The Securities and Exchange Commission voted to adopt three final rules aimed at reducing liquidity risk and enhancing reporting standards for mutual funds and other registered investment companies, but just one rule was unanimously favored.
SEC Commissioner Michael Piwowar voted against two measures — the modernization and enhancement of fund reporting and the “swing pricing” amendment — in the Oct. 13 open meeting.
As part of the investment company reporting modernization rule, registered firms, other than money market funds, will have to submit monthly portfolio reports. All registered firms will also submit an updated, streamlined annual census report to include more information on exchange traded funds (ETFs) and securities lending.
The reports will be submitted in a structured form the commission deems more accessible to the public.
SEC Commissioner Kara Stein lauded the new report structure, which will now come in XML format.
“This means that, while information can be read by a person, it can also be easily processed by computers for analysis.”
In addition, the commission will consider adopting amendments that would “require enhanced and standardized disclosures in financial statements that are required in fund registration statements and shareholder reports,” the SEC press release stated.
Under current requirements, firms do not have to provide specific information for swaps, futures and forwards. Amendments would require derivative holdings to be featured prominently in financial statements.
The final rule left out a key component of the original proposal, according to Piwowar. Rule 30e-3 would have permitted, but not required, funds to disseminate shareholder reports electronically.
“Rule 30e-3 was the one component of the proposal that promised a reduction in costs to shareholders,” Piwowar said. “There is a possibility rule 30e-3 will be presented at a commission meeting later this year, but with an already crowded agenda, I’m concerned that timeline is not going to be met.”
Stein said cost-cutting measures must be weighed against investor protection.
“Under current rules, some investors, who would be happy with [electronic] delivery, but have not yet opted [for electronic delivery] will end up with extra paper,” she said. “In contrast, under the [electronic] delivery rule, some investors are likely to end up with no reports.”
The “swing pricing” amendment, part of the SEC’s effort to enhance liquidity management, will pass transaction costs onto purchasing or redeeming shareholders in order to protect existing shareholders from necessary fees.
Once the level of net purchases or redemptions has exceeded a specified percentage of the fund’s net asset value (NAV) from the previous day’s trading, a specified value, no more than 2 percent, is added to or subtracted from the current NAV to reflect the transaction flows.
Open-ended funds, except ETFs and money market funds, will be permitted to implement swing pricing.
Swing pricing raises several investor protection concerns, according to Piwowar. The adoption of a swing-pricing threshold could allow gaming behavior from sophisticated investors timing their purchases and redemptions based on the timing of a fund’s NAV adjustment, he said.
“However, my primary investor protection concern is that swing pricing will be used to conceal from investors the true cost they will incur upon the purchase and sale of a fund’s shares,” he said.
Piwowar said it could be difficult for investors to discern fund performance from swing price effects.
“In other words, swing pricing gives regulatory approval for a fund to impose unpopular costs to investors in a non-transparent way,” he said.
All three commissioners voted in favor of the rule to implement new liquidity risk management programs. Rule 22e-4 will require open-ended investment companies, like mutual funds and ETFs, to establish programs that assess and review their individual liquidity risks, classify the liquidity of their investments, determine a highly-liquid investment minimum, limit illiquid investments and enhance board oversight.
The program will also require funds to notify the SEC when their illiquid assets exceed 15 percent of their total assets. Money market funds are exempt from the rule.
SEC Chairwoman Mary Jo White issued strong support for the liquidity risk program in her statement.
“These measures will fundamentally reform our oversight and regulation of liquidity management by open-end funds, and they have been strengthened by focused changes drawn from the comment process,” she said.
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