.-traded equivalents. Several commenters cited potential compliance costs, operational considerations (e.g., transacting in the foreign-traded security may entail lower transaction costs for the ETF), and possible disruptions to their investment strategy (e.g., tracking error) that might result due to this requirement.156 The proposed definition of foreign investment was designed to make relief from section 22(e) unavailable to an ETF that included a foreign issuer’s U.S.traded investment in its basket, thereby avoiding the settlement delay that is the basis for the relief.157 It was not intended to require an ETF to buy and sell the U.S.-traded equivalent of a foreign-traded security when one is available, nor was it intended to deny section 22(e) relief to an ETF that includes a foreign-traded security in its basket because a U.S.-traded equivalent exists. In order to address commenters’ concerns and potential confusion, however, we have eliminated the requirement that the foreign investment have ‘‘no established U.S. public trading market.’’ Instead, in relevant part, rule 6c–11(a)(1) will define ‘‘foreign investment’’ as an investment that ‘‘is traded on a trading market outside of the U.S.’’ 158 We believe this definition will capture the foreign investments that may experience settlement delays without creating unintended consequences for ETF portfolio management. Under rule 6c–11, a delay in settlement is permitted only to the 156 See, e.g., BlackRock Comment Letter (stating that ‘‘ETFs currently do not monitor whether a foreign issuer has equivalent securities that both trade on a US market and the foreign issuer’s local market since our primary investment practices are to invest in the securities of the underlying index.’’); Invesco Comment Letter; SSGA Comment Letter I. 157 See 2018 ETF Proposing Release, supra footnote 7, at n.166 and accompanying discussion. As proposed, the rule will 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)]. 158 See, e.g., BlackRock Comment Letter (recommending that ‘‘foreign investment’’ be defined by reference to whether ‘‘there is an established trading market [. . .] outside of the US’’). As proposed, we also are not requiring 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. See 2018 ETF Proposing Release, supra footnote 7, at n.161 and accompanying discussion. No commenters disagreed with this aspect of the proposal. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 extent that additional time for settlement is actually required due to a local market holiday or the extended delivery cycles in a foreign market. As a result, the exemption from section 22(e) already is unavailable where an ETF could readily trade an investment in its basket on a U.S. market. C. Conditions for Reliance on Rule 6c– 11 Rule 6c–11 requires ETFs to comply with certain conditions designed to protect investors and to be consistent with the purposes fairly intended by the policy and provisions of the Act in order to operate within the scope of the Act. These conditions generally are consistent with the conditions in 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 modifications that, based on our experience regulating ETFs and comments we received on the proposal, we believe will improve the overall regulatory framework for these products. 1. Issuance and Redemption of Shares As proposed, the definition of exchange-traded fund under rule 6c–11 will require that an ETF issue (and redeem) creation units to (and from) authorized participants in exchange for baskets and a cash balancing amount (if any).159 This definition is designed to preserve the existing ETF structure, reflected in our exemptive orders, which permit only an authorized participant of an ETF to purchase creation units from (or sell creation units to) the ETF. An orderly creation unit issuance and redemption process is essential to a properly functioning arbitrage mechanism. Commenters supported the proposed definition of exchange-traded fund.160 Rule 6c–11 will define an authorized participant to mean a member or participant of a clearing agency registered with the Commission that 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, as proposed.161 This definition differs from the definition of ‘‘authorized participant’’ in the Commission’s exemptive orders and Form N–CEN because it does not 159 See rule 6c–11(a)(1). See also infra section II.C.4.c. (discussing definitions of baskets and cash balancing amount). 160 See, e.g., Invesco Comment Letter. 161 See rule 6c–11(a)(1). PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 include a specific reference to an authorized participant’s participation in DTC, as DTC is itself a clearing agency.162 We proposed to amend Form N–CEN to make the two definitions consistent. We believe the definition that we are adopting remains largely consistent with the exemptive relief we have granted to ETFs, while eliminating unnecessary terms. Several commenters expressed support for the proposed definition of authorized participant.163 One commenter, however, asserted that rule 6c–11 should use the existing definition of authorized participant in Form N– CEN to avoid confusion and regulatory inconsistency.164 We believe that amending Form N–CEN to make the definition of authorized participant consistent with the definition in rule 6c–11 addresses this commenter’s concern.165 We also received several comments on issues relating to authorized participants more generally. One commenter, for example, suggested that the Commission confirm that authorized participants who buy and sell ETF shares in creation units are not considered, for that reason alone, ‘‘principal underwriters’’ under the Investment Company Act.166 The commenter stated that the plain language of section 2(a)(29) of the Act would exclude an authorized participant from the definition of principal underwriter when the authorized participant purchases ETF shares through a principal underwriter acting as agent for the ETF.167 We agree that an authorized participant that purchases ETF shares from the ETF’s principal underwriter is not a principal underwriter as defined in section 2(a)(29) of the Act solely because it buys and sells ETF shares in creation units. Another commenter suggested that the Commission require an ETF to have a minimum number of authorized participants (i.e., 2 or 3) to reduce the risk of anti-competitive behavior and to 162 See 2018 ETF Proposing Release, supra footnote 7, at nn.170–171. Form N–CEN, in relevant part, defined 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. See Form N–CEN, Item E.2. 163 See SSGA Comment Letter I; ICI Comment Letter; Cboe Comment Letter. 164 See Invesco Comment Letter. 165 See infra section II.J. 166 See ABA Comment Letter. 167 Id. (noting that the definition of principal underwriter excludes ‘‘a dealer who purchases from such company through a principal underwriter acting as agent.’’). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 safeguard the arbitrage mechanism.168 This commenter, however, also pointed to data indicating that large ETFs (with more than $790 million in assets) typically have an average of nine active authorized participants, and that smaller ETFs (with less than $27 million in assets) have an average of two active authorized participants.169 This commenter further noted that it has observed ETFs using single authorized participants in ‘‘some markets outside of the United States’’ but that this type of arrangement is ‘‘less common within the United States.’’ 170 We have not observed the types of ‘‘excessive deviations’’ between ETFs’ NAV and market price that, according to this commenter, could indicate that ETFs’ use of one authorized participant is a persistent problem.171 Additionally, based upon Form N–CEN data through September 5, 2019, we found that out of 1672 funds reviewed that could rely on rule 6c–11, only 30 (approximately 1.8% of the funds reviewed) reported having fewer than 2 authorized participants. We therefore do not believe that it is appropriate at this time to prescribe a minimum number of authorized participants that an ETF may use. As proposed, rule 6c–11 will 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).172 Rule 6c– 11 will not mandate a maximum or minimum creation unit size or otherwise place requirements on creation unit size. We continue to believe, and commenters agreed, that ETFs are incentivized to establish creation unit sizes that are appropriate for market demand pursuant to their investment strategies and objectives.173 168 See Comment Letter of Jane Street Capital, LLC (Oct. 1, 2018) (‘‘Jane Street Comment Letter’’). Another commenter suggested that the Commission should provide guidance regarding ETF sponsors giving certain APs special treatment in the negotiation of baskets. See Comment Letter of Bluefin Trading, LLC (Oct. 19, 2018) (‘‘Bluefin Comment Letter’’). We address this comment in our discussion of custom basket policies and procedures, infra, in section II.C.5.a. 169 See Jane Street Comment Letter (citing ‘‘The Role and Activities of Authorized Participants of Exchange-Traded Funds,’’ Investment Company Institute, March 2015). 170 See id. 171 See, e.g., 2018 ETF Proposing Release, supra footnote, at section II.B.2. 172 See rule 6c–11(a)(1). 173 See 2018 ETF Proposing Release, supra footnote 7, at nn.175–176 and accompanying text (noting that 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). See, VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 Thus, ETFs are not likely to set very large or very small creation unit sizes that could disrupt the arbitrage mechanism or prevent the use of in-kind baskets when in-kind baskets would otherwise be desirable for an ETF to obtain the typical efficiencies of ETFs. We also believe that the conditions in rule 6c–11, as adopted, are better suited to promote effective arbitrage than conditions related to creation unit size.174 An ETF generally would issue and redeem shares in creation unit size aggregations, rather than as individual shares, under the rule. We proposed to permit an ETF to sell or redeem individual shares on the day of consummation of a reorganization, merger, conversion, or liquidation.175 In these limited circumstances, an ETF may need to issue or redeem individual shares, and may need to transact without utilizing authorized participants. Commenters that addressed this aspect of the proposal generally supported it.176 One commenter, however, suggested that the rule should explicitly provide that an ETF may transact with investors other than authorized participants in these limited circumstances.177 We agree and have modified rule 6c–11 to clarify that, on the day of a reorganization, merger, conversion, or liquidation, an ETF may sell or redeem individual shares and is not limited to transacting with authorized participants.178 We believe that permitting ETFs to conduct redemptions with investors other than authorized participants in these circumstances is operationally necessary to facilitate these transactions and will allow an ETF to compensate individual shareholders exiting the e.g., ICI Comment Letter; SIFMA AMG Comment Letter I; Vanguard Comment Letter. See also Nasdaq Comment Letter (noting that minimum creation unit size requirement can lead to wider spreads, particularly for newer, thinly-traded ETFs). 174 One commenter also suggested that the rule should not require an ETF to define a specific creation unit size, noting that permitting variable creation unit sizes could help further facilitate market making and reduce transaction costs. See Nasdaq Comment Letter. The rule’s definition of ‘‘creation unit’’ will require an ETF to specify a single number of ETF shares composing a creation unit. Although an ETF could not use variable creation unit sizes under this definition, an ETF could change its specified creation unit size as conditions change over time. 175 See 2018 ETF Proposing Release, supra footnote 7, at text preceding n.82 (discussing proposed rule 6c–11(c)(5)). 176 See, e.g., BlackRock Comment Letter; Thompson Hine Comment Letter. 177 See Thompson Hine Comment Letter. This commenter also suggested moving this exception to the definition of exchange-traded fund because it is not a condition to reliance on the rule. We agree and have moved this exception to rule 6c–11(a)(2). 178 See rule 6c–11(a)(2). PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 57177 reorganized, merged, converted or liquidated ETF—activities likely to involve small amounts and to be outside the scope of an authorized participant’s expected role of transacting in creation units. Commenters also addressed the Commission’s proposed guidance concerning the extent to which an ETF may directly or indirectly suspend the issuance or redemption of ETF shares.179 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 harm investors that purchase shares at market prices above NAV per share and/or sell shares at market prices below NAV per share. With respect to redemptions, an ETF may suspend the redemption of creation units only in accordance with section 22(e) of the Act,180 and may charge transaction fees on these redemptions only in accordance with rule 22c–2.181 While no commenters disagreed with our statement in the 2018 ETF Proposing Release that an ETF may suspend redemptions only in compliance with section 22(e), several commenters requested that we eliminate the 2% cap on redemption fees for ETFs.182 One commenter asserted that, unlike the mutual fund redemption fees that were the Commission’s focus in adopting rule 22c–2, the transaction fees charged by an ETF on redemptions are not intended to inhibit frequent trading of the ETF’s shares, but are primarily designed to protect shareholders against the costs of certain cash redemptions.183 179 See 2018 ETF Proposing Release, supra footnote 7, at section II.C.1. 180 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 123, at n.36. 181 17 CFR 270.22c–2 (rule 22c–2) limits redemption fees to no more than 2% of the value of shares redeemed. See rule 22c–2(a)(1)(i). 182 See, e.g., Dechert Comment Letter; WisdomTree Comment Letter; Invesco Comment Letter (noting that the redemption fee framework for ETFs under rule 22c–2 is ‘‘workable’’ in most circumstances, but that in certain circumstances greater flexibility to charge redemption fees in excess of 2% would benefit ETFs). Commenters did not provide any fee-related data in support of their contention that the 2% limit on redemption fees should be eliminated for ETFs. 183 See Dechert Comment Letter. See also Invesco Comment Letter (noting that these fees include the difference between the cash in-lieu amount calculated on the trade date and the actual sale price of the security (reflecting market movement)). E:\FR\FM\24OCR2.SGM 24OCR2 57178 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations This commenter further stated that an ETF’s inability to pass through certain incremental costs to an authorized participant could adversely impact performance and result in dilution of the interests of the ETF’s remaining shareholders. As discussed above, we believe that ETFs should be regulated as open-end funds and that ETF shares are most appropriately classified as redeemable securities under the relevant provisions of the Act. In adopting the 2% limit on redemption fees under rule 22c–2, we stated that higher redemption fees would impose an undue restriction on the redeemability of shares.184 Consistent with this belief, our exemptive orders permitting ETFs to operate as open-end funds have not permitted ETFs to charge transaction fees in excess of the 2% limit. We believe the 2% limit allows ETFs to pass on certain costs related to the redemption transaction to authorized participants, while preserving the redeemability of ETF shares.185 Accordingly, we believe that ETFs may charge transaction fees on the redemption of creation units only in accordance with rule 22c–2. We also stated in the 2018 ETF Proposing Release that we believe that 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.186 Some commenters agreed that an ETF may suspend creations only for a limited time and only due to extraordinary circumstances, but requested that we provide clarification regarding the specific circumstances under which an ETF may suspend creations.187 Other commenters did not support our position on this issue. For example, one khammond on DSKJM1Z7X2PROD with RULES2 184 See Mutual Fund Redemption Fees, Investment Company Act Release No. 26782 (March 11, 2005) [70 FR 13328 (March 18, 2005)] (noting that a goal of the Commission under the Act is to preserve the redeemability of mutual fund shares). 185 See id. at text accompanying nn. 29–30. Mutual funds, particularly those that invest in foreign markets, may face similar types of costs and are subject to the 2% cap in rule 22c–2. 186 See 2018 ETF Proposing Release, supra footnote 7, at n.185 and accompanying text. In addition, we stated that an ETF could not set transaction fees so high as to effectively suspend the issuance of creation units. See id. One commenter addressed this issue, stating that ETFs generally do not set transaction fees at a level that would effectively suspend creations ‘‘in lieu of transparently informing the market that creations are halted.’’ Jane Street Comment Letter. 187 See, e.g., BlackRock Comment Letter; SIFMA AMG Comment Letter I; SSGA Comment Letter I; Vanguard Comment Letter; Invesco Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 commenter stated that current ETF practices for suspending creations have proven effective and advocated against limiting or imposing restrictions on the circumstances in which ETFs may suspend creations.188 Another commenter recommended that, rather than precluding an ETF from suspending the issuance of creation units, the Commission should require ETFs that suspend creations to add supplemental disclosures addressing the risk that the ETF’s market price may deviate from NAV per share.189 As discussed above, however, the expected close tie between an ETF’s market price and NAV per share provides a basis for our relief from section 22(d) and rule 22c–1 under rule 6c–11 (as well as our prior exemptive orders).190 If a suspension of creations impairs the arbitrage mechanism, it could lead to significant deviations between what retail investors pay (or receive) in the secondary market and the ETF’s approximate NAV. Such a result would run counter to the basis for relief from section 22(d) and rule 22c–1 and therefore would be inconsistent with rule 6c–11. 2. Listing on a National Securities Exchange As proposed, rule 6c–11 will define an ‘‘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.191 Exchange-listing is one of the fundamental characteristics that distinguishes ETFs 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. Exchange-listing provides an organized and ongoing trading market for the ETF shares at marketdetermined prices, and therefore is 188 See Comment Letter of ETF BILD LLC (Oct. 1, 2018) (‘‘ETF BILD Comment Letter’’) (‘‘[T]here may be a variety of reasons to suspend creations and limiting them or [restricting] certain activity will not allow for differentiation of the circumstances related to the underlying securities. . . . [C]urrent practices developed in the ETF industry allow for the flexibility needed to address this issue.’’). 189 See Eaton Vance Comment Letter. Another commenter suggested requiring any ETF that suspends creations, or otherwise has its creation process halted, to immediately notify the market via a Form 8–K or other mechanism. See Jane Street Comment Letter. 190 See supra section II.B.2 (discussing the potential concerns regarding shareholder dilution, unjust discrimination and preferential treatment among investors purchasing and redeeming fund shares that section 22(e) and rule 22c–1 were designed to address). 191 Rule 6c–11(a)(1). As proposed, rule 6c– 11(a)(1) also will define a ‘‘national securities exchange’’ as an exchange that is registered with the Commission under section 6 of the Exchange Act. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 important to a functioning arbitrage mechanism.192 The Commission has premised all of its previous exemptive orders on an ETF listing its shares for trading on a national securities exchange. Several commenters generally supported the requirement that an ETF list its shares on a national securities exchange.193 On the other hand, one commenter stated that ETFs that are temporarily suspended from listing or engaged in an orderly delisting and liquidation process should not fall outside of the scope of the proposed rule.194 Another commenter opined that delisted ETFs should remain within the rule to prevent a possible race to redeem the ETF’s shares that could result from confusion about the ETF’s regulatory status.195 This commenter stated the definition of exchange-traded fund instead should include ETFs that have been listed within the past 90 days. Other commenters requested that we clarify the specific circumstances that constitute a ‘‘delisting,’’ citing trading suspensions and trading halts as examples of circumstances that should not disqualify an ETF from relying on rule 6c–11.196 These commenters also urged the Commission to clarify that a temporary non-compliance notice from an exchange for failure to continuously meet the exchange’s listing standards would not disqualify an ETF from relying on the rule. As noted above, the listing requirement was designed to ensure that all ETF shares have an organized and ongoing secondary trading market to support an effective arbitrage mechanism. We therefore continue to believe that an ETF should no longer be 192 As proposed, the definition also requires that an ETF’s shares trade at market-determined prices. This 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 (‘‘ETMFs’’)). See 2018 ETF Proposing Release, supra footnote 7, at text accompanying n.192. Commenters did not address this aspect of the definition of exchangetraded fund. 193 See, e.g., ICI Comment Letter; SSGA Comment Letter I. 194 SIFMA AMG Comment Letter I. 195 Thompson Hine Comment Letter (‘‘[D]eeming the former ETF to no longer have [status as an ETF under the rule] may lead to confusion and a possible race to redeeming shares by remaining shareholders while liquid assets are still available.’’). 196 See SSGA Comment Letter I; ICI Comment Letter; Invesco Comment Letter. See also FINRA, Investor Alert, When Trading Halts: What You Need to Know About Halts, Suspensions and Other Interruptions (February 7, 2013), available at https:// www.finra.org/investors/alerts/when-trading-stopshalts-suspensions-other-interruptions (describing trading halts and trading suspensions). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations eligible to rely on rule 6c–11 and must meet individual redemption requests within seven days pursuant to section 22(e) of the Act or liquidate if it is not listed on an exchange.197 In response to commenters’ request that we clarify the specific circumstances constituting a ‘‘delisting’’ for purposes of rule 6c–11, an ETF is considered no longer listed on an exchange as of the effective date of the removal of the ETF’s shares from listing pursuant to rule 12d2–2 under the Exchange Act.198 Circumstances such as a trading suspension, a trading halt, or a temporary non-compliance notice from the exchange therefore would not constitute a ‘‘delisting’’ for purposes of rule 6c–11. An ETF also may request temporary relief from the Commission to permit the ETF to suspend redemptions for a limited period of time where necessary to protect ETF shareholders.199 khammond on DSKJM1Z7X2PROD with RULES2 3. Intraday Indicative Value (‘‘IIV’’) As proposed, rule 6c–11 will not require ETFs to disseminate an intraday estimate of their NAV per share (an ‘‘intraday indicative value’’ or ‘‘IIV’’) as a condition for reliance on the rule. Our orders require the dissemination of an 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 on an intraday basis.200 The exchange listing standards also currently require ETFs to disseminate an IIV at least every 15 seconds during regular trading hours.201 We did not propose, however, an IIV dissemination requirement under rule 6c–11 because of our concerns regarding the accuracy of IIV estimates for certain 197 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. 198 See 17 CFR 240.12d2–2 (rule 12d2–2 under the Exchange Act) (requiring a national securities exchange to file with the Commission an application on Form 25 (17 CFR 249.25) to strike a class of securities from listing on a national securities exchange and/or registration under section 12(b) of the Exchange Act). 199 See section 22(e)(3) of the Act. 200 See, e.g., 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’’). 201 See, e.g., NYSE Arca Equities Rule 5.2E(j)(3), Commentary .01(c) (stating that 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’’). The IIV is also sometimes referred to as the ‘‘iNAV’’ (indicative net asset value) or the ‘‘PIV’’ (portfolio indicative value). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 ETFs.202 For example, the IIV may not accurately reflect the value of an ETF that holds securities that trade less frequently. 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 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.203 Conversely, in today’s fast moving markets, given the dissemination lags, the IIV may not accurately reflect the value of an ETF that holds frequently traded component securities.204 Because there are no uniform methodology requirements, the IIV also can be calculated in different and potentially inconsistent ways. In addition, we understand that market makers and authorized participants no longer use IIV to evaluate arbitrage opportunities for ETFs that provide full portfolio transparency.205 These market participants 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 and generally use the IIV as a secondary or tertiary check on the value that their proprietary algorithms generate. The majority of commenters that addressed IIV requirements supported our proposed approach. For example, commenters agreed that authorized participants and other market participants calculate their own intraday values based on other sources of information such as an ETF’s 202 See 2018 ETF Proposing Release, supra footnote 7, at section II.C.3. The exemptive relief we provided to certain non-transparent ETFs included a condition requiring those ETFs to provide a verified intraday indicative value (‘‘VIIV’’) throughout the trading day. See 2019 Precidian, supra footnote 8. Those ETFs’ VIIV, considering their limited investment strategies, addressed the Commission’s concerns regarding the traditional IIV. See id. 203 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 ETF’s current holdings. 15 U.S.C. 80a– 2(a)(41)(B). 204 An ETF’s current portfolio value changes every time the value of any underlying component of the ETF changes. The IIV for an ETF that includes a more frequently traded component security might not reflect the most recent trading information for that underlying security. 205 See ETF Handbook, supra footnote 25. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 57179 published baskets and portfolio holdings.206 Some of these commenters stated, therefore, that the proposed rule’s conditions regarding daily portfolio holdings information would provide more useful information to market participants than IIV.207 Commenters also agreed that IIV can have significant limitations depending on the types of securities the ETF holds. For example, one commenter stated that these limitations for ETFs holding fixed income securities are the result of market structure issues and that increasing the frequency of the IIV publication would not change these limitations.208 Commenters also noted that under current regulatory requirements, IIV can be confusing or misleading to market participants. For example, one commenter stated that current requirements for IIV actually reduce ETF transparency, because the IIV does not reflect the true value of an ETF due to dissemination delays, stale pricing for underlying holdings, and inconsistent calculation methodologies.209 One commenter opined that IIV is inaccurate for 80% of all ETFs and the rule should not require its dissemination.210 Another commenter stated that ‘‘[IIV] is, at best, slow and likely stale and, at worst confusing, inaccurate, and misleading.’’ 211 In addition, several of these commenters stated that the IIV requirements across regulatory regimes applicable to ETFs should be harmonized.212 Specifically, these commenters noted that, even if rule 6c– 11 were to omit an IIV requirement, existing relief under the Exchange Act 206 See, e.g., Jane Street Comment Letter; Invesco Comment Letter; WisdomTree Comment Letter; Vanguard Comment Letter (‘‘These other sources of data include the ETF’s published basket, its last published portfolio holdings list, the index tracked by the ETF, and data from third party vendors’’). 207 See Comment Letter of Legg Mason, Inc. (Oct. 1, 2018) (‘‘Legg Mason Comment Letter’’); Cboe Comment Letter. See also SSGA Comment Letter I (‘‘[t]o the extent there is market demand for information similar to the IIV by market participants absent a regulatory mandate, we expect industry-led solutions will be available, perhaps as part of a broader discussion around market price validation.’’). 208 See Legg Mason Comment Letter (noting, for example, that fixed-income securities are predominantly traded by dealers and not on exchanges). See also ICI Comment Letter. 209 See SSGA Comment Letter I. 210 Comment Letter of ETF.com (Aug. 28, 2018) (‘‘ETF.com Comment Letter’’) (stating that ‘‘the idea of contemporaneous measure of fair value is enticing’’ but IIV ‘‘is not accurate enough for authorized participants to use in arbitrage analysis.’’). 211 Cboe Comment Letter. 212 See, e.g., Invesco Comment Letter; SIFMA AMG Comment Letter I; WisdomTree Comment Letter; SSGA Comment Letter I; ETF.com Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 57180 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 and certain exchange listing requirements would require ETFs to continue disseminating IIV. They encouraged the Commission to work with the exchanges to remove these listing requirements. Some commenters disagreed with this aspect of the proposal and encouraged the Commission to require ETFs to disseminate IIV as a requirement of the rule. These commenters generally asserted that IIV—despite its limitations—can be useful to retail investors.213 One such commenter stated that IIV is important for informed trading of ETFs (and other ETPs) by retail investors because it is an ‘‘important signal of the value of the underlying portfolio.’’ 214 One commenter stated that IIV allows investors to screen for significant price deviations that could signal breakdowns in the market maker arbitrage process.215 Some of these commenters noted that an ETF’s IIV may be the only source of pricing information publicly available to retail investors.216 Another commenter asserted that the rule should include an IIV requirement, but that market participants, particularly retail investors, also would benefit from an explanation of the potential limitations of IIV.217 Many of the commenters who recommended that the Commission retain an IIV requirement also recommended that the Commission standardize and otherwise improve the IIV calculation.218 After considering these comments, we continue to believe that rule 6c–11 should not require ETFs to disseminate IIV as IIV is not necessary to support the arbitrage mechanism for ETFs that provide daily portfolio holdings disclosure. Instead, rule 6c–11’s portfolio holdings disclosure will provide market participants with the relevant data to input into their internal algorithms and thus allow them to determine if arbitrage opportunities exist. We also do not believe that IIV will provide a reliable metric for retail investors to assess all ETFs relying on rule 6c–11 given the breadth of asset classes that ETFs may hold (and the 213 See, e.g., Angel Comment Letter; Nasdaq Comment Letter; IDS Comment Letter. 214 See Angel Comment Letter. 215 See Nasdaq Comment Letter. 216 See IDS Comment Letter. See also CFA Comment Letter; Eaton Vance Comment Letter. 217 See FIMSAC Comment Letter. 218 See, e.g., NYSE Comment Letter; IDS Comment Letter; Nasdaq Comment Letter; Eaton Vance Comment Letter. See also Angel Comment Letter (recommending dissemination on standard CQS and UTP feeds, one-second updates, and standardization of IIV suffixes). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 particular shortcomings of IIV when an ETF holds assets that do not trade contemporaneously with the ETF or are traded less frequently). Furthermore, retail investors do not have easy access to IIV through free, publicly available websites today even for those asset classes where an IIV may be more reliable. A staff review of the websites for the ten largest ETFs by assets under management found that none provides a real-time IIV on its website. Some of these ETFs disclose a specific ticker symbol for the ETF’s IIV (as opposed to the ticker symbol for the ETF itself) on their websites, others provide the IIV with a delay of up to 45 minutes, while others provide no information about the ETF’s IIV at all.219 A review of several publicly available, free financial websites also found that not all of these websites provide an ETF’s IIV.220 Where these websites did provide the IIV, it was delayed by at least 15 minutes.221 We believe this raises a significant risk that retail investors using these websites may be receiving stale IIVs for ETFs. We have noted, and commenters agreed, that even the 15-second interval for dissemination of an ETF’s IIV required under the exchange listing standards may be too infrequent to effectively reflect the full trading activity for component securities, and therefore to reflect the actual value of the ETF. Therefore, we do not believe that adopting rule 6c–11 without an IIV requirement would remove information from the market that retail investors could reliably use when making investment decisions. We considered whether to require an ETF to publicly disseminate a modified IIV on its website on a real time basis as a condition to rule 6c–11, requiring ETFs to calculate IIVs more frequently and in a more accessible manner. We also considered creating a methodology that takes into account circumstances when market prices for underlying assets are not available or should not be used to reflect the ETF’s intraday value. However, we believe that these modifications are not necessary given that an ETF operating in reliance on rule 6c–11 will provide full portfolio transparency on its website. We recognize that intraday information accurately reflecting the 219 Fewer than half of the ETFs included in the review use a specific ticker symbol that allows an investor to locate the ETF’s IIV (e.g., the ETF’s ticker symbol followed by ‘‘.iv’’ or ‘‘–iv’’). 220 When input into a free financial website, the IIV was provided with a delay of at least 15 minutes. 221 See, e.g., https://finance.yahoo.com/quote/ %5ESPY-IV/; https://www.morningstar.com/etfs/ arcx/spy/betaquote.html. PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 current value of an ETF’s shares can be important to retail investors and encourage the ETF industry to undertake efforts to develop intraday value metrics targeted at these investors.222 We believe that ETFs are in a position to consider and develop tailored metrics for ETFs holding different asset classes in a format that is useful for retail investors. As one commenter noted, rule 6c–11’s portfolio holdings disclosure requirements may promote a market-based solution to today’s IIV shortcomings by making the information required to calculate intraday values broadly available in a standardized, user-friendly format, which could ‘‘encourage pricing services and other potential providers to develop commercial ETF intraday valuation services that would compete in the market on the basis of timeliness, accuracy, reliability and price.’’ 223 4. Portfolio Holdings Disclosure Since the first exemptive order for an ETF, the Commission has relied on the existence of an arbitrage mechanism to keep market prices of ETF shares at or close to the NAV per share of the ETF. One mechanism that facilitates the arbitrage mechanism is daily portfolio transparency.224 Portfolio transparency provides authorized participants and other market participants with a tool to facilitate valuing the ETF’s portfolio on an intraday basis, which, in turn, enables them to identify arbitrage opportunities and to effectively hedge their positions. Accordingly, as proposed, rule 6c–11 will require an ETF to disclose prominently on its website, publicly available and free of charge, the portfolio holdings that will 222 One commenter noted that a lack of disclosure regarding potential intraday deviations could, in some circumstances, be misleading. See Comment Letter of Henry Hu and John Morley, Yale Law School (Aug, 27, 2018) ‘‘(Hu and Morley Comment Letter’’) (incorporating article by Henry T. C. Hu, University of Texas Law School and John D. Morley, A Regulatory Framework for ExchangeTraded Funds, 91 S. Cal. Law Review 839–941 (July 2018) at 920, which describes a particular ETF that ‘‘suffered extraordinary [intraday] departures from NAV on August 24, 2015’’ and noting how ‘‘[in looking] 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.’’). 223 See Eaton Vance Comment Letter. 224 Our exemptive orders for actively managed ETFs and recent orders for self-indexed ETFs have required full portfolio transparency. Exemptive orders for index-based ETFs with an unaffiliated index provider have required publication of the ETF’s baskets. We understand, however, that all ETFs that can rely on rule 6c–11 currently provide full transparency as a matter of industry practice. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 form the basis for each calculation of NAV per share.225 We received numerous comments on this aspect of the proposal. Many commenters generally supported requiring full, daily portfolio holdings disclosure on the ETF’s website as a condition for reliance on rule 6c–11.226 These commenters agreed with our view that portfolio transparency supports an efficient arbitrage mechanism and thus helps maintain the close tie between the market price of an ETF’s shares and the value of its portfolio. One commenter stated that portfolio transparency is important to individual investors because it allows them to better discern differences between ETFs that purport to track similar indexes or have similar investment objectives.227 On the other hand, one commenter did not support daily disclosure of an ETF’s full portfolio, opining that an effective arbitrage mechanism is sufficiently supported by disclosure of well-constructed baskets with performance that closely tracks the performance of both the fund and its index.228 This commenter further asserted that daily portfolio transparency may harm ETF investors by permitting market participants to front-run index funds, which could negatively impact the prices at which the ETF trades portfolio holdings and thus reduce investors’ returns. This commenter recommended, as an alternative to the proposed requirement, that the Commission require ETFs to provide daily disclosure of portfolio holdings, with an exception for the portion of holdings that are ‘‘subject to 225 Rule 6c–11(c)(1)(i). For purposes of this requirement, as well as other requirements to disclose information on a publicly available website under rule 6c–11, 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 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. However, this requirement does not preclude the ETF from making other, unrelated sections of its website private or password protected. We also 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. 226 See, e.g., Comment Letter of Stuart Cary (July 3, 2018) (‘‘Cary Comment Letter’’); ETF.com Comment Letter; Comment Letter of Jack Reagan (July 12, 2018) (‘‘Reagan Comment Letter’’); BlackRock Comment Letter; Cboe Comment Letter; BNY Mellon Comment Letter; Fidelity Comment Letter; SIFMA AMG Comment Letter I; CSIM Comment Letter; Virtu Comment Letter; Eaton Vance Comment Letter. 227 See CSIM Comment Letter. 228 Vanguard Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 sensitive trading strategies,’’ such as those related to index changes.229 One commenter supported requiring daily portfolio transparency for indexbased ETFs, but opposed requiring it for actively managed ETFs, due to the risk of market participants using the portfolio holdings disclosures to frontrun or piggyback on actively managed strategies.230 Similarly, another commenter asserted that daily portfolio transparency is not a necessary condition for effective arbitrage, and noted that the risks of front-running and ‘‘free riding’’ that arise from portfolio transparency were preventing it from offering more actively managed ETFs.231 We continue to believe ETFs relying on rule 6c–11 should provide full daily portfolio transparency in order to facilitate an efficient arbitrage process. Notably, we believe it is likely that all current ETFs that may rely on the rule already provide full portfolio transparency as a matter of market practice and this approach will eliminate regulatory distinctions between index-based and actively managed ETFs that rely on rule 6c–11. Moreover, although we recognize there are alternative approaches to facilitate efficient arbitrage, the Commission has limited experience with such approaches, which are new and continuing to evolve and we therefore believe that these alternatives should be considered within our exemptive applications process. Accordingly, rule 6c–11 will require full, daily portfolio holdings disclosure for ETFs relying on the rule. As discussed below, however, the portfolio transparency requirement we are adopting includes several modifications from the proposed rule, including modifications regarding the required timing and presentation of the portfolio holdings disclosure. a. Timing of Portfolio Holdings Disclosure Rule 6c–11 will require website disclosure of an ETF’s portfolio holdings on each business day before the opening of regular trading on the primary listing exchange of the ETF’s 57181 shares.232 Our proposal also would have required an ETF to disclose its portfolio holdings before the ETF starts accepting orders for the purchase or redemption of creation units.233 The proposed rule’s timing requirements were 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.234 We received several comments on this aspect of the proposal, particularly on the proposed requirement that an ETF disclose its portfolio holdings before the ETF starts accepting orders on a given business day. Several commenters opposed the proposed timing requirement because it could prevent certain ETFs from accepting creation and redemption orders shortly after the US market closes (‘‘T–1 orders’’).235 These commenters explained that T–1 orders allow ETFs, authorized participants, and other market participants to place orders for the purchase and sale of portfolio securities in non-U.S. markets with hours that do not overlap (or have limited overlap) with U.S. market hours when those markets are open.236 An ETF that holds Japanese equities, for example, may permit authorized participants to submit T–1 orders (between 4:00 p.m. ET and 5:00 p.m. ET) to allow for trading in the underlying Japanese securities before the Japanese market closes (2:00 a.m. ET).237 Some commenters explained that the operational steps necessary to disclose an ETF’s portfolio holdings would take 2–3 hours after NAV calculation (typically 4:00 p.m. ET) and the requirement to disclose portfolio holdings before accepting orders therefore would eliminate the T–1 order window.238 Several commenters discussed the benefits of permitting ETFs to accept T– 1 orders. Commenters stated that T–1 orders allow market participants to align the execution time of underlying securities transactions with the NAV calculation of the order, and thus minimize costs and support effective arbitrage.239 Some commenters stated 232 Rule 6c–11(c)(1)(i). proposed rule 6c–11(c)(1)(i). 234 See 2018 Proposing Release, supra footnote 7, at n.209 and accompanying text. 235 See, e.g., ICI Comment Letter; BlackRock Comment Letter. 236 See, e.g., Invesco Comment Letter. 237 See ICI Comment Letter. 238 See Invesco Comment Letter. 239 See, e.g., ICI Comment Letter (discussing the importance to authorized participants of the ability to trade or hedge the underlying exposures at the same time the ETF strikes its NAV); BlackRock Comment Letter; Jane Street Comment Letter 233 See 229 Id. (recommending that the rule permit ETFs to disseminate a list of index securities that, when combined with disclosed portfolio holdings, would be reasonably designed to track the ETF’s (and the index’s) performance). 230 See Invesco Comment Letter (recommending that the rule permit actively managed ETFs to delay disclosure of portfolio holdings at least two days). 231 See JPMAM Comment Letter. See also Dechert Comment Letter (urging the Commission to consider moving to a more uniform, standardized approach in determining whether to grant exemptive relief for non-fully transparent ETFs). PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM Continued 24OCR2 57182 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 that eliminating the T–1 order window may lead to wider bid-ask spreads, larger premiums/discounts, and greater tracking differences for these ETFs.240 One commenter stated that, without T– 1 orders, an ETF may have uninvested cash for longer periods of time (leading to increased tracking error) and authorized participants may need to hedge their exposures for longer than usual due to the delay between when the creation order is placed and when the ETF acquires the portfolio securities (leading to wider bid-ask spreads).241 Another commenter noted that moving the T–1 order window later into the evening to allow the ETF to calculate and disclose its portfolio holdings before accepting T–1 orders would require an additional staffing shift, and thus would impose additional staffing costs on sponsors, custodians, and other market participants.242 Commenters recommended alternatives to the proposed rule’s timing requirements. Several commenters suggested we require portfolio holdings disclosure only before the opening of regular trading on the primary listing exchange.243 These commenters asserted that authorized participants placing purchase or redemption orders on a T–1 basis are able to assess and hedge market risk associated with transacting in underlying foreign securities prior to regular trading in U.S. equity markets. Other alternatives suggested by commenters included: (i) Carving out ETFs investing in foreign markets from the proposed timing requirements; 244 and (ii) permitting ETFs to accept T–1 orders provided that they first share certain standardized information with authorized participants.245 (stating that ‘‘market participants have found that that benefits of agreeing to an order shortly after market close outweighs] the costs imposed by lack of certainty’’). 240 See, e.g., ICI Comment Letter (asserting that inability to trade at T–1 could introduce slippage, which in turn may lead to wider bid-ask spreads and larger premium/discounts); CSIM Comment Letter; Comment Letter of OppenheimerFunds (Oct. 1, 2018) (‘‘OppenheimerFunds Comment Letter’’). See also BlackRock Comment Letter (‘‘Many ETFs in the marketplace currently take orders prior to publication of basket or portfolio holdings information and operate efficiently and with tight spreads.’’). 241 See Dechert Comment Letter. 242 See Invesco Comment Letter. 243 See NYSE Comment Letter; CSIM Comment Letter; WisdomTree Comment Letter. 244 See Nasdaq Comment Letter. 245 See Invesco Comment Letter (suggesting that, as a condition for accepting T–1 orders, ETFs be required to provide APs with (1) the last-published portfolio holdings, (2) applicable corporate action information, (3) data relating to index changes, and (4) an updated basket file). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 After considering these comments, we are not adopting the proposed requirement that an ETF disclose its portfolio holdings before it starts accepting orders for the purchase or redemption of creation units. Instead, rule 6c–11 will require an ETF to disclose the portfolio holdings that will form the basis for the ETF’s next calculation of NAV per share each business day before the opening of regular trading on the primary listing exchange of the exchange-traded fund shares.246 This will accommodate T–1 orders, as requested by commenters, and is consistent with our existing exemptive orders.247 The goal of our proposed timing requirement was to facilitate effective arbitrage by providing authorized participants and other market participants buying and selling ETF shares with portfolio holdings information at the time of the transaction. We believe that accommodating T–1 orders, but requiring disclosure before the opening of regular trading on the primary listing exchange of the ETF’s shares, will nonetheless allow for effective arbitrage. Commenters stated that ETFs utilizing T–1 orders have shown relatively narrow bid-ask spreads and small premiums and discounts, and stated that precluding T–1 orders could have the unintended effect of actually widening bid-ask spreads and disrupting existing market practices.248 Moreover, staff review of the websites of several ETFs that disclose that they use T–1 orders indicates that these ETFs’ bid-ask spreads and premiums and discounts fall approximately within the same range as ETFs that do not use T– 1 orders. We considered whether to impose other conditions for the acceptance of T–1 orders, such as disclosure of the last published portfolio holdings. However, given the information already available to market participants and the data demonstrating that existing market practices have led to effective arbitrage, we do not believe additional conditions 246 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 rule 6c– 11(a)(1). 247 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), and related application (‘‘Salt Financial’’) (requiring disclosure of portfolio holdings before commencement of trading on the exchange). 248 See, e.g., Jane Street Comment Letter; ICI comment Letter; BlackRock Comment Letter; SIFMA AMG Comment Letter I. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 are currently necessary to facilitate arbitrage for these orders. b. Presentation of Portfolio Holdings Disclosure Rule 6c–11 will require an ETF to disclose standardized information regarding each portfolio holding.249 The rule, however, will not require this information to be presented and contain information in the manner prescribed within Article 12 of Regulation S–X as proposed.250 In response to concerns and suggestions of commenters, we have modified this condition to require ETFs to disclose a limited set of information for each portfolio holding.251 Commenters on this aspect of the proposal agreed that there currently is little consistency in the presentation of holdings information by ETFs,252 and generally agreed this disclosure should be standardized.253 Several commenters, however, stated that the specific presentation standard included in the proposed rule (i.e., Article 12 of Regulation S–X) is not an appropriate framework for daily portfolio holdings disclosures by ETFs.254 Commenters 249 Rule 6c–11(c)(1)(i). As proposed, the term ‘‘portfolio holdings’’ is defined to mean an ETF’s securities, assets, or other positions. See rule 6c– 11(a)(1). As a result, ETFs relying on rule 6c–11 are required to disclose securities, their cash holdings, as well as holdings that are not securities or assets, including short positions or written options. For example, an ETF will 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. We did not receive any comments on this definition. 250 See 2018 ETF Proposing Release, supra footnote 7, at nn.220–221 (noting that a staff review of ETF websites found little consistency in how portfolio holdings information was presented, particularly with respect to derivatives, which could lead to investor confusion). 251 See infra footnotes 257–260 and accompanying text. 252 See, e.g., Cary Comment Letter; ETF.com Comment Letter. 253 See, e.g., BlackRock Comment Letter; BNY Mellon Comment Letter; Fidelity Comment Letter. 254 See, e.g., Fidelity Comment Letter; ICI Comment Letter. The proposed Article 12 presentation requirements would have required an ETF to 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 the ETF’s investments in securities, securities sold short, and other investments. For derivatives, Article 12 would require disclosure that includes 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). See 17 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 asserted that certain of the Article 12 requirements are overly burdensome for daily disclosure or unnecessary to achieve the Commission’s goal of facilitating effective arbitrage.255 Some commenters recommended alternative approaches. Several commenters, for example, suggested using disclosure requirements based on the generic listing standards for actively managed ETFs.256 One of these commenters stated that using the generic listing standards would provide ‘‘more streamlined portfolio holdings disclosure that includes a subset of the items required by Article 12 that is most relevant and useful for investors.’’ 257 Other commenters stated that the Commission should consider a more limited set of requirements, such as: (i) The name of the security; (ii) the size of the position; (iii) the percentage exposure to such security; and (iv) the security’s value.258 Some commenters also recommended that, in addition to website disclosure, rule 6c–11 require CFR 210.12–12; 210.12–12A; 210.12–13; 210.12– 13A; 210.12–13B; 210.12–13C; and 210.12–13D. 255 See, e.g., WisdomTree Comment Letter (explaining that Article 12 requires detailed categorization of investments by investment type, industry, and country or geographic region and also requires identification of fair valued and nonincome producing securities); SIFMA AMG Comment Letter I (stating that information such as appreciation and depreciation for derivatives, as required under Article 12, would be difficult and impractical to calculate and disseminate on a daily basis); Comment Letter of Franklin Resources, Inc. (Oct. 1, 2018) (‘‘Franklin Templeton Comment Letter’’) (noting that certain data required under Article 12 is updated only on a quarterly basis and would not be easily accessible on a daily basis); BlackRock Comment Letter; ICI Comment Letter. 256 See, e.g., BlackRock Comment Letter; Fidelity Comment Letter; Eaton Vance Comment Letter. See also ICI Comment Letter (noting that standardizing ‘‘the presentation formats based on exchange listing requirements would obviate the need for two separate schedules, a costly and largely redundant exercise with no additional benefit’’). The listing exchanges’ current generic listing standards for actively managed ETFs require disclosure of ticker symbol; CUSIP or other identifier; description of the holding; identity of the asset upon which the derivative is based; strike price for any options; quantity of each security or other asset held as measured by (i) par value, (ii) notional value, (iii) number of shares, (iv) number of contracts, and (v) number of units; maturity date; coupon rate; effective date; market value; and percentage weight of the holding in the portfolio. See, e.g., NYSE Arca Rule 8.600–E(c)(2); Nasdaq Rule 5735(c)(2); Cboe BZX Rule 14.11(i)(3)(B). 257 See BlackRock Comment Letter. 258 See, e.g., WisdomTree Comment Letter. See also CSIM Comment Letter (suggesting that Commission adopt an ETF holdings disclosure requirement similar to what money market funds report on fund websites); Cary Comment Letter (recommending disclosure of the portfolio holding’s ticker symbol and weighting in the portfolio as minimum requirements); Comment Letter of ICE Data Services, Intercontinental Exchange (Oct. 1, 2018) (‘‘IDS Comment Letter’’) (stating that Commission should consider a standardized nomenclature for ETFs’ description of derivative holdings). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 ETFs to file portfolio holdings information in a central public location, such as EDGAR.259 We proposed the Article 12 framework because ETFs are already required to comply with Article 12 for periodic financial reporting purposes and therefore we believed that it would provide an efficient way to standardize daily portfolio holdings disclosure. After considering comments, however, we believe that a more streamlined requirement will provide standardized portfolio holdings disclosure in a more efficient, less costly, and less burdensome format, while still providing market participants with relevant information. Accordingly, rule 6c–11 will require an ETF to post a subset of the information required by the listing exchanges’ current generic listing standards for actively managed ETFs. Rule 6c–11 will require ETFs to disclose the following information for each portfolio holding on a daily basis: (1) Ticker symbol; (2) CUSIP or other identifier; (3) description of holding; (4) quantity of each security or other asset held; and (5) percentage weight of the holding in the portfolio.260 We believe that this framework will provide market participants with the information necessary to support an effective arbitrage mechanism and eliminate potential investor confusion due to a lack of standardization. As commenters suggested, to arbitrage an ETF’s holdings, market participants generally must be able to identify the security or asset held, the quantity held, and percentage weighting of the holding in the ETF’s portfolio.261 To enable market participants to identify the investment held, we are requiring the ETF to disclose the ticker, CUSIP or other identifier (where applicable) of the holding, and to provide a description of the holding. Because certain investments may not have been assigned a common securities identifier, we are requiring the ETF to provide a brief 259 See, e.g., Reagan Comment Letter. See also Morningstar Comment Letter (recommending that the Commission also require ETFs to disclose the information and other website disclosure requirements in structured format for analysis and comparison purposes); FIMSAC Comment Letter (recommending the rule require ETFs to file certain website disclosures on EDGAR or another public, centralized database). 260 Article 12 of Regulation S–X also generally requires disclosure of these items, but does not require a ticker, CUSIP, or other identifier for a holding. See, e.g., 17 CFR 210.12–12, 210.12–12A (requiring disclosure of name of issuer and title of issue). We believe that such identifiers can allow market participants to efficiently identify the asset or security held, and thus we included this requirement, which is required under the current generic listing standards for actively managed ETFs. 261 See, e.g., WisdomTree Comment Letter. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 57183 description of the investment to allow an investor to effectively hedge the ETF.262 For example, ETFs holding debt securities should include the security’s name, maturity date, coupon rate, and effective date, where applicable, to assist investors in identifying the specific security held.263 To indicate the quantity of a security or other asset held, the ETF generally should use the measure typically associated with quantifying that class of security, such as number of shares for equity securities, par value for debt securities, number of units for securities, such as UITs, that are measured in units, and dollar value for cash. With respect to derivatives, the ETF generally should provide both the notional value of the derivative and number of contracts, as well as a general description of the investment, which should include the type of derivative (i.e., swap, option, forward). ETFs also may want to consider several of the other reporting fields in Form N–PORT, for example, depending on the type of investment the ETF holds, in order to provide investors with the necessary information. We continue to believe that the ETF’s website is the most effective location for the disclosure of portfolio holdings information. By posting the portfolio information on its website, free of charge, the ETF makes the information available to a broad range of investors, including retail investors, and other market participants.264 We further believe, and commenters agreed, that requiring ETFs to file their portfolio holdings information on EDGAR would impose additional costs on ETFs that are not justified in light of other available disclosure methods.265 Moreover, the purpose of this requirement is to allow ETF investors to understand and potentially arbitrage the ETF’s holdings. We therefore do not believe that requiring ETFs to file daily portfolio 262 See, e.g., 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’’), at section II.A.4.g.i. (discussing use of unique securities identifiers for portfolio holdings and observing that some holdings lack such identifiers). 263 Based on our experience with structured portfolio reporting, such as Form N–PORT, we believe that this information will provide a sufficient amount of data for a market participant to understand the payment profile of the investment and therefore arbitrage the ETF’s portfolio holdings. See id., at section II.A.4.g.ii. 264 See 2018 ETF Proposing Release, supra footnote 7, at n.271 and accompanying text (discussing advantages of website posting over use of National Securities Clearing Corporation (‘‘NSCC’’) portfolio composition file). 265 See, e.g., Invesco Comment Letter (stating that additional dissemination requirements, such as EDGAR, would be costly). E:\FR\FM\24OCR2.SGM 24OCR2 57184 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations holding disclosure on EDGAR or other centralized location in order to provide potentially greater comparability across ETFs is justified in light of current market practices and the additional costs associated with such a requirement.266 In addition, other documents, such as reports on Form N– PORT or Form N–CEN, registration statements on Form N–1A, and consolidated structured datasets derived from those submissions, provide centralized, structured information, including information about portfolio holdings, that can be analyzed and compared across ETFs, albeit on a less frequent basis.267 khammond on DSKJM1Z7X2PROD with RULES2 c. Portfolio Holdings That Will Form the Basis for the ETF’s NAV Calculation As proposed, rule 6c–11 will 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.268 Changes in an ETF’s holdings of portfolio securities would therefore be reflected on a T+1 basis. We did not receive any comments on this proposed condition, which is consistent with current ETF practices. We continue to believe that requiring an ETF to disclose the portfolio that will form the basis for the next NAV calculation at the beginning of the business day will help to facilitate the efficient functioning of the arbitrage process while protecting against potential front-running of the ETF’s trades. Accordingly, rule 6c–11 will not require ETFs to disclose intraday changes in portfolio holdings because these changes would not affect the portfolio composition serving as a basis for NAV calculation until the next business day.269 We continue to believe that the selective disclosure of nonpublic information regarding intraday changes in portfolio holdings (or any advance disclosure of portfolio trades) could result in the front-running of an ETF’s trades, causing the ETF to pay more to obtain a security.270 We 266 As stated above, however, we encourage ETFs to consider whether there are technological means, such as including portfolio holdings information in a machine-readable format, to make these disclosures more accessible. See supra footnote 226. 267 See, e.g., Part C of Form N–PORT. 268 See rule 6c–11(c)(1)(i). See also 2018 Proposing Release, supra footnote 7, at nn.210–211 and accompanying text. 269 See 2018 ETF Proposing Release, supra footnote 7, at note 222 and accompanying text. 270 We also requested comment in the proposal on whether we should amend Regulation FD to apply to ETFs. Regulation FD prohibits the selective disclosure of material information by publicly traded companies and other issuers. See 2018 ETF Proposing Release, supra footnote 7, at n.228. We received two comments stating that ETFs should be VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 have stated that registered investment companies’ compliance policies and procedures required by 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.271 ETFs also are required to describe their policies and procedures on portfolio security disclosure in the Statement of Additional Information and post such policies and procedures on their websites.272 5. Baskets As proposed, rule 6c–11 will require an ETF relying on the rule to adopt and implement written policies and procedures governing the construction of baskets and the process that the ETF will use for the acceptance of baskets.273 In addition, as proposed, the rule will provide an ETF with flexibility to use ‘‘custom baskets’’ if the ETF has adopted 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 employees of the ETF’s investment adviser who are required to subject to Regulation FD. See Eaton Vance Comment Letter; Jane Street Comment Letter. However, we are not amending Regulation FD at this time in order to further explore certain aspects of applying Regulation FD to ETFs, which unlike other entities subject to this regulation, are continuously offered. 271 Rule 38a–1 Adopting Release, supra footnote 134. Pursuant to rule 6c–11, ETFs are required to disclose portfolio holdings information with greater frequency than other open-end funds, which are generally required to publicly disclose holdings on a quarterly basis. However, we have previously noted that 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. See 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. 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. Id. 272 See Items 9(d) and 16(f) of Form N–1A; see also Disclosure of Portfolio Holdings Release, supra footnote 272, at section II.C. 273 See rule 6c–11(c)(3). The rule will 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 rule 6c–11(a)(1). PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 review each custom basket for compliance with those parameters (‘‘custom basket policies and procedures’’).274 a. Basket Policies and Procedures When 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. Basket composition affects the costs of assembling and delivering the baskets exchanged for creation units as well as the costs of liquidating basket securities when redeeming creation units.275 Basket composition also is important to ETF portfolio management, as each in-kind creation or redemption increases or decreases positions in the ETF’s portfolio, and allows portfolio managers to add or remove certain portfolio holdings. 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, undesired changes to the portfolio may result, such as the loss of desirable bonds when paying redemptions in kind. The exemptive relief relating to baskets evolved over time. 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.276 Since approximately 2006, however, our orders placed tighter restrictions on an open-end ETF’s composition of baskets.277 These orders expressly require 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.278 274 See rule 6c–11(c)(3); see also infra footnote 299 and accompanying text. 275 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. 276 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. Our earliest ETF orders for ETFs organized as UITs provide 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. Given the unmanaged nature of the UIT structure, a UIT ETF’s basket generally reflected a pro rata representation of the ETF’s portfolio. See SPDR, supra footnote 51. 277 See, e.g., 2006 WisdomTree Investments, supra footnote 201. 278 See id.; see also 2018 ETF Proposing Release, supra footnote 7, at nn. 238–242 and accompanying E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 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 that favors an 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-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.279 Based on our experience with ETFs, however, we believe there are many circumstances, in addition to the specific circumstances enumerated in our orders, where allowing basket assets to differ from a pro rata representation or allowing the use of different baskets 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 basket when transacting in kind, making it more difficult and costly for authorized participants and other market participants to assemble or liquidate baskets. This could result in wider bidask spreads and potentially less efficient arbitrage. In such circumstances, these ETFs may be at a competitive disadvantage to ETFs with greater 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 later, more stringent restrictions on baskets. Moreover, certain exceptions to a pro rata basket requirement may help ETFs operate more efficiently. For example, ETFs, particularly fixed-income ETFs, that do not have basket flexibility may text (describing the circumstances when a basket could deviate from a pro rata representation of the ETF’s portfolio under recent exemptive orders). 279 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. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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.280 ETFs that meet redemptions in cash may 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.281 We therefore proposed to provide additional basket flexibility, subject to conditions designed to address concerns regarding the potential risk of overreaching. Specifically we proposed to require ETFs to adopt: (i) Policies and procedures governing the construction of baskets and the process that would be used for the acceptance of baskets generally; and (ii) heightened process requirements for ETFs using custom baskets, including policies and procedures specifically covering the use of custom baskets.282 Commenters generally supported requiring ETFs to adopt policies and procedures governing the construction of baskets.283 One commenter stated, for example, that this requirement is consistent with other investment and portfolio management processes that require guidelines, oversight and recordkeeping.284 Commenters also generally supported our proposal to permit ETFs relying on the rule to use custom baskets provided they adopt 280 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 LLCP, 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. 281 In-kind redemptions allow ETFs to avoid taxable events and certain transaction costs that arise when selling securities for cash within the ETF. See, e.g., Prudential Investments LLC, et al., Investment Company Act Release Nos. 32351 (Nov. 1, 2016) (notice) [81 FR 78228 (Nov. 7, 2016)] and 32374 (Nov. 30, 2016) (order) and related application (stating that cash redemptions may result in adverse tax consequences and higher transaction costs, such as brokerage costs, than inkind redemptions). Additionally, based upon Form N–CEN data through September 5, 2019, the median transaction fee charged to an authorized participant for the use of an in-kind basket to satisfy a redemption was approximately $350.00, while the median transaction fee for the use of a basket that was partially or fully composed of cash was approximately $375.00, when charged on a percreation-unit basis. 282 See 2018 ETF Proposing Release, supra footnote 7, at section II.5.a. 283 See, e.g., ICI Comment Letter; BlackRock Comment Letter; SIFMA AMG Comment Letter I. 284 See SIFMA AMG Comment Letter I. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 57185 certain heightened process requirements.285 These commenters agreed that providing ETFs with the flexibility to use custom baskets potentially could benefit ETF investors through more effective arbitrage and more efficient portfolio management.286 One commenter provided the results of an analysis it performed indicating that fixed-income ETFs with basket flexibility had narrower bid-ask spreads, had lower tracking differentials (i.e., the difference between the ETF’s daily return and the daily return of its benchmark), and traded at smaller discounts than fixed-income ETFs without basket flexibility.287 One commenter, however, asserted that the rule should not afford custom basket flexibility to all ETFs relying on it.288 Rather, this commenter opined that the rule should require fixedincome ETFs to make in-kind, pro rata redemptions upon shareholder request (with limited substitutions for holdings that cannot be settled or transferred) because, under certain market conditions, custom baskets can lead to greater price volatility and dislocation from NAV for these ETFs. Some commenters, although generally supporting custom basket flexibility and the proposed heightened process requirements, requested that we modify or clarify certain aspects of the proposed condition.289 For example, one commenter did not support requiring ‘‘detailed parameters’’ for the construction and acceptance of custom baskets, stating that the rule should permit ETF sponsors to develop broad policies and procedures to cover the wide range of circumstances that may arise relating to custom baskets.290 Another commenter stated that the Commission should explicitly set forth the appropriate considerations for custom basket policies and procedures, such as periodic monitoring and testing and oversight of the custom basket process.291 This commenter also stated that the Commission should clarify that an ETF has discretion to tailor its custom basket policies and procedures to address different risks, considerations, and requirements for 285 See, e.g., ICI Comment Letter; BlackRock Comment Letter; Invesco Comment Letter; BNY Mellon Comment Letter; IDC Comment Letter; Fidelity Comment Letter. 286 See, e.g., BlackRock Comment Letter. 287 See ICI Comment Letter. See also infra footnotes 574–575 and accompanying text. 288 See Bluefin Comment Letter. 289 See, e.g., ICI Comment Letter; BlackRock Comment Letter; Invesco Comment Letter; BNY Mellon Comment Letter; IDC Comment Letter; Fidelity Comment Letter; Dechert Comment Letter. 290 See Invesco Comment Letter. 291 See BlackRock Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 57186 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations different types of custom baskets, particularly those involving cash substitutions. We are adopting the basket conditions under rule 6c–11 as proposed. Rule 6c– 11 therefore will require an ETF 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 as proposed.292 These policies and procedures must cover the methodology that the ETF will use to construct baskets. For example, the policies and procedures should detail the circumstances under which the basket may omit positions that are not operationally feasible to transfer in kind. The policies and procedures also 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. 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 underlying securities market index, if applicable. We believe this policies and procedures requirement will protect against overreaching and other abusive practices in circumstances where an ETF uses a basket that does not reflect a pro rata slice of the ETF’s portfolio holdings, but does not meet the definition of custom basket. Rule 6c–11 also will require the policies and procedures to (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.293 We continue to believe that an ETF and its shareholders may benefit from custom baskets and that the heightened process requirements for custom baskets in rule 6c–11 serve to protect the ETF and its shareholders from the risks that custom baskets may present. 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. They also should describe the ETF’s approach for testing compliance with the custom basket policies and procedures and assessing (including 292 See rule 6c–11(c)(3). 6c–11(c)(3)(i) and (ii). 293 Rule VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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. An ETF should consistently apply the custom basket policies and procedures 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, an ETF’s custom basket policies and procedures should include reasonable controls designed to prevent inappropriate differential treatment among authorized participants. We do not believe that the requirement for ‘‘detailed parameters’’ would prevent an ETF sponsor from developing policies and procedures to cover the wide range of circumstances that may arise relating to custom baskets.294 ETFs may tailor their custom basket policies and procedures to address different risks and requirements for different types of custom baskets. For example, an ETF could develop tailored procedures when it uses cash substitutions that differ from the procedures it uses when substituting securities and other positions. An ETF’s custom basket policies and procedures also could address the differing considerations for custom baskets depending on the direction of the trade (i.e., whether the custom basket is being used for a creation or a redemption).295 This condition provides 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 facilitating portfolio management changes in a cost- and tax-efficient manner. Although one commenter opined that fixed-income ETFs present unique concerns, we believe that requiring fixed-income ETFs to establish detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders will address the risks associated with custom baskets. As discussed above, we also believe that fixed-income ETFs (and their shareholders) may experience the most pronounced benefits from basket flexibility.296 As a result, all ETFs that comply with the conditions in rule 6c– 11 will have basket flexibility. 294 See Invesco Comment Letter. BlackRock Comment Letter. 296 See supra footnotes 281–282 and accompanying text and footnote 288 and accompanying text. 295 See PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 One commenter stated that the Commission should confirm that the ‘‘best interests of the ETF and its shareholders’’ standard included in rule 6c–11(c)(3)(i) includes the ETF’s shareholders generally rather than individually, on the basis that the adviser to an ETF owes a fiduciary duty only to the ETF, and that ETFs cannot evaluate the interests of individual shareholders.297 The ‘‘best interests of the ETF and its shareholders’’ in this context is not intended to apply to each ETF shareholder individually, but rather to the ETF’s shareholders generally. This formulation is consistent with other Commission rules.298 As proposed, rule 6c–11 also will require an ETF, as part of its custom basket policies and procedures, to 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. Several commenters did not support this requirement as proposed.299 One of these commenters stated that the rule should require ETFs to identify only the employees that are responsible for approving custom baskets that deviate from the parameters set forth in the policies and procedures.300 Another commenter stated that the review requirement is overly prescriptive and could cause operational challenges when an ETF is sub-advised.301 In addition, several commenters did not support the statement in the 2018 ETF Proposing Release that 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.302 Commenters stated that approval of custom baskets is a typical portfolio management function, and that requiring non-investment personnel to review custom baskets before approving a creation or redemption would be 297 See SIFMA AMG Comment Letter I. e.g., 17 CFR 270.12b–1 (rule 12b–1 under the Act) (providing that fund board may approve distribution plan under rule 12b–1 only if, among other things, the board concludes ‘‘that there is a reasonable likelihood that the plan will benefit the company and its shareholders’’); 17 CFR 270.2a–7 (rule 2a–7 under the Act) (providing that board of a money market fund, in order to use certain share price calculation methods, must determine ‘‘that it is in the best interests of the fund and its shareholders’’ to maintain a stable net asset value per share). 299 See, e.g., SIFMA AMG Comment Letter I; WisdomTree Comment Letter I. 300 See SIFMA AMG Comment Letter I. 301 See WisdomTree Comment Letter. 302 See, e.g., Dechert Comment Letter; Fidelity Comment Letter; JPMAM Comment Letter; SIFMA AMG Comment Letter I; Invesco Comment Letter; CSIM Comment Letter; SSGA Comment Letter I. 298 See, E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 impractical, burdensome, and would detract from the flexibility custom baskets provide.303 One commenter requested that the Commission clarify that the requirement to approve custom baskets applies only to employees with discretionary or direct supervisory authority over custom baskets, and not to employees responsible for governance, back-testing, or periodic reviews.304 We continue to 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.305 We also believe that the adviser is in the best position to determine which employee (or employees) are responsible for determining whether an ETF’s custom baskets comply with the custom basket policies and procedures depending on its own structure, strategy, and other relevant circumstances (including whether the ETF is sub-advised). The ETF’s adviser (and personnel) are familiar with the ETF’s portfolio holdings and are able to assess whether the process and methodology used to construct or accept a custom basket is 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 will allow an ETF to establish a tailored framework for the use of custom baskets, while also requiring the ETF to put into place safeguards against abusive practices related to basket composition. To the extent that a particular ETF’s investment adviser determines that its portfolio management employees are the appropriate employees to be responsible for compliance with the custom basket policies and procedures, we believe that the requirements of rule 38a–1 under the Act provide appropriate safeguards to address possible conflicts of interest that could arise from such an arrangement. For example, ETFs 303 See, e.g., Dechert Comment Letter; Fidelity Comment Letter; JPMAM Comment Letter; Invesco Comment Letter; CSIM Comment Letter. 304 See BlackRock Comment Letter. 305 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 64, at n.68. See also supra footnote 64 (discussing certain other obligations for registered investment advisers). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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.306 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–1.307 For example, an ETF would be required to preserve the basket policies and procedures pursuant to the requirements of rule 38a–1(d)(1). Also, 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.308 b. Definition of Custom Baskets As proposed, rule 6c–11 will define ‘‘custom baskets’’ to include two categories of baskets. First, a basket containing a non-representative selection of the ETF’s portfolio holdings would constitute a custom basket.309 These types of custom baskets include, but are not limited to, baskets that do not reflect: (i) A pro rata representation of the ETF’s portfolio holdings; (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.310 306 See Rule 38a–1 Adopting Release, supra footnote 134. Among other things, rule 38a–1 requires a fund’s chief compliance officer to provide a written report to the fund’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). 307 The compliance policies and procedures could require, for example, the ETF’s chief compliance officer or other compliance professionals to conduct a post hoc, periodic review of a sample of custom baskets used by the ETF. 308 Several commenters expressed support for the description in the 2018 ETF Proposing Release of the oversight role of ETF boards, including with respect to custom basket policies and procedures. See ETF.com Comment Letter; IDC Comment Letter; Nasdaq Comment Letter. 309 Rule 6c–11(a)(1). 310 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’’ except to the extent different baskets are used in transactions on the same business day. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 57187 Second, if different baskets are used in transactions on the same business day, each basket after the initial basket would constitute a custom basket. For example, if an ETF exchanges a basket with either the same or another authorized participant that reflects a representative sampling that differs from the initial basket, that basket (and any such subsequent baskets) would be a custom basket.311 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 received a number of comments on the proposed definition of custom basket. Several commenters asserted that baskets including cash substitutions should not be subject to the heightened policies and procedures requirement for custom baskets, and thus should be excluded from the definition of custom baskets.312 These commenters asserted that baskets with cash substitutions do not raise the same concerns about conflicts or overreach as securities substitutions.313 Commenters also contended that the use of cash substitutions as part of standard (i.e., non-custom) baskets is a routine portfolio management matter that is necessary for the efficient operation of ETFs.314 One commenter suggested several technical changes to the proposed definition of custom basket in rule 6c–11 to treat cash substitutions as part of a non-custom, pro rata basket under certain enumerated circumstances.315 311 When making the best interest determination for such custom baskets, the ETF should consider how this change in sampling affects the ETF’s portfolio. 312 See, e.g., ICI Comment Letter; BlackRock Comment Letter; Fidelity Comment Letter; Dechert Comment Letter; SIFMA AMG Comment Letter I; SSGA Comment Letter I. 313 See, e.g., Fidelity Comment Letter (‘‘Purchasing or redeeming using a cash basket does not create opportunities for ‘cherry picking,’ ‘dumping’ or other abuses . . . and therefore does not give rise to the risk of overreaching that the proposed custom basket policies and procedures were designed to prevent.’’); ICI Comment Letter; BlackRock Comment Letter; SIFMA AMG Comment Letter I; JPMAM Comment Letter. 314 See, e.g., SIFMA AMG Comment Letter I (asserting that ‘‘the use of cash is driven by restrictions applicable to authorized participants, restrictions on in-kind transactions in certain markets, or authorized participants’ inability to access individual securities.’’); JPMAM Comment Letter. See also CSIM Comment Letter (recommending that the standard basket policies and procedures, rather than the custom basket policies and procedures, cover cash substitutions). 315 See BlackRock Comment Letter (recommending that we deem a basket to be pro rata if it: (1) Substitutes cash for odd lot positions or as a result of minimum trade sizes; (2) substitutes cash due to security specific restrictions, such as corporate actions or regulatory reasons; (3) E:\FR\FM\24OCR2.SGM Continued 24OCR2 57188 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations After consideration of these comments, we are adopting the definition of ‘‘custom basket’’ as proposed. While we generally agree with commenters that cash substitutions may not raise the same concerns as securities substitutions, an ETF’s use of cash substitutions may raise concerns regarding the potential for an authorized participant to overreach, particularly in connection with redemptions. For example, during periods of market stress, an authorized participant may demand cash from the ETF instead of less liquid securities in exchange for ETF shares, impacting the liquidity of the ETF’s portfolio and the ability of the ETF to satisfy additional cash redemption requests from authorized participants.316 We also considered excluding certain types of cash substitutions from the definition of custom baskets where authorized participant overreach is unlikely, consistent with the approach taken in our recent exemptive orders.317 However, we are concerned that such an approach may fail to effectively capture all circumstances in which an ETF may substitute cash. We believe that the policies and procedures requirements for custom baskets will provide ETFs with sufficient flexibility to design custom basket policies and procedures that are tailored to address the different risks that cash substitutions and securities substitutions may present. An ETF could, for example, design custom basket policies and procedures with more streamlined requirements for certain cash substitutions that present lower risks.318 c. Basket Publication Requirement khammond on DSKJM1Z7X2PROD with RULES2 Proposed rule 6c–11 would have required an ETF to post information regarding 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 (a ‘‘published basket’’) on its website each business day.319 This proposed disclosure requirement was designed to: (i) Facilitate arbitrage by providing authorized participants and other market participants with timely information regarding the contents of a basket that the ETF will accept each substitutes cash for positions or other instruments that cannot be delivered in-kind (e.g., derivatives, to-be-announced (or ‘‘TBA’’) transactions); or (4) is otherwise representative of the ETF). 316 See generally LRM Adopting Release, supra footnote 123. 317 For example, authorized participant overreach is unlikely where the ETF substitutes cash for odd lot positions or as a result of minimum trade sizes. 318 See BlackRock Comment Letter. 319 See proposed rule 6c–11(c)(1)(i). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 day; and (ii) allow market participants that do not have access to an ETF’s daily portfolio composition file to compare the ETF’s basket with its portfolio holdings, assist in building intraday hedges, and estimate the cash balancing amount. After considering comments, however, the Commission is not including a basket publication requirement in rule 6c–11. Commenters generally did not support requiring disclosure of a published basket on the ETF’s website.320 For example, one commenter asserted that the proposed published basket was ‘‘speculative,’’ and had little value, particularly for certain types of fixed-income ETFs.321 Several commenters contended that the contents of an ETF’s basket are irrelevant for secondary market investors and publication of an ETF’s basket could result in confusion, particularly if the basket is mistaken for portfolio holdings information.322 Other commenters stated that the publication requirement could delay the process by which the ETF and an authorized participant negotiate the contents of a custom creation or redemption basket.323 Another commenter stated that we should require an ETF to provide its published basket through the NSCC, rather than through its website, because the market participants that would use the published basket currently are able to access it either directly through the NSCC or through intermediaries.324 After considering these comments, the Commission is not including in rule 6c– 11 a requirement that an ETF post information regarding one published basket that it would exchange for orders to purchase or redeem creation units. We proposed this condition, in part, because we were concerned that certain market participants that needed access to basket information for arbitrage purposes would not have access to ETF portfolio composition files.325 However, 320 See, e.g., SIFMA AMG Comment Letter I; Invesco Comment Letter I; Nasdaq Comment Letter; CSIM Comment Letter. 321 See, e.g., SIFMA AMG Comment Letter I; see also CSIM Comment Letter (‘‘CSIM does not believe that disclosure of one standard basket for orders to create or redeem creation units on an ETF’s website would be useful disclosure to either individual investors or authorized participants as proposed.’’). 322 See, e.g., CSIM Comment Letter; ICI Comment Letter. One commenter also noted that the proposed amendments to Form N–1A eliminated other disclosure that were relevant only to authorized participants and potentially confusing to secondary market investors. See ICI Comment Letter. 323 See, e.g., Invesco Comment Letter; Nasdaq Comment Letter. 324 See OppenheimerFunds Comment Letter. 325 See 2018 ETF Proposing Release, supra footnote 7, at section II.5.b. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 we understand from commenters that market participants that use basket information, including those seeking to hedge exposure to an ETF, currently have access to this information through the NSCC, an intermediary, or the ETF itself. We are, however, requiring ETFs to provide daily website disclosure of portfolio holdings, which we believe will provide market participants with the necessary tools to determine if an arbitrage opportunity exists and to hedge the ETF’s portfolio.326 As a result, we believe that the publication of a single published basket would provide little additional value to market participants assessing the existence of arbitrage opportunities. We also agree with commenters’ concerns that some investors may confuse the published basket information with an ETF’s portfolio holdings information. We requested comment on whether we should require an ETF to publish certain information regarding each basket used by the ETF to ameliorate some of the limitations associated with publication of a single basket each day and to serve as an additional check against overreaching by authorized participants.327 However, commenters stated that such a requirement would be costly to implement and unnecessarily burdensome, particularly because basket composition information is not used by secondary market investors.328 In addition, commenters asserted that publication of each basket could raise the risk that market participants frontrun trades in basket securities or attempt to replicate authorized participants’ or other market makers’ trading strategies, particularly for those ETFs that have more frequent primary market transactions.329 Rule 6c–11 as adopted instead will require ETFs to maintain certain information regarding each basket exchanged with an authorized participant.330 We believe that this record keeping requirement is a more efficient way to ensure compliance with the rule, while 326 See rule 6c–11(c)(1); see also 2018 ETF Proposing Release, supra footnote 7, at section II.C.4. (stating that 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). 327 See 2018 ETF Proposing Release, supra footnote 7, text following nn.269 and 272. 328 See, e.g., ICI Comment Letter; SSGA Comment Letter I; Vanguard Comment Letter. 329 See, e.g., ICI Comment Letter; SSGA Comment Letter I; SIFMA Comment Letter; Vanguard Comment Letter (also opining that publication of each custom basket could confuse investors); but see Morningstar Comment Letter (advocating for disclosure of all baskets in a structured format). 330 See infra section II.D. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations mitigating concerns regarding potential overreaching by authorized participants. 6. Website Disclosure There has been a significant increase in the use of the internet as a tool for disseminating information, and many investors obtain information regarding ETFs on ETF websites.331 Rule 6c–11 therefore will require ETFs to disclose certain information on their websites as a condition to the rule.332 The website disclosure requirements 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, under rule 6c–11 the following information must be disclosed publicly and prominently on the ETF’s website: 333 • NAV per share, market price, and premium or discount, each as of the end of the prior business day; • A table and chart showing the number of days the ETF’s shares traded at a premium or discount during the most recently completed calendar year and calendar quarters of the current year; 334 • For ETFs whose premium or discount was greater than 2% for more than seven consecutive trading days, disclosure that the premium or discount was greater than 2%, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount; and • Median bid-ask spread over the most recent thirty calendar days. a. Disclosure of Prior Business Day’s NAV, Market Price, and Premium or Discount khammond on DSKJM1Z7X2PROD with RULES2 As proposed, rule 6c–11 will require an ETF to post on its website the ETF’s current NAV per share, market price, and premium or discount, each as of the end of the prior business day.335 This disclosure provides investors with a 331 See, e.g., Reporting Modernization Adopting Release supra footnote 263. 332 Rule 6c–11(c)(1). 333 See rule 6c–11(c)(1); see also supra footnote 226. 334 This requirement is similar to a current requirement in Item 11(g)(2) of Form N–1A, which requires disclosed percentages to be rounded to the nearest hundredth of one percent. See Current Instruction 2 to Item 11(g)(2) of Form N–1A. ETFs may similarly round percentages disclosed in response to this provision of rule 6c–11. 335 Rule 6c–11(c)(1)(ii); 2018 ETF Proposing Release, supra footnote 7, at section II.C.6. Proposed rule 6c–11 would have required this information ‘‘as of the prior business day.’’ Proposed rule 6c– 11(c)(1)(ii). For clarity, the final rule will specify that the information be provided ‘‘as of the end of the prior business day.’’ Rule 6c–11(c)(1)(ii). This is consistent with our existing exemptive orders. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 57189 ‘‘snapshot’’ view of the difference between an ETF’s NAV per share and market price on a daily basis. Commenters generally supported this requirement, observing that the investors should have easy access to the required information.336 Some commenters, however, questioned the benefits of the premium or discount disclosure requirement. One such commenter stated that premium and discount disclosures do not provide the same benefit to shareholders as NAV per share and market price.337 Another commenter, while not objecting to the posting of daily premiums or discounts, opined that emphasizing this information would be unnecessary and—to the extent that a discount might be understood by prospective investors as a bargain—potentially misleading.338 We continue to believe that daily website disclosure of NAV per share and market price will promote transparency and alert investors to the relationship between NAV per share and market price. We also believe that this information will help investors better understand the risk that an ETF’s market price may be higher or lower than the ETF’s NAV per share and compare this information across ETFs. Daily premium/discount disclosures also will provide investors with useful information regarding ETFs that frequently trade at a premium or discount to NAV per share.339 We believe that ETF investors use this information today.340 These disclosures are consistent with our exemptive orders except that rule 6c–11 includes a definition of ‘‘market price’’ that differs from the definition applicable to those orders. Rule 6c–11 defines ‘‘market price’’ as: (A) The official closing price of an ETF share; or (B) 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’’) as of that time.341 One commenter addressed our proposed definition of ‘‘market price’’ and asserted that the rule should permit ETFs to use the midpoint of the NBBO without evaluating whether it more accurately reflects the market value of the ETF’s shares.342 We continue to believe, however, that using the ‘‘official closing price’’ provides a more precise measurement of an ETF’s market price than other alternatives, including during disruptive market events.343 Requiring use of the midpoint of the NBBO only if it more accurately reflects market value also provides an appropriate degree of flexibility to an ETF when its closing price may be stale or otherwise does not reflect the ETF share’s market value, while at the same time providing a consistent and verifiable methodology for how ETFs determine market 336 See ETF.com Comment Letter; ICI Comment Letter (stating that the commenter does ‘‘not object to’’ the requirement); NYSE Comment Letter (stating that the website disclosure requirements in rule 6c– 11 ‘‘sufficiently address Commission concerns about investors’ better understanding trading costs’’); Virtu Comment Letter; CSIM Comment Letter. 337 See Invesco Comment Letter. 338 See SSGA Comment Letter I (‘‘Similarly, investors may choose not to buy ETF shares because of a premium, when in fact the NAV is based on stale prices from an earlier close.’’). One commenter recommended that we also require footnote disclosure when premium or discount information is known to include inaccurate data due to exchange-hours overlap issues (i.e., when the ETF does not trade contemporaneously with its underlying holdings). See ETF.com Comment Letter. Rule 6c–11 as adopted will not require additional footnote disclosure in these circumstances because a majority of ETFs do not have this type of timing issue and the recommended disclosure may not capture other circumstances where an ETF’s premium or discount reflects inaccurate data. ETFs may include this context alongside the premium/discount disclosures on their websites as applicable. 339 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, and an ETF with a less efficient arbitrage mechanism may frequently show this type of end of day deviation. 340 One commenter suggested that investors are more likely to look for information on the website of the entity with which they interact, such as a broker-dealer. See JPMAM Comment Letter. However, we believe that ETF issuers, as the entities that are the subject of this rule’s relief, should provide investors with this information to assist those shareholders who visit the ETF’s website in the first instance. Moreover, another commenter stated that smaller investors rely predominantly on website disclosures for their investment analysis. See ETF.com Comment Letter. 341 See rule 6c–11(a)(1). 342 See WisdomTree Comment Letter. An ETF uses the market price of an ETF share in calculating premiums and discounts. See rule 6c–11(a)(1) (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). 343 See 2018 ETF Proposing Release, supra footnote 7, at n.281 and accompanying text. We believe that using the ‘‘official closing price’’ is a better measure than, for example, only the last price at which ETF shares traded on their principal U.S. trading market during a regular trading session, 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. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations b. Disclosure of Table and Line Graphs of the ETF’s Premiums and Discounts As proposed, rule 6c–11 will 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.345 For new ETFs that do not yet have this information, the rule will require the ETF to post this information for the life of the fund.346 We believe that presenting the data as both a table and a line graph will provide investors with useful information in formats that are easy to view and understand, depending on the investor’s preference.347 This disclosure is similar to current requirements that allow an ETF to omit certain premium/discount disclosures from its prospectus and annual report if the ETF posts on its website a table showing the number of trading days the ETF traded at a premium and the number of days it traded at a discount.348 Commenters were generally supportive of this requirement.349 However, some commenters recommended that the rule require only one of the two presentations.350 We recognize, as commenters observed, that the same information underlies both presentations. However, each presentation highlights different information, as illustrated in Figure 1 and Table 1 below. The tabular disclosure shows investors how often the ETF traded at a premium or discount. The graphic disclosure shows investors the degree of those deviations, particularly during periods of market stress, and could assist some investors with understanding how the arbitrage mechanism performs for an ETF under various market conditions.351 Different audiences also may find one presentation more effective.352 Therefore, we continue to believe that the rule should require both disclosures, and are adopting this aspect of the rule as proposed. 344 Use of the midpoint of the NBBO, for example, mitigates the potential for gaming practices that could inaccurately minimize a deviation between market price and NAV per share when showing premiums and discounts. Because security information processors calculate NBBO continuously during the trading day, NBBO has the benefit of being a verifiable third-party quote. 345 Rule 6c–11(c)(1)(iii)–(iv). 346 For example, an ETF that has been in existence for 4 months should provide this disclosure for its first quarter of operations. 347 While past performance cannot predict how an ETF will trade in the future, 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. 348 See 2018 ETF Proposing Release, supra footnote 7, at n.300 and accompanying text; see also infra section II.H.2.c. (discussing the elimination of this requirement in Form N–1A for funds relying on rule 6c–11). 349 See, e.g., JPMAM Comment Letter; ETF.com Comment Letter; ICI Comment Letter (does not object to requirements). 350 John Hancock Comment Letter (recommending elimination of the proposed line graph requirement as it would result in disclosure duplicative of the table); WisdomTree Comment Letter (stating the line graph requirement would be adequate and that the required table would be too detailed). 351 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. 352 Another commenter recommended that we require ETFs to provide a separate line graph showing an ETF’s market price and NAV per share over the most recently completed calendar year and quarters. See JPMAM Comment Letter. While we agree that this context could be informative, we believe that the rule as proposed appropriately balances the usefulness of the line graph disclosure with the costs of preparation. Of course, ETFs may include this context alongside the required disclosures on their websites, so long as the information is not misleading. khammond on DSKJM1Z7X2PROD with RULES2 price.344 Therefore, we have determined to adopt the definition of ‘‘market price’’ for purposes of this website disclosure requirement as proposed. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00030 Fmt 4701 Sfmt 4725 E:\FR\FM\24OCR2.SGM 24OCR2 ER24OC19.018</GPH> 57190 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 57191 TABLE 1—SAMPLE PREMIUM AND DISCOUNT TABLE Calendar year 2018 Days traded at premium .......................................................................................................................................... Days traded at discount ........................................................................................................................................... The rule will require historical premium/discount information for the most recently completed calendar year and the most recently completed calendar quarters of the current year as proposed. Some commenters recommended that we require ETFs to update this information on a daily basis or require ETFs to present intra-day premiums or discounts in certain circumstances.353 However, after considering the usefulness of timely information for investors and other data users and the costs of more frequent collection and publication of the information, we continue to believe the rule should require disclosure of this information only on a quarterly basis. First, this period is consistent with existing prospectus disclosure requirements, and we believe the time period will allow investors to readily observe the extent and frequency of deviations from NAV per share in a graphic format. Second, as discussed above, although the trailing historical data is subject to a less frequent quarterly updating requirement, the current premium or discount is required to be disclosed daily. c. Disclosure of ETF Premiums or Discounts Greater Than 2% khammond on DSKJM1Z7X2PROD with RULES2 As proposed, rule 6c–11 will require an ETF whose premium or discount was greater than 2% for more than seven consecutive trading days to post that information on its website,354 along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount.355 We continue to believe that 353 See CFA Comment Letter; Eaton Vance Comment Letter; Comment Letter of Hagens Berman (Oct. 1, 2018) (‘‘Hagens Berman Comment Letter’’). (‘‘[T]he new rule should require disclosure of the gross discount spreads that have reoccurred during times of high volatility or lack of liquidity.’’). 354 We have modified the proposed rule text to further clarify that an ETF must post a statement that the ETF’s premium or discount, as applicable, was greater than 2%—and not only the factors reasonably believed to have materially contributed to the premium or discount. See rule 6c– 11(c)(1)(vi). 355 Rule 6c–11(c)(1)(vi). The rule will require ETFs to post this information 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 disclosure of such periods will promote transparency about the significance and persistence of deviations between market price and NAV per share, and may help investors to make more informed investment decisions.356 One commenter supported this requirement, stating that daily premium and discount information is an important metric for investors.357 This commenter stated that its internal metrics suggest that it would be unusual for ETFs to trigger the proposed disclosure requirement, and therefore the disclosure ‘‘would not be burdensome’’ for ETFs. Other commenters, however, opposed the proposed requirement, expressing concern that ETFs holding certain asset classes are more likely to trigger the requirement than others, and that disclosure by ETFs that frequently trigger the requirement could become inappropriately repetitive.358 We recognize that this disclosure requirement may affect certain categories of ETFs more than others. 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 for an extended period of time. We believe that this information could help to inform investors about the nature of these ETFs and the potential for frequent deviations. However, we believe this requirement will affect a broader range of ETFs than just those investing in certain foreign markets. For example, we estimate that, out of a total 2,046 ETFs, 11 alternative ETFs, 20 international equity ETFs, 2 sector equity ETFs, 1 taxable bond ETF, and 15 U.S. equity ETFs would have triggered the 2% premium or discount than 2%) and maintain it on their websites for at least one year following the first day it was posted. 356 2018 ETF Proposing Release, supra footnote 7, at text preceding n.307 (stating that the proposed information also may provide the market (and the Commission) with information regarding the efficiency of an ETF’s arbitrage mechanism). 357 See Invesco Comment Letter. 358 See, e.g., ICI Comment Letter; Nasdaq Comment Letter; WisdomTree Comment Letter. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 202 47 First quarter of 2019 59 2 disclosure requirement in 2018.359 In addition, during the period from 2008 to 2018, we estimate that the percentage of ETFs that would have triggered the reporting requirement at least once varied from 1.5% to 10%.360 Even if certain ETFs make the disclosure more frequently or predictably than others because of this variation, we believe that the requirement will promote transparency regarding the significance and persistence of deviations between market price and NAV per share, and thus may permit investors to make more informed investment decisions. Moreover, we believe that this disclosure helps inform investors that certain types of ETFs are more likely to experience persistent premiums or discounts than others. Other commenters expressed concern with the requirement that an ETF include a discussion of the factors that are reasonably believed to have contributed to the premium or discount.361 These commenters stated that an ETF may have difficulty identifying these factors before it makes the required disclosure. Although the required information will be subjective in some cases, we believe that this requirement can provide secondary market investors with useful context for the disclosed deviations. For example, the identification of factors that are reasonably believed to contribute to the premium or discount at that time may inform ETF investors and other market participants about factors potentially contributing to the premium or discount, even if additional contributing factors may later be identified. Such disclosed factors might include, for example, that many of an ETF’s portfolio securities are traded on foreign markets that are closed during the U.S. trading day or that the markets on 359 These figures are based on Bloomberg and Morningstar data for calendar year 2018 and estimate the number of ETFs with at least one instance that would have triggered the 2% premium or discount reporting requirement. As discussed in detail below, on a percentage basis, we estimate that 0.3% of taxable bond ETFs, 0.6% of sector equity ETFs, 3.1% of U.S. equity ETFs, 4.2% of international equity ETFs, and 4.8% of alternative ETFs would have triggered this disclosure requirement in 2018. 360 See infra footnote 598 and accompanying text. 361 See ICI Comment Letter; SSGA Comment Letter I. E:\FR\FM\24OCR2.SGM 24OCR2 57192 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations which the ETF’s underlying securities are traded were closed due to extended holidays or for other reasons. Because the requirement to disclose these factors will continue to apply while the premium or discount persists, the disclosure may change and become better developed over time as the ETF refines its analysis of what it reasonably believes is causing the persistent premium or discount. As a result, such a disclosure also could inform ETF investors and other market participants about the premium’s or discount’s persistence. Another commenter recommended that we shorten the time an ETF is required to maintain the disclosure on its website (to, e.g., 45 days), asserting that the required information is likely to be most useful when it is most recent and grows less important over time.362 Rule 6c–11, however, will require ETFs to maintain the disclosure on their website for at least one year following the first day it was posted to help investors identify ETFs that historically have had persistent deviations between market price and NAV per share. Additionally, although we are requiring maintenance of this disclosure for at least one year, the requirement to post the information will continue to apply as the premium or discount persists— that is, the one-year maintenance requirements will not obviate the need for an ETF to post more current information if otherwise required.363 Thus, the continued availability of the posted information over the required one-year period will not substitute for or prevent more current and timely disclosure. Finally, some commenters expressed concerns with the 2% threshold.364 For example, one commenter recommended a materiality standard instead of a 2% threshold.365 Another commenter recommended raising the threshold to 5 or 10% and shortening the period over which it is measured.366 As discussed 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.367 We therefore believe that limiting this disclosure to ETFs that have a premium or discount of greater than 2% for more than seven consecutive trading days will serve to highlight potentially unusual circumstances of an ETF with a persistent premium or discount. In Table 2 below, we summarize the effect that different variations on the proposed threshold recommended by the commenter would have had on the number of ETFs that would have triggered the requirement in 2018. TABLE 2—NUMBER OF ETFS THAT WOULD HAVE TRIGGERED THE REQUIREMENT IN 2018 3-Day period 7-Day period Category 2% 5% 10% 2% 5% 10% Allocation .................................................. Alternative ................................................ Commodities ............................................ International Equity .................................. Municipal Bond ........................................ Sector Equity ............................................ Taxable Bond ........................................... U.S. Equity ............................................... 2 15 ........................ 48 ........................ 10 3 29 ........................ 2 ........................ 4 ........................ 1 ........................ 5 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ 11 ........................ 20 ........................ 2 1 15 ........................ ........................ ........................ 1 ........................ 1 ........................ 3 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ Total .................................................. 107 12 None 49 5 None As shown above, a 10% threshold would not have required any ETFs to provide this information in 2018, and a 5% threshold, even over just a three-day period, would have only required disclosure by 12 ETFs. After considering the commenter’s recommended modifications to the threshold, we believe that the proposed threshold of 2% over more than seven consecutive trading days will more effectively highlight those patterns of sustained premiums or discounts that will be informative to investors than will the recommended alternatives. We also believe that in this circumstance the 362 CSIM Comment Letter. 6c–11(c)(1)(vi). 364 See John Hancock Comment Letter; Nasdaq Comment Letter; WisdomTree Comment Letter (asserting that the proposed threshold was ‘‘arbitrary’’). 365 See John Hancock Comment Letter. 366 See Nasdaq Comment Letter. 367 See supra footnote 360 and accompanying text; 2018 ETF Proposing Release, supra footnote 7, at nn.119–120, 307 and accompanying text (discussing the relatively small size of historic khammond on DSKJM1Z7X2PROD with RULES2 363 Rule VerDate Sep<11>2014 19:32 Oct 23, 2019 Jkt 250001 objective 2% threshold will result in more consistent application of the disclosure requirement than would a more subjective materiality standard. Furthermore, deviations that do not meet the objective 2% threshold, but that would be material to an investment decision, must be disclosed.368 d. Median Bid-Ask Spread Rule 6c–11 will require daily website disclosure of the ETF’s median bid-ask spread calculated over the most recent 30-day period.369 The bid-ask spread information is designed to inform investors that they may bear bid-ask deviations between ETF market prices and NAV per share in the context of calibrating the threshold). 368 See rule 10b–5 under the Exchange Act [17 CFR 240.10b–5]; see also section 34(b) of the Act [15 U.S.C. 80a–33]. 369 Rule 6c–11(c)(1)(v). In calculating the median bid-ask spread, an ETF would be required to: (i) Identify the ETF’s NBBO as of the end of each 10 second interval during each trading day of the last 30 calendar days; (ii) divide the difference between each such bid and offer by the midpoint of the NBBO; and (iii) identify the median of those values. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 spread costs when trading ETFs on the secondary market, which ultimately could impact the overall cost of the investment. We have modified this requirement from our proposal, which would have required an ETF to disclose the median bid-ask spread for the ETF’s most recent fiscal year on its website and in its prospectus.370 Comments on the proposed website disclosure of an ETF’s bid-ask spread were mixed. Many commenters opposed this requirement, asserting that the proposed disclosures would require ETFs to bear costs and liability for data 370 Although we proposed these bid-ask spread disclosure requirements as amendments to Forms N–1A and N–8B–2, rule 6c–11 will require ETFs relying on it to provide median bid-ask spread disclosure on its website as a condition to the rule. Our amendments to Form N–1A will provide an ETF that does not rely on rule 6c–11 with the option of providing the information required by rule 6c–11 on its website or the median bid-ask spread over the ETF’s most recent fiscal year in its prospectus. See infra section II.H.2.b. E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations collected by third parties,371 and that other sources (e.g., financial intermediaries, the Commission) were in a better position to provide bid-ask spread information.372 Some commenters noted that the bid-ask spread information may be misleading to investors if the historical information is not representative of current execution costs or if the bid-ask spread information is overemphasized.373 Others expressed concern that there is no uniform method for computing bidask spread, which could make bid-ask spreads difficult to compare across different investment options.374 Still others supported it as an alternative to the parallel proposed prospectus disclosure requirements.375 For example, some commenters stated that providing more recent bid-ask spread data on an ETF’s website alongside other ETF trading data would give investors more useful and timely information.376 Commenters also expressed concern about potential liability under section 11 of the Securities Act for bid-ask spread data included in the prospectus if an investor’s actual bid-ask spread costs differ materially from the bid-ask spread disclosed in the prospectus.377 While we recognize the costs for ETFs to collect and publish this bid-ask spread data, we believe that quantitative information regarding median bid-ask spreads will provide ETF investors with greater understanding of the costs associated with investing in ETFs. This will help investors make more informed investment decisions. We acknowledge that historical bid-ask spread data may reflect differences that result from varying methods of computing bid-ask spread. However, we have modified the proposal in several respects, such as using NBBO for computing the bid-ask spread, to make the computation more uniform. We therefore do not believe that the variance will be large enough to outweigh the importance of giving investors a greater understanding of these potential trading costs. We similarly understand that bid-ask spread may not reflect an individual investor’s actual spread, as an individual’s spread may depend on the execution strategies employed by an intermediary (such as mid-point pricing), the size of a particular order, or other factors. We nonetheless believe that the bid-ask spread is a helpful tool for investors making better informed trading decisions and that website disclosure can provide that information in a format that is easily accessible and relied upon by investors. Based on comments we received, however, we are modifying certain of the bid-ask spread requirements to make the disclosure more cost-effective for ETFs, while maintaining or enhancing the utility for investors. First, the rule will require an ETF to disclose its median bid-ask spread only on its website, instead of requiring disclosure both on an ETF’s website and in its prospectus as proposed.378 ETFs will present the median bid-ask spread disclosure alongside other ETF-specific disclosures, such as premium and discount and market price, which should mitigate some commenters’ concerns relating to the overemphasis of bid-ask spread data. Second, some commenters suggested shortening the look-back period for calculating the bid-ask spread metric, such as to a 30- or 45-day rolling period.379 One commenter noted that a shorter look-back period may show a more representative spread level, particularly for a newly launched ETF, as spreads are likely to tighten as the ETF matures.380 Several commenters also suggested that the Commission require ETFs to provide a time-weighted average bid-ask spread rather than the proposed median bid-ask spread.381 These commenters stated that a timeweighted average is more helpful for investors because it represents a ‘‘typical’’ bid-ask spread. We agree that a bid-ask spread metric based on the more recent inputs from the last 30 days may provide a better representation of the costs that an 371 See, e.g., BNY Mellon Comment Letter; John Hancock Comment Letter. 372 See, e.g., IDC Comment Letter; Invesco Comment Letter; SSGA Comment Letter I. 373 See, e.g., John Hancock Comment Letter; CSIM Comment Letter. 374 See, e.g., IDC Comment Letter; John Hancock Comment Letter. 375 See, e.g., Fidelity Comment Letter (expressing support for website disclosure with a rolling 30-day median calculation methodology); Dechert Comment Letter; Thomson Hine Comment Letter. 376 See, e.g., OppenheimerFunds Comment Letter; SIFMA AMG Comment Letter I. 377 See, e.g., ABA Comment Letter; CSIM Comment Letter; Dechert Comment Letter; 15 U.S.C. 77k. 378 See infra section II.H.3. (discussing our determination not to adopt certain prospectus disclosure requirements that we proposed). 379 See, e.g., BlackRock Comment Letter (30-day period); BNY Mellon Comment Letter (30-day period); Cboe Comment Letter (45-day period); ETF.com Comment Letter (45-day period). 380 See BlackRock Comment Letter (providing an example showing an ETF that saw its spread improve from 35 basis points at inception in January 2016 to 4.03 basis points in July 2018, and observing that its median bid-ask spread over the prior fiscal year ending July 31, 2018 was 6.34 basis points, while its median bid-ask spread over the prior month was 4.03 basis points). 381 See, e.g., Fidelity Comment Letter; JPMAM Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 57193 investor may incur when trading ETF shares. Accordingly, we are shortening the look-back period for calculating the bid-ask spread from the most recent fiscal year to the most recent 30-day period on a rolling basis.382 We think the 30-day look-back period strikes an appropriate balance between reflecting only very short term fluctuations and reflecting information that is no longer representative of current execution costs. We do not think it is necessary to require a time-weighted average rather than the proposed median, however, because rule 6c–11 requires an ETF to determine the median by first identifying the exchange-traded fund’s national best bid and national best offer as of the end of each 10 second interval during each trading day. This methodology (and the resulting number of data points) has the same effect as time-weighting. In addition, requiring an ETF to disclose the median of bid-ask spreads is less likely to give disproportionate effect to outlier values than a time-weighted average. Finally, we are modifying the proposal to require that an ETF use the NBBO in calculating median bid-ask spreads.383 While the proposal did not specify that the NBBO must be used, after considering comments recommending more uniformity regarding bid-ask spread disclosures,384 we believe that requiring ETFs to use the NBBO when calculating the median will increase consistency and comparability of the resulting disclosure across ETFs.385 In addition, we believe that requiring use of NBBO will help to reduce costs associated with obtaining the required information, because the NBBO also is an input to the market price disclosure requirement. We also proposed related amendments to Form N–1A that would have required an ETF to provide: (i) Examples in the ETF’s prospectus showing how bid-ask spreads impact the return on a hypothetical investment for both buy-and-hold and frequent traders; and (ii) an interactive calculator in a clear and prominent format on the ETF’s website that would allow an investor to customize the hypothetical bid-ask spread calculations to its specific investing situation.386 These 382 Rule 6c–11(c)(1)(v). 6c–11(c)(1)(v)(A)–(B). 