US SEC Approves New Rules for Mutual Funds and ETFs

- October 13th, 2016

The US Securities and Exchange Commission announced new rules requiring liquidity risk management and enhanced reporting for mutual funds and ETFs. SEC Chairman Mary Jo White claims it is “sweeping and transformative.”

On Thursday, the US Securities and Exchange Commission announced new rules requiring liquidity risk management and enhanced reporting for mutual funds and Exchange Traded Funds (ETFs).

The SEC’s press release stated, “The new rules are part of the Commission’s initiative to enhance its monitoring and regulation of the asset management industry.”

Liquidity risk management and reporting

Under the new rules, mutual funds and ETFs must classify investments as highly liquid, moderately liquid, less liquid and illiquid. Funds are also permitted to classify investments by asset class. Registered funds will now be required to file new monthly and annual reporting forms that require “census-type information” to allow the Commission better analysis of the information. The rules also impose a 15 percent limit on illiquid investments and will require further disclosure regarding fund liquidity and redemption practices.

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Swing pricing–the process of adjusting a fund’s net asset value to pass on to purchasing or redeeming shareholders–will be permitted for open-end funds (except ETFs or money market funds).
Bloomberg reports that under the revised rules, ETFs are exempt from certain new requirements if they redeem in-kind, or provide securities rather than cash as redemptions, and provide daily portfolio information. ETFs will also face liquidity risk management requirements, but those requirements will be specifically tailored to their structure.
The new rules approved by the SEC are a result of warnings from the Federal Reserve and International Monetary Fund that some funds with higher risk holdings may find it difficult to return cash to investors during a high redemption demand period. Bloomberg pointed out that in December 2015, a $788 million fund managed by Third Avenue Focused Credit Fund halted redemptions and resulted in a selloff in the high-yield market.

What investors need to know

In an interview with CNBC’s “Power Lunch”, SEC Chair Mary Jo White claims that the liquidity risk management ruling is “sweeping and transformative,” and that, “managing that liquidity risk when shareholders want to redeem them is obviously essential to the asset management industry.”

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She explains further that categorizing the liquidity of investments benefits investors because both the SEC and the fund’s board of directors can better monitor the liquidity risks.
She says, “The rule requires the categorizing, or you know, bucketing of highly liquid investments and the fund needs to impose with board approval. Basically, a minimum requirement for highly liquid and then two other categories or more liquid and less liquid, so they can both better monitor and the board can better monitor the liquidity risks as can the SEC. The second of those rules is really our reporting rules, enhancing the reporting of information. New and different and more and more frequent information to both the SEC and investors.”
The new rules will be in effect beginning December 1st, 2018 for most funds and June 1st, 2019 for fund complexes with less than a $1 billion in net assets.
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