The Securities and Exchange Commission has adopted amendments to liquidity-related disclosure requirements for certain open-end funds.
Under the amendments, approved on June 28, funds would discuss in their annual or semi-annual shareholder report the operation and effectiveness of their liquidity risk management programs.
The SEC adopted the open-end fund liquidity rule in October 2016, an effort to promote effective liquidity risk management programs in the fund industry. Changes were first proposed in March, with a plan to replace a requirement that funds publicly provide the aggregate liquidity classification profile of their portfolios on Form N-PORT on a quarterly basis.
The proposed amendments were intended “to improve the reporting and disclosure of liquidity information by registered open-end investment companies.”
“Management of liquidity risk is important to funds’ ability to meet their statutory obligation—and their investors’ expectations—regarding redeemability of their shares,” the SEC said in a statement on Thursday. “Since adoption of the 2016 rule, staff has engaged in extensive outreach to identify potential issues associated with the effective implementation of the rule.”
The Commission previously adopted a rule that extends by six months the compliance date for the classification and classification-related elements of the liquidity rule and related reporting requirements.
“The amendments will require funds to make information on a key aspect of effective portfolio management available to investors,” Chairman Jay Clayton said. “This additional information should enhance investor-specific evaluation and decision making.”
Improved liquidity disclosure
Under the now-approved amendments, funds would discuss, in their annual or semi-annual shareholder report, the operation and effectiveness of their liquidity risk management program, replacing a pending requirement that funds publicly provide the aggregate liquidity classification profile of their portfolios on Form N-PORT.
Enhanced N-PORT classification reporting
The amendments to Form N-PORT (the form that funds will file each month with portfolio holdings information) will provide funds the flexibility to split their portfolio holdings into more than one classification category in three specified circumstances when split reporting equally or more accurately reflects the liquidity of the investment or eases cost burdens.
Form N-PORT will require that funds disclose their holdings of cash and cash equivalents not reported elsewhere on the Form.
The effective date for the form amendments will be 60 days after publication in the Federal Register.
Commissioners Robert Jackson and Kara Stein objected to the amendments
“The final rule is based on the bizarre claim that investors might find information about liquidity so confusing that we serve them best by keeping the information secret,” Jackson said. “There is no more evidence today than there was at the proposal stage for that paternalistic premise.”
“What’s more, between the proposed and final stages the rule has taken a troubling turn,” he added. “Not content to keep investors in the dark, the majority today calls for comment on whether we should abolish the entire liquidity classification regime itself. Market participants who have invested millions of dollars and thousands of hours developing systems for liquidity reporting now have no basis to know what, if anything, the Commission might require in that respect in the future. We owe investors and the markets more certainty than this.”
Liquidity—or how long it takes to sell an investment and turn it into cash without affecting its price—can be an important piece of information for mutual fund and exchange-traded fund investors, Stein said. Securities law requires that investors in these funds be able to get their money within seven days of making a request to redeem their fund shares. If a fund is forced to sell an investment at an unfavorable price to comply with this requirement, the return on the investor’s capital can be impacted.
“This effect can be exacerbated during times of market stress, when investors en masse try to redeem their shares,” she said. “As a result, the liquidity of the investments in a mutual fund or ETF might be something an investor finds important when making investment decisions.”
The Commission’s current rule requires that certain funds categorize their portfolio investments into four categories or buckets, from easy-to-sell to hard-to-sell, Stein explained. The rule also requires quarterly public disclosure of the total percentage of investments the fund has in each bucket.
“Investors would have seen four numbers every quarter from their funds that could have helped them make their investment decisions,” she added. [This] amendments would eliminate the public reporting of these numbers… Why shouldn’t investors be able to get very basic liquidity information about a fund in which they are investing or about to invest?”
An amendment to eliminate public disclosure of basic liquidity information is problematic enough, but changes before the Commission appear “to be opening the door to something much worse,” Stein said. The release suggests that the Commission could “propose amendments to the liquidity rule to move to a more principles-based approach.”
“What’s wrong with a principles-based approach? Aren’t many of the Commission’s rules principles-based?” Stein asked. “I recognize that principles-based approaches can work well in certain circumstances, and I also appreciate the value of retrospectively reviewing our rules. But this rule hasn’t even taken effect yet. It’s too early to embark on a retrospective review. We are merely creating business uncertainty for all the funds working to comply with the rule. And this is after a robust, years-long rulemaking process that thoroughly weighed the pros and cons of a principles-based approach, and ultimately decided against such an approach.”
“What’s more, sometimes principles-based rules are code for letting registrants use their own discretion in complying with the rule. In this case, I suspect investment companies will say ‘leave it to us, we’ve got this’ in response to our requests for feedback,” Stein added.