Capital Markets Desk: The ETF Rule Has Finally Arrived!

Some thoughts on the recent adoption of the ETF Rule and what it means for investors.

    David Mann

    David MannHead of Global ETF Capital Markets, Franklin Templeton

    At the start of 2018, I predicted regulators might adopt a new Exchange-Traded Fund (ETF) Rule, and then also discussed the rule proposal in a little more detail. And, I gave our feedback on the Rule via a comment letter.

    The Securities and Exchange Commission (SEC) finally announced the adoption of the ETF Rule, which will soon go into effect. The SEC stated the Rule is designed to modernize the regulation of ETFs by establishing a clear and consistent framework for the vast majority of ETFs operating today, and will facilitate greater competition and innovation in the ETF marketplace. It will also allow ETFs to come to market more quickly.

    I think it will certainly even the playing field among ETF issuers. I wanted to reiterate that this rule treats active and index funds the SAME if the conditions are met. From the final rule:

    “Index-based and actively managed ETFs that comply with the rule’s conditions function similarly with respect to operational matters, despite different investment objectives or strategies;” and,

    “The distinction between index-based ETFs and actively managed ETFs in our current exemptive orders is largely a product of ETFs’ historical evolution…The Commission has observed how actively managed ETFs operate during this time, and has not identified any operational issues that suggest additional conditions for actively managed ETFs are warranted.”

    The above has been an ongoing issue when discussing our entire suite with investors as they often push back on our active ETF offerings for the simple reason that they have the “active” label. This rule explicitly states that from an operational perspective, they are largely the same, and we hope that over time, investors will start evolving their thinking on active ETFs.

    We saw a great example of this in action recently with our active low volatility fund, Franklin Liberty US Low Volatility ETF (FLLV). This fund just celebrated its three-year anniversary on September 22, 2019, with assets under management of only $18 million. The most common excuse for the lack of adoption of this fund we have heard among investors is that it’s an “active” fund, as in actively managed. Investors often consider the term ETF to mean a passive index-tracking fund.

    On Monday (9/23/19) an investor bought 1M shares ($37M) of FLLV within the bid/ask spread which was 3 cents at the time of the trade. 

    All the content we have written about ETF liquidity and leveraging the underlying basket applies to both active and passive, as was evident in this trade. Now, we finally have an ETF rule supporting that point as well, which in turn will allow active ETF issuers access to all the same tools (such as custom baskets) that have been available to index funds for quite some time.