Exchange-Traded Funds

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission”) is adopting a new rule under the Investment Company Act of 1940 (the “Investment Company Act” or the “Act”) that will permit exchange-traded funds (“ETFs”) that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order. In connection with the final rule, the Commission will rescind certain exemptive relief that has been granted to ETFs and their sponsors. The Commission also is adopting certain disclosure amendments to Form N-1A and Form N-8B-2 to provide investors who purchase and sell ETF shares on the secondary market with additional information regarding ETF trading and associated costs, regardless of whether such ETFs are structured as registered open-end management investment companies (“open-end funds”) or unit investment trusts (“UITs”). 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. The Commission also is adopting technical amendments to Form N-CSR, Form N-1A, Form N-8B-2, Form N-PORT, and Regulation S-X.

DATES:

Effective Date: This rule is effective December 23, 2019.

Compliance Dates: The applicable compliance dates are discussed in section II.L. of this final rule.

FOR FURTHER INFORMATION CONTACT:

Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), J. Matthew DeLesDernier (Senior Counsel), Jacob D. Krawitz (Branch Chief), Melissa S. Gainor (Assistant Director), and Brian McLaughlin Johnson (Assistant Director), Investment Company Regulation Office, at (202) 551-6792, Kay-Mario Vobis (Senior Counsel), Daniele Marchesani (Assistant Chief Counsel), Chief Counsel's Office, at (202) 551-6825, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is adopting 17 CFR 270.6c-11 (new rule 6c-11) under the Investment Company Act [15 U.S.C. 80a-1 et seq.]; amendments to Form N-1A [referenced in 17 CFR 274.11A] under the Investment Company Act and the Securities Act of 1933 [15 U.S.C. 77a et seq.] (“Securities Act”); and amendments to Forms N-8B-2 [referenced in 17 CFR 274.12] and N-CEN [referenced in 17 CFR 274.101] under the Investment Company Act. The Commission also is adopting technical amendments to Form N-CSR [referenced in § 274.128], Form N-1A, Form N-8B-2, and Form N-PORT [referenced in § 274.150] under the Investment Company Act, and 17 CFR 210.12-01 through 210.12-29 (Article 12 of Regulation S-X).

Table of Contents

I. Introduction

A. Overview of Exchange-Traded Funds

B. Operation of Exchange-Traded Funds

II. Discussion

A. Scope of Rule 6c-11

1. Organization as Open-End Funds

2. Index-Based ETFs and Actively Managed ETFs

3. Leveraged/Inverse ETFs

B. Exemptive Relief Under Rule 6c-11

1. Treatment of ETF Shares as “Redeemable Securities”

2. Trading of ETF Shares at Market-Determined Prices

3. Affiliated Transactions

4. Additional Time for Delivering Redemption Proceeds

C. Conditions for Reliance on Rule 6c-11

1. Issuance and Redemption of Shares

2. Listing on a National Securities Exchange

3. Intraday Indicative Value (“IIV”)

4. Portfolio Holdings Disclosure

5. Baskets

6. Website Disclosure

7. Marketing

8. ETF and ETP Nomenclature

D. Recordkeeping

E. Share Class ETFs

F. Master-Feeder ETFs

G. Effect of Rule 6c-11 on Prior Orders

H. Amendments to Form N-1A

1. Fee Disclosures for Mutual Funds and ETFs (Item 3)

2. Disclosures Regarding ETF Trading and Associated Costs (Item 6)

3. Eliminated Disclosures

I. Amendments to Form N-8B-2

J. Amendments to Form N-CEN

K. Technical and Conforming Amendments to Form N-1A, Form N-8B-2, Form N-CSR, Form N-PORT, and Regulation S-X

L. Compliance Dates

III. Other Matters

IV. Economic Analysis

A. Introduction

B. Economic Baseline

1. ETF Industry Growth and Trends

2. Exemptive Order Process and Certain Conditions Under Existing Orders

3. Market Participants

4. Secondary Market Trading, Arbitrage, and ETF Liquidity

C. Benefits and Costs of Rule 6c-11 and Form Amendments

1. Rule 6c-11

2. Amendments to Forms N-1A, N-8B-2, and N-CEN

D. Effects on Efficiency, Competition, and Capital Formation

1. Efficiency

2. Competition

3. Capital Formation

E. Reasonable Alternatives

1. Website Disclosure of Basket Information

2. Disclosure of ETF Premiums or Discounts Greater than 2%

3. Website and Prospectus Disclosure of the Median Bid-Ask Spread Calculated Over the Most Recent 1-Year Period

4. Additional Disclosures Showing the Impact of Bid-Ask Spreads

5. Website Disclosure of a Modified IIV

6. The Use of a Structured Format for Additional Website Disclosures and the Filing of Additional Website Disclosures in a Structured Format on EDGAR

7. Pro Rata Baskets

8. Treatment of Existing Exemptive Relief

9. ETFs Organized as UITs

10. Treatment of Leveraged/Inverse ETFs

V. Paperwork Reduction Act

A. Introduction

B. Rule 6c-11

1. Website Disclosures

2. Recordkeeping

3. Policies and Procedures

4. Estimated Total Burden

C. Rule 0-2

D. Form N-1A

E. Forms N-8B-2 and S-6

F. Form N-CEN

VI. Final Regulatory Flexibility Analysis

A. Need for and Objectives of the Rule and Form Amendments

B. Significant Issues Raised by Public Comments

C. Small Entities Subject to the Rule

D. Projected Reporting, Recordkeeping, and Other Compliance Requirements

1. Rule 6c-11

2. Other Disclosure and Reporting Requirements

E. Agency Action To Minimize Effect on Small Entities

VII. Statutory Authority

I. Introduction

The Commission is adopting rule 6c-11 under the Investment Company Act to permit ETFs that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order from the Commission under the Act. This rule will modernize the regulatory framework for ETFs to reflect our more than two decades of experience with these investment products. The rule is designed to further important Commission objectives, including establishing a consistent, transparent, and efficient regulatory framework for ETFs and facilitating greater competition and innovation among ETFs.

The Commission approved the first ETF in 1992. Since then, ETFs registered with the Commission have grown to $3.32 trillion in total net assets. They now account for approximately 16% of total net assets managed by investment companies, and are projected to continue to grow. ETFs currently rely on exemptive orders, which permit them to operate as investment companies under the Act, subject to representations and conditions that have evolved over time. We have granted over 300 of these orders over the last quarter century, resulting in differences in representations and conditions that have led to some variations in the regulatory structure for existing ETFs.

On June 28, 2018, we proposed new rule 6c-11 under the Investment Company Act, which would simplify this regulatory framework by eliminating conditions included within our exemptive orders that we no longer believe are necessary for our exemptive relief and removing historical distinctions between actively managed and index-based ETFs. We also proposed to rescind certain exemptive orders that have been granted to ETFs and their sponsors in order to level the playing field for ETFs that are organized as open-end funds and pursue the same or similar investment strategies. In addition, the Commission proposed certain disclosure amendments to Form N-1A and Form N-8B-2 to provide investors additional information regarding ETF trading and associated costs, regardless of whether ETFs are organized as open-end funds or UITs. Finally, the Commission proposed related amendments to Form N-CEN.

We received more than 85 comment letters on the proposal. As discussed in greater detail below, commenters were supportive of the adoption of an ETF rule and generally supported rule 6c-11 as proposed. Commenters did, however, recommend modifications or clarifications to certain aspects of the rule. For example, several commenters suggested expanding the scope of ETFs covered by the rule or the scope of certain exemptions. Many commenters recommended modifications to the proposed rule's conditions, particularly relating to the timing and presentation of portfolio holdings information, the requirements related to custom baskets, the publication of basket information, and the availability of an intraday indicative value. In addition, although commenters were largely supportive of our efforts to improve the information that ETFs disclose to investors about the trading costs of investing in ETFs, several commenters objected to the bid-ask spread disclosure requirements and the related interactive calculator. Others recommended alternatives to the proposed format and placement of the trading cost disclosures. Finally, commenters were largely supportive of our proposal to rescind certain exemptive orders that have been granted to ETFs and their sponsors and to replace such relief with rule 6c-11.

After consideration of the comments we received, we are adopting rule 6c-11 and the proposed form amendments with several modifications that are designed to reduce the operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful information regarding ETFs. As proposed, we also are rescinding the exemptive relief that we have issued to ETFs that fall within the scope of rule 6c-11, while retaining the exemptive relief granted to ETFs outside the scope of the rule. In addition, we are retaining the exemptive relief allowing ETFs to enter into fund of funds arrangements. We believe that the resulting regulatory framework will level the playing field for ETFs that are organized as open-end funds and pursue the same or similar investment strategies. The rule also will assist the Commission with regulating ETFs, as funds covered by the rule will no longer be subject to the varying provisions of exemptive orders granted over time. Furthermore, rule 6c-11 will allow Commission staff, as well as funds and advisers seeking exemptions, to focus exemptive relief on products that do not fall within the rule's scope.

The Commission will continue to monitor this large, diverse and important market. We welcome continued engagement with ETF sponsors, investors and other market participants on matters related to the ETF market, including with regard to ETFs that do not fall within the scope of rule 6c-11 and ETFs that may not function in a manner consistent with the expectations embodied in our regulatory framework.

A. Overview of Exchange-Traded Funds

ETFs are a type of exchange-traded product (“ETP”). ETFs possess characteristics of both mutual funds, which issue redeemable securities, and closed-end funds, which generally issue shares that trade at market-determined prices on a national securities exchange and are not redeemable. Because ETFs have characteristics that distinguish them from the types of investment companies contemplated by the Act, they require exemptions from certain provisions of the Investment Company Act in order to operate. The Commission routinely grants exemptive orders permitting ETFs to operate as investment companies under the Investment Company Act, generally subject to the provisions of the Act applicable to open-end funds (or UITs). The Commission also has approved the listing standards of national securities exchanges under which ETF shares are listed and traded.

As discussed above, ETFs have become an increasingly popular investment vehicle over the last 27 years, providing investors with a diverse set of investment options. They also have become a popular trading tool, making up a significant portion of secondary market equities trading. During the first quarter of 2019, for example, trading in U.S.-listed ETFs made up approximately 18.3% of U.S. equity trading by share volume and 27.2% of U.S. equity trading by dollar volume.

Investors can buy and hold shares of ETFs (sometimes as a core component of a portfolio) or trade them frequently as part of an active trading or hedging strategy. Because certain costs are either absent in the ETF structure or are otherwise partially externalized, many ETFs have lower operating expenses than mutual funds. ETFs also may offer certain tax efficiencies compared to other pooled investment vehicles because redemptions from ETFs are often made in kind (that is, by delivering certain assets from the ETF's portfolio, rather than in cash), thereby avoiding the need for the ETF to sell assets and potentially realize capital gains that are distributed to its shareholders.

B. Operation of Exchange-Traded Funds

An ETF issues shares that can be bought or sold throughout the day in the secondary market at a market-determined price. Like other investment companies, an ETF pools the assets of multiple investors and invests those assets according to its investment objective and principal investment strategies. Each share of an ETF represents an undivided interest in the underlying assets of the ETF. Similar to mutual funds, ETFs continuously offer their shares for sale.

Unlike mutual funds, however, ETFs do not sell or redeem individual shares. Instead, “authorized participants” that have contractual arrangements with the ETF (or its distributor) purchase and redeem ETF shares directly from the ETF in blocks called “creation units.” An authorized participant may act as a principal for its own account when purchasing or redeeming creation units from the ETF. Authorized participants also may act as agent for others, such as market makers, proprietary trading firms, hedge funds or other institutional investors, and receive fees for processing creation units on their behalf. Market makers, proprietary trading firms, and hedge funds provide additional liquidity to the ETF market through their trading activity. Institutional investors may engage in primary market transactions with an ETF through an authorized participant as a way to efficiently hedge a portion of their portfolio or balance sheet or to gain exposure to a strategy or asset class.

An authorized participant that purchases a creation unit of ETF shares directly from the ETF deposits with the ETF a “basket” of securities and other assets identified by the ETF that day, and then receives the creation unit of ETF shares in return for those assets. The basket is generally representative of the ETF's portfolio, and together with a cash balancing amount, it is equal in value to the aggregate net asset value (“NAV”) of the ETF shares in the creation unit. After purchasing a creation unit, the authorized participant may hold the individual ETF shares, or sell some or all of them in secondary market transactions. Investors then purchase individual ETF shares in the secondary market. The redemption process is the reverse of the purchase process: The authorized participant redeems a creation unit of ETF shares for a basket of securities and other assets.

The combination of the creation and redemption process with secondary market trading in ETF shares and underlying securities provides arbitrage opportunities that are designed to help keep the market price of ETF shares at or close to the NAV per share of the ETF. For example, if ETF shares are trading on national securities exchanges at a “discount” (a price below the NAV per share of the ETF), an authorized participant can purchase ETF shares in secondary market transactions and, after accumulating enough shares to compose a creation unit, redeem them from the ETF in exchange for the more valuable redemption basket. The authorized participant's purchase of an ETF's shares on the secondary market, combined with the sale of the ETF's basket assets, may create upward pressure on the price of the ETF shares, downward pressure on the price of the basket assets, or both, bringing the market price of ETF shares and the value of the ETF's portfolio holdings closer together. Alternatively, if ETF shares are trading at a “premium” (a price above the NAV per share of the ETF), the transactions in the arbitrage process are reversed and, when arbitrage is working effectively, keep the market price of the ETF's shares close to its NAV.

Market participants also can engage in arbitrage activity without using the creation or redemption processes. For example, if a market participant believes that an ETF is overvalued relative to its underlying or reference assets (i.e., trading at a premium), the market participant may sell ETF shares short and buy the underlying or reference assets, wait for the trading prices to move toward parity, and then close out the positions in both the ETF shares and the underlying or reference assets to realize a profit from the relative movement of their trading prices. Similarly, a market participant could buy ETF shares and sell the underlying or reference assets short in an attempt to profit when an ETF's shares are trading at a discount to the ETF's underlying or reference assets. As with the creation and redemption process, the trading of an ETF's shares and the ETF's underlying or reference assets may bring the prices of the ETF's shares and its portfolio assets closer together through market pressure.

The arbitrage mechanism is important because it provides a means to maintain a close tie between market price and NAV per share of the ETF, thereby helping to ensure ETF investors are treated equitably when buying and selling fund shares. In granting relief under section 6(c) of the Act for ETFs to operate, the Commission has relied on this close tie between what retail investors pay (or receive) in the secondary market and the ETF's approximate NAV to find that the required exemptions are necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. Investors also have come to expect that an ETF's market price will maintain a close tie to the ETF's NAV per share, which may lead some investors to view ETFs or some types of ETFs more favorably than similar closed-end funds. On the other hand, if the expectation of a close tie to NAV per share is not met, investors may sell or refrain from purchasing ETF shares.

II. Discussion

Given the growth in the ETF market, ETFs' popularity among retail and institutional investors, and our long experience regulating this investment vehicle, we believe that it is appropriate to adopt a rule that will allow most ETFs to operate without first obtaining an exemptive order from the Commission under the Act. We believe, and commenters on proposed rule 6c-11 generally agreed, that such a rule will help create a consistent, transparent, and efficient regulatory framework for the regulation of most ETFs and help level the playing field for these market participants.

As adopted, rule 6c-11 will exempt ETFs organized as open-end funds from certain provisions of the Act and our rules. The exemptions will permit an ETF to: (i) Redeem shares only in creation unit aggregations; (ii) permit ETF shares to be purchased and sold at market prices, rather than NAV; (iii) engage in in-kind transactions with certain affiliates; and (iv) in certain limited circumstances, pay authorized participants the proceeds from the redemption of shares in more than seven days.

These exemptions are subject to several conditions designed to address the concerns underlying the relevant statutory provisions and to support a Commission finding that the exemptions necessary to allow ETFs to operate are in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. The conditions are based upon existing exemptive relief for ETFs, which we believe has served to support an efficient arbitrage mechanism, but reflect several modifications based on our experience regulating this product and commenters' input on the proposed rule.

• First, rule 6c-11 will require an ETF to disclose portfolio holdings each business day on its website before the opening of trading on the ETF's primary listing exchange in a standardized manner. The rule also will require daily website disclosure of the ETF's NAV, market price, premium or discount, and the extent and frequency of an ETF's premiums and discounts. These disclosures are designed to promote an effective arbitrage mechanism and inform investors about the risks of deviation between market price and NAV when deciding whether to invest in ETFs generally or in a particular ETF.
• In addition, the rule will require daily website disclosure of the ETF's median bid-ask spread over the last thirty calendar days. This requirement is designed to provide investors with additional information regarding potential costs associated with buying and selling ETF shares.
• With respect to baskets, the rule will require an ETF to adopt and implement written policies and procedures that govern the construction of baskets and the process that will be used for the acceptance of baskets. The rule will allow ETFs to use “custom baskets” if their basket policies and procedures: (i) Set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interest of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (ii) specify the titles or roles of the employees of the ETF's investment adviser who are required to review each custom basket for compliance with those parameters. As discussed below, these conditions will provide ETFs with additional basket flexibility, which we believe could benefit investors through more efficient arbitrage and narrower bid-ask spreads, subject to protections designed to address the risks that such flexibility may present.
• Rule 6c-11 also will include a condition that excludes an ETF that seeks, directly or indirectly, to provide investment returns over a predetermined period of time that: (i) Correspond to the performance of a market index by a specified multiple; or (ii) have an inverse relationship to the performance of a market index (including by an inverse multiple) (“leveraged/inverse ETFs”).

• An ETF also must retain certain records under rule 6c-11, including information regarding each basket exchanged with an authorized participant.

In order to harmonize the regulation of most ETFs, we are rescinding, one year after the effective date of rule 6c-11, those portions of our prior ETF exemptive orders that grant relief related to the formation and operation of an ETF, including certain master-feeder relief. We are not rescinding the exemptive relief of UIT ETFs, leveraged/inverse ETFs, share class ETFs, and non-transparent ETFs, however, which are outside the scope of rule 6c-11. In addition, we are not rescinding the portions of our prior ETF exemptive orders allowing funds to invest in ETFs in excess of statutory limits in connection with this rulemaking and we are providing relief to allow newly formed ETFs to enter into certain fund of funds arrangements.

Finally, we are adopting amendments to Forms N-1A and N-8B-2 to eliminate certain disclosures that we believe are no longer necessary and to require ETFs that do not rely on rule 6c-11 to provide secondary market investors with disclosures regarding certain ETF trading and associated costs. For example, the form amendments will require such an ETF to provide median bid-ask spread information either on its website or in its prospectus. We believe these amendments will provide investors who purchase ETF shares in secondary market transactions with information to better understand the total costs of investing in an ETF.

A. Scope of Rule 6c-11

1. Organization as Open-End Funds

As proposed, rule 6c-11 will define an ETF as a registered open-end management investment company that: (i) Issues (and redeems) creation units to (and from) authorized participants in exchange for a basket and a cash balancing amount (if any); and (ii) issues shares that are listed on a national securities exchange and traded at market-determined prices. ETFs organized as UITs (“UIT ETFs”) will continue operating pursuant to their exemptive orders, which include terms and conditions more appropriately tailored to address the unique features of a UIT. Additionally, as proposed, our form amendments will require UIT ETFs to provide disclosures similar to those provided by other ETFs that are subject to the Investment Company Act.

We understand that most ETF sponsors prefer the open-end fund structure over the UIT structure given the increased investment flexibility the open-end structure affords. For example, ETFs organized as open-end funds can be actively managed or use a “sampling” strategy to track an index. An open-end ETF also may participate in securities lending programs, has greater flexibility to reinvest dividends, and may invest in derivatives, which typically require a degree of management that is not provided for in the UIT structure.

Commenters addressing this aspect of the proposal generally supported excluding UIT ETFs from the scope of rule 6c-11. These commenters stated that the structural and operational nuances associated with UIT ETFs would make their inclusion in rule 6c-11 impractical. These commenters also generally agreed that existing UIT ETFs should continue to rely on their individual exemptive orders, and that the Commission should review new UIT ETFs as part of the exemptive order process. One commenter suggested, however, that the Commission consider potential updates to UIT ETFs' exemptive orders to account for certain sponsor services that were not contemplated at the time the orders were granted.

After considering comments, we continue to believe that rule 6c-11 should apply only to ETFs organized as open-end funds, while UIT ETFs should continue to rely on their existing exemptive orders. We acknowledge that excluding UIT ETFs will result in a segment of ETF assets outside the regulatory framework of rule 6c-11. However, we do not believe there is a need to include UIT ETFs within the scope of the rule given the limited sponsor interest in developing ETFs organized as UITs.

In addition, even if we were to include UIT ETFs within the scope of the rule, the unique structural and operational aspects of UIT ETFs noted by commenters would necessitate a regulatory framework that differs from the structure we are adopting for open-end ETFs. We believe that the unmanaged nature of the UIT structure, in particular, would require conditions that differ from the conditions applicable to open-end ETFs. For example, rule 6c-11 will allow ETFs the flexibility to use baskets that differ from a pro rata representation of the ETF's portfolio if certain conditions are met. Because such conditions require ongoing management and board oversight, we do not believe that extending such basket flexibility to UIT ETFs would be appropriate. The relief granted to UIT ETFs also includes relief from sections of the Act that govern key aspects of a UIT's operations, which differ from the relief we are providing under rule 6c-11. In short, we believe including UIT ETFs within the scope of rule 6c-11 would complicate the rule significantly and would continue to result in a regulatory framework where the relief and conditions applicable to UIT ETFs and open-end ETFs differ.

To the extent that ETF sponsors develop novel UIT ETFs, we believe that the Commission should review such products as part of its exemptive process to determine whether the relief is necessary or appropriate in the public interest and consistent with the protection of investors. We also believe that the Commission's exemptive process is well-suited to handle requests to modify existing UIT ETF exemptive relief.

Consistent with the proposal, we are not rescinding existing exemptive orders that allow UIT ETFs to operate. Two commenters addressing the exclusion of UIT ETFs from the rule urged the Commission to clarify that UIT ETFs operating pursuant to their exemptive orders can nevertheless continue marketing themselves as “ETFs.” As discussed below, the Commission is not limiting use of the term “ETF” or “exchange-traded fund” to funds relying on rule 6c-11. UIT ETFs therefore may continue to use these terms in their marketing materials and otherwise hold themselves out as “ETFs.” Further, while UIT ETFs are excluded from the scope of rule 6c-11, we are adopting amendments to Form N-8B-2 that will require them to provide certain additional disclosures regarding ETF trading costs.

2. Index-Based ETFs and Actively Managed ETFs

Consistent with the proposal, rule 6c-11 will provide exemptions for both index-based ETFs and actively managed ETFs, but will not by its terms establish different requirements based on whether an ETF's investment objective is to seek returns that correspond to the returns of an index. 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. For example, both index-based and actively managed ETFs register under the Act, issue and redeem shares in creation unit sizes in exchange for baskets of assets, list on national securities exchanges, and allow investors to trade ETF shares throughout the day at market-determined prices in the secondary market.

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 did not approve the first actively managed ETF until nearly 15 years after index-based ETFs were introduced. Since 2008, however, the actively managed ETF market has grown considerably. 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.

Commenters that addressed this aspect of the proposal supported the rule's elimination of the historical distinction between index-based and actively managed ETFs. Specifically, commenters agreed that ETFs operate similarly irrespective of whether they are index-based or actively managed, and stated that there are no operational issues that warrant additional conditions for actively managed ETFs. In addition, one commenter stated that, in its experience, deviations between market price and NAV per share are more variable across asset classes underlying ETFs than between index-based and actively managed ETFs investing in the same asset class.

We continue to believe that index-based and actively managed ETFs do not present significantly different concerns under the provisions of the Act from which the rule grants relief because they function similarly with respect to operational matters. As noted below, the arbitrage mechanism for existing actively managed ETFs has worked effectively with small deviations between market price and NAV per share. Permitting index-based and actively managed open-end ETFs to operate under the rule subject to the same conditions also will provide a level playing field among those market participants.

Furthermore, we believe that it would be unreasonable to create a meaningful distinction within the rule between index-based and actively managed ETFs given the proliferation of highly customized, often methodologically complicated indexes. Commenters agreed that the proliferation of these indexes has blurred the distinction between index-based and actively managed ETFs, while ETF industry practices in areas such as portfolio transparency generally do not vary between these types of funds. We therefore believe that eliminating the regulatory distinction between index-based ETFs and actively managed ETFs for purposes of exemptive relief under the Act will help to provide a more consistent and transparent regulatory framework for ETFs organized as open-end funds. This approach is consistent with our regulation of other types of open-end funds, which does not distinguish between actively managed and index-based strategies.

In addition, consistent with our proposal, rule 6c-11 does not include additional conditions relating to index-based ETFs with affiliated index providers (“self-indexed ETFs”). Commenters generally agreed with the proposal's approach to self-indexed ETFs, indicating that existing securities laws adequately address any special concerns presented by these ETFs. One commenter, however, noted that the concerns that were expressed by the Commission when it granted individualized exemptive relief for self-indexed ETFs remain important. This commenter stated that the Commission should permit self-indexed ETFs only “on the condition that [an information] firewall between the index provider and the asset manager exists.”

We agree with the commenters who stated that the existing federal securities laws adequately address any special concerns that self-indexed ETFs present, including the potential ability of an affiliated index provider to manipulate an underlying index to the benefit or detriment of a self-indexed ETF. For example, ETF sponsors are likely to be in a position to understand the potential circumstances and relationships that could give rise to the misuse of non-public information, and can develop appropriate measures to address them. Therefore, we continue to believe that portfolio transparency combined with existing requirements should be sufficient to protect against the abuses addressed in exemptive applications of ETF sponsors that either use affiliated index providers or create their own indexes.

3. Leveraged/Inverse ETFs

As proposed, rule 6c-11 includes a condition that excludes leveraged/inverse ETFs. These ETFs may not rely on the rule, and will instead continue to operate pursuant to their exemptive orders. Broadly speaking, leveraged/inverse ETFs seek to amplify the returns of an underlying index by a specified multiple or to profit from a decline in the value of an underlying index over a predetermined period of time using financial derivatives. Leveraged/inverse ETFs also rebalance their portfolios on a daily or other periodic basis in order to maintain a constant leverage ratio. These funds' use of leverage together with this periodic rebalancing (or “reset”), and the resulting effects of compounding, can result in performance that differs significantly from some investors' expectations of how index investing generally works.

For example, as a result of compounding, a leveraged/inverse ETF can outperform a simple multiple of its index's returns over several days of consistently positive returns, or underperform a simple multiple of its index's returns over several days of volatile returns. Investors holding shares over periods longer than the time period targeted by the ETF's investment objective may experience performance that is different, and at times substantially different, from the returns of the targeted index over the same investment period. Buy-and-hold investors with an intermediate or long-term time horizon that invest in a leveraged/inverse ETF—who may not evaluate their portfolios frequently—may experience large and unexpected losses or otherwise experience returns that are different from what they anticipated. As a result, leveraged/inverse ETFs are complex products that serve a markedly different investment purpose than most other ETFs.

Leveraged/inverse ETFs' use of derivatives also raises issues under section 18 of the Act, which limits a fund's ability to obtain leverage. The Commission has been evaluating these section 18 issues as part of a broader consideration of derivatives use by registered funds and business development companies (“BDCs”). We therefore proposed to exclude leveraged/inverse ETFs from the scope of rule 6c-11 so that the Commission could consider these concerns in a comprehensive manner with other funds that use leverage. We also proposed to allow leveraged/inverse ETFs and their sponsors to continue to rely on their existing exemptive relief in order to preserve the status quo.

Most commenters who addressed this aspect of the proposal agreed that leveraged/inverse ETFs present issues and concerns that should be addressed outside the context of rule 6c-11. One such commenter stated that leveraged/inverse ETFs present “highly specific and accentuated risks” and stated that the Commission should regulate these products under tailored exemptive orders. Other commenters urged the Commission to consider additional investor protection requirements for leveraged/inverse ETFs, such as requiring marketing materials to notify retail investors about the risks of investing in these instruments or other enhanced disclosure requirements. Some commenters stated that the Commission should not permit leveraged/inverse ETFs to use the terms “ETF” or “exchange-traded fund” in their names, because investors might mistakenly assume that all products referred to as ETFs are structured and regulated like “traditional” ETFs.

Other commenters were less specific as to whether the Commission should regulate leveraged/inverse ETFs under exemptive orders or through a separate rule, but stated that leveraged/inverse ETFs should be regulated by means other than rule 6c-11. One commenter agreed that leveraged/inverse ETFs “raise important disclosure and investor protection issues,” but strongly encouraged the Commission to “initiate proceedings, whether as part of its consideration of derivative usage or otherwise, to determine what its future approach” to leveraged/inverse ETFs will be.

Sponsors of leveraged/inverse ETFs, however, advocated that the rule should not exclude leveraged/inverse ETFs. They asserted that leveraged/inverse ETF investors understand the special concerns related to these products, accept the products' risks, and utilize the products appropriately. One of these commenters stated that the rule's exemptive relief targets ETFs' structural and operational characteristics, and that leveraged/inverse ETFs are structured and operated in the same manner as other ETFs within the rule's scope. Among other similarities, the commenter noted that leveraged/inverse ETFs are structured as open-end funds, provide full portfolio transparency, and accept creation and redemption baskets using the same operating mechanisms as other ETFs. The commenter also opined that leveraged/inverse ETFs should not be excluded from the scope of the rule because other ETFs that utilize leverage in their investment strategies are not excluded from the scope of the rule.

Another commenter did not object to excluding leveraged/inverse ETFs from rule 6c-11, but opined that the proposed rule's condition excluding leveraged/inverse ETFs was overly broad, potentially capturing ETFs that have an inverse relationship to the performance of a market index or ETFs that use other hedging strategies to reduce risk. This commenter also asked the Commission to confirm that the exclusion would not, in effect, apply to every ETF that seeks to track an index that includes derivatives. Additionally, several commenters did not specifically address leveraged/inverse ETFs, but generally stated that rule 6c-11 should apply across all ETFs registered under the Investment Company Act to create an even playing field.

After considering these comments, we have determined to include a condition that prevents leveraged/inverse ETFs from relying on the rule. Although leveraged/inverse ETFs are structurally and operationally similar to other types of ETFs within the scope of rule 6c-11, we believe it is premature to permit sponsors to form and operate leveraged/inverse ETFs in reliance on the rule without first addressing the investor protection purposes and concerns underlying section 18 of the Act. We therefore believe that the Commission should complete its broader consideration of the use of derivatives by registered funds before considering allowing leveraged/inverse ETFs to rely on the rule.

Given that rule 6c-11 is intended to help create a consistent regulatory framework for ETFs and a level playing field among ETF sponsors, we acknowledge that excluding leveraged/inverse ETFs from the rule's scope and permitting existing leveraged/inverse ETFs to continue to operate pursuant to their exemptive orders at this time delays, in part, achieving those goals. However, because leveraged/inverse ETFs raise policy considerations that are different from those we seek to address in the rule, we believe rule 6c-11 should exclude leveraged/inverse ETFs.

As adopted, rule 6c-11 will exclude ETFs that seek to provide leveraged or inverse investment returns over a predetermined period of time. The periodic reset that such strategies necessitate distinguish leveraged/inverse ETFs from other types of ETFs that may use leverage. In the proposal we did not specify the period of time over which an ETF had to seek to deliver a leveraged or inverse return of an index to be covered by the proposed rule's leveraged/inverse ETF exclusion, and we similarly decline to specify a period of time here. However, the condition relating to leveraged/inverse ETFs continues to include a temporal element (i.e., “over a predetermined period of time”) in order to specifically capture ETFs that seek to deliver the leveraged or inverse return of a market index over a set period of time, daily or otherwise.

In addition, while the rule uses the term “multiple,” leveraged/inverse ETFs with strategies that seek directionally leveraged or inverse returns of an index present the investor protection concerns discussed above regardless of whether the amplification factor or inverse factor is evenly divisible by 100 (e.g., a fund that seeks to provide a daily investment return equal to 150% of the performance of an index). Thus, to clarify the rule's use of the term “multiple,” leveraged/inverse ETFs are excluded from the scope of the rule regardless of whether the returns they seek over a predetermined time period are evenly divisible by 100. The exclusion also includes strategies that pursue a specified range of a multiple or inverse multiple of an index's performance (e.g., 200% to 300% of an index's performance or −200% to −300% of an index's performance). This approach is consistent with our existing exemptive orders and will capture those ETFs that have historically been considered “leveraged/inverse ETFs” in the marketplace.

