Proposed Rule2022-24376
Open-End Fund Liquidity Risk Management Programs and Swing Pricing; Form N-PORT Reporting
Primary source
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Published
December 16, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing amendments to its current rules for open-end management investment companies ("open-end funds") regarding liquidity risk management programs and swing pricing. The proposed amendments are designed to improve liquidity risk management programs to better prepare funds for stressed conditions and improve transparency in liquidity classifications. The amendments are also designed to mitigate dilution of shareholders' interests in a fund by requiring any open-end fund, other than a money market fund or exchange-traded fund, to use swing pricing to adjust a fund's net asset value ("NAV") per share to pass on costs stemming from shareholder purchase or redemption activity to the shareholders engaged in that activity. In addition, to help operationalize the proposed swing pricing requirement, and to improve order processing more generally, the Commission is proposing a "hard close" requirement for these funds. Under this requirement, an order to purchase or redeem a fund's shares would be executed at the current day's price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order before the pricing time as of which the fund calculates its NAV. The Commission also is proposing amendments to reporting and disclosure requirements on Forms N-PORT, N-1A, and N-CEN that apply to certain registered investment companies, including registered open-end funds (other than money market funds), registered closed-end funds, and unit investment trusts. The proposed amendments would require more frequent reporting of monthly portfolio holdings and related information to the Commission and the public, amend certain reported identifiers, and make other amendments to require additional information about funds' liquidity risk management and use of swing pricing.
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<title>Federal Register, Volume 87 Issue 241 (Friday, December 16, 2022)</title>
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[Federal Register Volume 87, Number 241 (Friday, December 16, 2022)]
[Proposed Rules]
[Pages 77172-77296]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-24376]
[[Page 77171]]
Vol. 87
Friday,
No. 241
December 16, 2022
Part II
Securities and Exchange Commission
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17 CFR Parts 270 and 274
Open-End Fund Liquidity Risk Management Programs and Swing Pricing;
Form N-PORT Reporting; Proposed Rule
Federal Register / Vol. 87, No. 241 / Friday, December 16, 2022 /
Proposed Rules
[[Page 77172]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 270 and 274
[Release Nos. 33-11130; IC-34746; File No. S7-26-22]
RIN 3235-AM98
Open-End Fund Liquidity Risk Management Programs and Swing
Pricing; Form N-PORT Reporting
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing amendments to its current rules for open-end management
investment companies (``open-end funds'') regarding liquidity risk
management programs and swing pricing. The proposed amendments are
designed to improve liquidity risk management programs to better
prepare funds for stressed conditions and improve transparency in
liquidity classifications. The amendments are also designed to mitigate
dilution of shareholders' interests in a fund by requiring any open-end
fund, other than a money market fund or exchange-traded fund, to use
swing pricing to adjust a fund's net asset value (``NAV'') per share to
pass on costs stemming from shareholder purchase or redemption activity
to the shareholders engaged in that activity. In addition, to help
operationalize the proposed swing pricing requirement, and to improve
order processing more generally, the Commission is proposing a ``hard
close'' requirement for these funds. Under this requirement, an order
to purchase or redeem a fund's shares would be executed at the current
day's price only if the fund, its designated transfer agent, or a
registered securities clearing agency receives the order before the
pricing time as of which the fund calculates its NAV. The Commission
also is proposing amendments to reporting and disclosure requirements
on Forms N-PORT, N-1A, and N-CEN that apply to certain registered
investment companies, including registered open-end funds (other than
money market funds), registered closed-end funds, and unit investment
trusts. The proposed amendments would require more frequent reporting
of monthly portfolio holdings and related information to the Commission
and the public, amend certain reported identifiers, and make other
amendments to require additional information about funds' liquidity
risk management and use of swing pricing.
DATES: Comments should be received on or before February 14, 2023.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#cdbfb8a1a8e0aea2a0a0a8a3b9be8dbea8aee3aaa2bb"><span class="__cf_email__" data-cfemail="641611080149070b0909010a1017241701074a030b12">[email protected]</span></a>. Please include
File Number S7-26-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-26-22. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (<a href="https://www.sec.gov/rules/proposed.shtml">https://www.sec.gov/rules/proposed.shtml</a>). Comments are also available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Operating conditions may limit access to the
Commission's Public Reference Room. All comments received will be
posted without change. Persons submitting comments are cautioned that
we do not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on our website. To ensure direct electronic
receipt of such notifications, sign up through the ``Stay Connected''
option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Mykaila DeLesDernier, Y. Rachel Kuo,
James Maclean, Nathan R. Schuur, Senior Counsels; Angela Mokodean,
Branch Chief; Brian M. Johnson, Assistant Director, at (202) 551-6792
or <a href="/cdn-cgi/l/email-protection#a2ebef8ff0d7cec7d1e2d1c7c18cc5cdd4"><span class="__cf_email__" data-cfemail="b7fefa9ae5c2dbd2c4f7c4d2d499d0d8c1">[email protected]</span></a>, Investment Company Regulation Office, Division of
Investment Management, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is proposing to amend the
following rules and forms:
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\1\ 15 U.S.C. 80a-1 et seq. Unless otherwise noted, all
references to statutory sections are to the Investment Company Act,
and all references to rules under the Investment Company Act are to
title 17, part 270 of the Code of Federal Regulations [17 CFR part
270].
\2\ 15 U.S.C. 77a et seq.
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Commission reference CFR citation (17 CFR)
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Investment Company Act of 1940 (``Act'' or
``Investment Company Act''): \1\
Rule 22c-1............................... Sec. 270.22c-1.
Rule 22e-4............................... Sec. 270.22e-4.
Rule 30b1-9.............................. Sec. 270.30b1-9.
Rule 31a-2............................... Sec. 270.31a-2.
Form N-PORT.............................. Sec. 274.150.
Form N-CEN............................... Sec. 274.101.
Securities Act of 1933 (``Securities Act'')
\2\ and Investment Company Act:
Form N-1A................................ Sec. Sec. 239.15A and
274.11A.
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Table of Contents
I. Introduction
A. Open-End Funds and Existing Regulatory Framework
1. Liquidity Risk Management
2. Swing Pricing
B. March 2020 Market Events
C. Rulemaking Overview
II. Discussion
A. Amendments Concerning Funds' Liquidity Risk Management
Programs
[[Page 77173]]
1. Amendments to the Classification Framework
2. Highly Liquid Investment Minimums
3. Limit on Illiquid Investments
B. Swing Pricing
1. Proposed Swing Pricing Requirement
2. Amendments to Swing Threshold Framework
3. Determining Flows
4. Swing Factors
C. Hard Close
1. Purpose and Background
2. Pricing Requirements
3. Effects on Order Processing, Intermediaries and Investors,
and Certain Transaction Types
4. Other Proposed Amendments to Rule 22c-1
5. Amendments to Form N-1A
D. Alternatives to Swing Pricing and a Hard Close Requirement
1. Alternatives to Swing Pricing
2. Alternatives to a Hard Close
3. Additional Illustrative Examples
E. Reporting Requirements
1. Amendments to Form N-PORT
2. Amendments to Form N-CEN
F. Technical and Conforming Amendments
G. Exemptive Order Rescission and Withdrawal of Commission Staff
Statements
H. Transition Periods
III. Economic Analysis
A. Introduction
B. Baseline
1. Regulatory Baseline
2. Overview of Certain Industry Order Management Practices
3. Liquidity Externalities in the Mutual Fund Sector
4. Affected Entities
C. Benefits and Costs of the Proposed Amendments
1. Liquidity Risk Management Program
2. Swing Pricing
3. Hard Close Requirement
4. Commission Reporting and Public Disclosure
D. Effects on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Alternatives
1. Liquidity Risk Management
2. Swing Pricing
3. Hard Close Requirement
4. Commission Reporting and Public Disclosure
F. Request for Comment
IV. Paperwork Reduction Act
A. Introduction
B. Rule 22e-4
C. Rule 22c-1
D. Form N-PORT
E. Form N-1A
F. Form N-CEN
G. Request for Comment
V. Initial Regulatory Flexibility Analysis
A. Reasons for and Objectives of the Proposed Actions
B. Legal Basis
C. Small Entities Subject to the Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Liquidity Risk Management Programs
2. Swing Pricing
3. Hard Close
4. Reporting Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. General Request for Comment
VI. Consideration of Impact on the Economy
Statutory Authority
I. Introduction
When the Investment Company Act was enacted, a primary concern was
the potential for dilution of shareholders' interests in open-end
investment companies.\3\ In addition, the ability of shareholders to
redeem their shares in an investment company on demand is a defining
feature of open-end investment funds.\4\ Section 22 of the Act reflects
these concerns and priorities. For example, section 22(c) gives the
Commission broad powers to regulate the pricing of redeemable
securities for the purpose of eliminating or reducing so far as
reasonably practicable any dilution of the value of outstanding fund
shares.\5\ Section 22(e) of the Act establishes a shareholder right of
prompt redemption in open-end funds by requiring such funds to make
payments on shareholder redemption requests within seven days of
receiving the request.\6\
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\3\ See Investment Trusts and Investment Companies: Hearings on
S. 3580 before a Subcomm. of the Senate Comm. on Banking and
Currency, 76th Cong., 3d Sess. (1940), at 37, 137-145 (stating that
among the abuses that served as a backdrop for the Act were
practices that resulted in substantial dilution of investors'
interests, including backward pricing by fund insiders to increase
investment in the fund and thus enhance management fees, but causing
dilution of existing investors in the fund) (statements of
Commissioner Healy and Mr. Bane).
\4\ See Investment Trusts and Investment Companies: Letter from
the Acting Chairman of the SEC, A Report on Abuses and Deficiencies
in the Organization and Operation of Investment Trusts and
Investment Companies (1939), at n.206 (``[T]he salient
characteristic of the open-end investment company. . .was that the
investor was given a right of redemption so that he could liquidate
his investment at or about asset value at any time that he was
dissatisfied with the management or for any other reason.''). An
open-end investment company is required to redeem its securities on
demand from shareholders at a price approximating their
proportionate share of the fund's net asset value (``NAV'') next
calculated by the fund after receipt of such redemption request. See
section 22 of the Act; rule 22c-1.
\5\ Section 22(c) of the Act authorizes the Commission to make
rules and regulations applicable to registered investment companies
and to principal underwriters of, and dealers in, the redeemable
securities of any registered investment company related to the
method of computing purchase and redemption prices of redeemable
securities for the purpose of eliminating or reducing so far as
reasonably practicable any dilution of the value of other
outstanding securities of the fund or any other result of the
purchase or redemption that is unfair to investors in the fund's
other outstanding securities. See also section 22(a) of the Act
(authorizing a securities association registered under section 15A
of the Securities Exchange Act of 1934 (``Exchange Act'') similarly
to prescribe the prices at which a member may purchase or redeem an
investment company's redeemable securities for the purposes of
addressing dilution).
\6\ Section 22(e) of the Act provides, in part, that no
registered investment company shall suspend the right of redemption
or postpone the date of payment upon redemption of any redeemable
security in accordance with its terms for more than seven days after
tender of the security absent specified unusual circumstances.
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The open-end fund industry has grown significantly over the last
six years as more Americans rely on funds to gain exposure to financial
markets while having the ability to quickly redeem their
investments.\7\ At the end of 2021, assets in open-end funds (excluding
money market funds) were approximately $26 trillion, having grown from
about $15 trillion at the end of 2015.\8\ An estimated 102.6 million
Americans owned mutual funds at the end of 2021, up from an estimated
91 million individual investors at the end of 2015.\9\ Open-end funds
continue to be an important part of the financial markets, and as those
markets have grown more complex, some funds are pursuing more complex
investment strategies, including fixed income and
[[Page 77174]]
alternative investment strategies focused on less liquid asset classes.
For example, as of December 2021, bond funds had assets of more than $6
trillion, funds with alternative investment strategies had about $15
billion in assets, and bank loan funds had around $12 billion in
assets.\10\ Figure 1 below shows the amount of assets held by different
types of open-end funds.
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\7\ For purposes of this release, the term ``fund'' or ``open-
end fund'' generally refers to an open-end management investment
company registered on Form N-1A or a series thereof, excluding money
market funds, unless otherwise specified. Mutual funds and most
exchange-traded funds (``ETFs'') are open-end management companies
registered on Form N-1A. An open-end management investment company
is an investment company, other than a unit investment trust or
face-amount certificate company, that offers for sale or has
outstanding any redeemable security of which it is the issuer. See
sections 4 and 5(a)(1) of the Investment Company Act [15 U.S.C. 80a-
4 and 80a-5(a)(1)]. While a money market fund is an open-end
management investment company, money market funds generally are not
subject to the amendments we are proposing and thus are not included
when we refer to ``funds'' or ``open-end funds'' in this release
except where specified. Although unit investment trusts, like open-
end funds, issue redeemable securities, they are not included when
we refer to open-end funds in this release, unless otherwise
specified.
\8\ The $26 trillion figure is based on Form N-CEN filing data
as of Dec. 2021. Of the $26 trillion in assets, ETFs had $5.1
trillion in assets. See Investment Company Liquidity Risk Management
Programs, Investment Company Act Release No. 32315 (Oct. 13, 2016)
[81 FR 82142 (Nov. 18, 2016)] (``Liquidity Rule Adopting Release''),
at text accompanying n.1046 (estimating open-end fund assets of
approximately $15 trillion at the end of 2015).
\9\ See Investment Company Institute, 2022 Investment Company
Fact Book (2022) (``2022 ICI Fact Book''), at 44, available at
<a href="https://www.icifactbook.org/">https://www.icifactbook.org/</a>; Investment Company Institute, 2016
Investment Company Fact Book (2016), at 110, available at <a href="https://www.ici.org/fact-book">https://www.ici.org/fact-book</a>. Retail investors hold the vast majority of
mutual fund net assets. See 2022 ICI Fact Book, at 48 (estimating
that retail investors held 88% of mutual fund assets at year end
2021). An estimated 13.9 million U.S. households held ETFs in 2021,
in addition to many institutional investors. See id. at 83.
\10\ Based on Morningstar data. Unless otherwise indicated, data
discussed throughout this section is based on Morningstar data. Bond
funds include funds that invest in taxable bonds (approximately $5.5
trillion in assets) and funds that invest in municipal bonds
(approximately $1 trillion in assets).
[GRAPHIC] [TIFF OMITTED] TP16DE22.000
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[GRAPHIC] [TIFF OMITTED] TP16DE22.001
Without effective liquidity risk management, a fund may not be able
to make timely payment on shareholder redemptions, and sales of
portfolio investments to satisfy redemptions may result in the dilution
of outstanding fund shares. Moreover, even when a fund is managing its
liquidity effectively, the transaction costs associated with meeting
redemption requests or investing the proceeds of subscriptions can
create dilution for fund shareholders. These concerns are particularly
heightened in times of stress or in funds invested in less liquid
investments. To that end, the ability of funds to meet investor
redemptions, while mitigating the impact of this redemption activity on
remaining shareholders, is an important aspect of the regulatory regime
for open-end funds.
Commission rules currently provide open-end funds with several
tools to mitigate dilution from shareholder purchase or redemption
activity and facilitate a fund's ability to meet shareholder
redemptions in a timely manner. These tools include a fund's liquidity
risk management program, the option to use swing pricing for certain
funds, the ability to impose purchase or redemption fees, and/or the
ability to redeem in kind.\11\ In March 2020, in connection with the
economic shock from the onset of the COVID-19 pandemic, U.S. open-end
funds faced a significant volume of investor redemptions.\12\ As
investors sought to redeem fund investments to free up cash during a
time of market uncertainty, open-end funds faced significant
redemptions and liquidity concerns.\13\
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\11\ See Liquidity Rule Adopting Release, supra note 8;
Investment Company Swing Pricing, Investment Company Act Release No.
32316 (Oct. 13, 2016) [81 FR 82084 (Nov. 18, 2016)] (``Swing Pricing
Adopting Release'').
\12\ See infra section I.B for a discussion of the fund flows
for different types of open-end funds during the Mar. 2020 period.
\13\ See infra section I.B discussing the events of Mar. 2020.
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In light of these events, we have reviewed the effectiveness of
funds' current tools for managing liquidity and limiting dilution,
including through staff outreach and review of information funds are
required to report to the Commission.\14\ We have identified weaknesses
in funds' liquidity risk management programs that can cause delays in
identifying liquidity issues in stressed periods and cause funds to
over-estimate the liquidity of their investments, as well as limited
use of tools such as redemption fees or swing pricing that are designed
to limit dilution resulting from a fund's trading of portfolio
investments in response to shareholder redemptions or purchases. As a
result, we are proposing amendments to enhance funds' liquidity risk
management to help better prepare them for stressed market conditions
and to require the use of swing pricing for certain funds in certain
circumstances to limit dilution. We believe the proposed amendments
would enhance open-end fund resilience in periods of market stress by
promoting funds' ability to meet redemptions in a timely manner while
limiting dilution of remaining shareholders' interests in the fund.
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\14\ The review consisted of outreach with funds, advisers, and
liquidity vendors that funds use to help classify the liquidity of
their investments. In addition, staff reviewed data provided on Form
N-PORT, Form N-CEN, and Form-RN.
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A. Open-End Funds and Existing Regulatory Framework
Open-end funds are a popular investment choice for investors
seeking to gain professionally managed, diversified exposure to the
capital
[[Page 77176]]
markets while preserving liquidity.\15\ There are two kinds of open-end
funds: mutual funds and ETFs. Open-end funds offer investors daily
liquidity, but may invest in assets that cannot be liquidated quickly
without significantly affecting market prices. Since the 1940s, the
Commission has stated that open-end funds should maintain highly liquid
portfolios and recognized that this may limit their ability to
participate in certain transactions in the capital markets.\16\
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\15\ See Liquidity Rule Adopting Release, supra note 8. See also
supra note 9 and accompanying text (discussing an estimated number
of Americans who invest in mutual funds).
\16\ See Investment Trusts and Investment Companies: Report of
the Securities and Exchange Commission (1942), at 76 (``Open-end
investment companies, because of their security holders' right to
compel redemption of their shares by the company at any time, are
compelled to invest their funds predominantly in readily marketable
securities. Individual open-end investment companies, therefore, as
presently constituted, could participate in the financing of small
enterprises and new ventures only to a very limited extent.'').
