Many exchange-traded funds will avoid some aspects of sweeping new U.S. regulations meant to ensure that asset managers can easily meet investors' redemption demands.
The Securities and Exchange Commission had originally lumped ETFs in with mutual funds last year when proposing the rules, which try to make sure that firms can more easily sell assets to meet demands from investors who want to cash out during market downturns. ETF providers had pushed back on the inclusion, with BlackRock Inc., the world's largest asset manager, arguing that the structure of many
ETFs makes them more liquid than mutual funds. Vanguard Group is also one of the biggest providers of ETFs.
Under the revised rules that SEC commissioners unanimously
approved on Thursday, ETFs that redeem in-kind, or provide securities rather than cash as redemptions, and provide daily portfolio information are exempt from certain new requirements for mutual funds, including classifying the liquidity of investments and maintaining a set amount of highly liquid reserves. The ETFs will face liquidity risk management requirements however that are specifically tailored to their structure, according to the SEC.
The new SEC regulations follow warnings from the Federal Reserve and International Monetary Fund that some funds with riskier holdings could struggle to return cash to investors during a surge in redemption demands. Pressure on regulators mounted after a $788 million credit fund managed by Third Avenue Management halted redemptions in December and spurred a selloff in the high-yield market.
“It is imperative that open-end funds manage their liquidity carefully, both to ensure that redemptions can be fulfilled in a timely manner and to minimize the impact of redemptions on remaining investors,” SEC Chair Mary Jo White said. “The recommendation before us today includes all of the essential elements of the proposal, centered on a requirement for funds to establish a liquidity risk management program overseen by the fund's board of directors.”
The SEC will require mutual funds to “assess, manage, and periodically review their
liquidity risk, based on specified factors.” Specifically, funds will have to classify each investment in their portfolios based on how many days asset managers believe they would need to convert them to cash. The SEC outlined four classifications, ranging from “highly liquid” to “illiquid.”
Funds will also have to determine a minimum percentage of their net assets that must be invested in highly liquid investments, and face limits on the illiquid investments they can hold. Most funds will have to comply with the risk management rules by Dec. 1, 2018.
The agency also voted 2-1 to allow open-ended funds, not money market funds or ETFs, to use swing pricing, effectively letting asset managers pass on trading costs to investors who redeem. The change permits funds to cash out investors at less favorable pricing during periods of market stress, potentially slowing withdrawals. The SEC says the mechanism aims to keep fund shareholders from being diluted by purchases and redemptions.
The fast-growing ETF market has attracted about $162 billion in investor cash this year, according to data compiled by Bloomberg. ETFs are funds that trade on an exchange, like stocks, and tend to have lower fees than traditional actively managed mutual funds since they just track indexes.
