Citing liquidity concerns that arose during the market stress that accompanied the onset of the pandemic, the U.S. Securities and Exchange Commission (SEC) is proposing rule changes designed to improve funds’ liquidity risk management.
The SEC proposed a series of rule changes that are intended to enhance funds’ handling of periods of market stress. Among other things, the proposals would establish standards for classifying the liquidity of funds’ assets, require funds to use certain liquidity management tools, and mandate monthly reporting of portfolio holdings.
“A defining feature of open-end funds is the ability for shareholders to redeem their shares daily, in both normal times and times of stress. Open-end funds, though, have an underlying structural liquidity mismatch. This can raise issues for investor protection, our capital markets, and the broader economy,” SEC chair Gary Gensler said in a release.
“We saw such systemic issues during the onset of the Covid-19 pandemic, when many investors sought to redeem their investments from open-end funds. Today’s proposal addresses these investor protection and resiliency challenges,” he added.
Specifically, the proposals would introduce new minimum standards for assessing the liquidity of funds’ portfolio assets, including the impact of market stress.
“These changes are designed to help better prepare funds for stressed conditions and prevent funds from over-estimating the liquidity of their investments,” the SEC said.
Additionally, funds would have to maintain at least 10% of net assets in “highly liquid” assets to help them manage stressed conditions and higher redemption demands.
The proposals would also require funds to use “swing pricing” to prevent investor dilution by allocating the costs of funding redemptions to the investors that are seeking to cash out, instead of sharing those costs across the fund. It would also impose a “hard close” on redemption orders, typically 4 p.m. Eastern, to prevent late trading and to facilitate the implementation of swing pricing requirements.
Industry trade group the U.S. Investment Company Institute (ICI) immediately came out against the proposed swing pricing and hard close requirements.
The swing pricing proposal “could have an enormous negative impact” on investors, ICI president and CEO Eric Pan said in a statement.
“The proposal to mandate swing price is unnecessary. Its rationale is built on minimizing dilution — yet the SEC’s assertions lack detail or supporting evidence,” he said. “The swing pricing proposal faces insurmountable operational hurdles, risks confusing investors, and upending mutual funds’ longstanding and equitable share pricing methodology.”
Additionally, Pan said that the proposed changes to fund liquidity requirements would make the rule “more prescriptive” without benefiting fund investors.
“Instead, these changes will disrupt funds’ current practices at a significant cost to investors. The changes will negatively impact the operation of many funds that investors rely on to access certain investment strategies,” he said.
“The commission must realize that rushing ahead with consequential proposals, fundamentally altering the shareholder experience, is a hallmark of the ‘regulation-by-hypothesis’ approach that the agency’s leadership is now known for,” he added.
Separately, the SEC also adopted rule amendments that require more disclosure from investment funds about their proxy voting records, and will require fund managers to disclose how they voted on “say-on-pay” shareholder resolutions.
“I am pleased to support these amendments because they will allow investors to better understand and analyze how their funds and managers are voting on shares held on their behalf,” Gensler said.
The new disclosure requirements take effect for shareholder votes after July 1, 2023, with the first filings subject to the amendments due in 2024.
The proposed changes to fund liquidity rules will go out for a 60-day comment period after they’re published in the Federal Register.