More than a year ago, we explored challenges that asset managers were facing as they worked to implement the SEC’s Liquidity Rule. Now, 13 months later, many of those challenges still exist. With major compliance dates around the corner, here’s a look at what’s next and how things have changed.
What we said:
From the moment the US Securities and Exchange Commission (SEC) proposed its initial Liquidity Risk Management Program Rule (Liquidity Rule), the US asset management industry was skeptical. In fact, in the months that followed, the SEC received nearly 70 comment letters on the proposal, the vast majority of which were critical of the rule. At the time, many asset managers believed they already sufficiently track portfolio liquidity and didn’t think the SEC needs to prescribe to them how to do so. In response, regulators tried to draft a final rule that balanced their own desire for greater transparency and investor protection with the industry’s call for pragmatism. The sheer scope and complication to the final requirements have driven pushback as US managers now struggle to understand how they will implement the rule in a timely manner.
Not much! The Liquidity Rule underwent further delays and modifications in June 2018, giving asset managers more time to thoughtfully develop their liquidity risk management plans and their tactical plan to execute implementation.
Change of Plan
What we said:
On February 21, 2018 the SEC issued a widely anticipated delay to certain requirements of the liquidity rule citing “expressed concerns regarding the difficulties that funds are facing in preparing to comply in a timely matter.” They cited specific challenges due to interpretive guidance, service providers, and system readiness.
But even the delayed announcement itself felt like a moving target. A scheduled open meeting on the matter was cancelled without explanation at the last minute. Then, the reprieve was approved in private and announced the next day. Though the industry welcomed the delay, the positivity was tempered as only certain aspects of the rule were delayed and the exact timing of the delay remains unknown and up for negotiation. For example, funds needed to have a liquidity risk management program by the original compliance date of December 1, 2018 (for fund complexes with greater than $1 billion in net assets), but it will not need to be formally approved by the board until June 1, 2019. Funds and their boards will need to decide if those programs are the same or different, and if the same, those aforementioned challenges still exist.
In a surprising move, the SEC also sought further comments and feedback on interpretation and compliance dates through the release of the interim rule. After discussing the six-month compliance period extension, they requested comment on the appropriateness of that extension. Is six months enough time or should it be longer? Should it be shorter than six-months or should there be no extension at all?
In the table below, the SEC outlined the requirements that are subject to the extension:
As part of the February 2018 delay, the SEC cited “specific challenges due to interpretive guidance, service providers, and system readiness.” In June, they finalized changes to the Liquidity Rule that were considered in the February release and evaluated through the comment process. Though the changes ultimately help asset managers, the modifications further add to the challenges discussed back in February on guidance and readiness. Take these four primary changes as examples:
- Break out cash and cash equivalents separately in Form N-PORT – While this will help the SEC reconcile back to a fund’s highly liquid investment minimum, it requires development time for providers and systems in order to house new fields.
- Annual financial statement disclosure of operation and assessment of the Liquidity Risk Management Program – Asset managers and fund boards will need to evaluate what disclosure is appropriate for their shareholders to understand the sufficiency of the Liquidity Risk Management Program during the year.
- Elimination of certain public information related to liquidity on Form N-PORT –While many managers view this development as largely positive, keeping certain N-PORT data points private will still require development resources this far into the implementation process.
- Allowance for the circumstantial cross bucketing of positions – Probably the most significant of the modifications, the SEC has agreed to allow funds to cross bucket positions between liquidity levels when certain circumstances exist. Originally, the SEC ruled that a singular position within a fund would have one liquidity value. Sub-advised funds were negatively impacted by this and spent significant time and effort devising implementation strategies on how this would work in practice. And practically, it proved to be a prescriptive exercise and outside of the true intention of the rule.
- The change allows sub-advised funds to classify positions into more than one liquidity bucket based on how they or their sub-advisers would actually trade and thereby manage liquidity. In the end, that’s the best answer for everyone, but now asset managers in the sub-advised space need to revamp their entire liquidity risk management program to allow for this. Liquidity providers also need to modify their technology, think about data flow, and roll out product enhancements.
In the end, asset managers benefit from these most recent changes to the rule, but there is still hard work to be done. We expect this last year of the implementation effort will be more focused on administering the operational changes to the rule rather than refining the liquidity program itself.