We also continue to believe that it is important to specify that an ETF relying on the rule may not indirectly seek to provide investment returns that correspond to the performance of a market index by a specified multiple or to provide returns that have an inverse relationship to the performance of a market index over a predetermined period of time in order to prevent a fund from circumventing this condition, such as by embedding leverage in the underlying index. For example, an ETF could not circumvent the rule's conditions and rely on the rule to track an index if the index itself tracks 300% or −100% of the performance of the S&P 500. In response to commenter concerns discussed above, however, this does not mean that the exclusion would apply to every ETF that tracks an index with constituents that are derivatives. Whether a particular index is “leveraged” would depend on the economic characteristics of the index's constituents, and not just on whether some or all of the constituents are derivatives.

Finally, we are not adopting enhanced website or other disclosure requirements for leveraged/inverse ETFs at this time as some commenters had recommended. We believe all registered funds that pursue leveraged or inverse strategies raise similar disclosure issues. We therefore believe that the Commission should address any such potential disclosure issues separately for all leveraged/inverse registered funds.

B. Exemptive Relief Under Rule 6c-11

Rule 6c-11 will provide ETFs that fall within the scope of the rule exemptive relief from certain provisions of the Act that are necessary to allow ETFs to operate. These exemptions are consistent with the relief we have given to ETFs under our exemptive orders. As discussed below in section II.C., the exemptions will be subject to conditions that are designed to address the concerns underlying the relevant statutory provisions and to support a Commission finding that the exemptions are in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.

1. Treatment of ETF Shares as “Redeemable Securities”

Consistent with our proposal, ETFs relying on rule 6c-11 will be considered to issue a “redeemable security” within the meaning of section 2(a)(32) of the Act. ETFs have features that distinguish them from both traditional open-end and closed-end funds. A defining feature of open-end funds is that they offer redeemable securities, which allow the holder to receive his or her proportionate share of the fund's NAV per share upon presentation of the security to the issuer. Although individual ETF shares cannot be redeemed, except in limited circumstances, they can be redeemed in creation unit aggregations. Therefore, we believe that ETF shares are most appropriately classified under the final rule as redeemable securities within the meaning of section 2(a)(32), and that ETFs should be regulated as open-end funds within the meaning of section 5(a)(1) of the Act.

Unlike our exemptive orders, which have provided exemptions from the definitions of “redeemable security” in section 2(a)(32) and “open-end company” in section 5(a)(1), rule 6c-11 will not provide exemptions from these definitions. Instead, we believe that it is more appropriate for the rule to address these questions of status by classifying ETF shares as “redeemable securities.” Thus, any ETF that relies on the rule's conditions and requirements will be subject to requirements imposed under the Act and our rules that apply to open-end funds.

In addition, the rules under the Exchange Act that apply to transactions in redeemable securities issued by an open-end fund will apply to ETFs relying on rule 6c-11. Shares issued by ETFs relying on rule 6c-11 therefore are eligible for the “redeemable securities” exceptions in rules 101(c)(4) and 102(d)(4) of Regulation M and rule 10b-17(c) under the Exchange Act in connection with secondary market transactions in ETF shares and the creation or redemption of creation units. ETFs relying on rule 6c-11 similarly will qualify for the “registered open-end investment company” exemption in rule 11d1-2 under the Exchange Act.

Many commenters supported our proposed classification of ETF shares as “redeemable securities.” Commenters also supported our view that the arbitrage mechanism that is central to the operation of an ETF (and the conditions in the final rule designed to facilitate an effective arbitrage mechanism) serves to keep the market price of ETF shares at or close to the ETF's NAV per share. As a result, even though only authorized participants may redeem creation units at NAV per share, commenters agreed that investors are able to sell their ETF shares on the secondary market at or close to NAV, similar to investors in an open-end fund that redeem their shares at NAV per share.

Commenters also supported the resulting eligibility for the redeemable securities exceptions and the registered open-end investment company exemption under the Exchange Act rules discussed above. Commenters stated that such treatment would reduce regulatory complexity and eliminate potential inconsistencies between rule 6c-11 and this Exchange Act relief. Several commenters recommended extending the “redeemable security” classification to ETFs that are not eligible to rely on rule 6c-11, such as UIT ETFs or share class ETFs, to make them similarly eligible for the exceptions under the Exchange Act that apply to redeemable securities issued by an open-end fund.

After considering comments, we are clarifying that we view securities of all ETFs, including those that do not rely on rule 6c-11, as eligible for the redeemable securities exceptions in rules 101(c)(4) and 102(d)(4) of Regulation M and rule 10b-17(c) under the Exchange Act in connection with secondary market transactions in ETF shares and the creation or redemption of creation units and the exemption in rule 11d1-2 under the Exchange Act for securities issued by a registered open-end investment company or unit investment trust. We believe that securities issued by ETFs that are exempt from the definitions of “redeemable security” in section 2(a)(32) and “open-end company” in section 5(a)(1) of the Investment Company Act pursuant to their orders do not raise different concerns with respect to these Exchange Act provisions than those issued by ETFs relying on rule 6c-11.

Several commenters recommended further harmonization between rule 6c-11 and certain other Exchange Act relief that ETFs must currently seek in order to operate. Commenters expressed concern that this Exchange Act relief is duplicative or, in some cases, inconsistent with other requirements applicable to ETFs. In particular, commenters noted that rule 6c-11 as proposed would not address relief for ETFs from section 11(d)(l) of the Exchange Act as well as rules 10b-10, 15c1-5, 15c1-6, and 14e-5 thereunder. Commenters also recommended that the ETF generic listing standards of national securities exchanges be broadened and harmonized with any final ETF rule.

We agree that complementary exemptive relief under the Exchange Act could further reduce regulatory complexity, administrative delay, and eliminate potential inconsistencies between rule 6c-11 and the related Exchange Act relief that ETFs must obtain to operate. Accordingly, the Commission is issuing an order granting exemptive relief to ETFs operating in reliance on rule 6c-11 from the requirements of section 11(d)(1) of the Exchange Act and rules 10b-10, 15c1-5, 15c1-6, and 14e-5 under the Exchange Act for ETFs, where certain conditions are met.

Finally, commenters asked that we exempt ETF insiders and large shareholders from certain section 13(d) and section 16 reporting requirements under the Exchange Act beyond the conditions in several staff no-action letters. The staff no-action letters stated that the staff would not recommend enforcement action to the Commission if certain insiders and large shareholders of ETFs seeking to track the performance of a benchmark index through a replication strategy did not file reports under section 13(d) and section 16(a) based on certain facts and circumstances, including that there is no material deviation between the ETF's secondary market price and NAV. Commenters stated that the portfolio transparency requirements in rule 6c-11 would address the concerns underlying section 13(d) and section 16 without conditioning relief on there being no material deviation between the ETF's market price and NAV per share.

As discussed above, the exemptions we are providing today under rule 6c-11 are based on the existence of a close tie between market price and NAV per share. Expanding on the existing staff no-action letters by providing exemptions from the reporting requirements in sections 13(d) and 16 even when there is a material deviation between market price and NAV would be inconsistent with the exemptions in rule 6c-11. We therefore refrain from taking additional action concerning the conditions outlined in our existing staff no-action letters.

2. Trading of ETF Shares at Market-Determined Prices

Rule 6c-11 will provide exemptions from section 22(d) and rule 22c-1 to permit secondary market trading of ETF shares at market-determined prices as proposed. Section 22(d) of the Act, among other things, prohibits investment companies, their principal underwriters, and dealers from selling a redeemable security to the public except at a current public offering price described in the prospectus. Rule 22c-1 generally requires that a dealer selling, redeeming, or repurchasing a redeemable security do so only at a price based on its NAV. Together, section 22(d) and rule 22c-1 are designed to: (i) Prevent dilution caused by certain riskless trading practices of principal underwriters and dealers; (ii) prevent unjust discrimination or preferential treatment among investors purchasing and redeeming fund shares; and (iii) preserve an orderly distribution of investment company shares. ETFs seeking to register under the Act obtain exemptions from these provisions because investors may purchase and sell individual ETF shares from and to dealers on the secondary market at market-determined prices (i.e., at prices other than those described in the prospectus or based on NAV). Consistent with our prior exemptive orders, rule 6c-11 will provide exemptions from these provisions.

As discussed above, only authorized participants can purchase and redeem shares directly from an ETF at NAV per share and only in creation unit aggregations. Because authorized participants (and other market participants transacting through an authorized participant) can take advantage of disparities between the market price of ETF shares and NAV per share, they may be in a different position than investors who buy and sell individual ETF shares only on the secondary market. However, if the arbitrage mechanism is functioning effectively, entities taking advantage of these disparities in market price and NAV per share move the market price to a level at or close to the NAV per share of the ETF. The final rule will provide exemptions from section 22(d) and rule 22c-1 because we believe this arbitrage mechanism—and the conditions in this rule designed to promote a properly functioning arbitrage mechanism—have adequately addressed, over the significant operating history of ETFs, the potential concerns regarding shareholder dilution and unjust discrimination that these provisions were designed to address.

The arbitrage mechanism is the foundation for why retail and other secondary market investors generally can buy and sell ETF shares at prices that are at or close to the prices at which authorized participants are able to buy and redeem shares directly from the ETF at NAV. In the Commission's experience, the deviation between the market price of ETFs and NAV per share has generally been relatively small. However, we recognize that under certain circumstances, including during periods of market stress, the arbitrage mechanism may work less effectively. We also recognize that secondary market investors who trade in ETF shares during these periods may be harmed by trading at a price that is not close to the NAV per share of the ETF (or the contemporaneous value of the ETF's portfolio). On balance, however, we continue to believe these investors are more likely to weigh the potential benefits of ETFs (e.g., low cost and intraday trading) against any potential for market price deviations when deciding whether to utilize ETFs. Further, we believe that the conditions we are adopting as part of rule 6c-11, along with other recent actions that are designed to promote an effective arbitrage mechanism, will continue to result in a sufficiently close alignment between an ETF's market price and NAV per share in most circumstances, and provide an appropriate basis for the exemptive relief we are granting. We particularly find this to be the case given the benefits ETFs offer investors as discussed above.

Moreover, to the extent that there are instances where bid-ask spreads widen, or premiums and discounts persist, the final rule and disclosure amendments will require ETFs to disclose certain information on their website. These disclosure requirements are designed to increase investor awareness of these risks. We continue to believe that it is important for investors to be informed where costs may increase beyond what they would reasonably expect.

Commenters generally agreed that rule 6c-11 should provide the proposed exemptions from section 22(d) and rule 22c-1. These commenters highlighted the ability of investors to transact in ETF shares intraday at market-determined prices as one of the primary benefits of the ETF structure. Commenters also agreed with our observation that the arbitrage mechanism generally has kept the deviation between the ETF market price and NAV per share relatively small, and that an efficient arbitrage mechanism adequately addresses potential concerns under section 22(d) and rule 22c-1. One commenter agreed that, on balance, given the historically insignificant and short duration of unusual ETF premiums and discounts, and the relatively low risks presented to investors as a result, ETF investors are likely to weigh the potential benefits of ETFs against any potential for market price deviations when selecting an investment in ETFs.

3. Affiliated Transactions

As proposed, rule 6c-11 will provide exemptions from sections 17(a)(1) and (a)(2) of the Act with regard to the deposit and receipt of baskets by a person who is an affiliated person of an ETF (or who is an affiliated person of such a person) solely by reason of: (i) Holding with the power to vote 5% or more of an ETF's shares; or (ii) holding with the power to vote 5% or more of any investment company that is an affiliated person of the ETF. The relief from section 17(a) in rule 6c-11 is consistent with the exemptive relief that we have granted to ETF applicants.

Section 17(a) of the Act generally prohibits an affiliated person of a registered investment company, or an affiliated person of such person, from knowingly selling any security or other property to or purchasing any security from the company. Purchases and redemptions of ETF creation units are typically effected in kind, and section 17(a) would prohibit these in-kind purchases and redemptions by affiliated persons of the ETF. An affiliated person of an ETF includes, among others: (i) Any person directly or indirectly owning, controlling, or holding with power to vote, 5% or more of the outstanding voting securities of the ETF; (ii) any person 5% or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote by the ETF; and (iii) any person directly or indirectly controlling, controlled by, or under common control with the ETF.

Commenters expressed support for our proposed exemptions from sections 17(a)(1) and (a)(2), concurring with our view that this relief is necessary to facilitate the efficient functioning of the arbitrage mechanism. Commenters noted that, without this relief, an authorized participant or other market participant that becomes an affiliated person of the ETF due to its holdings would be prevented from engaging in arbitrage using an in-kind basket, which, in turn, could have the adverse effect of limiting the pool of market participants that could engage in arbitrage. Ultimately, this could result in the deviation between market price and NAV per share widening in cases where there are very few authorized participants or other market participants actively engaged in transactions with the ETF. Commenters also stated that in-kind purchases and redemptions of ETF creation units between an ETF and authorized participants, which may be affiliated persons, or affiliated persons of affiliated persons, as a result of such transactions are not the types of potentially harmful transactions that section 17(a) is designed to prevent.

We continue to believe that this relief is appropriate to facilitate the efficient functioning of the arbitrage mechanism after considering comments. As noted above, all purchases and redemptions of creation units with such an affiliated person are at an ETF's next-calculated NAV, and an ETF would value the securities deposited or delivered upon redemption in the same manner, using the same standards, as the ETF values those securities for purposes of calculating the ETF's NAV. We do not believe that these transactions will give rise to the policy concerns that section 17(a) is designed to prevent.

Several commenters asked us to confirm that the section 17(a) relief in rule 6c-11 would extend to entities that are affiliated with the ETF by virtue of holding more than 25% of the ETF's shares or more than 25% of any investment company that is an affiliated person of the ETF (“25% holders”), consistent with the terms of our existing exemptive orders. Our proposal was designed to provide relief from section 17(a) similar to our orders. We do not believe that an express reference to 25% holders in rule 6c-11(b)(3) is necessary, however, because the rule text will capture entities that are affiliated with the ETF by virtue of share ownership greater than 5%. We confirm that 25% holders are within the scope of this exemption.

A number of commenters also recommended expanding the relief to cover additional types of affiliated relationships, such as exempting broker-dealers that are affiliated with the ETF's adviser, or permitting an ETF's adviser or its affiliates to transact with the ETF to provide in-kind seed capital to the ETF. These commenters noted that increasing the entities eligible to transact with an ETF could further help facilitate the arbitrage mechanism, reduce concentration risk, and lower transaction costs. These commenters also noted that a fund's policies and procedures on baskets and custom baskets, as well as the federal securities laws and regulations that prohibit manipulative practices and misuse of nonpublic information, would address potential concerns regarding overreaching and similar abusive practices by these affiliated entities.

While permitting additional types of affiliated entities to transact with the ETF could provide additional benefits to an ETF, expanding the scope of affiliated persons covered by the exemption would constitute novel section 17(a) relief. To date, our exemptive orders have been narrowly tailored to permit in-kind purchases and redemptions between an ETF and certain affiliates to facilitate efficient arbitrage. Expanding this relief would raise novel affiliation issues that would require a careful consideration of whether the current protections embedded in our relief sufficiently address any risks posed by such transactions with additional categories of affiliates. This would be especially the case if the exemption were expanded to include affiliated entities such as the ETF's sponsor and other service providers that typically have greater ability to influence an ETF. Given that rule 6c-11 is generally intended to codify existing relief for ETFs, we therefore do not believe that it is appropriate to expand the scope of affiliated persons covered by the exemption as part of this rulemaking, although such exemptions may be considered within our regular exemptive applications process.

4. Additional Time for Delivering Redemption Proceeds

We are adopting, largely as proposed, an exemption from section 22(e) to permit an ETF to delay satisfaction of a redemption request in the case of certain foreign investments for which a local market holiday or the extended delivery cycles of another jurisdiction make timely delivery unfeasible. Section 22(e) of the Act generally prohibits a registered open-end management investment company from postponing the date of satisfaction of redemption requests for more than seven days after the tender of a security for redemption. This prohibition can cause operational difficulties for ETFs that hold foreign investments and exchange in-kind baskets for creation units. For example, local market delivery cycles for transferring foreign investments to redeeming investors, together with local market holiday schedules, can sometimes require a delivery process in excess of seven days.

Section 22(e) was designed to prevent unreasonable delays in the actual payment of redemption proceeds. Rule 6c-11 will provide an exemption from section 22(e) of the Act because we believe that the limited nature of the exemption addresses the concerns underlying this section of the Act. Rule 6c-11 will grant relief from section 22(e) to permit an ETF to delay satisfaction of a redemption request for more than seven days if a local market holiday, or series of consecutive holidays, or the extended delivery cycles for transferring foreign investments to redeeming authorized participants, or the combination thereof prevents timely delivery of the foreign investment included in the ETF's basket.

Under this exemption, an ETF must deliver foreign investments as soon as practicable, but in no event later than 15 days after the tender to the ETF. The exemption therefore will permit a delay only to the extent that additional time for settlement is actually required, when a local market holiday, or series of consecutive holidays, or the extended delivery cycles for transferring foreign investments to redeeming authorized participants prevents timely delivery of the foreign investment included in the ETF's basket. If a foreign investment settles in less than 15 days, the rule will require an ETF to deliver it pursuant to the standard settlement time of the local market where the investment trades. To the extent that settlement times continue to shorten, the “as soon as practicable” language embedded in the exemption is designed to minimize any unnecessary settlement delays.

Commenters generally supported our proposed exemption from section 22(e). Commenters stated that the relief would provide additional assurance that an ETF could postpone payment of redemption proceeds in certain circumstances outside of its control. One commenter observed that a period of 15 days, accompanied by a requirement that delivery be made as soon as practicable, is appropriate and reasonable. Another commenter agreed that it was appropriate to limit the exemption to the particular foreign investment and not the entire basket.

Proposed rule 6c-11 would have included a ten-year sunset provision in light of the continued movement toward shorter settlement times in markets around the world. Commenters generally objected to the proposed sunset provision, citing a number of reasons for why the section 22(e) relief would likely remain necessary beyond the sunset period. Although we continue to believe that technological innovation and changes in market infrastructures and operations should lead to further shortening of settlement cycles, we recognize commenters' concerns that these developments may be gradual and difficult to predict. Moreover, given that certain local market holidays may last for up to seven business days, we agree with commenters that settlement within seven days may continue to pose challenges even in light of continued technological progress and changes in market operations. We therefore are not adopting a sunset provision to limit the relief from section 22(e) to ten years from the rule's effective date.

The rule will define “foreign investment” as any security, asset or other position of the ETF issued by a foreign issuer (as defined by rule 3b-4 under the Exchange Act), and that is traded on a trading market outside of the U.S. As under the proposal, this definition is not limited to “foreign securities,” but also includes other investments that may not be considered securities. Although these other investments may not be securities, they may present the same challenges for timely settlement as foreign securities if they are transferred in kind. This approach is consistent with the terms of some recent exemptive orders that provide relief from section 22(e) for the delivery of foreign investments that may not be securities. We received no comments on this aspect of the definition of “foreign investment.”

Unlike our proposal, we are not defining “foreign investment” as an investment for which there is no “established U.S. public trading market.” A number of commenters recommended that we modify or eliminate this aspect of the definition. These commenters expressed concern that this requirement could make the exemption from section 22(e) unavailable whenever a foreign issuer has issued a security in the U.S. Commenters stated that ETFs investing in certain foreign markets typically hold the security that is traded in the foreign issuer's local trading market (“foreign-traded security”) rather than its U.S.-traded equivalent. These commenters explained that this is particularly true for ETFs tracking certain international indexes because those indexes often include foreign-traded securities, which generally have greater liquidity and trading volume than their U.S.-traded equivalents. Several commenters cited potential compliance costs, operational considerations (e.g., transacting in the foreign-traded security may entail lower transaction costs for the ETF), and possible disruptions to their investment strategy (e.g., tracking error) that might result due to this requirement.

The proposed definition of foreign investment was designed to make relief from section 22(e) unavailable to an ETF that included a foreign issuer's U.S.-traded investment in its basket, thereby avoiding the settlement delay that is the basis for the relief. It was not intended to require an ETF to buy and sell the U.S.-traded equivalent of a foreign-traded security when one is available, nor was it intended to deny section 22(e) relief to an ETF that includes a foreign-traded security in its basket because a U.S.-traded equivalent exists. In order to address commenters' concerns and potential confusion, however, we have eliminated the requirement that the foreign investment have “no established U.S. public trading market.” Instead, in relevant part, rule 6c-11(a)(1) will define “foreign investment” as an investment that “is traded on a trading market outside of the U.S.” We believe this definition will capture the foreign investments that may experience settlement delays without creating unintended consequences for ETF portfolio management. Under rule 6c-11, a delay in settlement is permitted only to the extent that additional time for settlement is actually required due to a local market holiday or the extended delivery cycles in a foreign market. As a result, the exemption from section 22(e) already is unavailable where an ETF could readily trade an investment in its basket on a U.S. market.

C. Conditions for Reliance on Rule 6c-11

Rule 6c-11 requires ETFs to comply with certain conditions designed to protect investors and to be consistent with the purposes fairly intended by the policy and provisions of the Act in order to operate within the scope of the Act. These conditions generally are consistent with the conditions in our exemptive orders, which we believe have effectively accommodated the unique structural and operational features of ETFs while maintaining appropriate protections for ETF investors. The conditions also reflect certain modifications that, based on our experience regulating ETFs and comments we received on the proposal, we believe will improve the overall regulatory framework for these products.

1. Issuance and Redemption of Shares

As proposed, the definition of exchange-traded fund under rule 6c-11 will require that an ETF issue (and redeem) creation units to (and from) authorized participants in exchange for baskets and a cash balancing amount (if any). This definition is designed to preserve the existing ETF structure, reflected in our exemptive orders, which permit only an authorized participant of an ETF to purchase creation units from (or sell creation units to) the ETF. An orderly creation unit issuance and redemption process is essential to a properly functioning arbitrage mechanism. Commenters supported the proposed definition of exchange-traded fund.

Rule 6c-11 will define an authorized participant to mean a member or participant of a clearing agency registered with the Commission that has a written agreement with the ETF or one of its service providers that allows the authorized participant to place orders for the purchase and redemption of creation units, as proposed. This definition differs from the definition of “authorized participant” in the Commission's exemptive orders and Form N-CEN because it does not include a specific reference to an authorized participant's participation in DTC, as DTC is itself a clearing agency. We proposed to amend Form N-CEN to make the two definitions consistent. We believe the definition that we are adopting remains largely consistent with the exemptive relief we have granted to ETFs, while eliminating unnecessary terms.

Several commenters expressed support for the proposed definition of authorized participant. One commenter, however, asserted that rule 6c-11 should use the existing definition of authorized participant in Form N-CEN to avoid confusion and regulatory inconsistency. We believe that amending Form N-CEN to make the definition of authorized participant consistent with the definition in rule 6c-11 addresses this commenter's concern.

We also received several comments on issues relating to authorized participants more generally. One commenter, for example, suggested that the Commission confirm that authorized participants who buy and sell ETF shares in creation units are not considered, for that reason alone, “principal underwriters” under the Investment Company Act. The commenter stated that the plain language of section 2(a)(29) of the Act would exclude an authorized participant from the definition of principal underwriter when the authorized participant purchases ETF shares through a principal underwriter acting as agent for the ETF. We agree that an authorized participant that purchases ETF shares from the ETF's principal underwriter is not a principal underwriter as defined in section 2(a)(29) of the Act solely because it buys and sells ETF shares in creation units.

Another commenter suggested that the Commission require an ETF to have a minimum number of authorized participants (i.e., 2 or 3) to reduce the risk of anti-competitive behavior and to safeguard the arbitrage mechanism. This commenter, however, also pointed to data indicating that large ETFs (with more than $790 million in assets) typically have an average of nine active authorized participants, and that smaller ETFs (with less than $27 million in assets) have an average of two active authorized participants. This commenter further noted that it has observed ETFs using single authorized participants in “some markets outside of the United States” but that this type of arrangement is “less common within the United States.” We have not observed the types of “excessive deviations” between ETFs' NAV and market price that, according to this commenter, could indicate that ETFs' use of one authorized participant is a persistent problem. Additionally, based upon Form N-CEN data through September 5, 2019, we found that out of 1672 funds reviewed that could rely on rule 6c-11, only 30 (approximately 1.8% of the funds reviewed) reported having fewer than 2 authorized participants. We therefore do not believe that it is appropriate at this time to prescribe a minimum number of authorized participants that an ETF may use.

As proposed, rule 6c-11 will define “creation unit,” to mean a specified number of ETF shares that the ETF will issue to (or redeem from) an authorized participant in exchange for the deposit (or delivery) of a basket and a cash balancing amount (if any). Rule 6c-11 will not mandate a maximum or minimum creation unit size or otherwise place requirements on creation unit size. We continue to believe, and commenters agreed, that ETFs are incentivized to establish creation unit sizes that are appropriate for market demand pursuant to their investment strategies and objectives. Thus, ETFs are not likely to set very large or very small creation unit sizes that could disrupt the arbitrage mechanism or prevent the use of in-kind baskets when in-kind baskets would otherwise be desirable for an ETF to obtain the typical efficiencies of ETFs. We also believe that the conditions in rule 6c-11, as adopted, are better suited to promote effective arbitrage than conditions related to creation unit size.

An ETF generally would issue and redeem shares in creation unit size aggregations, rather than as individual shares, under the rule. We proposed to permit an ETF to sell or redeem individual shares on the day of consummation of a reorganization, merger, conversion, or liquidation. In these limited circumstances, an ETF may need to issue or redeem individual shares, and may need to transact without utilizing authorized participants. Commenters that addressed this aspect of the proposal generally supported it. One commenter, however, suggested that the rule should explicitly provide that an ETF may transact with investors other than authorized participants in these limited circumstances. We agree and have modified rule 6c-11 to clarify that, on the day of a reorganization, merger, conversion, or liquidation, an ETF may sell or redeem individual shares and is not limited to transacting with authorized participants. We believe that permitting ETFs to conduct redemptions with investors other than authorized participants in these circumstances is operationally necessary to facilitate these transactions and will allow an ETF to compensate individual shareholders exiting the reorganized, merged, converted or liquidated ETF—activities likely to involve small amounts and to be outside the scope of an authorized participant's expected role of transacting in creation units.

Commenters also addressed the Commission's proposed guidance concerning the extent to which an ETF may directly or indirectly suspend the issuance or redemption of ETF shares. An ETF that suspends the issuance or redemption of creation units indefinitely could cause a breakdown of the arbitrage mechanism, resulting in significant deviations between market price and NAV per share. Such deviations may harm investors that purchase shares at market prices above NAV per share and/or sell shares at market prices below NAV per share.

With respect to redemptions, an ETF may suspend the redemption of creation units only in accordance with section 22(e) of the Act, and may charge transaction fees on these redemptions only in accordance with rule 22c-2. While no commenters disagreed with our statement in the 2018 ETF Proposing Release that an ETF may suspend redemptions only in compliance with section 22(e), several commenters requested that we eliminate the 2% cap on redemption fees for ETFs. One commenter asserted that, unlike the mutual fund redemption fees that were the Commission's focus in adopting rule 22c-2, the transaction fees charged by an ETF on redemptions are not intended to inhibit frequent trading of the ETF's shares, but are primarily designed to protect shareholders against the costs of certain cash redemptions.¹⁸³ This commenter further stated that an ETF's inability to pass through certain incremental costs to an authorized participant could adversely impact performance and result in dilution of the interests of the ETF's remaining shareholders.

As discussed above, we believe that ETFs should be regulated as open-end funds and that ETF shares are most appropriately classified as redeemable securities under the relevant provisions of the Act. In adopting the 2% limit on redemption fees under rule 22c-2, we stated that higher redemption fees would impose an undue restriction on the redeemability of shares. Consistent with this belief, our exemptive orders permitting ETFs to operate as open-end funds have not permitted ETFs to charge transaction fees in excess of the 2% limit. We believe the 2% limit allows ETFs to pass on certain costs related to the redemption transaction to authorized participants, while preserving the redeemability of ETF shares. Accordingly, we believe that ETFs may charge transaction fees on the redemption of creation units only in accordance with rule 22c-2.

We also stated in the 2018 ETF Proposing Release that we believe that an ETF generally may suspend the issuance of creation units only for a limited time and only due to extraordinary circumstances, such as when the markets on which the ETF's portfolio holdings are traded are closed for a limited period of time. Some commenters agreed that an ETF may suspend creations only for a limited time and only due to extraordinary circumstances, but requested that we provide clarification regarding the specific circumstances under which an ETF may suspend creations. Other commenters did not support our position on this issue. For example, one commenter stated that current ETF practices for suspending creations have proven effective and advocated against limiting or imposing restrictions on the circumstances in which ETFs may suspend creations. Another commenter recommended that, rather than precluding an ETF from suspending the issuance of creation units, the Commission should require ETFs that suspend creations to add supplemental disclosures addressing the risk that the ETF's market price may deviate from NAV per share.

As discussed above, however, the expected close tie between an ETF's market price and NAV per share provides a basis for our relief from section 22(d) and rule 22c-1 under rule 6c-11 (as well as our prior exemptive orders). If a suspension of creations impairs the arbitrage mechanism, it could lead to significant deviations between what retail investors pay (or receive) in the secondary market and the ETF's approximate NAV. Such a result would run counter to the basis for relief from section 22(d) and rule 22c-1 and therefore would be inconsistent with rule 6c-11.

2. Listing on a National Securities Exchange

As proposed, rule 6c-11 will define an “exchange-traded fund,” in part, to mean a fund that issues shares that are listed on a national securities exchange and traded at market-determined prices. Exchange-listing is one of the fundamental characteristics that distinguishes ETFs from other types of open-end funds (and UITs) and is one reason that ETFs need certain exemptions from the Act and the rules thereunder. Exchange-listing provides an organized and ongoing trading market for the ETF shares at market-determined prices, and therefore is important to a functioning arbitrage mechanism. The Commission has premised all of its previous exemptive orders on an ETF listing its shares for trading on a national securities exchange.

Several commenters generally supported the requirement that an ETF list its shares on a national securities exchange. On the other hand, one commenter stated that ETFs that are temporarily suspended from listing or engaged in an orderly delisting and liquidation process should not fall outside of the scope of the proposed rule. Another commenter opined that delisted ETFs should remain within the rule to prevent a possible race to redeem the ETF's shares that could result from confusion about the ETF's regulatory status. This commenter stated the definition of exchange-traded fund instead should include ETFs that have been listed within the past 90 days. Other commenters requested that we clarify the specific circumstances that constitute a “delisting,” citing trading suspensions and trading halts as examples of circumstances that should not disqualify an ETF from relying on rule 6c-11. These commenters also urged the Commission to clarify that a temporary non-compliance notice from an exchange for failure to continuously meet the exchange's listing standards would not disqualify an ETF from relying on the rule.

As noted above, the listing requirement was designed to ensure that all ETF shares have an organized and ongoing secondary trading market to support an effective arbitrage mechanism. We therefore continue to believe that an ETF should no longer be eligible to rely on rule 6c-11 and must meet individual redemption requests within seven days pursuant to section 22(e) of the Act or liquidate if it is not listed on an exchange. In response to commenters' request that we clarify the specific circumstances constituting a “delisting” for purposes of rule 6c-11, an ETF is considered no longer listed on an exchange as of the effective date of the removal of the ETF's shares from listing pursuant to rule 12d2-2 under the Exchange Act. Circumstances such as a trading suspension, a trading halt, or a temporary non-compliance notice from the exchange therefore would not constitute a “delisting” for purposes of rule 6c-11. An ETF also may request temporary relief from the Commission to permit the ETF to suspend redemptions for a limited period of time where necessary to protect ETF shareholders.

