Transparency—along with liquidity and low fees—is one of a trio of exchange-traded fund (ETF) advantages often touted by their manufacturers. And the U.S. Securities and Exchange Commission (SEC) aims to keep it that way, at least for now. Last week, the U.S. regulator rejected a proposal by BlackRock to launch a non-transparent ETF. The ETF provider is seeking to launch a fund that is permitted to keep its holdings hidden from investors.
It’s a key move in the ETF industry, which is looking to go beyond index-tracking funds and into active management—a move that would broaden its customer base. The problem right now is the fact that ETFs are required to make public their holdings on a daily basis—for an active manager, that makes it tough to get ahead of the market and leaves them open to other traders who might want to copy their strategies on a day-to-day basis.
The SEC listed a number of concerns in 60 pages of analysis, including the fact that the proposal to sidestep daily disclosure requirements didn’t provide a suitable alternative to the arbitrage activity in ETF shares that keeps them trading at the value of their underlying securities. Here’s what it says:
…the specific features proposed by the Applicants that would cause the proposed ETFs to operate without transparency fall far short of providing a suitable alternative to the arbitrage activity in ETF shares that is crucial to helping keep the market price of current ETF shares at or close to the NAV per share of the ETF. The Commission preliminarily believes that it is not in the public interest or consistent with the protection of investors or the purposes fairly intended by the policy and provisions of the Act to grant the exemptive relief under section 6(c) that the Applicants seek
The SEC is here referring to market makers—the people who work behind the scenes to keep the ETF universe moving. According to the SEC, lack of information about underlying portfolios could discourage market makers from doing what they need to do—making markets—particularly in times of stress, “when the need for real-time and verifiable pricing information becomes more acute,” said the notice.
BlackRock most certainly isn’t the only provider seeking to launch a non-transparent ETF—T. Rowe Price and Eaton Vance have also submitted proposals. Active ETFs account for less than 1% of U.S. ETF assets and, of those, most invest in bonds, where transparency is less of an issue.
Later last week, the SEC also rejected a proposal by NYSE Arca that would allow the exchange to actually trade non-transparent ETFs.
Whether or not the industry will be able to come up with a proposal that works for the SEC remains to be seen. Until then, it’s back to the drawing board.