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Securities and Exchange Commission

Mutual Fund Education

New Liquidity Risk Management Rules: Overview

Brian Mathews Jan 16, 2018


This new rule and the procedures with which each mutual fund will need to comply officially go into effect on December 1, 2018.

To familiarize yourself with regulations governing the mutual fund industry, read about the Investment Company Act of 1940.


The Need for the New Rule


The goal of the financial industry is to allow individual investors to pool their risk-taking activities. This is similar to the home insurance industry that routinely provides home insurance by grouping similar people according to the risks in their area. If many residents live in an area that is subject to natural disasters like earthquakes or hurricanes, everyone in that area is charged a similar rate as opposed to people who do not live in high-risk areas. Through mutual funds, the investment industry can pool the risks of many individual investors, like the insurance business. As a benefit to investors, a mutual fund can offer more diversification and access to investments that are normally not offered to individual investors but only institutions.

Learn more about the implications of liquidity risks for mutual funds here.


Liquidity Risk and the Current Rule


Another issue for investors and liquidity risk has to do with a fund’s holdings and its level of illiquid investments. Previously, there was a longstanding 15% guideline that limits a mutual fund to aggregate holdings of illiquid assets to 15% or less of the fund’s net assets. Simply, a fund cannot have more than 15% of holdings in assets that cannot be converted to cash within seven days. Mutual fund companies must pay the proceeds of the redemption amount to the investor within seven calendar days but typically pay in three days or less. For most investors, if they place a sell order on a mutual fund with a broker/dealer prior to 4:00 p.m. EST, the fund will usually redeem their order the same day. Then there is a one-to-two-day settlement period before the investor actually receives the funds in their account. This rule is called Rule 15c6-1(a) under the Securities and Exchange Act.

Along with the settlement rule and the 15% guideline, Rule 22c1 is another rule that mutual funds abide by. This rule is called the “forward pricing” rule, which requires funds and their principle underwriters to sell and redeem fund shares based on the fund’s net asset value.

SEC has also released rules for use of swing pricing by mutual funds. Click here to learn more about swing pricing.


The “Final Rule” Rule 22e-4


The next mandate the rule states is that each fund must review its classification of liquidity within its portfolio on at least a monthly basis. There are four categories each investment will fall under – highly liquid, moderately liquid, less liquid and illiquid. The highly liquid investments are convertible to cash within three business days, the moderately liquid are within three to seven and the less liquid within seven days. Illiquid investments are not saleable within seven calendar days.

The rule also dictates that each fund will determine its own highly liquid investment minimum. The required minimum amount will be specified as a percentage of the fund’s net assets to be invested in highly liquid, cash-type investments that can be converted to cash within three business days or less. However, in the case of a need for liquidity, these funds do not necessarily need to be the first to be accessed and are more considered a “rainy day” account. A fund may also breach its own minimum requirement, so long as it reports it to the SEC using the form N-LIQUID with the corresponding fund board reporting.

Similar to the 15% guideline that funds were already abiding by, the rule also states that a fund cannot have more than 15% of its NAV invested in illiquid investments. The fund would also have to issue the same N-LIQUID form to notify the SEC. However, the rule states that if a fund’s holdings were to grow above the 15% threshold, it does not have to divest to meet the requirements.

Finally, the rule states that the board of directors of the fund are to serve as an oversight committee when implementing and reviewing the liquidity risk management program. The fund must obtain the board’s written approval of its liquidity risk management program before it can be implemented and submitted to the SEC. The fund would also need the board’s approval to make any material changes to the risk management program as well. The board is also required to receive breach reports, where the fund either broke its highly liquid or illiquid thresholds.


Public Disclosure and Confidential Reporting Requirements


The N-PORT form requires funds to file electronically with the SEC the monthly portfolio investment information. In this report is a breakdown of each fund, categorized into the four levels of liquidity. These submissions will be done monthly and the information will not be available to the public until 60 days after the end of the third month of the fund’s fiscal quarter. However, liquidity information on any fund’s highly liquid investment minimum will be treated as confidential by the SEC.

The N-CEN form is the filing that is required on an annual basis and acts as a census to the fund. The form asks questions like the fund’s line of credits, interfund lending and interfund borrowing, all of which would be relevant to the fund’s overall liquidity position.


Implementation Schedule



The Bottom Line


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