ETF issuers pen letter urging SEC return to ‘first-to-file’ approvals

The current system for approving exchange-traded funds (ETFs) relies heavily on a “first-to-file” approach. This means that the first company to submit a complete and compliant application for a specific type of ETF generally receives approval, even if other companies subsequently submit similar applications. While this system has been in place for a considerable time, ETF issuers are increasingly vocal in their criticism, arguing it actively hinders innovation and rewards a lack of proactive effort.

Their central argument revolves around the idea that the first-to-file system discourages innovation because it creates a significant incentive to be the first to market, regardless of the quality or originality of the proposed ETF. Companies may rush applications, potentially sacrificing thoroughness and innovation in favor of speed. This could lead to a market flooded with similar, somewhat inferior products, all vying for a piece of the same investor pie, rather than a diverse landscape of truly distinct investment options.

Furthermore, the argument extends to the accusation that the system rewards “lazy behavior.” Companies that meticulously research and develop truly unique and potentially superior ETF offerings might find themselves losing out to competitors who simply submitted their application first, regardless of the relative merits of their product. This creates a perverse incentive structure; diligence and innovative thinking might be punished, while rapid filing, regardless of quality, might be rewarded.

The current system potentially stifles innovation by favoring swift action over superior product development. This concern is further compounded by the fact that a large portion of ETFs often track very similar indices or assets, leading to a level of market saturation that might not serve investors’ best interests. A shift away from the first-to-file approach could potentially encourage a more thoughtful and innovative approach to ETF development, resulting in a more diverse and potentially beneficial selection for investors. However, the potential drawbacks of such a shift would need careful consideration to avoid disrupting the existing market dynamics.