Investment advisers and broker-dealers can use National Compliance Services, Inc.’s registration and compliance services. The question of whether a share of an exchange-traded fund (“ETF”) structured as a unit investment trust (“UIT”) is a “reportable security” within the meaning of Rule 204A-1(e) has arisen in advising our clients on compliance with Rule 204A-1 under the Investment Advisers Act of 1940 (the “Advisers Act”) (10). We respectfully request the staff’s assurance that, unless the ETF is a “reportable fund” within the meaning of Rule 204A-1(e), it will not recommend enforcement action to the Commission against our clients who are registered investment advisers if they do not treat ETF shares as reportable securities (9).
An ETF is a registered investment company organized as an open-end management investment company, a unit investment trust, or a similar entity that holds securities constituting or otherwise based on or representing an investment in an index. Its shares or other securities are principally traded on a national securities exchange or through the facilities of a national securities association and reported as a national market security.
1ETFs only sell and redeem their shares in huge blocks known as creation units at net asset value.
Individual ETF shares, on the other hand, can be bought and sold at market prices by investors throughout the trading day.
Because of the arbitrage opportunities inherent in the ETF structure, ETF shares have rarely traded at a large premium or discount to net asset value in the secondary market.
12
In January 2005, the combined assets of the country’s ETFs were $222.89 billion.
3
The bulk of exchange-traded funds (ETFs) are structured as open-end management investment companies (OMICs).
Some of the larger ETFs, on the other hand, are structured as UITs.
DIAMONDS Trust, Series 1, had net trust assets of $8.19 billion on October 31, 2004;4 MidCap SPDR Trust, Series 1, had net trust assets of $6.54 billion on September 30, 2004;5 Nasdaq-100 Trust, Series 1, had net trust assets of $20.38 billion on September 30, 2004;6 and SPDR Trust, Series 1, had net trust assets of $45.72 billion on September 30, 2004.
7
According to Rule 204A-1, every registered investment adviser must establish, maintain, and enforce a written code of ethics that requires access persons to submit reports of their holdings of, and transactions in, reportable securities, among other things.
Rule 204A-1(e)(10) defines a “reportable security” as a security as defined in Section 202(a)(18) of the Advisers Act, with certain stated exceptions, such as shares issued by open-end registered investment organizations that are not reportable funds (i.e., registered investment companies with which the registered investment adviser has certain relationships).
8
Except for the tiny number of investment advisers for whom the ETF is a reportable fund, the majority of ETFs are open-end registered investment companies, and their shares are not reportable securities under Rule 204A-1.
ETFs constituted as UITs, on the other hand, do not qualify for any of the exceptions in Rule 204A-1(e)(10), and their shares are thus reportable securities in the strictest sense of the term.
9
The exceptions to the “reportable security” definition are designed to exclude stocks that appear to present minimal chance for the type of unlawful trading that the access person reports are designed to detect, according to the Commission’s Adopting Release.
10
We believe that ETFs, which are among the most transparent and liquid instruments available, are especially unlikely to provide possibilities for illegal trading.
Furthermore, there appears to be little need to distinguish between ETFs organized as unit investment trusts (UITs) and ETFs organized as open-end investment companies (OEICs).
Because of their generally larger size, better liquidity, and high level of transparency and liquidity of their underlying holdings, ETFs constituted as UITs are even less likely than other ETFs to present chances for inappropriate trading.
We believe that financial advisers regard ETF shares as a single type of security and that an arbitrary requirement to discriminate between ETFs organized as open-end investment companies and ETFs organized as unit investment trusts will confuse them.
It’s worth noting that the way ETFs are treated under Rule 204A-1 has generated some consternation in the industry.
This firm’s members have attended three conferences in the last few months where the topic has been discussed.
As a result, a no-action response would provide important guidance to the sector.
Are exchange-traded funds (ETFs) considered securities?
An exchange traded fund (ETF) is a form of securities that tracks an index, sector, commodity, or other asset and may be bought and sold on a stock exchange much like a regular stock. An ETF can be set up to track anything from a single commodity’s price to a big and diverse group of securities. ETFs can even be built to follow certain investment strategies.
The SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, is a well-known example.
Do ETFs have to register with the SEC?
- Regulatory framework. Most ETFs are registered as investment firms with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940, and the public shares they issue are registered under the Securities Act of 1933. Although their publicly-offered shares are registered under the Securities Act, several ETFs that invest in commodities, currencies, or commodity- or currency-based securities are not registered investment companies.
- Style of management Many ETFs, like index mutual funds, are meant to replicate a specific market index passively. By investing in all or a representative sample of the stocks included in the index, these ETFs try to attain the same return as the index they track. Actively managed ETFs have been a popular option for investors in recent years. Rather than monitoring an index, the portfolio manager of an actively managed ETF buys and sells equities in accordance with an investing plan.
- The goal of the investment. The investment objectives of each ETF, as well as the management style of each ETF, differ. The goal of passively managed exchange-traded funds (ETFs) is to match the performance of the index they monitor. Actively managed ETF advisers, on the other hand, make their own investment decisions in order to attain a certain investment goal. Some passively managed ETFs aim to achieve a return that is a multiple (inverse) of the return of a specific stock index. Leveraged or inverse ETFs are what they’re called. The investment objective of an ETF is indicated in the prospectus.
- Indices are being tracked. ETFs follow a wide range of indices. Some indices, such as total stock or bond market indexes, are very wide market indices. Other ETFs follow smaller indices, such as those made up of medium and small businesses, corporate bonds only, or overseas corporations exclusively. Some ETFs track extremely narrow—and, in some cases, brand-new—indices that aren’t entirely transparent or about which little is known.
Is an exchange-traded fund (ETF) considered an equity security?
An ETF, or Exchange Traded Fund, is a pool of securities such as stocks, bonds, and options that may be purchased and sold in real time on a stock exchange like a stock. Most ETFs are meant to track an index rather than being actively managed. The expense ratios of ETFs are, on average, quite modest. An ETF’s net asset value (NAV) is not computed every day like a mutual fund’s because it trades like a stock.
Both shares and ETFs have the potential to rise in value as a result of market price appreciation; yet, they are both exposed to market volatility and consequently to market price risk and potential principal loss.
Risks associated with exchange-traded funds are comparable to those associated with equities. Investment returns will fluctuate and are subject to market volatility, so an investor’s shares may be worth more or less than their initial cost when redeemed or sold. Shares in ETFs, unlike mutual funds, are not individually redeemable with the ETF; instead, they must be bought and sold on an exchange, just like individual stocks. Prospectuses are used to sell ETFs. Before investing, carefully examine the investment objectives, risks, charges, and expenses, as well as your personal best-interest concerns. Call your HSBC Securities (USA) Inc. to acquire the prospectus, which provides this and other information. Financial Expertise
Is an exchange-traded fund (ETF) a closed-end fund?
One of three main types of investment firms is a closed-end fund, sometimes known as a closed-end investment company. Open-end funds (typically mutual funds) and unit investment trusts are the other two forms of investment businesses (UITs). ETFs are often formed as open-end funds, although they can also be structured as unit investment trusts (UITs).
A closed-end fund invests the money it raises in stocks, bonds, money market instruments, and/or other securities after its initial public offering.
Closed-end funds have a number of conventional and distinguishing characteristics:
- A closed-end fund, on the other hand, does not sell its shares on a continuous basis, but rather sells a set amount of shares at a time. The fund usually trades on a market after its initial public offering, such as the New York Stock Exchange or the NASDAQ Stock Market.
- The market determines the price of closed-end fund shares that trade on a secondary market after their original public offering, which may be higher or lower than the shares’ net asset value (NAV). A premium is paid for shares that sell at a higher price than the NAV, while a discount is paid for shares that sell at a lower price than the NAV.
- A closed-end fund is not obligated to purchase back its shares from investors if they want it. Closed-end fund shares, on the other hand, are rarely redeemable. Furthermore, unlike mutual funds, they are permitted to hold a higher percentage of illiquid securities in their investing portfolios. In general, a “illiquid” investment is one that cannot be sold within seven days at the estimated price used by the fund to determine NAV.
