SEC Shutdown's Impact On ETFs

January 22, 2019

The government shutdown is taking its toll on all corners of the U.S. economy, including the ETF industry.

Delayed or suspended approvals, long wait times, and uncertainty over the status of pending filings are just some of the ETF-specific problems being reported during the government shutdown, which, as of this writing, is now 26 days long and is the longest such shutdown in U.S. history.

The longer the shutdown goes on, the likelier the problems will escalate. "If the SEC comes back six months from now, it could be mayhem," said one industry executive.

SEC Furloughs 94% Of Staff

As of Dec. 27, 2018, the Securities and Exchange Commission (SEC) had put 94% of its staff on furlough, leaving at the agency a skeleton crew of just under 300 employees to manage its essential operations. According to the agency's website, this includes "emergency situations involving market integrity and investor protection, including law enforcement."

All other employees have been told not to go into the office or use their government-issued work computers and phones. Nor may they answer calls or emails, not even on a volunteer basis.

Fortunately for investors, no trading disruptions were immediately apparent, and several new ETF launches have gone on as scheduled, including new products from Direxion, ProShares, First Trust and Innovator ETFs. There has even been a new entrant into the ETF industry, Syntax, though the firm's debut launch had been in the pipeline well in advance of the shutdown (read: "Newcomer's ETF Reweights S&P 500").

Yet the furlough has effectively put the SEC's filing process on autopilot. During the shutdown, new ETF-related filings may be made, and certain types of ETFs may be launched, but nothing that requires SEC review or approval can move forward.

"If you had a new product in the pipeline, then you're really in a crunch," said Fatima Sulaiman, partner at law firm K&L Gates.

No New ETF Issuers During Shutdown

Obviously the most important SEC filings are those concerning the launch of new ETFs. Launching funds, especially as a new issuer, is no simple matter, and often the process requires several rounds of back-and-forth with the SEC.

Before a prospective issuer can launch its own ETFs, it must first obtain from the SEC what is known as "exemptive relief"—literally an exemption from certain provisions of the 1940 Act, which governs how open-ended funds operate.

Unfortunately, however, no new applications for exemptive relief may be reviewed or approved during the furlough, effectively preventing any would-be issuers from entering the market.

Under the SEC's proposed ETF Rule, this exemptive relief requirement would be eliminated, and issuers could launch ETFs just like any other open-ended fund (read: "SEC Backs Major ETF Rule Change").

However, the review of this rule has been suspended indefinitely, due to the shutdown.

ETF Launches Become Largely Automatic

After issuers obtain their exemptive relief, they must then establish a trust for the specific purpose of launching ETFs and submit relevant paperwork to the SEC—which is no longer around to approve it; meaning, at the moment, no new ETF trusts may be approved.

However, existing trusts may file to launch new ETFs as usual. Most ETFs registered by existing trusts don't require explicit SEC approval, instead becoming automatically effective after a 60- or 75-day waiting period. (No approval is necessary because they tend to be substantively similar to existing funds that have already received the greenlight from the SEC.)

During the furlough, existing ETF issuers can and have made filings to launch new funds on the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system, the SEC database in which new and existing fund prospectuses and other relevant filings are published.

EDGAR is operated by a contractor and therefore remains functional, though disruptions to EDGAR service have been reported. Lag times and time-outs have increased, with some users reporting having to wait hours to access the system. reached out to a number of ETF issuers, and none of them reported hiccups in their filing or launch process. However, all the issuers contacted reported having no contact with SEC officials since the shutdown began.

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