3. Intraday Indicative Value (“IIV”)

As proposed, rule 6c-11 will not require ETFs to disseminate an intraday estimate of their NAV per share (an “intraday indicative value” or “IIV”) as a condition for reliance on the rule. Our orders require the dissemination of an IIV, and ETFs have stated in their exemptive applications that an ETF's IIV is useful to investors because it allows them to determine (by comparing the IIV to the market value of the ETF's shares) whether and to what extent the ETF's shares are trading at a premium or discount on an intraday basis. The exchange listing standards also currently require ETFs to disseminate an IIV at least every 15 seconds during regular trading hours.

We did not propose, however, an IIV dissemination requirement under rule 6c-11 because of our concerns regarding the accuracy of IIV estimates for certain ETFs. For example, the IIV may not accurately reflect the value of an ETF that holds securities that trade less frequently. The IIV can be stale or inaccurate for ETFs with foreign securities or less liquid debt instruments. For such ETFs, there may be a difference between the IIV, which is constructed using the last available market quotations or stale prices, and the ETF's NAV, which uses fair value when market quotations are not readily available. Conversely, in today's fast moving markets, given the dissemination lags, the IIV may not accurately reflect the value of an ETF that holds frequently traded component securities. Because there are no uniform methodology requirements, the IIV also can be calculated in different and potentially inconsistent ways.

In addition, we understand that market makers and authorized participants no longer use IIV to evaluate arbitrage opportunities for ETFs that provide full portfolio transparency. These market participants typically calculate their own intraday value of an ETF's portfolio with proprietary algorithms that use an ETF's daily portfolio disclosure and available pricing information about the assets held in the ETF's portfolio and generally use the IIV as a secondary or tertiary check on the value that their proprietary algorithms generate.

The majority of commenters that addressed IIV requirements supported our proposed approach. For example, commenters agreed that authorized participants and other market participants calculate their own intraday values based on other sources of information such as an ETF's published baskets and portfolio holdings. Some of these commenters stated, therefore, that the proposed rule's conditions regarding daily portfolio holdings information would provide more useful information to market participants than IIV. Commenters also agreed that IIV can have significant limitations depending on the types of securities the ETF holds. For example, one commenter stated that these limitations for ETFs holding fixed income securities are the result of market structure issues and that increasing the frequency of the IIV publication would not change these limitations.

Commenters also noted that under current regulatory requirements, IIV can be confusing or misleading to market participants. For example, one commenter stated that current requirements for IIV actually reduce ETF transparency, because the IIV does not reflect the true value of an ETF due to dissemination delays, stale pricing for underlying holdings, and inconsistent calculation methodologies. One commenter opined that IIV is inaccurate for 80% of all ETFs and the rule should not require its dissemination. Another commenter stated that “[IIV] is, at best, slow and likely stale and, at worst confusing, inaccurate, and misleading.” In addition, several of these commenters stated that the IIV requirements across regulatory regimes applicable to ETFs should be harmonized. Specifically, these commenters noted that, even if rule 6c-11 were to omit an IIV requirement, existing relief under the Exchange Act and certain exchange listing requirements would require ETFs to continue disseminating IIV. They encouraged the Commission to work with the exchanges to remove these listing requirements.

Some commenters disagreed with this aspect of the proposal and encouraged the Commission to require ETFs to disseminate IIV as a requirement of the rule. These commenters generally asserted that IIV—despite its limitations—can be useful to retail investors. One such commenter stated that IIV is important for informed trading of ETFs (and other ETPs) by retail investors because it is an “important signal of the value of the underlying portfolio.” One commenter stated that IIV allows investors to screen for significant price deviations that could signal breakdowns in the market maker arbitrage process.

Some of these commenters noted that an ETF's IIV may be the only source of pricing information publicly available to retail investors. Another commenter asserted that the rule should include an IIV requirement, but that market participants, particularly retail investors, also would benefit from an explanation of the potential limitations of IIV. Many of the commenters who recommended that the Commission retain an IIV requirement also recommended that the Commission standardize and otherwise improve the IIV calculation.

After considering these comments, we continue to believe that rule 6c-11 should not require ETFs to disseminate IIV as IIV is not necessary to support the arbitrage mechanism for ETFs that provide daily portfolio holdings disclosure. Instead, rule 6c-11's portfolio holdings disclosure will provide market participants with the relevant data to input into their internal algorithms and thus allow them to determine if arbitrage opportunities exist.

We also do not believe that IIV will provide a reliable metric for retail investors to assess all ETFs relying on rule 6c-11 given the breadth of asset classes that ETFs may hold (and the particular shortcomings of IIV when an ETF holds assets that do not trade contemporaneously with the ETF or are traded less frequently). Furthermore, retail investors do not have easy access to IIV through free, publicly available websites today even for those asset classes where an IIV may be more reliable. A staff review of the websites for the ten largest ETFs by assets under management found that none provides a real-time IIV on its website. Some of these ETFs disclose a specific ticker symbol for the ETF's IIV (as opposed to the ticker symbol for the ETF itself) on their websites, others provide the IIV with a delay of up to 45 minutes, while others provide no information about the ETF's IIV at all. A review of several publicly available, free financial websites also found that not all of these websites provide an ETF's IIV. Where these websites did provide the IIV, it was delayed by at least 15 minutes. We believe this raises a significant risk that retail investors using these websites may be receiving stale IIVs for ETFs. We have noted, and commenters agreed, that even the 15-second interval for dissemination of an ETF's IIV required under the exchange listing standards may be too infrequent to effectively reflect the full trading activity for component securities, and therefore to reflect the actual value of the ETF. Therefore, we do not believe that adopting rule 6c-11 without an IIV requirement would remove information from the market that retail investors could reliably use when making investment decisions.

We considered whether to require an ETF to publicly disseminate a modified IIV on its website on a real time basis as a condition to rule 6c-11, requiring ETFs to calculate IIVs more frequently and in a more accessible manner. We also considered creating a methodology that takes into account circumstances when market prices for underlying assets are not available or should not be used to reflect the ETF's intraday value. However, we believe that these modifications are not necessary given that an ETF operating in reliance on rule 6c-11 will provide full portfolio transparency on its website.

We recognize that intraday information accurately reflecting the current value of an ETF's shares can be important to retail investors and encourage the ETF industry to undertake efforts to develop intraday value metrics targeted at these investors. We believe that ETFs are in a position to consider and develop tailored metrics for ETFs holding different asset classes in a format that is useful for retail investors. As one commenter noted, rule 6c-11's portfolio holdings disclosure requirements may promote a market-based solution to today's IIV shortcomings by making the information required to calculate intraday values broadly available in a standardized, user‐friendly format, which could “encourage pricing services and other potential providers to develop commercial ETF intraday valuation services that would compete in the market on the basis of timeliness, accuracy, reliability and price.”

4. Portfolio Holdings Disclosure

Since the first exemptive order for an ETF, the Commission has relied on the existence of an arbitrage mechanism to keep market prices of ETF shares at or close to the NAV per share of the ETF. One mechanism that facilitates the arbitrage mechanism is daily portfolio transparency. Portfolio transparency provides authorized participants and other market participants with a tool to facilitate valuing the ETF's portfolio on an intraday basis, which, in turn, enables them to identify arbitrage opportunities and to effectively hedge their positions. Accordingly, as proposed, rule 6c-11 will require an ETF to disclose prominently on its website, publicly available and free of charge, the portfolio holdings that will form the basis for each calculation of NAV per share.

We received numerous comments on this aspect of the proposal. Many commenters generally supported requiring full, daily portfolio holdings disclosure on the ETF's website as a condition for reliance on rule 6c-11. These commenters agreed with our view that portfolio transparency supports an efficient arbitrage mechanism and thus helps maintain the close tie between the market price of an ETF's shares and the value of its portfolio. One commenter stated that portfolio transparency is important to individual investors because it allows them to better discern differences between ETFs that purport to track similar indexes or have similar investment objectives.

On the other hand, one commenter did not support daily disclosure of an ETF's full portfolio, opining that an effective arbitrage mechanism is sufficiently supported by disclosure of well-constructed baskets with performance that closely tracks the performance of both the fund and its index. This commenter further asserted that daily portfolio transparency may harm ETF investors by permitting market participants to front-run index funds, which could negatively impact the prices at which the ETF trades portfolio holdings and thus reduce investors' returns. This commenter recommended, as an alternative to the proposed requirement, that the Commission require ETFs to provide daily disclosure of portfolio holdings, with an exception for the portion of holdings that are “subject to sensitive trading strategies,” such as those related to index changes.

One commenter supported requiring daily portfolio transparency for index-based ETFs, but opposed requiring it for actively managed ETFs, due to the risk of market participants using the portfolio holdings disclosures to front-run or piggyback on actively managed strategies. Similarly, another commenter asserted that daily portfolio transparency is not a necessary condition for effective arbitrage, and noted that the risks of front-running and “free riding” that arise from portfolio transparency were preventing it from offering more actively managed ETFs.

We continue to believe ETFs relying on rule 6c-11 should provide full daily portfolio transparency in order to facilitate an efficient arbitrage process. Notably, we believe it is likely that all current ETFs that may rely on the rule already provide full portfolio transparency as a matter of market practice and this approach will eliminate regulatory distinctions between index-based and actively managed ETFs that rely on rule 6c-11. Moreover, although we recognize there are alternative approaches to facilitate efficient arbitrage, the Commission has limited experience with such approaches, which are new and continuing to evolve and we therefore believe that these alternatives should be considered within our exemptive applications process.

Accordingly, rule 6c-11 will require full, daily portfolio holdings disclosure for ETFs relying on the rule. As discussed below, however, the portfolio transparency requirement we are adopting includes several modifications from the proposed rule, including modifications regarding the required timing and presentation of the portfolio holdings disclosure.

a. Timing of Portfolio Holdings Disclosure

Rule 6c-11 will require website disclosure of an ETF's portfolio holdings on each business day before the opening of regular trading on the primary listing exchange of the ETF's shares. Our proposal also would have required an ETF to disclose its portfolio holdings before the ETF starts accepting orders for the purchase or redemption of creation units. The proposed rule's timing requirements were designed to prevent an ETF from disclosing its portfolio holdings only after the beginning of trading or after the ETF has begun accepting orders for the next business day.

We received several comments on this aspect of the proposal, particularly on the proposed requirement that an ETF disclose its portfolio holdings before the ETF starts accepting orders on a given business day. Several commenters opposed the proposed timing requirement because it could prevent certain ETFs from accepting creation and redemption orders shortly after the US market closes (“T-1 orders”). These commenters explained that T-1 orders allow ETFs, authorized participants, and other market participants to place orders for the purchase and sale of portfolio securities in non-U.S. markets with hours that do not overlap (or have limited overlap) with U.S. market hours when those markets are open. An ETF that holds Japanese equities, for example, may permit authorized participants to submit T-1 orders (between 4:00 p.m. ET and 5:00 p.m. ET) to allow for trading in the underlying Japanese securities before the Japanese market closes (2:00 a.m. ET). Some commenters explained that the operational steps necessary to disclose an ETF's portfolio holdings would take 2-3 hours after NAV calculation (typically 4:00 p.m. ET) and the requirement to disclose portfolio holdings before accepting orders therefore would eliminate the T-1 order window.

Several commenters discussed the benefits of permitting ETFs to accept T-1 orders. Commenters stated that T-1 orders allow market participants to align the execution time of underlying securities transactions with the NAV calculation of the order, and thus minimize costs and support effective arbitrage. Some commenters stated that eliminating the T-1 order window may lead to wider bid-ask spreads, larger premiums/discounts, and greater tracking differences for these ETFs. One commenter stated that, without T-1 orders, an ETF may have uninvested cash for longer periods of time (leading to increased tracking error) and authorized participants may need to hedge their exposures for longer than usual due to the delay between when the creation order is placed and when the ETF acquires the portfolio securities (leading to wider bid-ask spreads). Another commenter noted that moving the T-1 order window later into the evening to allow the ETF to calculate and disclose its portfolio holdings before accepting T-1 orders would require an additional staffing shift, and thus would impose additional staffing costs on sponsors, custodians, and other market participants.

Commenters recommended alternatives to the proposed rule's timing requirements. Several commenters suggested we require portfolio holdings disclosure only before the opening of regular trading on the primary listing exchange. These commenters asserted that authorized participants placing purchase or redemption orders on a T-1 basis are able to assess and hedge market risk associated with transacting in underlying foreign securities prior to regular trading in U.S. equity markets. Other alternatives suggested by commenters included: (i) Carving out ETFs investing in foreign markets from the proposed timing requirements; and (ii) permitting ETFs to accept T-1 orders provided that they first share certain standardized information with authorized participants.

After considering these comments, we are not adopting the proposed requirement that an ETF disclose its portfolio holdings before it starts accepting orders for the purchase or redemption of creation units. Instead, rule 6c-11 will require an ETF to disclose the portfolio holdings that will form the basis for the ETF's next calculation of NAV per share each business day before the opening of regular trading on the primary listing exchange of the exchange-traded fund shares. This will accommodate T-1 orders, as requested by commenters, and is consistent with our existing exemptive orders.

The goal of our proposed timing requirement was to facilitate effective arbitrage by providing authorized participants and other market participants buying and selling ETF shares with portfolio holdings information at the time of the transaction. We believe that accommodating T-1 orders, but requiring disclosure before the opening of regular trading on the primary listing exchange of the ETF's shares, will nonetheless allow for effective arbitrage. Commenters stated that ETFs utilizing T-1 orders have shown relatively narrow bid-ask spreads and small premiums and discounts, and stated that precluding T-1 orders could have the unintended effect of actually widening bid-ask spreads and disrupting existing market practices. Moreover, staff review of the websites of several ETFs that disclose that they use T-1 orders indicates that these ETFs' bid-ask spreads and premiums and discounts fall approximately within the same range as ETFs that do not use T-1 orders.

We considered whether to impose other conditions for the acceptance of T-1 orders, such as disclosure of the last published portfolio holdings. However, given the information already available to market participants and the data demonstrating that existing market practices have led to effective arbitrage, we do not believe additional conditions are currently necessary to facilitate arbitrage for these orders.

b. Presentation of Portfolio Holdings Disclosure

Rule 6c-11 will require an ETF to disclose standardized information regarding each portfolio holding. The rule, however, will not require this information to be presented and contain information in the manner prescribed within Article 12 of Regulation S-X as proposed. In response to concerns and suggestions of commenters, we have modified this condition to require ETFs to disclose a limited set of information for each portfolio holding.

Commenters on this aspect of the proposal agreed that there currently is little consistency in the presentation of holdings information by ETFs, and generally agreed this disclosure should be standardized. Several commenters, however, stated that the specific presentation standard included in the proposed rule (i.e., Article 12 of Regulation S-X) is not an appropriate framework for daily portfolio holdings disclosures by ETFs. Commenters asserted that certain of the Article 12 requirements are overly burdensome for daily disclosure or unnecessary to achieve the Commission's goal of facilitating effective arbitrage.

Some commenters recommended alternative approaches. Several commenters, for example, suggested using disclosure requirements based on the generic listing standards for actively managed ETFs. One of these commenters stated that using the generic listing standards would provide “more streamlined portfolio holdings disclosure that includes a subset of the items required by Article 12 that is most relevant and useful for investors.” Other commenters stated that the Commission should consider a more limited set of requirements, such as: (i) The name of the security; (ii) the size of the position; (iii) the percentage exposure to such security; and (iv) the security's value. Some commenters also recommended that, in addition to website disclosure, rule 6c-11 require ETFs to file portfolio holdings information in a central public location, such as EDGAR.

We proposed the Article 12 framework because ETFs are already required to comply with Article 12 for periodic financial reporting purposes and therefore we believed that it would provide an efficient way to standardize daily portfolio holdings disclosure. After considering comments, however, we believe that a more streamlined requirement will provide standardized portfolio holdings disclosure in a more efficient, less costly, and less burdensome format, while still providing market participants with relevant information. Accordingly, rule 6c-11 will require an ETF to post a subset of the information required by the listing exchanges' current generic listing standards for actively managed ETFs. Rule 6c-11 will require ETFs to disclose the following information for each portfolio holding on a daily basis: (1) Ticker symbol; (2) CUSIP or other identifier; (3) description of holding; (4) quantity of each security or other asset held; and (5) percentage weight of the holding in the portfolio. We believe that this framework will provide market participants with the information necessary to support an effective arbitrage mechanism and eliminate potential investor confusion due to a lack of standardization.

As commenters suggested, to arbitrage an ETF's holdings, market participants generally must be able to identify the security or asset held, the quantity held, and percentage weighting of the holding in the ETF's portfolio. To enable market participants to identify the investment held, we are requiring the ETF to disclose the ticker, CUSIP or other identifier (where applicable) of the holding, and to provide a description of the holding. Because certain investments may not have been assigned a common securities identifier, we are requiring the ETF to provide a brief description of the investment to allow an investor to effectively hedge the ETF. For example, ETFs holding debt securities should include the security's name, maturity date, coupon rate, and effective date, where applicable, to assist investors in identifying the specific security held. To indicate the quantity of a security or other asset held, the ETF generally should use the measure typically associated with quantifying that class of security, such as number of shares for equity securities, par value for debt securities, number of units for securities, such as UITs, that are measured in units, and dollar value for cash. With respect to derivatives, the ETF generally should provide both the notional value of the derivative and number of contracts, as well as a general description of the investment, which should include the type of derivative (i.e., swap, option, forward). ETFs also may want to consider several of the other reporting fields in Form N-PORT, for example, depending on the type of investment the ETF holds, in order to provide investors with the necessary information.

We continue to believe that the ETF's website is the most effective location for the disclosure of portfolio holdings information. By posting the portfolio information on its website, free of charge, the ETF makes the information available to a broad range of investors, including retail investors, and other market participants. We further believe, and commenters agreed, that requiring ETFs to file their portfolio holdings information on EDGAR would impose additional costs on ETFs that are not justified in light of other available disclosure methods. Moreover, the purpose of this requirement is to allow ETF investors to understand and potentially arbitrage the ETF's holdings. We therefore do not believe that requiring ETFs to file daily portfolio holding disclosure on EDGAR or other centralized location in order to provide potentially greater comparability across ETFs is justified in light of current market practices and the additional costs associated with such a requirement. In addition, other documents, such as reports on Form N-PORT or Form N-CEN, registration statements on Form N-1A, and consolidated structured datasets derived from those submissions, provide centralized, structured information, including information about portfolio holdings, that can be analyzed and compared across ETFs, albeit on a less frequent basis.

c. Portfolio Holdings That Will Form the Basis for the ETF's NAV Calculation

As proposed, rule 6c-11 will require the portfolio holdings that form the basis for the ETF's NAV calculation to be the ETF's portfolio holdings as of the close of business on the prior business day. Changes in an ETF's holdings of portfolio securities would therefore be reflected on a T+1 basis. We did not receive any comments on this proposed condition, which is consistent with current ETF practices. We continue to believe that requiring an ETF to disclose the portfolio that will form the basis for the next NAV calculation at the beginning of the business day will help to facilitate the efficient functioning of the arbitrage process while protecting against potential front-running of the ETF's trades.

Accordingly, rule 6c-11 will not require ETFs to disclose intraday changes in portfolio holdings because these changes would not affect the portfolio composition serving as a basis for NAV calculation until the next business day. We continue to believe that the selective disclosure of nonpublic information regarding intraday changes in portfolio holdings (or any advance disclosure of portfolio trades) could result in the front-running of an ETF's trades, causing the ETF to pay more to obtain a security. We have stated that registered investment companies' compliance policies and procedures required by rule 38a-1 under the Act should address potential misuses of nonpublic information, including the disclosure to third parties of material information about a fund's portfolio, its trading strategies, or pending transactions, and the purchase or sale of fund shares by advisory personnel based on material, nonpublic information about the fund's portfolio. ETFs also are required to describe their policies and procedures on portfolio security disclosure in the Statement of Additional Information and post such policies and procedures on their websites.

5. Baskets

As proposed, rule 6c-11 will require an ETF relying on the rule to adopt and implement written policies and procedures governing the construction of baskets and the process that the ETF will use for the acceptance of baskets. In addition, as proposed, the rule will provide an ETF with flexibility to use “custom baskets” if the ETF has adopted written policies and procedures that: (i) Set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (ii) specify the titles or roles of employees of the ETF's investment adviser who are required to review each custom basket for compliance with those parameters (“custom basket policies and procedures”).

a. Basket Policies and Procedures

When an ETF uses in-kind creations and redemptions, the composition of the basket is an important aspect of the efficient functioning of the arbitrage mechanism. Basket composition affects the costs of assembling and delivering the baskets exchanged for creation units as well as the costs of liquidating basket securities when redeeming creation units. Basket composition also is important to ETF portfolio management, as each in-kind creation or redemption increases or decreases positions in the ETF's portfolio, and allows portfolio managers to add or remove certain portfolio holdings. This can be an efficient way for a portfolio manager to execute changes in the ETF's portfolio because the manager can make the changes without incurring the additional expenses of trades in the market. When an ETF does not have flexibility to manage basket composition, however, undesired changes to the portfolio may result, such as the loss of desirable bonds when paying redemptions in kind.

The exemptive relief relating to baskets evolved over time. Early orders for ETFs organized as open-end funds included few explicit restrictions on baskets, and these orders did not expressly limit ETFs' baskets to a pro rata representation of the ETF's portfolio holdings. Since approximately 2006, however, our orders placed tighter restrictions on an open-end ETF's composition of baskets. These orders expressly require that an ETF's basket generally correspond pro rata to its portfolio holdings, while identifying certain limited circumstances under which an ETF may use a non-pro rata basket.

The requirement that baskets correspond pro rata to the ETF's portfolio holdings, and the increasingly limited exceptions to the pro rata requirement, were designed to address the risk that an authorized participant could take advantage of its relationship with the ETF and pressure the ETF to construct a basket that favors an authorized participant to the detriment of the ETF's shareholders. For example, because ETFs rely on authorized participants to maintain the secondary market by promoting an effective arbitrage mechanism, an authorized participant holding less liquid or less desirable securities potentially could pressure an ETF into accepting those securities in its basket in exchange for liquid ETF shares (i.e., dumping). An authorized participant also could pressure the ETF into including in its basket certain desirable securities in exchange for ETF shares tendered for redemption (i.e., cherry-picking). In either case, the ETF's other investors would be disadvantaged and would be left holding shares of an ETF with a less liquid or less desirable portfolio of securities.

Based on our experience with ETFs, however, we believe there are many circumstances, in addition to the specific circumstances enumerated in our orders, where allowing basket assets to differ from a pro rata representation or allowing the use of different baskets could benefit the ETF and its shareholders. For instance, ETFs without basket flexibility typically are required to include a greater number of individual securities within their basket when transacting in kind, making it more difficult and costly for authorized participants and other market participants to assemble or liquidate baskets. This could result in wider bid-ask spreads and potentially less efficient arbitrage. In such circumstances, these ETFs may be at a competitive disadvantage to ETFs with greater flexibility. As a result, these differing conditions and requirements for basket composition in our exemptive orders may have created a disadvantage for newer ETFs that are subject to our later, more stringent restrictions on baskets.

Moreover, certain exceptions to a pro rata basket requirement may help ETFs operate more efficiently. For example, ETFs, particularly fixed-income ETFs, that do not have basket flexibility may satisfy redemption requests entirely in cash in order to avoid losing hard-to-find securities and to preserve the ETF's ability to achieve its investment objectives. ETFs that meet redemptions in cash may maintain larger cash positions to meet redemption obligations, potentially resulting in cash drag on the ETF's performance. The use of cash baskets also may be less tax-efficient than using in-kind baskets to satisfy redemptions, and may result in additional transaction costs for the purchase and sale of portfolio holdings.

We therefore proposed to provide additional basket flexibility, subject to conditions designed to address concerns regarding the potential risk of overreaching. Specifically we proposed to require ETFs to adopt: (i) Policies and procedures governing the construction of baskets and the process that would be used for the acceptance of baskets generally; and (ii) heightened process requirements for ETFs using custom baskets, including policies and procedures specifically covering the use of custom baskets.

Commenters generally supported requiring ETFs to adopt policies and procedures governing the construction of baskets. One commenter stated, for example, that this requirement is consistent with other investment and portfolio management processes that require guidelines, oversight and recordkeeping. Commenters also generally supported our proposal to permit ETFs relying on the rule to use custom baskets provided they adopt certain heightened process requirements. These commenters agreed that providing ETFs with the flexibility to use custom baskets potentially could benefit ETF investors through more effective arbitrage and more efficient portfolio management. One commenter provided the results of an analysis it performed indicating that fixed-income ETFs with basket flexibility had narrower bid-ask spreads, had lower tracking differentials (i.e., the difference between the ETF's daily return and the daily return of its benchmark), and traded at smaller discounts than fixed-income ETFs without basket flexibility.

One commenter, however, asserted that the rule should not afford custom basket flexibility to all ETFs relying on it. Rather, this commenter opined that the rule should require fixed-income ETFs to make in-kind, pro rata redemptions upon shareholder request (with limited substitutions for holdings that cannot be settled or transferred) because, under certain market conditions, custom baskets can lead to greater price volatility and dislocation from NAV for these ETFs.

Some commenters, although generally supporting custom basket flexibility and the proposed heightened process requirements, requested that we modify or clarify certain aspects of the proposed condition. For example, one commenter did not support requiring “detailed parameters” for the construction and acceptance of custom baskets, stating that the rule should permit ETF sponsors to develop broad policies and procedures to cover the wide range of circumstances that may arise relating to custom baskets. Another commenter stated that the Commission should explicitly set forth the appropriate considerations for custom basket policies and procedures, such as periodic monitoring and testing and oversight of the custom basket process. This commenter also stated that the Commission should clarify that an ETF has discretion to tailor its custom basket policies and procedures to address different risks, considerations, and requirements for different types of custom baskets, particularly those involving cash substitutions.

We are adopting the basket conditions under rule 6c-11 as proposed. Rule 6c-11 therefore will require an ETF to adopt and implement written policies and procedures that govern the construction of baskets and the process that will be used for the acceptance of baskets as proposed. These policies and procedures must cover the methodology that the ETF will use to construct baskets. For example, the policies and procedures should detail the circumstances under which the basket may omit positions that are not operationally feasible to transfer in kind. The policies and procedures also should detail when the ETF would use representative sampling of its portfolio to create its basket, and how the ETF would sample in those circumstances. The policies and procedures also should detail how the ETF would replicate changes in the ETF's portfolio holdings as a result of the rebalancing or reconstitution of the ETF's underlying securities market index, if applicable. We believe this policies and procedures requirement will protect against overreaching and other abusive practices in circumstances where an ETF uses a basket that does not reflect a pro rata slice of the ETF's portfolio holdings, but does not meet the definition of custom basket.

Rule 6c-11 also will require the policies and procedures to (i) set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (ii) specify the titles or roles of the employees of the ETF's investment adviser who are required to review each custom basket for compliance with those parameters. We continue to believe that an ETF and its shareholders may benefit from custom baskets and that the heightened process requirements for custom baskets in rule 6c-11 serve to protect the ETF and its shareholders from the risks that custom baskets may present.

Effective custom basket policies and procedures should provide specific parameters regarding the methodology and process that the ETF would use to construct or accept each custom basket. They also should describe the ETF's approach for testing compliance with the custom basket policies and procedures and assessing (including through back testing or other periodic reviews) whether the parameters continue to result in custom baskets that are in the best interests of the ETF and its shareholders. An ETF should consistently apply the custom basket policies and procedures and must establish a process that the ETF will adhere to if it wishes to make any revisions to, or deviate from, the parameters. In addition, an ETF's custom basket policies and procedures should include reasonable controls designed to prevent inappropriate differential treatment among authorized participants.

We do not believe that the requirement for “detailed parameters” would prevent an ETF sponsor from developing policies and procedures to cover the wide range of circumstances that may arise relating to custom baskets. ETFs may tailor their custom basket policies and procedures to address different risks and requirements for different types of custom baskets. For example, an ETF could develop tailored procedures when it uses cash substitutions that differ from the procedures it uses when substituting securities and other positions. An ETF's custom basket policies and procedures also could address the differing considerations for custom baskets depending on the direction of the trade (i.e., whether the custom basket is being used for a creation or a redemption). This condition provides ETFs with flexibility to cover operational circumstances that make the inclusion of certain portfolio securities and other positions in a basket operationally difficult (or impossible), while facilitating portfolio management changes in a cost- and tax-efficient manner.

Although one commenter opined that fixed-income ETFs present unique concerns, we believe that requiring fixed-income ETFs to establish detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders will address the risks associated with custom baskets. As discussed above, we also believe that fixed-income ETFs (and their shareholders) may experience the most pronounced benefits from basket flexibility. As a result, all ETFs that comply with the conditions in rule 6c-11 will have basket flexibility.

One commenter stated that the Commission should confirm that the “best interests of the ETF and its shareholders” standard included in rule 6c-11(c)(3)(i) includes the ETF's shareholders generally rather than individually, on the basis that the adviser to an ETF owes a fiduciary duty only to the ETF, and that ETFs cannot evaluate the interests of individual shareholders. The “best interests of the ETF and its shareholders” in this context is not intended to apply to each ETF shareholder individually, but rather to the ETF's shareholders generally. This formulation is consistent with other Commission rules.

As proposed, rule 6c-11 also will require an ETF, as part of its custom basket policies and procedures, to specify the titles or roles of employees of the ETF's investment adviser who are required to review each custom basket for compliance with the parameters set forth in those policies and procedures. Several commenters did not support this requirement as proposed. One of these commenters stated that the rule should require ETFs to identify only the employees that are responsible for approving custom baskets that deviate from the parameters set forth in the policies and procedures. Another commenter stated that the review requirement is overly prescriptive and could cause operational challenges when an ETF is sub-advised.

In addition, several commenters did not support the statement in the 2018 ETF Proposing Release that an ETF may want to consider whether employees outside of portfolio management should review the components of custom baskets before approving a creation or redemption. Commenters stated that approval of custom baskets is a typical portfolio management function, and that requiring non-investment personnel to review custom baskets before approving a creation or redemption would be impractical, burdensome, and would detract from the flexibility custom baskets provide. One commenter requested that the Commission clarify that the requirement to approve custom baskets applies only to employees with discretionary or direct supervisory authority over custom baskets, and not to employees responsible for governance, back-testing, or periodic reviews.

We continue to believe that the ETF's investment adviser is in the best position to design and administer the custom basket policies and procedures and to establish parameters that are in the best interests of the ETF and its shareholders. We also believe that the adviser is in the best position to determine which employee (or employees) are responsible for determining whether an ETF's custom baskets comply with the custom basket policies and procedures depending on its own structure, strategy, and other relevant circumstances (including whether the ETF is sub-advised). The ETF's adviser (and personnel) are familiar with the ETF's portfolio holdings and are able to assess whether the process and methodology used to construct or accept a custom basket is in the best interests of the ETF and its shareholders and whether a particular custom basket complies with the parameters set forth in the custom basket policies and procedures. We believe that these requirements will allow an ETF to establish a tailored framework for the use of custom baskets, while also requiring the ETF to put into place safeguards against abusive practices related to basket composition.

To the extent that a particular ETF's investment adviser determines that its portfolio management employees are the appropriate employees to be responsible for compliance with the custom basket policies and procedures, we believe that the requirements of rule 38a-1 under the Act provide appropriate safeguards to address possible conflicts of interest that could arise from such an arrangement. For example, ETFs currently are required by rule 38a-1 under the Act to adopt, implement, and periodically review written policies and procedures reasonably designed to prevent violations of the federal securities laws. An ETF's compliance policies and procedures should be appropriately tailored to reflect its particular compliance risks. An ETF's basket policies and procedures (including its custom basket policies and procedures), therefore, should be covered by the ETF's compliance program and other requirements under rule 38a-1. For example, an ETF would be required to preserve the basket policies and procedures pursuant to the requirements of rule 38a-1(d)(1). Also, we believe that the ETF's board of directors' oversight of the ETF's compliance policies and procedures, as well as their general oversight of the ETF, would provide an additional layer of protection for an ETF's use of custom baskets.

b. Definition of Custom Baskets

As proposed, rule 6c-11 will define “custom baskets” to include two categories of baskets. First, a basket containing a non-representative selection of the ETF's portfolio holdings would constitute a custom basket. These types of custom baskets include, but are not limited to, baskets that do not reflect: (i) A pro rata representation of the ETF's portfolio holdings; (ii) a representative sampling of the ETF's portfolio holdings; or (iii) changes due to a rebalancing or reconstitution of the ETF's securities market index, if applicable.

