SEC Proposed Rule 6c-11
New rules are typically bad for business, but rule 6c-11 as proposed by the SEC would actually be great for the ETF industry!
Currently, the process to create and launch a new ETF is difficult, time consuming, and expensive. Once a new issuer has an idea for an ETF, they must get an exemption from the Investment Company Act of 1940. Getting this exemption typically takes 12-18 months and the SEC has awarded different companies more or less favorable exemptions. These favorable exemptions have enabled a small selection of ETF issuers to gain a dominant place in the industry. Rule 6c-11 as proposed by the SEC on 6/28/18 seeks to level this playing field. If approved it will be a huge win for small ETF issuers and ETF investors.
Small ETF issuers would be able to realize their vision of launching a new ETF in a much shorter time frame at a much lower expense. This should lead to a significant uptick in the number of ETFs issued per year. This will likely also lead to a significant uptick in the number of ETFs closed each year. Rule 6c-11 will make it easier for ETF issuers to experiment with new products and then close the products if they fail to build significant assets. Currently, many ETF issuers white label the ’40 Act exemption owned other companies. These companies receive a percentage of the ETF management fee as compensation. If ETF issuers can launch an ETF quickly and cheaply through Rule 6c-11, I would expect management fees across the industry to drop.
Rule 6c-11 will allow the use of custom baskets. Currently, when an ETF is issued, the Authorized Participant aggregates all of the securities that make up the ETF and exchanges those securities with the ETF issuer. Currently, unless the issuer has a special exemption, the basket of securities must exactly match the securities that are actually held by the ETF. In fixed income where the actual holdings are thinly traded, this action may be super expensive or even impossible. By allowing all ETF issuers to use custom baskets, the cost of recreating a given fixed income basket will drop significantly which will lead to a tighter bid/ask spread and ultimately better performance for the investor.
Rule 6c-11 will be good for investors as it will not only lower management fees but also expand the breadth of the industry. New asset classes and new segmentations of existing asset classes will emerge. The largest ETFs will remain large, but this new rule could offer the proverbial ‘little guy’ a chance.