384 See supra footnote 375 and accompanying text. 385 The NBBO also is used in the definition of market price in rule 6c–11. Rule 6c–11(a)(1); see also supra section II.C.6.a. Requiring NBBO is likely to result in more uniform and comparable calculations across funds. 386 See proposed amendment to Item 3 of Form N–1A. The proposed spread costs example would 383 Rule E:\FR\FM\24OCR2.SGM Continued 24OCR2 57194 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 requirements were 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. Commenters generally opposed requiring bid-ask spread examples in the summary prospectus or summary section. For example, some commenters expressed concerns regarding the costs of obtaining the underlying bid-ask spread data from third parties.387 Some commenters also noted that the historical bid-ask spread data, which ETFs would use to calculate the examples, is not representative of current trading costs and could mislead investors if disclosures overemphasize this information.388 Other commenters suggested alternatives to the proposed examples such as using hypothetical brokerage commissions and bid-ask spreads, rather than using actual historical bid-ask spreads.389 However one commenter supported this aspect of the proposal, stating that it would yield ‘‘relevant and helpful’’ information.390 Many commenters raised similar concerns regarding the proposed interactive calculator, including that varying data sources and calculation methodologies may result in an inconsistent investor experience across ETFs.391 Other commenters noted that the interactive calculator was limited to bid-ask spread data, which placed undue emphasis on spreads as a component of an ETF investor’s trading costs.392 Commenters also noted that the proposed requirement may result in additional vendor and licensing costs.393 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) and, to illustrate that more frequent trading can significantly increase costs, it would demonstrate the costs associated with 25 $10,000 round-trip trades (50 total trades). 2018 ETF Proposing Release, supra footnote 7, at section II.H.2. 387 See, e.g., BNY Mellon Comment Letter; ICI Comment Letter; John Hancock Comment Letter; OppenheimerFunds Comment Letter. 388 See, e.g., Vanguard Comment Letter (noting that in the second quarter of 2018, Vanguard’s retail brokerage clients paid less than 5% of the bid-ask spread when trading Vanguard ETFs with an effective spread/quoted spread of 1.89%, and approximately 97% of those market orders were executed inside the NBBO, with 94% of those orders at midpoint or better). See also ABA Comment Letter; BlackRock Comment Letter; CSIM Comment Letter. 389 See, e.g., SIFMA AMG Comment Letter II. 390 See FIMSAC Comment Letter. 391 Fidelity Comment Letter; Invesco Comment Letter; SIFMA Comment Letter I; Vanguard Comment Letter. 392 See, e.g., Vanguard Comment Letter. See also Eaton Vance Comment Letter (recommending replacing the proposed interactive calculator with new requirements for website trading information). 393 See, e.g.; ICI Comment Letter; JPMAM Comment Letter. See also WisdomTree Comment VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 After considering comments, we are not adopting the proposed bid-ask spread examples or interactive calculator requirements. We are instead requiring ETFs relying on rule 6c–11 to provide more recent bid-ask spread information on their website. We believe that streamlining the required bid-ask spread disclosures will mitigate commenters’ concerns that investors may fail to understand the relevance of the bid-ask spread information or the potential impact of bid-ask spreads on their specific trading situations. We are also persuaded by commenters that an interactive calculator focused solely on bid-ask spread costs may overemphasize those costs and thereby obscure the effect of other costs of investing in ETFs. 7. Marketing As proposed, rule 6c–11 will not include certain requirements related to ETF marketing, which were included in our exemptive orders. Specifically, rule 6c–11 will not require an ETF to: (i) Identify itself in its sales literature as an ETF that does not sell or redeem individual shares, and (ii) explain that investors may purchase or sell individual ETF shares through a broker via a national securities exchange.394 Our exemptive orders included a condition requiring this information to help prevent investors, particularly retail investors, from confusing ETFs with mutual funds, at a time when ETFs were not a well-known investment product. The comments on this aspect of the proposal were mixed. Commenters who supported the proposal generally agreed that the market has developed a familiarity with ETFs and that retail investors generally understand that, unlike mutual funds, individual ETF shares may be purchased and sold only on secondary markets.395 One commenter disagreed, asserting that many investors do not understand the distinctions between ETFs and mutual funds.396 This commenter suggested that the rule require an ETF to include a statement in its sales literature noting that buyers of ETF shares may pay more than the shares’ current value and that sellers of ETF shares may receive less than current value. Another commenter noted that requiring this type of disclosure in ETF sales literature would help put investors on notice that the Letter (stating that broker-dealers are better suited to provide the information required by the proposed interactive calculator). 394 See 2018 ETF Proposing Release, supra footnote 7. 395 See, e.g., Invesco Comment Letter; ICI Comment Letter. 396 Eaton Vance Comment Letter. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 ETF pricing mechanism works differently than that of mutual funds.397 We continue to believe that ETF investors have grown familiar with ETFs and the fundamental distinctions between ETFs and mutual funds, and that this disclosure is now unnecessary. The disclosure requirements we are adopting also should provide ETF investors, including retail investors, with useful information regarding the exchange-traded nature of ETFs and ETF pricing, including the potential for market price to deviate from NAV per share.398 8. ETF and ETP Nomenclature We requested comment on whether the Commission should address possible investor confusion arising from the nomenclature that has developed for identifying ETPs, including confusion between ETFs and other types of ETPs that are not registered under the Act.399 We asked, for example, whether the Commission should consider proposing to require a naming convention or other identification scheme to assist investors in distinguishing ETFs from other ETPs in a future rulemaking. We also asked whether we could address investor confusion by restricting certain sales practices, such as by proposing restrictions on how intermediaries communicate with retail investors about ETPs unless they disclose certain information designed to clearly differentiate ETPs that are not subject to the Act from ETFs that are registered investment companies. Several commenters generally supported a classification system for ETPs to assist investors in distinguishing among these different products.400 One commenter stated that leveraged/inverse ETFs, commodity pools, and exchange-traded notes have differences that investors should understand prior to making investment decisions.401 Commenters expressed varying views, however, regarding 397 CFA Comment Letter. website disclosure requirements are described in section II.C.6 and the amendments to Form N–1A are described in section II.H. 399 See 2018 ETF Proposing Release, supra footnote 7, at section II.C.7. See also supra footnote 16 (describing differences between ETFs and other types of ETPs, such as exchange-traded notes and commodity pools). 400 See, e.g., BlackRock Comment Letter; Invesco Comment Letter; Cboe Comment Letter; FIMSAC Comment Letter; Hu and Morely Comment Letter (incorporating article by comment letter’s authors suggesting that ETFs can be categorized into three groups, ‘‘Investment Company ETFs,’’ ‘‘Commodity Pool ETFs,’’ and ‘‘Operating Company ETFs,’’ based on the applicable regulatory framework, but not suggesting a related nomenclature system). 401 See Invesco Comment Letter. See also BlackRock Comment Letter. 398 The E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations which types of ETPs should call themselves ETFs under an ETP classification system. One commenter asserted that the Commission should permit only ETFs that fall squarely within proposed rule 6c–11 to call themselves ETFs.402 Two commenters provided examples of comprehensive classification systems for ETPs that would not permit ‘‘exchange-traded notes,’’ ‘‘exchange-traded commodities,’’ or ‘‘exchange-traded instruments’’ (including leveraged/ inverse ETFs) to refer to themselves as ETFs.403 One commenter opined that the Commission should not preclude leveraged/inverse ETFs from calling themselves ETFs, as that would ‘‘confuse investors and muddle both the existing regulatory framework applicable to ETFs and fund naming conventions.’’ 404 Another commenter asserted that UITs and other ETFs that fall outside the scope of the rule should nonetheless be permitted to call themselves ETFs.405 One commenter asserted that Commission action relating to ETP naming is premature at the present time.406 This commenter encouraged ETF market participants to engage in a dialogue ‘‘around refining existing ETP disclosures, adding new elements as useful to investors, and developing an industry-led standard ETP disclosure approach beneficial to investors and all market participants.’’ We agree that these issues need to be examined and discussed in more depth before the implementation of an ETP naming system. We will continue to consider the comments we received and, if appropriate, will take steps to address investor confusion relating to ETF and ETP nomenclature. At present, we believe that the term ‘‘ETF’’ is generally associated with ETPs regulated under the Investment Company Act. Leveraged/inverse ETFs, for example, are regulated under the Act and are structurally and operationally similar to ETFs that will rely on rule 6c– 11. As a result, we do not believe it is appropriate to require leveraged/inverse ETFs to use a naming convention that does not include the term ‘‘ETF.’’ Similarly, because UIT ETFs are subject to a substantially similar regulatory regime as ETFs structured as open-end funds (and subject to similar regulatory safeguards), we do not find it appropriate to require UIT ETFs to Invesco Comment Letter. BlackRock Comment Letter; FIMSAC Comment Letter. 404 See ProShares Comment Letter. 405 See SIFMA AMG Comment Letter I. 406 See Comment Letter of State Street Global Advisors (Feb. 4, 2019). utilize a naming convention that does not include the term ‘‘ETF.’’ We encourage ETP market participants to continue engaging with their investors, with each other, and with the Commission on these issues. D. Recordkeeping We are adopting, as proposed, an express requirement that ETFs relying on rule 6c–11 preserve and maintain copies of all written agreements between an authorized participant and the ETF (or one of the ETF’s service providers) that allow the authorized participant to purchase or redeem creation units (‘‘authorized participant agreements’’).407 One commenter supported this aspect of the proposal.408 Another commenter, however, stated that this requirement is unnecessary because ETFs already generally implement robust recordkeeping programs pursuant to their policies and procedures.409 After considering these comments, we believe it is appropriate for rule 6c–11 to specifically require that ETFs preserve and maintain authorized participant agreements. Authorized participants play a central role in the proper functioning of the ETF marketplace and authorized participant agreements are critical to understanding the relationship between an authorized participant and an ETF. Requiring the preservation of authorized participant agreements 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 rule 6c–11 and other provisions of the Act and rules thereunder, based on the specific terms of their written agreement. 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 believe it is appropriate to expressly require that ETFs relying on rule 6c–11 preserve and maintain copies of all such agreements. We also are adopting, largely as proposed, a requirement that ETFs maintain information regarding the baskets exchanged with authorized participants. Rule 6c–11 will require an ETF to maintain records setting forth the following information for each basket exchanged with an authorized 402 See 403 See VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 407 See rule 6c–11(d)(1). For example, an authorized participant and the ETF’s principal underwriter may enter into the authorized participant agreement. 408 See ICI Comment Letter. 409 See Invesco Comment Letter. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 57195 participant: (i) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket exchanged for creation units; 410 (ii) if applicable, an 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; (iii) cash balancing amounts (if any); and (iv) the identity of the authorized participant conducting the transaction.411 Commenters generally supported requiring ETFs to maintain records regarding baskets.412 One commenter stated that clear, auditable records would help Commission staff monitor custom basket usage and its impact on the ETF arbitrage process.413 Another agreed that the records would provide Commission staff with a basis to understand how baskets are being used by ETFs and to evaluate compliance with the rule and other requirements.414 As noted above, one commenter stated that it is unnecessary for the rule to contain any recordkeeping provisions.415 After considering these comments, we believe that requiring ETFs to maintain records regarding each basket exchanged with authorized participants will provide our examination staff with a basis to understand how baskets are being used by ETFs, particularly with respect to custom baskets. In order to provide our examination staff with detailed information regarding basket composition, however, we have modified rule 6c–11 to require the ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket exchanged for creation units as part of the basket records, instead of the name and quantities of each position as proposed.416 We believe that this additional information will better enable our examination staff to evaluate compliance with the rule and other applicable provisions of the federal securities laws. Moreover, we do not believe that requiring ETFs to maintain 410 As discussed below, proposed rule 6c–11 would have required ETFs to maintain the ‘‘names and quantities of the positions composing the basket’’ exchanged for creation units and did not require additional information about the ticker symbol, CUSIP or other identifier, or a description of the holding. See proposed rule 6c–11(d)(2). 411 See rule 6c–11(d)(2). 412 See ICI Comment Letter; Nasdaq Comment Letter; SIFMA AMG Comment Letter I. 413 See SIFMA AMG Comment Letter I. 414 See ICI Comment Letter. 415 See Invesco Comment Letter. 416 See proposed rule 6c–11(d)(2). E:\FR\FM\24OCR2.SGM 24OCR2 57196 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations detailed information regarding basket composition will create operational challenges or unduly burden ETFs because rule 6c–11 already requires ETFs to disclose the same information for each portfolio holding as part of the portfolio transparency requirements.417 As proposed, the rule will require ETFs 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 incorporate this type of retention period and we believe consistency with that period will minimize any compliance burdens to ETFs subject to rule 6c–11. The commenter that addressed this aspect of the recordkeeping requirement supported the proposed retention period.418 khammond on DSKJM1Z7X2PROD with RULES2 E. Share Class ETFs As proposed, rule 6c–11 does not provide 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) (the multiple class rule).419 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.420 These provisions also were designed to address certain inequitable and 417 This modification aligns the rule’s recordkeeping requirements in paragraph (d) with the information the ETF must already collect and disclose as part of the portfolio transparency requirements. Proposed rule 6c–11 would have required an ETF to post on its website information regarding a published basket at the beginning of each business day and to present the description, amount, value and unrealized gain/loss in the manner prescribed by Article 12 of Regulation S– X for each basket asset. As discussed above, we are not adopting a basket publication requirement as part of rule 6c–11, and therefore the rule does not set forth recordkeeping requirements relating to the proposed basket publication requirement. See supra section II.C.5.c. 418 See Invesco Comment Letter (agreeing with the five-year retention timeline despite generally objecting to the rule’s recordkeeping requirements). 419 See 15 U.S.C. 80a–18(f)(1) and (i). Section 18(f)(1) of the Act generally prohibits a registered open-end company 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 registered management company must have equal voting rights. 420 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. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 discriminatory shareholder voting provisions that were associated with many investment company securities before the enactment of the Act.421 Rule 18f–3 created a limited exception from sections 18(f)(1) and 18(i) for certain funds but requires, among other things, that each share class of a fund have the same rights and obligations as each other class.422 An ETF cannot rely on rule 18f–3 to operate as a share class within a fund, however, because the rights and obligations of the ETF shareholders would differ from those of investors in the fund’s mutual fund share classes.423 Therefore, absent any separate relief from sections 18(f)(1) or 18(i) of the Act, an ETF structured as a share class of a fund that issues multiple classes of shares representing interests in the same portfolio cannot operate in reliance on rule 6c–11. We recognize that the Commission has previously granted ETFs exemptive relief from the provisions of section 18 of the Act in the past, subject to various conditions.424 However, relief from section 18 raises policy considerations that are different from those we are seeking to address in this rule. 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.425 421 See id. 17 CFR 270.18f–3(a)(4); Exemption for Open-End Management 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. 423 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. 424 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’’). 425 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 422 See PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 Three commenters stated that it was unnecessary for rule 6c–11 to provide relief for share class ETFs.426 One commenter, a sponsor of share class ETFs, stated that it is unnecessary for the rule to encompass share class ETFs because it is currently uncommon for ETF issuers to seek the exemptive relief necessary for such ETFs.427 Another stated that our proposed treatment is appropriate given the nuances associated with those products, 428 and the third similarly indicated that share class ETFs present issues that would be more appropriately addressed through means other than rule 6c–11.429 Two other commenters, however, opined that rule 6c–11 (or a separate future rule) should provide relief for share class ETFs in order to create a more level ETF playing field.430 Additional commenters echoed the importance of leveling the ETF playing field without specifically addressing share class ETFs.431 Another commenter urged the Commission to explore granting relief from the relevant provisions of section 18 broadly to the fund industry.432 Leveling the ETF playing field is a goal for rule 6c–11, and we acknowledge that our approach will result in there being a segment of ETF assets that are unable to rely on the rule. At the same time, we continue to believe that share class ETFs raise policy considerations that are different from those we seek to address in the rule. With such concerns unresolved, we do not believe it is appropriate to broadly grant relief from sections 18(f)(1) and 18(i) of the Act for share class ETFs at this time. Share class ETFs are structurally and operationally different from the other types of ETFs within the scope of rule 6c–11.433 We with holding the cash necessary to satisfy mutual fund share class redemptions, and distributable capital gains associated with portfolio transactions. 426 See Vanguard Comment Letter; Invesco Comment Letter; SSGA Comment Letter I. 427 See Vanguard Comment Letter. 428 See Invesco Comment Letter. 429 See SSGA Comment Letter I. 430 See BNY Mellon Comment Letter; OppenheimerFunds Comment Letter. 431 See ETF.com Comment Letter (stating that the disclosure requirements of any final rule should apply to all ETFs, regardless of whether the ETFs rely on the final rule); Invesco Comment Letter (indicating that the Commission should generally abstain from regulatory actions that allow only certain market participants to benefit from innovation). 432 See MFDF Comment Letter. 433 For example, when an ETF is structured as a share class of an open-end fund, the open-end fund has other share classes representing interests in the same portfolio. These interests (and the cash flows associated with the other share classes) can impact the fund’s portfolio. In addition, share class ETFs E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations securities of the master fund.435 To accommodate the unique operational characteristics of these 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,436 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.437 The exemptive orders we have granted to master-feeder ETFs, however, do not include relief from section 18 under the Act inasmuch as investment F. Master-Feeder ETFs by several feeder funds or by mutual Many of our recent ETF orders allow fund and ETF feeder funds in the same ETFs to operate as feeder funds in a class of securities issued by a master master-feeder structure.434 In general, an fund generally does not involve a senior ETF that operates as a feeder fund in a security subject to section 18. We are master-feeder structure functions like concerned, as discussed above, that if an any other ETF. An authorized ETF feeder fund transacts with a master participant deposits a basket with the fund on an in-kind basis, but non-ETF ETF and receives a creation unit of ETF feeder funds transact with the master shares in return for those assets. fund on a cash basis, all feeder fund Conversely, an authorized participant shareholders would bear costs that redeems a creation unit of ETF associated with the cash transactions.438 shares receives a basket from the ETF. Due to these concerns, and the lack of In a master-feeder arrangement, market interest in this structure, we however, the feeder ETF then also proposed to rescind the master-feeder enters into a corresponding transaction relief granted to ETFs that did not rely with its master fund. The ETF may use on the relief as of the date of the the basket assets it receives from an proposal (June 28, 2018). We also authorized participant to purchase proposed to grandfather existing masteradditional shares of the master fund, or it may redeem shares of the master fund feeder arrangements involving ETF feeder funds, but prevent the formation in order to obtain basket assets and satisfy a redemption request. 435 Section 12(d)(1) of the Act limits the ability of Because the feeder ETF may, in the a fund to invest substantially in shares of another course of these transactions, temporarily fund. See sections 12(d)(1)(A)–(C) of the Act. hold the basket assets, it would not be Section 12(d)(1)(E) of the Act allows an investment company to invest all of its assets in one other fund able to rely on section 12(d)(1)(E) of the so that the acquiring fund is, in effect, a conduit Act, which requires that a feeder fund through which investors may access the acquired hold no investment securities other than fund. See section 12(d)(1)(E)(ii) of the Act. khammond on DSKJM1Z7X2PROD with RULES2 therefore continue to believe it is appropriate for share class ETFs 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 assess all relevant policy considerations in the context of the facts and circumstances of each particular applicant. We are not rescinding exemptive relief previously granted to share class ETFs. We also are adopting amendments to Form N–1A that will require share class ETFs to provide certain additional disclosures regarding ETF trading costs. As discussed in more detail below in section II.H., these disclosure amendments are designed to help ensure consistent disclosures to investors between ETFs relying on proposed rule 6c–11 and share class ETFs operating pursuant to individualized exemptive relief. The rule and form amendments require all ETFs that are subject to the Investment Company Act to provide similar disclosures in order to help investors compare products. do not provide daily portfolio transparency. See Vanguard orders, supra footnote 425. 434 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’’). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 436 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). 437 See 15 U.S.C. 80a–22(e) (generally requiring the satisfaction of redemptions within seven days). See also supra section II.B.4. 438 See supra footnote 426 and accompanying text. PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 57197 of new ones, by amending relevant exemptive orders. One commenter stated that it did not object to preventing the formation of new master-feeder arrangements and rescinding master-feeder relief (with the exception of master-feeder relief that funds actively relied on as of the date of the Proposing Release).439 Other commenters, however, indicated that the rule should provide relief for master-feeder structures 440 or that the Commission should not rescind existing master-feeder relief.441 Some of these commenters indicated that failing to provide relief for master-feeder structures would cause an uneven playing field among ETFs but did not address the concerns discussed above.442 Other commenters set forth potential methods for mitigating such concerns. For example, one commenter indicated that the Commission could address its concerns regarding potential crosssubsidization by requiring master funds to impose certain transaction fees,443 while another indicated that the Commission should address these concerns by requiring each feeder fund in a master-feeder structure to transact with the master fund consistently (i.e., only in cash or only in kind).444 An additional commenter suggested that an ETF’s board should evaluate whether a master-feeder structure’s overall benefits outweigh its overall costs in order to address these concerns.445 Another commenter indicated that it has already invested resources exploring various approaches to an ETF master-feeder structure, including models that it believed would address the Commission’s concerns.446 As discussed in the context of share class ETFs, leveling the ETF playing field is a goal for rule 6c–11, and we acknowledge that our approach will result in there being a segment of ETF assets that are unable to rely on the rule. Like share class ETFs, however, we continue to believe that master-feeder funds raise policy considerations that are different from those we seek to 439 See ICI Comment Letter. ETF.com Comment Letter; BNY Mellon Comment Letter; Dechert Comment Letter. 441 See Fidelity Comment Letter; Eaton Vance Comment Letter. 442 See ETF.com Comment Letter; BNY Mellon Comment Letter. 443 See Eaton Vance Comment Letter. 444 See Fidelity Comment Letter. 445 See Dechert Comment Letter. This commenter also opposed excluding exemptive relief for masterfeeder structures based on a lack of market interest because the ETF industry is dynamic and interest in master-feeder structures may develop in the future. Id. 446 See Fidelity Comment Letter. 440 See E:\FR\FM\24OCR2.SGM 24OCR2 57198 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 address in the rule and are structurally and operationally distinct from other ETFs within the scope of rule 6c–11. We do not believe it is appropriate to broadly grant exemptive relief for master-feeder funds. Instead, we continue to believe that the Commission should consider the special concerns presented by ETFs in master-feeder structures in the context of the facts and circumstances of each particular applicant through individualized exemptive applications. The Commission’s exemptive relief process is well-suited for applicants to set forth novel methods of mitigating the Commission’s concerns, such as the methods suggested above. The process allows applicants to experiment with many different approaches, and may eventually assist the Commission in identifying a particular solution that is appropriate for a broader rule. Any ETF that is exploring a particular approach is free to bring its methodology forward in an exemptive application, which should help mitigate commenters’ concerns about future changes in the ETF industry and resources already committed to such research. As proposed, therefore, we will rescind the master-feeder relief granted to ETFs that did not rely on the relief as of the date of the proposal (June 28, 2018).447 Only one fund complex had established as of June 28, 2018 masterfeeder arrangements involving ETF feeder funds, and each arrangement involves an ETF as the sole feeder fund. We understand that all but one of the complex’s original ETF feeder funds has discontinued its use of a master-feeder structure.448 Because this arrangement involves only one ETF feeder fund for its master fund, we do not believe it will raise the policy concerns discussed above without new, additional feeders, and therefore do not believe it is necessary to require this structure to change its existing investment practices by rescinding the relief.449 Instead, as 447 One commenter indicated that this date provided an insufficient notice period for ETFs interested in pursuing the master-feeder structure and recommended ‘‘a sunset provision of at least 3 years from the effective date of the final rule to allow ETFs that have been developing this structure sufficient time to test and implement it.’’ See id. Exemptive orders for existing ETF master-feeder structures that rely on the relief will not be rescinded, however, and ETFs interested in pursuing a master-feeder structure in the future may apply for individualized exemptive relief. We therefore believe that such a 3-year sunset provision is unnecessary. 448 See, e.g., SSGA Active Trust Prospectus (Oct. 31, 2017), available at https://www.sec.gov/ Archives/edgar/data/1516212/000119312 518313788/d635918d497.htm. 449 See 2018 ETF Proposing Release, supra footnote 7, at n.342 (noting that rescinding the relief VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 proposed, we are amending this fund complex’s existing exemptive orders to prevent the complex from forming new master-feeder ETFs.450 G. Effect of Rule 6c–11 on Prior Orders As proposed, we have determined to exercise our authority under the Act to amend and rescind the exemptive relief we have issued to ETFs that will be permitted to operate in reliance on rule 6c–11.451 Accordingly, one year following the effective date of rule 6c– 11, we will rescind those portions of our prior ETF exemptive orders that grant relief related to the formation and operation of an ETF, including masterfeeder relief except as described in section II.F. We will not rescind the exemptive orders of UIT ETFs, leveraged/inverse ETFs, share class ETFs, or non-transparent ETFs. We also are not rescinding the relief we have provided to ETFs from section 12(d)(1) and sections 17(a)(1) and (a)(2) under the Act related to fund of funds arrangements involving ETFs as discussed below. Commenters generally supported the rescission of the exemptive relief granted to ETFs that fall within the scope of rule 6c–11,452 while permitting ETFs that could not rely on rule 6c–11 to continue to rely on their individual exemptive orders.453 One commenter stated that rescission of these orders will further the Commission’s regulatory goal to create a consistent, transparent, and efficient regulatory framework for ETFs.454 After reviewing comments, we continue to believe that rescinding ETF exemptive relief in connection with rule 6c–11 will result in a consistent, for existing master-feeder ETFs would require them to change the manner in which they invest). 450 The amendment to the exemptive order will expressly provide that the complex cannot create new master-feeder structures as of June 28, 2018. 451 See section 38(a) of the Act, 15 U.S.C. 80a– 37(a). 452 See, e.g., ABA Comment Letter; ICI Comment Letter. 453 See, e.g., ICI Comment Letter; Eaton Vance Comment Letter. In addition, one commenter stated that, because the commenter has designed its ETFs around the basket flexibility afforded by its exemptive orders, it would oppose the rescission of prior orders if the final rule limits ETFs’ ability to use custom baskets. See Invesco Comment Letter. As discussed above, rule 6c–11 will permit an ETF to use custom baskets if it meets certain conditions. See supra section II.C.5.b. 454 See ABA Comment Letter. One commenter, a sponsor of ETMFs as well as ETFs, requested that the Commission amend the terms and conditions relating to custom baskets in the ETMF orders to correspond to the treatment of custom baskets in rule 6c–11. See Eaton Vance Comment Letter. We believe this request is beyond the scope of the proposal. However, the commenter may seek to amend its order as part of the exemptive application process. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 transparent, and efficient framework for ETFs that operate in reliance on rule 6c– 11, as those ETFs would no longer be subject to differing and sometimes inconsistent provisions of their exemptive relief. Moreover, investment companies that seek to operate an ETF under conditions that differ from those in rule 6c–11 are able to request exemptive relief from the Commission. In addition, approximately 200 of our current ETF exemptive orders automatically expire on the effective date of any Commission rule that provides relief permitting the operation of ETFs.455 We have determined, as proposed, to amend those orders to provide that the ETF relief contained therein will terminate one year following the effective date of rule 6c– 11 to allow time for these ETFs to make any adjustments necessary to rely on rule 6c–11. We continue to believe that the oneyear period for the termination of our ETF exemptive relief is sufficient to give ETFs that are operating under exemptive orders time to bring their operations into conformity with the requirements of rule 6c–11. We did not receive any comments on this aspect of the proposal. We also did not receive any comments stating that the need to comply with the requirements of rule 6c–11, as opposed to their exemptive relief, would significantly negatively affect the operations of existing ETFs. Finally, we did not propose to rescind the fund of funds exemptive relief included in our ETF exemptive orders.456 This relief permits an ETF to create fund of funds structures, subject to certain conditions set forth in the ETF’s exemptive application, 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. The conditions for fund of funds relief for ETFs are substantially similar across our exemptive orders. Commenters generally agreed that we should not rescind the fund of funds exemptive relief, but asserted that the Commission should include fund of funds relief in a final rule or provide such relief through other means.457 455 See 2018 ETF Proposing Release, supra footnote 7, at n.348 and accompanying text (noting that the Commission began including a condition in its 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). 456 See id. at n.344 and accompanying text. 457 See, e.g., Dechert Comment Letter; ABA Comment Letter; MFDF Comment Letter; SSGA E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 Some commenters stated that because fund of funds relief is part of standard ETF exemptive orders, the Commission also should permit new ETFs to rely on the terms and conditions of fund of funds relief previously granted to existing ETFs.458 These commenters stated that failing to provide this relief would frustrate the Commission’s purpose of allowing new ETFs to enter the market without obtaining an exemptive order from the Commission. In December 2018, we proposed new rule 12d1–4 under the Act to streamline and enhance the regulatory framework applicable to fund of funds arrangements for registered investment companies, including ETFs.459 In connection with that proposed rule, we also proposed to rescind our exemptive orders granting relief to certain fund of funds arrangements, including the relief from sections 12(d)(1)(A) and (B) that, as discussed above, has been included in our ETF exemptive orders. The Commission has not yet acted upon this proposal and is not rescinding the fund of funds relief in existing exemptive orders in connection with this rulemaking. We agree with commenters, however, that new entrants to the ETF market would be at disadvantage to existing ETFs without fund of funds relief. Accordingly, ETFs relying on rule 6c–11 that do not have exemptive relief from sections 12(d)(1)(A) and (B) and section 17(a)(1) and (2) of the Act may enter into fund of funds arrangements as set forth in our recent ETF exemptive orders, provided that they satisfy the terms and conditions for fund of funds relief in those orders.460 This relief will Comment Letter; WisdomTree Comment Letter; OppenheimerFunds Comment Letter. Commenters also suggested that the Commission should permit funds relying on sections 3(c)(l) and 3(c)(7) under the Act to be acquiring funds under any future fund of funds relief. See Dechert Comment Letter; OppenheimerFunds Comment Letter. While the subject matter of these comments falls outside the scope of the proposal of rule 6c–11, this issue is addressed as part of the proposed fund of funds rules. See FOF Proposing Release, supra footnote 40. 458 See, e.g., ABA Comment Letter; Dechert Comment Letter. 459 See FOF Proposing Release, supra footnote 40, at nn.236–237 and accompanying text. 460 See Salt Financial, supra footnote 248. Our exemptive orders permitting ETFs to enter into fund of funds arrangements include relief from section 17(a) of the Act. Section 17(a) would prohibit an ETF that is an acquiring fund that holds 5% or more of an acquired fund’s securities from making any additional investments in the acquired fund. In addition, fund of funds arrangements involving funds that are part of the same group of investment companies or that have the same investment adviser (or affiliated investment advisers) implicate section 17(a), regardless of whether an acquiring fund exceeds the 5% threshold. Furthermore, where an ETF is an acquired fund, section 17(a) would VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 be available only until the effective date of a new Commission rule permitting registered funds to acquire the securities of other registered funds in excess of the limits in section 12(d)(1), including rule 12d1–4 if adopted.461 H. Amendments to Form N–1A We are adopting 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, that are designed to provide ETF investors with additional information regarding ETF trading and associated costs. Commenters generally supported providing additional information to investors regarding ETF trading, but many suggested specific modifications to the proposals.462 After considering these comments, we are adopting the following amendments to Form N–1A: • Adding the term ‘‘selling’’ to current narrative disclosure requirements to clarify that the fees and expenses reflected in the expense table may be higher for investors if they buy, hold, and sell shares of the fund (Item 3); • Streamlined narrative disclosures relating to ETF trading costs, including bid-ask spreads (Item 6); • Requiring ETFs that do not rely on rule 6c–11 to disclose median bid-ask spread information on their websites or in their prospectus (Item 6); • Excluding ETFs that provide premium/discount disclosures in accordance with rule 6c–11 from the premium and discount disclosure prohibit the delivery or deposit of basket assets on an in-kind basis by an affiliated fund (that is, by exchanging certain assets from the ETF’s portfolio, rather than in cash). See FOF Proposing Release, supra footnote 40, at nn.60–64 and accompanying text. The relief we are providing from section 17(a) does not extend beyond the scope of the relief we have provided in our exemptive orders to ETFs. We are providing the relief from sections 12(d)(1)(A) and (B) and section 17(a) in accordance with our authority under sections 6(c), 12(d)(1)(J), and 17(b) of the Act. See 15 U.S.C. 80a–6(c), 15 U.S.C. 80a– 12(d)(1)(J), and 15 U.S.C. 80a–17(b). 461 For the reasons discussed above, we find that this 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. See 15 U.S.C. 80a–6(c). We similarly find that such an exemption is consistent with the public interest and the protection of investors. See 15 U.S.C. 80a–12(d)(1)(J). 462 We also received a comment requesting that we confirm the applicability of the civil liability provisions in sections 11 and 12 of the Securities Act to investors that purchase ETF shares on the secondary markets. See Hagens Berman Comment Letter. This rulemaking is intended to codify existing relief for ETFs relating to the formation and operation of ETFs under the Investment Company Act. Accordingly, the applicability of those Securities Act provisions is beyond the scope of this rulemaking. PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 57199 requirements in Form N–1A (Items 11 and 27); and • Eliminating disclosures relating to creation unit size and disclosures applying only to ETFs with creation unit sizes of less than 25,000 shares (Items 3, 6, 11 and 27). 1. Fee Disclosures for Mutual Funds and ETFs (Item 3) As proposed, we are adopting a narrative disclosure that will specify that the fees and expenses reflected in the Item 3 expense table also may be higher for investors if they sell shares of the fund.463 Currently, this item requires disclosure indicating only that the table describes fees and expenses investors may pay if they buy and hold shares of the fund. However, both mutual funds and ETF investors also may incur expenses other than redemption fees when selling fund shares.464 We are therefore amending this disclosure to specify that investors may pay the fees and expenses described in Item 3 if they buy, hold, and sell shares of the fund.465 Commenters who addressed this proposed change supported it because it will help investors better understand that they may incur costs in addition to those in the fee table.466 We also are adopting, as proposed, a requirement to include a statement that investors may be subject to other fees not reflected in the table, such as brokerage commissions and fees to financial intermediaries.467 Commenters who addressed this proposed requirement supported it.468 We continue to believe this is an appropriate disclosure for both ETFs 463 Item 3 of Form N–1A (requiring, for example, disclosure of sales loads, exchange fees, maximum account fees, and redemption fees that funds charge directly to shareholders). We also are amending Instruction 1(e) of Item 3, as proposed, to eliminate: (i) 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; and (ii) the instruction to 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 not 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 also Instruction 1(e)(ii) to Item 27(d)(1) (adopting the same modification for the expense example in an ETF’s annual and semi-annual reports). 464 For example, 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. 465 See Item 3 of Form N–1A. 466 See, e.g., CSIM Comment Letter; FIMSAC Comment Letter; IDC Comment Letter. 467 Item 3 of Form N–1A. 468 See, e.g., IDC Comment Letter; Invesco Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 57200 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations and mutual funds, as investors in ETFs and mutual funds alike may incur brokerage commissions and fees to financial intermediaries. 2. Disclosures Regarding ETF Trading and Associated Costs (Item 6) We are adopting amendments to Item 6 of Form N–1A that: (i) Will require an ETF to provide narrative disclosure identifying specific costs associated with buying and selling ETF shares and directing investors to its website for additional information; and (ii) allow an ETF that is not subject to rule 6c–11 the option to provide disclosure regarding the ETF’s median bid-ask spread on its website or in its prospectus.469 These form amendments differ in several respects from our proposal, which would have required an ETF to disclose information regarding how ETF shares trade and the associated costs, including information regarding bid-ask spreads, as part of the fund’s fee table disclosure. a. Narrative Disclosures khammond on DSKJM1Z7X2PROD with RULES2 Secondary market investors in ETF shares are subject to trading costs when purchasing and selling ETF shares that ETFs are not currently required to disclose in their prospectuses. Trading costs, like all costs and expenses, affect investors’ returns on their investment.470 In addition, some investors use ETFs more heavily as trading vehicles compared to mutual funds and may thus incur substantial trading costs. We believe that investors could overlook these costs and that additional disclosure would help them better understand these costs when purchasing or selling ETF shares. As a result, we proposed to require ETFs to include a series of questions and answers—or Q&As—in Item 3 that would have provided investors with narrative disclosure regarding ETF 469 Rule 6c–11 will require an ETF to disclose its median bid-ask spread for the last thirty calendar days on its website as a condition to the rule. Rule 6c–11(c)(1)(v). We also are amending the definition of ‘‘Exchange-Traded Fund’’ in Form N–1A to add a specific reference to rule 6c–11. See General Instruction A of Form N–1A (defining ‘‘exchangetraded fund’’ as 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). We are adopting this definition as proposed. 470 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/SB1000087239639044 4024204578044293008576204 . VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 trading and associated costs, as well as quantitative disclosures regarding bidask spreads.471 Although many commenters supported providing information regarding trading costs to investors, commenters raised concerns regarding the quantitative aspects of the bid-ask spread disclosures.472 In addition, comments on the proposed Q&A format were mixed. Some commenters supported the format, stating that it provided a user-friendly method for identifying certain costs.473 Many others expressed concerns that this format would significantly lengthen the summary prospectus, potentially resulting in less investor-friendly formats or increased printing costs.474 Some commenters asserted that the proposed Q&A format may be more appropriate for inclusion in the statutory prospectus rather than the summary prospectus.475 We continue to believe that investors could overlook certain trading costs when buying or selling ETF shares and that additional disclosure will help them better understand these costs. However, we agree with commenters that the extent of trading cost disclosures we proposed to require in Item 3 could obscure other key information regarding other fees and expenses and potentially give bid-ask spread disclosures undue prominence. We also agree that ETFs and their investors may benefit from flexibility in the manner of presenting the required information, especially if the proposed format would unduly distract from other key information. We therefore are permitting ETFs to use formats other than Q&As to present this 471 We also proposed to move certain disclosure regarding the purchase of ETF shares from Item 6 to Item 3, consolidating relevant disclosures regarding the fees and trading costs that an ETF investor may bear in one place. 2018 ETF Proposing Release, supra footnote 7, at text accompanying nn.391–394. 472 See also supra section II.C.6.d. (discussing median bid-ask spread disclosure requirements in rule 6c–11 and our determination not to adopt amendments that would have required an ETF to provide: (i) Hypothetical examples in its prospectus of how the bid-ask spread impacts return on investment; and (ii) an interactive calculator on its website to allow investors the ability to customize those hypothetical calculations). 473 See, e.g., CFA Institute Comment Letter; FIMSAC Comment Letter. 474 See, e.g., CSIM Comment Letter (stating the that proposed format would require ETFs to rethink the presentation of the summary); Fidelity Comment Letter (stating that the proposed format would subsume other more important information and that concise narrative disclosure would be preferable); Vanguard Comment Letter (stating the sponsors should be permitted to determine how best to present this information). 475 BlackRock Comment Letter; CSIM Comment Letter. PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 information.476 In addition, we are moving the narrative disclosures regarding trading costs to Item 6 of Form N–1A, which provides investors with information regarding the purchase and sale of fund shares to avoid overemphasizing these costs. We also are streamlining several of the narrative disclosure requirements we proposed. First, we are adopting a requirement that the ETF’s summary prospectus or summary section crossreference the ETF’s website.477 Rule 6c– 11 will require daily website disclosure of several items, including the NAV per share, market price, premium or discount, and bid-ask spread information. Form N–1A also will permit ETFs to omit certain information from their registration statements if they satisfy certain of the rule’s website disclosure conditions.478 This disclosure will inform investors how to access this information. Commenters did not specifically address this proposed requirement. However, in general, commenters expressed support for website disclosure requirements, including as a substitute for certain registration statement disclosure requirements.479 We believe a cross-reference in Form N– 1A to the required website disclosures will enable investors to receive timely and granular information that could assist with making an investment decision and are therefore adopting the 476 See Item 6(c) of Form N–1A. An ETF must provide the required information using plain English principles under rule 421(d) under the Securities Act. See General Instructions to Form N– 1A. The applicable standards provide ETFs and other funds with flexibility, for example, in determining whether to use headings in a questionand-answer format. Enhanced Disclosure and New Prospectus Delivery Option for Open-End Management Investment Companies, Investment Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546, 4549 n.39 (Jan. 26, 2009)] (‘‘Summary Prospectus Adopting Release’’). 477 Item 6(c)(4) of Form N–1A. The form amendments permit an ETF to combine the information required by this website cross-reference requirement into the information required by Item 1(b)(1) of Form N–1A and 17 CFR 230.498(b)(1)(v) (rule 498(b)(1)(v)) in order to avoid duplicative references to the ETF’s website. Instruction 4 to Item 6 of Form N–1A (referring to the website crossreference disclosure requirements in the summary prospectus cover page and the statutory prospectus back cover page). However, by requiring a crossreference to the ETF’s website, the Commission does not intend for such information to be incorporated by reference into the prospectus. 478 See, e.g., Instruction 1 to Item 6 of Form N– 1A. 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. 479 See, e.g., SIFMA AMG Comment Letter I; Fidelity Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 requirement substantially as proposed in Item 6. We also are adopting a requirement to provide narrative disclosure regarding bid-ask spreads.480 As noted above, commenters generally did not address the substance of the disclosures, but raised concerns regarding the length of the disclosures. One commenter, however, asserted that the proposed requirement to disclose certain additional costs associated with buying and selling ETF shares would be redundant of information required by Item 3.481 We continue to believe that narrative bid-ask spread disclosure will inform investors regarding the potential impact of spread costs and provide investors with additional context to understand that the costs attributable to the bid-ask spread may increase or decrease when certain market conditions exist or certain factors are present. However, streamlining this disclosure to provide investors with key information regarding bid-ask spreads will both aid investor understanding and eliminate some of the length associated with the proposed disclosure requirement. Accordingly, our amendments to Form N–1A will require an ETF to state that an investor may incur costs attributable to 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 shares of the ETF (ask) when buying or selling shares in the secondary market (‘‘the bid-ask spread’’).482 This information, combined with the website cross-reference requirement, will direct ETF investors to website disclosures regarding median bid-ask spreads. Finally, Item 6 will continue to require ETFs to disclose: (i) That individual shares may only be purchased and sold on secondary markets through a broker-dealer; and (ii) the price of ETF shares is based on market price, and since ETFs trade at market prices rather than at net asset value, shares may trade at a price greater 480 Our proposal would have required an ETF to: (i) 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 shares of the ETF (ask); (ii) 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; and (iii) identify a set of specific costs, including bid-ask spreads, associated with buying and selling ETF shares. See 2018 ETF Proposing Release, supra footnote 7, at section II.H.2. 481 See ABA Comment Letter. 482 See Item 6(c)(3) of Form N–1A. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 than net asset value (premium) or less than net asset value (discount).483 b. Median Bid-Ask Spread Requirement Rule 6c–11 will require an ETF to provide website disclosure of median bid-ask spreads.484 We believe that this disclosure will provide ETF investors with greater understanding of the costs associated with investing in ETFs. In order to provide similar disclosures to investors in ETFs that are outside the scope of rule 6c–11, we are adopting amendments to Form N–1A requiring the disclosure of median bid-ask spreads. We proposed amendments to Form N–1A that would have required all open-end ETFs to disclose quantitative information about bid-ask spreads, both in an ETF’s prospectus and on its website.485 As discussed above, some commenters expressed concerns with these requirements, and we have made several modifications to mitigate those concerns while maintaining or enhancing the usefulness of the required disclosures. Those modifications include not adopting the proposed requirement for hypothetical bid-ask spread examples in the ETF’s prospectus and interactive calculator, and instead only requiring ETFs relying on rule 6c–11 to provide disclosure of median bid-ask spread on their website.486 However, we continue to believe that all ETF investors should receive key information about bid-ask spread costs, and appreciate that ETFs that are not relying on rule 6c–11 may want the flexibility to provide more timely bidask spread information on their websites.487 We are therefore amending Form N–1A to require an ETF that is not subject to rule 6c–11 to: (i) Provide the ETF’s median bid-ask spread for its most recent fiscal year in its prospectus; or (ii) comply with the bid-ask spread website disclosure requirements in rule 6c–11(c)(1)(v).488 We believe that this 483 Item 6(c) of Form N–1A. We proposed to move this disclosure to Item 3 to consolidate background information relating to ETF trading in one place. 2018 ETF Proposing Release, supra footnote 7, at section II.H.3. However, we are not adopting the proposed amendments to Item 3 and instead adding additional disclosures regarding ETF trading costs to Item 6. As proposed, amended Item 6 also will replace the current reference to ‘‘national securities exchange’’ with ‘‘secondary markets’’ because ETFs can also be bought and sold over the counter. 484 See rule 6(c)(1)(v). 485 See 2018 ETF Proposing Release, supra footnote 7, at sections II.H.2.b and II.I. 486 See supra section II.C.6.d. 487 See infra section II.I. (discussing similar changes for Form N–8B–2). 488 See Item 6(c)(5) of Form N–1A (requiring disclosure of the median bid-ask spread for the ETF’s most recent fiscal year in the summary PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 57201 disclosure requirement will provide all ETF investors with quantitative bid-ask spread information, while providing ETFs not subject to rule 6c–11 with the flexibility to provide either website or prospectus disclosure.489 This requirement also is consistent with our current approach to the disclosure of premiums and discounts in Form N–1A and, based on our experience with that disclosure, we believe most ETFs will opt to post bid-ask spread information on their websites as some ETFs do today on a voluntary basis.490 Although rule 6c–11 contemplates more current website disclosure for ETFs relying on rule 6c–11, we are adopting a lookback period of the ETF’s most recent fiscal year for the prospectus bid-ask spread disclosure requirement. We are adopting this period for consistency with other disclosures in Form N–1A and to avoid establishing a requirement that would require more frequent updating of an ETF’s prospectus. ETFs that opt to provide this information on their website, however, will provide median bid-ask spread information for the most recent thirty-day period on a rolling basis. Finally, newly launched ETFs subject to this prospectus requirement with less than a year of trading data will be required to provide a brief statement to the effect that the ETF does not have sufficient trading history to report trading information and related costs as proposed.491 c. Historical Premium and Discount Disclosures (Items 11 and 27) Rule 6c–11 will require ETFs to provide certain disclosures regarding premiums and discounts on their websites.492 We believe premium/ discount disclosure will help investors prospectus or summary section of the prospectus); Instruction 1 to Item 6(c)(5) of Form N–1A (permitting an ETF to omit the information required if the ETF satisfies the requirements of paragraph (c)(1)(v) of rule 6c–11). As with the parallel website disclosure requirement, we are modifying the proposed methodology to clarify that the observations must be based on trades on the primary listing exchange and that the observations should be as of the end of each ten-second interval. Instruction 2 to Item 6(c)(5) of Form N–1A. We also are making similar amendments to Form N–8B–2 in order to extend this requirement to UIT ETFs. See infra section II.I. 489 Item 6(c)(5) of Form N–1A. See 2018 ETF Proposing Release, supra footnote 7, at section II.H.2.b. 490 See Items 11(g)(2) and 27(b)(7)(iv) of Form N– 1A. 491 Instruction 1 to Item 6(c) of Form N–1A. Newly launched ETFs seeking to satisfy the requirements of paragraph (c)(1)(v) of the rule should provide median bid-ask spread information for the most recent thirty-day period once the ETF has more than 30-days of trading data.information. 492 See rule 6c–11(c)(1). E:\FR\FM\24OCR2.SGM 24OCR2 57202 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 better understand that an ETF’s market price may be higher or lower than the ETF’s NAV per share and will provide investors with useful information regarding ETFs that frequently trade at a premium or discount to NAV. We are adopting amendments to Form N–1A that will exclude only those ETFs that provide premium/discount disclosures in accordance with rule 6c–11 from the premium and discount disclosure requirements in Form N–1A. We proposed to eliminate existing disclosure requirements regarding premiums and discounts in Form N–1A since rule 6c–11 would require an ETF to provide more timely information on its website.493 One commenter supported this amendment, stating that information relevant to premiums and discounts is already disclosed on a timely basis on ETF websites and therefore a duplicative registration statement requirement is not necessary.494 Another commenter, however, stated that the Commission should apply disclosure requirements to all ETFs, including those that cannot rely on rule 6c–11, so that all ETF investors receive the same information.495 After considering comments, we are eliminating the premium and discount requirements in Items 11(g)(2) and 27(b)(7)(iv) for ETFs relying on rule 6c– 11.496 However, ETFs not relying on rule 6c–11 must include premium and discount information in both the prospectus and annual report unless they choose to comply with the website disclosure requirements in rule 6c– 11(c)(1)(ii)–(iv) and (c)(1)(vi).497 We agree that all ETF investors should receive similar premium/discount disclosure, regardless of the form of exemptive relief. We acknowledge that the premium and discount disclosure requirements under rule 6c–11 are broader than what was required under Form N–1A.498 493 Item 11(g)(2) of Form N–1A currently requires 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. Item 27(b)(7)(iv) of Form N–1A requires an ETF to include a table with premium/ discount information in its annual reports for the five most recently completed fiscal years. ETFs currently are permitted to omit both disclosures by providing on their websites the premium/discount information required by Item 11(g)(2). 494 See Invesco Comment Letter. 495 See ETF.com Comment Letter. 496 Item 11(g)(2) of Form N–1A; Item 27(b)(7) of Form N–1A. 497 Items 11(g)(2) and 27(g)(2) of Form N–1A. 498 Unlike current Form N–1A, rule 6c–11 will require disclosure of 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 However, to ensure consistency of website disclosure across ETFs, we are amending Form N–1A to require that if an ETF not relying on rule 6c–11 chooses to disclose the premium and discount disclosures on its website to satisfy the Form N–1A requirement, it must conform with the requirements in rule 6c–11.499 Nonetheless, consistent with our experience with the current Form N–1A requirement, we believe that most ETFs not relying on rule 6c– 11 will choose to comply with the website disclosure requirements in rule 6c–11. 3. Eliminated Disclosures We are adopting the removal of certain disclosure requirements from Form N–1A relating to ETFs. We are removing the requirement that an ETF specify the number of shares it will issue or redeem in exchange for the deposit or delivery of basket assets.500 The number of shares the ETF issues or redeems in exchange for the deposit or delivery of baskets is largely duplicative of information provided in reports on Form N–CEN.501 Commenters did not address this aspect of the proposal, and we are adopting it as proposed. We also are eliminating several disclosure requirements in Items 6 and 11 that applied only to ETFs that issue or redeem shares in creation units of less than 25,000 shares.502 When we that year and disclosure regarding persistent premium or discount of greater than 2%, in addition to a table showing premiums and discounts, in order to omit the premium/discount disclosures in the ETF’s prospectus and annual report. 499 We also are retaining the definition of the term ‘‘Market Price’’ in Form N–1A and amending it to reference the market price definition in rule 6c–11 as a result of the premium/discount disclosure requirements in the form. See General Instruction A to Form N–1A. Harmonizing the definition of market price in Form N–1A and rule 6c–11 will reduce regulatory confusion and will result in a more uniform methodology for calculating premiums and discounts for ETFs that provide premium/discount disclosure in accordance with rule 6c–11 and ETFs that provide premium/ discount disclosures in their prospectuses and annual reports pursuant to these disclosure requirements. See id.; rule 6c–11(a)(1). We are making similar amendments to Form N–8B–2 in order to extend the premium/discount disclosure requirements to UIT ETFs. See infra section II.I. 500 Item 6(c)(i) of current Form N–1A. 501 See Item E.3.a of Form N–CEN. 502 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). Items 6(a) and (b) require funds to: (i) Disclose the minimum initial or subsequent investment requirements; (ii) disclose that the shares are redeemable; and (iii) describe the procedures for redeeming shares. Item 11(g)(1) currently provides 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. Item 11(a) requires a fund to disclose when calculations of NAV are made and that the PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 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.503 Based on staff experience, however, we believe that these disclosures are unnecessary as retail investors generally do not engage in primary transactions through authorized participants and the current flow of information about the purchase and redemption process is robust.504 One commenter supported eliminating these disclosure requirements, and we are eliminating these requirements as proposed.505 I. Amendments to Form N–8B–2 Form N–8B–2 is the registration form under the Investment Company Act for UITs that are currently issuing securities, and it is used for registration of ETFs organized as UITs.506 Because Form S–6 requires UIT prospectuses to include disclosure required by specified provisions of Form N–8B–2, the disclosure requirements of Form N–8B– 2 also apply to prospectuses on Form S– 6. We are adopting several amendments to Form N–8B–2 that will mirror requirements we are adopting in Form N–1A. Although we are not including UIT ETFs within the scope of rule 6c–11, we believe that it is important for investors to receive consistent disclosures for ETF investments, regardless of the ETF’s form of organization. Secondary market investors in UIT ETFs, like other ETFs, are subject to trading costs that unit holders could overlook. We believe that additional disclosure will help investors better understand the total costs of investing in a UIT ETF. We therefore proposed to amend Form N–8B–2 to require UIT ETFs to provide the same disclosures regarding ETF trading and the associated costs as ETFs organized price at which a purchase or redemption is effected is based on the next calculation of NAV after the order is placed. Items 11(b) and (c) require a fund to describe the procedures used when purchasing and redeeming the fund’s shares. 503 Summary Prospectus Adopting Release, supra footnote 477. 504 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. 505 See Invesco Comment Letter. 506 While open-end funds register with the Commission on Form N–1A, UITs must register on 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, requires certain content, mainly by reference to the disclosure requirements in Form N–8B–2. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations as open-end funds would disclose on Form N–1A. Commenters that addressed this proposed provision generally supported these changes,507 and we are amending Form N–8B–2 to mirror the amendments to Form N–1A with the modifications discussed above.508 As with other ETFs that are not within the scope of rule 6c– 11, these amendments will give UIT ETFs the option to forego certain disclosures relating to bid-ask spreads and premiums and discounts provided that the ETF conforms with rule 6c–11’s 57203 corresponding website disclosure requirements.509 Below, Table 3 summarizes the amendments to Form N–8B–2 and the corresponding requirements in Form N– 1A. TABLE 3 Form N–1A ETF disclosure requirement Definitions for Exchange-Traded Fund and Market Price. Information Concerning Fees and Costs ........... Information Concerning Purchase and Sale of Fund Shares. Table Showing Premium and Discount Information. General Instructions Part A ............................. General Instructions Definitions.510 Item 3. Risk/Return Summary: Fee Table ....... Item 6(c). Purchase and Sale of Fund Shares Item I.13(h). Item I.13(i). Item 11(g)(2) .................................................... Item I.13(j). Form N–CEN is a structured form that requires registered funds to provide census-type information to the Commission on an annual basis.511 As proposed, we are adopting a new requirement that will collect specific information on which ETFs are relying on rule 6c–11.512 We believe that this requirement will allow us to better monitor reliance on rule 6c–11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act.513 We also are changing the definition of ‘‘authorized participant’’ in Form N– CEN to conform the definition with rule 6c–11 by deleting a specific reference to an authorized participant’s participation in DTC.514 In addition to reducing regulatory confusion by harmonizing the definition of ‘‘authorized participant’’ with rule 6c–11, this change also will obviate the need for future amendments if additional clearing agencies become registered with the Commission.515 Commenters that addressed the proposed amendments to Form N–CEN expressed In October 2016, the Commission adopted new rules and forms and amended other rules and forms under the Investment Company Act to modernize the reporting and disclosure of information by registered investment companies.516 In February 2019, the Commission adopted an interim final rule that amended the timing requirements for filing reports on Form N–PORT.517 We are making the following technical corrections as a result of these rulemakings, as well as correcting certain other outdated citations and instructions: • Correcting footnote 1 of 17 CFR 210.12–14 (rule 12–14 of Regulation S– X) by replacing a reference to Column E with a reference to Column F.518 • Amending General Instruction B.4.(a) of Form N–1A to update outdated citation references to 17 CFR 230.400 through 230.498 (Regulation C) by replacing references to 17 CFR 230.497 (rule 497) with references to rule 498.519 • Amending General Instruction B.4.(d) of Form N–1A to update outdated citation references to 17 CFR 232.10 through 232.903 (Regulation S– T) by replacing references to rule 903 with references to rule 501.520 • Amending Instruction 4(b) to Item 13 of Form N–1A by deleting outdated instructions regarding changes in methodology for determining the ratio of expenses to average net assets.521 • Amending Form N–1A to require money market funds to state in their annual and semi-annual reports that: (i) Their monthly portfolio holdings are available on Form N–MFP; (ii) the money market fund’s reports on Form N–MFP are available on the Commission’s website; and (iii) the money market fund makes portfolio holdings information available to shareholders on its website.522 This amendment will reflect the fact that money market funds report monthly portfolio holdings on Form N–MFP rather than reporting portfolio holdings for the first and third fiscal quarters on Form N–PORT. 507 See ICI Comment Letter (supporting mirroring proposed disclosure changes in Form N–1A, subject to comments regarding the amendments to Form N– 1A). 508 Items I.13(h) and (i) of Form N–8B–2. See also supra section II.H. (describing the ETF trading information and related costs disclosure requirements). 509 Although UIT ETFs currently are not subject to website disclosure requirements regarding trading costs or other information, UIT ETFs generally disclose information regarding market price, NAV per share, premium and discounts, and spreads on their websites today. 510 The 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 cannot rely on rule 6c–11 to operate. Accordingly, the definition of ‘‘exchange-traded fund’’ in Form N– 8B–2 omits the reference to rule 6c–11. 511 See Reporting Modernization Adopting Release, supra footnote 263. 512 Item C.7.k of Form N–CEN. 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. In addition, Item C.3.a.i of Form N–CEN already requires funds to report if they are an ETF. 513 See Reporting Modernization Adopting Release, supra footnote 263. 514 Item E.2 of Form N–CEN. 515 As proposed, the amendments to Form N–CEN will define the term ‘‘authorized participant’’ 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.’’ See Instruction to Item E.2 of Form N–CEN. 516 See Reporting Modernization Adopting Release, supra footnote 263. 517 See Amendments to the Timing Requirements for Filing Reports on Form N–PORT, Investment Company Act Release No. 33384 (Feb. 27, 2019) [84 FR 7980 (Mar. 6, 2019)] (‘‘Interim Final Rule Release’’). 518 See rule 12–14, note 1. 519 See General Instruction B.4.(a) of Form N–1A. 520 See General Instruction B.4.(d) of Form N–1A. 521 See Instruction 4(b) to Item 13. 522 See Instruction to Item 27(d)(3) of Form N–1A. J. Amendments to Form N–CEN khammond on DSKJM1Z7X2PROD with RULES2 Corresponding Form N–8B–2 disclosure requirement Disclosure topic VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 support, and we have determined to adopt the amendments as proposed. K. Technical and Conforming Amendments to Form N–1A, Form N– 8B–2, Form N–CSR, Form N–PORT, and Regulation S–X PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM 24OCR2 57204 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations • Amending Form N–CSR to correct references to item numbers in General Instruction D and in the instruction to Item 13.523 • Amending General Instruction F (Public Availability) of Form N–PORT to read ‘‘With the exception of the nonpublic information discussed below, the information reported on Form N–PORT for the third month of each Fund’s fiscal quarter will be made publicly available upon filing.’’ 524 This amendment will reflect the Commission’s action making quarter-end reports on Form N–PORT public immediately upon filing, with the exception of the non-public fields identified in General Instruction F.525 • Withdrawing Instruction 23 of Reporting Modernization Adopting Release, which would have amended 17 CFR 232.401 (rule 401 of Regulation S– T) to remove references to Form N–Q.526 The amendment is no longer necessary because rule 401 was rescinded by a subsequent rulemaking.527 • Amending Item IX of Form N–8B– 2 to clarify the required designation of exhibits and the use of incorporation by reference in order to conform to similar instructions in other Investment Company forms.528 L. Compliance Dates The Commission is providing for a transition period for the amendments to Forms N–1A, N–8B–2, and N–CEN. Specifically, we are adopting compliance dates for our amendments to Form N–1A, Form N–8B–2, and Form N–CEN of December 22, 2020, one year following the amendments’ effective date. All registration statements, posteffective amendments, and reports on these forms filed on or after the compliance date must comply with the amendments. Based on the staff’s experience, we believe that this will provide adequate time for ETFs and other funds to compile and review the information that must be disclosed. khammond on DSKJM1Z7X2PROD with RULES2 III. Other Matters Pursuant to the Congressional Review Act,529 the Office of Information and Regulatory Affairs has designated this rule a ‘‘major rule,’’ as defined by 5 523 See General Instruction D to Form N–CSR and Item 13 of Instruction 13 of Form N–CSR. 524 See Instruction F to Form N–PORT. 525 See Interim Final Rule Release, supra footnote 518, at n.35 and accompanying text. 526 See Reporting Modernization Adopting Release, supra footnote 263; see also 17 CFR 232.401. 527 See Inline XBRL Filing of Tagged Data, Investment Company Act Release No. 33139 (June 28, 2018) [83 FR 40846 (Aug. 16, 2018)]. 528 See, e.g., Item 28 of Form N–1A.; Item 26 of Form N–6. 529 5 U.S.C. 801 et seq. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 U.S.C. 804(2). If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. IV. Economic Analysis We are mindful of the costs imposed by, and the benefits obtained from, our rules. Section 2(c) of the Investment Company Act, section 2(b) of the Securities Act, and section 3(f) of the Exchange Act state that when the Commission is engaging in rulmaking under such titles and is required to consider or determine whether the action is necessary or appropriate in (or, with respect to the Investment Company Act, consistent with) the public interest, the Commission shall consider whether the action will promote efficiency, competition, and capital formation, in addition to the protection of investors. Further, section 23(a)(2) of the Exchange Act requires the Commission to consider, among other matters, the impact such rules would have on competition and states that the Commission shall not adopt any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. The following analysis considers, in detail, the potential economic effects that may result from the rule, including the benefits and costs to investors and other market participants as well as the broader implications of the rule for efficiency, competition, and capital formation. A. Introduction ETFs 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 structure and operation of ETFs. 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 exemptive orders allow the sponsors to launch new funds under the terms and conditions of those orders, and because the terms in some of these orders may be more flexible than others. Rule 6c–11 will allow ETFs that satisfy certain conditions to operate without obtaining an exemptive order PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 from the Commission. The Commission also is rescinding the exemptive relief we have issued to ETFs that will be permitted to operate in reliance on the rule. However, we anticipate that ETFs whose exemptive relief will be rescinded under the rule generally will be able to rely on the rule without substantially changing their current operations, as the rule’s conditions are similar to those contained in existing exemptive relief, consistent with existing market practice, or generally more flexible than those contained within existing exemptive relief.530 ETFs that wish to operate in a manner not covered by the final exemptive rule can seek individual exemptive relief from the Commission.531 We believe that rule 6c–11 will 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 can rely on the rule. As such, the rule will enable increased product competition among certain ETF providers, which can lead to lower fees for investors, encourage financial innovation, and increase investor choice in the ETF market. The increased basket flexibility the rule affords in particular may benefit ETFs and their shareholders. To the extent that ETFs are able to implement basket policies and procedures that better facilitate the arbitrage mechanism, these ETFs may reduce their bid-ask spreads and thereby lower transaction costs for their investors. In addition, certain ETFs may be able to use the increased basket flexibility to reduce trading costs the ETF incurs.532 The amendments to Forms N–1A and N–8B–2 as well as the additional website disclosures required by the rule are intended to improve the information 530 As discussed in more detail below, some conditions in the rule and the scope of the relief provided are less flexible than those included in certain exemptive orders (e.g. the absence of masterfeeder relief) and others represent requirements that were not included in exemptive orders (e.g. basket policies and procedures and the recordkeeping requirements). 531 We are not rescinding the exemptive orders for certain categories of ETFs (i.e., UIT ETFs, share class ETFs, leveraged/inverse ETFs and nontransparent ETFs), with the exception of masterfeeder relief that funds did not rely on as of the date of the 2018 ETF Proposing Release (June 28, 2018). 532 Several of the anticipated benefits of rule 6c– 11 may be associated with metrics that will be measurable only after funds operate in reliance on the rule; such metrics include changes in bid-ask spreads, premiums/discounts to NAV per share, fund fees, and the number of ETFs. These metrics may help facilitate evaluation of the extent to which the rule has generated the anticipated benefits, although these metrics may also be affected by developments independent of rule 6c–11. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 about ETFs available to the market and to allow investors to more readily obtain information about fund products, resulting in reduced investor search costs. To the extent that the disclosure requirements will improve investors’ ability to evaluate the performance and other characteristics of fund products, the amendments may result in better informed investor decisions and more efficient allocation of investor capital among fund products, and may further promote competition among ETFs and between ETFs and mutual funds. The 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 rule will 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 customers and clients may show increased interest in and demand for ETFs. Moreover, because ETF shares are traded on the secondary market, the rule also can 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 U.S. ETF began trading in 1993.533 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 533 For the purpose of this release, we focus exclusively on ETFs that trade on U.S. exchanges. PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 57205 average of 137 new ETF entrants and an average growth of $241.2 billion annually. Since 2007, ETF net assets have grown at an average rate of 17.2% per year, which compares to 3.2% for closed-end funds and 6.3% for openend funds over the same period.534 At the end of December 2018, there were 1,978 registered ETFs, totaling $3.3 trillion in net assets and spanning six broad investment style categories. ETFs are predominantly structured as openend funds; however, eight UIT ETFs together represented 10.3% of ETF total net assets ($340.6 billion), and 68 share class ETFs together represented 25.6% of total net assets ($854.6 billion). The chart illustrates growth in ETF net assets by investment strategy beginning in 2000. It also tracks the percentage of net assets invested in actively managed ETFs. 534 Unless otherwise noted, the number and net assets of ETFs in this section of the Release 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. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 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 (in both index-based and actively managed ETFs). At the end of December 2018, there were 167 leveraged/inverse ETFs that were structured as open-end funds.535 In total, leveraged/inverse ETFs had total net assets of $29.64 billion or approximately 1% of all ETF net assets. None of the eight registered UIT ETFs employed leveraged or inverse investment strategies. Of the remaining unleveraged ETFs, both index-based and actively managed, 1,705 ETFs had combined net assets of $3 trillion 535 See supra footnote 92 (noting that the exemptive orders that we have issued to sponsors of leveraged/inverse ETFs do not provide relief to ETFs described as seeking investment returns that correspond to the performance of a leveraged or inverse leveraged market index over a predetermined period of time). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 operated as open-end funds, while eight UIT ETFs had $340.6 billion in net assets.536 There were 257 actively managed ETFs with total net assets of $69.5 billion. The remaining 1,721 ETFs, with a combined $3.23 trillion in net assets, were index-based ETFs. Of these, 1,713 ETFs with total net assets of $2.892 trillion were structured as open-end funds and eight UIT ETFs had total net assets of $340.6 billion. The majority of ETFs (1,615) held some foreign exposure in their portfolio according to Morningstar data. These ETFs had total net assets of $2.921 trillion. Of these funds, seven were UIT ETFs and had $320.6 billion in net assets. The remaining 1,608 ETFs accounting for $2.6 trillion in net assets were organized as open-end funds. On average, these ETFs reported foreign exposure of 40.15% (56.87% for UIT 536 Bloomberg defines actively managed or indexbased managed funds according to disclosure in the fund prospectus. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 ETFs and 40.07% for ETFs structured as open-end funds).537 2. Exemptive Order Process and Certain Conditions Under Existing Orders ETFs seeking to operate as investment companies required exemptive relief from the Commission. Since the first exemptive order was granted in 1992, the Commission has issued approximately 300 exemptive orders to ETFs. The average number of approved exemptive orders between 1992 and 2006 was approximately 2.5 per year, which has increased to approximately 29 per year since 2007. 537 We estimate funds’ foreign holdings on February 27, 2019 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 1,970 ETFs. In this data, 363 funds, one of which is a UIT ETF, reported holding no foreign securities and 8 funds from the original 1,978 are missing foreign holdings data. E:\FR\FM\24OCR2.SGM 24OCR2 ER24OC19.019</GPH> khammond on DSKJM1Z7X2PROD with RULES2 57206 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 Based on our review of exemptive orders that granted relief for unleveraged ETFs between January 2007 and early April 2019, the median processing time from the filing of an initial application to the issuance of an order was 213 days, although there was considerable variation.538 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 87 days) while others waited over one year for approval (the 90th percentile of the processing time was 669 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. These exemptive orders permit ETFs to operate as investment companies under the Investment Company Act, subject to representations and conditions, some of which have changed over time.539 For example, as discussed above, our orders have required ETFs that will rely on rule 6c– 11 to provide some degree of transparency regarding their portfolio holdings.540 Actively managed ETFs and some self-indexed ETFs have been required to disclose their full portfolio holdings each day, while other indexbased ETFs are permitted to specify the index they seek to track (as long as the index provider lists the constituent securities on its website) or disclose the components of their baskets. Based on a staff review of 150 randomly selected ETFs, which included 100 index-based ETFs and 50 actively managed ETFs, however, all 150 ETFs maintain a website and provide the ETF’s complete daily portfolio holdings. Therefore, we believe it is likely that all ETFs that can rely on the rule, including those that are not subject to a full transparency condition in their exemptive order, currently provide full portfolio transparency.541 538 The earliest order in our sample was approved on January 17, 2007 and the latest order was approved on April 2, 2019. This data does not include orders for non-transparent ETFs. 539 ETFs generally have obtained similar exemptive relief under these orders. However, over time, our exemptive orders generally have increased the maximum number of days that an ETF holding foreign investments can delay the satisfaction of redemptions as part of the relief from section 22(e) of the Act (from 12 days to 15 days). 540 See supra footnote 225. 541 The samples were randomly drawn from all index-based ETFs and all actively managed ETFs VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 ETFs’ flexibility to use custom baskets also has evolved over time under our exemptive orders. From 1996 to 2006, exemptive orders for open-end ETFs did not expressly limit baskets to a pro rata representation of the ETF’s portfolio holdings. Since approximately 2006, however, our exemptive orders placed increasingly tighter restrictions on ETFs’ composition of baskets.542 Because our exemptive orders have generally included future funds relief to allow sponsors to form and operate new ETFs, we are unable to quantify the number of funds operating under each of the different basket flexibility conditions included in our orders.543 Many exemptive orders also have required ETFs to provide certain website disclosures on their website, free of charge.544 Based on a staff review of the websites of 150 randomly selected ETFs, all 150 ETFs provided the previous day’s NAV, price of the ETF shares,545 and the premium or discount associated with the ETF share price at the market close. Accordingly, we believe that all ETFs that can rely on rule 6c–11 currently disclose this information on their website.546 Our exemptive orders also have included other requirements, including the publication of the ETF’s IIV every 15 seconds. 3. Market Participants Several non-ETF market participants may be affected by the rule, including fund sponsors, authorized participants, liquidity providers, trading venues, and institutional and retail investors. Using data from Bloomberg, we estimate that there are 81 unique ETF currently trading according to Bloomberg. We recognize that the selection of ETFs examined 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. Commenters did not disagree with statements in the proposing release that ETFs that can rely on the rule maintain a website and provide the ETF’s complete daily portfolio holdings. 542 See 2018 ETF Proposing Release, supra footnote 7, at nn.236–241 and accompanying text. 543 See supra footnote 5. 544 See 2018 ETF Proposing Release, supra footnote 7, at section II.C.6.c. Substantially all exemptive orders starting in 2008 include a requirement for daily website disclosures of NAV, closing price, and premiums and discounts—each as of the end of the prior business day. 545 One actively managed ETF provided a price based on the midpoint between the bid and ask prices, while the remainder of the actively managed ETFs and all index-based ETFs provided closing prices. 546 Commenters did not disagree with a statement in the proposing release that all ETFs that can rely on the rule currently provide this information on their website. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 57207 sponsors with approximately 1,978 ETFs as of December 31, 2018. The median number of ETFs per sponsor is six and the mean is 24, 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 965 ETFs, whereas the bottom half of sponsors operate only a combined 118 ETFs. An ETF (either directly or through a service provider) has contractual arrangements with authorized participants to purchase or redeem ETF shares in creation unit size aggregations in exchange for a basket of securities and other assets. Based on data from Form N–CEN as of July 26, 2019, the median ETF has 23 authorized participant agreements and 4 active authorized participants.547 548 Larger ETFs tend to have more authorized participant agreements, with the median number of authorized participant agreements ranging from 13 for the smallest quarter of ETFs to 33 for the largest quarter of ETFs. Larger ETFs also tend to have more active authorized participants, ranging from a median of 2 to 7 for the smallest and largest quarters of ETFs, respectively. A 2015 survey-based study of fifteen fund sponsors reports, however, 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.549 Some authorized participants also act as registered market makers in ETF shares. Other liquidity providers for ETF shares include market makers that are not authorized participants, hedge funds, and proprietary trading firms. According to a 2014 survey, the median number of liquidity providers for an ETF was 17, while the median number of authorized participants that are 547 Beginning July 30, 2018, ETFs started reporting information on authorized participants in response to Item E.2 of Form N–CEN. As of July 26, 2019, 1,739 ETFs had filed the form. 548 An active AP is an authorized participant that engaged in creation or redemption activity during the reporting period. Some market makers and other market participants engage in creation and redemptions indirectly through authorized participants. See supra section I.B. Data on the number of such market participants is not reported on Form N–CEN. 549 See Rochelle Antoniewicz & Jane Heinrichs, The Role and Activities of Authorized Participants of Exchange-Traded Funds, ICI Report (Mar. 2015) (‘‘Antoniewicz II’’). The study also points out that NSCC is the sole provider of clearing services for ETF primary market transactions and that 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 also 2019 ICI Factbook, supra footnote 3 (‘‘On average, 90 percent of the total daily activity in ETFs occurs on the secondary market.’’). E:\FR\FM\24OCR2.SGM 24OCR2 57208 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations registered market makers for an ETF was 4.550 ETF shares are mainly traded on national securities exchanges.551 Table 4 lists the 9 exchanges with the largest average daily ETF trading volume, measured over the 30 business days ending on March 7, 2019. The data shows that NYSE Arca handles the largest portion of ETF trades ($15.3 billion), followed by Cboe BZX Exchange ($6.6 billion), and Cboe EDGX Exchange ($4.5 billion). TABLE 4—ETFS TRADED ON NATIONAL EXCHANGES AND THEIR TRADING VOLUME Trading volume (billion) Number of ETFs Exchange NYSE Arca, Inc ........................................................................................................................................................ Cboe BZX Exchange, Inc ........................................................................................................................................ Cboe EDGX Exchange, Inc ..................................................................................................................................... Cboe BYX Exchange, Inc ........................................................................................................................................ The Nasdaq Stock Market LLC ............................................................................................................................... Cboe EDGA Exchange, Inc ..................................................................................................................................... Nasdaq PHLX LLC .................................................................................................................................................. Nasdaq BX, Inc ........................................................................................................................................................ NYSE Chicago, Inc .................................................................................................................................................. 1,939 1,813 1,815 1,721 348 1,668 1,070 1,671 184 $15.3 6.6 4.5 3.6 2.6 2.1 1.9 1.5 1.2 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 March 7, 2019. 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 Commission staff using data obtained through a subscription to Bloomberg. average using total net assets (‘‘TNA’’)— based weights. The difference between the equal-weighted and TNA-weighted average institutional ownership numbers—43% vs. 57%—suggests that institutional investors tend to hold larger ETFs. In addition, there is considerable variation in the degree to which ETF shares are held by Both institutional and retail investors participate in the ETF secondary market. As shown in Table 5 below, from the first quarter of 2015 to the fourth quarter of 2017, we estimate that institutions own, on average, 43% of ETF shares, when calculating the average using equal weights for all ETFs, and 57% when calculating the institutions, ranging from an average for the 5th percentile of 6% to an average for the 95th percentile of 90%.552 However, we observe that the average institutional holding did not change considerably over time during the sample period. TABLE 5—INSTITUTIONAL OWNERSHIP OF ETFS Quarter 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 Average Equalweighted average (%) ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ ............................ TNAweighted average (%) 41 42 44 44 44 43 43 44 43 44 43 44 43 54 55 56 57 57 56 56 57 58 55 61 58 57 SD (%) P5 (%) 24 25 26 26 26 26 26 25 25 25 25 24 25 P25 (%) 5 6 7 5 5 6 5 6 6 6 6 7 6 P50 (%) 22 23 25 24 24 23 24 24 24 25 24 25 24 P75 (%) 38 40 41 43 42 41 41 42 42 42 42 43 41 P95 (%) 58 60 62 62 62 61 62 61 61 61 61 61 61 85 91 94 92 92 92 91 91 91 90 88 87 90 khammond on DSKJM1Z7X2PROD with RULES2 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 2015Q1 to 2017Q4 obtained through a subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP). Further analysis shows that institutional ownership varies considerably by the type of ETF. Using Morningstar Categories, for the fourth quarter of 2017, Table 6 below shows that ETFs’ equal-weighted average institutional ownership ranges from 20% for alternative ETFs to 56% for taxable bond ETFs. We also find that 550 See Antoniewicz II, supra footnote 550; see also 2019 ICI Factbook, supra footnote 3. 551 In the first quarter of 2019, 64% of ETF trading by dollar volume was executed on exchanges, 26% over the counter without using alternative trading systems (ATSs), and 10% over the counter using 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. 552 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 not all institutional investors are required to file the form (which would lead to an understatement of institutional ownership). VerDate Sep<11>2014 19:32 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations TNA-weighted 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 larger ETFs within these categories. The 57209 converse is true for allocation, alternative, and commodity ETFs. The table also shows that there is large variation within categories.553 TABLE 6—INSTITUTIONAL OWNERSHIP OF ETFS BY MORNINGSTAR CATEGORY FOR 2017:Q4 Category Equalweighted average (%) Allocation .......................... Alternative ........................ Commodities .................... International Equity .......... Municipal Bond ................ Sector Equity .................... Taxable Bond ................... U.S. Equity ....................... TNAweighted average (%) 46 20 43 48 52 43 56 46 SD (%) 40 11 40 62 63 59 63 59 P5 (%) 27 20 16 22 16 21 20 21 P25 (%) 10 2 16 10 22 12 24 10 P50 (%) 22 6 39 33 40 27 43 31 P75 (%) 41 13 39 49 51 42 56 44 P95 (%) 67 26 57 66 64 57 69 61 94 64 61 85 74 82 89 87 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 2017Q4 obtained a through subscription to WRDS SEC Analytics Suite and the 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 NAV of the underlying ETF assets.554 As discussed above, however, authorized participants engage in primary market arbitrage activity that brings the market price of ETF shares and the NAV of the ETF’s portfolio closer together.555 Market participants also can engage in arbitrage activity in the secondary market by taking offsetting positions in the ETF shares and the underlying basket assets. Using data from Bloomberg, we find that ETFs, on average, have closing prices slightly higher than the NAV per share (i.e., trade at a premium at market close), as shown in Table 7 below. The equal-weighted and TNA-weighted average premium/discount over the last 15 years for all ETFs in the dataset are 0.07% and 0.06%, respectively, and the median is 0.02%, indicating that the closing 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.556 However, consistent with the study, we find that ETF premiums/ discounts vary significantly.557 For example, we find that the (weighted) average premium/discount ranges from 0.02% in 2018 to 0.14% in 2009, and the standard deviation of premiums/ discounts ranges from 0.16% in 2017 to 0.59% 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, on average. TABLE 7—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF PREMIUM/DISCOUNT (%) USING DAILY DATA Year khammond on DSKJM1Z7X2PROD with RULES2 2004 2005 2006 2007 2008 2009 2010 2011 Equalweighted average ................................. ................................. ................................. ................................. ................................. ................................. ................................. ................................. TNAweighted average 0.10 0.06 0.07 0.14 0.09 0.12 0.07 0.04 0.04 0.08 0.08 0.08 0.10 0.14 0.07 0.07 553 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 SD P5 0.26 0.28 0.34 0.38 0.59 0.53 0.35 0.41 P25 ¥0.26 ¥0.22 ¥0.34 ¥0.39 ¥0.77 ¥0.55 ¥0.43 ¥0.54 ¥0.06 ¥0.04 ¥0.04 ¥0.06 ¥0.14 ¥0.08 ¥0.05 ¥0.04 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. 554 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 PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 P50 0.02 0.04 0.03 0.03 0.05 0.02 0.02 0.02 P75 0.09 0.11 0.14 0.20 0.34 0.34 0.16 0.17 P95 0.55 0.62 0.67 0.64 1.03 1.02 0.63 0.76 than its NAV per share. See, e.g., Ananth Madhavan & Aleksander Sobczyk, Price Dynamics and Liquidity of Exchange-Traded Funds, Journal of Investment Management, Second Quarter 2016, at 1. 555 See supra section I.B. 556 See Antti Petajisto, Inefficiencies in the Pricing of Exchange-Traded Funds, Financial Analysts Journal, First Quarter 2017, at 24. 557 Commenters to our 2015 ETP Request for Comment, supra footnote 19, reported 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). E:\FR\FM\24OCR2.SGM 24OCR2 57210 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations TABLE 7—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF PREMIUM/DISCOUNT (%) USING DAILY DATA—Continued Year Equalweighted average 2012 ................................. 2013 ................................. 2014 ................................. 2015 ................................. 2016 ................................. 2017 ................................. 2018 ................................. Average ............................ TNAweighted average 0.06 0.06 0.05 0.04 0.03 0.07 0.03 0.07 SD 0.07 0.03 0.04 0.04 0.04 0.06 0.02 0.06 P5 0.28 0.28 0.22 0.23 0.23 0.16 0.22 0.31 P25 ¥0.31 ¥0.35 ¥0.25 ¥0.25 ¥0.22 ¥0.10 ¥0.32 ¥0.35 P50 ¥0.02 ¥0.03 ¥0.01 ¥0.01 ¥0.01 ¥0.01 ¥0.03 ¥0.04 0.02 0.02 0.02 0.02 0.01 0.02 0.01 0.02 P75 P95 0.14 0.09 0.08 0.08 0.09 0.09 0.07 0.14 0.58 0.43 0.35 0.40 0.39 0.33 0.36 0.57 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. Premiums or discounts are from daily Bloomberg data covering 2,235 ETFs for a total of 3,319,782 daily observations. Per Bloomberg, premium/discount (%) is the difference between the ETF’s closing price on the day of the most recent NAV and the NAV of the fund on that day. The data covers the period from 01/02/2004 to 12/31/2018. Premiums and discounts to NAV per share also vary considerably by the types of assets held by the ETF.558 We use Morningstar Investment Categories to divide ETFs into groups of similar assets and, in Table 8 below, report the for alternative ETFs to 0.183% for taxable bond ETFs. The results are qualitatively similar for the equalweighted average premium/discount. 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 0.002% TABLE 8—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF PREMIUM/DISCOUNT (%) BY MORNINGSTAR INVESTMENT CATEGORY Category Equalweighted average Allocation .......................... Alternative ........................ Commodities .................... International Equity .......... Municipal Bond ................ Sector Equity .................... Taxable Bond ................... U.S. Equity ....................... TNAweighted average 0.068 0.006 0.199 0.176 0.071 0.030 0.192 0.003 0.077 0.002 0.105 0.181 0.059 0.012 0.183 0.006 SD 0.222 0.317 0.446 0.422 0.290 0.183 0.196 0.076 P5 P25 P50 ¥0.124 ¥0.388 ¥0.501 ¥0.467 ¥0.351 ¥0.234 ¥0.075 ¥0.098 ¥0.039 ¥0.119 0.009 ¥0.071 ¥0.097 ¥0.070 0.080 ¥0.033 0.046 ¥0.004 0.079 0.192 0.050 0.005 0.175 0.008 P75 0.222 0.110 0.150 0.438 0.241 0.081 0.257 0.046 P95 0.287 0.444 0.924 0.799 0.477 0.294 0.506 0.109 The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The ETFs 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. Premiums or discounts are from daily Bloomberg data covering 2,235 ETFs for a total of 3,319,782 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund’s closing price on the day of the most recent NAV and the NAV of the fund on that day. The data covers the period from 01/02/2004 to 12/31/2018. When the ETF arbitrage mechanism functions effectively, ETFs also should trade at smaller bid-ask spreads.559 As shown in Table 9 below, the TNAweighted average bid-ask spread, as a percentage of the mid-price, has been relatively constant over the years, smaller bid-ask spreads. The table also shows that the bid-ask spread varies considerably between ETFs, with an average of the 5th percentile of bid-ask spreads of 0.01% and an average of the 95th percentile of bid-ask spreads at 0.16%. ranging from highs of 0.37% in 2012 and 2016 to a low of 0.31% in 2018.560 Equal-weighted average bid-ask spreads averaged 0.33% and were considerably higher than TNA-weighted bid-ask spreads, which averaged 0.04%, reflecting that larger ETFs tend to have TABLE 9—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF RELATIVE BID-ASK SPREAD (%) khammond on DSKJM1Z7X2PROD with RULES2 Year Equalweighted average 2012 ................................. 2013 ................................. TNAweighted average 0.37 0.33 0.06 0.05 558 See, e.g., Robert Engle & Debojyoti Sarkar, Premiums-Discounts and Exchange Traded Funds, Journal of Derivatives, Summer 2006, at 27 (observing that premiums and discounts for domestic ETFs are generally small and highly transient, and that while premiums and discounts VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 SD P5 0.12 0.10 P25 0.01 0.01 are larger and more persistent in international ETFs, they are smaller and less persistent than the premiums and discounts of international closedend funds). 559 See, e.g., Joanne M. Hill, Dave Nadig, & Matt Hougan, Comprehensive Guide to Exchange-Traded PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 P50 0.02 0.01 0.02 0.02 P75 0.05 0.05 P95 0.27 0.21 Funds (ETFS), CFA Institute Research Foundation (2015), available at https://www.cfapubs.org/doi/ pdf/10.2470/rf.v2015.n3.1 (‘‘CFA Guide’’). 560 This analysis starts in 2012 because the available data begins in that year. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 57211 TABLE 9—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF RELATIVE BID-ASK SPREAD (%)— Continued Year Equalweighted average 2014 ................................. 2015 ................................. 2016 ................................. 2017 ................................. 2018 ................................. Average ............................ TNAweighted average 0.27 0.32 0.37 0.34 0.31 0.33 SD 0.04 0.04 0.04 0.03 0.05 0.04 P5 0.06 0.07 0.07 0.07 0.09 0.08 P25 0.01 0.00 0.01 0.00 0.01 0.01 P50 0.01 0.01 0.01 0.01 0.01 0.01 0.02 0.02 0.02 0.02 0.02 0.02 P75 0.04 0.05 0.04 0.03 0.04 0.04 P95 0.11 0.12 0.11 0.11 0.16 0.16 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 2,235 ETFs for a total of 2,477,272 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 01/02/2004 to 12/31/2018. Table 10 below reports bid-ask spreads for ETF shares by Morningstar Category. U.S. Equity ETFs have the smallest average bid-ask spread of 0.03%, whereas allocation ETFs—ETFs 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 0.21%. TABLE 10—TIME-SERIES AVERAGES OF CROSS-SECTIONAL DESCRIPTIVE STATISTICS OF RELATIVE BID-ASK SPREAD (%) BY MORNINGSTAR INVESTMENT CATEGORY Category Equalweighted average Allocation .......................... Alternative ........................ Commodities .................... International Equity .......... Municipal Bond ................ Sector Equity .................... Taxable Bond ................... U.S. Equity ....................... TNAweighted average 0.57 0.38 0.30 0.43 0.29 0.28 0.29 0.21 0.21 0.10 0.06 0.07 0.10 0.06 0.04 0.03 SD P5 0.30 0.16 0.07 0.11 0.11 0.09 0.08 0.04 P25 0.06 0.02 0.02 0.02 0.03 0.01 0.01 0.01 P50 0.07 0.03 0.02 0.02 0.04 0.02 0.01 0.01 0.14 0.05 0.02 0.03 0.06 0.04 0.02 0.01 P75 0.22 0.09 0.08 0.08 0.10 0.06 0.04 0.03 P95 0.64 0.33 0.14 0.21 0.30 0.20 0.15 0.09 khammond on DSKJM1Z7X2PROD with RULES2 This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The ETFs 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 12/31/2018. 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 2,235 ETFs for a total of 2,477,272 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, 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. 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.561 561 See, e.g., Ananth Madhavan, Exchange-Traded Funds, Market Structure, and the Flash Crash, Financial Analysts Journal, July/Aug. 2012, at 20. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 C. Benefits and Costs of Rule 6c–11 and Form Amendments The Commission is sensitive to the economic effects that can result from rule 6c–11 and amendments to Forms N–1A and N–8B–2, including benefits and costs. Where possible, the Commission quantifies the likely economic effects; however, the Commission is unable to quantify certain economic effects because it lacks the information necessary to provide estimates or ranges. In some cases, quantification is particularly challenging due to the difficulty of predicting how market participants will act under the conditions of the rule. Nevertheless, as described more fully below, the Commission is providing both a qualitative assessment and quantified estimate of the economic effects, including the initial and ongoing costs of the additional disclosure requirements, where feasible. PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 1. Rule 6c–11 Rule 6c–11 will allow 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 are rescinding all existing ETF exemptive orders, with the exception of: (i) The section 12(d)(1) relief included in those orders that permit certain fund of funds arrangements; 562 and (ii) orders relating to UIT ETFs, leveraged/inverse ETFs, share class ETFs, and non-transparent ETFs. This section first evaluates the general considerations associated with the rulemaking and then discusses the 562 We will, however, rescind relief from sections 12(d)(1) and 17(a)(1) and (2) that have been provided to allow master-feeder arrangements for those ETFs that do not currently rely on the relief. See supra section II.F. In addition, we will grandfather existing master-feeder arrangements involving ETF feeder funds, but prevent the formation of new ones under existing orders, by amending relevant exemptive orders. See id. E:\FR\FM\24OCR2.SGM 24OCR2 57212 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations a. General Considerations Rule 6c–11 will grant exemptive relief from the provisions of the Act that 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 rule are either similar to those contained in existing exemptive orders, consistent with market practice, or generally provide more flexibility, we anticipate that the rule and the related rescission of ETF exemptive relief will not require any existing ETFs whose exemptive relief will be rescinded to significantly change the way they operate. Conversely, some ETFs whose exemptive orders contain conditions that are more restrictive than those contained in the rule may decide to change the way they operate in order to make use of such increased flexibility. Relative to the baseline, rule 6c–11 will 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 rule will be quicker, more predictable, less complex, and therefore less costly than obtaining an exemptive order as new ETFs that cannot rely on existing orders are currently required to do. ETFs that cannot rely on the rule will continue to be required to apply for an exemptive order to form and operate, unless they have an existing exemptive order that includes future fund relief.563 As described above in section IV.B.2, we estimate that the cost for a typical unleveraged 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 early April 2019, the median processing time from the filing of an initial application to the issuance of an order was 213 days, although there was considerable variation. Thus, any new ETF planning to operate within the parameters set forth by the rule will 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 each sponsor 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 will continue to need to apply for an exemptive order. Assuming that the number of new ETFs seeking to form and operate under the rule that would otherwise need to apply for exemptive relief is equal to the annual average number of ETFs that have applied for exemptive relief since 2007, these cost and time savings would accrue to approximately 29 ETFs per year.564 Using this assumption, the annual costs savings to this group of ETF sponsors are approximately $2.9 million.565 We are unable to quantify the benefit a new ETF will 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.566 By eliminating the need for ETFs that can rely on the rule to seek an exemptive order from the Commission, the rule will 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 rule will make it easier for some fund complexes to ensure that each ETF in 563 See supra footnote 42 (noting that UIT ETFs’ orders do not include relief for future ETFs formed pursuant to the same order). As discussed below, some ETFs will 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 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 rule, such as the increased basket flexibility and, for certain new ETFs, the reduced costs of forming the fund. 564 Compared to the baseline, these cost and time savings will only accrue to new ETFs whose sponsors have not received exemptive relief that would allow such ETFs to operate. 565 This estimate is based on the following calculation: 29 × $100,000 = $2,900,000. 566 Costs arising from the delay and the uncertainty associated with the exemptive order process include primarily forgone profits and costs associated with missed business opportunities. We do not have access to data on ETFs’ profits, and commenters did not provide such data. Additionally, forgone profits associated with missed business opportunities, such as forgoing a ‘‘first-mover advantage,’’ can be highly variable and dependent on specific circumstances. khammond on DSKJM1Z7X2PROD with RULES2 effects of the specific requirements and conditions of the rule. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 the complex is in compliance with regulations. Specifically, we anticipate that it will 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 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 rule. However, we believe that these costs will be relatively small.567 In addition, we anticipate that it will be more efficient for third-party providers, such as lawyers and compliance consultants, to offer services that help ETFs ensure compliance with the rule, 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 can rely on the rule, which may partially or fully offset the initial costs of studying the requirements of the rulemaking that ETFs may incur. We expect that the rule also will benefit ETF investors to the extent that it will remove a possible disincentive for sponsors to form and operate new ETFs that provide investors with additional investment choices if they 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. As we discuss below in section IV.D.2, we believe that the rule could increase competition in the ETF market as a whole, which could also lead to lower fees. Any effect of increased 567 We estimate that assessing the requirements of the final rule will require 5 hours of a compliance manager ($309 per hour) and 5 hours of a compliance attorney ($365 per hour), resulting in a cost of $3,370 (5 × $309 + 5 × $365) per fund. The total cost for all 1,735 ETFs that can rely on the rule will thus be $5,846,950 (1,735 × $3,370). 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 1800-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’’). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 competition on fees will likely be larger for segments of the ETF market that currently may be less competitive (e.g., actively managed ETFs) and smaller for segments of the market that currently may be more competitive (e.g., indexbased ETFs tracking major stock indices). By eliminating the need for individual exemptive relief, we anticipate that the rule will, over time, increase the number of ETFs and thus reinforce the current growth trend in the ETF industry. In addition, the rule will increase demand for such ETFs, to the extent that such ETFs lower their fees to investors and investors are sensitive to fees.568 To the extent that some ETFs will experience larger reductions in trading costs (e.g., fixed-income, international, and actively managed ETFs, as discussed below in section IV.C.1.b.i.) or larger increases in competition (e.g., actively managed ETFs, as discussed above in this section), demand for these types of ETFs will likely increase more than for other types of ETFs. The increased demand will 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.569 Consequently, the rule could increase total assets of ETFs and could decrease total assets of other funds. The size of these effects will depend on the degree to which ETFs will lower their fees or 568 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 Journal of Finance 1589 (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. 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 Review of Financial Studies 1405 (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 to hold for ETFs as well. We are not aware of any studies that specifically study the sensitivity of ETF investors to fees. 569 Investments in ETFs are one of many ways for investors to allocate savings. 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. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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, in part, because we cannot estimate the extent to which funds will lower their fees or experience reduced trading costs and how lower fees and trading costs will change investor demand. Since ETFs are traded in the secondary market, an increase in total assets of ETFs will likely coincide with larger trade volumes for the exchanges where ETFs are traded, as well as for the clearing agencies and broker-dealers involved in these trades. To the extent that these market participants are compensated by volume, the rule will thus benefit them by leading to an increase in revenues.570 In addition, we expect the rule to reduce the number of applications for ETF exemptive relief. This will allow Commission staff more time to review applications for exemptive relief from registered investment companies, including those for more complex or novel ETFs that will continue to require exemptive relief. To the extent that this speeds up the processing time for these remaining applications, the rule may reduce the indirect costs of forming and operating for ETFs that seek to operate outside its parameters and for other registered investment companies that require exemptive relief to operate and, as a result, may promote innovation among these types of funds. b. Conditions for Reliance on Rule 6c– 11 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, many of the conditions in rule 6c–11 do not offer 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. 570 To the extent that investors substitute away from products that are comparable to ETFs, such as mutual funds, an increase in revenue for entities facilitating ETF transactions may be offset by a decrease in revenue for entities facilitating fewer transactions in those other products. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 57213 i. Conditions That 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.571 As a consequence, arbitrageurs generate price pressure that works to equalize the prices of these assets across different markets. This is 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. There are several factors that are important for arbitrageurs to consider in order 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.572 The rule contains conditions that take these considerations into account and are designed to promote the effective functioning of the arbitrage mechanism for ETFs. The rule will 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 procedures specific to the creation of custom baskets if the ETF uses custom baskets. Although current exemptive orders contain varying provisions for basket flexibility, we do not believe that the rule will require existing ETFs to change how they construct baskets. Instead, the 571 See, e.g., Jonathan B. Berk & Peter DeMarzo, Corporate Finance (3rd ed. 2013). 572 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 bidask 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 are likely to decide to wait for any deviation 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. E:\FR\FM\24OCR2.SGM 24OCR2 57214 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 rule will give some ETFs more flexibility for constructing baskets than what is allowed by their existing exemptive orders, provided they adopt and implement custom basket policies and procedures. We believe that fixed-income, international, and actively managed ETFs will particularly benefit from the increased basket flexibility under the rule if they currently operate under exemptive orders that do not allow custom baskets. For example, 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, thus reducing trading costs for authorized participants. Similarly, international ETFs will be able to tailor their creation and redemption baskets to accommodate difficulties in transacting in certain international securities. In addition, actively managed ETFs will, 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 will be able to reduce certain transaction costs, such as those associated with bid-ask spreads. For these reasons, we believe that, to the extent that ETFs are able to implement procedures that facilitate the arbitrage mechanism or reduce costs for those ETFs, the rule will benefit ETFs that use the increased basket flexibility the rule affords and will ultimately benefit their investors. One commenter submitted results from an empirical analysis that supported this assessment.573 For example, the commenter observes that fixed-income ETFs that currently have increased basket flexibility exhibit smaller bid-ask spreads and reduced premiums and discounts to NAV, particularly during times of market stress.574 Due to a lack 573 See ICI Comment Letter (providing the results of an empirical analysis indicating that fixedincome ETFs with basket flexibility had narrower bid-ask spreads, lower tracking differentials, and traded at smaller discounts than fixed-income ETFs without basket flexibility). The commenter conducted a survey to identify fixed-income ETFs that currently have increased basket flexibility. While the commenter provided the results of an empirical analysis based on this data, the commenter did not provide the Commission with the survey responses themselves. 574 Conversely, another commenter stated that increased basket flexibility may reduce arbitrage efficiency for fixed-income ETFs, particularly during market stress. See Bluefin Comment Letter. This commenter observes that such ETFs may choose to include less liquid portfolio holdings in VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 of data, we are unable to quantify the number of ETFs that would choose to implement custom basket policies and procedures, and thus the potential benefits accruing to ETFs and their investors. To the extent that existing ETFs do not already have policies and procedures governing basket assets in place or that existing policies and procedures are not consistent with the requirements of the rule, ETFs will incur costs associated with developing and implementing such policies and procedures. However, such costs may be partially or totally offset by the basket flexibility discussed above. We estimate that an average ETF will incur an initial cost of $10,718 575 associated with establishing and implementing standard and custom basket policies and procedures. In addition, we estimate that an average ETF will incur an ongoing cost of $4,135 576 each year to review and update its basket policies and procedures. We thus estimate that the total industry cost associated with the policies and procedures requirement in the rule for ETFs that can rely on the rule in the first year will equal $25,769,955.577 Finally, although the rule’s custom basket policies and procedures requirements are designed to reduce the potential for cherry-picking, dumping, and other potential abuses, we acknowledge that this principles-based approach may not be effective at preventing all such abuses. However, ETFs will be required to maintain records related to the custom baskets redemption baskets in greater than pro-rata proportions, thereby increasing trading costs for arbitrageurs and leading to larger premiums and discounts. While we acknowledge this concern, ETFs generally are incentivized to choose custom baskets that reduce premiums and discounts for the benefit of transacting shareholders. In addition, as discussed above in section II.C.5.a, we believe that requiring fixed-income ETFs to establish detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders addresses the risks associated with custom baskets. 575 This estimate is based on the following calculations: 12 hours × $329 per hour (senior manager) + 7 hours × $530 (chief compliance officer) + 2 hours × $365 (compliance attorney) + 5 hours × $466 (assistant general counsel) = $10,718. See infra section V.B.3, Table 13. 576 This estimate is based on the following calculations: 5 hours × $329 per hour (senior manager) + 2.5 hours × $530 (chief compliance officer) + 2.5 hours × $466 (assistant general counsel) = $4,135. See infra section V.B.3, Table 13. 577 This estimate is based on the following calculation: ($10,718 + $4,135) × 1,735 ETFs = $25,769,955. 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. It also may overestimate costs because some fund complexes may use the same basket policies and procedures for all ETFs within the complex. PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 used, which will allow the Commission to examine for potential abuses. As proposed, the rule also will 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. This information allows authorized participants and other arbitrageurs to identify arbitrage opportunities and execute arbitrage trades that reduce premiums and discounts to NAV per share, ultimately benefiting all investors. In addition, we agree with a commenter who stated that portfolio transparency helps investors to better discern differences between ETFs that track similar indexes or have similar investment objectives.578 The requirements for portfolio transparency in existing exemptive orders have varied. However, based on a staff review of ETFs’ websites, we understand that all ETFs that can rely on the rule currently provide daily full portfolio transparency. Thus, ETFs that can rely on the rule already bear the ongoing costs associated with maintaining such disclosures.579 We believe that the ETFs that can rely on the rule will 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.580 We estimate this onetime cost to be $1,997 for the average ETF, resulting in an aggregate one-time cost of $3,463,928 for all ETFs that can rely on the rule.581 Some commenters raised concerns that providing daily portfolio information on an ETF’s website could expose the fund and its investors to 578 See CSIM Comment Letter. the 2018 ETF Proposing Release, we estimated that an ETF that does not currently maintain daily portfolio holdings on its website would spend approximately 5 hours of professional time to update the relevant web page daily at a cost of $1,405.50 each year. Because we believe all ETFs that can rely on the rule already provide this information on their websites, we believe that very few, if any, ETFs would have to bear these additional costs. 