On February 21, 2018, the SEC adopted an interim final rule (the Interim Rule) delaying by six months the date by which open-end funds must comply with certain requirements of Rule 22e-4 under the Investment Company Act of 1940, as amended (the Liquidity Rule), including the requirement to classify each fund’s investments into one of four liquidity categories (or “buckets”). The revised compliance date will be June 1, 2019, for larger entities6 (revised from December 1, 2018), and December 1, 2019, for smaller entities7 (revised from June 1, 2019).
Specifically, the following requirements of the Liquidity Rule have been delayed by six months pursuant to the Interim Rule:
- “bucketing” a fund’s investments and certain related requirements that are dependent upon the classification requirement;
- determining and monitoring a fund’s “highly liquid investment minimum” (or “HLIM”);
- board approval of a fund’s liquidity risk management (LRM) program, and the related annual review requirements; and
- recordkeeping and reporting requirements related to the elements of the Liquidity Rule that are being delayed.
The Interim Rule’s adopting release identifies certain operational and compliance challenges associated with the Liquidity Rule as the basis for delaying the compliance date, including:
- Role of Service Providers: the lack of readily available market data for certain asset classes (e.g., fixed income) means that implementing the bucketing requirement “will be heavily dependent on service providers . . . with scalable liquidity models and assessment tools”;
- Systems Readiness: “fund groups believe that full implementation of service provider and fund systems will require additional time for further refinement and testing of systems, classification models and liquidity data, as well as for finalizing certain policies and procedures”; and
- Interpretive Guidance: “funds are facing compliance challenges due to questions that they have raised about the Liquidity Rule Requirements that may require interpretive guidance,” which, once provided by the staff, will need to be evaluated by funds and incorporated into their processes, as necessary.
The Interim Rule’s adopting release states that the following requirements are not being delayed:
- The board’s designation of the LRM program administrator;
- The general obligation that each fund implement an LRM program, including the required assessment, management and periodic review of the fund’s liquidity risk;
- The 15% illiquid-investment limit and the related board and SEC reporting requirements; and
- The establishment of policies and procedures for redemptions in-kind for any fund that engages or reserves the right to engage in redemptions in-kind.
The Interim Rule’s adopting release also provides guidance for funds’ compliance with the 15% limitation on illiquid investments during the six-month delay period. The SEC suggests that a fund could preliminarily identify certain asset classes or investments that the fund reasonably believes are likely to be illiquid based on previous trading experience or an understanding of the general characteristics of the asset classes it is preliminarily evaluating, or through other means. The SEC also notes that funds already have experience following the 15% limitation restricting purchases of illiquid assets when considering whether to purchase additional illiquid assets, and it further stated that funds may use reasonable approaches other than the one described in the adopting release.
The Interim Rule’s adopting release also seeks comment on the delay in the classification, HLIM, and related reporting and recordkeeping requirements. For instance, the SEC asks if six months is a sufficient amount of time for funds to implement classification and other related requirements and, if not, how much additional time would be needed to comply. As to the board oversight requirements, the SEC asks if, instead of a delay, it should require the board to approve LRM programs without the classification and related requirements and, generally, whether the board approval requirements should be delayed. Comments on the foregoing and other questions raised in the adopting release must be received by the SEC on or before April 27, 2018.
The Interim Rule is available at: https://www.sec.gov/rules/interim/2018/ic-33010.pdf