(Bloomberg) — As money managers push to bring private credit to public markets, investors in a new breed of exchange-traded funds will want to know how to get out when markets are stressed. Their early plans leave no room for doubt.

The Securities and Exchange Commission will review three recent filings for private credit ETFs, including a proposed partnership between Apollo Global Management Inc. and State Street Corp. Securities law experts say the lack of information about how retail investors can easily withdraw money from funds loaded with illiquid assets is likely to lead to scrutiny, while consumer advocates are already drawing comparisons to imploded securities.

“The lack of detail in the application is quite astonishing,” said Elisabeth de Fontenay, a law professor at Duke University. “It feels like a cut-and-paste job from your standard ETF file.”

The SEC could reject or approve the plans in the coming months, with the caveat that the agency is likely to experience political changes regardless of who wins the US presidential election. A denial from the regulator risks drawing another legal challenge from the industry. A green light would open the floodgates for similar funds, fueling the $10 trillion U.S. ETF market and allowing the average investor to tap into opportunities often reserved for institutions and the wealthy.

But first, companies must clear hurdles that include strict scrutiny of liquidity, conflicts of interest and disclosure. Regulators’ concerns about the rapid growth of the broader private equity fund sector, which exceeds the size of the U.S. banking industry, could also cloud the picture for the State Street-Apollo ETF and other proposals from Virtus Investment Partners Inc. and BondBloxx.

The SEC, Apollo, State Street and Virtus declined to comment. BondBloxx did not respond to requests for comment.

The novelty of private credit ETFs and the big liquidity issue have worried investor advocates. In a letter to the SEC, the Consumer Federation of America described a hypothetical scenario in which stressed markets lead to liquidity pressures on the State Street-Apollo ETF. The group drew comparisons to the implosion of the securities market with auction prices during the 2008 financial crisis.

In that case, investors had been dependent on investment banks to provide liquidity to the market. But as banks experienced their own liquidity crises, they pulled back and auctions collapsed, Micah Hauptman, the CFA’s director of investor protection, wrote in the Oct. 4 letter.

“What were previously considered highly liquid, ‘cash-like’ assets suddenly became illiquid, causing significant financial hardship for tens of thousands of investors,” he said.

15% ch

The planned State Street-Apollo ETF will have to comply with SEC rules that impose a 15% cap on illiquid investments in a fund’s net assets. But the agreement between the two companies is not public, making it difficult to determine how they will ensure that the ETF does not cross the line, Hauptman said.

At least 80% of the fund’s net assets would be held in a portfolio of investment-grade debt securities, including those from Apollo private credit investments, based on the filing. That’s an indication that State Street and Apollo intend to treat the private credit portions of the fund as if they were liquid, according to SEC observers.

“That’s not how we usually define liquidity,” Duke’s de Fontenay said.

The disclosures, she said, do not indicate whether that treatment applies to all or just some of the assets in the fund.

SEC staff typically ask issuers for additional disclosures about their products. But for the private credit ETFs, the agency may push for more information about how the companies will navigate conflicts of interest and how they choose the underlying private credit assets. Many of these assets will consist of collateralized loans, a $1.3 trillion market that repackages leveraged loans into securities of varying risk and size.

The agency will find out whether any conflicts can be resolved through simple disclosures, or whether they need to be resolved, said Val Dahiya, a partner at the law firm Morrison Foerster and a former branch chief in the SEC’s Division of Trading and Markets. If they can’t be addressed, the agency is more likely to deny the proposals, she said.

Apollo plans to buy some of the private credit assets wrapped in an ETF, provide valuations for those assets and offer intraday trading liquidity for those assets, according to the SEC filing. The money manager has promised to buy a certain amount of the asset-backed and corporate-financed investments held by the ETF, up to a daily limit, at prices it sets.

State Street will act as investment adviser to the fund.

CLO market

BondBloxx and Virtus private credit ETFs would include a significant amount of collateralized loans in their investment mixes. In BondBloxx’s fund, CLOs can represent up to 80% of net assets. The company’s filing did not specify the debt ratings for the CLO assets. Virtus said it would maintain at least 80% of its portfolio in AAA-rated CLOs “under normal market conditions.”

“The idea that CLO ETFs are going to be able to turn their assets into cash to redeem services — it’s hard to see how that would really work in a distressed environment,” said Christopher Jackson, a partner at the New York law firm A&O Shearman who specialized in private lending.

The filings acknowledged the problem. Virtus wrote that the fund’s “ability to acquire or dispose of CLOs at a price and time that the fund deems advantageous may be impaired” during periods of limited liquidity or higher price volatility.

The new frontier for ETFs follows decades of expansion of the private credit market. SEC Chairman Gary Gensler said last week that private credit benefits capital markets and investors by encouraging greater competition in lending, but he also highlighted possible risks at its intersection with the insurance and banking sectors.

“Even if private credit has been around in some form for years, given that its size has grown significantly, how will it cope with stress on today’s or larger scale?” he asked during the Bloomberg Global Regulatory Forum.

Apollo CEO Marc Rowan recently said he expects the company’s ETF plan to further blur the lines between the retail and institutional markets. “When that happens, what’s the difference between public and private?”

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