On July 22, 2016, the SEC issued orders to BATS Exchange, Inc. (BATS) and NYSE Arca, Inc. (NYSE Arca) approving proposed rule changes to adopt generic listing standards for actively managed exchange-traded funds (ETFs). The orders will enable the exchanges to list actively managed ETFs that satisfy the applicable criteria without first having to seek separate approval from the SEC’s Division of Trading and Markets.

Section 19(b) of the Exchange Act requires a self-regulatory organization – including BATS, NYSE Arca and other exchanges – to obtain SEC approval for “any proposed rule or proposed change in, addition to, or deletion from” existing rules of the exchange. Since the listing or trading of a new securities derivative product qualifies as a proposed rule change, and ETFs are deemed to be “derivative products” for this purpose, exchanges, on behalf of an ETF sponsor, must seek SEC approval in order to launch a new ETF by submitting a rule change proposal with the SEC pursuant to Rule 19b-4 under the Exchange Act. This process, which can take several months or longer, can create uncertainty for the ETF sponsor.

Rule 19b-4(e) under the Exchange Act provides an exception from this requirement for ETF shares that satisfy “generic listing standards” that have already been approved by the SEC. In this connection, the SEC has already approved rule changes for several exchanges enabling passively managed, index-tracking ETFs that meet the generic listing requirements to be listed without SEC approval. However, prior to issuing the orders to BATS and NYSE Arca, the SEC had not approved generic listing standards for an actively managed ETF.

The generic listing standards in the orders to BATS and NYSE Arca generally codify various restrictions on portfolio composition that commonly appeared in the SEC’s prior Rule 19b-4 orders for actively managed ETFs and are based on the generic listing standards applicable to index-based ETFs. The standards establish portfolio requirements and limitations which vary based on asset class and relate to, among other things, in the case of equity securities, minimum market capitalization, minimum trading volume, portfolio weightings, number of issuers and issuer listing requirements, with certain differences in criteria for U.S. versus non-U.S. stocks. Similarly, an actively managed ETF’s fixed income portfolio securities must satisfy minimum original principal amount and other issuer criteria. The generic listing standards also set forth criteria for the portion of an actively managed ETF’s portfolio represented by derivatives, with key distinctions in the treatment of listed vs. over-the-counter derivative instruments. Listed actively managed ETFs will be required to meet the applicable portfolio composition requirements both at the time of listing and on an ongoing basis.

The exchanges will still be required to apply for relief before listing actively managed ETFs that do not meet the new listing standards. In addition, actively managed ETFs themselves will continue to be required to obtain exemptive relief under various provisions of the Investment Company Act, which would not otherwise allow the ETF structure.

The generic listing standards for actively managed ETFs also include expanded website portfolio disclosure requirements, require that intra-day indicative values for actively managed ETFs be widely disseminated by one or more major market data vendors at least every 15 seconds during the trading day, and require each actively managed ETF to adopt a stated investment objective to be adhered to during “normal market conditions.” In general, “normal market conditions” means the absence of trading halts in the applicable financial markets, operational issues such as systems failures causing the dissemination of inaccurate market information or force majeure events.

The SEC order issued to BATS is available at: https://www.sec.gov/rules/sro/bats/2016/34-78396.pdf.

The SEC order issued to NYSE Arca is available at: https://www.sec.gov/rules/sro/nysearca/2016/34-78397.pdf.