- Closed-end funds are regulated by the Securities and Exchange Commission (SEC). Furthermore, closed-end fund investment portfolios are often managed by independent organizations known as investment advisers who are likewise registered with the SEC.
- Monthly or quarterly payouts are customary for closed-end funds. These distributions can include interest income, dividends, or capital gains earned by the fund, as well as a return of principal/capital. The size of the fund’s assets is reduced when principal/capital is returned. When closed-end funds make distributions that involve a return of capital, they must issue a written notification, known as a 19(a) notice.
Closed-end funds come in a variety of shapes and sizes. Each investor may have distinct investment goals, techniques, and portfolios. They can also be vulnerable to a variety of risks, volatility, as well as fees and charges. Fees lower fund returns and are an essential aspect for investors to consider when purchasing stock.
Before buying fund shares, study all of the available information on the fund, including the prospectus and the most current shareholder report.
Are exchange-traded funds (ETFs) safer than stocks?
The gap between a stock and an ETF is comparable to that between a can of soup and an entire supermarket. When you buy a stock, you’re putting your money into a particular firm, such as Apple. When a firm does well, the stock price rises, and the value of your investment rises as well. When is it going to go down? Yipes! When you purchase an ETF (Exchange-Traded Fund), you are purchasing a collection of different stocks (or bonds, etc.). But, more importantly, an ETF is similar to investing in the entire market rather than picking specific “winners” and “losers.”
ETFs, which are the cornerstone of the successful passive investment method, have a few advantages. One advantage is that they can be bought and sold like stocks. Another advantage is that they are less risky than purchasing individual equities. It’s possible that one company’s fortunes can deteriorate, but it’s less likely that the worth of a group of companies will be as variable. It’s much safer to invest in a portfolio of several different types of ETFs, as you’ll still be investing in other areas of the market if one part of the market falls. ETFs also have lower fees than mutual funds and other actively traded products.
Do ETFs have assets backing them up?
ETFs are a sort of investment fund and exchange-traded vehicle, which means they are traded on stock markets. ETFs are comparable to mutual funds in many aspects, except that ETFs are bought and sold from other owners on stock exchanges throughout the day, whereas mutual funds are bought and sold from the issuer at the end of the day. An ETF is a mutual fund that invests in stocks, bonds, currencies, futures contracts, and/or commodities such as gold bars. It uses an arbitrage mechanism to keep its price close to its net asset value, however it can periodically deviate. The majority of ETFs are index funds, which means they hold the same securities in the same quantities as a stock or bond market index. The S&P 500 Index, the overall market index, the NASDAQ-100 index, the price of gold, the “growth” stocks in the Russell 1000 Index, or the index of the greatest technological companies are all replicated by the most popular ETFs in the United States. The list of equities that each ETF owns, as well as their weightings, is provided daily on the issuer’s website, with the exception of non-transparent actively managed ETFs. Although specialist ETFs can have yearly fees considerably in excess of 1% of the amount invested, the largest ETFs have annual costs as low as 0.03 percent of the amount invested. These fees are deducted from dividends received from underlying holdings or from the sale of assets and paid to the ETF issuer.
An ETF divides its ownership into shares, which are held by investors. The specifics of the structure (such as a corporation or trust) will vary by country, and even within a single country, various structures may exist. The fund’s assets are indirectly owned by the shareholders, who will normally get yearly reports. Shareholders are entitled to a portion of the fund’s profits, such as interest and dividends, as well as any residual value if the fund is liquidated.
Because of their low expenses, tax efficiency, and tradability, ETFs may be appealing as investments.
Globally, $9 trillion was invested in ETFs as of August 2021, with $6.6 trillion invested in the United States.
BlackRock iShares has a 35 percent market share in the United States, The Vanguard Group has a 28 percent market share, State Street Global Advisors has a 14 percent market share, Invesco has a 5% market share, and Charles Schwab Corporation has a 4% market share.
