The Securities and Exchange Commission on Thursday said it would adopt a new rule to modernize how exchange-traded funds (ETFs) are brought to the market and their regulation.
The long-awaited Rule 6c-11 - or the ETF rule as it is more commonly called - is aimed at simplifying rules governing ETFs and seeks to speed up the process of launching new ETFs while reducing associated costs.
Notably, the new rule does away with the exemptive-relief requirement in which would-be ETF issuers had to file with the regulator to get special permission to go around rules outlined in the Investment Company Act of 1940, which did not allow for ETFs.
“As the ETF industry continues to grow in size and importance, particularly to Main Street investors, it is important to have a consistent, transparent and efficient regulatory framework that eliminates regulatory hurdles while maintaining appropriate investor protections,” SEC Chairman Jay Clayton said in a statement.
Since 1992, the SEC has issued over 300 exemptive orders that allowed more than 2,000 ETFs to exist with more than $3.3 trillion in total net assets, according to data from the commission.
The new ETF rule will replace hundreds of those individual exemptive orders with a single rule.
“The ETF rule will level the playing field for ETF providers, allowing new participants to enter via a streamlined process,” said Elisabeth Kashner, FactSet’s director of ETF research.
BlackRock Inc, Vanguard, and State Street Corp currently dominate the ETF space.
“BlackRock has long supported ETF regulation that enhances transparency, market quality and choice for investors,” BlackRock Inc, the world’s largest issuer of ETFs, said in a statement.
“We look forward to reviewing the final rule in detail and sharing our thoughts in due course,” BlackRock said.
The new rule will allow all ETFs to use custom baskets, containing securities that do not match their ETF’s index, in the creation and redemption process instead of a basket that exactly replicates the index or cash in lieu of certain basket of securities.
The use of custom baskets, commonly allowed in the early days of ETFs, but not in recent years, has allowed older ETF firms like BlackRock and State Street to adjust their portfolio’s holdings efficiently and minimize capital gains from higher-turnover, active strategies.
“The custom basket provision, now extended to virtually all players, will increase access to the “heartbeat” trade, allowing newer entrants to re-balance portfolios without passing along capital gains,” said Kashner.
“Heartbeat trades” refer to transactions in which an investor puts money into an ETF only to make a quick withdrawal that is paid out in shares of the stocks held by the ETF, thereby avoiding significant capital gains for the fund.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.