In a significant development for the Exchange Traded Funds (ETF) industry, the U.S. Securities and Exchange Commission (SEC) has given conditional approval for a new non-transparent ETF structure, which avoids the need to disclose its portfolio holdings.
Since publication of the article below, the SEC has now given final approval to the non-transparent ETF structure, Active Shares, developed by Predician Investments. Its previous approval had been dependent on whether any interested party requested an additional hearing - none did so.
SEC gives conditional approval to ActiveShares
After an application originally made to it in 2014, the SEC has now granted conditional approval for Precidian Investments’ new type of actively managed ETF, called "ActiveShares". Like traditional active mutual funds (but unlike most current active ETFs) the new structure will not be required to disclose what it owns on a daily basis.
The fact that the SEC has given a green light to ActiveShares is significant for the active ETF product and is an exciting development, since it could revolutionise the ETF market for both managers and investors.
Typically, an index tracking ETF will publish its portfolio on a daily basis, either through publication on a web-site or through publication of a holding or pricing basket in the portfolio composition file.
One reason why many asset managers have not launched ETF versions of their strategies has been the fear that revealing their holdings on a daily basis could lead to an erosion of their competitive advantage. However, suggestions that ETFs could be developed which revealed holdings less regularly were met with concerns that the fund's price could differ from the value of its underlying assets.
To attempt to mitigate this issue, ActiveShares will quote their price every second, rather than every 15 seconds as regular ETFs do, to ensure the price stays consistent with the value of the assets.
The funds will also use a 'trusted agent' or authorised participant representative, who will be privy to the portfolio holdings of these funds, but who uses a confidential account to perform all creations and redemptions of shares on behalf of authorised participants.
The position in Europe
In Europe, regulators have taken the view that public disclosure of an ETF’s portfolio on a daily basis allows for transparency and is considered necessary for effective arbitrage (which, in turn, enables the exchange-traded price of an ETF to remain close to its net asset value). Portfolio transparency also permits investors to understand the ETF’s exposure on an ongoing basis.
However, many have seen this requirement as a barrier to entry for active managers who were unwilling to share their proprietary information (essentially, their “secret sauce”).
The “Guidelines on ETFs and other UCITS issues” published by the European Securities and Markets Authority (ESMA) currently require a UCITS ETF to disclose in its prospectus and other documentation its “policy regarding portfolio transparency and where information on the portfolio may be obtained, including where the indicative net asset value, if applicable, is published.”
Each EU Member State applies these guidelines through its national competent authority so, for example, the Central Bank of Ireland will not authorise a UCITS ETF in Ireland unless arrangements are put in place to ensure that information is provided on a daily basis regarding the identities and quantities of portfolio holdings. These arrangements must be disclosed in the Fund’s prospectus.
Whether as a result of these restrictions or otherwise, active ETFs have been slow to develop into a market subsector of any real significance. However, the SEC’s move to allow ActiveShares raises the prospect that this situation will now change. Certainly, active stock pickers in Europe will hope that ESMA will now take on board the SEC decision and allow European active ETF managers to maintain some degree of confidentiality around their trading strategies.
We consider the development to be potentially significant for the Irish funds industry and we will be monitoring the situation carefully.
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