Second, if different baskets are used in transactions on the same business day, each basket after the initial basket would constitute a custom basket. For example, if an ETF exchanges a basket with either the same or another authorized participant that reflects a representative sampling that differs from the initial basket, that basket (and any such subsequent baskets) would be a custom basket. Similarly, if an ETF substitutes cash in lieu of a portion of basket assets for a single authorized participant, that basket would be a custom basket.

We received a number of comments on the proposed definition of custom basket. Several commenters asserted that baskets including cash substitutions should not be subject to the heightened policies and procedures requirement for custom baskets, and thus should be excluded from the definition of custom baskets. These commenters asserted that baskets with cash substitutions do not raise the same concerns about conflicts or overreach as securities substitutions. Commenters also contended that the use of cash substitutions as part of standard (i.e., non-custom) baskets is a routine portfolio management matter that is necessary for the efficient operation of ETFs. One commenter suggested several technical changes to the proposed definition of custom basket in rule 6c-11 to treat cash substitutions as part of a non-custom, pro rata basket under certain enumerated circumstances.

After consideration of these comments, we are adopting the definition of “custom basket” as proposed. While we generally agree with commenters that cash substitutions may not raise the same concerns as securities substitutions, an ETF's use of cash substitutions may raise concerns regarding the potential for an authorized participant to overreach, particularly in connection with redemptions. For example, during periods of market stress, an authorized participant may demand cash from the ETF instead of less liquid securities in exchange for ETF shares, impacting the liquidity of the ETF's portfolio and the ability of the ETF to satisfy additional cash redemption requests from authorized participants.

We also considered excluding certain types of cash substitutions from the definition of custom baskets where authorized participant overreach is unlikely, consistent with the approach taken in our recent exemptive orders. However, we are concerned that such an approach may fail to effectively capture all circumstances in which an ETF may substitute cash. We believe that the policies and procedures requirements for custom baskets will provide ETFs with sufficient flexibility to design custom basket policies and procedures that are tailored to address the different risks that cash substitutions and securities substitutions may present. An ETF could, for example, design custom basket policies and procedures with more streamlined requirements for certain cash substitutions that present lower risks.

c. Basket Publication Requirement

Proposed rule 6c-11 would have required an ETF to post information regarding one basket that it would exchange for orders to purchase or redeem creation units to be priced based on the ETF's next calculation of NAV per share (a “published basket”) on its website each business day. This proposed disclosure requirement was designed to: (i) Facilitate arbitrage by providing authorized participants and other market participants with timely information regarding the contents of a basket that the ETF will accept each day; and (ii) allow market participants that do not have access to an ETF's daily portfolio composition file to compare the ETF's basket with its portfolio holdings, assist in building intraday hedges, and estimate the cash balancing amount. After considering comments, however, the Commission is not including a basket publication requirement in rule 6c-11.

Commenters generally did not support requiring disclosure of a published basket on the ETF's website. For example, one commenter asserted that the proposed published basket was “speculative,” and had little value, particularly for certain types of fixed-income ETFs. Several commenters contended that the contents of an ETF's basket are irrelevant for secondary market investors and publication of an ETF's basket could result in confusion, particularly if the basket is mistaken for portfolio holdings information. Other commenters stated that the publication requirement could delay the process by which the ETF and an authorized participant negotiate the contents of a custom creation or redemption basket. Another commenter stated that we should require an ETF to provide its published basket through the NSCC, rather than through its website, because the market participants that would use the published basket currently are able to access it either directly through the NSCC or through intermediaries.

After considering these comments, the Commission is not including in rule 6c-11 a requirement that an ETF post information regarding one published basket that it would exchange for orders to purchase or redeem creation units. We proposed this condition, in part, because we were concerned that certain market participants that needed access to basket information for arbitrage purposes would not have access to ETF portfolio composition files. However, we understand from commenters that market participants that use basket information, including those seeking to hedge exposure to an ETF, currently have access to this information through the NSCC, an intermediary, or the ETF itself. We are, however, requiring ETFs to provide daily website disclosure of portfolio holdings, which we believe will provide market participants with the necessary tools to determine if an arbitrage opportunity exists and to hedge the ETF's portfolio. As a result, we believe that the publication of a single published basket would provide little additional value to market participants assessing the existence of arbitrage opportunities. We also agree with commenters' concerns that some investors may confuse the published basket information with an ETF's portfolio holdings information.

We requested comment on whether we should require an ETF to publish certain information regarding each basket used by the ETF to ameliorate some of the limitations associated with publication of a single basket each day and to serve as an additional check against overreaching by authorized participants. However, commenters stated that such a requirement would be costly to implement and unnecessarily burdensome, particularly because basket composition information is not used by secondary market investors. In addition, commenters asserted that publication of each basket could raise the risk that market participants front-run trades in basket securities or attempt to replicate authorized participants' or other market makers' trading strategies, particularly for those ETFs that have more frequent primary market transactions. Rule 6c-11 as adopted instead will require ETFs to maintain certain information regarding each basket exchanged with an authorized participant. We believe that this record keeping requirement is a more efficient way to ensure compliance with the rule, while mitigating concerns regarding potential overreaching by authorized participants.

6. Website Disclosure

There has been a significant increase in the use of the internet as a tool for disseminating information, and many investors obtain information regarding ETFs on ETF websites. Rule 6c-11 therefore will require ETFs to disclose certain information on their websites as a condition to the rule. The website disclosure requirements are designed to provide investors with key metrics to evaluate their investment and trading decisions in a format that is easily accessible and frequently updated.

Specifically, under rule 6c-11 the following information must be disclosed publicly and prominently on the ETF's website:

• NAV per share, market price, and premium or discount, each as of the end of the prior business day;
• A table and chart showing the number of days the ETF's shares traded at a premium or discount during the most recently completed calendar year and calendar quarters of the current year;

• For ETFs whose premium or discount was greater than 2% for more than seven consecutive trading days, disclosure that the premium or discount was greater than 2%, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount; and
• Median bid-ask spread over the most recent thirty calendar days.

a. Disclosure of Prior Business Day's NAV, Market Price, and Premium or Discount

As proposed, rule 6c-11 will require an ETF to post on its website the ETF's current NAV per share, market price, and premium or discount, each as of the end of the prior business day. This disclosure provides investors with a “snapshot” view of the difference between an ETF's NAV per share and market price on a daily basis.

Commenters generally supported this requirement, observing that the investors should have easy access to the required information. Some commenters, however, questioned the benefits of the premium or discount disclosure requirement. One such commenter stated that premium and discount disclosures do not provide the same benefit to shareholders as NAV per share and market price. Another commenter, while not objecting to the posting of daily premiums or discounts, opined that emphasizing this information would be unnecessary and—to the extent that a discount might be understood by prospective investors as a bargain—potentially misleading.

We continue to believe that daily website disclosure of NAV per share and market price will promote transparency and alert investors to the relationship between NAV per share and market price. We also believe that this information will help investors better understand the risk that an ETF's market price may be higher or lower than the ETF's NAV per share and compare this information across ETFs. Daily premium/discount disclosures also will provide investors with useful information regarding ETFs that frequently trade at a premium or discount to NAV per share. We believe that ETF investors use this information today.

These disclosures are consistent with our exemptive orders except that rule 6c-11 includes a definition of “market price” that differs from the definition applicable to those orders. Rule 6c-11 defines “market price” as: (A) The official closing price of an ETF share; or (B) if it more accurately reflects the market value of an ETF share at the time as of which the ETF calculates current NAV per share, the price that is the midpoint of the national best bid and national best offer (“NBBO”) as of that time.

One commenter addressed our proposed definition of “market price” and asserted that the rule should permit ETFs to use the midpoint of the NBBO without evaluating whether it more accurately reflects the market value of the ETF's shares. We continue to believe, however, that using the “official closing price” provides a more precise measurement of an ETF's market price than other alternatives, including during disruptive market events. Requiring use of the midpoint of the NBBO only if it more accurately reflects market value also provides an appropriate degree of flexibility to an ETF when its closing price may be stale or otherwise does not reflect the ETF share's market value, while at the same time providing a consistent and verifiable methodology for how ETFs determine market price. Therefore, we have determined to adopt the definition of “market price” for purposes of this website disclosure requirement as proposed.

b. Disclosure of Table and Line Graphs of the ETF's Premiums and Discounts

As proposed, rule 6c-11 will require an ETF to post on its website both a table and line graph showing the ETF's premiums and discounts for the most recently completed calendar year and the most recently completed calendar quarters of the current year. For new ETFs that do not yet have this information, the rule will require the ETF to post this information for the life of the fund. We believe that presenting the data as both a table and a line graph will provide investors with useful information in formats that are easy to view and understand, depending on the investor's preference. This disclosure is similar to current requirements that allow an ETF to omit certain premium/discount disclosures from its prospectus and annual report if the ETF posts on its website a table showing the number of trading days the ETF traded at a premium and the number of days it traded at a discount.

Commenters were generally supportive of this requirement. However, some commenters recommended that the rule require only one of the two presentations. We recognize, as commenters observed, that the same information underlies both presentations. However, each presentation highlights different information, as illustrated in Figure 1 and Table 1 below. The tabular disclosure shows investors how often the ETF traded at a premium or discount. The graphic disclosure shows investors the degree of those deviations, particularly during periods of market stress, and could assist some investors with understanding how the arbitrage mechanism performs for an ETF under various market conditions. Different audiences also may find one presentation more effective. Therefore, we continue to believe that the rule should require both disclosures, and are adopting this aspect of the rule as proposed.

The rule will require historical premium/discount information for the most recently completed calendar year and the most recently completed calendar quarters of the current year as proposed. Some commenters recommended that we require ETFs to update this information on a daily basis or require ETFs to present intra-day premiums or discounts in certain circumstances. However, after considering the usefulness of timely information for investors and other data users and the costs of more frequent collection and publication of the information, we continue to believe the rule should require disclosure of this information only on a quarterly basis. First, this period is consistent with existing prospectus disclosure requirements, and we believe the time period will allow investors to readily observe the extent and frequency of deviations from NAV per share in a graphic format. Second, as discussed above, although the trailing historical data is subject to a less frequent quarterly updating requirement, the current premium or discount is required to be disclosed daily.

c. Disclosure of ETF Premiums or Discounts Greater Than 2%

As proposed, rule 6c-11 will require an ETF whose premium or discount was greater than 2% for more than seven consecutive trading days to post that information on its website, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount. We continue to believe that disclosure of such periods will promote transparency about the significance and persistence of deviations between market price and NAV per share, and may help investors to make more informed investment decisions.

One commenter supported this requirement, stating that daily premium and discount information is an important metric for investors. This commenter stated that its internal metrics suggest that it would be unusual for ETFs to trigger the proposed disclosure requirement, and therefore the disclosure “would not be burdensome” for ETFs. Other commenters, however, opposed the proposed requirement, expressing concern that ETFs holding certain asset classes are more likely to trigger the requirement than others, and that disclosure by ETFs that frequently trigger the requirement could become inappropriately repetitive.

We recognize that this disclosure requirement may affect certain categories of ETFs more than others. An ETF that invests in foreign securities, for example, may be more likely to experience a persistent deviation between market price and NAV per share given that many foreign markets are closed during the U.S. trading day. Such deviations may be pronounced if the market on which the ETF's underlying securities trade is closed for an extended period of time. We believe that this information could help to inform investors about the nature of these ETFs and the potential for frequent deviations.

However, we believe this requirement will affect a broader range of ETFs than just those investing in certain foreign markets. For example, we estimate that, out of a total 2,046 ETFs, 11 alternative ETFs, 20 international equity ETFs, 2 sector equity ETFs, 1 taxable bond ETF, and 15 U.S. equity ETFs would have triggered the 2% premium or discount disclosure requirement in 2018. In addition, during the period from 2008 to 2018, we estimate that the percentage of ETFs that would have triggered the reporting requirement at least once varied from 1.5% to 10%. Even if certain ETFs make the disclosure more frequently or predictably than others because of this variation, we believe that the requirement will promote transparency regarding the significance and persistence of deviations between market price and NAV per share, and thus may permit investors to make more informed investment decisions. Moreover, we believe that this disclosure helps inform investors that certain types of ETFs are more likely to experience persistent premiums or discounts than others.

Other commenters expressed concern with the requirement that an ETF include a discussion of the factors that are reasonably believed to have contributed to the premium or discount. These commenters stated that an ETF may have difficulty identifying these factors before it makes the required disclosure. Although the required information will be subjective in some cases, we believe that this requirement can provide secondary market investors with useful context for the disclosed deviations. For example, the identification of factors that are reasonably believed to contribute to the premium or discount at that time may inform ETF investors and other market participants about factors potentially contributing to the premium or discount, even if additional contributing factors may later be identified. Such disclosed factors might include, for example, that many of an ETF's portfolio securities are traded on foreign markets that are closed during the U.S. trading day or that the markets on which the ETF's underlying securities are traded were closed due to extended holidays or for other reasons. Because the requirement to disclose these factors will continue to apply while the premium or discount persists, the disclosure may change and become better developed over time as the ETF refines its analysis of what it reasonably believes is causing the persistent premium or discount. As a result, such a disclosure also could inform ETF investors and other market participants about the premium's or discount's persistence.

Another commenter recommended that we shorten the time an ETF is required to maintain the disclosure on its website (to, e.g., 45 days), asserting that the required information is likely to be most useful when it is most recent and grows less important over time. Rule 6c-11, however, will require ETFs to maintain the disclosure on their website for at least one year following the first day it was posted to help investors identify ETFs that historically have had persistent deviations between market price and NAV per share. Additionally, although we are requiring maintenance of this disclosure for at least one year, the requirement to post the information will continue to apply as the premium or discount persists—that is, the one-year maintenance requirements will not obviate the need for an ETF to post more current information if otherwise required. Thus, the continued availability of the posted information over the required one-year period will not substitute for or prevent more current and timely disclosure.

Finally, some commenters expressed concerns with the 2% threshold. For example, one commenter recommended a materiality standard instead of a 2% threshold. Another commenter recommended raising the threshold to 5 or 10% and shortening the period over which it is measured. As discussed above, in the Commission's experience, the deviation between the market price of ETFs and NAV per share, averaged across broad categories of ETF investment strategies and over time periods of several months, has been relatively small. We therefore believe that limiting this disclosure to ETFs that have a premium or discount of greater than 2% for more than seven consecutive trading days will serve to highlight potentially unusual circumstances of an ETF with a persistent premium or discount. In Table 2 below, we summarize the effect that different variations on the proposed threshold recommended by the commenter would have had on the number of ETFs that would have triggered the requirement in 2018.

As shown above, a 10% threshold would not have required any ETFs to provide this information in 2018, and a 5% threshold, even over just a three-day period, would have only required disclosure by 12 ETFs. After considering the commenter's recommended modifications to the threshold, we believe that the proposed threshold of 2% over more than seven consecutive trading days will more effectively highlight those patterns of sustained premiums or discounts that will be informative to investors than will the recommended alternatives. We also believe that in this circumstance the objective 2% threshold will result in more consistent application of the disclosure requirement than would a more subjective materiality standard. Furthermore, deviations that do not meet the objective 2% threshold, but that would be material to an investment decision, must be disclosed.

d. Median Bid-Ask Spread

Rule 6c-11 will require daily website disclosure of the ETF's median bid-ask spread calculated over the most recent 30-day period. The bid-ask spread information is designed to inform investors that they may bear bid-ask spread costs when trading ETFs on the secondary market, which ultimately could impact the overall cost of the investment. We have modified this requirement from our proposal, which would have required an ETF to disclose the median bid-ask spread for the ETF's most recent fiscal year on its website and in its prospectus.

Comments on the proposed website disclosure of an ETF's bid-ask spread were mixed. Many commenters opposed this requirement, asserting that the proposed disclosures would require ETFs to bear costs and liability for data collected by third parties, and that other sources (e.g., financial intermediaries, the Commission) were in a better position to provide bid-ask spread information. Some commenters noted that the bid-ask spread information may be misleading to investors if the historical information is not representative of current execution costs or if the bid-ask spread information is overemphasized. Others expressed concern that there is no uniform method for computing bid-ask spread, which could make bid-ask spreads difficult to compare across different investment options. Still others supported it as an alternative to the parallel proposed prospectus disclosure requirements. For example, some commenters stated that providing more recent bid-ask spread data on an ETF's website alongside other ETF trading data would give investors more useful and timely information. Commenters also expressed concern about potential liability under section 11 of the Securities Act for bid-ask spread data included in the prospectus if an investor's actual bid-ask spread costs differ materially from the bid-ask spread disclosed in the prospectus.

While we recognize the costs for ETFs to collect and publish this bid-ask spread data, we believe that quantitative information regarding median bid-ask spreads will provide ETF investors with greater understanding of the costs associated with investing in ETFs. This will help investors make more informed investment decisions. We acknowledge that historical bid-ask spread data may reflect differences that result from varying methods of computing bid-ask spread. However, we have modified the proposal in several respects, such as using NBBO for computing the bid-ask spread, to make the computation more uniform. We therefore do not believe that the variance will be large enough to outweigh the importance of giving investors a greater understanding of these potential trading costs. We similarly understand that bid-ask spread may not reflect an individual investor's actual spread, as an individual's spread may depend on the execution strategies employed by an intermediary (such as mid-point pricing), the size of a particular order, or other factors. We nonetheless believe that the bid-ask spread is a helpful tool for investors making better informed trading decisions and that website disclosure can provide that information in a format that is easily accessible and relied upon by investors.

Based on comments we received, however, we are modifying certain of the bid-ask spread requirements to make the disclosure more cost-effective for ETFs, while maintaining or enhancing the utility for investors. First, the rule will require an ETF to disclose its median bid-ask spread only on its website, instead of requiring disclosure both on an ETF's website and in its prospectus as proposed. ETFs will present the median bid-ask spread disclosure alongside other ETF-specific disclosures, such as premium and discount and market price, which should mitigate some commenters' concerns relating to the overemphasis of bid-ask spread data.

Second, some commenters suggested shortening the look-back period for calculating the bid-ask spread metric, such as to a 30- or 45-day rolling period. One commenter noted that a shorter look-back period may show a more representative spread level, particularly for a newly launched ETF, as spreads are likely to tighten as the ETF matures. Several commenters also suggested that the Commission require ETFs to provide a time-weighted average bid-ask spread rather than the proposed median bid-ask spread. These commenters stated that a time-weighted average is more helpful for investors because it represents a “typical” bid-ask spread.

We agree that a bid-ask spread metric based on the more recent inputs from the last 30 days may provide a better representation of the costs that an investor may incur when trading ETF shares. Accordingly, we are shortening the look-back period for calculating the bid-ask spread from the most recent fiscal year to the most recent 30-day period on a rolling basis. We think the 30-day look-back period strikes an appropriate balance between reflecting only very short term fluctuations and reflecting information that is no longer representative of current execution costs. We do not think it is necessary to require a time-weighted average rather than the proposed median, however, because rule 6c-11 requires an ETF to determine the median by first identifying the exchange-traded fund's national best bid and national best offer as of the end of each 10 second interval during each trading day. This methodology (and the resulting number of data points) has the same effect as time-weighting. In addition, requiring an ETF to disclose the median of bid-ask spreads is less likely to give disproportionate effect to outlier values than a time-weighted average.

Finally, we are modifying the proposal to require that an ETF use the NBBO in calculating median bid-ask spreads. While the proposal did not specify that the NBBO must be used, after considering comments recommending more uniformity regarding bid-ask spread disclosures, we believe that requiring ETFs to use the NBBO when calculating the median will increase consistency and comparability of the resulting disclosure across ETFs. In addition, we believe that requiring use of NBBO will help to reduce costs associated with obtaining the required information, because the NBBO also is an input to the market price disclosure requirement.

We also proposed related amendments to Form N-1A that would have required an ETF to provide: (i) Examples in the ETF's prospectus showing how bid-ask spreads impact the return on a hypothetical investment for both buy-and-hold and frequent traders; and (ii) an interactive calculator in a clear and prominent format on the ETF's website that would allow an investor to customize the hypothetical bid-ask spread calculations to its specific investing situation. These requirements were designed to allow secondary market investors to see the impact that bid-ask spreads can have on the investor's trading expenses and ultimately the return on investment.

Commenters generally opposed requiring bid-ask spread examples in the summary prospectus or summary section. For example, some commenters expressed concerns regarding the costs of obtaining the underlying bid-ask spread data from third parties. Some commenters also noted that the historical bid-ask spread data, which ETFs would use to calculate the examples, is not representative of current trading costs and could mislead investors if disclosures overemphasize this information. Other commenters suggested alternatives to the proposed examples such as using hypothetical brokerage commissions and bid-ask spreads, rather than using actual historical bid-ask spreads. However one commenter supported this aspect of the proposal, stating that it would yield “relevant and helpful” information.

Many commenters raised similar concerns regarding the proposed interactive calculator, including that varying data sources and calculation methodologies may result in an inconsistent investor experience across ETFs. Other commenters noted that the interactive calculator was limited to bid-ask spread data, which placed undue emphasis on spreads as a component of an ETF investor's trading costs. Commenters also noted that the proposed requirement may result in additional vendor and licensing costs.

After considering comments, we are not adopting the proposed bid-ask spread examples or interactive calculator requirements. We are instead requiring ETFs relying on rule 6c-11 to provide more recent bid-ask spread information on their website. We believe that streamlining the required bid-ask spread disclosures will mitigate commenters' concerns that investors may fail to understand the relevance of the bid-ask spread information or the potential impact of bid-ask spreads on their specific trading situations. We are also persuaded by commenters that an interactive calculator focused solely on bid-ask spread costs may overemphasize those costs and thereby obscure the effect of other costs of investing in ETFs.

7. Marketing

As proposed, rule 6c-11 will not include certain requirements related to ETF marketing, which were included in our exemptive orders. Specifically, rule 6c-11 will not require an ETF to: (i) Identify itself in its sales literature as an ETF that does not sell or redeem individual shares, and (ii) explain that investors may purchase or sell individual ETF shares through a broker via a national securities exchange. Our exemptive orders included a condition requiring this information to help prevent investors, particularly retail investors, from confusing ETFs with mutual funds, at a time when ETFs were not a well-known investment product.

The comments on this aspect of the proposal were mixed. Commenters who supported the proposal generally agreed that the market has developed a familiarity with ETFs and that retail investors generally understand that, unlike mutual funds, individual ETF shares may be purchased and sold only on secondary markets. One commenter disagreed, asserting that many investors do not understand the distinctions between ETFs and mutual funds. This commenter suggested that the rule require an ETF to include a statement in its sales literature noting that buyers of ETF shares may pay more than the shares' current value and that sellers of ETF shares may receive less than current value. Another commenter noted that requiring this type of disclosure in ETF sales literature would help put investors on notice that the ETF pricing mechanism works differently than that of mutual funds.

We continue to believe that ETF investors have grown familiar with ETFs and the fundamental distinctions between ETFs and mutual funds, and that this disclosure is now unnecessary. The disclosure requirements we are adopting also should provide ETF investors, including retail investors, with useful information regarding the exchange-traded nature of ETFs and ETF pricing, including the potential for market price to deviate from NAV per share.

8. ETF and ETP Nomenclature

We requested comment on whether the Commission should address possible investor confusion arising from the nomenclature that has developed for identifying ETPs, including confusion between ETFs and other types of ETPs that are not registered under the Act. We asked, for example, whether the Commission should consider proposing to require a naming convention or other identification scheme to assist investors in distinguishing ETFs from other ETPs in a future rulemaking. We also asked whether we could address investor confusion by restricting certain sales practices, such as by proposing restrictions on how intermediaries communicate with retail investors about ETPs unless they disclose certain information designed to clearly differentiate ETPs that are not subject to the Act from ETFs that are registered investment companies.

Several commenters generally supported a classification system for ETPs to assist investors in distinguishing among these different products. One commenter stated that leveraged/inverse ETFs, commodity pools, and exchange-traded notes have differences that investors should understand prior to making investment decisions. Commenters expressed varying views, however, regarding which types of ETPs should call themselves ETFs under an ETP classification system. One commenter asserted that the Commission should permit only ETFs that fall squarely within proposed rule 6c-11 to call themselves ETFs. Two commenters provided examples of comprehensive classification systems for ETPs that would not permit “exchange-traded notes,” “exchange-traded commodities,” or “exchange-traded instruments” (including leveraged/inverse ETFs) to refer to themselves as ETFs. One commenter opined that the Commission should not preclude leveraged/inverse ETFs from calling themselves ETFs, as that would “confuse investors and muddle both the existing regulatory framework applicable to ETFs and fund naming conventions.” Another commenter asserted that UITs and other ETFs that fall outside the scope of the rule should nonetheless be permitted to call themselves ETFs.

One commenter asserted that Commission action relating to ETP naming is premature at the present time. This commenter encouraged ETF market participants to engage in a dialogue “around refining existing ETP disclosures, adding new elements as useful to investors, and developing an industry-led standard ETP disclosure approach beneficial to investors and all market participants.”

We agree that these issues need to be examined and discussed in more depth before the implementation of an ETP naming system. We will continue to consider the comments we received and, if appropriate, will take steps to address investor confusion relating to ETF and ETP nomenclature. At present, we believe that the term “ETF” is generally associated with ETPs regulated under the Investment Company Act. Leveraged/inverse ETFs, for example, are regulated under the Act and are structurally and operationally similar to ETFs that will rely on rule 6c-11. As a result, we do not believe it is appropriate to require leveraged/inverse ETFs to use a naming convention that does not include the term “ETF.” Similarly, because UIT ETFs are subject to a substantially similar regulatory regime as ETFs structured as open-end funds (and subject to similar regulatory safeguards), we do not find it appropriate to require UIT ETFs to utilize a naming convention that does not include the term “ETF.” We encourage ETP market participants to continue engaging with their investors, with each other, and with the Commission on these issues.

D. Recordkeeping

We are adopting, as proposed, an express requirement that ETFs relying on rule 6c-11 preserve and maintain copies of all written agreements between an authorized participant and the ETF (or one of the ETF's service providers) that allow the authorized participant to purchase or redeem creation units (“authorized participant agreements”). One commenter supported this aspect of the proposal. Another commenter, however, stated that this requirement is unnecessary because ETFs already generally implement robust recordkeeping programs pursuant to their policies and procedures.

After considering these comments, we believe it is appropriate for rule 6c-11 to specifically require that ETFs preserve and maintain authorized participant agreements. Authorized participants play a central role in the proper functioning of the ETF marketplace and authorized participant agreements are critical to understanding the relationship between an authorized participant and an ETF. Requiring the preservation of authorized participant agreements is designed to provide our examination staff with a basis to determine whether the relationship between the ETF and the authorized participant is in compliance with the requirements of rule 6c-11 and other provisions of the Act and rules thereunder, based on the specific terms of their written agreement. While we believe that most ETFs are currently preserving copies of their written authorized participant agreements pursuant to our current recordkeeping rules, for avoidance of doubt, we believe it is appropriate to expressly require that ETFs relying on rule 6c-11 preserve and maintain copies of all such agreements.

We also are adopting, largely as proposed, a requirement that ETFs maintain information regarding the baskets exchanged with authorized participants. Rule 6c-11 will require an ETF to maintain records setting forth the following information for each basket exchanged with an authorized participant: (i) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket exchanged for creation units; (ii) if applicable, an identification of the basket as a “custom basket” and a record stating that the custom basket complies with the ETF's custom basket policies and procedures; (iii) cash balancing amounts (if any); and (iv) the identity of the authorized participant conducting the transaction.

Commenters generally supported requiring ETFs to maintain records regarding baskets. One commenter stated that clear, auditable records would help Commission staff monitor custom basket usage and its impact on the ETF arbitrage process. Another agreed that the records would provide Commission staff with a basis to understand how baskets are being used by ETFs and to evaluate compliance with the rule and other requirements. As noted above, one commenter stated that it is unnecessary for the rule to contain any recordkeeping provisions.

After considering these comments, we believe that requiring ETFs to maintain records regarding each basket exchanged with authorized participants will provide our examination staff with a basis to understand how baskets are being used by ETFs, particularly with respect to custom baskets. In order to provide our examination staff with detailed information regarding basket composition, however, we have modified rule 6c-11 to require the ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket exchanged for creation units as part of the basket records, instead of the name and quantities of each position as proposed. We believe that this additional information will better enable our examination staff to evaluate compliance with the rule and other applicable provisions of the federal securities laws. Moreover, we do not believe that requiring ETFs to maintain detailed information regarding basket composition will create operational challenges or unduly burden ETFs because rule 6c-11 already requires ETFs to disclose the same information for each portfolio holding as part of the portfolio transparency requirements.

As proposed, the rule will require ETFs to maintain these records for at least five years, the first two years in an easily accessible place. The retention period is consistent with the period provided in rules 22e-4 and 38a-1(d) under the Act. Funds currently have compliance program-related recordkeeping procedures in place that incorporate this type of retention period and we believe consistency with that period will minimize any compliance burdens to ETFs subject to rule 6c-11. The commenter that addressed this aspect of the recordkeeping requirement supported the proposed retention period.

E. Share Class ETFs

As proposed, rule 6c-11 does not provide relief from sections 18(f)(1) or 18(i) of the Act or expand the scope of 17 CFR 270.18f-3 (rule 18f-3) (the multiple class rule). Sections 18(f) and (i) of the Act were intended, in large part, to protect investors from certain abuses associated with complex investment company capital structures, including conflicts of interest among a fund's share classes. These provisions also were designed to address certain inequitable and discriminatory shareholder voting provisions that were associated with many investment company securities before the enactment of the Act. Rule 18f-3 created a limited exception from sections 18(f)(1) and 18(i) for certain funds but requires, among other things, that each share class of a fund have the same rights and obligations as each other class. An ETF cannot rely on rule 18f-3 to operate as a share class within a fund, however, because the rights and obligations of the ETF shareholders would differ from those of investors in the fund's mutual fund share classes. Therefore, absent any separate relief from sections 18(f)(1) or 18(i) of the Act, an ETF structured as a share class of a fund that issues multiple classes of shares representing interests in the same portfolio cannot operate in reliance on rule 6c-11.

We recognize that the Commission has previously granted ETFs exemptive relief from the provisions of section 18 of the Act in the past, subject to various conditions. However, relief from section 18 raises policy considerations that are different from those we are seeking to address in this rule. For example, an ETF share class that transacts with authorized participants on an in-kind basis and a mutual fund share class that transacts with shareholders on a cash basis may give rise to differing costs to the portfolio. As a result, while certain of these costs may result from the features of one share class or another, all shareholders would generally bear these portfolio costs.

Three commenters stated that it was unnecessary for rule 6c-11 to provide relief for share class ETFs. One commenter, a sponsor of share class ETFs, stated that it is unnecessary for the rule to encompass share class ETFs because it is currently uncommon for ETF issuers to seek the exemptive relief necessary for such ETFs. Another stated that our proposed treatment is appropriate given the nuances associated with those products, and the third similarly indicated that share class ETFs present issues that would be more appropriately addressed through means other than rule 6c-11.

Two other commenters, however, opined that rule 6c-11 (or a separate future rule) should provide relief for share class ETFs in order to create a more level ETF playing field. Additional commenters echoed the importance of leveling the ETF playing field without specifically addressing share class ETFs. Another commenter urged the Commission to explore granting relief from the relevant provisions of section 18 broadly to the fund industry.

