New standards are expected to simplify and expedite the process of launching an actively managed ETF.

On July 22, the US Securities and Exchange Commission (SEC) issued orders approving proposals by Bats BZX Exchange, Inc. and NYSE Arca, Inc. to adopt generic listing standards for shares of actively managed exchange-traded funds (Active ETFs).^[1] The Orders, which are substantively identical, are expected to ease the regulatory burden and decrease the amount of time associated with bringing Active ETFs to market.

Listing with an Exchange

As a general matter, listing an ETF with an exchange can be accomplished by

• meeting the exchange’s generic listing standards, which generally include provisions pertaining to the market value, trading volume, diversification, and weightings of the ETF’s components; or

• having the exchange file an application with the SEC’s Division of Trading and Markets pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 (Exchange Act) that, if granted, will permit the ETF’s shares to be listed and traded on the exchange.^[2]

Prior to the Orders, generic listing standards were only available to passively managed ETFs (i.e., ETFs that seek to track the performance of a specified index). Thus, issuers of Active ETFs will now be able to take advantage of a simplified, predictable listing process instead of having to undertake the expensive and sometimes uncertain Rule 19b-4 process. The Rule 19b-4 process, which subjects proposed Active ETFs to an additional layer of regulatory review, is widely recognized as a cumbersome process that can take several months and introduce uncertainty into the design of and timeframe for launch of an Active ETF. By eliminating the need to go through the Rule 19b-4 process, the Orders may significantly streamline the process of launching an Active ETF, provided that the Active ETF can meet the new generic listing standards.

The Rule 19b-4 process will still be available for those Active ETFs that cannot or do not wish to meet the generic listing standards. In addition, existing Active ETFs that have already obtained orders under Rule 19b-4 may wish to consider whether relying instead on the generic listing standards under the Orders would provide more or less flexibility with respect to portfolio management.

The Listing Standards

Under the Orders, Active ETFs seeking to rely on the generic listing standards are required to meet the following requirements at the time of listing and on a continuing basis:

Additional Requirements

Active ETFs relying on the generic listing standards are also required to comply with the following requirements:

1. Website Disclosures. The ETF must disclose on its website certain information regarding its portfolio including, as applicable, the following:

2. Investment Objective. Each ETF must have a stated investment objective, which must be adhered to under normal market conditions.^[12] As a practical matter, this does not introduce any new obligations on the ETFs that will use the generic listing standards.

3. Portfolio Indicative Value. A portfolio indicative value must be widely disseminated by one or more major market data vendors at least every 15 seconds during regular trading hours, rather than during all times that the shares trade on the exchange. Operationally, this is no different than how all ETFs are currently set up.

• Ticker Symbol
• CUSIP or other identifier
• Description of the holding
• Identity of the asset upon which the derivative is based
• Strike price for any options
• Quantity of each security or other asset held as measured by select metrics
• Maturity date
• Coupon rate
• Effective date
• •Market value
• •Percentage weight of the holding in the portfolio

Conclusion

Because listing in accordance with the generic listing standards of the Orders may have the effect of significantly streamlining the process of launching an Active ETF, sponsors of Active ETFs should consider taking into account the above-described standards as they develop new products. It is worth noting that the Orders solve only one of the three significant regulatory barriers to entry for Active ETFs—the 19b-4 process. New Active ETFs will still be required to file an application with the SEC to be granted exemptions from certain provisions of the Investment Company Act with which they functionally are not able to comply (e.g., trading at net asset value). In addition, the Orders do not solve the problem of portfolio transparency, which has been a disincentive for many active managers thinking of launching ETFs.^[13] Finally, issuers of existing Active ETFs should consider whether to continue relying on the orders they have obtained under Rule 19b-4 or whether it would be advantageous to rely instead on the generic listing standards of the Orders.^[14]

