Views on improving the integrity of global capital markets
19 February 2015

Eaton Vance Makes the Cut, BlackRock Doesn’t: Taking Stock of SEC ETF Policy


Perhaps it shouldn’t have come as a great surprise that the US Securities and Exchange Commission (SEC) recently denied BlackRock’s application to create an exchange-traded fund (ETF). After all, the underlying assets would have been hidden from investors. But given the popularity of diverse ETFs and the long review afforded to this particular application, its rejection has raised questions about the future direction of this segment of the market.

Introduced into the market in 1993 as just one of a range of exchange-traded products (ETPs), ETFs have grown in popularity over the years, holding $1.8 trillion in total net assets at the end of June 2014, according to ICI Research Perspective’s Understanding Exchange Traded Funds: How ETFs Work. Originally a straightforward investment vehicle that tracked US equity indexes, ETFs now present a range of options, including those that track a variety of indexes or are synthetic-based. Registered with the SEC as an open-end investment company or unit investment fund, ETFs have provided what many investors find to be a lower-cost way of investing than mutual funds, increasing their appeal especially among retail investors.

The SEC traditionally has required ETFs that are both actively and passively managed to disclose their portfolio holdings on a daily basis. Actively managed ETFs have traditionally shied away from entering the market, believing that requirements for daily disclosing holdings would allow competitors to take advantage of this information and front-run.

So with this concern in mind, together with the recent proliferation of various permutations of ETFs, the SEC’s denial of BlackRock’s application was not expected. BlackRock’s application proposed a new type of ETF that would not have disclosed underlying holdings on a daily basis, although the asset manager intended to keep the fund’s pricing in line with those undisclosed assets. The product potentially would suffer from a lack of accountability on pricing.

Further complicating the public understanding of what qualifies as an “acceptable” ETF structure was the SEC’s approval of an equally opaque ETF application from Eaton Vance. The distinction between the two apparently pivoted on the fact that Eaton Vance’s ETF would not price shares on a real-time basis, instead correlating them to the fund’s “next-determined” daily net asset value (NAV), similar to how mutual funds price. This new structure veers from the traditional ETF into a structure known as “exchange-traded managed funds,” or ETMFs, combining traits of mutual funds and ETFs.

It is unclear what the fine distinction between the two exchange-trade products bodes for the future expansion of this area. SEC staff and commissioners, alike, are directing new attention on the future role of ETFs and exchange-traded products, in general, recognizing the benefits they offer as well as the dangers they may pose.

In a November 2014 speech, SEC Commissioner Kara Stein questioned the effects on the broader market structure of continued growth in ETF market share. She expressed concern that this trend would amplify volatility in underlying securities. The “interconnected web of participants” raise further issues of systemic risk, she added. Both Commissioners Stein and Michael Piwowar have called on the SEC to re-examine ETF policymaking and establish more defined parameters for ETF operation.

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About the Author(s)
Linda Rittenhouse, JD

Linda Rittenhouse, JD, is a director of capital markets policy at CFA Institute. She focuses primarily on issues related to investment products and investment regulation. Rittenhouse holds a JD degree.

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