On September 22, the Securities and Exchange Commission published a proposed rule that would require mutual funds and exchange-traded funds (ETFs) to implement liquidity risk management programs. Additionally, the SEC proposes to enhance disclosure regarding fund liquidity and redemption practices. The aim is to better ensure that investors can redeem shares and receive assets in a timely manner, particularly when investors are looking to exit during times of market turmoil.
Friday, September 25. 2015
The proposed rule is open for public comment for 90 days after its publication in the Federal Registrar.
The following is an overview of the changes being proposed:
Liquidity Risk Management Programs
One of the major features of this proposal is Proposed Rule 22e-4, which would require mutual funds and other open-end investment companies (including open-end ETFs) to implement a liquidity risk program. This program would have a number of required components, such as:
– the classification of the liquidity of the assets in the fund’s portfolio;
– the assessment, periodic review and management of the fund’s liquidity risk;
– the establishment of a three-day liquid asset minimum; and
– the board’s review and approval of the fund’s liquidity risk management program.
The proposed rule also includes amendments to Rule 22c-1 of the Investment Company Act. These amendments would allow (but not require) open-end funds except for money market funds or ETFs to use “swing pricing”. “Swing pricing” is the process of reflecting the costs associated with shareholders’ trading activity in a fund’s net asset value (NAV). The funds’ administrator calculates the NAV for the fund before consideration of any subscriptions and redemptions. Then the NAV is adjusted by a pre-determined amount, depending on whether the fund is experiencing net inflows or outflows on the dealing day. If the fund is experiencing net inflows, that NAV is adjusted up. If the fund is experiencing net outflows, the NAV is adjusted down. “Swing pricing” allows a fund to pass the costs of trading activity on to the purchasing and redeeming shareholders while protecting non-dealing shareholders from those trading costs.
As with the liquidity risk management programs, there are certain components that the proposed rule would require be disclosed should a fund choose to use swing pricing, such as:
– the swing factor;
– the swing threshold;
– the consideration of certain factors to determine the swing factor and the swing threshold;
– the annual review of the swing threshold; and
– the board’s review and approval of the swing pricing policies and procedures.
New Disclosure and Reporting Requirements
Proposed amendments to Form N-1A would require funds to disclose swing pricing, if applicable, and the methods used to meet redemptions. Funds also would be required to file agreements related to lines of credit and reflect, as applicable, the use of swing pricing in the fund’s NAV per share in the financial highlights section of fund financial statements.
Proposed Form N-PORT
Proposed amendments to Form N-PORT (proposed previously by the SEC) would require a fund to report the liquidity classification of each of the fund’s assets based on the categories in proposed rule 22e-4. Funds also would be required to disclose the three-day liquid asset minimum. This is in addition to the requirement proposed earlier that funds report whether an asset is a 15 percent standard asset.
Proposed Form N-CEN
Proposed amendments to Form N-CEN (proposed previously by the SEC) would require funds to disclose information regarding committed lines of credit, interfund borrowing and lending, and swing pricing. The proposed amendments also would require ETFs to report whether they required an authorized participant to post collateral to the ETF or any of its designated service providers in connection with the purchase or redemption of ETF shares.
Other changes are also part of the proposal.
Additionally, the SEC has provided a white paper prepared by the SEC’s Division of Economic and Risk Analysis staff entitled, “Liquidity and Flows of U.S. Mutual Funds”, that is primarily concerned with how portfolio liquidity varies depending on a fund’s redemption history and how portfolio liquidity is affected by large redemptions
and which is referenced within the proposed rule.
Comments to the SEC are due 90 days after the publication of the proposed rule in the Federal Registrar. As of the date of this blog, the proposed rule has not been published. Comments that have already been received by the SEC are available here: http://www.sec.gov/comments/s7-16-15/s71615.shtml.
In addition, because this proposed rule includes amendments to the proposed Form N-CEN and proposed Form N-PORT, the SEC is proposing to reopen the comment period for Release No. 31610 (May 20, 2015) [80 FR 33589 (June 12, 2015)].