SEC Chairman Jay Clayton is working to streamline the agency’s ad hoc approach to approving new ETFs, putting a spotlight on an issue that has vexed the regulator for a decade.
Clayton, who joined the SEC in May, has asked staff to build upon a proposal that was nearly adopted before the 2008 financial crisis doomed its chances, three people familiar with the matter said. A new rule would likely be welcomed by much of the mutual fund industry, which often complains about the costs and how long it takes to get the agency’s sign-off.
“It’s about time,” said Paul Atkins, a former SEC commissioner who consults for some asset management firms as head of Patomak Global Partners. “People need to know what the rules are.”
The SEC has never developed comprehensive policies governing ETFs, which are similar to mutual funds but trade like stocks, even as more small investors have poured money into the products. As the funds have grown into a $3 trillion market in the U.S., companies have designed increasingly complicated products to offer more variety and compete for customers seeking higher returns.
While ETFs started as a way to buy into indexes like the S&P 500 and pay minimal fees and taxes, investors now can buy funds that employ strategies like leverage or short selling or focus on narrow, thinly-traded market sectors.
Those developments have raised concerns at the SEC that investors may not fully understand what they’re buying. Regulators also have looked into instances where ETFs trade differently from their underlying assets. Critics argue that the funds could exacerbate a market sell off.
Supporters in the industry have long urged the SEC to lay out formal steps for approving ETFs, ending the practice of having every firm that wants to start one apply and wait for a special order from the agency that allows them to operate.
The current approach gives more established firms a leg up because they can afford to shoulder the legal costs and often lengthy wait, critics say. The process also makes poor use of SEC resources, they say, because agency staff members have to spend a lot of time approving “plain vanilla” ETFs instead of focusing on more complex vehicles that might pose problems.
Money managers, including Goldman Sachs, which started its first ETF in 2015, and Pimco, have been lobbying for more flexibility in setting up the funds. Mark Wiedman, global head of BlackRock’s iShares business, said in an interview last month that the current process has created “an unlevel playing field.”
Chris Carofine, an SEC spokesman, declined to comment.
Completing a regulation would “speed up the process” and “save significant expense for investors,” said Norm Champ, a partner at law firm Kirkland & Ellis who formerly ran the SEC’s investment management unit.
The SEC tried most recently in 2008, proposing a rule designed to “eliminate unnecessary regulatory burdens” and set clear guidelines for issuing new ETFs. The proposal would have allowed mutual funds to increase their investments in the products. It also covered ETFs that mimic returns of a particular benchmark as well as actively-managed products.
The plan was shelved as the agency dealt with the financial crisis and its aftermath.
Nearly a decade later, the stars may be aligned for action at the SEC.
While Clayton is charged with scaling back financial rules, new ETF regulations might be embraced by Republicans in Congress and the White House because they could be promoted as cutting red tape.
To lead the effort, Clayton hired ETF specialist Dalia Blass to run the investment management unit. Blass, who worked on the earlier proposal as an SEC staff member. rejoined the agency in September after a stint at law firm Ropes & Gray. The firm advised Tyler and Cameron Winklevoss on their failed bid to win approval for a bitcoin ETF.
Blass has told some industry executives that the SEC is moving quickly on an ETF rule, according to one of the people. She also noted that Clayton prioritized ETF regulation in an outline of his regulatory agenda submitted last month to the Trump administration, the person said. The document hasn’t yet been made public.
In addition, the Trump administration has signaled its support. In a report released Oct. 26, the Treasury Department said the SEC should re-propose the 2008 plan or write a new one to allow entrants access to the market “without the cost and delay of obtaining exemptive relief orders.”
Adopting a rule would “reduce cost and delay for new entrants” and “reduce uneven treatment between ETFs,” Treasury Secretary Steven Mnuchin and his counselor Craig Phillips said in the report.
Before joining the Treasury, Phillips was head of BlackRock’s financial markets advisory business. The firm is the largest issuer of ETFs in both the U.S. and Europe and has $1.3 trillion of assets within its American ETFs, more than 40% of the market.
Even with an SEC staff that’s refocused on ETFs, it’s unclear how long it would take the agency to approve new rules and Clayton may wait for two open seats on the commission to be filled before moving ahead. Hester Peirce, a nominee for the open Republican seat, and Robert Jackson Jr., who’s been tapped for the Democratic opening, are awaiting a Senate confirmation vote.
The 2008 draft will also need significant updates given how much the industry has changed over the past decade. That means the SEC might need to go through a full rulemaking process, which could take many months.