The Securities and Exchange Commission (SEC) voted to adopt new rules governing mutual funds and exchange-traded funds (ETFs). Funds will have to comply with tighter restrictions on ownership of securities that are difficult to sell. Mutual funds will be able to implement swing pricing mechanisms to prevent large purchases or large redemptions from hurting other shareholders. A modernization rule implements new reporting rule requirements, but excludes a draft provision that would have allowed fund companies to provide shareholder reports via the internet instead of by postal mail.

The liquidity rule requires funds to periodically assess their ability to meet requests for share redemptions without harming the remaining shareholders. In doing so, fund companies will have to classify the investments held within their portfolios as being either highly liquid, moderately liquid, less liquid and illiquid.

Funds will determine the minimum percentage of assets that must be in highly liquid investments, meaning cash or convertible to cash within three business days without the sell transactions significantly changing the value of the investment. A cap of 15% of net assets will be placed on illiquid investments, which are those that cannot easily be sold at prevailing prices within seven days. Most funds will have to comply by December 1, 2018.

Money market funds are exempt from the rule’s liquidity requirements. In-kind ETFs, those that use only a minor amount of cash when creating or redeeming shares, will be exempt from certain requirements. Dave Nadig of Factset says that ETFs that invest in less liquid securities, such as high-yield debt or bank loans, will have to consider how aggressively they want to categorize portfolio holdings. He also believes that the liquidity rule could impact large funds due to the size of their portfolio positions.

Mutual funds (but not ETFs) will be able to adjust share prices by as much as 2% once the level of net purchases or redemptions exceeds a specified swing threshold. The swing pricing rule will become effective 24 months after publication in the Federal Register.

Source: “SEC Adopts Rules to Modernize Information Reported by Funds, Require Liquidity Risk Management Programs, and Permit Swing Pricing,” Securities and Exchange Commission, October 13, 2016; “A Deep Dive on New ETF Liquidity Rules,” Dave Nadig, Factset, October 14, 2016.