580 The rule will require ETFs to provide certain information for each portfolio holding. These item requirements are a more limited set of the information currently required by the listing exchanges’ generic listing standards for actively managed ETFs. 581 This estimate is based on the following calculations: 1.5 hours × $284 (senior systems analyst) + 1.5 hours × $331 (senior programmer) + 1 hour × $309 (compliance manager) + 1 hour × $365 (compliance attorney) + $400 for external website development = $1,997. The industry cost is 1,735 × $1,997 = 3,463,928. This estimate is conservative as it does not assume a cost reduction for actively managed ETFs that already comply with the listing standards on which the item requirements for the portfolio holding disclosure under the rule are based. 579 In E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations costs associated with ‘‘front-running’’ and, in the case of actively managed ETFs, ‘‘piggybacking.’’ 582 However, based on our understanding that all ETFs that can rely on the rule currently provide daily full portfolio transparency, the rule will not change the degree to which ETFs and their investors are exposed to such costs compared to the baseline. As proposed, rule 6c–11 would have required that an ETF’s portfolio holdings disclosure be made on each business day: (1) Before the opening of regular trading on the primary listing exchange of the ETF’s shares; and (2) before the ETF starts accepting orders for the purchase or redemption of creation units. The rule will omit the second requirement in order to accommodate the current industry practice of T–1 creation and redemption orders.583 We agree with commenters that T–1 orders facilitate ETF arbitrage for certain ETFs holding foreign securities by allowing arbitrageurs to align the execution time of underlying securities with the NAV calculation of the order.584 Compared to the proposal, we therefore believe that this aspect of the rule will lead to narrower bid-ask spreads and smaller premiums and discounts, benefiting investors in these ETFs. Compared to the proposal, the rule will require ETFs to present enumerated information regarding each portfolio holding (which are a more limited set of the disclosures currently required by the listing exchanges’ generic listing standards for actively managed ETFs), rather than the description, amount, value, and unrealized gain/loss of each position in the manner prescribed by Article 12 of Regulation S–X. As discussed above in section II.C.4.b, we believe that this information will focus the disclosure on the pieces of information that are most relevant to investors while reducing the burden for ETFs of complying with the disclosure requirement. As a result, we believe that the disclosure format under the rule will provide similar benefits to investors at lower costs to ETFs.585 khammond on DSKJM1Z7X2PROD with RULES2 ii. Other Cost Savings From the Rule Under the terms of the exemptive orders, ETFs are required to disclose in 582 See supra section II.C.4. supra section II.C.4.a. This timing requirement is consistent with the transparency requirements of our existing exemptive orders. 584 See id. 585 The cost estimates in this section of the economic analysis reflect the cost reduction, compared to the proposal, associated with the change in the format of the disclosure. See also infra footnote 684 and accompanying text. 583 See VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 their registration statement that redemptions may be postponed for foreign holidays. Rule 6c–11 does not contain such a requirement and will thus eliminate the cost of preparing and updating this disclosure for existing ETFs. This information is already covered by the agreement between the ETF and the authorized participant.586 The terms of the exemptive orders also 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. The rule will not include such a requirement, as 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 will lead to cost savings for existing and future ETFs associated with preparing and reviewing this disclosure for sales literature.587 iii. Intraday Indicative Value The rule will not require an ETF to disseminate its IIV, as is currently required under all exemptive orders and current exchange listing standards. To the extent that current exchange listing standards require IIV to be disseminated, the rule’s omission of such a requirement will not represent a change from the baseline and will not result in any costs or benefits to market participants. We believe, and commenters agreed, 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 addition, the IIV may not reflect the intrinsic value of certain ETFs’ 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).588 An investor who relies on stale or inaccurate IIV information to purchase or sell ETF shares could be exposed to 586 We believe that authorized participants would share this information with other market participants as necessary. For example, an authorized participant acting as agent typically would share this information with its customer if it is a necessary part of the creation or redemption process. 587 We estimate that the omission of this requirement will save 0.25 hours of a compliance attorney ($365 per hour), resulting in a cost savings of $91 (0.25 × $365) per fund each year. The total cost savings for all 1,735 ETFs that can rely on the rule will thus be $158,319 (1,735 × $91). 588 Commenters agreed that traditional IIV can have significant limitations, for example for ETFs holding fixed-income securities. See, e.g., ICI Comment Letter. See also supra footnote 203. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 57215 price risk until the position is closed and could incur the trading costs associated with these trades. Furthermore, as discussed above in section II.C.3, based on a staff review of the websites of the ten largest ETFs by assets under management and of several publicly available free websites, we do not believe that investors have easy access to IIV through free, publicly available websites. Some commenters stated that retail investors relying on IIV could see their ability to evaluate ETFs reduced without this metric.589 As we stated in the proposing release, we agree that the IIV may provide a reasonably accurate estimate of the value of certain ETFs’ portfolios, including those ETFs whose underlying assets are very liquid and frequently traded during the ETF’s trading day. However, as discussed above in section II.C.3, we have concerns regarding the accuracy of IIV estimates and the lack of uniform methodology requirements. Moreover, retail investors do not have easy access to IIV through free, publicly available websites today even for those assets classes where IIV may be more reliable. Therefore, we do not believe that IIV provides information that retail investors can reliably use when making investment decisions and thus do not believe that it is a necessary condition for ETFs that are operating in reliance on rule 6c–11. iv. Website Disclosure Provisions Rule 6c–11 will require an ETF to disclose certain information prominently on its website.590 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.591 589 See, e.g., Angel Comment Letter; Nasdaq Comment Letter; IDS Comment Letter. 590 See supra footnote 226. 591 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, U.S. Census Bureau ACS–37 (Sept. 2017), available at https://www.census.gov/content/ dam/Census/library/publications/2017/acs/acs37.pdf; see also Sarah Holden, Daniel Schrass, & Michael Bogdan, Ownership of Mutual Funds, Shareholder Sentiment, and Use of the Internet, 2017, ICI Research Perspective (Oct. 2017), available at https://www.ici.org/pdf/per23-07.pdf (stating that ‘‘[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, E:\FR\FM\24OCR2.SGM Continued 24OCR2 57216 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 Based on a staff review of ETFs’ websites, we believe that all ETFs that can rely on the rule currently have a website and currently provide daily website disclosures of NAV, closing price, and premiums or discounts.592 As a consequence, existing ETFs generally will not incur any additional cost associated with the creation and technical maintenance of a website or these specific website disclosure requirements. Our exemptive orders have not included requirements for line graph and tabular historical information regarding premiums and discounts. While Form N–1A contains tabular website disclosures related to historical premiums/discounts in Items 11(g)(2) and 27(b)(7)(iv), which we are eliminating for ETFs that will rely on rule 6c–11, we anticipate that all existing ETFs that fall within the scope of the rule will still incur some additional costs associated with these disclosures.593 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 allows ETFs to monitor the trading behavior of their shares), and 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 will 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 will incur a onetime cost of $1,997 594 for implementing this website disclosure and an ongoing cost of $491595 per year for updating the relevant web page with this information. We thus estimate the total cost, in the first year, to ETFs that can rely on the 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). We acknowledge that the benefits of the website disclosure requirement would be attenuated for those investors who lack internet access or otherwise are not able to access ETFs’ websites. 592 See supra section IV.B.4. 593 See supra section II.H.2.b. 594 This estimate is based on the following calculations: 1.5 hours × $284 (senior systems analyst) + 1.5 hours × $331 (senior programmer) + 1 hour × $309 (compliance manager) + 1 hour × $365 (compliance attorney) + $400 for external website development = $1,997. 595 This estimate is based on the following calculations: 0.25 hours × $284 (senior systems analyst) + 0.25 hours × $331 (senior programmer) + 0.5 hour × $309 (compliance manager) + 0.5 hour × $365 (compliance attorney) = $491. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 rule for providing this website disclosure, of $4,315,379.596 Our exemptive orders have not included a requirement for ETFs to provide disclosure if an ETF’s premium or discount is greater than 2% for more than seven consecutive trading days and the factors that materially contributed to a premium or discount, if known. As a result, under the rule those ETFs that experience such a premium or discount will 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 2018 using Bloomberg data, we believe that, on average, 4.5% of ETFs that can rely on the rule will trigger this disclosure requirement each year.597 As suggested by commenters, this disclosure requirement is likely to affect certain categories of ETFs more than others.598 For example, in 2018, we estimate that the reporting requirement would not have been triggered for any allocation ETFs, commodity ETFs, or municipal bond ETFs, while it would have been triggered for 0.3% of taxable bond ETFs, 0.6% of sector equity ETFs, 3.1% of U.S. equity ETFs, 4.2% of international equity ETFs, and 4.8% of alternative ETFs. We estimate that an ETF required to make such a disclosure in a given year will incur an average cost of $1,504, yielding a total annual industry cost of $117,405.599 The rule also will require additional disclosure by the ETF of the median bid-ask spread for the most recent 30596 This estimate is based on the following calculation: ($1,997 + $491) × 1,735 ETFs = $4,315,379. 597 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 rule. During the sample period from 2008 to 2018, the percentage of ETFs for which the reporting requirement was triggered at least once varied from 1.5% (2010) to 10% (2008). 598 See supra footnote 359 and accompanying text. 599 We believe that such disclosure will require 1.25 hours for a compliance attorney and the compliance manager to determine if this requirement has been triggered and produce a draft of the required disclosures + 0.75 hours for a senior programmer and a senior systems analyst to include the information on the website, at a time cost of (1.25 hours × $365 compliance attorney hourly rate) + (1.25 hours × $309 compliance manager hourly rate) + (0.75 hours × $331 senior programmer hourly rate) + (0.75 hours × $284 senior systems analyst hourly rate) in addition to $200 for external website development = $1,504. The annual cost of this requirement for those ETFs that can rely on the rule is calculated as 4.5% × 1,735 ETFs × $1,504 = $117,405. This estimate includes costs for website development, which would only be incurred by an ETF making this disclosure for the first time. PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 day period on its website. This requirement is modified from the proposal, which would have required an ETF to disclose the median bid-ask spread for the ETF’s most recent fiscal year on its website and in its prospectus. We believe that the rule’s disclosure requirement will 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. We agree with commenters that actual bid-ask spreads paid by ETF investors can be influenced by a variety of factors, including order size, market conditions, as well as the broker-dealer used.600 Nevertheless, we believe that requiring the disclosure of bid-ask spread information is still valuable to investors as it is indicative of the general magnitude of an ETF’s trading costs attributable to bid-ask spreads. In addition, we believe bid-ask spreads can help investors rank ETFs in terms of expected execution costs, as an ETF with historically larger bid-ask spreads can be expected to be more costly to trade than an ETF with historically lower bid-ask spreads, when holding other factors that impact execution costs, such as order size, market conditions, and the brokerdealer, constant. Existing exemptive orders do not require ETFs to disclose median bid-ask spreads. As a result, we assume that all ETFs operating under the final rule will have to implement processes and systems to compute the median bid-ask spreads and will have to accommodate a new data point on their web page to report this information.601 We estimate that an ETF will incur a one-time estimated cost of $8,294 to comply with this requirement.602 In addition, we estimate that an ETF that purchases 600 See, e.g., Vanguard Comment Letter (also pointing out that, in certain circumstances, brokerdealers can obtain price improvements leading to market orders being executed either within the NBBO or at midpoint or better). 601 Based on a review of 150 randomly selected ETFs, which included 100 index-based ETFs and 50 actively managed ETFs, 10 percent of index-based ETFs and 1.5 percent of actively managed ETFs provided some information on bid-ask spreads. However, all ETFs that provided such information displayed bid-ask spreads only for a particular point in time (for example as of the time the prior day’s NAV was struck) rather than median bid-ask spreads computed for the most recent 30-day period, as required by the rule. 602 This estimate is based on the following calculations: 6.5 hours × $284 (senior systems analyst) + 6.5 hours × $331 (senior programmer) + 4 hour × $309 (compliance manager) + 4 hour × $365 (compliance attorney) + $1,600 for external website development = $8,294. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations NBBO information to compute bid-ask spread will incur an additional ongoing annual cost of $4,042.603 Assuming that all ETFs will have to purchase data to satisfy this requirement, we estimate an upper bound for the total industry cost in the first year of $21,401,659.604 The requirement of disclosures on ETFs’ websites we are adopting will enable investors to more readily obtain certain key information for individual ETFs, potentially resulting in better informed trading decisions.605 The conditions standardize certain content requirements to facilitate investor analysis of information while allowing ETFs to select a layout for displaying the required information that the individual ETF finds most efficient and appropriate for its website. Because the information will be made available on individual websites, in the layout 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 ETFs and time periods may be limited. Investors seeking to compare multiple ETFs will have to visit the website of every ETF, navigate to the relevant section of the website, and extract the information provided in the layout chosen by the fund. Depending on the manner in which a typical fund investor will use the website disclosures, these considerations may decrease the information benefits of the new 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 will likely be lower than the cost they would khammond on DSKJM1Z7X2PROD with RULES2 603 In the 2018 ETF Proposing Release, we stated that we believed ETFs currently maintain a record of historical price data as a matter of current business practices which could be used to satisfy the requirement to compute bid-ask spreads at a nominal cost. See 2018 ETF Proposing Release, supra footnote 7, at section III.C.1. Some commenters, however, suggested that some ETFs would incur costs to purchase data collected by third parties, although these commenters did not provide specific estimates of such costs. See, e.g., BNY Mellon Comment Letter; John Hancock Comment Letter. Assuming a data cost of $2,500 per year, we estimate that an ETF that would need to purchase the data will incur the following ongoing cost: 1 hours × $284 (senior systems analyst) + 1 hours × $331 (senior programmer) + 1.375 hours × $309 (compliance manager) + 1.375 hours × $365 (compliance attorney) + $2,500 (data) = $4,042. 604 This estimate is based on the following calculation: ($8,294 + $4,042) × 1,735 ETFs = $21,401,659. 605 See supra footnote 226. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 incur 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 will ultimately provide an efficient means for facilitating investor access to information. c. Recordkeeping The rule will require ETFs to 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 will 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 also will promote internal supervision and compliance.606 As the agreement forms the contractual foundation on which authorized participants engage in arbitrage activity, compliance of the agreement with applicable rules is important for the arbitrage mechanism to function properly. We also are requiring ETFs to maintain information regarding the baskets exchanged with authorized participants on each business day, including a record identifying any custom basket and stating that the custom basket complies with the ETF’s custom basket policies and procedures. We believe that these records will 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 other applicable law, 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, or to prepare and maintain a record identifying each custom basket and stating that custom baskets comply with the custom basket policies and procedures. However, we believe that most ETFs, as a matter of established 606 ETFs already are 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 rule. PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 57217 business practice, already preserve and maintain copies of authorized participant agreements as well as data on baskets used.607 As discussed below in section V.B.2, we estimate the average annual cost for an ETF to comply with these recordkeeping requirements is $393 per year.608 Assuming that (1) 80% of ETFs already preserve and maintain copies of authorized participant agreements as well as information on basket composition; (2) no ETF currently maintains records identifying any custom basket and stating that the custom basket complies with the ETF’s custom basket policies and procedures; and (3) 25% of the total annual recordkeeping costs can be attributed to the new recordkeeping requirements for custom baskets, the total industry cost for ETFs that can rely on the rule will be $544,790 per year.609 d. Master-Feeder Relief We will rescind the master-feeder relief granted to ETFs, with the exception of master-feeder relief that funds relied on as of the date of the 2018 ETF Proposing Release (June 28, 2018). We are rescinding such relief because there generally is a lack of industry interest in ETF master-feeder arrangements, and certain master-feeder arrangements raise policy concerns, as discussed above in section II.F. 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 master-feeder arrangements with one master and one feeder fund each.610 We will grandfather existing master-feeder arrangements involving ETF feeder funds, but prevent the formation of new ones under existing orders, by amending relevant exemptive orders.611 As a result, we do 607 One commenter stated that ETFs generally already implement robust recordkeeping programs. See Invesco Comment Letter. 608 See infra section V.B.3, Table 12. An average ETF would have to maintain and store 24 authorized participant agreements. See also supra footnotes 548–550 and accompanying text. 609 This estimate is based on the following calculation: 1,735 ETFs × (20% + 80% * 75%) × $393 = $544,790. The final rule will require ETFs to maintain additional information on basket composition (ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket). We believe that this additional requirement does not present a significant additional recordkeeping cost. 610 See 2018 ETF Proposing Release, supra footnote 7, at n.339 and accompanying text. See also supra footnote 449 and accompanying text. 611 Without this relief, the affected funds could continue operating by effecting creation and redemption transactions between authorized E:\FR\FM\24OCR2.SGM Continued 24OCR2 57218 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations not expect that the rescission of the existing master-feeder relief will impose costs on ETFs that currently rely on the relief to structure master-feeder arrangements. However, to the extent that an ETF without a grandfathered master-feeder arrangement would apply for an exemptive order that grants master-feeder relief, such an ETF would incur costs associated with the exemptive order application.612 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.613 2. Amendments to Forms N–1A, N–8B– 2, and N–CEN khammond on DSKJM1Z7X2PROD with RULES2 The amendments to Forms N–1A and N–8B–2 are designed to provide investors with tailored information regarding the costs associated with investing in ETFs.614 As discussed in section II.H above, we believe that the new disclosures will 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. We are amending Forms N–1A and N–8B–2 to include information on ETF trading and associated costs that we anticipate will help investors better understand costs specific to ETFs, such 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 investors finding the fund to be a less attractive investment. 612 One commenter indicated that it has invested resources exploring various approaches to an ETF master-feeder structure. See Fidelity Comment Letter. 613 See supra section II.F. 614 As proposed, we also are amending Forms N– 1A and N–8B–2 to include narrative disclosures for both mutual funds and ETFs that will clarify that the fees and expenses reflected in the expense table may be higher for investors if they sell shares of the fund. See supra section II.H.2.a. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 as bid-ask spreads.615 In a departure from the proposal, we are eliminating the Q&A format for these disclosures, which will allow ETFs to determine the format for conveying the required disclosures to investors. In addition, the narrative disclosures will be streamlined and included in Item 6 of Form N–1A, whereas the proposed disclosure in Q&A format would have been included in Item 3. As discussed above in section II.H, we believe that the updated format and location will improve the usefulness of the disclosure to ETF investors. ETFs will incur costs associated with these new disclosures on Forms N–1A and N–8B–2.616 ETFs structured as open-end funds are currently required to disclose information about premiums and discounts to NAV per share in reports on Form N–1A. However, UIT ETFs, which file reports with the Commission on Form N–8B–2, are not required to make such disclosures. We estimate that this reporting requirement will increase the incremental cost for UIT ETFs compared to ETFs structured as open-end funds. In addition, ETFs that rely on rule 6c–11 will be exempt from the Form N–1A disclosure requirements related to bid-ask spreads and premiums and discounts to NAV per share (as such disclosures will be required under rule 6c–11 to be provided on their websites), which reduces the incremental cost we estimate for open-end funds that can rely on the rule compared to those that cannot. Taking these considerations into account, we estimate that each ETF that is structured as an open-end fund will incur a one-time cost of $3,799 617 and an ongoing cost of $1,899 618 per year if it can rely on rule 6c–11, and a one-time 615 Rule 6c–11 will require ETFs that rely on the rule to provide the median bid-ask spread for the last thirty calendar days and certain disclosures regarding premiums and discounts on their websites. Our amendments to Forms N–1A and N– 8B–2 will require ETFs that do not rely on rule 6c– 11 to disclose median bid-ask spread information on their websites or in their prospectus and exclude only those ETFs that provide premium/discount disclosures in accordance with rule 6c–11 from the premium and discount disclosure requirements in Form N–1A. 616 As discussed in more detail below in section V.E, 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. 617 This estimate is based on the following calculations: 5.46 hours × $365 (compliance attorney) + 5.46 hours × $331 (senior programmer) = $3,799. 618 This estimate is based on the following calculations: 2.73 hours × $365 (compliance attorney) + 2.73 hours × $331 (senior programmer) = $1,899. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 cost of $6,960 619 and an ongoing cost of $3,480 620 per year if it cannot rely on rule 6c–11. We estimate that a UIT ETF will incur a one-time cost of $8,352 621 and an ongoing cost of $3,480 622 per year. We thus estimate that the total industry cost for this requirement for ETFs in the first year would equal $12,434,736.623 As proposed, we are amending Form N–CEN to require identification of ETFs that are relying on rule 6c–11.624 We believe that this requirement will allow the Commission to better monitor reliance on rule 6c–11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act. We believe that the incremental cost of this requirement to ETFs is minimal. D. Effects on Efficiency, Competition, and Capital Formation This section evaluates the impact of rule 6c–11 and the amendments to Forms N–1A, N–8B–2, and N–CEN on efficiency, competition, and capital formation. However, as discussed in further detail below, the Commission is unable to quantify 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 rule will likely increase total assets of ETFs, as a result of reducing the expense and delay of forming and operating new ETFs organized as openend funds, reducing the cost for certain ETFs to monitor their own compliance with regulations, and increasing competition among ETFs as discussed below. At the same time, the rule could 619 This estimate is based on the following calculations: 10 hours × $365 (compliance attorney) + 10 hours × $331 (senior programmer) = $6,960. 620 This estimate is based on the following calculations: 5 hours × $365 (compliance attorney) + 5 hours × $331 (senior programmer) = $3,480. 621 This estimate is based on the following calculations: 12 hours × $365 (compliance attorney) + 12 hours × $331 (senior programmer) = $8,352. 622 This estimate is based on the following calculations: 5 hours × $365 (compliance attorney) + 5 hours × $331 (senior programmer) = $3,480. 623 This estimate is based on the following calculation: 1,735 ETFs structured as an open-end fund that can rely on the rule × ($3,799 + $1,899) + 235 ETFs structured as an open-end fund that cannot rely on the rule ($6,960 + $3,480) + 8 UIT ETFs ($8,352 + $3,480) = $12,434,736. 624 We also are changing the definition of ‘‘authorized participant’’ in Form N–CEN to conform the definition with rule 6c–11 by excluding specific reference to an authorized participant’s participation in DTC (Item E.2 of Form N–CEN). E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 lead to a decrease in total assets of other fund types that investors may regard as substitutes, such as certain mutual funds.625 As a result, ETF ownership (as a percentage of market capitalization) for some securities, such as stocks and bonds, will likely increase, and ownership by other funds, such as mutual funds, will likely decrease. We are aware of only a limited amount of academic literature regarding ETFs. This literature suggests that such a shift in ownership could have a limited effect on the price efficiency (i.e., the extent to which an asset price reflects all public information at any point in time) and liquidity of these portfolio securities.626 The literature also suggests that a shift in stock ownership towards ETFs may somewhat improve certain dimensions of price efficiency while possibly attenuating 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.627 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 U.S. equity index ETFs is associated with moderately higher volatility among component stocks and asserts that the increased volatility is non-fundamental.628 Another paper 625 The disclosure requirements will also serve to increase investors’ awareness of ETF trading costs, 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. 626 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 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. 627 Lawrence Glosten, Suresh Nallareddy, & Yuan Zou, ETF Trading and Informational Efficiency of Underlying Securities (Columbia Business School, Research Paper No. 16–71, 2016). 628 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 finds that higher authorized participant arbitrage activity in U.S. equity ETFs is associated with a moderately higher correlation of returns among stocks in the ETF’s portfolio.629 The authors observed that changes in the prices of these stocks tend to partially revert over the next trading day and state 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. To a limited extent, the rule could decrease the liquidity of stocks held by ETFs, as one study finds that higher ownership of a stock by U.S. equity ETFs is associated with somewhat lower liquidity as measured by market impact.630 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,631 another study finds that bonds included in ETFs experience improvements in their liquidity.632 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.633 The authors assert that this co-movement in liquidity exposes investors to the possibility that multiple assets in their portfolio will be illiquid at the same time. Since we do not know the degree to which the rule will increase ETF ownership of stocks and bonds, we are unable to quantify the rule’s effects on price efficiency and liquidity. However, the effects documented in the literature surveyed above are generally small, so 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. 629 Zhi Da & Sophie Shive, Exchange Traded Funds and Asset Return Correlations (Working Paper, 2016). 630 See Sophia J.W. Hamm, The Effect of ETFs on Stock Liquidity (Working Paper, 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. 631 Caitlin Dillon Dannhauser, The Impact of Innovation: Evidence from Corporate Bond ETFs, Journal of Financial Economics (forthcoming 2016) (‘‘Dannhauser Article’’). 632 Jayoung Nam, Market Accessibility, Corporate Bond ETFs, and Liquidity (Working Paper, 2017). 633 Vikas Agarwal et al., Do ETFs Increase the Commonality in Liquidity of Underlying Stocks (Working Paper, 2017). PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 57219 that we do not anticipate that the rule would have a significant effect on the price efficiency or liquidity of assets held by ETFs. As a result of the 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.634 During normal market conditions, this may lead those ETFs’ shares to trade at smaller bid-ask spreads, thus benefiting investors. Such a reduction in bid-ask spreads by overweighting more liquid securities may not continue to be possible during stressed market conditions, however, if a large proportion of such an ETF’s portfolio securities become less liquid.635 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 rule, which some investors may not anticipate and fail to fully take into account when making their investment decisions.636 Finally, the amendments to Forms N– 1A and N–8B–2 as well as the additional website disclosures required by rule 6c–11 we are adopting will allow investors and other market participants to better understand and compare ETFs using more relevant and standardized disclosure. For example, the amendments to Item 6 of Form N– 1A will add a requirement for ETFs to include a statement that ETF investors may be subject to other expenses that are specific to ETF trading, including 634 This would be the case for those ETFs that hold less liquid securities in their portfolios. 635 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 123. 636 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. 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 transacting and existing/remaining shareholders. E:\FR\FM\24OCR2.SGM 24OCR2 57220 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations bid-ask spreads.637 These costs are not currently required to be disclosed as part of the prospectus. Since these costs are incurred by ETF investors and not mutual fund investors, we believe that adding this disclosure requirement will 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 final rule could help investors make more informed investment decisions that are more suited to their investment objectives. The degree to which investors will 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. khammond on DSKJM1Z7X2PROD with RULES2 Furthermore, the new website disclosures and amendments to Forms N–1A and N–8B–2 will allow investors to better compare ETFs and mutual funds, which can further foster competition among these types of funds as well as between these types of funds and other types of funds that investors may perceive to be substitutes for ETFs and mutual funds, such as closed-end funds and certain ETPs. Increased competition will likely lead to lower fees for investors, encourage financial innovation, and increase consumer choice in the markets for ETFs, mutual funds, and other types of funds that investors may perceive to be substitutes.640 Due to the limited availability of data, however, we are unable to quantify these effects. To the extent the rule will increase 2. Competition the number and total assets of ETFs, more authorized participants or other The rule will likely increase market participants that engage in ETF competition among ETFs that can rely arbitrage, such as hedge funds and on the rule. The first channel through principal trading firms, may enter the which the rule will likely foster market. This may lead to increased competition is by reducing the costs for competition among authorized ETF sponsors to form new ETFs that participants or other market participants comply with the conditions set by the and result in authorized participants or rule. This cost reduction will lower the other market participants exploiting barriers to entering the ETF market, arbitrage opportunities sooner (i.e., which will likely lead to increased when premiums/discounts to NAV per competition among ETFs that can rely share are smaller). As a result, bid-ask on the rule. spreads may tighten and premiums/ In addition, new ETFs that enter the discounts to NAV per share for ETF market in reliance on the rule, as well shares may decrease. We would expect as those existing ETFs that will have new entries of authorized participants their exemptive relief rescinded and or other arbitrageurs as a result of the replaced by the rule, will no longer be subject to requirements that vary among rule to be limited, however, and any exemptive orders.638 Instead, these ETFs effects on bid-ask spreads and premiums/discounts to NAV per share will operate under uniform to be small. requirements, which will help promote competition among ETFs that can rely 3. Capital Formation on the rule. An increase in competition The rule may lead to increased capital among ETFs that can rely on the rule formation. Specifically, an increase in will likely also lead to an increase in the demand for ETFs, to the extent that competition among those ETFs, ETFs it increases demand for intermediated that cannot rely on the rule, and other assets as a whole, will likely spill over types of funds and products that into primary markets for equity and debt investors may perceive to be substitutes securities. As a consequence, companies 639 for ETFs. may be able to issue new debt and equity at higher prices in light of the 637 James J. Angel, Todd J. Broms, & Gary L. increased demand for these assets in Gastineau, ETF Transaction Costs Are Often Higher Than Investors Realize, Journal of Portfolio Management, Spring 2016, at 65, find that the cost of trading ETF shares depends both on bid-ask spreads as well as premiums and discounts to NAV per share. 638 Some fund sponsors that operate ETFs outside the scope of rule 6c–11 may voluntarily decide to comply with certain provisions of the rule. For example, one sponsor that operates share class ETFs stated that it intends to modify its current practices, as necessary, to be consistent with the custom basket requirements contemplated by the proposed rule for all its U.S. ETFs. See Vanguard Comment Letter. 639 The types of funds and products that investors may consider substitutes for ETFs would depend on an individual investor’s preferences and investment VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 objectives. Other types of products that some investors may consider to be substitutes for ETFs include mutual funds, closed-end funds, and other ETPs, such as exchange-traded notes and commodity pools. 640 The rule will likely lead to increased competition both among ETFs that can rely on the rule. as well as between ETFs that can rely on the rule and those that cannot, to the extent that investors perceive these ETFs as substitutes. While we believe that increased competition generally is conducive to innovation, any increased competition in the ETF market resulting from the rule will be more likely to involve novel ETFs that will continue to need to obtain exemptive relief from the Commission. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 secondary markets created by ETFs and 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 641 that finds that bonds with a higher share of ETF ownership have lower expected returns.642 Due to the limited availability of data, however, we are unable to quantify these effects of the rule on capital formation. E. Reasonable Alternatives 1. Website Disclosure of Basket Information Rule 6c–11 does not include a basket publication requirement. As an alternative, we considered requiring an ETF to post on its website one ‘‘published’’ basket each business day before the opening of trading of the ETF’s shares, as we proposed. This disclosure would allow smaller institutional investors and retail investors that are not NSCC members and do not currently have access to basket information to compare the ETF’s ‘‘published basket’’ with its portfolio holdings.643 However, we agree with commenters that the benefit of this information to these investors is likely to be limited, as secondary market arbitrage typically does not require information regarding an ETF’s basket composition.644 In addition, ETFs would incur additional costs associated with this disclosure.645 641 Dannhauser Article, supra footnote 632. acknowledge that there is research (see Yakov Amihud & Haim Mendelson, Asset Pricing and the Bid-Ask Spread, 17 Journal of Financial Economics 223 (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. 643 Commenters stated that authorized participants already have access to basket information through the daily portfolio composition file provided to NSCC. In addition, other institutional investors that use basket information for hedging purposes, such as an investor using an authorized participant as an agent, have access to this information through the NSCC, an intermediary (such as an authorized participant), or the ETF itself. See supra section II.C.5.c. 644 See, e.g., CSIM Comment Letter; ICI Comment Letter. 645 Our exemptive orders have not included requirements for daily website disclosures of ETF baskets, though some exemptive orders contemplate disclosure of daily basket assets through NSCC. 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 642 We E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations We also considered requiring an ETF to publish information regarding every custom basket used by the ETF after the close of trading on each business day. This information 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 the 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 rule contains conditions for basket policies and procedures, which seek to prevent overreaching. Moreover, the rule will require an ETF to maintain records regarding the baskets used, which will allow Commission staff to examine an ETF’s use of basket flexibility. We also agree with commenters that requiring publication of all baskets could disadvantage an ETF and its shareholders by allowing market participants to front-run trades by authorized participants (or other arbitrageurs that use an authorized participant as an agent) in basket securities, particularly for those ETFs that have more frequent primary market transactions.646 Consequently, we believe that the risk for abusive practices under the rule will be low while, at the same time, the rule will avoid additional operational and compliance costs for ETFs to post and review the information as well as potential costs associated with frontrunning trades in basket securities under the alternative. khammond on DSKJM1Z7X2PROD with RULES2 2. Disclosure of ETF Premiums or Discounts Greater Than 2% As proposed, the rule will 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. One commenter suggested that we raise the threshold for the size of the premiums or discounts to five or ten percent while shortening the period over which the premium or discount has to be sustained for the requirement 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. 646 See, e.g., ICI Comment Letter; SSGA Comment Letter I; Vanguard Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 to trigger.647 Based on this suggestion, we considered an alternative that would require any ETF whose premium or discount was greater than five percent for more than three consecutive trading days to post that information on its website, along with a discussion as required under the rule. Under both the rule and the alternative, ETFs with premiums or discounts greater than five percent for more than seven consecutive trading days would provide the disclosure. The disclosure threshold under the rule will also capture ETFs with premiums or discounts greater than two and up to five percent for more than seven consecutive trading days, which would not be captured under the alternative. Conversely, the disclosure threshold under the alternative would also capture ETFs with premiums or discounts greater than five percent for between three and six consecutive trading days, which will not be captured under the rule. We estimate that 1.7 percent of those ETFs that can rely on the rule would trigger the alternative disclosure threshold per year, compared to 4.5 percent under the rule. From 2008 and 2018, the percentage of ETFs that would have triggered the requirement would have been largest in 2008. In that year, 4.6 percent of ETFs that could have relied on the rule would have triggered the alternative threshold, compared to 10 percent under the rule.648 In addition, an ETF that triggers the reporting requirement under the alternative would make its disclosure sooner after the premium or discount first exceeds the threshold, as the measurement period is shorter compared to the rule. The lower incidence of reporting under the alternative would decrease the costs incurred by ETFs associated with making the disclosure,649 but also reduce the reporting of persistent premiums and discounts available to investors in that it would eliminate reporting of discounts below the 5% threshold. While the shorter observation period under the alternative would make the information about premiums and discounts available to investors sooner, rule 6c–11 will require ETFs to 647 Nasdaq Comment Letter. supra footnote 598 and accompanying text. Our estimate of the percentage of ETFs that would have to satisfy the requirement under the alternative is based on the same methodology and data as our estimate for the rule’s reporting threshold. 649 We estimate a total annual industry cost of $47,457,745 (= 1.7% × 1,735 ETFs × $1,609). This estimate uses the same assumptions as our estimate of the cost of this requirement under the rule. See supra footnote 600 and accompanying text. 648 See PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 57221 disclose the prior day’s premium/ discount to NAV per share on its website every day, so that timely information about the size of ETF’s premiums/discounts will still be available to investors under the rule. Another commenter suggested that we adopt a materiality standard rather than a fixed numerical threshold to trigger the reporting requirement.650 We considered an alternative under which each ETF would make its own determination as to when a premium/ discount to NAV per share is material and thus would be reported. As a result, ETFs would almost certainly differ in the size and duration of a premium/ discount that they would consider to be material. In addition, ETFs might adopt varying criteria to determine whether a premium/discount is deemed material based on the asset class of the ETF or general market conditions. While we are unable to predict how the alternative would impact the frequency of reporting compared to the rule, we believe that the alternative might lead to inconsistent reporting practices among ETFs, which would likely reduce the usefulness of the requirement to investors, compared to the rule. 3. Website and Prospectus Disclosure of the Median Bid-Ask Spread Calculated Over the Most Recent 1-Year Period Rule 6c–11 will require an ETF to disclose the median bid-ask spread calculated over the most recent 30-day period on its website.651 As an alternative, we considered requiring an ETF to disclose the median bid-ask spread for the ETF’s most recent fiscal year on its website and in its prospectus, as proposed. We agree with commenters that computing the median bid-ask spread over a 30-day rolling period, rather than over the proposed 1-year lookback period, may provide a more accurate predictor of trading costs for newly launched ETFs whose bid-ask spreads may tighten as the ETFs mature.652 In addition, as an ETF’s prospectus cannot be updated every day, we believe it is appropriate to require ETFs to make this 650 John Hancock Comment Letter (recommending a materiality standard instead of a 2% threshold). 651 Our amendments to Form N–1A will provide ETFs that do not rely on rule 6c–11 with the option to provide the same information on its website or the median bid-ask spread over the ETF’s most recent fiscal year in its prospectus. See supra section II.H.2.b. 652 See supra footnote 381 and accompanying text. Conversely, there may also be instances where future bid-ask spreads may be better predicted by the median bid-ask spread computed over a 1-year lookback period, as compared to a 30-day rolling period (e.g., when recent bid-ask spreads are not representative of how an ETF typically has traded. E:\FR\FM\24OCR2.SGM 24OCR2 57222 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations disclosure on their websites. As a result, we believe that requiring ETFs to disclose the median bid-ask spread over the most recent 30-day period on their websites will increase the benefits of the bid-ask spread disclosure to investors compared to the alternative, particularly for newly-launched ETFs. khammond on DSKJM1Z7X2PROD with RULES2 4. Additional Disclosures Showing the Impact of Bid-Ask Spreads We considered amending Forms N– 1A and N–8B–2 to require an ETF to provide: (1) Examples in the ETF’s prospectus showing how bid-ask spreads impact the return on a hypothetical investment for both buyand-hold and frequent traders; and (2) an interactive calculator on the ETF’s website that would allow an investor to customize the hypothetical bid-ask spread calculations to its specific investing situation, as proposed. Some investors may find the additional disclosures under this alternative useful to understand the effect of transaction costs resulting from bid-ask spreads on their investments; however, we agree with commenters that this benefit could be diminished by over-concentrating investor focus on bid-ask spreads, thereby potentially obscuring the importance of other components of ETF transaction costs (e.g., order size, market conditions, and the extent to which a broker-dealer improves upon quoted bid-ask spreads).653 In addition, the omission of these requirements will save ETFs the costs associated with providing examples showing how bidask spreads impact the return on a hypothetical investment and implementing the interactive calculator on its website. 5. Website Disclosure of a Modified IIV As proposed, rule 6c–11 will not require ETFs to disseminate IIV as a condition for reliance on the rule. As an alternative, we considered requiring an ETF to publicly disseminate a modified IIV on its website on a real time basis as a condition to rule 6c–11, requiring ETFs to calculate IIVs more frequently and in a more accessible manner. We also considered creating a methodology that takes into account circumstances when market prices for underlying assets are not available or should not be used to reflect the ETF’s intraday value. As we discussed above in section II.C.3, such a modified IIV would benefit retail and less sophisticated institutional investors by allowing them to better evaluate the value of an ETF intra-day. However, we are concerned that these 653 See, e.g., Vanguard Comment. See also Eaton Vance Comment Letter. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 modifications would not cure the shortcomings of IIV for ETFs in a uniform manner. We encourage the ETF industry to undertake efforts to develop intraday value metrics targeted at these investors as we believe that ETFs are in a position to consider and develop tailored metrics for ETFs holding different asset classes in a format that is useful for retail investors. 6. The Use of a Structured Format for Additional Website Disclosures and the Filing of Additional Website Disclosures in a Structured Format on EDGAR The rule will require ETFs to post on their websites certain disclosures to enable investors to more readily obtain certain key metrics for individual ETFs. As an alternative, we considered requiring 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.654 The resulting standardization under this alternative would allow for extraction, aggregation, comparison, and analysis of reported information through significantly more automated means than is possible with unstructured formats such as HTML.655 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 burden on investors and other data 654 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. 655 Several commenters agreed with our assessment of the benefits of a structured disclosure format. One commenter stated that ‘‘having such information submitted in a standardized, structured format to the Commission and available publicly would aid comparison and analysis.’’ The commenter further indicated that such information should be provided in the XBRL format on a daily basis. See Morningstar Comment Letter. Another commenter expressed general support for having ‘‘standardized basket reporting in XBRL.’’ See Angel Comment Letter. Another commenter recommended that ETFs ‘‘be required to disclose their daily portfolio holdings using a common downloadable or machine-readable format specified by the Commission.’’ See Eaton Vance Comment Letter. A different commenter recommended that ‘‘portfolio holdings information be supplied in a standard file format with comma-separated value.’’ See SSGA Comment Letter I. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 users of separately visiting each website to obtain each ETF’s disclosure. The structured data requirement could impose a cost on ETFs of tagging the information in a structured format, particularly to the extent that ETFs do not otherwise structure this data in this manner for their own purposes.656 However, we believe that if the XML format, for example, were used for structuring the additional disclosure, the incremental cost of tagging information in each such disclosure would likely be relatively modest.657 As another alternative, we considered requiring ETFs to make the additional website disclosures available in a centralized repository in a structured format, such as by filing them on EDGAR.658 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, such as third-party data aggregators, to efficiently extract information for purposes of aggregation, comparison, and analysis of information across multiple funds and time periods.659 Requiring the information to be filed on EDGAR also would enable data users to retain access to such historical information in the event that such information is subsequently removed from the fund’s website.660 We recognize that filers might incur 656 See, e.g., CSIM Comment Letter (stating that ‘‘[t]he alternatives described in the proposal, including the use of structured disclosures, will not be user-friendly for individual investors and will incur unnecessary costs to the ETF.’’). 657 For example, based on staff experience with XML filings, the costs of tagging the information in XML are minimal given the technology that would 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 would be able to accommodate XML data without significant costs, and large-scale changes would likely not be necessary to output structured data files. 658 The Commission has previously adopted rules requiring the structuring of certain information disclosed by funds. See, e.g., Reporting Modernization Adopting Release, supra footnote 263; Money Market Fund Reform, Investment Company Act Release No. 29132 (Feb. 23, 2010) [75 FR 10059 (Mar. 4, 2010)]; Interactive Data for Mutual Fund Risk/Return Summary, Investment Company Act Release No. 28617 (Feb. 11, 2009) [74 FR 7747 (Feb. 19, 2009)]. 659 One commenter agreed with the assessment in the 2018 ETF Proposing Release of the benefits of making the additional website disclosures available in a centralized repository in a structured format, stating that ‘‘[a]ll holdings and basket information should be filed in a central location (such as EDGAR) in a common format. It is too difficult to search many funds groups for this information and then putting it in a common format for analysis.’’ See Reagan Comment Letter. 660 See Reagan Comment Letter. E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations additional costs under this alternative, compared to the requirement in the rule to post the additional disclosures in an unstructured format on fund websites.661 Such costs would likely vary across filers, depending on the systems and processes they currently have in place, such as for internal reporting, posting of website updates, and submission of regulatory filings, and the manner in which filers currently maintain data required for the additional disclosures under the final rule.662 khammond on DSKJM1Z7X2PROD with RULES2 7. Pro Rata Baskets Rule 6c–11 will 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 we have done in our exemptive orders since approximately 2006.663 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, we believe that the rule’s additional policies and procedures requirements for custom baskets will 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, we believe that the increased basket flexibility under the rule will benefit the effective functioning of the arbitrage mechanism, particularly benefiting fixed-income, international, and actively managed ETFs.664 661 See Invesco Comment Letter (supporting dissemination via the ETF sponsor’s website and opposing any additional dissemination requirements, such as filing on EDGAR, stating that building a separate data feed would involve additional costs and internal resources). 662 Such costs would also depend on the specific nature of the EDGAR filing requirement under this alternative. 663 ETFs whose orders we are rescinding 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 in that they are required to adopt custom basket policies and procedures under rule 6c–11. 664 Section IV.C.1.b.i supra discusses the possibility that some ETFs may use the increased basket flexibility of the rule to over- or underweight 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 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 8. Treatment of Existing Exemptive Relief As proposed, we will rescind the exemptive relief we have issued to ETFs that will be permitted to rely on the 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 that would otherwise be subject to rule 6c–11 operate. Specifically, some ETFs that determine they do not need the additional flexibility (e.g., basket flexibility) the rule will provide could choose to continue operating under their existing relief rather than in reliance on conditions of the rule, such as standardized presentation of portfolio holdings. This self-selection would perpetuate existing disparity in the conditions under which these ETFs are allowed to operate. Measured against the baseline, the alternative would thus have smaller benefits arising from improved disclosure. For example, an ETF that chose to continue to operate under its existing exemptive relief would not be required to present its portfolio holdings in the standardized format prescribed by rule 6c–11. As discussed in section IV.C.1.b.i above, we believe that this requirement will benefit investors of ETFs that are subject to rule 6c–11 by allowing them to more easily identify arbitrage opportunities and compare ETFs that have similar investment objectives. In addition, the alternative would not level the playing field among ETFs subject to rule 6c–11 with regard to these conditions and thus not be as effective at promoting product competition as the rule. One commenter agreed, stating that the rescission of the orders will further the Commission’s regulatory goal of creating a consistent regulatory framework for ETFs.665 In addition, it would be more difficult for the Commission to evaluate compliance with applicable law under the alternative compared to the rule, as some of the ETFs whose exemptive relief we will rescind could choose to continue to operate under their exemptive relief. The Commission also believes that the costs to funds generally correspond pro rata to its portfolio holdings. 665 See supra footnote 455 and accompanying text. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 57223 associated with rescinding the existing exemptive relief would be minimal, as we anticipate that substantially all ETFs whose relief will be rescinded will be able to continue operating with only minor adjustments, other than being required to develop basket asset policies and procedures.666 9. ETFs Organized as UITs Rule 6c–11 will be available only to ETFs that are organized as open-end funds.667 As an alternative, we considered including ETFs organized as UITs in the scope of the rule. However, as discussed above in section II.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 ETFs have greater investment flexibility under the openend fund structure than the UIT structure, we believe that most new ETFs entering into the market will 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 rule.668 10. Treatment of Leveraged/Inverse ETFs As discussed in section II.A.3 above, leveraged/inverse ETFs will not be able to rely on final rule 6c–11. As an alternative, we considered permitting leveraged/inverse ETFs to rely on the rule, while maintaining the status quo of existing exemptive orders with respect to the amount of leveraged market exposure that leveraged/inverse ETFs may obtain (i.e., 300% of the return or inverse return).669 This alternative could benefit competition among leveraged/inverse 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/inverse ETFs would likely decrease and their assets could increase. 666 Under the alternative, some ETFs may volunarily change operational or compliance functions in order to be able to operate under the rule, if this provides the ETFs increased basket flexibility compared to operating under their existing exemptive orders. 667 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). 668 ETFs sponsors that plan to launch a new ETF organized as a UIT will continue to be able to rely on the exemptive order process. 669 See supra footnote 72. E:\FR\FM\24OCR2.SGM 24OCR2 57224 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations However, as discussed in detail in section II.A.3 above, while leveraged/ inverse ETFs are structurally and operationally similar to other types of ETFs within the scope of rule 6c–11, we believe it is premature to permit sponsors to form and operate leveraged/ inverse ETFs in reliance on the rule without first addressing the investor protection purposes and concerns underlying section 18 of the Act. We therefore believe that the Commission should first complete its broader consideration of the use of derivatives by registered funds before considering allowing leveraged/inverse ETFs to rely on the rule. khammond on DSKJM1Z7X2PROD with RULES2 V. Paperwork Reduction Act A. Introduction Rule 6c–11 will result in new ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).670 In addition, the amendments to Form N–1A, Form N– 8B–2, and Form N–CEN will impact the collection of information burden under those forms and Form S–6.671 Rule 6c– 11 also will impact the current collection of information burden of rule 0–2 under the Act.672 The titles for the existing collections 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– 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 670 44 U.S.C. 3501–3520. CFR 274.11A; 17 CFR 274.12; 17 CFR part 101; 17 CFR 239.16. 672 17 CFR 270.0–2. 671 17 VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 collection of information unless it displays a currently valid control number. We published notice soliciting comments on the collection of information requirements in the 2018 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. We received no comments on the collection of information requirements. We discuss below the collection of information burdens associated with rule 6c–11 and its impact on rule 0–2 as well as the amendments to Forms N–1A, N–8B–2, S–6 and N–CEN. B. Rule 6c–11 Rule 6c–11 will 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 rule attempts to eliminate historical distinctions and conditions that we no longer believe are necessary and thus appropriately level the playing field for open-end ETFs that pursue the same or similar investment strategies. Rule 6c–11 will require an ETF to disclose certain information on its website, to maintain certain records, and to adopt and implement written policies and procedures governing its 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 rule 6c–11 will be ETFs registered as open-end management investment companies other than share class ETFs, leveraged/ inverse ETFs, or non-transparent ETFs. This collection will not be mandatory, but will be necessary for those ETFs seeking to operate without individual exemptive orders, including all ETFs whose existing exemptive orders will be rescinded. In the 2018 ETF Proposing Release, we estimated that 1,635 ETFs would likely rely on rule 6c–11.673 We did not receive public comment on this estimate, but are updating the estimate to 1,735 ETFs to reflect industry data as 673 2018 ETF Proposing Release, supra footnote 7, at section IV.B. This estimate did not include UIT ETFs, share class ETFs, leveraged/inverse ETFs, or non-transparent ETFs. Id. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 of December 31, 2018.674 Information provided to the Commission in connection with staff examinations or investigations will be kept confidential subject to the provisions of applicable law. 1. Website Disclosures Rule 6c–11 will 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.675 The rule will require that the portfolio holdings information contain specified information, including description and amount of each position.676 Additionally, the rule will require an ETF to disclose on its website: (i) The ETF’s NAV per share, market price, and premium or discount, each as of the end of the prior business day; (ii) 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 (or for the life of the fund if shorter); and (iii) the ETF’s median bid-ask spread over the last thirty calendar days.677 Rule 6c–11(c)(1)(vi) also will 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.678 Given the threshold for this requirement, we do not believe that many ETFs will be required to disclose this information on a routine basis. In the 2018 ETF Proposing Release, we estimated that all ETFs will be required to make this disclosure only once in their lifetime.679 Therefore, we believed that this requirement will impose only initial costs and that there will be no ongoing costs associated with it.680 674 This figure is based on a staff analysis of Bloomberg data. 675 Rule 6c–11(c)(1)(i). 676 Rule 6c–11(c)(1)(i). 677 Rule 6c–11(c)(1)(ii)–(v). 678 Rule 6c–11(c)(1)(vi). 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 section II.C.6.c. 679 2018 ETF Proposing Release, supra footnote 7, at section IV.B.1. 680 For purposes of this analysis, we estimate that 1,735 ETFs would be required to make this disclosure at least once in their lifetime. E:\FR\FM\24OCR2.SGM 24OCR2 57225 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations TABLE 11—WEBSITE DISCLOSURE PRA ESTIMATES Initial hours Annual hours 1 Wage rate 2 Internal time costs Initial external cost burden $685 .................. $797.50. $506.60. $598.40. $274. $319. $372.50. $2,000 ............... $666.65 Annual external cost burden Proposed Estimates 3 Website development ............. Review of website disclosures Website updates .................... Review of updated website disclosure. Total annual burden per ETF. Number of ETFs ............. Total annual burden 7.5 7.5 5 5 ........................ ........................ 25 2.5 hours ........... 2.5 hours ........... 1.7 hours ........... 1.7 hours ........... 1 hour ................ 1 hour ................ 1.25 hours ......... × × × × × × × $274 $319 $298 $352 $274 $319 $298 1.25 hours ......... × $352 (compliance attorney) ... (senior systems analyst) (senior programmer) ..... (compliance manager) .. (compliance attorney) ... (senior systems analyst) (senior programmer) ..... (compliance manager) .. $440. 13.3 hours $3,971.30 .......... $2,000 ............... $666.65 ........................ × 1,635 × 1,635 .............. × 1,635 .............. × 1,635 ........................ 21,745.5 hours $6,493,075.50 ... $3,270,000 ........ $1,089,972.75 $1,065 ............... $3,000 4 ............. $1,000 $684.36. Final Estimates Website development ............. 4 11.25 3.75 hours ......... × 4 11.25 × × × × Review of website disclosures 4 7.5 Website updates .................... 4 7.5 ........................ 3.75 hours ......... 2.5 hours ........... 2.5 hours ........... 1.5 hours 4 ......... ........................ 1.5 hours 4 ......... 1.875 hours 4 ..... × × $284 (senior systems analyst) 5. $331 (senior programmer) 5 ... $309 (compliance manager) 5 $365 (compliance attorney) 5 $284 (senior systems analyst) 5. $331 (senior programmer) 5 ... $309 (compliance manager) 5 1.875 hours 4 ..... × $365 (compliance attorney) 5 Review of updated website disclosure. Total annual burden per ETF. Number of ETFs ............. Total annual burden 37.5 $1,241.25. $772.50. $912.50. $426. $496.50. $579.38. 19.25 hours $6,177.49 .......... $3,000 ............... $1,000 ........................ × 1,735 5 × 1,735 5 ............ × 1,735 5 ............ × 1,735 5 ........................ 33,398.75 hours $10,717,945.15 $5,205,000 ........ $1,735,000 khammond on DSKJM1Z7X2PROD with RULES2 Notes: 1 Includes initial burden estimates annualized over a three-year period. 2 See supra footnote 568. 3 2018 Proposing Release, supra footnote 7, at section IV.B.1. 4 Estimate revised to reflect modifications from the proposal. 5 Estimate revised to reflect updated industry data. Table 11 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the website disclosures in rule 6c–11.681 We did not receive public comment on our proposed estimates, but we have revised them as a result of updated industry data and modifications from the proposal. Specifically, we are increasing the initial and ongoing internal and external burden estimates by 50 percent each to account for our modification to the proposal that will require ETFs to disclose median bid-ask spread information on their websites as part of rule 6c–11, partially offset by the elimination of the proposed published basket requirement and the modification 681 2018 ETF Proposing Release, supra footnote 7, at section IV.B.1. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 to the proposed requirement to disclose portfolio holdings related to timing and presentation of those holdings.682 In addition, we are revising the estimated wage rates and estimated number of ETFs that will be subject to the rule to reflect updated industry data. 2. Recordkeeping Rule 6c–11 will require an ETF to preserve and maintain copies of all written authorized participant agreements.683 Additionally, the rule will require ETFs to maintain records setting forth the following information for each basket exchanged with an authorized participant: (i) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each 682 See supra section II.C.6.d, section II.C.5.c. rule 6c–11(d). 683See PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 holding, and percentage weight of each holding composing the basket; (ii) if applicable, 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.684 ETFs would have to maintain these records for at least five years, the first two years in an easily accessible place.685 684 See supra footnote 411 and accompanying text. Although we have modified the recordkeeping requirement from the proposal, we do not believe the modified requirements would increase the time or cost burdens set forth in the 2018 ETF Proposing Release. See 2018 ETF Proposing Release, supra footnote 7, at section IV.B.2. 685 Id. E:\FR\FM\24OCR2.SGM 24OCR2 57226 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations TABLE 12—RECORDKEEPING PRA ESTIMATES Initial hours Wage rate 1 Annual hours Initial external cost burden Internal time costs Annual external cost burden Proposed Estimates 2 × × Recordkeeping ....................... 0 0 2.5 hours ........... 2.5 hours ........... Total annual burden per ETF. Number of ETFs ............. 0 5 hours .............. $380. ........................ × 1,635 .............. × 1,635. 0 8,175 hours ....... Total annual burden $60 (general clerk) ................ $92 (senior computer operator). $150. $230. $621,300.00 ...... $0 ...................... $0 $0 ...................... $0 Final Estimates × × $62 (general clerk) 3 .............. $95 (senior computer operator) 3. Recordkeeping ....................... 0 0 2.5 hours ........... 2.5 hours ........... Total annual burden per ETF. Number of ETFs ............. 0 5 hours .............. $392.50. ........................ × 1,735 3 ............ × 1,735. ........................ 8,675 hours $680,987.50 ...... Total annual burden $155. $237.50. Notes: 1 Based on SIFMA Report, supra footnote 568, as modified by Commission staff. 2 See 2018 ETF Proposing Release at section IV.B.2. 3 Estimate revised to reflect updated industry data. Table 12 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the recordkeeping requirements in rule 6c– 11.686 We did not receive public comment on our proposed estimates, but we have revised the estimates as a result of updated industry data. Specifically, we have updated the estimated wage rates and the estimated number of ETFs that will be subject to the rule and thus the recordkeeping requirement. We do not estimate that there will be any initial or ongoing external costs associated with the recordkeeping requirement. 3. Policies and Procedures As proposed, rule 6c–11 will require 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 basket assets.687 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.688 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.689 Finally, as discussed above, an ETF using custom baskets would be required to maintain records detailing the composition of each custom basket. TABLE 13—POLICIES AND PROCEDURES PRA ESTIMATES Annual hours 1 Initial hours Wage rate 2 Internal time costs Initial external cost burden Annual external cost burden Proposed Estimates 3 3 1 hour ................ × $317 (senior manager) .......... $317. 2 .67 hours ........... × $340.67. 1 9 .33 hours ........... 3 hours .............. × × $511 (chief compliance officer). $352 (compliance attorney) ... $317 (senior manager) .......... 5 5 1.67 hours ......... 1.67 hours ......... × × 1 ........................ .33 hours ........... 5 hours .............. × × 2.5 hours ........... 2.5 hours ........... × × Establishing and implementing standard baskets policies and procedures. khammond on DSKJM1Z7X2PROD with RULES2 Establishing and implementing custom baskets policies and procedures. Reviewing and updating baskets policies and procedures. 686 See 2018 ETF Proposing Release, supra footnote 7, at section IV.B.2. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 687 See 688 See PO 00000 $449 (ass’t general counsel) $511 (chief compliance officer). $352 (compliance attorney) ... $317 (senior manager) .......... $449 (ass’t general counsel) $511 (chief compliance officer). rule 6c–11(c)(3). rule 6c–11(c)(3). Frm 00066 Fmt 4701 $117.33. $951. $748.33. $851.67. $117.33. $1,585. $1,122.50. $1,277.50. 689 See Sfmt 4700 E:\FR\FM\24OCR2.SGM supra text following footnote 294. 24OCR2 57227 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations TABLE 13—POLICIES AND PROCEDURES PRA ESTIMATES—Continued Internal time costs Initial hours Annual hours 1 Wage rate 2 Total annual burden per ETF. ........................ 18.67 hours ....... $7,428.33. Number of ETFs ............. Total annual burden ........................ ........................ × 1,635 .............. 30,525 hours 4 ... × 1,635. $12,145,320 4 .... Initial external cost burden Annual external cost burden $0 ...................... $0 $0 ...................... $0 Final Estimates Establishing and implementing standard baskets policies and procedures. Establishing and implementing custom baskets policies and procedures. 3 1 hour ................ × $329 (senior manager) 5 ........ $329. 2 .67 hours ........... × $353.33. 1 9 .33 hours ........... 3 hours .............. × × $530 (chief compliance officer) 5. $365 (compliance attorney) 5 $329 (senior manager) 5 ........ 5 5 1.67 hours ......... 1.67 hours ......... × × $776.67. $883.33. 1 .33 hours ........... 5 hours .............. × × $466 (ass’t general counsel) 5 $530 (chief compliance officer) 5. $365 (compliance attorney) 5 $329 (senior manager) 5 ........ 2.5 hours ........... 2.5 hours ........... × × $466 (ass’t general counsel) 5 $530 (chief compliance officer) 5. $1,165. $1,325. Reviewing and updating baskets policies and procedures. $121.67. $987. $121.67. $1,645. Total annual burden per ETF. 18.67 hours ....... $7,707.67 .......... Number of ETFs ............. Total annual burden × 1,735 5 ............ 32,392.45 hours × 1,735. $13,372,807.45 Notes: 1 Includes initial burden estimates annualized over a three-year period. 2 Based on SIFMA Report, supra footnote 568, as modified by Commission staff. 3 See 2018 ETF Proposing Release at section IV.B.3. 4 The proposed estimates shown here for the total annual hour and cost burdens (30,525 hours and $12,145,320) are not identical to the totals provided in the 2018 ETFs Proposing Release. See supra footnote 7, at section IV.B.2 (estimating total hour and cost burdens of 30,520 hours and $12,111,525). This discrepancy is due to our calculation of the annual hours in the 2018 ETF Proposing Release, in which the total initial burden hours were calculated before being amortized over 3 years (i.e., divided by 3). Here, the initial burden hours were amortized over 3 years before we calculated the total annual hour and cost burdens, resulting in slightly higher totals. This does not affect the final estimates set forth above. 5 Estimate revised to reflect updated industry data. Table 13 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the policies and procedures requirements in rule 6c–11.690 We did not receive public comment on our proposed estimates, but we are revising the estimates as a result of updated industry data. Specifically, we have updated the estimated wage rates and the estimated number of ETFs that will be subject to the rule and thus the policies and procedures requirement. We do not estimate that there will be any initial or ongoing external costs associated with this requirement. 4. Estimated Total Burden khammond on DSKJM1Z7X2PROD with RULES2 TABLE 14—RULE 6c–11 TOTAL PRA ESTIMATES Internal hour burden Internal burden time cost Website disclosure ..................................................................... Recordkeeping ........................................................................... Developing policies and procedures .......................................... 33,398.75 hours ............. 8,675 hours .................... 32,392.45 hours ............. $10,717,945.15 .............. $680,987.50 ................... $13,372,807.45 .............. $1,735,000 $0 $0 Total annual burden ............................................................ Number of ETFs .................................................................. 74,466.2 hours ............... ÷ 1,735 ........................... $24,771,740.10 .............. ÷ 1,735 ........................... $1,735,000 ÷ 1,735 Average annual burden per ETF ................................. 42.92 hours .................... $14,277.66 ..................... $1,000 As summarized in Table 14 above, we estimate that the total hour burdens and time costs associated with rule 6c–11, including the burden associated with website disclosure, recordkeeping, and developing policies and procedures will result in an average aggregate annual burden of 74,466.2 hours and an average aggregate time cost of $24,771,740.10. We also estimate that there are external costs of $1,735,000 associated with this collection of information. Therefore, 690 See 2018 ETF Proposing Release, supra footnote 7, at section IV.B.2. VerDate Sep<11>2014 20:53 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 External cost burden E:\FR\FM\24OCR2.SGM 24OCR2 57228 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations each ETF will incur an annual burden of approximately 42.92 hours, at an average time cost of approximately $14,277.66, and an external cost of $1,000 to comply with rule 6c–11. 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.691 As discussed above, rule 6c–11 will 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, rule 6c–11 will alleviate some of the burdens associated with rule 0–2 because it will reduce the number of entities that require exemptive relief in order to operate.692 Based on staff experience, we estimate that approximately one-third (rounded in the 2018 ETF Proposing Release and here to 30%) of the annual burdens associated with rule 0–2 are attributable to ETF applications. TABLE 15—RULE 0–2 PRA ESTIMATES Annual internal time cost Rule 0–2 burdens currently approved ........................................ Estimated effect of rule 6c–11 on rule 0–2 burdens ................. x = 5,340 ........................ ¥0.3(x) .......................... y = $2,029,200.60 .......... ¥0.3(y) .......................... z = $14,090,000 ¥0.3(z) Revised estimated burden .................................................. 3,738 hours .................... $1,420,440.42 ................ $9,863,000 Table 15 above summarizes the proposed estimates included in the 2018 ETF Proposing Release.693 We did not receive public comment on these estimates, and we have not revised them. D. Form N–1A Form N–1A is the registration form used by open-end management investment companies. The respondents to the amendments to Form N–1A are open-end management investment companies registered or registering with the Commission. Compliance with the 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 khammond on DSKJM1Z7X2PROD with RULES2 Annual external cost burden Annual hours 691 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). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 Form N–1A a total hour burden of 1,642,490 burden hours and external cost of $131,139,208.694 We are adopting amendments to Form N–1A designed to provide investors who purchase open-end ETF shares in secondary market transactions with tailored information regarding ETFs, including information regarding purchasing and selling shares of ETFs.695 Specifically, the amendments to Form N–1A will require new narrative disclosures regarding ETF trading and associated costs.696 In addition, we are requiring an ETF that does not rely on rule 6c–11 to disclose median bid-ask spread information on their websites or in their prospectuses.697 The amendments also exclude ETFs that provide premium/ 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 posteffective amendments to a previously effective registration statement (including post-effective amendments filed pursuant to rule 485(a) or 485(b) under the Securities Act, as applicable). 692 We expect to continue to receive applications for complex or novel ETF exemptive relief that are beyond the scope of the rule. See supra at text following footnote 570. 693 See 2018 ETF Proposing Release, supra footnote 7, at section IV.B.2. 694 This estimate is based on the last time the form’s information collection was submitted for PRA approval in 2019. When we issued the 2018 ETF Proposing Release, the current estimate for Form N–1A was 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. 695 See supra section II.H. 696 See supra section II.H.2.a. 697 See supra section II.H.2.b. 698 See supra section 0. 699 See supra section II.H.3. PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 discount disclosures on their websites in accordance with rule 6c–11 from the premium discount disclosure requirements in Form N–1A.698 We also are adopting amendments to Form N– 1A designed to eliminate certain disclosures for ETFs that are no longer necessary.699 E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 57229 TABLE 16—FORM N–1A PRA ESTIMATES Annual hours 1 Initial hours Internal time costs Wage rate 2 Annual external cost burden Proposed Estimates 3 Draft and finalize disclosure and amend registration statement. ........................ 1.67 hours ......... × $352 (compliance attorney) ................... $587.84. 5 5 1.67 hours ......... 1.67 hours ......... × × $319 (senior programmer) ..................... $352 (compliance attorney) ................... 532.73. 587.84. 5 ........................ ........................ ........................ 1.67 hours ......... 2.5 hours ........... 2.5 hours ........... 2.5 hours ........... × × × × $319 $352 $319 $352 (senior programmer) ..................... (compliance attorney) ................... (senior programmer) ..................... (compliance attorney) ................... 532.73. 880. 797.50. 880. ........................ 2.5 hours ........... × $319 (senior programmer) ..................... 797.50. 20 16.67 hours ....... × 1,892 .............. ........ ................................................................ 5,591.67 ............ × 1,892. ........................ 31,596.4 hours .. ........ ................................................................ 10,579,307.20. Bid-ask spread and interactive calculator requirements. Review and update disclosures ............. Maintain bid-ask spread and interactive calculator. Total new annual burden per ETF Number of ETFs. Total new annual burden ......... Final Estimates 1.67 hours ......... × $365 (compliance attorney) 4 ................. 609.55. 51 1.67 hours ......... 0.33 hours ......... × × programmer) 4 $331 (senior .................. $365 (compliance attorney) 4 ................. 552.77. 121.67. 51 ........................ ........................ ........................ ........................ 0.33 hours ......... 2.5 hours ........... 2.5 hours ........... 0.5 hours 5 ......... 0.5 hours 5 ......... × × × × × $331 $365 $331 $365 $331 (senior programmer) 4 .................. (compliance attorney) 4 ................. (senior programmer) 4 .................. (compliance attorney) 4 ................. (senior programmer) 4 .................. 110.33. 912.50. 827.50. 182.50. 165.50. 7 10 hours ............ × 1,970 4 ............ ........ ................................................................ 3,482.32 ............ × 1,970 4. ........................ ........................ 19,700 hours ..... + 1,642,490 hours. ........ ........ ................................................................ ................................................................ 6,860,170.40 ..... ........................... $0 + $131,139,208 ........................ 1,662,190 hours ........ ................................................................ ........................... $131,139,208 Draft and finalize disclosure and amend registration statement. 5 5 Bid-ask spread and premium or discount requirements. Review and update disclosures ............. Maintain bid-ask spread requirements .. Total new annual burden per ETF Number of ETFs. Total new annual burden ......... Current burden estimates ........ Revised burden estimates khammond on DSKJM1Z7X2PROD with RULES2 Notes: 1 Includes initial burden estimates annualized over a three-year period. 2 See supra footnote 568. 3 2018 Proposing Release, supra footnote 7, at section IV.D. 4 Estimate revised to reflect updated industry data. 5 Estimate revised to reflect modifications from the proposal. Table 16 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated Form N– 1A as amended.700 We did not receive public comment on our proposed PRA estimates, but we are revising our estimates as a result of updated industry data and modifications from the proposal. Specifically, we are decreasing the initial and ongoing internal and external burden estimates associated with the bid-ask spread and interactive calculator requirements by 80 percent each to account for our elimination of the hypothetical example and interactive calculator requirements and our decision to apply the prospectus bid-ask spread requirements only to those ETFs that do not comply with the website disclosure 700 2018 Proposing Release, supra footnote 7, at section IV.B.1. VerDate Sep<11>2014 19:32 Oct 23, 2019 Jkt 250001 requirements in rule 6c-11, partially offset by the additional premium or discount requirements.701 In addition, we are revising the estimated wage rates and estimated number of ETFs that will be subject to the rule to reflect updated industry data. As summarized in Table 16 above, we estimate that the total hour burdens and time costs associated with the amendments to Form N–1A will result in an average aggregate annual burden of 19,700 hours at an average aggregate time cost of $6,860,170.40. We do not estimate any change in external cost. Therefore the revised aggregate estimates for Form N–1A, including the new amendments, are 1,662,190 hours and $131,338,208 in external costs. 701 See PO 00000 supra sections II.H. Frm 00069 Fmt 4701 Sfmt 4700 E. 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.702 UITs are required to file Form S–6 in order to register offerings of securities with the Commission under the Securities Act.703 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.704 We currently estimate for Form S–6 a total burden of 107,245 702 See Form N–8B–2 [17 CFR 274.12]. 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. 704 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. 703 See E:\FR\FM\24OCR2.SGM 24OCR2 57230 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations hours, with an internal cost burden of approximately $34,163,955, and an external cost burden estimate of $68,108,956.705 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 $10,000.706 To assist investors with better understanding the total costs of investing in a UIT ETF, we are adopting disclosure requirements in Form N–8B– 2 that mirror those disclosures we are adopting for Form N–1A.707 All UIT ETFs will 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 will accrue on Form S– 6. TABLE 17—FORM S–6 PRA ESTIMATES Annual hours 1 Initial hours Wage rate 2 Internal time costs Annual external cost burden Proposed Estimates 3 10 3.33 hours ......... × $352 (compliance attorney) ................... $1,173.32 .......... 10 ........................ 3.33 hours ......... 5 hours .............. × × $319 (senior programmer) ..................... $352 (compliance attorney) ................... 1,063.33 ............ 1,760 ................. ........................ 5 ........................ × $319 (senior programmer) ..................... 1,595 ................. Total new annual burden per UIT ETF. 20 16.67 hours ....... ........ ................................................................ 5,591.65 ............ Number of UIT ETFs ...................... ........................ × 8 ..................... ........ ................................................................ × 8 ..................... Total new annual burden ......... ........................ 133.36 hours ..... ........ ................................................................ 44,733.20 .......... Draft and finalize disclosure and amend Form S-6. 4 12 Draft and finalize disclosure and amend Form S–6. Review and update disclosures on Form S-6. Final Estimates 4 hours .............. × $365 (compliance attorney) 5 ................. 1,460 ................. ........................ 4 hours .............. 5 hours .............. × × programmer) 5 $331 (senior .................. $365 (compliance attorney) 5 ................. 1,324 ................. 1,825 ................. ........................ 5 hours .............. × $331(senior programmer) .................... $1,655 ............... Total new annual burden per ETF Number of UIT ETFs ...................... 24 ........................ 18 hours ............ × 8 ..................... $6,264 ............... × 8 ..................... Total new annual burden ......... Current burden estimates ........ Revised burden estimates ........................ 114 hours .......... + 107,245 hours 107,359 hours ... $50,112 ............. 4 12 Review and update disclosures on Form S-6. ........................ ........................... $0 + $68,108,956 $68,108,956 Notes: 1 Includes initial burden estimates annualized over a three-year period. 2 See supra footnote 568. 3 2018 Proposing Release, supra footnote 7, at Section IV.E. 4 Estimate revised to reflect modifications from the proposal. 5 Estimate revised to reflect updated industry data. TABLE 18—FORM N–8B–2 PRA ESTIMATES Annual hours 1 Initial hours Wage rate 2 Internal time costs Proposed Estimates 3 10 3.33 hours ......... × $352 (compliance attorney) ................... $1,173.32 .......... 10 ........................ ........................ 3.33 hours ......... 5 hours .............. 5 hours .............. × × × $319 (senior programmer) ..................... $352 (compliance attorney) ................... $319 (senior programmer) ..................... $1,063.33 .......... $1,760 ............... $1,595 ............... Draft and finalize disclosure and file Form N–8B–2. Complete Form N–8B–2 ........................ Total new annual burden per UIT ETF. Number of new UIT ETFs .............. 20 16.67 hours ....... ........ ................................................................ $5,591.65 .......... ........................ × 1 ..................... ........ ................................................................ × 1 ..................... Total new annual burden ......... ........................ 16.67 hours ....... ........ ................................................................ $5,591.65 .......... Draft and finalize disclosure and file Form N–8B–2. 4 12 Final Estimates khammond on DSKJM1Z7X2PROD with RULES2 4 12 4 hours .............. × $365 (compliance attorney) 5 ................. $1,460 ............... × × × programmer) 5 $1,324 ............... $1,825 ............... $1,655 ............... Complete Form N–8B–2 ........................ ........................ ........................ 4 hours .............. 5 hours .............. 5 hours .............. Total new annual burden per UIT ETF. Number of new UIT ETFs .............. 24 18 hours ............ $6,264 ............... ........................ × 1 ..................... × 1 ..................... 705 This estimate is based on the last time the form’s information collection was submitted for PRA revision in 2019. VerDate Sep<11>2014 19:32 Oct 23, 2019 Jkt 250001 $331 (senior .................. $365 (compliance attorney) 5 ................. $331 (senior programmer) 5 .................. 706 This estimate is based on the last time the form’s information collection was submitted for PRA renewal in 2018. PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 707 See E:\FR\FM\24OCR2.SGM supra section II.I. 24OCR2 Annual external cost burden Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 57231 TABLE 18—FORM N–8B–2 PRA ESTIMATES—Continued Total new annual burden ......... Current burden estimates ........ Revised burden estimates Initial hours Annual hours 1 ........................ ........................ ........................ 18 hours ............ +10 hours .......... 28 hours ............ Internal time costs Wage rate 2 Annual external cost burden $6,264 ............... $0 + $10,000 $10,000 Notes: 1 Includes initial burden estimates annualized over a three-year period. 2 See supra footnote 568. 3 2018 Proposing Release, supra footnote 7, at section IV.E. 4 Estimate revised to reflect modifications from the proposal. 5 Estimate revised to reflect updated industry data. are revising the estimated wage rates to reflect updated industry data.710 As summarized in Table 17 above, we estimate that the total hour burdens and time costs associated with the amendments to Form S–6 will result in an average aggregate annual burden of 114 hours at an average aggregate time cost of $50,112. We do not estimate any change in external cost. Therefore, the revised aggregate estimates for Form S– 6, including the new amendments, are 107,359 hours and $68,108,956 in external costs. As summarized in Table 18 above, we estimate that the total hour burdens and time costs associated with the amendments affecting Form N–8B–2 will result in an average aggregate annual burden of 18 hours at an average Table 17 and Table 18 above summarize the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with Forms S–6 and N–8B– 2, respectively.708 We did not receive public comment on our proposed estimates, but we are revising our estimates as a result of updated industry data and modifications from the proposal. Specifically, we are increasing the initial internal burden estimate for both Form S–6 and Form N–8B–2 by 20 percent to account for the additional premium and discount requirement, partially offset by the modifications to the proposed fee and expense requirements, including those relating to bid-ask spreads.709 In addition, we aggregate time cost of $6,264. We do not estimate any change in external cost. Therefore, the revised aggregate estimates for Form N–8B–2, including the new amendments, are 28 hours and $10,000 in external costs. 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.711 Today, the Commission is adopting amendments to Form N– CEN to require ETFs to report if they are relying on rule 6c–11.712 We currently estimate for Form N–CEN total burden hours of 74,425 and external costs of $2,088,176.713 TABLE 19—FORM N–CEN PRA ESTIMATES Annual hours Annual external cost burden Proposed Estimates 1 Report reliance on rule 6c–11 ..................................................................................................................... Number of ETFs .......................................................................................................................................... 0.1 hours × 1,635 .............................. .............................. Total new annual burden ...................................................................................................................... 163.5 hours .............................. 0.1 hours × 1,735 2 173.5 hours + 74,425 hours 74,598 hours .............................. .............................. $0 + $2,088,176 $2,088,176 Final Estimates Report reliance on rule 6c–11 ..................................................................................................................... Number of ETFs .......................................................................................................................................... Total new annual burden ...................................................................................................................... Current burden estimates ..................................................................................................................... Revised burden estimates ............................................................................................................. khammond on DSKJM1Z7X2PROD with RULES2 Notes: 1 2018 Proposing Release, supra footnote 7, at section IV.F. 2 Estimate revised to reflect updated industry data. Table 19 above summarizes the proposed estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with Form N– CEN as amended.714 We did not receive public comment on these estimates, but we are revising our proposed estimates as a result of updated industry data. Specifically, we are revising the estimated number of ETFs that will be subject to the rule to reflect updated industry data. As summarized in Table 19, we estimate that the total hour burdens and time costs associated with the amendments to Form N–CEN will result in an average aggregate annual burden of 173.5 hours. We do not estimate any change in external cost. 708 2018 ETF Proposing Release, supra footnote 7, at section IV.E. 709 See supra section II.I. 710 After reviewing updated industry data, no revisions to the estimated number of UIT ETFs that will be subject to the form are necessary. 711 See Reporting Modernization Adopting Release, supra footnote 263. 712 See supra section II.J. 713 This estimate is based on the last time the form’s information collection was submitted for PRA approval in 2017. 714 2018 ETF Proposing Release, supra footnote 7, at section IV.F. VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 E:\FR\FM\24OCR2.SGM 24OCR2 57232 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations Therefore the revised aggregate estimates for Form N–CEN, including the new amendments, are 74,598 hours and $2,088,176 in external costs. VI. Final Regulatory Flexibility Analysis The Commission has prepared the following Final Regulatory Flexibility Analysis (‘‘FRFA’’) in accordance with section 4(a) of the Regulatory Flexibility Act (‘‘RFA’’),715 regarding new rule 6c– 11 and amendments to Form N–1A, Form N–8B–2, and Form N–CEN. An Initial Regulatory Flexibility Analysis (‘‘IRFA’’) was prepared in accordance with the RFA and included in the 2018 ETF Proposing Release.716 A. Need for and Objectives of the Rule and Form Amendments As described more fully above, rule 6c–11 will 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 amendments to Forms N– 1A and N–8B–2 will provide useful information to investors who purchase and sell ETF shares in secondary markets. Finally, the Commission believes the amendments to Form N– CEN will allow the Commission to better monitor reliance on rule 6c–11 and will assist the Commission with its accounting, auditing and oversight functions. All of these requirements are discussed in detail in section II above. The costs and burdens of these requirements on small ETFs are discussed below as well as above in our Economic Analysis and Paperwork Reduction Act Analysis, which discuss the costs and burdens on all ETFs. khammond on DSKJM1Z7X2PROD with RULES2 B. Significant Issues Raised by Public Comments In the 2018 ETF Proposing Release, we requested comment on every aspect of the IRFA, including the number of small entities that would be affected by the proposed rule and amendments, the existence or nature of the potential impact of the proposals on small entities discussed in the analysis and how to quantify the impact of the proposed rule and amendments. We also requested comment on the broader impact of the 715 See 5 U.S.C. 603. 2018 ETF Proposing Release, supra footnote 7, at section V. 716 See VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 proposed rule and amendments on all relevant entities, regardless of size. After consideration of the comments we received on the proposed rule and amendments, we are adopting the rule and amendments with several modifications that are designed to reduce certain operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful information regarding ETFs. However, none of the modifications were significant to the small-entity cost burden estimates discussed below. Revisions to the estimates are instead based on updated figures regarding the number of small entities impacted by the new rule and amendments and updated estimated wage rates. 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.717 Commission staff estimates that, as of December 2018, there are approximately 9 open-end ETFs that may be considered small entities.718 Commission staff estimates there are no UIT ETFs that would be considered small entities subject to the proposed disclosures for Form N–8B–2.719 D. Projected Reporting, Recordkeeping, and Other Compliance Requirements The new rule and amendments will impact current reporting, recordkeeping and other compliance requirements for ETFs considered small entities. 1. Rule 6c–11 Rule 6c–11 will require an ETF to disclose on its website: (i) Portfolio holding information 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, to post that information and a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount; (iv) a table and line graph showing the ETF’s premiums and discounts; and (v) the ETF’s median bid-ask spread over the 717 17 CFR 270.0–10(a). 718 This estimate is derived from an analysis of data reported on Form N–1A with the Commission for the period ending December, 2018. 719 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 2018. PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 last thirty calendar days.720 The new rule also will 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) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding 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.721 Additionally, rule 6c–11 will require 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 basket assets.722 ETFs using custom baskets under the rule must adopt custom basket policies and procedures that include certain enumerated requirements.723 We estimate that approximately 9 ETFs are small entities that will comply with rule 6c–11, and we do not believe that their costs would differ from other ETFs. As discussed above, we estimate that an ETF will incur an annual burden of approximately 36.97 hours, at an average time cost of approximately $11,758.97, and an external cost of $1,000.00.724 As we discuss in greater detail in section IV.C.1 above, we expect rule 6c– 11 to have other, generally unquantifiable economic effects. For example, by eliminating the need for ETFs that can rely on the rule to seek an exemptive order from the Commission, the rule will also eliminate certain indirect costs associated with the exemptive application process.725 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.726 We also believe that the rule could increase competition in the 720 See rule 6c–11(c)(1). rule 6c–11(d). 722 Rule 6c–11(c)(3). 723 Rule 6c–11(c)(3). 724 See supra Table 13. 725 See supra section IV.C.1. 726 See id. 721 See E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations ETF market as a whole, which could also lead to lower fees.727 2. Other Disclosure and Reporting Requirements The amendments to Form N–1A and Form N–8B–2 are 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, the amendments to Form N–1A will: (i) Require new disclosure regarding ETF trading and associated costs; (ii) require ETFs that are not subject to rule 6c–11 to disclose median bid-ask spread information on their websites or in their prospectuses; and (iii) exclude ETFs that provide premium/discount disclosures in accordance with rule 6c–11 from the premium and discount disclosure requirements in the form.728 Amendments to Form N–8B–2 mirror proposed disclosures for Form N–1A. In addition, amendments to Form N–CEN will require ETFs to report on Form N– CEN whether they are relying on rule 6c–11 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 (including ETFs that do not rely on rule 6c–11) will be subject to the amended Form N–1A or Form N–8B–2 (depending on the ETF’s structure as an open-end fund or UIT), and Form N– CEN disclosure and reporting requirements, including ETFs that are small entities. We estimate that 9 ETFs are small entities that will be required to comply with the requirements on Form N–1A and Form N–CEN.729 We estimate that each ETF, including ETFs that are small entities, will incur a onetime burden of 7 hours, at a time cost of $4,176 to draft and finalize the required disclosure and amend its registration statement.730 We also estimate that each ETF, including ETFs that are small entities, will incur an ongoing burden of an additional 3 hours, at a time cost of an additional $2,088, to comply with the Form N–1A disclosure requirements.731 We do not estimate any change to the external khammond on DSKJM1Z7X2PROD with RULES2 727 See id. supra section II.H.2. 729 See supra footnotes 720 and 721. As discussed above, the amendments to Form N–8B–2 mirror those made to Form N–1A. We therefore believe that UIT ETFs will incur the same costs as all ETFs associated with updating their registration statements. However, none of the UIT ETFs are small entities. 730 See supra Table 16. 731 See id. 728 See VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 costs associated with the amendments to Form N–1A.732 The total administrative cost for of the Form N– CEN disclosure requirement to ETFs is .1 hours.733 As we discuss in greater detail in section IV.C.2 above, we expect the new disclosure amendments to have other, generally unquantifiable economic effects. For example, we believe that the new disclosures will 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.734 We also believe the amendment to Form N– CEN will allow the Commission to better monitor reliance on rule 6c–11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act.735 E. Agency Action To Minimize Effect on Small Entities 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 adopted regulations: • Exempting ETFs that are small entities from the 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 rule 6c–11 or the related form amendments will 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 rule without 732 See id. supra Table 19. 734 See supra section IV.C.2. 735 See id. 733 See PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 57233 compromising our objectives. As discussed above, the conditions necessary to rely on 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 disclosure and reporting requirements or to exempt small ETFs from the recordkeeping requirements. We believe that all ETF investors, including investors in small ETFs, will benefit from disclosure and reporting requirements that permit them to make investment choices that better match their risk tolerances. Additionally, the current disclosure requirements for reports on Form N–1A and Form N–8B–2 do not distinguish between small entities and other funds.736 Finally, we believe that rule 6c–11 and related disclosure and reporting requirements appropriately use a combination of performance and design standards. 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 rule must be specifically designed to ensure that these investor and market protections are maintained. However, where we believe that flexibility is beneficial, we adopted performancebased standards that provide a regulatory framework, rather than prescriptive requirements, to give funds the opportunity to adopt policies and procedures tailored to their specific needs without raising investor or market protection concerns.737 736 See Reporting Modernization Adopting Release, supra footnote 263, 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). 737 See e.g., supra section II.C.5. (noting that rule 6c–11 will 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 Continued E:\FR\FM\24OCR2.SGM 24OCR2 57234 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations VII. Statutory Authority The Commission is adopting 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 adopting amendments to registration Forms N–1A and N–CSR 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 adopting 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 adopting amendments to Form N–CEN and Form N–PORT 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)]. The Commission is adopting amendments to Regulation S–X under the authority set forth in sections 7, 8, 10, and 19 of the Securities Act [15 U.S.C. 77g, 77h, 77j, 77s], and sections 8(b), 30(a), 31, and 38(a) of the Investment Company Act [15 U.S.C. 80a–8(b), 80a–29(a), 80a–30, and 80a–37(a)]. The Commission is providing relief in Section II.G, permitting ETFs relying on rule 6c–11 to enter into fund of funds arrangements, pursuant to the authority set forth in sections 6(c), 12(d)(1)(J) and 17(b). List of Subjects 17 CFR Part 210 Accounting, Investment companies, Reporting and recordkeeping requirements, Securities. 17 CFR Part 239 Reporting and recordkeeping requirements, Securities. Text of Rules and Form Amendments Correction In final rule FR Doc. 2016–25349, published in the issue of Friday, November 18, 2016 (81 FR 81870), make the following correction: On page 82019, in the second column, remove amendatory instruction 23 for § 232.401, which was to be effective August 1, 2019, but was delayed until May 1, 2020, in a rule published on December 14, 2017 (82 FR 58731). khammond on DSKJM1Z7X2PROD with RULES2 acceptance of custom baskets that are in the best interests of the ETF and its shareholders). VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PART 210—FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975 1. The authority citation for part 210 continues to read as follows: ■ Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j–1, 78l, 78m, 78n, 78o(d), 78q, 78u–5, 78w, 78ll, 78mm, 80a–8, 80a–20, 80a–29, 80a–30, 80a–31, 80a–37(a), 80b–3, 80b–11, 7202 and 7262, and sec. 102(c), Pub. L. 112–106, 126 Stat. 310 (2012), unless otherwise noted. § 210.12–14 [Amended] 2. Amend § 210.12–14 by removing the phrase in footnote 1 ‘‘(5) balance at close of period as shown in Column E’’ and adding in its place ‘‘(5) balance at close of period as shown in Column F’’. ■ PART 239—FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933 3. 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 4. The authority citation for part 270 is revised by adding a sectional authority for § 270.6c–11 in numerical order to read in part as follows: ■ 17 CFR Parts 270 and 274 Investment companies, Reporting and recordkeeping requirements, Securities. ■ For reasons set out in the preamble, title 17, chapter II of the Code of Federal Regulations is amended 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). * * * * * 5. Section 270.6c–11 is added to read as follows: ■ § 270.6c–11 Exchange-traded funds. (a) Definitions. (1) For purposes of this section: Authorized participant means a member or participant of a clearing agency registered with the Commission, PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 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: (A) A basket that is composed of a non-representative selection of the exchange-traded fund’s portfolio holdings; or (B) A representative basket that is different from the initial basket used in transactions on the same business day. Exchange-traded fund means a registered open-end management company: (A) That issues (and redeems) creation units to (and from) authorized participants in exchange for a basket and a cash balancing amount if any; and (B) 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 that is traded on a trading market outside of the United States. Market price means: (A) The official closing price of an exchange-traded fund share; or (B) If it more accurately reflects the market value of an exchange-traded 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 E:\FR\FM\24OCR2.SGM 24OCR2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations 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. (2) Notwithstanding the definition of exchange-traded fund in paragraph (a)(1) 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, and is not limited to transactions with authorized participants under these circumstances. (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. 80a22(d)) and § 270.22c–1(a) with regard to purchases, sales and repurchases of exchange-traded fund shares at marketdetermined prices. (3) Affiliated transactions. 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) and (ii) 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: (i) Holding with the power to vote 5% or more of the exchange-traded fund’s shares; or (ii) 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- VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 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 exchangetraded fund shares. (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, the following information (as applicable) for each portfolio holding that will form the basis of the next calculation of current net asset value per share: (A) Ticker symbol; (B) CUSIP or other identifier; (C) Description of holding; (D) Quantity of each security or other asset held; and (E) Percentage weight of the holding in the portfolio; (ii) The exchange-traded fund’s current net asset value per share, market price, and premium or discount, each as of the end 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); (v) The exchange-traded fund’s median bid-ask spread, expressed as a percentage rounded to the nearest hundredth, computed by: (A) Identifying the exchange-traded fund’s national best bid and national best offer as of the end of each 10 second interval during each trading day of the last 30 calendar days; (B) Dividing the difference between each such bid and offer by the midpoint of the national best bid and national best offer; and (C) Identifying the median of those values; and (vi) If the exchange-traded fund’s premium or discount is greater than 2% for more than seven consecutive trading days, a statement that the exchangetraded fund’s premium or discount, as PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 57235 applicable, was greater than 2% and 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. (2) The portfolio holdings that form the basis for the exchange-traded fund’s next calculation of current net asset value per share must be the ETF’s portfolio holdings as of the close of business on the prior business day. (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, these written policies and procedures also must: (i) 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 (ii) 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 investment returns that correspond to the performance of a market index by a specified multiple, or to provide investment returns that have an inverse relationship to the performance of a market index, over a predetermined period of time. (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 ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding 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 exchange-traded fund adopted pursuant to paragraph (c)(3) of this section; E:\FR\FM\24OCR2.SGM 24OCR2 57236 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations (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 6. The general authority citation for part 274 continues to read as follows: ■ * * * * * 7. Form N–1A (referenced in §§ 239.15A and 274.11A) is amended as follows: ■ a. In General Instruction A, revising the definition of ‘‘Exchange-Traded Fund.’’ ■ b. In General Instruction A, revising the definition of ‘‘Market Price.’’ ■ c. In General Instruction B.4.(a), removing the phrases ‘‘[17 CFR 230.400–230.497]’’ and ‘‘rules 480–485 and 495–497 of Regulation C’’ and adding in their place ‘‘[17 CFR 230.400– 230.498]’’ and ‘‘rules 480–485 and 495– 498 of Regulation C.’’ ■ d. In General Instruction B.4.(d), removing the phrase ‘‘Regulation S–T [17 CFR 232.10–232.903]’’ and adding in its place ‘‘Regulation S–T [17 CFR 232.10–232.501].’’ ■ e. In Item 3, revising the first paragraph under the heading ‘‘Fees and Expenses of the Fund’’. ■ f. Revising Instruction 1(e) of Item 3, Item 6(c), and Items 11(a)(1) and 11(g). ■ g. In instruction 4(b) to Item 13, removing the sentence ‘‘If a change in the methodology for determining the ratio of expenses to average net assets results from applying paragraph 2(g) of rule 6–07, explain in a note that the ratio reflects fees paid with brokerage commissions and fees reduced in connection with specific agreements only for periods ending after September 1, 1995.’’ ■ h. Revising Item 27(b)(7)(iv), Instruction 1(e)(ii) of Item 27(d)(1), and Item 27(d)(3). The additions and revisions read as follows: khammond on DSKJM1Z7X2PROD with RULES2 ■ Note: The text of Form N–1A does not, and this amendment will not, appear in the Code of Federal Regulations. * * * * * GENERAL INSTRUCTIONS * * * * * * * A. Definitions * * * VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 * * * * * * * ‘‘Market Price’’ has the same meaning as in rule 6c–11 [17 CFR 270.6c–11] under the Investment Company Act. * 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. Form N–1A (e) If the Fund is an Exchange-Traded Fund, exclude any fees charged for the purchase and redemption of the Fund’s creation units. Instructions 1. A Fund may omit the information required by paragraph (c)(5) of this Item if it satisfies the requirements of paragraph (c)(1)(v) of Rule 6c–11 [17 CFR 270.6c– 11(c)(1)(v)] under the Investment Company Act. 2. An Exchange-Traded Fund that had its initial listing on a national securities exchange at or before the beginning of the most recently completed fiscal year must include the median bid-ask spread for the Fund’s most recent 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. 3. Bid-Ask Spread (Median). Calculate the median bid-ask spread by dividing the difference between the national best bid and national best offer by the mid-point of the national best bid and national best offer as of the end of each ten-second interval throughout each trading day of the ExchangeTraded 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. 4. A Fund may combine the information required by Item 6(c)(4) into the information required by Item 1(b)(1) and Rule 498(b)(1)(v) [17 CFR 230.498(b)(1)(v)] under the Securities Act. ‘‘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. * * * * Item 3. Risk/Return Summary: Fee Table * * * * * 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, 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. * * * * * * * * * * * Instructions * * 1. General * * * * * * Item 6. Purchase and Sale of Fund Shares * * * * * (c) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund, the Fund may omit the information required by paragraphs (a) and (b) of this Item and must disclose: (1) That Individual Fund shares may only be bought and sold in the secondary market through a broker or dealer at a market price; (2) That 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); (3) That an investor may incur costs attributable to 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) when buying or selling shares in the secondary market (the ‘‘bid-ask spread’’); (4) If applicable, how to access recent information, including information on the Fund’s net asset value, Market Price, premiums and discounts, and bid-ask spreads, on the Exchange-Traded Fund’s website; and (5) The median bid-ask spread for the Fund’s most recent fiscal year. PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 * * * * 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 ExchangeTraded 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: (1) The Fund may omit from the prospectus the information required by Items 11(a)(2), (b), and (c). (2) Provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund’s net asset value and the number of days it was less than the Fund’s net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)–(iv) and (c)(1)(vi) of Rule 6c–11 [17 CFR 270.6c–11(c)(1)(ii)–(iv) and E:\FR\FM\24OCR2.SGM 24OCR2 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations (c)(1)(vi)] under the Investment Company Act. GENERAL INSTRUCTIONS FOR FORM N–8B–2 * * * * * * Item 27. Financial Statements * * * * * * * * * * * * (d) * * * (1) * * * 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. * * * * * (3) * * * Instruction A Money Market Fund will omit the statement required by Item 27(d)(3) and instead provide a statement that (i) the Money Market Fund files its complete schedule of portfolio holdings with the Commission each month on Form N–MFP; (ii) the Money Market Fund’s reports on Form N–MFP are available on the Commission’s website at https://www.sec.gov; and (iii) the Money Market Fund makes portfolio holdings information available to shareholders on its website. * * * * * 8. Form N–8B–2 (referenced in §§ 239.16 and 274.12) is amended as follows: ■ a. In the General Instructions, revising the definitions of ‘‘Exchange-Traded Fund’’ and ‘‘Market Price’’. ■ b. In Item 13, adding paragraphs (h), (i), and (j). ■ c. In Item IX, adding an undesignated paragraph following the heading. The additions and revisions read as follows: khammond on DSKJM1Z7X2PROD with RULES2 ■ Note: The text of Form N–8B–2 does not, and this amendment will not, appear in the Code of Federal Regulations. * * * VerDate Sep<11>2014 * * 18:07 Oct 23, 2019 * * * * Exchange-Traded Fund (ETF): The term ‘‘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. * * * * * Market Price. The term ‘‘Market Price’’ has the same meaning as in rule 6c–11 [17 CFR 270.6c–11] under the Investment Company Act. * * * * * 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 6(c) of Form N–1A [referenced in 17 CFR 274.11A]. Provide information specific to the trust as necessary, utilizing the ETF-specific methodology set forth in the Instructions to Form N–1A Item 6(c). The Fund may omit the information required by Item 6(c)(5) of Form N–1A if it satisfies the requirements of paragraph (c)(1)(v) of Rule 6c–11 [17 CFR 270.6c–11(c)(1)(v)] under the Investment Company Act. (j) If the trust is an Exchange-Traded Fund, provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund’s net asset value and the number of days it was less than the Fund’s net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)–(iv) and (c)(1)(vi) of Rule 6c–11 [17 CFR 270.6c–11(c)(1)(ii)–(iv) and (c)(1)(vi)] under the Investment Company Act. * * * * * IX EXHIBITS Subject to General Instruction 2(d) regarding incorporation by reference Form N–8B–2 * * * (iv) Provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund’s net asset value and the number of days it was less than the Fund’s net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)–(iv) and (c)(1)(vi) of Rule 6c–11 [17 CFR 270.6c–11(c)(1)(ii)–(iv) and (c)(1)(vi)] under the Investment Company Act. * * Definitions * (b) * * * (7) * * * * * Jkt 250001 PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 57237 and rule 483 under the Securities Act, file the exhibits listed below as part of the registration statement. Letter or number the exhibits in the sequence indicated, unless otherwise required by rule 483. Reflect any exhibit incorporated by reference in the list below and identify the previously filed document containing the incorporated material. * * * * * ■ 9. Amend Form N–CEN (referenced in § 274.101) as follows: ■ a. Adding Item C.7.k. ■ b. Revising the Instruction to Item E.2. The addition and revision 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): ll * * * Part E. Additional Questions for Exchange-Traded Funds and ExchangeTraded 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 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. * * * ■ 10. Amend Form N–CSR (referenced in § 274.128) as follows: ■ a. In General Instruction D, remove the phrase ‘‘Item 12(a)(1)’’ and add in its place ‘‘Item 13(a)(1)’’. ■ b. In the instruction to Item 13, remove the phrase ‘‘Instruction to Item 11’’ and add in its place ‘‘Instruction to Item 13’’. ■ 11. Amend Form N–PORT (referenced in § 274.150) by revising the first paragraph of General Instruction F to read as follows: E:\FR\FM\24OCR2.SGM 24OCR2 57238 Federal Register / Vol. 84, No. 206 / Thursday, October 24, 2019 / Rules and Regulations Note: The text of Form N–PORT does not, and this amendment will not, appear in the Code of Federal Regulations. GENERAL INSTRUCTIONS quarter will be made publicly available upon filing. * * * * * * * * F. Public Availability FORM N–PORT With the exception of the non-public information discussed below, the information reported on Form N–PORT for the third month of each Fund’s fiscal MONTHLY PORTFOLIO INVESTMENTS REPORT * * * By the Commission. Dated: September 25, 2019. Vanessa A. Countryman, Secretary. [FR Doc. 2019–21250 Filed 10–23–19; 8:45 am] khammond on DSKJM1Z7X2PROD with RULES2 BILLING CODE 8011–01–P VerDate Sep<11>2014 18:07 Oct 23, 2019 Jkt 250001 PO 00000 Frm 00078 Fmt 4701 Sfmt 9990 E:\FR\FM\24OCR2.SGM 24OCR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 84, Number 206 (Thursday, October 24, 2019)]
[Rules and Regulations]
[Pages 57162-57238]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-21250]

