Citi 2018 FinReg Outlook

US asset managers will need to implement and maintain comprehensive swing pricing policies. This will include determining when to swing a price, the methodology used, and how frequently the policy should be reviewed. Given that swing pricing is a new concept in the US, there could be a considerable learning curve for a fund‘s Treasury group and Board of Directors. period of time. The SEC is also making changes to Forms N-PORT, N-CEN, and N-1A, which require disclosure information regarding portfolio holdings’ liquidity, and various aspects of a fund’s liquidity risk management program. LIQUIDITY CLASSIFICATION CONCERNS Of all the elements in the new rules, the liquidity classification requirements have drawn the most criticism from the industry. The rule requires each security in a mutual fund portfolio be bucketed into one of four liquidity categories, ranging from Highly Liquid to Illiquid, based on how quickly the holdings could be reasonably expected to be liquidated, without taking a significant haircut on price. Highly Liquid – Cash and 3 days or less Moderately Liquid – 4-7 days Less Liquid – 7 days or less Illiquid – Over 7 days The industry’s concern with the liquidity classification is twofold. First, it is seen as overly prescriptive and that it will lead to a tremendous increase in workload and cost. Second, the industry is worried it will not be able to meet the 1 December deadline. Many, if not most, funds will rely on outside vendors to provide these classifications, and many industry participants do not think the vendors will be ready in time. As a result, the Investment Company Institute (ICI), the US industry association, has been leading the charge to convince the SEC to reconsider the liquidity classification requirements. The ICI has asked for amendments to the rule to permit each fund to formulate its own policies for determining how to classify the liquidity of its investments. Additionally, the ICI has asked for a one-year extension to 1 December 2019 for implementation of the categorization requirement. ONLY TIME WILL TELL So far, the SEC has not indicated whether it is willing to reconsider the rules or change the compliance date. As a result, funds continue to set their implementation project schedules assuming the rules will go live this December. Implementation will continue to consume large amounts of the mutual fund industry’s time and energy this year. This involves creating a written liquidity risk management program. Within that program, there must be a process to determine liquidity levels for each security held in each portfolio. Vendors for this purpose must be vetted and contracted. Interfaces between those vendors and fund accounting systems may need to be built to exchange information. In addition, liquidity information must be mapped and fed to fund administration teams, which are responsible for filing regulatory reports. These are just a few of the tasks that must be completed by fund groups prior to the posted compliance dates. Time will tell if all this effort truly pays dividends in the form of reducing redemption and dilution- related risks. SWING PRICING CHALLENGES The SEC’s liquidity rules introduce the concept of swing pricing into US mutual funds. A common feature in European funds, swing pricing allows managers to mitigate the impact of large shareholder activity on existing investors in a fund. This done by adjusting, or “swinging”, the price of a fund to account for large shareholder movement in or out of a fund. By adjusting the fund’s price, the cost of securities trading associated with the shareholder activity is not borne by the existing investors in the funds. Before swing pricing can be adopted by US funds, there are a couple of key challenges that must be overcome. None of these challenges are insurmountable. However, they will require some heavy lifting by the industry to overcome them. Unlike the rest of the liquidity rules, swing pricing is optional. So, there is no looming implementation deadline. Given the work required for the mandatory elements of the liquidity rules, it is likely that swing pricing will take a back seat for the time being. Nonetheless, swing pricing may offer real benefits to funds and investors. After the liquidity rules are bedded down asset managers, in particular those who have European funds, may then turn their attention to swing pricing. In the US, shareholder orders must be place by 1600 EST/EDT, which coincides with the valuation point of the funds. This does not leave a lot of time for groups to aggregate data and apply a swing factor before prices are published, typically at 18:05 EST/EDT. Beyond the timing issue, there are also challenges with the workflow and the potential for incomplete deal information. Finally, US shareholder activity tends to be a high volume of smaller trades, which adds to the challenge of administrating swing pricing within the tight dealing. Oversight Logistical Citi Custody & Fund Services – FinReg Outlook 2018 21 20