While technically a true "money market" ETF doesn't exist yet, there continues to be activity and interest in the shortest and safest segment of the fixed-income ETF market, particularly in the "collateral" segment. We learned at our Bond Fund Symposium last month that Invesco recently received an SEC "no-action" letter which allows its Powershares Treasury Collateral Portfolio (CLTL) to receive favorable "haircut" treatment as collateral for exchanges. The SEC's letter, entitled, "Re: Invesco PowerShares Capital Management LLC - Net Capital Treatment of PowerShares Treasury Collateral Portfolio," explains, "In your March 1, 2018 letter on behalf of Invesco PowerShares Capital Management LLC, you request written assurance that the staff of the Division of Trading and Markets of the U.S. Securities and Exchange Commission will not recommend enforcement action to the Commission under section 15(c) of the Securities Exchange Act of 1934 and Rule l5c3-1 thereunder. In particular, you request that the Division not recommend enforcement action if broker-dealers with positions in the PowerShares Treasury Collateral Portfolio ('CLTL') apply the haircut deduction in paragraph (c)(2)(vi)(D)(l) of Rule l5c3-1 (currently 2%) for the portion of the position eligible for redemption and the highest haircut deduction in paragraph (c)(2)(vi)(A) of Rule 15c3-l (currently 6%) for the portion of the position not eligible for redemption." (See our Feb. 6, 2017 News, "New Invesco Treasury Collateral ETF.")
Justo Gonzalez, Invesco's Head of Liquidity Credit Research, tells us, "This is groundbreaking in the collateral pledge area." ETFs previously had been lumped together with a 15% haircut, but the request asked the SEC to "look through" to the underlying investments. He adds, "A custody bank was asking for [the product].... We're targeting uncleared -- like FCMs (futures commission merchants) -- and cleared -- like CME and central counterparties -- channels." He emphasizes that it's not a money fund and not a cash equivalent but it should hold interest beyond the collateral demand. The ETF has an expense ratio of 8 bps and a current yield to maturity of 1.84%. (See Invesco's fund info here and see its ETF.com Award for "Best New U.S. Fixed-Income ETF" here.)
The original request, written by Morgan, Lewis & Bockius LLP's Mark Fitterman, explains, "On behalf of our client Invesco PowerShares Capital Management LLC, we are writing to request assurance that the staff of the Division of Trading and Markets of the Securities and Exchange Commission will not recommend enforcement action to the Commission under Section 15(c) of the Securities Exchange Act of 1934, and Rule 15c3-1 thereunder ('Net Capital Rule'), if broker-dealers with long and short positions in the PowerShares Treasury Collateral Portfolio ('CLTL'), an exchange traded fund ('ETF') whose portfolio consists solely of cash and/or U.S. Treasury fixed rate bills, notes and bonds with a remaining term to final maturity of 12 months or less, take a haircut deduction under paragraph (c)(2)(vi)(D)(1) of Rule 15c3-1 (currently 2%) of the greater of the market value of the broker-dealer's long or short position, for the portion of the position eligible for redemption {currently in increments of 10,000 shares, such as 10,000 shares, 20,000 shares, etc.), and the highest haircut deduction in paragraph (c)(2}(vi)(A) of Rule 15c3-1 (currently 6%) of the greater of the market value of the broker-dealer's long or short position, for the portion of the position not eligible for redemption (currently less than 10,000 shares)."
He explains, "CLTL is an ETF developed to serve as an efficient collateral pledge to cover margin requirements or non-margin collateral. It seeks investment results that generally correspond (before fees and expenses) to the price and yield of the ICE U.S. Treasury Short Term Bond Index. It generally invests at least 80% of its total assets in the components of the Underlying Index, which is designed to measure the performance of U.S. Treasury Obligations with a maximum remaining term to maturity of 12 months. It invests only in cash and/or U.S. Treasury fixed rate bills, notes and bonds with a remaining term to final maturity of 12 months or less."
