Key Takeaways
- • On October 13, 2016, the SEC finalized rules requiring open-end funds, including mutual funds and ETFs, to adopt liquidity risk management programs and permit mutual funds to use swing pricing, according to EisnerAmper's summary of the rules.
- • Rule 22e-4 caps illiquid investments at 15% of fund assets, defines illiquid as assets that cannot be converted to cash within 7 business days without significantly altering value, and requires monthly review of those holdings.
- • Funds must classify portfolio investments into four liquidity categories (highly liquid, moderately liquid, less liquid, illiquid), down from six in the original proposal, and maintain a minimum percentage of highly liquid assets.
- • Swing pricing is capped at a 2% NAV-per-share swing factor limit and must be approved by the fund board, which must also approve the liquidity program and receive an annual adequacy report.
- • Most funds must comply with the liquidity rule and file Forms N-PORT and N-CEN by December 1, 2018; fund complexes under $1 billion in net assets have until June 1, 2019.
Summary
On October 13, 2016, the Securities and Exchange Commission finalized rules requiring open-end funds, including mutual funds and exchange traded funds, to adopt liquidity risk management programs. The rules also allow mutual funds to use swing pricing, subject to specific requirements, and enhance data reporting for mutual funds and ETFs, according to EisnerAmper's analysis of the rule.
Under Rule 22e-4 of the Investment Company Act of 1940, the SEC defines liquidity risk as the risk that a fund could not meet redemption requests without significant dilution of remaining investors' interests. The Commission is particularly concerned about forced liquidation at fire-sale prices. Funds must classify investments by the number of days they expect to take to convert them to cash under existing market conditions, using four categories: highly liquid, moderately liquid, less liquid and illiquid. Funds must also set a minimum percentage of highly liquid assets, and the rule prohibits holdings of more than 15% of assets in illiquid investments. Illiquid investments are assets that cannot be expected to convert to cash within seven business days without significantly altering their value. Funds must review illiquid holdings at least monthly. Breaches of the 15% limit must be reported to the board with an explanation and a remediation plan; if a breach is not resolved within 30 days, the board must determine whether the remediation plan serves shareholders' best interests.
The final rule differs from the original proposal in several respects. It reduced liquidity classifications from six to four, exempted in-kind ETFs, where redemptions are made with a pro rata share of underlying assets rather than cash, and allows the board to determine how to rectify highly liquid minimum breaches, rather than barring funds from buying assets to restore the threshold.
Swing pricing is an anti-dilution tool that adjusts a fund's net asset value to protect existing shareholders from the costs of purchases and redemptions. Funds using it must document how they determine the swing threshold and swing factor, cap the swing factor at 2% of NAV per share, obtain board approval, and periodically review the policy. Changes to the swing factor limit or threshold require board approval.
The rules also expand reporting. Form N-PORT requires registered funds other than money market funds to report investment data monthly in a structured format, including security pricing, repurchase and securities lending agreements, counterparty exposures, derivatives terms, and portfolio holdings across the four liquidity categories. Form N-CEN requires all registered investment companies to report census information, including lines of credit, inter-fund lending and borrowing, and swing pricing use. Funds must also provide enhanced derivatives disclosures in financial statements and disclose fees paid to securities lending agents. The SEC said the data will improve investor information and support more targeted examinations.
Most funds must comply with the liquidity risk management rule and file Forms N-PORT and N-CEN by December 1, 2018. Fund complexes with less than $1 billion in net assets have until June 1, 2019.
Under Rule 22e-4 of the Investment Company Act of 1940, the SEC defines liquidity risk as the risk that a fund could not meet redemption requests without significant dilution of remaining investors' interests. The Commission is particularly concerned about forced liquidation at fire-sale prices. Funds must classify investments by the number of days they expect to take to convert them to cash under existing market conditions, using four categories: highly liquid, moderately liquid, less liquid and illiquid. Funds must also set a minimum percentage of highly liquid assets, and the rule prohibits holdings of more than 15% of assets in illiquid investments. Illiquid investments are assets that cannot be expected to convert to cash within seven business days without significantly altering their value. Funds must review illiquid holdings at least monthly. Breaches of the 15% limit must be reported to the board with an explanation and a remediation plan; if a breach is not resolved within 30 days, the board must determine whether the remediation plan serves shareholders' best interests.
The final rule differs from the original proposal in several respects. It reduced liquidity classifications from six to four, exempted in-kind ETFs, where redemptions are made with a pro rata share of underlying assets rather than cash, and allows the board to determine how to rectify highly liquid minimum breaches, rather than barring funds from buying assets to restore the threshold.
Swing pricing is an anti-dilution tool that adjusts a fund's net asset value to protect existing shareholders from the costs of purchases and redemptions. Funds using it must document how they determine the swing threshold and swing factor, cap the swing factor at 2% of NAV per share, obtain board approval, and periodically review the policy. Changes to the swing factor limit or threshold require board approval.
The rules also expand reporting. Form N-PORT requires registered funds other than money market funds to report investment data monthly in a structured format, including security pricing, repurchase and securities lending agreements, counterparty exposures, derivatives terms, and portfolio holdings across the four liquidity categories. Form N-CEN requires all registered investment companies to report census information, including lines of credit, inter-fund lending and borrowing, and swing pricing use. Funds must also provide enhanced derivatives disclosures in financial statements and disclose fees paid to securities lending agents. The SEC said the data will improve investor information and support more targeted examinations.
Most funds must comply with the liquidity risk management rule and file Forms N-PORT and N-CEN by December 1, 2018. Fund complexes with less than $1 billion in net assets have until June 1, 2019.
Go deeper than the headline
Research every firm in this story, track the ones that matter and get the daily briefing — free for 7 days.