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The Securities and Exchange Commission, in three separate but related rulemakings at an open meeting on October 13, has adopted rule amendments to require mutual funds and exchange-traded funds to adopt liquidity risk management programs, to modernize data reporting by registered investment companies, and to allow mutual funds to use swing pricing. The rule adoptions were important steps in the investment management regulatory agenda announced by SEC Chairman Mary Jo White in December 2014. The SEC previously adopted changes to investment adviser reporting in August of this year, and it has proposed but not yet adopted rules on fund leverage and derivatives and on investment adviser business continuity; it has not yet proposed rules to require stress testing by large funds and advisers, as required by the Dodd-Frank Act. White said at the meeting that she expects the Commission to consider the final rules on derivatives in the near term, with action to follow on the others as soon as possible. The SEC did not act on proposed rule 30e-3, which would allow funds to use a website to provide reports to shareholders who do not opt out; currently funds can do so only for shareholders who opt in. White said that she has directed the SEC staff to prepare a recommendation for the Commission’s consideration by the end of the year. Commissioner Kara Stein expressed skepticism concerning this proposal, while Commissioner Michael Piwowar expressed his strong support for it and committed to neither calling for, nor working on, any non-emergency rulemakings (beyond certain ones he mentioned) until the vote on this proposal. Fund Liquidity Risk Management: The most important rulemaking was the adoption of rules to require mutual funds, other than money market funds, to establish liquidity risk management programs. Release Nos. 33-10233, IC-32315 (Oct. 13, 2016). The program requirement would also apply to ETFs, although most of the specific program requirements would not apply to ETFs that meet redemptions through in-kind transfers of securities and other assets (other than a de minimis amount of cash) and that publish their portfolio holdings daily. Unit investment trusts generally would not be subject to the program requirement, but the UIT’s principal underwriter or depositor must determine that its illiquid investments at the date of deposit are consistent with the redeemable nature of the securities it issues. Mutual funds will be required to classify their portfolio assets into four categories (a reduction and simplification from the six categories that were proposed). A fund generally may classify assets based on their asset class, unless the fund or adviser knows of considerations that are reasonably expected to significantly affect the liquidity characteristics of an investment. The four categories are: –Highly liquid investments, meaning cash and investments convertible into cash in three business days or less. –Moderately liquid investments, meaning investments convertible into cash in more than three business days but in seven calendar days or less. Mutual funds will be required to determine a highly liquid investment minimum, which is a percentage of the fund’s net assets that the fund invests in highly liquid investments. This requirement does not apply to a fund that primarily holds assets that are highly liquid investments. The highly liquid investment minimum is a target rather than the strict requirement that was proposed, and funds will be allowed to acquire assets that are not highly liquid even if they do not meet the highly liquid investment minimum. However, reports to the SEC and the fund board are required if the shortfall lasts more than seven consecutive calendar days. In calculating whether the minimum has been met, the fund must exclude highly liquid investments that are used to cover derivatives that are not highly liquid. |
Mutual funds and ETFs will not be allowed to acquire any illiquid investments if, immediately afterward, the fund would exceed a 15% limit. This is a more demanding standard than the existing 15% limit on illiquid investments, because the fund must assess liquidity on an on-going basis (at least monthly, and more frequently if needed), and because the fund must take into account whether trades in the size the fund would anticipate trading would affect liquidity. Exceeding the 15% limit will require a confidential notification to the SEC within one business day on new Form N-LIQUID.
The compliance date for the liquidity risk management program requirement is December 1, 2018, for larger entities (i.e., funds in a group of related investment companies with aggregate net assets of $1 billion or more as of the end of the most recent fiscal year), and June 1, 2019, for smaller entities. This also applies to certain new disclosure requirements on Forms N-CEN and N-PORT. New disclosure requirements in Form N-1A have a compliance date of June 1, 2017.
Fund Data Reporting Modernization:
The SEC adopted rule amendments to require mutual funds, ETFs, and other registered funds to file enhanced and standardized disclosures. Release Nos. 33-10231, 34-79095, IC-32314 (Oct. 13, 2016). The rulemaking was adopted by a 2 – 1 vote, with Piwowar dissenting because the rules adopted do not include rule 30e-3.
New Form N-PORT will require registered funds other than money market funds to provide portfolio-wide and position-level holdings data to the SEC on a monthly basis. Information contained on reports for the last month of each fund’s fiscal quarter will be available to the public after 60 days, except for certain information that is excluded from public disclosure. Form N-Q, on which funds currently report certain portfolio holdings for the first and third fiscal quarters, will be rescinded.
New Form N-CEN will require registered funds to annually report certain census-type information to the SEC. Form N-CEN will replace Form N-SAR, which is a semiannual report.
The SEC also adopted amendments requiring enhanced and standardized disclosures in financial statements that are required in fund registration statements and shareholder reports. In addition, the SEC adopted amendments to fund registration statements requiring disclosures relating to fund securities lending activities, including the fees paid to securities lending agents in the prior fiscal year.
For Form N-PORT, larger entities will have a compliance date of June 1, 2018, and smaller entities will have a compliance date of June 1, 2019. All reports filed on Form N-PORT for the first six months following June 1, 2018, will be maintained as nonpublic. Form N-CEN will have a compliance date of June 1, 2018, for all entities. The new financial statement requirements will have a compliance date of August 1, 2017.
Swing Pricing:
The SEC adopted rule amendments to permit a mutual fund, other than a money market fund, to use swing pricing, which is the process of adjusting the fund’s net asset value per share to effectively pass on to purchasing or redeeming shareholders costs associated with their trading activity. Release Nos. 33-10234, IC- 32316 (Oct. 13, 2016). The rule change again was adopted by a 2 – 1 vote, with Piwowar dissenting.
A fund that chooses to use swing pricing would adjust its NAV by a swing factor once the level of net purchases into or net redemptions from the fund has exceeded a threshold percentage amount. The swing factor may not exceed 2% of NAV.
Swing pricing is currently used by many institutional funds in Europe. However, most American funds that reviewed the proposal concluded that infrastructure limitations and timing requirements would make swing pricing impractical for them, so it remains to be seen if it can achieve success in the American market.
The swing pricing rule amendments will be effective two years after publication in the Federal Register and will not have a separate compliance date.
The fund liquidity risk management adopting release is available online at:
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https://www.sec.gov/rules/final/2016/33-10233.pdf |