SEC liquidity risk management rules

 Securities
and Exchange Commission

Open Meeting

Liquidity Risk Management Programs & Reporting
Modernization

Thursday, October 13, 2016

Key
Topics & Takeaways

Final Rulemakings Approved: The Securities and
Exchange Commission (SEC) approved final rulemakings to: (i) modernize the
reporting and disclosure framework for investment funds; (ii) mandate the
establishment of liquidity risk management programs; and (iii) permit mutual
funds to adopt swing pricing.

Legal Entity Identifier: Commissioner Stein
praised the use of the Legal Entity Identifier (LEI) in the final modernization
reporting and disclosure framework, which she said will help with fund
identification and analysis.

Concerns with Swing Pricing: Commissioner Piwowar
voiced several concerns about the final swing pricing rule, which he said can
“open the door to harmful gaming behavior.”  He indicated that his primary
concern is that swing pricing will be used to “conceal from investors” the true
cost that they will incur upon the purchase and redemption of shares; and he
cautioned that the Commission’s adoption of the rule grants regulatory approval
for a fund to impose “unpopular costs on investors in a nontransparent way.”
Accordingly, Piwowar voted against the swing pricing rule.

Speakers

Mary Jo White, Chair, Securities and Exchange Commission
(SEC)

Kara Stein, Commissioner, SEC

Michael Piwowar, Commissioner, SEC

David Grim, Director, Division of Investment Management, SEC

Mark Flannery, Director and Chief Economist, Division of
Economic and Risk Analysis, SEC

Naseem Nixon, Senior Counsel, Division of Investment Management,
SEC  

Matthew DeLesDernier, Senior Counsel, Division of
Investment Management, SEC

Opening Remarks

Mary
Jo White, Chair, Securities and Exchange Commission

White underscored the importance of open-end funds for
everyday investors, noting that 44 percent of all U.S. households owned shares
of more than 17,000 mutual funds at the end of 2015. She explained that the
asset management industry is growing in complexity, and has introduced new fund
structures that may increase potential risks for portfolios and the broader
markets. White claimed that the two rulemakings being considered by the
Commission would enhance its regulatory framework to keep up with evolutions in
the asset management industry.  

White explained that the “sweeping” new reporting
requirements would enable the Commission to gather data that is necessary to
identify risks, inform rulemakings, and assist its examination and supervisory
efforts. She added that the modernized reporting framework will “fundamentally
change” how the Commission and investors assess potential risks within the fund
industry.

Staff Proposal: Modernized Reporting Framework

David Grim, Director, Division of Investment Management,
SEC

Grim summarized the SEC staff’s recommendation for the
Commission to adopt new and amended rules to modernize reporting and disclosure
for mutual funds, exchange-traded funds (ETFs) and other registered investment
companies. He referred to the new rules as a “game changer,” and noted that the
new structured data reporting framework will enhance the Commission’s ability
to effectively monitor and understand exposures in asset management industry.

Mark Flannery, Director and Chief Economist, Division of
Economic and Risk Analysis, SEC

Flannery noted that the size and complexity of asset
managers has increased, and that the final rule will modernize the content and
format requirements of reports and disclosures, which he said should improve
investors’ understanding of investment companies. Flannery also noted that the
disclosure rules were amended before being finalized to mitigate front-running
or other “predatory” practices.

Matthew DeLesDernier, Senior Counsel, Division
of Investment Management, SEC

DeLesDernier highlighted the three following principle
changes made by the modernized reporting framework: 1) the adoption of N-PORT,
a new form to report information regarding portfolio holdings on a monthly
basis; 2) amendments to Regulation S-X regarding form and contents of
registration requirements; and 3) the replacement of form N-SAR with new form
N-CEN. He added that modifications were made to the reporting requirements
before they were finalized, such as delaying public disclosure to 60 days,
consistent with other disclosure requirements, to avoid front-running and other
adverse effects. 

Commissioner Stein

Stein noted that the enhanced reporting and disclosure
rules will help the Commission monitor growth, trends, and patterns of
investment funds. She praised the use of the Legal Entity Identifier (LEI) in
the reporting framework, which she said will help with fund identification and
analysis.

Stein also voiced concerns with proposed e-delivery rules,
despite the fact that they were not part of the final reporting and disclosure
rules considered by the Commission in the meeting. She expressed concern that
the proposed e-delivery rule would pose an additional burden on investors and
negatively affect their engagement.  While she recognized the cost
reductions that would result from the adoption of a default e-delivery
standard, she argued that “cost must always be considered in balance with
investor protection.”  Stein doubted that the tradeoff is worthwhile, and
cautioned against “interfering with investor choice without clear evidence that
it will not do more harm than good.” 

Commissioner Piwowar

Piwowar praised the staff’s final liquidity risk management
rule, arguing that it illustrates what is “best about the Commission’s
rulemaking process” because it incorporates input received from external
stakeholders and was significantly improved over the initial proposal. Piwowar
noted that he would have preferred for the three-day liquid asset minimum to be
extended to seven days, to coincide with open-end funds’ obligation to honor
redemptions within seven days.  Still, he expressed his support for the
final rule.

Piwowar expressed several concerns about the final swing
pricing rule, which he said can “open the door to harmful gaming
behavior.”  He indicated that his primary concern is that swing pricing
will be used to “conceal from investors” the true cost that they will incur
upon the purchase and redemption of shares; and he cautioned that the
Commission’s adoption of the rule grants regulatory approval for a fund to
impose “unpopular costs on investors in a nontransparent way.” Accordingly,
Piwowar indicated that he would not support the swing pricing rule.

With regard to the reporting modernization framework,
Piwowar expressed support for the overall objective to enhance transparency,
but did not support the rule because it did not include the proposed Rule 33E,
which he said would reduce costs for fund shareholders. Piwowar urged the
Commission to forgo working on nonemergency rulemakings for the remainder of
the year until Rule 33E-3 is brought to a vote.

Vote

The final rule to enhance the reporting and disclosure
framework for investment companies was approved in a 2-1 vote, with Piwowar
dissenting.

Rule on Liquidity Risk Management Program & Swing Pricing

Mary
Jo White, Chair, SEC

White noted that managing the liquidity of an investment
portfolio is a “core responsibility” of funds. She explained that the final
liquidity risk management rule will “fundamentally reform” the Commission’s
oversight of funds. White noted that the Commission staff will monitor the
effects of these reforms over a two-year period and will update the Commission
on the implementation of these rules.

David
Grim, Director, Division of Investment Management, SEC

Grim summarized the staff recommendation for the Commission
to adopt a set of “transformational reforms” to improve the liquidity risk
management of funds. He explained that funds will be required to classify their
portfolio investments into four classifications based on their liquidity
characteristics, limit holdings of illiquid assets to 15 percent of total
assets, and maintain a minimum liquid asset buffer. Grim added that funds other
than money market funds and ETFs would be permitted to adopt swing pricing
under certain scenarios to mitigate the effect of significant shareholder
purchases (redemptions).

Mark
Flannery, Director and Chief Economist, Division of Economic and Risk Analysis,
SEC

Flannery noted that the final liquidity risk management and
swing pricing rules would promote investor protection by reducing the risk that
open-end funds could not meet their redemption obligations.  However, he
noted that those benefits come with costs, and that all funds will bear the
direct costs of establishing a liquidity risk management program, as well as
the indirect costs of altering their portfolio composition to add highly liquid
assets to meet the minimum requirement. Overall, Flannery maintained that the
rules will help funds more fairly distribute costs imposed by redeeming or
subscribing shareholders, and better manage the impact of redemptions on
existing shareholders.

Naseem Nixon,
Senior Counsel, Division of Investment Management, SEC  

Nixon explained that the final liquidity risk management
rule would be subject to approval by funds’ boards, and would have to
incorporate certain elements, such as classifying assets into four categories,
maintaining a three-day liquid asset minimum, and adopting policies and
procedures for responding to a shortfall in the liquid asset minimum. 

Nixon added that the swing pricing rule would permit mutual
funds to use swing pricing under certain circumstances, which would enable it to
adjust the net asset value (NAV) by the “swing factor” once a level of net
purchases (redemptions) breaches the established threshold.  Nixon added
that the upper limit for the swing factor may not exceed two percent of the
NAV, and that funds would be able to start using swing pricing two years from
the publication of the final rule in the Federal Register.

Commissioner
Stein

Stein expressed her support for the rules, noting that they
will help ensure the mutual funds can honor their obligation to meet
shareholder redemption requests within seven days. She claimed that these rules
would help improve fund resiliency.

Votes

The final rule on liquidity risk management programs and
related disclosures was approved unanimously by the Commission. 

The final rule permitting mutual funds to adopt swing
pricing was approved in a 2-1 vote, with Commissioner Piwowar dissenting.

Additional information about this event can be
accessed here