Leveling the ETF playing field is a goal for rule 6c-11, and we acknowledge that our approach will result in there being a segment of ETF assets that are unable to rely on the rule. At the same time, we continue to believe that share class ETFs raise policy considerations that are different from those we seek to address in the rule. With such concerns unresolved, we do not believe it is appropriate to broadly grant relief from sections 18(f)(1) and 18(i) of the Act for share class ETFs at this time. Share class ETFs are structurally and operationally different from the other types of ETFs within the scope of rule 6c-11. We therefore continue to believe it is appropriate for share class ETFs to request relief from sections 18(f)(1) and 18(i) of the Act through our exemptive application process, and for the Commission to continue to assess all relevant policy considerations in the context of the facts and circumstances of each particular applicant. We are not rescinding exemptive relief previously granted to share class ETFs.

We also are adopting amendments to Form N-1A that will require share class ETFs to provide certain additional disclosures regarding ETF trading costs. As discussed in more detail below in section II.H., these disclosure amendments are designed to help ensure consistent disclosures to investors between ETFs relying on proposed rule 6c-11 and share class ETFs operating pursuant to individualized exemptive relief. The rule and form amendments require all ETFs that are subject to the Investment Company Act to provide similar disclosures in order to help investors compare products.

F. Master-Feeder ETFs

Many of our recent ETF orders allow ETFs to operate as feeder funds in a master-feeder structure. In general, an ETF that operates as a feeder fund in a master-feeder structure functions like any other ETF. An authorized participant deposits a basket with the ETF and receives a creation unit of ETF shares in return for those assets. Conversely, an authorized participant that redeems a creation unit of ETF shares receives a basket from the ETF. In a master-feeder arrangement, however, the feeder ETF then also enters into a corresponding transaction with its master fund. The ETF may use the basket assets it receives from an authorized participant to purchase additional shares of the master fund, or it may redeem shares of the master fund in order to obtain basket assets and satisfy a redemption request.

Because the feeder ETF may, in the course of these transactions, temporarily hold the basket assets, it would not be able to rely on section 12(d)(1)(E) of the Act, which requires that a feeder fund hold no investment securities other than securities of the master fund. To accommodate the unique operational characteristics of these ETFs, our recent exemptive orders have allowed a feeder ETF to rely on section 12(d)(1)(E) without complying with section 12(d)(1)(E)(ii) of the Act to the extent that the ETF temporarily holds investment securities other than the master fund's shares for use as basket assets. These orders also provided the feeder ETF and its master fund with relief from sections 17(a)(1) and 17(a)(2) of the Act, with regard to the deposit by the feeder ETF with the master fund and the receipt by the feeder ETF from the master fund of basket assets in connection with the issuance or redemption of creation units, and section 22(e) of the Act if the feeder ETF includes a foreign security in its basket assets and a foreign holiday (or a series of consecutive holidays) prevents timely delivery of the foreign security.

The exemptive orders we have granted to master-feeder ETFs, however, do not include relief from section 18 under the Act inasmuch as investment by several feeder funds or by mutual fund and ETF feeder funds in the same class of securities issued by a master fund generally does not involve a senior security subject to section 18. We are concerned, as discussed above, that if an ETF feeder fund transacts with a master fund on an in-kind basis, but non-ETF feeder funds transact with the master fund on a cash basis, all feeder fund shareholders would bear costs associated with the cash transactions. Due to these concerns, and the lack of market interest in this structure, we proposed to rescind the master-feeder relief granted to ETFs that did not rely on the relief as of the date of the proposal (June 28, 2018). We also proposed to grandfather existing master-feeder arrangements involving ETF feeder funds, but prevent the formation of new ones, by amending relevant exemptive orders.

One commenter stated that it did not object to preventing the formation of new master-feeder arrangements and rescinding master-feeder relief (with the exception of master-feeder relief that funds actively relied on as of the date of the Proposing Release). Other commenters, however, indicated that the rule should provide relief for master-feeder structures or that the Commission should not rescind existing master-feeder relief. Some of these commenters indicated that failing to provide relief for master-feeder structures would cause an uneven playing field among ETFs but did not address the concerns discussed above.

Other commenters set forth potential methods for mitigating such concerns. For example, one commenter indicated that the Commission could address its concerns regarding potential cross-subsidization by requiring master funds to impose certain transaction fees, while another indicated that the Commission should address these concerns by requiring each feeder fund in a master-feeder structure to transact with the master fund consistently (i.e., only in cash or only in kind). An additional commenter suggested that an ETF's board should evaluate whether a master-feeder structure's overall benefits outweigh its overall costs in order to address these concerns. Another commenter indicated that it has already invested resources exploring various approaches to an ETF master-feeder structure, including models that it believed would address the Commission's concerns.

As discussed in the context of share class ETFs, leveling the ETF playing field is a goal for rule 6c-11, and we acknowledge that our approach will result in there being a segment of ETF assets that are unable to rely on the rule. Like share class ETFs, however, we continue to believe that master-feeder funds raise policy considerations that are different from those we seek to address in the rule and are structurally and operationally distinct from other ETFs within the scope of rule 6c-11. We do not believe it is appropriate to broadly grant exemptive relief for master-feeder funds. Instead, we continue to believe that the Commission should consider the special concerns presented by ETFs in master-feeder structures in the context of the facts and circumstances of each particular applicant through individualized exemptive applications. The Commission's exemptive relief process is well-suited for applicants to set forth novel methods of mitigating the Commission's concerns, such as the methods suggested above. The process allows applicants to experiment with many different approaches, and may eventually assist the Commission in identifying a particular solution that is appropriate for a broader rule. Any ETF that is exploring a particular approach is free to bring its methodology forward in an exemptive application, which should help mitigate commenters' concerns about future changes in the ETF industry and resources already committed to such research. As proposed, therefore, we will rescind the master-feeder relief granted to ETFs that did not rely on the relief as of the date of the proposal (June 28, 2018).

Only one fund complex had established as of June 28, 2018 master-feeder arrangements involving ETF feeder funds, and each arrangement involves an ETF as the sole feeder fund. We understand that all but one of the complex's original ETF feeder funds has discontinued its use of a master-feeder structure. Because this arrangement involves only one ETF feeder fund for its master fund, we do not believe it will raise the policy concerns discussed above without new, additional feeders, and therefore do not believe it is necessary to require this structure to change its existing investment practices by rescinding the relief. Instead, as proposed, we are amending this fund complex's existing exemptive orders to prevent the complex from forming new master-feeder ETFs.

G. Effect of Rule 6c-11 on Prior Orders

As proposed, we have determined to exercise our authority under the Act to amend and rescind the exemptive relief we have issued to ETFs that will be permitted to operate in reliance on rule 6c-11. Accordingly, one year following the effective date of rule 6c-11, we will rescind those portions of our prior ETF exemptive orders that grant relief related to the formation and operation of an ETF, including master-feeder relief except as described in section II.F. We will not rescind the exemptive orders of UIT ETFs, leveraged/inverse ETFs, share class ETFs, or non-transparent ETFs. We also are not rescinding the relief we have provided to ETFs from section 12(d)(1) and sections 17(a)(1) and (a)(2) under the Act related to fund of funds arrangements involving ETFs as discussed below.

Commenters generally supported the rescission of the exemptive relief granted to ETFs that fall within the scope of rule 6c-11, while permitting ETFs that could not rely on rule 6c-11 to continue to rely on their individual exemptive orders. One commenter stated that rescission of these orders will further the Commission's regulatory goal to create a consistent, transparent, and efficient regulatory framework for ETFs.

After reviewing comments, we continue to believe that rescinding ETF exemptive relief in connection with rule 6c-11 will result in a consistent, transparent, and efficient framework for ETFs that operate in reliance on rule 6c-11, as those ETFs would no longer be subject to differing and sometimes inconsistent provisions of their exemptive relief. Moreover, investment companies that seek to operate an ETF under conditions that differ from those in rule 6c-11 are able to request exemptive relief from the Commission.

In addition, approximately 200 of our current ETF exemptive orders automatically expire on the effective date of any Commission rule that provides relief permitting the operation of ETFs. We have determined, as proposed, to amend those orders to provide that the ETF relief contained therein will terminate one year following the effective date of rule 6c-11 to allow time for these ETFs to make any adjustments necessary to rely on rule 6c-11.

We continue to believe that the one-year period for the termination of our ETF exemptive relief is sufficient to give ETFs that are operating under exemptive orders time to bring their operations into conformity with the requirements of rule 6c-11. We did not receive any comments on this aspect of the proposal. We also did not receive any comments stating that the need to comply with the requirements of rule 6c-11, as opposed to their exemptive relief, would significantly negatively affect the operations of existing ETFs.

Finally, we did not propose to rescind the fund of funds exemptive relief included in our ETF exemptive orders. This relief permits an ETF to create fund of funds structures, subject to certain conditions set forth in the ETF's exemptive application, designed to prevent the abuses that led Congress to enact section 12(d)(1), including abuses associated with undue influence and control by acquiring fund shareholders, the payment of duplicative or excessive fees, and the creation of complex structures. The conditions for fund of funds relief for ETFs are substantially similar across our exemptive orders.

Commenters generally agreed that we should not rescind the fund of funds exemptive relief, but asserted that the Commission should include fund of funds relief in a final rule or provide such relief through other means. Some commenters stated that because fund of funds relief is part of standard ETF exemptive orders, the Commission also should permit new ETFs to rely on the terms and conditions of fund of funds relief previously granted to existing ETFs. These commenters stated that failing to provide this relief would frustrate the Commission's purpose of allowing new ETFs to enter the market without obtaining an exemptive order from the Commission.

In December 2018, we proposed new rule 12d1-4 under the Act to streamline and enhance the regulatory framework applicable to fund of funds arrangements for registered investment companies, including ETFs. In connection with that proposed rule, we also proposed to rescind our exemptive orders granting relief to certain fund of funds arrangements, including the relief from sections 12(d)(1)(A) and (B) that, as discussed above, has been included in our ETF exemptive orders. The Commission has not yet acted upon this proposal and is not rescinding the fund of funds relief in existing exemptive orders in connection with this rulemaking.

We agree with commenters, however, that new entrants to the ETF market would be at disadvantage to existing ETFs without fund of funds relief. Accordingly, ETFs relying on rule 6c-11 that do not have exemptive relief from sections 12(d)(1)(A) and (B) and section 17(a)(1) and (2) of the Act may enter into fund of funds arrangements as set forth in our recent ETF exemptive orders, provided that they satisfy the terms and conditions for fund of funds relief in those orders. This relief will be available only until the effective date of a new Commission rule permitting registered funds to acquire the securities of other registered funds in excess of the limits in section 12(d)(1), including rule 12d1-4 if adopted.

H. Amendments to Form N-1A

We are adopting several amendments to Form N-1A, the registration form used by open-end funds to register under the Act and to offer their securities under the Securities Act, that are designed to provide ETF investors with additional information regarding ETF trading and associated costs. Commenters generally supported providing additional information to investors regarding ETF trading, but many suggested specific modifications to the proposals. After considering these comments, we are adopting the following amendments to Form N-1A:

• Adding the term “selling” to current narrative disclosure requirements to clarify that the fees and expenses reflected in the expense table may be higher for investors if they buy, hold, and sell shares of the fund (Item 3);
• Streamlined narrative disclosures relating to ETF trading costs, including bid-ask spreads (Item 6);
• Requiring ETFs that do not rely on rule 6c-11 to disclose median bid-ask spread information on their websites or in their prospectus (Item 6);
• Excluding ETFs that provide premium/discount disclosures in accordance with rule 6c-11 from the premium and discount disclosure requirements in Form N-1A (Items 11 and 27); and
• Eliminating disclosures relating to creation unit size and disclosures applying only to ETFs with creation unit sizes of less than 25,000 shares (Items 3, 6, 11 and 27).

1. Fee Disclosures for Mutual Funds and ETFs (Item 3)

As proposed, we are adopting a narrative disclosure that will specify that the fees and expenses reflected in the Item 3 expense table also may be higher for investors if they sell shares of the fund. Currently, this item requires disclosure indicating only that the table describes fees and expenses investors may pay if they buy and hold shares of the fund. However, both mutual funds and ETF investors also may incur expenses other than redemption fees when selling fund shares. We are therefore amending this disclosure to specify that investors may pay the fees and expenses described in Item 3 if they buy, hold, and sell shares of the fund. Commenters who addressed this proposed change supported it because it will help investors better understand that they may incur costs in addition to those in the fee table.

We also are adopting, as proposed, a requirement to include a statement that investors may be subject to other fees not reflected in the table, such as brokerage commissions and fees to financial intermediaries. Commenters who addressed this proposed requirement supported it. We continue to believe this is an appropriate disclosure for both ETFs and mutual funds, as investors in ETFs and mutual funds alike may incur brokerage commissions and fees to financial intermediaries.

2. Disclosures Regarding ETF Trading and Associated Costs (Item 6)

We are adopting amendments to Item 6 of Form N-1A that: (i) Will require an ETF to provide narrative disclosure identifying specific costs associated with buying and selling ETF shares and directing investors to its website for additional information; and (ii) allow an ETF that is not subject to rule 6c-11 the option to provide disclosure regarding the ETF's median bid-ask spread on its website or in its prospectus. These form amendments differ in several respects from our proposal, which would have required an ETF to disclose information regarding how ETF shares trade and the associated costs, including information regarding bid-ask spreads, as part of the fund's fee table disclosure.

a. Narrative Disclosures

Secondary market investors in ETF shares are subject to trading costs when purchasing and selling ETF shares that ETFs are not currently required to disclose in their prospectuses. Trading costs, like all costs and expenses, affect investors' returns on their investment. In addition, some investors use ETFs more heavily as trading vehicles compared to mutual funds and may thus incur substantial trading costs. We believe that investors could overlook these costs and that additional disclosure would help them better understand these costs when purchasing or selling ETF shares.

As a result, we proposed to require ETFs to include a series of questions and answers—or QAs—in Item 3 that would have provided investors with narrative disclosure regarding ETF trading and associated costs, as well as quantitative disclosures regarding bid-ask spreads. Although many commenters supported providing information regarding trading costs to investors, commenters raised concerns regarding the quantitative aspects of the bid-ask spread disclosures. In addition, comments on the proposed QA format were mixed. Some commenters supported the format, stating that it provided a user-friendly method for identifying certain costs. Many others expressed concerns that this format would significantly lengthen the summary prospectus, potentially resulting in less investor-friendly formats or increased printing costs. Some commenters asserted that the proposed QA format may be more appropriate for inclusion in the statutory prospectus rather than the summary prospectus.

We continue to believe that investors could overlook certain trading costs when buying or selling ETF shares and that additional disclosure will help them better understand these costs. However, we agree with commenters that the extent of trading cost disclosures we proposed to require in Item 3 could obscure other key information regarding other fees and expenses and potentially give bid-ask spread disclosures undue prominence. We also agree that ETFs and their investors may benefit from flexibility in the manner of presenting the required information, especially if the proposed format would unduly distract from other key information. We therefore are permitting ETFs to use formats other than QAs to present this information. In addition, we are moving the narrative disclosures regarding trading costs to Item 6 of Form N-1A, which provides investors with information regarding the purchase and sale of fund shares to avoid overemphasizing these costs.

We also are streamlining several of the narrative disclosure requirements we proposed. First, we are adopting a requirement that the ETF's summary prospectus or summary section cross-reference the ETF's website. Rule 6c-11 will require daily website disclosure of several items, including the NAV per share, market price, premium or discount, and bid-ask spread information. Form N-1A also will permit ETFs to omit certain information from their registration statements if they satisfy certain of the rule's website disclosure conditions. This disclosure will inform investors how to access this information.

Commenters did not specifically address this proposed requirement. However, in general, commenters expressed support for website disclosure requirements, including as a substitute for certain registration statement disclosure requirements. We believe a cross-reference in Form N-1A to the required website disclosures will enable investors to receive timely and granular information that could assist with making an investment decision and are therefore adopting the requirement substantially as proposed in Item 6.

We also are adopting a requirement to provide narrative disclosure regarding bid-ask spreads. As noted above, commenters generally did not address the substance of the disclosures, but raised concerns regarding the length of the disclosures. One commenter, however, asserted that the proposed requirement to disclose certain additional costs associated with buying and selling ETF shares would be redundant of information required by Item 3.

We continue to believe that narrative bid-ask spread disclosure will inform investors regarding the potential impact of spread costs and provide investors with additional context to understand that the costs attributable to the bid-ask spread may increase or decrease when certain market conditions exist or certain factors are present. However, streamlining this disclosure to provide investors with key information regarding bid-ask spreads will both aid investor understanding and eliminate some of the length associated with the proposed disclosure requirement. Accordingly, our amendments to Form N-1A will require an ETF to state that an investor may incur costs attributable to the difference between the highest price a buyer is willing to pay to purchase shares of the ETF (bid) and the lowest price a seller is willing to accept for shares of the ETF (ask) when buying or selling shares in the secondary market (“the bid-ask spread”). This information, combined with the website cross-reference requirement, will direct ETF investors to website disclosures regarding median bid-ask spreads.

Finally, Item 6 will continue to require ETFs to disclose: (i) That individual shares may only be purchased and sold on secondary markets through a broker-dealer; and (ii) the price of ETF shares is based on market price, and since ETFs trade at market prices rather than at net asset value, shares may trade at a price greater than net asset value (premium) or less than net asset value (discount).

b. Median Bid-Ask Spread Requirement

Rule 6c-11 will require an ETF to provide website disclosure of median bid-ask spreads. We believe that this disclosure will provide ETF investors with greater understanding of the costs associated with investing in ETFs. In order to provide similar disclosures to investors in ETFs that are outside the scope of rule 6c-11, we are adopting amendments to Form N-1A requiring the disclosure of median bid-ask spreads.

We proposed amendments to Form N-1A that would have required all open-end ETFs to disclose quantitative information about bid-ask spreads, both in an ETF's prospectus and on its website. As discussed above, some commenters expressed concerns with these requirements, and we have made several modifications to mitigate those concerns while maintaining or enhancing the usefulness of the required disclosures. Those modifications include not adopting the proposed requirement for hypothetical bid-ask spread examples in the ETF's prospectus and interactive calculator, and instead only requiring ETFs relying on rule 6c-11 to provide disclosure of median bid-ask spread on their website.

However, we continue to believe that all ETF investors should receive key information about bid-ask spread costs, and appreciate that ETFs that are not relying on rule 6c-11 may want the flexibility to provide more timely bid-ask spread information on their websites. We are therefore amending Form N-1A to require an ETF that is not subject to rule 6c-11 to: (i) Provide the ETF's median bid-ask spread for its most recent fiscal year in its prospectus; or (ii) comply with the bid-ask spread website disclosure requirements in rule 6c-11(c)(1)(v). We believe that this disclosure requirement will provide all ETF investors with quantitative bid-ask spread information, while providing ETFs not subject to rule 6c-11 with the flexibility to provide either website or prospectus disclosure. This requirement also is consistent with our current approach to the disclosure of premiums and discounts in Form N-1A and, based on our experience with that disclosure, we believe most ETFs will opt to post bid-ask spread information on their websites as some ETFs do today on a voluntary basis.

Although rule 6c-11 contemplates more current website disclosure for ETFs relying on rule 6c-11, we are adopting a lookback period of the ETF's most recent fiscal year for the prospectus bid-ask spread disclosure requirement. We are adopting this period for consistency with other disclosures in Form N-1A and to avoid establishing a requirement that would require more frequent updating of an ETF's prospectus. ETFs that opt to provide this information on their website, however, will provide median bid-ask spread information for the most recent thirty-day period on a rolling basis. Finally, newly launched ETFs subject to this prospectus requirement with less than a year of trading data will be required to provide a brief statement to the effect that the ETF does not have sufficient trading history to report trading information and related costs as proposed.

c. Historical Premium and Discount Disclosures (Items 11 and 27)

Rule 6c-11 will require ETFs to provide certain disclosures regarding premiums and discounts on their websites. We believe premium/discount disclosure will help investors better understand that an ETF's market price may be higher or lower than the ETF's NAV per share and will provide investors with useful information regarding ETFs that frequently trade at a premium or discount to NAV. We are adopting amendments to Form N-1A that will exclude only those ETFs that provide premium/discount disclosures in accordance with rule 6c-11 from the premium and discount disclosure requirements in Form N-1A.

We proposed to eliminate existing disclosure requirements regarding premiums and discounts in Form N-1A since rule 6c-11 would require an ETF to provide more timely information on its website. One commenter supported this amendment, stating that information relevant to premiums and discounts is already disclosed on a timely basis on ETF websites and therefore a duplicative registration statement requirement is not necessary. Another commenter, however, stated that the Commission should apply disclosure requirements to all ETFs, including those that cannot rely on rule 6c-11, so that all ETF investors receive the same information.

After considering comments, we are eliminating the premium and discount requirements in Items 11(g)(2) and 27(b)(7)(iv) for ETFs relying on rule 6c-11. However, ETFs not relying on rule 6c-11 must include premium and discount information in both the prospectus and annual report unless they choose to comply with the website disclosure requirements in rule 6c-11(c)(1)(ii)-(iv) and (c)(1)(vi). We agree that all ETF investors should receive similar premium/discount disclosure, regardless of the form of exemptive relief.

We acknowledge that the premium and discount disclosure requirements under rule 6c-11 are broader than what was required under Form N-1A. However, to ensure consistency of website disclosure across ETFs, we are amending Form N-1A to require that if an ETF not relying on rule 6c-11 chooses to disclose the premium and discount disclosures on its website to satisfy the Form N-1A requirement, it must conform with the requirements in rule 6c-11. Nonetheless, consistent with our experience with the current Form N-1A requirement, we believe that most ETFs not relying on rule 6c-11 will choose to comply with the website disclosure requirements in rule 6c-11.

3. Eliminated Disclosures

We are adopting the removal of certain disclosure requirements from Form N-1A relating to ETFs. We are removing the requirement that an ETF specify the number of shares it will issue or redeem in exchange for the deposit or delivery of basket assets. The number of shares the ETF issues or redeems in exchange for the deposit or delivery of baskets is largely duplicative of information provided in reports on Form N-CEN. Commenters did not address this aspect of the proposal, and we are adopting it as proposed.

We also are eliminating several disclosure requirements in Items 6 and 11 that applied only to ETFs that issue or redeem shares in creation units of less than 25,000 shares. When we adopted these requirements, we reasoned that individual investors may be more likely to indirectly transact in creation units through authorized participants if the creation unit size was less than 25,000 shares. Based on staff experience, however, we believe that these disclosures are unnecessary as retail investors generally do not engage in primary transactions through authorized participants and the current flow of information about the purchase and redemption process is robust. One commenter supported eliminating these disclosure requirements, and we are eliminating these requirements as proposed.

I. Amendments to Form N-8B-2

Form N-8B-2 is the registration form under the Investment Company Act for UITs that are currently issuing securities, and it is used for registration of ETFs organized as UITs. Because Form S-6 requires UIT prospectuses to include disclosure required by specified provisions of Form N-8B-2, the disclosure requirements of Form N-8B-2 also apply to prospectuses on Form S-6. We are adopting several amendments to Form N-8B-2 that will mirror requirements we are adopting in Form N-1A.

Although we are not including UIT ETFs within the scope of rule 6c-11, we believe that it is important for investors to receive consistent disclosures for ETF investments, regardless of the ETF's form of organization. Secondary market investors in UIT ETFs, like other ETFs, are subject to trading costs that unit holders could overlook. We believe that additional disclosure will help investors better understand the total costs of investing in a UIT ETF. We therefore proposed to amend Form N-8B-2 to require UIT ETFs to provide the same disclosures regarding ETF trading and the associated costs as ETFs organized as open-end funds would disclose on Form N-1A.

Commenters that addressed this proposed provision generally supported these changes, and we are amending Form N-8B-2 to mirror the amendments to Form N-1A with the modifications discussed above. As with other ETFs that are not within the scope of rule 6c-11, these amendments will give UIT ETFs the option to forego certain disclosures relating to bid-ask spreads and premiums and discounts provided that the ETF conforms with rule 6c-11's corresponding website disclosure requirements.

Below, Table 3 summarizes the amendments to Form N-8B-2 and the corresponding requirements in Form N-1A.

J. Amendments to Form N-CEN

Form N-CEN is a structured form that requires registered funds to provide census-type information to the Commission on an annual basis. As proposed, we are adopting a new requirement that will collect specific information on which ETFs are relying on rule 6c-11. We believe that this requirement will allow us to better monitor reliance on rule 6c-11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act.

We also are changing the definition of “authorized participant” in Form N-CEN to conform the definition with rule 6c-11 by deleting a specific reference to an authorized participant's participation in DTC. In addition to reducing regulatory confusion by harmonizing the definition of “authorized participant” with rule 6c-11, this change also will obviate the need for future amendments if additional clearing agencies become registered with the Commission. Commenters that addressed the proposed amendments to Form N-CEN expressed support, and we have determined to adopt the amendments as proposed.

K. Technical and Conforming Amendments to Form N-1A, Form N-8B-2, Form N-CSR, Form N-PORT, and Regulation S-X

In October 2016, the Commission adopted new rules and forms and amended other rules and forms under the Investment Company Act to modernize the reporting and disclosure of information by registered investment companies. In February 2019, the Commission adopted an interim final rule that amended the timing requirements for filing reports on Form N-PORT. We are making the following technical corrections as a result of these rulemakings, as well as correcting certain other outdated citations and instructions:

• Correcting footnote 1 of 17 CFR 210.12-14 (rule 12-14 of Regulation S-X) by replacing a reference to Column E with a reference to Column F.

• Amending General Instruction B.4.(a) of Form N-1A to update outdated citation references to 17 CFR 230.400 through 230.498 (Regulation C) by replacing references to 17 CFR 230.497 (rule 497) with references to rule 498.

• Amending General Instruction B.4.(d) of Form N-1A to update outdated citation references to 17 CFR 232.10 through 232.903 (Regulation S-T) by replacing references to rule 903 with references to rule 501.

• Amending Instruction 4(b) to Item 13 of Form N-1A by deleting outdated instructions regarding changes in methodology for determining the ratio of expenses to average net assets.

• Amending Form N-1A to require money market funds to state in their annual and semi-annual reports that: (i) Their monthly portfolio holdings are available on Form N-MFP; (ii) the money market fund's reports on Form N-MFP are available on the Commission's website; and (iii) the money market fund makes portfolio holdings information available to shareholders on its website. This amendment will reflect the fact that money market funds report monthly portfolio holdings on Form N-MFP rather than reporting portfolio holdings for the first and third fiscal quarters on Form N-PORT.

• Amending Form N-CSR to correct references to item numbers in General Instruction D and in the instruction to Item 13.

• Amending General Instruction F (Public Availability) of Form N-PORT to read “With the exception of the non-public information discussed below, the information reported on Form N-PORT for the third month of each Fund's fiscal quarter will be made publicly available upon filing.” This amendment will reflect the Commission's action making quarter-end reports on Form N-PORT public immediately upon filing, with the exception of the non-public fields identified in General Instruction F.

• Withdrawing Instruction 23 of Reporting Modernization Adopting Release, which would have amended 17 CFR 232.401 (rule 401 of Regulation S-T) to remove references to Form N-Q. The amendment is no longer necessary because rule 401 was rescinded by a subsequent rulemaking.

• Amending Item IX of Form N-8B-2 to clarify the required designation of exhibits and the use of incorporation by reference in order to conform to similar instructions in other Investment Company forms.

L. Compliance Dates

The Commission is providing for a transition period for the amendments to Forms N-1A, N-8B-2, and N-CEN. Specifically, we are adopting compliance dates for our amendments to Form N-1A, Form N-8B-2, and Form N-CEN of December 22, 2020, one year following the amendments' effective date. All registration statements, post-effective amendments, and reports on these forms filed on or after the compliance date must comply with the amendments. Based on the staff's experience, we believe that this will provide adequate time for ETFs and other funds to compile and review the information that must be disclosed.

III. Other Matters

Pursuant to the Congressional Review Act, the Office of Information and Regulatory Affairs has designated this rule a “major rule,” as defined by 5 U.S.C. 804(2). If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application.

IV. Economic Analysis

We are mindful of the costs imposed by, and the benefits obtained from, our rules. Section 2(c) of the Investment Company Act, section 2(b) of the Securities Act, and section 3(f) of the Exchange Act state that when the Commission is engaging in rulmaking under such titles and is required to consider or determine whether the action is necessary or appropriate in (or, with respect to the Investment Company Act, consistent with) the public interest, the Commission shall consider whether the action will promote efficiency, competition, and capital formation, in addition to the protection of investors. Further, section 23(a)(2) of the Exchange Act requires the Commission to consider, among other matters, the impact such rules would have on competition and states that the Commission shall not adopt any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. The following analysis considers, in detail, the potential economic effects that may result from the rule, including the benefits and costs to investors and other market participants as well as the broader implications of the rule for efficiency, competition, and capital formation.

A. Introduction

ETFs currently need to obtain an order from the Commission that exempts them from certain provisions of the Act that otherwise would prohibit several features essential to the structure and operation of ETFs. Obtaining such exemptive relief typically has resulted in expenses and delays in forming new ETFs. In addition, the conditions in the exemptive orders issued by the Commission have evolved over time. As a result, some ETF sponsors may have a competitive advantage over other sponsors because some exemptive orders allow the sponsors to launch new funds under the terms and conditions of those orders, and because the terms in some of these orders may be more flexible than others.

Rule 6c-11 will allow ETFs that satisfy certain conditions to operate without obtaining an exemptive order from the Commission. The Commission also is rescinding the exemptive relief we have issued to ETFs that will be permitted to operate in reliance on the rule. However, we anticipate that ETFs whose exemptive relief will be rescinded under the rule generally will be able to rely on the rule without substantially changing their current operations, as the rule's conditions are similar to those contained in existing exemptive relief, consistent with existing market practice, or generally more flexible than those contained within existing exemptive relief. ETFs that wish to operate in a manner not covered by the final exemptive rule can seek individual exemptive relief from the Commission.

We believe that rule 6c-11 will establish a regulatory framework that: (1) Reduces the expense and delay currently associated with forming and operating certain ETFs unable to rely on existing orders; and (2) creates a level playing field for ETFs that can rely on the rule. As such, the rule will enable increased product competition among certain ETF providers, which can lead to lower fees for investors, encourage financial innovation, and increase investor choice in the ETF market.

The increased basket flexibility the rule affords in particular may benefit ETFs and their shareholders. To the extent that ETFs are able to implement basket policies and procedures that better facilitate the arbitrage mechanism, these ETFs may reduce their bid-ask spreads and thereby lower transaction costs for their investors. In addition, certain ETFs may be able to use the increased basket flexibility to reduce trading costs the ETF incurs.

The amendments to Forms N-1A and N-8B-2 as well as the additional website disclosures required by the rule are intended to improve the information about ETFs available to the market and to allow investors to more readily obtain information about fund products, resulting in reduced investor search costs. To the extent that the disclosure requirements will improve investors' ability to evaluate the performance and other characteristics of fund products, the amendments may result in better informed investor decisions and more efficient allocation of investor capital among fund products, and may further promote competition among ETFs and between ETFs and mutual funds.

The rule and amendments to Forms N-1A and N-8B-2 also may impact non-ETF products and market participants. To the extent that the rule will lead to lower investor search costs, lower fees, and increased product innovation and investor choice in the ETF market, investors may shift their investments towards ETFs and away from funds similar to ETFs, such as mutual funds. Such a shift in investor demand also may affect broker-dealers and investment advisers, whose customers and clients may show increased interest in and demand for ETFs. Moreover, because ETF shares are traded on the secondary market, the rule also can affect exchanges, alternative trading systems, facilities for OTC trading, broker-dealers, and clearing agencies to the extent that the rule causes changes in the ETF trading activity they support.

B. Economic Baseline

1. ETF Industry Growth and Trends

The ETF industry has experienced extensive growth since the first U.S. ETF began trading in 1993. From 1993 to 2002, an average of 10 new ETFs registered each year and ETF net assets increased by an average of $10.7 billion annually. Industry growth accelerated from 2003 to 2006, when, on average, 62 new ETFs and $77 billion in net assets were added to the industry annually. Since 2007, the industry has seen an average of 137 new ETF entrants and an average growth of $241.2 billion annually. Since 2007, ETF net assets have grown at an average rate of 17.2% per year, which compares to 3.2% for closed-end funds and 6.3% for open-end funds over the same period.

