On June 12, 2015, the SEC issued a release (the “Release”) seeking public comment relating to the listing and trading of exchange-traded products (“ETPs”), which include exchange-traded funds (including open-end funds and unit investment trusts, in each case registered under the 1940 Act), pooled investment vehicles (including commodity trusts and partnerships that are registered under the Securities Act but not the 1940 Act) and exchange-traded notes (senior debt instruments issued by a financial institution that pay a return based on the performance of a reference asset), and the sale of these products by broker-dealers. Unlike the SEC’s previous requests for public comment, the Release focuses on a broader group of ETPs—not just 1940 Act-registered exchange-traded funds (the largest category of ETPs)—and the oversight of the products under the Exchange Act. Citing the “enormous growth” in the number, aggregate market capitalization and variety of ETPs, including the increasing scope and complexity of ETP investment strategies in recent years, the SEC solicited public comment on 53 specific multi-part requests, divided into the following categories:
- Arbitrage and Market Pricing: The SEC requested comment on all aspects of the ETP arbitrage mechanism, including the nature, extent and potential causes of premiums and discounts across the ETP spectrum. Specifically, the Release sets forth 18 multi-part requests for comment on the efficient and effective use of the ETP arbitrage mechanism. In the Release, the SEC noted its reliance upon ETP sponsor representations regarding the continued effectiveness and efficiency of arbitrage mechanisms when considering whether to grant exemptive relief under the Exchange Act. Issues identified for comment in this category include whether a listing exchange should have an obligation to monitor the effectiveness of an ETP’s arbitrage mechanism on an ongoing basis and whether and ow arbitrage mechanisms may affect trading in underlying or reference assets (including whether this varies by underlying asset type).
- Exemptive and No-Action Relief under the Exchange Act: Rules 101 and 102 of Regulation M under the Exchange Act generally prohibit distribution participants, issuers, selling security holders and their affiliated purchasers from purchasing, bidding for or attempting to induce others to purchase or bid for covered securities during the restricted period of a distribution of securities. Because ETPs are in continuous distribution, they generally, on an ongoing basis, need to meet the conditions of the Regulation M relief that has been extended to them and to meet the representations made in seeking relief under Regulation M. The SEC requested comment on the application of Rules 101 and 102, noting the increased complexity of ETP investment strategies and the expanded types of underlying assets. Specifically, the SEC sets forth three multi-part requests for comment on approaches for preventing manipulation of ETP distributions by persons who may be incentivized to do so in light of the increasingly complex products and markets. The SEC also invites comment through four multi-part requests on existing conditions pertaining to ETP exemptive and no-action relief.
- Exchange Listing Standards: The SEC requested comment on the interplay between the national securities exchanges and the SEC in determining whether the proposed listing and trading of ETPs is consistent with the Exchange Act. The nine multi-part requests for comment generally relate to whether the SEC’s and the exchanges’ independent obligations complement each other or overlap, and if they overlap, how the responsibilities should be more appropriately allocated.
- Broker-Dealer Sales Practices and Investor Use of, and Understanding of, ETPs: The Release also requests comment on the practices of broker-dealers in recommending or selling ETPs to retail investors. The 15 multi-part requests for comment generally relate to how broker-dealers meet their obligations to customers and the extent to which investors’ investment decisions are based on such broker-dealer recommendations. The Release also seeks comment on the extent to which individual investors understand the nature and operation of ETPs and on the ways ETPs are used by investors. For instance, the Release asks whether investors understand the arbitrage mechanisms of ETPs and whether there are aspects of such mechanisms that should be prominently disclosed to investors.
The comment period ended on August 17, 2015. The Release is available at: https://www.federalregister. gov/articles/2015/06/17/2015-14890/request-for-comment-on-exchange-traded-products.