Citi 2018 FinReg Outlook

Preparing for US Liquidity Rules The SEC’s liquidity rules come into force in December. Are you ready? In December, the US mutual fund industry will start operating under a new liquidity risk management framework. The Securities and Exchange Commission (SEC) introduced the rules out of concern the old liquidity guidance had not kept pace with mutual fund practices, which could lead to a fund’s inability to meet redemptions and dilution of the interests of shareholders who remain in the fund. This concern was crystallized by the collapse of Third Avenue’s Focused Credit Fund in late 2015. The fund held a large number of illiquid securities and, when faced with large scale redemptions, could not keep pace. As a result, the fund abruptly closed to redemptions, and shortly after announced it was liquidating. The new SEC liquidity rules are designed to reduce the chances of mutual funds facing a similar liquidity crisis in the future. LIQUIDITY RISK MANAGEMENT PROGRAMS ARE REQUIRED The new rules require all registered mutual funds, except money market funds, to create a liquidity risk management program. The program must be approved by the fund’s board of directors, and its effectiveness reviewed annually. These programs are required to be reasonably designed to mitigate the risks associated with meeting redemptions and the potential dilution of the value of mutual fund shares. Each liquidity risk management program must include an assessment and periodic review of the fund’s liquidity risk, including classifying the liquidity of the fund’s portfolio investments. The program must also determine a highly liquid investment minimum, which is the percentage of its net assets that the fund invests in highly- liquid investments. Funds must adopt procedures for responding to a shortfall of their highly-liquid investments below that minimum, including reporting to the fund’s board of directors no later than its next regularly scheduled meeting. The new liquidly rules retain the requirement that a fund’s investment in illiquid investments not exceed 15% of its net assets. However, the rules add reporting requirements, such that if a fund holds more than 15% of its net assets in illiquid investments, it must report that information to the fund’s board of directors within one business day. If the amount of the fund’s illiquid investments is still above 15% of net assets 30 days from the initial occurrence, the fund board must assess whether the plan previously presented to it continues to be in the fund’s best interest. Additional changes to reporting requirements under the new rules include Form N-LIQUID, which requires a fund to confidentially notify the SEC when its level of illiquid investments exceeds 15% of its net assets, or when its highly- liquid investments fall below its self- determined minimum for a specified ROGER PRIES JR. Vice President, NAM Custody and Fund Services Americas Citi Custody & Fund Services – FinReg Outlook 2018 19 18