SEC Alert – SEC Issues Staff Letter Detailing Concerns Related to Cryptocurrency ETFs and Mutual Funds
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On January 17, 2018, the Director of the Division of Investment Management at the U.S. Securities and Exchange Commission (“SEC”) issued a public letter detailing the SEC’s concerns with green-lighting cryptocurrency exchange-traded funds (“ETFs”) and mutual funds. This public letter comes after a recent string of proposed ETF filings were withdrawn by their sponsors at the request of the SEC.
Fund professionals have been attempting to get a bitcoin ETF listed for quite a while now. The Winklevoss brothers first began working on a bitcoin-backed ETF back in 2013, however, after four years of working with the SEC to iron out the details of the ETF, the SEC ultimately rejected their proposal. This formal rejection temporarily cooled the interest of fund professionals in the possibility of cryptocurrency ETFs, but the fervor was reignited in late 2017 following the approval of the CME and CBOE futures markets for Bitcoin. Fund professionals viewed those approvals as an indicator that regulators were warming to the application of traditional financial instruments to the cryptocurrency world. In response to this perceived regulatory thawing, many funds proposed new ETFs tied to the futures markets and filed their proposals with the SEC.
Then, in early to mid-January 2018, most of these funds began pulling their proposed ETFs, citing SEC staff concerns. These withdrawals left the market clamoring for more information regarding the SEC’s specific concerns about these ETFs. Thus, the SEC’s staff letter provides the market with much-desired insight into the SEC’s hesitation with regards to cryptocurrency ETFs.
The SEC’s letter clearly shows that the SEC is still very much in an information-gathering stage. Rather than taking a firm stance on any issues, the letter simply raises questions that need to be answered before the SEC can make a decision on cryptocurrency ETF or other proposals. In particular, the SEC staff highlighted five main concerns with cryptocurrency-related financial products: valuation, liquidity, custody, arbitrage and market manipulation. Questions related to these concerns included: Would funds have the information necessary to adequately value cryptocurrencies or cryptocurrency-related products, given their volatility, the fragmentation and general lack of regulation of underlying cryptocurrency markets, and the nascent state and current trading volume in the cryptocurrency futures markets? What steps would funds investing in cryptocurrencies or cryptocurrency-related products take to assure that they would have sufficiently liquid assets to meet redemptions daily? How would a fund intend to validate existence, exclusive ownership and software functionality of private cryptocurrency keys and other ownership records?
It is important to note that the SEC staff was not entirely dismissive of the possibility of a cryptocurrency ETF ever being approved. In fact, the SEC specifically called for an open dialogue with fund professionals, stating “[a]s we have in the past, the Division stands ready to engage in dialogue with sponsors regarding the potential development of these funds.” However, given the amount of information called for by the SEC staff, we do not expect to see an ETF approval coming very soon.
A full version of the letter is available here.
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