A New Vision: Regulators Push ETFs to Modern Era

January 15, 2020
Regulators in the US, Europe, and Asia are paving the way for new types of ETFs, which could keep the ETF boom alive for years to come.

With assets in exchange traded funds (ETF) growing to over $6 trillion globally at the end of 2019, it might seem hard to imagine how ETFs have further room to grow. However, separate decisions by regulators to ease ETF registration and permit the issuance of several new fund breeds — ranging from so-called semi-transparent funds in the US to comingled listed and unlisted shares in an ETF structure in Ireland — are likely to keep the boom alive for years to come.

Beyond new ETF product types, global regulators continue to assess liquidity and counterparty risks relating to the ETF market and whether further mitigants are needed. So far, they've stopped short of proposing any additional limits. New European rules about settlement failure could prompt changes to market structure and product design. And in the Asia Pacific region, regulators are positioning ETFs for further growth and scale. Here, we break down key regulatory developments in the US, Europe, and Asia Pacific regions.

US leads the regulatory easing

In the US, we expect to see a new crop of managers enter the ETF space in 2020, thanks to two decisions handed down by the Securities and Exchange Commission (SEC).

  1. Adoption of Rule 6c-11 (dubbed the ETF rule) will have far-reaching implications. Ever since the first US ETF was born in 1993 (the S&P 500 SPDR), the SEC required ETF sponsors to go through a lengthy and costly process to obtain what it called “exemptive relief” from the 1940 Investment Company Act (’40 Act).

    However, in 2019, the SEC publicly recognized the benefits of ETFs to US investors and sought to enshrine these products with their own regulatory framework, rather than continue to shoe-horn approvals under regulations intended for mutual funds. In 2020, ETFs that qualify for the rule (e.g., ‘40 Act open-ended RICs) can simply file a registration statement and comply with the applicable ETF regulations.

    The adoption of the ETF rule helped to modernize ETFs and create a more even playing field for managers. A key element of the regulation permits and standardizes the use of custom baskets for all ETF issuers. ETFs publish a basket of securities each day, usually based on an index or a pro-rata slice of the fund’s holdings, to inform authorized participants (APs) what securities to deliver to the fund when creating ETF shares, or what securities they should expect to receive when redeeming. Custom baskets allow ETF managers to create baskets for specific create or redeem orders which can help improve the fund’s tax efficiency and liquidity. However, only a subset of managers had SEC approval to use these types of baskets. This provision in the ETF should allow for a more consistent approach and oversight in how custom baskets are used.

    Additional provisions in the rule did away with the requirement of an intraday indicative valuation (IIV) and clarifies ETF disclosure policies of fund holdings and secondary market trading metrics.
  2. The second major development focused on active ETFs and gave a boost to a new class of ETF structures that will not have to disclose their current holdings to the public on a daily basis. This change had long been sought by active managers concerned about tipping off the market as to the implementation of their investment strategies.

    A number of firms had proposed various approaches to changing the disclosure requirements of ETF holdings, including Precidian, the New York Stock Exchange (NYSE), Fidelity, Blue Tractor, and T. Rowe Price. Precidian's ActiveShares SM ETFs became the first to win SEC approval in late spring, followed by other so-called proxy-based, non-transparent active ETFs.

Following these moves by the SEC, the listing exchanges (NYSE, NASDAQ, and CBOE) all sought rule changes that would make listing ETFs more consistent with the new ETF rule. ETFs that qualify for 6c-11 will automatically fall under the exchanges' generic listing standards, remove the IIV from listing requirements, and reduce the necessary seed capital to list an ETF to $100,000.

With the new disclosure policies available and the ETF rule making it easier to launch products, managers will have more choices available to enter the ETF market. Active firms that have been on the sidelines now have a new path to protect their IP and take advantage of the lower cost and tax-efficient ETF wrapper.

Europe gauges the risks

Across the Atlantic, European regulators haven't yet accepted the SEC's liberal views on transparency. Instead, their focus has been on the upcoming implementation of the Central Securities Depository Regulation (CSDR). ETFs are likely to be heavily affected when the regulation starts imposing what is termed "settlement discipline" later this year, penalizing settlement failures with two types of fines.

The reason ETFs are likely to be the first to suffer is that ETFs often have a high rate of settlement failure. That's because of a structural mismatch between the ETF and the underlying securities: the ETF shares may settle in two days (T+2), while the investments underlying the ETF shares may require five or more days to deliver (T+5).

Two things may happen in 2020 as a result. Increased costs to ETFs for failures could be passed on to investors. Alternatively, the market may be prompted to change the way the system operates, particularly the way in which APs, who create and redeem shares. These impacts may be felt by an ETF holding European securities, regardless of the funds’ domicile.