Even though they are funds and are traded on an exchange, closed-end funds are not considered ETFs. Debt instruments that are not exchange-traded funds are known as exchange-traded notes.
Do ETFs qualify as NMS securities?
The Securities and Exchange Commission (SEC) proposed Rule 610T of Regulation NMS on March 14, 2018, to conduct a transaction fee pilot program (Pilot) with National Market System (NMS) equities. All of the major stock exchanges, as well as additional facilities and companies utilized by broker-dealers to complete trade orders for securities, including ETF shares, are included in the NMS, the national system for trading equities in the United States. Across three test groups, the Pilot will apply new temporary pricing limits to stock exchange transaction and alternative trading systems (ATS) fee pricing, including “maker-taker” fee-and-rebate pricing structures.
The exchanges and ATS will gather and publicly publish data on the impact of the three pilots, which will be evaluated by the SEC and industry participants in order to improve pricing, liquidity, and trade execution quality. Any regulation changes resulting from the Pilot will have a direct influence on ETFs on the most fundamental level: ETF share liquidity and execution quality, as well as the equity shares owned by the ETF. Prior to its introduction, ETF sponsors will have the opportunity to comment on the proposed Pilot.
The SEC’s adoption of Regulation NMS in 2005 aided the transformation of US equities markets from single trading systems to a large number of trading centers that comprise electronically linked stock exchanges and ATS. Orders, bid/ask quotations, available market players, and liquidity are scattered over the trading environment under NMS. NMS established regulations to protect orders and regulate intermarket trading, as well as rules to provide fair and efficient access to quotations and set costs for accessing protected quotations.
Since the passage of Regulation NMS, the SEC has conducted several evaluations of market structure and market events, reviewed and implemented new rules, and solicited feedback from the securities industry on how well and equitably NMS operates. The SEC has received input from the Equity Market Structure Advisory Committee (EMSAC) and other industry participants, including a recommendation for a pilot program that tests real-time theories on how changes to equity exchange transaction fees and rebates affect order routing behavior, execution quality, and overall market quality.
Exchanges and other trading centers collect orders from market participants to buy and sell ETFs and other securities and levy fees to its members and users when they match a purchase order against a sell request, resulting in an execution. As trading center rivalry heated up in the late 1990s, ATSs and subsequently exchanges began to provide rebates to entice order flow. According to the SEC’s announcement proposing the Pilot, the “maker-taker” fee model has emerged in the U.S. equities markets, in which a trading center charges a per-share fee at execution, pays a broker-dealer participant a per-share rebate to provide (i.e., “make”) liquidity in the securities, and assesses a fee to remove (i.e., “take”) liquidity. For example, a firm that facilitates a trade by posting buy and sell offers is compensated with a fee of approximately 20 to 30 cents per 100 shares transacted. A fee is imposed to companies that accept those shares. The difference between the charge paid by the taker of liquidity and the rebate paid to the provider or maker of liquidity is the trading center’s revenue.
Other pricing models exist, such as the “taker-maker” model (also known as an inverted model), in which a trading center taxes the liquidity provider and offers a rebate to the liquidity taker. The “access fees” that trading centers charge to access their quotes are governed by Regulation NMS Rule 610(c), which prohibits them from imposing, or permitting to be imposed, “any fee or fees for the execution of an order against a protected quotation… that exceed or accumulate to more than $0.003 per share.”
Several issues have been raised in recent years concerning the maker-taker fee model, including rebates offered to entice orders. Some have questioned whether the current fee structure has created a conflict of interest for broker-dealers, who must pursue the best execution of their customers’ orders while facing potentially conflicting economic incentives from the trading centers to which they direct those orders for execution to avoid fees or earn rebates—both of which are typically not passed through the broker-dealer to its customers.
The SEC proposed the following Pilot after obtaining information from a variety of sources, including the EMSAC. The Pilot consists of three test groups, as stated in the table below: one will restrict rebates and linked pricing, while the other two will set caps of $0.0015 and $0.0005 for removing or supplying displayed liquidity, respectively.