By Amy Leisinger, J.D.
In comments on the SEC’s new liquidity risk management rule, Federated Investors, Inc. urged the Commission to re-propose Rule 22e-4 to eliminate the bucketing framework and related portfolio-level liquidity disclosures. Instead, Federated recommended adoption of a more principles-based regime to enable advisers to provide liquidity risks estimates in connection with both normal and stressed market conditions based on more practical liquidity assessments.
Liquidity risk management. In October 2016, the Commission approved Rule 22e-4 to require open-end management investment companies to adopt liquidity risk management programs that include classifications of the liquidity of portfolio assets and to conduct periodic evaluations of liquidity risk. The final rule provides four liquidity time-frame categories and requires reporting of the percentage of each classification on a quarterly basis. The changes require enhanced disclosure regarding fund liquidity and redemption practices, and funds must periodically review whether assets have become illiquid over time. The rule excludes money market funds from all requirements and ETFs that qualify as “in-kind ETFs” from certain requirements.
The Commission delayed implementation of the reporting obligations under the rule late last year to further review potential issues with the reporting process.
Further review, new requirements. In a rulemaking petition, Federated opines that, as it completes its review, the Commission also should consider new evidence that the disclosure requirements of Rule 22e-4 may have unanticipated consequences. The public disclosure mandate is designed to alert investors to potential liquidity risks in stressed market conditions, but the current bucketing requirements under the rule could inadvertently lead to dissemination of false or misleading information and cause investors to underestimate true liquidity risk.
The current process requires an adviser to consider reasonably foreseeable stressed market conditions and related redemptions, determine how a portfolio holding would be sold to meet redemptions without significantly harming remaining shareholders and assign each holding to one of the four liquidity buckets, and disclose the results to the Commission and shareholders. In making the assessments, SEC guidance directs an adviser to use current market conditions for the expected transaction costs, not transaction costs that reasonably could be expected to prevail during periods of market stress. This difference could result in an understatement of liquidity risks in disclosures, according to the petition.
As such, Federated recommends re-proposal of Rule 22e-4 to eliminate the “onerous and defective” bucketing regime in favor of simpler, more reliable liquidity metrics governed by a principles-based framework. Proposed methods should enable advisers to provide realistic liquidity risk estimates with regard to both normal and stressed conditions, the firm concludes.