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While the Act requires open-end funds to pay redemptions within
seven days, as a practical matter most investors expect to receive
redemption proceeds in fewer than seven days. For example, many mutual
funds represent in their prospectuses that they will pay redemption
proceeds on the next business day after the redemption. In addition,
open-end funds redeemed through broker-dealers must meet redemption
requests within two business days because of rule 15c6-1 under the
Exchange Act, which establishes a two-day (T+2) settlement period for
trades effected by broker-dealers.\17\
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\17\ The Commission has proposed to amend rule 15c6-1 to
establish a T+1 settlement period for broker-dealer trades. See
Shortening the Securities Transaction Settlement Cycle, Exchange Act
Release No. 34-94196 (Feb. 9, 2022) [87 FR 10436 (Feb. 24, 2022)].
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In terms of pricing, an order to purchase or redeem fund shares
must receive a price based on the current NAV next computed after
receipt of the order.\18\ Open-end funds typically calculate their NAVs
once a day. Purchase and redemption requests submitted throughout the
day receive the NAV calculated at the end of that day, which is
typically calculated as of 4 p.m. ET.\19\ These provisions are designed
to promote equitable treatment of fund shareholders when buying and
selling fund shares.
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\18\ Rule 22c-1 under the Act. The process of calculating or
``striking'' the NAV of the fund's shares on any given trading day
is based on several factors, including the market value of portfolio
securities, fund liabilities, and the number of outstanding fund
shares, among others. Rule 2a-4 requires, when determining the NAV,
that funds reflect changes in holdings of portfolio securities and
changes in the number of outstanding shares resulting from
distributions, redemptions, and repurchases no later than the first
business day following the trade date. As indicated in the adopting
release for rule 2a-4, this calculation method provides funds with
additional time and flexibility to incorporate last-minute portfolio
transactions into their NAV calculations on the business day
following the trade date, rather than on the trade date. See
Adoption of Rule 2a-4 Defining the Term ``Current Net Asset Value''
in Reference to Redeemable Securities Issued by a Registered
Investment Company, Investment Company Act Release No. 4105 (Dec.
22, 1964) [29 FR 19100 (Dec. 30, 1964)].
\19\ Commission rules do not require that a fund calculate its
NAV at, or as of, a specific time of day. Current NAV must be
computed at least once daily, subject to limited exceptions, Monday
through Friday, at the pricing time set by the board of directors.
See rule 22c-1(b)(1).
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A characteristic of open-end funds is that fund shareholders share
the gains and losses of the fund, as well as the costs. As a result,
there are circumstances in which the transaction activity of certain
investors leads to costs that are distributed across all shareholders,
unfairly reducing the value (or ``diluting'') the interests of
shareholders who did not engage in the underlying transactions. For
example, while redemption orders receive the next computed NAV, the
fund may incur costs on subsequent days to meet those redemptions,
because the fund may engage in trading activity and make other changes
in its portfolio holdings over multiple business days following the
redemption order. As a result, the costs of providing liquidity to
redeeming investors can be borne by the remaining investors in the fund
and dilute the interests of non-redeeming shareholders. Similarly, when
shareholders purchase shares in the fund, costs may arise when the fund
buys portfolio investments to invest the proceeds of the purchase, and
the fund and its shareholders may bear those costs in days following
the purchase request, diluting the interests of the non-purchasing
shareholders.
Transaction costs associated with redemptions or purchases can
vary. The less liquid the fund's portfolio holdings, the greater the
liquidity costs associated with redemption and purchase activity can
become and the greater the possibility of dilution effects on fund
shareholders. For example, during times of heightened market volatility
and wider bid-ask spreads for the fund's underlying holdings, selling
fund investments to meet investor redemptions results in greater costs
to the fund. Moreover, funds also incur transaction costs outside of
stressed periods. Although these costs would generally be smaller than
in times of heighted market volatility, they also are borne by fund
investors and, particularly over time, also can result in dilution.
In times of liquidity stress, there may be incentives for
shareholders to redeem fund shares quickly to avoid further losses, to
redeem fund shares for cash in times of uncertainty, or to obtain a
``first-mover'' advantage by avoiding anticipated trading costs and
dilution associated with other investors' redemptions. This perceived
advantage may lead to increasing outflows, further exacerbating the
effect on remaining shareholders and incentivizing increased
shareholder redemptions. Whether investors redeem because they need
cash or want to capitalize on a first-mover advantage, the remaining
investors in the fund may, particularly in times of stress, experience
dilution of their interests in the fund.
1. Liquidity Risk Management
In 2016, the Commission adopted rule 22e-4 under the Act (the
``liquidity rule'') to require open-end funds to adopt and implement
liquidity risk management programs. Rule 22e-4 was designed to address
concerns that open-end funds investing in less liquid securities may
have difficulty meeting redemption requests without significant
dilution of remaining investors' interests in the fund.\20\ Rule 22e-4
requires: (1) assessment, management, and periodic review of a fund's
liquidity risk; (2) classification of the liquidity of each of a fund's
portfolio investments into one of four prescribed categories--ranging
from highly liquid investments to illiquid investments--including at-
least-monthly reviews of these classifications; (3) determination and
periodic review of a highly liquid investment minimum for certain
funds; (4) limitation on illiquid investments; and (5) board oversight.
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\20\ See Liquidity Rule Adopting Release, supra note 8, at
section II.B.
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Funds are also subject to related reporting requirements. For
example, funds must report the liquidity classifications of their
holdings confidentially to the Commission on Form N-PORT. A fund also
must immediately report to the Commission on Form N-RN and to the
fund's board if its portfolio becomes more than 15% illiquid, as well
as if the fund breaches a highly liquid investment minimum
[[Page 77177]]
established as part of its liquidity risk management program for seven
consecutive days.\21\ While the compliance dates for specific
provisions of rule 22e-4 varied, most funds were required to be in
compliance with all requirements of the rule in 2019.\22\
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\21\ Form N-RN was previously titled Form N-LIQUID. See Use of
Derivatives by Registered Investment Companies and Business
Development Companies, Investment Company Act Release No. 34084
(Nov. 2, 2020) [85 FR 83162 (Dec. 21, 2020)] (``Derivatives Adopting
Release'').
\22\ Small entities were required to be in compliance with the
reporting requirements under Form N-PORT by Mar. 1, 2020. See
Investment Company Liquidity Disclosure, Investment Company Act
Release No. 33142 (June 28, 2018) [83 FR 31859 (July 10, 2018)]
(``2018 Liquidity Disclosure Adopting Release'').
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In 2018, the Commission adopted amendments designed to improve the
reporting and disclosures of liquidity information by open-end
funds.\23\ These amendments modified certain aspects of the liquidity
framework by requiring funds to disclose information about the
operation and effectiveness of their liquidity risk management program
in their shareholder reports instead of requiring funds to disclose
aggregate liquidity classifications publicly in Form N-PORT.\24\ Since
that time, some individual investors have stated that they care about
being able to redeem but do not need narrative information about how a
fund manages its liquidity, while some other commenters have suggested
that aggregate liquidity classifications would be more helpful than
narrative shareholder report disclosure.\25\ We recently removed the
narrative disclosure requirement because, in practice, it did not
meaningfully augment other information already available to
shareholders.\26\
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\23\ Id.
\24\ The Commission also adopted amendments to Form N-PORT to
allow funds classifying the liquidity of their investments pursuant
to their liquidity risk management programs to report multiple
liquidity classification categories for a single position under
specified circumstances. See 2018 Liquidity Disclosure Adopting
Release, supra note 22.
\25\ See infra notes 303 to 305 and accompanying text
(discussing these comments in more detail).
\26\ See Tailored Shareholder Reports for Mutual Funds and
Exchange-Traded Funds; Fee Information in Investment Company
Advertisements, Investment Company Act Release No. 34731 (Oct. 26,
2022) (``Tailored Shareholder Reports Adopting Release'') at nn.462-
472 and accompanying text.
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When the Commission adopted the 2018 amendments, it stated that
Commission staff would continue to monitor and solicit feedback on the
implementation of the liquidity framework and inform the Commission
what steps, if any, the staff recommends in light of this
monitoring.\27\ The Commission stated its expectation that this
evaluation would take into account at least one full year's worth of
liquidity classification data from large and small entities to allow
funds and the Commission to gain experience with the classification
process and to allow analysis of its benefits and costs based on actual
practice. As discussed below, we have had the opportunity since the
adoption of these amendments to evaluate the liquidity framework while
taking into account the data available to us regarding funds' liquidity
risk management programs.\28\ We discuss our evaluation of the current
liquidity framework throughout this release.
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\27\ See 2018 Liquidity Disclosure Adopting Release, supra note
22, at paragraph accompanying n.125.
\28\ See infra sections I.B and II.A.
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2. Swing Pricing
In 2016, the Commission adopted a rule permitting registered open-
end funds (except money market funds or ETFs), under certain
circumstances, to use swing pricing, which is the process of adjusting
the price above or below a fund's NAV per share to effectively pass on
the costs stemming from shareholder purchase or redemption activity to
the shareholders associated with that activity.\29\ When a shareholder
purchases or redeems fund shares, the price of those shares does not
typically account for the transactions costs, including trading costs
and changes in market prices, that may arise when the fund buys
portfolio investments to invest proceeds from purchasing shareholders
or sells portfolio investments to meet shareholder redemptions.\30\
Swing pricing is an investor protection tool currently available to
funds to mitigate potential dilution and manage fund liquidity as a
result of investor redemption and purchase activity.
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\29\ Swing Pricing Adopting Release, supra note 11; rule 22c-
1(a)(3).
\30\ See Swing Pricing Adopting Release, supra note 11, at
section II.A.1.
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The 2016 swing pricing rule requires that, for funds choosing to
use swing pricing, the fund's NAV is adjusted by a specified amount
(the ``swing factor'') once the level of net purchases into or net
redemptions from the fund has exceeded a specified percentage of the
fund's NAV (the ``swing threshold''). A fund's swing factor is
permitted to take into account only the near-term costs expected to be
incurred by the fund as a result of net purchases or net redemptions on
that day and may not exceed an upper limit of 2% of the NAV per share.
The rule also requires a fund that uses swing pricing to adopt swing
pricing policies and procedures that specify the process for
determining the fund's swing factor and swing threshold. The fund's
board must approve the fund's swing pricing policies and procedures,
the fund's swing factor upper limit, and the swing threshold. The board
also must review a written report on the adequacy and effectiveness of
the fund's swing pricing policies and procedures at least annually.
In the time since the adoption of the rule, no U.S. funds have
implemented swing pricing. While swing pricing has been a commonly
employed anti-dilution tool in Europe, including among U.S.-based fund
managers that also operate funds in Europe, U.S. funds face unique
operational obstacles in its implementation. When considering the
adoption of the 2016 swing pricing rule, the Commission received
comment letters articulating the operational issues that funds may
encounter if they implemented swing pricing.\31\ In response to the
concerns raised by commenters, the Commission adopted an extended
effective date to allow for the creation of industry-wide operational
solutions to facilitate the implementation of swing pricing more
effectively. In that release, the Commission stated that it had
directed Commission staff to review, two years after the rule's
effective date, market practices associated with funds' use of swing
pricing to mitigate dilution and to provide the Commission with the
results of its review.\32\ Since that time, we have evaluated market
practices associated with funds' lack of use of swing pricing, and this
release reflects that evaluation. Despite over five years passing since
adoption, the industry has not developed an operational solution to
facilitate implementation of swing pricing, nor have individual market
participants.\33\
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\31\ See Comment Letter of BlackRock on Open-End Fund Liquidity
Risk Management Programs; Swing Pricing; Re-Opening of Comment
Period for Investment Company Reporting Modernization Release,
Investment Company Act File No. 31835 (Sep. 22, 2015) [80 FR 62274
(Oct. 15, 2015)] (``2015 Proposing Release''), File No. S7-16-15;
Comment Letter of Dodge & Cox on 2015 Proposing Release, File No.
S7-16-15; Comment Letter of Pacific Investment Management Company
LLC on 2015 Proposing Release, File No. S7-16-15; Comment Letter of
Securities Industry and Financial Markets Association on 2015
Proposing Release, File No. S7-16-15. The comment file for the 2015
Proposing Release, where these comment letters can be accessed, is
available at <a href="https://www.sec.gov/comments/s7-16-15/s71615.shtml">https://www.sec.gov/comments/s7-16-15/s71615.shtml</a>.
\32\ See Swing Pricing Adopting Release, supra note 11, at
section II.A.1.
\33\ After the Commission adopted the current swing pricing
rule, the industry formed working groups to explore potential
operational solutions to facilitate funds' ability to implement
swing pricing. See Evaluating Swing Pricing: Operational
Considerations, Addendum (June 2017), available at <a href="https://www.ici.org/system/files/attachments/ppr_17_swing_pricing_summary.pdf">https://www.ici.org/system/files/attachments/ppr_17_swing_pricing_summary.pdf</a> (``2017 ICI Swing Pricing White
Paper'').
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[[Page 77178]]
We understand that the industry has been unable to develop an
operational solution to implement swing pricing largely because funds
currently are unable to obtain sufficient fund flow information before
they finalizes their NAVs, a necessary precursor to determining whether
a fund needs to use swing pricing on any particular day. Generating
fund flow information involves a broad network of market participants
with multiple layers of systems, including, among others, funds,
transfer agents, broker-dealers, retirement plan recordkeepers, banks,
and the National Securities Clearing Corporation (``NSCC''). In
general, many mutual funds use prices as of 4 p.m. ET (or the ``pricing
time'') to value the funds' underlying holdings for purposes of
computing their NAVs for the current day. This time is established by
the fund's board of directors. Typically, investors may place orders to
purchase or redeem mutual fund shares with the fund's transfer agent or
with intermediaries as late as 3:59 p.m. ET for execution at that day's
NAV. When the transfer agent or an intermediary receives an order
before the pricing time, that order typically receives that day's
price. An investor who submits an order after the pricing time must
receive the next day's price.
While some investors may place orders by opening an account
directly with the fund's transfer agent, we understand that the
majority of mutual fund orders are placed with intermediaries, such as
broker-dealers, banks, and retirement plan recordkeepers.\34\ Some
intermediaries do not transmit flow details to the fund's transfer
agent or the clearing agency until after the fund has finalized its NAV
calculation and disseminated the NAV to pricing vendors, media, and
intermediaries (``NAV dissemination''). NAV dissemination tends to
occur between 6 p.m. ET and 8 p.m. ET. Indeed, the fund's transfer
agent or the clearing agency often do not receive a significant portion
of orders until after midnight--i.e., the next day.\35\ This
contributes to a mismatch between the extent of flow information funds
require to implement swing pricing and the flow information funds
currently have before the pricing time. For example, based on staff
outreach, we understand that some funds receive only around half of
their daily volume by 6 p.m. ET.\36\ We are also aware of a separate
review of funds' receipt of flow data for a quarter in 2016, which
found that only 70% of actual and estimated trade flow could be
delivered by 6 p.m. ET.\37\ Without sufficient actual or estimated flow
information before the fund finalizes its NAV, funds cannot implement
swing pricing because the determination of whether to swing the fund's
NAV depends on the size of net flows.
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\34\ In 2021, an estimated 18% of U.S. households owning mutual
funds purchased them directly from the mutual fund company. See 2022
ICI Fact Book, supra note 9, at Figure 7.8.
\35\ NSCC currently is the only registered clearing agency for
fund shares. A significant portion of mutual fund orders are
processed through NSCC's Fund/SERV platform. See Depositary Trust
and Clearing Corporation 2021 Annual Report, available at <a href="https://www.dtcc.com/annuals/2021/performance/dashboard">https://www.dtcc.com/annuals/2021/performance/dashboard</a> (stating that the
value of transactions Fund/SERV processed in 2021 was $8.5 trillion
and the volume for this period was 261 million transactions). A part
of the platform, referred to as Defined Contribution Clearance &
Settlement, focuses on purchase, redemption, and exchange
transactions in defined contribution and other retirement plans.
This service handled a volume of nearly 154 million transactions in
2021. See id.
\36\ We understand based on staff outreach that the time by
which a fund receives flow information varies to some extent based
on the fund's investor base. For example, funds with large
investments by retirement plans generally receive a larger portion
of their flow information after 6 p.m. ET than other funds.
\37\ See 2017 ICI Swing Pricing White Paper, supra note 33
(stating that, for instance, intermediaries trading via traditional
Fund/SERV, such as traditional brokerage and managed account
activity, transmit orders to the fund by 7 p.m. ET but, with system
and procedural enhancements, processing and submission of orders as
actual trades might be able to occur prior to 6 p.m. ET). This paper
also suggested that 90% to 100% of trade flow (actual or estimated)
is required to apply swing pricing between 4 p.m. and 6 p.m. ET.
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B. March 2020 Market Events
In March 2020, at the onset of the COVID-19 pandemic in the United
States, most segments of the open-end fund market witnessed large-scale
investor outflows. Investors' concerns about the potential impact of
the COVID-19 pandemic led investors to reallocate their assets into
cash and short-dated, near-cash investments.\38\ The resulting outflows
from many open-end funds placed pressure on these funds to generate
liquidity quickly in order to meet investor redemptions. Equity and
debt security prices fell as yields rose. Uncertainty throughout the
U.S. economy and asset-price volatility rose, and credit spreads and
bid-ask spreads widened.\39\ The large outflows open-end funds faced
during March 2020, combined with the widening bid-ask spreads funds
encountered when purchasing or selling portfolio investments at that
time, likely contributed to dilution of the value of funds' shares for
remaining investors.\40\
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\38\ See SEC Staff Report on U.S. Credit Markets
Interconnectedness and the Effects of the COVID-19 Economic Shock
(Oct. 2020) (``SEC Staff Interconnectedness Report''), at 17 to 18,
available at <a href="https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf">https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf</a>. Staff reports and other staff documents (including
those cited herein) represent the views of Commission staff and are
not a rule, regulation, or statement of the Commission. The
Commission has neither approved nor disapproved the content of these
documents and, like all staff statements, they have no legal force
or effect, do not alter or amend applicable law, and create no new
or additional obligations for any person.
\39\ See id., at 3 and 6 to 8 (discussing that the market
structure of certain segments of the credit market contributed to
market stress in Mar. 2020, including reduced dealer inventories and
reluctance to accommodate customer demand in some cases). On Apr. 1,
2020, the Board of Governors of the Federal Reserve System
(``Federal Reserve'') made a temporary change to its supplementary
leverage ratio rule to allow banking organizations to expand their
balance sheets as appropriate to continue to serve as financial
intermediaries, stating that the rule's regulatory restrictions may
constrain the firms' ability to continue to serve as financial
intermediaries and to provide credit to households and businesses in
the face of rapid deteriorations in Treasury market liquidity
conditions and significant inflows of customer deposits and
increased reserve levels. See Federal Reserve Board Announces
Temporary Changes to its Supplementary Leverage Ratio Rule to Ease
Strains in the Treasury Market Resulting from the Coronavirus and
Increase Banking Organizations' Ability to Provide Credit to
Households and Businesses (Apr. 1, 2020), available at <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200401a.htm">https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200401a.htm</a>.
