(Article from Registered Funds Regulatory Update, October 2024)
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The SEC recently adopted amendments to reporting requirements on Forms N-PORT and N-CEN to provide the SEC and investors with more timely information, and provided guidance on open-end fund liquidity risk management program requirements. Notably, after receiving significant industry opposition to its “swing pricing” and “hard close” proposals, the SEC chose not to adopt them.
SEC Declines to Adopt Swing Pricing and Hard Close Proposals
The SEC declined to adopt proposals relating to mandatory use of swing pricing and a hard close time for transacting in fund shares for all open-end funds other than money market funds and exchange-traded funds, as well as amendments that would have made changes to the so-called “Liquidity Rule’s” (Rule 22e-4 under the Investment Company Act) liquidity classification framework. As such, funds will not be required to report swing-pricing related information on Form N-PORT or comply with the proposed changes to liquidity classifications. The SEC also declined to adopt proposed amendments that would have required funds to include their complete portfolio holdings presented in accordance with Regulation S-X with respect to each month’s reporting period. Given the SEC’s regulatory agenda and the fact that liquidity risk management is a stated priority of the SEC’s Division of Enforcement in 2024, it is important to note that certain of the proposed amendments could be reproposed next year.
Forms N-PORT and N-CEN Amendments
The adopted amendments to Form N-PORT increase both the frequency with which portfolio holdings information must be filed with the SEC (from quarterly to monthly within 30 days of the end of each month) and the public availability of such information (to be made publicly available 60 days after the end of the applicable month or, put another way, 30 days after the filing deadline). Where previously the information for the first two months of each quarter remained confidential, under the amendments each monthly report will be made public 60 days after the end of the applicable month. Because these reports will now be publicly available on a monthly instead of quarterly basis, information about fund returns and flows (including net change in unrealized appreciation or depreciation and net realized gain or loss) will only be required for the month to which the report pertains. Items that are non-public under the current regime, including individual portfolio investment liquidity classifications, will remain nonpublic in individual reports under the amendments.
While some commenters pushed back on publicizing Form N-PORT information on a monthly basis, arguing that to do so would overburden funds and service providers and could increase the risk of predatory trading (e.g., front running) by others in the market, harming funds and their shareholders, the SEC pointed to a number of mitigating factors for such concerns, such as the monthly N-PORT disclosure regime aligning with many funds’ existing practice of disclosing portfolio holdings on a monthly basis. The SEC also noted that, each month, funds will be allowed to publicly report an aggregate amount of holdings (e.g., securities that are purchased by a fund while building a position that has not previously been publicly disclosed) as “miscellaneous securities” on a non-public basis, with more detailed information about the individual holdings to be provided on a non-public basis to the SEC, provided that such holdings do not exceed five percent of a fund and have not previously been disclosed to the public.
The amendments to Form N-CEN will require open-end funds, closed-end funds, and unit investment trusts that use liquidity service providers to include more information about such service providers to enable the SEC and other industry participants to track certain liquidity risk management programs and requirements.
The amendments to Forms N-PORT and N-CEN will become effective on November 17, 2025. Funds will generally be required to comply with the amendments for reports filed on or after that date, except that fund groups with net assets of less than $1 billion will have until May 18, 2026 to comply with the Form N-PORT amendments.
The SEC Provides Guidance on Mutual Fund Liquidity Risk Management Requirements
While the SEC did not adopt the proposed amendments to the Liquidity Rule, the SEC did provide guidance on liquidity risk management requirements. The SEC’s guidance to funds subject to the Liquidity Rule, informed by its outreach in connection with recent market stress events, including the onset of the COVID-19 pandemic, clarifies three key areas of liquidity risk management without introducing new requirements: (i) the frequency of classification; (ii) the meaning of “cash;” and (iii) highly liquid investment minimums.
Under the current Liquidity Rule, funds are required to review liquidity classifications more often than monthly if intramonth changes to relevant market, trading, and investment-specific considerations are reasonably expected to materially affect one or more of its investment classifications. Funds must also adopt and implement policies and procedures reasonably designed to ensure the funds are able to conduct an intramonth review if such changes in conditions have occurred. When considering intramonth changes in investment-specific considerations, the SEC noted that funds generally should consider reviewing liquidity classifications on an intramonth basis if (x) portfolio composition changes, such as a substantial decrease or increase in the size of a position, or (y) the acquisition of a particular investment could reasonably be expected to materially affect one or more investment classifications or the liquidity profile of a fund, respectively.
The Liquidity Rule requires a fund to determine whether an investment can be classified as highly liquid or moderately liquid, which determination requires consideration of the amount of time reasonably expected for such investment to be “convertible to cash” (e.g., sold and settled) without significantly changing the market value of the investment. The SEC clarified in its recent guidance that, for purposes of determining the proper investment classification, “cash” means U.S. dollars only, not foreign currencies or cash equivalents and that non-U.S. currencies should be classified based on conversion time to U.S. dollars. Funds must consider currency conversion time when classifying international investments, and if a fund does not reasonably expect to be able to convert a foreign currency into U.S. dollars within seven calendar days, then the foreign currency should be classified as an illiquid investment.
Finally, the SEC reiterated previous guidance relating to highly liquid investment minimums, particularly for funds with portfolios on the lower end of the liquidity spectrum. The SEC advised that funds with less liquid or illiquid investments or greater volatility of flows should consider higher minimums than their more liquid peers or those whose strategies tend to cause less flow volatility. While credit lines or similar financing arrangements can be considered for purposes of a fund’s highly liquid investment minimum, portfolio construction should be the primary method of liquidity risk management. Notably, the highly liquid investment minimum requirement does not impose a requirement to continuously maintain a specific level of highly liquid assets. If a fund drops below its minimum, the Liquidity Rule requires board notification of the shortfall and, if the shortfall continues for more than seven consecutive calendar days, confidential SEC reporting on Form N-RN within one business day, but does not prevent the fund from using such highly liquid assets for redemptions.
Form N-PORT and Form N-CEN Reporting; Guidance on Open-End Fund Liquidity Risk Management Programs, Release No. IC-35308 (Aug. 28, 2024), available at: https://www.sec.gov/files/rules/final/2024/ic-35308.pdf.