April 17, 2014

SEC to Consider Exemptive Requests for Certain Actively Managed Exchange Traded Funds (ETFs)

Division of Investment Management to lift the moratorium on exemptive requests for actively managed ETFs investing in derivatives; new chapter signaled in the development of ETF industry.

On December 6, Norm Champ, the director of the Securities and Exchange Commission's (SEC's) Division of Investment Management (the Division), announced that the Division would no longer defer consideration of exemptive requests for actively managed exchange traded funds (ETFs) that intend to invest in derivatives. The announcement was made as part of a speech at the American Law Institute Continuing Legal Education Group's Conference on Investment Adviser Regulation: Legal and Compliance Forum on Institutional Advisory Services.[1]

SEC to Consider Exemptive Requests When Two Conditions Are Met

In March 2010, the SEC announced that the staff would conduct a review of mutual funds, ETFs, and other investment companies that use derivatives.[2] For the almost three years since the review was announced, the Division has suspended consideration of exemptive requests under the Investment Company Act of 1940 for actively managed ETFs that invest in derivatives. In fact, the Division has required requests for active ETF relief to affirmatively state that the ETF will not invest in options contracts, futures contracts, or swaps. This policy created an unusual regulatory dichotomy. Actively managed ETFs that were granted SEC relief prior to 2010 were, in some cases, permitted to make extensive use of derivatives; those that came after were not.

In August 2011, the SEC issued a Concept Release and solicited public comment on derivative use by investment companies, including ETFs.[3] In his speech, Director Champ stated that, although the SEC is still reviewing the issues raised in the Concept Release, the Division will now consider exemptive requests relating to actively managed ETFs that use derivatives. He noted that any exemptive request must include the following representations:

  • That the ETF's board periodically will review and approve the ETF's use of derivatives and how the ETF's investment adviser assesses and manages risk with respect to the ETF's use of derivatives
  • That the ETF's disclosure of its use of derivatives in its offering documents and periodic reports is consistent with relevant SEC and staff guidance

Director Champ noted, however, that the Division will continue to defer consideration of exemptive requests relating to leveraged and inverse ETFs.


Director Champ's statements clearly signal the beginning of a new chapter in the development of the ETF industry. By eliminating the moratorium on derivatives in active ETFs (other than leveraged and inverse ETFs), the staff has significantly expanded the realm of potential ETF products and strategies. This is likely to prompt ETF sponsors to seek amendments to their existing SEC exemptive orders to take advantage of the additional portfolio flexibility. This also may spur new entrants into the ETF market, such as managers of alternative asset classes or strategies that use derivatives to help achieve their investment objectives. While Director Champ's comments signify that the staff is becoming increasingly comfortable with most ETFs, the full import of these comments will become clearer during the coming months as the Division responds to exemptive requests and clarifies the permissible scope of derivative use by actively managed ETFs. It is also worth noting that Director Champ did not address any issues relating to the listing of actively managed ETFs, including the requirements of the SEC's Division of Trading and Markets with respect to such listings. The continued development of these requirements will also shape the market for active ETFs.

[1]. View Director Champ's speech here.

[2]. View the SEC's announcement here.

[3]. View the Concept Release here.

Copyright © 2014 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

About the Author


Richard F. Morris is a partner in Morgan Lewis's Investment Management and Securities Industry Practice. Mr. Morris's practice focuses on representing exchange-traded funds (ETFs), mutual funds, and investment advisers. He has more than 20 years of experience as an asset management lawyer and has been at the forefront of ETF representation since 2000, when he helped launch the iShares family of ETFs.

Mr. Morris counsels clients on the full range of legal, regulatory, and compliance issues applicable to ETFs, investment companies, and registered investment...


About the Author


Kaitlyn L. Piper is an associate in Morgan Lewis's Investment Management Practice. The lawyers in our Investment Management Practice focus on regulatory issues affecting broker-dealers, investment advisers, futures clearing merchants, CTAs, swap dealers and security-based swap dealers, securities, futures and swap exchanges, crossing platforms, and clearinghouses and public and private funds.


We provide a full range of legal services to clients in the financial services industry in the United States and abroad. Our investment management clients include nine of the ten largest money managers listed by Institutional Investor, over 500 mutual funds, venture capital, private equity, and hedge funds, the largest business development company in the U.S., banks and trust companies, insurance companies, public and private pension funds, fiduciaries and consultants, transfer agents, fund administrators, and other businesses in the investment management...


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