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SEC Commissioners: New ETF Structure Has Major Liquidity Problems

Two commissioners argue that in market downturns, investors won’t get a fair price for their shares in nontransparent active ETFs.

Last week, the Securities and Exchange Commission announced plans to approve applications from T. Rowe Price, Natixis, Fidelity and Blue Tractor to launch nontransparent active ETFs.

But a statement by SEC Commissioners Robert J. Jackson Jr. and Allison Herren Lee shows further divide over regulatory actions at the commission.

Active ETFs with transparent portfolios have existed for quite a while, but they are a small slice of the ETF landscape. Many active managers have avoided the ETF structure as they believe daily transparency would limit the effectiveness of their portfolios, and some firms have been working with the SEC to approve a nontransparent ETF structure. These funds won’t provide full daily transparency.

But the two commissioners argue that in market downturns, investors won’t get a fair price for their shares in these funds.

“For that reason, applications that do not address the potentially serious liquidity problems arising from the fundamental structure of nontransparent ETFs should give the Commission great pause,” they say.

Historically, ETF sponsors were required to ensure that the market price for ETF shares doesn’t deviate too far from the value of the underlying holdings.

Jackson and Lee applauded the applicants for the guardrails they have put around their funds to address the liquidity issues. But they also said they’re skeptical of nontransparent ETFs focused on different asset classes without those guardrails.

“We also want to keep close watch over the appropriate disclosure regime for nontransparent ETFs,” they said in the statement. “In particular, we wonder whether additional disclosure of the risks, as well as enhanced board oversight of the efficiency of these ETFs, is necessary. Because these products have not yet launched, we are only in the early stages of determining the information investors need to evaluate the unique risks of nontransparent ETFs, including mechanisms to ensure accuracy and price efficiency. We urge our colleagues to consider whether prospectus disclosure of these measures is necessary going forward.”

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