The expiration of Vanguard’s 30-year-old ETF patent – which reportedly helped the firm’s clients add billions of dollars in gains – is being greeted tentatively by companies unsure over how the government will react to efforts to use the patent’s structure to create new funds.
The patent that permitted Vanguard to create ETF shares from mutual funds expired on 16 May.
The firm was given an exemption in 2000 from certain regulations in the Investment Company Act of 1940 in 2000, allowing it to issue ETF shares as a class of shares for its existing mutual funds.
Vanguard would go on to patent the structure in 2003, and according to Morningstar, create dozens of ETFs that hold hundreds of billions of dollars in assets.
Despite the success of the model – Bloomberg reported this week that $100bn in added gains went to clients as a result – firms are not rushing in.
It appears that, so far, only the US arm of Australia’s Perpetual Group has filed to roll out ETF share classes for its actively managed mutual funds. Its application is for actively-managed funds, which differs from Vanguard’s focus on index funds.
“While the Securities and Exchange Commission’s (SEC) reaction to Perpetual’s application may be a bellwether, it may not be,” Aisha Hunt, a lawyer at Principal and Kelley Hunt & Charles, which specialises in the Investment Act of 1940, told etf.com.
“We have clients doing due diligence on applying for an exemption but without more clarity from the SEC, it is hard to move forward.”
The structure permitted Vanguard to easily create and launch ETFs from existing mutual funds. The new ETFs were able to benefit from the existing infrastructure and economy of scale that its mutual funds had.
“It is the best of both worlds,” Hunt noted.
Since Vanguard originally received its exemption, the SEC has had concerns about whether the structure unfairly has ETF shareholders subsidising mutual fund shareholders.
The SEC wants all shareholders to be treated equally, and to make sure ETF holders are not penalised with fees for the benefit of mutual fund shareholders. This means any SEC approval would likely come with stipulations to ensure fairness.
The alternatives to Vanguard’s structure are either launching a new ETF, which then cannot benefit from the enormous pool of assets currently in mutual funds, or converting a mutual fund to an ETF.
“That is what we call a ‘heavy lift’ administratively,” Hunt said, because of the number of issues it raises, such as combining the multiple share classes many mutual funds have into one ETF and ensuring all the mutual fund investors have brokers they can trade the ETF through, among others.
“Whether opening a share class is easier than that, however, depends substantially on both the fund involved, [and] also on what conditions the SEC puts on the exemption,” Hunt added.
This article was originally published on ETF.com
