Securities Regulation Daily SEC would provide exemption for ETFs not subject to daily portfolio transparency condition
Monday, April 8, 2019

SEC would provide exemption for ETFs not subject to daily portfolio transparency condition

By Amy Leisinger, J.D.

The Commission concluded that a "verified intraday indicative value" reflecting the ETFs’ portfolio holdings calculated per second during the trading day would effectively facilitate arbitrage.

Unless a hearing is ordered, the SEC intends to grant exemptive relief to actively managed exchange-traded funds without requiring them to conform to the daily portfolio transparency requirement currently applicable to other actively managed ETFs under their respective exemptive orders. According to the Commission, the ETFs’ proposed "verified intraday indicative value" (VIIV) calculated on a second-by-second basis (rather than every 15 seconds like existing ETFs) would adequately reflect the value of their portfolio holdings. Market participants would be able to identify potential arbitrage opportunities when the VIIV and secondary market price diverge (Precidian ETFs Trust, et al.; Notice of ApplicationRelease No. IC-33440, April 8, 2019).

ETF features and terms. In past ETF exemptive relief, the SEC has required a mechanism to keep the market price of an ETF share from diverging from the net asset value (NAV) per share, which has typically been dependent on the existence of daily portfolio transparency to enable market participants to effectively assess whether an arbitrage opportunity exists. Arbitrage opportunities play a substantial role in keeping market price in line with NAV, and this close tie is the main reason why the price at which retail investors buy and sell ETF shares is similar to that paid and recouped by authorized participants interacting directly with an ETF.

Previous application. The applicants sought to develop a novel type of actively managed ETF that would not be required to disclose its portfolio holdings on a daily basis (ActiveShares ETFs), but in 2014, the SEC took the position that the proposed structure would not provide an adequate substitute for full portfolio transparency. The Commission stated that an ETF’s typical intraday indicative value, calculated every 15 seconds, is not reliable as the "primary pricing signal" for an ETF because it provides stale data and is not subject to uniform methodologies. The applicants thereafter withdrew the application.

Updated ETF terms. In their updated application, the applicants maintain that operating fully transparent actively managed ETFs would make the proposed ETFs susceptible to "front running" and "free riding," disadvantaging the ActiveShares ETFs and their shareholders. To protect the identity and weightings of their portfolio holdings, the applicants explained that the ActiveShares ETFs would sell and redeem their shares to authorized participants through unaffiliated broker-dealers and would disclose to authorized participants or their representatives the basket of securities that the relevant ActiveShares ETF would exchange for its shares; the authorized participant or representative would keep the identity and weightings of the basket securities confidential.

To facilitate arbitrage, each ActiveShares ETF would disseminate a VIIV reflecting the value of its portfolio holdings, calculated each second during the trading day, using uniform parameters for calculation across all ActiveShares ETFs, according to the applicants, and the secondary market for ActiveShares ETF shares would provide reliable input for the VIIV calculation. An accurate VIIV on a second-by-second basis and the ability to create and redeem ETF shares in exchange for a basket is sufficient to facilitate effective arbitrage, the applicants stated. As arbitrage transactions are executed, the ETF shares will trade at a market price at or near NAV.

The applicants pledged that ActiveShares ETFs will provide disclosures to explain to investors how the ActiveShares ETFs differ from traditional, fully transparent ETFs and how their bid-ask spreads and premiums and discounts may be larger than those for traditional ETFs as a result of the change in transparency. The applicants also agreed to comply with the provisions of Regulation Fair Disclosure, which would prohibit the ActiveShares ETFs from making selective disclosure of any material nonpublic information. The applicants also stressed that the ActiveShares ETFs will take remedial actions as necessary if problems arise and report to the Commission as requested.

The SEC stated its belief that the proposed alternative arbitrage mechanism could efficiently maintain ActiveShares ETFs’ secondary market prices close to NAV and noted that investors would benefit from the opportunity to invest in active strategies.

Interested persons may request a hearing on the application before May 3, 2019.

The release is No. IC-33440.

Companies: Precidian Funds LLC

MainStory: TopStory InvestmentCompanies

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