ETF Capital Markets Desk: Summing Up Our ETF Rule Comment Letter

    David Mann

    David MannHead of Capital Markets, Global Exchange-Traded Funds (ETFs), Franklin Templeton Investments

    While many (if not most) market predictions don’t come true, one that David Mann made at the start of the year was the revival of the “ETF Rule,” which now seems likely to soon come to fruition. Mann, who is Franklin Templeton’s head of Capital Markets, Global Exchange-Traded Funds (ETFs), offers some highlights of Franklin Templeton’s comment letter to regulators on the rule.

    As I’ve written about previously, the long-anticipated “ETF Rule” was officially published in the Securities and Exchange Commission (SEC) Federal Register on July 31, 2018, and the comment period was opened.

    On October 1, Franklin Templeton Investments submitted our comment letter to the SEC. The comment letter can be found here.

    The focus of our comment letter was on the bid/ask spread disclosures and what it means in terms of an investor’s total cost of owning an ETF. I will say a little more about that in a second.

    First, it is worth remembering that ETFs are funds that trade on an exchange (hence the name!).

    The proposed ETF rule had sections that touched on the manufacturing of funds (custom baskets, treatment of index versus active) and parts that touched on their trading (bid/ask spread disclosures). We were broadly supportive of the former in the proposal, and thus focused on the latter for our comments.

    Costs are a very difficult thing to quantify accurately for ETFs, because there is not a clean way to apply the traditional stock-trading metrics like bid/ask spreads and broker commissions to funds that have an underlying value and an expense ratio. All of these will factor into the investor experience of owning an ETF.

    For example, which is better: a tight bid/ask spread but higher-than-expected premiums and discounts to net asset value (NAV)or a wider bid/ask spread with a very low management fee? There is no right or wrong answer to that one, because only looking at one of the ETF cost factors is not sufficient. As we say in our comment letter:

    We recommend clear disclosures that highlight all the factors that could impact the cost of both trading (e.g., commissions and market impact) and owning (e.g., management fee and tracking error) an ETF.  The investor can then use those factors when having an informed conversation with their executing broker on the expected cost of investing in an ETF. 

    Here at Capital Markets Corner, I will continue to address all these factors, such that investors are more informed when trading ETFs.

    David Mann’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

    This information is intended for US residents only.

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    1. Net Asset Value (NAV) represents an ETF’s per-share-value. The NAV per share is determined by dividing the total NAV of the Fund by the number of shares outstanding.

    What are the Risks?

    All investments involve risks, including possible loss of principal. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.