Statement on Adoption of Open-End Fund Liquidity Risk Management Programs and Swing Pricing
Commissioner Kara M. Stein
Oct. 13, 2016
Open-End Fund Liquidity Risk Management Programs
I want to thank the staff for their hard work on these rules. In particular, I want to thank Zeena Abdul-Rahman, John Foley, Andrea Ottomanelli Magovern, Naseem Nixon, Amanda Hollander Wagner, Thoreau Bartmann, Melissa Gainor, Kathy Joaquin, Christof Stahel and Sarah ten Siethoff.
I noted earlier how important mutual funds and ETFs have become to American households. Investors count on these funds to prudently manage their savings. And when investors decide to withdraw their money, they expect to be able to redeem their shares and get their money out quickly. This ability to redeem within a short period of time is a defining feature of these open-end funds.
Today, we are adopting a new rule that will help to ensure that mutual funds and ETFs are able to stand by their obligation to redeem investors’ shares on request. Currently, our rules provide little guidance on how registered funds should manage their holdings to meet these obligations. This leaves the door open to potential harm to shareholders. As we saw last year in the case of a particular mutual fund, when funds become concentrated in securities they cannot easily sell, they may be unable to satisfy their obligation to redeem investors’ shares in a timely way. The growth in funds that focus on complex alternative investment strategies and fixed income investments highlights the need for more guidance. Today’s rule is an important step toward improving fund resiliency and ensuring that funds manage their holdings consistent with their obligation to honor redemption requests.
In particular, today’s adopting release requires that mutual funds and ETFs adopt a liquidity risk management program. Under these programs, they must assess and manage their holdings to ensure that they can sell assets in time to meet shareholder redemption requests. Mutual funds will also be required to periodically classify, or “bucket,” their holdings based on how quickly they can be sold for cash. They then must report this information to the Commission. This will give us important data regarding whether funds are well-positioned to meet redemptions.
The final rule differs in a number of ways from the proposal. Some of these changes reflect sensible revisions to address the concern, expressed by a broad range of commenters, that the bucketing scheme was overly complicated. The final rule also imposes and strengthens a 15% limit on having assets in the fund that cannot be sold within seven days. This limit is important because these assets are the mostly likely to cause problems when a fund needs to sell assets quickly to meet redemption requests.
The rule release also includes guidance to help open-end funds apply the new Commission requirements. For example, it offers guidance to funds that are planning to hold a significant amount of securities, like certain bank loans, that take more than seven days to turn into cash. This guidance should help fund organizers decide, when considering whether to create a new fund, whether it can appropriately commit to make redemptions as an open-end fund.
I support the rule before us today because it represents a significant improvement to current requirements. I hope that we will monitor the effectiveness of the rule closely and not wait another 25 years to revisit these requirements again.
We also have before us a recommendation to adopt swing pricing for mutual funds. Swing pricing allows a fund to allocate certain costs associated with the purchase and redemption of shares to the shareholders who are actually doing the buying and selling. This is done by adjusting the fund’s share price to reflect those costs. In many cases today, a fund’s remaining shareholders are forced to bear these transaction costs, even though they do not benefit directly from the activity. The rule will give mutual funds the option of swing pricing, but will not require it.
Before a mutual fund may use swing pricing, its board must approve important aspects of the program. This includes the circumstances under which swing pricing will be triggered, the maximum cost adjustment to the fund’s share price, and how the adjustments will be made.
While swing pricing may enable funds to more fairly pass on costs to the shareholders who are actually doing the buying and selling, we must also be careful to ensure that the rule itself does not create the potential for misuse or abuse.
Accordingly, today’s rule makes a number of changes from the proposal to strengthen investor protections. For example, the cost adjustment will be limited to a maximum of two percent (2%), consistent with similar Commission rules. In addition, in determining the amount of the adjustment, mutual funds will only be permitted to consider the near-term costs of the purchases and redemptions. Mutual funds will also be required to report to their boards at least annually on how well the program is working. Finally, the Commission is also directing the staff to conduct a study two years after the effective date of the rule to ensure that we closely monitor this new tool.
In consideration of these enhanced protections, I will support today’s adopting release allowing mutual funds to use swing pricing.
Thank you again to the rulemaking teams for your work on these releases.