Congress Rethinking Marijuana; ETFs May Benefit

July 08, 2019

Why Legalization Has Tripped Up Marijuana ETFs

To date, legalization has remained the greatest barrier facing marijuana ETFs, but not for the reasons one might expect.

Businesses within the marijuana industry have flourished in recent months, and many companies that have gone public over the past 18-24 months have experienced double-, even triple-digit returns year to date.

However, banks who custody stocks on behalf of ETFs remain reticent to hold marijuana stocks. So long as marijuana remains illegal at the federal level, holding these stocks explicitly for a marijuana fund could potentially run custodian banks afoul of federal banking laws, costing them their license, charter and/or FDIC insurance.

That's true even if marijuana is fully legal in the country in which those stocks are domiciled (e.g., Canadian stocks). Although foreign stocks may fall outside the jurisdiction of the U.S. Department of Justice, the custodian bank holding them does not (read: "Promise & Peril Of Marijuana ETFs").

Custodial risk isn't just theoretical: The oldest and largest marijuana ETF, the $1.1 billion ETFMG Alternative Harvest ETF (MJ), suddenly parted ways with its former custodian bank over precisely this question of legality. Last September, MJ instead signed on as custodian a privately held broker-dealer who had never custodied an ETF; trading issues have persisted ever since (read: "Marijuana ETF Shifts Custody").

Other Approaches To Resolving Custodial Risk

The second pure-play marijuana fund to launch, the $59 million AdvisorShares Pure Cannabis ETF (YOLO), has taken a different approach to mitigate custodial risk.

In the year prior to launch, YOLO submitted a list of potential fund holdings to both its intended custodian and to the Securities and Exchange Commission, obtaining their approval first.

Since launch, YOLO has also begun investing in the swaps contracts of multi-state operators based in the U.S., which technically are not stocks and therefore could serve as a workaround for wary custodians.

Amplify ETFs and Global X both have proposals for marijuana ETFs in the works. No custodian is listed for the Amplify fund, but Brown Brothers Harriman would serve as the custodian for the Global X fund.

Another proposed fund from Innovation Shares, which remains in the quiet period, would use a broker-dealer for its custodian (read: "New Wrinkle To Marijuana ETFs").

Matt Markiewicz, managing director of Innovation Shares, is one of the panelists on tomorrow's "The Case for Cannabis ETFs" webinar.

Contact Lara Crigger at [email protected]

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