Baker To SEC: Get Moving

June 03, 2006

Louisiana Republican Richard Baker tells the SEC it needs to speed up its exemptive relief process, or ETF innovation will move overseas.

Richard Baker, the Republican Congressman from the 6th district of Louisiana, has a message for the Securities and Exchange Commission (SEC): Get moving on exchange-traded funds (ETFs), or the ETF industry will get moving itself … overseas.

The blunt-speaking Congressman, who chairs the Congressional Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, has a history of prodding the SEC on competitive issues.  He famously called Regulation NMS "the worst public policy I have seen in my nearly two decades in Congress."

In his latest move, Baker sent a letter to the SEC recently telling them - in no uncertain terms - that they need to streamline the approval process for ETFs, or else the innovative engine of the ETF industry will move overseas.  Noting that some ETFs have been waiting for over two years to be approved (ProFunds, anyone?), and that investors clearly want these new funds, Baker said that the U.S. risks falling behind markets like Europe and Asia.  He told the SEC that it needed to develop new solutions, such as standardized rules and a dedicated staff whose only focus is on ETFs.

There is some truth to what Baker says.  A number of ETF providers have mentioned how difficult it is to get products approved in the U.S., and some of the more innovative recent product launches have come first overseas: gold ETFs, oil ETFs and commodities ETFs being the prime examples. 

Nonetheless, so far, the follow-on products in the States have still been huge successes.  Given the size of the U.S. market, it's clear that ETF providers will never turn their backs entirely on U.S. investors.  That may change a bit as developments like the Euronext-NYSE merger further blur international lines, but still, the U.S. market will remain a hotbed for ETF activity, regardless of the SEC's relative efficiency.

Moreover, we have seen signs of improvement at the SEC, particularly with the recent fast approval of the DBC Commodities ETF (DBC) and the U.S. Oil Fund (USO).  The fact that we are nearing approval for the ProFunds ETFs marks yet another milestone. After languishing at the SEC for six (six!) years, the funds recently entered the "public comment" period, which is typically one of the last stages before approval.  If they do get the nod, the ProFunds will be the first equity-based ETFs to offer leverage and/or inverse exposure.  They will also be the first to use "swaps," or privately negotiated notes, which would represent a huge breakthrough for ETFs.  Swaps can theoretically cover anything, so if the SEC allows swaps, ETFs will theoretically be possible on anything as well.

Baker filed his protest letter prior to the recent near-approval of the ProFunds ETFs.  It's not clear if Baker's letter prodded the SEC to act.

Baker's effort may ultimately be largely irrelevant, however, as with the ProFunds near-approval, we have likely entered a new era in ETF regulation already.  The SEC has historically taken its time in approving the first type of any given ETF - be it the first equity ETF, the first commodity ETF, or the first ETF to use leverage.  Follow-on products, however, have won approval much more quickly, as we saw with the iShares Silver Trust (SLV), which went from filing to market in less than a year.  With most of the major "type" barriers already conquered (equities, fixed-income, commodities, futures, bullion, leverage, swaps, short-sales, etc.), the approval process may now steam ahead much more quickly.  The sole remaining exception is truly active ETFs, a topic the SEC has been working on behind the scenes for quite some time.

The SEC is expected to officially respond to Baker's comments soon.

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