[[Page 57161]]

Vol. 84

Thursday,

No. 206

October 24, 2019

Part II

Securities and Exchange Commission

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17 CFR Parts 210, 232, 239, et al.

Exchange-Traded Funds; Final Rule

Federal Register / Vol. 84 , No. 206 / Thursday, October 24, 2019 /
Rules and Regulations

[[Page 57162]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 232, 239, 270, and 274

[Release Nos. 33-10695; IC-33646; File No. S7-15-18]
RIN 3235-AJ60

Exchange-Traded Funds

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
adopting a new rule under the Investment Company Act of 1940 (the
``Investment Company Act'' or the ``Act'') that will 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 final rule, the Commission will rescind certain
exemptive relief that has been granted to ETFs and their sponsors. The
Commission also is adopting 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 and associated 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 adopting related amendments to Form N-CEN. The final rule
and form amendments are designed to create a consistent, transparent,
and efficient regulatory framework for ETFs that are organized as open-
end funds and to facilitate greater competition and innovation among
ETFs. The Commission also is adopting technical amendments to Form N-
CSR, Form N-1A, Form N-8B-2, Form N-PORT, and Regulation S-X.

DATES:
Effective Date: This rule is effective December 23, 2019.
Compliance Dates: The applicable compliance dates are discussed in
section II.L. of this final rule.

FOR FURTHER INFORMATION CONTACT: Joel Cavanaugh (Senior Counsel), John
Foley (Senior Counsel), J. Matthew DeLesDernier (Senior Counsel), Jacob
D. Krawitz (Branch Chief), Melissa S. Gainor (Assistant Director), and
Brian McLaughlin Johnson (Assistant Director), Investment Company
Regulation Office, at (202) 551-6792, Kay-Mario Vobis (Senior Counsel),
Daniele Marchesani (Assistant Chief Counsel), Chief Counsel's Office,
at (202) 551-6825, Division of Investment Management, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is adopting 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\ The Commission also is adopting technical
amendments to Form N-CSR [referenced in Sec. 274.128], Form N-1A, Form
N-8B-2, and Form N-PORT [referenced in Sec. 274.150] under the
Investment Company Act, and 17 CFR 210.12-01 through 210.12-29 (Article
12 of Regulation S-X).
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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 Rule 6c-11
1. Organization as Open-End Funds
2. Index-Based ETFs and Actively Managed ETFs
3. Leveraged/Inverse ETFs
B. Exemptive Relief Under 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 Rule 6c-11
1. Issuance and Redemption of Shares
2. Listing on a National Securities Exchange
3. Intraday Indicative Value (``IIV'')
4. Portfolio Holdings Disclosure
5. Baskets
6. Website Disclosure
7. Marketing
8. ETF and ETP Nomenclature
D. Recordkeeping
E. Share Class ETFs
F. Master-Feeder ETFs
G. Effect of Rule 6c-11 on Prior Orders
H. Amendments to Form N-1A
1. Fee Disclosures for Mutual Funds and ETFs (Item 3)
2. Disclosures Regarding ETF Trading and Associated Costs (Item
6)
3. Eliminated Disclosures
I. Amendments to Form N-8B-2
J. Amendments to Form N-CEN
K. Technical and Conforming Amendments to Form N-1A, Form N-8B-
2, Form N-CSR, Form N-PORT, and Regulation S-X
L. Compliance Dates
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Economic Baseline
1. ETF Industry Growth and Trends
2. Exemptive Order Process and Certain Conditions Under Existing
Orders
3. Market Participants
4. Secondary Market Trading, Arbitrage, and ETF Liquidity
C. Benefits and Costs of Rule 6c-11 and Form Amendments
1. Rule 6c-11
2. Amendments to Forms N-1A, N-8B-2, and N-CEN
D. Effects on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Reasonable Alternatives
1. Website Disclosure of Basket Information
2. Disclosure of ETF Premiums or Discounts Greater than 2%
3. Website and Prospectus Disclosure of the Median Bid-Ask
Spread Calculated Over the Most Recent 1-Year Period
4. Additional Disclosures Showing the Impact of Bid-Ask Spreads
5. Website Disclosure of a Modified IIV
6. The Use of a Structured Format for Additional Website
Disclosures and the Filing of Additional Website Disclosures in a
Structured Format on EDGAR
7. Pro Rata Baskets
8. Treatment of Existing Exemptive Relief
9. ETFs Organized as UITs
10. Treatment of Leveraged/Inverse ETFs
V. Paperwork Reduction Act
A. Introduction
B. 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. Forms N-8B-2 and S-6
F. Form N-CEN
VI. Final Regulatory Flexibility Analysis
A. Need for and Objectives of the Rule and Form Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rule
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Rule 6c-11
2. Other Disclosure and Reporting Requirements
E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority

I. Introduction

The Commission is adopting rule 6c-11 under the Investment Company
Act to permit ETFs that satisfy certain conditions to operate without
the

[[Page 57163]]

expense and delay of obtaining an exemptive order from the Commission
under the Act. This rule will modernize the regulatory framework for
ETFs to reflect our more than two decades of experience with these
investment products. The rule is designed to further important
Commission objectives, including establishing a consistent,
transparent, and efficient regulatory framework for ETFs and
facilitating greater competition and innovation among ETFs.
The Commission approved the first ETF in 1992. Since then, ETFs
registered with the Commission have grown to $3.32 trillion in total
net assets.\2\ They now account for approximately 16% 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 2018, there were approximately 2,000 ETFs registered with
the Commission.
\3\ ICI, 2019 Investment Company Fact Book (59th ed., 2019)
(``2019 ICI Fact Book''), available at https://www.ici.org/pdf/2019_factbook.pdf, at 93. 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 reach $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., 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.
\6\ In addition, since 2000, our ETF exemptive orders have
provided relief for future ETFs. See id. 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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On June 28, 2018, we proposed new rule 6c-11 under the Investment
Company Act, which 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.\7\ We also proposed to rescind certain exemptive orders that have
been granted to ETFs and their sponsors in order to level the playing
field for ETFs that are organized as open-end funds and pursue the same
or similar investment strategies.\8\ In addition, the Commission
proposed certain disclosure amendments to Form N-1A and Form N-8B-2 to
provide investors additional information regarding ETF trading and
associated costs, regardless of whether ETFs are organized as open-end
funds or UITs. Finally, the Commission proposed related amendments to
Form N-CEN.
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\7\ See Exchange-Traded Funds, Investment Company Act Release
No. 33140 (June 28, 2018) [83 FR 37332 (July 31, 2018)] (``2018 ETF
Proposing Release'').
\8\ Proposed rule 6c-11 did 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; 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''). Under the proposal,
these ETFs would continue to operate pursuant to the terms of their
exemptive orders. Since that time, we have granted an exemptive
order permitting certain ETFs that are actively managed to operate
without being subject to the daily portfolio transparency condition
included in other actively managed ETF orders (``non-transparent
ETFs''). See Precidian ETFs Trust, et al., Investment Company Act
Release Nos. 33440 (Apr. 8, 2019) [84 FR 14690 (Apr. 11, 2019)]
(notice) and 33477 (May 20, 2019) (order) and related application
(``2019 Precidian''). Because these non-transparent ETFs do not
provide daily portfolio transparency, they would not meet the
conditions of rule 6c-11. We use the term ``actively managed ETFs''
in this release to refer to actively managed ETFs that provide daily
portfolio transparency and ``non-transparent ETFs'' to refer to
actively managed ETFs that do not.
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We received more than 85 comment letters on the proposal.\9\ As
discussed in greater detail below, commenters were supportive of the
adoption of an ETF rule and generally supported rule 6c-11 as proposed.
Commenters did, however, recommend modifications or clarifications to
certain aspects of the rule. For example, several commenters suggested
expanding the scope of ETFs covered by the rule or the scope of certain
exemptions.\10\ Many commenters recommended modifications to the
proposed rule's conditions, particularly relating to the timing and
presentation of portfolio holdings information, the requirements
related to custom baskets, the publication of basket information, and
the availability of an intraday indicative value.\11\ In addition,
although commenters were largely supportive of our efforts to improve
the information that ETFs disclose to investors about the trading costs
of investing in ETFs, several commenters objected to the bid-ask spread
disclosure requirements and the related interactive calculator.\12\
Others recommended alternatives to the proposed format and placement of
the trading cost disclosures.\13\ Finally, commenters were largely
supportive of our proposal to rescind certain exemptive orders that
have been granted to ETFs and their sponsors and to replace such relief
with rule 6c-11.\14\
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\9\ The comment letters on the 2018 ETF Proposing Release (File
No. S7-15-18) are available at https://www.sec.gov/comments/s7-15-18/s71518.htm.
\10\ See, e.g., Comment Letter of BNY Mellon (Sept. 27, 2018)
(``BNY Mellon Comment Letter'') (suggesting the rule should cover
all ETFs registered under the Investment Company Act); Comment
Letter of Dechert LLP (Sept. 28, 2018) (``Dechert Comment Letter'')
(suggesting that the Commission should provide ETFs with uniform
exemptive relief from certain provisions of the Securities Exchange
Act of 1934 (the ``Exchange Act'')).
\11\ See, e.g., Comment Letter of the Asset Management Group of
the Securities Industry and Financial Markets Association (Sept. 28,
2018) (``SIFMA AMG Comment Letter I'') (relating to the timing and
presentation of portfolio holdings and basket information); Comment
Letter of the Investment Company Institute (Sept. 21, 2018) (``ICI
Comment Letter'') (relating to custom baskets); Comment Letter of
Professor James G. Angel, Georgetown University (Oct. 1, 2018)
(``Angel Comment Letter'') (relating to intraday indicative values).
\12\ See, e.g., Comment Letter of Independent Directors Council
(Sept. 27, 2018) (``IDC Comment Letter''); Comment Letter of State
Street Global Advisors (Oct. 1, 2018) (``SSGA Comment Letter I'').
\13\ See e.g., Comment Letter of The Vanguard Group, Inc. (Sept.
28, 2018) (``Vanguard Comment Letter''); Comment Letter of
BlackRock, Inc. (Sept. 26, 2018) (``BlackRock Comment Letter''); IDC
Comment Letter; Comment Letter of Fidelity Investments (Sept. 28,
2018) (``Fidelity Comment Letter'').
\14\ See, e.g., Comment Letter of Federal Regulation of
Securities Committee, Business Law Section, American Bar Association
(Oct. 11, 2018) (``ABA Comment Letter''); ICI Comment Letter;
Comment Letter of Invesco Ltd. (Sept. 26, 2018) (``Invesco Comment
Letter''). Exemptive orders granted to ETFs and their sponsors often
include relief allowing funds to invest in other funds in excess of
statutory limits. We did not propose to rescind that relief. See
infra section II.G.
---------------------------------------------------------------------------

After consideration of the comments we received, we are adopting
rule 6c-11 and the proposed form amendments with several modifications
that are designed to reduce the operational challenges that commenters
identified, while maintaining protections for investors and providing
investors with useful information regarding ETFs. As proposed, we also
are rescinding the exemptive relief that we have issued to ETFs that
fall within the scope of rule 6c-11, while retaining the exemptive
relief granted to ETFs outside the scope of the rule. In addition, we
are retaining the exemptive relief allowing ETFs to enter into fund of
funds arrangements. We believe that the resulting regulatory framework
will level the playing field

[[Page 57164]]

for ETFs that are organized as open-end funds and pursue the same or
similar investment strategies.\15\ The rule also will assist the
Commission with regulating ETFs, as funds covered by the rule will no
longer be subject to the varying provisions of exemptive orders granted
over time. Furthermore, rule 6c-11 will allow Commission staff, as well
as funds and advisers seeking exemptions, to focus exemptive relief on
products that do not fall within the rule's scope.
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\15\ Additionally, as discussed below in section II.B, the
Commission is issuing an order granting an exemption from certain
provisions of the Exchange Act and the rules thereunder for certain
transactions in securities of ETFs that can rely on rule 6c-11. See
Order Granting a Conditional Exemption from Exchange Act Section
11(d)(1) and Exchange Act Rules 10b-10; 15c1-5; 15c1-6; and 14e-5
for Certain Exchange Traded Funds, Release No. 34-87110 (September
25, 2019) (``ETF Exchange Act Order'').
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The Commission will continue to monitor this large, diverse and
important market. We welcome continued engagement with ETF sponsors,
investors and other market participants on matters related to the ETF
market, including with regard to ETFs that do not fall within the scope
of rule 6c-11 and ETFs that may not function in a manner consistent
with the expectations embodied in our regulatory framework.

A. Overview of Exchange-Traded Funds

ETFs are a type of exchange-traded product (``ETP'').\16\ 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.\17\ Because ETFs 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 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).\18\ The
Commission also has approved the listing standards of national
securities exchanges under which ETF shares are listed and traded.\19\
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\16\ 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.
\17\ 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 rule 23c-3 under the Act.
Other closed-end funds may repurchase their shares in tender offers
pursuant to rule 13e-4 under the Exchange Act.
\18\ 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'').
\19\ 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); and 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)). See
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.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).
---------------------------------------------------------------------------

As discussed above, ETFs have become an increasingly popular
investment vehicle over the last 27 years, providing investors with a
diverse set of investment options.\20\ They also have become a popular
trading tool, making up a significant portion of secondary market
equities trading. During the first quarter of 2019, for example,
trading in U.S.-listed ETFs made up approximately 18.3% of U.S. equity
trading by share volume and 27.2% of U.S. equity trading by dollar
volume.\21\
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\20\ 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. 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
predetermined period of time. 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. Investors also have the ability to
invest in ETFs that do not track a particular index and are actively
managed. See 2018 ETF Proposing Release, supra footnote 7, at nn.18-
20.
\21\ These estimates are based on trade and quote data from the
New York Stock Exchange and Trade Reporting Facility data from
FINRA.
---------------------------------------------------------------------------

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.\22\ Because certain costs are either
absent in the ETF structure or are otherwise partially externalized,
many ETFs have lower operating expenses than mutual funds.\23\ 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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\22\ 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). ETF investors also
can sell ETF shares short, write options on them, and set market,
limit, and stop-loss orders on them.
\23\ 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.
---------------------------------------------------------------------------

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.'' \24\
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.\25\ Market makers, proprietary

[[Page 57165]]

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 gain exposure to a strategy or asset class.\26\
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\24\ As discussed below, rule 6c-11(a)(1) defines ``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.
\25\ See David J. Abner, The ETF Handbook: How to Value and
Trade Exchange Traded Funds, 2nd ed. (2016) (``ETF Handbook'').
\26\ 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.\27\ The basket is generally representative of the ETF's
portfolio,\28\ and together with a cash balancing amount, it is equal
in value to the aggregate net asset value (``NAV'') of the ETF shares
in the creation unit.\29\ 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.\30\ 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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\27\ 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'').
\28\ 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.4.c.
\29\ 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). 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'').
\30\ 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'').
---------------------------------------------------------------------------

The combination of the creation and redemption process with
secondary market trading in ETF shares and underlying securities
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.\31\ 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 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.\32\ 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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\31\ The arbitrage mechanism for ETFs that would be subject to
rule 6c-11 has been dependent on daily portfolio transparency.
\32\ 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 basket assets, 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.\33\
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\33\ 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 I''), 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.''); 2019 ICI Factbook, supra footnote 3
(``On average, 90 percent of the total daily activity in ETFs occurs
on the secondary market.'').
---------------------------------------------------------------------------

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.\34\ 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 or some types of ETFs more favorably than similar closed-end
funds.\35\ On the other hand, if the expectation of a close tie to NAV
per share is not met, investors may sell or refrain from purchasing ETF
shares.\36\
---------------------------------------------------------------------------

\34\ See 15 U.S.C. 80a-6(c).
\35\ 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, 2018, total net assets of ETFs were
$3.4 trillion compared to $250 billion for closed-end funds. See
2019 ICI Fact Book, supra footnote 3.
\36\ 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.
---------------------------------------------------------------------------

II. Discussion

Given the growth in the ETF market, ETFs' popularity among retail
and institutional investors, and our long experience regulating this
investment vehicle, we believe that it is appropriate to adopt a rule
that will allow most ETFs to operate without first obtaining

[[Page 57166]]

an exemptive order from the Commission under the Act. We believe, and
commenters on proposed rule 6c-11 generally agreed, that such a rule
will help create a consistent, transparent, and efficient regulatory
framework for the regulation of most ETFs and help level the playing
field for these market participants.\37\
---------------------------------------------------------------------------

\37\ See, e.g., BlackRock Comment Letter; IDC Comment Letter;
Fidelity Comment Letter; Angel Comment Letter; Comment Letter of
Nasdaq, Inc. (Sept. 28, 2018) (``Nasdaq Comment Letter'').
---------------------------------------------------------------------------

As adopted, rule 6c-11 will exempt ETFs organized as open-end funds
from certain provisions of the Act and our rules. The exemptions will
permit an ETF to: (i) Redeem shares only in creation unit aggregations;
(ii) permit ETF shares to be purchased and sold at market prices,
rather than NAV; (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.
These exemptions are subject to 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 conditions are based upon existing
exemptive relief for ETFs, which we believe has served to support an
efficient arbitrage mechanism, but reflect several modifications based
on our experience regulating this product and commenters' input on the
proposed rule.
First, rule 6c-11 will require an ETF to disclose
portfolio holdings each business day on its website before the opening
of trading on the ETF's primary listing exchange in a standardized
manner. The rule also will require daily website disclosure of the
ETF's NAV, market price, premium or discount, and the extent and
frequency of an ETF's premiums and discounts. These disclosures are
designed to promote an effective arbitrage mechanism and inform
investors about the risks of deviation between market price and NAV
when deciding whether to invest in ETFs generally or in a particular
ETF.
In addition, the rule will require daily website
disclosure of the ETF's median bid-ask spread over the last thirty
calendar days. This requirement is designed to provide investors with
additional information regarding potential costs associated with buying
and selling ETF shares.
With respect to baskets, the rule will require an ETF 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. The rule will allow ETFs to use ``custom
baskets'' if their basket policies and procedures: (i) Set forth
detailed parameters for the construction and acceptance of custom
baskets that are in the best interest 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. As discussed below, these
conditions will provide ETFs with additional basket flexibility, which
we believe could benefit investors through more efficient arbitrage and
narrower bid-ask spreads, subject to protections designed to address
the risks that such flexibility may present.
Rule 6c-11 also will include a condition that excludes an
ETF that seeks, directly or indirectly, to provide investment returns
over a predetermined period of time that: (i) Correspond to the
performance of a market index by a specified multiple; or (ii) have an
inverse relationship to the performance of a market index (including by
an inverse multiple) (``leveraged/inverse ETFs'').\38\
---------------------------------------------------------------------------

\38\ See infra section II.A.3.
---------------------------------------------------------------------------

An ETF also must retain certain records under rule 6c-11,
including information regarding each basket exchanged with an
authorized participant.
In order to harmonize the regulation of most ETFs, we are
rescinding, one year after the effective date of rule 6c-11, those
portions of our prior ETF exemptive orders that grant relief related to
the formation and operation of an ETF, including certain master-feeder
relief.\39\ We are not rescinding the exemptive relief of UIT ETFs,
leveraged/inverse ETFs, share class ETFs, and non-transparent ETFs,
however, which are outside the scope of rule 6c-11. In addition, we are
not rescinding the portions of our prior ETF exemptive orders allowing
funds to invest in ETFs in excess of statutory limits in connection
with this rulemaking and we are providing relief to allow newly formed
ETFs to enter into certain fund of funds arrangements.\40\
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\39\ See infra sections II.F. and II.G. We are also amending
approximately 200 ETF exemptive orders that automatically expire on
the effective date of a rule permitting the operation of ETFs to
give them time to make any adjustments necessary to rely on rule 6c-
11.
\40\ See infra section II.G. In December 2018, we proposed new
17 CFR 270.12d1-4 (rule 12d1-4 under the Act) to streamline and
enhance the regulatory framework applicable to fund of funds
arrangements. See Fund of Funds Arrangements, Investment Company Act
Release No. 33329 (Dec. 19, 2018) [84 FR 1286 (Feb. 1, 2019)]
(proposing release) (``FOF Proposing Release''). In connection with
proposed rule 12d1-4, we also proposed to rescind the exemptive
orders granting relief for certain fund of funds arrangements,
including the relief from sections 12(d)(1)(A) and (B) that has been
included in our ETF exemptive orders. See id. at nn.236-237 and
accompanying text.
---------------------------------------------------------------------------

Finally, we are adopting amendments to Forms N-1A and N-8B-2 to
eliminate certain disclosures that we believe are no longer necessary
and to require ETFs that do not rely on rule 6c-11 to provide secondary
market investors with disclosures regarding certain ETF trading and
associated costs. For example, the form amendments will require such an
ETF to provide median bid-ask spread information either on its website
or in its prospectus. We believe these amendments will provide
investors who purchase ETF shares in secondary market transactions with
information to better understand the total costs of investing in an
ETF.

A. Scope of Rule 6c-11

1. Organization as Open-End Funds
As proposed, rule 6c-11 will 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.\41\ ETFs organized as UITs (``UIT ETFs'') will
continue operating pursuant to their exemptive orders, which include
terms and conditions more appropriately tailored to address the unique
features of a UIT.\42\ Additionally, as proposed,

[[Page 57167]]

our form amendments will require UIT ETFs to provide disclosures
similar to those provided by other ETFs that are subject to the
Investment Company Act.
---------------------------------------------------------------------------

\41\ See rule 6c-11(a)(1). Under the rule, the term ``basket''
will 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 will
include ETFs that transact on an in-kind basis, on a cash basis, or
both.
\42\ 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. See section 4(2) of the Act [15 U.S.C. 80a-4].
By statute, a UIT is unmanaged and its portfolio is fixed.
Substitution of securities may take place only under certain pre-
defined circumstances. A UIT does not have a board of directors,
corporate officers, or an investment adviser to render advice during
the life of the trust. See 2018 ETF Proposing Release, supra
footnote 7, at section II.A.1.
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.
---------------------------------------------------------------------------

We understand that most ETF sponsors prefer the open-end fund
structure over the UIT structure given the increased investment
flexibility the open-end structure affords.\43\ For example, ETFs
organized as open-end funds can be actively managed or use a
``sampling'' strategy to track an index.\44\ An open-end ETF also may
participate in securities lending programs, has greater flexibility to
reinvest dividends, and may invest in derivatives, which typically
require a degree of management that is not provided for in the UIT
structure.\45\
---------------------------------------------------------------------------

\43\ 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. See 2018 ETF Proposing Release, supra footnote 7, at section
II.A.1.
\44\ UIT ETFs seek to track the performance of an index by
investing in the component securities of an index in the same
approximate proportions as in the index (i.e., ``replicating'' the
index) rather than acquiring a subset of the underlying index's
component securities or other financial instruments that the ETF's
adviser believes will help the ETF track the underlying index (i.e.,
``sampling'' the index). In addition, because the exemptive relief
granted to UIT ETFs does not provide relief from the portion of
section 4(2) that requires UIT securities to represent an undivided
interest in a unit of ``specified securities,'' the investment
strategies that a UIT ETF can pursue are limited. See id. at n.37.
\45\ 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.
---------------------------------------------------------------------------

Commenters addressing this aspect of the proposal generally
supported excluding UIT ETFs from the scope of rule 6c-11. These
commenters stated that the structural and operational nuances
associated with UIT ETFs would make their inclusion in rule 6c-11
impractical.\46\ These commenters also generally agreed that existing
UIT ETFs should continue to rely on their individual exemptive orders,
and that the Commission should review new UIT ETFs as part of the
exemptive order process. One commenter suggested, however, that the
Commission consider potential updates to UIT ETFs' exemptive orders to
account for certain sponsor services that were not contemplated at the
time the orders were granted.\47\
---------------------------------------------------------------------------

\46\ See, e.g., Invesco Comment Letter; SSGA Comment Letter I;
Comment Letter of CFA Institute (Nov. 15, 2018) (``CFA Institute
Comment Letter''); Comment Letter of Cboe Global Markets, Inc. (Oct.
1, 2018) (``Cboe Comment Letter'') (stating that the ``unique issue
set applicable to UITs as compared to non-UIT ETFs warrant the
disparate treatment between UITs and other ETFs.'').
\47\ Invesco Comment Letter (stating that these services include
chief compliance officer services and ongoing trading services). UIT
ETFs have obtained exemptive relief from section 26(a)(2)(C) of the
Act to allow the ETF to pay certain enumerated expenses. See 2018
ETF Proposing Release, supra footnote 7, at n.52 and accompanying
text.
---------------------------------------------------------------------------

After considering comments, we continue to believe that rule 6c-11
should apply only to ETFs organized as open-end funds, while UIT ETFs
should continue to rely on their existing exemptive orders.\48\ We
acknowledge that excluding UIT ETFs will result in a segment of ETF
assets outside the regulatory framework of rule 6c-11. However, we do
not believe there is a need to include UIT ETFs within the scope of the
rule given the limited sponsor interest in developing ETFs organized as
UITs.
---------------------------------------------------------------------------

\48\ The vast majority of ETFs currently in operation are
organized as open-end funds, though the earliest ETFs were organized
as UIT ETFs, and these early UIT ETFs represent a significant
portion of the assets within the ETF industry. As of Dec. 31, 2018,
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).
---------------------------------------------------------------------------

In addition, even if we were to include UIT ETFs within the scope
of the rule, the unique structural and operational aspects of UIT ETFs
noted by commenters would necessitate a regulatory framework that
differs from the structure we are adopting for open-end ETFs. We
believe that the unmanaged nature of the UIT structure, in particular,
would require conditions that differ from the conditions applicable to
open-end ETFs. For example, rule 6c-11 will 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 such conditions
require ongoing management and board oversight, we do not believe that
extending such basket flexibility to UIT ETFs would be appropriate.\50\
The relief granted to UIT ETFs also includes relief from sections of
the Act that govern key aspects of a UIT's operations, which differ
from the relief we are providing under rule 6c-11.\51\ In short, we
believe including UIT ETFs within the scope of rule 6c-11 would
complicate the rule significantly and would continue to result in a
regulatory framework where the relief and conditions applicable to UIT
ETFs and open-end ETFs differ.
---------------------------------------------------------------------------

\49\ See infra section II.C.4.c.
\50\ See 2018 ETF Proposing Release, supra footnote 7, at nn.46-
48 and accompanying text.
\51\ 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'').
---------------------------------------------------------------------------

To the extent that ETF sponsors develop 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 also believe that the Commission's exemptive process
is well-suited to handle requests to modify existing UIT ETF exemptive
relief.
Consistent with the proposal, we are not rescinding existing
exemptive orders that allow UIT ETFs to operate. Two commenters
addressing the exclusion of UIT ETFs from the rule urged the Commission
to clarify that UIT ETFs operating pursuant to their exemptive orders
can nevertheless continue marketing themselves as ``ETFs.'' \52\ As
discussed below, the Commission is not limiting use of the term ``ETF''
or ``exchange-traded fund'' to funds relying on rule 6c-11. UIT ETFs
therefore may continue to use these terms in their marketing materials
and otherwise hold themselves out as ``ETFs.'' Further, while UIT ETFs
are excluded from the scope of rule 6c-11, we are adopting amendments
to Form N-8B-2 that will require them to provide certain additional
disclosures regarding ETF trading costs.\53\
---------------------------------------------------------------------------

\52\ See SSGA Comment Letter I; SIFMA AMG Comment Letter I.
\53\ See Form N-8B-2 disclosure requirements infra section II.I.
---------------------------------------------------------------------------

2. Index-Based ETFs and Actively Managed ETFs
Consistent with the proposal, rule 6c-11 will provide exemptions
for both index-based ETFs and actively managed ETFs, but will 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. Index-based and actively managed ETFs that comply with the
rule's conditions function similarly with respect to operational
matters, despite different investment objectives or strategies. 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.

[[Page 57168]]

The Commission did not approve the first actively managed ETF until
nearly 15 years after index-based ETFs were introduced.\54\ Since 2008,
however, the actively managed ETF market has grown considerably.\55\
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.
---------------------------------------------------------------------------

\54\ See 2018 ETF Proposing Release, supra footnote 7, at n.58.
Approximately 100 exemptive orders have been issued since 2008 for
actively managed, transparent ETFs.
\55\ Based on data obtained from MIDAS, Bloomberg and
Morningstar Direct as of December 31, 2018, we estimate that there
are now over 270 actively managed ETFs with approximately $72
billion in assets.
---------------------------------------------------------------------------

Commenters that addressed this aspect of the proposal supported the
rule's elimination of the historical distinction between index-based
and actively managed ETFs.\56\ Specifically, commenters agreed that
ETFs operate similarly irrespective of whether they are index-based or
actively managed, and stated that there are no operational issues that
warrant additional conditions for actively managed ETFs.\57\ In
addition, one commenter stated that, in its experience, deviations
between market price and NAV per share are more variable across asset
classes underlying ETFs than between index-based and actively managed
ETFs investing in the same asset class.\58\
---------------------------------------------------------------------------

\56\ See, e.g., ICI Comment Letter; Invesco Comment Letter;
Comment Letter of the Index Industry Association (Sept. 30, 2018);
Comment Letter of the Fixed Income Market Structure Advisory
Committee (Oct. 29, 2018) (``FIMSAC Comment Letter''); Comment
Letter of NYSE Arca, Inc. (Oct. 10, 2018) (``NYSE Arca Comment
Letter''); CFA Institute Comment Letter; Comment Letter of J.P.
Morgan Asset Management (Oct. 1, 2018) (``JPMAM Comment Letter'').
\57\ See, e.g., NYSE Arca Comment Letter; Comment Letter of
WisdomTree Asset Management, Inc. (Oct. 1, 2018) (``WisdomTree
Comment Letter''). As discussed in section II.C.4. infra, however,
some commenters opposed, or suggested alternatives to, full
portfolio transparency for actively managed ETFs.
We also received 43 comment letters requesting that the
Commission approve an ETP with an investment objective that seeks
results that correspond to the performance of bitcoins or other
digital assets. See, e.g., Comment Letter of Charles Brown (July 12,
2018); Comment Letter of Lars Hoffman (July 14, 2018). Rule 6c-11,
however, is based on existing relief for ETFs relating to the
formation and operation of ETFs under the Investment Company Act and
does not relate to specific strategies. See Letter from Dalia Blass,
Director of Investment Management, to Paul Schott Stevens, President
and CEO, Investment Company Institute and Timothy W. Cameron, Asset
Management Group--Head, Securities Industry and Financial Markets
Association (Jan. 18, 2018), available at https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm (noting
that in the staff's view ETFs and other funds that hold substantial
amounts of cryptocurrencies and related products raise significant
questions regarding how they would satisfy certain other
requirements of the Investment Company Act and its rules). The
Commission continues to welcome engagement with the public on issues
related to cryptocurrency ETPs.
\58\ See JPMAM Comment Letter (``[O]ur active ETFs trade with
similar, and at times lower, deviations than our index ETFs; all of
them typically trade within 50 basis points of their NAVs.'').
---------------------------------------------------------------------------

We continue to believe that index-based and actively managed ETFs
do not present significantly different concerns under the provisions of
the Act from which the rule grants relief because they function
similarly with respect to operational matters. As noted below, the
arbitrage mechanism for existing actively managed ETFs has worked
effectively with small deviations between market price and NAV per
share.\59\ Permitting index-based and actively managed open-end ETFs to
operate under the rule subject to the same conditions also will provide
a level playing field among those market participants.
---------------------------------------------------------------------------

\59\ See supra section II.B.2.
---------------------------------------------------------------------------

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 proliferation of highly customized, often
methodologically complicated indexes. Commenters agreed that the
proliferation of these indexes has blurred the distinction between
index-based and actively managed ETFs, while ETF industry practices in
areas such as portfolio transparency generally do not vary between
these types of funds.\60\ We therefore believe that eliminating the
regulatory distinction between index-based ETFs and actively managed
ETFs for purposes of exemptive relief under the Act will help to
provide a more consistent and transparent regulatory framework for ETFs
organized as open-end funds. This approach is consistent with our
regulation of other types of open-end funds, which does not distinguish
between actively managed and index-based strategies.
---------------------------------------------------------------------------

\60\ See FIMSAC Comment Letter (``[I]ndustry participants note
that distinctions between active and passive products . . . are
increasingly blurred with the advent of `smart beta' or factor
products, or of index products with active elements . . . .); JPMAM
Comment Letter (``[A]s the proposal notes, practices around
portfolio transparency have converged across index-based and
actively managed ETFs.'').
---------------------------------------------------------------------------

In addition, consistent with our proposal, rule 6c-11 does not
include additional conditions relating to index-based ETFs with
affiliated index providers (``self-indexed ETFs''). Commenters
generally agreed with the proposal's approach to self-indexed ETFs,
indicating that existing securities laws adequately address any special
concerns presented by these ETFs.\61\ One commenter, however, noted
that the concerns that were expressed by the Commission when it granted
individualized exemptive relief for self-indexed ETFs remain
important.\62\ This commenter stated that the Commission should permit
self-indexed ETFs only ``on the condition that [an information]
firewall between the index provider and the asset manager exists.''
\63\
---------------------------------------------------------------------------

\61\ See Invesco Comment Letter; BlackRock Comment Letter; IIA
Comment Letter; JPMAM Comment Letter; SSGA Comment Letter
(``[C]urrent regulatory requirements . . . effectively require a
heightened set of requirements associated with affiliated index
providers . . .''); WisdomTree Comment Letter (``Advisers are
already required to adopt policies designed to prevent portfolio
information from being misappropriated.'').
\62\ See Morningstar Comment Letter. See also 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
(``Guggenheim Funds'') (discussing concerns regarding the ability of
an affiliated index provider to manipulate an underlying index to
the benefit or detriment of a self-indexed ETF and the potential for
conflicts that may arise with respect to the personal trading
activity of an affiliated index provider's personnel). Guggenheim
Funds permitted a self-indexed ETF to address these concerns through
full portfolio transparency, instead of certain policies and
procedures that had been required in earlier exemptive orders for
self-indexed ETFs. But 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.
\63\ See Morningstar Comment Letter.
---------------------------------------------------------------------------

We agree with the commenters who stated that the existing federal
securities laws adequately address any special concerns that self-
indexed ETFs present, including the potential ability of an affiliated
index provider to manipulate an underlying index to the benefit or
detriment of a self-indexed ETF.\64\ For

[[Page 57169]]

example, ETF sponsors are likely to be in a position to understand the
potential circumstances and relationships that could give rise to the
misuse of non-public information, and can develop appropriate measures
to address them. Therefore, we continue to believe that portfolio
transparency combined with existing requirements should be sufficient
to protect against the abuses addressed in exemptive applications of
ETF sponsors that either use affiliated index providers or create their
own indexes.\65\
---------------------------------------------------------------------------

\64\ See 17 CFR 270.38a-1 (rule 38a-1 under the Act) (requiring
funds to adopt policies and procedures reasonably designed to
prevent violation of federal securities laws); 17 CFR 270.17j-
1(c)(1) (rule 17j-1(c)(1) under the Investment Company Act)
(requiring funds to adopt a code of ethics containing provisions
designed to prevent certain fund personnel (``access persons'') from
misusing information regarding fund transactions); section 204A of
the Investment Advisers Act of 1940 (``Advisers Act'') (15 U.S.C.
80b-204A) (requiring an adviser to adopt policies and procedures
that are reasonably designed, taking into account the nature of its
business, to prevent the misuse of material, non-public information
by the adviser or any associated person, in violation of the
Advisers Act or the Exchange Act, or the rules or regulations
thereunder); section 15(g) of the Exchange Act (15 U.S.C. 78o(f))
(requiring a registered broker or dealer to adopt policies and
procedures reasonably designed, taking into account the nature of
the broker's or dealer's business, to prevent the misuse of
material, nonpublic information by the broker or dealer or any
person associated with the broker or dealer, in violation of the
Exchange Act or the rules or regulations thereunder).
Cf., e.g., Rule Commentary .02(b)(i) of NYSE American Rule 1000A
(requiring a ``fire wall'' between an ETF and an affiliated index
provider).
\65\ See infra section II.C.4. (discussing requirements in rule
6c-11 regarding portfolio transparency).
---------------------------------------------------------------------------

3. Leveraged/Inverse ETFs
As proposed, rule 6c-11 includes a condition that excludes
leveraged/inverse ETFs.\66\ These ETFs may not rely on the rule, and
will instead continue to operate pursuant to their exemptive
orders.\67\ Broadly speaking, leveraged/inverse ETFs seek to amplify
the returns of an underlying index by a specified multiple or to profit
from a decline in the value of an underlying index over a predetermined
period of time using financial derivatives. Leveraged/inverse ETFs also
rebalance their portfolios on a daily or other periodic basis in order
to maintain a constant leverage ratio.\68\ These funds' use of leverage
together with this periodic rebalancing (or ``reset''), and the
resulting effects of compounding, can result in performance that
differs significantly from some investors' expectations of how index
investing generally works.
---------------------------------------------------------------------------

\66\ See rule 6c-11(c)(4).
\67\ As of December 2018, 167 ETFs employed leveraged or inverse
investment strategies. These ETFs had total net assets of $29.64
billion or approximately 1% of all ETF assets.
\68\ See 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 II'')
(providing a description of maintaining a stated ratio to an
underlying index as a daily investment objective).
---------------------------------------------------------------------------

For example, as a result of compounding, a leveraged/inverse ETF
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.\69\ Investors holding shares over periods longer than the time
period targeted by the ETF's investment objective may experience
performance that is different, and at times substantially different,
from the returns of the targeted index over the same investment period.
Buy-and-hold investors with an intermediate or long-term time horizon
that invest in a leveraged/inverse ETF--who may not evaluate their
portfolios frequently--may experience large and unexpected losses or
otherwise experience returns that are different from what they
anticipated.\70\ As a result, leveraged/inverse ETFs are complex
products that serve a markedly different investment purpose than most
other ETFs.\71\
---------------------------------------------------------------------------

\69\ 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'').
\70\ See FINRA Regulatory Notice 09-31, supra footnote 69
(reminding member firms of their sales practice obligations relating
to leveraged/inverse ETFs and noting that leveraged/inverse ETFs are
typically not suitable for retail investors who plan to hold these
products for more than one trading session).
\71\ See Commission Interpretation Regarding Standard of Conduct
for Investment Advisers, Investment Advisers Act Release No. 5248
(June 5, 2019) [84 FR 33669 (July 12, 2019)] at n.39 and
accompanying text (``[I]nverse or leveraged exchange-traded products
that are designed primarily as short-term trading tools for
sophisticated investors may not be in the best interest of a retail
client absent an identified, short-term, client-specific trading
objective and, to the extent that such products are in the best
interest of a retail client initially, they would require daily
monitoring by the adviser''). See also Regulation Best Interest,
Exchange Act Release No. 86031 (June 5, 2019) [84 FR 33318 (July 12,
2019)] at text accompanying n.596 (stating that broker-dealers
recommending leveraged or inverse exchange-traded products with a
daily reset should understand that such products may not be suitable
for, and as a consequence also not in the best interest of, retail
customers who plan to hold them for longer than one trading session,
particularly in volatile markets); Order Granting Approval of a
Proposed Rule Change, as Modified by Amendment No. 2, to Amend
Nasdaq Rules 5705 and 5710 to Adopt a Disclosure Requirement for
Certain Securities, Exchange Act Release No. 85362 (Mar. 19, 2019)
[84 FR 11148 (Mar. 25, 2019)] (adopting certain disclosure
requirements for leveraged/inverse ETFs).
---------------------------------------------------------------------------

Leveraged/inverse ETFs' use of derivatives also raises issues under
section 18 of the Act, which limits a fund's ability to obtain
leverage.\72\ The Commission has been evaluating these section 18
issues as part of a broader consideration of derivatives use by
registered funds and business development companies (``BDCs'').\73\ We
therefore proposed to exclude leveraged/inverse ETFs from the scope of
rule 6c-11 so that the Commission could consider these concerns in a
comprehensive manner with other funds that use leverage.\74\ We also
proposed to allow leveraged/inverse ETFs and their sponsors to continue
to rely on their existing exemptive relief in order to preserve the
status quo.\75\
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\72\ 15 U.S.C. 80a-18.
\73\ See Derivatives Proposing Release, supra footnote 45
(proposing new rule 18f-4 under the Act, which 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' (including
leveraged/inverse ETFs') use of derivatives transactions).
\74\ Proposed rule 6c-11 would have provided that an ETF relying
on the rule ``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.''
See proposed rule 6c-11(c)(4).
\75\ The staff has not supported new exemptive relief for
leveraged/inverse ETFs since 2009. The orders issued to current
leveraged/inverse ETF sponsors, as amended over time, relate to
leveraged/inverse ETFs that seek daily 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 (``Rafferty
I''). 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 II,
supra footnote 68.
---------------------------------------------------------------------------

Most commenters who addressed this aspect of the proposal agreed
that leveraged/inverse ETFs present issues and concerns that should be
addressed outside the context of rule 6c-11.\76\ One such commenter
stated that leveraged/inverse ETFs present ``highly specific and
accentuated risks'' and stated that the Commission should regulate
these products under tailored exemptive orders.\77\ Other commenters
urged the Commission to consider additional investor protection
requirements for leveraged/inverse ETFs, such as requiring marketing
materials to notify retail investors about the risks of investing in
these instruments or other enhanced disclosure requirements.\78\ Some
commenters stated that the Commission should not permit

[[Page 57170]]

leveraged/inverse ETFs to use the terms ``ETF'' or ``exchange-traded
fund'' in their names, because investors might mistakenly assume that
all products referred to as ETFs are structured and regulated like
``traditional'' ETFs.\79\
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\76\ See BlackRock Comment Letter; Invesco Comment Letter; SSGA
Comment Letter I; Comment Letter of ICE Data Services (Oct. 1, 2018)
(``IDS Comment Letter''); FIMSAC Comment Letter; CFA Institute
Comment Letter; see also Cboe Comment Letter (indicating that these
ETFs should be ``treated differently'' but not specifically stating
whether such ETFs should be excluded from the scope of the rule).
\77\ See Invesco Comment Letter.
\78\ See CFA Institute Comment Letter; Nasdaq Comment Letter
(stating that there is significant investor confusion regarding
existing leveraged/inverse ETFs' daily investment horizon). See also
Comment Letter of Rafferty Asset Management, LLC (Oct. 1, 2018)
(``Direxion Comment Letter'') (supporting enhanced disclosure
requirements for leveraged/inverse ETFs if reliance on rule 6c-11 is
allowed for the operation of leveraged/inverse ETFs).
\79\ See BlackRock Comment Letter; FIMSAC Comment Letter.
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Other commenters were less specific as to whether the Commission
should regulate leveraged/inverse ETFs under exemptive orders or
through a separate rule, but stated that leveraged/inverse ETFs should
be regulated by means other than rule 6c-11.\80\ One commenter agreed
that leveraged/inverse ETFs ``raise important disclosure and investor
protection issues,'' but strongly encouraged the Commission to
``initiate proceedings, whether as part of its consideration of
derivative usage or otherwise, to determine what its future approach''
to leveraged/inverse ETFs will be.\81\
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\80\ See SSGA Comment Letter I (``Leveraged ETFs . . . present
issues which are appropriately addressed through means other than
the Proposed ETF Rule.''); IDS Comment Letter (``IDS believes that
leveraged and inverse ETFs strategies carry significantly different
risk profiles than index-based ETFs. For that reason we agree that
they should be excluded from the scope of funds that may rely on the
proposed rule.'').
\81\ Comment Letter of the Mutual Fund Directors Forum (Oct. 1,
2018) (``MFDF Comment Letter'').
---------------------------------------------------------------------------

Sponsors of leveraged/inverse ETFs, however, advocated that the
rule should not exclude leveraged/inverse ETFs. They asserted that
leveraged/inverse ETF investors understand the special concerns related
to these products, accept the products' risks, and utilize the products
appropriately.\82\ One of these commenters stated that the rule's
exemptive relief targets ETFs' structural and operational
characteristics, and that leveraged/inverse ETFs are structured and
operated in the same manner as other ETFs within the rule's scope.\83\
Among other similarities, the commenter noted that leveraged/inverse
ETFs are structured as open-end funds, provide full portfolio
transparency, and accept creation and redemption baskets using the same
operating mechanisms as other ETFs. The commenter also opined that
leveraged/inverse ETFs should not be excluded from the scope of the
rule because other ETFs that utilize leverage in their investment
strategies are not excluded from the scope of the rule.
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\82\ See Direxion Comment Letter (``Given [certain data findings
and educational efforts by regulators, brokerage firms, and the ETFs
themselves] we believe it would be hard for investors not to
understand that our leveraged ETFs are complex products that are
`different' from other ETFs, and we have not seen any recent
empirical data or other evidence to the contrary.''); Comment Letter
of ProShare Advisors LLC (Oct. 1, 2018) (``ProShares Comment
Letter'').
\83\ See ProShares Comment Letter.
---------------------------------------------------------------------------

Another commenter did not object to excluding leveraged/inverse
ETFs from rule 6c-11, but opined that the proposed rule's condition
excluding leveraged/inverse ETFs was overly broad, potentially
capturing ETFs that have an inverse relationship to the performance of
a market index or ETFs that use other hedging strategies to reduce
risk.\84\ This commenter also asked the Commission to confirm that the
exclusion would not, in effect, apply to every ETF that seeks to track
an index that includes derivatives. Additionally, several commenters
did not specifically address leveraged/inverse ETFs, but generally
stated that rule 6c-11 should apply across all ETFs registered under
the Investment Company Act to create an even playing field.\85\
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\84\ See Cboe Comment Letter (stating that the exclusion should
cover only those inverse ETFs that seek to provide returns that
exceed the performance of a market index by a ``specified inverse
multiple'').
\85\ See, e.g., BNY Mellon Comment Letter.
---------------------------------------------------------------------------

After considering these comments, we have determined to include a
condition that prevents leveraged/inverse ETFs from relying on the
rule.\86\ Although leveraged/inverse ETFs are structurally and
operationally similar to other types of ETFs within the scope of rule
6c-11, we believe it is premature to permit sponsors to form and
operate leveraged/inverse ETFs in reliance on the rule without first
addressing the investor protection purposes and concerns underlying
section 18 of the Act. We therefore believe that the Commission should
complete its broader consideration of the use of derivatives by
registered funds before considering allowing leveraged/inverse ETFs to
rely on the rule.
---------------------------------------------------------------------------

\86\ See Rule 6c-11(c)(4).
---------------------------------------------------------------------------

Given that rule 6c-11 is intended to help create a consistent
regulatory framework for ETFs and a level playing field among ETF
sponsors, we acknowledge that excluding leveraged/inverse ETFs from the
rule's scope and permitting existing leveraged/inverse ETFs to continue
to operate pursuant to their exemptive orders at this time delays, in
part, achieving those goals. However, because leveraged/inverse ETFs
raise policy considerations that are different from those we seek to
address in the rule, we believe rule 6c-11 should exclude leveraged/
inverse ETFs.
As adopted, rule 6c-11 will exclude ETFs that seek to provide
leveraged or inverse investment returns over a predetermined period of
time. The periodic reset that such strategies necessitate distinguish
leveraged/inverse ETFs from other types of ETFs that may use leverage.
In the proposal we did not specify the period of time over which an ETF
had to seek to deliver a leveraged or inverse return of an index to be
covered by the proposed rule's leveraged/inverse ETF exclusion, and we
similarly decline to specify a period of time here.\87\ However, the
condition relating to leveraged/inverse ETFs continues to include a
temporal element (i.e., ``over a predetermined period of time'') in
order to specifically capture ETFs that seek to deliver the leveraged
or inverse return of a market index over a set period of time, daily or
otherwise.\88\
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\87\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.A.3.
\88\ See rule 6c-11(c)(4). The current exemptive orders that
allow leveraged/inverse ETFs contemplate a daily reset, because the
orders relate to ETFs that pursue daily investment objectives. See
2018 ETF Proposing Release, supra footnote 7 at n.77 and related
discussion. Proposed rule 6c-11 used the term ``fixed period of
time'' to prevent both these ETFs and leveraged/inverse ETFs
contemplating non-daily resets (e.g., weekly or monthly resets) from
relying on the rule. See proposed rule 6c-11(c)(4). Rule 6c-11 as
adopted uses the term ``predetermined period of time'' to clarify
that leveraged/inverse ETFs contemplating predetermined but variable
resets (e.g., leveraged/inverse ETFs that contemplate a range of
daily-to-weekly resets) are similarly prohibited from relying on the
rule.
---------------------------------------------------------------------------

In addition, while the rule uses the term ``multiple,'' leveraged/
inverse ETFs with strategies that seek directionally leveraged or
inverse returns of an index present the investor protection concerns
discussed above regardless of whether the amplification factor or
inverse factor is evenly divisible by 100 (e.g., a fund that seeks to
provide a daily investment return equal to 150% of the performance of
an index). Thus, to clarify the rule's use of the term ``multiple,''
leveraged/inverse ETFs are excluded from the scope of the rule
regardless of whether the returns they seek over a predetermined time
period are evenly divisible by 100.\89\ The exclusion also includes
strategies that pursue a specified range of a multiple or inverse
multiple of an index's performance (e.g., 200% to 300% of an index's
performance or -200% to -300% of an index's performance). This approach
is consistent with our existing exemptive orders and will capture those
ETFs that have historically been considered ``leveraged/inverse ETFs''
in the marketplace.
---------------------------------------------------------------------------

\89\ Additionally, though a strict mathematical interpretation
of the term ``multiple'' may include a multiple of 100%, an ETF that
simply seeks to track the performance of an index is not considered
``leveraged'' for these purposes and may rely on the rule. But see
infra footnotes 90-91 and accompanying text.

