Fund companies looking for regulator permission to include
derivatives in active
ETFs
will no longer have the Securities and Exchange Commission standing
in their way-in the first tangible outcome of an SEC review of
derivatives use in mutual funds and ETFs that began in March
2010.
The commission didn't say it was lifting the moratorium on new
leveraged and inverse funds, but the ruling that will allow
derivatives in active funds could have a quick effect on popular
active ETFs such as Bill Gross' $3.83 billion Pimco Total Return
ETF (NYSEArca:BOND) that can't currently make use of
derivatives.
"Although the Division continues its ongoing review of the use
of derivatives by funds, Division staff will no longer defer
consideration of exemptive requests under the Investment Company
Act relating to actively managed ETFs that make use of
derivatives," Norm Champ, the Director of the SEC's Division of
Investment Management, said today in prepared remarks during a
conference in New York.
While Champ didn't officially close the inquiry, he framed the
question of the SEC's position on leverage and inverse funds in
such a manner as to suggest that perhaps those firms hoping to get
a piece of a business dominated by Bethesda, Md.-based ProShares
and Newton, Mass.-based Direxion ought not hold their breath for an
SEC change of heart.
"Because of concerns regarding leveraged ETFs, however, we
continue not to support new exemptive relief for such ETFs," Champ
said.
That's important because derivatives use in leveraged and
inverse funds "were at the root of the moratorium originally," said
Kathleen Moriarity, a New York-based securities lawyer with Katten
Muchin Rosenman LLP who has written countless ETF prospectuses,
including the one for the first U.S. fund, the now $110 billion
SPDR S&P 500 ETF (NYSEArca:SPY).
Marquee Managers To Benefit
Moreover, the ruling won't necessarily change the difficulty
active ETFs are having in gaining market share, but it will help
fund companies with brand-name managers like Gross gain a measure
of flexibility in how they run their active portfolios in an
ETF wrapper.
"The lifting of the ban on active management isn't likely to be
a floodgate," said Dave Nadig, Director of Research at
IndexUniverse in an interview.
"The real deal in active management would be the entry of
traditional players with 'brand track record' that could make up
for a lack of a real track record," Nadig added, noting
however that the ban on derivatives hasn't really discouraged huge
players like Fidelity from rolling out funds.
'I don't think the active ban has kept anyone from ETFs. The
transparency of ETFs and fee erosion has," he said, adding that the
lifting of the band may well encourage existing active ETFs to use
simple derivatives such as futures to equitize small portions of
their portfolios for tracking purposes.
He also noted that the fact that the SEC continues to balk at
the idea of approving new funds that use derivatives in leveraged
and inverse funds isn't a big deal as the pocket is already
inhabited and pretty much covered by ProShares, Direxion and iPath,
the exchange-traded note firm backed by UK-based Barclays Plc.
The Background
The SEC review applied to actively managed and leveraged ETFs,
particularly those that plan to use swaps and other derivative
instruments to achieve investment objectives.
It never affected firms that already had permission to use
derivatives, much to the frustration of ETF sponsors who felt they
were caught in the wrong place at the wrong time.
Specifically, the SEC inquiry precluded the approval of any
pending or planned "exemptive relief" petition seeking permission
to market funds making use of derivatives.
Exemptive relief grants ETF firms exception to sections of the
Investment Act of 1940 and is just the first step in the path to
launching ETFs.
It often takes at least six to 12 months from the date of the
initial filing for a company's first ETF to hit the market, though
the SEC inquiry has left petitions languishing at the commission
for more than 2 1/2 years.
Champ's speech was at the ALI CLE 2012 Conference on Investment
Adviser Regulation today in New York.
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