\40\ We do not have specific data about the dilution fund
shareholders experienced in Mar. 2020 because funds do not report
information about their trading activity and the prices at which
they purchase and sell each instrument. However, European funds
experienced similar market conditions as U.S. funds and, to mitigate
dilution during this period, many European funds increased their use
of swing pricing and the size of their swing factors. See infra
paragraph accompanying note 60. European funds are subject to
regulatory regimes that differ in some respects from the U.S. regime
for open-end funds. We are not aware, however, of differences
between the regimes that would have significantly reduced dilution
for U.S. funds relative to European funds during this period, such
that European funds needed to use swing pricing to mitigate dilution
that U.S. funds were not experiencing due to regulatory or other
differences.
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Open-end funds are a large and important component of U.S. markets.
At the end of 2019, assets in open-end funds totaled $21 trillion.\41\
Fixed-income funds accounted for $5.3 trillion, or 25% of total open-
end fund assets.\42\ Bank loan assets were nearly $100 billion, or less
than 2% of total fixed-income fund assets. At the end of March 2020,
following the height of the COVID-19 related market stress, assets in
open-end funds (including ETFs) fell
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\41\ Of this amount, ETFs had assets of $4.4 trillion and other
open-end funds had assets of $16.4 trillion. Money market funds and
funds of funds are excluded from calculations relating to the size
and redemptions of open-end funds.
\42\ Fixed-income funds, excluding ETFs, had assets of $4.5
trillion, and fixed-income ETFs had assets of $800 billion.
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[[Page 77179]]
17% ($3.6 trillion) from $20.8 trillion in December 2019 to a total of
$17.2 trillion. Assets of open-end funds excluding ETFs fell 18% ($2.9
trillion) from $16.4 trillion to $13.5 trillion, and ETF assets fell
17% (approximately $760 billion) from $4.4 trillion to $3.7 trillion.
Of this amount, fixed-income mutual fund assets fell 5.5%, although
fixed-income ETFs' assets increased slightly.\43\ In addition, bank
loan fund assets fell by 30% in March 2020, or from $100 billion to $70
billion, compared to the level of assets reported in December 2019.
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\43\ Fixed-income funds, excluding ETFs, had assets of
approximately $4.1 trillion, while fixed-income ETFs' assets
increased slightly from Dec. 2019 levels to $830 billion.
[GRAPHIC] [TIFF OMITTED] TP16DE22.002
[[Page 77180]]
The market disruptions of the March 2020 period included
significant redemption activity in open-end funds.\44\ Throughout 2019,
net flows into open-end funds averaged approximately $32.4 billion, or
0.2% per month.\45\ During this same period, fixed-income funds
experienced a steady inflow of approximately $41.7 billion, or 0.9% per
month on average.\46\ In March 2020, however, open-end funds had
outflows totaling $329.4 billion, or 1.7% of prior period assets.\47\
The majority of these outflows were from fixed-income funds, which had
$286.6 billion in outflows.\48\ Taxable bond funds had outflows of
$241.7 billion (or 5.2% of prior period assets), of which, bank loan
funds had outflows of $12.4 billion (or 13.4% of prior period assets in
these funds).\49\ Municipal bond funds had $44.9 billion in outflows
(or 4.9% of prior period assets).\50\
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\44\ Open-end funds also experienced heightened outflows in
other stressed periods, such as the last quarter of 2008, but
outflows in March 2020 surpassed those witnessed in these other
periods. For example, during the last quarter of 2008, investors
withdrew $65 billion from bond funds. Total outflows for bond funds
during this period never exceeded 1.5% of total net assets. See ICI,
2009 Investment Company Fact Book, Figure 2.10 and accompanying
text, available at <a href="https://www.ici.org/system/files/attachments/2009_factbook.pdf">https://www.ici.org/system/files/attachments/2009_factbook.pdf</a> (calculating net flows as a three-month moving
average of net flows as a percentage of previous month-end assets,
and excluding high yield bond funds).
\45\ Open-end funds (excluding ETFs) had average net flows of
approximately $4.8 billion (or 0.04% per month). ETFs had average
net flows of approximately $27.7 billion (or 0.7% per month).
\46\ Fixed-income funds (excluding ETFs) had inflows of $28.8
billion (or 0.7% per month on average). Fixed-income ETFs had
inflows of $12.5 billion (or 1.7% per month on average).
\47\ Open-end funds (excluding ETFs) had outflows totaling
$336.8 billion, or 1.7% of prior period assets. ETFs had inflows
totaling $7.3 billion, or 2% of prior period assets. The majority of
ETF inflows were for equity ETFs, which had $14.7 billion in
inflows. Allocation, alternative, commodity, and miscellaneous/other
ETFs had inflows of $13.2 billion. The inflows into some types of
ETFs were partially offset by outflows of $20.6 billion from fixed-
income ETFs.
\48\ Open-end funds (excluding ETFs) had outflows of
approximately $266 billion, and ETFs had outflows of approximately
$20.6 billion.
\49\ For open-end funds (excluding ETFs) this included outflows
of $223.3 billion (5.9%) for taxable bond funds (of which, bank loan
funds had outflows of $11.4 billion (13.6%)). For ETFs this included
outflows of $18.4 billion (2.2%) for taxable bond ETFs (of which,
bank loan ETFs had outflows of approximately $1 billion (11.2%))
\50\ For open-end funds (excluding ETFs) this included outflows
of $42.6 billion (5%) for municipal bond funds. For ETFs this
included outflows of $2.2 billion (4.3%) for municipal bond ETFs.
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[[Page 77181]]
[GRAPHIC] [TIFF OMITTED] TP16DE22.003
During the period of market turmoil, bid-ask spreads spiked by as
much as 100 basis points for high-yield bonds and 150-200 basis points
for investment-grade bonds.\51\ In general, the bond market and bank
loan market experienced significant price declines in March 2020. The
price for 10 year U.S. Treasuries increased by roughly 4.6%. The price
of corporate bonds declined by 7%.\52\ The price of leveraged loans
decreased by roughly 13%.\53\ The heightened volatility and demand for
liquidity drove stress throughout the market, particularly in the bond
fund and bank loan fund markets. Price declines were not limited to
these markets, however. For example, the price for U.S. small cap
equities decreased by roughly 24%.\54\
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\51\ See SEC Staff Interconnectedness Report, supra note 38, at
37.
\52\ The decline in the price of corporate bonds is measured by
the BBG U.S. Corporate Bond Index.
\53\ The decline in the price of leveraged loans was measured by
the S&P Leveraged Loan Price Index.
\54\ The decline in the price of U.S. small cap equities was
measured by the Russell 2000 Total Return Index.
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[[Page 77182]]
Beginning in mid-March 2020, the Federal Reserve, with the approval
of the Department of the Treasury, used its emergency powers to
intervene by providing timely and sizable interventions in an effort to
stabilize the markets. The official sector interventions included,
among others, the Secondary Market Corporate Credit Facility,
introduced on March 23, 2020. This facility supported market liquidity
by purchasing in the secondary market corporate bonds issued by
investment grade U.S. companies, as well as U.S.-listed ETFs whose
investment objective is to provide broad exposure to the market for
U.S. corporate bonds.\55\
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\55\ See, e.g., Press Release, Federal Reserve Announces
Extensive New Measures to Support the Economy (Mar. 23, 2020),
available at <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm">https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm</a>; <a href="https://www.federalreserve.gov/monetarypolicy/smccf.htm">https://www.federalreserve.gov/monetarypolicy/smccf.htm</a> (describing the Secondary Market Corporate
Credit Facility in particular).
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After the Federal Reserve announced that it would be using its
emergency powers for official sector interventions, market stress
relating to the COVID-19 pandemic began to subside. Assets in open-end
funds, including fixed income funds, began to increase. By December
2020, open-end fund assets had increased to $24 trillion, with fixed-
income funds (excluding ETFs) reaching $6 trillion in assets, and
fixed-income ETFs surpassing $1 trillion in assets.\56\ Bank loan fund
assets remained essentially unchanged, however, from March 2020 levels
and remained at $68 billion.
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\56\ From Apr. to Dec. 2020, fixed-income funds averaged $75
billion in inflows, or 1.4% per month. Ultrashort and short-term
bond funds experienced average monthly inflows of $16 billion and 2%
of assets over this period.
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Other Observations From March 2020
Beyond data evidencing the liquidity stress funds faced in March
2020, we also observed the stress through staff outreach to the
industry. During this period, fund managers discussed their liquidity
concerns with Commission staff and the potential need for emergency
relief. Fund managers explored various emergency relief actions. For
example, some fund managers requested emergency relief that would
provide additional flexibility for interfund lending and other short-
term funding to help meet redemptions, which the Commission
provided.\57\ Some managers suggested emergency relief to permit funds
to impose redemption fees that exceed 2% to mitigate dilution,
including fees that ETFs can charge authorized participants to cover
liquidity and transaction costs.\58\ Some fund managers that have
successfully used swing pricing in Europe urged the Commission to
explore emergency actions to facilitate funds' ability to
operationalize the Commission's current swing pricing rule. Some fund
managers also suggested there was a need for Federal Reserve
interventions. These discussions indicated that fund managers sought
additional means to quickly address liquidity and dilution concerns
during this period of financial stress.
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\57\ See Order Under Sections 6(c), 12(d)(1)(J), 17(b), 17(d)
and 38(b) of the Investment Company Act of 1940 and Rule 17d-1
Thereunder Granting Exemptions from Specified Provisions of the
Investment Company Act and Certain Rules Thereunder, Investment
Company Act Release No. 33821 (Mar. 23, 2020), available at <a href="https://www.sec.gov/rules/other/2020/ic-33821.pdf">https://www.sec.gov/rules/other/2020/ic-33821.pdf</a>. Although the Commission
provided this relief for a period of time, we understand funds
generally did not use it.
\58\ ETFs typically externalize the costs associated with
purchases and redemptions of shares by redeeming in kind and by
charging a fixed and/or variable fee to authorized participants to
offset both transfer and other transaction costs that an ETF (or its
service provider) may incur, as well as brokerage, tax-related,
foreign exchange, execution, market impact, and other costs and
expenses related to the execution of trades resulting from such
transaction. The amount of these fixed and variable fees typically
depends on whether the authorized participant effects transactions
in kind or with cash and is related to the costs and expenses
associated with transactions effected in kind versus in cash. For
example, when an authorized participants redeems ETF shares by
selling a creation unit to the ETF, the fees that the ETF imposes
defray the costs of liquidity the redeeming authorized participant
receives. This, in turn, mitigates the risk of diluting non-
redeeming authorized participants when an ETF redeems its shares.
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During these conversations, several fund managers with operations
in both the U.S. and Europe discussed their experience with swing
pricing in Europe and indicated that swing pricing would have been a
useful tool for U.S. funds to have had in March 2020. Swing pricing was
widely used in several European jurisdictions during the March 2020
stressed period to reduce dilution from rising transaction costs.\59\
In these jurisdictions, some funds used partial swing pricing (where a
NAV adjustment occurs only if net flows exceed a swing threshold), some
funds used full swing pricing (where a NAV adjustment occurs any time a
fund has net inflows or net outflows), and some funds did not use swing
pricing. Many European funds increased their use of swing pricing and
increased the size of their swing factors during the stressed period.
For example, a voluntary survey conducted by the Bank of England and
Financial Conduct Authority of a subset of fund managers in the United
Kingdom (``UK'') indicated that the use of swing pricing more than
doubled from the last quarter of 2019 to the first quarter of 2020.\60\
Due to increasing transaction costs, several European funds lowered
their swing thresholds in March 2020, with some moving to full swing
pricing for net redemptions.\61\ Funds also increased the size of their
swing factors to account for the increase in liquidity and transaction
costs. For example, a survey of Luxembourg UCITS found that while the
average swing factor for the survey sample hovered around zero before
the turmoil, it increased by more than 100 basis points on average
during the market stress.\62\ The survey of UK-authorized
[[Page 77183]]
funds similarly found that the size of swing factors increased during
this period and that some funds that had capped the size of their swing
factors needed to temporarily remove these caps.\63\ In terms of the
effects of using swing pricing during March 2020, one study found that
swing pricing allowed surveyed funds to recoup roughly 0.06% of total
net assets on average from redeeming investors during three weeks of
elevated redemptions in March 2020.\64\
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\59\ Funds in countries such as Luxembourg, Ireland, the United
Kingdom, and the Netherlands had implemented swing pricing and it
was well-established market practice. In Mar. 2020, funds in some
countries, such as France, Spain, and Germany, had more recently
begun to employ swing pricing as an anti-dilution method. See
Lessons from COVID-19: Liquidity Risk Management and Open-Ended
Funds, BlackRock ViewPoint (Jan. 2021), available at <a href="https://www.blackrock.com/corporate/literature/whitepaper/viewpoint-addendum-lessons-from-covid-liquidity-risk-management-is-central-to-open-ended-funds-january-2021.pdf">https://www.blackrock.com/corporate/literature/whitepaper/viewpoint-addendum-lessons-from-covid-liquidity-risk-management-is-central-to-open-ended-funds-january-2021.pdf</a>.
\60\ See Liquidity management in UK open-ended funds: Report
based on a joint Bank of England and Financial Conduct Authority
survey (Mar. 2021), available at <a href="https://www.bankofengland.co.uk/report/2021/liquidity-management-in-uk-open-ended-funds">https://www.bankofengland.co.uk/report/2021/liquidity-management-in-uk-open-ended-funds</a> (``Bank of
England Survey''). The increase in the use of partial and full swing
pricing included the increase in the number of funds using swing
pricing as well as the increase in the frequency of its use for
funds that already used swing pricing. The survey also found that
some funds did not use swing pricing or other tools during the
period because, for example, net outflows of certain funds were
below levels at which they would consider applying swing pricing or
other tools.
\61\ See id. (stating that, out of a total of 202 surveyed funds
that were authorized to use swing pricing, 45 funds decided to
reduce their swing threshold during this period, including 18 funds
that switched temporarily to full swing pricing during the market
stress); ICI, Experiences of European Markets, UCITS, and European
ETFs During the COVID-19 Crisis (Dec. 2020), available at <a href="https://www.ici.org/doc-server/pdf%3A20_rpt_covid4.pdf">https://www.ici.org/doc-server/pdf%3A20_rpt_covid4.pdf</a> (``Respondents
reported that some UCITS lowered their partial swing thresholds
during March to take into consideration the impact flows could have
on investors from increased transaction costs in underlying markets.
. . Some UCITS using partial swing pricing lowered their threshold
for redemptions to zero in March (which is equivalent to full swing
pricing) in response to market volatility that had caused bid-ask
spreads to widen on underlying securities.''); Claessens, Stijn, and
Lewrick, Ulf, ``Open-ended bond funds: systemic risks and policy
implications'' (Dec. 2021) available at <a href="https://www.bis.org/publ/qtrpdf/r_qt2112c.pdf">https://www.bis.org/publ/qtrpdf/r_qt2112c.pdf</a> (stating that, in a survey of 57 Luxembourg
actively managed bond UCITS based on a supervisory data collection,
these funds lowered swing thresholds on average from net outflows of
1% of total net assets before Mar. 2020 to less than 0.5% of total
net assets) (``Claessens and Lewrick''). See also CSSF Working
Paper: An Assessment of Investment Funds' Liquidity Management Tools
(June 2022), available at <a href="https://www.cssf.lu/en/2022/06/publication-of-cssf-working-paper-an-assessment-of-investment-funds-liquidity-management-tools/">https://www.cssf.lu/en/2022/06/publication-of-cssf-working-paper-an-assessment-of-investment-funds-liquidity-management-tools/</a>(``CSSF Paper'').
\62\ See Claessens and Lewrick, supra note 61; CSSF Paper, supra
note 61 (stating that ``[t]he average swing factor of the 42 bond
funds participating in the CSSF survey increased by more than 100
basis points on average during Mar. 2020 (the median and maximum
swing factor were 60 and 350 basis points, respectively)'').
\63\ See Bank of England Survey, supra note 60 (stating that of
the 17 surveyed funds that had a cap on their swing factors, which
ranged from 0.25% to 3%, 13 funds temporarily removed the caps in
response to heightened outflows and a few managers overrode the
caps). We also understand that in response to funds' requests to use
swing factors above their disclosed caps, some jurisdictions
provided guidance on when this is permitted. See Commission de
Surveillance du Secteur Financier, Swing Pricing Mechanism--FAQ,
available at <a href="https://www.cssf.lu/en/Document/cssf-faq-swing-pricing-mechanism/">https://www.cssf.lu/en/Document/cssf-faq-swing-pricing-mechanism/</a> (providing guidance for increasing the swing factor above
the maximum level identified in a fund's prospectus under certain
circumstances, and noting that typical maximum swing factors
observed in fund prospectuses are between 1% and 3%).
\64\ See Claessens and Lewrick, supra note 61.
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We also observed funds' liquidity risk management in March 2020
through funds' filings with the Commission and other staff outreach.
Specifically, during and following the market events of March 2020,
Commission staff assessed liquidity-related data reported on Forms N-
PORT and N-RN, as well as the development of liquidity risk management
programs through staff outreach to funds, advisers, and liquidity
classification vendors.\65\ Based on review of Form N-PORT filings for
February and March 2020, approximately two-thirds of funds did not
appear to reclassify any investment held in both months despite the
market events described above.\66\ We saw that reclassifications
increased from 25% of funds that held the same investment in both
January and February 2020 to 33% of funds in March 2020, and stayed
elevated for April 2020. We understand that many fund and liquidity
vendor classification models use data lookback periods of 30 days or
more that made them slowly adjust to changing market conditions,
leaving these firms unable to consider their classifications and
reclassify when market conditions changed quickly. In addition, we
understand that classification models generally tend to assess
liquidity based on relatively small sale sizes that do not necessarily
reflect the amount a fund may need to sell to meet heightened levels of
redemptions in stress periods, and most models do not automatically
adjust to a higher trade size when market conditions change. Moreover,
our data indicate that in March 2020 cash levels in the aggregate
increased and relatively few funds made use of borrowing to meet
redemptions, suggesting that funds generally were selling portfolio
assets to meet redemptions and potentially for other purposes, such as
to raise cash in anticipation of future redemptions. During March 2020,
more than a dozen funds (primarily fixed-income funds) filed reports on
Form N-RN. Most of these Form N-RN filings related to breaches of the
15% limit on illiquid investments.