---------------------------------------------------------------------------

[[Page 57171]]

We also continue to believe that it is important to specify that an
ETF relying on the rule may not indirectly seek to provide investment
returns that correspond to 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 predetermined
period of time in order to prevent a fund from circumventing this
condition, such as by embedding leverage in the underlying index.\90\
For example, an ETF could not circumvent the rule's conditions and rely
on the rule to track an index if the index itself tracks 300% or -100%
of the performance of the S&P 500.\91\ In response to commenter
concerns discussed above, however, this does not mean that the
exclusion would apply to every ETF that tracks an index with
constituents that are derivatives.\92\ Whether a particular index is
``leveraged'' would depend on the economic characteristics of the
index's constituents, and not just on whether some or all of the
constituents are derivatives.
---------------------------------------------------------------------------

\90\ Rule 6c-11(c)(4) (emphasis added). See also 2018 ETF
Proposing Release, supra footnote 7, at text following n.82.
\91\ The exemptive orders that we have issued to sponsors of
leveraged/inverse ETFs do not provide relief to ETFs described as
seeking investment returns that correspond to the performance of a
leveraged or inverse leveraged market index over a predetermined
period of time. See supra footnote 75.
\92\ See supra footnote 84 and following text.
---------------------------------------------------------------------------

Finally, we are not adopting enhanced website or other disclosure
requirements for leveraged/inverse ETFs at this time as some commenters
had recommended. We believe all registered funds that pursue leveraged
or inverse strategies raise similar disclosure issues. We therefore
believe that the Commission should address any such potential
disclosure issues separately for all leveraged/inverse registered
funds.

B. Exemptive Relief Under Rule 6c-11

Rule 6c-11 will provide ETFs that fall within the scope of the rule
exemptive relief from certain provisions of the Act that are necessary
to allow ETFs to operate. These exemptions are consistent with the
relief we have given to ETFs under our exemptive orders.\93\ As
discussed below in section II.C., the exemptions will be subject to
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.\94\
---------------------------------------------------------------------------

\93\ See 2018 ETF Proposing Release, supra footnote 7, at n.88
and related discussion. 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. See infra section II.F. (discussing
our treatment of master-feeder relief) and section II.G. (discussing
our treatment of other relief for fund investments in ETFs).
\94\ See 15 U.S.C. 80a-6(c).
---------------------------------------------------------------------------

1. Treatment of ETF Shares as ``Redeemable Securities''
Consistent with our proposal, ETFs relying on rule 6c-11 will be
considered to issue a ``redeemable security'' within the meaning of
section 2(a)(32) of the Act.\95\ 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, they can be redeemed in creation unit aggregations.\96\
Therefore, we believe that ETF shares are most appropriately classified
under the final rule as redeemable securities within the meaning of
section 2(a)(32), and that ETFs should be regulated as open-end funds
within the meaning of section 5(a)(1) of the Act.\97\
---------------------------------------------------------------------------

\95\ Rule 6c-11(b)(1).
\96\ See rule 6c-11(a)(1) (defining an exchange-traded fund, in
part, as a registered open-end management company that issues and
redeems its shares in creation units). The rule defines ``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 rule 6c-11(a)(1). See also infra section II.C.1.
(discussing circumstances where ETF shares can be individually
redeemed).
\97\ 15 U.S.C. 80a-2(a)(32) (defining ``redeemable security'');
15 U.S.C. 80a-5(a)(1) (defining ``open-end company'' as ``a
management company which is offering for sale or has outstanding any
redeemable security of which it is the issuer''). If ETF shares were
not classified as redeemable securities within the meaning of
section 2(a)(32) of the Act, an ETF that is a management company (as
defined under the Act) 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).
---------------------------------------------------------------------------

Unlike our exemptive orders, which have provided exemptions from
the definitions of ``redeemable security'' in section 2(a)(32) and
``open-end company'' in section 5(a)(1), rule 6c-11 will not provide
exemptions from these definitions. Instead, we believe that it is more
appropriate for the rule to address these questions of status by
classifying ETF shares as ``redeemable securities.'' Thus, any ETF that
relies on the rule's conditions and requirements will be subject to
requirements imposed under the Act and our rules that apply to open-end
funds.\98\
---------------------------------------------------------------------------

\98\ See, e.g., 15 U.S.C. 80a-22; 17 CFR 270.22c-1. ETFs that
are management companies and operate in reliance on rule 6c-11 and
those that operate in reliance on an exemptive order would equally
be subject to the Act and our rules as open-end funds.
---------------------------------------------------------------------------

In addition, the rules under the Exchange Act that apply to
transactions in redeemable securities issued by an open-end fund will
apply to ETFs relying on rule 6c-11.\99\ Shares issued by ETFs relying
on rule 6c-11 therefore are eligible for 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 in connection with secondary market
transactions in ETF shares and the creation or redemption of creation
units. ETFs relying on rule 6c-11 similarly will qualify for the
``registered open-end investment company'' exemption in rule 11d1-2
under the Exchange Act.
---------------------------------------------------------------------------

\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)] (shortening the standard
settlement cycle for most broker-dealer securities transactions to
two business days).
---------------------------------------------------------------------------

Many commenters supported our proposed classification of ETF shares
as ``redeemable securities.'' \100\ Commenters also supported our view
that the arbitrage mechanism that is central to the operation of an ETF
(and the conditions in the final rule 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.\101\ As a result, even
though only authorized participants may redeem creation units at NAV
per share, commenters agreed that 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 at NAV per share.\102\
---------------------------------------------------------------------------

\100\ See, e.g., ICI Comment Letter; Fidelity Comment Letter;
Comment Letter of the Asset Management Group of the Securities
Industry and Financial Markets Association (Feb. 22, 2019) (``SIFMA
AMG Comment Letter II''); Vanguard Comment Letter; SSGA Comment
Letter; Comment Letter of Virtu Financial, Inc. (Oct. 3, 2018)
(Virtu Comment Letter''); Comment Letter of Eaton Vance Corp. (Oct.
4, 2018) (``Eaton Vance Comment Letter''); ABA Comment Letter.
\101\ See, e.g., ICI Comment Letter. See also 2018 ETF Proposing
Release, supra footnote 7, at n.95 and related discussion.
\102\ See, e.g., ICI Comment Letter; Virtu Comment Letter.
---------------------------------------------------------------------------

Commenters also supported the resulting eligibility for the
redeemable securities exceptions and the registered open-end investment
company exemption under the Exchange Act

[[Page 57172]]

rules discussed above.\103\ Commenters stated that such treatment would
reduce regulatory complexity and eliminate potential inconsistencies
between rule 6c-11 and this Exchange Act relief.\104\ Several
commenters recommended extending the ``redeemable security''
classification to ETFs that are not eligible to rely on rule 6c-11,
such as UIT ETFs or share class ETFs, to make them similarly eligible
for the exceptions under the Exchange Act that apply to redeemable
securities issued by an open-end fund.\105\
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\103\ See, e.g., Dechert Comment Letter; BlackRock Comment
Letter; Invesco Comment Letter I; ABA Letter.
\104\ See, e.g., Vanguard Comment Letter; Dechert Comment
Letter; WisdomTree Comment Letter; ABA Comment Letter; SIFMA AMG
Comment Letter I.
\105\ See ICI Comment Letter; Dechert Comment Letter; SIFMA AMG
Comment Letter I; Vanguard Comment Letter; SSGA Comment Letter I;
ABA Comment Letter; BlackRock Comment Letter.
---------------------------------------------------------------------------

After considering comments, we are clarifying that we view
securities of all ETFs, including those that do not rely on rule 6c-11,
as eligible for 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
in connection with secondary market transactions in ETF shares and the
creation or redemption of creation units and the exemption in rule
11d1-2 under the Exchange Act for securities issued by a registered
open-end investment company or unit investment trust. We believe that
securities issued by ETFs that are exempt from the definitions of
``redeemable security'' in section 2(a)(32) and ``open-end company'' in
section 5(a)(1) of the Investment Company Act pursuant to their orders
do not raise different concerns with respect to these Exchange Act
provisions than those issued by ETFs relying on rule 6c-11.
Several commenters recommended further harmonization between rule
6c-11 and certain other Exchange Act relief that ETFs must currently
seek in order to operate.\106\ Commenters expressed concern that this
Exchange Act relief is duplicative or, in some cases, inconsistent with
other requirements applicable to ETFs.\107\ In particular, commenters
noted that rule 6c-11 as proposed would not address relief for ETFs
from section 11(d)(l) of the Exchange Act as well as rules 10b-10,
15c1-5, 15c1-6, and 14e-5 thereunder.\108\ Commenters also recommended
that the ETF generic listing standards of national securities exchanges
be broadened and harmonized with any final ETF rule.\109\
---------------------------------------------------------------------------

\106\ See, e.g., BlackRock Comment Letter; ICI Comment Letter;
Fidelity Comment Letter; SIFMA AMG Comment Letter I; Comment Letter
of John Hancock Investments (Oct. 1, 2018) (``John Hancock Comment
Letter''); Comment Letter of Flow Traders US LLP (Oct. 1, 2018)
(``Flow Traders Comment Letter'').
\107\ See, e.g., BlackRock Comment Letter. See also, e.g., ICI
Comment Letter (``Currently, ETFs often must satisfy multiple and
sometimes conflicting requirements from different divisions within
the SEC.''). Commenters also expressed concerns about the
administrative delay in obtaining these additional approvals. See,
e.g., SIFMA AMG Comment Letter I.
\108\ See, e.g., Dechert Comment Letter; see also 2015 ETP
Request for Comment, supra footnote 19.
\109\ See, e.g., Cboe Comment Letter (``Cboe encourages the
Commission to evaluate exchange proposals to broaden their generic
listing standards . . . in order to achieve efficiencies with
exchange listing processes in a manner very similar to those which
[rule 6c-11] is designed to accomplish.''). See also, e.g., ABA
Comment Letter, Nasdaq Comment Letter.
---------------------------------------------------------------------------

We agree that complementary exemptive relief under the Exchange Act
could further reduce regulatory complexity, administrative delay, and
eliminate potential inconsistencies between rule 6c-11 and the related
Exchange Act relief that ETFs must obtain to operate. Accordingly, the
Commission is issuing an order granting exemptive relief to ETFs
operating in reliance on rule 6c-11 from the requirements of section
11(d)(1) of the Exchange Act and rules 10b-10, 15c1-5, 15c1-6, and 14e-
5 under the Exchange Act for ETFs, where certain conditions are
met.\110\
---------------------------------------------------------------------------

\110\ See ETF Exchange Act Order, supra footnote 15. ETFs that
do not operate in reliance on rule 6c-11 and currently have relief
from the Exchange Act provisions discussed above may continue to
rely on such relief.
---------------------------------------------------------------------------

Finally, commenters asked that we exempt ETF insiders and large
shareholders from certain section 13(d) and section 16 reporting
requirements under the Exchange Act beyond the conditions in several
staff no-action letters.\111\ The staff no-action letters stated that
the staff would not recommend enforcement action to the Commission if
certain insiders and large shareholders of ETFs seeking to track the
performance of a benchmark index through a replication strategy did not
file reports under section 13(d) and section 16(a) based on certain
facts and circumstances, including that there is no material deviation
between the ETF's secondary market price and NAV.\112\ Commenters
stated that the portfolio transparency requirements in rule 6c-11 would
address the concerns underlying section 13(d) and section 16 without
conditioning relief on there being no material deviation between the
ETF's market price and NAV per share.\113\
---------------------------------------------------------------------------

\111\ See, e.g., Fidelity Comment Letter; Comment Letter of
Thompson Hine LLP (Oct. 1, 2018) (``Thompson Hine Comment Letter'').
\112\ See PDR Services Corporation, SEC Staff No-Action Letter
(pub. avail. December 14, 1998) (``PDR Services Letter''); Select
Sector SPDR Trust, SEC Staff No-Action Letter (pub. avail. May 6,
1999) (``Select Sector SPDR Trust Letter'').
\113\ See, e.g., Thompson Hine Comment Letter.
---------------------------------------------------------------------------

As discussed above, the exemptions we are providing today under
rule 6c-11 are based on the existence of a close tie between market
price and NAV per share. Expanding on the existing staff no-action
letters by providing exemptions from the reporting requirements in
sections 13(d) and 16 even when there is a material deviation between
market price and NAV would be inconsistent with the exemptions in rule
6c-11. We therefore refrain from taking additional action concerning
the conditions outlined in our existing staff no-action letters.
2. Trading of ETF Shares at Market-Determined Prices
Rule 6c-11 will provide exemptions from section 22(d) and rule 22c-
1 to permit secondary market trading of ETF shares at market-determined
prices as proposed. 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.\114\ 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.\115\ 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.\116\ 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, rule 6c-11 will provide exemptions from these provisions.\117\
---------------------------------------------------------------------------

\114\ 15 U.S.C. 80a-22(d).
\115\ See 17 CFR 270.22c-1.
\116\ 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)).
\117\ See rule 6c-11(b)(2). The reference in the rule to
``repurchases . . . at market-determined prices'' refers to
secondary market transactions with dealers. Thus, the rule will not
allow an ETF to repurchase shares from an investor at market-
determined prices.

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[[Page 57173]]

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.\118\ 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 final rule will provide exemptions
from section 22(d) and rule 22c-1 because we believe this 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.
---------------------------------------------------------------------------

\118\ See 2018 ETF Proposing Release, supra footnote 7, at n.113
and accompanying discussion.
---------------------------------------------------------------------------

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 has generally been relatively
small.\119\ However, we recognize that under certain circumstances,
including during periods of market stress, the arbitrage mechanism may
work less effectively.\120\ 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 continue to 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.\121\ Further, we believe that the
conditions we are adopting as part of rule 6c-11, along with other
recent actions that are designed to promote an effective arbitrage
mechanism, will 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
granting.\122\ We particularly find this to be the case given the
benefits ETFs offer investors as discussed above.
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\119\ In an analysis of various asset classes during 2017-2018,
end-of-day deviations between closing price of ETFs and NAV were
relatively rare and generally not persistent. See also id., at
nn.119-123 and accompanying text (discussing similar staff analysis
for 2016-2017 period).
\120\ 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. 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. See 2018 ETF Proposing Release, supra
footnote 7, at nn.124-130 and accompanying text.
\121\ See id., at n.131 and accompanying text. The Commission
also 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 Act
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 Act Release No.78660 (Aug. 24, 2016) [81 FR 59676
(Aug. 30, 2016)].
\122\ For example, 17 CFR 270.22e-4 (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 Investment Company Liquidity Risk
Management Programs, Investment Company Act Release No. 32315 (Oct.
13, 2016) [81 FR 82142 (Nov. 18, 2016)] (``LRM Adopting Release'').
We have taken these requirements into consideration in adopting the
conditions in rule 6c-11.
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Moreover, to the extent that there are instances where bid-ask
spreads widen, or premiums and discounts persist, the final rule and
disclosure amendments will require ETFs to disclose certain information
on their website.\123\ These disclosure requirements are designed to
increase investor awareness of these risks. We continue to believe that
it is important for investors to be informed where costs may increase
beyond what they would reasonably expect.
---------------------------------------------------------------------------

\123\ See infra section II.C.6.
---------------------------------------------------------------------------

Commenters generally agreed that rule 6c-11 should provide the
proposed exemptions from section 22(d) and rule 22c-1.\124\ These
commenters highlighted the ability of investors to transact in ETF
shares intraday at market-determined prices as one of the primary
benefits of the ETF structure. Commenters also agreed with our
observation that the arbitrage mechanism generally has kept the
deviation between the ETF market price and NAV per share relatively
small, and that an efficient arbitrage mechanism adequately addresses
potential concerns under section 22(d) and rule 22c-1.\125\ One
commenter agreed that, on balance, given the historically insignificant
and short duration of unusual ETF premiums and discounts, and the
relatively low risks presented to investors as a result, ETF investors
are likely to weigh the potential benefits of ETFs against any
potential for market price deviations when selecting an investment in
ETFs.\126\
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\124\ See, e.g., ICI Comment Letter; SSGA Comment Letter I;
Invesco Comment Letter.
\125\ See, e.g., ICI Comment Letter; Invesco Comment Letter.
\126\ See Invesco Comment Letter.
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3. Affiliated Transactions
As proposed, rule 6c-11 will provide exemptions from sections
17(a)(1) and (a)(2) of the Act with regard to the deposit and receipt
of baskets by 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.\127\ The relief from section 17(a) in
rule 6c-11 is consistent with the exemptive relief that we have granted
to ETF applicants.\128\
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\127\ See rule 6c-11(b)(3).
\128\ 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''). 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. 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. See 2018 ETF Proposing Release, supra footnote 7, at nn.140-
141 and accompanying discussion.
---------------------------------------------------------------------------

Section 17(a) of the Act generally prohibits an affiliated person
of a registered investment company, or an affiliated person of such
person, from knowingly selling any security or other

[[Page 57174]]

property to or purchasing any security from the company.\129\ Purchases
and redemptions of ETF creation units are typically effected in kind,
and section 17(a) would prohibit 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.\130\
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\129\ 15 U.S.C. 80a-17(a).
\130\ 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).
---------------------------------------------------------------------------

Commenters expressed support for our proposed exemptions from
sections 17(a)(1) and (a)(2), concurring with our view that this relief
is necessary to facilitate the efficient functioning of the arbitrage
mechanism.\131\ Commenters noted that, without this relief, 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, which, in turn,
could have the adverse effect of limiting the pool of market
participants that could engage in arbitrage.\132\ Ultimately, this
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. Commenters also stated that in-kind purchases and redemptions of
ETF creation units between an ETF and authorized participants, which
may be affiliated persons, or affiliated persons of affiliated persons,
as a result of such transactions are not the types of potentially
harmful transactions that section 17(a) is designed to prevent.\133\
---------------------------------------------------------------------------

\131\ See e.g., Thompson Hine Comment Letter; ICI Comment
Letter; JPMAM Comment Letter; SSGA Comment Letter I; Fidelity
Comment Letter; SIFMA AMG Comment Letter I.
\132\ See, e.g., ICI Comment Letter. Newly launched ETFs could
face particular challenges 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.
\133\ See, e.g., Thompson Hine Comment Letter; see also
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'') (``To
prevent self-dealing and overreaching by persons in a position to
take advantage of the fund, the Investment Company Act prohibits
funds from entering into certain transactions with affiliated
persons.'') (internal citations omitted).
---------------------------------------------------------------------------

We continue to believe that this relief is appropriate to
facilitate the efficient functioning of the arbitrage mechanism after
considering comments. As noted above, all purchases and redemptions of
creation units with such an affiliated person are at an ETF's next-
calculated NAV, and an ETF would value the securities deposited or
delivered upon redemption in the same manner, using the same standards,
as the ETF values those securities for purposes of calculating the
ETF's NAV. We do not believe that these transactions will give rise to
the policy concerns that section 17(a) is designed to prevent.
Several commenters asked us to confirm that the section 17(a)
relief in rule 6c-11 would extend to entities that are affiliated with
the ETF by virtue of holding more than 25% of the ETF's shares or more
than 25% of any investment company that is an affiliated person of the
ETF (``25% holders''), consistent with the terms of our existing
exemptive orders.\134\ Our proposal was designed to provide relief from
section 17(a) similar to our orders.\135\ We do not believe that an
express reference to 25% holders in rule 6c-11(b)(3) is necessary,
however, because the rule text will capture entities that are
affiliated with the ETF by virtue of share ownership greater than 5%.
We confirm that 25% holders are within the scope of this exemption.
---------------------------------------------------------------------------

\134\ See e.g., SIFMA Comment Letter I. The related exemptive
application to our orders usually includes an express reference to
holders of 25% or more of the ETF's shares or 25% or more of an
investment company that is an affiliated person of the ETF. See,
e.g., Pacer Funds, et al., Investment Company Act Release Nos. 33374
(Feb. 13, 2019) [84 FR 5125 (Feb. 20, 2019)] (notice) and 33397
(March 12, 2019) (order).
\135\ Our 2008 proposal expressly included section 17(a) relief
for 25% holders. See 2008 ETF Proposing Release, supra footnote 3.
One commenter on that proposal stated that the reference to 25%
holders was superfluous in light of the reference to 5% holders. See
Comment Letter of Stradley Ronan Stevens & Young, LLP (May 19,
2008).
---------------------------------------------------------------------------

A number of commenters also recommended expanding the relief to
cover additional types of affiliated relationships, such as exempting
broker-dealers that are affiliated with the ETF's adviser,\136\ or
permitting an ETF's adviser or its affiliates to transact with the ETF
to provide in-kind seed capital to the ETF.\137\ These commenters noted
that increasing the entities eligible to transact with an ETF could
further help facilitate the arbitrage mechanism, reduce concentration
risk, and lower transaction costs. These commenters also noted that a
fund's policies and procedures on baskets and custom baskets, as well
as the federal securities laws and regulations that prohibit
manipulative practices and misuse of nonpublic information, would
address potential concerns regarding overreaching and similar abusive
practices by these affiliated entities.
---------------------------------------------------------------------------

\136\ See ICI Comment Letter; JPMAM Comment Letter; SSGA Comment
Letter I.
\137\ See Fidelity Comment Letter; SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

While permitting additional types of affiliated entities to
transact with the ETF could provide additional benefits to an ETF,
expanding the scope of affiliated persons covered by the exemption
would constitute novel section 17(a) relief. To date, our exemptive
orders have been narrowly tailored to permit in-kind purchases and
redemptions between an ETF and certain affiliates to facilitate
efficient arbitrage. Expanding this relief would raise novel
affiliation issues that would require a careful consideration of
whether the current protections embedded in our relief sufficiently
address any risks posed by such transactions with additional categories
of affiliates. This would be especially the case if the exemption were
expanded to include affiliated entities such as the ETF's sponsor and
other service providers that typically have greater ability to
influence an ETF. Given that rule 6c-11 is generally intended to codify
existing relief for ETFs, we therefore do not believe that it is
appropriate to expand the scope of affiliated persons covered by the
exemption as part of this rulemaking, although such exemptions may be
considered within our regular exemptive applications process.
4. Additional Time for Delivering Redemption Proceeds
We are adopting, largely as proposed, an exemption from section
22(e) to permit an ETF to delay satisfaction of a redemption request in
the case of certain foreign investments for which a local market
holiday or the extended delivery cycles of another jurisdiction make
timely delivery unfeasible. 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.\138\
This prohibition can cause operational difficulties for ETFs that hold
foreign investments and exchange in-kind baskets for creation

[[Page 57175]]

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.\139\
---------------------------------------------------------------------------

\138\ 15 U.S.C. 80a-22(e).
\139\ ETFs that hold foreign investments 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.
---------------------------------------------------------------------------

Section 22(e) was designed to prevent unreasonable delays in the
actual payment of redemption proceeds.\140\ Rule 6c-11 will 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. Rule 6c-11 will 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, or 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.\141\
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\140\ 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).
\141\ Rule 6c-11(b)(4). The relief from section 22(e) does not
affect any obligations arising under rule 15c6-1 under the Exchange
Act, which requires that most securities transactions settle within
two business days of the trade date. 17 CFR 240.15c6-1.
---------------------------------------------------------------------------

Under this exemption, an ETF must deliver foreign investments as
soon as practicable, but in no event later than 15 days after the
tender to the ETF. The exemption therefore will 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.\142\ If a foreign
investment settles in less than 15 days, the rule will require an ETF
to deliver it pursuant to the standard settlement time of the local
market where the investment trades. 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.\143\
---------------------------------------------------------------------------

\142\ This exemption permits a delay in the delivery of foreign
investments only if the foreign investment is being transferred in
kind as part of the basket. 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.
\143\ See 2018 ETF Proposing Release, supra footnote 7, at n.155
(discussing settlement cycles for various foreign markets).
---------------------------------------------------------------------------

Commenters generally supported our proposed exemption from section
22(e).\144\ Commenters stated that the relief would provide additional
assurance that an ETF could postpone payment of redemption proceeds in
certain circumstances outside of its control.\145\ One commenter
observed that a period of 15 days, accompanied by a requirement that
delivery be made as soon as practicable, is appropriate and
reasonable.\146\ Another commenter agreed that it was appropriate to
limit the exemption to the particular foreign investment and not the
entire basket.\147\
---------------------------------------------------------------------------

\144\ See, e.g., ICI Comment Letter; Fidelity Comment Letter;
Comment Letter of Charles Schwab Investment Management (Oct. 1,
2018) (``CSIM Comment Letter''); John Hancock Comment Letter.
\145\ See John Hancock Comment Letter; ICI Comment Letter.
\146\ See CSIM Comment Letter.
\147\ See ICI Comment Letter.
---------------------------------------------------------------------------

Proposed rule 6c-11 would have included a ten-year sunset provision
in light of the continued movement toward shorter settlement times in
markets around the world.\148\ Commenters generally objected to the
proposed sunset provision, citing a number of reasons for why the
section 22(e) relief would likely remain necessary beyond the sunset
period. Although we continue to believe that technological innovation
and changes in market infrastructures and operations should lead to
further shortening of settlement cycles, we recognize commenters'
concerns that these developments may be gradual and difficult to
predict.\149\ Moreover, given that certain local market holidays may
last for up to seven business days, we agree with commenters that
settlement within seven days may continue to pose challenges even in
light of continued technological progress and changes in market
operations.\150\ We therefore are not adopting a sunset provision to
limit the relief from section 22(e) to ten years from the rule's
effective date.
---------------------------------------------------------------------------

\148\ See 2018 ETF Proposing Release, supra footnote 7, at n.156
and accompanying text (proposing that the exemption from section
22(e) for postponement of delivering redemption proceeds expire ten
years from the rule's effective date).
\149\ See, e.g., Dechert Comment Letter; CSIM Comment Letter;
ICI Comment Letter; Invesco Comment Letter; Fidelity Comment Letter;
WisdomTree Comment Letter; ABA Comment Letter.
\150\ See, e.g., Invesco Comment Letter (citing Taiwan market
holidays); CSIM Comment Letter; Fidelity Comment Letter; ICI Comment
Letter; John Hancock Comment Letter.
---------------------------------------------------------------------------

The rule will 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), and that is traded on a trading
market outside of the U.S.\151\ As under the proposal, this definition
is not limited to ``foreign securities,'' but also includes 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.\152\ We
received no comments on this aspect of the definition of ``foreign
investment.''
---------------------------------------------------------------------------

\151\ See rule 6c-11(a)(1). We believe this approach is
appropriate because it creates consistency with a long-accepted
definition under Exchange Act rules.
\152\ 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.
---------------------------------------------------------------------------

Unlike our proposal, we are not defining ``foreign investment'' as
an investment for which there is no ``established U.S. public trading
market.'' \153\ A number of commenters recommended that we modify or
eliminate this aspect of the definition.\154\ These commenters
expressed concern that this requirement could make the exemption from
section 22(e) unavailable whenever a foreign issuer has issued a
security in the U.S. Commenters stated that ETFs investing in certain
foreign markets typically hold the security that is traded in the
foreign issuer's local trading market (``foreign-traded security'')
rather than its U.S.-traded equivalent.\155\ These commenters explained
that this is particularly true for ETFs tracking certain international
indexes because those indexes often include foreign-traded securities,
which

[[Page 57176]]

generally have greater liquidity and trading volume than their U.S.-
traded equivalents. Several commenters cited potential compliance
costs, operational considerations (e.g., transacting in the foreign-
traded security may entail lower transaction costs for the ETF), and
possible disruptions to their investment strategy (e.g., tracking
error) that might result due to this requirement.\156\
---------------------------------------------------------------------------

\153\ See 2018 ETF Proposing Release, supra footnote 7, at n.166
and accompanying text (proposing to 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)).
\154\ See ICI Comment letter; SIFMA AMG Comment Letter I; SSGA
Comment Letter I; BlackRock Comment Letter; Invesco Comment Letter.
\155\ See, e.g., ICI Comment Letter; SIFMA Comment Letter I.
\156\ See, e.g., BlackRock Comment Letter (stating that ``ETFs
currently do not monitor whether a foreign issuer has equivalent
securities that both trade on a US market and the foreign issuer's
local market since our primary investment practices are to invest in
the securities of the underlying index.''); Invesco Comment Letter;
SSGA Comment Letter I.
---------------------------------------------------------------------------

The proposed definition of foreign investment was designed to make
relief from section 22(e) unavailable to an ETF that included a foreign
issuer's U.S.-traded investment in its basket, thereby avoiding the
settlement delay that is the basis for the relief.\157\ It was not
intended to require an ETF to buy and sell the U.S.-traded equivalent
of a foreign-traded security when one is available, nor was it intended
to deny section 22(e) relief to an ETF that includes a foreign-traded
security in its basket because a U.S.-traded equivalent exists. In
order to address commenters' concerns and potential confusion, however,
we have eliminated the requirement that the foreign investment have
``no established U.S. public trading market.'' Instead, in relevant
part, rule 6c-11(a)(1) will define ``foreign investment'' as an
investment that ``is traded on a trading market outside of the U.S.''
\158\ We believe this definition will capture the foreign investments
that may experience settlement delays without creating unintended
consequences for ETF portfolio management. Under rule 6c-11, a delay in
settlement is permitted only to the extent that additional time for
settlement is actually required due to a local market holiday or the
extended delivery cycles in a foreign market. As a result, the
exemption from section 22(e) already is unavailable where an ETF could
readily trade an investment in its basket on a U.S. market.
---------------------------------------------------------------------------

\157\ See 2018 ETF Proposing Release, supra footnote 7, at n.166
and accompanying discussion. As proposed, the rule will 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)].
\158\ See, e.g., BlackRock Comment Letter (recommending that
``foreign investment'' be defined by reference to whether ``there is
an established trading market [. . .] outside of the US''). As
proposed, we also are not requiring 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. See 2018 ETF Proposing Release, supra footnote
7, at n.161 and accompanying discussion. No commenters disagreed
with this aspect of the proposal.
---------------------------------------------------------------------------

C. Conditions for Reliance on Rule 6c-11

Rule 6c-11 requires ETFs to comply with certain conditions designed
to protect investors and to be consistent with the purposes fairly
intended by the policy and provisions of the Act in order to operate
within the scope of the Act. These conditions generally are consistent
with the conditions in 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 modifications that, based on our
experience regulating ETFs and comments we received on the proposal, we
believe will improve the overall regulatory framework for these
products.
1. Issuance and Redemption of Shares
As proposed, the definition of exchange-traded fund under rule 6c-
11 will require that an ETF issue (and redeem) creation units to (and
from) authorized participants in exchange for baskets and a cash
balancing amount (if any).\159\ This definition is designed to preserve
the existing ETF structure, reflected in our exemptive orders, which
permit only an authorized participant of an ETF to purchase creation
units from (or sell creation units to) the ETF. An orderly creation
unit issuance and redemption process is essential to a properly
functioning arbitrage mechanism. Commenters supported the proposed
definition of exchange-traded fund.\160\
---------------------------------------------------------------------------

\159\ See rule 6c-11(a)(1). See also infra section II.C.4.c.
(discussing definitions of baskets and cash balancing amount).
\160\ See, e.g., Invesco Comment Letter.
---------------------------------------------------------------------------

Rule 6c-11 will define an authorized participant to mean a member
or participant of a clearing agency registered with the Commission that
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, as proposed.\161\ This definition
differs from the definition of ``authorized participant'' in the
Commission's exemptive orders and Form N-CEN because it does not
include a specific reference to an authorized participant's
participation in DTC, as DTC is itself a clearing agency.\162\ We
proposed to amend Form N-CEN to make the two definitions consistent. We
believe the definition that we are adopting remains largely consistent
with the exemptive relief we have granted to ETFs, while eliminating
unnecessary terms.
---------------------------------------------------------------------------

\161\ See rule 6c-11(a)(1).
\162\ See 2018 ETF Proposing Release, supra footnote 7, at
nn.170-171. Form N-CEN, in relevant part, defined 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. See Form N-CEN, Item E.2.
---------------------------------------------------------------------------

Several commenters expressed support for the proposed definition of
authorized participant.\163\ One commenter, however, asserted that rule
6c-11 should use the existing definition of authorized participant in
Form N-CEN to avoid confusion and regulatory inconsistency.\164\ We
believe that amending Form N-CEN to make the definition of authorized
participant consistent with the definition in rule 6c-11 addresses this
commenter's concern.\165\
---------------------------------------------------------------------------

\163\ See SSGA Comment Letter I; ICI Comment Letter; Cboe
Comment Letter.
\164\ See Invesco Comment Letter.
\165\ See infra section II.J.
---------------------------------------------------------------------------

We also received several comments on issues relating to authorized
participants more generally. One commenter, for example, suggested that
the Commission confirm that authorized participants who buy and sell
ETF shares in creation units are not considered, for that reason alone,
``principal underwriters'' under the Investment Company Act.\166\ The
commenter stated that the plain language of section 2(a)(29) of the Act
would exclude an authorized participant from the definition of
principal underwriter when the authorized participant purchases ETF
shares through a principal underwriter acting as agent for the
ETF.\167\ We agree that an authorized participant that purchases ETF
shares from the ETF's principal underwriter is not a principal
underwriter as defined in section 2(a)(29) of the Act solely because it
buys and sells ETF shares in creation units.
---------------------------------------------------------------------------

\166\ See ABA Comment Letter.
\167\ Id. (noting that the definition of principal underwriter
excludes ``a dealer who purchases from such company through a
principal underwriter acting as agent.'').
---------------------------------------------------------------------------

Another commenter suggested that the Commission require an ETF to
have a minimum number of authorized participants (i.e., 2 or 3) to
reduce the risk of anti-competitive behavior and to

[[Page 57177]]

safeguard the arbitrage mechanism.\168\ This commenter, however, also
pointed to data indicating that large ETFs (with more than $790 million
in assets) typically have an average of nine active authorized
participants, and that smaller ETFs (with less than $27 million in
assets) have an average of two active authorized participants.\169\
This commenter further noted that it has observed ETFs using single
authorized participants in ``some markets outside of the United
States'' but that this type of arrangement is ``less common within the
United States.'' \170\ We have not observed the types of ``excessive
deviations'' between ETFs' NAV and market price that, according to this
commenter, could indicate that ETFs' use of one authorized participant
is a persistent problem.\171\ Additionally, based upon Form N-CEN data
through September 5, 2019, we found that out of 1672 funds reviewed
that could rely on rule 6c-11, only 30 (approximately 1.8% of the funds
reviewed) reported having fewer than 2 authorized participants. We
therefore do not believe that it is appropriate at this time to
prescribe a minimum number of authorized participants that an ETF may
use.
---------------------------------------------------------------------------

\168\ See Comment Letter of Jane Street Capital, LLC (Oct. 1,
2018) (``Jane Street Comment Letter''). Another commenter suggested
that the Commission should provide guidance regarding ETF sponsors
giving certain APs special treatment in the negotiation of baskets.
See Comment Letter of Bluefin Trading, LLC (Oct. 19, 2018)
(``Bluefin Comment Letter''). We address this comment in our
discussion of custom basket policies and procedures, infra, in
section II.C.5.a.
\169\ See Jane Street Comment Letter (citing ``The Role and
Activities of Authorized Participants of Exchange-Traded Funds,''
Investment Company Institute, March 2015).
\170\ See id.
\171\ See, e.g., 2018 ETF Proposing Release, supra footnote, at
section II.B.2.
---------------------------------------------------------------------------

As proposed, rule 6c-11 will 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).\172\ Rule
6c-11 will not mandate a maximum or minimum creation unit size or
otherwise place requirements on creation unit size. We continue to
believe, and commenters agreed, that ETFs are incentivized to establish
creation unit sizes that are appropriate for market demand pursuant to
their investment strategies and objectives.\173\ Thus, ETFs are not
likely to set very large or very small creation unit sizes that could
disrupt the arbitrage mechanism or prevent the use of in-kind baskets
when in-kind baskets would otherwise be desirable for an ETF to obtain
the typical efficiencies of ETFs. We also believe that the conditions
in rule 6c-11, as adopted, are better suited to promote effective
arbitrage than conditions related to creation unit size.\174\
---------------------------------------------------------------------------

\172\ See rule 6c-11(a)(1).
\173\ See 2018 ETF Proposing Release, supra footnote 7, at
nn.175-176 and accompanying text (noting that 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). See, e.g., ICI Comment
Letter; SIFMA AMG Comment Letter I; Vanguard Comment Letter. See
also Nasdaq Comment Letter (noting that minimum creation unit size
requirement can lead to wider spreads, particularly for newer,
thinly-traded ETFs).
\174\ One commenter also suggested that the rule should not
require an ETF to define a specific creation unit size, noting that
permitting variable creation unit sizes could help further
facilitate market making and reduce transaction costs. See Nasdaq
Comment Letter. The rule's definition of ``creation unit'' will
require an ETF to specify a single number of ETF shares composing a
creation unit. Although an ETF could not use variable creation unit
sizes under this definition, an ETF could change its specified
creation unit size as conditions change over time.
---------------------------------------------------------------------------

An ETF generally would issue and redeem shares in creation unit
size aggregations, rather than as individual shares, under the rule. We
proposed to permit an ETF to sell or redeem individual shares on the
day of consummation of a reorganization, merger, conversion, or
liquidation.\175\ In these limited circumstances, an ETF may need to
issue or redeem individual shares, and may need to transact without
utilizing authorized participants. Commenters that addressed this
aspect of the proposal generally supported it.\176\ One commenter,
however, suggested that the rule should explicitly provide that an ETF
may transact with investors other than authorized participants in these
limited circumstances.\177\ We agree and have modified rule 6c-11 to
clarify that, on the day of a reorganization, merger, conversion, or
liquidation, an ETF may sell or redeem individual shares and is not
limited to transacting with authorized participants.\178\ We believe
that permitting ETFs to conduct redemptions with investors other than
authorized participants in these circumstances is operationally
necessary to facilitate these transactions and will allow an ETF to
compensate individual shareholders exiting the reorganized, merged,
converted or liquidated ETF--activities likely to involve small amounts
and to be outside the scope of an authorized participant's expected
role of transacting in creation units.
---------------------------------------------------------------------------

\175\ See 2018 ETF Proposing Release, supra footnote 7, at text
preceding n.82 (discussing proposed rule 6c-11(c)(5)).
\176\ See, e.g., BlackRock Comment Letter; Thompson Hine Comment
Letter.
\177\ See Thompson Hine Comment Letter. This commenter also
suggested moving this exception to the definition of exchange-traded
fund because it is not a condition to reliance on the rule. We agree
and have moved this exception to rule 6c-11(a)(2).
\178\ See rule 6c-11(a)(2).
---------------------------------------------------------------------------

Commenters also addressed the Commission's proposed guidance
concerning the extent to which an ETF may directly or indirectly
suspend the issuance or redemption of ETF shares.\179\ 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 harm investors that purchase shares at market prices
above NAV per share and/or sell shares at market prices below NAV per
share.
---------------------------------------------------------------------------

\179\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.C.1.
---------------------------------------------------------------------------

With respect to redemptions, an ETF may suspend the redemption of
creation units only in accordance with section 22(e) of the Act,\180\
and may charge transaction fees on these redemptions only in accordance
with rule 22c-2.\181\ While no commenters disagreed with our statement
in the 2018 ETF Proposing Release that an ETF may suspend redemptions
only in compliance with section 22(e), several commenters requested
that we eliminate the 2% cap on redemption fees for ETFs.\182\ One
commenter asserted that, unlike the mutual fund redemption fees that
were the Commission's focus in adopting rule 22c-2, the transaction
fees charged by an ETF on redemptions are not intended to inhibit
frequent trading of the ETF's shares, but are primarily designed to
protect shareholders against the costs of certain cash
redemptions.\183\

[[Page 57178]]

This commenter further stated that an ETF's inability to pass through
certain incremental costs to an authorized participant could adversely
impact performance and result in dilution of the interests of the ETF's
remaining shareholders.
---------------------------------------------------------------------------

\180\ 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 123, at
n.36.
\181\ 17 CFR 270.22c-2 (rule 22c-2) limits redemption fees to no
more than 2% of the value of shares redeemed. See rule 22c-
2(a)(1)(i).
\182\ See, e.g., Dechert Comment Letter; WisdomTree Comment
Letter; Invesco Comment Letter (noting that the redemption fee
framework for ETFs under rule 22c-2 is ``workable'' in most
circumstances, but that in certain circumstances greater flexibility
to charge redemption fees in excess of 2% would benefit ETFs).
Commenters did not provide any fee-related data in support of their
contention that the 2% limit on redemption fees should be eliminated
for ETFs.
\183\ See Dechert Comment Letter. See also Invesco Comment
Letter (noting that these fees include the difference between the
cash in-lieu amount calculated on the trade date and the actual sale
price of the security (reflecting market movement)).
---------------------------------------------------------------------------

As discussed above, we believe that ETFs should be regulated as
open-end funds and that ETF shares are most appropriately classified as
redeemable securities under the relevant provisions of the Act. In
adopting the 2% limit on redemption fees under rule 22c-2, we stated
that higher redemption fees would impose an undue restriction on the
redeemability of shares.\184\ Consistent with this belief, our
exemptive orders permitting ETFs to operate as open-end funds have not
permitted ETFs to charge transaction fees in excess of the 2% limit. We
believe the 2% limit allows ETFs to pass on certain costs related to
the redemption transaction to authorized participants, while preserving
the redeemability of ETF shares.\185\ Accordingly, we believe that ETFs
may charge transaction fees on the redemption of creation units only in
accordance with rule 22c-2.
---------------------------------------------------------------------------

\184\ See Mutual Fund Redemption Fees, Investment Company Act
Release No. 26782 (March 11, 2005) [70 FR 13328 (March 18, 2005)]
(noting that a goal of the Commission under the Act is to preserve
the redeemability of mutual fund shares).
\185\ See id. at text accompanying nn. 29-30. Mutual funds,
particularly those that invest in foreign markets, may face similar
types of costs and are subject to the 2% cap in rule 22c-2.
---------------------------------------------------------------------------

We also stated in the 2018 ETF Proposing Release that we believe
that 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.\186\ Some commenters agreed that
an ETF may suspend creations only for a limited time and only due to
extraordinary circumstances, but requested that we provide
clarification regarding the specific circumstances under which an ETF
may suspend creations.\187\ Other commenters did not support our
position on this issue. For example, one commenter stated that current
ETF practices for suspending creations have proven effective and
advocated against limiting or imposing restrictions on the
circumstances in which ETFs may suspend creations.\188\ Another
commenter recommended that, rather than precluding an ETF from
suspending the issuance of creation units, the Commission should
require ETFs that suspend creations to add supplemental disclosures
addressing the risk that the ETF's market price may deviate from NAV
per share.\189\
---------------------------------------------------------------------------

\186\ See 2018 ETF Proposing Release, supra footnote 7, at n.185
and accompanying text. In addition, we stated that an ETF could not
set transaction fees so high as to effectively suspend the issuance
of creation units. See id. One commenter addressed this issue,
stating that ETFs generally do not set transaction fees at a level
that would effectively suspend creations ``in lieu of transparently
informing the market that creations are halted.'' Jane Street
Comment Letter.
\187\ See, e.g., BlackRock Comment Letter; SIFMA AMG Comment
Letter I; SSGA Comment Letter I; Vanguard Comment Letter; Invesco
Comment Letter.
\188\ See Comment Letter of ETF BILD LLC (Oct. 1, 2018) (``ETF
BILD Comment Letter'') (``[T]here may be a variety of reasons to
suspend creations and limiting them or [restricting] certain
activity will not allow for differentiation of the circumstances
related to the underlying securities. . . . [C]urrent practices
developed in the ETF industry allow for the flexibility needed to
address this issue.'').
\189\ See Eaton Vance Comment Letter. Another commenter
suggested requiring any ETF that suspends creations, or otherwise
has its creation process halted, to immediately notify the market
via a Form 8-K or other mechanism. See Jane Street Comment Letter.
---------------------------------------------------------------------------

As discussed above, however, the expected close tie between an
ETF's market price and NAV per share provides a basis for our relief
from section 22(d) and rule 22c-1 under rule 6c-11 (as well as our
prior exemptive orders).\190\ If a suspension of creations impairs the
arbitrage mechanism, it could lead to significant deviations between
what retail investors pay (or receive) in the secondary market and the
ETF's approximate NAV. Such a result would run counter to the basis for
relief from section 22(d) and rule 22c-1 and therefore would be
inconsistent with rule 6c-11.
---------------------------------------------------------------------------

\190\ See supra section II.B.2 (discussing the potential
concerns regarding shareholder dilution, unjust discrimination and
preferential treatment among investors purchasing and redeeming fund
shares that section 22(e) and rule 22c-1 were designed to address).
---------------------------------------------------------------------------

2. Listing on a National Securities Exchange
As proposed, rule 6c-11 will define an ``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.\191\
Exchange-listing is one of the fundamental characteristics that
distinguishes ETFs 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. Exchange-listing provides an organized and ongoing trading
market for the ETF shares at market-determined prices, and therefore is
important to a functioning arbitrage mechanism.\192\ The Commission has
premised all of its previous exemptive orders on an ETF listing its
shares for trading on a national securities exchange.
---------------------------------------------------------------------------

\191\ Rule 6c-11(a)(1). As proposed, rule 6c-11(a)(1) also will
define a ``national securities exchange'' as an exchange that is
registered with the Commission under section 6 of the Exchange Act.
\192\ As proposed, the definition also requires that an ETF's
shares trade at market-determined prices. This 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 (``ETMFs'')).
See 2018 ETF Proposing Release, supra footnote 7, at text
accompanying n.192. Commenters did not address this aspect of the
definition of exchange-traded fund.
---------------------------------------------------------------------------

Several commenters generally supported the requirement that an ETF
list its shares on a national securities exchange.\193\ On the other
hand, one commenter stated that ETFs that are temporarily suspended
from listing or engaged in an orderly delisting and liquidation process
should not fall outside of the scope of the proposed rule.\194\ Another
commenter opined that delisted ETFs should remain within the rule to
prevent a possible race to redeem the ETF's shares that could result
from confusion about the ETF's regulatory status.\195\ This commenter
stated the definition of exchange-traded fund instead should include
ETFs that have been listed within the past 90 days. Other commenters
requested that we clarify the specific circumstances that constitute a
``delisting,'' citing trading suspensions and trading halts as examples
of circumstances that should not disqualify an ETF from relying on rule
6c-11.\196\ These commenters also urged the Commission to clarify that
a temporary non-compliance notice from an exchange for failure to
continuously meet the exchange's listing standards would not disqualify
an ETF from relying on the rule.
---------------------------------------------------------------------------

\193\ See, e.g., ICI Comment Letter; SSGA Comment Letter I.
\194\ SIFMA AMG Comment Letter I.
\195\ Thompson Hine Comment Letter (``[D]eeming the former ETF
to no longer have [status as an ETF under the rule] may lead to
confusion and a possible race to redeeming shares by remaining
shareholders while liquid assets are still available.'').
\196\ See SSGA Comment Letter I; ICI Comment Letter; Invesco
Comment Letter. See also FINRA, Investor Alert, When Trading Halts:
What You Need to Know About Halts, Suspensions and Other
Interruptions (February 7, 2013), available at https://www.finra.org/investors/alerts/when-trading-stops-halts-suspensions-other-interruptions (describing trading halts and trading suspensions).
---------------------------------------------------------------------------

As noted above, the listing requirement was designed to ensure that
all ETF shares have an organized and ongoing secondary trading market
to support an effective arbitrage mechanism. We therefore continue to
believe that an ETF should no longer be

[[Page 57179]]

eligible to rely on rule 6c-11 and must meet individual redemption
requests within seven days pursuant to section 22(e) of the Act or
liquidate if it is not listed on an exchange.\197\ In response to
commenters' request that we clarify the specific circumstances
constituting a ``delisting'' for purposes of rule 6c-11, an ETF is
considered no longer listed on an exchange as of the effective date of
the removal of the ETF's shares from listing pursuant to rule 12d2-2
under the Exchange Act.\198\ Circumstances such as a trading
suspension, a trading halt, or a temporary non-compliance notice from
the exchange therefore would not constitute a ``delisting'' for
purposes of rule 6c-11. An ETF also may request temporary relief from
the Commission to permit the ETF to suspend redemptions for a limited
period of time where necessary to protect ETF shareholders.\199\
---------------------------------------------------------------------------

\197\ 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.
\198\ See 17 CFR 240.12d2-2 (rule 12d2-2 under the Exchange Act)
(requiring a national securities exchange to file with the
Commission an application on Form 25 (17 CFR 249.25) to strike a
class of securities from listing on a national securities exchange
and/or registration under section 12(b) of the Exchange Act).
\199\ See section 22(e)(3) of the Act.
---------------------------------------------------------------------------

3. Intraday Indicative Value (``IIV'')
As proposed, rule 6c-11 will not require ETFs to disseminate an
intraday estimate of their NAV per share (an ``intraday indicative
value'' or ``IIV'') as a condition for reliance on the rule. Our orders
require the dissemination of an 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 on an intraday basis.\200\ The
exchange listing standards also currently require ETFs to disseminate
an IIV at least every 15 seconds during regular trading hours.\201\
---------------------------------------------------------------------------

\200\ See, e.g., 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'').
\201\ See, e.g., NYSE Arca Equities Rule 5.2E(j)(3), Commentary
.01(c) (stating that 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''). The IIV is also sometimes referred to as the ``iNAV''
(indicative net asset value) or the ``PIV'' (portfolio indicative
value).
---------------------------------------------------------------------------

We did not propose, however, an IIV dissemination requirement under
rule 6c-11 because of our concerns regarding the accuracy of IIV
estimates for certain ETFs.\202\ For example, the IIV may not
accurately reflect the value of an ETF that holds securities that trade
less frequently. 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 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.\203\ Conversely, in today's fast moving markets, given the
dissemination lags, the IIV may not accurately reflect the value of an
ETF that holds frequently traded component securities.\204\ Because
there are no uniform methodology requirements, the IIV also can be
calculated in different and potentially inconsistent ways.
---------------------------------------------------------------------------

\202\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.C.3. The exemptive relief we provided to certain non-
transparent ETFs included a condition requiring those ETFs to
provide a verified intraday indicative value (``VIIV'') throughout
the trading day. See 2019 Precidian, supra footnote 8. Those ETFs'
VIIV, considering their limited investment strategies, addressed the
Commission's concerns regarding the traditional IIV. See id.
\203\ 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
ETF's current holdings. 15 U.S.C. 80a-2(a)(41)(B).
\204\ An ETF's current portfolio value changes every time the
value of any underlying component of the ETF changes. The IIV for an
ETF that includes a more frequently traded component security might
not reflect the most recent trading information for that underlying
security.
---------------------------------------------------------------------------

In addition, we understand that market makers and authorized
participants no longer use IIV to evaluate arbitrage opportunities for
ETFs that provide full portfolio transparency.\205\ These market
participants 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 and generally use the IIV as a secondary or
tertiary check on the value that their proprietary algorithms generate.
---------------------------------------------------------------------------

\205\ See ETF Handbook, supra footnote 25.
---------------------------------------------------------------------------

The majority of commenters that addressed IIV requirements
supported our proposed approach. For example, commenters agreed that
authorized participants and other market participants calculate their
own intraday values based on other sources of information such as an
ETF's published baskets and portfolio holdings.\206\ Some of these
commenters stated, therefore, that the proposed rule's conditions
regarding daily portfolio holdings information would provide more
useful information to market participants than IIV.\207\ Commenters
also agreed that IIV can have significant limitations depending on the
types of securities the ETF holds. For example, one commenter stated
that these limitations for ETFs holding fixed income securities are the
result of market structure issues and that increasing the frequency of
the IIV publication would not change these limitations.\208\
---------------------------------------------------------------------------

\206\ See, e.g., Jane Street Comment Letter; Invesco Comment
Letter; WisdomTree Comment Letter; Vanguard Comment Letter (``These
other sources of data include the ETF's published basket, its last
published portfolio holdings list, the index tracked by the ETF, and
data from third party vendors'').
\207\ See Comment Letter of Legg Mason, Inc. (Oct. 1, 2018)
(``Legg Mason Comment Letter''); Cboe Comment Letter. See also SSGA
Comment Letter I (``[t]o the extent there is market demand for
information similar to the IIV by market participants absent a
regulatory mandate, we expect industry-led solutions will be
available, perhaps as part of a broader discussion around market
price validation.'').
\208\ See Legg Mason Comment Letter (noting, for example, that
fixed-income securities are predominantly traded by dealers and not
on exchanges). See also ICI Comment Letter.
---------------------------------------------------------------------------

Commenters also noted that under current regulatory requirements,
IIV can be confusing or misleading to market participants. For example,
one commenter stated that current requirements for IIV actually reduce
ETF transparency, because the IIV does not reflect the true value of an
ETF due to dissemination delays, stale pricing for underlying holdings,
and inconsistent calculation methodologies.\209\ One commenter opined
that IIV is inaccurate for 80% of all ETFs and the rule should not
require its dissemination.\210\ Another commenter stated that ``[IIV]
is, at best, slow and likely stale and, at worst confusing, inaccurate,
and misleading.'' \211\ In addition, several of these commenters stated
that the IIV requirements across regulatory regimes applicable to ETFs
should be harmonized.\212\ Specifically, these commenters noted that,
even if rule 6c-11 were to omit an IIV requirement, existing relief
under the Exchange Act

[[Page 57180]]

and certain exchange listing requirements would require ETFs to
continue disseminating IIV. They encouraged the Commission to work with
the exchanges to remove these listing requirements.
---------------------------------------------------------------------------

\209\ See SSGA Comment Letter I.
\210\ Comment Letter of ETF.com (Aug. 28, 2018) (``ETF.com
Comment Letter'') (stating that ``the idea of contemporaneous
measure of fair value is enticing'' but IIV ``is not accurate enough
for authorized participants to use in arbitrage analysis.'').
\211\ Cboe Comment Letter.
\212\ See, e.g., Invesco Comment Letter; SIFMA AMG Comment
Letter I; WisdomTree Comment Letter; SSGA Comment Letter I; ETF.com
Comment Letter.
---------------------------------------------------------------------------

Some commenters disagreed with this aspect of the proposal and
encouraged the Commission to require ETFs to disseminate IIV as a
requirement of the rule. These commenters generally asserted that IIV--
despite its limitations--can be useful to retail investors.\213\ One
such commenter stated that IIV is important for informed trading of
ETFs (and other ETPs) by retail investors because it is an ``important
signal of the value of the underlying portfolio.'' \214\ One commenter
stated that IIV allows investors to screen for significant price
deviations that could signal breakdowns in the market maker arbitrage
process.\215\
---------------------------------------------------------------------------

\213\ See, e.g., Angel Comment Letter; Nasdaq Comment Letter;
IDS Comment Letter.
\214\ See Angel Comment Letter.
\215\ See Nasdaq Comment Letter.
---------------------------------------------------------------------------

Some of these commenters noted that an ETF's IIV may be the only
source of pricing information publicly available to retail
investors.\216\ Another commenter asserted that the rule should include
an IIV requirement, but that market participants, particularly retail
investors, also would benefit from an explanation of the potential
limitations of IIV.\217\ Many of the commenters who recommended that
the Commission retain an IIV requirement also recommended that the
Commission standardize and otherwise improve the IIV calculation.\218\
---------------------------------------------------------------------------

\216\ See IDS Comment Letter. See also CFA Comment Letter; Eaton
Vance Comment Letter.
\217\ See FIMSAC Comment Letter.
\218\ See, e.g., NYSE Comment Letter; IDS Comment Letter; Nasdaq
Comment Letter; Eaton Vance Comment Letter. See also Angel Comment
Letter (recommending dissemination on standard CQS and UTP feeds,
one-second updates, and standardization of IIV suffixes).
---------------------------------------------------------------------------

After considering these comments, we continue to believe that rule
6c-11 should not require ETFs to disseminate IIV as IIV is not
necessary to support the arbitrage mechanism for ETFs that provide
daily portfolio holdings disclosure. Instead, rule 6c-11's portfolio
holdings disclosure will provide market participants with the relevant
data to input into their internal algorithms and thus allow them to
determine if arbitrage opportunities exist.
We also do not believe that IIV will provide a reliable metric for
retail investors to assess all ETFs relying on rule 6c-11 given the
breadth of asset classes that ETFs may hold (and the particular
shortcomings of IIV when an ETF holds assets that do not trade
contemporaneously with the ETF or are traded less frequently).
Furthermore, retail investors do not have easy access to IIV through
free, publicly available websites today even for those asset classes
where an IIV may be more reliable. A staff review of the websites for
the ten largest ETFs by assets under management found that none
provides a real-time IIV on its website. Some of these ETFs disclose a
specific ticker symbol for the ETF's IIV (as opposed to the ticker
symbol for the ETF itself) on their websites, others provide the IIV
with a delay of up to 45 minutes, while others provide no information
about the ETF's IIV at all.\219\ A review of several publicly
available, free financial websites also found that not all of these
websites provide an ETF's IIV.\220\ Where these websites did provide
the IIV, it was delayed by at least 15 minutes.\221\ We believe this
raises a significant risk that retail investors using these websites
may be receiving stale IIVs for ETFs. We have noted, and commenters
agreed, that even the 15-second interval for dissemination of an ETF's
IIV required under the exchange listing standards may be too infrequent
to effectively reflect the full trading activity for component
securities, and therefore to reflect the actual value of the ETF.
Therefore, we do not believe that adopting rule 6c-11 without an IIV
requirement would remove information from the market that retail
investors could reliably use when making investment decisions.
---------------------------------------------------------------------------

\219\ Fewer than half of the ETFs included in the review use a
specific ticker symbol that allows an investor to locate the ETF's
IIV (e.g., the ETF's ticker symbol followed by ``.iv'' or ``-iv'').
\220\ When input into a free financial website, the IIV was
provided with a delay of at least 15 minutes.
\221\ See, e.g., https://finance.yahoo.com/quote/%5ESPY-IV/;
https://www.morningstar.com/etfs/arcx/spy/betaquote.html.
---------------------------------------------------------------------------

We considered whether to require an ETF to publicly disseminate a
modified IIV on its website on a real time basis as a condition to rule
6c-11, requiring ETFs to calculate IIVs more frequently and in a more
accessible manner. We also considered creating a methodology that takes
into account circumstances when market prices for underlying assets are
not available or should not be used to reflect the ETF's intraday
value. However, we believe that these modifications are not necessary
given that an ETF operating in reliance on rule 6c-11 will provide full
portfolio transparency on its website.
We recognize that intraday information accurately reflecting the
current value of an ETF's shares can be important to retail investors
and encourage the ETF industry to undertake efforts to develop intraday
value metrics targeted at these investors.\222\ We believe that ETFs
are in a position to consider and develop tailored metrics for ETFs
holding different asset classes in a format that is useful for retail
investors. As one commenter noted, rule 6c-11's portfolio holdings
disclosure requirements may promote a market-based solution to today's
IIV shortcomings by making the information required to calculate
intraday values broadly available in a standardized,
user[hyphen]friendly format, which could ``encourage pricing services
and other potential providers to develop commercial ETF intraday
valuation services that would compete in the market on the basis of
timeliness, accuracy, reliability and price.'' \223\
---------------------------------------------------------------------------

\222\ One commenter noted that a lack of disclosure regarding
potential intraday deviations could, in some circumstances, be
misleading. See Comment Letter of Henry Hu and John Morley, Yale Law
School (Aug, 27, 2018) ``(Hu and Morley Comment Letter'')
(incorporating article by Henry T. C. Hu, University of Texas Law
School and John D. Morley, A Regulatory Framework for Exchange-
Traded Funds, 91 S. Cal. Law Review 839-941 (July 2018) at 920,
which describes a particular ETF that ``suffered extraordinary
[intraday] departures from NAV on August 24, 2015'' and noting how
``[in looking] 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.'').
\223\ See Eaton Vance Comment Letter.
---------------------------------------------------------------------------

4. Portfolio Holdings Disclosure
Since the first exemptive order for an ETF, the Commission has
relied on the existence of an arbitrage mechanism to keep market prices
of ETF shares at or close to the NAV per share of the ETF. One
mechanism that facilitates the arbitrage mechanism is daily portfolio
transparency.\224\ Portfolio transparency provides authorized
participants and other market participants with a tool to facilitate
valuing the ETF's portfolio on an intraday basis, which, in turn,
enables them to identify arbitrage opportunities and to effectively
hedge their positions. Accordingly, as proposed, rule 6c-11 will
require an ETF to disclose prominently on its website, publicly
available and free of charge, the portfolio holdings that will

[[Page 57181]]

form the basis for each calculation of NAV per share.\225\
---------------------------------------------------------------------------

\224\ Our exemptive orders for actively managed ETFs and recent
orders for self-indexed ETFs have required full portfolio
transparency. Exemptive orders for index-based ETFs with an
unaffiliated index provider have required publication of the ETF's
baskets. We understand, however, that all ETFs that can rely on rule
6c-11 currently provide full transparency as a matter of industry
practice.
\225\ Rule 6c-11(c)(1)(i). For purposes of this requirement, as
well as other requirements to disclose information on a publicly
available website under rule 6c-11, 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 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.
However, this requirement does not preclude the ETF from making
other, unrelated sections of its website private or password
protected. We also 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.
---------------------------------------------------------------------------

We received numerous comments on this aspect of the proposal. Many
commenters generally supported requiring full, daily portfolio holdings
disclosure on the ETF's website as a condition for reliance on rule 6c-
11.\226\ These commenters agreed with our view that portfolio
transparency supports an efficient arbitrage mechanism and thus helps
maintain the close tie between the market price of an ETF's shares and
the value of its portfolio. One commenter stated that portfolio
transparency is important to individual investors because it allows
them to better discern differences between ETFs that purport to track
similar indexes or have similar investment objectives.\227\
---------------------------------------------------------------------------

\226\ See, e.g., Comment Letter of Stuart Cary (July 3, 2018)
(``Cary Comment Letter''); ETF.com Comment Letter; Comment Letter of
Jack Reagan (July 12, 2018) (``Reagan Comment Letter''); BlackRock
Comment Letter; Cboe Comment Letter; BNY Mellon Comment Letter;
Fidelity Comment Letter; SIFMA AMG Comment Letter I; CSIM Comment
Letter; Virtu Comment Letter; Eaton Vance Comment Letter.
\227\ See CSIM Comment Letter.
---------------------------------------------------------------------------

On the other hand, one commenter did not support daily disclosure
of an ETF's full portfolio, opining that an effective arbitrage
mechanism is sufficiently supported by disclosure of well-constructed
baskets with performance that closely tracks the performance of both
the fund and its index.\228\ This commenter further asserted that daily
portfolio transparency may harm ETF investors by permitting market
participants to front-run index funds, which could negatively impact
the prices at which the ETF trades portfolio holdings and thus reduce
investors' returns. This commenter recommended, as an alternative to
the proposed requirement, that the Commission require ETFs to provide
daily disclosure of portfolio holdings, with an exception for the
portion of holdings that are ``subject to sensitive trading
strategies,'' such as those related to index changes.\229\
---------------------------------------------------------------------------

\228\ Vanguard Comment Letter.
\229\ Id. (recommending that the rule permit ETFs to disseminate
a list of index securities that, when combined with disclosed
portfolio holdings, would be reasonably designed to track the ETF's
(and the index's) performance).
---------------------------------------------------------------------------

One commenter supported requiring daily portfolio transparency for
index-based ETFs, but opposed requiring it for actively managed ETFs,
due to the risk of market participants using the portfolio holdings
disclosures to front-run or piggyback on actively managed
strategies.\230\ Similarly, another commenter asserted that daily
portfolio transparency is not a necessary condition for effective
arbitrage, and noted that the risks of front-running and ``free
riding'' that arise from portfolio transparency were preventing it from
offering more actively managed ETFs.\231\
---------------------------------------------------------------------------

\230\ See Invesco Comment Letter (recommending that the rule
permit actively managed ETFs to delay disclosure of portfolio
holdings at least two days).
\231\ See JPMAM Comment Letter. See also Dechert Comment Letter
(urging the Commission to consider moving to a more uniform,
standardized approach in determining whether to grant exemptive
relief for non-fully transparent ETFs).
---------------------------------------------------------------------------

We continue to believe ETFs relying on rule 6c-11 should provide
full daily portfolio transparency in order to facilitate an efficient
arbitrage process. Notably, we believe it is likely that all current
ETFs that may rely on the rule already provide full portfolio
transparency as a matter of market practice and this approach will
eliminate regulatory distinctions between index-based and actively
managed ETFs that rely on rule 6c-11. Moreover, although we recognize
there are alternative approaches to facilitate efficient arbitrage, the
Commission has limited experience with such approaches, which are new
and continuing to evolve and we therefore believe that these
alternatives should be considered within our exemptive applications
process.
Accordingly, rule 6c-11 will require full, daily portfolio holdings
disclosure for ETFs relying on the rule. As discussed below, however,
the portfolio transparency requirement we are adopting includes several
modifications from the proposed rule, including modifications regarding
the required timing and presentation of the portfolio holdings
disclosure.
a. Timing of Portfolio Holdings Disclosure
Rule 6c-11 will require website disclosure of an ETF's portfolio
holdings on each business day before the opening of regular trading on
the primary listing exchange of the ETF's shares.\232\ Our proposal
also would have required an ETF to disclose its portfolio holdings
before the ETF starts accepting orders for the purchase or redemption
of creation units.\233\ The proposed rule's timing requirements were
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.\234\
---------------------------------------------------------------------------

\232\ Rule 6c-11(c)(1)(i).
\233\ See proposed rule 6c-11(c)(1)(i).
\234\ See 2018 Proposing Release, supra footnote 7, at n.209 and
accompanying text.
---------------------------------------------------------------------------

We received several comments on this aspect of the proposal,
particularly on the proposed requirement that an ETF disclose its
portfolio holdings before the ETF starts accepting orders on a given
business day. Several commenters opposed the proposed timing
requirement because it could prevent certain ETFs from accepting
creation and redemption orders shortly after the US market closes (``T-
1 orders'').\235\ These commenters explained that T-1 orders allow
ETFs, authorized participants, and other market participants to place
orders for the purchase and sale of portfolio securities in non-U.S.
markets with hours that do not overlap (or have limited overlap) with
U.S. market hours when those markets are open.\236\ An ETF that holds
Japanese equities, for example, may permit authorized participants to
submit T-1 orders (between 4:00 p.m. ET and 5:00 p.m. ET) to allow for
trading in the underlying Japanese securities before the Japanese
market closes (2:00 a.m. ET).\237\ Some commenters explained that the
operational steps necessary to disclose an ETF's portfolio holdings
would take 2-3 hours after NAV calculation (typically 4:00 p.m. ET) and
the requirement to disclose portfolio holdings before accepting orders
therefore would eliminate the T-1 order window.\238\
---------------------------------------------------------------------------

\235\ See, e.g., ICI Comment Letter; BlackRock Comment Letter.
\236\ See, e.g., Invesco Comment Letter.
\237\ See ICI Comment Letter.
\238\ See Invesco Comment Letter.
---------------------------------------------------------------------------

Several commenters discussed the benefits of permitting ETFs to
accept T-1 orders. Commenters stated that T-1 orders allow market
participants to align the execution time of underlying securities
transactions with the NAV calculation of the order, and thus minimize
costs and support effective arbitrage.\239\ Some commenters stated

[[Page 57182]]

that eliminating the T-1 order window may lead to wider bid-ask
spreads, larger premiums/discounts, and greater tracking differences
for these ETFs.\240\ One commenter stated that, without T-1 orders, an
ETF may have uninvested cash for longer periods of time (leading to
increased tracking error) and authorized participants may need to hedge
their exposures for longer than usual due to the delay between when the
creation order is placed and when the ETF acquires the portfolio
securities (leading to wider bid-ask spreads).\241\ Another commenter
noted that moving the T-1 order window later into the evening to allow
the ETF to calculate and disclose its portfolio holdings before
accepting T-1 orders would require an additional staffing shift, and
thus would impose additional staffing costs on sponsors, custodians,
and other market participants.\242\
---------------------------------------------------------------------------

\239\ See, e.g., ICI Comment Letter (discussing the importance
to authorized participants of the ability to trade or hedge the
underlying exposures at the same time the ETF strikes its NAV);
BlackRock Comment Letter; Jane Street Comment Letter (stating that
``market participants have found that that benefits of agreeing to
an order shortly after market close outweighs] the costs imposed by
lack of certainty'').
\240\ See, e.g., ICI Comment Letter (asserting that inability to
trade at T-1 could introduce slippage, which in turn may lead to
wider bid-ask spreads and larger premium/discounts); CSIM Comment
Letter; Comment Letter of OppenheimerFunds (Oct. 1, 2018)
(``OppenheimerFunds Comment Letter''). See also BlackRock Comment
Letter (``Many ETFs in the marketplace currently take orders prior
to publication of basket or portfolio holdings information and
operate efficiently and with tight spreads.'').
\241\ See Dechert Comment Letter.
\242\ See Invesco Comment Letter.
---------------------------------------------------------------------------

Commenters recommended alternatives to the proposed rule's timing
requirements. Several commenters suggested we require portfolio
holdings disclosure only before the opening of regular trading on the
primary listing exchange.\243\ These commenters asserted that
authorized participants placing purchase or redemption orders on a T-1
basis are able to assess and hedge market risk associated with
transacting in underlying foreign securities prior to regular trading
in U.S. equity markets. Other alternatives suggested by commenters
included: (i) Carving out ETFs investing in foreign markets from the
proposed timing requirements; \244\ and (ii) permitting ETFs to accept
T-1 orders provided that they first share certain standardized
information with authorized participants.\245\
---------------------------------------------------------------------------

\243\ See NYSE Comment Letter; CSIM Comment Letter; WisdomTree
Comment Letter.
\244\ See Nasdaq Comment Letter.
\245\ See Invesco Comment Letter (suggesting that, as a
condition for accepting T-1 orders, ETFs be required to provide APs
with (1) the last-published portfolio holdings, (2) applicable
corporate action information, (3) data relating to index changes,
and (4) an updated basket file).
---------------------------------------------------------------------------

After considering these comments, we are not adopting the proposed
requirement that an ETF disclose its portfolio holdings before it
starts accepting orders for the purchase or redemption of creation
units. Instead, rule 6c-11 will require an ETF to disclose the
portfolio holdings that will form the basis for the ETF's next
calculation of NAV per share each business day before the opening of
regular trading on the primary listing exchange of the exchange-traded
fund shares.\246\ This will accommodate T-1 orders, as requested by
commenters, and is consistent with our existing exemptive orders.\247\
---------------------------------------------------------------------------

\246\ 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
rule 6c-11(a)(1).
\247\ 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), and related application
(``Salt Financial'') (requiring disclosure of portfolio holdings
before commencement of trading on the exchange).
---------------------------------------------------------------------------

The goal of our proposed timing requirement was to facilitate
effective arbitrage by providing authorized participants and other
market participants buying and selling ETF shares with portfolio
holdings information at the time of the transaction. We believe that
accommodating T-1 orders, but requiring disclosure before the opening
of regular trading on the primary listing exchange of the ETF's shares,
will nonetheless allow for effective arbitrage. Commenters stated that
ETFs utilizing T-1 orders have shown relatively narrow bid-ask spreads
and small premiums and discounts, and stated that precluding T-1 orders
could have the unintended effect of actually widening bid-ask spreads
and disrupting existing market practices.\248\ Moreover, staff review
of the websites of several ETFs that disclose that they use T-1 orders
indicates that these ETFs' bid-ask spreads and premiums and discounts
fall approximately within the same range as ETFs that do not use T-1
orders.
---------------------------------------------------------------------------

\248\ See, e.g., Jane Street Comment Letter; ICI comment Letter;
BlackRock Comment Letter; SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

We considered whether to impose other conditions for the acceptance
of T-1 orders, such as disclosure of the last published portfolio
holdings. However, given the information already available to market
participants and the data demonstrating that existing market practices
have led to effective arbitrage, we do not believe additional
conditions are currently necessary to facilitate arbitrage for these
orders.
b. Presentation of Portfolio Holdings Disclosure
Rule 6c-11 will require an ETF to disclose standardized information
regarding each portfolio holding.\249\ The rule, however, will not
require this information to be presented and contain information in the
manner prescribed within Article 12 of Regulation S-X as proposed.\250\
In response to concerns and suggestions of commenters, we have modified
this condition to require ETFs to disclose a limited set of information
for each portfolio holding.\251\
---------------------------------------------------------------------------

\249\ Rule 6c-11(c)(1)(i). As proposed, the term ``portfolio
holdings'' is defined to mean an ETF's securities, assets, or other
positions. See rule 6c-11(a)(1). As a result, ETFs relying on rule
6c-11 are required to disclose securities, their cash holdings, as
well as holdings that are not securities or assets, including short
positions or written options. For example, an ETF will 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. We did not receive any comments on this
definition.
\250\ See 2018 ETF Proposing Release, supra footnote 7, at
nn.220-221 (noting that a staff review of ETF websites found little
consistency in how portfolio holdings information was presented,
particularly with respect to derivatives, which could lead to
investor confusion).
\251\ See infra footnotes 257-260 and accompanying text.
---------------------------------------------------------------------------

Commenters on this aspect of the proposal agreed that there
currently is little consistency in the presentation of holdings
information by ETFs,\252\ and generally agreed this disclosure should
be standardized.\253\ Several commenters, however, stated that the
specific presentation standard included in the proposed rule (i.e.,
Article 12 of Regulation S-X) is not an appropriate framework for daily
portfolio holdings disclosures by ETFs.\254\ Commenters

[[Page 57183]]

asserted that certain of the Article 12 requirements are overly
burdensome for daily disclosure or unnecessary to achieve the
Commission's goal of facilitating effective arbitrage.\255\
---------------------------------------------------------------------------

\252\ See, e.g., Cary Comment Letter; ETF.com Comment Letter.
\253\ See, e.g., BlackRock Comment Letter; BNY Mellon Comment
Letter; Fidelity Comment Letter.
\254\ See, e.g., Fidelity Comment Letter; ICI Comment Letter.
The proposed Article 12 presentation requirements would have
required an ETF to 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 the ETF's investments in securities, securities
sold short, and other investments. For derivatives, Article 12 would
require disclosure that includes 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). 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.
\255\ See, e.g., WisdomTree Comment Letter (explaining that
Article 12 requires detailed categorization of investments by
investment type, industry, and country or geographic region and also
requires identification of fair valued and non-income producing
securities); SIFMA AMG Comment Letter I (stating that information
such as appreciation and depreciation for derivatives, as required
under Article 12, would be difficult and impractical to calculate
and disseminate on a daily basis); Comment Letter of Franklin
Resources, Inc. (Oct. 1, 2018) (``Franklin Templeton Comment
Letter'') (noting that certain data required under Article 12 is
updated only on a quarterly basis and would not be easily accessible
on a daily basis); BlackRock Comment Letter; ICI Comment Letter.
---------------------------------------------------------------------------

Some commenters recommended alternative approaches. Several
commenters, for example, suggested using disclosure requirements based
on the generic listing standards for actively managed ETFs.\256\ One of
these commenters stated that using the generic listing standards would
provide ``more streamlined portfolio holdings disclosure that includes
a subset of the items required by Article 12 that is most relevant and
useful for investors.'' \257\ Other commenters stated that the
Commission should consider a more limited set of requirements, such as:
(i) The name of the security; (ii) the size of the position; (iii) the
percentage exposure to such security; and (iv) the security's
value.\258\ Some commenters also recommended that, in addition to
website disclosure, rule 6c-11 require ETFs to file portfolio holdings
information in a central public location, such as EDGAR.\259\
---------------------------------------------------------------------------

\256\ See, e.g., BlackRock Comment Letter; Fidelity Comment
Letter; Eaton Vance Comment Letter. See also ICI Comment Letter
(noting that standardizing ``the presentation formats based on
exchange listing requirements would obviate the need for two
separate schedules, a costly and largely redundant exercise with no
additional benefit''). The listing exchanges' current generic
listing standards for actively managed ETFs require disclosure of
ticker symbol; CUSIP or other identifier; description of the
holding; identity of the asset upon which the derivative is based;
strike price for any options; quantity of each security or other
asset held as measured by (i) par value, (ii) notional value, (iii)
number of shares, (iv) number of contracts, and (v) number of units;
maturity date; coupon rate; effective date; market value; and
percentage weight of the holding in the portfolio. See, e.g., NYSE
Arca Rule 8.600-E(c)(2); Nasdaq Rule 5735(c)(2); Cboe BZX Rule
14.11(i)(3)(B).
\257\ See BlackRock Comment Letter.
\258\ See, e.g., WisdomTree Comment Letter. See also CSIM
Comment Letter (suggesting that Commission adopt an ETF holdings
disclosure requirement similar to what money market funds report on
fund websites); Cary Comment Letter (recommending disclosure of the
portfolio holding's ticker symbol and weighting in the portfolio as
minimum requirements); Comment Letter of ICE Data Services,
Intercontinental Exchange (Oct. 1, 2018) (``IDS Comment Letter'')
(stating that Commission should consider a standardized nomenclature
for ETFs' description of derivative holdings).
\259\ See, e.g., Reagan Comment Letter. See also Morningstar
Comment Letter (recommending that the Commission also require ETFs
to disclose the information and other website disclosure
requirements in structured format for analysis and comparison
purposes); FIMSAC Comment Letter (recommending the rule require ETFs
to file certain website disclosures on EDGAR or another public,
centralized database).
---------------------------------------------------------------------------

We proposed the Article 12 framework because ETFs are already
required to comply with Article 12 for periodic financial reporting
purposes and therefore we believed that it would provide an efficient
way to standardize daily portfolio holdings disclosure. After
considering comments, however, we believe that a more streamlined
requirement will provide standardized portfolio holdings disclosure in
a more efficient, less costly, and less burdensome format, while still
providing market participants with relevant information. Accordingly,
rule 6c-11 will require an ETF to post a subset of the information
required by the listing exchanges' current generic listing standards
for actively managed ETFs. Rule 6c-11 will require ETFs to disclose the
following information for each portfolio holding on a daily basis: (1)
Ticker symbol; (2) CUSIP or other identifier; (3) description of
holding; (4) quantity of each security or other asset held; and (5)
percentage weight of the holding in the portfolio.\260\ We believe that
this framework will provide market participants with the information
necessary to support an effective arbitrage mechanism and eliminate
potential investor confusion due to a lack of standardization.
---------------------------------------------------------------------------

\260\ Article 12 of Regulation S-X also generally requires
disclosure of these items, but does not require a ticker, CUSIP, or
other identifier for a holding. See, e.g., 17 CFR 210.12-12, 210.12-
12A (requiring disclosure of name of issuer and title of issue). We
believe that such identifiers can allow market participants to
efficiently identify the asset or security held, and thus we
included this requirement, which is required under the current
generic listing standards for actively managed ETFs.
---------------------------------------------------------------------------

As commenters suggested, to arbitrage an ETF's holdings, market
participants generally must be able to identify the security or asset
held, the quantity held, and percentage weighting of the holding in the
ETF's portfolio.\261\ To enable market participants to identify the
investment held, we are requiring the ETF to disclose the ticker, CUSIP
or other identifier (where applicable) of the holding, and to provide a
description of the holding. Because certain investments may not have
been assigned a common securities identifier, we are requiring the ETF
to provide a brief description of the investment to allow an investor
to effectively hedge the ETF.\262\ For example, ETFs holding debt
securities should include the security's name, maturity date, coupon
rate, and effective date, where applicable, to assist investors in
identifying the specific security held.\263\ To indicate the quantity
of a security or other asset held, the ETF generally should use the
measure typically associated with quantifying that class of security,
such as number of shares for equity securities, par value for debt
securities, number of units for securities, such as UITs, that are
measured in units, and dollar value for cash. With respect to
derivatives, the ETF generally should provide both the notional value
of the derivative and number of contracts, as well as a general
description of the investment, which should include the type of
derivative (i.e., swap, option, forward). ETFs also may want to
consider several of the other reporting fields in Form N-PORT, for
example, depending on the type of investment the ETF holds, in order to
provide investors with the necessary information.
---------------------------------------------------------------------------

\261\ See, e.g., WisdomTree Comment Letter.
\262\ See, e.g., 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''), at section II.A.4.g.i. (discussing use of
unique securities identifiers for portfolio holdings and observing
that some holdings lack such identifiers).
\263\ Based on our experience with structured portfolio
reporting, such as Form N-PORT, we believe that this information
will provide a sufficient amount of data for a market participant to
understand the payment profile of the investment and therefore
arbitrage the ETF's portfolio holdings. See id., at section
II.A.4.g.ii.
---------------------------------------------------------------------------

We continue to believe that the ETF's website is the most effective
location for the disclosure of portfolio holdings information. By
posting the portfolio information on its website, free of charge, the
ETF makes the information available to a broad range of investors,
including retail investors, and other market participants.\264\ We
further believe, and commenters agreed, that requiring ETFs to file
their portfolio holdings information on EDGAR would impose additional
costs on ETFs that are not justified in light of other available
disclosure methods.\265\ Moreover, the purpose of this requirement is
to allow ETF investors to understand and potentially arbitrage the
ETF's holdings. We therefore do not believe that requiring ETFs to file
daily portfolio

[[Page 57184]]

holding disclosure on EDGAR or other centralized location in order to
provide potentially greater comparability across ETFs is justified in
light of current market practices and the additional costs associated
with such a requirement.\266\ In addition, other documents, such as
reports on Form N-PORT or Form N-CEN, registration statements on Form
N-1A, and consolidated structured datasets derived from those
submissions, provide centralized, structured information, including
information about portfolio holdings, that can be analyzed and compared
across ETFs, albeit on a less frequent basis.\267\
---------------------------------------------------------------------------

\264\ See 2018 ETF Proposing Release, supra footnote 7, at n.271
and accompanying text (discussing advantages of website posting over
use of National Securities Clearing Corporation (``NSCC'') portfolio
composition file).
\265\ See, e.g., Invesco Comment Letter (stating that additional
dissemination requirements, such as EDGAR, would be costly).
\266\ As stated above, however, we encourage ETFs to consider
whether there are technological means, such as including portfolio
holdings information in a machine-readable format, to make these
disclosures more accessible. See supra footnote 226.
\267\ See, e.g., Part C of Form N-PORT.
---------------------------------------------------------------------------

c. Portfolio Holdings That Will Form the Basis for the ETF's NAV
Calculation
As proposed, rule 6c-11 will 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.\268\
Changes in an ETF's holdings of portfolio securities would therefore be
reflected on a T+1 basis. We did not receive any comments on this
proposed condition, which is consistent with current ETF practices. We
continue to believe that requiring an ETF to disclose the portfolio
that will form the basis for the next NAV calculation at the beginning
of the business day will help to facilitate the efficient functioning
of the arbitrage process while protecting against potential front-
running of the ETF's trades.
---------------------------------------------------------------------------

\268\ See rule 6c-11(c)(1)(i). See also 2018 Proposing Release,
supra footnote 7, at nn.210-211 and accompanying text.
---------------------------------------------------------------------------

Accordingly, rule 6c-11 will not require ETFs to disclose intraday
changes in portfolio holdings because these changes would not affect
the portfolio composition serving as a basis for NAV calculation until
the next business day.\269\ We continue to believe that the selective
disclosure of nonpublic information regarding intraday changes in
portfolio holdings (or any advance disclosure of portfolio trades)
could result in the front-running of an ETF's trades, causing the ETF
to pay more to obtain a security.\270\ We have stated that registered
investment companies' compliance policies and procedures required by
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.\271\ ETFs also are required to describe their
policies and procedures on portfolio security disclosure in the
Statement of Additional Information and post such policies and
procedures on their websites.\272\
---------------------------------------------------------------------------

\269\ See 2018 ETF Proposing Release, supra footnote 7, at note
222 and accompanying text.
\270\ We also requested comment in the proposal on whether we
should amend Regulation FD to apply to ETFs. Regulation FD prohibits
the selective disclosure of material information by publicly traded
companies and other issuers. See 2018 ETF Proposing Release, supra
footnote 7, at n.228. We received two comments stating that ETFs
should be subject to Regulation FD. See Eaton Vance Comment Letter;
Jane Street Comment Letter. However, we are not amending Regulation
FD at this time in order to further explore certain aspects of
applying Regulation FD to ETFs, which unlike other entities subject
to this regulation, are continuously offered.
\271\ Rule 38a-1 Adopting Release, supra footnote 134. Pursuant
to rule 6c-11, ETFs are required to disclose portfolio holdings
information with greater frequency than other open-end funds, which
are generally required to publicly disclose holdings on a quarterly
basis. However, we have previously noted that 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. See 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. 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. Id.
\272\ See Items 9(d) and 16(f) of Form N-1A; see also Disclosure
of Portfolio Holdings Release, supra footnote 272, at section II.C.
---------------------------------------------------------------------------

5. Baskets
As proposed, rule 6c-11 will require an ETF relying on the rule to
adopt and implement written policies and procedures governing the
construction of baskets and the process that the ETF will use for the
acceptance of baskets.\273\ In addition, as proposed, the rule will
provide an ETF with flexibility to use ``custom baskets'' if the ETF
has adopted 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 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'').\274\
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\273\ See rule 6c-11(c)(3). The rule will 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 rule 6c-11(a)(1).
\274\ See rule 6c-11(c)(3); see also infra footnote 299 and
accompanying text.
---------------------------------------------------------------------------

a. Basket Policies and Procedures
When 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. Basket composition affects the costs of
assembling and delivering the baskets exchanged for creation units as
well as the costs of liquidating basket securities when redeeming
creation units.\275\ Basket composition also is important to ETF
portfolio management, as each in-kind creation or redemption increases
or decreases positions in the ETF's portfolio, and allows portfolio
managers to add or remove certain portfolio holdings. 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, undesired
changes to the portfolio may result, such as the loss of desirable
bonds when paying redemptions in kind.
---------------------------------------------------------------------------

\275\ 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.
---------------------------------------------------------------------------

The exemptive relief relating to baskets evolved over time. 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.\276\ Since approximately 2006, however, our orders placed
tighter restrictions on an open-end ETF's composition of baskets.\277\
These orders expressly require 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.\278\
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\276\ 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.
Our earliest ETF orders for ETFs organized as UITs provide 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. Given the unmanaged nature of the UIT
structure, a UIT ETF's basket generally reflected a pro rata
representation of the ETF's portfolio. See SPDR, supra footnote 51.
\277\ See, e.g., 2006 WisdomTree Investments, supra footnote
201.
\278\ See id.; see also 2018 ETF Proposing Release, supra
footnote 7, at nn. 238-242 and accompanying text (describing the
circumstances when a basket could deviate from a pro rata
representation of the ETF's portfolio under recent exemptive
orders).