^{[1] Self-Regulatory Organizations; BATS Exchange, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 6, to Amend BATS Rule 14.11(i) to Adopt Generic Listing Standards for Managed Fund Shares (July 22, 2016); Self-Regulatory Organizations; NYSE Arca, Inc.; Order Granting Approval of Proposed Rule Change, as Modified by Amendment No. 7 Thereto, Amending NYSE Arca Equities Rule 8.600 to Adopt Generic Listing Standards for Managed Fund Shares (July 22, 2016). The orders are referred to collectively herein as “Orders.” On July 25, 2016 NASDAQ Stock Market LLC filed a substantively identical rule proposal with the SEC. See NASDAQ Stock Market LLC; Proposal to Amend Nasdaq Rule 5735 to Adopt Generic Listing Standards for Managed Fund Shares (July 25, 2016).}

^{[2] Under the Exchange Act, exchanges are required to obtain SEC approval for the listing or trading of any new ETF. Rule 19b-4 under the Exchange Act, however, creates an exception from this requirement for ETF shares that meet generic listing standards that have already been approved by the SEC. The Rule 19b-4 process is separate and in addition to the relief ETFs are required to obtain from the SEC exempting them from certain provisions of the Investment Company Act of 1940.}

^{[3] Equity Securities consist of US Component Stocks, Non-US Component Stocks, Derivatives Securities Products, and Index-Linked Securities listed on a national securities exchange.}

^{[4] A US Component Stock is an equity security registered under Sections 12(b) or 12(g) of the Exchange Act or an ADR, the underlying equity security of which is registered under Sections 12(b) or 12(g) of the Exchange Act.}

^{[5] A Non-US Component Stock is an equity security not registered under Sections 12(b) or 12(g) of the Exchange Act and that is issued by an entity that (a) is not organized, domiciled or incorporated in the United States, and (b) is an operating company (including REITs and income trusts, but excluding investment trusts, unit trusts, mutual funds, and derivatives).}

^{[6] Derivatives Securities Products include shares of ETFs, portfolio depository receipts, and trust issued receipts; Index-Linked Securities Products include securities linked to the performance of indexes and commodities, such as exchange-traded notes.}

^{[7] Any security or class of securities (other than options) for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan.}

^{[8] Fixed Income Securities are debt securities that consist of notes, bonds, debentures or evidence of indebtedness that include, but are not limited to, US Department of Treasury securities, government-sponsored entity securities (GSE Securities), municipal securities, trust preferred securities, supranational debt and debt of a foreign country or a subdivision thereof, investment grade and high yield corporate debt, bank loans, mortgage and asset backed securities, and commercial paper.}

^{[9] Cash Equivalents include short-term instruments with maturities of less than 3 months. Short-term instruments include the following: (i) US Government securities, including bills, notes and bonds differing as to maturity and rates of interest, which are either issued or guaranteed by the US Treasury or by US Government agencies or instrumentalities; (ii) certificates of deposit issued against funds deposited in a bank or savings and loan association; (iii) bankers’ acceptances, which are short-term credit instruments used to finance commercial transactions; (iv) repurchase agreements and reverse repurchase agreements; (v) bank time deposits, which are monies kept on deposit with banks or savings and loan associations for a stated period of time at a fixed rate of interest; (vi) commercial paper, which are short-term unsecured promissory notes; and (vii) money market funds.}

^{[10] Listed Derivatives include futures, options and swaps on commodities, currencies and financial instruments (e.g., stocks, fixed income, interest rates, and volatility) or a basket or index of any of the foregoing.}

^{[11] Over-the-Counter (OTC) Derivatives include forwards, options and swaps on commodities, currencies and financial instruments (e.g., stocks, fixed income, interest rates, and volatility) or a basket or index of any of the foregoing.}

^{[12] The Orders define “normal market conditions” as circumstances including, but not limited to the absence of: trading halts in the applicable financial markets generally; operational issues causing dissemination of inaccurate market information or systems failure; or force majeure type events such as natural or man-made disaster, act of God, armed conflict, act of terrorism, riot or labor disruption, or any similar intervening circumstance.}

^{[13] Indeed, growth in the number and net assets of index based ETFs has far outpaced that of Active ETFs. See Investment Company Institute, 2016 Investment Company Fact Book 200-201 (2016).}

^{[14] To the extent an Active ETF wishes to begin relying on the generic listing standards instead of a previously-obtained Rule 19b-4 order, it may wish to consider coordinating with the listing exchange in advance to effect such change.}