SEC’s Proposed ETF Rule Removes Some Conditions Compared to Prior Exemptive Orders, But Adds Others

ETF Update

Date: August 01, 2018

Key Notes:

  • Proposed rule 6c-11 omits representations and conditions contained in prior exemptive orders, including the requirement for the dissemination of an intraday indicative value and certain marketing requirements.
  • The rule also includes additional requirements not found in prior orders, including those relating to custom baskets and website disclosures.

All exchange-traded funds (ETFs) operate subject to a variety of conditions and required representations imposed by their respective exemptive orders they received from the Securities and Exchange Commission (SEC). While ETFs would be spared the expense and delay of obtaining an exemptive order if newly proposed rule 6c-11 under the Investment Company Act of 1940 (1940 Act) is adopted, they nevertheless would be required to satisfy a number of conditions. We compare and contrast the representations and conditions imposed by exemptive orders with those in the proposed rule 6c-11, including new requirements that the proposed rule would add.[1]

Present ETF Exemptive Order Representations and Conditions Compared to Proposed Rule 6c?11’s Conditions

Required representations and conditions in ETF exemptive orders issued since 1992 have evolved and expanded over time. We focus on the representations and conditions found in recent exemptive orders issued within the past year, excluding conditions associated with Section 12(d)(1) relief and master-feeder relief, as both of these were not addressed in the proposed rule.

Exemptive relief for ETFs granted by the SEC’s Division of Investment Management generally falls into two categories: active and passive. Within the category of passive ETFs are subcategories of ETFs that follow specialized indices, such as those created by an affiliated index provider (self-indexed ETFs), or those that follow indices that are designed to emulate long/short or 130/30 strategies (long/short ETFs).

Under proposed rule 6c-11, any active or passive ETF, including self-indexed ETFs and long/short ETFs, can rely on the rule instead of filing an application for an exemptive order, provided that it can meet the conditions of the rule. The chart in the appendix summarizes and compares the significant representations and conditions from recent active and passive ETF exemptive orders with the conditions of proposed rule 6c-11. The significant differences are discussed below.

Marketing Condition

Unlike prior active and passive ETF exemptive orders, proposed rule 6c-11 would no longer require ETFs to identify themselves as such in advertising. Furthermore, the proposed rule would not require ETFs to prominently disclose that the shares are not individually redeemable if advertising refers to redeemability or describes how creation units are purchased or redeemed. The proposing release notes that this requirement was dropped because general familiarity with ETFs has increased in the 26 years since ETFs have become available in the marketplace.

Although this condition was dropped from proposed rule 6c-11, the proposed revisions to Form N-1A would require additional disclosures about the nature of ETF trading on an exchange, and about the expenses associated with purchasing and selling ETF shares on the exchange, including information about brokerage costs and spreads.

T+1 Disclosure of Trades and Inclusion in Net Asset Value (NAV)

Proposed rule 6c-11 would require disclosure of trades in the ETF’s portfolio the next business day (T+1), and that the ETF include those trades in the ETF’s NAV for that day. Previously, ETF applicants represented that current accounting procedures would result in such disclosure and NAV treatment. Because this condition of proposed rule 6c?11 is not tied to applicable accounting rules or procedures, if the rule is adopted in its current form, ETFs would arguably lose the flexibility to change this practice if accounting rules or procedures for investment companies change in the future.

Intraday Indicative Value (IIV)

Proposed rule 6c-11 would not require the dissemination of an IIV. This measure is intended to help arbitrageurs in deciding whether or not to create or redeem shares of an ETF. The SEC recognized the limited use of the IIV by market makers, who use IIV, if at all, only as a fall-back check on their own calculations.