---------------------------------------------------------------------------
\65\ The Mar. 2020 data collected on Form N-PORT often was not
available to the Commission until June or July 2020 because a fund
files data covering each month of its fiscal quarter on Form N-PORT
no later than 60 days after the end of each fiscal quarter.
\66\ See infra note 128 (discussing that fewer equity funds
reported reclassifications of investments held in both Feb. and Mar.
2020 than fixed-income funds).
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Overall, the market events in March 2020 show how liquidity can
deteriorate rapidly and significantly. In the face of such rapid market
changes, liquidity risk management program features of some funds
adjusted slowly, making them less effective during the stress period
for managing liquidity risk. Additionally, tools, such as swing
pricing, that may have helped open-end funds limit dilution as both
transaction costs and redemptions rose were unavailable because of
operational challenges, although these tools were used in other
jurisdictions during this period.
C. Rulemaking Overview
In March 2020, some open-end funds were not prepared for the sudden
market stress that arose after many years of relative calm and, as the
market stress and outflows grew, several funds began to explore
emergency relief requests or suggest a need for government intervention
in an effort to withstand or alleviate liquidity stress, address
dilution, and improve overall market conditions. The period of market
stress in March 2020 was relatively brief ending upon Federal Reserve
interventions, and no funds sought to suspend redemptions during this
period. We believe there are meaningful lessons from this period that
our rules should reflect, while also recognizing the possibility that
future stressed periods--whether specific to certain funds or the
markets as a whole--may be more protracted or more severe than March
2020, particularly absent Federal Reserve action. Fundamentally, we
believe funds should be better prepared for future stressed conditions,
which can occur suddenly and unexpectedly, and should have well-
functioning tools for managing through stress without significantly
diluting the interests of their shareholders. We are proposing
amendments to rules 22e-4 and 22c-1 that are designed to achieve these
key objectives and to reflect our experience with the rules since they
were adopted, as well as supporting amendments to Form N-PORT and other
reporting and disclosure forms.
Specifically, recognizing that it can be difficult to predict when
market stress will occur, the proposed amendments to rule 22e-4 would
require funds to incorporate stress into their liquidity
classifications by assuming the sale of a stressed trade size, which
would be 10% of each portfolio investment, rather than the rule's
current approach of assuming the sale of a ``reasonably anticipated
trade size'' in current market conditions. Requiring a fund's
classification model to assume the sale of larger-than-typical position
sizes may better emulate the potential effects of stress on the fund's
portfolio, similar to an ongoing stress test, and help better prepare a
fund for future stress or other periods where the fund faces higher
than typical redemptions. The proposal also would establish other
minimum standards for classifying the liquidity of an investment, which
are designed to improve the quality of classifications by preventing
funds from over-estimating the liquidity of their investments and to
provide clearer guideposts for liquidity classifications, reflecting
the more effective practices we have observed.
In addition, we propose to remove the less liquid investment
category and to treat these investments as illiquid. The less liquid
category consists of investments that can be sold in seven calendar
days but that take longer to settle. For example, many bank loans take
longer than seven days to settle. The proposed amendment is designed to
reduce the mismatch between the receipt of cash upon the sale of assets
with longer settlement periods and the payment of shareholder
redemptions. This would better position funds to meet redemptions,
including in times of stress. Currently, treating these investments as
``less liquid''--as opposed to ``illiquid''--allows funds to invest in
these assets beyond the 15% limit on illiquid investments,
notwithstanding that ``less liquid'' investments settle beyond the
statutory seven-day period to pay redemptions. We are also proposing to
amend the definition of illiquid investment to
[[Page 77184]]
include investments whose fair value is measured using an unobservable
input that is significant to the overall measurement. We understand
many funds classify these investments as illiquid today.
We also propose to require daily liquidity classifications. We
believe this change would promote better monitoring of a fund's
liquidity and an ability to more rapidly understand and respond to
changes that affect the liquidity of the fund's portfolio, including
the fund's compliance with its highly liquid investment minimum and the
rule's limit on illiquid investments.
As another means to prepare funds for stressed conditions, we are
proposing to amend the highly liquid investment minimum provisions in
the rule to require all funds to determine and maintain a minimum
amount of highly liquid assets of at least 10% of net assets. This
aspect of the proposal is designed to ensure that funds have sufficient
liquid investments for managing heightened levels of redemptions.
Finally, we are proposing amendments to how the highly liquid
investment minimum calculation and the calculation of the 15% limit on
illiquid investments take into account the value of assets that are
posted as margin or collateral for certain derivatives transactions to
reflect that the fund cannot access the value of posted assets to meet
redemptions until the fund is able to exit the derivatives
transactions.
In addition, to reduce shareholder dilution during stress and other
periods, we are proposing to amend rule 22c-1 to require all open-end
funds, other than ETFs and money market funds, to implement swing
pricing. Today, no fund has implemented swing pricing, and funds rarely
use redemption fees to address dilution other than in the case of
short-term trading of fund shares, meaning shareholders may experience
dilution both in normal and stressed conditions, particularly when
purchases or redemptions are large or when funds invest in markets with
high transaction costs relative to other markets.\67\ We believe swing
pricing is an important and effective tool for dynamically addressing
such dilution by recognizing that costs associated with shareholder
purchases and redemptions rise as net flows increase and liquidity and
transaction costs grow.
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\67\ Based on an analysis of fund prospectuses, approximately
551 open-end funds (or around 4.6% of funds) state that they apply
redemption fees under certain circumstances for at least one share
class of the fund. Approximately 3.3% of fund classes have a
redemption fee, or 0.6% of net fund assets.
---------------------------------------------------------------------------
In addition to proposing mandatory swing pricing, we are proposing
to amend the swing pricing framework in rule 22c-1 to apply lessons
learned from March 2020, including information about the European
experience with swing pricing during that period. Specifically, we
propose to amend both when and how a fund would adjust its NAV, which
would vary depending on whether a fund has net purchases or net
redemptions. Rather than require funds to determine their own swing
thresholds, we propose to specify the amount of net inflows or net
outflows that would trigger a pricing adjustment in the rule, informed
by an analysis of historical flow amounts.
In addition, we propose a specific method of calculating the swing
factor price adjustment, which would require a fund to make good faith
estimates of the transaction costs of selling or purchasing a pro rata
amount of its portfolio investments (or a ``vertical slice'') to
satisfy that day's redemptions or to invest the proceeds from that
day's purchases. Under the proposal, a fund would be required to apply
a swing factor on any day it has net redemptions. When net redemptions
exceed 1% of net assets, the swing factor would also account for market
impacts of selling a vertical slice of the portfolio to capture the
dilutive effect of trading in response to large outflows better. We
believe trading in response to small levels of net inflows is less
likely to have a dilutive effect than trading in response to net
outflows and, as a result, we propose to require a fund to apply a
swing factor for net purchases only if net purchases exceed 2% of net
assets. In addition, we propose to remove the 2% swing factor upper
limit from the current rule because we are proposing a more specific
framework for determining swing factors, some European funds used swing
factors above 2% in order to mitigate dilution in March 2020, and we
received requests for emergency relief in the United States during this
period to allow funds to charge redemptions fees exceeding 2% to
mitigate dilution. The proposed swing pricing amendments are designed
to reduce the dilution of an investor's interest in a fund that is
caused by the redemption or purchase activity of other investors in the
fund and to fairly allocate the costs associated with redemption and
purchase activity. These amendments also may reduce potential first-
mover advantages that might incentivize early redemptions to avoid
anticipated trading costs and dilution associated with other investors'
redemptions.
To operationalize the proposed swing pricing requirement and
provide other benefits, we are also proposing to amend rule 22c-1 to
require that the fund, its transfer agent, or a registered clearing
agency receive purchase and redemption orders by an established cut-off
time to receive a given day's price (a ``hard close''). Specifically,
for an order to be eligible to receive a day's price, these designated
parties would have to receive the order before the pricing time, which
is typically 4 p.m. ET. The proposed hard close would facilitate the
receipt of timely flow information to inform swing pricing decisions.
In addition, we believe it would help prevent late trading and reduce
operational risk.
To promote transparency related to fund liquidity and use of swing
pricing, we are proposing amendments to Form N-PORT to require funds to
report their aggregate liquidity classifications publicly, as well as
the frequency and amount of swing pricing adjustments. With respect to
liquidity disclosure, this amendment is designed to provide investors
with meaningful information about fund liquidity, taking into account
that our proposed amendments to the liquidity classification framework
should result in more objective and comparable liquidity
classifications across funds.\68\ As for the proposed swing pricing
reporting requirements, we believe the proposed frequency and size
information would allow investors to better understand the operation
and effects of swing pricing.
---------------------------------------------------------------------------
\68\ In certain cases, investors consume reported information
indirectly through other data users. These other data users can
include, for example, regulators such as the Commission, fund
analysts, and third-party data providers. Throughout this release,
references to consumption of information by investors include
indirect consumption by investors enabled by other data users.
---------------------------------------------------------------------------
We also propose broader changes to Form N-PORT to require all
registered investment companies that report on the form, which include
open-end funds (other than money-market funds), registered closed-end
funds, and ETFs registered as unit investment trusts, to file monthly
reports with the Commission within 30 days of month-end. These monthly
reports would subsequently be publicly available 60 days after month-
end. These proposed amendments would require filers to provide the
Commission with more timely information and would provide investors
with access to monthly rather than quarterly information. We observed
in March 2020 that timely and full disclosure can be particularly
important
[[Page 77185]]
during and immediately after stress events. Finally, we propose
amendments to Forms N-PORT, N-CEN, and N-1A to, among other things,
conform to our other proposed amendments and to improve entity
identifiers.
Taken together, these proposed amendments are designed to provide
investors with increased protection regarding how liquidity in their
funds is managed, thereby reducing the risk that funds will be unable
to meet redemptions and mitigating dilution of the interests of fund
shareholders. These reforms also are intended to give investors
information to make more informed investment decisions, and to give the
Commission more timely information to conduct comprehensive oversight
of an ever-evolving fund industry.
II. Discussion
A. Amendments Concerning Funds' Liquidity Risk Management Programs
1. Amendments to the Classification Framework
Rule 22e-4 currently requires a fund to classify each portfolio
investment based on the number of days within which it reasonably
expects the investment would be convertible to cash, sold or disposed
of, without significantly changing its market value.\69\ Under this
framework, funds must, using information obtained after reasonable
inquiry and taking into account relevant market, trading, and
investment-specific considerations, classify each portfolio investment
into one of four liquidity classifications: highly liquid, moderately
liquid, less liquid, and illiquid.\70\ A fund may generally classify
and review its investments by asset class unless the fund or adviser
has information about any market, trading, and investment-specific
considerations that it reasonably expects to significantly affect the
liquidity characteristics of an investment compared to the fund's other
portfolio holdings within that asset class.\71\ In classifying its
investments, a fund must analyze the number of days that it reasonably
expects it would take to sell, or convert to cash, portions of a
position in a particular investment or asset class that the fund would
reasonably anticipate trading (the ``reasonably anticipated trade
size'') without significantly changing its market value (``value
impact'').\72\ A fund must review its liquidity classifications at
least monthly in connection with reporting the liquidity classification
for each investment on Form N-PORT, and more frequently if changes in
relevant market, trading, and investment-specific considerations are
reasonably expected to materially affect one or more of its
investments' classifications.\73\
---------------------------------------------------------------------------
\69\ In-kind ETFs are included when we refer to ``funds'' or
``open-end funds'' throughout this release when discussing rule 22e-
4, except in the sections discussing classifying the liquidity of a
fund's investments and the highly liquid investment minimum
requirement, from which in-kind ETFs are excepted. See proposed rule
22e-4(a) (defining ``in-kind ETF'' as an ETF that meets redemptions
through in-kind transfers of securities, positions, and assets other
than a de minimis amount of U.S. dollars and that publishes its
portfolio holdings daily); see also rule 22e-4(b)(1)(ii) and 22e-
4(b)(1)(iii). In-kind ETFs do not present the same kind of liquidity
risks as other funds because the redeeming shareholder typically
bears the direct costs associated with its liquidity needs. See
Liquidity Rule Adopting Release, supra note 8, at paragraphs
accompanying n.842.
\70\ See rule 22e-4(b)(1)(ii).
\71\ See rule 22e-4(b)(1)(ii)(A).
\72\ See rule 22e-4(b)(1)(ii)(B) (requiring a fund to determine
whether trading varying portions of a position in sizes that the
fund would reasonably anticipate trading is reasonably expected to
significantly affect its liquidity). The definition of each
liquidity category sets out the number of days in which a fund
reasonably expects to sell, or convert to cash, an investment
without significantly changing its market value. See rule 22e-
4(a)(6), rule 22e-4(a)(8), rule 22e-4(a)(10), and rule 22e-4(a)(12).
\73\ See rule 22e-4(b)(1)(ii).
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The liquidity classifications are integral to rule 22e-4. Among
other things, these classifications help a fund monitor its liquidity,
including compliance with the fund's highly liquid investment minimum
and the 15% limit on illiquid investments.\74\ The fund's
classifications also provide liquidity information to the Commission
and, under our proposal, to the public.
---------------------------------------------------------------------------
\74\ See rule 22e-4(b)(1)(iii) and rule 22e-4(b)(1)(iv).
---------------------------------------------------------------------------
The current rule allows funds considerable discretion in how funds
determine the classification of investments.\75\ Funds may choose which
investments to classify individually or by asset class, with the
composition of asset classes determined by the fund. Funds also may use
different reasonably anticipated trade sizes and have different
standards for evaluating value impact. Through staff outreach, we
observed that funds had varied approaches in their classifications
processes. The proposed amendments to the liquidity classifications are
intended to better prepare funds for future stressed conditions. For
example, the reasonably expected trade sizes and value impact standards
some funds and liquidity classification vendors used tended to over-
estimate a fund's liquidity in March 2020 because they considered
relatively smaller trade sizes or used value impact methodologies with
longer lookback periods.
---------------------------------------------------------------------------
\75\ See Liquidity Rule Adopting Release, supra note 8, at n.163
and accompanying text (stating that the primary goals of the
liquidity rule program requirements were to reduce the risk that
funds would be unable to meet redemption and other legal
obligations, minimize dilution, and elevate the overall quality of
liquidity risk management across the fund industry while at the same
time providing funds with reasonable flexibility to adopt policies
and procedures that would be most appropriate to assess and manage
their liquidity risk).
---------------------------------------------------------------------------
Based on our observations from March 2020 and our review of funds'
liquidity risk management practices and classifications, we are
proposing amendments to the classification framework. The proposed
amendments would provide additional standards for making liquidity
determinations, amend certain aspects of the liquidity categories, and
require more frequent liquidity classifications. Specifically, we
propose to provide objective minimum standards that funds would use to
classify investments, including by: (1) requiring funds to assume the
sale of a set stressed trade size, rather than the rule's current
approach of assuming the sale of a reasonably anticipated trade size in
current market conditions; and (2) defining the value impact standard
with more specificity on when a sale or disposition would significantly
change the market value of an investment. We also propose to remove
classification by asset class. These proposed amendments are designed
to improve the quality of classifications by preventing funds from
over-estimating the liquidity of their investments, including in times
of stress, and to provide classification standards that are consistent
with more effective practices the staff has observed. In addition, a
more objective and comparable framework for how funds classify the
liquidity of their investments would enhance the Commission's ability
to analyze trends across funds' classifications and establish the
groundwork for classification information that investors could use to
analyze and compare funds.
We also propose to remove the less liquid investment category,
which would reduce the number of liquidity categories from four to
three, and expand the scope of the illiquid investment category. We
believe these changes would reduce the risk of a fund not being able to
meet shareholder redemptions. Finally, we propose to require daily
classifications, which we believe would promote better monitoring by
liquidity risk program administrators of a fund's liquidity and an
ability to more rapidly understand
[[Page 77186]]
and respond to changes that affect the liquidity of the fund's
portfolio.\76\
---------------------------------------------------------------------------
\76\ See rule 22e-4(a)(13) (defining ``person(s) designated to
administer the program'', in part, as the investment adviser,
officer, or officers responsible for administrating the program).
---------------------------------------------------------------------------
Table 1 sets forth the primary proposed changes to the rule's
liquidity classification framework, which are described in more detail
below.
Table 1--Proposed Changes to the Liquidity Classifications
------------------------------------------------------------------------
Liquidity classifications
and related terms Current rule 22e-4 Proposed rule 22e-4
------------------------------------------------------------------------
Definitions
------------------------------------------------------------------------
Highly Liquid Investment.... Any cash held by a Any U.S. dollars
fund and any held by a fund and
investment that the any investment that
fund reasonably the fund reasonably
expects to be expects to be
convertible into convertible to U.S.
cash in current dollars in current
market conditions market conditions
in three business in three business
days or less days or less
without the without
conversion to cash significantly
significantly changing the market
changing the market value of the
value of the investment.
investment.
Moderately Liquid Investment Any investment that Any investment that
the fund reasonably is neither a highly
expects to be liquid investment
convertible into nor an illiquid
cash in current investment.
market conditions
in more than three
calendar days but
in seven calendar
days or less,
without the
conversion to cash
significantly
changing the market
value of the
investment.
Less Liquid Investment...... Any investment that Removed.
the fund reasonably
expects to be able
to sell or dispose
of in current
market conditions
in seven calendar
days or less
without the sale or
disposition
significantly
changing the market
value of the
investment, but
where the sale or
disposition is
reasonably expected
to settle in more
than seven calendar
days.
Illiquid Investment......... Any investment that Any investment that
the fund reasonably the fund reasonably
expects cannot be expects not to be
sold or disposed of convertible to U.S.
in current market dollars in current
conditions in seven market conditions
calendar days or in seven calendar
less without the days or less
sale or disposition without
significantly significantly
changing the market changing the market
value of the value of the
investment. investment and any
investment whose
fair value is
measured using an
unobservable input
that is significant
to the overall
measurement.
Convertible to Cash/U.S The ability to be The ability to be
Dollars. sold, with the sale sold or disposed
settled. of, with the sale
or disposition
settled in U.S.
dollars.
