‘Complex Challenges’ Ahead as SEC Nears Dual-Share-Class Approval

The Investment Company Institute outlined the operational, regulatory and technological considerations—and the potential challenges—for asset managers preparing to launch exchange-traded-fund share classes within existing mutual fund portfolios, describing them as a “significant modernization in the asset management industry.”

The ICI’s publication, “ETF Share Class Operational Considerations,” comes on the heels of the Securities and Exchange Commission’s September 29 indication of its intent to grant exemptive relief permitting the dual-share-class structure. According to the ICI, at least 75 asset managers have filed seeking the relief necessary to offer both mutual funds and ETF share classes under the same portfolio.

The report underscored that, while the dual-share-class model could improve efficiency and investor choice, it will introduce “potentially complex challenges for intermediaries.” Among these are technological integration, compliance with the SEC’s Regulation Best Interest, and revenue model changes.

To prepare for the structural shift, the ICI convened in April a series of working groups focused on intermediary considerations, investor experience, reporting requirements, interclass exchange mechanics and technology. The groups were composed of asset managers, service providers and intermediaries.

The ICI cautioned that “each organization is unique, with its own set of circumstances, and must make independent determinations in considering these matters,” stressing that the document is not a set of recommendations, but “a consolidated overview of the many areas that industry members might consider.”

The ICI’s working groups highlighted that “most platforms lack the connectivity to support both structures for the same fund” and that automated inter-class exchange functionality “is expected to be available by mid-2026.”

On compliance, the paper noted that broker/dealers will face heightened scrutiny under Reg BI, as they must “evaluate the costs and features of a particular class of a fund in determining whether that class is in the best interest of a customer.”

The report also pointed to potential revenue shifts, since ETFs typically do not pay annual marketing or distribution fees (which mutual funds typically do) or sub-transfer agent fees to intermediaries. Firms will, therefore, have to “assess potential revenue impact of any change to product mix that may result from the introduction of a dual share class strategy.”

Data, Oversight, Cross-Subsidization

The paper outlined rigorous reporting requirements for asset managers under the proposed SEC framework, including an initial adviser report and annual ongoing adviser reports to fund boards.

These reports must address cost savings, portfolio transaction impacts and potential conflicts of interest, which should address a core SEC concern: that an ETF share class and a mutual fund share class may give rise to differing costs to the portfolio, potentially leading shareholders to bear the costs.

The ICI provided detailed, hypothetical analyses of “cross-subsidization” risks, including trading costs, tax drag and cash drag. It also described possible cost savings and economies of scale, presenting illustrative examples of how expense ratios might decline when ETF share classes are introduced.