Direct answer: SEC Rule 6c-11, effective in March 2020, was the most significant regulatory change for ETFs in decades: it allowed most ETFs to operate without custom exemptive relief, standardized the in-kind creation/redemption process, permitted custom baskets (non-pro-rata creation/redemption), and enabled non-transparent active ETFs for the first time. For investors, these changes have primarily resulted in lower costs and a broader range of active strategies available in ETF form.
What Changed: ETF Regulation and Structure
Key Takeaways
- Rule 6c-11 standardized ETF operation under a single rule rather than requiring each ETF sponsor to obtain individual exemptive orders from the SEC, reducing launch costs and time for new ETFs.
- Non-transparent active ETFs (approved 2019 to 2020) allow active managers to conceal their portfolios from daily disclosure, enabling strategies that could not be offered as ETFs before without revealing tradeable positions to arbitrageurs.
- Custom basket relief under Rule 6c-11 allows ETFs to create and redeem shares using baskets that differ from the fund's actual portfolio composition, improving tax efficiency and operational flexibility for complex portfolios.
- The ETF market has grown from approximately $3 trillion in 2019 to over $9 trillion in assets under management by 2024, with Rule 6c-11 cited as a catalyst for new entrants and innovation.
- Direct indexing (personalized index ownership of individual stocks) has emerged as an alternative to ETFs for high-net-worth investors who want index-like exposure with tax-loss harvesting at the individual security level.
What Rule 6c-11 Changed
Before Rule 6c-11, each ETF sponsor had to obtain a custom exemptive order from the SEC to operate, a process that could take years. The rule streamlined this by creating a single regulatory framework that most ETFs could self-certify into. Key operational changes: ETFs can now use custom baskets (the set of securities delivered in creation/redemption can differ from the fund's exact composition), full disclosure requirements were codified (a portfolio transparency standard), and the rule provided a framework for non-transparent active ETFs with approved alternative portfolio disclosure mechanisms.
Non-Transparent Active ETFs: What They Mean for Investors
Traditional ETFs disclose their full portfolio holdings daily, which enables arbitrage that keeps the market price close to NAV but also reveals the portfolio to front-runners. Non-transparent active ETFs (T-REX, Fidelity ActiveShares, NYSE-AMS approaches) use proxy portfolios or other mechanisms to give authorized participants the information they need for arbitrage without revealing the full portfolio. For investors, the practical difference is modest: these ETFs trade with wider bid-ask spreads than fully transparent ETFs because arbitrageurs have less information, and their NAV premium/discount can be larger. For active managers, they can now offer active strategies in ETF form.
ETF Tax Efficiency: The In-Kind Creation/Redemption Advantage
The primary tax efficiency advantage of ETFs (versus mutual funds) comes from in-kind creation/redemption: when an institutional investor redeems shares, the ETF can deliver low-cost-basis securities in-kind rather than selling them for cash, avoiding taxable capital gains. This mechanism has become more efficient with custom basket flexibility. For investors in taxable accounts, this means equity index ETFs typically distribute no capital gains (unlike many active mutual funds), making them substantially more tax-efficient. Rule 6c-11's custom basket provisions enhanced this efficiency for complex portfolios.
What Has Changed for Retail ETF Investors
For retail investors, the practical impact of ETF regulatory changes has been: lower fees (competition from new entrants under streamlined regulation has pushed costs down), broader product availability (more ETF choices including non-transparent active strategies), and the gradual convergence of mutual fund and ETF structures (some fund families now offer dual-class funds with an ETF and mutual fund share class on the same portfolio). The fundamental ETF investment experience (buy and sell on exchange, pay expense ratio, receive dividends, track an index or strategy) is unchanged.
Frequently Asked Questions
What is the difference between an ETF and an ETP?
An ETF (Exchange-Traded Fund) is a type of exchange-traded product (ETP) registered under the Investment Company Act of 1940. Other ETPs include ETNs (Exchange-Traded Notes, which are debt securities with return linked to an index, not a fund) and ETCs (Exchange-Traded Commodities, which in the U.S. are typically structured as commodity pools or grantor trusts). ETNs carry issuer credit risk (if the issuing bank fails, the note may not be honored); ETFs do not, because they hold actual assets.
How has direct indexing changed the competitive landscape for ETFs?
Direct indexing (owning the individual stocks in an index directly, rather than through a fund) has become accessible to investors with $100,000 to $500,000 (down from $5 million to $10 million minimums) due to fractional share trading and lower technology costs. For taxable accounts, direct indexing provides ETF-like index exposure with the ability to tax-loss harvest at the individual security level, potentially generating significant tax alpha versus an index ETF. ETF providers have responded by offering direct indexing products (Vanguard, Fidelity, Schwab all offer versions), blurring the line between ETF and direct ownership.
Are ETF expense ratios going to zero?
Several major index ETFs (Fidelity ZERO funds) already have 0% expense ratios; these generate revenue through securities lending and capturing portfolio management efficiencies. While the trend toward lower costs is structural, most ETFs will retain some expense ratio because portfolio management, custody, and compliance have real costs. The practical floor for most index ETFs is 0.03% to 0.05%, where the remaining costs are genuine operational expenses rather than profit margin.