---------------------------------------------------------------------------

[[Page 57185]]

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 that favors an 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-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.\279\
---------------------------------------------------------------------------

\279\ 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.
---------------------------------------------------------------------------

Based on our experience with ETFs, however, we believe there are
many circumstances, in addition to the specific circumstances
enumerated in our orders, where allowing basket assets to differ from a
pro rata representation or allowing the use of different baskets 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 basket when transacting in kind,
making it more difficult and costly for authorized participants and
other market participants to assemble or liquidate baskets. 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 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 later, more stringent restrictions on baskets.
Moreover, certain exceptions to a pro rata basket requirement may
help ETFs operate more efficiently. For example, ETFs, particularly
fixed-income ETFs, that do not have basket flexibility may 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.\280\ ETFs that meet redemptions in cash may
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.\281\
---------------------------------------------------------------------------

\280\ 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
LLCP, 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.
\281\ In-kind redemptions allow ETFs to avoid taxable events and
certain transaction costs that arise when selling securities for
cash within the ETF. See, e.g., Prudential Investments LLC, et al.,
Investment Company Act Release Nos. 32351 (Nov. 1, 2016) (notice)
[81 FR 78228 (Nov. 7, 2016)] and 32374 (Nov. 30, 2016) (order) and
related application (stating that cash redemptions may result in
adverse tax consequences and higher transaction costs, such as
brokerage costs, than in-kind redemptions). Additionally, based upon
Form N-CEN data through September 5, 2019, the median transaction
fee charged to an authorized participant for the use of an in-kind
basket to satisfy a redemption was approximately $350.00, while the
median transaction fee for the use of a basket that was partially or
fully composed of cash was approximately $375.00, when charged on a
per-creation-unit basis.
---------------------------------------------------------------------------

We therefore proposed to provide additional basket flexibility,
subject to conditions designed to address concerns regarding the
potential risk of overreaching. Specifically we proposed to require
ETFs to adopt: (i) Policies and procedures governing the construction
of baskets and the process that would be used for the acceptance of
baskets generally; and (ii) heightened process requirements for ETFs
using custom baskets, including policies and procedures specifically
covering the use of custom baskets.\282\
---------------------------------------------------------------------------

\282\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.5.a.
---------------------------------------------------------------------------

Commenters generally supported requiring ETFs to adopt policies and
procedures governing the construction of baskets.\283\ One commenter
stated, for example, that this requirement is consistent with other
investment and portfolio management processes that require guidelines,
oversight and recordkeeping.\284\ Commenters also generally supported
our proposal to permit ETFs relying on the rule to use custom baskets
provided they adopt certain heightened process requirements.\285\ These
commenters agreed that providing ETFs with the flexibility to use
custom baskets potentially could benefit ETF investors through more
effective arbitrage and more efficient portfolio management.\286\ One
commenter provided the results of an analysis it performed indicating
that fixed-income ETFs with basket flexibility had narrower bid-ask
spreads, had lower tracking differentials (i.e., the difference between
the ETF's daily return and the daily return of its benchmark), and
traded at smaller discounts than fixed-income ETFs without basket
flexibility.\287\
---------------------------------------------------------------------------

\283\ See, e.g., ICI Comment Letter; BlackRock Comment Letter;
SIFMA AMG Comment Letter I.
\284\ See SIFMA AMG Comment Letter I.
\285\ See, e.g., ICI Comment Letter; BlackRock Comment Letter;
Invesco Comment Letter; BNY Mellon Comment Letter; IDC Comment
Letter; Fidelity Comment Letter.
\286\ See, e.g., BlackRock Comment Letter.
\287\ See ICI Comment Letter. See also infra footnotes 574-575
and accompanying text.
---------------------------------------------------------------------------

One commenter, however, asserted that the rule should not afford
custom basket flexibility to all ETFs relying on it.\288\ Rather, this
commenter opined that the rule should require fixed-income ETFs to make
in-kind, pro rata redemptions upon shareholder request (with limited
substitutions for holdings that cannot be settled or transferred)
because, under certain market conditions, custom baskets can lead to
greater price volatility and dislocation from NAV for these ETFs.
---------------------------------------------------------------------------

\288\ See Bluefin Comment Letter.
---------------------------------------------------------------------------

Some commenters, although generally supporting custom basket
flexibility and the proposed heightened process requirements, requested
that we modify or clarify certain aspects of the proposed
condition.\289\ For example, one commenter did not support requiring
``detailed parameters'' for the construction and acceptance of custom
baskets, stating that the rule should permit ETF sponsors to develop
broad policies and procedures to cover the wide range of circumstances
that may arise relating to custom baskets.\290\ Another commenter
stated that the Commission should explicitly set forth the appropriate
considerations for custom basket policies and procedures, such as
periodic monitoring and testing and oversight of the custom basket
process.\291\ This commenter also stated that the Commission should
clarify that an ETF has discretion to tailor its custom basket policies
and procedures to address different risks, considerations, and
requirements for

[[Page 57186]]

different types of custom baskets, particularly those involving cash
substitutions.
---------------------------------------------------------------------------

\289\ See, e.g., ICI Comment Letter; BlackRock Comment Letter;
Invesco Comment Letter; BNY Mellon Comment Letter; IDC Comment
Letter; Fidelity Comment Letter; Dechert Comment Letter.
\290\ See Invesco Comment Letter.
\291\ See BlackRock Comment Letter.
---------------------------------------------------------------------------

We are adopting the basket conditions under rule 6c-11 as proposed.
Rule 6c-11 therefore will require an ETF 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 as
proposed.\292\ These policies and procedures must cover the methodology
that the ETF will use to construct baskets. For example, the policies
and procedures should detail the circumstances under which the basket
may omit positions that are not operationally feasible to transfer in
kind. The policies and procedures also 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. 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 underlying securities market index, if
applicable. We believe this policies and procedures requirement will
protect against overreaching and other abusive practices in
circumstances where an ETF uses a basket that does not reflect a pro
rata slice of the ETF's portfolio holdings, but does not meet the
definition of custom basket.
---------------------------------------------------------------------------

\292\ See rule 6c-11(c)(3).
---------------------------------------------------------------------------

Rule 6c-11 also will require the policies and procedures to (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.\293\ We continue to
believe that an ETF and its shareholders may benefit from custom
baskets and that the heightened process requirements for custom baskets
in rule 6c-11 serve to protect the ETF and its shareholders from the
risks that custom baskets may present.
---------------------------------------------------------------------------

\293\ Rule 6c-11(c)(3)(i) and (ii).
---------------------------------------------------------------------------

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. They also 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. An ETF should consistently apply the custom basket
policies and procedures 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, an ETF's custom basket policies and procedures
should include reasonable controls designed to prevent inappropriate
differential treatment among authorized participants.
We do not believe that the requirement for ``detailed parameters''
would prevent an ETF sponsor from developing policies and procedures to
cover the wide range of circumstances that may arise relating to custom
baskets.\294\ ETFs may tailor their custom basket policies and
procedures to address different risks and requirements for different
types of custom baskets. For example, an ETF could develop tailored
procedures when it uses cash substitutions that differ from the
procedures it uses when substituting securities and other positions. An
ETF's custom basket policies and procedures also could address the
differing considerations for custom baskets depending on the direction
of the trade (i.e., whether the custom basket is being used for a
creation or a redemption).\295\ This condition provides 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 facilitating portfolio
management changes in a cost- and tax-efficient manner.
---------------------------------------------------------------------------

\294\ See Invesco Comment Letter.
\295\ See BlackRock Comment Letter.
---------------------------------------------------------------------------

Although one commenter opined that fixed-income ETFs present unique
concerns, we believe that requiring fixed-income ETFs to establish
detailed parameters for the construction and acceptance of custom
baskets that are in the best interests of the ETF and its shareholders
will address the risks associated with custom baskets. As discussed
above, we also believe that fixed-income ETFs (and their shareholders)
may experience the most pronounced benefits from basket
flexibility.\296\ As a result, all ETFs that comply with the conditions
in rule 6c-11 will have basket flexibility.
---------------------------------------------------------------------------

\296\ See supra footnotes 281-282 and accompanying text and
footnote 288 and accompanying text.
---------------------------------------------------------------------------

One commenter stated that the Commission should confirm that the
``best interests of the ETF and its shareholders'' standard included in
rule 6c-11(c)(3)(i) includes the ETF's shareholders generally rather
than individually, on the basis that the adviser to an ETF owes a
fiduciary duty only to the ETF, and that ETFs cannot evaluate the
interests of individual shareholders.\297\ The ``best interests of the
ETF and its shareholders'' in this context is not intended to apply to
each ETF shareholder individually, but rather to the ETF's shareholders
generally. This formulation is consistent with other Commission
rules.\298\
---------------------------------------------------------------------------

\297\ See SIFMA AMG Comment Letter I.
\298\ See, e.g., 17 CFR 270.12b-1 (rule 12b-1 under the Act)
(providing that fund board may approve distribution plan under rule
12b-1 only if, among other things, the board concludes ``that there
is a reasonable likelihood that the plan will benefit the company
and its shareholders''); 17 CFR 270.2a-7 (rule 2a-7 under the Act)
(providing that board of a money market fund, in order to use
certain share price calculation methods, must determine ``that it is
in the best interests of the fund and its shareholders'' to maintain
a stable net asset value per share).
---------------------------------------------------------------------------

As proposed, rule 6c-11 also will require an ETF, as part of its
custom basket policies and procedures, to 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. Several commenters did not support this
requirement as proposed.\299\ One of these commenters stated that the
rule should require ETFs to identify only the employees that are
responsible for approving custom baskets that deviate from the
parameters set forth in the policies and procedures.\300\ Another
commenter stated that the review requirement is overly prescriptive and
could cause operational challenges when an ETF is sub-advised.\301\
---------------------------------------------------------------------------

\299\ See, e.g., SIFMA AMG Comment Letter I; WisdomTree Comment
Letter I.
\300\ See SIFMA AMG Comment Letter I.
\301\ See WisdomTree Comment Letter.
---------------------------------------------------------------------------

In addition, several commenters did not support the statement in
the 2018 ETF Proposing Release that 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.\302\
Commenters stated that approval of custom baskets is a typical
portfolio management function, and that requiring non-investment
personnel to review custom baskets before approving a creation or
redemption would be

[[Page 57187]]

impractical, burdensome, and would detract from the flexibility custom
baskets provide.\303\ One commenter requested that the Commission
clarify that the requirement to approve custom baskets applies only to
employees with discretionary or direct supervisory authority over
custom baskets, and not to employees responsible for governance, back-
testing, or periodic reviews.\304\
---------------------------------------------------------------------------

\302\ See, e.g., Dechert Comment Letter; Fidelity Comment
Letter; JPMAM Comment Letter; SIFMA AMG Comment Letter I; Invesco
Comment Letter; CSIM Comment Letter; SSGA Comment Letter I.
\303\ See, e.g., Dechert Comment Letter; Fidelity Comment
Letter; JPMAM Comment Letter; Invesco Comment Letter; CSIM Comment
Letter.
\304\ See BlackRock Comment Letter.
---------------------------------------------------------------------------

We continue to 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.\305\ We also believe that the adviser
is in the best position to determine which employee (or employees) are
responsible for determining whether an ETF's custom baskets comply with
the custom basket policies and procedures depending on its own
structure, strategy, and other relevant circumstances (including
whether the ETF is sub-advised). The ETF's adviser (and personnel) are
familiar with the ETF's portfolio holdings and are able to assess
whether the process and methodology used to construct or accept a
custom basket is 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 will allow an ETF to establish a tailored framework
for the use of custom baskets, while also requiring the ETF to put into
place safeguards against abusive practices related to basket
composition.
---------------------------------------------------------------------------

\305\ 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 64,
at n.68. See also supra footnote 64 (discussing certain other
obligations for registered investment advisers).
---------------------------------------------------------------------------

To the extent that a particular ETF's investment adviser determines
that its portfolio management employees are the appropriate employees
to be responsible for compliance with the custom basket policies and
procedures, we believe that the requirements of rule 38a-1 under the
Act provide appropriate safeguards to address possible conflicts of
interest that could arise from such an arrangement. For example, 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.\306\ 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.\307\ For example, an
ETF would be required to preserve the basket policies and procedures
pursuant to the requirements of rule 38a-1(d)(1). Also, 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.\308\
---------------------------------------------------------------------------

\306\ See Rule 38a-1 Adopting Release, supra footnote 134. Among
other things, rule 38a-1 requires a fund's chief compliance officer
to provide a written report to the fund'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).
\307\ The compliance policies and procedures could require, for
example, the ETF's chief compliance officer or other compliance
professionals to conduct a post hoc, periodic review of a sample of
custom baskets used by the ETF.
\308\ Several commenters expressed support for the description
in the 2018 ETF Proposing Release of the oversight role of ETF
boards, including with respect to custom basket policies and
procedures. See ETF.com Comment Letter; IDC Comment Letter; Nasdaq
Comment Letter.
---------------------------------------------------------------------------

b. Definition of Custom Baskets
As proposed, rule 6c-11 will define ``custom baskets'' to include
two categories of baskets. First, a basket containing a non-
representative selection of the ETF's portfolio holdings would
constitute a custom basket.\309\ These types of custom baskets include,
but are not limited to, baskets that do not reflect: (i) A pro rata
representation of the ETF's portfolio holdings; (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.\310\
---------------------------------------------------------------------------

\309\ Rule 6c-11(a)(1).
\310\ 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'' except
to the extent different baskets are used in transactions on the same
business day.
---------------------------------------------------------------------------

Second, if different baskets are used in transactions on the same
business day, each basket after the initial basket would constitute a
custom basket. For example, if an ETF exchanges a basket with either
the same or another authorized participant that reflects a
representative sampling that differs from the initial basket, that
basket (and any such subsequent baskets) would be a custom basket.\311\
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.
---------------------------------------------------------------------------

\311\ When making the best interest determination for such
custom baskets, the ETF should consider how this change in sampling
affects the ETF's portfolio.
---------------------------------------------------------------------------

We received a number of comments on the proposed definition of
custom basket. Several commenters asserted that baskets including cash
substitutions should not be subject to the heightened policies and
procedures requirement for custom baskets, and thus should be excluded
from the definition of custom baskets.\312\ These commenters asserted
that baskets with cash substitutions do not raise the same concerns
about conflicts or overreach as securities substitutions.\313\
Commenters also contended that the use of cash substitutions as part of
standard (i.e., non-custom) baskets is a routine portfolio management
matter that is necessary for the efficient operation of ETFs.\314\ One
commenter suggested several technical changes to the proposed
definition of custom basket in rule 6c-11 to treat cash substitutions
as part of a non-custom, pro rata basket under certain enumerated
circumstances.\315\
---------------------------------------------------------------------------

\312\ See, e.g., ICI Comment Letter; BlackRock Comment Letter;
Fidelity Comment Letter; Dechert Comment Letter; SIFMA AMG Comment
Letter I; SSGA Comment Letter I.
\313\ See, e.g., Fidelity Comment Letter (``Purchasing or
redeeming using a cash basket does not create opportunities for
`cherry picking,' `dumping' or other abuses . . . and therefore does
not give rise to the risk of overreaching that the proposed custom
basket policies and procedures were designed to prevent.''); ICI
Comment Letter; BlackRock Comment Letter; SIFMA AMG Comment Letter
I; JPMAM Comment Letter.
\314\ See, e.g., SIFMA AMG Comment Letter I (asserting that
``the use of cash is driven by restrictions applicable to authorized
participants, restrictions on in-kind transactions in certain
markets, or authorized participants' inability to access individual
securities.''); JPMAM Comment Letter. See also CSIM Comment Letter
(recommending that the standard basket policies and procedures,
rather than the custom basket policies and procedures, cover cash
substitutions).
\315\ See BlackRock Comment Letter (recommending that we deem a
basket to be pro rata if it: (1) Substitutes cash for odd lot
positions or as a result of minimum trade sizes; (2) substitutes
cash due to security specific restrictions, such as corporate
actions or regulatory reasons; (3) substitutes cash for positions or
other instruments that cannot be delivered in-kind (e.g.,
derivatives, to-be-announced (or ``TBA'') transactions); or (4) is
otherwise representative of the ETF).

---------------------------------------------------------------------------

[[Page 57188]]

After consideration of these comments, we are adopting the
definition of ``custom basket'' as proposed. While we generally agree
with commenters that cash substitutions may not raise the same concerns
as securities substitutions, an ETF's use of cash substitutions may
raise concerns regarding the potential for an authorized participant to
overreach, particularly in connection with redemptions. For example,
during periods of market stress, an authorized participant may demand
cash from the ETF instead of less liquid securities in exchange for ETF
shares, impacting the liquidity of the ETF's portfolio and the ability
of the ETF to satisfy additional cash redemption requests from
authorized participants.\316\
---------------------------------------------------------------------------

\316\ See generally LRM Adopting Release, supra footnote 123.
---------------------------------------------------------------------------

We also considered excluding certain types of cash substitutions
from the definition of custom baskets where authorized participant
overreach is unlikely, consistent with the approach taken in our recent
exemptive orders.\317\ However, we are concerned that such an approach
may fail to effectively capture all circumstances in which an ETF may
substitute cash. We believe that the policies and procedures
requirements for custom baskets will provide ETFs with sufficient
flexibility to design custom basket policies and procedures that are
tailored to address the different risks that cash substitutions and
securities substitutions may present. An ETF could, for example, design
custom basket policies and procedures with more streamlined
requirements for certain cash substitutions that present lower
risks.\318\
---------------------------------------------------------------------------

\317\ For example, authorized participant overreach is unlikely
where the ETF substitutes cash for odd lot positions or as a result
of minimum trade sizes.
\318\ See BlackRock Comment Letter.
---------------------------------------------------------------------------

c. Basket Publication Requirement
Proposed rule 6c-11 would have required an ETF to post information
regarding 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 (a ``published basket'') on its website each business
day.\319\ This proposed disclosure requirement was designed to: (i)
Facilitate arbitrage by providing authorized participants and other
market participants with timely information regarding the contents of a
basket that the ETF will accept each day; and (ii) allow market
participants that do not have access to an ETF's daily portfolio
composition file to compare the ETF's basket with its portfolio
holdings, assist in building intraday hedges, and estimate the cash
balancing amount. After considering comments, however, the Commission
is not including a basket publication requirement in rule 6c-11.
---------------------------------------------------------------------------

\319\ See proposed rule 6c-11(c)(1)(i).
---------------------------------------------------------------------------

Commenters generally did not support requiring disclosure of a
published basket on the ETF's website.\320\ For example, one commenter
asserted that the proposed published basket was ``speculative,'' and
had little value, particularly for certain types of fixed-income
ETFs.\321\ Several commenters contended that the contents of an ETF's
basket are irrelevant for secondary market investors and publication of
an ETF's basket could result in confusion, particularly if the basket
is mistaken for portfolio holdings information.\322\ Other commenters
stated that the publication requirement could delay the process by
which the ETF and an authorized participant negotiate the contents of a
custom creation or redemption basket.\323\ Another commenter stated
that we should require an ETF to provide its published basket through
the NSCC, rather than through its website, because the market
participants that would use the published basket currently are able to
access it either directly through the NSCC or through
intermediaries.\324\
---------------------------------------------------------------------------

\320\ See, e.g., SIFMA AMG Comment Letter I; Invesco Comment
Letter I; Nasdaq Comment Letter; CSIM Comment Letter.
\321\ See, e.g., SIFMA AMG Comment Letter I; see also CSIM
Comment Letter (``CSIM does not believe that disclosure of one
standard basket for orders to create or redeem creation units on an
ETF's website would be useful disclosure to either individual
investors or authorized participants as proposed.'').
\322\ See, e.g., CSIM Comment Letter; ICI Comment Letter. One
commenter also noted that the proposed amendments to Form N-1A
eliminated other disclosure that were relevant only to authorized
participants and potentially confusing to secondary market
investors. See ICI Comment Letter.
\323\ See, e.g., Invesco Comment Letter; Nasdaq Comment Letter.
\324\ See OppenheimerFunds Comment Letter.
---------------------------------------------------------------------------

After considering these comments, the Commission is not including
in rule 6c-11 a requirement that an ETF post information regarding one
published basket that it would exchange for orders to purchase or
redeem creation units. We proposed this condition, in part, because we
were concerned that certain market participants that needed access to
basket information for arbitrage purposes would not have access to ETF
portfolio composition files.\325\ However, we understand from
commenters that market participants that use basket information,
including those seeking to hedge exposure to an ETF, currently have
access to this information through the NSCC, an intermediary, or the
ETF itself. We are, however, requiring ETFs to provide daily website
disclosure of portfolio holdings, which we believe will provide market
participants with the necessary tools to determine if an arbitrage
opportunity exists and to hedge the ETF's portfolio.\326\ As a result,
we believe that the publication of a single published basket would
provide little additional value to market participants assessing the
existence of arbitrage opportunities. We also agree with commenters'
concerns that some investors may confuse the published basket
information with an ETF's portfolio holdings information.
---------------------------------------------------------------------------

\325\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.5.b.
\326\ See rule 6c-11(c)(1); see also 2018 ETF Proposing Release,
supra footnote 7, at section II.C.4. (stating that 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).
---------------------------------------------------------------------------

We requested comment on whether we should require an ETF to publish
certain information regarding each basket used by the ETF to ameliorate
some of the limitations associated with publication of a single basket
each day and to serve as an additional check against overreaching by
authorized participants.\327\ However, commenters stated that such a
requirement would be costly to implement and unnecessarily burdensome,
particularly because basket composition information is not used by
secondary market investors.\328\ In addition, commenters asserted that
publication of each basket could raise the risk that market
participants front-run trades in basket securities or attempt to
replicate authorized participants' or other market makers' trading
strategies, particularly for those ETFs that have more frequent primary
market transactions.\329\ Rule 6c-11 as adopted instead will require
ETFs to maintain certain information regarding each basket exchanged
with an authorized participant.\330\ We believe that this record
keeping requirement is a more efficient way to ensure compliance with
the rule, while

[[Page 57189]]

mitigating concerns regarding potential overreaching by authorized
participants.
---------------------------------------------------------------------------

\327\ See 2018 ETF Proposing Release, supra footnote 7, text
following nn.269 and 272.
\328\ See, e.g., ICI Comment Letter; SSGA Comment Letter I;
Vanguard Comment Letter.
\329\ See, e.g., ICI Comment Letter; SSGA Comment Letter I;
SIFMA Comment Letter; Vanguard Comment Letter (also opining that
publication of each custom basket could confuse investors); but see
Morningstar Comment Letter (advocating for disclosure of all baskets
in a structured format).
\330\ See infra section II.D.
---------------------------------------------------------------------------

6. Website Disclosure
There has been a significant increase in the use of the internet as
a tool for disseminating information, and many investors obtain
information regarding ETFs on ETF websites.\331\ Rule 6c-11 therefore
will require ETFs to disclose certain information on their websites as
a condition to the rule.\332\ The website disclosure requirements 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.
---------------------------------------------------------------------------

\331\ See, e.g., Reporting Modernization Adopting Release supra
footnote 263.
\332\ Rule 6c-11(c)(1).
---------------------------------------------------------------------------

Specifically, under rule 6c-11 the following information must be
disclosed publicly and prominently on the ETF's website: \333\
---------------------------------------------------------------------------

\333\ See rule 6c-11(c)(1); see also supra footnote 226.
---------------------------------------------------------------------------

NAV per share, market price, and premium or discount, each
as of the end of the prior business day;
A table and chart showing the number of days the ETF's
shares traded at a premium or discount during the most recently
completed calendar year and calendar quarters of the current year;
\334\
---------------------------------------------------------------------------

\334\ This requirement is similar to a current requirement in
Item 11(g)(2) of Form N-1A, which requires disclosed percentages to
be rounded to the nearest hundredth of one percent. See Current
Instruction 2 to Item 11(g)(2) of Form N-1A. ETFs may similarly
round percentages disclosed in response to this provision of rule
6c-11.
---------------------------------------------------------------------------

For ETFs whose premium or discount was greater than 2% for
more than seven consecutive trading days, disclosure that the premium
or discount was greater than 2%, along with a discussion of the factors
that are reasonably believed to have materially contributed to the
premium or discount; and
Median bid-ask spread over the most recent thirty calendar
days.
a. Disclosure of Prior Business Day's NAV, Market Price, and Premium or
Discount
As proposed, rule 6c-11 will require an ETF to post on its website
the ETF's current NAV per share, market price, and premium or discount,
each as of the end of the prior business day.\335\ 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.
---------------------------------------------------------------------------

\335\ Rule 6c-11(c)(1)(ii); 2018 ETF Proposing Release, supra
footnote 7, at section II.C.6. Proposed rule 6c-11 would have
required this information ``as of the prior business day.'' Proposed
rule 6c-11(c)(1)(ii). For clarity, the final rule will specify that
the information be provided ``as of the end of the prior business
day.'' Rule 6c-11(c)(1)(ii). This is consistent with our existing
exemptive orders.
---------------------------------------------------------------------------

Commenters generally supported this requirement, observing that the
investors should have easy access to the required information.\336\
Some commenters, however, questioned the benefits of the premium or
discount disclosure requirement. One such commenter stated that premium
and discount disclosures do not provide the same benefit to
shareholders as NAV per share and market price.\337\ Another commenter,
while not objecting to the posting of daily premiums or discounts,
opined that emphasizing this information would be unnecessary and--to
the extent that a discount might be understood by prospective investors
as a bargain--potentially misleading.\338\
---------------------------------------------------------------------------

\336\ See ETF.com Comment Letter; ICI Comment Letter (stating
that the commenter does ``not object to'' the requirement); NYSE
Comment Letter (stating that the website disclosure requirements in
rule 6c-11 ``sufficiently address Commission concerns about
investors' better understanding trading costs''); Virtu Comment
Letter; CSIM Comment Letter.
\337\ See Invesco Comment Letter.
\338\ See SSGA Comment Letter I (``Similarly, investors may
choose not to buy ETF shares because of a premium, when in fact the
NAV is based on stale prices from an earlier close.''). One
commenter recommended that we also require footnote disclosure when
premium or discount information is known to include inaccurate data
due to exchange-hours overlap issues (i.e., when the ETF does not
trade contemporaneously with its underlying holdings). See ETF.com
Comment Letter. Rule 6c-11 as adopted will not require additional
footnote disclosure in these circumstances because a majority of
ETFs do not have this type of timing issue and the recommended
disclosure may not capture other circumstances where an ETF's
premium or discount reflects inaccurate data. ETFs may include this
context alongside the premium/discount disclosures on their websites
as applicable.
---------------------------------------------------------------------------

We continue to believe that daily website disclosure of NAV per
share and market price will promote transparency and alert investors to
the relationship between NAV per share and market price. We also
believe that this information will help investors better understand the
risk that an ETF's market price may be higher or lower than the ETF's
NAV per share and compare this information across ETFs. Daily premium/
discount disclosures also will provide investors with useful
information regarding ETFs that frequently trade at a premium or
discount to NAV per share.\339\ We believe that ETF investors use this
information today.\340\
---------------------------------------------------------------------------

\339\ 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, and an ETF with a less efficient arbitrage mechanism
may frequently show this type of end of day deviation.
\340\ One commenter suggested that investors are more likely to
look for information on the website of the entity with which they
interact, such as a broker-dealer. See JPMAM Comment Letter.
However, we believe that ETF issuers, as the entities that are the
subject of this rule's relief, should provide investors with this
information to assist those shareholders who visit the ETF's website
in the first instance. Moreover, another commenter stated that
smaller investors rely predominantly on website disclosures for
their investment analysis. See ETF.com Comment Letter.
---------------------------------------------------------------------------

These disclosures are consistent with our exemptive orders except
that rule 6c-11 includes a definition of ``market price'' that differs
from the definition applicable to those orders. Rule 6c-11 defines
``market price'' as: (A) The official closing price of an ETF share; or
(B) 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'') as of that time.\341\
---------------------------------------------------------------------------

\341\ See rule 6c-11(a)(1).
---------------------------------------------------------------------------

One commenter addressed our proposed definition of ``market price''
and asserted that the rule should permit ETFs to use the midpoint of
the NBBO without evaluating whether it more accurately reflects the
market value of the ETF's shares.\342\ We continue to believe, however,
that using the ``official closing price'' provides a more precise
measurement of an ETF's market price than other alternatives, including
during disruptive market events.\343\ Requiring use of the midpoint of
the NBBO only if it more accurately reflects market value also provides
an appropriate degree of flexibility to an ETF when its closing price
may be stale or otherwise does not reflect the ETF share's market
value, while at the same time providing a consistent and verifiable
methodology for how ETFs determine market

[[Page 57190]]

price.\344\ Therefore, we have determined to adopt the definition of
``market price'' for purposes of this website disclosure requirement as
proposed.
---------------------------------------------------------------------------

\342\ See WisdomTree Comment Letter. An ETF uses the market
price of an ETF share in calculating premiums and discounts. See
rule 6c-11(a)(1) (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).
\343\ See 2018 ETF Proposing Release, supra footnote 7, at n.281
and accompanying text. We believe that using the ``official closing
price'' is a better measure than, for example, only the last price
at which ETF shares traded on their principal U.S. trading market
during a regular trading session, 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.
\344\ Use of the midpoint of the NBBO, for example, mitigates
the potential for gaming practices that could inaccurately minimize
a deviation between market price and NAV per share when showing
premiums and discounts. Because security information processors
calculate NBBO continuously during the trading day, NBBO has the
benefit of being a verifiable third-party quote.
---------------------------------------------------------------------------

b. Disclosure of Table and Line Graphs of the ETF's Premiums and
Discounts
As proposed, rule 6c-11 will 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.\345\ For new ETFs that
do not yet have this information, the rule will require the ETF to post
this information for the life of the fund.\346\ We believe that
presenting the data as both a table and a line graph will provide
investors with useful information in formats that are easy to view and
understand, depending on the investor's preference.\347\ This
disclosure is similar to current requirements that allow an ETF to omit
certain premium/discount disclosures from its prospectus and annual
report if the ETF posts on its website a table showing the number of
trading days the ETF traded at a premium and the number of days it
traded at a discount.\348\
---------------------------------------------------------------------------

\345\ Rule 6c-11(c)(1)(iii)-(iv).
\346\ For example, an ETF that has been in existence for 4
months should provide this disclosure for its first quarter of
operations.
\347\ While past performance cannot predict how an ETF will
trade in the future, 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.
\348\ See 2018 ETF Proposing Release, supra footnote 7, at n.300
and accompanying text; see also infra section II.H.2.c. (discussing
the elimination of this requirement in Form N-1A for funds relying
on rule 6c-11).
---------------------------------------------------------------------------

Commenters were generally supportive of this requirement.\349\
However, some commenters recommended that the rule require only one of
the two presentations.\350\ We recognize, as commenters observed, that
the same information underlies both presentations. However, each
presentation highlights different information, as illustrated in Figure
1 and Table 1 below. The tabular disclosure shows investors how often
the ETF traded at a premium or discount. The graphic disclosure shows
investors the degree of those deviations, particularly during periods
of market stress, and could assist some investors with understanding
how the arbitrage mechanism performs for an ETF under various market
conditions.\351\ Different audiences also may find one presentation
more effective.\352\ Therefore, we continue to believe that the rule
should require both disclosures, and are adopting this aspect of the
rule as proposed.
---------------------------------------------------------------------------

\349\ See, e.g., JPMAM Comment Letter; ETF.com Comment Letter;
ICI Comment Letter (does not object to requirements).
\350\ John Hancock Comment Letter (recommending elimination of
the proposed line graph requirement as it would result in disclosure
duplicative of the table); WisdomTree Comment Letter (stating the
line graph requirement would be adequate and that the required table
would be too detailed).
\351\ 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.
\352\ Another commenter recommended that we require ETFs to
provide a separate line graph showing an ETF's market price and NAV
per share over the most recently completed calendar year and
quarters. See JPMAM Comment Letter. While we agree that this context
could be informative, we believe that the rule as proposed
appropriately balances the usefulness of the line graph disclosure
with the costs of preparation. Of course, ETFs may include this
context alongside the required disclosures on their websites, so
long as the information is not misleading.
[GRAPHIC] [TIFF OMITTED] TR24OC19.018

[[Page 57191]]

Table 1--Sample Premium and Discount Table
------------------------------------------------------------------------
Calendar year First quarter
2018 of 2019
------------------------------------------------------------------------
Days traded at premium.................. 202 59
Days traded at discount................. 47 2
------------------------------------------------------------------------

The rule will require historical premium/discount information for
the most recently completed calendar year and the most recently
completed calendar quarters of the current year as proposed. Some
commenters recommended that we require ETFs to update this information
on a daily basis or require ETFs to present intra-day premiums or
discounts in certain circumstances.\353\ However, after considering the
usefulness of timely information for investors and other data users and
the costs of more frequent collection and publication of the
information, we continue to believe the rule should require disclosure
of this information only on a quarterly basis. First, this period is
consistent with existing prospectus disclosure requirements, and we
believe the time period will allow investors to readily observe the
extent and frequency of deviations from NAV per share in a graphic
format. Second, as discussed above, although the trailing historical
data is subject to a less frequent quarterly updating requirement, the
current premium or discount is required to be disclosed daily.
---------------------------------------------------------------------------

\353\ See CFA Comment Letter; Eaton Vance Comment Letter;
Comment Letter of Hagens Berman (Oct. 1, 2018) (``Hagens Berman
Comment Letter''). (``[T]he new rule should require disclosure of
the gross discount spreads that have reoccurred during times of high
volatility or lack of liquidity.'').
---------------------------------------------------------------------------

c. Disclosure of ETF Premiums or Discounts Greater Than 2%
As proposed, rule 6c-11 will require an ETF whose premium or
discount was greater than 2% for more than seven consecutive trading
days to post that information on its website,\354\ along with a
discussion of the factors that are reasonably believed to have
materially contributed to the premium or discount.\355\ We continue to
believe that disclosure of such periods will promote transparency about
the significance and persistence of deviations between market price and
NAV per share, and may help investors to make more informed investment
decisions.\356\
---------------------------------------------------------------------------

\354\ We have modified the proposed rule text to further clarify
that an ETF must post a statement that the ETF's premium or
discount, as applicable, was greater than 2%--and not only the
factors reasonably believed to have materially contributed to the
premium or discount. See rule 6c-11(c)(1)(vi).
\355\ Rule 6c-11(c)(1)(vi). The rule will require ETFs to post
this information 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.
\356\ 2018 ETF Proposing Release, supra footnote 7, at text
preceding n.307 (stating that the proposed information also may
provide the market (and the Commission) with information regarding
the efficiency of an ETF's arbitrage mechanism).
---------------------------------------------------------------------------

One commenter supported this requirement, stating that daily
premium and discount information is an important metric for
investors.\357\ This commenter stated that its internal metrics suggest
that it would be unusual for ETFs to trigger the proposed disclosure
requirement, and therefore the disclosure ``would not be burdensome''
for ETFs. Other commenters, however, opposed the proposed requirement,
expressing concern that ETFs holding certain asset classes are more
likely to trigger the requirement than others, and that disclosure by
ETFs that frequently trigger the requirement could become
inappropriately repetitive.\358\
---------------------------------------------------------------------------

\357\ See Invesco Comment Letter.
\358\ See, e.g., ICI Comment Letter; Nasdaq Comment Letter;
WisdomTree Comment Letter.
---------------------------------------------------------------------------

We recognize that this disclosure requirement may affect certain
categories of ETFs more than others. 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 for an extended period of time. We believe
that this information could help to inform investors about the nature
of these ETFs and the potential for frequent deviations.
However, we believe this requirement will affect a broader range of
ETFs than just those investing in certain foreign markets. For example,
we estimate that, out of a total 2,046 ETFs, 11 alternative ETFs, 20
international equity ETFs, 2 sector equity ETFs, 1 taxable bond ETF,
and 15 U.S. equity ETFs would have triggered the 2% premium or discount
disclosure requirement in 2018.\359\ In addition, during the period
from 2008 to 2018, we estimate that the percentage of ETFs that would
have triggered the reporting requirement at least once varied from 1.5%
to 10%.\360\ Even if certain ETFs make the disclosure more frequently
or predictably than others because of this variation, we believe that
the requirement will promote transparency regarding the significance
and persistence of deviations between market price and NAV per share,
and thus may permit investors to make more informed investment
decisions. Moreover, we believe that this disclosure helps inform
investors that certain types of ETFs are more likely to experience
persistent premiums or discounts than others.
---------------------------------------------------------------------------

\359\ These figures are based on Bloomberg and Morningstar data
for calendar year 2018 and estimate the number of ETFs with at least
one instance that would have triggered the 2% premium or discount
reporting requirement. As discussed in detail below, on a percentage
basis, we estimate that 0.3% of taxable bond ETFs, 0.6% of sector
equity ETFs, 3.1% of U.S. equity ETFs, 4.2% of international equity
ETFs, and 4.8% of alternative ETFs would have triggered this
disclosure requirement in 2018.
\360\ See infra footnote 598 and accompanying text.
---------------------------------------------------------------------------

Other commenters expressed concern with the requirement that an ETF
include a discussion of the factors that are reasonably believed to
have contributed to the premium or discount.\361\ These commenters
stated that an ETF may have difficulty identifying these factors before
it makes the required disclosure. Although the required information
will be subjective in some cases, we believe that this requirement can
provide secondary market investors with useful context for the
disclosed deviations. For example, the identification of factors that
are reasonably believed to contribute to the premium or discount at
that time may inform ETF investors and other market participants about
factors potentially contributing to the premium or discount, even if
additional contributing factors may later be identified. Such disclosed
factors might include, for example, that many of an ETF's portfolio
securities are traded on foreign markets that are closed during the
U.S. trading day or that the markets on

[[Page 57192]]

which the ETF's underlying securities are traded were closed due to
extended holidays or for other reasons. Because the requirement to
disclose these factors will continue to apply while the premium or
discount persists, the disclosure may change and become better
developed over time as the ETF refines its analysis of what it
reasonably believes is causing the persistent premium or discount. As a
result, such a disclosure also could inform ETF investors and other
market participants about the premium's or discount's persistence.
---------------------------------------------------------------------------

\361\ See ICI Comment Letter; SSGA Comment Letter I.
---------------------------------------------------------------------------

Another commenter recommended that we shorten the time an ETF is
required to maintain the disclosure on its website (to, e.g., 45 days),
asserting that the required information is likely to be most useful
when it is most recent and grows less important over time.\362\ Rule
6c-11, however, will require ETFs to maintain the disclosure on their
website for at least one year following the first day it was posted to
help investors identify ETFs that historically have had persistent
deviations between market price and NAV per share. Additionally,
although we are requiring maintenance of this disclosure for at least
one year, the requirement to post the information will continue to
apply as the premium or discount persists--that is, the one-year
maintenance requirements will not obviate the need for an ETF to post
more current information if otherwise required.\363\ Thus, the
continued availability of the posted information over the required one-
year period will not substitute for or prevent more current and timely
disclosure.
---------------------------------------------------------------------------

\362\ CSIM Comment Letter.
\363\ Rule 6c-11(c)(1)(vi).
---------------------------------------------------------------------------

Finally, some commenters expressed concerns with the 2%
threshold.\364\ For example, one commenter recommended a materiality
standard instead of a 2% threshold.\365\ Another commenter recommended
raising the threshold to 5 or 10% and shortening the period over which
it is measured.\366\ As discussed 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.\367\ We therefore believe that limiting this disclosure to ETFs
that have a premium or discount of greater than 2% for more than seven
consecutive trading days will serve to highlight potentially unusual
circumstances of an ETF with a persistent premium or discount. In Table
2 below, we summarize the effect that different variations on the
proposed threshold recommended by the commenter would have had on the
number of ETFs that would have triggered the requirement in 2018.
---------------------------------------------------------------------------

\364\ See John Hancock Comment Letter; Nasdaq Comment Letter;
WisdomTree Comment Letter (asserting that the proposed threshold was
``arbitrary'').
\365\ See John Hancock Comment Letter.
\366\ See Nasdaq Comment Letter.
\367\ See supra footnote 360 and accompanying text; 2018 ETF
Proposing Release, supra footnote 7, at nn.119-120, 307 and
accompanying text (discussing the relatively small size of historic
deviations between ETF market prices and NAV per share in the
context of calibrating the threshold).

Table 2--Number of ETFs That Would Have Triggered the Requirement in 2018
--------------------------------------------------------------------------------------------------------------------------------------------------------
3-Day period 7-Day period
Category -----------------------------------------------------------------------------------------------
2% 5% 10% 2% 5% 10%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation.............................................. 2 .............. .............. .............. .............. ..............
Alternative............................................. 15 2 .............. 11 .............. ..............
Commodities............................................. .............. .............. .............. .............. .............. ..............
International Equity.................................... 48 4 .............. 20 1 ..............
Municipal Bond.......................................... .............. .............. .............. .............. .............. ..............
Sector Equity........................................... 10 1 .............. 2 1 ..............
Taxable Bond............................................ 3 .............. .............. 1 .............. ..............
U.S. Equity............................................. 29 5 .............. 15 3 ..............
-----------------------------------------------------------------------------------------------
Total............................................... 107 12 None 49 5 None
--------------------------------------------------------------------------------------------------------------------------------------------------------

As shown above, a 10% threshold would not have required any ETFs to
provide this information in 2018, and a 5% threshold, even over just a
three-day period, would have only required disclosure by 12 ETFs. After
considering the commenter's recommended modifications to the threshold,
we believe that the proposed threshold of 2% over more than seven
consecutive trading days will more effectively highlight those patterns
of sustained premiums or discounts that will be informative to
investors than will the recommended alternatives. We also believe that
in this circumstance the objective 2% threshold will result in more
consistent application of the disclosure requirement than would a more
subjective materiality standard. Furthermore, deviations that do not
meet the objective 2% threshold, but that would be material to an
investment decision, must be disclosed.\368\
---------------------------------------------------------------------------

\368\ See rule 10b-5 under the Exchange Act [17 CFR 240.10b-5];
see also section 34(b) of the Act [15 U.S.C. 80a-33].
---------------------------------------------------------------------------

d. Median Bid-Ask Spread
Rule 6c-11 will require daily website disclosure of the ETF's
median bid-ask spread calculated over the most recent 30-day
period.\369\ The bid-ask spread information is 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 have modified this requirement from our proposal,
which would have required an ETF to disclose the median bid-ask spread
for the ETF's most recent fiscal year on its website and in its
prospectus.\370\
---------------------------------------------------------------------------

\369\ Rule 6c-11(c)(1)(v). In calculating the median bid-ask
spread, an ETF would be required to: (i) Identify the ETF's NBBO as
of the end of each 10 second interval during each trading day of the
last 30 calendar days; (ii) divide the difference between each such
bid and offer by the midpoint of the NBBO; and (iii) identify the
median of those values.
\370\ Although we proposed these bid-ask spread disclosure
requirements as amendments to Forms N-1A and N-8B-2, rule 6c-11 will
require ETFs relying on it to provide median bid-ask spread
disclosure on its website as a condition to the rule. Our amendments
to Form N-1A will provide an ETF that does not rely on rule 6c-11
with the option of providing the information required by rule 6c-11
on its website or the median bid-ask spread over the ETF's most
recent fiscal year in its prospectus. See infra section II.H.2.b.
---------------------------------------------------------------------------

Comments on the proposed website disclosure of an ETF's bid-ask
spread were mixed. Many commenters opposed this requirement, asserting
that the proposed disclosures would require ETFs to bear costs and
liability for data

[[Page 57193]]

collected by third parties,\371\ and that other sources (e.g.,
financial intermediaries, the Commission) were in a better position to
provide bid-ask spread information.\372\ Some commenters noted that the
bid-ask spread information may be misleading to investors if the
historical information is not representative of current execution costs
or if the bid-ask spread information is overemphasized.\373\ Others
expressed concern that there is no uniform method for computing bid-ask
spread, which could make bid-ask spreads difficult to compare across
different investment options.\374\ Still others supported it as an
alternative to the parallel proposed prospectus disclosure
requirements.\375\ For example, some commenters stated that providing
more recent bid-ask spread data on an ETF's website alongside other ETF
trading data would give investors more useful and timely
information.\376\ Commenters also expressed concern about potential
liability under section 11 of the Securities Act for bid-ask spread
data included in the prospectus if an investor's actual bid-ask spread
costs differ materially from the bid-ask spread disclosed in the
prospectus.\377\
---------------------------------------------------------------------------

\371\ See, e.g., BNY Mellon Comment Letter; John Hancock Comment
Letter.
\372\ See, e.g., IDC Comment Letter; Invesco Comment Letter;
SSGA Comment Letter I.
\373\ See, e.g., John Hancock Comment Letter; CSIM Comment
Letter.
\374\ See, e.g., IDC Comment Letter; John Hancock Comment
Letter.
\375\ See, e.g., Fidelity Comment Letter (expressing support for
website disclosure with a rolling 30-day median calculation
methodology); Dechert Comment Letter; Thomson Hine Comment Letter.
\376\ See, e.g., OppenheimerFunds Comment Letter; SIFMA AMG
Comment Letter I.
\377\ See, e.g., ABA Comment Letter; CSIM Comment Letter;
Dechert Comment Letter; 15 U.S.C. 77k.
---------------------------------------------------------------------------

While we recognize the costs for ETFs to collect and publish this
bid-ask spread data, we believe that quantitative information regarding
median bid-ask spreads will provide ETF investors with greater
understanding of the costs associated with investing in ETFs. This will
help investors make more informed investment decisions. We acknowledge
that historical bid-ask spread data may reflect differences that result
from varying methods of computing bid-ask spread. However, we have
modified the proposal in several respects, such as using NBBO for
computing the bid-ask spread, to make the computation more uniform. We
therefore do not believe that the variance will be large enough to
outweigh the importance of giving investors a greater understanding of
these potential trading costs. We similarly understand that bid-ask
spread may not reflect an individual investor's actual spread, as an
individual's spread may depend on the execution strategies employed by
an intermediary (such as mid-point pricing), the size of a particular
order, or other factors. We nonetheless believe that the bid-ask spread
is a helpful tool for investors making better informed trading
decisions and that website disclosure can provide that information in a
format that is easily accessible and relied upon by investors.
Based on comments we received, however, we are modifying certain of
the bid-ask spread requirements to make the disclosure more cost-
effective for ETFs, while maintaining or enhancing the utility for
investors. First, the rule will require an ETF to disclose its median
bid-ask spread only on its website, instead of requiring disclosure
both on an ETF's website and in its prospectus as proposed.\378\ ETFs
will present the median bid-ask spread disclosure alongside other ETF-
specific disclosures, such as premium and discount and market price,
which should mitigate some commenters' concerns relating to the
overemphasis of bid-ask spread data.
---------------------------------------------------------------------------

\378\ See infra section II.H.3. (discussing our determination
not to adopt certain prospectus disclosure requirements that we
proposed).
---------------------------------------------------------------------------

Second, some commenters suggested shortening the look-back period
for calculating the bid-ask spread metric, such as to a 30- or 45-day
rolling period.\379\ One commenter noted that a shorter look-back
period may show a more representative spread level, particularly for a
newly launched ETF, as spreads are likely to tighten as the ETF
matures.\380\ Several commenters also suggested that the Commission
require ETFs to provide a time-weighted average bid-ask spread rather
than the proposed median bid-ask spread.\381\ These commenters stated
that a time-weighted average is more helpful for investors because it
represents a ``typical'' bid-ask spread.
---------------------------------------------------------------------------

\379\ See, e.g., BlackRock Comment Letter (30-day period); BNY
Mellon Comment Letter (30-day period); Cboe Comment Letter (45-day
period); ETF.com Comment Letter (45-day period).
\380\ See BlackRock Comment Letter (providing an example showing
an ETF that saw its spread improve from 35 basis points at inception
in January 2016 to 4.03 basis points in July 2018, and observing
that its median bid-ask spread over the prior fiscal year ending
July 31, 2018 was 6.34 basis points, while its median bid-ask spread
over the prior month was 4.03 basis points).
\381\ See, e.g., Fidelity Comment Letter; JPMAM Comment Letter.
---------------------------------------------------------------------------

We agree that a bid-ask spread metric based on the more recent
inputs from the last 30 days may provide a better representation of the
costs that an investor may incur when trading ETF shares. Accordingly,
we are shortening the look-back period for calculating the bid-ask
spread from the most recent fiscal year to the most recent 30-day
period on a rolling basis.\382\ We think the 30-day look-back period
strikes an appropriate balance between reflecting only very short term
fluctuations and reflecting information that is no longer
representative of current execution costs. We do not think it is
necessary to require a time-weighted average rather than the proposed
median, however, because rule 6c-11 requires an ETF to determine the
median by first identifying the exchange-traded fund's national best
bid and national best offer as of the end of each 10 second interval
during each trading day. This methodology (and the resulting number of
data points) has the same effect as time-weighting. In addition,
requiring an ETF to disclose the median of bid-ask spreads is less
likely to give disproportionate effect to outlier values than a time-
weighted average.
---------------------------------------------------------------------------

\382\ Rule 6c-11(c)(1)(v).
---------------------------------------------------------------------------

Finally, we are modifying the proposal to require that an ETF use
the NBBO in calculating median bid-ask spreads.\383\ While the proposal
did not specify that the NBBO must be used, after considering comments
recommending more uniformity regarding bid-ask spread disclosures,\384\
we believe that requiring ETFs to use the NBBO when calculating the
median will increase consistency and comparability of the resulting
disclosure across ETFs.\385\ In addition, we believe that requiring use
of NBBO will help to reduce costs associated with obtaining the
required information, because the NBBO also is an input to the market
price disclosure requirement.
---------------------------------------------------------------------------

\383\ Rule 6c-11(c)(1)(v)(A)-(B).
\384\ See supra footnote 375 and accompanying text.
\385\ The NBBO also is used in the definition of market price in
rule 6c-11. Rule 6c-11(a)(1); see also supra section II.C.6.a.
Requiring NBBO is likely to result in more uniform and comparable
calculations across funds.
---------------------------------------------------------------------------

We also proposed related amendments to Form N-1A that would have
required an ETF to provide: (i) Examples in the ETF's prospectus
showing how bid-ask spreads impact the return on a hypothetical
investment for both buy-and-hold and frequent traders; and (ii) an
interactive calculator in a clear and prominent format on the ETF's
website that would allow an investor to customize the hypothetical bid-
ask spread calculations to its specific investing situation.\386\ These

[[Page 57194]]

requirements were 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.
---------------------------------------------------------------------------

\386\ See proposed amendment to Item 3 of Form N-1A. The
proposed 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) and, to illustrate that
more frequent trading can significantly increase costs, it would
demonstrate the costs associated with 25 $10,000 round-trip trades
(50 total trades). 2018 ETF Proposing Release, supra footnote 7, at
section II.H.2.
---------------------------------------------------------------------------

Commenters generally opposed requiring bid-ask spread examples in
the summary prospectus or summary section. For example, some commenters
expressed concerns regarding the costs of obtaining the underlying bid-
ask spread data from third parties.\387\ Some commenters also noted
that the historical bid-ask spread data, which ETFs would use to
calculate the examples, is not representative of current trading costs
and could mislead investors if disclosures overemphasize this
information.\388\ Other commenters suggested alternatives to the
proposed examples such as using hypothetical brokerage commissions and
bid-ask spreads, rather than using actual historical bid-ask
spreads.\389\ However one commenter supported this aspect of the
proposal, stating that it would yield ``relevant and helpful''
information.\390\
---------------------------------------------------------------------------

\387\ See, e.g., BNY Mellon Comment Letter; ICI Comment Letter;
John Hancock Comment Letter; OppenheimerFunds Comment Letter.
\388\ See, e.g., Vanguard Comment Letter (noting that in the
second quarter of 2018, Vanguard's retail brokerage clients paid
less than 5% of the bid-ask spread when trading Vanguard ETFs with
an effective spread/quoted spread of 1.89%, and approximately 97% of
those market orders were executed inside the NBBO, with 94% of those
orders at midpoint or better). See also ABA Comment Letter;
BlackRock Comment Letter; CSIM Comment Letter.
\389\ See, e.g., SIFMA AMG Comment Letter II.
\390\ See FIMSAC Comment Letter.
---------------------------------------------------------------------------

Many commenters raised similar concerns regarding the proposed
interactive calculator, including that varying data sources and
calculation methodologies may result in an inconsistent investor
experience across ETFs.\391\ Other commenters noted that the
interactive calculator was limited to bid-ask spread data, which placed
undue emphasis on spreads as a component of an ETF investor's trading
costs.\392\ Commenters also noted that the proposed requirement may
result in additional vendor and licensing costs.\393\
---------------------------------------------------------------------------

\391\ Fidelity Comment Letter; Invesco Comment Letter; SIFMA
Comment Letter I; Vanguard Comment Letter.
\392\ See, e.g., Vanguard Comment Letter. See also Eaton Vance
Comment Letter (recommending replacing the proposed interactive
calculator with new requirements for website trading information).
\393\ See, e.g.; ICI Comment Letter; JPMAM Comment Letter. See
also WisdomTree Comment Letter (stating that broker-dealers are
better suited to provide the information required by the proposed
interactive calculator).
---------------------------------------------------------------------------

After considering comments, we are not adopting the proposed bid-
ask spread examples or interactive calculator requirements. We are
instead requiring ETFs relying on rule 6c-11 to provide more recent
bid-ask spread information on their website. We believe that
streamlining the required bid-ask spread disclosures will mitigate
commenters' concerns that investors may fail to understand the
relevance of the bid-ask spread information or the potential impact of
bid-ask spreads on their specific trading situations. We are also
persuaded by commenters that an interactive calculator focused solely
on bid-ask spread costs may overemphasize those costs and thereby
obscure the effect of other costs of investing in ETFs.
7. Marketing
As proposed, rule 6c-11 will not include certain requirements
related to ETF marketing, which were included in our exemptive orders.
Specifically, rule 6c-11 will not require an ETF to: (i) Identify
itself in its sales literature as an ETF that does not sell or redeem
individual shares, and (ii) explain that investors may purchase or sell
individual ETF shares through a broker via a national securities
exchange.\394\ Our exemptive orders included a condition requiring this
information to help prevent investors, particularly retail investors,
from confusing ETFs with mutual funds, at a time when ETFs were not a
well-known investment product.
---------------------------------------------------------------------------

\394\ See 2018 ETF Proposing Release, supra footnote 7.
---------------------------------------------------------------------------

The comments on this aspect of the proposal were mixed. Commenters
who supported the proposal generally agreed that the market has
developed a familiarity with ETFs and that retail investors generally
understand that, unlike mutual funds, individual ETF shares may be
purchased and sold only on secondary markets.\395\ One commenter
disagreed, asserting that many investors do not understand the
distinctions between ETFs and mutual funds.\396\ This commenter
suggested that the rule require an ETF to include a statement in its
sales literature noting that buyers of ETF shares may pay more than the
shares' current value and that sellers of ETF shares may receive less
than current value. Another commenter noted that requiring this type of
disclosure in ETF sales literature would help put investors on notice
that the ETF pricing mechanism works differently than that of mutual
funds.\397\
---------------------------------------------------------------------------

\395\ See, e.g., Invesco Comment Letter; ICI Comment Letter.
\396\ Eaton Vance Comment Letter.
\397\ CFA Comment Letter.
---------------------------------------------------------------------------

We continue to believe that ETF investors have grown familiar with
ETFs and the fundamental distinctions between ETFs and mutual funds,
and that this disclosure is now unnecessary. The disclosure
requirements we are adopting also should provide ETF investors,
including retail investors, with useful information regarding the
exchange-traded nature of ETFs and ETF pricing, including the potential
for market price to deviate from NAV per share.\398\
---------------------------------------------------------------------------

\398\ The website disclosure requirements are described in
section II.C.6 and the amendments to Form N-1A are described in
section II.H.
---------------------------------------------------------------------------

8. ETF and ETP Nomenclature
We requested comment on whether the Commission should address
possible investor confusion arising from the nomenclature that has
developed for identifying ETPs, including confusion between ETFs and
other types of ETPs that are not registered under the Act.\399\ We
asked, for example, whether the Commission should consider proposing to
require a naming convention or other identification scheme to assist
investors in distinguishing ETFs from other ETPs in a future
rulemaking. We also asked whether we could address investor confusion
by restricting certain sales practices, such as by proposing
restrictions on how intermediaries communicate with retail investors
about ETPs unless they disclose certain information designed to clearly
differentiate ETPs that are not subject to the Act from ETFs that are
registered investment companies.
---------------------------------------------------------------------------

\399\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.C.7. See also supra footnote 16 (describing differences
between ETFs and other types of ETPs, such as exchange-traded notes
and commodity pools).
---------------------------------------------------------------------------

Several commenters generally supported a classification system for
ETPs to assist investors in distinguishing among these different
products.\400\ One commenter stated that leveraged/inverse ETFs,
commodity pools, and exchange-traded notes have differences that
investors should understand prior to making investment decisions.\401\
Commenters expressed varying views, however, regarding

[[Page 57195]]

which types of ETPs should call themselves ETFs under an ETP
classification system. One commenter asserted that the Commission
should permit only ETFs that fall squarely within proposed rule 6c-11
to call themselves ETFs.\402\ Two commenters provided examples of
comprehensive classification systems for ETPs that would not permit
``exchange-traded notes,'' ``exchange-traded commodities,'' or
``exchange-traded instruments'' (including leveraged/inverse ETFs) to
refer to themselves as ETFs.\403\ One commenter opined that the
Commission should not preclude leveraged/inverse ETFs from calling
themselves ETFs, as that would ``confuse investors and muddle both the
existing regulatory framework applicable to ETFs and fund naming
conventions.'' \404\ Another commenter asserted that UITs and other
ETFs that fall outside the scope of the rule should nonetheless be
permitted to call themselves ETFs.\405\
---------------------------------------------------------------------------

\400\ See, e.g., BlackRock Comment Letter; Invesco Comment
Letter; Cboe Comment Letter; FIMSAC Comment Letter; Hu and Morely
Comment Letter (incorporating article by comment letter's authors
suggesting that ETFs can be categorized into three groups,
``Investment Company ETFs,'' ``Commodity Pool ETFs,'' and
``Operating Company ETFs,'' based on the applicable regulatory
framework, but not suggesting a related nomenclature system).
\401\ See Invesco Comment Letter. See also BlackRock Comment
Letter.
\402\ See Invesco Comment Letter.
\403\ See BlackRock Comment Letter; FIMSAC Comment Letter.
\404\ See ProShares Comment Letter.
\405\ See SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

One commenter asserted that Commission action relating to ETP
naming is premature at the present time.\406\ This commenter encouraged
ETF market participants to engage in a dialogue ``around refining
existing ETP disclosures, adding new elements as useful to investors,
and developing an industry-led standard ETP disclosure approach
beneficial to investors and all market participants.''
---------------------------------------------------------------------------

\406\ See Comment Letter of State Street Global Advisors (Feb.
4, 2019).
---------------------------------------------------------------------------

We agree that these issues need to be examined and discussed in
more depth before the implementation of an ETP naming system. We will
continue to consider the comments we received and, if appropriate, will
take steps to address investor confusion relating to ETF and ETP
nomenclature. At present, we believe that the term ``ETF'' is generally
associated with ETPs regulated under the Investment Company Act.
Leveraged/inverse ETFs, for example, are regulated under the Act and
are structurally and operationally similar to ETFs that will rely on
rule 6c-11. As a result, we do not believe it is appropriate to require
leveraged/inverse ETFs to use a naming convention that does not include
the term ``ETF.'' Similarly, because UIT ETFs are subject to a
substantially similar regulatory regime as ETFs structured as open-end
funds (and subject to similar regulatory safeguards), we do not find it
appropriate to require UIT ETFs to utilize a naming convention that
does not include the term ``ETF.'' We encourage ETP market participants
to continue engaging with their investors, with each other, and with
the Commission on these issues.

D. Recordkeeping

We are adopting, as proposed, an express requirement that ETFs
relying on rule 6c-11 preserve and maintain copies of all written
agreements between an authorized participant and the ETF (or one of the
ETF's service providers) that allow the authorized participant to
purchase or redeem creation units (``authorized participant
agreements'').\407\ One commenter supported this aspect of the
proposal.\408\ Another commenter, however, stated that this requirement
is unnecessary because ETFs already generally implement robust
recordkeeping programs pursuant to their policies and procedures.\409\
---------------------------------------------------------------------------

\407\ See rule 6c-11(d)(1). For example, an authorized
participant and the ETF's principal underwriter may enter into the
authorized participant agreement.
\408\ See ICI Comment Letter.
\409\ See Invesco Comment Letter.
---------------------------------------------------------------------------

After considering these comments, we believe it is appropriate for
rule 6c-11 to specifically require that ETFs preserve and maintain
authorized participant agreements. Authorized participants play a
central role in the proper functioning of the ETF marketplace and
authorized participant agreements are critical to understanding the
relationship between an authorized participant and an ETF. Requiring
the preservation of authorized participant agreements 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 rule 6c-11 and other provisions of
the Act and rules thereunder, based on the specific terms of their
written agreement. 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
believe it is appropriate to expressly require that ETFs relying on
rule 6c-11 preserve and maintain copies of all such agreements.
We also are adopting, largely as proposed, a requirement that ETFs
maintain information regarding the baskets exchanged with authorized
participants. Rule 6c-11 will require an ETF to maintain records
setting forth the following information for each basket exchanged with
an authorized participant: (i) Ticker symbol, CUSIP or other
identifier, description of holding, quantity of each holding, and
percentage weight of each holding composing the basket exchanged for
creation units; \410\ (ii) if applicable, an 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;
(iii) cash balancing amounts (if any); and (iv) the identity of the
authorized participant conducting the transaction.\411\
---------------------------------------------------------------------------

\410\ As discussed below, proposed rule 6c-11 would have
required ETFs to maintain the ``names and quantities of the
positions composing the basket'' exchanged for creation units and
did not require additional information about the ticker symbol,
CUSIP or other identifier, or a description of the holding. See
proposed rule 6c-11(d)(2).
\411\ See rule 6c-11(d)(2).
---------------------------------------------------------------------------

Commenters generally supported requiring ETFs to maintain records
regarding baskets.\412\ One commenter stated that clear, auditable
records would help Commission staff monitor custom basket usage and its
impact on the ETF arbitrage process.\413\ Another agreed that the
records would provide Commission staff with a basis to understand how
baskets are being used by ETFs and to evaluate compliance with the rule
and other requirements.\414\ As noted above, one commenter stated that
it is unnecessary for the rule to contain any recordkeeping
provisions.\415\
---------------------------------------------------------------------------

\412\ See ICI Comment Letter; Nasdaq Comment Letter; SIFMA AMG
Comment Letter I.
\413\ See SIFMA AMG Comment Letter I.
\414\ See ICI Comment Letter.
\415\ See Invesco Comment Letter.
---------------------------------------------------------------------------

After considering these comments, we believe that requiring ETFs to
maintain records regarding each basket exchanged with authorized
participants will provide our examination staff with a basis to
understand how baskets are being used by ETFs, particularly with
respect to custom baskets. In order to provide our examination staff
with detailed information regarding basket composition, however, we
have modified rule 6c-11 to require the ticker symbol, CUSIP or other
identifier, description of holding, quantity of each holding, and
percentage weight of each holding composing the basket exchanged for
creation units as part of the basket records, instead of the name and
quantities of each position as proposed.\416\ We believe that this
additional information will better enable our examination staff to
evaluate compliance with the rule and other applicable provisions of
the federal securities laws. Moreover, we do not believe that requiring
ETFs to maintain

[[Page 57196]]

detailed information regarding basket composition will create
operational challenges or unduly burden ETFs because rule 6c-11 already
requires ETFs to disclose the same information for each portfolio
holding as part of the portfolio transparency requirements.\417\
---------------------------------------------------------------------------

\416\ See proposed rule 6c-11(d)(2).
\417\ This modification aligns the rule's recordkeeping
requirements in paragraph (d) with the information the ETF must
already collect and disclose as part of the portfolio transparency
requirements. Proposed rule 6c-11 would have required an ETF to post
on its website information regarding a published basket at the
beginning of each business day and to present the description,
amount, value and unrealized gain/loss in the manner prescribed by
Article 12 of Regulation S-X for each basket asset. As discussed
above, we are not adopting a basket publication requirement as part
of rule 6c-11, and therefore the rule does not set forth
recordkeeping requirements relating to the proposed basket
publication requirement. See supra section II.C.5.c.
---------------------------------------------------------------------------

As proposed, the rule will require ETFs 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 incorporate this
type of retention period and we believe consistency with that period
will minimize any compliance burdens to ETFs subject to rule 6c-11. The
commenter that addressed this aspect of the recordkeeping requirement
supported the proposed retention period.\418\
---------------------------------------------------------------------------

\418\ See Invesco Comment Letter (agreeing with the five-year
retention timeline despite generally objecting to the rule's
recordkeeping requirements).
---------------------------------------------------------------------------

E. Share Class ETFs

As proposed, rule 6c-11 does not provide 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) (the multiple class rule).\419\ 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.\420\
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.\421\ Rule 18f-3 created a limited exception from sections 18(f)(1)
and 18(i) for certain funds but requires, among other things, that each
share class of a fund have the same rights and obligations as each
other class.\422\ An ETF cannot rely on rule 18f-3 to operate as a
share class within a fund, however, because the rights and obligations
of the ETF shareholders would differ from those of investors in the
fund's mutual fund share classes.\423\ Therefore, absent any separate
relief from sections 18(f)(1) or 18(i) of the Act, an ETF structured as
a share class of a fund that issues multiple classes of shares
representing interests in the same portfolio cannot operate in reliance
on rule 6c-11.
---------------------------------------------------------------------------

\419\ See 15 U.S.C. 80a-18(f)(1) and (i). Section 18(f)(1) of
the Act generally prohibits a registered open-end company 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 registered management company must have equal
voting rights.
\420\ 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.
\421\ See id.
\422\ See 17 CFR 270.18f-3(a)(4); Exemption for Open-End
Management 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.
\423\ 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.
---------------------------------------------------------------------------

We recognize that the Commission has previously granted ETFs
exemptive relief from the provisions of section 18 of the Act in the
past, subject to various conditions.\424\ However, relief from section
18 raises policy considerations that are different from those we are
seeking to address in this rule. 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.\425\
---------------------------------------------------------------------------

\424\ 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'').
\425\ 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.
---------------------------------------------------------------------------

Three commenters stated that it was unnecessary for rule 6c-11 to
provide relief for share class ETFs.\426\ One commenter, a sponsor of
share class ETFs, stated that it is unnecessary for the rule to
encompass share class ETFs because it is currently uncommon for ETF
issuers to seek the exemptive relief necessary for such ETFs.\427\
Another stated that our proposed treatment is appropriate given the
nuances associated with those products, \428\ and the third similarly
indicated that share class ETFs present issues that would be more
appropriately addressed through means other than rule 6c-11.\429\
---------------------------------------------------------------------------

\426\ See Vanguard Comment Letter; Invesco Comment Letter; SSGA
Comment Letter I.
\427\ See Vanguard Comment Letter.
\428\ See Invesco Comment Letter.
\429\ See SSGA Comment Letter I.
---------------------------------------------------------------------------

Two other commenters, however, opined that rule 6c-11 (or a
separate future rule) should provide relief for share class ETFs in
order to create a more level ETF playing field.\430\ Additional
commenters echoed the importance of leveling the ETF playing field
without specifically addressing share class ETFs.\431\ Another
commenter urged the Commission to explore granting relief from the
relevant provisions of section 18 broadly to the fund industry.\432\
---------------------------------------------------------------------------

\430\ See BNY Mellon Comment Letter; OppenheimerFunds Comment
Letter.
\431\ See ETF.com Comment Letter (stating that the disclosure
requirements of any final rule should apply to all ETFs, regardless
of whether the ETFs rely on the final rule); Invesco Comment Letter
(indicating that the Commission should generally abstain from
regulatory actions that allow only certain market participants to
benefit from innovation).
\432\ See MFDF Comment Letter.
---------------------------------------------------------------------------

Leveling the ETF playing field is a goal for rule 6c-11, and we
acknowledge that our approach will result in there being a segment of
ETF assets that are unable to rely on the rule. At the same time, we
continue to believe that share class ETFs raise policy considerations
that are different from those we seek to address in the rule. With such
concerns unresolved, we do not believe it is appropriate to broadly
grant relief from sections 18(f)(1) and 18(i) of the Act for share
class ETFs at this time. Share class ETFs are structurally and
operationally different from the other types of ETFs within the scope
of rule 6c-11.\433\ We

[[Page 57197]]

therefore continue to believe it is appropriate for share class ETFs 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
assess all relevant policy considerations in the context of the facts
and circumstances of each particular applicant. We are not rescinding
exemptive relief previously granted to share class ETFs.
---------------------------------------------------------------------------

\433\ For example, when an ETF is structured as a share class of
an open-end fund, the open-end fund has other share classes
representing interests in the same portfolio. These interests (and
the cash flows associated with the other share classes) can impact
the fund's portfolio. In addition, share class ETFs do not provide
daily portfolio transparency. See Vanguard orders, supra footnote
425.
---------------------------------------------------------------------------

We also are adopting amendments to Form N-1A that will require
share class ETFs to provide certain additional disclosures regarding
ETF trading costs. As discussed in more detail below in section II.H.,
these disclosure amendments are designed to help ensure consistent
disclosures to investors between ETFs relying on proposed rule 6c-11
and share class ETFs operating pursuant to individualized exemptive
relief. The rule and form amendments require all ETFs that are subject
to the Investment Company Act to provide similar disclosures in order
to help investors compare products.

F. Master-Feeder ETFs

Many of our recent ETF orders allow ETFs to operate as feeder funds
in a master-feeder structure.\434\ 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 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.
---------------------------------------------------------------------------

\434\ 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'').
---------------------------------------------------------------------------

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.\435\
To accommodate the unique operational characteristics of these 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,\436\ 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.\437\
---------------------------------------------------------------------------

\435\ 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. 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.
\436\ 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).
\437\ See 15 U.S.C. 80a-22(e) (generally requiring the
satisfaction of redemptions within seven days). See also supra
section II.B.4.
---------------------------------------------------------------------------

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
does 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.\438\ Due to these concerns, and the lack of market
interest in this structure, we proposed to rescind the master-feeder
relief granted to ETFs that did not rely on the relief as of the date
of the proposal (June 28, 2018). We also proposed to grandfather
existing master-feeder arrangements involving ETF feeder funds, but
prevent the formation of new ones, by amending relevant exemptive
orders.
---------------------------------------------------------------------------

\438\ See supra footnote 426 and accompanying text.
---------------------------------------------------------------------------

One commenter stated that it did not object to preventing the
formation of new master-feeder arrangements and rescinding master-
feeder relief (with the exception of master-feeder relief that funds
actively relied on as of the date of the Proposing Release).\439\ Other
commenters, however, indicated that the rule should provide relief for
master-feeder structures \440\ or that the Commission should not
rescind existing master-feeder relief.\441\ Some of these commenters
indicated that failing to provide relief for master-feeder structures
would cause an uneven playing field among ETFs but did not address the
concerns discussed above.\442\
---------------------------------------------------------------------------

\439\ See ICI Comment Letter.
\440\ See ETF.com Comment Letter; BNY Mellon Comment Letter;
Dechert Comment Letter.
\441\ See Fidelity Comment Letter; Eaton Vance Comment Letter.
\442\ See ETF.com Comment Letter; BNY Mellon Comment Letter.
---------------------------------------------------------------------------

Other commenters set forth potential methods for mitigating such
concerns. For example, one commenter indicated that the Commission
could address its concerns regarding potential cross-subsidization by
requiring master funds to impose certain transaction fees,\443\ while
another indicated that the Commission should address these concerns by
requiring each feeder fund in a master-feeder structure to transact
with the master fund consistently (i.e., only in cash or only in
kind).\444\ An additional commenter suggested that an ETF's board
should evaluate whether a master-feeder structure's overall benefits
outweigh its overall costs in order to address these concerns.\445\
Another commenter indicated that it has already invested resources
exploring various approaches to an ETF master-feeder structure,
including models that it believed would address the Commission's
concerns.\446\
---------------------------------------------------------------------------

\443\ See Eaton Vance Comment Letter.
\444\ See Fidelity Comment Letter.
\445\ See Dechert Comment Letter. This commenter also opposed
excluding exemptive relief for master-feeder structures based on a
lack of market interest because the ETF industry is dynamic and
interest in master-feeder structures may develop in the future. Id.
\446\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

As discussed in the context of share class ETFs, leveling the ETF
playing field is a goal for rule 6c-11, and we acknowledge that our
approach will result in there being a segment of ETF assets that are
unable to rely on the rule. Like share class ETFs, however, we continue
to believe that master-feeder funds raise policy considerations that
are different from those we seek to

[[Page 57198]]

address in the rule and are structurally and operationally distinct
from other ETFs within the scope of rule 6c-11. We do not believe it is
appropriate to broadly grant exemptive relief for master-feeder funds.
Instead, we continue to believe that the Commission should consider the
special concerns presented by ETFs in master-feeder structures in the
context of the facts and circumstances of each particular applicant
through individualized exemptive applications. The Commission's
exemptive relief process is well-suited for applicants to set forth
novel methods of mitigating the Commission's concerns, such as the
methods suggested above. The process allows applicants to experiment
with many different approaches, and may eventually assist the
Commission in identifying a particular solution that is appropriate for
a broader rule. Any ETF that is exploring a particular approach is free
to bring its methodology forward in an exemptive application, which
should help mitigate commenters' concerns about future changes in the
ETF industry and resources already committed to such research. As
proposed, therefore, we will rescind the master-feeder relief granted
to ETFs that did not rely on the relief as of the date of the proposal
(June 28, 2018).\447\
---------------------------------------------------------------------------

\447\ One commenter indicated that this date provided an
insufficient notice period for ETFs interested in pursuing the
master-feeder structure and recommended ``a sunset provision of at
least 3 years from the effective date of the final rule to allow
ETFs that have been developing this structure sufficient time to
test and implement it.'' See id. Exemptive orders for existing ETF
master-feeder structures that rely on the relief will not be
rescinded, however, and ETFs interested in pursuing a master-feeder
structure in the future may apply for individualized exemptive
relief. We therefore believe that such a 3-year sunset provision is
unnecessary.
---------------------------------------------------------------------------

Only one fund complex had established as of June 28, 2018 master-
feeder arrangements involving ETF feeder funds, and each arrangement
involves an ETF as the sole feeder fund. We understand that all but one
of the complex's original ETF feeder funds has discontinued its use of
a master-feeder structure.\448\ Because this arrangement involves only
one ETF feeder fund for its master fund, we do not believe it will
raise the policy concerns discussed above without new, additional
feeders, and therefore do not believe it is necessary to require this
structure to change its existing investment practices by rescinding the
relief.\449\ Instead, as proposed, we are amending this fund complex's
existing exemptive orders to prevent the complex from forming new
master-feeder ETFs.\450\
---------------------------------------------------------------------------

\448\ See, e.g., SSGA Active Trust Prospectus (Oct. 31, 2017),
available at https://www.sec.gov/Archives/edgar/data/1516212/000119312518313788/d635918d497.htm.
\449\ See 2018 ETF Proposing Release, supra footnote 7, at n.342
(noting that rescinding the relief for existing master-feeder ETFs
would require them to change the manner in which they invest).
\450\ The amendment to the exemptive order will expressly
provide that the complex cannot create new master-feeder structures
as of June 28, 2018.
---------------------------------------------------------------------------

G. Effect of Rule 6c-11 on Prior Orders

As proposed, we have determined to exercise our authority under the
Act to amend and rescind the exemptive relief we have issued to ETFs
that will be permitted to operate in reliance on rule 6c-11.\451\
Accordingly, one year following the effective date of rule 6c-11, we
will rescind those portions of our prior ETF exemptive orders that
grant relief related to the formation and operation of an ETF,
including master-feeder relief except as described in section II.F. We
will not rescind the exemptive orders of UIT ETFs, leveraged/inverse
ETFs, share class ETFs, or non-transparent ETFs. We also are not
rescinding the relief we have provided to ETFs from section 12(d)(1)
and sections 17(a)(1) and (a)(2) under the Act related to fund of funds
arrangements involving ETFs as discussed below.
---------------------------------------------------------------------------

\451\ See section 38(a) of the Act, 15 U.S.C. 80a-37(a).
---------------------------------------------------------------------------

Commenters generally supported the rescission of the exemptive
relief granted to ETFs that fall within the scope of rule 6c-11,\452\
while permitting ETFs that could not rely on rule 6c-11 to continue to
rely on their individual exemptive orders.\453\ One commenter stated
that rescission of these orders will further the Commission's
regulatory goal to create a consistent, transparent, and efficient
regulatory framework for ETFs.\454\
---------------------------------------------------------------------------

\452\ See, e.g., ABA Comment Letter; ICI Comment Letter.
\453\ See, e.g., ICI Comment Letter; Eaton Vance Comment Letter.
In addition, one commenter stated that, because the commenter has
designed its ETFs around the basket flexibility afforded by its
exemptive orders, it would oppose the rescission of prior orders if
the final rule limits ETFs' ability to use custom baskets. See
Invesco Comment Letter. As discussed above, rule 6c-11 will permit
an ETF to use custom baskets if it meets certain conditions. See
supra section II.C.5.b.
\454\ See ABA Comment Letter. One commenter, a sponsor of ETMFs
as well as ETFs, requested that the Commission amend the terms and
conditions relating to custom baskets in the ETMF orders to
correspond to the treatment of custom baskets in rule 6c-11. See
Eaton Vance Comment Letter. We believe this request is beyond the
scope of the proposal. However, the commenter may seek to amend its
order as part of the exemptive application process.
---------------------------------------------------------------------------

After reviewing comments, we continue to believe that rescinding
ETF exemptive relief in connection with rule 6c-11 will result in a
consistent, transparent, and efficient framework for ETFs that operate
in reliance on rule 6c-11, as those ETFs would no longer be subject to
differing and sometimes inconsistent provisions of their exemptive
relief. Moreover, investment companies that seek to operate an ETF
under conditions that differ from those in rule 6c-11 are able to
request exemptive relief from the Commission.
In addition, approximately 200 of our current ETF exemptive orders
automatically expire on the effective date of any Commission rule that
provides relief permitting the operation of ETFs.\455\ We have
determined, as proposed, to amend those orders to provide that the ETF
relief contained therein will terminate one year following the
effective date of rule 6c-11 to allow time for these ETFs to make any
adjustments necessary to rely on rule 6c-11.
---------------------------------------------------------------------------

\455\ See 2018 ETF Proposing Release, supra footnote 7, at n.348
and accompanying text (noting that the Commission began including a
condition in its 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).
---------------------------------------------------------------------------

We continue to believe that the one-year period for the termination
of our ETF exemptive relief is sufficient to give ETFs that are
operating under exemptive orders time to bring their operations into
conformity with the requirements of rule 6c-11. We did not receive any
comments on this aspect of the proposal. We also did not receive any
comments stating that the need to comply with the requirements of rule
6c-11, as opposed to their exemptive relief, would significantly
negatively affect the operations of existing ETFs.
Finally, we did not propose to rescind the fund of funds exemptive
relief included in our ETF exemptive orders.\456\ This relief permits
an ETF to create fund of funds structures, subject to certain
conditions set forth in the ETF's exemptive application, 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. The conditions for fund
of funds relief for ETFs are substantially similar across our exemptive
orders.
---------------------------------------------------------------------------

\456\ See id. at n.344 and accompanying text.
---------------------------------------------------------------------------

Commenters generally agreed that we should not rescind the fund of
funds exemptive relief, but asserted that the Commission should include
fund of funds relief in a final rule or provide such relief through
other means.\457\

[[Page 57199]]

Some commenters stated that because fund of funds relief is part of
standard ETF exemptive orders, the Commission also should permit new
ETFs to rely on the terms and conditions of fund of funds relief
previously granted to existing ETFs.\458\ These commenters stated that
failing to provide this relief would frustrate the Commission's purpose
of allowing new ETFs to enter the market without obtaining an exemptive
order from the Commission.
---------------------------------------------------------------------------

\457\ See, e.g., Dechert Comment Letter; ABA Comment Letter;
MFDF Comment Letter; SSGA Comment Letter; WisdomTree Comment Letter;
OppenheimerFunds Comment Letter. Commenters also suggested that the
Commission should permit funds relying on sections 3(c)(l) and
3(c)(7) under the Act to be acquiring funds under any future fund of
funds relief. See Dechert Comment Letter; OppenheimerFunds Comment
Letter. While the subject matter of these comments falls outside the
scope of the proposal of rule 6c-11, this issue is addressed as part
of the proposed fund of funds rules. See FOF Proposing Release,
supra footnote 40.
\458\ See, e.g., ABA Comment Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

In December 2018, we proposed new rule 12d1-4 under the Act to
streamline and enhance the regulatory framework applicable to fund of
funds arrangements for registered investment companies, including
ETFs.\459\ In connection with that proposed rule, we also proposed to
rescind our exemptive orders granting relief to certain fund of funds
arrangements, including the relief from sections 12(d)(1)(A) and (B)
that, as discussed above, has been included in our ETF exemptive
orders. The Commission has not yet acted upon this proposal and is not
rescinding the fund of funds relief in existing exemptive orders in
connection with this rulemaking.
---------------------------------------------------------------------------

\459\ See FOF Proposing Release, supra footnote 40, at nn.236-
237 and accompanying text.
---------------------------------------------------------------------------

We agree with commenters, however, that new entrants to the ETF
market would be at disadvantage to existing ETFs without fund of funds
relief. Accordingly, ETFs relying on rule 6c-11 that do not have
exemptive relief from sections 12(d)(1)(A) and (B) and section 17(a)(1)
and (2) of the Act may enter into fund of funds arrangements as set
forth in our recent ETF exemptive orders, provided that they satisfy
the terms and conditions for fund of funds relief in those orders.\460\
This relief will be available only until the effective date of a new
Commission rule permitting registered funds to acquire the securities
of other registered funds in excess of the limits in section 12(d)(1),
including rule 12d1-4 if adopted.\461\
---------------------------------------------------------------------------

\460\ See Salt Financial, supra footnote 248. Our exemptive
orders permitting ETFs to enter into fund of funds arrangements
include relief from section 17(a) of the Act. Section 17(a) would
prohibit an ETF that is an acquiring fund that holds 5% or more of
an acquired fund's securities from making any additional investments
in the acquired fund. In addition, fund of funds arrangements
involving funds that are part of the same group of investment
companies or that have the same investment adviser (or affiliated
investment advisers) implicate section 17(a), regardless of whether
an acquiring fund exceeds the 5% threshold. Furthermore, where an
ETF is an acquired fund, section 17(a) would prohibit the delivery
or deposit of basket assets on an in-kind basis by an affiliated
fund (that is, by exchanging certain assets from the ETF's
portfolio, rather than in cash). See FOF Proposing Release, supra
footnote 40, at nn.60-64 and accompanying text. The relief we are
providing from section 17(a) does not extend beyond the scope of the
relief we have provided in our exemptive orders to ETFs. We are
providing the relief from sections 12(d)(1)(A) and (B) and section
17(a) in accordance with our authority under sections 6(c),
12(d)(1)(J), and 17(b) of the Act. See 15 U.S.C. 80a-6(c), 15 U.S.C.
80a-12(d)(1)(J), and 15 U.S.C. 80a-17(b).
\461\ For the reasons discussed above, we find that this 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. See 15
U.S.C. 80a-6(c). We similarly find that such an exemption is
consistent with the public interest and the protection of investors.
See 15 U.S.C. 80a-12(d)(1)(J).
---------------------------------------------------------------------------

H. Amendments to Form N-1A

We are adopting 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, that are designed to provide
ETF investors with additional information regarding ETF trading and
associated costs. Commenters generally supported providing additional
information to investors regarding ETF trading, but many suggested
specific modifications to the proposals.\462\ After considering these
comments, we are adopting the following amendments to Form N-1A:
---------------------------------------------------------------------------

\462\ We also received a comment requesting that we confirm the
applicability of the civil liability provisions in sections 11 and
12 of the Securities Act to investors that purchase ETF shares on
the secondary markets. See Hagens Berman Comment Letter. This
rulemaking is intended to codify existing relief for ETFs relating
to the formation and operation of ETFs under the Investment Company
Act. Accordingly, the applicability of those Securities Act
provisions is beyond the scope of this rulemaking.
---------------------------------------------------------------------------

Adding the term ``selling'' to current narrative
disclosure requirements to clarify that the fees and expenses reflected
in the expense table may be higher for investors if they buy, hold, and
sell shares of the fund (Item 3);
Streamlined narrative disclosures relating to ETF trading
costs, including bid-ask spreads (Item 6);
Requiring ETFs that do not rely on rule 6c-11 to disclose
median bid-ask spread information on their websites or in their
prospectus (Item 6);
Excluding ETFs that provide premium/discount disclosures
in accordance with rule 6c-11 from the premium and discount disclosure
requirements in Form N-1A (Items 11 and 27); and
Eliminating disclosures relating to creation unit size and
disclosures applying only to ETFs with creation unit sizes of less than
25,000 shares (Items 3, 6, 11 and 27).
1. Fee Disclosures for Mutual Funds and ETFs (Item 3)
As proposed, we are adopting a narrative disclosure that will
specify that the fees and expenses reflected in the Item 3 expense
table also may be higher for investors if they sell shares of the
fund.\463\ Currently, this item requires disclosure indicating only
that the table describes fees and expenses investors may pay if they
buy and hold shares of the fund. However, both mutual funds and ETF
investors also may incur expenses other than redemption fees when
selling fund shares.\464\ We are therefore amending this disclosure to
specify that investors may pay the fees and expenses described in Item
3 if they buy, hold, and sell shares of the fund.\465\ Commenters who
addressed this proposed change supported it because it will help
investors better understand that they may incur costs in addition to
those in the fee table.\466\
---------------------------------------------------------------------------

\463\ Item 3 of Form N-1A (requiring, for example, disclosure of
sales loads, exchange fees, maximum account fees, and redemption
fees that funds charge directly to shareholders). We also are
amending Instruction 1(e) of Item 3, as proposed, to eliminate: (i)
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; and (ii) the instruction to 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 not 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 also Instruction
1(e)(ii) to Item 27(d)(1) (adopting the same modification for the
expense example in an ETF's annual and semi-annual reports).
\464\ For example, 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.
\465\ See Item 3 of Form N-1A.
\466\ See, e.g., CSIM Comment Letter; FIMSAC Comment Letter; IDC
Comment Letter.
---------------------------------------------------------------------------

We also are adopting, as proposed, a requirement to include a
statement that investors may be subject to other fees not reflected in
the table, such as brokerage commissions and fees to financial
intermediaries.\467\ Commenters who addressed this proposed requirement
supported it.\468\ We continue to believe this is an appropriate
disclosure for both ETFs

[[Page 57200]]

and mutual funds, as investors in ETFs and mutual funds alike may incur
brokerage commissions and fees to financial intermediaries.
---------------------------------------------------------------------------

