One day, three rules – understanding recent regulatory changes

Understanding where a flurry of new rules intersect could be the key to achieving compliance.

By Dan Houlihan editors@globalcustodian.com 

Thirteenth October 2016 was an important day for mutual funds. Why? On that day, the Securities and Exchange Commission adopted three significant rules and reforms that will change the regulatory landscape with regard to liquidity risk management, swing pricing and investment company reporting modernisation. And the industry is taking notice.

These three rules are different, and it’s important to understand the distinctions. Let’s consider each rule individually:

Liquidity Risk Management: New Rule 22e-4 under the Investment Company Act of 1940 (1940 Act) requires that all open-end funds (excluding money markets) establish written liquidity risk management programs. The rule requires classification of assets into defined buckets and ongoing monitoring of the asset classification program’s effectiveness. SEC leaders have said that funds are responsible for creating and adhering to the liquidity risk management program, with a designated program administrator and board approval. Fund managers expecting that a service provider can simply provide a data point for asset classification may be missing the bigger picture.

Swing Pricing: Under new paragraph (a)(3) of Rule 22c-1 under the 1940 Act, the SEC allows mutual funds other than money markets to optionally use swing pricing, defined as “The process of adjusting the fund’s net asset value (“NAV”) per share to effectively pass on the costs stemming from shareholder purchase or redemption activity to the shareholders associated with that activity.” Funds choosing to use swing pricing will need to base their decisions and plans on a number of factors. They must consider not only how the application of a swing factor may pass on trading costs to transacting investors while insulating others in the funds, but also their distribution channels, and the operational practicalities of implementing the practice.

Investment Company Reporting Modernisation: In the suite of new reports and report changes encompassed under this rule, we see that data from both the liquidity risk management program and, if used, the swing pricing practices will be required for ongoing reporting by funds to the SEC, with a significant amount of data available publicly. The reporting changes will require funds to align data from a number of sources, compile it in a compressed timeframe and file it to the SEC in XML format.

The key point of intersection for the three rules is in the provision of data to the SEC.

By understanding how the three rules intersect, we can better communicate, collaborate and support the ultimate goals of regulatory compliance: protection and education of investors and industry-wide risk mitigation.