TRENDS
November 2016
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SEC Adopts Rules to:
- Modernize Information Reported by Funds
- Enhance Liquidity Risk Management Programs
- Permit Swing Pricing
By Lorenzo Prestigiacomo, CPA | Partner
Background:
In October 2016, the Securities and Exchange Commission (“SEC”) voted to adopt changes for better reporting and disclosure of information by registered investment companies, and to enhance liquidity risk management by open-end funds, including mutual funds and exchange-traded funds (ETFs). The new rules are part of the SEC’s initiative to improve transparency and increase monitoring and regulation of the asset management industry.
SEC Chair Mary Jo White stated in the SEC press release, “These new rules represent a sweeping change for the industry by requiring strong transparency provisions and enhanced investor protections,” and “Funds will more effectively manage liquidity risk and both Commission staff and investors will receive additional and better quality information about fund holdings.”
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MODERNIZE INFORMATION REPORTED BY FUNDS
The new rules will improve the quality of information available to investors, and will allow the SEC to more effectively collect and use data reported by funds. Most funds will be required to begin filing reports on new Forms N-PORT and N-CEN after June 1, 2018, whereas fund complexes with less than a $1 billion in net assets will be required to begin filing reports on Form N-PORT after June 1, 2019.
Portfolio Reporting
Portfolio Reporting
A new monthly portfolio reporting form – Form N-PORT – will require registered funds (other than money market funds) to provide portfolio and position holdings data to the SEC on a monthly basis. The form will require monthly reporting of the fund’s investments and:
- data related to the pricing of portfolio securities,
- information regarding repurchase agreements, securities lending activities, and counterparty exposures,
- terms of derivatives contracts, and
- discrete portfolio level and position level risk measures to better understand fund exposure to changes in market conditions.
The information in these reports for the last month of each fund’s fiscal quarter will be available to the public after 60 days.
Step 2. Identify and Understand Your Exposure Risk. The ACFE identified certain common characteristics (“red flags”) that many occupational fraudsters exhibited. Organizations of different sizes and in different industries tend to have different fraud risks. Identifying potential fraud exposure areas is not an easy process. Because these exposure areas can be difficult to spot, it is more useful to ensure that proper anti-fraud measures are in place. Specific industries are more vulnerable to certain types of fraudulent schemes. A fraud specialist can use this knowledge to assist clients to focus their attention on preventing or uncovering types of fraud most commonly committed in their industry.
Census Reporting
Form N-CEN – a new annual reporting form – will require registered funds to report certain census-type information to the SEC annually. These reports will be filed within 75 days of the end of the fund’s fiscal year.
Structured Data Format
Funds will report portfolio and census information in a structured data format, which will improve the ability of both the SEC and the public to analyze information across all funds and to link the reported information with information from other sources. The SEC currently receives this type of information from money market funds through Form N-MFP, and from certain private fund advisers through Form PF.
Reporting on Fund Financial Statements
The SEC amendments require enhanced and standardized disclosures in financial statements that are required as part of fund registration statements and shareholder reports. The amendments will include more specific information related to derivatives, similar to the information about derivatives that is already required in the monthly portfolio holdings reports.
Additionally, in order to make fund derivatives holdings easier to review, the amended rules will require derivative disclosures to be displayed prominently in the financial statements, rather than in the notes.
Increased Disclosure Concerning Securities Lending Activities
The new rules require more disclosures relating to fund securities lending activities, including income and fees.
ENHANCE LIQUIDITY RISK MANAGEMENT PROGRAMS
The rule requires mutual funds and other open-end management investment companies, including ETFs, to establish liquidity risk-management programs. Most funds will be required to comply with the liquidity risk-management program requirements by December 1, 2018, whereas funds with less than a $1 billion in net assets will be required to do so by June 1, 2019. The liquidity risk-management program must include:
Assessment, Management, and Periodic Review of a Fund’s Liquidity Risk
The funds are required to assess, manage, and periodically review their liquidity risk. Liquidity risk is defined as the risk that a fund could not meet requests to redeem shares issued by the fund without significant dilution of remaining investors’ interests in the fund.
Classification of the Liquidity of Fund Portfolio Investments
Each fund is required to classify each of the investments in its portfolio. The classification is based on the number of days in which the fund reasonably expects the investment will be convertible to cash in today’s current market conditions without significantly changing the market value of the investment.
Funds will be required to classify each investment into one of the following liquidity categories:
- highly liquid investments,
- moderately liquid investments,
- less liquid investments, and
- illiquid investments.
Determination of a Highly Liquid Investment Minimum
A fund will be required to determine a minimum percentage of its net assets that must be invested in highly liquid investments, defined as cash or investments that are reasonably expected to be converted to cash within three business days without significantly changing the market value of the investment. The fund also will be required to have policies and procedures for how to respond to a situation in which a highly liquid investment minimum is not met.
Limitation on Illiquid Investments
A fund will not be permitted to purchase additional illiquid investments if more than 15 percent of its net assets are illiquid. If a fund goes over the 15 percent limit, it must report that fact to the fund’s board, along with how the fund plans to bring its illiquid investments back to the 15 percent limit within a reasonable timeframe.
The new form – Form N-LIQUID – generally will require a fund to notify the SEC confidentially when the fund’s level of illiquid assets exceeds 15 percent of its net assets, or when the amount of highly liquid investments falls below its designated minimum for more than a brief period of time.
Board Oversight
A fund’s board will be required to approve the fund’s liquidity risk-management program and the designation of the fund’s adviser or officer to oversee the program. The fund’s board also will be required to review, at least annually, a written report on the program and its effectiveness.
PERMIT SWING PRICING
The swing-pricing rule will permit, but will not require, mutual funds to use swing pricing. Swing pricing is the process of adjusting a fund’s net asset value to pass on to shareholders the costs associated with their purchase or redemption trading activity. Swing pricing can promote investor protection by giving funds an additional tool to mitigate the potentially dilutive effects to shareholder purchase or redemption activity. The fund’s board will be required to approve the swing pricing policies and procedures, and to review a written swing-pricing report for implementation and effectiveness. The fund’s board will also be required to approve the fund’s swing-factor upper limit, swing-pricing threshold, and other changes.
The final rule will be effective two years after the date of publication in the Federal Register.
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