As money managers push to bring private credit to public markets, investors in a new breed of exchange-traded fund will want to know how they can get out when markets are stressed. Their early plans aren't resolving doubts.
The Securities and Exchange Commission is set to review three recent filings for private-credit ETFs, including a proposed partnership between Apollo Global Management Inc. and State Street Corp.
Securities law experts say the lack of information on how retail investors can easily withdraw money from funds loaded with illiquid assets will likely prompt scrutiny, while consumer advocates are already drawing comparisons to securities that imploded.
"The lack of details in the filing is pretty staggering," said Elisabeth de Fontenay, a law professor at Duke University. "It feels like a cut-and-paste job from your usual ETF filing."
The SEC could reject or approve the plans in the next few months, with the caveat that the agency is likely to experience policy shifts regardless of who wins the U.S. presidential election.
A denial from the regulator risks drawing another legal challenge by industry. A green light would open the floodgates for similar funds, adding fuel to the $10 trillion U.S. ETF market and letting the average investor tap opportunities often reserved for institutions and the wealthy.
But first, the firms must clear hurdles that will include sharp scrutiny of liquidity, conflicts of interest and disclosures.
Regulators' concerns about the rapid growth of the broader private fund sector, which exceeds the size of the U.S. bank industry, could also cloud the picture for the State Street-Apollo ETF and other proposals by Virtus Investment Partners Inc. and BondBloxx.
The SEC, Apollo, State Street and Virtus declined to comment. BondBloxx didn't respond to requests for comment.
The novelty of private-credit ETFs and the big liquidity question have alarmed investor advocates. In a letter to the SEC, the Consumer Federation of America described a hypothetical scenario where stressed markets lead to liquidity strains on the State Street-Apollo ETF.
The group made comparisons to the implosion of the auction-rate securities market during the 2008 financial crisis.
In that case, investors had depended on investment banks to provide liquidity for the market. But when the banks experienced their own liquidity crises, they retreated and auctions collapsed, Micah Hauptman, the CFA's investor protection director, wrote in the Oct. 4 letter.
"What had previously been considered highly liquid, 'cash like' assets suddenly became illiquid, causing significant financial hardship for tens of thousands of investors," he said.
15% Cap
The planned State Street-Apollo ETF will have to comply with SEC rules that impose a 15% cap on illiquid investments in a fund's net assets. But the agreement between the two firms isn't public, making it hard to determine how they will ensure the ETF doesn't go past the limit, Hauptman said.
At least 80% of the fund's net assets would be in a portfolio of investment grade debt securities, including those from private credit investments sourced by Apollo, based on the filing.
That's an indication that State Street and Apollo intend to treat the private credit portions of the fund as though they were liquid, according to SEC observers.
"That's not the way we usually define liquidity," Duke's de Fontenay said.