Custom Basket Conditions

An ETF issues or redeems blocks of shares called “creation units” in exchange for a basket of securities, assets or other positions (baskets). Proposed rule 6c-11 would replace cumbersome conditions and limitations on the use of “custom baskets” and cash-in-lieu of securities in the ETF’s portfolio contained in recent ETF exemptive orders with required policies and procedures governing the use of custom baskets (i.e., (i) if baskets that are not representative of an ETF’s holdings are used or (ii) if different baskets representative of an ETF’s holdings are used on the same day in transactions with different authorized participants). The SEC noted in the proposing release that the proposed rule provides more flexibility for ETFs to use custom baskets to enable more efficient portfolio management (e.g., fixed income ETFs that track a bond index would not need to accept or redeem thinly traded bonds included in the index). [2] This flexibility is somewhat limited because the proposed rule defines custom basket to include any basket that is not uniformly used in transactions with authorized participants on the same day (including substituting a cash-in-lieu amount for certain securities in the basket for one authorized participant but not others transacting on the same day). Under prior ETF exemptive orders, a permitted cash-in-lieu portion did not necessarily need to be uniform across authorized participants.

Self-Indexed ETFs and Long/Short ETFs

Proposed rule 6c-11 would not impose additional conditions on ETFs that seek to track an affiliated or long/short index (self-indexed ETFs), although the proposing release specifically requested comment on whether the SEC should impose conditions on self-indexed ETFs. Self-indexed ETFs that have received exemptive orders also made additional representations largely tied to existing requirements of the 1940 Act and Investment Advisers Act of 1940 (Advisers Act) and rules thereunder. These representations concerned required compliance policies and procedures, codes of ethics, and confidentiality of information received by the adviser to the self-indexed ETF, including with respect to securities included in the basket.

Prohibition of Certain Affiliated Transactions

Prior active ETF and self-indexed ETF orders contain a condition that prohibits indirect affiliate transactions in basket assets caused by an ETF’s adviser or sub-adviser through an authorized participant or the investor on whose behalf the authorized participant is acting. The omission of this condition is not discussed in the proposing release. Except for the limited exemption in proposed rule 6c-11 with respect to purchases and redemptions by authorized participants owning greater than 5 percent of an ETF’s voting securities, existing affiliate restrictions applicable to ETFs and other investment companies would apply to transactions between the ETF and its affiliates.

Additional Conditions and Other Requirements in Proposed Rule 6c-11

Proposed rule 6c-11 contains significantly new website disclosure requirements (e.g., presenting additional information about portfolio holdings in the manner prescribed in Article 12 of Regulation S-X) and recordkeeping requirements (e.g., maintenance of agreements with authorized participants and information about basket transactions) that were not contained in prior exemptive orders (see our July 9 Update for a discussion of these requirements).


Although certain representations and conditions have been dropped from proposed rule 6c-11, the proposing release includes a multitude of questions and requests for comment, including in areas covered by these omissions. As a consequence, some version of the omitted requirements may be restored in the final version of the rule depending on the nature of the comments.


For more information, please contact:

Bibb Strench

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Representation or Condition in Recent Active and Passive ETF Exemptive Applications

Condition in Proposed Rule 6c-11

ETF is an open-end fund (i) that issues and redeems creation units in exchange for a basket and cash balancing amount, if any and (ii) whose shares are listed on a national securities exchange and traded at market determined prices.

Same condition in the rule.

The ETF will not be advertised or marketed as an open-end investment company or a mutual fund and advertising material must contain disclosures about redeemability.

No comparable condition in the rule.

