SEC Adopts Rules Addressing Liquidity Risk Management and “Swing Pricing” for Open-End Funds: New Rules and Amendments to Rules and Forms Require Most Open-End Funds to Implement Liquidity Risk Management Programs and Permit their Use of Swing Pricing

Sullivan & Cromwell LLP - October 27, 2016

On October 13, 2016, the Securities and Exchange Commission approved the adoption of two new rules and associated forms, and amendments to rules and forms, under the Investment Company Act of 1940 aimed at promoting effective liquidity risk management.  Among other things, the adopted rules and amendments will:

  • require most registered open-end funds, including most ETFs but excluding money market funds, to develop and implement a liquidity risk management program and to classify the liquidity of each of their portfolio positions into one of four liquidity categories;
  • require such funds to establish a minimum percentage of net assets to be invested in “highly liquid investments” (i.e., assets that the fund believes could be converted to cash in current market conditions within three business days without significantly changing the market value of the investments) and adopt policies and procedures regarding any shortfall from the established minimum;
  • Prohibit a fund from acquiring any illiquid investment if doing so would result in the fund holding more than 15% of its net assets in illiquid investments;
  • allow, but not require, registered open-end funds other than money market funds and ETFs to use “swing pricing,” a process of adjusting the net asset value of a fund’s shares in order to pass the cost of trading in such shares to purchasing or redeeming shareholders;
  • require new disclosure and reporting related to a fund’s liquidity risk management program and swing pricing policies, including the reporting of any breach of the fund’s established highly liquid investment minimum on new Form N-LIQUID; and
  • require initial approval and periodic review of the liquidity risk management program and swing pricing policies by the fund’s board of directors, including a majority of independent directors.
Funds in complexes with net assets of $1 billion or more will be required to comply with the rules pertaining to liquidity risk management by December 1, 2018, while other funds  must comply by June 1, 2019.