Exchange-Traded Funds

Federal RegisterOct 24, 2019

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 232, 239, 270, and 274

[Release Nos. 33-10695; IC-33646; File No. S7-15-18]

RIN 3235-AJ60

Exchange-Traded Funds

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission”) is adopting a new rule under the Investment Company Act of 1940 (the “Investment Company Act” or the “Act”) that will permit exchange-traded funds (“ETFs”) that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order. In connection with the final rule, the Commission will rescind certain exemptive relief that has been granted to ETFs and their sponsors. The Commission also is adopting certain disclosure amendments to Form N-1A and Form N-8B-2 to provide investors who purchase and sell ETF shares on the secondary market with additional information regarding ETF trading and associated costs, regardless of whether such ETFs are structured as registered open-end management investment companies (“open-end funds”) or unit investment trusts (“UITs”). Finally, the Commission is adopting related amendments to Form N-CEN. The final rule and form amendments are designed to create a consistent, transparent, and efficient regulatory framework for ETFs that are organized as open-end funds and to facilitate greater competition and innovation among ETFs. The Commission also is adopting technical amendments to Form N-CSR, Form N-1A, Form N-8B-2, Form N-PORT, and Regulation S-X.

DATES:

Effective Date:

This rule is effective December 23, 2019.

Compliance Dates:

The applicable compliance dates are discussed in section II.L. of this final rule.

FOR FURTHER INFORMATION CONTACT:

Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), J. Matthew DeLesDernier (Senior Counsel), Jacob D. Krawitz (Branch Chief), Melissa S. Gainor (Assistant Director), and Brian McLaughlin Johnson (Assistant Director), Investment Company Regulation Office, at (202) 551-6792, Kay-Mario Vobis (Senior Counsel), Daniele Marchesani (Assistant Chief Counsel), Chief Counsel's Office, at (202) 551-6825, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is adopting 17 CFR 270.6c-11 (new rule 6c-11) under the Investment Company Act [15 U.S.C. 80a-1

et seq.

]; amendments to Form N-1A [referenced in 17 CFR 274.11A] under the Investment Company Act and the Securities Act of 1933 [15 U.S.C. 77a

et seq.

] (“Securities Act”); and amendments to Forms N-8B-2 [referenced in 17 CFR 274.12] and N-CEN [referenced in 17 CFR 274.101] under the Investment Company Act.

The Commission also is adopting technical amendments to Form N-CSR [referenced in § 274.128], Form N-1A, Form N-8B-2, and Form N-PORT [referenced in § 274.150] under the Investment Company Act, and 17 CFR 210.12-01 through 210.12-29 (Article 12 of Regulation S-X).

Unless otherwise noted, all references to statutory sections are to the Investment Company Act, and all references to rules under the Investment Company Act are to title 17, part 270 of the Code of Federal Regulations [17 CFR part 270].

Table of Contents

I. Introduction

A. Overview of Exchange-Traded Funds

B. Operation of Exchange-Traded Funds

II. Discussion

A. Scope of Rule 6c-11

1. Organization as Open-End Funds

2. Index-Based ETFs and Actively Managed ETFs

3. Leveraged/Inverse ETFs

B. Exemptive Relief Under Rule 6c-11

1. Treatment of ETF Shares as “Redeemable Securities”

2. Trading of ETF Shares at Market-Determined Prices

3. Affiliated Transactions

4. Additional Time for Delivering Redemption Proceeds

C. Conditions for Reliance on Rule 6c-11

1. Issuance and Redemption of Shares

2. Listing on a National Securities Exchange

3. Intraday Indicative Value (“IIV”)

4. Portfolio Holdings Disclosure

5. Baskets

6. Website Disclosure

7. Marketing

8. ETF and ETP Nomenclature

D. Recordkeeping

E. Share Class ETFs

F. Master-Feeder ETFs

G. Effect of Rule 6c-11 on Prior Orders

H. Amendments to Form N-1A

1. Fee Disclosures for Mutual Funds and ETFs (Item 3)

2. Disclosures Regarding ETF Trading and Associated Costs (Item 6)

3. Eliminated Disclosures

I. Amendments to Form N-8B-2

J. Amendments to Form N-CEN

K. Technical and Conforming Amendments to Form N-1A, Form N-8B-2, Form N-CSR, Form N-PORT, and Regulation S-X

L. Compliance Dates

III. Other Matters

IV. Economic Analysis

A. Introduction

B. Economic Baseline

1. ETF Industry Growth and Trends

2. Exemptive Order Process and Certain Conditions Under Existing Orders

3. Market Participants

4. Secondary Market Trading, Arbitrage, and ETF Liquidity

C. Benefits and Costs of Rule 6c-11 and Form Amendments

1. Rule 6c-11

2. Amendments to Forms N-1A, N-8B-2, and N-CEN

D. Effects on Efficiency, Competition, and Capital Formation

1. Efficiency

2. Competition

3. Capital Formation

E. Reasonable Alternatives

1. Website Disclosure of Basket Information

2. Disclosure of ETF Premiums or Discounts Greater than 2%

3. Website and Prospectus Disclosure of the Median Bid-Ask Spread Calculated Over the Most Recent 1-Year Period

4. Additional Disclosures Showing the Impact of Bid-Ask Spreads

5. Website Disclosure of a Modified IIV

6. The Use of a Structured Format for Additional Website Disclosures and the Filing of Additional Website Disclosures in a Structured Format on EDGAR

7. Pro Rata Baskets

8. Treatment of Existing Exemptive Relief

9. ETFs Organized as UITs

10. Treatment of Leveraged/Inverse ETFs

V. Paperwork Reduction Act

A. Introduction

B. Rule 6c-11

1. Website Disclosures

2. Recordkeeping

3. Policies and Procedures

4. Estimated Total Burden

C. Rule 0-2

D. Form N-1A

E. Forms N-8B-2 and S-6

F. Form N-CEN

VI. Final Regulatory Flexibility Analysis

A. Need for and Objectives of the Rule and Form Amendments

B. Significant Issues Raised by Public Comments

C. Small Entities Subject to the Rule

D. Projected Reporting, Recordkeeping, and Other Compliance Requirements

1. Rule 6c-11

2. Other Disclosure and Reporting Requirements

E. Agency Action To Minimize Effect on Small Entities

VII. Statutory Authority

I. Introduction

The Commission is adopting rule 6c-11 under the Investment Company Act to permit ETFs that satisfy certain conditions to operate without the

expense and delay of obtaining an exemptive order from the Commission under the Act. This rule will modernize the regulatory framework for ETFs to reflect our more than two decades of experience with these investment products. The rule is designed to further important Commission objectives, including establishing a consistent, transparent, and efficient regulatory framework for ETFs and facilitating greater competition and innovation among ETFs.

The Commission approved the first ETF in 1992. Since then, ETFs registered with the Commission have grown to $3.32 trillion in total net assets.

They now account for approximately 16% of total net assets managed by investment companies,

and are projected to continue to grow.

ETFs currently rely on exemptive orders, which permit them to operate as investment companies under the Act, subject to representations and conditions that have evolved over time.

We have granted over 300 of these orders over the last quarter century, resulting in differences in representations and conditions that have led to some variations in the regulatory structure for existing ETFs.

This figure is based on data obtained from Bloomberg. As of December 2018, there were approximately 2,000 ETFs registered with the Commission.

ICI, 2019 Investment Company Fact Book (59th ed., 2019) (“2019 ICI Fact Book”),

available at https://www.ici.org/pdf/2019_factbook.pdf,

at 93. When the Commission first proposed a rule for ETFs in 2008, aggregate ETF assets were less than 7% of total net assets held by mutual funds.

See

Exchange-Traded Funds, Investment Company Act Release No. 28193 (Mar. 11, 2008) [73 FR 14618 (Mar. 18, 2008)] (“2008 ETF Proposing Release”).

See

Greg Tusar,

The evolution of the ETF industry,

Pension & Investments (Jan. 31, 2017),

available at http://www.pionline.com/article/20170131/ONLINE/170139973/the-evolution-of-the-etf-industry

(describing projections that ETF assets could reach $6 trillion by 2020).

As the orders are subject to the terms and conditions set forth in the applications requesting exemptive relief, references in this release to “exemptive relief” or “exemptive orders” include the terms and conditions described in the related application.

See, e.g.,

Barclays Global Fund Advisors, Investment Company Act Release Nos. 24394 (Apr. 17, 2000) [65 FR 21215 (Apr. 20, 2000)] (notice) and 24451 (May 12, 2000) (order) and related application.

In addition, since 2000, our ETF exemptive orders have provided relief for future ETFs.

See id.

This relief has allowed ETF sponsors to form ETFs without filing new applications to the extent that the new ETFs meet the terms and conditions set forth in the exemptive order. Applications granted before 2000, unless subsequently amended, did not include this relief.

On June 28, 2018, we proposed new rule 6c-11 under the Investment Company Act, which would simplify this regulatory framework by eliminating conditions included within our exemptive orders that we no longer believe are necessary for our exemptive relief and removing historical distinctions between actively managed and index-based ETFs.

We also proposed to rescind certain exemptive orders that have been granted to ETFs and their sponsors in order to level the playing field for ETFs that are organized as open-end funds and pursue the same or similar investment strategies.

In addition, the Commission proposed certain disclosure amendments to Form N-1A and Form N-8B-2 to provide investors additional information regarding ETF trading and associated costs, regardless of whether ETFs are organized as open-end funds or UITs. Finally, the Commission proposed related amendments to Form N-CEN.

See

Exchange-Traded Funds, Investment Company Act Release No. 33140 (June 28, 2018) [83 FR 37332 (July 31, 2018)] (“2018 ETF Proposing Release”).

Proposed rule 6c-11 did not include ETFs that: (i) Are organized as UITs; (ii) seek to exceed the performance of a market index by a specified multiple or to provide returns that have an inverse relationship to the performance of a market index, over a fixed period of time; or (iii) are structured as a share class of a fund that issues multiple classes of shares representing interests in the same portfolio (“share class ETFs”). Under the proposal, these ETFs would continue to operate pursuant to the terms of their exemptive orders. Since that time, we have granted an exemptive order permitting certain ETFs that are actively managed to operate without being subject to the daily portfolio transparency condition included in other actively managed ETF orders (“non-transparent ETFs”).

See

Precidian ETFs Trust,

et al.,

Investment Company Act Release Nos. 33440 (Apr. 8, 2019) [84 FR 14690 (Apr. 11, 2019)] (notice) and 33477 (May 20, 2019) (order) and related application (“2019 Precidian”). Because these non-transparent ETFs do not provide daily portfolio transparency, they would not meet the conditions of rule 6c-11. We use the term “actively managed ETFs” in this release to refer to actively managed ETFs that provide daily portfolio transparency and “non-transparent ETFs” to refer to actively managed ETFs that do not.

We received more than 85 comment letters on the proposal.

As discussed in greater detail below, commenters were supportive of the adoption of an ETF rule and generally supported rule 6c-11 as proposed. Commenters did, however, recommend modifications or clarifications to certain aspects of the rule. For example, several commenters suggested expanding the scope of ETFs covered by the rule or the scope of certain exemptions.

Many commenters recommended modifications to the proposed rule's conditions, particularly relating to the timing and presentation of portfolio holdings information, the requirements related to custom baskets, the publication of basket information, and the availability of an intraday indicative value.

In addition, although commenters were largely supportive of our efforts to improve the information that ETFs disclose to investors about the trading costs of investing in ETFs, several commenters objected to the bid-ask spread disclosure requirements and the related interactive calculator.

Others recommended alternatives to the proposed format and placement of the trading cost disclosures.

