SEC Rejects Non-Transparent ETFs in Setback for Industry

U.S. regulators rejected a proposal by NYSE Arca Inc. to allow trading of a new type of exchange-traded fund, the second setback this week to investment firms’ plans to expand ETFs beyond passive products.

The U.S. Securities and Exchange Commission disapproved a Feb. 7 request by NYSE Arca, a unit of Intercontinental Exchange Inc., for a rule change that would have allowed the listing of managed portfolios, or shares of funds that disclose holdings quarterly instead of daily, according to a letter yesterday on the regulator’s website.

The ruling follows a preliminary decision this week by the SEC denying requests by BlackRock Inc. and Precidian Investments for non-transparent ETFs.

Firms including Capital Group Cos. have asked for approval of similar products as they seek to expand offerings in the fastest-growing product in the asset-management industry. Money managers have argued that the requirement for daily disclosure of holdings would make it easy for competitors to copy, and traders to anticipate, a manager’s portfolio changes.

The agency found that the change proposed by NYSE Arca wasn’t consistent with the exchange act requiring rules “designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and to protect investors and the public interest,” the SEC wrote. Additionally, approving trading in the ETFs would require exemptive relief for the product, which the SEC just ruled against.

Filings ‘Drumbeat’

“These filings are a drumbeat against active ETFs,” Todd Rosenbluth, director of mutual-fund and ETF research at S&P Capital IQ in New York, said in a telephone interview. “This commission appears to be quite concerned about the trading and liquidity and efficiency of this structure.”

NYSE had proposed to list and trade shares of the ActiveShares Large-Cap Fund, ActiveShares Mid-Cap Fund, and ActiveShares Multi-Cap Fund, all issued by Bedminster, New Jersey-based Precidian.

Daniel McCabe, Precidian’s chief executive officer, declined to comment on the decision.

The Precidian proposal for a non-transparent, actively managed ETF fell “far short of providing a suitable alternative to the arbitrage activity in ETF shares that is crucial to helping keep the market price of current ETF shares at or close” to its net asset value, Kevin O’Neill, a deputy secretary at the SEC, wrote in a letter dated Oct. 21 outlining the earlier ruling.

Attracting Scrutiny

ETF providers must disclose holdings every day to enable market makers to execute trades that keep the share price in line with the underlying value of the fund’s assets. Firms including BlackRock, Precidian and Guggenheim Partners LLC proposed structures that they say would allow the funds to remain priced in line with assets, without revealing specific positions.

T. Rowe Price Group Inc. in Baltimore and Boston-based Eaton Vance Corp. are also among fund firms still seeking SEC approval for non-transparent active ETFs. None of the applications has been approved.

Actively managed ETFs account for less than 1 percent of U.S. ETF assets and are dominated by products that invest in bonds. Transparency is less of an issue on the fixed-income side, where the opacity and negotiated nature of transactions in the over-the-counter bond market protect managers.

ETFs have attracted regulatory scrutiny as assets surged more than 10-fold in the U.S. over the past decade to $1.7 trillion as of the end of 2013, according to the Investment Company Institute. The products are bundles of securities that trade on an exchange, like stocks. Investors in most mutual funds can buy or sell shares once a day, typically after markets close, and only directly with the fund.

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