In April 2020, the Securities and Exchange Commission (SEC) approved rule change proposals of the three primary listing exchanges for exchange-traded funds (ETFs). The new rules extend automatic listing to all ETFs that are eligible to rely on Rule 6c-11 under the Investment Company Act of 1940 (the 1940 Act), removing one of the last barriers to entry and further standardizing ETF regulation.
On September 26, 2019, the SEC adopted Rule 6c-11 under the 1940 Act to remove for most ETFs the requirement to obtain or rely on individual exemptive orders from the SEC. Note that Rule 6c-11 does not apply to leveraged, inverse or nontransparent ETFs or ETFs structured as share classes or unit investment trusts.
The primary listing exchanges for ETFs, the Nasdaq Stock Market LLC (Nasdaq), Cboe BZX Exchange, Inc. (Cboe) and NYSE Arca, Inc. (NYSE Arca), have had generic listing requirements for most index-based and actively managed ETFs.1 These rules impose certain quantitative requirements, among other things, regarding issuer size, liquidity and portfolio diversity that must be met. If an ETF cannot meet these requirements, the ETF must obtain an individual exemptive order under Rule 19b-4 under the Securities Exchange Act of 1934 to list its shares, which can be a lengthy process.
New Exchange Rules
The SEC approved new listing rules proposed by Nasdaq (Rule 5704) and Cboe (Rule 14.11(l)) on April 3 and April 6, 2020, respectively, for eligible ETFs. On April 13, 2020, NYSE Arca became the last major ETF exchange to have its analogous proposal, Rule 5.2(j)(8), approved.
These new Exchange rules will allow all eligible ETFs, whether index-based or actively managed, to qualify for listing and trading on the Exchange both on an initial and continued basis by meeting and maintaining compliance with the criteria set forth in Rule 6c-11. ETFs that previously would have had to obtain individual exemptive orders under Rule 19b-4 because they did not satisfy the Exchange requirements for issuer size, liquidity or portfolio, e.g., would also be able to automatically list their shares if they comply with Rule 6c-11.
The new Exchange rules also eliminate differences between Rule 6c-11 and current Exchange requirements. Among other things, to conform with Rule 6c-11, the proposed Exchange rules no longer require an ETF to publish its intraday net asset values periodically throughout the trading day.
Conditions of the New Exchange Rules
An ETF must satisfy the following requirements of the new Exchange rule, including among other things:
- Meeting the requirements of Rule 6c-11(c) on an initial and continued listing basis
- Having a minimum number of ETF shares outstanding at the time of commencement of trading on the Exchange
- Having at least 50 beneficial holders of the ETF following the initial 12-month period after commencement of trading on the Exchange
Moreover, the following “firewall” requirements apply to index-based and actively managed ETF shares on an initial and continued listing basis:
- Index-Based ETF Shares:
- If the index is maintained by a broker-dealer or fund adviser, the broker-dealer or fund 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 fund adviser.
- Any advisory committee, supervisory board or similar entity that makes decisions on the index composition and methodology must implement and maintain procedures designed to prevent the use and dissemination of material nonpublic information regarding the applicable index.
- Actively Managed ETF Shares:
- If the investment adviser to the investment company issuing ETF shares is affiliated with a broker-dealer, the investment adviser must erect and maintain a firewall between the investment adviser and broker-dealer with respect to information concerning the composition and/or changes to the ETF portfolio.
- Reporting authorities that provide information relating to the ETF portfolio must implement and maintain procedures designed to prevent the use and dissemination of material nonpublic information regarding the portfolio.
The new Exchange rules are part of the process of harmonizing and streamlining ETF regulation, reducing the time and expense to offer new ETFs. New ETFs and existing ETFs, currently relying on the generic Exchange listing requirements or individual Rule 19b-4 orders, should contact their listing Exchange regarding the transition to the new Exchange rules if they are eligible to operate under Rule 6c-11. ETF sponsors should also review their compliance procedures and operations to ensure that the relevant firewalls are in place and working effectively.
- Cboe (previously Bats BZX Exchange, Inc.) BZX Rules 14.11(c) and 14.11(i); Nasdaq Rules 5705 and 5735; NYSE Arca Equities Rule 5.2(j)(3) and 8.600.