© Copyright 2018 by K&L Gates LLP. All rights reserved.

Stacy L. Fuller, Partner, K&L Gates LLPAlyssa B. Sherman, Associate, K&L Gates LLP

Exchange-Traded Funds (ETFs)

2019 Washington D.C. Investment Management Conference

OVERVIEW Industry Background ETF Mechanics New ETF Rule and Implications Periodically Disclosed ETFs

INDUSTRY BACKGROUND

71 88 106157 237 314 433 621 542

794 1,012 1,0621,350

1,7012,009 2,130

2,550

3,420 3,391

4,045

95 118 130 134 169 221381

673844

925

1099

13701445

15361661

18451971

21162241 2303

0

500

1000

1500

2000

2500

0

500

1000

1500

2000

2500

3000

3500

4000

4500

U.S. ETP Assets & Number of ETPs by Year # of ETPsAssets ($bn)

Source: ETFGI data sourced from ETF/ETP sponsors, exchanges, regulatory filings, Thomson Reuters/Lipper, Bloomberg, publicly available sources, and data generated in-house.

INDUSTRY BACKGROUND

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$4,710

$107

Global ETF/ETP Assets in USD (in Billions)

Index ETFs Active ETFs

Source: ETFGI data sourced from ETF/ETP sponsors, exchanges, regulatory filings, Thomson Reuters/Lipper, Bloomberg, publicly available sources,and data generated in-house. Data as of December 31, 2018.

INDUSTRY BACKGROUND ETF Popularity Lower expenses

enhanced returns Portfolio transparency Tax efficiencies Investor protections

Intra-day liquidity Market timing

Hurdles to Entry Broad-based passive

market saturated Active ETF Issues

Smaller market share Underperformance Portfolio transparency

concerns Front-running and

reverse engineering

Periodically disclosed ETFs

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MUTUAL FUND MECHANICS

PrivateInvestors Brokers Fund

Cash

Shares

Transfer Agent

ETF MECHANICSPrimary MarketSecondary Market

PrivateInvestors Brokers Stock

Exchange

Authorized Participants

ETF

Subscription in kind –The AP delivers a basket of

securities and the ETF issues a unit of shares (“Creation Units”)

Redemption in kind –The AP delivers Creation

Units and the ETF pays the redemption proceeds with a

basket of securities

Offer for Shares

Secondary Market

Shares

Securities

Cash

SharesShares

Market M

akersBid for Shares

Transfer Agent

Custodian

Distributor

ETF MECHANICS ETFs sell and redeem their shares at NAV

directly to unaffiliated broker-dealers with whom the ETF has entered into an agreement (“Authorized Participants” or “APs”)

These “primary market” transactions occur in large blocks of (usually, at least 25,000) shares called “Creation Units”

ETF MECHANICS Authorized Participants (who purchase Creation

Units) sell individual ETF shares on the stock exchange

Authorized Participants purchase and redeem Creation Units in-kind in exchange for the “Creation Basket” Pro rata slice requirement Exceptions to pro rata slice requirement

Early exemptive orders provide more flexibility

ETF MECHANICS ETF structure enables arbitrage between market price and NAV

1. Buy ETF, sell index portfolio short2. Redeem ETF at NAV in exchange for

index portfolio3. Close short by selling index portfolio at

profitOR

1. Buy ETF shares in the open market2. Redeem block of ETF shares at NAV

NAV

Market Price at premium to NAV

Market Price at discount to

NAV

NAV

1. Buy index portfolio, sell ETF short2. Deliver index portfolio to create ETF at

NAV3. Close short by selling ETF at profit

OR1. Create ETF shares at NAV2. Sell them for a profit in the open

market

This allows the ETF shares to trade close to NAV The NAV does not change; the market price does

NEW ETF RULE AND IMPLICATIONS On September 25, 2019, the SEC approved

Rule 6c-11 under the Investment Company Act of 1940 (the “Rule”) and related amendments to Form N-1A (“Disclosure Amendments”)

The Rule will rescind previously-issued exemptive orders of ETFs that are “permitted to rely” on it one year from its effective date, which is December 23, 2019.

NEW ETF RULE AND IMPLICATIONS Permitted to rely on

the Rule: Index-based ETFs Fully transparent

active ETFs

Not permitted to rely on the Rule: ETFs organized as

UITs Leveraged and inverse

ETFs Multi-class ETFs Periodically disclosed

active ETFs Allow the “vast majority” of ETFs to operate

without obtaining an SEC exemptive order

NEW ETF RULE AND IMPLICATIONS “Exchange-traded fund” – a registered open-end

management company: that issues (and redeems) creation units to (and from)

authorized participants in exchange for a basket and a cash balancing

amount if any; and whose shares are listed on a national securities

exchange and traded at market-determined prices.

