In January 2014, the staff of the SEC’s Division of Investment Management (the “IM Staff”) published an IM Guidance Update concerning risk management and disclosure practices in changing fixed income market conditions (the “Guidance Update”). The Guidance Update cites to the increased volatility experienced by fixed income markets during June 2013, along with changes in bond market size and structure, as a reminder of the importance of sound risk management and disclosure practices by fixed income mutual funds and exchange-traded funds. According to the Guidance Update, while the net assets of fixed income funds are at near-historic highs, the fixed income markets have experienced a significant reduction in dealer market-making capacity. The IM Staff expressed concerns that this reduction in dealer capacity may result in decreased liquidity and increased volatility in the fixed income markets.
The Guidance Update describes several steps that fund advisers may want to consider in terms of risk management and disclosure, including:
- Assessing and Stress Testing Liquidity – assessing fund liquidity needs during both normal and stressed environments, including assessing sources of liquidity (such as cash holdings and other assets that would not require selling into declining or dislocating markets);
- Conducting More General Stress Tests/Scenario Analyses – assessing the impact (beyond solely liquidity) of various stress tests, such as stress tests involving interest rate hikes, widening spreads, price shocks to fixed income products, or increased volatility;
- Conducting a Risk Management Evaluation – using the outcomes of any assessments, analyses and conversations to evaluate what risk management strategies and actions are most appropriate in response to changing fixed income market conditions at a fund and/or complex level;
- Communicating with Fund Boards – considering what information should be provided to fund directors to inform them of the risk exposures and liquidity position of the fund, and the fund’s ability to adapt to changing interest rate and market conditions; and
- Communicating with Shareholders – assessing the adequacy of fund disclosures in light of any additional risks due to recent events in the fixed income markets and the potential impact of tapering of quantitative easing and/or rising interest rates, including the potential for periods of volatility and increased redemptions.
The Guidance Update can be found here.