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Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 8 offices, was ranked number 1 in the category “Most innovative North American law firms: New working models” by The Financial Times and was 1 of 7 firms shortlisted for The American Lawyer’s inaugural Legal Services Innovation Award. The firm has been recognized by the National Law Journal as a Legal Technology Trailblazer and featured by Bloomberg for its innovative service delivery models, which drive accuracy and predictability. The firm’s commitment to innovation is embodied in Thompson Hine SmartPaTHTM – a smarter way to work – predictable, efficient and aligned with client goals. For more information, please visit ThompsonHine.com and ThompsonHine.com/SmartPaTH.

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In our January 2019 ETF Reg Insights, <a href="https://www.thompsonhine.com/publications/preparing-for-the-next-generation-of-actively-managed-etfs" target="_blank" rel="noopener">“Preparing for the Next Generation of Actively Managed ETFs”</a> (January Update), we alerted the ETF industry to the high probability of the advent of non-transparent actively managed ETFs (NTAM ETFs), and now that day is nearly here. The SEC recently issued a notice in response to an exemptive application filed by Precidian ETFs Trust that would permit ActiveShares, the first NTAM ETF.[1] Based on the Notice’s return date, the order formally permitting ActiveShares ETFs could be issued as early as May 5, 2019.

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As explained in the Notice, the lynchpin of an ETF is the mechanism that keeps the market prices of ETF shares at or close to the NAV per share of ETF. Since the first ETF was launched over 20 years ago, that mechanism has been the requirement that the ETF display its entire portfolio on a daily basis. Index ETFs have had no issue with this requirement since the indexes they track daily publish their constituents. Investment advisers to actively managed funds have in large part been reluctant to launch ETFs because of the fear that daily disclosure of their ETF holdings would allow competitors to figure out their proprietary stock-picking strategies by backtesting past daily portfolio holdings.

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At least six financial firms or groups of firms have attempted to overcome the actively managed ETF barrier by devising acceptable alternatives to the requirement that an actively managed ETF expose its portfolio each trading day.[2] As we noted in our January Update, this group of firms has developed ETFs that in lieu of daily exposing their portfolios make available enough information that theoretically allows arbitragers to exploit any discrepancy between the ETF’s NAV and share price without disclosing the ETF’s full portfolio to the public.

Note that the SEC’s notice does not grant exemptive relief – it only signals the SEC’s intention to grant the relief while giving the public an opportunity to request a hearing prior to May 5, 2019. Assuming that no one requests a hearing (which is a rare occurrence), Precidian, with its ActiveShares ETFs, will be the first sponsor through the gate.

The ActiveShares ETFs will utilize an “AP Representative Structure” approach. Unlike traditional ETF APs that transact directly with the ETF through the distributor or TA, APs for these NTAM ETFs will need to transact through an “AP Representative” that will be privy to the NTAM ETF’s creation basket but will be contractually required to maintain the confidentiality of the basket’s contents. The AP Representative will use a confidential brokerage account on behalf of each AP for this purpose. While creation and redemption transactions with the NTAM ETF will generally be on an in-kind basis, from the AP’s perspective, transactions will essentially be made on a cash basis because of the interposition of the AP Representative. The AP Representative will purchase securities in the basket (in the case of a creation) or liquidate securities transferred from the NTAM ETF’s custodian (in the case of a redemption).

Precidian will disseminate a verified intraday indicative value (VIIV) of the actual NTAM ETF’s portfolio throughout the trading day. The VIIV will be calculated every second throughout trading day and on a per share basis based on the value of the actual securities in the fund’s portfolio, cash and any accrued interest and declared but unpaid dividends, minus accrued liabilities. Using a current VIIV along with existing fund disclosures, APs are expected to do a regression analysis and construct dynamic hedge portfolios to hold shares and arbitrage the difference in the market price/NAV of shares when the opportunity arises.

The Notice summarizes Precidian’s application that was most recently amended on April 4, 2019. Below is a summary of some of the significant provisions that were added or changed compared to the application that was noticed and the prior application filed in May 2018 that we discussed in our January Update:

The issuance of the Notice allowing ActiveShares ETFs is just the first chapter in the NTAM ETF story, as five other applications are still pending. Also, Precidian anticipates licensing the methodologies and technology behind ActiveShares ETFs to financial firms. It remains to be seen if and when financial firms will file applications seeking exemptive relief from the SEC for their versions of the AP Representative Structure.

Bibb Strench 202.973.2727 <a href="mailto:Bibb.Strench@ThompsonHine.com" target="_self" rel="noopener">Bibb.Strench@ThompsonHine.com</a>

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions.

[1] Precidian ETFs Trust, et al., Notice of Application, IC Rel. No. 33440, File No. 812-14405 (Apr. 8, 2019), available at <a href="https://www.sec.gov/rules/ic/2019/ic-33440.pdf" target="_blank" rel="noopener">https://www.sec.gov/rules/ic/2019/ic-33440.pdf</a> (Notice).

[2] We discussed five financial firms that were potential sponsors of NTAM ETFs in our January Update, which were Fidelity, NYSE/Natixis, T. Rowe Price and Blue Tractor, in addition to Precidian. Since that time, Eaton Vance has also filed an application for its version of NTAM ETFs (see https://www.sec.gov/Archives/edgar/data/1076598/000094039419000345/clearhedge40app.htm).

https://admin.thompsonhine.com/wp-content/uploads/2022/04/ETF_Reg_Insights_-_SEC_Poised_to_Permit_ActiveShares_ETF_-_First_Non-Transparent_Actively_Managed_ETF.pdf

SEC Poised to Permit ActiveShares ETF: First Non-Transparent Actively Managed ETF

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