OVERVIEW OF THE ETF RULE Condition #1: Each business day, an ETF must

disclose certain information prominently on its website, which is publicly available and free of charge: Full portfolio transparency

OVERVIEW OF THE ETF RULE Condition #1: Each business day, an ETF must

disclose certain information prominently on its website, which is publicly available and free of charge: Full portfolio transparency Bid-ask spread information

OVERVIEW OF THE ETF RULE Condition #1: Each business day, an ETF must

disclose certain information prominently on its website, which is publicly available and free of charge: Full portfolio transparency Bid-ask spread information Daily premium/discount calculation

OVERVIEW OF THE ETF RULE Condition #1: Each business day, an ETF must

disclose certain information prominently on its website, which is publicly available and free of charge: Full portfolio transparency Bid-ask spread information Daily premium/discount information Premium/discount table of frequency

OVERVIEW OF THE ETF RULE

TABLE 1: SAMPLE PREMIUM AND DISCOUNT TABLE

OVERVIEW OF THE ETF RULE Condition #1: Each business day, an ETF must

disclose certain information prominently on its website, which is publicly available and free of charge: Full portfolio transparency Bid-ask spread information Daily premium/discount information Premium/discount table of frequency Premium/discount line graph of amounts

OVERVIEW OF THE ETF RULE

200150

100

50

0-50

-100

-150

-200Jan 2018 Apr 2018 Jul 2018 Oct 2018 Jan 2019

Prem

ium

or D

isco

unt (

bps)

FIGURE 1: SAMPLE PREMIUM AND

DISCOUNT LINE GRAPH

OVERVIEW OF THE ETF RULE Condition #2: ETF calculates NAV only once per

day

OVERVIEW OF THE ETF RULE Condition #3: Policies and procedures that

govern the construction of baskets and the process that will be used for the acceptance of baskets If the ETF utilizes a custom basket, these written

procedures must: Be more detailed; and Identify adviser employees responsible for basket-by-basket

Recordkeeping required for all AP agreements and baskets

OVERVIEW OF THE ETF RULE Condition #4: ETF cannot be leveraged

EXEMPTIONS PROVIDED BY THE RULE Section 22(d) and Rule 22c-1 Exemption permits secondary market trading of

ETF shares at market-determined prices

EXEMPTIONS PROVIDED BY THE RULE Section 17(a) Exemption permits APs to deposit and receive

in-kind baskets in creation unit transactions if only affiliation with ETF comes from share ownership

EXEMPTIONS PROVIDED BY THE RULE Section 22(e) Exemption permits delivery of foreign

investments as soon as practicable but in no event later than 15 days after the tender to the ETF

CHANGES MADE BY THE RULE TO THE CURRENT ETF REGULATORY SCHEME No minimum creation unit size More detailed premium-discount disclosure and

new bid-ask disclosure on website Basket flexibility No intraday indicative value (“IIV”) required

CHANGES MADE BY THE RULE TO THE CURRENT ETF REGULATORY SCHEME All ETF shares deemed to be redeemable

securities of open-end investment companies Certain exemptions under Exchange Act become

available to ETFs for secondary market transactions in ETF shares

SEC issued exemptive order granting other necessary relief for secondary market transactions in ETF shares

PERIODICALLY DISCLOSED ETFSTransparency substitute Tax efficiency Arbitrage mechanism“A close tie between market price and NAV per share of

the ETF is the foundation for why the prices at which retail investors buy and sell ETF shares are similar to the

prices at which Authorized Participants are able to buy and redeem shares directly from the ETF at NAV.”

Statistical arbitrage Market volatility

Misleading baskets Front-running/free-

riding

Role in 6(c) findings “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]”

PERIODICALLY DISCLOSED ETFS Value Arbitrage Proposal

Portfolio transparency provided to confidential agent of blind trust for bona fide arbitrage

Verified Intraday Indicative Value published every second throughout the trading day

Concomitant ability of AP contemporaneously to purchase and sell both creation units of ETFand the ETF’s portfolio securities

Reflief granted to Precidian and ActiveShares ETFs Available for license by active

managers

Hedge Portfolio Proposals Partial portfolio transparency

provided through public disclosure of partially overlapping hedge portfolio

Tracking error, daily deviation and other statistical correlations provided for portfolio and hedge portfolios

Applicants: T. Rowe Price; Fidelity; NYSE Arca/Natixis; Blue Tractor

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QUESTIONS