The suspension of redemptions at a Third Avenue Management junk bond fund could give a big boost to the SEC as it works to impose rigorous liquidity-management procedures on mutual funds and ETFs.

News of the freeze at the Third Avenue Focused Credit Fund added to a big sell-off Friday in the already shaky high-yield market.
The SEC proposal, floated in September, would require both mutual funds and ETFs to maintain a certain amount of liquid assets to meet redemptions.
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The agency has grown increasingly concerned about liquidity issues with fixed-income and alternative funds. Assets in bond funds and fixed-income ETFs grew from $1.5 trillion at the end of 2008 to $3.5 trillion at the end of 2014, the SEC rule filing says.
But the fund industry is concerned that the proposed SEC rule could put a crimp in the management of bond funds and other portfolios with relatively illiquid assets, and would add impractical procedures that ultimately wouldn’t be much use in guarding against unpredictable liquidity risks.
The SEC’s proposal would require open-end funds and ETFs (but not money market funds) to establish a liquidity risk-management program to classify and monitor asset liquidity.
One new requirement would establish a minimum amount of assets that must be held in cash and assets that a fund believes are convertible to cash within three business days at a price that does not “materially affect” the value. The SEC also wants to formalize current SEC guidance that limits illiquid holdings (subject to a seven-day liquidity test) to no more than 15% of assets.
The amount of assets meeting the three-day liquidity requirement would be left up to each mutual fund, based on various factors.

“This proposed requirement is aimed at decreasing the likelihood that funds would be unable to meet their redemption obligations and promote effective liquidity risk management,” the SEC said in its rule filing.

The agency is taking comments until January 13, 2016.
Separately, the proposed rule would allow mutual funds to use a “swing pricing” process to adjust NAVs and protect existing shareholders from dilution caused by heavy redemptions or purchases.
Industry sources say fund groups are already looking at ways to beef up credit lines and trading procedures that could bolster liquidity in a panic.
Some observers fear that imposing strict liquidity requirements could hurt many types of funds with relatively illiquid assets.
“Whole swaths of funds could be decimated,” said Dave Nadig, director of exchange-traded funds at FactSet Research Systems. Emerging markets and small-cap funds could also be stressed to meet the requirements in addition to many types of bond funds, he said.
Nadig believes the SEC will have to backtrack from proposing strict requirements in favor of more disclosure about liquidity risks.
An SEC spokesperson declined comment.