SEC Rejects ETF As IIV No Substitute For Transparency

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As companies get more and more inventive with their actively managed ETFs, it was only a matter of time before someone tried to complete the circle and create an ETF-mutual fund hybrid, fortunately, the Securities and Exchange Commission has turned them down. Precidian ETFs Trust applied to create a new line of ETFs that would only disclose positions at the end of the quarter, just as mutual funds do, but would provide traders with an Intraday Interactive Value (IIV) to use instead, but the SEC says the proposal has too many defects to get the go ahead.

SEC: Precidian wants the best of both worlds

From the SEC’s point of view, one of the key differences between ETFs and other open-end funds is that they primarily trade on secondary markets, and they have to show that there is a mechanism in place that will allow investors to trade in ETF share at or near NAV in order to get SEC approval. For most ETFs, the mechanism is the combination of creation/redemption of new units with brokers and portfolio transparency. If the ETF price strays too far from the NAV it creates an arbitrage opportunity that naturally pushes it back in place.

Precidian wanted to issue a non-transparent ETF to avoid the disadvantages that come with telling everyone what you’re doing in real time. Instead, a third-party would calculate the ETF’s IIV and distribute it every fifteen seconds, with full disclosure every quarter.

IIV is no substitute for transparency

“Market makers calculate their own NAV per share of the ETF with proprietary algorithms that use an ETF’s daily portfolio disclosure and available pricing information about the assets held in the ETF’s portfolio,” says the SEC decision. “They generally use the IIV, if at all, as a secondary or tertiary check on the values that their proprietary algorithms generate.”

If you didn’t catch the tone, the SEC is unimpressed with Precidian’s plan, and it has a laundry list of reasons why. Right off the bat, IIV data is stale. Fifteen seconds is probably good enough for a retail investors, but it’s far too slow for a broker. There’s also the fact that IIV doesn’t have any meaningful standards (since no one bases their business on it), and it’s based on market quotes instead of fair value. That means you can’t really take a position on the proposed Precidian ETFs, since you don’t know the underlying, but it also means that the price might include illiquid assets whose latest quotes aren’t very meaningful.

The possibility of IIV inaccuracies may also increase tracking errors and prevent market makers from creating effective hedging strategies. In a stressed market, market makers would have to decide how much they trust the IIV, and are likely to respond by setting very wide spreads and could stop trading in the non-transparent ETFs altogether.

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