SEC Extends Liquidity Rule Classification Deadline by Six Months
Mutual fund managers concerned about the requirements of the SEC’s Liquidity Risk Management Rule got a partial reprieve on the evening of February 21. The Commission voted to create an interim final rule extending the compliance deadline for the most contentious part of the Rule – the requirement that open-end funds classify their securities into four liquidity groupings, often referred to in the industry as "buckets" – by six months.
The new compliance dates for classification are now June 1, 2019 for fund groups with more than $1 billion in assets, and December 1, 2019 for smaller fund groups. The deadline extension would also apply to the determination of a minimum percentage of a fund’s net assets that must be highly liquid, as well as fund board oversight.
All other parts of the Rule, including the requirement that fund groups limit illiquid investments in their portfolios to no more than 15 percent of a fund’s portfolio, still need to comply by the original dates of December 1, 2018 for fund groups with more than $1 billion in assets, and June 1, 2019 for those that have less than $1 billion.
"Today’s Commission action is a measured step designed to help preserve key market oversight and investor protection benefits of the Commission’s liquidity rule, while addressing certain concerns that have been raised since adoption," said SEC chairman Jay Clayton. "I expect that our action will promote a smoother and more effective implementation process for the rule."
The SEC’s passage of the compliance date extension, while discussed and hoped for among members of the asset management community, came as something of a surprise, as earlier the same day the SEC cancelled a previously announced open meeting that had the compliance date extension on the agenda. No reason was given for the cancellation. Another, unrelated topic on the original meeting agenda, approving guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents, also was approved by the Commission some time after the open meeting was cancelled.
Whatever the rationale for the cancelled public meeting and subsequent approvals, there is little doubt that the Liquidity Rule compliance date extension for classifications would be welcomed by those who would be affected by it.
"The reassessment will be welcomed by many," said Willkie Farr partner and former SEC deputy chief of staff James Burns. Describing the compliance date postponement as "a highly unusual step," he said that "it’s an exceptionally encouraging sign when the SEC pauses to take stock of a new rule to better determine whether it is serving its intended purpose or whether there might be unanticipated consequences that have arisen since adoption."
"The delay will give funds more time to deal with what are clearly the most difficult and controversial parts of this rule, while keeping the more principles-based elements of the rule on track," said Morgan Lewis partner John McGuire.
"The most expensive and operationally burdensome element of the Liquidity Rule is the bucketing requirement, so a betting man would assume that was most ripe to be revisited," said Shearman & Sterling partner Nathan Greene.
Forms and FAQs
Some further changes are expected. For one, the SEC said that it "anticipates considering in the future proposed amendments to Form N-PORT and Form N-1A related to disclosures of liquidity risk management for open-end management investment companies."
The agency staff on February 21 also issued an additional set of answers to FAQs related to the Liquidity Rule, focusing on questions involving the liquidity classification process. These FAQs, which follow a January 10 set of FAQs involving the role of subadvisers and exchange-traded funds (ACA Insight, 1/22/18), deal with questions involving topics such as asset class liquidity classification, reasonably anticipated trading size, a price impact standard, classifying investments in pooled investment vehicles, provisional investment classification activity, timing and frequency of investment classifications, and pre-trade activity and the 15 percent limit on illiquid investments.
The SEC adopted the Liquidity Rule in October 2016. The final Rule, perhaps in response to industry comments, reduced the number of proposed classification buckets from the six that were in the proposed rule to four. Nonetheless, while that change and others were welcomed, industry associations were not exactly pleased with the final product.
"This is a tough set of new rules that will spur a number of operational changes across the registered fund industry," the Investment Company Institute said in a statement after the final Rule was adopted.
"There will be a significant amount of work involved for investment companies to determine their liquidity holdings as required," said a spokesperson for the Investment Adviser Association at the time.
In addition to the requirements discussed above, the Liquidity Rule requires mutual funds and other open-end management funds, including exchange-traded funds, to establish a liquidity risk management program and to periodically review a fund’s liquidity risk.