At its open meeting in mid-October, the Securities and Exchange Commission adopted liquidity rules for mutual funds and ETFs — called “sweeping” by Chairwoman Mary Jo White — to allow fund boards, the SEC and investors to “better monitor liquidity risks” in those investing vehicles.
In introducing the rules approved during the meeting on Oct. 13, White said they were meant to “modernize and enhance liquidity risk management” and improve reporting on fund holdings by registered investment companies for mutual funds and exchange-traded funds (ETFs).
White characterized the new rules as part of her nearly two-year-long effort to institute “a series of transformative reforms” meant to “enhance the SEC’s oversight and regulation of the asset management industry,” and for the commission to catch up with changes in that industry.
In a brief interview with CNBC following the SEC meeting, White said fund holdings in illiquid investments would be capped at 15% of the portfolio. She said the goal was to institute a “minimum requirement for highly liquid” holdings.
Specifically, funds will now be required to report their complete portfolio holdings to the SEC monthly using the new Form N-PORT, and annually using Form N-CEN. The “census-type information” in those forms will be provided in a “structured format immediately useful for analysis,” and will include information on the funds’ use of “derivatives, basic risk metrics, securities lending activities, liquidity and pricing of portfolio instruments.”
Each of the investments in a fund portfolio will be placed into one of four liquidity categories, “based on the number of days in which the fund’s investment would be convertible to cash in current market conditions without the sale significantly changing the market value.” In addition, every fund must designate a “minimum amount that the fund must invest in highly liquid investments convertible to cash within three business days without significantly changing the investment’s market value.” Finally, there is the requirement that illiquid assets will be limited to 15% or less of the fund’s net assets.
The SEC said the “controls around the accumulation of illiquid positions have been tightened,” promising increased oversight when a fund “dips below its highly liquid investment minimum or exceeds the limit on illiquid investments.”
Timothy Cameron, head of SIFMA’s Asset Management Group (AMG), said that while the industry group was still reviewing the final rules, it lauded the SEC for “showing thoughtful consideration of comments by SIFMA AMG and others.”
The Investment Company Institute was less complimentary, with ICI President and CEO Paul Schott Stevens releasing a statement noting that “this is a tough set of new rules that will spur a number of operational changes across the registered fund industry,” and will “likely add complexity and cost.”
The new rules for larger fund companies to start filing their N-PORT and N-CEN reports is June 1, 2018. For fund companies with less than $1 billion in net assets, the deadline to start filing those reports will be June 1, 2019.
Money Market Funds Ready but Wary
The day after the SEC adopted the new liquidity rules for mutual funds and ETFs, a 2014 rule regarding money market funds finally became effective.
While ICI says funds are ready to comply with the SEC’s new rules for money market funds that kicked in last month, the mutual fund industry trade group warned advisors and investors to tread carefully.
Coupled with the 2010 money market fund reforms, the rule, passed in 2014 and effective Oct. 14, required funds “to make a number of significant operational changes on a very aggressive timeframe,” said ICI’s Stevens in statement. “Thanks to substantial effort, planning and execution within the industry, funds are prepared to meet the new requirements on time.”
Washington-based ICI explained in a mid-October blog that the new SEC rules “are pushing investors toward government money market funds — those that invest principally in securities issued by the U.S. Treasury or government agencies (or repurchase agreements backed by government securities).”
Institutional investors who prefer money market funds with stable $1 NAVs, and retail investors who want to avoid even the remote chance of redemption fees or gates, “will have no choice but to invest in a government money market fund,” ICI stated.
Indeed, “as of right now, the minimal yield difference between prime and government funds is such that investors aren’t being properly compensated for assuming the (possible) risk and (possible) lack of liquidity,” Brad McMillan, chief investment officer for Commonwealth Financial Network, told ThinkAdvisor.com the same day the rule became effective.
Most advisors “are concerned about the floating NAV and explaining to their clients some of the potential pitfalls of the prime funds,” McMillan said. “As such, they are generally sticking with government funds. That said, if the FOMC raises rates one or two times, the payoff will be more appealing and potentially worth it.”
The SEC’s new rules center around two key reforms:
Prime and tax-exempt money market funds that are sold to institutional investors must price their shares and transactions using a “floating” net asset value (NAV), rather than the stable $1 NAV that such funds have long maintained.
All nongovernment money market funds (i.e., prime and tax-exempt funds, whether retail or institutional) can impose delays (“gates”) or redemption fees on redeeming shareholders under limited situations. A fund is required to impose redemption fees if the fund’s weekly liquid assets fall below 10% of its total assets, unless the fund’s board decides a redemption fee is not in the fund’s best interests.
ICI’s Stevens noted that with the new rules, “three things” are clear: “Today’s money market funds are very different products than their pre-crisis predecessors; investors value the vital role that money market funds play in helping meet their cash management needs; and money market funds do not need further reform.”
Prime Funds’ Cash Locked Behind Fees, Gates
Brandon Swensen, vice president and co-head of U.S. Fixed Income at RBC Global Asset Management, told ThinkAdvisor.com in an email that “because of fees and gates, prime funds no longer offer unconditional access to cash. If a fund has liquidity issues, cash could be unavailable to settle trades in a sweep account.”
Swensen said that RBC doesn’t “think the cash allocation of a portfolio should be subject to such risks. Post reform, U.S. government or Treasury money funds will be the pure money market fund sweep option left,” so advisors “looking to help clients earn additional income, without a lot of interest rate risk, should look at short-term bond funds as a complement to a government money fund.”
Jerome Schneider, PIMCO’s head of short-term portfolio management, noted in his October blog post that the SEC’s new money market fund regulations “should also mark a point of reflection for investors.”
PIMCO is thus encouraging investors to consider the impact of the SEC changes, including “the deteriorating purchasing power protection of money funds. ”
Kevin Mansfield, national director of stable value investments at New York Life, urged plan sponsors to review their capital preservation options. “While there are plan sponsors who chose to not take the time to review and instead default into a government money market fund, that non-action is a fiduciary decision,” he said.