Finally, commenters were largely supportive of our proposal to rescind certain exemptive orders that have been granted to ETFs and their sponsors and to replace such relief with rule 6c-11.

The comment letters on the 2018 ETF Proposing Release (File No. S7-15-18) are available at https://www.sec.gov/comments/s7-15-18/s71518.htm.

See, e.g.,

Comment Letter of BNY Mellon (Sept. 27, 2018) (“BNY Mellon Comment Letter”) (suggesting the rule should cover all ETFs registered under the Investment Company Act); Comment Letter of Dechert LLP (Sept. 28, 2018) (“Dechert Comment Letter”) (suggesting that the Commission should provide ETFs with uniform exemptive relief from certain provisions of the Securities Exchange Act of 1934 (the “Exchange Act”)).

See, e.g.,

Comment Letter of the Asset Management Group of the Securities Industry and Financial Markets Association (Sept. 28, 2018) (“SIFMA AMG Comment Letter I”) (relating to the timing and presentation of portfolio holdings and basket information); Comment Letter of the Investment Company Institute (Sept. 21, 2018) (“ICI Comment Letter”) (relating to custom baskets); Comment Letter of Professor James G. Angel, Georgetown University (Oct. 1, 2018) (“Angel Comment Letter”) (relating to intraday indicative values).

See, e.g.,

Comment Letter of Independent Directors Council (Sept. 27, 2018) (“IDC Comment Letter”); Comment Letter of State Street Global Advisors (Oct. 1, 2018) (“SSGA Comment Letter I”).

See e.g.,

Comment Letter of The Vanguard Group, Inc. (Sept. 28, 2018) (“Vanguard Comment Letter”); Comment Letter of BlackRock, Inc. (Sept. 26, 2018) (“BlackRock Comment Letter”); IDC Comment Letter; Comment Letter of Fidelity Investments (Sept. 28, 2018) (“Fidelity Comment Letter”).

See, e.g.,

Comment Letter of Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Oct. 11, 2018) (“ABA Comment Letter”); ICI Comment Letter; Comment Letter of Invesco Ltd. (Sept. 26, 2018) (“Invesco Comment Letter”). Exemptive orders granted to ETFs and their sponsors often include relief allowing funds to invest in other funds in excess of statutory limits. We did not propose to rescind that relief.

See infra

section II.G.

After consideration of the comments we received, we are adopting rule 6c-11 and the proposed form amendments with several modifications that are designed to reduce the operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful information regarding ETFs. As proposed, we also are rescinding the exemptive relief that we have issued to ETFs that fall within the scope of rule 6c-11, while retaining the exemptive relief granted to ETFs outside the scope of the rule. In addition, we are retaining the exemptive relief allowing ETFs to enter into fund of funds arrangements. We believe that the resulting regulatory framework will level the playing field

for ETFs that are organized as open-end funds and pursue the same or similar investment strategies.

The rule also will assist the Commission with regulating ETFs, as funds covered by the rule will no longer be subject to the varying provisions of exemptive orders granted over time. Furthermore, rule 6c-11 will allow Commission staff, as well as funds and advisers seeking exemptions, to focus exemptive relief on products that do not fall within the rule's scope.

Additionally, as discussed below in section II.B, the Commission is issuing an order granting an exemption from certain provisions of the Exchange Act and the rules thereunder for certain transactions in securities of ETFs that can rely on rule 6c-11.

See

Order Granting a Conditional Exemption from Exchange Act Section 11(d)(1) and Exchange Act Rules 10b-10; 15c1-5; 15c1-6; and 14e-5 for Certain Exchange Traded Funds, Release No. 34-87110 (September 25, 2019) (“ETF Exchange Act Order”).

The Commission will continue to monitor this large, diverse and important market. We welcome continued engagement with ETF sponsors, investors and other market participants on matters related to the ETF market, including with regard to ETFs that do not fall within the scope of rule 6c-11 and ETFs that may not function in a manner consistent with the expectations embodied in our regulatory framework.

A. Overview of Exchange-Traded Funds

ETFs are a type of exchange-traded product (“ETP”).

ETFs possess characteristics of both mutual funds, which issue redeemable securities, and closed-end funds, which generally issue shares that trade at market-determined prices on a national securities exchange and are not redeemable.

Because ETFs have characteristics that distinguish them from the types of investment companies contemplated by the Act, they require exemptions from certain provisions of the Investment Company Act in order to operate. The Commission routinely grants exemptive orders permitting ETFs to operate as investment companies under the Investment Company Act, generally subject to the provisions of the Act applicable to open-end funds (or UITs).

The Commission also has approved the listing standards of national securities exchanges under which ETF shares are listed and traded.

ETFs are investment companies registered under the Investment Company Act.

See

15 U.S.C. 80a-3(a)(1). Other types of ETPs are pooled investment vehicles with shares that trade on a securities exchange, but they are not “investment companies” under the Act because they do not invest primarily in securities. Such ETPs may invest primarily in assets other than securities, such as futures, currencies, or physical commodities (

e.g.,

precious metals). Still other ETPs are not pooled investment vehicles. For example, exchange-traded notes are senior, unsecured, unsubordinated debt securities that are linked to the performance of a market index and trade on securities exchanges.

The Act defines “redeemable security” as any security that allows the holder to receive his or her proportionate share of the issuer's current net assets upon presentation to the issuer. 15 U.S.C. 80a-2(a)(32). While closed-end fund shares are not redeemable, certain closed-end funds may elect to repurchase their shares at periodic intervals pursuant to rule 23c-3 under the Act. Other closed-end funds may repurchase their shares in tender offers pursuant to rule 13e-4 under the Exchange Act.

Historically, ETFs have been organized as open-end funds or UITs.

See

15 U.S.C. 80a-5(a)(1) (defining the term “open-end company”) and 15 U.S.C. 80a-4(2) (defining the term “unit investment trust”).

Additionally, ETFs regularly request relief from 17 CFR 242.101 and 242.102 (rules 101 and 102 of Regulation M); section 11(d)(1) of the Exchange Act and 17 CFR 240.11d1-2 (rule 11d1-2 under the Exchange Act); and certain other rules under the Exchange Act (

i.e.,

17 CFR 240.10b-10, 240.10b-17, 240.14e-5, 240.15c1-5, and 240.15c1-6 (rules 10b-10, 10b-17, 14e-5, 15c1-5, and 15c1-6)).

See

Request for Comment on Exchange-Traded Products, Exchange Act Release No. 75165 (June 12, 2015) [80 FR 34729 (June 17, 2015)] (“2015 ETP Request for Comment”), at section I.D.2 (discussing the exemptive and no-action relief granted to ETPs under the Exchange Act and the listing process for ETP securities for trading on a national securities exchange).

As discussed above, ETFs have become an increasingly popular investment vehicle over the last 27 years, providing investors with a diverse set of investment options.

They also have become a popular trading tool, making up a significant portion of secondary market equities trading. During the first quarter of 2019, for example, trading in U.S.-listed ETFs made up approximately 18.3% of U.S. equity trading by share volume and 27.2% of U.S. equity trading by dollar volume.

While the first ETFs held portfolios of securities that replicated the component securities of broad-based domestic stock market indexes, some ETFs now track more specialized indexes, including international equity indexes, fixed-income indexes, or indexes focused on particular industry sectors. Some ETFs seek to track highly customized or bespoke indexes, while others seek to provide a level of leveraged or inverse exposure to an index over a predetermined period of time. The Commission historically has referred to ETFs that have stated investment objectives of maintaining returns that correspond to the returns of a securities index as “index-based” ETFs. Investors also have the ability to invest in ETFs that do not track a particular index and are actively managed.

See

2018 ETF Proposing Release,

supra

footnote 7, at nn.18-20.

These estimates are based on trade and quote data from the New York Stock Exchange and Trade Reporting Facility data from FINRA.

Investors can buy and hold shares of ETFs (sometimes as a core component of a portfolio) or trade them frequently as part of an active trading or hedging strategy.

Because certain costs are either absent in the ETF structure or are otherwise partially externalized, many ETFs have lower operating expenses than mutual funds.

ETFs also may offer certain tax efficiencies compared to other pooled investment vehicles because redemptions from ETFs are often made in kind (that is, by delivering certain assets from the ETF's portfolio, rather than in cash), thereby avoiding the need for the ETF to sell assets and potentially realize capital gains that are distributed to its shareholders.

See, e.g.,

Chris Dieterich,

Are You An ETF `Trader' Or An ETF `Investor'?,

Barrons (Aug. 8, 2017),

available at https://www.barrons.com/articles/are-you-an-etf-trader-or-an-etf-investor1470673638;

Greenwich Associates,

Institutions Find New, Increasingly Strategic Uses for ETFs

(May 2012). ETF investors also can sell ETF shares short, write options on them, and set market, limit, and stop-loss orders on them.

For instance, ETFs typically do not bear distribution or shareholder servicing fees. In addition, ETFs that transact on an in-kind basis can execute changes in the ETF's portfolio without incurring brokerage costs, leading to transaction cost savings.

B. Operation of Exchange-Traded Funds

An ETF issues shares that can be bought or sold throughout the day in the secondary market at a market-determined price. Like other investment companies, an ETF pools the assets of multiple investors and invests those assets according to its investment objective and principal investment strategies. Each share of an ETF represents an undivided interest in the underlying assets of the ETF. Similar to mutual funds, ETFs continuously offer their shares for sale.

Unlike mutual funds, however, ETFs do not sell or redeem individual shares. Instead, “authorized participants” that have contractual arrangements with the ETF (or its distributor) purchase and redeem ETF shares directly from the ETF in blocks called “creation units.”

An authorized participant may act as a principal for its own account when purchasing or redeeming creation units from the ETF. Authorized participants also may act as agent for others, such as market makers, proprietary trading firms, hedge funds or other institutional investors, and receive fees for processing creation units on their behalf.

Market makers, proprietary

trading firms, and hedge funds provide additional liquidity to the ETF market through their trading activity. Institutional investors may engage in primary market transactions with an ETF through an authorized participant as a way to efficiently hedge a portion of their portfolio or balance sheet or to gain exposure to a strategy or asset class.

As discussed below, rule 6c-11(a)(1) defines “authorized participant” as a member or participant of a clearing agency registered with the Commission, which has a written agreement with the ETF or one of its service providers that allows the authorized participant to place orders for the purchase and redemption of creation units.

See

David J. Abner, The ETF Handbook: How to Value and Trade Exchange Traded Funds, 2nd ed. (2016) (“ETF Handbook”).

Id.

An authorized participant that purchases a creation unit of ETF shares directly from the ETF deposits with the ETF a “basket” of securities and other assets identified by the ETF that day, and then receives the creation unit of ETF shares in return for those assets.

The basket is generally representative of the ETF's portfolio,

and together with a cash balancing amount, it is equal in value to the aggregate net asset value (“NAV”) of the ETF shares in the creation unit.

After purchasing a creation unit, the authorized participant may hold the individual ETF shares, or sell some or all of them in secondary market transactions.

Investors then purchase individual ETF shares in the secondary market. The redemption process is the reverse of the purchase process: The authorized participant redeems a creation unit of ETF shares for a basket of securities and other assets.

An ETF may impose fees in connection with the purchase or redemption of creation units that are intended to defray operational processing and brokerage costs to prevent possible shareholder dilution (“transaction fees”).

The basket might not reflect a

pro rata

slice of an ETF's portfolio holdings. Subject to the terms of the applicable exemptive relief, an ETF may substitute other securities or cash in the basket for some (or all) of the ETF's portfolio holdings. Restrictions related to flexibility in baskets have varied over time.

See infra

section II.C.4.c.

An open-end fund is required by law to redeem its securities on demand from shareholders at a price approximating their proportionate share of the fund's NAV at the time of redemption.