At the end of December 2018, there were 1,978 registered ETFs, totaling $3.3 trillion in net assets and spanning six broad investment style categories. ETFs are predominantly structured as open-end funds; however, eight UIT ETFs together represented 10.3% of ETF total net assets ($340.6 billion), and 68 share class ETFs together represented 25.6% of total net assets ($854.6 billion). The chart illustrates growth in ETF net assets by investment strategy beginning in 2000. It also tracks the percentage of net assets invested in actively managed ETFs.

Although indexing is still the most common ETF strategy, over time ETFs have evolved to offer, among other things, active management, leveraged and inverse investment strategies, and exposure to various types of foreign securities (in both index-based and actively managed ETFs). At the end of December 2018, there were 167 leveraged/inverse ETFs that were structured as open-end funds. In total, leveraged/inverse ETFs had total net assets of $29.64 billion or approximately 1% of all ETF net assets. None of the eight registered UIT ETFs employed leveraged or inverse investment strategies. Of the remaining unleveraged ETFs, both index-based and actively managed, 1,705 ETFs had combined net assets of $3 trillion operated as open-end funds, while eight UIT ETFs had $340.6 billion in net assets.

There were 257 actively managed ETFs with total net assets of $69.5 billion. The remaining 1,721 ETFs, with a combined $3.23 trillion in net assets, were index-based ETFs. Of these, 1,713 ETFs with total net assets of $2.892 trillion were structured as open-end funds and eight UIT ETFs had total net assets of $340.6 billion.

The majority of ETFs (1,615) held some foreign exposure in their portfolio according to Morningstar data. These ETFs had total net assets of $2.921 trillion. Of these funds, seven were UIT ETFs and had $320.6 billion in net assets. The remaining 1,608 ETFs accounting for $2.6 trillion in net assets were organized as open-end funds. On average, these ETFs reported foreign exposure of 40.15% (56.87% for UIT ETFs and 40.07% for ETFs structured as open-end funds).

2. Exemptive Order Process and Certain Conditions Under Existing Orders

ETFs seeking to operate as investment companies required exemptive relief from the Commission. Since the first exemptive order was granted in 1992, the Commission has issued approximately 300 exemptive orders to ETFs. The average number of approved exemptive orders between 1992 and 2006 was approximately 2.5 per year, which has increased to approximately 29 per year since 2007.

Based on our review of exemptive orders that granted relief for unleveraged ETFs between January 2007 and early April 2019, the median processing time from the filing of an initial application to the issuance of an order was 213 days, although there was considerable variation. Depending on the complexity of a fund's application, some ETF sponsors received exemptive relief in a relatively short period of time (the 10th percentile of the processing time was 87 days) while others waited over one year for approval (the 90th percentile of the processing time was 669 days).

In addition to the processing time associated with applying for an exemptive order, Commission staff estimates that the direct cost of a typical fund's application for ETF relief (associated with, for example, legal fees) is approximately $100,000, which may vary considerably depending on the complexity of the prospective fund.

These exemptive orders permit ETFs to operate as investment companies under the Investment Company Act, subject to representations and conditions, some of which have changed over time. For example, as discussed above, our orders have required ETFs that will rely on rule 6c-11 to provide some degree of transparency regarding their portfolio holdings. Actively managed ETFs and some self-indexed ETFs have been required to disclose their full portfolio holdings each day, while other index-based ETFs are permitted to specify the index they seek to track (as long as the index provider lists the constituent securities on its website) or disclose the components of their baskets. Based on a staff review of 150 randomly selected ETFs, which included 100 index-based ETFs and 50 actively managed ETFs, however, all 150 ETFs maintain a website and provide the ETF's complete daily portfolio holdings. Therefore, we believe it is likely that all ETFs that can rely on the rule, including those that are not subject to a full transparency condition in their exemptive order, currently provide full portfolio transparency.

ETFs' flexibility to use custom baskets also has evolved over time under our exemptive orders. From 1996 to 2006, exemptive orders for open-end ETFs did not expressly limit baskets to a pro rata representation of the ETF's portfolio holdings. Since approximately 2006, however, our exemptive orders placed increasingly tighter restrictions on ETFs' composition of baskets. Because our exemptive orders have generally included future funds relief to allow sponsors to form and operate new ETFs, we are unable to quantify the number of funds operating under each of the different basket flexibility conditions included in our orders.

Many exemptive orders also have required ETFs to provide certain website disclosures on their website, free of charge. Based on a staff review of the websites of 150 randomly selected ETFs, all 150 ETFs provided the previous day's NAV, price of the ETF shares, and the premium or discount associated with the ETF share price at the market close. Accordingly, we believe that all ETFs that can rely on rule 6c-11 currently disclose this information on their website. Our exemptive orders also have included other requirements, including the publication of the ETF's IIV every 15 seconds.

3. Market Participants

Several non-ETF market participants may be affected by the rule, including fund sponsors, authorized participants, liquidity providers, trading venues, and institutional and retail investors.

Using data from Bloomberg, we estimate that there are 81 unique ETF sponsors with approximately 1,978 ETFs as of December 31, 2018. The median number of ETFs per sponsor is six and the mean is 24, suggesting that a small number of sponsors have a large share of the ETF market (in terms of number of ETFs). Indeed, the top five sponsors operate a combined 965 ETFs, whereas the bottom half of sponsors operate only a combined 118 ETFs.

An ETF (either directly or through a service provider) has contractual arrangements with authorized participants to purchase or redeem ETF shares in creation unit size aggregations in exchange for a basket of securities and other assets. Based on data from Form N-CEN as of July 26, 2019, the median ETF has 23 authorized participant agreements and 4 active authorized participants. Larger ETFs tend to have more authorized participant agreements, with the median number of authorized participant agreements ranging from 13 for the smallest quarter of ETFs to 33 for the largest quarter of ETFs. Larger ETFs also tend to have more active authorized participants, ranging from a median of 2 to 7 for the smallest and largest quarters of ETFs, respectively. A 2015 survey-based study of fifteen fund sponsors reports, however, that creation and redemption transactions occurred only on between 10% to 20% of trading days and that only 10% of the daily activity in all ETF shares (by volume) are creations or redemptions.

Some authorized participants also act as registered market makers in ETF shares. Other liquidity providers for ETF shares include market makers that are not authorized participants, hedge funds, and proprietary trading firms. According to a 2014 survey, the median number of liquidity providers for an ETF was 17, while the median number of authorized participants that are registered market makers for an ETF was 4.

ETF shares are mainly traded on national securities exchanges. Table 4 lists the 9 exchanges with the largest average daily ETF trading volume, measured over the 30 business days ending on March 7, 2019. The data shows that NYSE Arca handles the largest portion of ETF trades ($15.3 billion), followed by Cboe BZX Exchange ($6.6 billion), and Cboe EDGX Exchange ($4.5 billion).

Both institutional and retail investors participate in the ETF secondary market. As shown in Table 5 below, from the first quarter of 2015 to the fourth quarter of 2017, we estimate that institutions own, on average, 43% of ETF shares, when calculating the average using equal weights for all ETFs, and 57% when calculating the average using total net assets (“TNA”)—based weights. The difference between the equal-weighted and TNA-weighted average institutional ownership numbers—43% vs. 57%—suggests that institutional investors tend to hold larger ETFs. In addition, there is considerable variation in the degree to which ETF shares are held by institutions, ranging from an average for the 5th percentile of 6% to an average for the 95th percentile of 90%. However, we observe that the average institutional holding did not change considerably over time during the sample period.

Further analysis shows that institutional ownership varies considerably by the type of ETF. Using Morningstar Categories, for the fourth quarter of 2017, Table 6 below shows that ETFs' equal-weighted average institutional ownership ranges from 20% for alternative ETFs to 56% for taxable bond ETFs. We also find that TNA-weighted average institutional ownership is higher than equal-weighted average institutional ownership for international equity, municipal bond, sector equity, taxable bond, and U.S. ETFs, suggesting that institutional investors tend to hold larger ETFs within these categories. The converse is true for allocation, alternative, and commodity ETFs. The table also shows that there is large variation within categories.

4. Secondary Market Trading, Arbitrage, and ETF Liquidity

Unlike shares of open-end funds, ETF shares are traded in the secondary market at prices that may deviate from the ETF's NAV. As a result, ETF investors may trade shares at prices that do not necessarily reflect the NAV of the underlying ETF assets. As discussed above, however, authorized participants engage in primary market arbitrage activity that brings the market price of ETF shares and the NAV of the ETF's portfolio closer together. Market participants also can engage in arbitrage activity in the secondary market by taking offsetting positions in the ETF shares and the underlying basket assets.

Using data from Bloomberg, we find that ETFs, on average, have closing prices slightly higher than the NAV per share (i.e., trade at a premium at market close), as shown in Table 7 below. The equal-weighted and TNA-weighted average premium/discount over the last 15 years for all ETFs in the dataset are 0.07% and 0.06%, respectively, and the median is 0.02%, indicating that the closing prices of ETF shares are, on average, higher than the NAV per share. One study finds similar results and concludes that, on average, ETF market prices tend to reflect NAV per share closely. However, consistent with the study, we find that ETF premiums/discounts vary significantly. For example, we find that the (weighted) average premium/discount ranges from 0.02% in 2018 to 0.14% in 2009, and the standard deviation of premiums/discounts ranges from 0.16% in 2017 to 0.59% in 2008. Moreover, not all ETF shares trade at a premium. For example, the table shows, in a given year, at least 25% of ETF shares trade at a discount, on average.

Premiums and discounts to NAV per share also vary considerably by the types of assets held by the ETF. We use Morningstar Investment Categories to divide ETFs into groups of similar assets and, in Table 8 below, report the time-series averages of cross-sectional descriptive statistics for premiums/discounts in the different Morningstar Investment Categories. We find that the TNA-weighted average premium/discount ranges from as low as 0.002% for alternative ETFs to 0.183% for taxable bond ETFs. The results are qualitatively similar for the equal-weighted average premium/discount.

When the ETF arbitrage mechanism functions effectively, ETFs also should trade at smaller bid-ask spreads. As shown in Table 9 below, the TNA-weighted average bid-ask spread, as a percentage of the mid-price, has been relatively constant over the years, ranging from highs of 0.37% in 2012 and 2016 to a low of 0.31% in 2018. Equal-weighted average bid-ask spreads averaged 0.33% and were considerably higher than TNA-weighted bid-ask spreads, which averaged 0.04%, reflecting that larger ETFs tend to have smaller bid-ask spreads. The table also shows that the bid-ask spread varies considerably between ETFs, with an average of the 5th percentile of bid-ask spreads of 0.01% and an average of the 95th percentile of bid-ask spreads at 0.16%.

Table 10 below reports bid-ask spreads for ETF shares by Morningstar Category. U.S. Equity ETFs have the smallest average bid-ask spread of 0.03%, whereas allocation ETFs—ETFs that seek to provide both income and capital appreciation by investing in multiple asset classes, including stocks, bonds, and cash strategy—have the largest average bid-ask spread of 0.21%.

The summary statistics presented thus far in this section suggest that the arbitrage mechanism generally functions effectively during normal market conditions. However, the Commission has observed periods of market stress during which the arbitrage mechanism has functioned less effectively and during which there were significant deviations for some ETFs between market price and NAV per share and when bid-ask spreads widened considerably. These conditions only persisted for very short periods of time for the periods of market stress we have observed, suggesting that the arbitrage mechanism recovered quickly.

C. Benefits and Costs of Rule 6c-11 and Form Amendments

The Commission is sensitive to the economic effects that can result from rule 6c-11 and amendments to Forms N-1A and N-8B-2, including benefits and costs. Where possible, the Commission quantifies the likely economic effects; however, the Commission is unable to quantify certain economic effects because it lacks the information necessary to provide estimates or ranges. In some cases, quantification is particularly challenging due to the difficulty of predicting how market participants will act under the conditions of the rule. Nevertheless, as described more fully below, the Commission is providing both a qualitative assessment and quantified estimate of the economic effects, including the initial and ongoing costs of the additional disclosure requirements, where feasible.

1. Rule 6c-11

Rule 6c-11 will allow ETFs to operate in reliance on a rule rather than individual exemptive orders if they meet the requirements and conditions of the rule. In addition, we are rescinding all existing ETF exemptive orders, with the exception of: (i) The section 12(d)(1) relief included in those orders that permit certain fund of funds arrangements; and (ii) orders relating to UIT ETFs, leveraged/inverse ETFs, share class ETFs, and non-transparent ETFs. This section first evaluates the general considerations associated with the rulemaking and then discusses the effects of the specific requirements and conditions of the rule.

a. General Considerations

Rule 6c-11 will grant exemptive relief from the provisions of the Act that otherwise prohibit several features essential to the ETF structure. This section evaluates the overall effect of reducing the expense and delay of operating certain new ETFs by granting this exemptive relief as part of a rule rather than through the individual exemptive order process.

As the requirements and conditions of the rule are either similar to those contained in existing exemptive orders, consistent with market practice, or generally provide more flexibility, we anticipate that the rule and the related rescission of ETF exemptive relief will not require any existing ETFs whose exemptive relief will be rescinded to significantly change the way they operate. Conversely, some ETFs whose exemptive orders contain conditions that are more restrictive than those contained in the rule may decide to change the way they operate in order to make use of such increased flexibility.

Relative to the baseline, rule 6c-11 will eliminate the costs associated with applying to the Commission for an exemptive order to form and operate as an ETF for funds relying on the rule. Specifically, the process of forming new ETFs in reliance on the rule will be quicker, more predictable, less complex, and therefore less costly than obtaining an exemptive order as new ETFs that cannot rely on existing orders are currently required to do. ETFs that cannot rely on the rule will continue to be required to apply for an exemptive order to form and operate, unless they have an existing exemptive order that includes future fund relief.

As described above in section IV.B.2, we estimate that the cost for a typical unleveraged ETF of filing for exemptive relief is $100,000. In addition, based on our review of exemptive orders that granted relief for unleveraged ETFs between January 2007 and early April 2019, the median processing time from the filing of an initial application to the issuance of an order was 213 days, although there was considerable variation. Thus, any new ETF planning to operate within the parameters set forth by the rule will save this expected cost and avoid this delay. In addition, such ETFs would avoid the uncertainty about the length of the delay associated with the exemptive order process, allowing each sponsor to better control the timetable for launching a new ETF product in a way that maximizes benefits to its business. Conversely, funds that are not able to comply with the conditions of the rule will continue to need to apply for an exemptive order. Assuming that the number of new ETFs seeking to form and operate under the rule that would otherwise need to apply for exemptive relief is equal to the annual average number of ETFs that have applied for exemptive relief since 2007, these cost and time savings would accrue to approximately 29 ETFs per year. Using this assumption, the annual costs savings to this group of ETF sponsors are approximately $2.9 million. We are unable to quantify the benefit a new ETF will derive from avoiding the delay and the uncertainty about the length of the delay associated with the exemptive order process as the cost of a delayed registration for a new ETF is inherently difficult to measure.

By eliminating the need for ETFs that can rely on the rule to seek an exemptive order from the Commission, the rule will also eliminate certain indirect costs associated with the exemptive application process. Specifically, ETFs that apply for an order forgo potential market opportunities until they receive the order, while others forgo the market opportunity entirely rather than seek an exemptive order because they have concluded that the cost of seeking an exemptive order would exceed the anticipated benefit of the market opportunity.

In addition, we believe that the rule will make it easier for some fund complexes to ensure that each ETF in the complex is in compliance with regulations. Specifically, we anticipate that it will be easier, and thus less costly, for ETF complexes that today operate funds under multiple exemptive orders to ensure compliance with a single set of requirements and conditions contained in the rule rather than with multiple exemptive orders to the extent that the orders vary in the requirements and conditions they contain.

We acknowledge that fund complexes may initially incur costs associated with assessing the requirements of the rule. However, we believe that these costs will be relatively small. In addition, we anticipate that it will be more efficient for third-party providers, such as lawyers and compliance consultants, to offer services that help ETFs ensure compliance with the rule, which will have broad applicability, than is currently the case with ETFs relying on exemptive orders with varying conditions. As a result, third party service providers may be able to reduce the price of their services, compared to the baseline, for ETFs that can rely on the rule, which may partially or fully offset the initial costs of studying the requirements of the rulemaking that ETFs may incur.

We expect that the rule also will benefit ETF investors to the extent that it will remove a possible disincentive for sponsors to form and operate new ETFs that provide investors with additional investment choices if they currently do not have relief. As noted above, the direct and indirect costs of the exemptive application process may discourage potential sponsors, particularly sponsors interested in offering smaller, more narrowly focused ETFs that may serve the particular investment needs of certain investors.

As we discuss below in section IV.D.2, we believe that the rule could increase competition in the ETF market as a whole, which could also lead to lower fees. Any effect of increased competition on fees will likely be larger for segments of the ETF market that currently may be less competitive (e.g., actively managed ETFs) and smaller for segments of the market that currently may be more competitive (e.g., index-based ETFs tracking major stock indices).

By eliminating the need for individual exemptive relief, we anticipate that the rule will, over time, increase the number of ETFs and thus reinforce the current growth trend in the ETF industry. In addition, the rule will increase demand for such ETFs, to the extent that such ETFs lower their fees to investors and investors are sensitive to fees. To the extent that some ETFs will experience larger reductions in trading costs (e.g., fixed-income, international, and actively managed ETFs, as discussed below in section IV.C.1.b.i.) or larger increases in competition (e.g., actively managed ETFs, as discussed above in this section), demand for these types of ETFs will likely increase more than for other types of ETFs. The increased demand will likely be due in part to investors substituting away from comparable types of funds, such as mutual funds, and possibly due to investors increasing the rate at which they save. Consequently, the rule could increase total assets of ETFs and could decrease total assets of other funds. The size of these effects will depend on the degree to which ETFs will lower their fees or experience reduced trading costs, as well as on the sensitivity of investor demand for ETFs and other funds to changes in ETF fees and trading costs. We are unable to quantify these effects on investor demand, in part, because we cannot estimate the extent to which funds will lower their fees or experience reduced trading costs and how lower fees and trading costs will change investor demand.

Since ETFs are traded in the secondary market, an increase in total assets of ETFs will likely coincide with larger trade volumes for the exchanges where ETFs are traded, as well as for the clearing agencies and broker-dealers involved in these trades. To the extent that these market participants are compensated by volume, the rule will thus benefit them by leading to an increase in revenues.

In addition, we expect the rule to reduce the number of applications for ETF exemptive relief. This will allow Commission staff more time to review applications for exemptive relief from registered investment companies, including those for more complex or novel ETFs that will continue to require exemptive relief. To the extent that this speeds up the processing time for these remaining applications, the rule may reduce the indirect costs of forming and operating for ETFs that seek to operate outside its parameters and for other registered investment companies that require exemptive relief to operate and, as a result, may promote innovation among these types of funds.

b. Conditions for Reliance on Rule 6c-11

Rule 6c-11 contains several conditions that are designed to facilitate an effective arbitrage mechanism, reduce costs, and inform and protect investors. Beyond the general impact of reducing the expense and delay of new ETFs, many of the conditions in rule 6c-11 do not offer additional benefits or costs when measured against the baseline, as they are generally codifications of the current regulatory practice. However, some conditions are departures from current exemptive orders or current market practice and we discuss the effects of these departures in more detail below.

i. Conditions That May Facilitate an Effective Arbitrage Mechanism

Arbitrage is the practice of buying and selling equivalent or similar assets (or portfolios of assets) in different markets to take advantage of a price difference. As a consequence, arbitrageurs generate price pressure that works to equalize the prices of these assets across different markets. This is important for investors as it helps ensure that asset prices reflect market fundamentals (i.e., are efficient) irrespective of the market in which they are traded.

There are several factors that are important for arbitrageurs to consider in order to determine the existence of arbitrage opportunities and execute an arbitrage strategy effectively. First, when the assets involved in the arbitrage are similar but not the same, as is the case for ETFs, arbitrage will be more effective the more closely the prices of the two assets track each other and the more transparency arbitrageurs have into any factors that may cause price differences between the two assets. In addition, arbitrage requires that arbitrageurs have the ability to enter into the trades necessary to execute the arbitrage strategy, and arbitrage is more effective the smaller and more predictable the associated trading costs are. The rule contains conditions that take these considerations into account and are designed to promote the effective functioning of the arbitrage mechanism for ETFs.

The rule will require ETFs relying on the rule to adopt and implement written policies and procedures that govern the construction of basket assets and the process that will be used for the acceptance of basket assets, including policies and procedures specific to the creation of custom baskets if the ETF uses custom baskets.

Although current exemptive orders contain varying provisions for basket flexibility, we do not believe that the rule will require existing ETFs to change how they construct baskets. Instead, the rule will give some ETFs more flexibility for constructing baskets than what is allowed by their existing exemptive orders, provided they adopt and implement custom basket policies and procedures.

We believe that fixed-income, international, and actively managed ETFs will particularly benefit from the increased basket flexibility under the rule if they currently operate under exemptive orders that do not allow custom baskets. For example, the increased basket flexibility should allow fixed-income ETFs to avoid losing hard-to-find bonds when meeting redemptions or to use sampling techniques to construct baskets that are composed of fewer individual bonds, thus reducing trading costs for authorized participants. Similarly, international ETFs will be able to tailor their creation and redemption baskets to accommodate difficulties in transacting in certain international securities. In addition, actively managed ETFs will, in certain instances, be able to use the increased basket flexibility to acquire or dispose of securities by adjusting the composition of the creation or redemption basket rather than by directly purchasing or selling the securities. In these instances, actively managed funds will be able to reduce certain transaction costs, such as those associated with bid-ask spreads.

For these reasons, we believe that, to the extent that ETFs are able to implement procedures that facilitate the arbitrage mechanism or reduce costs for those ETFs, the rule will benefit ETFs that use the increased basket flexibility the rule affords and will ultimately benefit their investors. One commenter submitted results from an empirical analysis that supported this assessment. For example, the commenter observes that fixed-income ETFs that currently have increased basket flexibility exhibit smaller bid-ask spreads and reduced premiums and discounts to NAV, particularly during times of market stress. Due to a lack of data, we are unable to quantify the number of ETFs that would choose to implement custom basket policies and procedures, and thus the potential benefits accruing to ETFs and their investors.

To the extent that existing ETFs do not already have policies and procedures governing basket assets in place or that existing policies and procedures are not consistent with the requirements of the rule, ETFs will incur costs associated with developing and implementing such policies and procedures. However, such costs may be partially or totally offset by the basket flexibility discussed above. We estimate that an average ETF will incur an initial cost of $10,718 associated with establishing and implementing standard and custom basket policies and procedures. In addition, we estimate that an average ETF will incur an ongoing cost of $4,135 each year to review and update its basket policies and procedures. We thus estimate that the total industry cost associated with the policies and procedures requirement in the rule for ETFs that can rely on the rule in the first year will equal $25,769,955.

Finally, although the rule's custom basket policies and procedures requirements are designed to reduce the potential for cherry-picking, dumping, and other potential abuses, we acknowledge that this principles-based approach may not be effective at preventing all such abuses. However, ETFs will be required to maintain records related to the custom baskets used, which will allow the Commission to examine for potential abuses.

As proposed, the rule also will require an ETF to disclose prominently on its website the portfolio holdings that will form the basis for the next calculation of NAV per share. This information allows authorized participants and other arbitrageurs to identify arbitrage opportunities and execute arbitrage trades that reduce premiums and discounts to NAV per share, ultimately benefiting all investors. In addition, we agree with a commenter who stated that portfolio transparency helps investors to better discern differences between ETFs that track similar indexes or have similar investment objectives.

The requirements for portfolio transparency in existing exemptive orders have varied. However, based on a staff review of ETFs' websites, we understand that all ETFs that can rely on the rule currently provide daily full portfolio transparency. Thus, ETFs that can rely on the rule already bear the ongoing costs associated with maintaining such disclosures. We believe that the ETFs that can rely on the rule will incur a one-time cost associated with reviewing whether their current portfolio disclosure is compliant with the requirements of proposed rule 6c-11 and, if necessary, make changes to the information that is presented on their website. We estimate this one-time cost to be $1,997 for the average ETF, resulting in an aggregate one-time cost of $3,463,928 for all ETFs that can rely on the rule.

Some commenters raised concerns that providing daily portfolio information on an ETF's website could expose the fund and its investors to costs associated with “front-running” and, in the case of actively managed ETFs, “piggybacking.” However, based on our understanding that all ETFs that can rely on the rule currently provide daily full portfolio transparency, the rule will not change the degree to which ETFs and their investors are exposed to such costs compared to the baseline.

As proposed, rule 6c-11 would have required that an ETF's portfolio holdings disclosure be made on each business day: (1) Before the opening of regular trading on the primary listing exchange of the ETF's shares; and (2) before the ETF starts accepting orders for the purchase or redemption of creation units. The rule will omit the second requirement in order to accommodate the current industry practice of T-1 creation and redemption orders. We agree with commenters that T-1 orders facilitate ETF arbitrage for certain ETFs holding foreign securities by allowing arbitrageurs to align the execution time of underlying securities with the NAV calculation of the order. Compared to the proposal, we therefore believe that this aspect of the rule will lead to narrower bid-ask spreads and smaller premiums and discounts, benefiting investors in these ETFs.

Compared to the proposal, the rule will require ETFs to present enumerated information regarding each portfolio holding (which are a more limited set of the disclosures currently required by the listing exchanges' generic listing standards for actively managed ETFs), rather than the description, amount, value, and unrealized gain/loss of each position in the manner prescribed by Article 12 of Regulation S-X. As discussed above in section II.C.4.b, we believe that this information will focus the disclosure on the pieces of information that are most relevant to investors while reducing the burden for ETFs of complying with the disclosure requirement. As a result, we believe that the disclosure format under the rule will provide similar benefits to investors at lower costs to ETFs.

ii. Other Cost Savings From the Rule

Under the terms of the exemptive orders, ETFs are required to disclose in their registration statement that redemptions may be postponed for foreign holidays. Rule 6c-11 does not contain such a requirement and will thus eliminate the cost of preparing and updating this disclosure for existing ETFs. This information is already covered by the agreement between the ETF and the authorized participant.

The terms of the exemptive orders also require an ETF to identify itself in any sales literature as an ETF that does not sell or redeem individual shares and explain that investors may purchase or sell individual ETF shares through a broker via a national securities exchange. The rule will not include such a requirement, as we no longer believe that it is necessary given that markets have become familiar with ETFs in the multiple decades they have been available. The omission of such a requirement will lead to cost savings for existing and future ETFs associated with preparing and reviewing this disclosure for sales literature.

iii. Intraday Indicative Value

The rule will not require an ETF to disseminate its IIV, as is currently required under all exemptive orders and current exchange listing standards. To the extent that current exchange listing standards require IIV to be disseminated, the rule's omission of such a requirement will not represent a change from the baseline and will not result in any costs or benefits to market participants.

We believe, and commenters agreed, that many sophisticated institutional market participants do not rely on the IIV to value an ETF's assets, as discussed above in section II.C.3. In addition, the IIV may not reflect the intrinsic value of certain ETFs' assets (e.g., for funds that invest in foreign securities whose markets are closed during the ETF's trading day or funds whose assets trade infrequently, as is the case for certain bond funds). An investor who relies on stale or inaccurate IIV information to purchase or sell ETF shares could be exposed to price risk until the position is closed and could incur the trading costs associated with these trades. Furthermore, as discussed above in section II.C.3, based on a staff review of the websites of the ten largest ETFs by assets under management and of several publicly available free websites, we do not believe that investors have easy access to IIV through free, publicly available websites.

Some commenters stated that retail investors relying on IIV could see their ability to evaluate ETFs reduced without this metric. As we stated in the proposing release, we agree that the IIV may provide a reasonably accurate estimate of the value of certain ETFs' portfolios, including those ETFs whose underlying assets are very liquid and frequently traded during the ETF's trading day. However, as discussed above in section II.C.3, we have concerns regarding the accuracy of IIV estimates and the lack of uniform methodology requirements. Moreover, retail investors do not have easy access to IIV through free, publicly available websites today even for those assets classes where IIV may be more reliable. Therefore, we do not believe that IIV provides information that retail investors can reliably use when making investment decisions and thus do not believe that it is a necessary condition for ETFs that are operating in reliance on rule 6c-11.

iv. Website Disclosure Provisions

Rule 6c-11 will require an ETF to disclose certain information prominently on its website. The goal of these disclosure requirements is to provide investors with key metrics to evaluate their trading and investment decisions in a location that is easily accessible and frequently updated. Based on a staff review of ETFs' websites, we believe that all ETFs that can rely on the rule currently have a website and currently provide daily website disclosures of NAV, closing price, and premiums or discounts. As a consequence, existing ETFs generally will not incur any additional cost associated with the creation and technical maintenance of a website or these specific website disclosure requirements.

Our exemptive orders have not included requirements for line graph and tabular historical information regarding premiums and discounts. While Form N-1A contains tabular website disclosures related to historical premiums/discounts in Items 11(g)(2) and 27(b)(7)(iv), which we are eliminating for ETFs that will rely on rule 6c-11, we anticipate that all existing ETFs that fall within the scope of the rule will still incur some additional costs associated with these disclosures. We believe that substantially all ETFs already have the required data available to them as part of their regular operations (as it is required by Form N-1A and allows ETFs to monitor the trading behavior of their shares), and have systems (such as computer equipment, an internet connection, and a website) in place that can be used for processing this data and uploading it to their websites. However, these ETFs will incur the costs associated with establishing and following (potentially automated) processes for processing and uploading this data to their websites. We estimate that an average ETF will incur a one-time cost of $1,997 for implementing this website disclosure and an ongoing cost of $491 per year for updating the relevant web page with this information. We thus estimate the total cost, in the first year, to ETFs that can rely on the rule for providing this website disclosure, of $4,315,379.

Our exemptive orders have not included a requirement for ETFs to provide disclosure if an ETF's premium or discount is greater than 2% for more than seven consecutive trading days and the factors that materially contributed to a premium or discount, if known. As a result, under the rule those ETFs that experience such a premium or discount will incur additional costs associated with determining what factors contributed to the premiums or discounts and drafting and uploading a discussion to their website.

Based on a staff analysis of historical data on ETF premiums and discounts from 2008 to 2018 using Bloomberg data, we believe that, on average, 4.5% of ETFs that can rely on the rule will trigger this disclosure requirement each year. As suggested by commenters, this disclosure requirement is likely to affect certain categories of ETFs more than others. For example, in 2018, we estimate that the reporting requirement would not have been triggered for any allocation ETFs, commodity ETFs, or municipal bond ETFs, while it would have been triggered for 0.3% of taxable bond ETFs, 0.6% of sector equity ETFs, 3.1% of U.S. equity ETFs, 4.2% of international equity ETFs, and 4.8% of alternative ETFs. We estimate that an ETF required to make such a disclosure in a given year will incur an average cost of $1,504, yielding a total annual industry cost of $117,405.

The rule also will require additional disclosure by the ETF of the median bid-ask spread for the most recent 30-day period on its website. This requirement is modified from the proposal, which would have required an ETF to disclose the median bid-ask spread for the ETF's most recent fiscal year on its website and in its prospectus.

We believe that the rule's disclosure requirement will further inform investors about the expected cost of trading an ETF and facilitate comparison of transaction costs across ETFs. As such, the disclosure of median bid-ask spreads could reduce investors' uncertainty about the trading environment. We agree with commenters that actual bid-ask spreads paid by ETF investors can be influenced by a variety of factors, including order size, market conditions, as well as the broker-dealer used. Nevertheless, we believe that requiring the disclosure of bid-ask spread information is still valuable to investors as it is indicative of the general magnitude of an ETF's trading costs attributable to bid-ask spreads. In addition, we believe bid-ask spreads can help investors rank ETFs in terms of expected execution costs, as an ETF with historically larger bid-ask spreads can be expected to be more costly to trade than an ETF with historically lower bid-ask spreads, when holding other factors that impact execution costs, such as order size, market conditions, and the broker-dealer, constant.

