The Investment Company Institute is questioning the “purpose and benefit” of a Nasdaq proposal to implement a new order type, pegged to the intraday net asset value of an exchange-traded fund.
“As we understand it, the proposed new order type would allow market participants to enter a buy or sell order at an ETF’s published INAV, plus or minus any specified offset,” ICI Deputy General Counsel Dorothy Donohue noted in a November 8 letter to the Securities and Exchange Commission. “The order would be priced as of the time it was entered; that price would update as the INAV changed, and the order would execute when or if an offer (for a buy order) or bid (for a sell order) was available at the established price.”
The potential problems, according to the ICI letter:
1. The INAV would not be a ‘fair value’ of the securities inside the ETF. The calculation uses the last sale price of each security. But for securities that don’t trade frequently, that “may not be reflective of the security’s value.”
2. The INAV may not be a fair estimate of the overall value of the ETF. That’s because some components “may trade at a consistent premium or discount, which is not taken into account.’’
ICI, which represents the interests of mutual fund, money market fund and exchange-traded fund operators, is recommending that the commission carefully consider whether an INAV pegged order provides benefits to the marketplace that outweigh potential risks.
Nasdaq did not respond to several requests to comment on the ICI letter.
In its letter, ICI noted that the Nasdaq proposal indicates ETF sponsors “routinely deal with investors that have been subject to inferior executions and that the vast majority of these complaints result from people using market orders where the prevailing market price either does not correlate to the fund’s value, or the quoted size does not meet the demand of the order.”
ICI counters that the use of limit orders would generally address these concerns. ”Moreover, the problems with executions typically occur in ETFs that would not be covered by the new order type, i.e. those based on fixed income and non-US equity securities.
The Nasdaq proposal states that if an INAV data feed temporarily stopped being disseminated or was compromised, the use of the order type would be suspended for that ETF, and INAV orders already in the system would be cancelled.
ICI questioned what constitutes a compromised INAV, and asked, in its letter, how Nasdaq would determine whether to suspend new orders and cancel existing ones.
Among ICI’s other stated concerns:
• Would Nasdaq propose to audit the calculation of each INAV to ensure it is accurate, or will an INAV only be considered compromised if its varies by some predetermined amount or percentage from the ETF market price?
• How would market participants be notified that their orders have been cancelled due to a problem with the INAV calculation?
• How frequently could this happen?
Finally ICI warns that if calculation agents and pricing vendors could be held liable by investors using INAV pegged orders for inaccuracies in INAVs, “it is possible, if not likely, that the firms would cease providing such services” or make it impossible or more costly to distribute new values.
A spokesperson for the SEC said the commission could not comment on the proposal until comments have been received.
