The Securities and Exchange Commission took a step toward streamlining the approval process for actively managed ETFs last week by approving rule proposals from two securities exchanges.
The order issued to BATS Exchange, Inc. (BATS) allows BATS to adopt “generic listing standards” for actively managed ETFs. Up until now, generic listing standards applied only to passively managed ETFs that track an index.
The SEC issued a similar order to NYSE Arca, Inc.
This regulatory relief, originally proposed by the exchanges in November 2015, effectively removes a hurdle that actively managed ETFs faced when applying for a listing on the exchange.
Although actively managed ETFs that meet the new generic listing standards may list and trade their shares on the exchange without first obtaining separate approval from the SEC, the new rules do not eliminate or change the requirement for actively managed ETFs to obtain an order from the SEC exempting them from various prohibitions contained in the Investment Company Act of 1940. Actively managed ETFs that do not meet the new generic listing standards must continue to rely on the exchange to apply for and receive an order from the SEC before they can be listed.
Previously, Rule 19b-4 of the Securities Exchange Act of 1934 required an exchange that seeks to list an actively managed ETF to file a proposed rule change with the SEC, which subjects the proposed listing to another level of regulatory review. Rule 19b-4 requires the SEC to approve any rule change necessary to list and trade a new derivative securities product on an exchange. ETFs are considered derivatives for this purpose, and thus exchanges had to file an application under Rule 19b-4 before listing actively managed ETFs.
The new generic listing standards include limitations on the types of equity and fixed-income securities that actively managed ETFs can hold, and limitations on use of certain leveraged derivatives. The new generic listing standards also subject actively managed ETFs to minimum capitalizations of portfolio securities and minimum trading volumes for portfolio securities, among other criteria.
The generic listing standards differ from those that apply to index-based funds in several aspects. For example, the generic listing criteria for index fund shares do not permit an ETF to include any non-exchange-traded ADRs in the underlying index, but actively managed ETFs may hold a limited amount of non-exchange-traded ADRs.
In addition, the generic listing standards include a requirement that an actively managed ETF have a stated investment objective, which shall be adhered to under “Normal Market Conditions,” as defined by the exchange. Generally, Normal Market Conditions means circumstances including, but not limited to, the absence of: trading halts in the applicable financial markets generally; operational issues causing dissemination of inaccurate market information or systems failure; or force majeure events, among other things.
The changes also loosen a continuing listing criterion for all actively managed ETFs. That is, managed ETFs will be required to publish Intraday Indicative Values (IIV) at least every 15 seconds, rather than during all times that the ETFs are traded.