Existing exemptive orders do not require ETFs to disclose median bid-ask spreads. As a result, we assume that all ETFs operating under the final rule will have to implement processes and systems to compute the median bid-ask spreads and will have to accommodate a new data point on their web page to report this information. We estimate that an ETF will incur a one-time estimated cost of $8,294 to comply with this requirement. In addition, we estimate that an ETF that purchases NBBO information to compute bid-ask spread will incur an additional ongoing annual cost of $4,042. Assuming that all ETFs will have to purchase data to satisfy this requirement, we estimate an upper bound for the total industry cost in the first year of $21,401,659.

The requirement of disclosures on ETFs' websites we are adopting will enable investors to more readily obtain certain key information for individual ETFs, potentially resulting in better informed trading decisions. The conditions standardize certain content requirements to facilitate investor analysis of information while allowing ETFs to select a layout for displaying the required information that the individual ETF finds most efficient and appropriate for its website. Because the information will be made available on individual websites, in the layout chosen by the ETF, we acknowledge that an investor's ability to efficiently extract information from website disclosures for purposes of aggregation, comparison, and analysis across multiple ETFs and time periods may be limited. Investors seeking to compare multiple ETFs will have to visit the website of every ETF, navigate to the relevant section of the website, and extract the information provided in the layout chosen by the fund. Depending on the manner in which a typical fund investor will use the website disclosures, these considerations may decrease the information benefits of the new disclosures. However, we recognize that investors may rely on third-party providers that aggregate such information for all ETFs into a structured format that investors can more easily access and process for the purpose of statistical and comparative analyses. While investors may incur costs of obtaining information from third-party service providers, it will likely be lower than the cost they would incur if they performed the collection themselves, and the cost of such services may otherwise be reduced as a result of competition among service providers. Overall, we believe that requiring ETFs to provide this information on their websites will ultimately provide an efficient means for facilitating investor access to information.

c. Recordkeeping

The rule will require ETFs to preserve and maintain copies of all written authorized participant agreements for at least five years, the first two years in an easily accessible place. This requirement will provide Commission examination staff with a basis to evaluate whether the authorized participant agreement is in compliance with the rule and other provisions of the Investment Company Act and the rules thereunder, and also will promote internal supervision and compliance. As the agreement forms the contractual foundation on which authorized participants engage in arbitrage activity, compliance of the agreement with applicable rules is important for the arbitrage mechanism to function properly.

We also are requiring ETFs to maintain information regarding the baskets exchanged with authorized participants on each business day, including a record identifying any custom basket and stating that the custom basket complies with the ETF's custom basket policies and procedures. We believe that these records will help our examination staff understand how baskets are being used by ETFs, evaluate compliance with the rule and other provisions of the Act and rules thereunder and other applicable law, and examine for potential overreach by ETFs in connection with the use of custom baskets or transactions with affiliates.

Existing exemptive orders have not required ETFs to preserve and maintain copies of authorized participant agreements or information about basket composition, or to prepare and maintain a record identifying each custom basket and stating that custom baskets comply with the custom basket policies and procedures. However, we believe that most ETFs, as a matter of established business practice, already preserve and maintain copies of authorized participant agreements as well as data on baskets used.

As discussed below in section V.B.2, we estimate the average annual cost for an ETF to comply with these recordkeeping requirements is $393 per year. Assuming that (1) 80% of ETFs already preserve and maintain copies of authorized participant agreements as well as information on basket composition; (2) no ETF currently maintains records identifying any custom basket and stating that the custom basket complies with the ETF's custom basket policies and procedures; and (3) 25% of the total annual recordkeeping costs can be attributed to the new recordkeeping requirements for custom baskets, the total industry cost for ETFs that can rely on the rule will be $544,790 per year.

d. Master-Feeder Relief

We will rescind the master-feeder relief granted to ETFs, with the exception of master-feeder relief that funds relied on as of the date of the 2018 ETF Proposing Release (June 28, 2018). We are rescinding such relief because there generally is a lack of industry interest in ETF master-feeder arrangements, and certain master-feeder arrangements raise policy concerns, as discussed above in section II.F. While there are currently many exemptive orders that contain the master-feeder relief, it is our understanding that only one fund complex currently relies on this relief to structure master-feeder arrangements with one master and one feeder fund each. We will grandfather existing master-feeder arrangements involving ETF feeder funds, but prevent the formation of new ones under existing orders, by amending relevant exemptive orders. As a result, we do not expect that the rescission of the existing master-feeder relief will impose costs on ETFs that currently rely on the relief to structure master-feeder arrangements. However, to the extent that an ETF without a grandfathered master-feeder arrangement would apply for an exemptive order that grants master-feeder relief, such an ETF would incur costs associated with the exemptive order application. At the same time, the rescission of the relief may benefit investors in prospective feeder ETFs to the extent that it protects them from any concerns associated with feeder ETFs discussed above.

2. Amendments to Forms N-1A, N-8B-2, and N-CEN

The amendments to Forms N-1A and N-8B-2 are designed to provide investors with tailored information regarding the costs associated with investing in ETFs. As discussed in section II.H above, we believe that the new disclosures will benefit investors by helping them better understand and compare specific funds, potentially resulting in more informed investment decisions, more efficient allocation of investor capital, and greater competition for investor capital among funds.

We are amending Forms N-1A and N-8B-2 to include information on ETF trading and associated costs that we anticipate will help investors better understand costs specific to ETFs, such as bid-ask spreads. In a departure from the proposal, we are eliminating the QA format for these disclosures, which will allow ETFs to determine the format for conveying the required disclosures to investors. In addition, the narrative disclosures will be streamlined and included in Item 6 of Form N-1A, whereas the proposed disclosure in QA format would have been included in Item 3. As discussed above in section II.H, we believe that the updated format and location will improve the usefulness of the disclosure to ETF investors.

ETFs will incur costs associated with these new disclosures on Forms N-1A and N-8B-2. ETFs structured as open-end funds are currently required to disclose information about premiums and discounts to NAV per share in reports on Form N-1A. However, UIT ETFs, which file reports with the Commission on Form N-8B-2, are not required to make such disclosures. We estimate that this reporting requirement will increase the incremental cost for UIT ETFs compared to ETFs structured as open-end funds. In addition, ETFs that rely on rule 6c-11 will be exempt from the Form N-1A disclosure requirements related to bid-ask spreads and premiums and discounts to NAV per share (as such disclosures will be required under rule 6c-11 to be provided on their websites), which reduces the incremental cost we estimate for open-end funds that can rely on the rule compared to those that cannot. Taking these considerations into account, we estimate that each ETF that is structured as an open-end fund will incur a one-time cost of $3,799 and an ongoing cost of $1,899 per year if it can rely on rule 6c-11, and a one-time cost of $6,960 and an ongoing cost of $3,480 per year if it cannot rely on rule 6c-11. We estimate that a UIT ETF will incur a one-time cost of $8,352 and an ongoing cost of $3,480 per year. We thus estimate that the total industry cost for this requirement for ETFs in the first year would equal $12,434,736.

As proposed, we are amending Form N-CEN to require identification of ETFs that are relying on rule 6c-11. We believe that this requirement will allow the Commission to better monitor reliance on rule 6c-11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act. We believe that the incremental cost of this requirement to ETFs is minimal.

D. Effects on Efficiency, Competition, and Capital Formation

This section evaluates the impact of rule 6c-11 and the amendments to Forms N-1A, N-8B-2, and N-CEN on efficiency, competition, and capital formation. However, as discussed in further detail below, the Commission is unable to quantify the effects on efficiency, competition and capital formation either because they are inherently difficult to quantify or because it lacks the information necessary to provide a reasonable estimate.

1. Efficiency

The rule will likely increase total assets of ETFs, as a result of reducing the expense and delay of forming and operating new ETFs organized as open-end funds, reducing the cost for certain ETFs to monitor their own compliance with regulations, and increasing competition among ETFs as discussed below. At the same time, the rule could lead to a decrease in total assets of other fund types that investors may regard as substitutes, such as certain mutual funds. As a result, ETF ownership (as a percentage of market capitalization) for some securities, such as stocks and bonds, will likely increase, and ownership by other funds, such as mutual funds, will likely decrease. We are aware of only a limited amount of academic literature regarding ETFs. This literature suggests that such a shift in ownership could have a limited effect on the price efficiency (i.e., the extent to which an asset price reflects all public information at any point in time) and liquidity of these portfolio securities.

The literature also suggests that a shift in stock ownership towards ETFs may somewhat improve certain dimensions of price efficiency while possibly attenuating price efficiency along other dimensions. Specifically, the results in one paper suggest that stock prices incorporate systematic information more quickly when they are held in ETF portfolios. The evidence in this paper thus indicates that ETF activity increases stock market efficiency with regard to systematic information, i.e., information relating to market-wide risks. On the other hand, some studies find that an increase in ETF ownership may introduce non-fundamental volatility into stock prices, i.e., cause temporary deviations of stock prices from their fundamental values. For example, one paper finds that ownership by U.S. equity index ETFs is associated with moderately higher volatility among component stocks and asserts that the increased volatility is non-fundamental. Another paper finds that higher authorized participant arbitrage activity in U.S. equity ETFs is associated with a moderately higher correlation of returns among stocks in the ETF's portfolio. The authors observed that changes in the prices of these stocks tend to partially revert over the next trading day and state that the increased co-movement in returns is thus a sign of excessive price movement due to non-fundamental shocks that ETF trading helps propagate.

To a limited extent, the rule could decrease the liquidity of stocks held by ETFs, as one study finds that higher ownership of a stock by U.S. equity ETFs is associated with somewhat lower liquidity as measured by market impact. Conversely, the academic literature offers mixed evidence regarding the impact of ETFs on bond liquidity. While one paper finds that increased ETF ownership is associated with lower bond liquidity for investment grade bonds, another study finds that bonds included in ETFs experience improvements in their liquidity.

A shift in stock ownership towards ETFs could also have an effect on the co-movement of liquidity for stocks held by ETFs. Specifically, one paper observes that the liquidity of a stock with high ETF ownership co-moves with the liquidity of other stocks that also have high ETF ownership. The authors assert that this co-movement in liquidity exposes investors to the possibility that multiple assets in their portfolio will be illiquid at the same time.

Since we do not know the degree to which the rule will increase ETF ownership of stocks and bonds, we are unable to quantify the rule's effects on price efficiency and liquidity. However, the effects documented in the literature surveyed above are generally small, so that we do not anticipate that the rule would have a significant effect on the price efficiency or liquidity of assets held by ETFs.

As a result of the rule's allowance of increased basket flexibility, some ETFs that did not already have this flexibility in their baskets may choose to increase the weight of more liquid securities and decrease the weight of less liquid securities in their baskets compared to their portfolios. During normal market conditions, this may lead those ETFs' shares to trade at smaller bid-ask spreads, thus benefiting investors. Such a reduction in bid-ask spreads by over-weighting more liquid securities may not continue to be possible during stressed market conditions, however, if a large proportion of such an ETF's portfolio securities become less liquid. As a result, the gap between bid-ask spreads of some ETFs' shares during normal and stressed market periods may grow as a result of the rule, which some investors may not anticipate and fail to fully take into account when making their investment decisions.

Finally, the amendments to Forms N-1A and N-8B-2 as well as the additional website disclosures required by rule 6c-11 we are adopting will allow investors and other market participants to better understand and compare ETFs using more relevant and standardized disclosure. For example, the amendments to Item 6 of Form N-1A will add a requirement for ETFs to include a statement that ETF investors may be subject to other expenses that are specific to ETF trading, including bid-ask spreads. These costs are not currently required to be disclosed as part of the prospectus. Since these costs are incurred by ETF investors and not mutual fund investors, we believe that adding this disclosure requirement will help investors and other market participants better assess and compare fees and expenses between certain funds and fund types, such as ETFs and mutual funds. Thus, the final rule could help investors make more informed investment decisions that are more suited to their investment objectives. The degree to which investors will benefit from the ability to make more informed investment decisions is inherently difficult to quantify, so we are unable to estimate the size of this benefit.

2. Competition

The rule will likely increase competition among ETFs that can rely on the rule. The first channel through which the rule will likely foster competition is by reducing the costs for ETF sponsors to form new ETFs that comply with the conditions set by the rule. This cost reduction will lower the barriers to entering the ETF market, which will likely lead to increased competition among ETFs that can rely on the rule.

In addition, new ETFs that enter the market in reliance on the rule, as well as those existing ETFs that will have their exemptive relief rescinded and replaced by the rule, will no longer be subject to requirements that vary among exemptive orders. Instead, these ETFs will operate under uniform requirements, which will help promote competition among ETFs that can rely on the rule. An increase in competition among ETFs that can rely on the rule will likely also lead to an increase in competition among those ETFs, ETFs that cannot rely on the rule, and other types of funds and products that investors may perceive to be substitutes for ETFs.

Furthermore, the new website disclosures and amendments to Forms N-1A and N-8B-2 will allow investors to better compare ETFs and mutual funds, which can further foster competition among these types of funds as well as between these types of funds and other types of funds that investors may perceive to be substitutes for ETFs and mutual funds, such as closed-end funds and certain ETPs.

Increased competition will likely lead to lower fees for investors, encourage financial innovation, and increase consumer choice in the markets for ETFs, mutual funds, and other types of funds that investors may perceive to be substitutes. Due to the limited availability of data, however, we are unable to quantify these effects.

To the extent the rule will increase the number and total assets of ETFs, more authorized participants or other market participants that engage in ETF arbitrage, such as hedge funds and principal trading firms, may enter the market. This may lead to increased competition among authorized participants or other market participants and result in authorized participants or other market participants exploiting arbitrage opportunities sooner (i.e., when premiums/discounts to NAV per share are smaller). As a result, bid-ask spreads may tighten and premiums/discounts to NAV per share for ETF shares may decrease. We would expect new entries of authorized participants or other arbitrageurs as a result of the rule to be limited, however, and any effects on bid-ask spreads and premiums/discounts to NAV per share to be small.

3. Capital Formation

The rule may lead to increased capital formation. Specifically, an increase in the demand for ETFs, to the extent that it increases demand for intermediated assets as a whole, will likely spill over into primary markets for equity and debt securities. As a consequence, companies may be able to issue new debt and equity at higher prices in light of the increased demand for these assets in secondary markets created by ETFs and the cost of capital for firms could fall, facilitating capital formation.

The conclusion that an increase in the demand for ETFs may lower the firm's cost of capital is further supported by a paper that finds that bonds with a higher share of ETF ownership have lower expected returns. Due to the limited availability of data, however, we are unable to quantify these effects of the rule on capital formation.

E. Reasonable Alternatives

1. Website Disclosure of Basket Information

Rule 6c-11 does not include a basket publication requirement. As an alternative, we considered requiring an ETF to post on its website one “published” basket each business day before the opening of trading of the ETF's shares, as we proposed. This disclosure would allow smaller institutional investors and retail investors that are not NSCC members and do not currently have access to basket information to compare the ETF's “published basket” with its portfolio holdings. However, we agree with commenters that the benefit of this information to these investors is likely to be limited, as secondary market arbitrage typically does not require information regarding an ETF's basket composition. In addition, ETFs would incur additional costs associated with this disclosure.

We also considered requiring an ETF to publish information regarding every custom basket used by the ETF after the close of trading on each business day. This information could reveal whether an authorized participant has pressured an ETF into accepting illiquid securities in exchange for liquid ETF shares (i.e., dumping) or into giving the authorized participant desirable securities in exchange for ETF shares tendered for redemption (i.e., cherry-picking) by comparing an ETF's portfolio assets and published basket to the baskets used by various authorized participants throughout the day.

However, the rule contains conditions for basket policies and procedures, which seek to prevent overreaching. Moreover, the rule will require an ETF to maintain records regarding the baskets used, which will allow Commission staff to examine an ETF's use of basket flexibility. We also agree with commenters that requiring publication of all baskets could disadvantage an ETF and its shareholders by allowing market participants to front-run trades by authorized participants (or other arbitrageurs that use an authorized participant as an agent) in basket securities, particularly for those ETFs that have more frequent primary market transactions.

Consequently, we believe that the risk for abusive practices under the rule will be low while, at the same time, the rule will avoid additional operational and compliance costs for ETFs to post and review the information as well as potential costs associated with front-running trades in basket securities under the alternative.

2. Disclosure of ETF Premiums or Discounts Greater Than 2%

As proposed, the rule will require any ETF whose premium or discount was greater than 2% for more than seven consecutive trading days to post that information on its website, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount. One commenter suggested that we raise the threshold for the size of the premiums or discounts to five or ten percent while shortening the period over which the premium or discount has to be sustained for the requirement to trigger. Based on this suggestion, we considered an alternative that would require any ETF whose premium or discount was greater than five percent for more than three consecutive trading days to post that information on its website, along with a discussion as required under the rule.

Under both the rule and the alternative, ETFs with premiums or discounts greater than five percent for more than seven consecutive trading days would provide the disclosure. The disclosure threshold under the rule will also capture ETFs with premiums or discounts greater than two and up to five percent for more than seven consecutive trading days, which would not be captured under the alternative. Conversely, the disclosure threshold under the alternative would also capture ETFs with premiums or discounts greater than five percent for between three and six consecutive trading days, which will not be captured under the rule.

We estimate that 1.7 percent of those ETFs that can rely on the rule would trigger the alternative disclosure threshold per year, compared to 4.5 percent under the rule. From 2008 and 2018, the percentage of ETFs that would have triggered the requirement would have been largest in 2008. In that year, 4.6 percent of ETFs that could have relied on the rule would have triggered the alternative threshold, compared to 10 percent under the rule. In addition, an ETF that triggers the reporting requirement under the alternative would make its disclosure sooner after the premium or discount first exceeds the threshold, as the measurement period is shorter compared to the rule.

The lower incidence of reporting under the alternative would decrease the costs incurred by ETFs associated with making the disclosure, but also reduce the reporting of persistent premiums and discounts available to investors in that it would eliminate reporting of discounts below the 5% threshold. While the shorter observation period under the alternative would make the information about premiums and discounts available to investors sooner, rule 6c-11 will require ETFs to disclose the prior day's premium/discount to NAV per share on its website every day, so that timely information about the size of ETF's premiums/discounts will still be available to investors under the rule.

Another commenter suggested that we adopt a materiality standard rather than a fixed numerical threshold to trigger the reporting requirement. We considered an alternative under which each ETF would make its own determination as to when a premium/discount to NAV per share is material and thus would be reported. As a result, ETFs would almost certainly differ in the size and duration of a premium/discount that they would consider to be material. In addition, ETFs might adopt varying criteria to determine whether a premium/discount is deemed material based on the asset class of the ETF or general market conditions. While we are unable to predict how the alternative would impact the frequency of reporting compared to the rule, we believe that the alternative might lead to inconsistent reporting practices among ETFs, which would likely reduce the usefulness of the requirement to investors, compared to the rule.

3. Website and Prospectus Disclosure of the Median Bid-Ask Spread Calculated Over the Most Recent 1-Year Period

Rule 6c-11 will require an ETF to disclose the median bid-ask spread calculated over the most recent 30-day period on its website. As an alternative, we considered requiring an ETF to disclose the median bid-ask spread for the ETF's most recent fiscal year on its website and in its prospectus, as proposed.

We agree with commenters that computing the median bid-ask spread over a 30-day rolling period, rather than over the proposed 1-year lookback period, may provide a more accurate predictor of trading costs for newly launched ETFs whose bid-ask spreads may tighten as the ETFs mature. In addition, as an ETF's prospectus cannot be updated every day, we believe it is appropriate to require ETFs to make this disclosure on their websites. As a result, we believe that requiring ETFs to disclose the median bid-ask spread over the most recent 30-day period on their websites will increase the benefits of the bid-ask spread disclosure to investors compared to the alternative, particularly for newly-launched ETFs.

4. Additional Disclosures Showing the Impact of Bid-Ask Spreads

We considered amending Forms N-1A and N-8B-2 to require an ETF to provide: (1) Examples in the ETF's prospectus showing how bid-ask spreads impact the return on a hypothetical investment for both buy-and-hold and frequent traders; and (2) an interactive calculator on the ETF's website that would allow an investor to customize the hypothetical bid-ask spread calculations to its specific investing situation, as proposed. Some investors may find the additional disclosures under this alternative useful to understand the effect of transaction costs resulting from bid-ask spreads on their investments; however, we agree with commenters that this benefit could be diminished by over-concentrating investor focus on bid-ask spreads, thereby potentially obscuring the importance of other components of ETF transaction costs (e.g., order size, market conditions, and the extent to which a broker-dealer improves upon quoted bid-ask spreads). In addition, the omission of these requirements will save ETFs the costs associated with providing examples showing how bid-ask spreads impact the return on a hypothetical investment and implementing the interactive calculator on its website.

5. Website Disclosure of a Modified IIV

As proposed, rule 6c-11 will not require ETFs to disseminate IIV as a condition for reliance on the rule. As an alternative, we considered requiring an ETF to publicly disseminate a modified IIV on its website on a real time basis as a condition to rule 6c-11, requiring ETFs to calculate IIVs more frequently and in a more accessible manner. We also considered creating a methodology that takes into account circumstances when market prices for underlying assets are not available or should not be used to reflect the ETF's intraday value. As we discussed above in section II.C.3, such a modified IIV would benefit retail and less sophisticated institutional investors by allowing them to better evaluate the value of an ETF intra-day. However, we are concerned that these modifications would not cure the shortcomings of IIV for ETFs in a uniform manner. We encourage the ETF industry to undertake efforts to develop intraday value metrics targeted at these investors as we believe that ETFs are in a position to consider and develop tailored metrics for ETFs holding different asset classes in a format that is useful for retail investors.

6. The Use of a Structured Format for Additional Website Disclosures and the Filing of Additional Website Disclosures in a Structured Format on EDGAR

The rule will require ETFs to post on their websites certain disclosures to enable investors to more readily obtain certain key metrics for individual ETFs. As an alternative, we considered requiring ETFs to post the disclosures in a structured format on their websites. Structured disclosures are made machine-readable by having reported disclosure items labeled (tagged) using a markup language that can be processed by software for analysis. The resulting standardization under this alternative would allow for extraction, aggregation, comparison, and analysis of reported information through significantly more automated means than is possible with unstructured formats such as HTML. This alternative would facilitate the extraction and analysis through automated means of an individual fund's disclosures over time which would offer the greatest benefit for higher-frequency ETF disclosures and potentially the comparison of disclosures across a small number of ETFs. However, requiring a structured disclosure format would not lower the burden on investors and other data users of separately visiting each website to obtain each ETF's disclosure.

The structured data requirement could impose a cost on ETFs of tagging the information in a structured format, particularly to the extent that ETFs do not otherwise structure this data in this manner for their own purposes. However, we believe that if the XML format, for example, were used for structuring the additional disclosure, the incremental cost of tagging information in each such disclosure would likely be relatively modest.

As another alternative, we considered requiring ETFs to make the additional website disclosures available in a centralized repository in a structured format, such as by filing them on EDGAR. Making the information available in a structured format on EDGAR would likely improve its accessibility and the ability of investors, the Commission, and other data users, such as third-party data aggregators, to efficiently extract information for purposes of aggregation, comparison, and analysis of information across multiple funds and time periods. Requiring the information to be filed on EDGAR also would enable data users to retain access to such historical information in the event that such information is subsequently removed from the fund's website. We recognize that filers might incur additional costs under this alternative, compared to the requirement in the rule to post the additional disclosures in an unstructured format on fund websites. Such costs would likely vary across filers, depending on the systems and processes they currently have in place, such as for internal reporting, posting of website updates, and submission of regulatory filings, and the manner in which filers currently maintain data required for the additional disclosures under the final rule.

7. Pro Rata Baskets

Rule 6c-11 will require ETFs relying on the rule to adopt and implement written policies and procedures that govern the construction of basket assets and the process that will be used for the acceptance of basket assets. As an alternative, we considered requiring that an ETF's basket generally correspond pro rata to its portfolio holdings, while identifying certain limited circumstances under which an ETF may use a non-pro rata basket, as we have done in our exemptive orders since approximately 2006.

The requirement included in these orders was designed to address the risk that an authorized participant or other market participant could take advantage of its relationship with the ETF (i.e., engage in cherry picking or dumping). However, we believe that the rule's additional policies and procedures requirements for custom baskets will provide a principles-based approach that is designed to limit potential abuses so that they would be unlikely to cause significant harm to investors. In addition, we believe that the increased basket flexibility under the rule will benefit the effective functioning of the arbitrage mechanism, particularly benefiting fixed-income, international, and actively managed ETFs.

8. Treatment of Existing Exemptive Relief

As proposed, we will rescind the exemptive relief we have issued to ETFs that will be permitted to rely on the rule. As an alternative, we considered allowing ETFs with existing exemptive relief in orders that do not contain a self-termination clause to continue operating under their relief rather than requiring them to operate in reliance on the rule.

The Commission believes that allowing ETFs to continue operating under their existing relief would create differences in the conditions under which funds that would otherwise be subject to rule 6c-11 operate. Specifically, some ETFs that determine they do not need the additional flexibility (e.g., basket flexibility) the rule will provide could choose to continue operating under their existing relief rather than in reliance on conditions of the rule, such as standardized presentation of portfolio holdings. This self-selection would perpetuate existing disparity in the conditions under which these ETFs are allowed to operate.

Measured against the baseline, the alternative would thus have smaller benefits arising from improved disclosure. For example, an ETF that chose to continue to operate under its existing exemptive relief would not be required to present its portfolio holdings in the standardized format prescribed by rule 6c-11. As discussed in section IV.C.1.b.i above, we believe that this requirement will benefit investors of ETFs that are subject to rule 6c-11 by allowing them to more easily identify arbitrage opportunities and compare ETFs that have similar investment objectives. In addition, the alternative would not level the playing field among ETFs subject to rule 6c-11 with regard to these conditions and thus not be as effective at promoting product competition as the rule. One commenter agreed, stating that the rescission of the orders will further the Commission's regulatory goal of creating a consistent regulatory framework for ETFs. In addition, it would be more difficult for the Commission to evaluate compliance with applicable law under the alternative compared to the rule, as some of the ETFs whose exemptive relief we will rescind could choose to continue to operate under their exemptive relief. The Commission also believes that the costs to funds associated with rescinding the existing exemptive relief would be minimal, as we anticipate that substantially all ETFs whose relief will be rescinded will be able to continue operating with only minor adjustments, other than being required to develop basket asset policies and procedures.

9. ETFs Organized as UITs

Rule 6c-11 will be available only to ETFs that are organized as open-end funds. As an alternative, we considered including ETFs organized as UITs in the scope of the rule. However, as discussed above in section II.A.1, we believe that the terms and conditions of the existing exemptive orders for UITs are appropriately tailored to address the unique features of the UIT structure.

In addition, as ETFs have greater investment flexibility under the open-end fund structure than the UIT structure, we believe that most new ETFs entering into the market will prefer to operate under the open-end fund structure rather than the UIT structure. No new UIT ETFs have come to market in recent years, and we do not think that there would be significant economic benefits to including UITs in the scope of the rule.

10. Treatment of Leveraged/Inverse ETFs

As discussed in section II.A.3 above, leveraged/inverse ETFs will not be able to rely on final rule 6c-11. As an alternative, we considered permitting leveraged/inverse ETFs to rely on the rule, while maintaining the status quo of existing exemptive orders with respect to the amount of leveraged market exposure that leveraged/inverse ETFs may obtain (i.e., 300% of the return or inverse return).

This alternative could benefit competition among leveraged/inverse ETFs as compared to the baseline, as fund sponsors that currently do not have an exemptive order permitting them to operate this type of ETF could enter the market. As a result, fees for leveraged/inverse ETFs would likely decrease and their assets could increase. However, as discussed in detail in section II.A.3 above, while leveraged/inverse ETFs are structurally and operationally similar to other types of ETFs within the scope of rule 6c-11, we believe it is premature to permit sponsors to form and operate leveraged/inverse ETFs in reliance on the rule without first addressing the investor protection purposes and concerns underlying section 18 of the Act. We therefore believe that the Commission should first complete its broader consideration of the use of derivatives by registered funds before considering allowing leveraged/inverse ETFs to rely on the rule.

V. Paperwork Reduction Act

A. Introduction

Rule 6c-11 will result in new “collection of information” requirements within the meaning of the Paperwork Reduction Act of 1995 (“PRA”). In addition, the amendments to Form N-1A, Form N-8B-2, and Form N-CEN will impact the collection of information burden under those forms and Form S-6. Rule 6c-11 also will impact the current collection of information burden of rule 0-2 under the Act.

The titles for the existing collections of information are: “Form N-1A under the Securities Act of 1933 and under the Investment Company Act of 1940, Registration Statement for Open-End Management Companies” (OMB No. 3235-0307); “Form N-8B-2 under the Investment Company Act of 1940, Registration Statement of Unit Investment Trusts Which are Currently Issuing Securities” (OMB No. 3235-0186); “Form S-6 [17 CFR 239.19], for registration under the Securities Act of 1933 of Unit Investment Trusts registered on Form N-8B-2” (OMB Control No. 3235-0184); “Form N-CEN” (OMB Control No. 3235-0730); and “Rule 0-2 under the Investment Company Act of 1940, General Requirements of Papers and Applications” (OMB Control No. 3235-0636). The title for the new collection of information would be: “Rule 6c-11 under the Investment Company Act of 1940, `Exchange-traded funds.' ” The Commission is submitting these collections of information to the Office of Management and Budget (“OMB”) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number.

We published notice soliciting comments on the collection of information requirements in the 2018 ETF Proposing Release and submitted the proposed collections of information to OMB for review and approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. We received no comments on the collection of information requirements. We discuss below the collection of information burdens associated with rule 6c-11 and its impact on rule 0-2 as well as the amendments to Forms N-1A, N-8B-2, S-6 and N-CEN.

B. Rule 6c-11

Rule 6c-11 will permit ETFs that satisfy certain conditions to operate without first obtaining an exemptive order from the Commission. The rule is designed to create a consistent, transparent, and efficient regulatory framework for such ETFs and facilitate greater competition and innovation among ETFs. The rule attempts to eliminate historical distinctions and conditions that we no longer believe are necessary and thus appropriately level the playing field for open-end ETFs that pursue the same or similar investment strategies.

Rule 6c-11 will require an ETF to disclose certain information on its website, to maintain certain records, and to adopt and implement written policies and procedures governing its constructions of baskets, as well as written policies and procedures that set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders. These requirements are collections of information under the PRA.

The respondents to rule 6c-11 will be ETFs registered as open-end management investment companies other than share class ETFs, leveraged/inverse ETFs, or non-transparent ETFs. This collection will not be mandatory, but will be necessary for those ETFs seeking to operate without individual exemptive orders, including all ETFs whose existing exemptive orders will be rescinded. In the 2018 ETF Proposing Release, we estimated that 1,635 ETFs would likely rely on rule 6c-11. We did not receive public comment on this estimate, but are updating the estimate to 1,735 ETFs to reflect industry data as of December 31, 2018. Information provided to the Commission in connection with staff examinations or investigations will be kept confidential subject to the provisions of applicable law.

1. Website Disclosures

Rule 6c-11 will require an ETF to disclose on its website, each business day, the portfolio holdings that will form the basis for each calculation of NAV per share. The rule will require that the portfolio holdings information contain specified information, including description and amount of each position. Additionally, the rule will require an ETF to disclose on its website: (i) The ETF's NAV per share, market price, and premium or discount, each as of the end of the prior business day; (ii) a tabular chart and line graph showing the ETF's premiums and discounts for the most recently completed calendar year and the most recently completed calendar quarters of the current year (or for the life of the fund if shorter); and (iii) the ETF's median bid-ask spread over the last thirty calendar days.

Rule 6c-11(c)(1)(vi) also will require any ETF whose premium or discount was greater than 2% for more than seven consecutive trading days to post that information on its website, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount. Given the threshold for this requirement, we do not believe that many ETFs will be required to disclose this information on a routine basis. In the 2018 ETF Proposing Release, we estimated that all ETFs will be required to make this disclosure only once in their lifetime. Therefore, we believed that this requirement will impose only initial costs and that there will be no ongoing costs associated with it.