------------------------------------------------------------------------
Related Concepts
------------------------------------------------------------------------
Assumed Trade Size.......... Sizes that the fund 10% of the fund's
would reasonably net assets by
anticipate trading. reducing each
investment by 10%.
Value Impact Standard....... Significantly Significantly
changing the market changing the market
value of the value of an
investment. investment means:
(1) For shares
listed on a
national securities
exchange or a
foreign exchange,
any sale or
disposition of more
than 20% of average
daily trading
volume of those
shares, as measured
over the preceding
20 business days.
(2) For any other
investment, any
sale or disposition
that the fund
reasonably expects
would result in a
decrease in sale
price of more than
1%.
------------------------------------------------------------------------
a. Stressed Trade Size and Significant Changes in Market Value
i. Replacing Reasonably Anticipated Trade Size With Stressed Trade Size
Currently, when a fund makes liquidity classifications under rule
22e-4, it must determine whether trading varying portions of a position
in a particular portfolio investment or asset class, in sizes that the
fund would reasonably anticipate trading, is reasonably expected to
significantly affect its liquidity.\77\ This determination of a
reasonably anticipated trade size helps a fund analyze market depth.
For example, if a fund anticipates trading a large investment position
relative to the market's total trading volume, the size of the trade
might affect liquidity and price.\78\
---------------------------------------------------------------------------
\77\ See rule 22e-4(b)(1)(ii)(B).
\78\ See Liquidity Rule Adopting Release, supra note 8, at
paragraphs accompanying n.440 and n.450.
---------------------------------------------------------------------------
Using a small reasonably anticipated trade size to analyze market
depth leads to a more liquid classification, as a smaller position can
be sold more quickly without significantly affecting the investment's
liquidity than a larger position. In contrast, using a larger
reasonably anticipated trade size would often lead to less liquid
classifications. Under the current rule, a fund may determine its own
reasonably anticipated trade size, and we have observed wide variation
in practice.\79\ From staff outreach, we observed that funds may
consider a variety of different factors, such as their flow history,
flow trends of other similar funds, and shareholder makeup and
concentration,
[[Page 77187]]
and a fund may weigh the importance of those factors differently to
determine what it would reasonably anticipate trading. We believe that
using a reasonably anticipated trade size based on these, or a subset
of these factors, may not help funds prepare for future stressed
conditions. Even if a fund increased its reasonably anticipated trade
size during periods of stress, the resulting adjustments in the fund's
liquidity risk management may be too late to help the fund prepare for
the stressed environment and, thus, may have limited utility.
---------------------------------------------------------------------------
\79\ See SEC staff Investment Company Liquidity Risk Management
Programs Frequently Asked Questions (Apr. 10, 2019) (``Liquidity
FAQs''), available at <a href="https://www.sec.gov/investment/investment-company-liquidity-risk-management-programs-faq">https://www.sec.gov/investment/investment-company-liquidity-risk-management-programs-faq</a> for discussion of
factors funds may consider in determining reasonably anticipated
trading size. The Commission has observed that many funds have set
reasonably anticipated trade size values at 3%. Others have set
values of below 3% and up to 100%, signifying wide variation.
---------------------------------------------------------------------------
In response to the variability in funds' reasonably anticipated
trade sizes and the potential ineffectiveness of small trade sizes in
helping a fund prepare for stress, we propose to require funds to
assume the sale of a set stressed trade size. Specifically, for a fund
to determine the liquidity classification of each investment, we
propose that it must measure the number of days in which the investment
is reasonably expected to be convertible to U.S. dollars without
significantly changing the market value of the investment, while
assuming the sale of 10% of the fund's net assets by reducing each
investment by 10%.\80\ The proposed stressed trade size may result in
funds classifying fewer investments as highly liquid, and may increase
the number of investments that are subject to the 15% limit on illiquid
investments. These changes, in turn, may lead some funds to rebalance
their portfolio holdings to comply with the proposed changes, which
could negatively affect the performance of these funds. However, a lack
of preparation for higher than normal redemptions also can negatively
affect fund performance when such redemptions occur.\81\ We believe
that requiring a fund's classification model to assume the sale of
larger-than-typical position sizes would better emulate the potential
effects of stress on the fund's portfolio, similar to an ongoing stress
test, and help better prepare a fund for future stress or other periods
where the fund faces higher than typical redemptions.
---------------------------------------------------------------------------
\80\ The liquidity classifications define the number of days as
business days for highly liquid investments or calendar days for
illiquid investments. See Table 1. See also rule 22e-4(a)(2)
(defining ``business day'' to exclude customary business holidays).
\81\ See Liquidity Rule Adopting Release, supra note 8, at
paragraphs accompanying nn.109 and 110 (stating that staff had
observed that some funds with more thorough liquidity risk
management practices appeared to be able to better meet periods of
higher than typical redemptions without significantly altering their
risk profile or materially affecting their performance, while some
funds with substantially less rigorous liquidity risk management
practices experienced particularly poor performance compared with
their benchmark when faced with higher than normal redemptions).
---------------------------------------------------------------------------
Based on an analysis of weekly flows of equity and fixed-income
funds over a period of more than ten years, outflows greater than 6.6%
occurred 1% of the time in a pooled sample across weeks and funds.\82\
Based on this analysis, we estimate that a random fund in a random week
has approximately a 0.5% chance of experiencing redemptions in excess
of the 10% stressed trade size, and there were 3.4% of weeks where more
than 1% of funds experienced net redemptions exceeding the proposed
stressed trade size. We believe that weekly outflows at the 99th
percentile is a useful approximation of the level of outflows funds may
experience in future stressed conditions.\83\ However, because it is
difficult to predict future stress events, including the effect and
length of such events--particularly without official sector
interventions--we believe it is appropriate to require funds to use a
stressed trade size amount of 10%, which is moderately higher than the
6.6% weekly outflow figure discussed above. We also considered, during
this same historical period, equity and fixed-income funds had weekly
inflows of greater than 8% for 1% of the time in a pooled sample across
weeks and funds. In addition, large, concentrated inflows have the
possibility of translating to similarly large outflows. For example, if
the large inflows are the result of investment by an institutional
investor or a fund's inclusion in a model portfolio, the fund may
experience similarly large outflows if the investor mandate changes or
if the fund is removed from the model portfolio.
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\82\ Based on an analysis of historical Morningstar weekly fund
flow data for equity and fixed income funds from 2009 through 2021.
See infra sections III.B.4.a and III.C.1.a.i (providing additional
equity and fixed income flow data and discussing this analysis in
more detail). While some Morningstar data is available for 2008, we
have not included that data in our historical flow analyses in this
release because of gaps in the 2008 data (e.g., the 2008 dataset
covers a more limited set of funds). Other available flow
information for 2008, such as from the ICI Fact Book, is not
granular enough for purposes of our analyses.
\83\ We believe weekly outflows is a better proxy for the
stressed trade size than daily outflows because stressed conditions
may take some time to fully present in flows and often result in
outflows that continue over several days or more.
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Under the proposed approach, a fund would apply its stressed trade
size to each investment to determine its liquidity classifications. We
have observed that funds generally determine and apply a reasonably
anticipated trade size to each investment or asset class currently
(commonly referred to as pro rata or vertical slice methods). We have
also observed, however, that some funds have applied the reasonably
anticipated trade size in such a manner that the trading would be
satisfied largely by selling the fund's most liquid investments,
resulting in smaller assumed trade sizes for purposes of classifying
the fund's less liquid investments.\84\ As recognized above, small
assumed sale sizes can result in more liquid classifications generally,
as sales of small amounts are less likely to affect the market value of
the investment significantly and typically can be converted to U.S.
dollars more quickly. We are particularly concerned that use of small
assumed sale sizes for non-highly liquid investments can overstate the
liquidity of these investments and reduce the effectiveness of a fund's
liquidity risk management program when a fund needs to sell a larger-
than-assumed portion to meet redemptions under stressed conditions or
for any other portfolio management reason. Requiring funds to apply the
10% stressed trade size to each investment would better prepare funds
to manage their liquidity in stressed conditions, when a fund may be
required to sell positions that are larger than the assumed sale sizes
some funds are using currently. The amendments to replace the
determination of a reasonably anticipated trade size with a stressed
trade size are designed to enhance a fund's preparation for stressed
conditions, including the potential for sizeable outflows.
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\84\ See Liquidity Rule Adopting Release, supra note 8, at
paragraph accompanying n.1084. We do not suggest that a fund should
only, or primarily, use its most liquid investments to meet
shareholder redemptions. See id., at n.661 and accompanying
paragraph.
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We request comment on the proposed requirement for funds to apply a
stressed trade size to each investment in their liquidity
classification determinations:
1. Should we require funds to use a stressed trade size, as
proposed? Would the change from reasonably anticipated trade size to
stressed trade size materially change the proportion of investments
classified in a given liquidity category? If yes, how? Would the
proposed stressed trade size affect certain types of funds more than
others? Would the proposed stressed trade size be likely to overstate
or understate liquidity?
2. Is the proposed stressed trade size of 10% appropriate? If not,
what minimum trade size would be appropriate and why? For example,
should we increase or decrease the stressed trade size to, for example,
15% or 5% or some other threshold? Is there
[[Page 77188]]
other data that should factor into setting the stressed trade size?
3. Should the stressed trade size vary for different types of funds
and, if so, how? For instance, should the stressed trade size be a
function of the fund's flow history, such as the 99th percentile
highest week of the fund's absolute or net flows over a given period
(e.g., 3 years, 5 years, 10 years, or the life of the fund)? Should the
stressed trade size be the higher of a specified value applied to each
investment or the 99th percentile highest week of absolute flows?
4. Should the method of applying the stressed trade size to each
investment vary for different types of funds and, if so, how? Are there
types of investments that should be excluded or use a different
stressed trade size? Are there other, more appropriate methods of
applying a stressed trade size across different type of investments and
portfolios?
5. Instead of establishing a set stressed trade size, should we set
a minimum stressed trade size and provide factors for determining if a
fund should have a higher stressed trade size? If so, what factors
should funds consider in setting their stressed trade size?
ii. Determining a Significant Change to Market Value
Currently, when a fund makes liquidity classifications under rule
22e-4, it must analyze whether a sale or disposition would
significantly change the market value of the investment. In the
adopting release for rule 22e-4, the Commission explained that this
value impact analysis captures the risk of a fund only being able to
meet redemption requests in a manner that significantly dilutes the
non-redeeming shareholders.\85\ The Commission established the value
impact standard to capture the risk of dilution in cases of inadequate
liquidity, while not requiring funds to account for every possible
value movement.\86\ We propose to establish a minimum value impact
standard that defines more specifically what constitutes a significant
change in market value.\87\ We believe the proposed change would
improve the quality of funds' liquidity classifications by preventing
funds from over-estimating the liquidity of their investments and would
improve comparability of funds' liquidity classifications. In addition,
the proposed approach is consistent with more effective practices we
have observed from some funds and liquidity classification vendors, as
discussed below.
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\85\ See Liquidity Rule Adopting Release, supra note 8, at
paragraph accompanying n.334.
\86\ See id., at paragraph accompanying n.339.
\87\ See proposed rule 22e-4(a) (definition of ``Significantly
changing the market value of an investment'').
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Under the current rule, a fund may determine value impact in a
variety of ways, depending on the type of asset, or vendor, model, or
system used. There also is variation in the depth and sophistication of
funds' analyses. We believe the variation in how a fund may determine
value impact leads to differences in the quality of funds'
classifications, limits comparability of funds' classifications across
the same or similar investments, and may cause funds to over-estimate
the liquidity of their investments.
The proposed definition of a significant change in market value
would require a fund to consider the size of the sale relative to the
depth of the market for the instrument.\88\ This would vary depending
on the type of investment. For shares listed on a national securities
exchange or a foreign exchange, we believe selling or disposing of more
than 20% of the security's average daily trading volume would indicate
a level of market participation that is significant.\89\ We understand
that if a fund sold more than 20% of the average daily trading volume
of a listed equity security, such a large sale is likely to result in a
significant change in the security's market value, which would dilute
remaining investors in the fund. We have observed that a standard based
on average daily trading volume is consistent with practices many funds
and vendors apply for assessing value impact for listed equity
investments today.\90\ To determine average daily trading volume, we
propose to require funds to measure the average daily trading volume
over the preceding 20 business days. We believe using a period of 20
business days provides an appropriate measure of daily trading volume,
which would reflect current market conditions as well as consider a
period of recent market history. The 20 business day period is intended
to strike a balance between longer periods that are less reflective of
current conditions and shorter periods that can be skewed easily by an
abnormally high or low volume day. For purposes of measuring average
daily trading volume, the preceding 20 business days include those days
where U.S. markets are open but where one or more international markets
are closed, such as ``Golden Week,'' a week in Japan including multiple
Japanese public holidays. A fund would count these and any other
trading days where shares were not traded as zero volume days for the
relevant investment.
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\88\ The proposed rule would continue to provide that an
investment's classification is based on a fund's reasonable
expectations in current market conditions. See Liquidity Rule
Adopting Release, supra note 8, at section III.C.1.d (discussing
comments and suggestions on the consideration of market conditions).
Thus, a fund would be able to rely on its reasonable expectations at
the time it makes the value impact assessment. Although we are
proposing to require funds to assume an element of stressed
conditions in their liquidity classifications through the stressed
trade size, a broader requirement to predict how an investment may
trade in stressed market conditions would introduce additional
variables into the classification process that could increase the
risk of misclassifications and decrease the data quality of funds'
liquidity-related reporting and disclosure.
\89\ Under this proposal, the sale or disposition must be below
20% of the security's average daily trading volume. A fund may
choose to impose a stricter limitation of any percentage under 20%,
for example, 15% of average daily trading volume.
\90\ Through staff outreach, we observed many funds using some
percent of average daily trading volume (e.g., 15%, 20%, or 25%)
that the fund's investment can represent if it wants to be able to
sell into daily volume without affecting market prices. In practice,
this meant funds would estimate the number of days it would take to
sell or dispose of the reasonably anticipated trade size without
approaching the set percentage of average daily trading volume to
avoid impacting the value significantly. We observed funds
calculating the average daily trading volume taking into account
different sources, and for different time periods, ranging from 10
days to 6 months.
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For any investments other than shares listed on a national
securities exchange or a foreign exchange, such as fixed-income
securities and derivatives, we propose to define a significant change
in market value as any sale or disposition that a fund reasonably
expects would result in a decrease in sale price of more than 1%. Funds
currently use a variety of methods to determine significant changes in
market value in fixed-income securities, taking into account different
groups of comparable securities, asset class characteristics and
volatility, number and depth of market makers, bid-offer spread size,
volume of the security or similar securities, and elasticity of prices
in the security or similar securities. For purposes of the proposed
rule, a decrease of more than 1% would indicate a level of value impact
that is significant because the fund is selling or disposing of a
relatively large position or because the market for the investment has
constricted, and bid-ask spreads have widened. We also understand that
several commonly employed liquidity models currently use this price
decrease measure. We acknowledge that not all liquidity models specify
a price decrease explicitly as the determination for a significant
change in market value and some funds would have to make changes to
convert to this more
[[Page 77189]]
objective threshold. The proposed value impact standard would improve
funds' abilities to perform quality checks and back testing and would
allow the Commission to better analyze classification data across
funds.
In considering whether a sale is reasonably expected to result in a
price decrease of more than 1%, the fund would be required to consider
the size of the sale relative to the depth of the market for the
instrument. As part of that analysis, we believe a fund generally
should consider, among other things, the width of bid-offer spreads.
This is because the width of bid-offer spreads is an important
consideration in analyzing the costs of selling a security and thus
whether a sale would result in a price decrease exceeding 1%. For
example, a sale would be more likely to result in a price decline of
more than 1% if the trade size is large in relation to the market for
that instrument or if bid-ask spreads are wide, or if both are the
case. Wide, or widening, bid-ask spreads may indicate a lower level of
demand for the instrument, which makes it more likely that a sale of
the instrument would result in a price decline of more than 1%.
We request comment on our proposed definition of significant change
in market value:
6. Would funds have to make significant changes to their liquidity
classification methodologies to reflect the proposed amendments to the
value impact standard? If so, what effect would those changes have on a
fund's liquidity risk management program?
7. Should we define value impact through average daily trading
volume or price decline, as proposed? Should we use a different
definition of value impact instead, and if so, should it depend on the
type of investment? Should different types of funds have different
value impact standards? If yes, what standards, and for what types of
funds?
8. For shares listed on a national securities exchange or a foreign
exchange, should we define a significant change in market value as
selling or disposing of more than 20% of the average daily trading
volume, as proposed? Are there other types of investments for which an
average daily trading volume test would be appropriate? For example, is
there data available for fixed-income securities that funds could use
objectively to analyze market participation under a value impact
standard?
9. Should the percent of average daily trading volume be higher or
lower (e.g., 15% or 25%)? Should the measurement period for the average
daily trading volume be longer or shorter than the proposed 20 business
days (e.g., 10, 30, or 40 business days)? Should days where shares were
not traded be counted as zero volume days as proposed or in some other
manner? Are there circumstances in which the average daily trading
volume test should vary by instrument, type of instrument, or trading
venue?
10. For investments that are not listed on a national securities
exchange or foreign exchange, should we define a significant change in
market value as any sale or disposition that the fund reasonably
expects would result in a price decline of more than 1%, as proposed?
Should the identified percentage be higher or lower (e.g., 0.5% or 2%)?
Should this standard for determining a significant change in market
value apply to all investments? Would funds need additional guidance or
parameters to measure this standard consistently, including what inputs
or comparable investments may be used in determining the price decline?
11. Should the 1% price decline definition of value impact be
applied against the fund's last valuation of an investment, which would
include both the effect of the fund's sale and market moves?
iii. Removing Asset Class Classification
Under current rule 22e-4, a fund may generally classify and review
its portfolio investments (including the fund's derivatives
transactions) according to their asset class. However, a fund must
separately classify and review any investment within an asset class if
the fund or its adviser has information about any market, trading, or
investment-specific considerations that are reasonably expected to
significantly affect the liquidity characteristics of that investment
as compared to the fund's other portfolio holdings within that asset
class.\91\ The current provision was intended to strike a balance
between reducing operational burdens associated with classification and
providing reasonably precise liquidity classifications that
appropriately reflect investments' liquidity characteristics.\92\ The
burden to determine individual investment classifications may have
decreased since the adoption of the rule for many funds as these funds
became more familiar with and developed their liquidity risk management
programs and, in some cases, developed automated processes for
classifying investments or employed sophisticated liquidity
classification vendors that provide economies of scale. In addition, in
practice there may be weaknesses in asset class level classifications
that may result in a lack of reasonably precise classifications.