See

15 U.S.C. 80a-22(d). 17 CFR 270.22c-1 (“rule 22c-1”) generally requires that funds calculate their NAV per share at least once daily Monday through Friday.

See

rule 22c-1(b)(1). Today, most funds calculate NAV per share as of the time the major U.S. stock exchanges close (typically at 4:00 p.m. Eastern Time). Under rule 22c-1, an investor who submits an order before the 4:00 p.m. pricing time receives that day's price, and an investor who submits an order after the pricing time receives the next day's price.

See also

17 CFR 270.2a-4 (“rule 2a-4”) (defining “current net asset value”).

ETFs register offerings of shares under the Securities Act, and list their shares for trading under the Exchange Act. Depending on the facts and circumstances, authorized participants that purchase a creation unit and sell the shares may be deemed to be participants in a distribution, which could render them statutory underwriters and subject them to the prospectus delivery and liability provisions of the Securities Act.

See

15 U.S.C. 77b(a)(11) (defining the term “underwriter”).

The combination of the creation and redemption process with secondary market trading in ETF shares and underlying securities provides arbitrage opportunities that are designed to help keep the market price of ETF shares at or close to the NAV per share of the ETF.

For example, if ETF shares are trading on national securities exchanges at a “discount” (a price below the NAV per share of the ETF), an authorized participant can purchase ETF shares in secondary market transactions and, after accumulating enough shares to compose a creation unit, redeem them from the ETF in exchange for the more valuable redemption basket. The authorized participant's purchase of an ETF's shares on the secondary market, combined with the sale of the ETF's basket assets, may create upward pressure on the price of the ETF shares, downward pressure on the price of the basket assets, or both, bringing the market price of ETF shares and the value of the ETF's portfolio holdings closer together.

Alternatively, if ETF shares are trading at a “premium” (a price above the NAV per share of the ETF), the transactions in the arbitrage process are reversed and, when arbitrage is working effectively, keep the market price of the ETF's shares close to its NAV.

The arbitrage mechanism for ETFs that would be subject to rule 6c-11 has been dependent on daily portfolio transparency.

As part of this arbitrage process, authorized participants are likely to hedge their intraday risk. For example, when ETF shares are trading at a discount to an estimated intraday NAV per share of the ETF, an authorized participant may short the securities composing the ETF's redemption basket. After the authorized participant returns a creation unit of ETF shares to the ETF in exchange for the ETF's basket assets, the authorized participant can then use the basket assets to cover its short positions.

Market participants also can engage in arbitrage activity without using the creation or redemption processes. For example, if a market participant believes that an ETF is overvalued relative to its underlying or reference assets (

i.e.,

trading at a premium), the market participant may sell ETF shares short and buy the underlying or reference assets, wait for the trading prices to move toward parity, and then close out the positions in both the ETF shares and the underlying or reference assets to realize a profit from the relative movement of their trading prices. Similarly, a market participant could buy ETF shares and sell the underlying or reference assets short in an attempt to profit when an ETF's shares are trading at a discount to the ETF's underlying or reference assets. As with the creation and redemption process, the trading of an ETF's shares and the ETF's underlying or reference assets may bring the prices of the ETF's shares and its portfolio assets closer together through market pressure.

Some studies have found the majority of all ETF-related trading activity takes place on the secondary market.

See, e.g.,

Rochelle Antoniewicz & Jane Heinrichs,

Understanding Exchange-Traded Funds: How ETFs Work,

ICI Research Perspective 20, No. 5 (Sept. 2014) (“Antoniewicz I”),

available at https://www.ici.org/pdf/per20-05.pdf,

at 2 (“On most trading days, the vast majority of ETFs do not have any primary market activity—that is, they do not create or redeem shares.”); 2019 ICI Factbook,

supra

footnote 3 (“On average, 90 percent of the total daily activity in ETFs occurs on the secondary market.”).

The arbitrage mechanism is important because it provides a means to maintain a close tie between market price and NAV per share of the ETF, thereby helping to ensure ETF investors are treated equitably when buying and selling fund shares. In granting relief under section 6(c) of the Act for ETFs to operate, the Commission has relied on this close tie between what retail investors pay (or receive) in the secondary market and the ETF's approximate NAV to find that the required exemptions are necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.

Investors also have come to expect that an ETF's market price will maintain a close tie to the ETF's NAV per share, which may lead some investors to view ETFs or some types of ETFs more favorably than similar closed-end funds.

On the other hand, if the expectation of a close tie to NAV per share is not met, investors may sell or refrain from purchasing ETF shares.

See

15 U.S.C. 80a-6(c).

Scott W. Barnhart & Stuart Rosenstein,

Exchange-Traded Fund Introductions and Closed-End Fund Discounts and Volume,

45 The Financial Review 4 (Nov. 2010) (within a year of the introduction of a similar ETF, the average discount widens significantly and volume falls significantly in U.S. domestic equity, international equity, and U.S. bond closed-end funds, which may indicate that closed-end funds lose some desirability when a substitute ETF becomes available). As of December 31, 2018, total net assets of ETFs were $3.4 trillion compared to $250 billion for closed-end funds.

See

2019 ICI Fact Book,

supra

footnote 3.

See

Staff of the Office of Analytics and Research, Division of Trading and Markets,

Research Note: Equity Market Volatility on August 24, 2015

(Dec. 2015) (“August 24 Staff Report”),

available at https://www.sec.gov/marketstructure/research/equity_market_volatility.pdf.

II. Discussion

Given the growth in the ETF market, ETFs' popularity among retail and institutional investors, and our long experience regulating this investment vehicle, we believe that it is appropriate to adopt a rule that will allow most ETFs to operate without first obtaining

an exemptive order from the Commission under the Act. We believe, and commenters on proposed rule 6c-11 generally agreed, that such a rule will help create a consistent, transparent, and efficient regulatory framework for the regulation of most ETFs and help level the playing field for these market participants.

See, e.g.,

BlackRock Comment Letter; IDC Comment Letter; Fidelity Comment Letter; Angel Comment Letter; Comment Letter of Nasdaq, Inc. (Sept. 28, 2018) (“Nasdaq Comment Letter”).

As adopted, rule 6c-11 will exempt ETFs organized as open-end funds from certain provisions of the Act and our rules. The exemptions will permit an ETF to: (i) Redeem shares only in creation unit aggregations; (ii) permit ETF shares to be purchased and sold at market prices, rather than NAV; (iii) engage in in-kind transactions with certain affiliates; and (iv) in certain limited circumstances, pay authorized participants the proceeds from the redemption of shares in more than seven days.

These exemptions are subject to several conditions designed to address the concerns underlying the relevant statutory provisions and to support a Commission finding that the exemptions necessary to allow ETFs to operate are in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. The conditions are based upon existing exemptive relief for ETFs, which we believe has served to support an efficient arbitrage mechanism, but reflect several modifications based on our experience regulating this product and commenters' input on the proposed rule.

• First, rule 6c-11 will require an ETF to disclose portfolio holdings each business day on its website before the opening of trading on the ETF's primary listing exchange in a standardized manner. The rule also will require daily website disclosure of the ETF's NAV, market price, premium or discount, and the extent and frequency of an ETF's premiums and discounts. These disclosures are designed to promote an effective arbitrage mechanism and inform investors about the risks of deviation between market price and NAV when deciding whether to invest in ETFs generally or in a particular ETF.

• In addition, the rule will require daily website disclosure of the ETF's median bid-ask spread over the last thirty calendar days. This requirement is designed to provide investors with additional information regarding potential costs associated with buying and selling ETF shares.

• With respect to baskets, the rule will require an ETF to adopt and implement written policies and procedures that govern the construction of baskets and the process that will be used for the acceptance of baskets. The rule will allow ETFs to use “custom baskets” if their basket policies and procedures: (i) Set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interest of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (ii) specify the titles or roles of the employees of the ETF's investment adviser who are required to review each custom basket for compliance with those parameters. As discussed below, these conditions will provide ETFs with additional basket flexibility, which we believe could benefit investors through more efficient arbitrage and narrower bid-ask spreads, subject to protections designed to address the risks that such flexibility may present.

• Rule 6c-11 also will include a condition that excludes an ETF that seeks, directly or indirectly, to provide investment returns over a predetermined period of time that: (i) Correspond to the performance of a market index by a specified multiple; or (ii) have an inverse relationship to the performance of a market index (including by an inverse multiple) (“leveraged/inverse ETFs”).

See infra

section II.A.3.

• An ETF also must retain certain records under rule 6c-11, including information regarding each basket exchanged with an authorized participant.

In order to harmonize the regulation of most ETFs, we are rescinding, one year after the effective date of rule 6c-11, those portions of our prior ETF exemptive orders that grant relief related to the formation and operation of an ETF, including certain master-feeder relief.

We are not rescinding the exemptive relief of UIT ETFs, leveraged/inverse ETFs, share class ETFs, and non-transparent ETFs, however, which are outside the scope of rule 6c-11. In addition, we are not rescinding the portions of our prior ETF exemptive orders allowing funds to invest in ETFs in excess of statutory limits in connection with this rulemaking and we are providing relief to allow newly formed ETFs to enter into certain fund of funds arrangements.

See infra

sections II.F. and II.G. We are also amending approximately 200 ETF exemptive orders that automatically expire on the effective date of a rule permitting the operation of ETFs to give them time to make any adjustments necessary to rely on rule 6c-11.

See infra

section II.G. In December 2018, we proposed new 17 CFR 270.12d1-4 (rule 12d1-4 under the Act) to streamline and enhance the regulatory framework applicable to fund of funds arrangements.

See

Fund of Funds Arrangements, Investment Company Act Release No. 33329 (Dec. 19, 2018) [84 FR 1286 (Feb. 1, 2019)] (proposing release) (“FOF Proposing Release”). In connection with proposed rule 12d1-4, we also proposed to rescind the exemptive orders granting relief for certain fund of funds arrangements, including the relief from sections 12(d)(1)(A) and (B) that has been included in our ETF exemptive orders.

See id.

at nn.236-237 and accompanying text.

Finally, we are adopting amendments to Forms N-1A and N-8B-2 to eliminate certain disclosures that we believe are no longer necessary and to require ETFs that do not rely on rule 6c-11 to provide secondary market investors with disclosures regarding certain ETF trading and associated costs. For example, the form amendments will require such an ETF to provide median bid-ask spread information either on its website or in its prospectus. We believe these amendments will provide investors who purchase ETF shares in secondary market transactions with information to better understand the total costs of investing in an ETF.

A. Scope of Rule 6c-11

1. Organization as Open-End Funds

As proposed, rule 6c-11 will define an ETF as a registered open-end management investment company that: (i) Issues (and redeems) creation units to (and from) authorized participants in exchange for a basket and a cash balancing amount (if any); and (ii) issues shares that are listed on a national securities exchange and traded at market-determined prices.

ETFs organized as UITs (“UIT ETFs”) will continue operating pursuant to their exemptive orders, which include terms and conditions more appropriately tailored to address the unique features of a UIT.

Additionally, as proposed,

our form amendments will require UIT ETFs to provide disclosures similar to those provided by other ETFs that are subject to the Investment Company Act.

See

rule 6c-11(a)(1). Under the rule, the term “basket” will be defined to mean the securities, assets, or other positions in exchange for which an ETF issues (or in return for which it redeems) creation units. The term “exchange-traded fund” thus will include ETFs that transact on an in-kind basis, on a cash basis, or both.

A UIT is an investment company organized under a trust indenture or similar instrument that issues redeemable securities, each of which represents an undivided interest in a unit of specified securities.

