With the recent market rout still fresh for most of us, the US Securities and Exchange Commission (SEC) has proposed a new rule and changes to other guidance to ensure that mutual and exchange-traded funds can withstand a run on them by panicked investors.
The proposal's goal is liquidity risk management for what are called open-end funds. That, in turn, would reduce the risk that funds won't be able to meet redemption obligations, according to sections 22(e) and rule 22c-1 under the Investment Company Act.
The proposal includes the following six measures:
1. New Rule 22e-4 would require every registered open-end fund (but not money market funds) to set up a liquidity risk management program. The program would be required to:
- Classify the liquidity of fund portfolio assets according to how long it would take to convert an asset to cash without a market impact.
- Assess, review, and manage a fund's liquidity risk.
- Establish a fund's three-day liquid asset minimum.
The program's features also require board review and approval.
2. Codification of the 15 percent limit on illiquid assets included in current guidelines.
3. Amendments to Rule 22c-1 would allow a fund in certain situations to use âswing pricingâ in which the net asset value of a fund's shares are adjusted so that shareholders who make purchases or redemptions shoulder the costs of those transactions. The intent is to protect existing shareholders from dilution associated with shareholder purchases and redemptions.
4. Amendments to Rule 31a-2 would require funds to keep records of the swing pricing.
5. Amendments to Form N-1A would require disclosure of redemption policies and use of swing pricing.
6. Amendments to Form N-PORT and proposed Form N-CEN would require disclosure about the liquidity of a fund's holdings and its liquidity risk management practices.
âPromoting stronger liquidity risk management is essential to protecting the interests of the millions of Americans who invest in mutual funds and exchange-traded funds,â SEC Chairwoman Mary Jo White said in a prepared statement. âThese significant reforms would require funds to better manage their liquidity risks, give them new tools to meet that requirement, and enhance the commission's oversight.â
It's no small matter. According to a white paper prepared for Mark Flannery, director and chief economist of the SEC Division of Economic and Risk Analysis, and posted in September on the SEC's website, there are 7,378 mutual funds alone â that's omitting money market funds, ETFs, and variable annuities. The amount of assets held by US mutual funds (excluding money market mutual funds and ETFs) grew from $4.4 trillion in 2000 to $12.7 trillion in 2014.
Because of the proposed amendments, the SEC reopened the comment period for its Release No. 31610 issued in May. Comments on that and the most recent action must be received within 90 days of publication in the Federal Register. All electronic and mailed comments submitted should refer to File Number S7-16-15 or S7-08-15. Instructions on how to submit comments are contained in the proposed rule document. Comments will be posted at http://www.sec.gov/rules/proposed.shtml.