Subject: File No. S7-11-15
From: Danny Reich

July 2, 2015

Exchange Traded Products with the exception of the SPY, QQQQ, and DIA are a disaster waiting to happen, and the promulgation of these products under the auspice of the SEC is misleading to both the public and majority of institutional investors with an accent on the current trend of Robo-advisors.

The first problem not addressed is the perception of liquidity versus the actual liquidity (see Howard Mark's memo). ETPs are marketed as tradeable during market hours. The implication is that there is equal liquidity in the underlying assets to that of the ETP. This assumption could not be more false, particularly in the more thinly traded securities more specifically in the BOND ETPs. The false assumption is that the underlying assets have liquidity equal to the ETP. In a market disruption the correlation breaks down. Bond markets are offered without a bid, therefore the ETP's liquidity will cease. This lack of underlying liquidity had been dramatically increased by the Dodd Frank legislation limiting the risk Investment Banks can take beyond their market-making role. Not that the banks were open to taking liquidity risk in a volatile situation before, simply stated the legislation precludes it (in other words the banks have backing by the government not to risk capital). Additionally, the quote stuffing allowed under SEC rules gives the appearance of liquidity when in fact it creates more illiquidity (see attachment)

The second problem is the redemption mechanism which creates an additional liquidity problem. When a bank redeems an ETP, the pressure is to the downside. In a market disruption, the ETPs are forced sellers into a down and illiquid market. This will become a self fulfilling implosion, and there is no backstop if a Barclays or Blackrock blows up.

The third problem evolving is the Robo Advisors using specific firm products (for example Schwab's program that specifically uses Schwab ETFs) With no one at the Robo-Advisor switch, a dynamic change in market sentiment would force selling automatically which in many cases will impede the capital of the creator of the ETF, in this case Schwab. With limited capital resources, they will be forced sellers of their own product but to whom. Not to be overlooked is the forced liquidation will cause margin calls or cash calls. In Schwab's case, with $65 Billion in municipal market money markets, they have no outlet to build liquidity fast enough to meet demand which will force the money market fund to break the buck, adding more fuel to the fire.

One of the unmentioned items is the inability to borrow many ETPs, particularly the bond ETPs like TBT and TLT. Not being able to borrow the security is one indication that this is not a liquid product (most stocks that trade an average of 8mm shares per day are borrowable) The liquidity argument has serious flaws if the security lacks a borrow, or in this case there maybe a more delitirous flaw.

I'm not opposed to ETPs when constructed, monitored and administered correctly. The bottom line is these products have a high degree of financial engineering which as in the case of CDOs, and Securitizations in/prior 2008 were sanctioned by the SEC but completely misunderstood.

[Copyrighted material redacted. Author cites memo from Howard Marks, Oaktree Capital Management, L.P.]