See

section 4(2) of the Act [15 U.S.C. 80a-4]. By statute, a UIT is unmanaged and its portfolio is fixed. Substitution of securities may take place only under certain pre-defined circumstances. A UIT does not have a board of directors, corporate officers, or an investment adviser to render advice during the life of the trust.

See

2018 ETF Proposing Release,

supra

footnote 7, at section II.A.1.

Unlike the exemptive relief we have granted to certain ETFs organized as open-end funds (

see supra

footnote 6), the relief we have granted to ETFs organized as UITs does not provide relief for future ETFs formed pursuant to the same order.

We understand that most ETF sponsors prefer the open-end fund structure over the UIT structure given the increased investment flexibility the open-end structure affords.

For example, ETFs organized as open-end funds can be actively managed or use a “sampling” strategy to track an index.

An open-end ETF also may participate in securities lending programs, has greater flexibility to reinvest dividends, and may invest in derivatives, which typically require a degree of management that is not provided for in the UIT structure.

We have received very few exemptive applications for new UIT ETFs since 2002, and no new UIT ETFs have come to market in that time.

See

2018 ETF Proposing Release,

supra

footnote 7, at section II.A.1.

UIT ETFs seek to track the performance of an index by investing in the component securities of an index in the same approximate proportions as in the index (

i.e.,

“replicating” the index) rather than acquiring a subset of the underlying index's component securities or other financial instruments that the ETF's adviser believes will help the ETF track the underlying index (

i.e.,

“sampling” the index). In addition, because the exemptive relief granted to UIT ETFs does not provide relief from the portion of section 4(2) that requires UIT securities to represent an undivided interest in a unit of “specified securities,” the investment strategies that a UIT ETF can pursue are limited.

See id.

at n.37.

See

Use of Derivatives by Registered Investment Companies and Business Development Companies, Investment Company Act Release No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)] (“Derivatives Proposing Release”), at n.139.

Commenters addressing this aspect of the proposal generally supported excluding UIT ETFs from the scope of rule 6c-11. These commenters stated that the structural and operational nuances associated with UIT ETFs would make their inclusion in rule 6c-11 impractical.

These commenters also generally agreed that existing UIT ETFs should continue to rely on their individual exemptive orders, and that the Commission should review new UIT ETFs as part of the exemptive order process. One commenter suggested, however, that the Commission consider potential updates to UIT ETFs' exemptive orders to account for certain sponsor services that were not contemplated at the time the orders were granted.

See, e.g.,

Invesco Comment Letter; SSGA Comment Letter I; Comment Letter of CFA Institute (Nov. 15, 2018) (“CFA Institute Comment Letter”); Comment Letter of Cboe Global Markets, Inc. (Oct. 1, 2018) (“Cboe Comment Letter”) (stating that the “unique issue set applicable to UITs as compared to non-UIT ETFs warrant the disparate treatment between UITs and other ETFs.”).

Invesco Comment Letter (stating that these services include chief compliance officer services and ongoing trading services). UIT ETFs have obtained exemptive relief from section 26(a)(2)(C) of the Act to allow the ETF to pay certain enumerated expenses.

See

2018 ETF Proposing Release,

supra

footnote 7, at n.52 and accompanying text.

After considering comments, we continue to believe that rule 6c-11 should apply only to ETFs organized as open-end funds, while UIT ETFs should continue to rely on their existing exemptive orders.

We acknowledge that excluding UIT ETFs will result in a segment of ETF assets outside the regulatory framework of rule 6c-11. However, we do not believe there is a need to include UIT ETFs within the scope of the rule given the limited sponsor interest in developing ETFs organized as UITs.

The vast majority of ETFs currently in operation are organized as open-end funds, though the earliest ETFs were organized as UIT ETFs, and these early UIT ETFs represent a significant portion of the assets within the ETF industry. As of Dec. 31, 2018, the eight existing UIT ETFs had total assets of approximately $379 billion, representing approximately 11.3% of total assets invested in ETFs (based on data obtained from MIDAS, Bloomberg, and Morningstar Direct).

In addition, even if we were to include UIT ETFs within the scope of the rule, the unique structural and operational aspects of UIT ETFs noted by commenters would necessitate a regulatory framework that differs from the structure we are adopting for open-end ETFs. We believe that the unmanaged nature of the UIT structure, in particular, would require conditions that differ from the conditions applicable to open-end ETFs. For example, rule 6c-11 will allow ETFs the flexibility to use baskets that differ from a

pro rata

representation of the ETF's portfolio if certain conditions are met.

Because such conditions require ongoing management and board oversight, we do not believe that extending such basket flexibility to UIT ETFs would be appropriate.

The relief granted to UIT ETFs also includes relief from sections of the Act that govern key aspects of a UIT's operations, which differ from the relief we are providing under rule 6c-11.

In short, we believe including UIT ETFs within the scope of rule 6c-11 would complicate the rule significantly and would continue to result in a regulatory framework where the relief and conditions applicable to UIT ETFs and open-end ETFs differ.

See infra

section II.C.4.c.

See

2018 ETF Proposing Release,

supra

footnote 7, at nn.46-48 and accompanying text.

See, e.g.,

SPDR Trust, Series 1, Investment Company Act Release Nos. 18959 (Sept. 17, 1992) [57 FR 43996 (Sept. 23, 1992)] (notice) and 19055 (Oct. 26, 1992) (order) and related application (“SPDR”).

To the extent that ETF sponsors develop novel UIT ETFs, we believe that the Commission should review such products as part of its exemptive process to determine whether the relief is necessary or appropriate in the public interest and consistent with the protection of investors. We also believe that the Commission's exemptive process is well-suited to handle requests to modify existing UIT ETF exemptive relief.

Consistent with the proposal, we are not rescinding existing exemptive orders that allow UIT ETFs to operate. Two commenters addressing the exclusion of UIT ETFs from the rule urged the Commission to clarify that UIT ETFs operating pursuant to their exemptive orders can nevertheless continue marketing themselves as “ETFs.”

As discussed below, the Commission is not limiting use of the term “ETF” or “exchange-traded fund” to funds relying on rule 6c-11. UIT ETFs therefore may continue to use these terms in their marketing materials and otherwise hold themselves out as “ETFs.” Further, while UIT ETFs are excluded from the scope of rule 6c-11, we are adopting amendments to Form N-8B-2 that will require them to provide certain additional disclosures regarding ETF trading costs.

See

SSGA Comment Letter I; SIFMA AMG Comment Letter I.

See

Form N-8B-2 disclosure requirements

infra

section II.I.

2. Index-Based ETFs and Actively Managed ETFs

Consistent with the proposal, rule 6c-11 will provide exemptions for both index-based ETFs and actively managed ETFs, but will not by its terms establish different requirements based on whether an ETF's investment objective is to seek returns that correspond to the returns of an index. Index-based and actively managed ETFs that comply with the rule's conditions function similarly with respect to operational matters, despite different investment objectives or strategies. For example, both index-based and actively managed ETFs register under the Act, issue and redeem shares in creation unit sizes in exchange for baskets of assets, list on national securities exchanges, and allow investors to trade ETF shares throughout the day at market-determined prices in the secondary market.

The distinction between index-based ETFs and actively managed ETFs in our current exemptive orders is largely a product of ETFs' historical evolution.

The Commission did not approve the first actively managed ETF until nearly 15 years after index-based ETFs were introduced.

Since 2008, however, the actively managed ETF market has grown considerably.

The Commission has observed how actively managed ETFs operate during this time, and has not identified any operational issues that suggest additional conditions for actively managed ETFs are warranted.

See

2018 ETF Proposing Release,

supra

footnote 7, at n.58. Approximately 100 exemptive orders have been issued since 2008 for actively managed, transparent ETFs.

Based on data obtained from MIDAS, Bloomberg and Morningstar Direct as of December 31, 2018, we estimate that there are now over 270 actively managed ETFs with approximately $72 billion in assets.

Commenters that addressed this aspect of the proposal supported the rule's elimination of the historical distinction between index-based and actively managed ETFs.

Specifically, commenters agreed that ETFs operate similarly irrespective of whether they are index-based or actively managed, and stated that there are no operational issues that warrant additional conditions for actively managed ETFs.

In addition, one commenter stated that, in its experience, deviations between market price and NAV per share are more variable across asset classes underlying ETFs than between index-based and actively managed ETFs investing in the same asset class.

See, e.g.,

ICI Comment Letter; Invesco Comment Letter; Comment Letter of the Index Industry Association (Sept. 30, 2018); Comment Letter of the Fixed Income Market Structure Advisory Committee (Oct. 29, 2018) (“FIMSAC Comment Letter”); Comment Letter of NYSE Arca, Inc. (Oct. 10, 2018) (“NYSE Arca Comment Letter”); CFA Institute Comment Letter; Comment Letter of J.P. Morgan Asset Management (Oct. 1, 2018) (“JPMAM Comment Letter”).

See, e.g.,

NYSE Arca Comment Letter; Comment Letter of WisdomTree Asset Management, Inc. (Oct. 1, 2018) (“WisdomTree Comment Letter”). As discussed in section II.C.4.

infra,

however, some commenters opposed, or suggested alternatives to, full portfolio transparency for actively managed ETFs.

We also received 43 comment letters requesting that the Commission approve an ETP with an investment objective that seeks results that correspond to the performance of bitcoins or other digital assets.

See, e.g.,

Comment Letter of Charles Brown (July 12, 2018); Comment Letter of Lars Hoffman (July 14, 2018). Rule 6c-11, however, is based on existing relief for ETFs relating to the formation and operation of ETFs under the Investment Company Act and does not relate to specific strategies.

See

Letter from Dalia Blass, Director of Investment Management, to Paul Schott Stevens, President and CEO, Investment Company Institute and Timothy W. Cameron, Asset Management Group—Head, Securities Industry and Financial Markets Association (Jan. 18, 2018),

available at

http://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm

(noting that in the staff's view ETFs and other funds that hold substantial amounts of cryptocurrencies and related products raise significant questions regarding how they would satisfy certain other requirements of the Investment Company Act and its rules). The Commission continues to welcome engagement with the public on issues related to cryptocurrency ETPs.

See

JPMAM Comment Letter (“[O]ur active ETFs trade with similar, and at times lower, deviations than our index ETFs; all of them typically trade within 50 basis points of their NAVs.”).

We continue to believe that index-based and actively managed ETFs do not present significantly different concerns under the provisions of the Act from which the rule grants relief because they function similarly with respect to operational matters. As noted below, the arbitrage mechanism for existing actively managed ETFs has worked effectively with small deviations between market price and NAV per share.

Permitting index-based and actively managed open-end ETFs to operate under the rule subject to the same conditions also will provide a level playing field among those market participants.

See supra

section II.B.2.

Furthermore, we believe that it would be unreasonable to create a meaningful distinction within the rule between index-based and actively managed ETFs given the proliferation of highly customized, often methodologically complicated indexes. Commenters agreed that the proliferation of these indexes has blurred the distinction between index-based and actively managed ETFs, while ETF industry practices in areas such as portfolio transparency generally do not vary between these types of funds.

We therefore believe that eliminating the regulatory distinction between index-based ETFs and actively managed ETFs for purposes of exemptive relief under the Act will help to provide a more consistent and transparent regulatory framework for ETFs organized as open-end funds. This approach is consistent with our regulation of other types of open-end funds, which does not distinguish between actively managed and index-based strategies.

See

FIMSAC Comment Letter (“[I]ndustry participants note that distinctions between active and passive products . . . are increasingly blurred with the advent of `smart beta' or factor products, or of index products with active elements . . . .); JPMAM Comment Letter (“[A]s the proposal notes, practices around portfolio transparency have converged across index-based and actively managed ETFs.”).