Therefore, we propose to remove the asset class method of
classification from the rule.
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\91\ See rule 22e-4(b)(1)(ii)(A).
\92\ See Liquidity Rule Adopting Release, supra note 8, at
section III.C.3.a. The current approach was also intended to
leverage fund managers' current practices and to recognize that many
investments within an asset class may be considered interchangeable
from a liquidity perspective.
---------------------------------------------------------------------------
Through outreach, we understand that asset class level
classifications are not widely used by many funds. But, where these
asset class level classifications are used, this method runs the risk
of over-estimating the liquidity of a fund's investments and not
adjusting quickly in times of stress. After a fund has begun to use
asset class level classifications, and particularly if classifications
are reviewed only on a monthly basis, it might be difficult for a fund
to identify instances where a given investment's liquidity
characteristics do not align with the characteristics of other
investments in the asset class because individual investment liquidity
data is not being collected and analyzed. Through outreach, we observed
that funds generally established a process and timing for liquidity
assessments and did not change those processes or timing as market
conditions changed, and particularly were unlikely to do so under
stressed conditions. For example, during a stress event like March
2020, a fund using asset class level classifications may not be
equipped to re-classify a subset of investments in an asset class
adeptly in response to changing conditions that affect those
investments directly. Also, because funds classify a significant
portion of their holdings as highly liquid, we believe this potential
gap in identifying investments that a fund should classify differently
from other investments in the asset class is more likely to over-
estimate, rather than under-estimate, the liquidity of a fund's
investments. These tendencies run counter to the premise of the current
rule's classification system, which presumed that a fund would use
efficiencies such as asset class level classifications and monthly
review of classifications only when market conditions or other factors
did not indicate that a shift to a more granular or frequent
classification is appropriate.\93\ Therefore, we are
[[Page 77190]]
proposing to remove asset class level classifications to provide more
precise liquidity classifications that appropriately reflect
investments' liquidity characteristics.
---------------------------------------------------------------------------
\93\ See rule 22e-4(b)(1)(ii) (identifying the circumstances in
which a fund must review its portfolio investments' classifications
more frequently than monthly); rule 22e-4(b)(1)(ii)(A) (identifying
the circumstances in which a fund must separately classify and
review an investment within an asset class instead of classifying
according to the investment's asset class).
---------------------------------------------------------------------------
Moreover, asset class level classifications are not compatible with
the other changes we are proposing to the classification framework,
including the proposed definitions of the value impact standard. It
would also be difficult for a fund to meaningfully apply at the asset
class level a standard based on average daily trading volume or a price
decline in a given investment because the average trading volume, or
market depth generally, can vary from investment to investment even
within the same asset class. Classifying each investment separately
therefore allows a more precise assessment of that investment's
liquidity. In addition, because the proposed rule would include
specific minimum standards for classifying investments, it may reduce
burdens of classifying investments while improving the quality of
classifications relative to the current rule, consistent with the
Commission's objectives in originally allowing asset class level
classifications. Finally, staff has observed through outreach that
liquidity risk management programs have developed so that specific and
individual portfolio investment liquidity classifications are widely
used and the removal of asset class level classifications is consistent
with that approach.
We request comment on the proposed removal of the provision
permitting funds to classify the liquidity of their investments by
asset class.
12. Should we preserve the ability of funds to use asset classes
for liquidity determinations, as currently permitted? To what extent do
funds currently rely on the provision allowing liquidity
classifications by asset class? Would it be more or less burdensome for
funds to classify investments individually under the proposal's
specific minimum standards (such as the stressed trade size and the
defining the value impact standard) than to separately classify any
investment within an asset class whenever the fund or its adviser has
market, trading, or investment-specific information indicating that the
investment should be classified separately rather than as part of the
relevant asset class?
13. Would the operational burden of individually classifying be
balanced by the improved quality of data for each individual investment
as compared to classifying by asset class? To what extent would
investment-by-investment classifications differ compared to asset class
level classification? Are there other benefits to removing asset class
level classification, such as timely, useful, improved, or increased
data?
14. Is reliance on this provision more common for certain types of
funds or certain asset classes? Should asset class level
classifications be limited to specific types of funds or asset classes?
15. If we permitted asset class level classifications, how should
the stressed trade size and value impact standard in the proposal apply
to asset class level classifications?
b. Amendments to Liquidity Classification Categories
We are proposing changes to the liquidity classification categories
to improve funds' abilities to make timely payment on shareholder
redemptions, without the sale of portfolio investments resulting in the
dilution of outstanding fund shares. Section 22(e) of the Act
establishes a right of prompt redemption in open-end funds by requiring
such funds to make payments on shareholder redemption requests within
seven days of receiving the request. In March 2020, in connection with
the economic shock from the onset of the COVID-19 pandemic, open-end
funds faced a significant amount of investor redemptions, and we
believe additional changes to rule 22e-4 would assist funds in managing
investor redemptions in future stressed conditions.
Rule 22e-4 currently allows funds to classify as less liquid
investments those that the fund reasonably expects to be able to sell
or dispose of in seven calendar days or less without significantly
changing the market value of the investment, but that are reasonably
expected to settle in more than seven calendar days.\94\ Under the
current rule, an investment is classified as illiquid if it cannot be
sold or disposed of in seven calendar days or less without
significantly changing the market value of the investment.\95\ We
propose to eliminate the less liquid classification category and amend
the definition of illiquid investment to include those investments that
a fund reasonably expects not to be convertible to U.S. dollars in
current market conditions in seven calendar days or less without
significantly changing the market value of the investment, as well as
those investments whose fair value is measured using an unobservable
input that is significant to the overall measurement.\96\ Under the
proposal to eliminate the less liquid classification category, the rule
would therefore have only three liquidity classifications: highly
liquid investments, moderately liquid investments, and illiquid
investments. We also propose to amend the term ``convertible to cash''
to ``convertible to U.S. dollars,'' codifying prior Commission
statements.\97\ Finally, we propose to specify how to count the
identified number of days an investment is convertible to U.S. dollars
for purposes of the liquidity categories.
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\94\ See rule 22e-4(a)(10) (defining ``less liquid
investment'').
\95\ See rule 22e-4(a)(8) (defining ``illiquid investment'').
\96\ See proposed rule 22e-4(a).
\97\ See Liquidity Rule Adopting Release, supra note 8, at n.848
(``Cash means cash held in U.S. dollars, and would not include, for
example, cash equivalents or foreign currency.'').
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i. Removing the Less Liquid Investment Category and Classifying These
Investments as Illiquid
We propose to eliminate the less liquid classification category and
amend the definition of illiquid investment to include investments, in
part, that a fund reasonably expects not to be convertible to U.S.
dollars in seven calendar days or less without significantly changing
the market value of the investment. Investments that funds currently
classify as less liquid would become illiquid investments under the
proposed amendments, absent changes to shorten the settlement time of
many of those investments. Section 22(e) of the Act requires open-end
funds to make payment on shareholder redemption requests within seven
days of receiving the request. The proposed amendment to define an
investment as illiquid if it does not settle to U.S. dollars in seven
calendar days is designed to reduce the mismatch between the receipt of
cash upon the sale of assets with longer settlement periods and the
payment of shareholder redemptions. This would help prepare funds for
future stressed conditions by reducing the risk of a fund not being
able to meet shareholder redemptions. Unlike the current rule, the
proposed rule would directly limit to 15% the amount of fund assets
that are not reasonably expected to be convertible to U.S. dollars in
seven days.
While funds may classify different types of investments as less
liquid investments today, the most common type of investment in this
category is bank loans.\98\ Fund investments make
[[Page 77191]]
up approximately 15% of the bank loan market.\99\ Filings on Form N-
PORT show that over 90% of bank loan investments reported by open-end
funds are classified as less liquid.\100\ In 2015, commenters
addressing concerns about liquidity in the bank loan market stated that
significant efforts were then underway to materially improve settlement
times in the bank loan market, which are typically longer than other
asset classes.\101\ Bank loans are not standardized and have
individualized legal documentation. This provides flexibility of terms
for bank loans, but also increases the time for a fund to settle a bank
loan trade and receive proceeds from the sale, thus increasing the risk
of the fund not being able to meet shareholder redemptions.\102\
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\98\ Based on Form N-PORT data, bank loans made up 77% and 60%
of investments reported as less liquid in Feb. and Mar. 2020,
respectively. In addition to bank loans, a smaller number of fixed-
income securities, mortgage-backed securities, and equities are
categorized as less liquid investments.
\99\ See Leveraged Loan Primer (last visited Oct. 4, 2022),
available at <a href="https://pitchbook.com/leveraged-commentary-data/leveraged-loan-primer#market-size">https://pitchbook.com/leveraged-commentary-data/leveraged-loan-primer#market-size</a> (stating that the Morningstar LSTA
U.S. Leveraged Loan Index, which is used as a proxy for market size
in the U.S., totaled approximately $1.375 trillion as of Feb. 2022).
As of Dec. 2021, there are 746 open-end funds that classified
approximately $204 billion in bank loan interests as reported on
Form N-PORT. Using this data, we estimate that funds held
approximately 15% of the bank loan market.
\100\ Based on Form N-PORT data, in 2021, more than 90% of the
gross value of loans reported by open-end funds were classified as
less liquid. This was also the case in Feb. and Mar. 2020.
\101\ See, e.g., Comment Letter of the Loan Syndications and
Trading Association on 2015 Proposing Release, supra note 31, File
No. S7-16-15, available at <a href="https://www.sec.gov/comments/s7-16-15/s71615-57.pdf">https://www.sec.gov/comments/s7-16-15/s71615-57.pdf</a> (``LSTA Comment Letter'') (stating the goal of
transforming syndicated loan settlement to a similar settlement
period as most other asset classes).
\102\ See id.
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Around the time that the Commission adopted the liquidity rule, the
median settlement time for a loan sale was about 12 days.\103\ In the
Liquidity Rule Adopting Release, the Commission stated that a fund may
need to consider re-classifying an investment as illiquid in the event
of an extended settlement period.\104\ By July 2021, the average time
to settle a bank loan par trade in the secondary market increased to a
then seven-year high of T+23, and the median was at T+15.\105\ While
median settlement time for bank loans in which funds invest has
generally increased, Form N-PORT data has not shown funds reclassifying
these investments to take into account extended settlement times.
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\103\ See LSTA Comment Letter.
\104\ See Liquidity Rule Adopting Release, supra note 8, at
n.380 and accompanying text.
\105\ See LSTA, Secondary Trading & Settlement: Monthly July
Executive Summary (Aug. 19, 2021), available at <a href="https://www.lsta.org/news-resources/secondary-trading-settlement-monthly-july-executive-summary/?utm_source=rss&utm_medium=rss&utm_campaign=secondary-trading-settlement-monthly-july-executive-summary">https://www.lsta.org/news-resources/secondary-trading-settlement-monthly-july-executive-summary/?utm_source=rss&utm_medium=rss&utm_campaign=secondary-trading-settlement-monthly-july-executive-summary</a>. In addition, fewer trades
settled within T+7, (just 20% of trades settled within the LSTA
guideline during July, a nine-percentage point reduction from the
previous year's monthly average) and settlements wider than T+20
increased 10-percentage points as of July 2021, to a 39% market
share, nearly double that of the T+7 distribution.
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We are proposing changes to remove the less liquid investment
classification to reduce the risk that funds that invest significantly
in less liquid investments may not be able to meet shareholder
redemptions. While bank loan funds were able to meet redemption
requests during March 2020, a period of significant outflows, we are
concerned that they may not be able to meet shareholder redemptions in
future stressed conditions, especially as investments in this asset
class increase. During the month of March 2020, bank loan funds
experienced outflows of approximately 13% of assets, more than any
other type of fund. In addition, since March 2020, total registered
investment company investments in bank loans have increased 50% to
approximately $200 billion.\106\ We understand that in past times of
large outflows, the median buy-side settlement time for bank loans
generally decreased and funds had a degree of success in effecting
shorter settlement periods for these investments to help meet
redemptions.\107\ We are concerned, however, that in future stress
events these attempts to shorten settlement times may fail since loans
are not standardized, have individualized legal documentation, and rely
on manual processes for settlement. We also understand that funds with
significant extended settlement investments have used borrowing through
lines of credit to meet redemptions, but lines of credit may not be
available to all funds and borrowing imposes costs that can dilute the
value of the fund for remaining investors. Based on Form N-CEN filings,
several bank loan funds have accessed their lines of credit in their
most recent reporting period.\108\ We understand that the costs of
borrowing have risen and credit has become more difficult to obtain
over time.
---------------------------------------------------------------------------
\106\ This is based on Form N-PORT information as of Jan. 31,
2022.
\107\ See LSTA Comment Letter (stating that settlement times
have decreased in periods of large outflows, for example, in Aug.
2011, when bank loan funds experienced $8 billion of outflows
(approximately 13% of assets). Similarly, in Mar. 2020, when bank
loan funds experienced $12 billion of outflows (approximately 13% of
assets), we understand that settlement times also generally
decreased.
\108\ See infra note 459 and accompanying text (providing
information about bank loan funds' use of lines of credit as of Dec.
2021).
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We believe that investments that funds currently classify as less
liquid should be classified as illiquid investments and be subject to
the 15% limit on illiquid investments, so that funds may be better
prepared to satisfy redemptions in future stressed conditions without
delay and without significant dilution. Using Form N-PORT data, we
estimate that approximately 200 funds during March 2020 would have had
illiquid investments over the 15% limit if this proposed change had
been in effect, with bank loan funds being the largest type of affected
fund.\109\ As a result of the proposed amendments, more bank loan funds
may contract for expedited settlement, which would involve costs.
Alternatively, advisers with strategies that have 15% or more of assets
in investments classified as less liquid and illiquid may change those
strategies, close funds, or consider using a closed-end fund or other
investment vehicle structure that is not subject to rule 22e-4.
Further, potential additional demand for these investments could
provide incentives to shorten the settlement cycle for bank loans more
generally, which may reduce trading costs.\110\ We believe that these
amendments would reduce the risk of a fund not being able to satisfy
redemptions without diluting the interests of remaining shareholders
while waiting for the proceeds from the sale of an investment with
extended settlement.
---------------------------------------------------------------------------
\109\ The number of funds is estimated by dividing the aggregate
gross value in the relevant categories by the aggregate gross value
reported.
\110\ See infra section III.C.1.b.
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ii. Additional Amendments to the Definition of Illiquid Investment
We also propose to amend the definition of illiquid investment to
include investments whose fair value is measured using an unobservable
input that is significant to the overall measurement. U.S. GAAP
establishes a fair value hierarchy that categorizes into three levels
the inputs to valuation techniques used to measure fair value.\111\ The
fair value measurements of investments are categorized in accordance
with this three-level
[[Page 77192]]
hierarchy. The highest-level measurements are those developed using
quoted, observable inputs in active markets for identical assets and
liabilities (Level 1), such as prices for identical investments on a
securities exchange; the lowest are those developed using unobservable
inputs (Level 3).\112\ We acknowledge that observability is a valuation
concept and may not always correspond to liquidity. The proposed
amendment would require those funds not already classifying investments
valued using unobservable inputs that are significant to the overall
measurement as illiquid to change their classification practices and
may change the liquidity profile for those funds under the rule to be
less liquid. To the extent there is a liquid market for affected
investments, this proposed amendment would cause funds to over-estimate
the illiquidity of their portfolios. As of December 2021, 2,006 open-
end funds held investments that were valued using unobservable inputs
that are significant to the overall measurement (Level 3 investments),
comprising $76.3 billion, or 0.27% of all open-end fund assets.\113\
Among these, $16.9 billion were classified as highly liquid investments
and $2.1 billion as moderately liquid investments.\114\ Accordingly, we
estimate that approximately 0.07% of all open-end fund assets would be
affected by this amendment.
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\111\ See FASB ASC 820-10-35-37, which sets out a fair value
hierarchy for accounting purposes, as compared to rule 2a-5, which
provides a framework for fund valuation practices and determining
fair value (including applying an appropriate methodology consistent
with the principles of FASB Accounting Standard Codification Topic
820: Fair Value Measurement (``ASC Topic 820'')) for purposes of the
Act. See Good Faith Determinations of Fair Value, Investment Company
Act Release No. 34128 (Dec. 3, 2020) [86 FR 748 (Jan. 6, 2021)
(``Valuation Adopting Release'')].
\112\ See ASC Topic 820. U.S. GAAP requires funds to maximize
the use of relevant observable inputs and minimize the use of
unobservable inputs in valuing any asset or liability. In some
cases, the inputs used to measure fair value might be categorized
within different levels of the fair value hierarchy. In those cases,
the fair value measurement is categorized in its entirety in the
same level of the fair value hierarchy as the lowest level input
that is significant to the overall measurement. See ASC 820-10-35-
16AA and 820-10-35-37A. Examples of particular assets and
liabilities that may be measured using Level 3 inputs include long-
dated currency swaps, three-year options on exchange-traded shares,
interest rate swaps, asset retirement obligations at initial
recognition, and reporting units. See FASB ASC 820-10-55-22.
\113\ See infra note 424 and accompanying paragraph. We observed
that the investments classified as highly liquid that were Level 3
investments primarily were mortgage-backed securities.
\114\ We recognize that, in light of the proposed removal of the
less liquid category, only those investments valued using
unobservable inputs that are significant to the overall measurement
that are classified as highly liquid or moderately liquid would be
affected by this proposed amendment.
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Where an investment is valued using unobservable inputs that are
significant to the overall measurement, this may indicate that an
active, liquid, and visible market for the investment does not exist.
Where there is no active, liquid, and visible market for an investment,
there may be a corresponding risk that the fund cannot sell the
investment in time to meet redemptions without dilution. The proposal
defines investments whose fair value is measured using unobservable
inputs that are significant to the overall measurement as illiquid for
purposes of this rule, which is intended to reduce this risk. By
classifying these investments as illiquid, the proposal would establish
a minimum standard for classifying the liquidity of an investment,
which is designed to provide more consistent guideposts for liquidity
classifications.
iii. Other Amendments Related to Liquidity Classification Categories
Amendments to the Definition of Moderately Liquid Investment
We propose to simplify the definition of moderately liquid
investment to mean any investment that is neither a highly liquid
investment nor an illiquid investment.\115\ The moderately liquid
investment category would continue to provide information about the
portion of a fund's portfolio that is not on the most liquid end of the
spectrum, but that still is sufficiently liquid to meet redemption
requests within the statutory seven day period.
