ETF Share Class Shift Puts $30B in Fees in Jeopardy: Cerulli

As much as $30 billion in fees paid to broker/dealers may be at risk if a plan to create ETF share classes from mutual funds is approved by the Securities and Exchange Commission, a report said.

According to a new study from Boston-based Cerulli Associates, $15 billion to $30 billion in mutual fund marketing and distribution fees are at risk. While the amount is a long-term, worst-case scenario, based on all of such fees paid by mutual fund managers, Cerulli wrote that the potential rules change "poses an outsized economic challenge" to broker dealers.

As efforts gain steam to change rules to more easily permit the creation of ETFs from mutual funds, views on the matter from those issuing funds and those offering them to clients have diverged.

The issue of creating ETF share classes from mutual funds mostly boils down to eager anticipation from asset managers, while wealth managers are fretting about lost fees, compliance and implementation of the rules should they be passed.

The SEC is weighing 59 applications, according to Washington, D.C. law firm Stradley Ronon, for exemptive relief from rules that allow the creation of exchange-traded funds from mutual funds. SEC Commissioner Mark Uyeda is pushing for a rapid review of those applications from asset managers including BlackRock Inc. (BLK) and Morgan Stanley (MS), which have piled up over the past few years.

Deciding winners and losers should exemptive relief be granted may be tricky. ETFs are hauling in assets, reaching $10 trillion in the U.S. last year, in part as issuers convert mutual funds to ETFs and investors increasingly show a preference for them due to ease of trading and tax benefits. ETFs now represent one-third of fund assets, Morningstar reported in January, up from 14% in 2014.

Added Regulation and Exchange Issues

Besides the risk of losing fees, brokerages will be faced with a series of challenges by offering the new share classes such as regulations and the exchange mechanism for conversion, according to Cerulli.

“A key pain point will be the exchange mechanism,” Cerulli associate director Chris Swansey said in the statement. “Solving the infrastructure gaps will be costly, resource-intensive, and there are many unknowns.”

On the other hand, asset managers may get the benefits of the preferred ETF structure with its tradability and tax benefits, he wrote.

“For asset managers, the dual-share-class option offers the best of both worlds by allowing an investor or their advisor to use their preferred structure and secure the benefits associated with it,” he said.

Vanguard Group’s decades old exclusive patent on creating ETFs from mutual funds expired in 2023.

Note: 5th paragraph is updated to note that 59 applications for ETF share class exemptive relief are pending, as of May 9, according to Stradley Ronon.