On Wednesday, July 10, the U.S. House of Representatives will take up the question of how to end the longstanding federal criminalization of cannabis, potentially clearing the way for marijuana ETFs to attract billions in new investment assets.

The Judiciary Crime, Terrorism and Homeland Security subcommittee hearing—serendipitously scheduled the day after ETF.com's "The Case For Cannabis ETFs" webinar (sign up at the “Register Today” link)—will be effectively the first congressional conversation on how to end the federal prohibition on marijuana.

4 Proposals To Decriminalize Marijuana

The committee will likely discuss several extant legislative proposals, including the STATES Act, the Marijuana Justice Act, the Marijuana Freedom and Opportunity Act and the Ending Federal Marijuana Prohibition Act.

Each of these bills, if passed, would have different effects, though all four would remove marijuana from the list of Schedule 1 drugs that are federally outlawed for any usage.

The Ending Federal Marijuana Prohibition Act, the narrowest of the four proposals, would simply eliminate marijuana's status as a controlled substance and do away with the felony offenses surrounding its use, sale or possession.

The STATES Act would do this and also explicitly allow individual states to establish their own laws regarding marijuana sale, possession and usage without federal intervention, thus encoding the current de facto paradigm into federal law.

The Marijuana Freedom and Opportunity Act has a similar impact to the STATES Act, while also expunging low-level marijuana convictions and providing funding for minority- and women-owned marijuana businesses.

The Marijuana Justice Act would also automatically expunge criminal records of use- and possession-related crimes; additionally, it would establish a community fund to reinvest money toward the communities of color most impacted by the war on drugs.

Quickly Evolving Attitudes In Congress

Even if committee members cast no votes on these proposals during the hearing, the mere fact that Congress is discussing decriminalization represents a massive shift in the government's attitude toward marijuana.

Just two years ago, after years of gradually relaxing restrictions on cannabis commerce, former U.S. Attorney General Jeff Sessions threw out the Cole memorandum and renewed the Department of Justice's efforts on prosecuting federal marijuana-related crimes.

Since his departure, marijuana legalization has become a bipartisan issue, with Congressional Democrats and Republicans alike finding common ground in recent months over legislation designed to protect cannabis-related businesses and financial institutions serving the industry.

Voters clearly favor legalization: Thirty-three states have now legalized some form of marijuana usage, with 11 of those having legalized full recreational usage by adults; the other 22 have legalized the use of marijuana for medical purposes.

Why Legalization Has Tripped Up Marijuana ETFs

To date, legalization has remained the greatest barrier facing marijuana ETFs, but not for the reasons one might expect.

Businesses within the marijuana industry have flourished in recent months, and many companies that have gone public over the past 18-24 months have experienced double-, even triple-digit returns year to date.

However, banks who custody stocks on behalf of ETFs remain reticent to hold marijuana stocks. So long as marijuana remains illegal at the federal level, holding these stocks explicitly for a marijuana fund could potentially run custodian banks afoul of federal banking laws, costing them their license, charter and/or FDIC insurance.

That's true even if marijuana is fully legal in the country in which those stocks are domiciled (e.g., Canadian stocks). Although foreign stocks may fall outside the jurisdiction of the U.S. Department of Justice, the custodian bank holding them does not (read: "Promise & Peril Of Marijuana ETFs").

Custodial risk isn't just theoretical: The oldest and largest marijuana ETF, the $1.1 billion ETFMG Alternative Harvest ETF (MJ), suddenly parted ways with its former custodian bank over precisely this question of legality. Last September, MJ instead signed on as custodian a privately held broker-dealer who had never custodied an ETF; trading issues have persisted ever since (read: "Marijuana ETF Shifts Custody").

Other Approaches To Resolving Custodial Risk

The second pure-play marijuana fund to launch, the $59 million AdvisorShares Pure Cannabis ETF (YOLO), has taken a different approach to mitigate custodial risk.

In the year prior to launch, YOLO submitted a list of potential fund holdings to both its intended custodian and to the Securities and Exchange Commission, obtaining their approval first.

Since launch, YOLO has also begun investing in the swaps contracts of multi-state operators based in the U.S., which technically are not stocks and therefore could serve as a workaround for wary custodians.

Amplify ETFs and Global X both have proposals for marijuana ETFs in the works. No custodian is listed for the Amplify fund, but Brown Brothers Harriman would serve as the custodian for the Global X fund.

Another proposed fund from Innovation Shares, which remains in the quiet period, would use a broker-dealer for its custodian (read: "New Wrinkle To Marijuana ETFs").

Matt Markiewicz, managing director of Innovation Shares, is one of the panelists on tomorrow's "The Case for Cannabis ETFs" webinar.

Contact Lara Crigger at lcrigger@etf.com

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