The SEC, comprised of four Commissioners, does have the ability to review these decisions. SEC Commissioner Hester Peirce tweeted they plan to do just that but have not yet disclosed when.
In response to these rejections, the SEC states:
“the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.”
Valuation
The SEC articulates concern over the issue of policies and procedures a fund would need to put in place in order to value their products:
Mutual funds and ETFs must value their assets on each business day in order to strike a net asset value (“NAV”). 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?
Liquidity
When looking at the liquidity of an ETF, the SEC is concerned with how it applies to the new fund liquidity rule, rule 22e-4, which states funds must implement a liquidity risk management program:
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 funds classify the liquidity of cryptocurrency and cryptocurrency-related products for purposes of the new fund liquidity rule? How would a fund prepare for the possibility that funds investing in cryptocurrency-related futures could grow to represent a substantial portion of the cryptocurrency-related futures markets? How would such a development impact the fund’s portfolio management and liquidity analysis?
Custody
In regards to custody, the SEC points to the 1940 Act which is in place to make sure registered funds can hold onto their holdings:
How would a fund intend to validate existence, exclusive ownership and software functionality of private cryptocurrency keys and other ownership records? To what extent would cybersecurity threats or the potential for hacks on digital wallets impact the safekeeping of fund assets under the 1940 Act?
Arbitrage (for ETFs)
According to SEC guidelines in place to protect investors, the market price of an ETF should not deviate too far from it's NAV:
In light of the fragmentation, volatility and trading volume of the cryptocurrency marketplace, how would ETFs comply with this term of their orders? How would the shutdown of a cryptocurrency exchange affect the market price or arbitrage mechanism?
Potential Manipulation and Other Risks
The SEC says cryptocurrency markets leave investors vulnerable to fraud and manipulation, specifically pointing to the news media:
How would you weigh these concerns in considering whether offering a proposed fund is appropriate for the wide range of investors, including retail investors, who might invest in the fund? Would investors, including retail investors, have sufficient information to consider any cryptocurrency-related funds and to understand the risks?
