The ETF Transparency Issue: Part 1

Recently an application for exemptive relief was filed for active ETFs. What makes this application noteworthy is that the sponsor is proposing to not disclose the funds’ holdings each day. This clearly would make them quite different from current ETFs (active and passive), which have daily disclosure of fund holdings as a condition of their exemptive relief.  This raises many intriguing issues which we will attempt to tackle in the next few blogs. First, though, lets deal with some background on this idea.

The concept of less frequent disclosure of fund holdings for an active ETF is not a new one. In fact, the NYSE (through the now-acquired Amex), and this author, became involved with this issue back in 1999. In addition, the SEC issued a Concept Release regarding active ETFs in 2001 which discussed the subject at some length. That Concept Release can be found here. Since that time, there have been several exemptive relief applications submitted to the SEC which have contemplated not disclosing fund holdings on a daily basis. All are still pending approval. This recent application is the latest to join that group.

This idea of less than daily disclosure has come to be termed by many in the ETF industry as “non-disclosed”. In fact, this is a misnomer. The reason is quite simple. In every case that we are aware of the issuer asking for this exemptive relief anticipates providing disclosure of fund holdings AT LEAST as often as is required of current open-end mutual funds. Thus, while these proposed active ETFs would have less transparency regarding daily fund holdings than current ETFs, the use of the term “non-disclosed” is certainly not accurate.

It’s also important to understand that the primary purpose served by disclosure is to provide market participants with sufficient information for the ETF to trade effectively. In general terms, this means that no matter what information is given to the market, it is important that it be sufficient to provide for the efficient functioning of the arbitrage mechanism inherent in the ETF market structure such that:

  1. The prices at which intra-day trades take place remain close to the underlying value of the fund.

  2. The “spread” between bid and offer prices quoted intraday are “tight”.

Thus, daily disclosure of fund holdings serves as an information disclosure process for the market. As evidenced by current ETFs, this process certainly would appear to provide the necessary information for effective trading to occur. However, the group of applications proposing less than daily disclosure are maintaining that it is not the only process that accomplishes these goals.

Another misconception is that daily disclosure of fund holdings is the only information disclosure process that the SEC is willing to contemplate for listing an ETF. Not true. Daily disclosure of fund holdings is an information disclosure process that the SEC has been comfortable with, but, as the Concept Release cited above makes clear, they are also willing to consider other methods for disclosing information to the marketplace in order to allow an ETF to trade effectively. It is true that daily disclosure is the only process that has made it through the approval process to date, but other processes are being considered.

In the next  blog, we’ll attempt to delve more deeply into why the disclosure process is even an issue.

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