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\115\ We also are proposing to remove a provision that addresses
how to classify an investment that could be viewed as either a
highly liquid investment or a moderately liquid investment because
the ambiguity in classification that provision addresses is no
longer present under the proposed amendments to those
classifications. See note to paragraph (b)(1)(ii) introductory text
in current rule 22e-4.
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Amendments to the Definition of Convertible to Cash and References to
Cash
We propose to amend the term ``convertible to cash'' to
``convertible to U.S. dollars'' and to make conforming amendments to
the definition of this term to refer to the ability for a fund to sell
or dispose of an investment, and for it to settle in U.S. dollars.\116\
These amendments codify prior Commission statements. In the adopting
release for rule 22e-4, the Commission stated that cash means ``cash
held in U.S. dollars, and would not include, for example, cash
equivalents or foreign currency.'' \117\ The Commission also provided
an example in that release in which the period of time it took to
repatriate or convert a foreign currency to dollars factored into the
analysis of how quickly a foreign security could convert to cash.\118\
Some funds are classifying foreign investments as highly liquid taking
into account solely the time it would take to convert the proceeds of a
sale to the foreign currency. Similarly, some funds classify foreign
currency as highly liquid without further analysis about the time that
would be needed to convert that currency to U.S. dollars. We believe it
is important to view the liquidity of fund investments in terms of
convertibility to U.S. dollars within a specified period so that a fund
is able to satisfy redemption requests in U.S. dollars.\119\ This
amendment is intended to promote the ability of funds to meet
redemptions without diluting the interests of the remaining
shareholders and increase consistency in how funds classify the
liquidity of investments, including in foreign investments and foreign
currencies. In addition to the definition of convertible to cash, we
also propose to amend other references in rule 22e-4 to refer to U.S.
dollars instead of cash for consistency and clarity.\120\
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\116\ See proposed rule 22e-4(a) (defining ``convertible to U.S.
dollars'' as the ability to be sold or disposed of, with the sale or
disposition settled in U.S. dollars) (emphasis added). We also
propose to amend the definition of convertible to U.S. dollars to
refer to disposition of an investment, and not only sales. This is a
conforming amendment, as current rule 22e-4 classifications
otherwise refer to the ability to sell or dispose of an investment.
\117\ See Liquidity Rule Adopting Release, supra note 8, at
n.848.
\118\ See id., at paragraph accompanying n.379 (providing an
example where certain foreign securities may be able to be sold in
seven calendar days or less, but may be subject to capital controls
that would limit the extent to which the foreign currency could be
repatriated or converted to dollars within this time frame and
explaining that these securities would be considered to be less
liquid investments because they would be reasonably expected to
settle in more than seven calendar days).
\119\ See id., at n.105 and accompanying text (noting concerns
about the potential mismatch between the timing of receipt of cash
for sales of fund assets and the payment of cash for shareholder
redemptions).
\120\ See proposed rule 22e-4(a) (defining ``highly liquid
investment'' and ``in-kind exchange traded fund''); and proposed
rule 22e-4(b)(1)(i)(C) (listing liquidity risk factors).
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Method for Counting the Number of Days
We propose to specify when a fund must start to measure the
identified number of days in which it reasonably expects a stressed
trade size of an investment would be convertible to U.S. dollars
without significantly changing its market value. Currently, the rule
does not directly specify when to begin counting the number of days an
investment would be convertible to U.S. dollars, and funds have
inconsistent practices as to when they begin this measurement. This
inconsistency may lead certain funds to overestimate their liquidity
classifications, and reduce
[[Page 77193]]
their ability to meet redemptions. This also detracts from
comparability when analyzing trends across funds. For example, some
funds may consider an investment highly liquid if it could be converted
to U.S. dollars three business days after the date of the
classification analysis, while others include the date of
classification when counting the number of days. Those funds that begin
counting after the date of the classification would have the advantage
of counting an additional day as compared to those funds that include
the date of classification, and their liquidity classifications may
appear to be more liquid than a similar fund that begins counting on
the date of classification. Therefore, we propose to specify that funds
must count the day of classification when determining the period in
which an investment is reasonably expected to be convertible to U.S.
dollars.\121\ For example, in order for a fund to classify an
investment as highly liquid on Monday, it would need to reasonably
expect that the investment could be sold and settled to U.S. dollars by
Wednesday at the latest.
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\121\ See proposed rule 22e-4(b)(1)(ii)(A).
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We request comment on the proposed amendments to the liquidity
classification categories:
16. As proposed, should we eliminate the less liquid investment
category and amend the illiquid investment definition to include an
investment that a fund reasonably expects can be sold within seven
calendar days without significantly changing the market value but is
not convertible to U.S. dollars within that period (i.e., investments
that are currently classified as less liquid under the rule)? What
effect would these proposed amendments have and how would those funds
that significantly invest in such less liquid investments likely
change?
17. Would the proposed amendment cause funds that currently hold
less liquid investments to contract for expedited settlement for such
investments? What are the advantages or limitations of contracting for
expedited settlement? Would the proposed amendments provide an
incentive to reduce settlement times in bank loan and other relevant
markets more generally? If so, how long might it take to reduce
settlement times in response to the rule and what would be the burdens
associated with this change? Are there certain categories of bank loans
or other investments for which market participants may be unable to
reduce the settlement time to seven calendar days or less? Which
investments and why? What other effects may occur, for example, would
some funds change their strategies, liquidate, or choose to be
structured as a different investment vehicle, such as a closed-end
fund? If some funds would convert to closed-end funds, what type of
closed-end fund would they likely choose (e.g., interval fund, or a
closed-end fund listed on an exchange)? Should we amend other rules, or
provide relief from any specific rules or provisions of the Federal
securities laws, to expedite changes to strategies or conversions to
closed-end funds or other investment vehicles?
18. Some funds classify certain bank loans as highly liquid or
moderately liquid today. What characteristics of these bank loans lead
to a reasonable expectation that they will be convertible to cash in
seven days or less without significantly changing the market value? Are
funds considering contracts for expedited settlement? Would funds need
additional guidance on how to assess the period in which a bank loan or
other investment is reasonably expected to be convertible to U.S.
dollars? For example, should we revise the proposed rule to require
that funds consider, or provide guidance suggesting that funds may wish
to consider: settlement time history for the individual or similar
investments, average settlement times for the market, and guarantees
for settlement or expedited settlement, as well as the contractual
settlement period?
19. Have the costs of borrowing risen and has credit become more
difficult to obtain over time for bank loan funds, particularly during
stressed periods?
20. As proposed, should we remove the less liquid category and
require funds to use a three category classification framework? Would
the proposed changes simplify classifications and reduce burdens over
time, after funds updated systems to reflect the change? Would the
proposed changes appropriately reflect the liquidity of a fund, or
would the current framework be more appropriate? Should funds be
permitted to invest above 15% in less liquid investments if there are
other methods or mechanisms to reduce the mismatch between the receipt
of cash upon the sale of assets with longer settlement periods and the
payment of shareholder redemptions or to address potential dilution
associated with this mismatch? If so, what other methods or mechanisms
should these funds be required or permitted to use (for example, swing
pricing, gates to suspend redemptions, redemption fees, redemptions in
kind, additional limits on less liquid investments, notice periods, or
lengthening the settlement period for paying redemptions)? \122\ If we
permit (to the extent not already permitted) or require use of one or
more of these tools, how should they be used (individually, in some
combination with each other, or with other protections, such as
disclosure, board approval, and Commission reporting)? Should we amend
other rules, or provide relief from any specific rules or provisions of
the Federal securities laws, to expedite or permit use of these methods
and mechanisms? \123\
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\122\ With a notice period, an investor's redemption request
would not be processed until the end of a notice period (e.g., after
2 to 5 days). The investor would receive the next calculated price
after the notice period ends, with payment occurring at the end of a
settlement period. With a lengthened settlement period, a redeeming
investor would receive the price next calculated after submitting
the redemption order but would not receive payment until the end of
a lengthened settlement period (e.g., 5 to 7 days after trade date).
\123\ See, e.g., section 22(e) of the Act (providing the
conditions under which a registered investment company may suspend
the right, or postpone the date, of redemption for more than seven
days).
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21. Should we provide that an investment is illiquid if it is not
reasonably expected to be convertible to U.S. dollars in a shorter or
longer period than seven calendar days? How would a shorter or longer
period align with the requirement in section 22(e) of the Act for a
fund to satisfy redemptions within seven days? If we provided a longer
period of time to convert to U.S. dollars before an investment is
classified as illiquid, how would funds prepare for the potential
mismatch during stressed situations between the amount of available
cash and the size of shareholder redemptions? Should we provide
additional exemptions to allow funds to delay redemptions to
shareholders under certain limited circumstances and conditions, such
as independent director approval?
22. Are there circumstances in which an investment is fair valued
using an unobservable input that is significant to the overall
measurement, but the investment should not be treated as illiquid for
purposes of the rule? Please explain and provide supporting data.
Should we permit a fund to classify certain types of investments that
are fair valued using unobservable inputs that are significant to the
overall measurement as highly liquid or moderately liquid and, if so,
which types? Should we instead treat investments that are fair valued
using unobservable inputs that are significant to the overall
measurement as presumptively illiquid, but permit funds to rebut this
presumption? If so, what process should we require for rebutting the
presumption? For example, should
[[Page 77194]]
we require funds to maintain records describing why they did not
classify such an investment as illiquid? Should we require funds to
disclose on Form N-PORT any circumstances in which they did not
classify such an investment as illiquid?
23. Are there other types or characteristics of investments that we
should include in the definition of illiquid investment? If so, which
ones?
24. Should we amend the definition of moderately liquid investment,
as proposed? Alternatively, should we retain the details in the current
definition that specify the number of days in which a fund must
reasonably expect an investment to be convertible to U.S. dollars in
order to classify it as moderately liquid?
25. Would the proposed changes to the liquidity classifications
affect investment options available to investors? For example, would
bank loan funds only be available in non-open-end investment vehicles?
What effect would these proposed changes have on those asset classes
that are less available for investment by open-end funds for liquidity
reasons, the availability of credit to borrowers, and more generally,
on capital formation?
26. Should we amend the definition of convertible to cash and other
references to cash in rule 22e-4 to refer to U.S. dollars, as proposed?
Would these amendments raise issues for specific types of funds? If so,
which ones and how? Would these amendments affect funds' investment
strategies, including their allocation to foreign investments and U.S.
dollars, or their performance?
27. Are there circumstances in which a fund would pay redemptions
in a different currency than U.S. dollars? If so, would it be
appropriate for that fund to be able to assess the time in which an
investment could convert to that other currency for purposes of the
rule?
28. In addition to sale and disposition, are there other ways an
investment may be converted to U.S. dollars that should be included in
the definition of convertible to U.S. dollars? If so, what are they?
29. Would the amendment to refer to U.S. dollars instead of cash in
the definitions of highly liquid investment and convertible to cash
materially change how funds classify highly liquid investments
currently? If so, how?
30. Should we require funds to include the day of classification
when counting the number of days to convert to U.S. dollars as
proposed, or should we require funds to begin to count the number of
days to convert to U.S. dollars on the following day? What are the
advantages and disadvantages of this alternative? Would this
alternative result in less conservative liquidity classifications for
some funds or investments (i.e., by causing some investments that
otherwise would have been classified as moderately liquid to be
classified as highly liquid) or impair a fund's ability to meet
redemptions?
31. Instead of using the days an investment would be convertible to
U.S. dollars in the liquidity classifications as proposed, should we
separately set the number of days to: (1) make the trade; and (2)
settle the trade or otherwise dispose of an investment, in determining
liquidity classifications? Why or why not? Is there a different way the
rule should measure the period that an investment is convertible to
U.S. dollars?
c. Frequency of Classifications
Rule 22e-4 currently requires that funds review their liquidity
classifications at least monthly in connection with reporting on Form
N-PORT, and more frequently if changes in relevant market, trading, and
investment-specific considerations are reasonably expected to
materially affect one or more of their investments'
classifications.\124\ The current rule also requires a fund to monitor
and take timely actions related to the liquidity of its investments,
including changes to its liquidity profile. Specifically, the rule
prohibits a fund from acquiring any illiquid investment if, immediately
after the acquisition, the fund would have invested more than 15% of
its net assets in illiquid investments that are assets.\125\ In
addition, the rule requires a fund to provide timely notice to its
board, and to the Commission on Form N-RN, if the fund exceeds the 15%
limit on illiquid investments, or if there is a shortfall of the fund's
highly liquid investments below its highly liquid investment minimum
for seven consecutive calendar days.\126\
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\124\ See rule 22e-4(b)(1)(ii).
\125\ See rule 22e-4(b)(1)(iv).
\126\ See rule 22e-4(b)(1)(iv)(A) and rule 22e-
4(b)(1)(iii)(A)(3); Form N-RN Parts B through D.
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We propose amendments to require a fund to classify all of its
portfolio investments each business day instead of at least
monthly.\127\ Daily classification would reflect current market
conditions more accurately and would provide funds with more data for
analysis to prepare for future stressed conditions. We believe that
daily classifications would assist liquidity risk program
administrators in better monitoring of a fund's liquidity and enhance a
fund's ability to more rapidly respond to changes that affect the
liquidity of the fund's portfolio, reflecting more effective practices
we have observed. In addition, daily classifications would help ensure
that funds timely report shortfalls below the highly liquid investment
minimum or breaches of the 15% limit on illiquid investments to the
fund's board and to the Commission, which would better achieve the
goals of the current provisions to provide board and Commission
oversight of the fund's liquidity risk management program and its
effectiveness.
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\127\ See proposed rule 22e-4(b)(1)(ii). Although rule 22e-4
currently requires funds to classify each of the fund's portfolio
investments (including each of the fund's derivatives transactions),
we have observed that some funds are not classifying all investments
in their portfolios, such as positions in to-be-announced (TBA)
contracts to trade mortgage-backed securities or the reinvestment of
cash collateral received in securities lending arrangements.
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Most funds did not report reclassifications of their portfolio
investments despite extraordinary liquidity constraints in March
2020.\128\ Based on the liquidity classification practices we observed
in March 2020 and on filings covering this period, we are concerned
that some funds effectively are equipped to classify their investments
primarily on a monthly basis to meet reporting requirements and are not
prepared to review classifications intra-month. Because intra-month
analyses for these funds would be out of the ordinary and only occur
when a fund determines that changes in relevant market, trading, and
investment-specific considerations are reasonably expected to
materially affect one or more of their investments' classifications, it
may be especially challenging during stressed conditions for these
funds to reclassify their investments intra-month. Requiring daily
classification, while involving costs, may ultimately lead to a more
efficient classification process for funds than monitoring trading
conditions to determine if and when intra-month classifications are
required. For
[[Page 77195]]
example, a daily classification requirement, in combination with the
minimum standards we propose for trade size and value impact, may lead
funds to modify their liquidity classification processes, which would
make the process more standardized, timely, and efficient.
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\128\ Despite the liquidity constraints in Mar. 2020, we
observed through Form N-PORT filings that roughly 75% of funds did
not reclassify any investment held in both Feb. and Mar. 2020.
Specifically, roughly 80% of U.S. equity funds did not reclassify
any holding that was held in both Feb. and Mar. 2020, while roughly
10% reclassified at least one investment into a more liquid category
and roughly 13% reclassified at least one investment into a less
liquid category. Roughly 55% of taxable bond funds reclassified on
average 4% of their portfolios, with the median fund reclassifying
1% of its portfolio. Of the funds that reclassified, roughly 30%
reclassified at least one investment into a more liquid category and
roughly 44% reclassified at least one investment into a less liquid
category. More funds did, however, reclassify in Mar. 2020 period
than for either Feb. or Apr. 2020.
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We request comment on the proposed amendments to require funds to
classify the liquidity of their investments on a daily basis.
32. Should we require funds to classify all portfolio investments
on a daily basis, as proposed? Would this proposed amendment result in
a material change to how funds are currently classifying? To what
extent do funds already classify the liquidity of their investments on
a daily basis or collect the information they would need to classify
daily? Would this proposed amendment better integrate liquidity risk
management and portfolio management systems?
33. We also are proposing that funds use a stressed trade size and
a defined value impact standard in determining liquidity
classifications. Would those changes affect the burdens of classifying
on a daily basis? Would those effects be different for different types
of funds? For example, would it be easier to determine on a daily basis
whether the sale of a stressed trade size of shares listed on an
exchange would exceed 20% of the average daily trading volume for those
shares than to determine whether the sale of a stressed trade size of
other investments would result in a price decline of more than 1%?
34. Instead of classifying on a daily basis, should we require
funds to classify the liquidity of their investments at some other
frequency (e.g., weekly, biweekly, or monthly)? If so, should we
maintain the requirement for a fund to classify more frequently if
changes in relevant market, trading, and investment-specific
considerations are reasonably expected to materially affect one or more
of its investments' classifications? Is there a different approach we
should use effectively to require a fund to classify its investments in
response to changing conditions? Are there certain types of funds that
should be excluded from daily classifications? If so, which funds?
35. If we require funds to classify on a non-daily frequency, how
would they monitor for compliance with the 15% limit on illiquid
investments and the highly liquid investment minimum? How are those
limits monitored for compliance now?
2. Highly Liquid Investment Minimums
a. Proposed Scope of the Requirement and Determination of the Minimum
Rule 22e-4 currently requires a fund to determine a highly liquid
investment minimum if it does not primarily hold assets that are highly
liquid investments. Funds that are subject to the highly liquid
investment minimum requirements must determine a highly liquid
investment minimum considering several factors, review the minimum at
least annually, and adopt policies and procedures to respond to a
shortfall of the fund's highly liquid investments below the minimum
required.\129\ We propose to require all funds to determine and
maintain a highly liquid investment minimum of at least 10% of the
fund's net assets, which is equivalent to the stressed trade size. In
connection with this proposed requirement, we would remove the
exclusion for funds that primarily invest in highly liquid investments
(the ``primarily exclusion''). The proposed amendments are designed to
ensure that funds have sufficient liquid investments for managing
stressed conditions and heightened levels of redemptions.
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\129\ See rule 22e-4(b)(1)(iii).
