Controversy as buy side forces U-turn on US liquidity rule

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By Jonathan Weitzmann.

The liquidity risk management financial rule (Rule 22e-4) was approved on 28 June 2018 by US regulator the Securities and Exchange Commission (SEC) amid controversy over lobbying and a potential rollback of the newly adopted rule itself.

The rule, originally proposed in late 2015, requires that mutual and exchange-traded funds disclose the liquidity of assets in their portfolios to investors. The intention is to empower investor understanding by holding funds accountable for their management practices, and ultimately enhance transparency, towards investors themselves and the SEC.

However the very structured disclosure model the rule used, along with quarterly reporting, was heavily criticised by investment managers. Having agreed a final rule in 2016, the SEC went on to re-propose the rule on 14 March 2018, which raised hackles within the Commission itself.

“A bare majority of the Commission recently took the unusual step of re-proposing a unanimously adopted, already-final rule that would have given investors critical information about the liquidity of the mutual funds they own,” said SEC Commissioner Robert Jackson, in his 28 June statement on the adoption. “What’s more, between the proposed and final stages the rule has taken a troubling turn. Not content to keep investors in the dark, the majority today calls for comment on whether we should abolish the entire liquidity classification regime itself.”

Commissioner Kara Stein also objected in her statement, saying, “As I consider this rollback of public disclosure, I have to ask: why now? Shouldn’t we first see how the disclosures, and more broadly the full liquidity risk management paradigm, which the Commission unanimously voted for just a short while ago, are used by investors, and then assess their impact? At a minimum, shouldn’t the Commission at least assess the liquidity information it receives non-publicly first, before deciding on whether to remove the public disclosure?”

SEC Commissioner Michael Piwowar said in his statement regarding adoption that the original Rule 22e-4 was over-simplistic and misleading, with public disclosure not having the intended benefit of helping investors make better investment decisions. His stated preference is revision as opposed to amendment, commenting that Rule 22-e4 is “More costly and complex than we anticipated.”

Many buy-side firms objected to the rule, arguing that disclosure would confuse investors, not help them, while increasing cost and complexity.

A letter written by Marc Bryant, chief legal officer for Fidelity Investments recommended replacing Rule 22e-4’s form (N-Port) – which requires public disclosure on a quarterly basis – with a more narrative stance that will require funds to briefly describe in their annual report the operation and effectiveness of their liquidity risk management programme, along with rescinding the publication of liquidity data.

“Public disclosure of aggregate liquidity classification information, without sufficient context, would not meaningfully or accurately portray a fund’s liquidity risk to investors and could lead to imprudent investor behaviour,” he wrote.

Gregory Davis, chief investment officer for Vanguard wrote in his comment letter, “The {SEC] should reassess the liquidity classification requirements of Rule 22e-4 because the holdings level assessment is misleading and expensive; the Commission avoids releasing misleading data to investors by eliminating the public disclosure of aggregate liquidity classification information; a proportionate liquidity risk narrative in the annual shareholder report promotes investor understanding of fund liquidity risks.”

Yet despite concerns over lobbying and the changes themselves, Jackson was positive about the speed at which the SEC worked in dealing with comments and putting rules in place,

“I hope and expect that we will proceed with finalising the required Dodd-Frank rules with as much alacrity as we did with this one,” he said. “The law requires no less.”

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