Friday, May 31, 2019

Commissioner Peirce shares thoughts on 25 years of ETFs

By Rodney F. Tonkovic, J.D.

SEC Commissioner Hester M. Peirce shared her thoughts on exchange-traded funds at the May 21, 2019 ETFs Global Markets Roundtable. Peirce's speech marked the 25 years since the first ETF was launched in 1993, and she took the occasion to share her views not only how ETFs can be used to facilitate further financial experimentation and innovations but also on how the SEC can fulfill its regulatory role without slowing any of these innovations.

ETFs are all grown up. Peirce, often called "CryptoMom," observed that, while ETFs have matured as an asset class since their 1993 launch, the SEC is "still smothering them with personalized attention as if they were infants." ETFs, she said, now have nearly $4 trillion in total net assets, but acquiring the necessary flexibility under the securities laws has required 300 separate exemptive orders. A 2018 rule proposal codifying these exemptions would level the playing field, she said, and she hopes that the proposal will be finalized in 2019.

"Indecision." Pierce also noted that taking 25 years to come up with a rule for "plain vanilla" ETFs does not bode well for, as an example, ETFs with a cryptocurrency angle. The SEC has been cautious in approving new types of ETFs, and she indicated that the Commission is perhaps overly concerned with the worthiness of these investments. This caution, however, makes it difficult for fund sponsors to plan the launch of a new product "with the great unknown of Commission timing lurking in the background," she said.

As an example of what she called "Commission indecision," Pierce offered the case of requests for exemptive relief for non-fully transparent actively-managed ETFs. The first ETF of this type was authorized on the day before this speech, eight years after the first applicant for exemptive relief to allow a non-fully transparent actively managed ETF publicly filed its application. It "took a considerable amount of time for the Commission to get comfortable," she remarked.

Another example is the Commission’s treatment of leveraged and inverse ETFs, also known as "geared" ETFs. No orders allowing the operation of geared ETFs have been issued since 2008. This moratorium, Peirce explained, seems to be a reflection of the Commission's concern that retail investors might be confused about the performance objectives of these funds. While these concerns are understandable, she continued, the disclosures being made by leveraged or inverse funds to have been "pretty unvarnished" and clearly lay out their investment objective, strategy, risks, and target audience. Moreover, an oligopoly has been created for ETF sponsors that obtained a leveraged or inverse ETF order before the moratorium took effect, and investors are left with limited options for portfolio diversification.

Bitcoin. Finally, Peirce said that she would like to see the Division of Investment Management entertain an exemptive application for an ETF or approve an exchange rule allowing for the operation of crypto ETFs or other exchange-traded products (ETPs). While the Commission has a number of concerns, she said, its role should not be that of arbiter of what constitutes an appropriate investment. Pointing to the disapproved Winklevoss Bitcoin Trust, she said that the Commission should have focused on how the exchange-traded wrapper would work rather than on the underlying characteristics of bitcoin. That said, SEC permission for a cryptocurrency ETP to trade would not be a seal of approval, and investors would still need to do their own homework.