Table 11 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the website disclosures in rule 6c-11. We did not receive public comment on our proposed estimates, but we have revised them as a result of updated industry data and modifications from the proposal. Specifically, we are increasing the initial and ongoing internal and external burden estimates by 50 percent each to account for our modification to the proposal that will require ETFs to disclose median bid-ask spread information on their websites as part of rule 6c-11, partially offset by the elimination of the proposed published basket requirement and the modification to the proposed requirement to disclose portfolio holdings related to timing and presentation of those holdings. In addition, we are revising the estimated wage rates and estimated number of ETFs that will be subject to the rule to reflect updated industry data.

2. Recordkeeping

Rule 6c-11 will require an ETF to preserve and maintain copies of all written authorized participant agreements. Additionally, the rule will require ETFs to maintain records setting forth the following information for each basket exchanged with an authorized participant: (i) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket; (ii) if applicable, identification of the basket as a “custom basket” and a record stating that the custom basket complies with the ETF's custom basket policies and procedures (if applicable); (iii) cash balancing amounts (if any); and (iv) the identity of the authorized participant conducting the transaction. ETFs would have to maintain these records for at least five years, the first two years in an easily accessible place.

Table 12 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the recordkeeping requirements in rule 6c-11. We did not receive public comment on our proposed estimates, but we have revised the estimates as a result of updated industry data. Specifically, we have updated the estimated wage rates and the estimated number of ETFs that will be subject to the rule and thus the recordkeeping requirement. We do not estimate that there will be any initial or ongoing external costs associated with the recordkeeping requirement.

3. Policies and Procedures

As proposed, rule 6c-11 will require ETFs relying on the rule to adopt and implement written policies and procedures that govern the construction of baskets and the process that will be used for the acceptance of basket assets. Additionally, to use custom baskets, an ETF would be required to adopt and implement written policies and procedures setting forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders. These policies and procedures also may include a periodic review requirement in order to ensure that the ETF's custom basket procedures are being consistently followed. Finally, as discussed above, an ETF using custom baskets would be required to maintain records detailing the composition of each custom basket.

Table 13 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with the policies and procedures requirements in rule 6c-11. We did not receive public comment on our proposed estimates, but we are revising the estimates as a result of updated industry data. Specifically, we have updated the estimated wage rates and the estimated number of ETFs that will be subject to the rule and thus the policies and procedures requirement. We do not estimate that there will be any initial or ongoing external costs associated with this requirement.

4. Estimated Total Burden

As summarized in Table 14 above, we estimate that the total hour burdens and time costs associated with rule 6c-11, including the burden associated with website disclosure, recordkeeping, and developing policies and procedures will result in an average aggregate annual burden of 74,466.2 hours and an average aggregate time cost of $24,771,740.10. We also estimate that there are external costs of $1,735,000 associated with this collection of information. Therefore, each ETF will incur an annual burden of approximately 42.92 hours, at an average time cost of approximately $14,277.66, and an external cost of $1,000 to comply with rule 6c-11.

C. Rule 0-2

Section 6(c) of the Act provides the Commission with authority to conditionally or unconditionally exempt persons, securities or transactions from any provision of the Act if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. Rule 0-2 under the Act, entitled “General Requirements of Papers and Applications,” prescribes general instructions for filing an application seeking exemptive relief with the Commission.

As discussed above, rule 6c-11 will permit ETFs that satisfy the conditions of the rule to operate without the need to obtain an exemptive order from the Commission under the Act. Therefore, rule 6c-11 will alleviate some of the burdens associated with rule 0-2 because it will reduce the number of entities that require exemptive relief in order to operate. Based on staff experience, we estimate that approximately one-third (rounded in the 2018 ETF Proposing Release and here to 30%) of the annual burdens associated with rule 0-2 are attributable to ETF applications.

Table 15 above summarizes the proposed estimates included in the 2018 ETF Proposing Release. We did not receive public comment on these estimates, and we have not revised them.

D. Form N-1A

Form N-1A is the registration form used by open-end management investment companies. The respondents to the amendments to Form N-1A are open-end management investment companies registered or registering with the Commission. Compliance with the disclosure requirements of Form N-1A is mandatory for open-end funds (to the extent applicable) including all ETFs organized as open-end funds. Responses to the disclosure requirements are not confidential. We currently estimate for Form N-1A a total hour burden of 1,642,490 burden hours and external cost of $131,139,208.

We are adopting amendments to Form N-1A designed to provide investors who purchase open-end ETF shares in secondary market transactions with tailored information regarding ETFs, including information regarding purchasing and selling shares of ETFs. Specifically, the amendments to Form N-1A will require new narrative disclosures regarding ETF trading and associated costs. In addition, we are requiring an ETF that does not rely on rule 6c-11 to disclose median bid-ask spread information on their websites or in their prospectuses. The amendments also exclude ETFs that provide premium/discount disclosures on their websites in accordance with rule 6c-11 from the premium discount disclosure requirements in Form N-1A. We also are adopting amendments to Form N-1A designed to eliminate certain disclosures for ETFs that are no longer necessary.

Form N-1A generally imposes two types of reporting burdens on investment companies: (i) The burden of preparing and filing the initial registration statement; and (ii) the burden of preparing and filing post-effective amendments to a previously effective registration statement (including post-effective amendments filed pursuant to rule 485(a) or 485(b) under the Securities Act, as applicable).

Table 16 above summarizes the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated Form N-1A as amended. We did not receive public comment on our proposed PRA estimates, but we are revising our estimates as a result of updated industry data and modifications from the proposal. Specifically, we are decreasing the initial and ongoing internal and external burden estimates associated with the bid-ask spread and interactive calculator requirements by 80 percent each to account for our elimination of the hypothetical example and interactive calculator requirements and our decision to apply the prospectus bid-ask spread requirements only to those ETFs that do not comply with the website disclosure requirements in rule 6c-11, partially offset by the additional premium or discount requirements. In addition, we are revising the estimated wage rates and estimated number of ETFs that will be subject to the rule to reflect updated industry data.

As summarized in Table 16 above, we estimate that the total hour burdens and time costs associated with the amendments to Form N-1A will result in an average aggregate annual burden of 19,700 hours at an average aggregate time cost of $6,860,170.40. We do not estimate any change in external cost. Therefore the revised aggregate estimates for Form N-1A, including the new amendments, are 1,662,190 hours and $131,338,208 in external costs.

E. Forms N-8B-2 and S-6

Form N-8B-2 is used by UITs to initially register under the Investment Company Act pursuant to section 8 thereof. UITs are required to file Form S-6 in order to register offerings of securities with the Commission under the Securities Act. As a result, UITs file Form N-8B-2 only once when the UIT is initially created and then use Form S-6 to file all post-effective amendments to their registration statements in order to update their prospectuses. We currently estimate for Form S-6 a total burden of 107,245 hours, with an internal cost burden of approximately $34,163,955, and an external cost burden estimate of $68,108,956. Additionally, we currently estimate for Form N-8B-2 a total burden of 10 hours, with an internal cost burden of approximately $3,360, and an external burden estimate of $10,000.

To assist investors with better understanding the total costs of investing in a UIT ETF, we are adopting disclosure requirements in Form N-8B-2 that mirror those disclosures we are adopting for Form N-1A. All UIT ETFs will be subject to these disclosure requirements. For existing UIT ETFs, the one-time and ongoing costs of complying with the amendments to Form N-8B-2 will accrue on Form S-6.

Table 17 and Table 18 above summarize the proposed PRA estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with Forms S-6 and N-8B-2, respectively. We did not receive public comment on our proposed estimates, but we are revising our estimates as a result of updated industry data and modifications from the proposal. Specifically, we are increasing the initial internal burden estimate for both Form S-6 and Form N-8B-2 by 20 percent to account for the additional premium and discount requirement, partially offset by the modifications to the proposed fee and expense requirements, including those relating to bid-ask spreads. In addition, we are revising the estimated wage rates to reflect updated industry data.

As summarized in Table 17 above, we estimate that the total hour burdens and time costs associated with the amendments to Form S-6 will result in an average aggregate annual burden of 114 hours at an average aggregate time cost of $50,112. We do not estimate any change in external cost. Therefore, the revised aggregate estimates for Form S-6, including the new amendments, are 107,359 hours and $68,108,956 in external costs.

As summarized in Table 18 above, we estimate that the total hour burdens and time costs associated with the amendments affecting Form N-8B-2 will result in an average aggregate annual burden of 18 hours at an average aggregate time cost of $6,264. We do not estimate any change in external cost. Therefore, the revised aggregate estimates for Form N-8B-2, including the new amendments, are 28 hours and $10,000 in external costs.

F. Form N-CEN

As discussed above, Form N-CEN is a structured form that requires registered funds to provide census-type information to the Commission on an annual basis. Today, the Commission is adopting amendments to Form N-CEN to require ETFs to report if they are relying on rule 6c-11. We currently estimate for Form N-CEN total burden hours of 74,425 and external costs of $2,088,176.

Table 19 above summarizes the proposed estimates included in the 2018 ETF Proposing Release and the final PRA estimates associated with Form N-CEN as amended. We did not receive public comment on these estimates, but we are revising our proposed estimates as a result of updated industry data. Specifically, we are revising the estimated number of ETFs that will be subject to the rule to reflect updated industry data. As summarized in Table 19, we estimate that the total hour burdens and time costs associated with the amendments to Form N-CEN will result in an average aggregate annual burden of 173.5 hours. We do not estimate any change in external cost. Therefore the revised aggregate estimates for Form N-CEN, including the new amendments, are 74,598 hours and $2,088,176 in external costs.

VI. Final Regulatory Flexibility Analysis

The Commission has prepared the following Final Regulatory Flexibility Analysis (“FRFA”) in accordance with section 4(a) of the Regulatory Flexibility Act (“RFA”), regarding new rule 6c-11 and amendments to Form N-1A, Form N-8B-2, and Form N-CEN. An Initial Regulatory Flexibility Analysis (“IRFA”) was prepared in accordance with the RFA and included in the 2018 ETF Proposing Release.

A. Need for and Objectives of the Rule and Form Amendments

As described more fully above, rule 6c-11 will allow ETFs that meet the conditions of the rule to form and operate without the expense and delay of obtaining an exemptive order from the Commission. The Commission's objective is to create a consistent, transparent and efficient regulatory framework for ETFs and to facilitate greater competition and innovation among ETFs. The Commission also believes the amendments to Forms N-1A and N-8B-2 will provide useful information to investors who purchase and sell ETF shares in secondary markets. Finally, the Commission believes the amendments to Form N-CEN will allow the Commission to better monitor reliance on rule 6c-11 and will assist the Commission with its accounting, auditing and oversight functions.

All of these requirements are discussed in detail in section II above. The costs and burdens of these requirements on small ETFs are discussed below as well as above in our Economic Analysis and Paperwork Reduction Act Analysis, which discuss the costs and burdens on all ETFs.

B. Significant Issues Raised by Public Comments

In the 2018 ETF Proposing Release, we requested comment on every aspect of the IRFA, including the number of small entities that would be affected by the proposed rule and amendments, the existence or nature of the potential impact of the proposals on small entities discussed in the analysis and how to quantify the impact of the proposed rule and amendments. We also requested comment on the broader impact of the proposed rule and amendments on all relevant entities, regardless of size. After consideration of the comments we received on the proposed rule and amendments, we are adopting the rule and amendments with several modifications that are designed to reduce certain operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful information regarding ETFs. However, none of the modifications were significant to the small-entity cost burden estimates discussed below. Revisions to the estimates are instead based on updated figures regarding the number of small entities impacted by the new rule and amendments and updated estimated wage rates.

C. Small Entities Subject to the Rule

An investment company is a small entity if, together with other investment companies in the same group of related investment companies, it has net assets of $50 million or less as of the end of its most recent fiscal year. Commission staff estimates that, as of December 2018, there are approximately 9 open-end ETFs that may be considered small entities. Commission staff estimates there are no UIT ETFs that would be considered small entities subject to the proposed disclosures for Form N-8B-2.

D. Projected Reporting, Recordkeeping, and Other Compliance Requirements

The new rule and amendments will impact current reporting, recordkeeping and other compliance requirements for ETFs considered small entities.

1. Rule 6c-11

Rule 6c-11 will require an ETF to disclose on its website: (i) Portfolio holding information each business day; (ii) the ETF's current NAV per share, market price, and premium or discount, each as of the end of the prior business day; (iii) if an ETF's premium or discount is greater than 2% for more than seven consecutive trading days, to post that information and a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount; (iv) a table and line graph showing the ETF's premiums and discounts; and (v) the ETF's median bid-ask spread over the last thirty calendar days. The new rule also will require that ETFs preserve and maintain copies of all written authorized participant agreements, as well as records setting forth the following information for each basket exchanged with an authorized participant: (i) Ticker symbol, CUSIP or other identifier, description of holding, quantity of each holding, and percentage weight of each holding composing the basket; (ii) identification of the basket as a “custom basket” and a record stating that the custom basket complies with the ETF's policies and procedures (if applicable); (iii) cash balancing amounts (if any); and (iv) the identity of the authorized participant conducting the transaction. Additionally, rule 6c-11 will require ETFs relying on the rule to adopt and implement written policies and procedures that govern the construction of baskets and the process that will be used for the acceptance of basket assets. ETFs using custom baskets under the rule must adopt custom basket policies and procedures that include certain enumerated requirements.

We estimate that approximately 9 ETFs are small entities that will comply with rule 6c-11, and we do not believe that their costs would differ from other ETFs. As discussed above, we estimate that an ETF will incur an annual burden of approximately 36.97 hours, at an average time cost of approximately $11,758.97, and an external cost of $1,000.00.

As we discuss in greater detail in section IV.C.1 above, we expect rule 6c-11 to have other, generally unquantifiable economic effects. For example, by eliminating the need for ETFs that can rely on the rule to seek an exemptive order from the Commission, the rule will also eliminate certain indirect costs associated with the exemptive application process. Specifically, ETFs that apply for an order forgo potential market opportunities until they receive the order, while others forgo the market opportunity entirely rather than seek an exemptive order because they have concluded that the cost of seeking an exemptive order would exceed the anticipated benefit of the market opportunity. We also believe that the rule could increase competition in the ETF market as a whole, which could also lead to lower fees.

2. Other Disclosure and Reporting Requirements

The amendments to Form N-1A and Form N-8B-2 are designed to provide investors who purchase ETF shares in secondary market transactions with tailored information regarding ETFs, including information regarding costs associated with an investment in ETFs. Specifically, the amendments to Form N-1A will: (i) Require new disclosure regarding ETF trading and associated costs; (ii) require ETFs that are not subject to rule 6c-11 to disclose median bid-ask spread information on their websites or in their prospectuses; and (iii) exclude ETFs that provide premium/discount disclosures in accordance with rule 6c-11 from the premium and discount disclosure requirements in the form. Amendments to Form N-8B-2 mirror proposed disclosures for Form N-1A. In addition, amendments to Form N-CEN will require ETFs to report on Form N-CEN whether they are relying on rule 6c-11 to assist us with monitoring reliance on rule 6c-11 as well with our accounting, auditing and oversight functions, including compliance with the PRA.

All ETFs (including ETFs that do not rely on rule 6c-11) will be subject to the amended Form N-1A or Form N-8B-2 (depending on the ETF's structure as an open-end fund or UIT), and Form N-CEN disclosure and reporting requirements, including ETFs that are small entities. We estimate that 9 ETFs are small entities that will be required to comply with the requirements on Form N-1A and Form N-CEN. We estimate that each ETF, including ETFs that are small entities, will incur a one-time burden of 7 hours, at a time cost of $4,176 to draft and finalize the required disclosure and amend its registration statement. We also estimate that each ETF, including ETFs that are small entities, will incur an ongoing burden of an additional 3 hours, at a time cost of an additional $2,088, to comply with the Form N-1A disclosure requirements. We do not estimate any change to the external costs associated with the amendments to Form N-1A. The total administrative cost for of the Form N-CEN disclosure requirement to ETFs is .1 hours.

As we discuss in greater detail in section IV.C.2 above, we expect the new disclosure amendments to have other, generally unquantifiable economic effects. For example, we believe that the new disclosures will benefit investors by helping them better understand and compare specific funds, potentially resulting in more informed investment decisions, more efficient allocation of investor capital, and greater competition for investor capital among funds. We also believe the amendment to Form N-CEN will allow the Commission to better monitor reliance on rule 6c-11 and assist us with our accounting, auditing, and oversight functions, including compliance with the Paperwork Reduction Act.

E. Agency Action To Minimize Effect on Small Entities

The RFA directs the Commission to consider significant alternatives that would accomplish our stated objectives, while minimizing any significant economic impact on small entities. We considered the following alternatives for small entities in relation to the adopted regulations:

• Exempting ETFs that are small entities from the disclosure, reporting or recordkeeping requirements, to account for resources available to small entities;
• establishing different disclosure, reporting or recordkeeping requirements or different frequency of these requirements, to account for resources available to small entities;
• clarifying, consolidating, or simplifying the compliance requirements under the amendments for small entities; and
• using performance rather than design standards.

We do not believe that exempting any subset of ETFs, including small entities, from rule 6c-11 or the related form amendments will permit us to achieve our stated objectives. Nor do we believe establishing different disclosure, reporting or recordkeeping requirements or different frequency of these requirements for small entities would permit us to achieve our stated objectives. Similarly, we do not believe that we can establish simplified or consolidated compliance requirements for small entities under the rule without compromising our objectives. As discussed above, the conditions necessary to rely on rule 6c-11 and the reporting, recordkeeping and disclosure requirements are designed to provide investor protection benefits, including, among other things, tailored information regarding ETFs, including information regarding costs associated with an investment in ETFs. These benefits should apply to investors in smaller funds as well as investors in larger funds. Similarly, we do not believe it would be in the interest of investors to exempt small ETFs from the disclosure and reporting requirements or to exempt small ETFs from the recordkeeping requirements. We believe that all ETF investors, including investors in small ETFs, will benefit from disclosure and reporting requirements that permit them to make investment choices that better match their risk tolerances. Additionally, the current disclosure requirements for reports on Form N-1A and Form N-8B-2 do not distinguish between small entities and other funds.

Finally, we believe that rule 6c-11 and related disclosure and reporting requirements appropriately use a combination of performance and design standards. Rule 6c-11 provides ETFs that satisfy the requirements of the rule with exemptions from certain provisions of the Act necessary for ETFs to operate. Because the provisions of the Act from which ETFs would be exempt provide important investor and market protections, the conditions of the rule must be specifically designed to ensure that these investor and market protections are maintained. However, where we believe that flexibility is beneficial, we adopted performance-based standards that provide a regulatory framework, rather than prescriptive requirements, to give funds the opportunity to adopt policies and procedures tailored to their specific needs without raising investor or market protection concerns.

VII. Statutory Authority

The Commission is adopting new rule 6c-11 pursuant to the authority set forth in sections 6(c), 22(c), and 38(a) of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-22(c), and 80a-37(a)]. The Commission is adopting amendments to registration Forms N-1A and N-CSR under the authority set forth in sections 6, 7(a), 10 and 19(a) of the Securities Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and sections 8(b), 24(a), and 30 of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-24(a), and 80a-29]. The Commission is adopting amendments to registration Form N-8B-2 under the authority set forth in section 8(b) and 38(a) of the Investment Company Act [15 U.S.C. 80a-8(b) and 80a-37(a)]. The Commission is adopting amendments to Form N-CEN and Form N-PORT under the authority set forth sections 8(b), 30(a), and 38(a) of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-29(a), and 80a-37(a)]. The Commission is adopting amendments to Regulation S-X under the authority set forth in sections 7, 8, 10, and 19 of the Securities Act [15 U.S.C. 77g, 77h, 77j, 77s], and sections 8(b), 30(a), 31, and 38(a) of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-29(a), 80a-30, and 80a-37(a)]. The Commission is providing relief in Section II.G, permitting ETFs relying on rule 6c-11 to enter into fund of funds arrangements, pursuant to the authority set forth in sections 6(c), 12(d)(1)(J) and 17(b).

List of Subjects

17 CFR Part 210

• Accounting
• Investment companies
• Reporting and recordkeeping requirements
• Securities

17 CFR Part 239

• Reporting and recordkeeping requirements
• Securities

17 CFR Parts 270 and 274

• Investment companies
• Reporting and recordkeeping requirements
• Securities

Text of Rules and Form Amendments

Correction

In final rule FR Doc. 2016-25349, published in the issue of Friday, November 18, 2016 (81 FR 81870), make the following correction:

On page 82019, in the second column, remove amendatory instruction 23 for § 232.401, which was to be effective August 1, 2019, but was delayed until May 1, 2020, in a rule published on December 14, 2017 (82 FR 58731).

For reasons set out in the preamble, title 17, chapter II of the Code of Federal Regulations is amended as follows:

PART 210—FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

1. The authority citation for part 210 continues to read as follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j-1, 78l, 78m, 78n, 78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30, 80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, and sec. 102(c), Pub. L. 112-106, 126 Stat. 310 (2012), unless otherwise noted.

2. Amend § 210.12-14 by removing the phrase in footnote 1 “(5) balance at close of period as shown in Column E” and adding in its place “(5) balance at close of period as shown in Column F”.

PART 239—FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

3. The authority citation for part 239 continues to read, in part, as follows:

Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 77sss, 78c, 78 l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78 ll, 78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 80a-29, 80a-30, and 80a-37; and sec. 107 Pub. L. 112-106, 126 Stat. 312, unless otherwise noted.

PART 270—RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

4. The authority citation for part 270 is revised by adding a sectional authority for § 270.6c-11 in numerical order to read in part as follows:

Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.

Section 270.6c-11 is also issued under 15 U.S.C. 80a-6(c) and 80a-37(a).

5. Section 270.6c-11 is added to read as follows:

PART 274—FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

6. The general authority citation for part 274 continues to read as follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.

7. Form N-1A (referenced in §§ 239.15A and 274.11A) is amended as follows:

a. In General Instruction A, revising the definition of “Exchange-Traded Fund.”

b. In General Instruction A, revising the definition of “Market Price.”

c. In General Instruction B.4.(a), removing the phrases “[ 17 CFR 230.400-230.497]” and “rules 480-485 and 495-497 of Regulation C” and adding in their place “[17 CFR 230.400-230.498]” and “rules 480-485 and 495-498 of Regulation C.”

d. In General Instruction B.4.(d), removing the phrase “Regulation S-T [ 17 CFR 232.10-232.903]” and adding in its place “Regulation S-T [17 CFR 232.10-232.501].”

e. In Item 3, revising the first paragraph under the heading “Fees and Expenses of the Fund”.

f. Revising Instruction 1(e) of Item 3, Item 6(c), and Items 11(a)(1) and 11(g).

g. In instruction 4(b) to Item 13, removing the sentence “If a change in the methodology for determining the ratio of expenses to average net assets results from applying paragraph 2(g) of rule 6-07, explain in a note that the ratio reflects fees paid with brokerage commissions and fees reduced in connection with specific agreements only for periods ending after September 1, 1995.”

h. Revising Item 27(b)(7)(iv), Instruction 1(e)(ii) of Item 27(d)(1), and Item 27(d)(3).

The additions and revisions read as follows:

Note:

The text of Form N-1A does not, and this amendment will not, appear in the Code of Federal Regulations.

Form N-1A

GENERAL INSTRUCTIONS

A. Definitions

“Exchange-Traded Fund” means a Fund or Class, the shares of which are listed and traded on a national securities exchange, and that has formed and operates under an exemptive order granted by the Commission or in reliance on rule 6c-11 [17 CFR 270.6c-11] under the Investment Company Act.

“Market Price” has the same meaning as in rule 6c-11 [17 CFR 270.6c-11] under the Investment Company Act.

Item 3. Risk/Return Summary: Fee Table

Fees and Expenses of the Fund

This table describes the fees and expenses that you may pay if you buy, hold, and sell shares of the Fund. You may pay other fees, such as brokerage commissions and other fees to financial intermediaries, which are not reflected in the tables and examples below. You may qualify for sales charge discounts if you and your family invest, or agree to invest in the future, at least $[ ] in [name of fund family] funds. More information about these and other discounts is available from your financial intermediary and in [identify section heading and page number] of the Fund's prospectus and [identify section heading and page number] of the Fund's statement of additional information.

Instructions

1. General

(e) If the Fund is an Exchange-Traded Fund, exclude any fees charged for the purchase and redemption of the Fund's creation units.

Item 6. Purchase and Sale of Fund Shares

(c) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund, the Fund may omit the information required by paragraphs (a) and (b) of this Item and must disclose:

(1) That Individual Fund shares may only be bought and sold in the secondary market through a broker or dealer at a market price;

(2) That because ETF shares trade at market prices rather than net asset value, shares may trade at a price greater than net asset value (premium) or less than net asset value (discount);

(3) That an investor may incur costs attributable to the difference between the highest price a buyer is willing to pay to purchase shares of the Fund (bid) and the lowest price a seller is willing to accept for shares of the Fund (ask) when buying or selling shares in the secondary market (the “bid-ask spread”);

(4) If applicable, how to access recent information, including information on the Fund's net asset value, Market Price, premiums and discounts, and bid-ask spreads, on the Exchange-Traded Fund's website; and

(5) The median bid-ask spread for the Fund's most recent fiscal year.

Instructions

1. A Fund may omit the information required by paragraph (c)(5) of this Item if it satisfies the requirements of paragraph (c)(1)(v) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(v)] under the Investment Company Act.

2. An Exchange-Traded Fund that had its initial listing on a national securities exchange at or before the beginning of the most recently completed fiscal year must include the median bid-ask spread for the Fund's most recent fiscal year. For an Exchange-Traded Fund that had an initial listing after the beginning of the most recently completed fiscal year, explain that the Exchange-Traded Fund did not have a sufficient trading history to report trading information and related costs. Information should be based on the most recently completed fiscal year end.

3. Bid-Ask Spread (Median). Calculate the median bid-ask spread by dividing the difference between the national best bid and national best offer by the mid-point of the national best bid and national best offer as of the end of each ten-second interval throughout each trading day of the Exchange-Traded Fund's most recent fiscal year. Once the bid-ask spread for each ten-second interval throughout the fiscal year is determined, sort the spreads from lowest to highest. If there is an odd number of spread intervals, then the median is the middle number. If there is an even number of spread intervals, then the median is the average between the two middle numbers. Express the spread as a percentage, rounded to the nearest hundredth percent.

4. A Fund may combine the information required by Item 6(c)(4) into the information required by Item 1(b)(1) and Rule 498(b)(1)(v) [17 CFR 230.498(b)(1)(v)] under the Securities Act.

Item 11. Shareholder Information

(a) Pricing of Fund Shares. Describe the procedures for pricing the Fund's shares, including:

(1) An explanation that the price of Fund shares is based on the Fund's net asset value and the method used to value Fund shares (market price, fair value, or amortized cost); except that if the Fund is an Exchange-Traded Fund, an explanation that the price of Fund shares is based on a market price.

(g) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund:

(1) The Fund may omit from the prospectus the information required by Items 11(a)(2), (b), and (c).

(2) Provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund's net asset value and the number of days it was less than the Fund's net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)-(iv) and (c)(1)(vi) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and (c)(1)(vi)] under the Investment Company Act.

Item 27. Financial Statements

(b) * * *

(7) * * *

(iv) Provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund's net asset value and the number of days it was less than the Fund's net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)-(iv) and (c)(1)(vi) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and (c)(1)(vi)] under the Investment Company Act.

(d) * * *

(1) * * *

Instructions

1. General.

(e) If the fund is an Exchange-Traded Fund:

(ii) Exclude any fees charged for the purchase and redemption of the Fund's creation units.

(3) * * *

Instruction

A Money Market Fund will omit the statement required by Item 27(d)(3) and instead provide a statement that (i) the Money Market Fund files its complete schedule of portfolio holdings with the Commission each month on Form N-MFP; (ii) the Money Market Fund's reports on Form N-MFP are available on the Commission's website at http://www.sec.gov;; and (iii) the Money Market Fund makes portfolio holdings information available to shareholders on its website.

8. Form N-8B-2 (referenced in §§ 239.16 and 274.12) is amended as follows:

a. In the General Instructions, revising the definitions of “Exchange-Traded Fund” and “Market Price”.

b. In Item 13, adding paragraphs (h), (i), and (j).

c. In Item IX, adding an undesignated paragraph following the heading.

The additions and revisions read as follows:

Note:

The text of Form N-8B-2 does not, and this amendment will not, appear in the Code of Federal Regulations.

Form N-8B-2

GENERAL INSTRUCTIONS FOR FORM N-8B-2

Definitions

Exchange-Traded Fund (ETF): The term “Exchange-Traded Fund” means a Fund or Class, the shares of which are listed and traded on a national securities exchange, and that has formed and operates under an exemptive order granted by the Commission.

Market Price. The term “Market Price” has the same meaning as in rule 6c-11 [17 CFR 270.6c-11] under the Investment Company Act.

Information Concerning Loads, Fees, Charges, and Expenses

13.

(h) If the trust is an Exchange-Traded Fund, furnish an explanation indicating that an ETF investor may pay additional fees not described by any other item in this form, such as brokerage commissions and other fees to financial intermediaries.

(i) If the trust is an Exchange-Traded Fund, furnish the disclosures and information set forth in Item 6(c) of Form N-1A [referenced in 17 CFR 274.11A]. Provide information specific to the trust as necessary, utilizing the ETF-specific methodology set forth in the Instructions to Form N-1A Item 6(c). The Fund may omit the information required by Item 6(c)(5) of Form N-1A if it satisfies the requirements of paragraph (c)(1)(v) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(v)] under the Investment Company Act.

(j) If the trust is an Exchange-Traded Fund, provide a table showing the number of days the Market Price of the Fund shares was greater than the Fund's net asset value and the number of days it was less than the Fund's net asset value (i.e., premium or discount) for the most recently completed calendar year, and the most recently completed calendar quarters since that year (or the life of the Fund, if shorter). The Fund may omit the information required by this paragraph if it satisfies the requirements of paragraphs (c)(1)(ii)-(iv) and (c)(1)(vi) of Rule 6c-11 [17 CFR 270.6c-11(c)(1)(ii)-(iv) and (c)(1)(vi)] under the Investment Company Act.

IX

EXHIBITS

Subject to General Instruction 2(d) regarding incorporation by reference and rule 483 under the Securities Act, file the exhibits listed below as part of the registration statement. Letter or number the exhibits in the sequence indicated, unless otherwise required by rule 483. Reflect any exhibit incorporated by reference in the list below and identify the previously filed document containing the incorporated material.

9. Amend Form N-CEN (referenced in § 274.101) as follows:

a. Adding Item C.7.k.

b. Revising the Instruction to Item E.2.

The addition and revision read as follows:

Note:

The text of Form N-CEN does not, and this amendment will not, appear in the Code of Federal Regulations.

FORM N-CEN

ANNUAL REPORT FOR REGISTERED INVESTMENT COMPANIES

Part C. Additional Questions for Management Investment Companies

* * *

Item C.7.

* * *

k. Rule 6(c)-11 (17 CFR 270.6c-11):__

* * *

Part E. Additional Questions for Exchange-Traded Funds and Exchange-Traded Managed Funds

* * *

Item E.2.

* * *

Instruction. The term “authorized participant” means a member or participant of a clearing agency registered with the Commission, which has a written agreement with the Exchange-Traded Fund or Exchange-Traded Managed Fund or one of its service providers that allows the authorized participant to place orders for the purchase and redemption of creation units.

* * *

10. Amend Form N-CSR (referenced in § 274.128) as follows:

a. In General Instruction D, remove the phrase “Item 12(a)(1)” and add in its place “Item 13(a)(1)”.

b. In the instruction to Item 13, remove the phrase “Instruction to Item 11” and add in its place “Instruction to Item 13”.

11. Amend Form N-PORT (referenced in § 274.150) by revising the first paragraph of General Instruction F to read as follows:

Note:

The text of Form N-PORT does not, and this amendment will not, appear in the Code of Federal Regulations.

FORM N-PORT

MONTHLY PORTFOLIO INVESTMENTS REPORT

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GENERAL INSTRUCTIONS

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F. Public Availability

With the exception of the non-public information discussed below, the information reported on Form N-PORT for the third month of each Fund's fiscal quarter will be made publicly available upon filing.