Reporting Modernization and Liquidity Risk Management: The Clock is Ticking

With the SEC’s approval of the reporting modernization and liquidity rules in October, asset managers need to start preparing for the first compliance date in August 2017. 

Almost two years ago, the SEC announced a monumental five part plan to enhance the way registered investment companies are regulated.  Everyone in the fund industry, and some unexpected, but now interested parties, had some issue with one or all of the proposals, which resulted in almost 750 comment letters to the SEC. The industry had little indication from the SEC on whether they were taking any direction from the comment letters, in person meetings, or industry wide discussions.  This left many to speculate on the scope and timing related to the final rules. With only about a week’s notice, the SEC met on 13 October to vote on only two of the proposed rules, reporting modernization, and liquidity risk management including swing pricing.

Reporting Modernization

The final rule for reporting modernization was adopted largely as proposed, with only a couple of changes.  The final rule kept more monthly information confidential and allowed only quarterly filings to be made public, similar to today’s N-Q process. The major change to the rule was the elimination of e-delivery proposals. Under the proposed rule, a fund could have satisfied its obligations to transmit shareholder reports if the fund made the reports and certain other materials accessible on its website and satisfied certain conditions. A fund would have been subject to conditions relating to:

  1. Availability of the shareholder report and other required information on the website
  2. Implied shareholder consent
  3. Notice to shareholders of the availability of shareholder reports on the website
  4. Shareholder ability to request paper copies of the shareholder report or other required information

E-delivery was an eco-friendly proposal which could have resulted in substantial cost savings to investors. However, arguments ranging from elderly people not having internet access to paper companies going out of business and impacting the economy rang loud and often.

SEC Chair Mary Jo White indicated that the SEC will revisit this specific proposal by the end of the year.  However, the complexity of the upcoming agenda items, coupled with where we are on the calendar and a presidential election in the middle of it, seem to mount the odds against e-delivery making an appearance again. The one part of the rule that would’ve saved shareholders money, now hangs in limbo with a doubtful resurrection.

 Liquidity Rule

The liquidity rule had more substantial changes from the original proposals. A liquidity risk management program is still required, although it is less prescriptive and allows funds to tailor procedures within the program to match each fund’s assessed risk profile.  For example, each fund must identify a percentage of its net asset to be held in highly liquid investments and must create policies and procedures to correct for when the portfolio falls below that percentage. Similarly, a fund will also be prohibited from holding more than 15% of illiquid securities and will need to determine procedures if that threshold is breached to bring the illiquid investments back into threshold. If this threshold is passed, it triggers board reporting and possible notification to the SEC on a newly created Form N-LIQUID.  The liquidity bucketing also got a break in the final rule decreasing the categories from six to four. While funds will have to bucket each security within the portfolio for Form N-PORT filings, public information will only show the percentage holdings, bifurcated across the four buckets.

Investment Liquidity Classifications


Swing Pricing

Finally, the permissibly of swing pricing for open-end funds was finalized along with specific requirements for pricing policies and procedures for funds that choose to swing.  While reporting modernization and liquidity are prescriptive rules, swing pricing gives funds some options. Due to the logistical challenges associated with swing pricing in the US, it is not expected that a majority of funds will implement swing pricing.  Swing pricing does however provide a competitive advantage to funds. Many fund complexes will need to spend considerable time and effort evaluating the opportunity cost to make it happen.

There’s a lot to absorb but what should be focused on is the heightened involvement of the fund’s board, primarily with the liquidity and swing rules. Under the liquidity rule, the board must approve each fund’s liquidity risk management program and will also designate the group or individual that will administer the program. The board must review, at least annually, the written report of the design and implementation of the program’s effectiveness. Correspondingly, under the swing pricing rules, the board must approve the swing pricing policies and procedures which include the swing factor upper limit and swing pricing threshold. Like the liquidity program, the board is responsible for reviewing a written report on the effectiveness of the program.

The clock is ticking on these changes with the first compliance date on 1 August 2017.  Though the entire industry knew these rules were coming, it was impossible to fully prepare with so many major initiatives still in flux. Now fund managers must quickly get to work writing policy, revamping accounting systems, and evaluating the need for additional resources.