As the Securities and Exchange Commission prepares to establish rules that will ultimately force mutual funds to keep more cash on hand to accommodate investors attempting to quickly withdraw their money, fund companies have been responding with alarm and criticism.
David Chase, a former SEC attorney who now privately practices securities law, says the alarm is understandable, but fund companies and regulators are closer on the issue than they appear.
In September 2015, the SEC proposed rules to address liquidity concerns in mutual funds as several high-yield debt funds struggled to meet redemptions, most notably the Third Avenue Focused Credit fund that collapsed in December as commodity prices declined.
“It’s been an issue for a long time, but like anything when an issue becomes public as liquidity did with the Third Avenue fund, it pushes the issue to the forefront,” Chase says. “The regulators feel pressured to make it a front-burner issue. My personal view is that they’re right, there is an issue as far as the adequacy of liquidity, disclosure and the ability to honor investor redemptions.”
Under the SEC’s plan, fund managers would be responsible for classifying their investments by liquidity, disclosing their ability to meet redemptions and maintaining a cash cushion to cover redemptions of their more illiquid assets according to standards set by the SEC.
Chase, who is based in Fort Lauderdale, Fla., says the new rules have the potential to radically change the way mutual funds operate.
“I could imagine that it would raise some real issues on how some of these highly illiquid mutual funds, these funds that concentrate on alternatives, for example, would continue to do business,” Chase says. “For other funds, it may impact their portfolio composition. Before they would have more flexibility and could hold a larger percent of illiquid securities; that’s likely to change.”
But mutual fund companies are acknowledging that liquidity risk issues need to be studied and better understood, says Chase
“The industry seems to be more inclined to agree that there’s an issue, but disagree with how the SEC should go about addressing it,” Chase says. “The fund companies want flexibility; they’re arguing that it isn’t easy to classify some investments according to their liquidity.”
As a result, many fund companies are taking a soft approach to battling the rule. In comments to the SEC, Fidelity Trustee Marie Knowles argued that the SEC is blowing the issue out of proportion.