In addition, consistent with our proposal, rule 6c-11 does not include additional conditions relating to index-based ETFs with affiliated index providers (“self-indexed ETFs”). Commenters generally agreed with the proposal's approach to self-indexed ETFs, indicating that existing securities laws adequately address any special concerns presented by these ETFs.

One commenter, however, noted that the concerns that were expressed by the Commission when it granted individualized exemptive relief for self-indexed ETFs remain important.

This commenter stated that the Commission should permit self-indexed ETFs only “on the condition that [an information] firewall between the index provider and the asset manager exists.”

See

Invesco Comment Letter; BlackRock Comment Letter; IIA Comment Letter; JPMAM Comment Letter; SSGA Comment Letter (“[C]urrent regulatory requirements . . . effectively require a heightened set of requirements associated with affiliated index providers . . .”); WisdomTree Comment Letter (“Advisers are already required to adopt policies designed to prevent portfolio information from being misappropriated.”).

See

Morningstar Comment Letter.

See also

Guggenheim Funds Investment Advisors, LLC, et al., Investment Company Act Release Nos. 30560 (June 14, 2013) [78 FR 37614 (June 21, 2013)] (notice) and 30598 (July 10, 2013) (order) and related application (“Guggenheim Funds”) (discussing concerns regarding the ability of an affiliated index provider to manipulate an underlying index to the benefit or detriment of a self-indexed ETF and the potential for conflicts that may arise with respect to the personal trading activity of an affiliated index provider's personnel). Guggenheim Funds permitted a self-indexed ETF to address these concerns through full portfolio transparency, instead of certain policies and procedures that had been required in earlier exemptive orders for self-indexed ETFs.

But see, e.g.,

HealthShares Inc.,

et al.,

Investment Company Act Release Nos. 27916 (July 27, 2007) [72 FR 42447 (Aug. 2, 2007)] (notice) and 27930 (Aug. 20, 2007) (order) and related application.

See

Morningstar Comment Letter.

We agree with the commenters who stated that the existing federal securities laws adequately address any special concerns that self-indexed ETFs present, including the potential ability of an affiliated index provider to manipulate an underlying index to the benefit or detriment of a self-indexed ETF.

For

example, ETF sponsors are likely to be in a position to understand the potential circumstances and relationships that could give rise to the misuse of non-public information, and can develop appropriate measures to address them. Therefore, we continue to believe that portfolio transparency combined with existing requirements should be sufficient to protect against the abuses addressed in exemptive applications of ETF sponsors that either use affiliated index providers or create their own indexes.

See

17 CFR 270.38a-1 (rule 38a-1 under the Act) (requiring funds to adopt policies and procedures reasonably designed to prevent violation of federal securities laws); 17 CFR 270.17j-1(c)(1) (rule 17j-1(c)(1) under the Investment Company Act) (requiring funds to adopt a code of ethics containing provisions designed to prevent certain fund personnel (“access persons”) from misusing information regarding fund transactions); section 204A of the Investment Advisers Act of 1940 (“Advisers Act”) (15 U.S.C. 80b-204A) (requiring an adviser to adopt policies and procedures that are reasonably designed, taking into account the nature of its business, to prevent the misuse of material, non-public information by the adviser or any associated person, in violation of the Advisers Act or the Exchange Act, or the rules or regulations thereunder); section 15(g) of the Exchange Act (15 U.S.C. 78o(f)) (requiring a registered broker or dealer to adopt policies and procedures reasonably designed, taking into account the nature of the broker's or dealer's business, to prevent the misuse of material, nonpublic information by the broker or dealer or any person associated with the broker or dealer, in violation of the Exchange Act or the rules or regulations thereunder).

Cf., e.g.,

Rule Commentary .02(b)(i) of NYSE American Rule 1000A (requiring a “fire wall” between an ETF and an affiliated index provider).

See infra

section II.C.4. (discussing requirements in rule 6c-11 regarding portfolio transparency).

3. Leveraged/Inverse ETFs

As proposed, rule 6c-11 includes a condition that excludes leveraged/inverse ETFs.

These ETFs may not rely on the rule, and will instead continue to operate pursuant to their exemptive orders.

Broadly speaking, leveraged/inverse ETFs seek to amplify the returns of an underlying index by a specified multiple or to profit from a decline in the value of an underlying index over a predetermined period of time using financial derivatives. Leveraged/inverse ETFs also rebalance their portfolios on a daily or other periodic basis in order to maintain a constant leverage ratio.

These funds' use of leverage together with this periodic rebalancing (or “reset”), and the resulting effects of compounding, can result in performance that differs significantly from some investors' expectations of how index investing generally works.

See

rule 6c-11(c)(4).

As of December 2018, 167 ETFs employed leveraged or inverse investment strategies. These ETFs had total net assets of $29.64 billion or approximately 1% of all ETF assets.

See

Rafferty Asset Management, LLC,

et al.,

Investment Company Act Release Nos. 28889 (Aug. 27, 2009) [74 FR 45495 (Sept. 2, 2009)] (notice) and 28905 (Sept. 22, 2009) (order) and related application (amending the applicant's prior order) (“Rafferty II”) (providing a description of maintaining a stated ratio to an underlying index as a daily investment objective).

For example, as a result of compounding, a leveraged/inverse ETF can outperform a simple multiple of its index's returns over several days of consistently positive returns, or underperform a simple multiple of its index's returns over several days of volatile returns.

Investors holding shares over periods longer than the time period targeted by the ETF's investment objective may experience performance that is different, and at times substantially different, from the returns of the targeted index over the same investment period. Buy-and-hold investors with an intermediate or long-term time horizon that invest in a leveraged/inverse ETF—who may not evaluate their portfolios frequently—may experience large and unexpected losses or otherwise experience returns that are different from what they anticipated.

As a result, leveraged/inverse ETFs are complex products that serve a markedly different investment purpose than most other ETFs.

See

Office of Investor Education and Advocacy, SEC,

Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors

Investor Alert and Bulletins (Aug. 1, 2009),

available at

http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm;

FINRA,

Non-Traditional ETFs: FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds,

Regulatory Notice 09-31 (June 2009),

available at

http://www.finra.org/sites/default/files/NoticeDocument/p118952.pdf

(“FINRA Regulatory Notice 09-31”).

See

FINRA Regulatory Notice 09-31,

supra

footnote 69 (reminding member firms of their sales practice obligations relating to leveraged/inverse ETFs and noting that leveraged/inverse ETFs are typically not suitable for retail investors who plan to hold these products for more than one trading session).

See

Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)] at n.39 and accompanying text (“[I]nverse or leveraged exchange-traded products that are designed primarily as short-term trading tools for sophisticated investors may not be in the best interest of a retail client absent an identified, short-term, client-specific trading objective and, to the extent that such products are in the best interest of a retail client initially, they would require daily monitoring by the adviser”).

See also

Regulation Best Interest, Exchange Act Release No. 86031 (June 5, 2019) [84 FR 33318 (July 12, 2019)] at text accompanying n.596 (stating that broker-dealers recommending leveraged or inverse exchange-traded products with a daily reset should understand that such products may not be suitable for, and as a consequence also not in the best interest of, retail customers who plan to hold them for longer than one trading session, particularly in volatile markets); Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 2, to Amend Nasdaq Rules 5705 and 5710 to Adopt a Disclosure Requirement for Certain Securities, Exchange Act Release No. 85362 (Mar. 19, 2019) [84 FR 11148 (Mar. 25, 2019)] (adopting certain disclosure requirements for leveraged/inverse ETFs).

Leveraged/inverse ETFs' use of derivatives also raises issues under section 18 of the Act, which limits a fund's ability to obtain leverage.

The Commission has been evaluating these section 18 issues as part of a broader consideration of derivatives use by registered funds and business development companies (“BDCs”).

We therefore proposed to exclude leveraged/inverse ETFs from the scope of rule 6c-11 so that the Commission could consider these concerns in a comprehensive manner with other funds that use leverage.

We also proposed to allow leveraged/inverse ETFs and their sponsors to continue to rely on their existing exemptive relief in order to preserve the status quo.

15 U.S.C. 80a-18.

See

Derivatives Proposing Release,

supra

footnote 45 (proposing new rule 18f-4 under the Act, which was designed to address the investor protection purposes and concerns underlying section 18 of the Act and to provide an updated and more comprehensive approach to the regulation of funds' (including leveraged/inverse ETFs') use of derivatives transactions).

Proposed rule 6c-11 would have provided that an ETF relying on the rule “may not seek, directly or indirectly, to provide returns that exceed the performance of a market index by a specified multiple, or to provide returns that have an inverse relationship to the performance of a market index, over a fixed period of time.”

See

proposed rule 6c-11(c)(4).

The staff has not supported new exemptive relief for leveraged/inverse ETFs since 2009. The orders issued to current leveraged/inverse ETF sponsors, as amended over time, relate to leveraged/inverse ETFs that seek daily investment results of up to 300% of the return (or inverse of the return) of the underlying index. Rydex ETF Trust,

et al.,

Investment Company Act Release Nos. 27703 (Feb. 20, 2007) [72 FR 8810 (Feb. 27, 2007)] (notice) and 27754 (Mar. 20, 2007) (order) and related application; Rafferty Asset Management, LLC,

et al.,

Investment Company Act Release Nos. 28379 (Sept. 12, 2008) [73 FR 54179 (Sept. 18, 2008)] (notice) and 28434 (Oct. 6, 2008) (order) and related application (“Rafferty I”).

See also

ProShares Trust,

et al.,

Investment Company Act Release Nos. 28696 (Apr. 14, 2009) [74 FR 18265 Apr. 21, 2009)] (notice) and 28724 (May 12, 2009) (order) and related application (amending the applicant's prior order) (“ProShares”); Rafferty II,

supra

footnote 68.

Most commenters who addressed this aspect of the proposal agreed that leveraged/inverse ETFs present issues and concerns that should be addressed outside the context of rule 6c-11.

One such commenter stated that leveraged/inverse ETFs present “highly specific and accentuated risks” and stated that the Commission should regulate these products under tailored exemptive orders.

Other commenters urged the Commission to consider additional investor protection requirements for leveraged/inverse ETFs, such as requiring marketing materials to notify retail investors about the risks of investing in these instruments or other enhanced disclosure requirements.

Some commenters stated that the Commission should not permit

leveraged/inverse ETFs to use the terms “ETF” or “exchange-traded fund” in their names, because investors might mistakenly assume that all products referred to as ETFs are structured and regulated like “traditional” ETFs.

See

BlackRock Comment Letter; Invesco Comment Letter; SSGA Comment Letter I; Comment Letter of ICE Data Services (Oct. 1, 2018) (“IDS Comment Letter”); FIMSAC Comment Letter; CFA Institute Comment Letter;

See also

Comment Letter of Rafferty Asset Management, LLC (Oct. 1, 2018) (“Direxion Comment Letter”) (supporting enhanced disclosure requirements for leveraged/inverse ETFs if reliance on rule 6c-11 is allowed for the operation of leveraged/inverse ETFs).

See

BlackRock Comment Letter; FIMSAC Comment Letter.

Other commenters were less specific as to whether the Commission should regulate leveraged/inverse ETFs under exemptive orders or through a separate rule, but stated that leveraged/inverse ETFs should be regulated by means other than rule 6c-11.

One commenter agreed that leveraged/inverse ETFs “raise important disclosure and investor protection issues,” but strongly encouraged the Commission to “initiate proceedings, whether as part of its consideration of derivative usage or otherwise, to determine what its future approach” to leveraged/inverse ETFs will be.

See

SSGA Comment Letter I (“Leveraged ETFs . . . present issues which are appropriately addressed through means other than the Proposed ETF Rule.”); IDS Comment Letter (“IDS believes that leveraged and inverse ETFs strategies carry significantly different risk profiles than index-based ETFs. For that reason we agree that they should be excluded from the scope of funds that may rely on the proposed rule.”).

