The ETF Rule:'s Comment Letter

The SEC asked for comments on its proposed ETF rule. We have thoughts.

Reviewed by: Dave Nadig
Edited by: Dave Nadig

[Editor’s Note: As we have covered extensively on, the SEC is considering new rules that would simplify and streamline the process of launching ETFs. You can read the full text of the rule here. Following is the official comment letter submitted on behalf of by our Managing Director, Dave Nadig.]


Submitted via email to [email protected]


Mr. Brent J. Fields
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549


Re: Exchange Traded Funds: File No. S7-15-18


Dear Mr. Fields:

This letter is in response to the Securities and Exchange Commission (“SEC”) request for comments on the proposed changes to the Investment Company Act of 1940 to standardize the regulation of exchange-traded funds (ETFs).

In general, we voice our strong agreement with the intent and basic framework of the proposal as much needed and long overdue. However, we believe there is room for clarification and further detail, particularly in regard to the proposed disclosures and applications of the rule, which this letter will attempt to address.

General Comments:

1: While the proposed rule goes a long way toward leveling the playing field, it may not go far enough.

As proposed, the new rule would not apply to share-class ETFs or master-feeder structures. While there are solid reasons these special cases may require additional relief not included in the proposed rule, by exempting them from the entirety of the rule, share-class ETFs will not be required to make the same, important disclosures to investors as covered ETFs. Since share-class ETFs are solely the province of a single issuer due to patent protection (Vanguard), this will lead to a broad discrepancy in what investors can expect from issuers in terms of useful data.

We would recommend broadening the disclosure requirements to extend outside the four corners of 6c-11 and apply separately to all classes of ETFs.

2: The index vs. active discussion is largely irrelevant, but index methodologies require better disclosures.

As proposed, the rule effectively eliminates any meaningful distinction between index and active ETFs, and this is a good thing. However, ETFs claiming to follow an index as their investment strategy should be required to provide an index construction methodology through their website, regardless of whether or not the index is affiliated. The rise of so-called smart-beta index strategies has led to a proliferation of indexes, and in the absence of required disclosures, the transparency of these strategies varies widely.

We propose a simple test: Any index tracked by an ETF must disclose the index methodology in sufficient detail that someone practiced in the art could reconstruct a current portfolio based on publicly available information.

3: IIV/INAV is irrelevant and should be deprecated.

While the idea of a contemporaneous measure of fair value is enticing, in practice, it is inaccurate for 80% of all ETFs (ETFs holding securities that do not trade precisely contemporaneously with U.S. equity markets) and is not accurate enough for authorized participants to use in arbitrage analysis. We support the removal of INAV from the 1940 Act requirements and encourage exchanges and the Division of Trading and Markets to remove it from their rules as well.

4: Portfolio transparency is the right call, but structure is important.

The commission correctly asserts that full portfolio transparency is useful for investors and market participants broadly speaking, and we applaud both the mandate and simplification of the requirement. However, currently, portfolio disclosures vary widely, leaving individual investors at the mercy of websites, where institutional investors can rely on standardized feeds from (expensive) data providers.

We suggest portfolio disclosure be more clearly defined to include:

  • Standard file form: comma-separated values
  • Disclosure to include: security name, exchange, security identifiers (ticker, ISIN, SEDOL), number of securities, price or assessed value, weight (%)

Such disclosure matches best-in-class industry practice, and should apply equally to all classes of exchange-traded products (share class, master-feeder, UIT, grantor trust, etc.). Disclosure should be sufficient for the calculation of net asset value on the reported day, and thus needs to include all assets and liabilities of the fund.

5: Leveling the playing field on custom baskets is excellent, but implementation may be challenging.

Broad availability of custom baskets is perhaps the most important signature change in the proposed rule. We support relying on the fund board to review and monitor custom-basket rules to mitigate any opportunity for misuse. However, it is important to note that implementing full disclosure of both the daily standard basket and any custom baskets as used may be difficult for smaller issuers and service providers. Current practice of providing baskets (portfolio composition files or “PCFs”) to a central clearing firm (NSCC) and then relying on members to pull those baskets themselves is not particularly efficient. Many market participants have come to rely on third-party data vendors to “scrub” these files to make them commonly useful.

We propose using the same standard used for portfolio disclosure for these baskets, or another standard that the staff determines appropriate; however, we would recommend a significant transition period (perhaps 12 months) to allow the industry to build and test these website-based basket disclosures. Nothing in the proposed rule suggests that the existing PCF-based system for processing creations/redemptions will be deprecated, so some time is appropriate here.

6: Website disclosures need clear, unambiguous standards.

While we applaud the requirement for additional disclosures, several of the required items leave too much room for interpretation, potentially leading to “apples/oranges” comparisons, particularly for small investors who will rely predominately on website disclosures for their investment analysis.

NAV, Market Price & Premium/Discount

We broadly agree with the proposed disclosures here; however, we would suggest that the SEC require that premium/discount be flagged and footnoted when it is known to include inaccurate data due to exchange-hours overlap issues. This would apply to both the proposed daily and historical required data.

Bid/Ask Spreads

The proposal to require bid/ask spread disclosure belies the complexity of this calculation. Based on work done by FactSet Data Systems in calculating this, we propose the following explicit standard for calculating an “average spread” for a single trading day:

1) From the National Best Bid/Offer (NBBO), record every inside bid price, offer price and time stamp during the trading day.

2) For every unique bid/offer/time range (defined as the milliseconds elapsed between time stamp of the bid/offer and the next bid/offer (either bid or offer can update), calculate:

a. spread in % ((offer-bid)/mid)
b. elapsed time, in milliseconds
c. elapsed time as % of # of milliseconds in the trading day

3) Multiply spread * elapsed time (%, as in 2.c.)

4) Sum all spread * elapsed time % between market open and market close

The resulting calculation is time-weighted bid/ask spread. Rather than posting an annual figure, we recommend requiring disclosure of a 45-trading-day average, along with the historical daily figure, as it can vary dramatically for newly launched/illiquid funds.

Further, we believe presenting this as a percentage with simple explanatory language is more in investor interests than in requiring the development of interactive calculators so investors can test round-trip costs. Such a requirement disproportionately impacts small ETF issuers, would limit competition, and ultimately provides no more information than a percentage, or table of percentages, and explanatory text.


We applaud the work of the commission and its staff in developing this much-needed proposed rule, and believe that with some minor modifications as mentioned above, the new rule will help improve both innovation and investor outcomes.

If the staff has any questions, we would be happy to follow up with an in-person meeting at their convenience.


Dave Nadig

Managing Director (a subsidiary of Cboe Global Markets)



The Honorable Jay Clayton
Securities and Exchange Commission

The Honorable Robert J. Jackson Jr.
Securities and Exchange Commission

The Honorable Hester M. Peirce
Securities and Exchange Commission

The Honorable Kara M. Stein
Securities and Exchange Commission

Dalia Blass
Division of Investment Management
Securities and Exchange Commission

Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.