SEC Approach To ETFs Uneven

January 08, 2015

Steven Wallman was a commissioner with the SEC in the mid-1990s. An authority on securities markets and trading, today he leads an ETF-centered online brokerage, Folio Investing. Wallman is also keen on seeing the SEC start using a thoughtful “holistic” method to evaluate the worthiness of new ETFs as opposed to a more case-by-case approach.


That could have far-reaching effects on the availability of innovative nontransparent actively managed wrappers, Wallman told in a recent interview. He held up Eaton Vance and Precidian’s different experiences at SEC in the past few years as each pursues distinct nontransparent active ETFs as examples of a need for a new approach. Both Eaton Vance and Precidian are looking to launch nontransparent exchange-traded products. They are different structures, but why do you think the SEC approved one and not the other? Is it all centered on their tradability?


Steven Wallman: The Eaton Vance one that has been approved, from what I’ve read, allows people to sort of bid off of the indicated NAV that will be changing on a 15-minute basis during the day. And then you would be bidding a basis point up or down off of that, depending on what you think the market and the securities are doing.


It does have an intraday element to it. Precidian’s was designed more as sort of the equivalent of a nontransparent but actively managed ETF that would allow for intraday trading. But the question is, allow it for what, on what basis? How do you make a decision?


What is the SEC is trying to protect against? What is it that it’s trying to permit? And what actually makes the most sense for it to be able to do? The lack of a holistic, clear outline with a proposal for how they would be addressing this is what seems to me to be missing. And in part, that’s why it’s taken so many years for this to develop and for ETFs, on the active side, to come to market.


It’s a little bit strange how the commission has addressed some of this. Its approach to these new products has been sort of piecemeal without the benefit of an overall theory guiding it. Has this lack of a consistent approach been a big barrier to entry for active ETFs?


Wallman: It’s clearly been a significant barrier for active ETFs at the moment, and that is evidenced by the fact that there are several that have been attempted for many years and there still are very few of them.


With passive vehicles, that has been run to the ground a little bit more easily. By now, we have a more certain template and model for what would work at this point than for active.


On the other hand, remember that it took passive years to be able to come to market as well. At the beginning, there was no good mechanism that allowed it to slot in. You just had a framework that basically said, “Unless you fit into this one very particular kind of framework, nothing else is permitted unless the SEC provides a waiver.”


We’re in this sort of one-by-one-by-one analysis for all of these, and I think now—and it probably should have done so quite a while ago—the SEC ought to shift to a much more holistic view of what is the whole issue here and how do we resolve it, as opposed to, “This one looks OK; that one doesn’t look OK,” even if it’s hard for people to tell the difference. Are these nontransparent structures more focused on issuer survival than on investor well-being, and maybe that is what the SEC is concerned about here? Are they just a result of mutual fund companies trying to find a spot in the ETF world?


Wallman: I don’t think so. A lot of the ETF providers at this point are mutual fund companies. Vanguard, for example, has a huge array of ETFs, and they’re certainly a well-known mutual fund company. You also have a number of providers of ETFs that are not mutual fund companies.


The proliferation of ETFs and the rise of them as a good vehicle for certain cohorts of investors to utilize is a good thing for the market. It is a new innovation—or it was a new innovation 25 years ago. It’s an increasingly used innovation.


The fact that there are providers of mutual funds who also want to come up with new vehicles is a good thing. So I don’t think any of this is about survival of the mutual fund industry. How would an ETF like the bitcoin ETF fit into this so-called lack of consistency in the approval process? That’s another innovation that has been sitting in the pipeline for a while.


Wallman: I don’t know I would view that as an innovation of any sort. If you think of bitcoin as simply a commodity, there have been commodity-based ETFs for a long time. They do what they do and they are what they are; there is no innovation by looking at it and saying in one case it’s oil and in one case it’s gold and in another case it may be bitcoin.


Bitcoin itself may be a different kind of a commodity than some of the others. It may be more volatile. It may be more risky. There may be real questions as to how you monitor it and manage it. There may be questions over whether over time it’s actually going to grow.


Obviously, many different people have many different views on all those questions. But in terms of it being a different kind of ETF, clearly the price for bitcoins is available and it’s something you can find, and it can be indexed through the multiple exchanges that provide bitcoin pricing.


So, that strikes me as actually less of an issue. I view that as a somewhat more passive commodity-based index ETF structure rather than the actively managed either nontransparent- or transparent-type ETF structures we were just talking about. So do you see any changes coming in terms of their regulatory process?


Wallman: The SEC is under so much pressure at the moment to finish some of the Dodd/Frank rule-making. Rule-making is still outstanding on a number of other really high-profile, major issues that are very time-consuming.


The notion that there would be a transformational, foundational and holistic approach to permission to have new ETF-type-products brought to the table is one that a number of people at the commission do care about, and have cared about for a long time.


When I was at the SEC in the ’90s, there was something I wanted to push forward at that time, and we just ran out of time to do it and other things had gotten in the way. But as you see more and more applications not only on the passive side increasingly but also on the active side, you’re going to see more and more pressure building from everyone—industry as well as internal at the SEC as well as consumer advocates—calling for a thoughtful debate about what makes sense to do here, as opposed to being a one-by-one process. 




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