\467\ Item 3 of Form N-1A.
\468\ See, e.g., IDC Comment Letter; Invesco Comment Letter.
---------------------------------------------------------------------------

2. Disclosures Regarding ETF Trading and Associated Costs (Item 6)
We are adopting amendments to Item 6 of Form N-1A that: (i) Will
require an ETF to provide narrative disclosure identifying specific
costs associated with buying and selling ETF shares and directing
investors to its website for additional information; and (ii) allow an
ETF that is not subject to rule 6c-11 the option to provide disclosure
regarding the ETF's median bid-ask spread on its website or in its
prospectus.\469\ These form amendments differ in several respects from
our proposal, which would have required an ETF to disclose information
regarding how ETF shares trade and the associated costs, including
information regarding bid-ask spreads, as part of the fund's fee table
disclosure.
---------------------------------------------------------------------------

\469\ Rule 6c-11 will require an ETF to disclose its median bid-
ask spread for the last thirty calendar days on its website as a
condition to the rule. Rule 6c-11(c)(1)(v). We also are amending the
definition of ``Exchange-Traded Fund'' in Form N-1A to add a
specific reference to rule 6c-11. See General Instruction A of Form
N-1A (defining ``exchange-traded fund'' as 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). We are adopting this definition as proposed.
---------------------------------------------------------------------------

a. Narrative Disclosures
Secondary market investors in ETF shares are subject to trading
costs when purchasing and selling ETF shares that ETFs are not
currently required to disclose in their prospectuses. Trading costs,
like all costs and expenses, affect investors' returns on their
investment.\470\ In addition, some investors use ETFs more heavily as
trading vehicles compared to mutual funds and may thus incur
substantial trading costs. We believe that investors could overlook
these costs and that additional disclosure would help them better
understand these costs when purchasing or selling ETF shares.
---------------------------------------------------------------------------

\470\ 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 .
---------------------------------------------------------------------------

As a result, we proposed to require ETFs to include a series of
questions and answers--or Q&As--in Item 3 that would have provided
investors with narrative disclosure regarding ETF trading and
associated costs, as well as quantitative disclosures regarding bid-ask
spreads.\471\ Although many commenters supported providing information
regarding trading costs to investors, commenters raised concerns
regarding the quantitative aspects of the bid-ask spread
disclosures.\472\ In addition, comments on the proposed Q&A format were
mixed. Some commenters supported the format, stating that it provided a
user-friendly method for identifying certain costs.\473\ Many others
expressed concerns that this format would significantly lengthen the
summary prospectus, potentially resulting in less investor-friendly
formats or increased printing costs.\474\ Some commenters asserted that
the proposed Q&A format may be more appropriate for inclusion in the
statutory prospectus rather than the summary prospectus.\475\
---------------------------------------------------------------------------

\471\ We also proposed to move certain disclosure regarding the
purchase of ETF shares from Item 6 to Item 3, consolidating relevant
disclosures regarding the fees and trading costs that an ETF
investor may bear in one place. 2018 ETF Proposing Release, supra
footnote 7, at text accompanying nn.391-394.
\472\ See also supra section II.C.6.d. (discussing median bid-
ask spread disclosure requirements in rule 6c-11 and our
determination not to adopt amendments that would have required an
ETF to provide: (i) Hypothetical examples in its prospectus of how
the bid-ask spread impacts return on investment; and (ii) an
interactive calculator on its website to allow investors the ability
to customize those hypothetical calculations).
\473\ See, e.g., CFA Institute Comment Letter; FIMSAC Comment
Letter.
\474\ See, e.g., CSIM Comment Letter (stating the that proposed
format would require ETFs to rethink the presentation of the
summary); Fidelity Comment Letter (stating that the proposed format
would subsume other more important information and that concise
narrative disclosure would be preferable); Vanguard Comment Letter
(stating the sponsors should be permitted to determine how best to
present this information).
\475\ BlackRock Comment Letter; CSIM Comment Letter.
---------------------------------------------------------------------------

We continue to believe that investors could overlook certain
trading costs when buying or selling ETF shares and that additional
disclosure will help them better understand these costs. However, we
agree with commenters that the extent of trading cost disclosures we
proposed to require in Item 3 could obscure other key information
regarding other fees and expenses and potentially give bid-ask spread
disclosures undue prominence. We also agree that ETFs and their
investors may benefit from flexibility in the manner of presenting the
required information, especially if the proposed format would unduly
distract from other key information. We therefore are permitting ETFs
to use formats other than Q&As to present this information.\476\ In
addition, we are moving the narrative disclosures regarding trading
costs to Item 6 of Form N-1A, which provides investors with information
regarding the purchase and sale of fund shares to avoid overemphasizing
these costs.
---------------------------------------------------------------------------

\476\ See Item 6(c) of Form N-1A. An ETF must provide the
required information using plain English principles under rule
421(d) under the Securities Act. See General Instructions to Form N-
1A. The applicable standards provide ETFs and other funds with
flexibility, for example, in determining whether to use headings in
a question-and-answer format. Enhanced Disclosure and New Prospectus
Delivery Option for Open-End Management Investment Companies,
Investment Company Act Release No. 28584 (Jan. 13, 2009) [74 FR
4546, 4549 n.39 (Jan. 26, 2009)] (``Summary Prospectus Adopting
Release'').
---------------------------------------------------------------------------

We also are streamlining several of the narrative disclosure
requirements we proposed. First, we are adopting a requirement that the
ETF's summary prospectus or summary section cross-reference the ETF's
website.\477\ Rule 6c-11 will require daily website disclosure of
several items, including the NAV per share, market price, premium or
discount, and bid-ask spread information. Form N-1A also will permit
ETFs to omit certain information from their registration statements if
they satisfy certain of the rule's website disclosure conditions.\478\
This disclosure will inform investors how to access this information.
---------------------------------------------------------------------------

\477\ Item 6(c)(4) of Form N-1A. The form amendments permit an
ETF to combine the information required by this website cross-
reference requirement into the information required by Item 1(b)(1)
of Form N-1A and 17 CFR 230.498(b)(1)(v) (rule 498(b)(1)(v)) in
order to avoid duplicative references to the ETF's website.
Instruction 4 to Item 6 of Form N-1A (referring to the website
cross-reference disclosure requirements in the summary prospectus
cover page and the statutory prospectus back cover page). However,
by requiring a cross-reference to the ETF's website, the Commission
does not intend for such information to be incorporated by reference
into the prospectus.
\478\ See, e.g., Instruction 1 to Item 6 of Form N-1A. 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.
---------------------------------------------------------------------------

Commenters did not specifically address this proposed requirement.
However, in general, commenters expressed support for website
disclosure requirements, including as a substitute for certain
registration statement disclosure requirements.\479\ We believe a
cross-reference in Form N-1A to the required website disclosures will
enable investors to receive timely and granular information that could
assist with making an investment decision and are therefore adopting
the

[[Page 57201]]

requirement substantially as proposed in Item 6.
---------------------------------------------------------------------------

\479\ See, e.g., SIFMA AMG Comment Letter I; Fidelity Comment
Letter.
---------------------------------------------------------------------------

We also are adopting a requirement to provide narrative disclosure
regarding bid-ask spreads.\480\ As noted above, commenters generally
did not address the substance of the disclosures, but raised concerns
regarding the length of the disclosures. One commenter, however,
asserted that the proposed requirement to disclose certain additional
costs associated with buying and selling ETF shares would be redundant
of information required by Item 3.\481\
---------------------------------------------------------------------------

\480\ Our proposal would have required an ETF to: (i) 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 shares of the ETF
(ask); (ii) 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; and (iii) identify a set of specific costs, including
bid-ask spreads, associated with buying and selling ETF shares. See
2018 ETF Proposing Release, supra footnote 7, at section II.H.2.
\481\ See ABA Comment Letter.
---------------------------------------------------------------------------

We continue to believe that narrative bid-ask spread disclosure
will inform investors regarding the potential impact of spread costs
and provide investors with additional context to understand that the
costs attributable to the bid-ask spread may increase or decrease when
certain market conditions exist or certain factors are present.
However, streamlining this disclosure to provide investors with key
information regarding bid-ask spreads will both aid investor
understanding and eliminate some of the length associated with the
proposed disclosure requirement. Accordingly, our amendments to Form N-
1A will require an ETF to state that an investor may incur costs
attributable to 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 shares of the ETF (ask) when buying
or selling shares in the secondary market (``the bid-ask
spread'').\482\ This information, combined with the website cross-
reference requirement, will direct ETF investors to website disclosures
regarding median bid-ask spreads.
---------------------------------------------------------------------------

\482\ See Item 6(c)(3) of Form N-1A.
---------------------------------------------------------------------------

Finally, Item 6 will continue to require ETFs to disclose: (i) That
individual shares may only be purchased and sold on secondary markets
through a broker-dealer; and (ii) the price of ETF shares is based on
market 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).\483\
---------------------------------------------------------------------------

\483\ Item 6(c) of Form N-1A. We proposed to move this
disclosure to Item 3 to consolidate background information relating
to ETF trading in one place. 2018 ETF Proposing Release, supra
footnote 7, at section II.H.3. However, we are not adopting the
proposed amendments to Item 3 and instead adding additional
disclosures regarding ETF trading costs to Item 6. As proposed,
amended Item 6 also will replace the current reference to ``national
securities exchange'' with ``secondary markets'' because ETFs can
also be bought and sold over the counter.
---------------------------------------------------------------------------

b. Median Bid-Ask Spread Requirement
Rule 6c-11 will require an ETF to provide website disclosure of
median bid-ask spreads.\484\ We believe that this disclosure will
provide ETF investors with greater understanding of the costs
associated with investing in ETFs. In order to provide similar
disclosures to investors in ETFs that are outside the scope of rule 6c-
11, we are adopting amendments to Form N-1A requiring the disclosure of
median bid-ask spreads.
---------------------------------------------------------------------------

\484\ See rule 6(c)(1)(v).
---------------------------------------------------------------------------

We proposed amendments to Form N-1A that would have required all
open-end ETFs to disclose quantitative information about bid-ask
spreads, both in an ETF's prospectus and on its website.\485\ As
discussed above, some commenters expressed concerns with these
requirements, and we have made several modifications to mitigate those
concerns while maintaining or enhancing the usefulness of the required
disclosures. Those modifications include not adopting the proposed
requirement for hypothetical bid-ask spread examples in the ETF's
prospectus and interactive calculator, and instead only requiring ETFs
relying on rule 6c-11 to provide disclosure of median bid-ask spread on
their website.\486\
---------------------------------------------------------------------------

\485\ See 2018 ETF Proposing Release, supra footnote 7, at
sections II.H.2.b and II.I.
\486\ See supra section II.C.6.d.
---------------------------------------------------------------------------

However, we continue to believe that all ETF investors should
receive key information about bid-ask spread costs, and appreciate that
ETFs that are not relying on rule 6c-11 may want the flexibility to
provide more timely bid-ask spread information on their websites.\487\
We are therefore amending Form N-1A to require an ETF that is not
subject to rule 6c-11 to: (i) Provide the ETF's median bid-ask spread
for its most recent fiscal year in its prospectus; or (ii) comply with
the bid-ask spread website disclosure requirements in rule 6c-
11(c)(1)(v).\488\ We believe that this disclosure requirement will
provide all ETF investors with quantitative bid-ask spread information,
while providing ETFs not subject to rule 6c-11 with the flexibility to
provide either website or prospectus disclosure.\489\ This requirement
also is consistent with our current approach to the disclosure of
premiums and discounts in Form N-1A and, based on our experience with
that disclosure, we believe most ETFs will opt to post bid-ask spread
information on their websites as some ETFs do today on a voluntary
basis.\490\
---------------------------------------------------------------------------

\487\ See infra section II.I. (discussing similar changes for
Form N-8B-2).
\488\ See Item 6(c)(5) of Form N-1A (requiring disclosure of the
median bid-ask spread for the ETF's most recent fiscal year in the
summary prospectus or summary section of the prospectus);
Instruction 1 to Item 6(c)(5) of Form N-1A (permitting an ETF to
omit the information required if the ETF satisfies the requirements
of paragraph (c)(1)(v) of rule 6c-11). As with the parallel website
disclosure requirement, we are modifying the proposed methodology to
clarify that the observations must be based on trades on the primary
listing exchange and that the observations should be as of the end
of each ten-second interval. Instruction 2 to Item 6(c)(5) of Form
N-1A. We also are making similar amendments to Form N-8B-2 in order
to extend this requirement to UIT ETFs. See infra section II.I.
\489\ Item 6(c)(5) of Form N-1A. See 2018 ETF Proposing Release,
supra footnote 7, at section II.H.2.b.
\490\ See Items 11(g)(2) and 27(b)(7)(iv) of Form N-1A.
---------------------------------------------------------------------------

Although rule 6c-11 contemplates more current website disclosure
for ETFs relying on rule 6c-11, we are adopting a lookback period of
the ETF's most recent fiscal year for the prospectus bid-ask spread
disclosure requirement. We are adopting this period for consistency
with other disclosures in Form N-1A and to avoid establishing a
requirement that would require more frequent updating of an ETF's
prospectus. ETFs that opt to provide this information on their website,
however, will provide median bid-ask spread information for the most
recent thirty-day period on a rolling basis. Finally, newly launched
ETFs subject to this prospectus requirement with less than a year of
trading data will be required to provide a brief statement to the
effect that the ETF does not have sufficient trading history to report
trading information and related costs as proposed.\491\
---------------------------------------------------------------------------

\491\ Instruction 1 to Item 6(c) of Form N-1A. Newly launched
ETFs seeking to satisfy the requirements of paragraph (c)(1)(v) of
the rule should provide median bid-ask spread information for the
most recent thirty-day period once the ETF has more than 30-days of
trading data.information.
---------------------------------------------------------------------------

c. Historical Premium and Discount Disclosures (Items 11 and 27)
Rule 6c-11 will require ETFs to provide certain disclosures
regarding premiums and discounts on their websites.\492\ We believe
premium/discount disclosure will help investors

[[Page 57202]]

better understand that an ETF's market price may be higher or lower
than the ETF's NAV per share and will provide investors with useful
information regarding ETFs that frequently trade at a premium or
discount to NAV. We are adopting amendments to Form N-1A that will
exclude only those ETFs that provide premium/discount disclosures in
accordance with rule 6c-11 from the premium and discount disclosure
requirements in Form N-1A.
---------------------------------------------------------------------------

\492\ See rule 6c-11(c)(1).
---------------------------------------------------------------------------

We proposed to eliminate existing disclosure requirements regarding
premiums and discounts in Form N-1A since rule 6c-11 would require an
ETF to provide more timely information on its website.\493\ One
commenter supported this amendment, stating that information relevant
to premiums and discounts is already disclosed on a timely basis on ETF
websites and therefore a duplicative registration statement requirement
is not necessary.\494\ Another commenter, however, stated that the
Commission should apply disclosure requirements to all ETFs, including
those that cannot rely on rule 6c-11, so that all ETF investors receive
the same information.\495\
---------------------------------------------------------------------------

\493\ Item 11(g)(2) of Form N-1A currently requires 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. Item 27(b)(7)(iv) of Form N-1A requires an ETF to
include a table with premium/discount information in its annual
reports for the five most recently completed fiscal years. ETFs
currently are permitted to omit both disclosures by providing on
their websites the premium/discount information required by Item
11(g)(2).
\494\ See Invesco Comment Letter.
\495\ See ETF.com Comment Letter.
---------------------------------------------------------------------------

After considering comments, we are eliminating the premium and
discount requirements in Items 11(g)(2) and 27(b)(7)(iv) for ETFs
relying on rule 6c-11.\496\ However, ETFs not relying on rule 6c-11
must include premium and discount information in both the prospectus
and annual report unless they choose to comply with the website
disclosure requirements in rule 6c-11(c)(1)(ii)-(iv) and
(c)(1)(vi).\497\ We agree that all ETF investors should receive similar
premium/discount disclosure, regardless of the form of exemptive
relief.
---------------------------------------------------------------------------

\496\ Item 11(g)(2) of Form N-1A; Item 27(b)(7) of Form N-1A.
\497\ Items 11(g)(2) and 27(g)(2) of Form N-1A.
---------------------------------------------------------------------------

We acknowledge that the premium and discount disclosure
requirements under rule 6c-11 are broader than what was required under
Form N-1A.\498\ However, to ensure consistency of website disclosure
across ETFs, we are amending Form N-1A to require that if an ETF not
relying on rule 6c-11 chooses to disclose the premium and discount
disclosures on its website to satisfy the Form N-1A requirement, it
must conform with the requirements in rule 6c-11.\499\ Nonetheless,
consistent with our experience with the current Form N-1A requirement,
we believe that most ETFs not relying on rule 6c-11 will choose to
comply with the website disclosure requirements in rule 6c-11.
---------------------------------------------------------------------------

\498\ Unlike current Form N-1A, rule 6c-11 will require
disclosure of 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
and disclosure regarding persistent premium or discount of greater
than 2%, in addition to a table showing premiums and discounts, in
order to omit the premium/discount disclosures in the ETF's
prospectus and annual report.
\499\ We also are retaining the definition of the term ``Market
Price'' in Form N-1A and amending it to reference the market price
definition in rule 6c-11 as a result of the premium/discount
disclosure requirements in the form. See General Instruction A to
Form N-1A. Harmonizing the definition of market price in Form N-1A
and rule 6c-11 will reduce regulatory confusion and will result in a
more uniform methodology for calculating premiums and discounts for
ETFs that provide premium/discount disclosure in accordance with
rule 6c-11 and ETFs that provide premium/discount disclosures in
their prospectuses and annual reports pursuant to these disclosure
requirements. See id.; rule 6c-11(a)(1). We are making similar
amendments to Form N-8B-2 in order to extend the premium/discount
disclosure requirements to UIT ETFs. See infra section II.I.
---------------------------------------------------------------------------

3. Eliminated Disclosures
We are adopting the removal of certain disclosure requirements from
Form N-1A relating to ETFs. We are removing the requirement that an ETF
specify the number of shares it will issue or redeem in exchange for
the deposit or delivery of basket assets.\500\ The number of shares the
ETF issues or redeems in exchange for the deposit or delivery of
baskets is largely duplicative of information provided in reports on
Form N-CEN.\501\ Commenters did not address this aspect of the
proposal, and we are adopting it as proposed.
---------------------------------------------------------------------------

\500\ Item 6(c)(i) of current Form N-1A.
\501\ See Item E.3.a of Form N-CEN.
---------------------------------------------------------------------------

We also are eliminating several disclosure requirements in Items 6
and 11 that applied only to ETFs that issue or redeem shares in
creation units of less than 25,000 shares.\502\ 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.\503\ Based on staff experience, however, we believe that these
disclosures are unnecessary as retail investors generally do not engage
in primary transactions through authorized participants and the current
flow of information about the purchase and redemption process is
robust.\504\ One commenter supported eliminating these disclosure
requirements, and we are eliminating these requirements as
proposed.\505\
---------------------------------------------------------------------------

\502\ 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). Items 6(a) and (b) require funds to:
(i) Disclose the minimum initial or subsequent investment
requirements; (ii) disclose that the shares are redeemable; and
(iii) describe the procedures for redeeming shares. Item 11(g)(1)
currently provides 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. Item 11(a)
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.
Items 11(b) and (c) require a fund to describe the procedures used
when purchasing and redeeming the fund's shares.
\503\ Summary Prospectus Adopting Release, supra footnote 477.
\504\ 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.
\505\ See Invesco Comment Letter.
---------------------------------------------------------------------------

I. Amendments to Form N-8B-2

Form N-8B-2 is the registration form under the Investment Company
Act for UITs that are currently issuing securities, and it is used for
registration of ETFs organized as UITs.\506\ Because Form S-6 requires
UIT prospectuses to include disclosure required by specified provisions
of Form N-8B-2, the disclosure requirements of Form N-8B-2 also apply
to prospectuses on Form S-6. We are adopting several amendments to Form
N-8B-2 that will mirror requirements we are adopting in Form N-1A.
---------------------------------------------------------------------------

\506\ While open-end funds register with the Commission on Form
N-1A, UITs must register on 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, requires certain content, mainly by
reference to the disclosure requirements in Form N-8B-2.
---------------------------------------------------------------------------

Although we are not including UIT ETFs within the scope of rule 6c-
11, we believe that it is important for investors to receive consistent
disclosures for ETF investments, regardless of the ETF's form of
organization. Secondary market investors in UIT ETFs, like other ETFs,
are subject to trading costs that unit holders could overlook. We
believe that additional disclosure will help investors better
understand the total costs of investing in a UIT ETF. We therefore
proposed to amend Form N-8B-2 to require UIT ETFs to provide the same
disclosures regarding ETF trading and the associated costs as ETFs
organized

[[Page 57203]]

as open-end funds would disclose on Form N-1A.
Commenters that addressed this proposed provision generally
supported these changes,\507\ and we are amending Form N-8B-2 to mirror
the amendments to Form N-1A with the modifications discussed
above.\508\ As with other ETFs that are not within the scope of rule
6c-11, these amendments will give UIT ETFs the option to forego certain
disclosures relating to bid-ask spreads and premiums and discounts
provided that the ETF conforms with rule 6c-11's corresponding website
disclosure requirements.\509\
---------------------------------------------------------------------------

\507\ See ICI Comment Letter (supporting mirroring proposed
disclosure changes in Form N-1A, subject to comments regarding the
amendments to Form N-1A).
\508\ Items I.13(h) and (i) of Form N-8B-2. See also supra
section II.H. (describing the ETF trading information and related
costs disclosure requirements).
\509\ Although UIT ETFs currently are not subject to website
disclosure requirements regarding trading costs or other
information, UIT ETFs generally disclose information regarding
market price, NAV per share, premium and discounts, and spreads on
their websites today.
---------------------------------------------------------------------------

Below, Table 3 summarizes the amendments to Form N-8B-2 and the
corresponding requirements in Form N-1A.
---------------------------------------------------------------------------

\510\ The 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 cannot rely on rule 6c-
11 to operate. Accordingly, the definition of ``exchange-traded
fund'' in Form N-8B-2 omits the reference to rule 6c-11.

Table 3
------------------------------------------------------------------------
Form N-1A ETF Corresponding Form N-
Disclosure topic disclosure 8B-2 disclosure
requirement requirement
------------------------------------------------------------------------
Definitions for Exchange- General Instructions General Instructions
Traded Fund and Market Part A. Definitions.\510\
Price.
Information Concerning Fees Item 3. Risk/Return Item I.13(h).
and Costs. Summary: Fee Table.
Information Concerning Item 6(c). Purchase Item I.13(i).
Purchase and Sale of Fund and Sale of Fund
Shares. Shares.
Table Showing Premium and Item 11(g)(2)....... Item I.13(j).
Discount Information.
------------------------------------------------------------------------

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.\511\ As proposed, we are adopting a new requirement that will
collect specific information on which ETFs are relying on rule 6c-
11.\512\ We believe that this requirement will allow us to better
monitor reliance on rule 6c-11 and assist us with our accounting,
auditing, and oversight functions, including compliance with the
Paperwork Reduction Act.\513\
---------------------------------------------------------------------------

\511\ See Reporting Modernization Adopting Release, supra
footnote 263.
\512\ Item C.7.k of Form N-CEN. 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. In
addition, Item C.3.a.i of Form N-CEN already requires funds to
report if they are an ETF.
\513\ See Reporting Modernization Adopting Release, supra
footnote 263.
---------------------------------------------------------------------------

We also are changing the definition of ``authorized participant''
in Form N-CEN to conform the definition with rule 6c-11 by deleting a
specific reference to an authorized participant's participation in
DTC.\514\ In addition to reducing regulatory confusion by harmonizing
the definition of ``authorized participant'' with rule 6c-11, this
change also will obviate the need for future amendments if additional
clearing agencies become registered with the Commission.\515\
Commenters that addressed the proposed amendments to Form N-CEN
expressed support, and we have determined to adopt the amendments as
proposed.
---------------------------------------------------------------------------

\514\ Item E.2 of Form N-CEN.
\515\ As proposed, the amendments to Form N-CEN will define the
term ``authorized participant'' 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.'' See Instruction to Item E.2 of Form N-CEN.
---------------------------------------------------------------------------

K. Technical and Conforming Amendments to Form N-1A, Form N-8B-2, Form
N-CSR, Form N-PORT, and Regulation S-X

In October 2016, the Commission adopted new rules and forms and
amended other rules and forms under the Investment Company Act to
modernize the reporting and disclosure of information by registered
investment companies.\516\ In February 2019, the Commission adopted an
interim final rule that amended the timing requirements for filing
reports on Form N-PORT.\517\ We are making the following technical
corrections as a result of these rulemakings, as well as correcting
certain other outdated citations and instructions:
---------------------------------------------------------------------------

\516\ See Reporting Modernization Adopting Release, supra
footnote 263.
\517\ See Amendments to the Timing Requirements for Filing
Reports on Form N-PORT, Investment Company Act Release No. 33384
(Feb. 27, 2019) [84 FR 7980 (Mar. 6, 2019)] (``Interim Final Rule
Release'').
---------------------------------------------------------------------------

Correcting footnote 1 of 17 CFR 210.12-14 (rule 12-14 of
Regulation S-X) by replacing a reference to Column E with a reference
to Column F.\518\
---------------------------------------------------------------------------

\518\ See rule 12-14, note 1.
---------------------------------------------------------------------------

Amending General Instruction B.4.(a) of Form N-1A to
update outdated citation references to 17 CFR 230.400 through 230.498
(Regulation C) by replacing references to 17 CFR 230.497 (rule 497)
with references to rule 498.\519\
---------------------------------------------------------------------------

\519\ See General Instruction B.4.(a) of Form N-1A.
---------------------------------------------------------------------------

Amending General Instruction B.4.(d) of Form N-1A to
update outdated citation references to 17 CFR 232.10 through 232.903
(Regulation S-T) by replacing references to rule 903 with references to
rule 501.\520\
---------------------------------------------------------------------------

\520\ See General Instruction B.4.(d) of Form N-1A.
---------------------------------------------------------------------------

Amending Instruction 4(b) to Item 13 of Form N-1A by
deleting outdated instructions regarding changes in methodology for
determining the ratio of expenses to average net assets.\521\
---------------------------------------------------------------------------

\521\ See Instruction 4(b) to Item 13.
---------------------------------------------------------------------------

Amending Form N-1A to require money market funds to state
in their annual and semi-annual reports that: (i) Their monthly
portfolio holdings are available on Form N-MFP; (ii) the money market
fund's reports on Form N-MFP are available on the Commission's website;
and (iii) the money market fund makes portfolio holdings information
available to shareholders on its website.\522\ This amendment will
reflect the fact that money market funds report monthly portfolio
holdings on Form N-MFP rather than reporting portfolio holdings for the
first and third fiscal quarters on Form N-PORT.
---------------------------------------------------------------------------

\522\ See Instruction to Item 27(d)(3) of Form N-1A.

---------------------------------------------------------------------------

[[Page 57204]]

Amending Form N-CSR to correct references to item numbers
in General Instruction D and in the instruction to Item 13.\523\
---------------------------------------------------------------------------

\523\ See General Instruction D to Form N-CSR and Item 13 of
Instruction 13 of Form N-CSR.
---------------------------------------------------------------------------

Amending General Instruction F (Public Availability) of
Form N-PORT to read ``With the exception of the non-public information
discussed below, the information reported on Form N-PORT for the third
month of each Fund's fiscal quarter will be made publicly available
upon filing.'' \524\ This amendment will reflect the Commission's
action making quarter-end reports on Form N-PORT public immediately
upon filing, with the exception of the non-public fields identified in
General Instruction F.\525\
---------------------------------------------------------------------------

\524\ See Instruction F to Form N-PORT.
\525\ See Interim Final Rule Release, supra footnote 518, at
n.35 and accompanying text.
---------------------------------------------------------------------------

Withdrawing Instruction 23 of Reporting Modernization
Adopting Release, which would have amended 17 CFR 232.401 (rule 401 of
Regulation S-T) to remove references to Form N-Q.\526\ The amendment is
no longer necessary because rule 401 was rescinded by a subsequent
rulemaking.\527\
---------------------------------------------------------------------------

\526\ See Reporting Modernization Adopting Release, supra
footnote 263; see also 17 CFR 232.401.
\527\ See Inline XBRL Filing of Tagged Data, Investment Company
Act Release No. 33139 (June 28, 2018) [83 FR 40846 (Aug. 16, 2018)].
---------------------------------------------------------------------------

Amending Item IX of Form N-8B-2 to clarify the required
designation of exhibits and the use of incorporation by reference in
order to conform to similar instructions in other Investment Company
forms.\528\
---------------------------------------------------------------------------

\528\ See, e.g., Item 28 of Form N-1A.; Item 26 of Form N-6.
---------------------------------------------------------------------------

L. Compliance Dates

The Commission is providing for a transition period for the
amendments to Forms N-1A, N-8B-2, and N-CEN. Specifically, we are
adopting compliance dates for our amendments to Form N-1A, Form N-8B-2,
and Form N-CEN of December 22, 2020, one year following the amendments'
effective date. All registration statements, post-effective amendments,
and reports on these forms filed on or after the compliance date must
comply with the amendments. Based on the staff's experience, we believe
that this will provide adequate time for ETFs and other funds to
compile and review the information that must be disclosed.

III. Other Matters

Pursuant to the Congressional Review Act,\529\ the Office of
Information and Regulatory Affairs has designated this rule a ``major
rule,'' as defined by 5 U.S.C. 804(2). If any of the provisions of
these rules, or the application thereof to any person or circumstance,
is held to be invalid, such invalidity shall not affect other
provisions or application of such provisions to other persons or
circumstances that can be given effect without the invalid provision or
application.
---------------------------------------------------------------------------

\529\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

IV. Economic Analysis

We are mindful of the costs imposed by, and the benefits obtained
from, our rules. Section 2(c) of the Investment Company Act, section
2(b) of the Securities Act, and section 3(f) of the Exchange Act state
that when the Commission is engaging in rulmaking under such titles and
is required to consider or determine whether the action is necessary or
appropriate in (or, with respect to the Investment Company Act,
consistent with) the public interest, the Commission shall consider
whether the action will promote efficiency, competition, and capital
formation, in addition to the protection of investors. Further, section
23(a)(2) of the Exchange Act requires the Commission to consider, among
other matters, the impact such rules would have on competition and
states that the Commission shall not adopt any rule that would impose a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act. The following analysis considers, in
detail, the potential economic effects that may result from the rule,
including the benefits and costs to investors and other market
participants as well as the broader implications of the rule for
efficiency, competition, and capital formation.

A. Introduction

ETFs 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 structure and operation of
ETFs. 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 exemptive orders allow the sponsors to
launch new funds under the terms and conditions of those orders, and
because the terms in some of these orders may be more flexible than
others.
Rule 6c-11 will allow ETFs that satisfy certain conditions to
operate without obtaining an exemptive order from the Commission. The
Commission also is rescinding the exemptive relief we have issued to
ETFs that will be permitted to operate in reliance on the rule.
However, we anticipate that ETFs whose exemptive relief will be
rescinded under the rule generally will be able to rely on the rule
without substantially changing their current operations, as the rule's
conditions are similar to those contained in existing exemptive relief,
consistent with existing market practice, or generally more flexible
than those contained within existing exemptive relief.\530\ ETFs that
wish to operate in a manner not covered by the final exemptive rule can
seek individual exemptive relief from the Commission.\531\
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\530\ As discussed in more detail below, some conditions in the
rule and the scope of the relief provided are less flexible than
those included in certain exemptive orders (e.g. the absence 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).
\531\ We are not rescinding the exemptive orders for certain
categories of ETFs (i.e., UIT ETFs, share class ETFs, leveraged/
inverse ETFs and non-transparent ETFs), with the exception of
master-feeder relief that funds did not rely on as of the date of
the 2018 ETF Proposing Release (June 28, 2018).
---------------------------------------------------------------------------

We believe that rule 6c-11 will 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 can rely on the
rule. As such, the rule will enable increased product competition among
certain ETF providers, which can lead to lower fees for investors,
encourage financial innovation, and increase investor choice in the ETF
market.
The increased basket flexibility the rule affords in particular may
benefit ETFs and their shareholders. To the extent that ETFs are able
to implement basket policies and procedures that better facilitate the
arbitrage mechanism, these ETFs may reduce their bid-ask spreads and
thereby lower transaction costs for their investors. In addition,
certain ETFs may be able to use the increased basket flexibility to
reduce trading costs the ETF incurs.\532\
---------------------------------------------------------------------------

\532\ Several of the anticipated benefits of rule 6c-11 may be
associated with metrics that will be measurable only after funds
operate in reliance on the rule; such metrics include changes in
bid-ask spreads, premiums/discounts to NAV per share, fund fees, and
the number of ETFs. These metrics may help facilitate evaluation of
the extent to which the rule has generated the anticipated benefits,
although these metrics may also be affected by developments
independent of rule 6c-11.
---------------------------------------------------------------------------

The amendments to Forms N-1A and N-8B-2 as well as the additional
website disclosures required by the rule are intended to improve the
information

[[Page 57205]]

about ETFs available to the market and to allow investors to more
readily obtain information about fund products, resulting in reduced
investor search costs. To the extent that the disclosure requirements
will improve investors' ability to evaluate the performance and other
characteristics of fund products, the amendments may result in better
informed investor decisions and more efficient allocation of investor
capital among fund products, and may further promote competition among
ETFs and between ETFs and mutual funds.
The 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 rule
will 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 rule also
can 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
U.S. ETF began trading in 1993.\533\ 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 137 new ETF entrants and an average growth of
$241.2 billion annually. Since 2007, ETF net assets have grown at an
average rate of 17.2% per year, which compares to 3.2% for closed-end
funds and 6.3% for open-end funds over the same period.\534\
---------------------------------------------------------------------------

\533\ For the purpose of this release, we focus exclusively on
ETFs that trade on U.S. exchanges.
\534\ Unless otherwise noted, the number and net assets of ETFs
in this section of the Release 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 2018, there were 1,978 registered ETFs,
totaling $3.3 trillion in net assets and spanning six broad investment
style categories. ETFs are predominantly structured as open-end funds;
however, eight UIT ETFs together represented 10.3% of ETF total net
assets ($340.6 billion), and 68 share class ETFs together represented
25.6% of total net assets ($854.6 billion). The chart illustrates
growth in ETF net assets by investment strategy beginning in 2000. It
also tracks the percentage of net assets invested in actively managed
ETFs.

[[Page 57206]]

[GRAPHIC] [TIFF OMITTED] TR24OC19.019

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 (in both index-based and actively managed
ETFs). At the end of December 2018, there were 167 leveraged/inverse
ETFs that were structured as open-end funds.\535\ In total, leveraged/
inverse ETFs had total net assets of $29.64 billion or approximately 1%
of all ETF net assets. None of the eight registered UIT ETFs employed
leveraged or inverse investment strategies. Of the remaining
unleveraged ETFs, both index-based and actively managed, 1,705 ETFs had
combined net assets of $3 trillion operated as open-end funds, while
eight UIT ETFs had $340.6 billion in net assets.\536\
---------------------------------------------------------------------------

\535\ See supra footnote 92 (noting that the exemptive orders
that we have issued to sponsors of leveraged/inverse ETFs do not
provide relief to ETFs described as seeking investment returns that
correspond to the performance of a leveraged or inverse leveraged
market index over a predetermined period of time).
\536\ Bloomberg defines actively managed or index-based managed
funds according to disclosure in the fund prospectus.
---------------------------------------------------------------------------

There were 257 actively managed ETFs with total net assets of $69.5
billion. The remaining 1,721 ETFs, with a combined $3.23 trillion in
net assets, were index-based ETFs. Of these, 1,713 ETFs with total net
assets of $2.892 trillion were structured as open-end funds and eight
UIT ETFs had total net assets of $340.6 billion.
The majority of ETFs (1,615) held some foreign exposure in their
portfolio according to Morningstar data. These ETFs had total net
assets of $2.921 trillion. Of these funds, seven were UIT ETFs and had
$320.6 billion in net assets. The remaining 1,608 ETFs accounting for
$2.6 trillion in net assets were organized as open-end funds. On
average, these ETFs reported foreign exposure of 40.15% (56.87% for UIT
ETFs and 40.07% for ETFs structured as open-end funds).\537\
---------------------------------------------------------------------------

\537\ We estimate funds' foreign holdings on February 27, 2019
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 1,970 ETFs. In this data, 363 funds, one of which
is a UIT ETF, reported holding no foreign securities and 8 funds
from the original 1,978 are missing foreign holdings data.
---------------------------------------------------------------------------

2. Exemptive Order Process and Certain Conditions Under Existing Orders
ETFs seeking to operate as investment companies required exemptive
relief from the Commission. Since the first exemptive order was granted
in 1992, the Commission has issued approximately 300 exemptive orders
to ETFs. The average number of approved exemptive orders between 1992
and 2006 was approximately 2.5 per year, which has increased to
approximately 29 per year since 2007.

[[Page 57207]]

Based on our review of exemptive orders that granted relief for
unleveraged ETFs between January 2007 and early April 2019, the median
processing time from the filing of an initial application to the
issuance of an order was 213 days, although there was considerable
variation.\538\ 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 87 days)
while others waited over one year for approval (the 90th percentile of
the processing time was 669 days).
---------------------------------------------------------------------------

\538\ The earliest order in our sample was approved on January
17, 2007 and the latest order was approved on April 2, 2019. This
data does not include orders for non-transparent ETFs.
---------------------------------------------------------------------------

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.
These exemptive orders permit ETFs to operate as investment
companies under the Investment Company Act, subject to representations
and conditions, some of which have changed over time.\539\ For example,
as discussed above, our orders have required ETFs that will rely on
rule 6c-11 to provide some degree of transparency regarding their
portfolio holdings.\540\ Actively managed ETFs and some self-indexed
ETFs have been required to disclose their full portfolio holdings each
day, while other index-based ETFs are permitted to specify the index
they seek to track (as long as the index provider lists the constituent
securities on its website) or disclose the components of their baskets.
Based on a staff review of 150 randomly selected ETFs, which included
100 index-based ETFs and 50 actively managed ETFs, however, all 150
ETFs maintain a website and provide the ETF's complete daily portfolio
holdings. Therefore, we believe it is likely that all ETFs that can
rely on the rule, including those that are not subject to a full
transparency condition in their exemptive order, currently provide full
portfolio transparency.\541\
---------------------------------------------------------------------------

\539\ ETFs generally have obtained similar exemptive relief
under these orders. However, over time, our exemptive orders
generally have increased the maximum number of days that an ETF
holding foreign investments can delay the satisfaction of
redemptions as part of the relief from section 22(e) of the Act
(from 12 days to 15 days).
\540\ See supra footnote 225.
\541\ 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
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.
Commenters did not disagree with statements in the proposing release
that ETFs that can rely on the rule maintain a website and provide
the ETF's complete daily portfolio holdings.
---------------------------------------------------------------------------

ETFs' flexibility to use custom baskets also has evolved over time
under our exemptive orders. From 1996 to 2006, exemptive orders for
open-end ETFs did not expressly limit baskets to a pro rata
representation of the ETF's portfolio holdings. Since approximately
2006, however, our exemptive orders placed increasingly tighter
restrictions on ETFs' composition of baskets.\542\ Because our
exemptive orders have generally included future funds relief to allow
sponsors to form and operate new ETFs, we are unable to quantify the
number of funds operating under each of the different basket
flexibility conditions included in our orders.\543\
---------------------------------------------------------------------------

\542\ See 2018 ETF Proposing Release, supra footnote 7, at
nn.236-241 and accompanying text.
\543\ See supra footnote 5.
---------------------------------------------------------------------------

Many exemptive orders also have required ETFs to provide certain
website disclosures on their website, free of charge.\544\ Based on a
staff review of the websites of 150 randomly selected ETFs, all 150
ETFs provided the previous day's NAV, price of the ETF shares,\545\ and
the premium or discount associated with the ETF share price at the
market close. Accordingly, we believe that all ETFs that can rely on
rule 6c-11 currently disclose this information on their website.\546\
Our exemptive orders also have included other requirements, including
the publication of the ETF's IIV every 15 seconds.
---------------------------------------------------------------------------

\544\ See 2018 ETF Proposing Release, supra footnote 7, at
section II.C.6.c. Substantially all exemptive orders starting in
2008 include a requirement for daily website disclosures of NAV,
closing price, and premiums and discounts--each as of the end of the
prior business day.
\545\ One actively managed ETF provided a price based on the
midpoint between the bid and ask prices, while the remainder of the
actively managed ETFs and all index-based ETFs provided closing
prices.
\546\ Commenters did not disagree with a statement in the
proposing release that all ETFs that can rely on the rule currently
provide this information on their website.
---------------------------------------------------------------------------

3. Market Participants
Several non-ETF market participants may be affected by the rule,
including fund sponsors, authorized participants, liquidity providers,
trading venues, and institutional and retail investors.
Using data from Bloomberg, we estimate that there are 81 unique ETF
sponsors with approximately 1,978 ETFs as of December 31, 2018. The
median number of ETFs per sponsor is six and the mean is 24, 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 965 ETFs, whereas the bottom half of sponsors operate only a
combined 118 ETFs.
An ETF (either directly or through a service provider) has
contractual arrangements with authorized participants to purchase or
redeem ETF shares in creation unit size aggregations in exchange for a
basket of securities and other assets. Based on data from Form N-CEN as
of July 26, 2019, the median ETF has 23 authorized participant
agreements and 4 active authorized participants.\547\ \548\ Larger ETFs
tend to have more authorized participant agreements, with the median
number of authorized participant agreements ranging from 13 for the
smallest quarter of ETFs to 33 for the largest quarter of ETFs. Larger
ETFs also tend to have more active authorized participants, ranging
from a median of 2 to 7 for the smallest and largest quarters of ETFs,
respectively. A 2015 survey-based study of fifteen fund sponsors
reports, however, 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.\549\
---------------------------------------------------------------------------

\547\ Beginning July 30, 2018, ETFs started reporting
information on authorized participants in response to Item E.2 of
Form N-CEN. As of July 26, 2019, 1,739 ETFs had filed the form.
\548\ An active AP is an authorized participant that engaged in
creation or redemption activity during the reporting period. Some
market makers and other market participants engage in creation and
redemptions indirectly through authorized participants. See supra
section I.B. Data on the number of such market participants is not
reported on Form N-CEN.
\549\ See Rochelle Antoniewicz & Jane Heinrichs, The Role and
Activities of Authorized Participants of Exchange-Traded Funds, ICI
Report (Mar. 2015) (``Antoniewicz II''). The study also points out
that NSCC is the sole provider of clearing services for ETF primary
market transactions and that 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 also
2019 ICI Factbook, supra footnote 3 (``On average, 90 percent of the
total daily activity in ETFs occurs on the secondary market.'').
---------------------------------------------------------------------------

Some authorized participants also act as registered market makers
in ETF shares. Other liquidity providers for ETF shares include market
makers that are not authorized participants, hedge funds, and
proprietary trading firms. According to a 2014 survey, the median
number of liquidity providers for an ETF was 17, while the median
number of authorized participants that are

[[Page 57208]]

registered market makers for an ETF was 4.\550\
---------------------------------------------------------------------------

\550\ See Antoniewicz II, supra footnote 550; see also 2019 ICI
Factbook, supra footnote 3.
---------------------------------------------------------------------------

ETF shares are mainly traded on national securities exchanges.\551\
Table 4 lists the 9 exchanges with the largest average daily ETF
trading volume, measured over the 30 business days ending on March 7,
2019. The data shows that NYSE Arca handles the largest portion of ETF
trades ($15.3 billion), followed by Cboe BZX Exchange ($6.6 billion),
and Cboe EDGX Exchange ($4.5 billion).
---------------------------------------------------------------------------

\551\ In the first quarter of 2019, 64% of ETF trading by dollar
volume was executed on exchanges, 26% over the counter without using
alternative trading systems (ATSs), and 10% over the counter using
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 4--ETFS Traded on National Exchanges and Their Trading Volume
------------------------------------------------------------------------
Trading volume
Exchange Number of ETFs (billion)
------------------------------------------------------------------------
NYSE Arca, Inc.......................... 1,939 $15.3
Cboe BZX Exchange, Inc.................. 1,813 6.6
Cboe EDGX Exchange, Inc................. 1,815 4.5
Cboe BYX Exchange, Inc.................. 1,721 3.6
The Nasdaq Stock Market LLC............. 348 2.6
Cboe EDGA Exchange, Inc................. 1,668 2.1
Nasdaq PHLX LLC......................... 1,070 1.9
Nasdaq BX, Inc.......................... 1,671 1.5
NYSE Chicago, Inc....................... 184 1.2
------------------------------------------------------------------------
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 March 7, 2019. 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 Commission staff using data
obtained through a subscription to Bloomberg.

Both institutional and retail investors participate in the ETF
secondary market. As shown in Table 5 below, from the first quarter of
2015 to the fourth quarter of 2017, we estimate that institutions own,
on average, 43% of ETF shares, when calculating the average using equal
weights for all ETFs, and 57% 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. 57%--suggests that institutional investors tend to hold larger
ETFs. In addition, there is considerable variation in the degree to
which ETF shares are held by institutions, ranging from an average for
the 5th percentile of 6% to an average for the 95th percentile of
90%.\552\ However, we observe that the average institutional holding
did not change considerably over time during the sample period.
---------------------------------------------------------------------------

\552\ 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 not all institutional
investors are required to file the form (which would lead to an
understatement of institutional ownership).

Table 5--Institutional Ownership of ETFs
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal- TNA-
weighted weighted
Quarter average average SD (%) P5 (%) P25 (%) P50 (%) P75 (%) P95 (%)
(%) (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
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
2017Q1.......................................... 43 58 25 6 24 42 61 91
2017Q2.......................................... 44 55 25 6 25 42 61 90
2017Q3.......................................... 43 61 25 6 24 42 61 88
2017Q4.......................................... 44 58 24 7 25 43 61 87
Average......................................... 43 57 25 6 24 41 61 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 2015Q1
to 2017Q4 obtained through a subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).

Further analysis shows that institutional ownership varies
considerably by the type of ETF. Using Morningstar Categories, for the
fourth quarter of 2017, Table 6 below shows that ETFs' equal-weighted
average institutional ownership ranges from 20% for alternative ETFs to
56% for taxable bond ETFs. We also find that

[[Page 57209]]

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 larger ETFs within these
categories. The converse is true for allocation, alternative, and
commodity ETFs. The table also shows that there is large variation
within categories.\553\
---------------------------------------------------------------------------

\553\ 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 6--Institutional Ownership of ETFs by Morningstar Category for 2017:Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal- TNA-
weighted weighted
Category average average SD (%) P5 (%) P25 (%) P50 (%) P75 (%) P95 (%)
(%) (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation...................................... 46 40 27 10 22 41 67 94
Alternative..................................... 20 11 20 2 6 13 26 64
Commodities..................................... 43 40 16 16 39 39 57 61
International Equity............................ 48 62 22 10 33 49 66 85
Municipal Bond.................................. 52 63 16 22 40 51 64 74
Sector Equity................................... 43 59 21 12 27 42 57 82
Taxable Bond.................................... 56 63 20 24 43 56 69 89
U.S. Equity..................................... 46 59 21 10 31 44 61 87
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 2017Q4 obtained a through subscription to WRDS SEC Analytics Suite and the 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 NAV of the underlying ETF assets.\554\ As
discussed above, however, authorized participants engage in primary
market arbitrage activity that brings the market price of ETF shares
and the NAV of the ETF's portfolio closer together.\555\ Market
participants also can engage in arbitrage activity in the secondary
market by taking offsetting positions in the ETF shares and the
underlying basket assets.
---------------------------------------------------------------------------

\554\ 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., Ananth Madhavan &
Aleksander Sobczyk, Price Dynamics and Liquidity of Exchange-Traded
Funds, Journal of Investment Management, Second Quarter 2016, at 1.
\555\ See supra section I.B.
---------------------------------------------------------------------------

Using data from Bloomberg, we find that ETFs, on average, have
closing prices slightly higher than the NAV per share (i.e., trade at a
premium at market close), as shown in Table 7 below. The equal-weighted
and TNA-weighted average premium/discount over the last 15 years for
all ETFs in the dataset are 0.07% and 0.06%, respectively, and the
median is 0.02%, indicating that the closing 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.\556\ However, consistent with the study,
we find that ETF premiums/discounts vary significantly.\557\ For
example, we find that the (weighted) average premium/discount ranges
from 0.02% in 2018 to 0.14% in 2009, and the standard deviation of
premiums/discounts ranges from 0.16% in 2017 to 0.59% 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,
on average.
---------------------------------------------------------------------------

\556\ See Antti Petajisto, Inefficiencies in the Pricing of
Exchange-Traded Funds, Financial Analysts Journal, First Quarter
2017, at 24.
\557\ Commenters to our 2015 ETP Request for Comment, supra
footnote 19, reported 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 7--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
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004............................................ 0.10 0.04 0.26 -0.26 -0.06 0.02 0.09 0.55
2005............................................ 0.06 0.08 0.28 -0.22 -0.04 0.04 0.11 0.62
2006............................................ 0.07 0.08 0.34 -0.34 -0.04 0.03 0.14 0.67
2007............................................ 0.14 0.08 0.38 -0.39 -0.06 0.03 0.20 0.64
2008............................................ 0.09 0.10 0.59 -0.77 -0.14 0.05 0.34 1.03
2009............................................ 0.12 0.14 0.53 -0.55 -0.08 0.02 0.34 1.02
2010............................................ 0.07 0.07 0.35 -0.43 -0.05 0.02 0.16 0.63
2011............................................ 0.04 0.07 0.41 -0.54 -0.04 0.02 0.17 0.76

[[Page 57210]]

2012............................................ 0.06 0.07 0.28 -0.31 -0.02 0.02 0.14 0.58
2013............................................ 0.06 0.03 0.28 -0.35 -0.03 0.02 0.09 0.43
2014............................................ 0.05 0.04 0.22 -0.25 -0.01 0.02 0.08 0.35
2015............................................ 0.04 0.04 0.23 -0.25 -0.01 0.02 0.08 0.40
2016............................................ 0.03 0.04 0.23 -0.22 -0.01 0.01 0.09 0.39
2017............................................ 0.07 0.06 0.16 -0.10 -0.01 0.02 0.09 0.33
2018............................................ 0.03 0.02 0.22 -0.32 -0.03 0.01 0.07 0.36
Average......................................... 0.07 0.06 0.31 -0.35 -0.04 0.02 0.14 0.57
--------------------------------------------------------------------------------------------------------------------------------------------------------
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. Premiums or
discounts are from daily Bloomberg data covering 2,235 ETFs for a total of 3,319,782 daily observations. Per Bloomberg, premium/discount (%) is the
difference between the ETF's closing price on the day of the most recent NAV and the NAV of the fund on that day. The data covers the period from 01/
02/2004 to 12/31/2018.

Premiums and discounts to NAV per share also vary considerably by
the types of assets held by the ETF.\558\ We use Morningstar Investment
Categories to divide ETFs into groups of similar assets and, in Table 8
below, 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 0.002% for alternative ETFs to 0.183%
for taxable bond ETFs. The results are qualitatively similar for the
equal-weighted average premium/discount.
---------------------------------------------------------------------------

\558\ See, e.g., Robert Engle & Debojyoti Sarkar, Premiums-
Discounts and Exchange Traded Funds, Journal of Derivatives, Summer
2006, at 27 (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).

Table 8--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...................................... 0.068 0.077 0.222 -0.124 -0.039 0.046 0.222 0.287
Alternative..................................... 0.006 0.002 0.317 -0.388 -0.119 -0.004 0.110 0.444
Commodities..................................... 0.199 0.105 0.446 -0.501 0.009 0.079 0.150 0.924
International Equity............................ 0.176 0.181 0.422 -0.467 -0.071 0.192 0.438 0.799
Municipal Bond.................................. 0.071 0.059 0.290 -0.351 -0.097 0.050 0.241 0.477
Sector Equity................................... 0.030 0.012 0.183 -0.234 -0.070 0.005 0.081 0.294
Taxable Bond.................................... 0.192 0.183 0.196 -0.075 0.080 0.175 0.257 0.506
U.S. Equity..................................... 0.003 0.006 0.076 -0.098 -0.033 0.008 0.046 0.109
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The ETFs 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. Premiums or discounts are from daily Bloomberg data covering 2,235 ETFs for a total of
3,319,782 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund's closing price on the day of the most recent NAV
and the NAV of the fund on that day. The data covers the period from 01/02/2004 to 12/31/2018.

When the ETF arbitrage mechanism functions effectively, ETFs also
should trade at smaller bid-ask spreads.\559\ As shown in Table 9
below, the TNA-weighted average bid-ask spread, as a percentage of the
mid-price, has been relatively constant over the years, ranging from
highs of 0.37% in 2012 and 2016 to a low of 0.31% in 2018.\560\ Equal-
weighted average bid-ask spreads averaged 0.33% and were considerably
higher than TNA-weighted bid-ask spreads, which averaged 0.04%,
reflecting that larger ETFs tend to have smaller bid-ask spreads. The
table also shows that the bid-ask spread varies considerably between
ETFs, with an average of the 5th percentile of bid-ask spreads of 0.01%
and an average of the 95th percentile of bid-ask spreads at 0.16%.
---------------------------------------------------------------------------

\559\ See, e.g., Joanne M. Hill, Dave Nadig, & Matt Hougan,
Comprehensive Guide to Exchange-Traded Funds (ETFS), CFA Institute
Research Foundation (2015), available at https://www.cfapubs.org/doi/pdf/10.2470/rf.v2015.n3.1 (``CFA Guide'').
\560\ This analysis starts in 2012 because the available data
begins in that year.

Table 9--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............................................ 0.37 0.06 0.12 0.01 0.02 0.02 0.05 0.27
2013............................................ 0.33 0.05 0.10 0.01 0.01 0.02 0.05 0.21

[[Page 57211]]

2014............................................ 0.27 0.04 0.06 0.01 0.01 0.02 0.04 0.11
2015............................................ 0.32 0.04 0.07 0.00 0.01 0.02 0.05 0.12
2016............................................ 0.37 0.04 0.07 0.01 0.01 0.02 0.04 0.11
2017............................................ 0.34 0.03 0.07 0.00 0.01 0.02 0.03 0.11
2018............................................ 0.31 0.05 0.09 0.01 0.01 0.02 0.04 0.16
Average......................................... 0.33 0.04 0.08 0.01 0.01 0.02 0.04 0.16
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 2,235 ETFs for a total of 2,477,272 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 01/02/2004 to 12/31/2018.

Table 10 below reports bid-ask spreads for ETF shares by
Morningstar Category. U.S. Equity ETFs have the smallest average bid-
ask spread of 0.03%, whereas allocation ETFs--ETFs 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 0.21%.

Table 10--Time-Series Averages of Cross-Sectional Descriptive Statistics of Relative Bid-Ask Spread (%) by Morningstar Investment Category
--------------------------------------------------------------------------------------------------------------------------------------------------------
Equal- TNA-
Category weighted weighted SD P5 P25 P50 P75 P95
average average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation...................................... 0.57 0.21 0.30 0.06 0.07 0.14 0.22 0.64
Alternative..................................... 0.38 0.10 0.16 0.02 0.03 0.05 0.09 0.33
Commodities..................................... 0.30 0.06 0.07 0.02 0.02 0.02 0.08 0.14
International Equity............................ 0.43 0.07 0.11 0.02 0.02 0.03 0.08 0.21
Municipal Bond.................................. 0.29 0.10 0.11 0.03 0.04 0.06 0.10 0.30
Sector Equity................................... 0.28 0.06 0.09 0.01 0.02 0.04 0.06 0.20
Taxable Bond.................................... 0.29 0.04 0.08 0.01 0.01 0.02 0.04 0.15
U.S. Equity..................................... 0.21 0.03 0.04 0.01 0.01 0.01 0.03 0.09
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The ETFs 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 12/31/
2018. 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 2,235 ETFs for a total of 2,477,272 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, 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. 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.\561\
---------------------------------------------------------------------------

\561\ See, e.g., Ananth Madhavan, Exchange-Traded Funds, Market
Structure, and the Flash Crash, Financial Analysts Journal, July/
Aug. 2012, at 20.
---------------------------------------------------------------------------

C. Benefits and Costs of Rule 6c-11 and Form Amendments

The Commission is sensitive to the economic effects that can result
from rule 6c-11 and amendments to Forms N-1A and N-8B-2, including
benefits and costs. Where possible, the Commission quantifies the
likely economic effects; however, the Commission is unable to quantify
certain economic effects because it lacks the information necessary to
provide estimates or ranges. In some cases, quantification is
particularly challenging due to the difficulty of predicting how market
participants will act under the conditions of the rule. Nevertheless,
as described more fully below, the Commission is providing both a
qualitative assessment and quantified estimate of the economic effects,
including the initial and ongoing costs of the additional disclosure
requirements, where feasible.
1. Rule 6c-11
Rule 6c-11 will allow 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 are rescinding all existing ETF
exemptive orders, with the exception of: (i) The section 12(d)(1)
relief included in those orders that permit certain fund of funds
arrangements; \562\ and (ii) orders relating to UIT ETFs, leveraged/
inverse ETFs, share class ETFs, and non-transparent ETFs. This section
first evaluates the general considerations associated with the
rulemaking and then discusses the

[[Page 57212]]

effects of the specific requirements and conditions of the rule.
---------------------------------------------------------------------------

\562\ We will, however, rescind relief from sections 12(d)(1)
and 17(a)(1) and (2) that have been provided to allow master-feeder
arrangements for those ETFs that do not currently rely on the
relief. See supra section II.F. In addition, we will grandfather
existing master-feeder arrangements involving ETF feeder funds, but
prevent the formation of new ones under existing orders, by amending
relevant exemptive orders. See id.
---------------------------------------------------------------------------

a. General Considerations
Rule 6c-11 will grant exemptive relief from the provisions of the
Act that 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 rule are either similar
to those contained in existing exemptive orders, consistent with market
practice, or generally provide more flexibility, we anticipate that the
rule and the related rescission of ETF exemptive relief will not
require any existing ETFs whose exemptive relief will be rescinded to
significantly change the way they operate. Conversely, some ETFs whose
exemptive orders contain conditions that are more restrictive than
those contained in the rule may decide to change the way they operate
in order to make use of such increased flexibility.
Relative to the baseline, rule 6c-11 will 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 rule will be
quicker, more predictable, less complex, and therefore less costly than
obtaining an exemptive order as new ETFs that cannot rely on existing
orders are currently required to do. ETFs that cannot rely on the rule
will continue to be required to apply for an exemptive order to form
and operate, unless they have an existing exemptive order that includes
future fund relief.\563\
---------------------------------------------------------------------------

\563\ See supra footnote 42 (noting that UIT ETFs' orders do not
include relief for future ETFs formed pursuant to the same order).
As discussed below, some ETFs will 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 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 rule, such as the increased basket
flexibility and, for certain new ETFs, the reduced costs of forming
the fund.
---------------------------------------------------------------------------

As described above in section IV.B.2, we estimate that the cost for
a typical unleveraged 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 early April 2019,
the median processing time from the filing of an initial application to
the issuance of an order was 213 days, although there was considerable
variation. Thus, any new ETF planning to operate within the parameters
set forth by the rule will 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 each sponsor 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 will continue to need to apply for an exemptive order.
Assuming that the number of new ETFs seeking to form and operate under
the rule that would otherwise need to apply for exemptive relief is
equal to the annual average number of ETFs that have applied for
exemptive relief since 2007, these cost and time savings would accrue
to approximately 29 ETFs per year.\564\ Using this assumption, the
annual costs savings to this group of ETF sponsors are approximately
$2.9 million.\565\ We are unable to quantify the benefit a new ETF will
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.\566\
---------------------------------------------------------------------------

\564\ Compared to the baseline, these cost and time savings will
only accrue to new ETFs whose sponsors have not received exemptive
relief that would allow such ETFs to operate.
\565\ This estimate is based on the following calculation: 29 x
$100,000 = $2,900,000.
\566\ Costs arising from the delay and the uncertainty
associated with the exemptive order process include primarily
forgone profits and costs associated with missed business
opportunities. We do not have access to data on ETFs' profits, and
commenters did not provide such data. Additionally, forgone profits
associated with missed business opportunities, such as forgoing a
``first-mover advantage,'' can be highly variable and dependent on
specific circumstances.
---------------------------------------------------------------------------

By eliminating the need for ETFs that can rely on the rule to seek
an exemptive order from the Commission, the rule will 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 rule will 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 will 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 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 rule. However, we
believe that these costs will be relatively small.\567\ In addition, we
anticipate that it will be more efficient for third-party providers,
such as lawyers and compliance consultants, to offer services that help
ETFs ensure compliance with the rule, 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 can rely on the rule, which may
partially or fully offset the initial costs of studying the
requirements of the rulemaking that ETFs may incur.
---------------------------------------------------------------------------

\567\ We estimate that assessing the requirements of the final
rule will require 5 hours of a compliance manager ($309 per hour)
and 5 hours of a compliance attorney ($365 per hour), resulting in a
cost of $3,370 (5 x $309 + 5 x $365) per fund. The total cost for
all 1,735 ETFs that can rely on the rule will thus be $5,846,950
(1,735 x $3,370). 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 1800-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'').
---------------------------------------------------------------------------

We expect that the rule also will benefit ETF investors to the
extent that it will remove a possible disincentive for sponsors to form
and operate new ETFs that provide investors with additional investment
choices if they 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.
As we discuss below in section IV.D.2, we believe that the rule
could increase competition in the ETF market as a whole, which could
also lead to lower fees. Any effect of increased

[[Page 57213]]

competition on fees will likely be larger for segments of the ETF
market that currently may be less competitive (e.g., actively managed
ETFs) and smaller for segments of the market that currently may be more
competitive (e.g., index-based ETFs tracking major stock indices).
By eliminating the need for individual exemptive relief, we
anticipate that the rule will, over time, increase the number of ETFs
and thus reinforce the current growth trend in the ETF industry. In
addition, the rule will increase demand for such ETFs, to the extent
that such ETFs lower their fees to investors and investors are
sensitive to fees.\568\ To the extent that some ETFs will experience
larger reductions in trading costs (e.g., fixed-income, international,
and actively managed ETFs, as discussed below in section IV.C.1.b.i.)
or larger increases in competition (e.g., actively managed ETFs, as
discussed above in this section), demand for these types of ETFs will
likely increase more than for other types of ETFs. The increased demand
will 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.\569\ Consequently,
the rule could increase total assets of ETFs and could decrease total
assets of other funds. The size of these effects will depend on the
degree to which ETFs will 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, in part, because
we cannot estimate the extent to which funds will lower their fees or
experience reduced trading costs and how lower fees and trading costs
will change investor demand.
---------------------------------------------------------------------------

\568\ 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 Journal of Finance
1589 (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. 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 Review of Financial Studies
1405 (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 to hold for ETFs as well.
We are not aware of any studies that specifically study the
sensitivity of ETF investors to fees.
\569\ Investments in ETFs are one of many ways for investors to
allocate savings. 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.
---------------------------------------------------------------------------

Since ETFs are traded in the secondary market, an increase in total
assets of ETFs will likely coincide with larger trade volumes for the
exchanges where ETFs are traded, as well as for the clearing agencies
and broker-dealers involved in these trades. To the extent that these
market participants are compensated by volume, the rule will thus
benefit them by leading to an increase in revenues.\570\
---------------------------------------------------------------------------

\570\ To the extent that investors substitute away from products
that are comparable to ETFs, such as mutual funds, an increase in
revenue for entities facilitating ETF transactions may be offset by
a decrease in revenue for entities facilitating fewer transactions
in those other products.
---------------------------------------------------------------------------

In addition, we expect the rule to reduce the number of
applications for ETF exemptive relief. This will allow Commission staff
more time to review applications for exemptive relief from registered
investment companies, including those for more complex or novel ETFs
that will continue to require exemptive relief. To the extent that this
speeds up the processing time for these remaining applications, the
rule may reduce the indirect costs of forming and operating for ETFs
that seek to operate outside its parameters and for other registered
investment companies that require exemptive relief to operate and, as a
result, may promote innovation among these types of funds.
b. Conditions for Reliance on Rule 6c-11
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, many of the conditions in rule 6c-11 do
not offer 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 That 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.\571\ As a consequence, arbitrageurs
generate price pressure that works to equalize the prices of these
assets across different markets. This is 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.
---------------------------------------------------------------------------

\571\ See, e.g., Jonathan B. Berk & Peter DeMarzo, Corporate
Finance (3rd ed. 2013).
---------------------------------------------------------------------------

There are several factors that are important for arbitrageurs to
consider in order 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.\572\ The
rule contains conditions that take these considerations into account
and are designed to promote the effective functioning of the arbitrage
mechanism for ETFs.
---------------------------------------------------------------------------

\572\ 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 are likely to decide to wait for any deviation 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.
---------------------------------------------------------------------------

The rule will 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 procedures specific to the
creation of custom baskets if the ETF uses custom baskets.
Although current exemptive orders contain varying provisions for
basket flexibility, we do not believe that the rule will require
existing ETFs to change how they construct baskets. Instead, the

[[Page 57214]]

rule will give some ETFs more flexibility for constructing baskets than
what is allowed by their existing exemptive orders, provided they adopt
and implement custom basket policies and procedures.
We believe that fixed-income, international, and actively managed
ETFs will particularly benefit from the increased basket flexibility
under the rule if they currently operate under exemptive orders that do
not allow custom baskets. For example, 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, thus reducing trading
costs for authorized participants. Similarly, international ETFs will
be able to tailor their creation and redemption baskets to accommodate
difficulties in transacting in certain international securities. In
addition, actively managed ETFs will, 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 will be able to reduce certain
transaction costs, such as those associated with bid-ask spreads.
For these reasons, we believe that, to the extent that ETFs are
able to implement procedures that facilitate the arbitrage mechanism or
reduce costs for those ETFs, the rule will benefit ETFs that use the
increased basket flexibility the rule affords and will ultimately
benefit their investors. One commenter submitted results from an
empirical analysis that supported this assessment.\573\ For example,
the commenter observes that fixed-income ETFs that currently have
increased basket flexibility exhibit smaller bid-ask spreads and
reduced premiums and discounts to NAV, particularly during times of
market stress.\574\ Due to a lack of data, we are unable to quantify
the number of ETFs that would choose to implement custom basket
policies and procedures, and thus the potential benefits accruing to
ETFs and their investors.
---------------------------------------------------------------------------

\573\ See ICI Comment Letter (providing the results of an
empirical analysis indicating that fixed-income ETFs with basket
flexibility had narrower bid-ask spreads, lower tracking
differentials, and traded at smaller discounts than fixed-income
ETFs without basket flexibility). The commenter conducted a survey
to identify fixed-income ETFs that currently have increased basket
flexibility. While the commenter provided the results of an
empirical analysis based on this data, the commenter did not provide
the Commission with the survey responses themselves.
\574\ Conversely, another commenter stated that increased basket
flexibility may reduce arbitrage efficiency for fixed-income ETFs,
particularly during market stress. See Bluefin Comment Letter. This
commenter observes that such ETFs may choose to include less liquid
portfolio holdings in redemption baskets in greater than pro-rata
proportions, thereby increasing trading costs for arbitrageurs and
leading to larger premiums and discounts. While we acknowledge this
concern, ETFs generally are incentivized to choose custom baskets
that reduce premiums and discounts for the benefit of transacting
shareholders. In addition, as discussed above in section II.C.5.a,
we believe that requiring fixed-income ETFs to establish detailed
parameters for the construction and acceptance of custom baskets
that are in the best interests of the ETF and its shareholders
addresses the risks associated with custom baskets.
---------------------------------------------------------------------------

To the extent that existing ETFs do not already have policies and
procedures governing basket assets in place or that existing policies
and procedures are not consistent with the requirements of the rule,
ETFs will incur costs associated with developing and implementing such
policies and procedures. However, such costs may be partially or
totally offset by the basket flexibility discussed above. We estimate
that an average ETF will incur an initial cost of $10,718 \575\
associated with establishing and implementing standard and custom
basket policies and procedures. In addition, we estimate that an
average ETF will incur an ongoing cost of $4,135 \576\ each year to
review and update its basket policies and procedures. We thus estimate
that the total industry cost associated with the policies and
procedures requirement in the rule for ETFs that can rely on the rule
in the first year will equal $25,769,955.\577\
---------------------------------------------------------------------------

\575\ This estimate is based on the following calculations: 12
hours x $329 per hour (senior manager) + 7 hours x $530 (chief
compliance officer) + 2 hours x $365 (compliance attorney) + 5 hours
x $466 (assistant general counsel) = $10,718. See infra section
V.B.3, Table 13.
\576\ This estimate is based on the following calculations: 5
hours x $329 per hour (senior manager) + 2.5 hours x $530 (chief
compliance officer) + 2.5 hours x $466 (assistant general counsel) =
$4,135. See infra section V.B.3, Table 13.
\577\ This estimate is based on the following calculation:
($10,718 + $4,135) x 1,735 ETFs = $25,769,955. 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. It also may overestimate costs
because some fund complexes may use the same basket policies and
procedures for all ETFs within the complex.
---------------------------------------------------------------------------

Finally, although the rule's custom basket policies and procedures
requirements are designed to reduce the potential for cherry-picking,
dumping, and other potential abuses, we acknowledge that this
principles-based approach may not be effective at preventing all such
abuses. However, ETFs will be required to maintain records related to
the custom baskets used, which will allow the Commission to examine for
potential abuses.
As proposed, the rule also will 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. This information
allows authorized participants and other arbitrageurs to identify
arbitrage opportunities and execute arbitrage trades that reduce
premiums and discounts to NAV per share, ultimately benefiting all
investors. In addition, we agree with a commenter who stated that
portfolio transparency helps investors to better discern differences
between ETFs that track similar indexes or have similar investment
objectives.\578\
---------------------------------------------------------------------------

\578\ See CSIM Comment Letter.
---------------------------------------------------------------------------

The requirements for portfolio transparency in existing exemptive
orders have varied. However, based on a staff review of ETFs' websites,
we understand that all ETFs that can rely on the rule currently provide
daily full portfolio transparency. Thus, ETFs that can rely on the rule
already bear the ongoing costs associated with maintaining such
disclosures.\579\ We believe that the ETFs that can rely on the rule
will 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.\580\ We estimate this one-time cost
to be $1,997 for the average ETF, resulting in an aggregate one-time
cost of $3,463,928 for all ETFs that can rely on the rule.\581\
---------------------------------------------------------------------------

\579\ In the 2018 ETF Proposing Release, we estimated that an
ETF that does not currently maintain daily portfolio holdings on its
website would spend approximately 5 hours of professional time to
update the relevant web page daily at a cost of $1,405.50 each year.
Because we believe all ETFs that can rely on the rule already
provide this information on their websites, we believe that very
few, if any, ETFs would have to bear these additional costs.
\580\ The rule will require ETFs to provide certain information
for each portfolio holding. These item requirements are a more
limited set of the information currently required by the listing
exchanges' generic listing standards for actively managed ETFs.
\581\ This estimate is based on the following calculations: 1.5
hours x $284 (senior systems analyst) + 1.5 hours x $331 (senior
programmer) + 1 hour x $309 (compliance manager) + 1 hour x $365
(compliance attorney) + $400 for external website development =
$1,997. The industry cost is 1,735 x $1,997 = 3,463,928. This
estimate is conservative as it does not assume a cost reduction for
actively managed ETFs that already comply with the listing standards
on which the item requirements for the portfolio holding disclosure
under the rule are based.
---------------------------------------------------------------------------

Some commenters raised concerns that providing daily portfolio
information on an ETF's website could expose the fund and its investors
to

[[Page 57215]]

costs associated with ``front-running'' and, in the case of actively
managed ETFs, ``piggybacking.'' \582\ However, based on our
understanding that all ETFs that can rely on the rule currently provide
daily full portfolio transparency, the rule will not change the degree
to which ETFs and their investors are exposed to such costs compared to
the baseline.
---------------------------------------------------------------------------

\582\ See supra section II.C.4.
---------------------------------------------------------------------------

As proposed, rule 6c-11 would have required that an ETF's portfolio
holdings disclosure be made on each business day: (1) Before the
opening of regular trading on the primary listing exchange of the ETF's
shares; and (2) before the ETF starts accepting orders for the purchase
or redemption of creation units. The rule will omit the second
requirement in order to accommodate the current industry practice of T-
1 creation and redemption orders.\583\ We agree with commenters that T-
1 orders facilitate ETF arbitrage for certain ETFs holding foreign
securities by allowing arbitrageurs to align the execution time of
underlying securities with the NAV calculation of the order.\584\
Compared to the proposal, we therefore believe that this aspect of the
rule will lead to narrower bid-ask spreads and smaller premiums and
discounts, benefiting investors in these ETFs.
---------------------------------------------------------------------------

\583\ See supra section II.C.4.a. This timing requirement is
consistent with the transparency requirements of our existing
exemptive orders.
\584\ See id.
---------------------------------------------------------------------------

Compared to the proposal, the rule will require ETFs to present
enumerated information regarding each portfolio holding (which are a
more limited set of the disclosures currently required by the listing
exchanges' generic listing standards for actively managed ETFs), rather
than the description, amount, value, and unrealized gain/loss of each
position in the manner prescribed by Article 12 of Regulation S-X. As
discussed above in section II.C.4.b, we believe that this information
will focus the disclosure on the pieces of information that are most
relevant to investors while reducing the burden for ETFs of complying
with the disclosure requirement. As a result, we believe that the
disclosure format under the rule will provide similar benefits to
investors at lower costs to ETFs.\585\
---------------------------------------------------------------------------

\585\ The cost estimates in this section of the economic
analysis reflect the cost reduction, compared to the proposal,
associated with the change in the format of the disclosure. See also
infra footnote 684 and accompanying text.
---------------------------------------------------------------------------

ii. Other Cost Savings From the Rule
Under the terms of the exemptive orders, ETFs are required to
disclose in their registration statement that redemptions may be
postponed for foreign holidays. Rule 6c-11 does not contain such a
requirement and will thus eliminate the cost of preparing and updating
this disclosure for existing ETFs. This information is already covered
by the agreement between the ETF and the authorized participant.\586\
---------------------------------------------------------------------------

\586\ We believe that authorized participants would share this
information with other market participants as necessary. For
example, an authorized participant acting as agent typically would
share this information with its customer if it is a necessary part
of the creation or redemption process.
---------------------------------------------------------------------------

The terms of the exemptive orders also 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. The rule will not include such a requirement, as 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 will lead to cost savings for existing
and future ETFs associated with preparing and reviewing this disclosure
for sales literature.\587\
---------------------------------------------------------------------------

\587\ We estimate that the omission of this requirement will
save 0.25 hours of a compliance attorney ($365 per hour), resulting
in a cost savings of $91 (0.25 x $365) per fund each year. The total
cost savings for all 1,735 ETFs that can rely on the rule will thus
be $158,319 (1,735 x $91).
---------------------------------------------------------------------------

iii. Intraday Indicative Value
The rule will not require an ETF to disseminate its IIV, as is
currently required under all exemptive orders and current exchange
listing standards. To the extent that current exchange listing
standards require IIV to be disseminated, the rule's omission of such a
requirement will not represent a change from the baseline and will not
result in any costs or benefits to market participants.
We believe, and commenters agreed, 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 addition, the
IIV may not reflect the intrinsic value of certain ETFs' 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).\588\ An investor who relies on
stale or inaccurate IIV information to purchase or sell ETF shares
could be exposed to price risk until the position is closed and could
incur the trading costs associated with these trades. Furthermore, as
discussed above in section II.C.3, based on a staff review of the
websites of the ten largest ETFs by assets under management and of
several publicly available free websites, we do not believe that
investors have easy access to IIV through free, publicly available
websites.
---------------------------------------------------------------------------

\588\ Commenters agreed that traditional IIV can have
significant limitations, for example for ETFs holding fixed-income
securities. See, e.g., ICI Comment Letter. See also supra footnote
203.
---------------------------------------------------------------------------

Some commenters stated that retail investors relying on IIV could
see their ability to evaluate ETFs reduced without this metric.\589\ As
we stated in the proposing release, we agree that the IIV may provide a
reasonably accurate estimate of the value of certain ETFs' portfolios,
including those ETFs whose underlying assets are very liquid and
frequently traded during the ETF's trading day. However, as discussed
above in section II.C.3, we have concerns regarding the accuracy of IIV
estimates and the lack of uniform methodology requirements. Moreover,
retail investors do not have easy access to IIV through free, publicly
available websites today even for those assets classes where IIV may be
more reliable. Therefore, we do not believe that IIV provides
information that retail investors can reliably use when making
investment decisions and thus do not believe that it is a necessary
condition for ETFs that are operating in reliance on rule 6c-11.
---------------------------------------------------------------------------

\589\ See, e.g., Angel Comment Letter; Nasdaq Comment Letter;
IDS Comment Letter.
---------------------------------------------------------------------------

iv. Website Disclosure Provisions
Rule 6c-11 will require an ETF to disclose certain information
prominently on its website.\590\ 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.\591\

[[Page 57216]]

Based on a staff review of ETFs' websites, we believe that all ETFs
that can rely on the rule currently have a website and currently
provide daily website disclosures of NAV, closing price, and premiums
or discounts.\592\ As a consequence, existing ETFs generally will not
incur any additional cost associated with the creation and technical
maintenance of a website or these specific website disclosure
requirements.
---------------------------------------------------------------------------

\590\ See supra footnote 226.
\591\ 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, U.S.
Census Bureau 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, ICI Research Perspective (Oct. 2017), available at
https://www.ici.org/pdf/per23-07.pdf (stating that ``[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). We acknowledge that the benefits of the
website disclosure requirement would be attenuated for those
investors who lack internet access or otherwise are not able to
access ETFs' websites.
\592\ See supra section IV.B.4.
---------------------------------------------------------------------------

Our exemptive orders have not included requirements for line graph
and tabular historical information regarding premiums and discounts.
While Form N-1A contains tabular website disclosures related to
historical premiums/discounts in Items 11(g)(2) and 27(b)(7)(iv), which
we are eliminating for ETFs that will rely on rule 6c-11, we anticipate
that all existing ETFs that fall within the scope of the rule will
still incur some additional costs associated with these
disclosures.\593\ 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 allows ETFs to monitor the trading
behavior of their shares), and 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 will 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
will incur a one-time cost of $1,997 \594\ for implementing this
website disclosure and an ongoing cost of $491\595\ per year for
updating the relevant web page with this information. We thus estimate
the total cost, in the first year, to ETFs that can rely on the rule
for providing this website disclosure, of $4,315,379.\596\
---------------------------------------------------------------------------

\593\ See supra section II.H.2.b.
\594\ This estimate is based on the following calculations: 1.5
hours x $284 (senior systems analyst) + 1.5 hours x $331 (senior
programmer) + 1 hour x $309 (compliance manager) + 1 hour x $365
(compliance attorney) + $400 for external website development =
$1,997.
\595\ This estimate is based on the following calculations: 0.25
hours x $284 (senior systems analyst) + 0.25 hours x $331 (senior
programmer) + 0.5 hour x $309 (compliance manager) + 0.5 hour x $365
(compliance attorney) = $491.
\596\ This estimate is based on the following calculation:
($1,997 + $491) x 1,735 ETFs = $4,315,379.
---------------------------------------------------------------------------

Our exemptive orders have not included a requirement for ETFs to
provide disclosure if an ETF's premium or discount is greater than 2%
for more than seven consecutive trading days and the factors that
materially contributed to a premium or discount, if known. As a result,
under the rule those ETFs that experience such a premium or discount
will 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 2018 using Bloomberg data, we believe that, on
average, 4.5% of ETFs that can rely on the rule will trigger this
disclosure requirement each year.\597\ As suggested by commenters, this
disclosure requirement is likely to affect certain categories of ETFs
more than others.\598\ For example, in 2018, we estimate that the
reporting requirement would not have been triggered for any allocation
ETFs, commodity ETFs, or municipal bond ETFs, while it would have been
triggered for 0.3% of taxable bond ETFs, 0.6% of sector equity ETFs,
3.1% of U.S. equity ETFs, 4.2% of international equity ETFs, and 4.8%
of alternative ETFs. We estimate that an ETF required to make such a
disclosure in a given year will incur an average cost of $1,504,
yielding a total annual industry cost of $117,405.\599\
---------------------------------------------------------------------------

\597\ 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 rule. During
the sample period from 2008 to 2018, the percentage of ETFs for
which the reporting requirement was triggered at least once varied
from 1.5% (2010) to 10% (2008).
\598\ See supra footnote 359 and accompanying text.
\599\ We believe that such disclosure will require 1.25 hours
for a compliance attorney and the compliance manager to determine if
this requirement has been triggered and produce a draft of the
required disclosures + 0.75 hours for a senior programmer and a
senior systems analyst to include the information on the website, at
a time cost of (1.25 hours x $365 compliance attorney hourly rate) +
(1.25 hours x $309 compliance manager hourly rate) + (0.75 hours x
$331 senior programmer hourly rate) + (0.75 hours x $284 senior
systems analyst hourly rate) in addition to $200 for external
website development = $1,504. The annual cost of this requirement
for those ETFs that can rely on the rule is calculated as 4.5% x
1,735 ETFs x $1,504 = $117,405. This estimate includes costs for
website development, which would only be incurred by an ETF making
this disclosure for the first time.
---------------------------------------------------------------------------

The rule also will require additional disclosure by the ETF of the
median bid-ask spread for the most recent 30-day period on its website.
This requirement is modified from the proposal, which would have
required an ETF to disclose the median bid-ask spread for the ETF's
most recent fiscal year on its website and in its prospectus.
We believe that the rule's disclosure requirement will 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. We agree with commenters
that actual bid-ask spreads paid by ETF investors can be influenced by
a variety of factors, including order size, market conditions, as well
as the broker-dealer used.\600\ Nevertheless, we believe that requiring
the disclosure of bid-ask spread information is still valuable to
investors as it is indicative of the general magnitude of an ETF's
trading costs attributable to bid-ask spreads. In addition, we believe
bid-ask spreads can help investors rank ETFs in terms of expected
execution costs, as an ETF with historically larger bid-ask spreads can
be expected to be more costly to trade than an ETF with historically
lower bid-ask spreads, when holding other factors that impact execution
costs, such as order size, market conditions, and the broker-dealer,
constant.
---------------------------------------------------------------------------

\600\ See, e.g., Vanguard Comment Letter (also pointing out
that, in certain circumstances, broker-dealers can obtain price
improvements leading to market orders being executed either within
the NBBO or at midpoint or better).
---------------------------------------------------------------------------

Existing exemptive orders do not require ETFs to disclose median
bid-ask spreads. As a result, we assume that all ETFs operating under
the final rule will have to implement processes and systems to compute
the median bid-ask spreads and will have to accommodate a new data
point on their web page to report this information.\601\ We estimate
that an ETF will incur a one-time estimated cost of $8,294 to comply
with this requirement.\602\ In addition, we estimate that an ETF that
purchases

[[Page 57217]]

NBBO information to compute bid-ask spread will incur an additional
ongoing annual cost of $4,042.\603\ Assuming that all ETFs will have to
purchase data to satisfy this requirement, we estimate an upper bound
for the total industry cost in the first year of $21,401,659.\604\
---------------------------------------------------------------------------

\601\ Based on a review of 150 randomly selected ETFs, which
included 100 index-based ETFs and 50 actively managed ETFs, 10
percent of index-based ETFs and 1.5 percent of actively managed ETFs
provided some information on bid-ask spreads. However, all ETFs that
provided such information displayed bid-ask spreads only for a
particular point in time (for example as of the time the prior day's
NAV was struck) rather than median bid-ask spreads computed for the
most recent 30-day period, as required by the rule.
\602\ This estimate is based on the following calculations: 6.5
hours x $284 (senior systems analyst) + 6.5 hours x $331 (senior
programmer) + 4 hour x $309 (compliance manager) + 4 hour x $365
(compliance attorney) + $1,600 for external website development =
$8,294.
\603\ In the 2018 ETF Proposing Release, we stated that we
believed ETFs currently maintain a record of historical price data
as a matter of current business practices which could be used to
satisfy the requirement to compute bid-ask spreads at a nominal
cost. See 2018 ETF Proposing Release, supra footnote 7, at section
III.C.1. Some commenters, however, suggested that some ETFs would
incur costs to purchase data collected by third parties, although
these commenters did not provide specific estimates of such costs.
See, e.g., BNY Mellon Comment Letter; John Hancock Comment Letter.
Assuming a data cost of $2,500 per year, we estimate that an ETF
that would need to purchase the data will incur the following
ongoing cost: 1 hours x $284 (senior systems analyst) + 1 hours x
$331 (senior programmer) + 1.375 hours x $309 (compliance manager) +
1.375 hours x $365 (compliance attorney) + $2,500 (data) = $4,042.
\604\ This estimate is based on the following calculation:
($8,294 + $4,042) x 1,735 ETFs = $21,401,659.
---------------------------------------------------------------------------

The requirement of disclosures on ETFs' websites we are adopting
will enable investors to more readily obtain certain key information
for individual ETFs, potentially resulting in better informed trading
decisions.\605\ The conditions standardize certain content requirements
to facilitate investor analysis of information while allowing ETFs to
select a layout for displaying the required information that the
individual ETF finds most efficient and appropriate for its website.
Because the information will be made available on individual websites,
in the layout 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 ETFs
and time periods may be limited. Investors seeking to compare multiple
ETFs will have to visit the website of every ETF, navigate to the
relevant section of the website, and extract the information provided
in the layout chosen by the fund. Depending on the manner in which a
typical fund investor will use the website disclosures, these
considerations may decrease the information benefits of the new
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 will likely be lower than the cost they would incur 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 will ultimately provide an efficient
means for facilitating investor access to information.
---------------------------------------------------------------------------

\605\ See supra footnote 226.
---------------------------------------------------------------------------

c. Recordkeeping
The rule will require ETFs to 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 will
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 also will promote internal supervision and
compliance.\606\ As the agreement forms the contractual foundation on
which authorized participants engage in arbitrage activity, compliance
of the agreement with applicable rules is important for the arbitrage
mechanism to function properly.
---------------------------------------------------------------------------

\606\ ETFs already are 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 rule.
---------------------------------------------------------------------------

We also are requiring ETFs to maintain information regarding the
baskets exchanged with authorized participants on each business day,
including a record identifying any custom basket and stating that the
custom basket complies with the ETF's custom basket policies and
procedures. We believe that these records will 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 other applicable law, 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, or to prepare and maintain a record
identifying each custom basket and stating that custom baskets comply
with the custom basket policies and procedures. However, we believe
that most ETFs, as a matter of established business practice, already
preserve and maintain copies of authorized participant agreements as
well as data on baskets used.\607\
---------------------------------------------------------------------------

\607\ One commenter stated that ETFs generally already implement
robust recordkeeping programs. See Invesco Comment Letter.
---------------------------------------------------------------------------

As discussed below in section V.B.2, we estimate the average annual
cost for an ETF to comply with these recordkeeping requirements is $393
per year.\608\ Assuming that (1) 80% of ETFs already preserve and
maintain copies of authorized participant agreements as well as
information on basket composition; (2) no ETF currently maintains
records identifying any custom basket and stating that the custom
basket complies with the ETF's custom basket policies and procedures;
and (3) 25% of the total annual recordkeeping costs can be attributed
to the new recordkeeping requirements for custom baskets, the total
industry cost for ETFs that can rely on the rule will be $544,790 per
year.\609\
---------------------------------------------------------------------------

