Exchanges Adopt Streamlined ETF Generic Listing Standards
ETF Reg Insights
Date: April 13, 2020
***UPDATED April 14, 2020***
In orders issued on April 3 to Nasdaq Stock Market LLC (Nasdaq), on April 6 to CBOE BZX Exchange Inc. (CBOE) and on April 13 to NYSE Arca, Inc. (NYSE) (each an “Exchange” and, collectively, the “Exchanges”), the SEC created a new category of generic listing standards called “Exchange Traded Fund Shares,” or “ETF Shares,” for ETFs that meet the requirements of Rule 6c-11 under the Investment Company Act of 1940. These new standards were proposed by the Exchanges and subsequently approved by the SEC in response to last year’s adoption of Rule 6c-11, which replaced the cumbersome ETF exemptive order regulatory scheme with an ETF rule that could be relied upon immediately. One of the Exchanges’ stated goals was to dovetail their generic listing standards with Rule 6c-11 to significantly reduce the time frame and costs associated with bringing ETFs to market.
New Generic Listing Standards
The ETF Shares generic listing standards found in CBOE Rule 14.11(l), Nasdaq Rule 5704 and NYSE Rule 5.2-E(j)(8) generally require that:
- the ETF meets the requirements of Rule 6c-11;
- the ETF meets the Exchange’s minimum requirement for the number of ETF shares required to be outstanding at the time trading commences on the Exchange (the Exchanges generally consider at least one creation unit outstanding at the time of listing to be sufficient for the purposes of complying with this requirement);
- the ETF, following the initial 12-month period after trading commences on the Exchange, has at least 50 beneficial holders for 30 or more consecutive trading days; and
- certain firewalls are implemented designed to prevent prohibited insider trading.
If an ETF can meet these streamlined listing requirements, it does not have to meet the current generic listing standards’ more onerous requirements for actively managed and index ETFs.
The type of firewall required by the ETF Shares generic listing standards depends on whether the ETF is actively or passively managed and other factors related to various entities’ roles in the index construction and operation. Firewalls are techniques and devices financial firms use to restrict the flow of material nonpublic information to those inside the firm and service providers who need to know the information to perform their jobs and prevent the communication of such information to others.
If the ETF is an index ETF and the index is maintained by a broker-dealer or the ETF’s investment adviser, the broker-dealer or investment adviser must erect and maintain a firewall around the personnel who have access to information concerning changes and adjustments to the index, and the index must be calculated by a third party who is not a broker-dealer or the ETF’s investment adviser. In addition, any advisory committee, supervisory board or similar entity that advises a Reporting Authority or makes decisions on the composition, methodology and related matters of an index underlying the ETF’s shares must implement and maintain, or be subject to, procedures designed to prevent the use and dissemination of material nonpublic information regarding the applicable index. A Reporting Authority is the ETF’s listing exchange, an institution or a reporting service designated by the exchange as the official source for calculating and reporting information relating to such series, including, but not limited to, the amount of any cash distribution to holders of the ETF’s shares, net asset value, or other information relating to the issuance, redemption or trading of the ETF’s shares. An ETF may have more than one Reporting Authority, each having different functions.
If the ETF is an actively managed ETF, personnel who make decisions on the portfolio composition must be subject to procedures designed to prevent the use and dissemination of material nonpublic information regarding the ETF’s investment portfolio. If the ETF’s investment adviser is affiliated with a broker-dealer, the investment adviser must erect and maintain a firewall between the itself and the broker-dealer with respect to access to information concerning the composition and/or changes to the ETF’s portfolio.
Existing Generic Listing Standards
Each Exchange’s existing generic listing standards are still in place; they were not replaced by the new ETF Shares generic listing standards. Thus, new and existing ETFs now have five options:
- Rely on the ETF Shares generic listing standards
- Rely on the Managed Fund Shares (Nasdaq and NYSE) or Managed Portfolio Shares (CBOE) generic listing standards
- Rely on the Index Fund Shares generic listing standards
- Begin relying on the ETF Shares generic listing standards instead of the Index Fund Shares or Managed Fund Shares/Managed Portfolio Shares generic listing standards
- Apply through the Exchange for a 19b-4 order with the SEC
With respect to the first three options, an Exchange will notify the SEC by filing a Form 19b-4(e) when an ETF lists on the Exchange, identifying the Exchange rule under which the ETF is being generically listed. With respect to the fourth option, the Exchange will file a Form 19b-4(e) for an ETF that decides to switch from operating under the Index Fund or Managed Fund Shares generic listing standards to operating in compliance with Rule 6c-11 and in conformity with the ETF Shares generic listing standards. Importantly, this switch is not reviewed by the SEC. ETFs that are unable to meet the first three options, such as actively managed semi-transparent ETFs, multiple leveraged and inverse leveraged ETFs, and those that invest significantly in derivatives, must choose the fifth option.
Exchange Monitoring for Compliance
As is the case with the existing generic listing standards, the SEC requires the Exchanges to monitor for compliance with the ETF Shares generic listing standards. Importantly, for the first time, the Exchanges will be monitoring for an ETF’s compliance with Rule 6c-11 in addition to the generic listing standards described above. For example, the SEC expects the Exchanges will periodically review ETFs’ websites to ensure that the requirements of Rule 6c-11 are being met. If an ETF is not in compliance with Rule 6c-11 and the applicable listing requirements, the Exchange may subject the ETF to trading halts and/or commence delisting procedures.
ETF Self-Policing and Reporting
The new ETF Shares generic listing standards require an ETF to notify the Exchange promptly after the ETF becomes aware of any noncompliance with the requirements of the generic listing standards, which would encompass any failure by the issuer to comply with Rule 6c-11. An issuer’s failure to notify the Exchange of noncompliance would itself be considered noncompliance with the requirements of the ETF Shares generic listing standards and subject the ETF to potential trading halts and the delisting process. Additionally, an ETF must file periodic certifications with the SEC that it has maintained compliance with Rule 6c-11 and applicable Exchange generic listing requirements.
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