SEC Proposes Tweaks to Funds’ Public Disclosures About Liquidity Risks

(CN) – The Securities and Exchange Commission has proposed switching liquidity-related public disclosures for open-ended funds from a new quarterly disclosure on an XML form where results can be coded to the funds’ less structured annual reports.

“Under the proposal, funds would discuss in their annual report the operation and effectiveness of their liquidity risk management program, replacing a pending requirement that funds publicly provide the aggregate liquidity classification profile of their portfolios on Form N-PORT on a quarterly basis,” the SEC announced.

“The commission adopted the open-end fund liquidity rule in October 2016 in an effort to promote effective liquidity risk management programs in the fund industry,” its announcement stated.

Toward implementing the 2016 rule, the commission said it had already “adopted a rule that extends by six months the compliance date for the classification and classification-related elements … and related reporting requirements,” and “the staff issued new guidance intended to assist funds in complying with the liquidity rule’s classification requirements.”

“Together with today’s proposal, these actions are aimed at providing investors with accessible and useful information about liquidity risk management of the funds they hold while providing sufficient time for funds to implement the requirement to classify their holdings in an efficient and effective manner,” the SEC stated in a release announcing the proposal.

With the changes, the commission “protects investors while minimizing unnecessary costs on funds,” Chairman Jay Clayton said.

The N-PORT profiles would have had liquidity classifications “intended to take into account relevant market-, trading-, and investment-specific considerations, as well as market depth and whether sales of an investment would significantly change the market value of the investment,” according to the 2016 rule requiring the N-PORT form.

Under the 2016 rule, the funds were to be classified as: Highly Liquid Investments; Moderately Liquid Investments; Less Liquid Investments and Illiquid Investments in a days-to-cash framework for the more liquid investments. A classification was to be selected for each portfolio investment, and if a portfolio was split among classifications a percentage amount was to be attributed to each liquidity classification. Certain rules applied to using multiple classification categories.

Regarding cost, in the proposal for the 2016 rule, using 2014 data for registered funds, the SEC “estimated that 8,734 funds would be required to file, on a monthly basis, additional information on Form N-PORT” as a result of what would be newly mandated liquidity information. The SEC also expected “that funds would incur a one-time internal burden to initially classify a fund’s portfolio securities and program existing systems to conduct the ongoing classifications and reviews required under the proposal for reporting purposes.”

The SEC’s latest proposal states, “In light of the comments we have received, we preliminarily believe that providing different information to investors via a different form would more effectively achieve the commission’s policy goal of promoting investor understanding of the liquidity risks of the funds in which they have invested, while minimizing risks of investor confusion.”

Secondly, the SEC is “proposing additional amendments to Form N-PORT that would allow a fund to report a single portfolio holding in multiple classification buckets under certain defined circumstances. Currently, a fund is required to choose only one classification bucket, even in circumstances where splitting that holding up into multiple classification buckets may better reflect the actual liquidity characteristics of that position. [The SEC staff believes] that permitting funds to split a single portfolio holding into multiple buckets under circumstances where [it believes] that such reporting would be more or equally accurate, and in some cases less burdensome, would provide [the SEC] with equal or better information at lower cost to funds (and thus, to fund shareholders).” (Parentheses in original.)

Finally, the SEC is “proposing to require funds and other registrants to report holdings of cash and cash equivalents on Form N-PORT so that [the SEC] may monitor trends in the use of cash and cash equivalents and, in the case of funds, more accurately assess the composition of a fund’s highly liquid investment minimum.”

The SEC responded to a request for comment on how the changes would affect prospects of catching, enforcing the rules against, or prosecuting those breaking SEC rules by stating it is “currently accepting public comment and as such has not formed conclusions."

SEC’s San Francisco Regional Office did not respond to a request for comment.

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