SEC Staff Issues No-Action Relief for Exchange-Traded Funds during Passive Concentration Exceedances

Sponsors may utilize in-kind creation baskets even during periods of passive exceedance of an ETF’s concentration policy.

Authors:

At a Glance

ETFs experiencing a passive exceedance no longer need to reject or restructure creation baskets that fall within the three scenarios addressed by the relief solely to avoid potential concentration violations.
Sponsors may wish to review their custom basket policies and procedures under Rule 6c-11 in light of this SEC staff position.
The explicit confirmation that relief applies to actively managed ETFs is particularly significant, as active ETFs exercise portfolio management discretion that could otherwise complicate arguments about non-volitional basket acceptance.

On July 27, 2026, the staff (Staff) of the Securities and Exchange Commission's (SEC) Division of Investment Management issued a no-action letter in response to a request by the Investment Company Institute (ICI) regarding creation baskets for exchange-traded funds (ETFs) that are experiencing a passive exceedance of their concentration policy. The letter confirms that the Staff will not recommend enforcement action against an ETF that accepts certain creation baskets during a period in which the ETF is experiencing a passive exceedance of its disclosed industry concentration policy.

Background

Under the Investment Company Act of 1940 (1940 Act), a registered fund must disclose its fundamental concentration policy — i.e., whether it will invest more than 25% of its net assets in a particular industry or group of industries — and may not deviate from that policy without shareholder approval.

Unlike traditional mutual funds, ETFs issue and redeem shares through "creation units" delivered to authorized participants, who submit a basket of securities to the ETF (and, where applicable, cash-in-lieu). ETF portfolio managers generally cannot control the timing of creation orders. From time to time, market movements may cause an ETF's holdings in a particular industry to exceed the 25% concentration threshold – through no choice of the ETF's manager, even where that ETF has disclosed a policy not to concentrate in that industry.

Relief Sought and SEC Response

Prior Staff guidance on concentration was developed in the context of traditional mutual funds and did not address how ETFs should treat in-kind creation baskets during a passive exceedance. Accordingly, the ICI requested assurance that the Staff would not recommend enforcement action under Sections 13(a)(3) or 34(b) of the 1940 Act against an ETF that, while experiencing a passive exceedance, engages in any of three specific scenarios:

Accepting a pro rata creation basket that includes one or more investments in the industry with respect to which the ETF is experiencing a passive exceedance of its concentration policy. The ICI argued that accepting a pro rata creation basket (a creation basket that reflects a pro rata representation of the ETF's portfolio holdings) during passive exceedance does not reflect the manager's investment decision but rather is a mechanical function of the creation/redemption process, and from the shareholders' perspective, the ETF's proportional exposure to the relevant industry remains unchanged by accepting a pro rata basket (aside from market movements).
Using the cash-in-lieu component of a creation basket (where that component represents an investment in the relevant passively exceeded industry) to purchase the component security, up to an amount consistent with a pro rata creation basket. The ICI argued that this use of cash-in-lieu is "non-volitional," because the need for cash arises from operational constraints unrelated to portfolio management decisions, such as odd lots or in-kind transfer restrictions.
Receiving a non-pro rata creation basket in which the weighting of the relevant passively exceeded industry is consistent with the weighting that would apply in a pro rata creation basket. The ICI argued that accepting a non-pro rata basket is consistent with Staff guidance and policy underlying the concentration limitations, and that in this non-pro rata creation basket the ETF would not be any more exposed to the relevant industry than the pro rata basket contemplated in the first scenario.

The Staff granted the requested no-action relief and confirmed that the no-action position applies equally to actively managed and index-based ETFs. With this relief, an ETF experiencing a passive exceedance will not be forced to alter basket composition or substitute assets, which could otherwise disadvantage shareholders.

Practical Implications

This letter provides clarity for ETF sponsors regarding their ETF's fundamental concentration policies. Key practical considerations include:

Operational continuity. ETFs experiencing a passive exceedance no longer need to reject or restructure creation baskets that fall within the three scenarios addressed by the relief solely to avoid potential concentration violations. This reduces operational disruption and the risk of wider bid-ask spreads if market makers price in unpredictability around basket composition.
Shareholder protection. The relief avoids scenarios where ETFs would be forced to shift portfolio exposure into industries the manager would not otherwise choose at that time, which could disadvantage shareholders.
Custom basket policies. Sponsors may wish to review their custom basket policies and procedures under Rule 6c-11 in light of this Staff position.
Applicability to active ETFs. The Staff's explicit confirmation that relief applies to actively managed ETFs is particularly significant, as active ETFs exercise portfolio management discretion that could otherwise complicate arguments about non-volitional basket acceptance.
Record maintenance. Sponsors should document passive exceedances carefully. Because the relief is fact-specific, maintaining records demonstrating that any concentration breach was market-driven (and that baskets stayed within pro rata limits) will be important in the event of Staff inquiry.

As with all no-action letters, the Staff's response reflects only its enforcement views based on the specific facts represented by the ICI.

For More Information

For further information, please feel free to contact the authors or another member of the investment management team.

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