	Introduction

Exchange-traded funds (ETFs) offer investors a way to pool money in a fund that invests in multiple stocks, bonds, or other combinations of financial assets. Over the past 25 years, ETFs have become common investment vehicles to help American retail investors build financial nest eggs and to help institutional investors meet financial obligations. The report also discusses other key policy issues, including ETFs' relevance to financial stability considerations, the implication of the rise of passively managed funds (a category that encompasses the majority of ETFs), the higher risks often associated with nontraditional ETPs, investor protection issues, and the SEC's recent ETF rulemaking, among other topics. They package a portfolio of assets like a mutual fund and can be traded on exchanges like a stock. When purchasing an ETF share, public investors are buying and selling a collective exposure to the underlying basket of securities. But ETF shares are traded intraday on exchanges; as such, an ETF's market share price (in the secondary market) could differ, at a particular time, from the value of its underlying basket (in the primary market) as expressed in the fund's NAV. Arbitrageurs would simultaneously buy or sell ETF shares and their underlying assets. Regulatory Framework

The first U.S. ETF was introduced in 1993 to track the S&P 500 index. Because it was an innovative product at the time, it did not fit completely within any of the existing statutory schemes for securities, investment companies, or listing standards. ETFs generally have the following characteristics:
Investment companies that comply with and gain exemptive relief from the Investment Company Act of 1940 (1940 A ct). The SEC proposed a new ETF approval process on June 28, 2018. It would replace individual exemptive orders with a single rule for index-based and actively managed open-end ETFs (in-scope ETFs). Financial Stability

With U.S. ETFs accounting for more than $3.4 trillion in assets under management and 30% of all U.S. equity trading volume, ETFs' scale and continued growth give rise to financial stability considerations. ETFs' involvement in any future financial crisis is likely, given their scale of representation in financial markets. However, it is uncertain whether ETFs would simply be affected by the next financial crisis (e.g., their value would fall with the value of other assets) or would amplify it. As such, some consider ETFs to have not yet experienced a truly extreme market downturn. Many industry practitioners assert that liquidity mismatch is among the most widely misunderstood aspects of ETF structure and mechanics. Higher-Risk Products

ETFs are one main type of investment within a broader category of all portfolio products that trade on exchanges called exchange-traded products (ETPs). Not all ETPs are created equal. To add to the confusion, many of the complex and high-risk ETPs are also referred to as ETFs. The industry has not adopted a consistent naming convention for ETFs and ETPs. The vast majority (92.5%) of the global market consists of plain-vanilla ETFs that are physically backed, and the rest of the market (7.5%) is relatively small, yet filled with more complex ETPs. Although plain-vanilla physically backed ETFs, which make up the vast majority of the ETP market, are generally considered lower risk, a small subset of ETPs is the source of concerns over investor protection and systemic risk. This has led to multifaceted discussions of concentration risk. Investors in physically backed ETFs, which represent the vast majority of the ETF market, would each own a small share of the underlying securities and would generally not be exposed to credit risk in the event of issuer default.
Exchange-traded funds (ETFs) are common ways for Americans to invest. An ETF is an investment vehicle that, similar to a mutual fund, offers public investors shares of a pool of assets; unlike a mutual fund, however, an ETF can be traded on exchanges like a stock. The catchall category of exchange-traded products (ETPs) includes all portfolio products that trade on exchanges.
U.S. ETF domestic listings stand at more than $3.4 trillion, making ETFs among the most important investment methods and critical components of the financial system. The first U.S. ETF was introduced in 1993 to track the S&P 500 stock index. That was the first time a public investor could buy or sell a basket of stocks in a single publicly traded share. It was considered as one of the most important financial innovations in decades and one that transformed the asset management industry. In the ensuing 25 years, ETFs have grown to become a mainstream investment vehicle held by 6% of U.S. households and representing 30% of all U.S. equity trading, according to data from Investment Company Institute and iShares.
The rapid growth of the ETF market has simultaneously elevated its importance in the global financial system and brought risk and regulatory considerations to the fore. A key consideration is ETFs' behavior under market stress. ETFs drew media attention when market distress occurred in 2010, 2015, and 2018. These events have led to global discussions of ETFs' effects on financial stability. Although the events did not seem to leave long-lasting impacts on financial markets, they revealed aspects of ETFs' vulnerability that could not be observed under normal market conditions.
Given ETFs' scale of representation in financial markets, it is likely that they would be affected by any future financial crisis (e.g., their value would fall with the value of other assets), but it is uncertain whether ETFs would also amplify it. At the center of the debate over ETFs and financial stability is "liquidity mismatch," which is often discussed under the context of the difficulty of buying and selling ETFs during a market downturn. This mismatch points to a relatively complex ETF operational structure that has generated misunderstanding.
Not all ETFs are created equal. The majority of ETFs are "plain vanilla" index-tracking products that are considered lower risk. There is also a growing subset of complex, higher-risk ETFs that are sources of concern over financial stability and investor protection. To add to the confusion, the industry does not currently have a consistent naming convention to differentiate the types of products that vary in risk exposure.
Lastly, despite ETFs' common usage, the Securities and Exchange Commission (SEC) has not yet established a comprehensive listing standard. As such, each aspiring issuer must typically be approved by the SEC under an exemption to the Investment Company Act of 1940 and other securities regulations. The SEC proposed a new ETF approval process on June 28, 2018, that would replace individual exemptive orders with a single rule for plain vanilla ETFs. The proposed approach excludes certain higher-risk ETFs and mandates new disclosures and other conditions generally on index-based and actively managed ETFs.