Comment Letter of the Mutual Fund Directors Forum (Oct. 1, 2018) (“MFDF Comment Letter”).

Sponsors of leveraged/inverse ETFs, however, advocated that the rule should not exclude leveraged/inverse ETFs. They asserted that leveraged/inverse ETF investors understand the special concerns related to these products, accept the products' risks, and utilize the products appropriately.

One of these commenters stated that the rule's exemptive relief targets ETFs' structural and operational characteristics, and that leveraged/inverse ETFs are structured and operated in the same manner as other ETFs within the rule's scope.

Among other similarities, the commenter noted that leveraged/inverse ETFs are structured as open-end funds, provide full portfolio transparency, and accept creation and redemption baskets using the same operating mechanisms as other ETFs. The commenter also opined that leveraged/inverse ETFs should not be excluded from the scope of the rule because other ETFs that utilize leverage in their investment strategies are not excluded from the scope of the rule.

See

Direxion Comment Letter (“Given [certain data findings and educational efforts by regulators, brokerage firms, and the ETFs themselves] we believe it would be hard for investors

not

to understand that our leveraged ETFs are complex products that are `different' from other ETFs, and we have not seen any recent empirical data or other evidence to the contrary.”); Comment Letter of ProShare Advisors LLC (Oct. 1, 2018) (“ProShares Comment Letter”).

See

ProShares Comment Letter.

Another commenter did not object to excluding leveraged/inverse ETFs from rule 6c-11, but opined that the proposed rule's condition excluding leveraged/inverse ETFs was overly broad, potentially capturing ETFs that have an inverse relationship to the performance of a market index or ETFs that use other hedging strategies to reduce risk.

This commenter also asked the Commission to confirm that the exclusion would not, in effect, apply to every ETF that seeks to track an index that includes derivatives. Additionally, several commenters did not specifically address leveraged/inverse ETFs, but generally stated that rule 6c-11 should apply across all ETFs registered under the Investment Company Act to create an even playing field.

See

Cboe Comment Letter (stating that the exclusion should cover only those inverse ETFs that seek to provide returns that exceed the performance of a market index by a “specified inverse multiple”).

See, e.g.,

BNY Mellon Comment Letter.

After considering these comments, we have determined to include a condition that prevents leveraged/inverse ETFs from relying on the rule.

Although leveraged/inverse ETFs are structurally and operationally similar to other types of ETFs within the scope of rule 6c-11, we believe it is premature to permit sponsors to form and operate leveraged/inverse ETFs in reliance on the rule without first addressing the investor protection purposes and concerns underlying section 18 of the Act. We therefore believe that the Commission should complete its broader consideration of the use of derivatives by registered funds before considering allowing leveraged/inverse ETFs to rely on the rule.

See

Rule 6c-11(c)(4).

Given that rule 6c-11 is intended to help create a consistent regulatory framework for ETFs and a level playing field among ETF sponsors, we acknowledge that excluding leveraged/inverse ETFs from the rule's scope and permitting existing leveraged/inverse ETFs to continue to operate pursuant to their exemptive orders at this time delays, in part, achieving those goals. However, because leveraged/inverse ETFs raise policy considerations that are different from those we seek to address in the rule, we believe rule 6c-11 should exclude leveraged/inverse ETFs.

As adopted, rule 6c-11 will exclude ETFs that seek to provide leveraged or inverse investment returns over a predetermined period of time. The periodic reset that such strategies necessitate distinguish leveraged/inverse ETFs from other types of ETFs that may use leverage. In the proposal we did not specify the period of time over which an ETF had to seek to deliver a leveraged or inverse return of an index to be covered by the proposed rule's leveraged/inverse ETF exclusion, and we similarly decline to specify a period of time here.

However, the condition relating to leveraged/inverse ETFs continues to include a temporal element (

i.e.,

“over a predetermined period of time”) in order to specifically capture ETFs that seek to deliver the leveraged or inverse return of a market index over a set period of time, daily or otherwise.

See

2018 ETF Proposing Release,

supra

footnote 7, at section II.A.3.

See

rule 6c-11(c)(4). The current exemptive orders that allow leveraged/inverse ETFs contemplate a daily reset, because the orders relate to ETFs that pursue daily investment objectives.

See

2018 ETF Proposing Release,

supra

footnote 7 at n.77 and related discussion. Proposed rule 6c-11 used the term “fixed period of time” to prevent both these ETFs and leveraged/inverse ETFs contemplating non-daily resets (

e.g.,

weekly or monthly resets) from relying on the rule.

See

proposed rule 6c-11(c)(4). Rule 6c-11 as adopted uses the term “predetermined period of time” to clarify that leveraged/inverse ETFs contemplating predetermined but variable resets (

e.g.,

leveraged/inverse ETFs that contemplate a range of daily-to-weekly resets) are similarly prohibited from relying on the rule.

In addition, while the rule uses the term “multiple,” leveraged/inverse ETFs with strategies that seek directionally leveraged or inverse returns of an index present the investor protection concerns discussed above regardless of whether the amplification factor or inverse factor is evenly divisible by 100 (

e.g.,

a fund that seeks to provide a daily investment return equal to 150% of the performance of an index). Thus, to clarify the rule's use of the term “multiple,” leveraged/inverse ETFs are excluded from the scope of the rule regardless of whether the returns they seek over a predetermined time period are evenly divisible by 100.

The exclusion also includes strategies that pursue a specified range of a multiple or inverse multiple of an index's performance (

e.g.,

200% to 300% of an index's performance or −200% to −300% of an index's performance). This approach is consistent with our existing exemptive orders and will capture those ETFs that have historically been considered “leveraged/inverse ETFs” in the marketplace.

Additionally, though a strict mathematical interpretation of the term “multiple” may include a multiple of 100%, an ETF that simply seeks to track the performance of an index is not considered “leveraged” for these purposes and may rely on the rule.

But see infra

footnotes 90-91 and accompanying text.

We also continue to believe that it is important to specify that an ETF relying on the rule may not

indirectly

seek to provide investment returns that correspond to the performance of a market index by a specified multiple or to provide returns that have an inverse relationship to the performance of a market index over a predetermined period of time in order to prevent a fund from circumventing this condition, such as by embedding leverage in the underlying index.

For example, an ETF could not circumvent the rule's conditions and rely on the rule to track an index if the index itself tracks 300% or −100% of the performance of the S&P 500.

In response to commenter concerns discussed above, however, this does not mean that the exclusion would apply to every ETF that tracks an index with constituents that are derivatives.

Whether a particular index is “leveraged” would depend on the economic characteristics of the index's constituents, and not just on whether some or all of the constituents are derivatives.

Rule 6c-11(c)(4) (emphasis added).

See also

2018 ETF Proposing Release,

supra

footnote 7, at text following n.82.

The exemptive orders that we have issued to sponsors of leveraged/inverse ETFs do not provide relief to ETFs described as seeking investment returns that correspond to the performance of a leveraged or inverse leveraged market index over a predetermined period of time.

See supra

footnote 75.

See supra

footnote 84 and following text.

Finally, we are not adopting enhanced website or other disclosure requirements for leveraged/inverse ETFs at this time as some commenters had recommended. We believe all registered funds that pursue leveraged or inverse strategies raise similar disclosure issues. We therefore believe that the Commission should address any such potential disclosure issues separately for all leveraged/inverse registered funds.

B. Exemptive Relief Under Rule 6c-11

Rule 6c-11 will provide ETFs that fall within the scope of the rule exemptive relief from certain provisions of the Act that are necessary to allow ETFs to operate. These exemptions are consistent with the relief we have given to ETFs under our exemptive orders.

As discussed below in section II.C., the exemptions will be subject to conditions that are designed to address the concerns underlying the relevant statutory provisions and to support a Commission finding that the exemptions are in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.

See

2018 ETF Proposing Release,

supra

footnote 7, at n.88 and related discussion. Our exemptive orders also provide relief allowing certain types of funds to invest in ETFs beyond the limits of section 12(d)(1) of the Act.

See infra

section II.F. (discussing our treatment of master-feeder relief) and section II.G. (discussing our treatment of other relief for fund investments in ETFs).

See

15 U.S.C. 80a-6(c).

1. Treatment of ETF Shares as “Redeemable Securities”

Consistent with our proposal, ETFs relying on rule 6c-11 will be considered to issue a “redeemable security” within the meaning of section 2(a)(32) of the Act.

ETFs have features that distinguish them from both traditional open-end and closed-end funds. A defining feature of open-end funds is that they offer redeemable securities, which allow the holder to receive his or her proportionate share of the fund's NAV per share upon presentation of the security to the issuer. Although individual ETF shares cannot be redeemed, except in limited circumstances, they can be redeemed in creation unit aggregations.

Therefore, we believe that ETF shares are most appropriately classified under the final rule as redeemable securities within the meaning of section 2(a)(32), and that ETFs should be regulated as open-end funds within the meaning of section 5(a)(1) of the Act.

Rule 6c-11(b)(1).

See

rule 6c-11(a)(1) (defining an exchange-traded fund, in part, as a registered open-end management company that issues and redeems its shares in creation units). The rule defines “creation unit” to mean a specified number of ETF shares that the ETF will issue to (or redeem from) an authorized participant in exchange for the deposit (or delivery) of a basket and a cash balancing amount (if any).

See

rule 6c-11(a)(1).

See also

Securities Transaction Settlement Cycle, Exchange Act Release No. 80295 (Mar. 22, 2017) [82 FR 15564 (Mar. 29, 2017)] (shortening the standard settlement cycle for most broker-dealer securities transactions to two business days).

Many commenters supported our proposed classification of ETF shares as “redeemable securities.”

100

Commenters also supported our view that the arbitrage mechanism that is central to the operation of an ETF (and the conditions in the final rule designed to facilitate an effective arbitrage mechanism) serves to keep the market price of ETF shares at or close to the ETF's NAV per share.

101

As a result, even though only authorized participants may redeem creation units at NAV per share, commenters agreed that investors are able to sell their ETF shares on the secondary market at or close to NAV, similar to investors in an open-end fund that redeem their shares at NAV per share.

102

100

See, e.g.,

ICI Comment Letter; Fidelity Comment Letter; Comment Letter of the Asset Management Group of the Securities Industry and Financial Markets Association (Feb. 22, 2019) (“SIFMA AMG Comment Letter II”); Vanguard Comment Letter; SSGA Comment Letter; Comment Letter of Virtu Financial, Inc. (Oct. 3, 2018) (Virtu Comment Letter”); Comment Letter of Eaton Vance Corp. (Oct. 4, 2018) (“Eaton Vance Comment Letter”); ABA Comment Letter.

101

See, e.g.,

ICI Comment Letter.

See also

2018 ETF Proposing Release,

supra

footnote 7, at n.95 and related discussion.

102

See, e.g.,

ICI Comment Letter; Virtu Comment Letter.

Commenters also supported the resulting eligibility for the redeemable securities exceptions and the registered open-end investment company exemption under the Exchange Act

rules discussed above.

103

Commenters stated that such treatment would reduce regulatory complexity and eliminate potential inconsistencies between rule 6c-11 and this Exchange Act relief.

104

Several commenters recommended extending the “redeemable security” classification to ETFs that are not eligible to rely on rule 6c-11, such as UIT ETFs or share class ETFs, to make them similarly eligible for the exceptions under the Exchange Act that apply to redeemable securities issued by an open-end fund.

105

103

See, e.g.,

Dechert Comment Letter; BlackRock Comment Letter; Invesco Comment Letter I; ABA Letter.