\608\ See infra section V.B.3, Table 12. An average ETF would
have to maintain and store 24 authorized participant agreements. See
also supra footnotes 548-550 and accompanying text.
\609\ This estimate is based on the following calculation: 1,735
ETFs x (20% + 80% * 75%) x $393 = $544,790. The final rule will
require ETFs to maintain additional information on basket
composition (ticker symbol, CUSIP or other identifier, description
of holding, quantity of each holding, and percentage weight of each
holding composing the basket). We believe that this additional
requirement does not present a significant additional recordkeeping
cost.
---------------------------------------------------------------------------

d. Master-Feeder Relief
We will rescind the master-feeder relief granted to ETFs, with the
exception of master-feeder relief that funds relied on as of the date
of the 2018 ETF Proposing Release (June 28, 2018). We are rescinding
such relief because there generally is a lack of industry interest in
ETF master-feeder arrangements, and certain master-feeder arrangements
raise policy concerns, as discussed above in section II.F. 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 master-feeder arrangements with one
master and one feeder fund each.\610\ We will grandfather existing
master-feeder arrangements involving ETF feeder funds, but prevent the
formation of new ones under existing orders, by amending relevant
exemptive orders.\611\ As a result, we do

[[Page 57218]]

not expect that the rescission of the existing master-feeder relief
will impose costs on ETFs that currently rely on the relief to
structure master-feeder arrangements. However, to the extent that an
ETF without a grandfathered master-feeder arrangement would apply for
an exemptive order that grants master-feeder relief, such an ETF would
incur costs associated with the exemptive order application.\612\ 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.\613\
---------------------------------------------------------------------------

\610\ See 2018 ETF Proposing Release, supra footnote 7, at n.339
and accompanying text. See also supra footnote 449 and accompanying
text.
\611\ 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 investors finding the fund to be a less attractive
investment.
\612\ One commenter indicated that it has invested resources
exploring various approaches to an ETF master-feeder structure. See
Fidelity Comment Letter.
\613\ See supra section II.F.
---------------------------------------------------------------------------

2. Amendments to Forms N-1A, N-8B-2, and N-CEN
The amendments to Forms N-1A and N-8B-2 are designed to provide
investors with tailored information regarding the costs associated with
investing in ETFs.\614\ As discussed in section II.H above, we believe
that the new disclosures will 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.
---------------------------------------------------------------------------

\614\ As proposed, we also are amending Forms N-1A and N-8B-2 to
include narrative disclosures for both mutual funds and ETFs that
will clarify that the fees and expenses reflected in the expense
table may be higher for investors if they sell shares of the fund.
See supra section II.H.2.a.
---------------------------------------------------------------------------

We are amending Forms N-1A and N-8B-2 to include information on ETF
trading and associated costs that we anticipate will help investors
better understand costs specific to ETFs, such as bid-ask spreads.\615\
In a departure from the proposal, we are eliminating the Q&A format for
these disclosures, which will allow ETFs to determine the format for
conveying the required disclosures to investors. In addition, the
narrative disclosures will be streamlined and included in Item 6 of
Form N-1A, whereas the proposed disclosure in Q&A format would have
been included in Item 3. As discussed above in section II.H, we believe
that the updated format and location will improve the usefulness of the
disclosure to ETF investors.
---------------------------------------------------------------------------

\615\ Rule 6c-11 will require ETFs that rely on the rule to
provide the median bid-ask spread for the last thirty calendar days
and certain disclosures regarding premiums and discounts on their
websites. Our amendments to Forms N-1A and N-8B-2 will require ETFs
that do not rely on rule 6c-11 to disclose median bid-ask spread
information on their websites or in their prospectus and exclude
only those ETFs that provide premium/discount disclosures in
accordance with rule 6c-11 from the premium and discount disclosure
requirements in Form N-1A.
---------------------------------------------------------------------------

ETFs will incur costs associated with these new disclosures on
Forms N-1A and N-8B-2.\616\ ETFs structured as open-end funds are
currently required to disclose information about premiums and discounts
to NAV per share in reports on Form N-1A. However, UIT ETFs, which file
reports with the Commission on Form N-8B-2, are not required to make
such disclosures. We estimate that this reporting requirement will
increase the incremental cost for UIT ETFs compared to ETFs structured
as open-end funds. In addition, ETFs that rely on rule 6c-11 will be
exempt from the Form N-1A disclosure requirements related to bid-ask
spreads and premiums and discounts to NAV per share (as such
disclosures will be required under rule 6c-11 to be provided on their
websites), which reduces the incremental cost we estimate for open-end
funds that can rely on the rule compared to those that cannot. Taking
these considerations into account, we estimate that each ETF that is
structured as an open-end fund will incur a one-time cost of $3,799
\617\ and an ongoing cost of $1,899 \618\ per year if it can rely on
rule 6c-11, and a one-time cost of $6,960 \619\ and an ongoing cost of
$3,480 \620\ per year if it cannot rely on rule 6c-11. We estimate that
a UIT ETF will incur a one-time cost of $8,352 \621\ and an ongoing
cost of $3,480 \622\ per year. We thus estimate that the total industry
cost for this requirement for ETFs in the first year would equal
$12,434,736.\623\
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\616\ As discussed in more detail below in section V.E, 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.
\617\ This estimate is based on the following calculations: 5.46
hours x $365 (compliance attorney) + 5.46 hours x $331 (senior
programmer) = $3,799.
\618\ This estimate is based on the following calculations: 2.73
hours x $365 (compliance attorney) + 2.73 hours x $331 (senior
programmer) = $1,899.
\619\ This estimate is based on the following calculations: 10
hours x $365 (compliance attorney) + 10 hours x $331 (senior
programmer) = $6,960.
\620\ This estimate is based on the following calculations: 5
hours x $365 (compliance attorney) + 5 hours x $331 (senior
programmer) = $3,480.
\621\ This estimate is based on the following calculations: 12
hours x $365 (compliance attorney) + 12 hours x $331 (senior
programmer) = $8,352.
\622\ This estimate is based on the following calculations: 5
hours x $365 (compliance attorney) + 5 hours x $331 (senior
programmer) = $3,480.
\623\ This estimate is based on the following calculation: 1,735
ETFs structured as an open-end fund that can rely on the rule x
($3,799 + $1,899) + 235 ETFs structured as an open-end fund that
cannot rely on the rule ($6,960 + $3,480) + 8 UIT ETFs ($8,352 +
$3,480) = $12,434,736.
---------------------------------------------------------------------------

As proposed, we are amending Form N-CEN to require identification
of ETFs that are relying on rule 6c-11.\624\ We believe that this
requirement will allow the Commission to better monitor reliance on
rule 6c-11 and assist us with our accounting, auditing, and oversight
functions, including compliance with the Paperwork Reduction Act. We
believe that the incremental cost of this requirement to ETFs is
minimal.
---------------------------------------------------------------------------

\624\ We also are changing the definition of ``authorized
participant'' in Form N-CEN to conform the definition with rule 6c-
11 by excluding specific reference to an authorized participant's
participation in DTC (Item E.2 of Form N-CEN).
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D. Effects on Efficiency, Competition, and Capital Formation

This section evaluates the impact of rule 6c-11 and the amendments
to Forms N-1A, N-8B-2, and N-CEN on efficiency, competition, and
capital formation. However, as discussed in further detail below, the
Commission is unable to quantify 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 rule will 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 increasing
competition among ETFs as discussed below. At the same time, the rule
could

[[Page 57219]]

lead to a decrease in total assets of other fund types that investors
may regard as substitutes, such as certain mutual funds.\625\ As a
result, ETF ownership (as a percentage of market capitalization) for
some securities, such as stocks and bonds, will likely increase, and
ownership by other funds, such as mutual funds, will likely decrease.
We are aware of only a limited amount of academic literature regarding
ETFs. This literature suggests that such a shift in ownership could
have a limited effect on the price efficiency (i.e., the extent to
which an asset price reflects all public information at any point in
time) and liquidity of these portfolio securities.\626\
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\625\ The disclosure requirements will also serve to increase
investors' awareness of ETF trading costs, 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.
\626\ 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 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 also suggests that a shift in stock ownership
towards ETFs may somewhat improve certain dimensions of price
efficiency while possibly attenuating 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.\627\ 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 U.S. equity
index ETFs is associated with moderately higher volatility among
component stocks and asserts that the increased volatility is non-
fundamental.\628\ Another paper finds that higher authorized
participant arbitrage activity in U.S. equity ETFs is associated with a
moderately higher correlation of returns among stocks in the ETF's
portfolio.\629\ The authors observed that changes in the prices of
these stocks tend to partially revert over the next trading day and
state 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.
---------------------------------------------------------------------------

\627\ Lawrence Glosten, Suresh Nallareddy, & Yuan Zou, ETF
Trading and Informational Efficiency of Underlying Securities
(Columbia Business School, Research Paper No. 16-71, 2016).
\628\ 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.
\629\ Zhi Da & Sophie Shive, Exchange Traded Funds and Asset
Return Correlations (Working Paper, 2016).
---------------------------------------------------------------------------

To a limited extent, the rule could decrease the liquidity of
stocks held by ETFs, as one study finds that higher ownership of a
stock by U.S. equity ETFs is associated with somewhat lower liquidity
as measured by market impact.\630\ 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,\631\ another study
finds that bonds included in ETFs experience improvements in their
liquidity.\632\
---------------------------------------------------------------------------

\630\ See Sophia J.W. Hamm, The Effect of ETFs on Stock
Liquidity (Working Paper, 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.
\631\ Caitlin Dillon Dannhauser, The Impact of Innovation:
Evidence from Corporate Bond ETFs, Journal of Financial Economics
(forthcoming 2016) (``Dannhauser Article'').
\632\ Jayoung Nam, Market Accessibility, Corporate Bond ETFs,
and Liquidity (Working Paper, 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.\633\ The authors assert that this co-movement in
liquidity exposes investors to the possibility that multiple assets in
their portfolio will be illiquid at the same time.
---------------------------------------------------------------------------

\633\ Vikas Agarwal et al., Do ETFs Increase the Commonality in
Liquidity of Underlying Stocks (Working Paper, 2017).
---------------------------------------------------------------------------

Since we do not know the degree to which the rule will increase ETF
ownership of stocks and bonds, we are unable to quantify the rule's
effects on price efficiency and liquidity. However, the effects
documented in the literature surveyed above are generally small, so
that we do not anticipate that the rule would have a significant effect
on the price efficiency or liquidity of assets held by ETFs.
As a result of the 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.\634\ During normal market
conditions, this may lead those ETFs' shares to trade at smaller bid-
ask spreads, thus benefiting investors. Such a reduction in bid-ask
spreads by over-weighting more liquid securities may not continue to be
possible during stressed market conditions, however, if a large
proportion of such an ETF's portfolio securities become less
liquid.\635\ 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 rule, which some investors may not anticipate and fail to fully
take into account when making their investment decisions.\636\
---------------------------------------------------------------------------

\634\ This would be the case for those ETFs that hold less
liquid securities in their portfolios.
\635\ 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 123.
\636\ 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. 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 transacting
and existing/remaining shareholders.
---------------------------------------------------------------------------

Finally, the amendments to Forms N-1A and N-8B-2 as well as the
additional website disclosures required by rule 6c-11 we are adopting
will allow investors and other market participants to better understand
and compare ETFs using more relevant and standardized disclosure. For
example, the amendments to Item 6 of Form N-1A will add a requirement
for ETFs to include a statement that ETF investors may be subject to
other expenses that are specific to ETF trading, including

[[Page 57220]]

bid-ask spreads.\637\ These costs are not currently required to be
disclosed as part of the prospectus. Since these costs are incurred by
ETF investors and not mutual fund investors, we believe that adding
this disclosure requirement will 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
final rule could help investors make more informed investment decisions
that are more suited to their investment objectives. The degree to
which investors will 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.
---------------------------------------------------------------------------

\637\ James J. Angel, Todd J. Broms, & Gary L. Gastineau, ETF
Transaction Costs Are Often Higher Than Investors Realize, Journal
of Portfolio Management, Spring 2016, at 65, 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 rule will likely increase competition among ETFs that can rely
on the rule. The first channel through which the rule will likely
foster competition is by reducing the costs for ETF sponsors to form
new ETFs that comply with the conditions set by the rule. This cost
reduction will lower the barriers to entering the ETF market, which
will likely lead to increased competition among ETFs that can rely on
the rule.
In addition, new ETFs that enter the market in reliance on the
rule, as well as those existing ETFs that will have their exemptive
relief rescinded and replaced by the rule, will no longer be subject to
requirements that vary among exemptive orders.\638\ Instead, these ETFs
will operate under uniform requirements, which will help promote
competition among ETFs that can rely on the rule. An increase in
competition among ETFs that can rely on the rule will likely also lead
to an increase in competition among those ETFs, ETFs that cannot rely
on the rule, and other types of funds and products that investors may
perceive to be substitutes for ETFs.\639\
---------------------------------------------------------------------------

\638\ Some fund sponsors that operate ETFs outside the scope of
rule 6c-11 may voluntarily decide to comply with certain provisions
of the rule. For example, one sponsor that operates share class ETFs
stated that it intends to modify its current practices, as
necessary, to be consistent with the custom basket requirements
contemplated by the proposed rule for all its U.S. ETFs. See
Vanguard Comment Letter.
\639\ 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 mutual funds, closed-end funds, and other ETPs, such as
exchange-traded notes and commodity pools.
---------------------------------------------------------------------------

Furthermore, the new website disclosures and amendments to Forms N-
1A and N-8B-2 will allow investors to better compare ETFs and mutual
funds, which can further foster competition among these types of funds
as well as between these types of funds and other types of funds that
investors may perceive to be substitutes for ETFs and mutual funds,
such as closed-end funds and certain ETPs.
Increased competition will likely lead to lower fees for investors,
encourage financial innovation, and increase consumer choice in the
markets for ETFs, mutual funds, and other types of funds that investors
may perceive to be substitutes.\640\ Due to the limited availability of
data, however, we are unable to quantify these effects.
---------------------------------------------------------------------------

\640\ The rule will likely lead to increased competition both
among ETFs that can rely on the rule. as well as between ETFs that
can rely on the rule and those that cannot, to the extent that
investors perceive these ETFs as substitutes. While we believe that
increased competition generally is conducive to innovation, any
increased competition in the ETF market resulting from the rule will
be more likely to involve novel ETFs that will continue to need to
obtain exemptive relief from the Commission.
---------------------------------------------------------------------------

To the extent the rule will increase the number and total assets of
ETFs, more authorized participants or other market participants that
engage in ETF arbitrage, such as hedge funds and principal trading
firms, may enter the market. This may 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. We
would expect new entries of authorized participants or other
arbitrageurs as a result of the rule to be limited, however, and any
effects on bid-ask spreads and premiums/discounts to NAV per share to
be small.
3. Capital Formation
The rule may lead to increased capital formation. Specifically, an
increase in the demand for ETFs, to the extent that it increases demand
for intermediated assets as a whole, will 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 and 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 \641\ that
finds that bonds with a higher share of ETF ownership have lower
expected returns.\642\ Due to the limited availability of data,
however, we are unable to quantify these effects of the rule on capital
formation.
---------------------------------------------------------------------------

\641\ Dannhauser Article, supra footnote 632.
\642\ We acknowledge that there is research (see Yakov Amihud &
Haim Mendelson, Asset Pricing and the Bid-Ask Spread, 17 Journal of
Financial Economics 223 (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.
---------------------------------------------------------------------------

E. Reasonable Alternatives

1. Website Disclosure of Basket Information
Rule 6c-11 does not include a basket publication requirement. As an
alternative, we considered requiring an ETF to post on its website one
``published'' basket each business day before the opening of trading of
the ETF's shares, as we proposed. This disclosure would allow smaller
institutional investors and retail investors that are not NSCC members
and do not currently have access to basket information to compare the
ETF's ``published basket'' with its portfolio holdings.\643\ However,
we agree with commenters that the benefit of this information to these
investors is likely to be limited, as secondary market arbitrage
typically does not require information regarding an ETF's basket
composition.\644\ In addition, ETFs would incur additional costs
associated with this disclosure.\645\
---------------------------------------------------------------------------

\643\ Commenters stated that authorized participants already
have access to basket information through the daily portfolio
composition file provided to NSCC. In addition, other institutional
investors that use basket information for hedging purposes, such as
an investor using an authorized participant as an agent, have access
to this information through the NSCC, an intermediary (such as an
authorized participant), or the ETF itself. See supra section
II.C.5.c.
\644\ See, e.g., CSIM Comment Letter; ICI Comment Letter.
\645\ Our exemptive orders have not included requirements for
daily website disclosures of ETF baskets, though some exemptive
orders contemplate disclosure of daily basket assets through NSCC.
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.

---------------------------------------------------------------------------

[[Page 57221]]

We also considered requiring an ETF to publish information
regarding every custom basket used by the ETF after the close of
trading on each business day. This information 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 the 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 rule contains conditions for basket policies and
procedures, which seek to prevent overreaching. Moreover, the rule will
require an ETF to maintain records regarding the baskets used, which
will allow Commission staff to examine an ETF's use of basket
flexibility. We also agree with commenters that requiring publication
of all baskets could disadvantage an ETF and its shareholders by
allowing market participants to front-run trades by authorized
participants (or other arbitrageurs that use an authorized participant
as an agent) in basket securities, particularly for those ETFs that
have more frequent primary market transactions.\646\
---------------------------------------------------------------------------

\646\ See, e.g., ICI Comment Letter; SSGA Comment Letter I;
Vanguard Comment Letter.
---------------------------------------------------------------------------

Consequently, we believe that the risk for abusive practices under
the rule will be low while, at the same time, the rule will avoid
additional operational and compliance costs for ETFs to post and review
the information as well as potential costs associated with front-
running trades in basket securities under the alternative.
2. Disclosure of ETF Premiums or Discounts Greater Than 2%
As proposed, the rule will 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. One commenter suggested that we
raise the threshold for the size of the premiums or discounts to five
or ten percent while shortening the period over which the premium or
discount has to be sustained for the requirement to trigger.\647\ Based
on this suggestion, we considered an alternative that would require any
ETF whose premium or discount was greater than five percent for more
than three consecutive trading days to post that information on its
website, along with a discussion as required under the rule.
---------------------------------------------------------------------------

\647\ Nasdaq Comment Letter.
---------------------------------------------------------------------------

Under both the rule and the alternative, ETFs with premiums or
discounts greater than five percent for more than seven consecutive
trading days would provide the disclosure. The disclosure threshold
under the rule will also capture ETFs with premiums or discounts
greater than two and up to five percent for more than seven consecutive
trading days, which would not be captured under the alternative.
Conversely, the disclosure threshold under the alternative would also
capture ETFs with premiums or discounts greater than five percent for
between three and six consecutive trading days, which will not be
captured under the rule.
We estimate that 1.7 percent of those ETFs that can rely on the
rule would trigger the alternative disclosure threshold per year,
compared to 4.5 percent under the rule. From 2008 and 2018, the
percentage of ETFs that would have triggered the requirement would have
been largest in 2008. In that year, 4.6 percent of ETFs that could have
relied on the rule would have triggered the alternative threshold,
compared to 10 percent under the rule.\648\ In addition, an ETF that
triggers the reporting requirement under the alternative would make its
disclosure sooner after the premium or discount first exceeds the
threshold, as the measurement period is shorter compared to the rule.
---------------------------------------------------------------------------

\648\ See supra footnote 598 and accompanying text. Our estimate
of the percentage of ETFs that would have to satisfy the requirement
under the alternative is based on the same methodology and data as
our estimate for the rule's reporting threshold.
---------------------------------------------------------------------------

The lower incidence of reporting under the alternative would
decrease the costs incurred by ETFs associated with making the
disclosure,\649\ but also reduce the reporting of persistent premiums
and discounts available to investors in that it would eliminate
reporting of discounts below the 5% threshold. While the shorter
observation period under the alternative would make the information
about premiums and discounts available to investors sooner, rule 6c-11
will require ETFs to disclose the prior day's premium/discount to NAV
per share on its website every day, so that timely information about
the size of ETF's premiums/discounts will still be available to
investors under the rule.
---------------------------------------------------------------------------

\649\ We estimate a total annual industry cost of $47,457,745 (=
1.7% x 1,735 ETFs x $1,609). This estimate uses the same assumptions
as our estimate of the cost of this requirement under the rule. See
supra footnote 600 and accompanying text.
---------------------------------------------------------------------------

Another commenter suggested that we adopt a materiality standard
rather than a fixed numerical threshold to trigger the reporting
requirement.\650\ We considered an alternative under which each ETF
would make its own determination as to when a premium/discount to NAV
per share is material and thus would be reported. As a result, ETFs
would almost certainly differ in the size and duration of a premium/
discount that they would consider to be material. In addition, ETFs
might adopt varying criteria to determine whether a premium/discount is
deemed material based on the asset class of the ETF or general market
conditions. While we are unable to predict how the alternative would
impact the frequency of reporting compared to the rule, we believe that
the alternative might lead to inconsistent reporting practices among
ETFs, which would likely reduce the usefulness of the requirement to
investors, compared to the rule.
---------------------------------------------------------------------------

\650\ John Hancock Comment Letter (recommending a materiality
standard instead of a 2% threshold).
---------------------------------------------------------------------------

3. Website and Prospectus Disclosure of the Median Bid-Ask Spread
Calculated Over the Most Recent 1-Year Period
Rule 6c-11 will require an ETF to disclose the median bid-ask
spread calculated over the most recent 30-day period on its
website.\651\ As an alternative, we considered requiring an ETF to
disclose the median bid-ask spread for the ETF's most recent fiscal
year on its website and in its prospectus, as proposed.
---------------------------------------------------------------------------

\651\ Our amendments to Form N-1A will provide ETFs that do not
rely on rule 6c-11 with the option to provide the same information
on its website or the median bid-ask spread over the ETF's most
recent fiscal year in its prospectus. See supra section II.H.2.b.
---------------------------------------------------------------------------

We agree with commenters that computing the median bid-ask spread
over a 30-day rolling period, rather than over the proposed 1-year
lookback period, may provide a more accurate predictor of trading costs
for newly launched ETFs whose bid-ask spreads may tighten as the ETFs
mature.\652\ In addition, as an ETF's prospectus cannot be updated
every day, we believe it is appropriate to require ETFs to make this

[[Page 57222]]

disclosure on their websites. As a result, we believe that requiring
ETFs to disclose the median bid-ask spread over the most recent 30-day
period on their websites will increase the benefits of the bid-ask
spread disclosure to investors compared to the alternative,
particularly for newly-launched ETFs.
---------------------------------------------------------------------------

\652\ See supra footnote 381 and accompanying text. Conversely,
there may also be instances where future bid-ask spreads may be
better predicted by the median bid-ask spread computed over a 1-year
lookback period, as compared to a 30-day rolling period (e.g., when
recent bid-ask spreads are not representative of how an ETF
typically has traded.
---------------------------------------------------------------------------

4. Additional Disclosures Showing the Impact of Bid-Ask Spreads
We considered amending Forms N-1A and N-8B-2 to require an ETF to
provide: (1) Examples in the ETF's prospectus showing how bid-ask
spreads impact the return on a hypothetical investment for both buy-
and-hold and frequent traders; and (2) an interactive calculator on the
ETF's website that would allow an investor to customize the
hypothetical bid-ask spread calculations to its specific investing
situation, as proposed. Some investors may find the additional
disclosures under this alternative useful to understand the effect of
transaction costs resulting from bid-ask spreads on their investments;
however, we agree with commenters that this benefit could be diminished
by over-concentrating investor focus on bid-ask spreads, thereby
potentially obscuring the importance of other components of ETF
transaction costs (e.g., order size, market conditions, and the extent
to which a broker-dealer improves upon quoted bid-ask spreads).\653\ In
addition, the omission of these requirements will save ETFs the costs
associated with providing examples showing how bid-ask spreads impact
the return on a hypothetical investment and implementing the
interactive calculator on its website.
---------------------------------------------------------------------------

\653\ See, e.g., Vanguard Comment. See also Eaton Vance Comment
Letter.
---------------------------------------------------------------------------

5. Website Disclosure of a Modified IIV
As proposed, rule 6c-11 will not require ETFs to disseminate IIV as
a condition for reliance on the rule. As an alternative, we considered
requiring an ETF to publicly disseminate a modified IIV on its website
on a real time basis as a condition to rule 6c-11, requiring ETFs to
calculate IIVs more frequently and in a more accessible manner. We also
considered creating a methodology that takes into account circumstances
when market prices for underlying assets are not available or should
not be used to reflect the ETF's intraday value. As we discussed above
in section II.C.3, such a modified IIV would benefit retail and less
sophisticated institutional investors by allowing them to better
evaluate the value of an ETF intra-day. However, we are concerned that
these modifications would not cure the shortcomings of IIV for ETFs in
a uniform manner. We encourage the ETF industry to undertake efforts to
develop intraday value metrics targeted at these investors as we
believe that ETFs are in a position to consider and develop tailored
metrics for ETFs holding different asset classes in a format that is
useful for retail investors.
6. The Use of a Structured Format for Additional Website Disclosures
and the Filing of Additional Website Disclosures in a Structured Format
on EDGAR
The rule will require ETFs to post on their websites certain
disclosures to enable investors to more readily obtain certain key
metrics for individual ETFs. As an alternative, we considered requiring
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.\654\ The resulting standardization
under this alternative would allow for extraction, aggregation,
comparison, and analysis of reported information through significantly
more automated means than is possible with unstructured formats such as
HTML.\655\ 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 burden on investors and other data users of
separately visiting each website to obtain each ETF's disclosure.
---------------------------------------------------------------------------

\654\ 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.
\655\ Several commenters agreed with our assessment of the
benefits of a structured disclosure format. One commenter stated
that ``having such information submitted in a standardized,
structured format to the Commission and available publicly would aid
comparison and analysis.'' The commenter further indicated that such
information should be provided in the XBRL format on a daily basis.
See Morningstar Comment Letter. Another commenter expressed general
support for having ``standardized basket reporting in XBRL.'' See
Angel Comment Letter. Another commenter recommended that ETFs ``be
required to disclose their daily portfolio holdings using a common
downloadable or machine[hyphen]readable format specified by the
Commission.'' See Eaton Vance Comment Letter. A different commenter
recommended that ``portfolio holdings information be supplied in a
standard file format with comma-separated value.'' See SSGA Comment
Letter I.
---------------------------------------------------------------------------

The structured data requirement could impose a cost on ETFs of
tagging the information in a structured format, particularly to the
extent that ETFs do not otherwise structure this data in this manner
for their own purposes.\656\ However, we believe that if the XML
format, for example, were used for structuring the additional
disclosure, the incremental cost of tagging information in each such
disclosure would likely be relatively modest.\657\
---------------------------------------------------------------------------

\656\ See, e.g., CSIM Comment Letter (stating that ``[t]he
alternatives described in the proposal, including the use of
structured disclosures, will not be user-friendly for individual
investors and will incur unnecessary costs to the ETF.'').
\657\ For example, based on staff experience with XML filings,
the costs of tagging the information in XML are minimal given the
technology that would 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 would be able to accommodate XML data without
significant costs, and large-scale changes would likely not be
necessary to output structured data files.
---------------------------------------------------------------------------

As another alternative, we considered requiring ETFs to make the
additional website disclosures available in a centralized repository in
a structured format, such as by filing them on EDGAR.\658\ 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, such as third-party data aggregators, to
efficiently extract information for purposes of aggregation,
comparison, and analysis of information across multiple funds and time
periods.\659\ Requiring the information to be filed on EDGAR also would
enable data users to retain access to such historical information in
the event that such information is subsequently removed from the fund's
website.\660\ We recognize that filers might incur

[[Page 57223]]

additional costs under this alternative, compared to the requirement in
the rule to post the additional disclosures in an unstructured format
on fund websites.\661\ Such costs would likely vary across filers,
depending on the systems and processes they currently have in place,
such as for internal reporting, posting of website updates, and
submission of regulatory filings, and the manner in which filers
currently maintain data required for the additional disclosures under
the final rule.\662\
---------------------------------------------------------------------------

\658\ The Commission has previously adopted rules requiring the
structuring of certain information disclosed by funds. See, e.g.,
Reporting Modernization Adopting Release, supra footnote 263; Money
Market Fund Reform, Investment Company Act Release No. 29132 (Feb.
23, 2010) [75 FR 10059 (Mar. 4, 2010)]; Interactive Data for Mutual
Fund Risk/Return Summary, Investment Company Act Release No. 28617
(Feb. 11, 2009) [74 FR 7747 (Feb. 19, 2009)].
\659\ One commenter agreed with the assessment in the 2018 ETF
Proposing Release of the benefits of making the additional website
disclosures available in a centralized repository in a structured
format, stating that ``[a]ll holdings and basket information should
be filed in a central location (such as EDGAR) in a common format.
It is too difficult to search many funds groups for this information
and then putting it in a common format for analysis.'' See Reagan
Comment Letter.
\660\ See Reagan Comment Letter.
\661\ See Invesco Comment Letter (supporting dissemination via
the ETF sponsor's website and opposing any additional dissemination
requirements, such as filing on EDGAR, stating that building a
separate data feed would involve additional costs and internal
resources).
\662\ Such costs would also depend on the specific nature of the
EDGAR filing requirement under this alternative.
---------------------------------------------------------------------------

7. Pro Rata Baskets
Rule 6c-11 will 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 we have done in our exemptive orders
since approximately 2006.\663\
---------------------------------------------------------------------------

\663\ ETFs whose orders we are rescinding 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 in that
they are required to adopt custom basket policies and procedures
under rule 6c-11.
---------------------------------------------------------------------------

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, we believe that the rule's
additional policies and procedures requirements for custom baskets will
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, we believe that the increased basket
flexibility under the rule will benefit the effective functioning of
the arbitrage mechanism, particularly benefiting fixed-income,
international, and actively managed ETFs.\664\
---------------------------------------------------------------------------

\664\ Section IV.C.1.b.i supra discusses the possibility that
some ETFs may use the increased basket flexibility of the 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.
---------------------------------------------------------------------------

8. Treatment of Existing Exemptive Relief
As proposed, we will rescind the exemptive relief we have issued to
ETFs that will be permitted to rely on the 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 that would otherwise be subject to rule 6c-11
operate. Specifically, some ETFs that determine they do not need the
additional flexibility (e.g., basket flexibility) the rule will provide
could choose to continue operating under their existing relief rather
than in reliance on conditions of the rule, such as standardized
presentation of portfolio holdings. This self-selection would
perpetuate existing disparity in the conditions under which these ETFs
are allowed to operate.
Measured against the baseline, the alternative would thus have
smaller benefits arising from improved disclosure. For example, an ETF
that chose to continue to operate under its existing exemptive relief
would not be required to present its portfolio holdings in the
standardized format prescribed by rule 6c-11. As discussed in section
IV.C.1.b.i above, we believe that this requirement will benefit
investors of ETFs that are subject to rule 6c-11 by allowing them to
more easily identify arbitrage opportunities and compare ETFs that have
similar investment objectives. In addition, the alternative would not
level the playing field among ETFs subject to rule 6c-11 with regard to
these conditions and thus not be as effective at promoting product
competition as the rule. One commenter agreed, stating that the
rescission of the orders will further the Commission's regulatory goal
of creating a consistent regulatory framework for ETFs.\665\ In
addition, it would be more difficult for the Commission to evaluate
compliance with applicable law under the alternative compared to the
rule, as some of the ETFs whose exemptive relief we will 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 ETFs whose relief will be rescinded
will be able to continue operating with only minor adjustments, other
than being required to develop basket asset policies and
procedures.\666\
---------------------------------------------------------------------------

\665\ See supra footnote 455 and accompanying text.
\666\ Under the alternative, some ETFs may volunarily change
operational or compliance functions in order to be able to operate
under the rule, if this provides the ETFs increased basket
flexibility compared to operating under their existing exemptive
orders.
---------------------------------------------------------------------------

9. ETFs Organized as UITs
Rule 6c-11 will be available only to ETFs that are organized as
open-end funds.\667\ As an alternative, we considered including ETFs
organized as UITs in the scope of the rule. However, as discussed above
in section II.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.
---------------------------------------------------------------------------

\667\ 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 ETFs have greater investment flexibility under the
open-end fund structure than the UIT structure, we believe that most
new ETFs entering into the market will 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 rule.\668\
---------------------------------------------------------------------------

\668\ ETFs sponsors that plan to launch a new ETF organized as a
UIT will continue to be able to rely on the exemptive order process.
---------------------------------------------------------------------------

10. Treatment of Leveraged/Inverse ETFs
As discussed in section II.A.3 above, leveraged/inverse ETFs will
not be able to rely on final rule 6c-11. As an alternative, we
considered permitting leveraged/inverse ETFs to rely on the rule, while
maintaining the status quo of existing exemptive orders with respect to
the amount of leveraged market exposure that leveraged/inverse ETFs may
obtain (i.e., 300% of the return or inverse return).\669\
---------------------------------------------------------------------------

\669\ See supra footnote 72.
---------------------------------------------------------------------------

This alternative could benefit competition among leveraged/inverse
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/inverse ETFs
would likely decrease and their assets could increase.

[[Page 57224]]

However, as discussed in detail in section II.A.3 above, while
leveraged/inverse ETFs are structurally and operationally similar to
other types of ETFs within the scope of rule 6c-11, we believe it is
premature to permit sponsors to form and operate leveraged/inverse ETFs
in reliance on the rule without first addressing the investor
protection purposes and concerns underlying section 18 of the Act. We
therefore believe that the Commission should first complete its broader
consideration of the use of derivatives by registered funds before
considering allowing leveraged/inverse ETFs to rely on the rule.

V. Paperwork Reduction Act

A. Introduction

Rule 6c-11 will result in new ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\670\ In addition, the amendments to Form N-1A, Form N-8B-2,
and Form N-CEN will impact the collection of information burden under
those forms and Form S-6.\671\ Rule 6c-11 also will impact the current
collection of information burden of rule 0-2 under the Act.\672\
---------------------------------------------------------------------------

\670\ 44 U.S.C. 3501-3520.
\671\ 17 CFR 274.11A; 17 CFR 274.12; 17 CFR part 101; 17 CFR
239.16.
\672\ 17 CFR 270.0-2.
---------------------------------------------------------------------------

The titles for the existing collections 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-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 2018 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. We
received no comments on the collection of information requirements. We
discuss below the collection of information burdens associated with
rule 6c-11 and its impact on rule 0-2 as well as the amendments to
Forms N-1A, N-8B-2, S-6 and N-CEN.

B. Rule 6c-11

Rule 6c-11 will 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 rule attempts to eliminate historical
distinctions and conditions that we no longer believe are necessary and
thus appropriately level the playing field for open-end ETFs that
pursue the same or similar investment strategies.
Rule 6c-11 will require an ETF to disclose certain information on
its website, to maintain certain records, and to adopt and implement
written policies and procedures governing its 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 rule 6c-11 will be ETFs registered as open-end
management investment companies other than share class ETFs, leveraged/
inverse ETFs, or non-transparent ETFs. This collection will not be
mandatory, but will be necessary for those ETFs seeking to operate
without individual exemptive orders, including all ETFs whose existing
exemptive orders will be rescinded. In the 2018 ETF Proposing Release,
we estimated that 1,635 ETFs would likely rely on rule 6c-11.\673\ We
did not receive public comment on this estimate, but are updating the
estimate to 1,735 ETFs to reflect industry data as of December 31,
2018.\674\ Information provided to the Commission in connection with
staff examinations or investigations will be kept confidential subject
to the provisions of applicable law.
---------------------------------------------------------------------------

\673\ 2018 ETF Proposing Release, supra footnote 7, at section
IV.B. This estimate did not include UIT ETFs, share class ETFs,
leveraged/inverse ETFs, or non-transparent ETFs. Id.
\674\ This figure is based on a staff analysis of Bloomberg
data.
---------------------------------------------------------------------------

1. Website Disclosures
Rule 6c-11 will 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.\675\ The rule will require that the
portfolio holdings information contain specified information, including
description and amount of each position.\676\ Additionally, the rule
will require an ETF to disclose on its website: (i) The ETF's NAV per
share, market price, and premium or discount, each as of the end of the
prior business day; (ii) 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 (or for the life of the fund if shorter); and (iii) the ETF's
median bid-ask spread over the last thirty calendar days.\677\
---------------------------------------------------------------------------

\675\ Rule 6c-11(c)(1)(i).
\676\ Rule 6c-11(c)(1)(i).
\677\ Rule 6c-11(c)(1)(ii)-(v).
---------------------------------------------------------------------------

Rule 6c-11(c)(1)(vi) also will 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.\678\ Given the threshold for
this requirement, we do not believe that many ETFs will be required to
disclose this information on a routine basis. In the 2018 ETF Proposing
Release, we estimated that all ETFs will be required to make this
disclosure only once in their lifetime.\679\ Therefore, we believed
that this requirement will impose only initial costs and that there
will be no ongoing costs associated with it.\680\
---------------------------------------------------------------------------

\678\ Rule 6c-11(c)(1)(vi). 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 section II.C.6.c.
\679\ 2018 ETF Proposing Release, supra footnote 7, at section
IV.B.1.
\680\ For purposes of this analysis, we estimate that 1,735 ETFs
would be required to make this disclosure at least once in their
lifetime.

[[Page 57225]]

Table 11--Website Disclosure PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Internal time Initial external Annual external
Initial hours Annual hours \1\ Wage rate \2\ costs cost burden cost burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Website development........... 7.5 2.5 hours........... x $274 (senior $685............... $2,000............. $666.65
systems
analyst).
7.5 2.5 hours........... x $319 (senior $797.50............
programmer).
Review of website disclosures. 5 1.7 hours........... x $298 (compliance $506.60............
manager).
5 1.7 hours........... x $352 (compliance $598.40............
attorney).
Website updates............... .............. 1 hour.............. x $274 (senior $274...............
systems
analyst).
1 hour.............. x $319 (senior $319...............
programmer).
Review of updated website .............. 1.25 hours.......... x $298 (compliance $372.50............
disclosure. manager).
1.25 hours.......... x $352 (compliance $440...............
attorney).
-------------------------------------------------------------------------------------------------------------------------
Total annual burden per 25 13.3 hours $3,971.30.......... $2,000............. $666.65
ETF.
Number of ETFs............ .............. x 1,635 x 1,635............ x 1,635............ x 1,635
-------------------------------------------------------------------------------------------------------------------------
Total annual burden... .............. 21,745.5 hours $6,493,075.50...... $3,270,000......... $1,089,972.75
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Website development........... \4\ 11.25 3.75 hours.......... x $284 (senior $1,065............. $3,000 \4\......... $1,000
systems
analyst) \5\.
\4\ 11.25 3.75 hours.......... x $331 (senior $1,241.25..........
programmer) \5\.
Review of website disclosures. \4\ 7.5 2.5 hours........... x $309 (compliance $772.50............
manager) \5\.
\4\ 7.5 2.5 hours........... x $365 (compliance $912.50............
attorney) \5\.
Website updates............... .............. 1.5 hours \4\....... x $284 (senior $426...............
systems
analyst) \5\.
1.5 hours \4\....... x $331 (senior $496.50............
programmer) \5\.
Review of updated website .............. 1.875 hours \4\..... x $309 (compliance $579.38............
disclosure. manager) \5\.
1.875 hours \4\..... x $365 (compliance $684.36............
attorney) \5\.
-------------------------------------------------------------------------------------------------------------------------
Total annual burden per 37.5 19.25 hours $6,177.49.......... $3,000............. $1,000
ETF.
Number of ETFs............ .............. x 1,735 \5\ x 1,735 \5\........ x 1,735 \5\........ x 1,735 \5\
-------------------------------------------------------------------------------------------------------------------------
Total annual burden... .............. 33,398.75 hours..... $10,717,945.15..... $5,205,000......... $1,735,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Includes initial burden estimates annualized over a three-year period.
\2\ See supra footnote 568.
\3\ 2018 Proposing Release, supra footnote 7, at section IV.B.1.
\4\ Estimate revised to reflect modifications from the proposal.
\5\ Estimate revised to reflect updated industry data.

Table 11 above summarizes the proposed PRA estimates included in
the 2018 ETF Proposing Release and the final PRA estimates associated
with the website disclosures in rule 6c-11.\681\ We did not receive
public comment on our proposed estimates, but we have revised them as a
result of updated industry data and modifications from the proposal.
Specifically, we are increasing the initial and ongoing internal and
external burden estimates by 50 percent each to account for our
modification to the proposal that will require ETFs to disclose median
bid-ask spread information on their websites as part of rule 6c-11,
partially offset by the elimination of the proposed published basket
requirement and the modification to the proposed requirement to
disclose portfolio holdings related to timing and presentation of those
holdings.\682\ In addition, we are revising the estimated wage rates
and estimated number of ETFs that will be subject to the rule to
reflect updated industry data.
---------------------------------------------------------------------------

\681\ 2018 ETF Proposing Release, supra footnote 7, at section
IV.B.1.
\682\ See supra section II.C.6.d, section II.C.5.c.
---------------------------------------------------------------------------

2. Recordkeeping
Rule 6c-11 will require an ETF to preserve and maintain copies of
all written authorized participant agreements.\683\ Additionally, the
rule will require ETFs to maintain records setting forth the following
information for each basket exchanged with an authorized participant:
(i) Ticker symbol, CUSIP or other identifier, description of holding,
quantity of each holding, and percentage weight of each holding
composing the basket; (ii) if applicable, 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.\684\
ETFs would have to maintain these records for at least five years, the
first two years in an easily accessible place.\685\
---------------------------------------------------------------------------

\683\See rule 6c-11(d).
\684\ See supra footnote 411 and accompanying text. Although we
have modified the recordkeeping requirement from the proposal, we do
not believe the modified requirements would increase the time or
cost burdens set forth in the 2018 ETF Proposing Release. See 2018
ETF Proposing Release, supra footnote 7, at section IV.B.2.
\685\ Id.

[[Page 57226]]

Table 12--Recordkeeping PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Internal time Initial external Annual external
Initial hours Annual hours Wage rate \1\ costs cost burden cost burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \2\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Recordkeeping................. 0 2.5 hours........... x $60 (general $150...............
clerk).
0 2.5 hours........... x $92 (senior $230...............
computer
operator).
-------------------------------------------------------------------------------------------------------------------------
Total annual burden per 0 5 hours............. $380...............
ETF.
Number of ETFs............ .............. x 1,635............. x 1,635............
-------------------------------------------------------------------------------------------------------------------------
Total annual burden... 0 8,175 hours......... $621,300.00........ $0................. $0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Recordkeeping................. 0 2.5 hours........... x $62 (general $155...............
clerk) \3\.
0 2.5 hours........... x $95 (senior $237.50............
computer
operator) \3\.
-------------------------------------------------------------------------------------------------------------------------
Total annual burden per 0 5 hours............. $392.50............
ETF.
Number of ETFs............ .............. x 1,735 \3\......... x 1,735............
-------------------------------------------------------------------------------------------------------------------------
Total annual burden... .............. 8,675 hours $680,987.50........ $0................. $0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Based on SIFMA Report, supra footnote 568, as modified by Commission staff.
\2\ See 2018 ETF Proposing Release at section IV.B.2.
\3\ Estimate revised to reflect updated industry data.

Table 12 above summarizes the proposed PRA estimates included in
the 2018 ETF Proposing Release and the final PRA estimates associated
with the recordkeeping requirements in rule 6c-11.\686\ We did not
receive public comment on our proposed estimates, but we have revised
the estimates as a result of updated industry data. Specifically, we
have updated the estimated wage rates and the estimated number of ETFs
that will be subject to the rule and thus the recordkeeping
requirement. We do not estimate that there will be any initial or
ongoing external costs associated with the recordkeeping requirement.
---------------------------------------------------------------------------

\686\ See 2018 ETF Proposing Release, supra footnote 7, at
section IV.B.2.
---------------------------------------------------------------------------

3. Policies and Procedures
As proposed, rule 6c-11 will require 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 basket assets.\687\ 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.\688\ 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.\689\ Finally,
as discussed above, an ETF using custom baskets would be required to
maintain records detailing the composition of each custom basket.
---------------------------------------------------------------------------

\687\ See rule 6c-11(c)(3).
\688\ See rule 6c-11(c)(3).
\689\ See supra text following footnote 294.

Table 13--Policies and Procedures PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial external Annual external
Initial hours Annual hours \1\ Wage rate \2\ Internal time costs cost burden cost burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Establishing and implementing 3 1 hour.............. x $317 (senior $317...............
standard baskets policies and manager).
procedures.
2 .67 hours........... x $511 (chief $340.67............
compliance
officer).
1 .33 hours........... x $352 (compliance $117.33............
attorney).
Establishing and implementing 9 3 hours............. x $317 (senior $951...............
custom baskets policies and manager).
procedures.
5 1.67 hours.......... x $449 (ass't $748.33............
general
counsel).
5 1.67 hours.......... x $511 (chief $851.67............
compliance
officer).
1 .33 hours........... x $352 (compliance $117.33............
attorney).
Reviewing and updating baskets .............. 5 hours............. x $317 (senior $1,585.............
policies and procedures. manager).
2.5 hours........... x $449 (ass't $1,122.50..........
general
counsel).
2.5 hours........... x $511 (chief $1,277.50..........
compliance
officer).

[[Page 57227]]

Total annual burden per .............. 18.67 hours......... $7,428.33..........
ETF.
-------------------------------------------------------------------------------------------------------------------------
Number of ETFs............ .............. x 1,635............. x 1,635............
Total annual burden... .............. 30,525 hours \4\.... $12,145,320 \4\.... $0................. $0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Establishing and implementing 3 1 hour.............. x $329 (senior $329...............
standard baskets policies and manager) \5\.
procedures.
2 .67 hours........... x $530 (chief $353.33............
compliance
officer) \5\.
1 .33 hours........... x $365 (compliance $121.67............
attorney) \5\.
Establishing and implementing 9 3 hours............. x $329 (senior $987...............
custom baskets policies and manager) \5\.
procedures.
5 1.67 hours.......... x $466 (ass't $776.67............
general
counsel) \5\.
5 1.67 hours.......... x $530 (chief $883.33............
compliance
officer) \5\.
1 .33 hours........... x $365 (compliance $121.67............
attorney) \5\.
Reviewing and updating baskets 5 hours............. x $329 (senior $1,645.............
policies and procedures. manager) \5\.
2.5 hours........... x $466 (ass't $1,165.............
general
counsel) \5\.
2.5 hours........... x $530 (chief $1,325.............
compliance
officer) \5\.
-------------------------------------------------------------------------------------------------------------------------
Total annual burden per 18.67 hours......... $7,707.67.......... $0................. $0
ETF.
-------------------------------------------------------------------------------------------------------------------------
Number of ETFs............ x 1,735 \5\......... x 1,735............
Total annual burden... 32,392.45 hours..... $13,372,807.45..... ...................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Includes initial burden estimates annualized over a three-year period.
\2\ Based on SIFMA Report, supra footnote 568, as modified by Commission staff.
\3\ See 2018 ETF Proposing Release at section IV.B.3.
\4\ The proposed estimates shown here for the total annual hour and cost burdens (30,525 hours and $12,145,320) are not identical to the totals provided
in the 2018 ETFs Proposing Release. See supra footnote 7, at section IV.B.2 (estimating total hour and cost burdens of 30,520 hours and $12,111,525).
This discrepancy is due to our calculation of the annual hours in the 2018 ETF Proposing Release, in which the total initial burden hours were
calculated before being amortized over 3 years (i.e., divided by 3). Here, the initial burden hours were amortized over 3 years before we calculated
the total annual hour and cost burdens, resulting in slightly higher totals. This does not affect the final estimates set forth above.
\5\ Estimate revised to reflect updated industry data.

Table 13 above summarizes the proposed PRA estimates included in
the 2018 ETF Proposing Release and the final PRA estimates associated
with the policies and procedures requirements in rule 6c-11.\690\ We
did not receive public comment on our proposed estimates, but we are
revising the estimates as a result of updated industry data.
Specifically, we have updated the estimated wage rates and the
estimated number of ETFs that will be subject to the rule and thus the
policies and procedures requirement. We do not estimate that there will
be any initial or ongoing external costs associated with this
requirement.
---------------------------------------------------------------------------

\690\ See 2018 ETF Proposing Release, supra footnote 7, at
section IV.B.2.
---------------------------------------------------------------------------

4. Estimated Total Burden

Table 14--Rule 6c-11 Total PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Internal hour burden Internal burden time cost External cost burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Website disclosure................. 33,398.75 hours...................... $10,717,945.15....................... $1,735,000
Recordkeeping...................... 8,675 hours.......................... $680,987.50.......................... $0
Developing policies and procedures. 32,392.45 hours...................... $13,372,807.45....................... $0
--------------------------------------------------------------------------------------------------------------------
Total annual burden............ 74,466.2 hours....................... $24,771,740.10....................... $1,735,000
Number of ETFs................. / 1,735.............................. / 1,735.............................. / 1,735
--------------------------------------------------------------------------------------------------------------------
Average annual burden per 42.92 hours.......................... $14,277.66........................... $1,000
ETF.
--------------------------------------------------------------------------------------------------------------------------------------------------------

As summarized in Table 14 above, we estimate that the total hour
burdens and time costs associated with rule 6c-11, including the burden
associated with website disclosure, recordkeeping, and developing
policies and procedures will result in an average aggregate annual
burden of 74,466.2 hours and an average aggregate time cost of
$24,771,740.10. We also estimate that there are external costs of
$1,735,000 associated with this collection of information. Therefore,

[[Page 57228]]

each ETF will incur an annual burden of approximately 42.92 hours, at
an average time cost of approximately $14,277.66, and an external cost
of $1,000 to comply with rule 6c-11.

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.\691\
---------------------------------------------------------------------------

\691\ 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).
---------------------------------------------------------------------------

As discussed above, rule 6c-11 will 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, rule 6c-
11 will alleviate some of the burdens associated with rule 0-2 because
it will reduce the number of entities that require exemptive relief in
order to operate.\692\ Based on staff experience, we estimate that
approximately one-third (rounded in the 2018 ETF Proposing Release and
here to 30%) of the annual burdens associated with rule 0-2 are
attributable to ETF applications.
---------------------------------------------------------------------------

\692\ We expect to continue to receive applications for complex
or novel ETF exemptive relief that are beyond the scope of the rule.
See supra at text following footnote 570.

Table 15--Rule 0-2 PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual hours Annual internal time cost Annual external cost burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Rule 0-2 burdens currently approved x = 5,340............................ y = $2,029,200.60.................... z = $14,090,000
Estimated effect of rule 6c-11 on -0.3(x).............................. -0.3(y).............................. -0.3(z)
rule 0-2 burdens.
--------------------------------------------------------------------------------------------------------------------
Revised estimated burden....... 3,738 hours.......................... $1,420,440.42........................ $9,863,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

Table 15 above summarizes the proposed estimates included in the
2018 ETF Proposing Release.\693\ We did not receive public comment on
these estimates, and we have not revised them.
---------------------------------------------------------------------------

\693\ See 2018 ETF Proposing Release, supra footnote 7, at
section IV.B.2.
---------------------------------------------------------------------------

D. Form N-1A

Form N-1A is the registration form used by open-end management
investment companies. The respondents to the amendments to Form N-1A
are open-end management investment companies registered or registering
with the Commission. Compliance with the 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 hour burden of 1,642,490 burden hours and external
cost of $131,139,208.\694\
---------------------------------------------------------------------------

\694\ This estimate is based on the last time the form's
information collection was submitted for PRA approval in 2019. When
we issued the 2018 ETF Proposing Release, the current estimate for
Form N-1A was 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.
---------------------------------------------------------------------------

We are adopting amendments to Form N-1A designed to provide
investors who purchase open-end ETF shares in secondary market
transactions with tailored information regarding ETFs, including
information regarding purchasing and selling shares of ETFs.\695\
Specifically, the amendments to Form N-1A will require new narrative
disclosures regarding ETF trading and associated costs.\696\ In
addition, we are requiring an ETF that does not rely on rule 6c-11 to
disclose median bid-ask spread information on their websites or in
their prospectuses.\697\ The amendments also exclude ETFs that provide
premium/discount disclosures on their websites in accordance with rule
6c-11 from the premium discount disclosure requirements in Form N-
1A.\698\ We also are adopting amendments to Form N-1A designed to
eliminate certain disclosures for ETFs that are no longer
necessary.\699\
---------------------------------------------------------------------------

\695\ See supra section II.H.
\696\ See supra section II.H.2.a.
\697\ See supra section II.H.2.b.
\698\ See supra section 0.
\699\ See supra section II.H.3.
---------------------------------------------------------------------------

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 rule
485(a) or 485(b) under the Securities Act, as applicable).

[[Page 57229]]

Table 16--Form N-1A PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual external cost
Initial hours Annual hours \1\ Wage rate \2\ Internal time costs burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and .............. 1.67 hours.............. x $352 (compliance $587.84................
amend registration statement. attorney).
5 1.67 hours.............. x $319 (senior 532.73.................
programmer).
Bid-ask spread and interactive 5 1.67 hours.............. x $352 (compliance 587.84.................
calculator requirements. attorney).
5 1.67 hours.............. x $319 (senior 532.73.................
programmer).
Review and update disclosures..... .............. 2.5 hours............... x $352 (compliance 880....................
attorney).
.............. 2.5 hours............... x $319 (senior 797.50.................
programmer).
Maintain bid-ask spread and .............. 2.5 hours............... x $352 (compliance 880....................
interactive calculator. attorney).
.............. 2.5 hours............... x $319 (senior 797.50.................
programmer).
---------------------------------------------------------------------------------------------------------------------
Total new annual burden per 20 16.67 hours............. . ..................... 5,591.67...............
ETF. x 1,892................. x 1,892................
Number of ETFs................
---------------------------------------------------------------------------------------------------------------------
Total new annual burden... .............. 31,596.4 hours.......... . ..................... 10,579,307.20..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and 5 1.67 hours.............. x $365 (compliance 609.55.................
amend registration statement. attorney) \4\.
5 1.67 hours.............. x $331 (senior 552.77.................
programmer) \4\.
Bid-ask spread and premium or \5\ 1 0.33 hours.............. x $365 (compliance 121.67.................
discount requirements. attorney) \4\.
\5\ 1 0.33 hours.............. x $331 (senior 110.33.................
programmer) \4\.
Review and update disclosures..... .............. 2.5 hours............... x $365 (compliance 912.50.................
attorney) \4\.
.............. 2.5 hours............... x $331 (senior 827.50.................
programmer) \4\.
Maintain bid-ask spread .............. 0.5 hours \5\........... x $365 (compliance 182.50.................
requirements. attorney) \4\.
.............. 0.5 hours \5\........... x $331 (senior 165.50.................
programmer) \4\.
---------------------------------------------------------------------------------------------------------------------
Total new annual burden per 7 10 hours................ . ..................... 3,482.32...............
ETF. x 1,970 \4\............. x 1,970 \4\............
Number of ETFs................
---------------------------------------------------------------------------------------------------------------------
Total new annual burden... .............. 19,700 hours............ . ..................... 6,860,170.40........... $ 0
Current burden estimates.. .............. + 1,642,490 hours....... . ..................... ....................... + $131,139,208
---------------------------------------------------------------------------------------------------------------------
Revised burden .............. 1,662,190 hours......... . ..................... ....................... $131,139,208
estimates.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Includes initial burden estimates annualized over a three-year period.
\2\ See supra footnote 568.
\3\ 2018 Proposing Release, supra footnote 7, at section IV.D.
\4\ Estimate revised to reflect updated industry data.
\5\ Estimate revised to reflect modifications from the proposal.

Table 16 above summarizes the proposed PRA estimates included in
the 2018 ETF Proposing Release and the final PRA estimates associated
Form N-1A as amended.\700\ We did not receive public comment on our
proposed PRA estimates, but we are revising our estimates as a result
of updated industry data and modifications from the proposal.
Specifically, we are decreasing the initial and ongoing internal and
external burden estimates associated with the bid-ask spread and
interactive calculator requirements by 80 percent each to account for
our elimination of the hypothetical example and interactive calculator
requirements and our decision to apply the prospectus bid-ask spread
requirements only to those ETFs that do not comply with the website
disclosure requirements in rule 6c-11, partially offset by the
additional premium or discount requirements.\701\ In addition, we are
revising the estimated wage rates and estimated number of ETFs that
will be subject to the rule to reflect updated industry data.
---------------------------------------------------------------------------

\700\ 2018 Proposing Release, supra footnote 7, at section
IV.B.1.
\701\ See supra sections II.H.
---------------------------------------------------------------------------

As summarized in Table 16 above, we estimate that the total hour
burdens and time costs associated with the amendments to Form N-1A will
result in an average aggregate annual burden of 19,700 hours at an
average aggregate time cost of $6,860,170.40. We do not estimate any
change in external cost. Therefore the revised aggregate estimates for
Form N-1A, including the new amendments, are 1,662,190 hours and
$131,338,208 in external costs.

E. 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.\702\ UITs are
required to file Form S-6 in order to register offerings of securities
with the Commission under the Securities Act.\703\ 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.\704\ We
currently estimate for Form S-6 a total burden of 107,245

[[Page 57230]]

hours, with an internal cost burden of approximately $34,163,955, and
an external cost burden estimate of $68,108,956.\705\ 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.\706\
---------------------------------------------------------------------------

\702\ See Form N-8B-2 [17 CFR 274.12].
\703\ 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.
\704\ 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.
\705\ This estimate is based on the last time the form's
information collection was submitted for PRA revision in 2019.
\706\ This estimate is based on the last time the form's
information collection was submitted for PRA renewal in 2018.
---------------------------------------------------------------------------

To assist investors with better understanding the total costs of
investing in a UIT ETF, we are adopting disclosure requirements in Form
N-8B-2 that mirror those disclosures we are adopting for Form N-
1A.\707\ All UIT ETFs will 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 will accrue on Form S-6.
---------------------------------------------------------------------------

\707\ See supra section II.I.

Table 17--Form S-6 PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual external cost
Initial hours Annual hours \1\ Wage rate \2\ Internal time costs burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and 10 3.33 hours.............. x $352 (compliance $1,173.32.............. .......................
amend Form S-6. attorney).
10 3.33 hours.............. x $319 (senior 1,063.33............... .......................
programmer).
Review and update disclosures on .............. 5 hours................. x $352 (compliance 1,760.................. .......................
Form S[dash]6. attorney).
.............. 5....................... x $319 (senior 1,595.................. .......................
programmer).
---------------------------------------------------------------------------------------------------------------------
Total new annual burden per 20 16.67 hours............. . ..................... 5,591.65............... .......................
UIT ETF.
---------------------------------------------------------------------------------------------------------------------
Number of UIT ETFs............ .............. x 8..................... . ..................... x 8.................... .......................
---------------------------------------------------------------------------------------------------------------------
Total new annual burden... .............. 133.36 hours............ . ..................... 44,733.20.............. .......................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and \4\ 12 4 hours................. x $365 (compliance 1,460.................. .......................
amend Form S[dash]6. attorney) \5\.
\4\ 12 4 hours................. x $331 (senior 1,324.................. .......................
programmer) \5\.
Review and update disclosures on .............. 5 hours................. x $365 (compliance 1,825.................. .......................
Form S[dash]6. attorney) \5\.
.............. 5 hours................. x $331(senior $1,655................. .......................
programmer) \5\.
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Total new annual burden per 24 18 hours................ $6,264................. .......................
ETF.
Number of UIT ETFs............ .............. x 8..................... x 8.................... .......................
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Total new annual burden... .............. 114 hours............... $50,112................ $ 0
Current burden estimates.. + 107,245 hours......... + $68,108,956
Revised burden .............. 107,359 hours........... ....................... $68,108,956
estimates.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Includes initial burden estimates annualized over a three-year period.
\2\ See supra footnote 568.
\3\ 2018 Proposing Release, supra footnote 7, at Section IV.E.
\4\ Estimate revised to reflect modifications from the proposal.
\5\ Estimate revised to reflect updated industry data.

Table 18--Form N-8B-2 PRA Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual external cost
Initial hours Annual hours \1\ Wage rate \2\ Internal time costs burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Estimates \3\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and 10 3.33 hours.............. x $352 (compliance $1,173.32.............. .......................
file Form N-8B-2. attorney).
10 3.33 hours.............. x $319 (senior $1,063.33.............. .......................
programmer).
Complete Form N-8B-2.............. .............. 5 hours................. x $352 (compliance $1,760................. .......................
attorney).
.............. 5 hours................. x $319 (senior $1,595................. .......................
programmer).
---------------------------------------------------------------------------------------------------------------------
Total new annual burden per 20 16.67 hours............. . ..................... $5,591.65.............. .......................
UIT ETF.
Number of new UIT ETFs........ .............. x 1..................... . ..................... x 1.................... .......................
---------------------------------------------------------------------------------------------------------------------
Total new annual burden... .............. 16.67 hours............. . ..................... $5,591.65.............. .......................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Final Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Draft and finalize disclosure and \4\ 12 4 hours................. x $365 (compliance $1,460................. .......................
file Form N-8B-2. attorney) \5\.
\4\ 12 4 hours................. x $331 (senior $1,324................. .......................
programmer) \5\.
Complete Form N-8B-2.............. .............. 5 hours................. x $365 (compliance $1,825................. .......................
attorney) \5\.
.............. 5 hours................. x $331 (senior $1,655................. .......................
programmer) \5\.
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Total new annual burden per 24 18 hours................ $6,264.................
UIT ETF.
Number of new UIT ETFs........ .............. x 1..................... x 1....................
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr

[[Page 57231]]

Total new annual burden... .............. 18 hours................ $6,264................. $0
Current burden estimates.. .............. +10 hours............... + $10,000
Revised burden .............. 28 hours................ $10,000
estimates.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:
\1\ Includes initial burden estimates annualized over a three-year period.
\2\ See supra footnote 568.
\3\ 2018 Proposing Release, supra footnote 7, at section IV.E.
\4\ Estimate revised to reflect modifications from the proposal.
\5\ Estimate revised to reflect updated industry data.

Table 17 and Table 18 above summarize the proposed PRA estimates
included in the 2018 ETF Proposing Release and the final PRA estimates
associated with Forms S-6 and N-8B-2, respectively.\708\ We did not
receive public comment on our proposed estimates, but we are revising
our estimates as a result of updated industry data and modifications
from the proposal. Specifically, we are increasing the initial internal
burden estimate for both Form S-6 and Form N-8B-2 by 20 percent to
account for the additional premium and discount requirement, partially
offset by the modifications to the proposed fee and expense
requirements, including those relating to bid-ask spreads.\709\ In
addition, we are revising the estimated wage rates to reflect updated
industry data.\710\
---------------------------------------------------------------------------

\708\ 2018 ETF Proposing Release, supra footnote 7, at section
IV.E.
\709\ See supra section II.I.
\710\ After reviewing updated industry data, no revisions to the
estimated number of UIT ETFs that will be subject to the form are
necessary.
---------------------------------------------------------------------------

As summarized in Table 17 above, we estimate that the total hour
burdens and time costs associated with the amendments to Form S-6 will
result in an average aggregate annual burden of 114 hours at an average
aggregate time cost of $50,112. We do not estimate any change in
external cost. Therefore, the revised aggregate estimates for Form S-6,
including the new amendments, are 107,359 hours and $68,108,956 in
external costs.
As summarized in Table 18 above, we estimate that the total hour
burdens and time costs associated with the amendments affecting Form N-
8B-2 will result in an average aggregate annual burden of 18 hours at
an average aggregate time cost of $6,264. We do not estimate any change
in external cost. Therefore, the revised aggregate estimates for Form
N-8B-2, including the new amendments, are 28 hours and $10,000 in
external costs.

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.\711\ Today, the Commission is adopting amendments
to Form N-CEN to require ETFs to report if they are relying on rule 6c-
11.\712\ We currently estimate for Form N-CEN total burden hours of
74,425 and external costs of $2,088,176.\713\
---------------------------------------------------------------------------

\711\ See Reporting Modernization Adopting Release, supra
footnote 263.
\712\ See supra section II.J.
\713\ This estimate is based on the last time the form's
information collection was submitted for PRA approval in 2017.

Table 19--Form N-CEN PRA Estimates
------------------------------------------------------------------------
Annual external
Annual hours cost burden
------------------------------------------------------------------------
Proposed Estimates \1\
------------------------------------------------------------------------
Report reliance on rule 6c-11..... 0.1 hours .................
Number of ETFs.................... x 1,635 .................
-------------------------------------
Total new annual burden....... 163.5 hours .................
------------------------------------------------------------------------
Final Estimates
------------------------------------------------------------------------
Report reliance on rule 6c-11..... 0.1 hours .................
Number of ETFs.................... x 1,735 \2\ .................
Total new annual burden....... 173.5 hours $ 0
Current burden estimates...... + 74,425 hours + $2,088,176
Revised burden estimates.. 74,598 hours $2,088,176
------------------------------------------------------------------------
Notes:
\1\ 2018 Proposing Release, supra footnote 7, at section IV.F.
\2\ Estimate revised to reflect updated industry data.

Table 19 above summarizes the proposed estimates included in the
2018 ETF Proposing Release and the final PRA estimates associated with
Form N-CEN as amended.\714\ We did not receive public comment on these
estimates, but we are revising our proposed estimates as a result of
updated industry data. Specifically, we are revising the estimated
number of ETFs that will be subject to the rule to reflect updated
industry data. As summarized in Table 19, we estimate that the total
hour burdens and time costs associated with the amendments to Form N-
CEN will result in an average aggregate annual burden of 173.5 hours.
We do not estimate any change in external cost.

[[Page 57232]]

Therefore the revised aggregate estimates for Form N-CEN, including the
new amendments, are 74,598 hours and $2,088,176 in external costs.
---------------------------------------------------------------------------

\714\ 2018 ETF Proposing Release, supra footnote 7, at section
IV.F.
---------------------------------------------------------------------------

VI. Final Regulatory Flexibility Analysis

The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with section 4(a) of the
Regulatory Flexibility Act (``RFA''),\715\ regarding new rule 6c-11 and
amendments to Form N-1A, Form N-8B-2, and Form N-CEN. An Initial
Regulatory Flexibility Analysis (``IRFA'') was prepared in accordance
with the RFA and included in the 2018 ETF Proposing Release.\716\
---------------------------------------------------------------------------

\715\ See 5 U.S.C. 603.
\716\ See 2018 ETF Proposing Release, supra footnote 7, at
section V.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule and Form Amendments

As described more fully above, rule 6c-11 will 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
amendments to Forms N-1A and N-8B-2 will provide useful information to
investors who purchase and sell ETF shares in secondary markets.
Finally, the Commission believes the amendments to Form N-CEN will
allow the Commission to better monitor reliance on rule 6c-11 and will
assist the Commission with its accounting, auditing and oversight
functions.
All of these requirements are discussed in detail in section II
above. The costs and burdens of these requirements on small ETFs are
discussed below as well as above in our Economic Analysis and Paperwork
Reduction Act Analysis, which discuss the costs and burdens on all
ETFs.

B. Significant Issues Raised by Public Comments

In the 2018 ETF Proposing Release, we requested comment on every
aspect of the IRFA, including the number of small entities that would
be affected by the proposed rule and amendments, the existence or
nature of the potential impact of the proposals on small entities
discussed in the analysis and how to quantify the impact of the
proposed rule and amendments. We also requested comment on the broader
impact of the proposed rule and amendments on all relevant entities,
regardless of size. After consideration of the comments we received on
the proposed rule and amendments, we are adopting the rule and
amendments with several modifications that are designed to reduce
certain operational challenges that commenters identified, while
maintaining protections for investors and providing investors with
useful information regarding ETFs. However, none of the modifications
were significant to the small-entity cost burden estimates discussed
below. Revisions to the estimates are instead based on updated figures
regarding the number of small entities impacted by the new rule and
amendments and updated estimated wage rates.

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.\717\ Commission staff estimates that, as of
December 2018, there are approximately 9 open-end ETFs that may be
considered small entities.\718\ Commission staff estimates there are no
UIT ETFs that would be considered small entities subject to the
proposed disclosures for Form N-8B-2.\719\
---------------------------------------------------------------------------

\717\ 17 CFR 270.0-10(a).
\718\ This estimate is derived from an analysis of data reported
on Form N-1A with the Commission for the period ending December,
2018.
\719\ 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 2018.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements

The new rule and amendments will impact current reporting,
recordkeeping and other compliance requirements for ETFs considered
small entities.
1. Rule 6c-11
Rule 6c-11 will require an ETF to disclose on its website: (i)
Portfolio holding information 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, to post
that information and a discussion of the factors that are reasonably
believed to have materially contributed to the premium or discount;
(iv) a table and line graph showing the ETF's premiums and discounts;
and (v) the ETF's median bid-ask spread over the last thirty calendar
days.\720\ The new rule also will 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) Ticker symbol, CUSIP or
other identifier, description of holding, quantity of each holding, and
percentage weight of each holding 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.\721\ Additionally, rule 6c-11 will require 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 basket assets.\722\ ETFs using custom baskets
under the rule must adopt custom basket policies and procedures that
include certain enumerated requirements.\723\
---------------------------------------------------------------------------

\720\ See rule 6c-11(c)(1).
\721\ See rule 6c-11(d).
\722\ Rule 6c-11(c)(3).
\723\ Rule 6c-11(c)(3).
---------------------------------------------------------------------------

We estimate that approximately 9 ETFs are small entities that will
comply with rule 6c-11, and we do not believe that their costs would
differ from other ETFs. As discussed above, we estimate that an ETF
will incur an annual burden of approximately 36.97 hours, at an average
time cost of approximately $11,758.97, and an external cost of
$1,000.00.\724\
---------------------------------------------------------------------------

\724\ See supra Table 13.
---------------------------------------------------------------------------

As we discuss in greater detail in section IV.C.1 above, we expect
rule 6c-11 to have other, generally unquantifiable economic effects.
For example, by eliminating the need for ETFs that can rely on the rule
to seek an exemptive order from the Commission, the rule will also
eliminate certain indirect costs associated with the exemptive
application process.\725\ 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.\726\ We also believe that the rule could increase
competition in the

[[Page 57233]]

ETF market as a whole, which could also lead to lower fees.\727\
---------------------------------------------------------------------------

\725\ See supra section IV.C.1.
\726\ See id.
\727\ See id.
---------------------------------------------------------------------------

2. Other Disclosure and Reporting Requirements
The amendments to Form N-1A and Form N-8B-2 are 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, the
amendments to Form N-1A will: (i) Require new disclosure regarding ETF
trading and associated costs; (ii) require ETFs that are not subject to
rule 6c-11 to disclose median bid-ask spread information on their
websites or in their prospectuses; and (iii) exclude ETFs that provide
premium/discount disclosures in accordance with rule 6c-11 from the
premium and discount disclosure requirements in the form.\728\
Amendments to Form N-8B-2 mirror proposed disclosures for Form N-1A. In
addition, amendments to Form N-CEN will require ETFs to report on Form
N-CEN whether they are relying on rule 6c-11 to assist us with
monitoring reliance on rule 6c-11 as well with our accounting, auditing
and oversight functions, including compliance with the PRA.
---------------------------------------------------------------------------

\728\ See supra section II.H.2.
---------------------------------------------------------------------------

All ETFs (including ETFs that do not rely on rule 6c-11) will be
subject to the amended Form N-1A or Form N-8B-2 (depending on the ETF's
structure as an open-end fund or UIT), and Form N-CEN disclosure and
reporting requirements, including ETFs that are small entities. We
estimate that 9 ETFs are small entities that will be required to comply
with the requirements on Form N-1A and Form N-CEN.\729\ We estimate
that each ETF, including ETFs that are small entities, will incur a
one-time burden of 7 hours, at a time cost of $4,176 to draft and
finalize the required disclosure and amend its registration
statement.\730\ We also estimate that each ETF, including ETFs that are
small entities, will incur an ongoing burden of an additional 3 hours,
at a time cost of an additional $2,088, to comply with the Form N-1A
disclosure requirements.\731\ We do not estimate any change to the
external costs associated with the amendments to Form N-1A.\732\ The
total administrative cost for of the Form N-CEN disclosure requirement
to ETFs is .1 hours.\733\
---------------------------------------------------------------------------

\729\ See supra footnotes 720 and 721. As discussed above, the
amendments to Form N-8B-2 mirror those made to Form N-1A. We
therefore believe that UIT ETFs will incur the same costs as all
ETFs associated with updating their registration statements.
However, none of the UIT ETFs are small entities.
\730\ See supra Table 16.
\731\ See id.
\732\ See id.
\733\ See supra Table 19.
---------------------------------------------------------------------------

As we discuss in greater detail in section IV.C.2 above, we expect
the new disclosure amendments to have other, generally unquantifiable
economic effects. For example, we believe that the new disclosures will
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.\734\ We also believe the
amendment to Form N-CEN will allow the Commission to better monitor
reliance on rule 6c-11 and assist us with our accounting, auditing, and
oversight functions, including compliance with the Paperwork Reduction
Act.\735\
---------------------------------------------------------------------------

\734\ See supra section IV.C.2.
\735\ See id.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

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 adopted
regulations:
Exempting ETFs that are small entities from the
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 rule 6c-11 or the related form amendments will
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 rule without
compromising our objectives. As discussed above, the conditions
necessary to rely on 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 disclosure and reporting requirements or to exempt small ETFs
from the recordkeeping requirements. We believe that all ETF investors,
including investors in small ETFs, will benefit from disclosure and
reporting requirements that permit them to make investment choices that
better match their risk tolerances. Additionally, the current
disclosure requirements for reports on Form N-1A and Form N-8B-2 do not
distinguish between small entities and other funds.\736\
---------------------------------------------------------------------------

\736\ See Reporting Modernization Adopting Release, supra
footnote 263, 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 rule 6c-11 and related disclosure and
reporting requirements appropriately use a combination of performance
and design standards. 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 rule must be specifically designed
to ensure that these investor and market protections are maintained.
However, where we believe that flexibility is beneficial, we adopted
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 needs without
raising investor or market protection concerns.\737\
---------------------------------------------------------------------------

\737\ See e.g., supra section II.C.5. (noting that rule 6c-11
will 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).

---------------------------------------------------------------------------

[[Page 57234]]

VII. Statutory Authority

The Commission is adopting 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
adopting amendments to registration Forms N-1A and N-CSR 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 adopting 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 adopting amendments to Form N-CEN and Form N-
PORT 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)]. The Commission is adopting amendments to Regulation S-X under
the authority set forth in sections 7, 8, 10, and 19 of the Securities
Act [15 U.S.C. 77g, 77h, 77j, 77s], and sections 8(b), 30(a), 31, and
38(a) of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-29(a),
80a-30, and 80a-37(a)]. The Commission is providing relief in Section
II.G, permitting ETFs relying on rule 6c-11 to enter into fund of funds
arrangements, pursuant to the authority set forth in sections 6(c),
12(d)(1)(J) and 17(b).

List of Subjects

17 CFR Part 210

Accounting, Investment companies, Reporting and recordkeeping
requirements, Securities.

17 CFR Part 239

Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

Investment companies, Reporting and recordkeeping requirements,
Securities.

Text of Rules and Form Amendments

Correction

0
In final rule FR Doc. 2016-25349, published in the issue of Friday,
November 18, 2016 (81 FR 81870), make the following correction:
On page 82019, in the second column, remove amendatory instruction
23 for Sec. 232.401, which was to be effective August 1, 2019, but was
delayed until May 1, 2020, in a rule published on December 14, 2017 (82
FR 58731).
For reasons set out in the preamble, title 17, chapter II of the
Code of Federal Regulations is amended as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF
1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF
1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

0
1. The authority citation for part 210 continues to read as follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j-1, 78l, 78m, 78n,
78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30,
80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, and sec. 102(c),
Pub. L. 112-106, 126 Stat. 310 (2012), unless otherwise noted.

Sec. 210.12-14 [Amended]

0
2. Amend Sec. 210.12-14 by removing the phrase in footnote 1 ``(5)
balance at close of period as shown in Column E'' and adding in its
place ``(5) balance at close of period as shown in Column F''.

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
3. 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
4. The authority citation for part 270 is revised by adding a sectional
authority for Sec. 270.6c-11 in numerical order to read in part 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
5. Section 270.6c-11 is added to read as follows:

Sec. 270.6c-11 Exchange-traded funds.

(a) Definitions. (1) 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:
(A) A basket that is composed of a non-representative selection of
the exchange-traded fund's portfolio holdings; or
(B) A representative basket that is different from the initial
basket used in transactions on the same business day.
Exchange-traded fund means a registered open-end management
company:
(A) That issues (and redeems) creation units to (and from)
authorized participants in exchange for a basket and a cash balancing
amount if any; and
(B) 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 that is traded on a trading market outside
of the United States.
Market price means:
(A) The official closing price of an exchange-traded fund share; or
(B) If it more accurately reflects the market value of an exchange-
traded 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

[[Page 57235]]

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.
(2) Notwithstanding the definition of exchange-traded fund in
paragraph (a)(1) 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,
and is not limited to transactions with authorized participants under
these circumstances.
(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. 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) and (ii) 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:
(i) Holding with the power to vote 5% or more of the exchange-
traded fund's shares; or
(ii) 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.
(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, the following information
(as applicable) for each portfolio holding that will form the basis of
the next calculation of current net asset value per share:
(A) Ticker symbol;
(B) CUSIP or other identifier;
(C) Description of holding;
(D) Quantity of each security or other asset held; and
(E) Percentage weight of the holding in the portfolio;
(ii) The exchange-traded fund's current net asset value per share,
market price, and premium or discount, each as of the end 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);
(v) The exchange-traded fund's median bid-ask spread, expressed as
a percentage rounded to the nearest hundredth, computed by:
(A) Identifying the exchange-traded fund's national best bid and
national best offer as of the end of each 10 second interval during
each trading day of the last 30 calendar days;
(B) Dividing the difference between each such bid and offer by the
midpoint of the national best bid and national best offer; and
(C) Identifying the median of those values; and
(vi) If the exchange-traded fund's premium or discount is greater
than 2% for more than seven consecutive trading days, a statement that
the exchange-traded fund's premium or discount, as applicable, was
greater than 2% and 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.
(2) The portfolio holdings that form the basis for the exchange-
traded fund's next calculation of current net asset value per share
must be the ETF's portfolio holdings as of the close of business on the
prior business day.
(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, these
written policies and procedures also must:
(i) 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
(ii) 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 investment returns that correspond to the performance of a
market index by a specified multiple, or to provide investment returns
that have an inverse relationship to the performance of a market index,
over a predetermined period of time.
(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 ticker symbol, CUSIP or other identifier, description of
holding, quantity of each holding, and percentage weight of each
holding 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 exchange-traded fund adopted pursuant to paragraph
(c)(3) of this section;

[[Page 57236]]

(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
6. The general authority citation for part 274 continues to read 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
7. Form N-1A (referenced in Sec. Sec. 239.15A and 274.11A) is amended
as follows:
0
a. In General Instruction A, revising the definition of ``Exchange-
Traded Fund.''
0
b. In General Instruction A, revising the definition of ``Market
Price.''
0
c. In General Instruction B.4.(a), removing the phrases ``[17 CFR
230.400-230.497]'' and ``rules 480-485 and 495-497 of Regulation C''
and adding in their place ``[17 CFR 230.400-230.498]'' and ``rules 480-
485 and 495-498 of Regulation C.''
0
d. In General Instruction B.4.(d), removing the phrase ``Regulation S-T
[17 CFR 232.10-232.903]'' and adding in its place ``Regulation S-T [17
CFR 232.10-232.501].''
0
e. In Item 3, revising the first paragraph under the heading ``Fees and
Expenses of the Fund''.
0
f. Revising Instruction 1(e) of Item 3, Item 6(c), and Items 11(a)(1)
and 11(g).
0
g. In instruction 4(b) to Item 13, removing the sentence ``If a change
in the methodology for determining the ratio of expenses to average net
assets results from applying paragraph 2(g) of rule 6-07, explain in a
note that the ratio reflects fees paid with brokerage commissions and
fees reduced in connection with specific agreements only for periods
ending after September 1, 1995.''
0
h. Revising Item 27(b)(7)(iv), Instruction 1(e)(ii) of Item 27(d)(1),
and Item 27(d)(3).
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.
* * * * *
``Market Price'' has the same meaning as in rule 6c-11 [17 CFR
270.6c-11] under the Investment Company Act.
* * * * *

Item 3. Risk/Return Summary: Fee Table

* * * * *

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,
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.
* * * * *

Instructions

* * * * *
1. General
* * * * *
(e) If the Fund is an Exchange-Traded Fund, exclude any fees
charged for the purchase and redemption of the Fund's creation
units.
* * * * *

Item 6. Purchase and Sale of Fund Shares

* * * * *
(c) Exchange-Traded Funds. If the Fund is an Exchange-Traded
Fund, the Fund may omit the information required by paragraphs (a)
and (b) of this Item and must disclose:
(1) That Individual Fund shares may only be bought and sold in
the secondary market through a broker or dealer at a market price;
(2) That 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);
(3) That an investor may incur costs attributable to 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) when buying or
selling shares in the secondary market (the ``bid-ask spread'');
(4) If applicable, how to access recent information, including
information on the Fund's net asset value, Market Price, premiums
and discounts, and bid-ask spreads, on the Exchange-Traded Fund's
website; and
(5) The median bid-ask spread for the Fund's most recent fiscal
year.

Instructions

1. A Fund may omit the information required by paragraph (c)(5)
of this Item if it satisfies the requirements of paragraph (c)(1)(v)
of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(v)] under the Investment
Company Act.
2. An Exchange-Traded Fund that had its initial listing on a
national securities exchange at or before the beginning of the most
recently completed fiscal year must include the median bid-ask
spread for the Fund's most recent 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.
3. Bid-Ask Spread (Median). Calculate the median bid-ask spread
by dividing the difference between the national best bid and
national best offer by the mid-point of the national best bid and
national best offer as of the end of 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.
4. A Fund may combine the information required by Item 6(c)(4)
into the information required by Item 1(b)(1) and Rule 498(b)(1)(v)
[17 CFR 230.498(b)(1)(v)] under the Securities Act.
* * * * *
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:
(1) The Fund may omit from the prospectus the information
required by Items 11(a)(2), (b), and (c).
(2) Provide a table showing the number of days the Market Price
of the Fund shares was greater than the Fund's net asset value and
the number of days it was less than the Fund's net asset value
(i.e., premium or discount) for the most recently completed calendar
year, and the most recently completed calendar quarters since that
year (or the life of the Fund, if shorter). The Fund may omit the
information required by this paragraph if it satisfies the
requirements of paragraphs (c)(1)(ii)-(iv) and (c)(1)(vi) of Rule
6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and

[[Page 57237]]

(c)(1)(vi)] under the Investment Company Act.
* * * * *
Item 27. Financial Statements
* * * * *
(b) * * *
(7) * * *
* * * * *
(iv) Provide a table showing the number of days the Market Price
of the Fund shares was greater than the Fund's net asset value and
the number of days it was less than the Fund's net asset value
(i.e., premium or discount) for the most recently completed calendar
year, and the most recently completed calendar quarters since that
year (or the life of the Fund, if shorter). The Fund may omit the
information required by this paragraph if it satisfies the
requirements of paragraphs (c)(1)(ii)-(iv) and (c)(1)(vi) of Rule
6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and (c)(1)(vi)] under the
Investment Company Act.
* * * * *
(d) * * *
(1) * * *

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.
* * * * *
(3) * * *

Instruction

A Money Market Fund will omit the statement required by Item
27(d)(3) and instead provide a statement that (i) the Money Market
Fund files its complete schedule of portfolio holdings with the
Commission each month on Form N-MFP; (ii) the Money Market Fund's
reports on Form N-MFP are available on the Commission's website at
https://www.sec.gov; and (iii) the Money Market Fund makes portfolio
holdings information available to shareholders on its website.
* * * * *

0
8. Form N-8B-2 (referenced in Sec. Sec. 239.16 and 274.12) is amended
as follows:
0
a. In the General Instructions, revising the definitions of ``Exchange-
Traded Fund'' and ``Market Price''.
0
b. In Item 13, adding paragraphs (h), (i), and (j).
0
c. In Item IX, adding an undesignated paragraph following the heading.
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'' 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.
* * * * *
Market Price. The term ``Market Price'' has the same meaning as in
rule 6c-11 [17 CFR 270.6c-11] under the Investment Company Act.
* * * * *

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 6(c) of Form N-1A
[referenced in 17 CFR 274.11A]. Provide information specific to the
trust as necessary, utilizing the ETF-specific methodology set forth in
the Instructions to Form N-1A Item 6(c). The Fund may omit the
information required by Item 6(c)(5) of Form N-1A if it satisfies the
requirements of paragraph (c)(1)(v) of Rule 6c-11 [17 CFR 270.6c-
11(c)(1)(v)] under the Investment Company Act.
(j) If the trust is an Exchange-Traded Fund, provide a table
showing the number of days the Market Price of the Fund shares was
greater than the Fund's net asset value and the number of days it was
less than the Fund's net asset value (i.e., premium or discount) for
the most recently completed calendar year, and the most recently
completed calendar quarters since that year (or the life of the Fund,
if shorter). The Fund may omit the information required by this
paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)-
(iv) and (c)(1)(vi) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and
(c)(1)(vi)] under the Investment Company Act.
* * * * *
IX
EXHIBITS
Subject to General Instruction 2(d) regarding incorporation by
reference and rule 483 under the Securities Act, file the exhibits
listed below as part of the registration statement. Letter or number
the exhibits in the sequence indicated, unless otherwise required by
rule 483. Reflect any exhibit incorporated by reference in the list
below and identify the previously filed document containing the
incorporated material.
* * * * *

0
9. Amend Form N-CEN (referenced in Sec. 274.101) as follows:
0
a. Adding Item C.7.k.
0
b. Revising the Instruction to Item E.2.
The addition and revision 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.
* * *

0
10. Amend Form N-CSR (referenced in Sec. 274.128) as follows:
0
a. In General Instruction D, remove the phrase ``Item 12(a)(1)'' and
add in its place ``Item 13(a)(1)''.
0
b. In the instruction to Item 13, remove the phrase ``Instruction to
Item 11'' and add in its place ``Instruction to Item 13''.

0
11. Amend Form N-PORT (referenced in Sec. 274.150) by revising the
first paragraph of General Instruction F to read as follows:

[[Page 57238]]

Note: The text of Form N-PORT does not, and this amendment will
not, appear in the Code of Federal Regulations.

FORM N-PORT
MONTHLY PORTFOLIO INVESTMENTS REPORT
* * *
GENERAL INSTRUCTIONS
* * *
F. Public Availability
With the exception of the non-public information discussed below,
the information reported on Form N-PORT for the third month of each
Fund's fiscal quarter will be made publicly available upon filing.
* * * * *

By the Commission.

Dated: September 25, 2019.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2019-21250 Filed 10-23-19; 8:45 am]
BILLING CODE 8011-01-P

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