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We assessed liquidity-related data reported on Forms N-PORT, as
well as the development of liquidity risk management programs, through
staff outreach to funds and advisers. Based on Form N-PORT filings,
most funds do not determine a highly liquid investment minimum and
instead rely on the primarily exclusion.\130\ For those funds that have
highly liquid investment minimums, the rule currently requires that
they consider various liquidity factors, such as their investment
strategy and cash-flow projections, in both normal and reasonably
foreseeable stressed conditions.\131\ We understand that those funds
additionally consider factors such as asset class, market volatility,
and shareholder concentration in their determinations.
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\130\ Approximately 83% of funds holding 85% of net assets do
not report setting a highly liquid investment minimum on Form N-
PORT.
\131\ For these purposes, funds are required to consider certain
factors during stressed conditions only to the extent they are
reasonably foreseeable during the period until the next review of
the highly liquid investment minimum. See rule 22e-
4(b)(1)(iii)(A)(1).
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As discussed above, by requiring fund liquidity classifications to
assume the sale or disposition of a set stressed trade size, the
proposal is intended to better prepare all funds for future stressed
conditions.\132\ To help further prepare a fund for heightened levels
of redemptions in stressed conditions, we are proposing to require the
highly liquid investment minimum to be equal to or higher than the
assumed stressed trade size. In setting the highly liquid investment
minimum to be at least the stressed trade size, we considered data on
fund flows for setting the stressed trade size as well as data reported
on Form N-PORT on funds' current highly liquid investment minimums. As
of March 2020, for funds that had determined a highly liquid investment
minimum, the majority of those funds reported setting a highly liquid
investment minimum of less than 10% of the fund's net assets. In
contrast, approximately 8% of those funds reported setting a highly
liquid investment minimum of more than 50% of the fund's net assets.
Thus, while there is a wide divergence in highly liquid investment
minimums, most of these funds have a minimum that is lower than the
proposed 10% level. Given the level of weekly outflows some funds have
experienced and the difficulty in predicting future stress events, we
believe that a regulatory minimum of 10% for the highly liquid
investment minimum would benefit investors by improving the ability of
funds to meet shareholder redemptions in stressed scenarios.
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\132\ See supra section II.A.1.a.i for discussion of the
stressed trade size and of fund flow data.
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In addition, the proposal's requirement for funds to both assume a
stressed trade size to determine liquidity classifications and also
maintain an equal or higher minimum of highly liquid investments is
intended to work together to better prepare them for future stressed
conditions and to reduce the risk of dilution. Not only would funds
have highly liquid investments in an amount needed to meet the stressed
trade size, they would also have more highly liquid assets to meet
redemptions without having to sell less liquid investments at
discounted prices. Funds would continue to be required to periodically
review the highly liquid investment minimum and have policies and
procedures to address any shortfall in highly liquid investments below
the minimum.
While the proposed minimum of 10% of a fund's net assets may be a
suitable highly liquid investment minimum for most funds, certain funds
may find a higher amount appropriate depending on a fund's liquidity
risk factors and investment objectives. Consistent with the current
rule, a fund would be required to consider a specified set of liquidity
risk factors to determine whether its highly liquid investment
[[Page 77196]]
minimum should be above 10%.\133\ We continue to believe that the
liquidity risk factors funds must consider in determining a highly
liquid investment minimum under the current rule and the associated
guidance the Commission provided in the Liquidity Rule Adopting Release
regarding these factors are appropriate for a fund to take into account
for these purposes.\134\
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\133\ See Liquidity Rule Adopting Release, supra note 8, at
paragraph following n.669.
\134\ See id., at section III.B.2.
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A broad variety of investments, as well as cash, may qualify
towards the highly liquid investment minimum.\135\ Since approximately
83% of funds currently rely on the primarily exclusion, we would not
expect this proposal to affect their strategies. We recognize, however,
that imposing a highly liquid investment minimum of at least 10% would
require some other funds to hold a larger amount of highly liquid
assets than they currently do, and thus may affect these funds'
performance or strategies.\136\ For funds with strategies focused on
investments that would not be considered highly liquid, they would have
to determine how to constitute a portfolio of investments that would
allow the fund to meet its strategy and investing parameters while
maintaining a highly liquid investment minimum of at least 10%. All
funds would be subject to the same highly liquid investment minimum of
at least 10%, which would minimize any competitive advantage for
similar funds associated with the proposed highly liquid investment
minimum requirements. We believe it is important that all funds be
prepared to meet redemptions in future stressed scenarios, and that
funds would be better able to do so with the proposed highly liquid
investment minimum requirements.
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\135\ See id., at n.663 and accompanying text.
\136\ As recognized above, being unprepared for higher than
normal redemptions also can affect a fund's performance when such
redemptions occur. See supra note 81. For instance, although less
liquid assets generally offer a higher return, the trading costs
associated with selling these assets during periods of increased
redemptions may offset this risk premium, potentially resulting in a
lower overall return for fund investors. See infra note 351 and
accompanying text.
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In establishing a uniform floor for the highly liquid investment
minimum, we are also proposing to remove the exclusion for funds that
invest primarily in highly liquid investments. The Commission adopted
the primarily exclusion because it believed the benefits associated
with requiring such funds to determine and review a highly liquid
investment minimum, or to adopt shortfall procedures, would not justify
the associated burdens.\137\ Since that time, however, we have observed
that a fund relying on the primarily exclusion may experience
significant declines in its liquidity that result in the fund holding
less than 50% of its portfolio in highly liquid investments for a
period of time. For example, a fund that invests significantly in a
given foreign market and that generally classifies those investments as
highly liquid can experience substantial declines in the amount of its
highly liquid investments if, for example, there is political or
economic turmoil in or an extended holiday closure of that foreign
market. Funds that currently use the primarily exclusion instead of
determining and maintaining a highly liquid investment minimum do not
have the benefit of shortfall procedures, including board oversight, to
respond to events or market conditions that may cause the fund to fall
under its previously determined level of primarily held highly liquid
investments. By requiring a highly liquid investment minimum for all
funds, investors would enjoy the benefit of policies and procedures
that are designed to ensure not only oversight by the liquidity risk
program administrator but also the fund's board.
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\137\ Liquidity Rule Adopting Release, supra note 8, at
paragraph accompanying n.724.
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Moreover, the burdens of complying with highly liquid investment
minimum requirements for funds that currently use the primarily
exclusion may be reduced because many fund complexes already have
experience developing highly liquid investment minimum shortfall
policies and procedures. It may be possible for funds in the same
complex to leverage this experience to reduce the burdens of developing
these policies and procedures for funds that previously qualified for
the primarily exclusion. As liquidity risk management programs have
matured, and continue to mature, many fund complexes continue to gain
experience with highly liquid investment minimum shortfall policies and
procedures, which may also reduce burdens. By requiring all funds to
adopt a highly liquid investment minimum, we are seeking to help ensure
that funds would be better prepared to handle future stressed
conditions, which may occur suddenly and unexpectedly, as they would
have sufficient liquid investments for managing heightened levels of
redemptions.
We request comment on the proposed amendments to highly liquid
investment minimum requirements.
36. Should we require all funds to determine and maintain a highly
liquid investment minimum, as proposed? What effect would this proposal
have on funds? For example, would some funds have to change their
strategies or expect effects on performance?
37. Should some types of funds be excluded from the requirement to
have a highly liquid investment minimum? If yes, which ones and why?
For example, should we preserve the exclusion for funds that primarily
hold highly liquid assets? Alternatively, should funds currently using
the primarily exclusion have a higher highly liquid investment minimum
requirement? Would funds using the primarily exclusion be as prepared
to meet redemptions in stressed scenarios without a highly liquid
investment minimum and its corresponding policies and procedures?
38. If the primarily exclusion is kept, should we define the amount
of highly liquid assets a fund must maintain under this standard (e.g.,
investing at least 51% of the fund's net assets in highly liquid
assets, or a higher or lower amount)?
39. Should we establish a regulatory minimum for the amount of
highly liquid investments of 10%, as proposed, or should it be set at
15% or 5% (or some other higher or lower amount)? Would establishing a
regulatory minimum reduce the burdens associated with determining and
periodically reviewing the fund's highly liquid investment minimum?
40. Rather than propose a regulatory minimum with factors that a
fund must consider to determine whether its own highly liquid
investment minimum should be higher, should we require all funds to use
the same highly liquid investment minimum? Would this set a level
playing field for all funds and diminish any competitive advantage for
a fund with a lower highly liquid investment minimum? If so, what
amount would be appropriate for a uniform highly liquid investment
minimum for all funds (e.g., 5%, 10%, 15%, or a higher or lower
amount)?
41. Would providing more detail or guidance on the liquidity risk
factors be helpful? If so, which factors?
42. Would funds that do not currently have a highly liquid
investment minimum be able to leverage policies and procedures already
developed for highly liquid investment minimums, for example by other
funds in the same complex, to reduce the burdens of developing these
policies and procedures? If not, what costs would funds incur to adopt
and implement highly liquid investment minimum policies and procedures?
[[Page 77197]]
b. Calculation of the Highly Liquid Investment Minimum
We are proposing amendments to rule 22e-4 that are designed to help
ensure that the highly liquid investments a fund holds to meet its
highly liquid investment minimum are available to support the fund's
ability to meet redemptions. A key aim of the highly liquid investment
minimum requirement is to decrease the likelihood that funds would be
unable to meet their redemption obligations.\138\ Building on existing
aspects of rule 22e-4, the proposed amendments would require that, when
determining the amount of assets a fund has classified as highly liquid
that count toward the highly liquid investment minimum, the fund
account for limitations in its ability to use some of those assets to
meet redemptions.\139\ Specifically, in assessing compliance with the
fund's highly liquid investment minimum, the fund would be required to:
(1) subtract the value of any highly liquid assets that are posted as
margin or collateral in connection with any derivatives transaction
that is classified as moderately liquid or illiquid; and (2) subtract
any fund liabilities.\140\
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\138\ See Liquidity Rule Adopting Release, supra note 8, at text
following n.117.
\139\ As the Commission explained at the time it adopted rule
22e-4, this is not meant to suggest that a fund should only, or
primarily, use highly liquid investments to meet shareholder
redemptions. Instead, we believe that a fund holding sufficient
highly liquid assets will support the fund in meeting redemption
requests in a non-dilutive manner, and assist it in readjusting its
portfolio in times of market stress, heightened volatility, and
managing its obligations to derivatives counterparties. See
Liquidity Rule Adopting Release, supra note 8, at n.680 and
accompanying text.
\140\ Proposed rule 22e-4(b)(1)(iii)(B)(1); 22e-
4(b)(1)(iii)(B)(2). Rule 22e-4 currently refers to a ``pledge'' of
margin or collateral, rather than ``posting.'' We are proposing to
use the term ``post'' because we believe this term is more commonly
used within the industry and by other regulators to refer to
instances where a party provides margin or collateral to its
counterparty to meet the performance of its obligation under one or
more derivatives transactions as a result of a change in the value
of such obligations since the trade was executed or the last time
such collateral was provided (commonly referred to as variation
margin) or is provided to secure potential future exposure following
default of a counterparty (commonly referred to as initial margin).
See, e.g., Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 86 FR 6850 (Jan. 25, 2021).
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i. Margin or Collateral of Moderately Liquid and Illiquid Derivatives
The requirement for a fund to reduce the value of its highly liquid
assets by the amount posted as margin or collateral in connection with
a non-highly liquid derivatives transaction reflects that this amount
of highly liquid assets is not available for the fund to use to meet
redemptions.\141\ This is because, where a fund enters into a
moderately liquid or illiquid derivative and posts highly liquid assets
as margin or collateral, the posted collateral is highly liquid, but
the fund cannot access the value of posted assets unless the fund exits
the derivatives transaction. Since the fund has classified the
derivative as moderately liquid or illiquid, it does not reasonably
expect to be able to exit the derivatives transaction within three
business days. We recognize that the fund may be able to access the
specific assets posted as margin or collateral by replacing them with
other assets acceptable to the fund's counterparty. But regardless of
the specific assets posted, the value of collateral posted in
connection with a moderately liquid or illiquid derivative would not be
convertible to U.S. dollars within three business days or less.
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\141\ See Liquidity Rule Adopting Release, supra note 8, at
nn.727-730 and accompanying text. This aspect of the proposed rule
would only require an adjustment to the amount of a fund's highly
liquid investments that are assets, since investments that are in a
liability position are unable to be used to meet redemption
requests. See proposed rule 22e-4(b)(1)(iii)(B)(1).
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Under the current rule, a fund is required to identify the
percentage of the fund's highly liquid investments that it has posted
as margin or collateral in connection with derivatives transactions
that the fund has classified as less than highly liquid.\142\ The
Commission believed that this approach struck an appropriate balance
between providing transparency and reducing burdens on funds.\143\ The
Commission observed that a fund generally would not need to
specifically identify particular assets that are posted as margin or
collateral to cover particular derivatives transactions, but instead
would calculate the percentage of highly liquid investments posted as
margin or collateral for derivatives transactions classified in each of
the other classification categories.\144\ Under the rule, a fund that
has posted both highly liquid investments and non-highly liquid
investments as margin or collateral in connection with a non-highly
liquid derivatives transaction should reduce its highly liquid
investments, rather than assume that posted non-highly liquid
investments would first cover the derivatives transaction, unless the
fund specifically identifies non-highly liquid investments as margin or
collateral in connection with a derivatives transaction.\145\ Finally,
the Commission observed that the current approach responds to
commenters' concerns that linking the liquidity of specific assets
posted as margin or collateral to the liquidity of a fund's derivatives
transactions could understate the liquidity of those assets, since a
fund may be able to readily substitute another liquid asset for the
asset posted as margin or collateral.\146\
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\142\ Rule 22e-4(b)(1)(ii)(C). In addition, funds currently also
are required to exclude highly liquid assets that are posted as
margin or collateral in connection with non-highly liquid
derivatives transactions when determining whether the fund primarily
holds highly liquid assets. Rule 22e-4(b)(1)(iii)(B).
\143\ See Liquidity Rule Adopting Release, supra note 8, at
n.476 and accompanying text.
\144\ Id. at n.489 and accompanying text.
\145\ Note 1 to proposed rule 22e-4(b)(1)(iii)(B)(1). Cf. Note 1
to rule 22e-4(b)(1)(ii)(C). See also Liquidity Rule Adopting
Release, supra note 8, at nn.489-490 and accompanying text
(explaining that in the absence of such an instruction, some funds
might instead take the opposite approach, and assume that posted
non-highly liquid investments first cover these less liquid
derivatives transactions, creating inconsistencies between funds).
\146\ We recognize that margin or collateral may be determined
and paid by funds on the basis of a group of derivatives
transactions, with the fund posting or receiving a net amount of
margin or collateral. When a fund pays margin or collateral in
connection with a group that includes derivatives transactions that
are highly liquid and non-highly liquid, funds already must
determine the amount of margin or collateral attributable to the
non-highly liquid derivatives under the current rule. For example, a
fund must perform this attribution in order to identify the
percentage of the fund's highly liquid investments that it has
posted as margin or collateral in connection with derivatives
transactions that are not themselves highly liquid.
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The proposed approach is intended to enhance investor protection
while continuing to strike an appropriate balance with the potential
increased burdens on funds. The proposed approach would not require
funds to identify and reclassify specific assets posted as margin or
collateral, but rather to reduce the value of the fund's highly liquid
assets available to meet the fund's highly liquid investment minimum by
the value of the assets posted as margin or collateral. We also propose
to maintain, with conforming changes, the explanatory note discussed
above guiding the allocation of amounts posted as margin or
collateral.\147\ By reducing the fund's highly liquid investments by
the value of amounts posted as margin or collateral, the proposed
approach would avoid burdens associated with tracking specific
securities posted as margin or collateral and reclassifying investments
as they are posted as margin or collateral and recalled. It also would
not
[[Page 77198]]
understate the liquidity of specific securities that are posted as
margin or collateral because each security would continue to be
classified based on its own characteristics, and instead the
adjustments would only be made at the aggregate level.\148\ Moreover,
many of the operational concerns commenters raised when rule 22e-4 was
proposed, which led the Commission to adopt the current approach,
related to the treatment of assets segregated under the Commission's
Investment Company Act Release 10666, which the Commission has since
rescinded, effective August 19, 2022.\149\ We therefore believe the
proposed amendments would enhance investor protections by helping to
ensure a fund's highly liquid assets are in fact available to meet
redemptions, while continuing to balance the value of the provision
against the operational burdens to implement it.
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\147\ See supra note 145. In connection with the proposed
amendments to the rule's highly liquid investment minimum
provisions, we propose to re-number certain existing paragraphs and
to add paragraphs to the rule. As a result, we propose to update
cross-references to the highly liquid investment minimum provisions
within the rule. See proposed rule 22e-4(b)(1)(iii)(C) through (E)
and proposed rule 22e-4(b)(3)(iii).
\148\ See Liquidity Rule Adopting Release, supra note 8, at
n.491 and accompanying text.
\149\ See Liquidity Rule Adopting Release, supra note 8, at
nn.468-472 and accompanying text (operational concerns); Derivatives
Adopting Release, supra note 21, at section II.L (withdrawal of
Investment Company Act Release 10666).
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ii. Fund Liabilities
Under the proposal, a fund would also be required to reduce the
amount of highly liquid assets that count toward the fund's highly
liquid investment minimum by the amount of the fund's liabilities. This
proposed change is intended to result in a more accurate calculation of
the highly liquid investment minimum.\150\ The proposed approach would
include any liabilities, as defined in 17 CFR 210.6-04 (rule 6.04 of
Regulation S-X). For example, this would include investment liabilities
and amounts payable for investment advisory, management, and service
fees. Reducing the amount of highly liquid assets by fund liabilities
reflects that fund liabilities are generally paid in cash, meaning that
highly liquid assets may need to be liquidated in order to satisfy
those liabilities rather than to meet redemptions.
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\150\ The highly liquid investment minimum is the percentage of
a fund's net assets that it invests in highly liquid assets that are
eligible to count toward the minimum under the rule. See rule 22e-
4(a)(7) (defining highly liquid investment minimum). Because this
calculation uses net assets as the denominator (which reflects the
amount of assets less any liabilities), we believe the numerator of
eligible highly liquid assets similarly should be net of
liabilities.
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Based on staff outreach, it is our understanding that the proposal
reflects many funds' existing practices. For example, when a fund has
significant liabilities, they generally will be incurred in connection
with derivatives transactions or other inves
[…truncated; see source link]Indexed from Federal Register on December 16, 2022.
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