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Banking

SEC Questions Illiquidity Risk In Niche ETFS

The Securities and Exchange Commission in its proposed codification of exemptive relief for exchange-traded funds has raised questions about the liquidity of ETFs that focus on narrow sectors

The agency invited public comment on whether illiquidity would be problem in the case of such ETFs. Open-end funds cannot hold more than 15% of their portfolio in illiquid securities. The SEC raised the issue for public discussion, asking whether in the case of certain ETFs the percentage should be less.

In seeking comments, the proposal asks what liquidity requirements might be needed and why. “Should the chance (or likelihood) that substantial discounts or premiums may occur if an ETF portfolio contains less liquid securities or assets be a regulatory concern for the Commission, or should it be treated as a material risk?” it asks. “Would liquidity requirements preclude the development of specialty ETFs that serve narrow investment purposes but which may satisfy particular investment needs of certain investors?”

John McGuire, partner at Morgan Lewis & Bockius who works with ETF firms, said he did not think that the SEC was concerned about liquidity issues but was simply asking if anyone in the industry had such concerns. He said he was confident that market makers would ensure that no ETFs suffered liquidity issues. 

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