The NYSE Arca, Inc. filed a rule proposal with the Securities and Exchange Commission to list and trade AdvisorShares Pure US Cannabis ETF under ticker symbol MJUS. The managed fund will invest in US cannabis and hemp companies or derivatives of companies that provide similar economic characteristics.
What needs to be done before Pure US Cannabis ETF can trade?
The SEC must approve the NYSE’s rule proposal before the ETF can trade in the US markets. The ETF is a great way for investors to gain exposure to US cannabis and hemp businesses. Current regulations prevent a direct investment in these entities until cannabis is legalized at the federal level. AdvisorShare’s ETF will sidestep this regulatory hurdle by investing in OTC derivative products such as swaps that provide similar economics.
Will the SEC Agree with this approach?
We don’t think so. We expect the SEC to take a hard look at this rule proposal for a few reasons. Although the SEC does not determine the quality of financial products, it does determine whether they meet an exchange’s listing standards. Listing standards protect investors by requiring governance, disclosure, and minimum protections.
NYSE Arca is asking the SEC to waive the current rule that caps investment in OTC derivatives to 20% and allow AdvisorShares to increase that cap to 60% of the fund’s assets. This is a tremendous ask. The SEC uses the threshold to limit an investor’s risk due to leverage or counterparty risk. AdvisorShares states that it will use the derivatives to achieve the goal of investing in US cannabis businesses and not obtaining leverage.
The SEC may also focus on how the ETF uses derivatives to mimic the economics of the US cannabis market. The SEC is generally not a fan of letting companies do something indirectly that they cannot do directly. The fundamental problem is that cannabis is still illegal in the US, which is the main risk factor for investors. By approving this rule, the SEC could be establishing a precedent that firms could use financial instruments to avoid US regulations.
What’s next for US cannabis stocks?
The next couple of years will be tricky for cannabis and hemp companies. The market downturn may test the adequacy of risk disclosures and the current off-shore listing structure for cannabis companies. US financial institutions struggle to provide US investors with access to these securities at an unknown risk of doing so. The lack of regulatory guidance increases this uncertainty. The road forward for the transition of cannabis and hemp companies into the public markets will be a bumpy one. Just like the regulators – the market will just wait and see.