What Is the ETF Rule?
The “ETF Rule” is a rule adopted by the U.S. Securities and Exchange Commission (SEC) that allows exchange-traded funds (ETFs) that meet certain conditions to go to market without the delay of obtaining an exemptive order. Passed in 2019, the rule also made custom creation/redemption baskets available for all ETFs.
Key Takeaways
- A rule referred to as the "ETF Rule" was passed in September 2019 by the Securities and Exchange Commission (SEC).
- The rule removed "exemptive order" regulations, enabling ETF issuers to more easily bring new strategies to market.
- It also made customized creation/redemption baskets available for all types of covered ETFs.
Understanding the ETF Rule
The first exchange-traded fund was approved by the SEC in 1992. Since then, these products have grown in popularity and use due to their accessibility and low-cost nature. However, the Investment Company Act of 1940 required that the Commission issue an exemptive order to approve ETFs because of how it was worded regarding reissuing securities.
Exemptive orders were necessary before the rule because the act prevented the approval of ETFs, so the SEC was required to issue exemptions to specific requirements. Each fund was required to file for an exemption—once filed, the application was placed in a queue for review, a process that could take months.
Initially proposed in 2018, the “ETF Rule” was passed by the Securities and Exchange Commission in September 2019. The rule and its amendments went into effect 60 days after its publication in the Federal Register.
The ETF rule, 6c-11, allowed the SEC to eliminate certain regulatory requirements that created these ETF speedbumps. This became known as "exemptive relief" because funds could get their products onto the market much quicker and cheaper.
The rule applies to both passive and active open-ended funds but does not cover closed-end funds or leveraged and inverse ETFs.
Impact on Exemptive Orders
Designed to improve ETF regulation, the rule also aimed to streamline ETF approval because it removed the conditions that required exemption orders, making it easier for companies to bring ETFs of all types to market by removing certain funds from the lengthy process.
According to SEC Commissioner Hester M. Peirce, this helped codify regulations that began when ETFs were first launched in 1992. Commissioner Peirce said in her remarks at an ETF Global Markets Roundtable that “a level playing field without long approval queues makes for better competition, which is good for investors, capital formation, and the health of our markets.”
Allows for Custom Baskets
One of the other key attributes of the “ETF Rule” is the fact that it made custom creation/redemption baskets available for all of the ETFs it covers. This allowed for potential tax benefits for companies issuing ETFs and made it easier for companies and investors alike to understand transaction costs associated with those funds.
What Is the 6c-11 Rule for ETFs?
Rule 6c-11 allows open-end funds to operate without obtaining an exemptive order. ETFs that rely on rule 6c-11 are eligible for the "redeemable securities" and "registered open-end investment company" exemptions.
What are Rules-Based ETFs?
Rules-based ETFs are funds where asset selection is based on pre-determined rules so that only assets that meet the requirements are selected for the fund.
What Is the ETF Method?
ETFs are companies that buy selected assets and issue fractionalized shares that represent all of the assets—commonly called a basket of assets—for investors to buy. Using this method, investors gain access to assets they may not previously have been able to.
The Bottom Line
The ETF rule is a measure taken by the Securities and Exchange Commission that provides relief for funds waiting in line for approval. The rule creates a faster track for funds by removing certain previous requirements.
FAQs
The ETF rule is a measure taken by the Securities and Exchange Commission that provides relief for funds waiting in line for approval. The rule creates a faster track for funds by removing certain previous requirements.
What is an ETF and why is it important? ›
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.
What is the final rule of ETF? ›
Finally, the Commission is adopting related amendments to Form N-CEN. The final rule and form amendments are designed to create a consistent, transparent, and efficient regulatory framework for ETFs that are organized as open- end funds and to facilitate greater competition and innovation among ETFs.
What is the best way to explain ETF? ›
Exchange-traded funds (ETFs) are a type of index funds that track a basket of securities. Mutual funds are pooled investments into bonds, securities, and other instruments.
What is an ETF in layman's terms? ›
An ETF, or Exchange Traded Fund is a simple and easy way to get access to investment markets. It is a pre-defined basket of bonds, stocks or commodities that we wrap into a fund and then we list onto the exchange so that everyone can use it.
What is a rules-based ETF? ›
Rules-based ETF investing seeks to solve for these implementation and investment challenges. It entails a simple, transparent process to define a liquid investment universe which is then refined by fundamentals and rebalanced periodically.
What is ETF for dummies? ›
A cross between an index fund and a stock, they're transparent, easy to trade, and tax-efficient. They're also enticing because they consist of a bundle of assets (such as an index, sector, or commodity), so diversifying your portfolio is easy. You might have even seen them offered in your 401(k) or 529 college plan.
What is ETF advantages and disadvantages? ›
Advantages and disadvantages of ETFs
Investing in ETFs helps to mitigate unsystematic risks due to its passive investment strategy. It also lowers one's overall investment risk. It greatly helps with portfolio diversification. With the limited role of fund managers, ETF investments are comparatively cost-effective.
Is investing in ETF good or bad? ›
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.
What is the 30 day rule on ETFs? ›
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
Known as the 4% rule, Bengen argued that investors could safely set their annual withdrawal rate to 4% of their initial retirement pot and adjust it for inflation without running out of money over a 30-year time horizon.
What is the rule of 72 in ETF? ›
Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double. As you can see, a one-time contribution of $10,000 doubles six more times at 12 percent than at 3 percent.
What is ETF in simple words? ›
An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. In the simple terms, ETFs are funds that track indexes such as CNX Nifty or BSE Sensex, etc.
What is the main benefit of an ETF? ›
Positive aspects of ETFs
The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
What is the 3 5 10 rule for ETF? ›
Specifically, a fund is prohibited from: acquiring more than 3% of a registered investment company's shares (the “3% Limit”); investing more than 5% of its assets in a single registered investment company (the “5% Limit”); or. investing more than 10% of its assets in registered investment companies (the “10% Limit”).
How long do I have to hold an ETF before selling? ›
For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
How long should you leave money in an ETF? ›
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
