(Bloomberg) — Outside the Fontainebleau Hotel in Miami, Florida last week, dozens of drones moved slowly through the night sky, projecting the Bitcoin symbol far and wide above one of the biggest ETF rallies of the year.
But within the annual ExcHAnGE conference, industry insiders were fixated on an event that could prove a much bigger deal for the $8.4 trillion business than the long-awaited launch of spot Bitcoin ETFs: Regulatory approval of new class structures shares.
It's something of a mystery compared to the boom-crash-boom of crypto — no one has ever launched drones to celebrate different classes of investors like Grayscale Investments did for its $23 billion Bitcoin fund. But the question of whether the U.S. Securities and Exchange Commission would allow the firms to replicate the fund model used exclusively by Vanguard Group for more than two years decades was the hot topic among the industry professionals in attendance.
For good reason. This structure would allow an ETF to be listed as a share class of a broader mutual fund—effectively bringing the famed exchange-traded fund's tax efficiency to the entire vehicle. Vanguard's patent preventing copycat funds expired in May. Now, the only hurdle is SEC approval.
“While Bitcoin ETFs are currently dominating the headlines, those products are merely a sideshow compared to the potential impact of the multi-class structure,” said Nate Geraci, president of The ETF Store, an advisory firm. .
Heavyweights including Fidelity, Morgan Stanley and Dimensional Fund Advisors have them all asked the regulator for permission to use the model, which could transfer the tax advantages of ETFs to trillions of dollars in mutual fund assets. It's a tantalizing prospect for an industry looking for the next wave of growth after quadrupling in size over the past decade. There are already more than 3,300 ETFs listed in the US, and SEC approval could open the gates to thousands more.
“If the SEC allows share classes, especially for active mutual funds, I think it's huge for the ETF industry,” said Michael Venuto, chief investment officer at Tidal Financial Group. “There are 10,000 mutual funds. The idea that 20% of them would add an ETF share class doesn't seem crazy to me.”
Mutual funds have largely shed assets in recent years as ETFs have grown in popularity. As a result, legacy asset managers have found themselves fighting for a piece of the increasingly saturated ETF market. In Miami, each conference attendee received a gift bag filled with swag from T. Rowe Price and Matthews Asia. The earth itself bore the logo of the Hermes Federation.
Against this backdrop, Lara Crigger of data provider VettaFi says it's clear why mutual fund managers want the multi-share class structure.
“If they can launch ETFs as a share class of their existing mutual funds, then the mutual fund can use the ETF's creation/redemption mechanism to get rid of the shares in its stock portfolio with gains higher potentials,” Crigger said. Fund investors will get the added tax efficiency without having to switch to another product, she said.
There is no deadline by which the SEC must make a decision, and there is no guarantee that the watchdog will enable further use of the facility. Since its approval of Vanguard years ago, regulators have expressed concern about conflicts of interest between mutual fund and ETF investors.
Conference participants also speculated that the SEC may want to address proposed rule changes around “price rate” — a liquidity mechanism based on a fund's structure and objective — before acting on applications to mimic the Vanguard approach.
The launchers are likely to keep up the pressure. While ETFs have won the popularity contest among investors for years now, mutual funds retain some advantages, such as a key role in the US pension system. Being able to issue an ETF share class of an existing mutual fund instead of completely changing the structure would give an issuer the best of both worlds, according to Douglas Yones of the New York Stock Exchange.
“If the SEC gives its blessing to hybrid structures, there are not hundreds of ETFs that could enter the market,” said Yones, head of ETF products at the NYSE. “There are thousands.”