SEC Proposes Enhancements to Open-End Fund Liquidity Framework

The Securities and Exchange Commission today voted to propose amendments to better prepare open-end funds for stressed conditions and to mitigate dilution of shareholders’ interests. The rule and form amendments would enhance how funds manage their liquidity risks, require mutual funds to implement liquidity management tools, and provide for more timely and detailed reporting of fund information.

“A defining feature of open-end funds is the ability for shareholders to redeem their shares daily, in both normal times and times of stress,” said SEC Chair Gary Gensler. “Open-end funds, though, have an underlying structural liquidity mismatch. This can raise issues for investor protection, our capital markets, and the broader economy. We saw such systemic issues during the onset of the COVID-19 pandemic, when many investors sought to redeem their investments from open-end funds. Today’s proposal addresses these investor protection and resiliency challenges.”

Currently, open-end funds other than money market funds and most exchange-traded funds are required to classify the liquidity of their investments into four categories, ranging from highly liquid to illiquid. The proposal seeks to improve these funds’ liquidity classifications by establishing new minimum standards for classification analyses, including some that incorporate stressed conditions, and by updating the liquidity categories to limit the extent of a fund’s investments in securities that do not settle within seven days. These changes are designed to help better prepare funds for stressed conditions and prevent funds from over-estimating the liquidity of their investments. Affected funds would also be required to maintain a minimum amount of highly liquid assets of at least 10 percent of net assets to help manage stressed conditions and heightened redemption levels. These funds would publicly report certain information about their liquidity profiles to improve the availability of information about liquidity risk for investors as well as information about use of liquidity classification service providers.

In addition, the proposal would require open-end funds other than money market funds and exchange-traded funds to use a liquidity management tool called “swing pricing,” which is a method to allocate costs stemming from inflows or outflows to the investors engaged in that activity, rather than diluting other shareholders. The proposal would also require a “hard close” for relevant funds. With a hard close, investor orders would need to be received by the fund, its transfer agent, or a registered clearing agency by the time of the fund’s pricing, typically 4 p.m. ET, to receive that day’s price. In addition to helping to operationalize swing pricing, a hard close would help prevent late trading of fund shares and improve order processing. The release also includes questions about alternative liquidity management tools, such as the use of liquidity fees.

Finally, the proposal would provide the Commission and investors with timelier information. As proposed, funds would be required to file portfolio and other information on Form N-PORT on a monthly basis within 30 days, with the report becoming public after 30 additional days. This change would triple the amount of information currently available to investors and would apply to all registrants that report on Form N-PORT, including most open-end funds and registered closed-end funds, with certain exceptions.

The proposal will be published in the Federal Register. The comment period will remain open for 60 days after publication in the Federal Register.