The request continues, "CLTL is an open-end management investment company registered under the Investment Company Act of 1940. CLTL offers and redeems shares only with Authorized Participants and only in creation unit size (in increments of 10,000 shares). CLTL offers and redeems shares on the same day (if creation or redemption orders are received before 12:00 p.m. Eastern time) or the next business day (if creation or redemption orders are received on or after 12:00 p.m. Eastern time) at the net asset value ('NAV') next calculated in creation units of 10,000 shares in exchange for the deposit or delivery of a basket of securities and/or cash. The Bank of New York Mellon, the fund's custodian, calculates CLTL's NAV twice per business day."
It adds, "Because CLTL was created, among other things, to offer an efficient collateral pledge to cover margin requirements or non-margin collateral, applying a normal ETF net capital haircut of 10-15% would make CLTL uncompetitive for this purpose compared to other possible pledge vehicles, such as Treasury securities with a maturity of less than 12 months (which currently carry a maximum haircut of 1.0%) or money market funds (which, as noted above, currently carry a haircut of 2%). However, since CLTL tracks the ICE U.S. Treasury Short Term Bond Index, and the underlying index consists of cash and/or U.S. Treasury fixed rate bills, notes and bonds with a remaining term to final maturity of 12 months or less, CLTL is expected to deliver similar market and risk attributes as direct investments in Treasury securities that comprise the underlying index. As a result, we believe that a haircut closer to the haircut currently applicable to short-term Treasury securities would better reflect the market risk and liquidity associated with CLTL."
The SEC's response, written by Michael Macchiaroli of the Division of Trading and Markets, tells us, "Pursuant to Rule l5c3-l, a broker-dealer computing its net capital is required to deduct the percentages specified in paragraphs (c)(2)(vi) and (vii) of the rule (or the deductions set forth in Appendix A to Rule l5c3-l) from the market value of all securities, money market instruments, or options in the proprietary or other accounts of the broker-dealer."
It explains, "Although CLTL is not a money market fund (which has a haircut of 2%), you represent that this ETF shares certain characteristics of a money market fund, because it meets certain of Rule 2a-7's conditions applicable to money market funds. In particular, you represent that: (1) CLTL is an open-end management investment company registered under the 1940 Act that issues redeemable securities at net asset value; (2) that the CLTL portfolio consists solely of cash and/or U.S. Treasury fixed rate bills, notes and bonds with a remaining term to final maturity of 12 months or less; and (3) that the U.S. government securities comprising the portfolio are all eligible securities under paragraph (a)(11) of Rule 2a-7."
The SEC writes, "CLTL's share price on the secondary market has fluctuated by less than 2% since the ETF began trading in January 2017.... Finally, as stated above, there are currently approximately only 50 authorized participants, who can redeem shares of CLTL in 10,000 share increments.... `Based on the facts and representations set forth in your letter (and without necessarily agreeing with your conclusions and analysis), Division staff will not recommend enforcement action to the Commission under section 15 of the Exchange Act and Rule 15c3-1 thereunder if broker-dealers take the haircut deduction in paragraph (c)(2)(vi)(D)(l) of Rule l5c3-l (currently 2%) on the greater of the market value of the portion of the broker-dealer's long or short position in units of CLTL shares eligible for redemption."
They add, "In addition, based on your representation that CLTL is an ETF that only holds cash and/or U.S. Treasury fixed rate bills, notes and bonds (and without necessarily agreeing with your conclusions and analysis), Division staff will not recommend enforcement action to the Commission under section 15 of the Exchange Act and Rule 15c3-1 thereunder if broker-dealers take the highest haircut deduction in paragraph (c)(2)(vi)(A) of Rule 15c3-l (currently 6%) on the greater of the market value of the portion of the broker-dealer's long or short position in units of CLTL shares not eligible for redemption."
For more on "cash-like" ETFs, see these Crane Data News stories (or see our Bond Fund Intelligence product, which tracks ETFs): BlackRock Collateral Trust ETF to Own Govt MMFs (5/4/16), TT on Goldman 0-1 Year ETF (10/28/16), New Goldman Treasury Cash ETF (9/19/16), Invesco ETF of Govt MMFs (7/1/16), and ETF Trends on Short-Term Bond ETFs (4/1/14).