Another regulation that is likely to impact the European market is the Central Bank of Ireland’s (CBI) decision to allow sponsors to comingle ETFs and unlisted (mutual fund) share classes in the same UCITS structure. With comingled assets, the ruling promotes economies of scale, attracts investors who prefer investing via the mutual fund wrapper, and may succeed in attracting new institutional investors that have minimum fund size thresholds for investment. A similar rule exists in Luxembourg, which is the second largest ETF domicile in Europe market. In the US, funds with comingled mutual fund and ETF share classes are only offered by Vanguard as they have a business method patent on this structure. [Notably, the SEC did not include this type of ETF in rule 6c-11 and will still require these structures to seek exemptive relief.  In Asia, Hong Kong’s funds regulator added this share class structure in early 2019.]

Finally, European regulators continue to assess ETF liquidity and interconnectivity of the market participants. Key themes within this area are the risk of contagion, how much attention should regulators pay to the interconnectivity of the ETF eco-system, and the ability for investors to redeem if there is an event which impacts the secondary market. ETFs are already regulated by a triumvirate of EU legislation: UCITS, MiFID II, and EMIR to some extent. The question now is: are more ETF specific rules needed?

Asia Pacific looks to standardize

Regulators in Asia Pacific are focused on positioning the ETF industry in their respective markets for further growth and scalability. Many of the new enhancements have emphasized the importance of standardization in the market and aligning the region with international best practices.


Since the middle of 2018, the onshore ETF market in China has grown rapidly to exceed $70 billion in assets as of the end of November 2019.1 Even with the recent outsized growth, ETFs are still a nascent industry in China and only accounts for approximately seven percent of total investment fund AUM. But a number of reforms are likely to bring about a shift in assets from the traditional wealth management channels into public funds, with ETFs particularly well positioned to capitalize on this reallocation of assets because of their flexible, transparent, and low-cost structure.

Hong Kong

Hong Kong is also spearheading several initiatives focused on enhancing liquidity for ETFs listed in the territory, including launching the Designated Specialist program, which allowed a broader group of global market makers access to provide liquidity for Hong Kong ETFs.

In July, the Hong Kong Exchange (HKEX) launched a pilot program to provide an ETF buy-in exemption for market makers. This program provides these institutions one extra day on top of the standard settlement cycle to cover any short positions resulting from their market making activities. In December, the Hong Kong exchange announced a new ETF-specific spread table, which is scheduled to be introduced in late February 2020. The new spread table, as well as a new set of market making obligations, will align Hong Kong with international standards.

In Hong Kong, expect to see the first ETF issuers take advantage of the Hong Kong Exchange being added to the international central securities depository (ICSD) ETF settlement model. This enhancement allows a streamlined settlement process for UCITS ETFs that are cross-listed into Hong Kong, while significantly reducing the risk of settlement failure of the ETF shares.

Issuers are planning to bring a wide range of new products to the market. Supporting product design, the Securities & Futures Commission (SFC) recently announced streamlined eligibility requirements for ETFs adopting a master-feeder structure. This structure allows Hong Kong domiciled ETFs to invest into a single master fund, which would need to be regulated in a recognized jurisdiction, have a minimum asset size of $1 billion, a track record of more than five years, along with other requirements.

Global ETF issuers should watch this development as it could provide an efficient and cost-effective way to enable distribution into Hong Kong and the broader Asian market.


Transparency is also under the microscope with the funds regulator in Australia (ASIC) pausing approvals of new actively managed ETFs in July 2019 due to concerns related to market making. The review was focused on the internal market making function where the ETF issuer acts in this capacity in Australia. ASIC published their findings in December 2019, including recommendations for compliance, oversight, and ensuring information barriers are in place and functioning properly. ASIC will continue to monitor international ETF developments in these areas and they have re-opened the door for new actively managed ETF listings.

What's next?

2019 was a momentous year for ETF regulation. Rule makers across the globe acknowledged the importance of ETFs to retail and institutional investors alike and brought standardization to much of the global market. 2020 will see many of these rules take effect, with impacts across product development, regulatory compliance, and operations. Further rules may be coming as analysis of liquidity, product structures, and transparency all remain at the forefront of the regulatory agenda.

This article was originally published in the 2020 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead.


Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. Pursuant to information regarding the provision of applicable services or products by BBH, please note the following: Brown Brothers Harriman Fund Administration Services (Ireland) Limited and Brown Brothers Harriman Trustee Services (Ireland) Limited are regulated by the Central Bank of Ireland, Brown Brothers Harriman Investor Services Limited is authorised and regulated by the Financial Conduct Authority, Brown Brothers Harriman (Luxembourg) S.C.A is regulated by the Commission de Surveillance du Secteur Financier. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2020. All rights reserved.  IS-05804-2020-01-09

This browser is not fully supported by our public website and may not display or function as expected for this reason. Please note, the Infuse Portal and BBH client applications fully support the IE 11 browser.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com

captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction