SEC Adopts Final Liquidity Rules

The Securities and Exchange Commission (SEC) voted to adopt changes to modernize and enhance the reporting and disclosure of information by registered investment companies and to enhance liquidity risk management by open-end funds, including mutual funds and exchange-traded funds (ETFs).

Previously, John Hollyer, global head of Vanguard’s Investment Risk Management Group in Malvern, Pennsylvania, told PLANADVISER mutual funds have a very strong track record of managing risk and liquidity. “So you could argue that plan sponsors have been well-served by regulations so far, and … sponsors could benefit from knowing firms have higher standards for risk management,” he said.

However, “If mutual funds were less fully invested in the market because of liquidity requirements, that could be a detriment, particularly to long-term investors,” Hollyer added. And, there could be the potential for increased costs passed to investors by mutual funds.

In order to provide funds with an additional tool to mitigate potential dilution and to manage fund liquidity, the SEC proposed amendments to rule 22c–1 under the Investment Company Act to permit funds—except money market funds and exchange-traded funds (ETFs)—to use ‘‘swing pricing,’’ a process of adjusting the net asset value of a fund’s shares to pass on to purchasing or redeeming shareholders more of the costs associated with their trading activity. Those amendments were adopted by the SEC as well.

Hollyer explained that this means when cash flows in or out rise above a certain threshold, the mutual fund could choose to adjust the cost of the fund that day to account for the number of investors who bought or sold on that day. Long-term investors, such as retirement plan participants, would benefit from this because they would not bear the cost of frequent traders.

According to the SEC, the reporting modernization rules will enhance data reporting for mutual funds, ETFs and other registered investment companies. With these rules, registered funds will be required to file a new monthly portfolio reporting form (Form N-PORT) and a new annual reporting form (Form N-CEN) that will require census-type information. 

The information will be reported in a structured data format, which will allow the Commission and the public to better analyze the information. The rules also will require enhanced and standardized disclosures in financial statements and will add new disclosures in fund registration statements relating to a fund’s securities lending activities.

The liquidity risk management rules are designed to promote effective liquidity risk management for mutual funds and ETFs, reducing the risk that funds will not be able to meet shareholder redemptions and mitigating potential dilution of the interests of fund shareholders. They will require mutual funds and ETFs to establish liquidity risk management programs that address multiple elements, including classification of the liquidity of fund portfolio investments and a highly liquid investment minimum. The rules also strengthen the 15% limit on illiquid investments and will require enhanced disclosure regarding fund liquidity and redemption practices.

The new rules and forms will be published on the SEC’s website and in the Federal Register.