On June 28, 2018, the SEC adopted amendments to the disclosure requirements concerning certain fund liquidity information largely as proposed.3 Fund liquidity reporting relates to new Rule 22e-4 under the Investment Company Act of 1940 (the Liquidity Rule), which requires each fund (other than money market funds and closed-end funds) to adopt and implement a written liquidity risk management (LRM) program reasonably designed to assess and manage the fund’s liquidity risk.4 A fund’s LRM program must include certain components, including, among other things, that a fund classify the liquidity of each portfolio investment into one of four categories (or “buckets”): highly liquid investments, moderately liquid investments, less-liquid investments and illiquid investments. Previously, Form N-PORT5 —on which funds have not yet begun reporting—would have required a fund to publicly report the aggregate percentage of its portfolio investments that falls into each of the four liquidity buckets. The SEC’s final rule rescinds the foregoing public reporting requirement and, in its place, creates a new requirement that funds disclose information about the operation and effectiveness of their LRM programs in their shareholder reports.
Specifically, the amendments adopted by the SEC will:
- rescind the requirement in Form N-PORT that funds publicly disclose aggregate liquidity portfolio classification information on a quarterly basis;
- require funds to “briefly discuss” the operation and effectiveness of the LRM program during the most recently completed fiscal year in the next shareholder report (annual or semi-annual)6 following the board’s review of the LRM program, in order to “provide investors with enough detail to appreciate the manner in which a fund manages its liquidity risk”;7
- make nonpublic the reporting about the percentage of a fund’s highly liquid investments that are segregated to cover, or pledged to satisfy margin requirements in connection with, less-liquid derivatives transactions;
- allow funds the option of splitting a fund’s holding into more than one liquidity bucket in three specified circumstances:
- if portions of a position have differing liquidity features that justify treating the portions separately, such as when a fund holds a put option on a portion, but not all, of the fund’s holding of the asset that significantly affects the liquidity characteristics of the portion of the asset subject to the put;
- if a fund has multiple sub-advisers with differing liquidity views, such as situations in which sub-advisers manage different sleeves of a fund and a single holding is held in multiple sleeves, a fund may report each sub-adviser’s classification of the proportional holding it manages—effectively treating each portion as two separate and distinct securities—rather than putting the entire holding into one bucket, thus avoiding “the need for costly reconciliation”; and
- if the fund chooses to classify the position through an evaluation of how long it would take to liquidate the entire position (rather than basing it on the sizes it would reasonably anticipate trading)—referred to as the “proportionality” approach; and
- require funds to publicly report holdings of cash and cash equivalents on a quarterly basis on Form N-PORT
As proposed, the required narrative discussion of the operation and effectiveness of a fund’s LRM program during its most recently completed fiscal year would have been provided in the “management’s discussion of fund performance” (MDFP) section of the fund’s annual report. However, under the final amendments adopted by the SEC, the required narrative discussion will be included in a new section of a fund’s shareholder report following the discussion of board approval of advisory contracts. The adopting release notes that, because the MDFP section is only required in a fund’s annual report, moving the new required disclosure to a new section that may be included in either a fund’s annual or semi-annual report will allow a fund to synchronize the annual board review of the fund’s LRM program, as required under the Liquidity Rule, with the production of this narrative discussion in the shareholder report.
As noted in the adopting release, the SEC staff will continue to monitor and solicit feedback on the implementation of the Liquidity Rule and will inform the SEC what steps, if any, the staff recommends in light of its monitoring. As part of this evaluation process, the SEC expects that its staff will consider whether publishing a periodic report containing “aggregated and anonymized information about the fund industry’s liquidity” would be useful and will provide a recommendation in this regard to the SEC.
The adopting release provides for a tiered set of compliance dates based on asset size, largely as proposed. Specifically, the compliance dates for the adopted amendments, other than the new shareholder report disclosure requirement, are aligned with the revised compliance dates previously adopted for Form N-PORT.8 However, in a change from the proposed rule, the SEC is not aligning the compliance dates for the new shareholder report disclosure requirement with the revised compliance dates previously adopted for Form N-PORT. Instead, the SEC is providing funds with additional time so that funds have at least a full year of experience with their LRM programs before they are required to produce the new shareholder report disclosure.
Accordingly, the compliance dates for the amendments are as follows:
The adopting release is available at: https://www.sec.gov/rules/final/2018/ic-33142.pdf