104

See, e.g.,

Vanguard Comment Letter; Dechert Comment Letter; WisdomTree Comment Letter; ABA Comment Letter; SIFMA AMG Comment Letter I.

105

See

ICI Comment Letter; Dechert Comment Letter; SIFMA AMG Comment Letter I; Vanguard Comment Letter; SSGA Comment Letter I; ABA Comment Letter; BlackRock Comment Letter.

After considering comments, we are clarifying that we view securities of all ETFs, including those that do not rely on rule 6c-11, as eligible for the redeemable securities exceptions in rules 101(c)(4) and 102(d)(4) of Regulation M and rule 10b-17(c) under the Exchange Act in connection with secondary market transactions in ETF shares and the creation or redemption of creation units and the exemption in rule 11d1-2 under the Exchange Act for securities issued by a registered open-end investment company or unit investment trust. We believe that securities issued by ETFs that are exempt from the definitions of “redeemable security” in section 2(a)(32) and “open-end company” in section 5(a)(1) of the Investment Company Act pursuant to their orders do not raise different concerns with respect to these Exchange Act provisions than those issued by ETFs relying on rule 6c-11.

Several commenters recommended further harmonization between rule 6c-11 and certain other Exchange Act relief that ETFs must currently seek in order to operate.

106

Commenters expressed concern that this Exchange Act relief is duplicative or, in some cases, inconsistent with other requirements applicable to ETFs.

107

In particular, commenters noted that rule 6c-11 as proposed would not address relief for ETFs from section 11(d)(l) of the Exchange Act as well as rules 10b-10, 15c1-5, 15c1-6, and 14e-5 thereunder.

108

Commenters also recommended that the ETF generic listing standards of national securities exchanges be broadened and harmonized with any final ETF rule.

109

106

See, e.g.,

BlackRock Comment Letter; ICI Comment Letter; Fidelity Comment Letter; SIFMA AMG Comment Letter I; Comment Letter of John Hancock Investments (Oct. 1, 2018) (“John Hancock Comment Letter”); Comment Letter of Flow Traders US LLP (Oct. 1, 2018) (“Flow Traders Comment Letter”).

107

See, e.g.,

BlackRock Comment Letter.

See also

Nasdaq Comment Letter (noting that minimum creation unit size requirement can lead to wider spreads, particularly for newer, thinly-traded ETFs).

174

One commenter also suggested that the rule should not require an ETF to define a specific creation unit size, noting that permitting variable creation unit sizes could help further facilitate market making and reduce transaction costs.

See

Nasdaq Comment Letter. The rule's definition of “creation unit” will require an ETF to specify a single number of ETF shares composing a creation unit. Although an ETF could not use variable creation unit sizes under this definition, an ETF could change its specified creation unit size as conditions change over time.

An ETF generally would issue and redeem shares in creation unit size aggregations, rather than as individual shares, under the rule. We proposed to permit an ETF to sell or redeem individual shares on the day of consummation of a reorganization, merger, conversion, or liquidation.

175

In these limited circumstances, an ETF may need to issue or redeem individual shares, and may need to transact without utilizing authorized participants. Commenters that addressed this aspect of the proposal generally supported it.

176

One commenter, however, suggested that the rule should explicitly provide that an ETF may transact with investors other than authorized participants in these limited circumstances.

177

We agree and have modified rule 6c-11 to clarify that, on the day of a reorganization, merger, conversion, or liquidation, an ETF may sell or redeem individual shares and is not limited to transacting with authorized participants.

178

We believe that permitting ETFs to conduct redemptions with investors other than authorized participants in these circumstances is operationally necessary to facilitate these transactions and will allow an ETF to compensate individual shareholders exiting the reorganized, merged, converted or liquidated ETF—activities likely to involve small amounts and to be outside the scope of an authorized participant's expected role of transacting in creation units.

175

See

2018 ETF Proposing Release,

supra

footnote 7, at text preceding n.82 (discussing proposed rule 6c-11(c)(5)).

176

See, e.g.,

BlackRock Comment Letter; Thompson Hine Comment Letter.

177

See

Thompson Hine Comment Letter. This commenter also suggested moving this exception to the definition of exchange-traded fund because it is not a condition to reliance on the rule. We agree and have moved this exception to rule 6c-11(a)(2).

178

See

rule 6c-11(a)(2).

Commenters also addressed the Commission's proposed guidance concerning the extent to which an ETF may directly or indirectly suspend the issuance or redemption of ETF shares.

179

An ETF that suspends the issuance or redemption of creation units indefinitely could cause a breakdown of the arbitrage mechanism, resulting in significant deviations between market price and NAV per share. Such deviations may harm investors that purchase shares at market prices above NAV per share and/or sell shares at market prices below NAV per share.

179

See

2018 ETF Proposing Release,

supra

footnote 7, at section II.C.1.

With respect to redemptions, an ETF may suspend the redemption of creation units only in accordance with section 22(e) of the Act,

180

and may charge transaction fees on these redemptions only in accordance with rule 22c-2.

181

While no commenters disagreed with our statement in the 2018 ETF Proposing Release that an ETF may suspend redemptions only in compliance with section 22(e), several commenters requested that we eliminate the 2% cap on redemption fees for ETFs.

182

One commenter asserted that, unlike the mutual fund redemption fees that were the Commission's focus in adopting rule 22c-2, the transaction fees charged by an ETF on redemptions are not intended to inhibit frequent trading of the ETF's shares, but are primarily designed to protect shareholders against the costs of certain cash redemptions.

183

This commenter further stated that an ETF's inability to pass through certain incremental costs to an authorized participant could adversely impact performance and result in dilution of the interests of the ETF's remaining shareholders.

180

Section 22(e) of the Act permits open-end funds to suspend redemptions and postpone payment for redemptions already tendered for any period during which the New York Stock Exchange is closed (other than customary weekend and holiday closings) and in three additional situations if the Commission has made certain determinations.

See

LRM Adopting Release,

supra

footnote 123, at n.36.

181

17 CFR 270.22c-2 (rule 22c-2) limits redemption fees to no more than 2% of the value of shares redeemed.

See

rule 22c-2(a)(1)(i).

182

See, e.g.,

Dechert Comment Letter; WisdomTree Comment Letter; Invesco Comment Letter (noting that the redemption fee framework for ETFs under rule 22c-2 is “workable” in most circumstances, but that in certain circumstances greater flexibility to charge redemption fees in excess of 2% would benefit ETFs). Commenters did not provide any fee-related data in support of their contention that the 2% limit on redemption fees should be eliminated for ETFs.

183

See

Dechert Comment Letter.

See also

Invesco Comment Letter (noting that these fees include the difference between the cash in-lieu amount calculated on the trade date and the actual sale price of the security (reflecting market movement)).

As discussed above, we believe that ETFs should be regulated as open-end funds and that ETF shares are most appropriately classified as redeemable securities under the relevant provisions of the Act. In adopting the 2% limit on redemption fees under rule 22c-2, we stated that higher redemption fees would impose an undue restriction on the redeemability of shares.

184

Consistent with this belief, our exemptive orders permitting ETFs to operate as open-end funds have not permitted ETFs to charge transaction fees in excess of the 2% limit. We believe the 2% limit allows ETFs to pass on certain costs related to the redemption transaction to authorized participants, while preserving the redeemability of ETF shares.

185

Accordingly, we believe that ETFs may charge transaction fees on the redemption of creation units only in accordance with rule 22c-2.

184

See

Mutual Fund Redemption Fees, Investment Company Act Release No. 26782 (March 11, 2005) [70 FR 13328 (March 18, 2005)] (noting that a goal of the Commission under the Act is to preserve the redeemability of mutual fund shares).

185

See id.

at text accompanying nn. 29-30. Mutual funds, particularly those that invest in foreign markets, may face similar types of costs and are subject to the 2% cap in rule 22c-2.

We also stated in the 2018 ETF Proposing Release that we believe that an ETF generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF's portfolio holdings are traded are closed for a limited period of time.

186

Some commenters agreed that an ETF may suspend creations only for a limited time and only due to extraordinary circumstances, but requested that we provide clarification regarding the specific circumstances under which an ETF may suspend creations.

187

Other commenters did not support our position on this issue. For example, one commenter stated that current ETF practices for suspending creations have proven effective and advocated against limiting or imposing restrictions on the circumstances in which ETFs may suspend creations.

188

Another commenter recommended that, rather than precluding an ETF from suspending the issuance of creation units, the Commission should require ETFs that suspend creations to add supplemental disclosures addressing the risk that the ETF's market price may deviate from NAV per share.

189

186

See

2018 ETF Proposing Release,

supra

footnote 7, at n.185 and accompanying text. In addition, we stated that an ETF could not set transaction fees so high as to effectively suspend the issuance of creation units.

See id.

One commenter addressed this issue, stating that ETFs generally do not set transaction fees at a level that would effectively suspend creations “in lieu of transparently informing the market that creations are halted.” Jane Street Comment Letter.

187

See, e.g.,

BlackRock Comment Letter; SIFMA AMG Comment Letter I; SSGA Comment Letter I; Vanguard Comment Letter; Invesco Comment Letter.

188

See

Comment Letter of ETF BILD LLC (Oct. 1, 2018) (“ETF BILD Comment Letter”) (“[T]here may be a variety of reasons to suspend creations and limiting them or [restricting] certain activity will not allow for differentiation of the circumstances related to the underlying securities. . . . [C]urrent practices developed in the ETF industry allow for the flexibility needed to address this issue.”).

189

See

Eaton Vance Comment Letter. Another commenter suggested requiring any ETF that suspends creations, or otherwise has its creation process halted, to immediately notify the market via a Form 8-K or other mechanism.

See

Jane Street Comment Letter.

As discussed above, however, the expected close tie between an ETF's market price and NAV per share provides a basis for our relief from section 22(d) and rule 22c-1 under rule 6c-11 (as well as our prior exemptive orders).

190

If a suspension of creations impairs the arbitrage mechanism, it could lead to significant deviations between what retail investors pay (or receive) in the secondary market and the ETF's approximate NAV. Such a result would run counter to the basis for relief from section 22(d) and rule 22c-1 and therefore would be inconsistent with rule 6c-11.

190

See supra

section II.B.2 (discussing the potential concerns regarding shareholder dilution, unjust discrimination and preferential treatment among investors purchasing and redeeming fund shares that section 22(e) and rule 22c-1 were designed to address).

2. Listing on a National Securities Exchange

As proposed, rule 6c-11 will define an “exchange-traded fund,” in part, to mean a fund that issues shares that are listed on a national securities exchange and traded at market-determined prices.

191

Exchange-listing is one of the fundamental characteristics that distinguishes ETFs from other types of open-end funds (and UITs) and is one reason that ETFs need certain exemptions from the Act and the rules thereunder. Exchange-listing provides an organized and ongoing trading market for the ETF shares at market-determined prices, and therefore is important to a functioning arbitrage mechanism.

192

The Commission has premised all of its previous exemptive orders on an ETF listing its shares for trading on a national securities exchange.

191

Rule 6c-11(a)(1). As proposed, rule 6c-11(a)(1) also will define a “national securities exchange” as an exchange that is registered with the Commission under section 6 of the Exchange Act.

192

As proposed, the definition also requires that an ETF's shares trade at market-determined prices. This requirement is not designed to establish a minimum level of trading volume for ETFs necessary in order to rely on the rule, but rather to distinguish ETFs from other products that are listed on exchanges but trade at NAV-based prices (

i.e.,

exchange-traded managed funds (“ETMFs”)).

See

2018 ETF Proposing Release,

supra

footnote 7, at text accompanying n.192. Commenters did not address this aspect of the definition of exchange-traded fund.

Several commenters generally supported the requirement that an ETF list its shares on a national securities exchange.

