I recently received an email from our legal department letting me know that the long-awaited ETF Rule was posted to the Federal Register—the official journal of the US Federal Government. While I’m not in the habit of regularly perusing the Federal Register, I certainly had to check out the posting of Rule 6c-11. The new rule is a real coming-of-age moment for the ETF market, and, in my eyes, very good news for the ever-expanding body of investors who make use of this flexible investment access tool.
Establishing a more appropriate framework for regulating ETFs
The majority of ETFs available in the US are registered under the Investment Company Act of 1940. Naturally, the ’40 Act, as it is affectionately called, was created to regulate the product structures available at the time. Although it has proven resilient, it hasn’t been a perfect fit for ETFs—a product introduced to the US in the early 1990s.
Because of the mismatch between the operations of an ETF versus the parameters established for fund operations in the ’40 Act, ETF sponsors have historically needed to apply for “exemptive relief” with the SEC in order to issue an ETF. Essentially, sponsors receive permission from the SEC for each new type of ETF that comes to market. This process has created a lot of work for sponsors and the SEC, and it has ultimately created an uneven playing field over the years as different sponsors have received different permissions from the SEC regarding how funds can be managed.
In June 2018, the SEC proposed a rule that would create a common set of requirements for the majority of ETFs, replacing hundreds of previously granted individual exemptive orders. The rule would lower the barrier to entry for new firms, allow certain straightforward ETFs to come to market more quickly and reduce the amount of time the SEC spends reviewing applications for these ETFs.
The SEC offered up its proposed rule for comment last year, then reviewed all the various comments made on the proposal. The final rule establishes a consistent regulatory framework built around how the vast majority of ETFs operate today. As a result, many new ETFs will now be able to come to market more quickly, without the time or expense of applying for individual exemptive relief.
A positive outcome for investors
While the ETF Rule’s standardized framework sounds good for sponsors and the SEC—and perhaps sounds bad for the law firms that manage all the paperwork (but I’m sure we’ll create some new business for them yet)—I believe it’s an even better outcome for investors. Because the exemptive relief process has been in place for more than 25 years, different sponsors have varying levels of permissions around how they manage their ETFs. These differences create various outcomes in client experience and can even dissuade competition in some areas. Consider, for example, index funds and their ability to track a benchmark. When we rebalance a fund to match changes to the benchmark, we look to minimize frictional costs to that rebalance in order to achieve tighter tracking. One tool we have to rebalance is to customize baskets around the creation and redemption process at the time of the change. Some ETF sponsors have had permission to use custom baskets when rebalancing, while others have not. Under the new rule, all sponsors can use the custom basket technique, giving everyone the same capability to improve performance relative to a benchmark—certainly a good outcome for investors.
As the longest-running provider of ETFs in the US, we have been fortunate to have a wide set of exemptive relief permissions at our disposal; however, we have been highly supportive of the ETF Rule. An equal playing field for all competitors and more options for clients ultimately means a better experience for investors. Given the efficiencies and cost savings that ETFs offer—along with the many unexpected ways we see our clients using ETFs—the ETF Rule can only be a good thing for investors.
The ETF Rule will be effective 60 days after publication in the Federal Register, but there will be a one-year transition period for compliance with certain amendments. Follow SPDR® Blog for more updates on the topic.