SEC Staff Provides Relief for ETFs Experiencing Passive Concentration Exceedances
Who may be interested: Registered Investment Companies; Directors of Registered Investment Companies; Investment Advisers; and Compliance Officers.
Quick Take: The SEC staff issued a no-action letter stating that it would not recommend enforcement action when an ETF that has passively exceeded its disclosed concentration policy because of market movements continues to engage in certain creation basket transactions. The relief applies to pro rata creation baskets, certain cash-in-lieu purchases, and non-pro rata creation baskets that maintain the same industry weighting as a pro rata creation basket. The position applies to both actively-managed and index-based ETFs.
The staff of the SEC Division of Investment Management issued a no-action letter addressing certain ETF creation basket transactions that occur when an ETF is experiencing a passive exceedance of its disclosed concentration policy due to market movements. Under Section 8 of the 1940 Act, registered funds must disclose their policies regarding concentration in a particular industry or group of industries and generally may not deviate from those policies without shareholder approval.
The no-action letter addresses situations where an ETF passively exceeds its concentration limit because of changes in market value rather than portfolio management decisions. According to the request, these exceedances may occur when changes in market values cause investments in a particular industry to exceed 25% of an ETF’s assets, notwithstanding the ETF’s disclosed policy not to concentrate in any industry. The no-action letter notes that ETFs issue and redeem shares through creation baskets and generally cannot control the timing of creation orders, which may increase holdings in an industry during passive concentration exceedance. The request letter argued that, absent the requested relief, ETFs experiencing a passive concentration exceedance could be forced to alter basket composition, substitute assets, or pursue other potentially costly alternatives.
The SEC staff stated it would not recommend enforcement action if an ETF: (1) receives a pro rata creation basket that includes one or more investments in such industry; (2) uses cash received in lieu of a creation basket component, where such component represents an investment in such industry, to purchase the component security up to an amount consistent with a pro rata creation basket; or (3) receives a non-pro rata creation basket where the weighting of such industry is consistent with the weighting of the industry in a pro rata creation basket.
Although limited to the facts presented, the no-action letter states that the SEC staff would not recommend enforcement action when an ETF, experiencing a passive exceedance of its concentration policy, engages in the creation basket transactions specified in the No-Action Letter.
The SEC No-Action Letter is available here.