The SEC proposes major changes to the open-end fund liquidity framework
Today, a vote was taken by the Securities and Exchange Commission (SEC) to propose amendments that would better prepare open-end funds for stressful conditions and reduce the likelihood of dilution of shareholder interests.
The amendments to the rules and forms would improve the way in which funds manage their liquidity risks, require mutual funds to implement tools for liquidity management, and make it possible for funds to report their information in a more timely and comprehensive manner.
According to Gary Gensler, Chairman of the Securities and Exchange Commission (SEC), “the ability for shareholders to redeem their shares on a daily basis, in both normal times and times of stress, is a defining feature of open-end funds.” “However, open-end funds have a fundamental structural liquidity mismatch,” the author writes.
This may give rise to concerns with regard to the protection of investors, our capital markets, and the economy as a whole. We observed these kinds of systemic problems at the beginning of the COVID-19 pandemic, when a lot of investors tried to get their money out of open-end funds where they had invested it. The current proposal addresses these concerns regarding the protection of investors and the resilience of the market.
At the moment, all open-end funds other than money market funds and the vast majority of exchange-traded funds are required to categorize the level of liquidity of their investments into one of four categories, ranging from highly liquid to illiquid. The proposal intends to improve the liquidity classifications of these funds by establishing new minimum standards for classification analyses, some of which will incorporate stressed conditions, and by updating the liquidity categories to limit the extent to which a fund can invest in securities that do not settle within seven days.
These changes will be made in order to improve the classifications of these funds. These modifications are intended to assist funds in better preparing for stressful conditions and to prevent funds from overestimating the liquidity of their investments. In addition, the affected funds would be required to keep a minimum amount of highly liquid assets equal to at least 10 percent of their total net assets.
This requirement is intended to assist the funds in managing stressful conditions and increased redemption levels. These funds would be required to make certain information regarding their liquidity profiles publically available in order to improve the availability of information regarding liquidity risk for investors, as well as information regarding the use of liquidity classification service providers.
In addition, the proposal would mandate that open-end funds other than money market funds and exchange-traded funds use a liquidity management tool known as “swing pricing.” Swing pricing is a method to allocate costs resulting from inflows or outflows to the investors engaged in that activity, rather than diluting other shareholders’ stakes in the company.
This would be required of open-end funds that are not money market funds or exchange-traded funds. In addition to that, the proposal would call for a “hard close” for all funds that are pertinent. When a fund uses a hard close, investor orders must be received by the fund, its transfer agent, or a registered clearing agency by the time the fund prices its shares, which is typically 4 p.m. Eastern Time (ET), in order to receive that day’s price.
If the fund does not use a hard close, orders can be placed until the end of the trading day. A hard close would not only assist in the operationalization of swing pricing, but it would also assist in the prevention of late trading of fund shares and the improvement of order processing. Additionally, the release contains questions regarding alternative liquidity management tools, such as the utilization of liquidity fees.
Lastly, the proposal would make the information that is provided to the Commission as well as investors more timely. According to the proposal, mutual funds would be required to submit their portfolios and any other relevant information on Form N-PORT on a monthly basis and within 30 days, with the report being made public after an additional 30 days have passed.
This modification would triple the amount of information that is currently available to investors and would apply to all registrants that report on Form N-PORT, with certain exceptions. This would include the majority of open-end funds and registered closed-end funds.
The proposal will be released into the public domain via publication in the Federal Register. After the notice is published in the Federal Register, the comment period will remain open for another sixty days.
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