Statement at Open Meeting on Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of Comment Period for Investment Company Reporting Modernization Release
Commissioner Michael S. Piwowar
Sept. 22, 2015
Thank you, Chair White.
And thanks to the staff who worked so hard on this rulemaking. The numerous evenings and weekends you sacrificed have not gone unnoticed, and the results of those efforts are clearly reflected in the quality of this comprehensive proposal.
This proposal marks the second in a series of initiatives aimed at ensuring that the Commission’s regulatory program fully addresses the increasingly complex portfolio composition and operations of the asset management industry. In May, we proposed two rulemakings intended to modernize and enhance data reporting for funds and investment advisers to reflect today’s markets and technology. Future rulemakings will target the growth in the use of derivatives by registered funds and the impact on investors of a market stress event or when an investment adviser is no longer able to serve its clients.
Today’s rulemaking focuses on liquidity management by open-end investment companies other than money market funds (“funds”). Open-end funds are required to redeem their securities on demand from shareholders at a price approximating their proportionate share of the fund’s net asset value (“NAV”) at the time of redemption. Funds must make payment to redeeming shareholders within seven days of the shares being tendered. As a result, it is important that funds adequately manage the liquidity of their portfolios so they can meet their redemption obligations. In addition, the costs of providing liquidity to redeeming investors could be borne at least partially by the remaining investors in the fund, potentially diluting the interests of non-redeeming shareholders. Today’s proposals are intended to promote effective fund liquidity risk management, reduce the risk that funds will not be able to meet redemption obligations, and mitigate potential dilution of shareholders’ interests in funds.
The key features of the rulemaking are a requirement that funds establish a liquidity risk management program and an option that funds other than exchange-traded funds may use “swing pricing,” the process of adjusting the NAV of a fund’s shares to pass on the costs stemming from a shareholder’s purchase or redemption activity to that shareholder.
As proposed, a fund’s liquidity risk management program would have to include, among other things, the classification of the liquidity of each of the fund’s positions in a portfolio asset into one of six categories based on the number of days within which the fund’s position in a portfolio asset would be convertible to cash at a price that does not materially affect the value of that asset immediately prior to sale; an assessment and periodic review of the fund’s liquidity risk based on certain factors enumerated in proposed new rule 22e-4; and management of the fund’s liquidity risk, including that the fund will invest a set minimum portion of net assets in assets that the fund has classified as being convertible to cash within three business days (“three-day liquid asset minimum”). The rule would require that the three-day liquid asset minimum be determined based on the same enumerated factors as the fund’s assessment of its liquidity risk.
I support publishing today’s proposal for public comment, but I am concerned about the rule’s three-day liquid asset minimum requirement. While in practice many funds may make payment to shareholders for securities tendered for redemption in less than seven days, section 22(e) of the Investment Company Act only requires that the fund make payment within seven days of the securities being tendered. I would prefer that the rule track the statute and require a seven-day liquid asset minimum rather than the proposed three-day liquid asset minimum. I hope that commenters will provide feedback on this issue.
I also encourage commenters to provide their views on the proposed swing pricing option. I am not convinced that swing pricing is the best way to allocate the costs stemming from a shareholder’s purchase or redemption activity to that shareholder. There are other means by which a fund could mitigate dilution and ensure that redeeming shareholders bear the bulk of the costs associated with their redemptions. For example, funds could use liquidity or redemption fees to serve a similar purpose as swing pricing, without affecting the fund’s NAV. In fact, money market funds are permitted to impose liquidity fees on redemptions under certain conditions. We would benefit from comments on whether swing pricing is the appropriate method for attempting to assess costs incurred due to shareholder purchasing and redemption activity.
As is pointed out in the release, adopting a swing pricing threshold also could create the potential for shareholder gaming behavior because a fund’s shareholders could attempt to time their purchases and redemptions based on the likelihood that a fund would adjust its NAV. In addition, swing pricing would likely increase the volatility of a fund’s NAV. I hope that comments on swing pricing will also discuss the potential for gaming behavior and how swing pricing would affect comparisons of common risk-adjusted measures of mutual fund performance, such as alpha, beta, Sharpe ratio, and tracking error. The views of academic economists on these two issues could be particularly helpful.
I am pleased to support the overall package of reforms we are considering today and look forward to the comments on all aspects of today’s proposal. I would like to close by expressing my appreciation for the collaborative approach that staff took in formulating today’s proposal. I have no questions.