Is the SEC about to make peace with the self-indexing movement?
[This article previously appeared on our sister site, IndexUniverse.eu.]
The Securities and Exchange Commission has started easing the requirements for ‘self-indexing’ or ‘affiliated index’ exchange traded funds in a move that could see ETF managers shift to a self-indexing ETF model.
The change in requirements allows ETFs and their underlying indexes to operate more flexibly than existing self-indexing ETFs.
The move saw the SEC recently issue several Orders to sponsors of affiliated ETFs, which eased the requirements for self-indexing, compared to previous Orders issued to ETF sponsors.
According to Richard Morris, partner at law firm Morgan Lewis, the move is likely to make the self-indexing model more attractive for certain ETF sponsors.
He says: “…the changes reflected in the Orders will contribute to two important trends in the ETF industry. The first is a continued move by some ETF sponsors toward self-indexing and away from established, third-party indexes. The second is price competition among certain categories of index-based ETFs. The leveling of the requirements applicable to third-party and affiliated index ETFs, and the potential for cost savings from the self-indexing ETF model, is likely to make the self-indexing model more attractive for certain ETF sponsors and further drive these two trends.”
“The potentially lower costs associated with a self-indexing business model could help some ETF sponsors maintain higher margins while charging lower fees,” Morris adds.
ETFs launched on these indices are commonly referred to as affiliated index ETFs or self-indexed ETFs because the ETF and the index are often created by the same issuer, provider or person – and therefore ‘affiliated’ in some way.
Firms like WisdomTree and IndexIQ pioneered so-called affiliated indexes and more recently has seen Northern Trust’s ETF unit, FlexShares launch the products. In the US Deutsche Bank also recently applied for permission to build its own long/short indices.
In Europe Societe Generale launched the Quality Income Index in the first half of last year and saw its first ETF launched by the bank’s Asset Management arm, Lyxor, in October.
Some of the changes in the requirements include self-indexing ETFs to post daily portfolio holdings on its website, each Order does not require each underlying index to be rules based and does not require the underlying index methodology and index components to be made publicly available. The Orders also do not require that changes to the index methodology be disclosed at least 60 days prior to implementation, that an Independent Calculation Agent be used, or that specific firewall procedures be in place. Instead, the Orders rely primarily on the daily transparency of the ETF's portfolio holdings to address potential conflicts of interest, according to Morris.