On October 13, 2016, the Securities and Exchange Commission (“SEC”) adopted a set of broad and sweeping rules mandating that certain open-end management investment companies, including mutual funds and exchange-traded funds (“ETFs”), develop and implement formalized and written liquidity risk management programs and related disclosures (“Liquidity Rules”). In approving the Liquidity Rules, SEC Chair Mary Jo White noted that it is imperative that open-end funds manage their liquidity carefully, both to ensure that redemptions can be fulfilled in a timely manner and to minimize the impact of redemptions on remaining investors and on the broader marketplace. She also noted that the recent growth of certain less-liquid strategies has made the effective management of fund liquidity more important than ever, for both investors and the markets in general.

In addition, the SEC adopted rules to modernize and enhance reporting of information provided by registered investment companies (“Reporting Modernization Rules”). In adopting the Reporting Modernization Rules, Chair White noted that the SEC seeks to improve the quality and type of data that all registered investment companies provide to the SEC and investors. She commented that the current reporting requirements have not substantially changed in decades. Therefore, these current requirements do not fully capture the volume and complexity of information relevant to the SEC, investors and the markets in general. The SEC, however, did not adopt proposed Rule 30e-3 which would have permitted, but not required, registered investment companies to transmit periodic reports to their shareholders by making the reports accessible on a website and satisfying certain other conditions.

Finally, the SEC also adopted new rules that would permit open-end management investment companies, except money market funds and ETFs, to use “swing pricing” under certain circumstances (“Swing Pricing Rules”). Chair White noted that swing pricing is designed to provide funds with an additional, optional tool to mitigate potential shareholder dilution and to better manage fund liquidity.

Under the Reporting Modernization Rules the SEC will require funds to begin filing reports on new Forms N-PORT and N-CEN after June 1, 2018, while fund complexes with less than a $1 billion in net assets will be required to begin filing reports on Form N-PORT after June 1, 2019.

Funds will be required to comply with the liquidity risk management program requirements on December 1, 2018, while funds with less than $1 billion in net assets will be required to do so on June 1, 2019. The Commission is delaying the effective date of the amendments that would permit funds to use swing pricing. The final swing pricing amendments, if adopted, would become effective 24 months after publication in the Federal Register.

Below we outline some of the key concepts of each Adopting Release. A future Paul Hastings Client Alert will provide further analysis of the new Rules.

Liquidity Rules: Key Takeaways

  • Rule 22e-4 would require that mutual funds and certain ETFs establish liquidity risk management programs (“LRMP”).
    • LRMPs would require, among other things, (1) board oversight; (2) limitation on illiquid investments; and (3) assessment, management, and periodic review of a fund’s liquidity risk.
  • A fund’s board, including a majority of independent directors, will be required to approve a Fund’s LRMP, including a determination of whether a particular investment strategy is appropriate in an open-end fund structure.
  • Unlike the proposal, the SEC adopted a requirement that would involve four liquidity categories, instead of six: (1) highly liquid investments; (2) moderately liquid investments; (3) less liquid investments; and (4) illiquid investments.
    • Illiquid investments—The SEC noted that an illiquid investment is an investment that a fund reasonably expects cannot be sold in current market conditions in seven calendar days without significantly changing the market value of the investment.
  • The new Liquidity Rules will require mutual funds not to acquire any illiquid investments if, immediately afterward, such fund would exceed the 15 percent limit on illiquid investments. The SEC Staff noted that if a fund breaches the 15 percent limit, it would need to notify the SEC of such breach on a new form.
    • Form N-LIQUID—submitted confidentially to the SEC and would notify the SEC when a fund’s level of illiquid assets exceeds 15 percent of its net assets or when its highly liquid investments fall below its minimum for more than a brief period of time.
  • Under the new Liquidity Rules, a fund must review its portfolio investments’ classifications at least monthly and more frequently if changes in relevant market, trading and investment-specific considerations are reasonably expected to materially affect one or more of its investments’ classifications.
  • The new Liquidity Rules were passed unanimously by the SEC.

Reporting Modernization Rules: Key Takeaways

  • Form N-PORT: Substantially similar to that proposed in 2015, the new Form N-Port will replace the current form N-Q. The new form will require monthly reporting to the SEC and information provided on this form will be made public on a quarterly basis, with a 60-day lag.
    • The SEC Staff noted that fund complexes may use internal or third-party methodologies when providing information required under Form N-PORT.
    • Form N-PORT would require funds to provide information regarding derivative positions, information regarding repurchase agreements, securities lending activities and counterparty exposure.
  • Form N-1A: Amendments to Form N-1A would require funds to describe their procedures for redeeming fund shares, the number of days in which the fund typically expects to pay redemption proceeds, and the methods for meeting redemption requests.
  • Form N-CEN: This form would replace the current Form N-SAR and require funds to provide annual, census-type reporting. Reports on Form N-CEN must be filed no more than 75 days of the end of a fund’s fiscal year, which is a change from the proposal that would have required funds to provide information no more than 60 days after a fund’s fiscal year end.
  • The information on the new forms will be reported in a structured XML format that would allow for easy processing of data reported and potentially allow the SEC to better analyze fund data.
  • The Reporting Modernization Rules passed two to one, with Commissioner Piwowar voting against these new rules.
  • As noted above, proposed Rule 30e-3 was not adopted. Chair White noted that she expects the SEC Staff to continue analyzing proposed Rule 30e-3 and expects the SEC Staff to come back with its analysis by year end with respect to the proposed Rule. Commissioner Stein spoke out against proposed Rule 30e-3, noting that certain investors would be harmed if the Rule was adopted as proposed. Commissioner Piwowar discussed the benefits associated with the proposed Rule, including significant savings to shareholders.

Swing Pricing Rules: Key Takeaways

  • Swing pricing will be an optional tool for mutual funds with the aim to prevent the dilution of interest to the non-redeeming investors.
  • A fund’s swing pricing policies and procedures would have to specify the process for how the fund’s swing factor and swing threshold would be determined (taking into account certain considerations) and establish and disclose an upper limit on the swing factor used, which may not exceed two percent of net asset value per share.

A copy of the SEC’s fact sheet on the adopted rules may be found here.

A copy of the SEC’s final rules may be found here.