Exchange traded funds: Regulations eased in the US
The usually laborious task of bringing a new exchange traded fund product to market in the US looks set to become a thing of the past once new SEC rules come into play.
"This will certainly make it easier to launch a product. The legal hurdle has been removed, but some of the business hurdles will still be there"
In March, the SEC agreed to introduce new rulings that would permit ETFs to operate without the need to obtain individual exemptive orders from the regulator, making it much easier to list a new product. Even though the US has the world’s largest ETF market, existing SEC rules require that any new ETF gain exemption from certain securities laws before it can be made available to the public. This makes the listing of new products, especially those that provide leveraged exposures, a slow and cumbersome process, much to the annoyance of product providers.
"In the past, whenever you wanted to do something that was new you had to go and get exemptive relief from the SEC, which is a process that can take anywhere between one and six years," says Bruce Lavine, chief operating officer at WisdomTree, a New York-based ETF provider.
"The regulatory process heretofore was very much a barrier to entry," adds Joe Keenan, New York-based managing director at BNY Mellon Asset Servicing. "Whether you were a large global asset manager or a small entrepreneurial firm, you would have to have at least $1 million to spend with attorneys." This is not helped by the fact that only a few law firms have the expertise to put together an application for exemptions, while a typical application to the SEC would run to between 400 and 500 pages, adds Keenan. "The SEC would check every word and every comma in these 500-page documents," he says.
In effect, the proposed rule changes will codify the regulatory process, so that new products that are similar to an ETF that has previously been approved will automatically be passed. The SEC has not stated when it intends to implement the rules but ETF providers expect the new system to be in place by the end of this year. "Once this is published it will be possible for a leveraged ETF provider to come in and, simply by signing a registration statement, gain approval in a 60- to 90-day process," says Lavine.
The regulatory easing comes at the same time as the first managed ETF products hit the market. The SEC says "fully transparent" actively managed ETFs can also be automatically approved. Rather than track an index benchmark, as most ETFs do, an actively managed ETF seeks to outperform a benchmark and generate alpha – returns that cannot be attributed to normal market returns. Bear Stearns launched the first actively managed ETF in March. The Bear Stearns Current Yield Fund is now trading on the American Stock Exchange and is made up of a portfolio of short-term fixed-income securities, including US government bonds, municipal debt and asset-backed securities. A portfolio manager has discretion to choose securities for the fund, with the fund’s holdings disclosed daily. The ETF is expected to be rebranded following JPMorgan’s acquisition of Bear Stearns.
PowerShares, another big ETF provider, launched its own version of an actively managed fixed-income ETF in April – the PowerShares Active Low Duration Fund. At the same time, it launched the first actively managed equity ETF in the form of the PowerShare’s Active Mega Cap Fund, the Active AlphaQ Fund and the Active Alpha Multi-Cap Fund. All trade on the New York Stock Exchange. Other providers are also expected to enter the market, with WisdomTree planning to launch five foreign-currency-based money market ETFs on the NYSE in May. Barclays Global Investors and State Street are also planning to launch actively managed ETFs.
Many potential ETF sellers are said to be waiting on the sidelines for the new SEC regime to kick in before launching their own products. But Noel Archard, head of iShares and iPath (Barclays ETF and exchange traded notes products, respectively) product development at Barclays Global Investors in San Francisco, warns new entrants that it would be a mistake to think that running an ETF will now be easy. "This will certainly make it easier to launch a product, but it won’t make it easier to give it the proper amount of support that you need to from a back-office perspective," he says. "The legal hurdle has been removed, but some of the business hurdles will still be there."