Roye Outlines SEC's ETF Agenda
January 21, 2002
The Securities and Exchange Commission's comment period on actively managed exchange-traded funds ended last week, but the new type of ETFs that will likely soon be approved by the Commission are those based on fixed-income indices.
The SEC has worked out most of the nuances involved with fixed-income ETFs and they are likely to be approved soon, said Paul Roye, director of the SEC's division of investment management, speaking before executives attending an American Stock Exchange conference in New York.
Last June, Barclays Global Investors filed applications for five fixed-income iShares based on Lehman Brothers' treasury indices, said Christine Hudacko, a spokeswoman for Barclays (MFMN 7/10/01). At the time, Hudacko anticipated that the SEC would approve the new products in the fourth quarter of 2001.
"Clearly, the next thing will be the fixed-income products," Roye said. "There are some unique issues, but they're things we could get our arms around."
There are several issues that are unique to fixed-income indices, Roye said. The Commission had to consider what types of fixed-income securities would make up the ETF and if they would offer sufficient liquidity. Also, trading fixed-income securities involves different mechanisms for settling and clearing, he said. Finally, the issue of credit risk had to be examined, especially for ETFs that will be based on junk bonds and other less stable investments.
Actively managed ETFs are not as clear, although "as chairman [Harvey] Pitt has stated, the Commission will not stand in the way of innovation," Roye said. The main issue with active ETFs is the disclosure of the product's portfolio holdings, which do not pose a problem with the index-based funds, but hinder active management. The Commission is reviewing the comments received on the concept release it issued in November 2001. (See sidebar on comments from Barclays and the ICI)
The SEC has already received applications from two separate fund companies for leveraged ETFs, Roye said. While the products would essentially be passively managed, they are being viewed as active ETFs because they do not seek to match the performance of an index, but rather seek to double its performance, he said.
Another ETF development that Roye hinted at was the possibility of the Commission amending the Investment Company Act of 1940 to allow companies to launch ETFs without having to secure an exemptive order every time they want to issue a new product. As it stands now, ETFs have to file for exemptions from the 40 Act because the shares are not individually redeemable, they use exchange-negotiated prices and they offer in-kind transactions with affiliates.
The SEC has already granted "prospective relief" for ETFs within a series. If a company has already received an exemptive order for an ETF, it can file for further similar ETFs based on other indices without having to apply for additional exemptive orders. Amending the 40 Act, however, would streamline the process even more.
"We're always looking for ways to fast-track things," Roye said. "What we typically try to do when we've had enough experience in an area is to codify the rules of the orders pertaining to an issue. If we anticipate enough interest, we would seriously look to recommend a rule to the Commission in the area."
There are several global developments for ETFs to look for this year as well. Last year, Japan amended its investment trust regulation to allow for ETFs. However, they are only allowed to track Japanese indices, such as the Nikkei or TOPEX, said Shunzo Kayanuma, general manager of the Tokyo Stock Exchange.
"This year, our government is flexible enough to expand that and allow us to trade ETFs on other indices," said Kayanuma.
Fixed-income indices have generated a lot of interest in Europe, and the creation of those indices will result in ETFs, said Vincent Remay, director of strategic marketing for Euronext Paris S.A. Euronext is the first pan-European exchange.
"People are more and more interested in a bond index," Remay said. "I think we'll see in the near future some bond indices and as soon as we see the bond indices, we'll see Trackers, [Euronext ETFs] on it. This year for sure."