The Securities and Exchange Commission has declined an appeal by active fund managers to allow ETFs to trade without disclosing their underlying holdings.
The preliminary decisions on applications by BlackRock and Precidian Investments delivers a blow to an industry eager to capture the growth in exchange-traded funds.
Today, those funds largely track a benchmark. But a range of mutual fund managers want to be able to offer the products without disclosing their strategies immediately to other traders. Some of those managers have lost market share in their core products to competitive ETFs, which are often cheaper and usually aim to track — rather than outperform — a benchmark.
But in 60 pages of analysis posted late Tuesday, the SEC said some long-discussed proposals to sidestep requirements that fund managers constantly disclose their holdings fell “far short of providing a suitable alternative to the arbitrage activity in ETF shares” that keeps them trading at or close to the underlying value of their securities.
“The commission intends to deny applicants' request for an exemption … as not necessary or appropriate in the public interest and as not consistent with the protection of investors and the purposes fairly intended by the policy and provisions” of the Investment Advisers Act of 1940, read the notice.
But Precidian CEO Daniel J. McCabe said Wednesday that the investment management industry has registered broad support for the proposals before the SEC, and he is optimistic any issues could be resolved.
“These are things that can be worked though,” Mr. McCabe said. “It's not a process that I enjoy, but when you do novel things it takes longer than if you do standard things.”
The SEC's analysis of the product structure revealed some discomfort with the ability of the complex ecosystem that underpins ETFs to work normally with more opaque products, particularly in times of market stress.
Because ETF managers do not issue securities directly to investors, the market for those products depends on the activities of institutional traders known as market makers. The SEC has been polling those market makers on non-transparent products in recent weeks.
The lack of information about underlying portfolios “likely would discourage market makers from making markets … particularly under stressed market conditions when the need for real-time and verifiable pricing information becomes more acute,” Kevin M. O'Neill, deputy secretary at the commission, wrote in a notice.