Recommendations on Amendments to Rule 17a-7

Summary

SIFMA AMG provided recommendations to the SEC to modernize and expand Rule 17a-7 under the Investment Company Act of 1940. The recommendations call for expanding eligible cross trades to include assets valued using observable market inputs, including certain fixed income securities, to improve execution quality, reduce trading costs, and benefit registered fund investors.

Excerpt

The Asset Management Group of the Securities Industry and Financial Markets Association (“SIFMA AMG”) supports the recent initiative of the Securities and Exchange Commission (the “SEC” or the “Commission”) to modernize and expand the availability of Rule 17a-7 under the Investment Company Act of 1940 (the “1940 Act”). SIFMA AMG appreciates the opportunity to provide our members’ recommendations for consideration by Commission staff regarding potential amendments to modernize Rule 17a-7 that we have summarized herein, which we believe in turn will improve execution quality of cross trades and reduce trading costs, in each case for the benefit of registered fund investors.

I. The Commission should amend Rule 17a-7(a) to expand the universe of eligible assets that may be crossed under the rule by replacing paragraph (a) with the following: “The transaction is a purchase or sale, for no consideration other than cash payment against prompt delivery of a security for which market quotations are readily available or that can be valued based on observable inputs, either directly or indirectly[.]” The proposing and adopting releases should clarify that this term is intended to encompass level 1 and level 2 assets under the U.S. GAAP ASC 820 and IFRS 13 fair value hierarchies.

• As the Commission staff stated in the Staff Statement on Investment Company Cross Trading, ¹ the term “for which market quotations are readily available,” has the same meaning under Rule 17a-7 and the valuation provisions of the 1940 Act and rules thereunder, including Rule 2a-5. As the Commission prescribed in the Rule 2a-5 Adopting Release, the definition ascribed to “readily available market quotations” “is consistent with the definition of a level 1 input in the fair value hierarchy outlined in U.S. GAAP [and] a security will be considered to have readily available market quotations if its value is determined solely by reference to these level 1 inputs.” ²
• We propose that Rule 17a-7 be amended to allow cross trades in investments that can be valued based on observable inputs developed by using market data (level 2 assets). Permitting cross trades in level 1 and level 2 assets would (i) allow investment companies to resume cross trading in fixed income assets in a manner generally consistent with that permitted under Rule 17a-7 prior to the adoption of Rule 2a-5; (ii) establish a clear and durable eligibility standard informed by fair value hierarchy under U.S. GAAP and IFRS; and (iii) continue to restrict cross trades in assets for which prices cannot be derived from observable inputs (level 3 assets).
• The Rule 17a-7 rulemaking should be expressly designed to modernize a regulatory framework that is appropriate for cross trades and that is separate from Rule 2a-5 and its related definition of “readily available market quotation”, since Rule 17a-7 is intended to serve different policy purposes.