193

On the other hand, one commenter stated that ETFs that are temporarily suspended from listing or engaged in an orderly delisting and liquidation process should not fall outside of the scope of the proposed rule.

194

Another commenter opined that delisted ETFs should remain within the rule to prevent a possible race to redeem the ETF's shares that could result from confusion about the ETF's regulatory status.

195

This commenter stated the definition of exchange-traded fund instead should include ETFs that have been listed within the past 90 days. Other commenters requested that we clarify the specific circumstances that constitute a “delisting,” citing trading suspensions and trading halts as examples of circumstances that should not disqualify an ETF from relying on rule 6c-11.

196

These commenters also urged the Commission to clarify that a temporary non-compliance notice from an exchange for failure to continuously meet the exchange's listing standards would not disqualify an ETF from relying on the rule.

193

See, e.g.,

ICI Comment Letter; SSGA Comment Letter I.

194

SIFMA AMG Comment Letter I.

195

Thompson Hine Comment Letter (“[D]eeming the former ETF to no longer have [status as an ETF under the rule] may lead to confusion and a possible race to redeeming shares by remaining shareholders while liquid assets are still available.”).

196

See SSGA Comment Letter I; ICI Comment Letter; Invesco Comment Letter. See also FINRA, Investor Alert, When Trading Halts: What You Need to Know About Halts, Suspensions and Other Interruptions (February 7, 2013), available at

http://www.finra.org/investors/alerts/when-trading-stops-halts-suspensions-other-interruptions

(describing trading halts and trading suspensions).

As noted above, the listing requirement was designed to ensure that all ETF shares have an organized and ongoing secondary trading market to support an effective arbitrage mechanism. We therefore continue to believe that an ETF should no longer be

eligible to rely on rule 6c-11 and must meet individual redemption requests within seven days pursuant to section 22(e) of the Act or liquidate if it is not listed on an exchange.

197

In response to commenters' request that we clarify the specific circumstances constituting a “delisting” for purposes of rule 6c-11, an ETF is considered no longer listed on an exchange as of the effective date of the removal of the ETF's shares from listing pursuant to rule 12d2-2 under the Exchange Act.

198

Circumstances such as a trading suspension, a trading halt, or a temporary non-compliance notice from the exchange therefore would not constitute a “delisting” for purposes of rule 6c-11. An ETF also may request temporary relief from the Commission to permit the ETF to suspend redemptions for a limited period of time where necessary to protect ETF shareholders.

199

197

Indeed, an ETF that does not comply with the provisions of the rule would be required to comply with the Investment Company Act in all respects unless it was relying on other relief.

198

See

17 CFR 240.12d2-2 (rule 12d2-2 under the Exchange Act) (requiring a national securities exchange to file with the Commission an application on Form 25 (17 CFR 249.25) to strike a class of securities from listing on a national securities exchange and/or registration under section 12(b) of the Exchange Act).

199

See

section 22(e)(3) of the Act.

3. Intraday Indicative Value (“IIV”)

As proposed, rule 6c-11 will not require ETFs to disseminate an intraday estimate of their NAV per share (an “intraday indicative value” or “IIV”) as a condition for reliance on the rule. Our orders require the dissemination of an IIV, and ETFs have stated in their exemptive applications that an ETF's IIV is useful to investors because it allows them to determine (by comparing the IIV to the market value of the ETF's shares) whether and to what extent the ETF's shares are trading at a premium or discount on an intraday basis.

200

The exchange listing standards also currently require ETFs to disseminate an IIV at least every 15 seconds during regular trading hours.

201

200

See, e.g.,

WisdomTree Investments, Inc.,

et al.,

Investment Company Act Release Nos. 27324 (May 18, 2006) [71 FR 29995 (May 24, 2006)] (notice) and 27391 (June 12, 2006) (order) and related application (“2006 WisdomTree Investments”).

201

See, e.g.,

NYSE Arca Equities Rule 5.2E(j)(3), Commentary .01(c) (stating that IIV may be based upon “current information regarding the required deposit of securities and cash amount to permit creation of new shares of the series or upon the index value”). The IIV is also sometimes referred to as the “iNAV” (indicative net asset value) or the “PIV” (portfolio indicative value).

We did not propose, however, an IIV dissemination requirement under rule 6c-11 because of our concerns regarding the accuracy of IIV estimates for certain ETFs.

202

For example, the IIV may not accurately reflect the value of an ETF that holds securities that trade less frequently. The IIV can be stale or inaccurate for ETFs with foreign securities or less liquid debt instruments. For such ETFs, there may be a difference between the IIV, which is constructed using the last available market quotations or stale prices, and the ETF's NAV, which uses fair value when market quotations are not readily available.

203

Conversely, in today's fast moving markets, given the dissemination lags, the IIV may not accurately reflect the value of an ETF that holds frequently traded component securities.

204

Because there are no uniform methodology requirements, the IIV also can be calculated in different and potentially inconsistent ways.

202

See

2018 ETF Proposing Release,

supra

footnote 7, at section II.C.3. The exemptive relief we provided to certain non-transparent ETFs included a condition requiring those ETFs to provide a verified intraday indicative value (“VIIV”) throughout the trading day.

See

2019 Precidian,

supra

footnote 8. Those ETFs' VIIV, considering their limited investment strategies, addressed the Commission's concerns regarding the traditional IIV.

See id.

203

Section 2(a)(41)(B) of the Act defines “value” as: “(i) with respect to securities for which market quotations are readily available, the market value of such securities; and (ii) with respect to other securities and assets, fair value as determined in good faith by the board of directors.” This definition also is used in rule 2a-4 under the Act as the required basis for computing a fund's current NAV per share. With daily portfolio disclosure, market participants can estimate fair value on their own for the ETF's current holdings. 15 U.S.C. 80a-2(a)(41)(B).

204

An ETF's current portfolio value changes every time the value of any underlying component of the ETF changes. The IIV for an ETF that includes a more frequently traded component security might not reflect the most recent trading information for that underlying security.

In addition, we understand that market makers and authorized participants no longer use IIV to evaluate arbitrage opportunities for ETFs that provide full portfolio transparency.

205

These market participants typically calculate their own intraday value of an ETF's portfolio with proprietary algorithms that use an ETF's daily portfolio disclosure and available pricing information about the assets held in the ETF's portfolio and generally use the IIV as a secondary or tertiary check on the value that their proprietary algorithms generate.

205

See

ETF Handbook,

supra

footnote 25.

The majority of commenters that addressed IIV requirements supported our proposed approach. For example, commenters agreed that authorized participants and other market participants calculate their own intraday values based on other sources of information such as an ETF's published baskets and portfolio holdings.

206

Some of these commenters stated, therefore, that the proposed rule's conditions regarding daily portfolio holdings information would provide more useful information to market participants than IIV.

207

Commenters also agreed that IIV can have significant limitations depending on the types of securities the ETF holds. For example, one commenter stated that these limitations for ETFs holding fixed income securities are the result of market structure issues and that increasing the frequency of the IIV publication would not change these limitations.

208

206

See, e.g.,

Jane Street Comment Letter; Invesco Comment Letter; WisdomTree Comment Letter; Vanguard Comment Letter (“These other sources of data include the ETF's published basket, its last published portfolio holdings list, the index tracked by the ETF, and data from third party vendors”).

207

See

Comment Letter of Legg Mason, Inc. (Oct. 1, 2018) (“Legg Mason Comment Letter”); Cboe Comment Letter.

See also

SSGA Comment Letter I (“[t]o the extent there is market demand for information similar to the IIV by market participants absent a regulatory mandate, we expect industry-led solutions will be available, perhaps as part of a broader discussion around market price validation.”).

208

See

Legg Mason Comment Letter (noting, for example, that fixed-income securities are predominantly traded by dealers and not on exchanges).

See also

ICI Comment Letter.

Commenters also noted that under current regulatory requirements, IIV can be confusing or misleading to market participants. For example, one commenter stated that current requirements for IIV actually reduce ETF transparency, because the IIV does not reflect the true value of an ETF due to dissemination delays, stale pricing for underlying holdings, and inconsistent calculation methodologies.

209

One commenter opined that IIV is inaccurate for 80% of all ETFs and the rule should not require its dissemination.

210

Another commenter stated that “[IIV] is, at best, slow and likely stale and, at worst confusing, inaccurate, and misleading.”

211

In addition, several of these commenters stated that the IIV requirements across regulatory regimes applicable to ETFs should be harmonized.

212

Specifically, these commenters noted that, even if rule 6c-11 were to omit an IIV requirement, existing relief under the Exchange Act

and certain exchange listing requirements would require ETFs to continue disseminating IIV. They encouraged the Commission to work with the exchanges to remove these listing requirements.

209

See

SSGA Comment Letter I.

210

Comment Letter of

ETF.com

(Aug. 28, 2018) (“

ETF.com

Comment Letter”) (stating that “the idea of contemporaneous measure of fair value is enticing” but IIV “is not accurate enough for authorized participants to use in arbitrage analysis.”).

211

Cboe Comment Letter.

212

See, e.g.,

Invesco Comment Letter; SIFMA AMG Comment Letter I; WisdomTree Comment Letter; SSGA Comment Letter I;

ETF.com

Comment Letter.

Some commenters disagreed with this aspect of the proposal and encouraged the Commission to require ETFs to disseminate IIV as a requirement of the rule. These commenters generally asserted that IIV—despite its limitations—can be useful to retail investors.

213

One such commenter stated that IIV is important for informed trading of ETFs (and other ETPs) by retail investors because it is an “important signal of the value of the underlying portfolio.”

214

One commenter stated that IIV allows investors to screen for significant price deviations that could signal breakdowns in the market maker arbitrage process.

215

213

See, e.g.,

Angel Comment Letter; Nasdaq Comment Letter; IDS Comment Letter.

214

See

Angel Comment Letter.

215

See

Nasdaq Comment Letter.

Some of these commenters noted that an ETF's IIV may be the only source of pricing information publicly available to retail investors.

216

Another commenter asserted that the rule should include an IIV requirement, but that market participants, particularly retail investors, also would benefit from an explanation of the potential limitations of IIV.

217

Many of the commenters who recommended that the Commission retain an IIV requirement also recommended that the Commission standardize and otherwise improve the IIV calculation.

218

216

See

IDS Comment Letter.

See also

CFA Comment Letter; Eaton Vance Comment Letter.

217

See

FIMSAC Comment Letter.

218

See, e.g.,

NYSE Comment Letter; IDS Comment Letter; Nasdaq Comment Letter; Eaton Vance Comment Letter.

See also

Angel Comment Letter (recommending dissemination on standard CQS and UTP feeds, one-second updates, and standardization of IIV suffixes).

After considering these comments, we continue to believe that rule 6c-11 should not require ETFs to disseminate IIV as IIV is not necessary to support the arbitrage mechanism for ETFs that provide daily portfolio holdings disclosure. Instead, rule 6c-11's portfolio holdings disclosure will provide market participants with the relevant data to input into their internal algorithms and thus allow them to determine if arbitrage opportunities exist.

We also do not believe that IIV will provide a reliable metric for retail investors to assess all ETFs relying on rule 6c-11 given the breadth of asset classes that ETFs may hold (and the particular shortcomings of IIV when an ETF holds assets that do not trade contemporaneously with the ETF or are traded less frequently). Furthermore, retail investors do not have easy access to IIV through free, publicly available websites today even for those asset classes where an IIV may be more reliable. A staff review of the websites for the ten largest ETFs by assets under management found that none provides a real-time IIV on its website. Some of these ETFs disclose a specific ticker symbol for the ETF's IIV (as opposed to the ticker symbol for the ETF itself) on their websites, others provide the IIV with a delay of up to 45 minutes, while others provide no info

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