Navigating the New ETF Rule
The introduction of the exchange-traded fund (ETF) brought a wealth of opportunities for investors looking to pool funds into diverse investment wrappers. But lagging behind the product’s strong growth trajectory has long been a patchwork of required approvals and regulations for bringing funds to market.
Since 1992, the US Securities and Exchange Commission (SEC) has issued more than 300 exemptive orders allowing ETFs to operate under the Investment Company Act of 1940.
As ETF assets grow in size and product innovation proliferates, the SEC sought to provide a ‘clear and consistent’ framework for the majority of ETFs in operation. With unanimous agreement, the SEC approved the adoption of Rule 6c-11 or the ‘ETF Rule’ on September 26, 2019.
In what’s being called a ‘win’ for investors, here’s what you need to know about the new rule and how State Street can help.
What this means for you
The SEC is modernizing the ETF regulatory framework by allowing investment managers to launch ETFs structured as standalone open-end investment companies without having to obtain an order from its Division of Investment Management. For investment managers, this means faster time to market, as they will no longer need to spend time or money applying for individual exemptive relief.
The goal of the new rule is to create greater competition and innovation across the market, and ultimately more choice for investors. Aimed at enhancing transparency, ETF providers will be required to post daily disclosure of portfolio holdings before the opening of regular trading on their firms’ website. Portfolio holdings must be disclosed publicly and free of charge without restrictive terms. ETF providers will also be responsible for expanded website reporting to give investors greater clarity on the total costs associated with trading and holding ETFs, as well as additional recordkeeping obligations. As ETF providers work through the new mandates, they will need to consider if they will manage the SEC’s added requirements through in-house resources or by working with a trusted partner.
Another important change from the SEC is around custom baskets. The use of custom baskets as part of the creation and redemption process will give managers more flexibility in managing their portfolios. While this is likely to open up more opportunities and additional access to liquidity, it may also add to portfolio and workflow complexity.
It’s important to note that complex ETF products such as leveraged funds, unit investment trusts and non-transparent ETFs will still require individual approval.
The updated go-to-market process will take effect 60 days after publication in the Federal Register. For ETFs previously exempt from the approval process, the SEC has issued a one-year transition period before products must begin to adhere to the new rule.
How State Street can help
What’s exciting about this rule is that it’s leveling the playing field by helping new participants enter the market through a more streamlined regulatory process. Still, ETFs are intricate structures that are very different from mutual funds. As part of their unique servicing requirements, ETF trading baskets are created and settled in the primary market, while orders are taken by market makers and routed to the exchange in the secondary market.
For those just entering the ETF market, we provide pre- and post-launch support at each step of the ETF life cycle. Our dedicated ETF specialist team works closely with clients to incorporate best practices into their processes, and help them stay educated as product innovation and regulatory mandates evolve. Through our consultative approach, clients receive a tailored servicing model that delivers standardized outputs and integrated data. Clients also have the benefit of customizing workflows and avoiding incremental technology spend. And with access to our web-based trading portal, clients can manage the creation and redemption process through a single point of access.
For clients already in the market, the rule will help ETF providers focus more sharply on product development and execution. That said, there will be some adjustments clients will need to make. We are working to create standards to help clients submit trade-date holding and disclosure requirements, and we already support a number of the data elements now required with the ETF Rule. When it comes to custom baskets, we have existing processes and expertise in supporting clients in the creation and redemption process. Our direct connectivity with Bloomberg’s BSKT service allows for the negotiation of baskets on a deal-by-deal basis with authorized participants. After a deal is approved by the ETF manager, our settlement system receives a record of the negotiated deal and our electronic order-taking platform, Fund Connect®, is able to cue up the trade for the authorized participant to submit. Our flexible systems can also help clients who want to use their own in-house capabilities to create custom baskets.
Through our commitment to innovation and our multi-year product enhancement roadmap, we provide clients with the agility to address market changes — both regulatory and technology — and adapt at speed to change. Our global operating model offers a common experience and consistency across basket services, order-taking, custody, accounting and fund administration. By working with State Street, clients have seamless access to our liquidity solutions across trading and securities lending to help enhance the value of their portfolio. Our operating model also gives clients the opportunity to automate workflows and boost operational performance.
To help clients stay connected with the ETF industry’s thinking and intentions, we maintain relationships with policy-makers, depositories, regulators and industry advisory committees. And our dedicated regulatory oversight team is focused on providing expert insight into the changing regulatory environment so that we are prepared to support our clients as new regulations — such as the ETF Rule — come into play.
 SEC Proposes New Approval Process for Certain Exchange-Traded Funds, June 28, 2018
 SEC Adopts New Rule to Modernize Regulation of Exchange-Traded Funds, September 26, 2019