The ETF’s website will disclose:

  1. the prior business day’s NAV
  2. the market closing price or bid/ask price of the shares
  3. a calculation of the premium or discount of the market closing price or bid/ask price against such NAV
  4. with respect to active ETFs, self-indexed ETFs and long/short ETFs, prior to the commencement of trading, the ETF’s portfolio assets that will form the basis of the fund’s calculation of NAV at the end of the business day
  5. each business day, before market opening, the ETF will cause to be published through the NSCC the names and quantities of the instruments comprising the basket, as well as the estimated cash balancing amount (if any), for that day

The ETF’s website will disclose:

  1. the prior business day’s NAV
  2. the “market price,” defined as the official closing price or the midpoint of the national best bid offer, calculated as of the time NAV is calculated
  3. a calculation of the premium or discount of the market closing price or bid/ask price against such NAV
  4. with respect to all ETFs, before market opening and accepting orders for purchase or redemption of creation units:
    1. the portfolio assets that will form the basis of the fund’s calculation of NAV at the end of the business day
    2. the basket
    3. the estimated cash balancing amount, if any
  5. a table showing the number of days the ETF’s shares traded at a premium or discount during the prior year and prior quarters since that year
  6. a line graph showing ETF share premiums or discounts for the prior year and prior quarters since that year
  7. if the ETF’s premium or discount is greater than 2% for more than seven consecutive trading days, a discussion of the factors that contributed to the premium or discount
  8. the description, amount, value and unrealized gain/loss in the manner prescribed within Article 12 of Regulation S-X for each portfolio holding or basket asset

Under accounting procedures followed by the ETFs, prior business day trades will be booked and reflected in NAV on the current business day (T+1).

An ETF must reflect changes in its portfolio holdings in the first calculation of NAV on T+1.

Each listing exchange or other major market data provider will disseminate, every 15 seconds during regular exchange trading hours, the IIV.

No comparable condition in the rule.

With respect to creations and redemptions of creation units in exchange for baskets:

  1. The baskets will correspond pro rata to the positions in the ETF’s portfolio (including cash positions) except in certain limited circumstances.
  2. Purchases and redemptions of creation units may be made in whole or in part on a cash basis, rather than in-kind, only in certain limited circumstances.

An ETF must 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; provided, however, if the ETF uses custom baskets, the policies and procedures must meet additional requirements.

With respect to self-indexing ETFs:

  1. Each adviser and any sub-adviser has written policies and procedures designed to prevent violations of the Advisers Act and the rules thereunder, procedures to prevent the misuse, in violation of the Advisers Act or the Securities Exchange Act of 1934 or the rules thereunder, of material non-public information by the adviser or associated persons, and codes of ethics pursuant to rule 17j-1 under the 1940 Act and rule 204A-1 under the Advisers Act.
  2. The self-indexed ETF has confidentiality agreements with any of its service providers who are provided information on the basket.
  3. The portfolio managers responsible for day-to-day portfolio management of the self-indexing ETFs and any account following a self-indexed ETF’s affiliated index and their supervisors will be employees or officers of an adviser or a sub-adviser.
  4. Neither any adviser nor any sub-adviser will receive incentive fees for outperforming the underlying index of any self-indexing fund or affiliated account.
  5. To the extent the self-indexing funds transact with an affiliated person of an adviser or sub-adviser, such transactions will comply with the 1940 Act, the rules thereunder and the relevant exemptive order.
  6. Each self-indexing fund's board will periodically review the self-indexing fund's use of an affiliated index provider.
  7. Any services provided by an adviser, adviser affiliates, sub-adviser and sub-adviser affiliates will be performed in accordance with the provisions of the 1940 Act, the rules thereunder and SEC guidelines.

No comparable condition in the rule.

For active and self-indexed ETFs, no adviser or sub-adviser, directly or indirectly, will cause any authorized participant (or any investor on whose behalf an authorized participant may transact with the ETF) to acquire any basket asset through a transaction in which the ETF could not engage directly.

No comparable condition in the rule.

[1] For previous coverage of proposed rule 6c-11 generally, see the July 9, 2018 Thompson Hine client update, “Proposed ETF Rule Comes with Widely Expected Conditions and Some Notable Twists.” Thompson Hine ETF’s practice group will delve into the other issues that rule 6c-11 raises in subsequent alerts.

[2] An “authorized participant” is a broker-dealer or bank or participant of a clearing agency, 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. Only authorized participants may place such orders.

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