Investors and fund companies should brace themselves for a blizzard of new mutual-fund rules.
The Securities and Exchange Commission is increasing its watch over the $60 trillion money-management business. Previewed by SEC Chairman Mary Jo White in December, the series of moves is similar to what happened to banks after the 2008 crisis.
What does it all mean? More costs for fund companies, warn some analysts. There might even be required “stress tests” for funds, like the banks undergo. But in theory, it’s more protection for investors. Here’s a guide.
What has happened so far? The first rules, proposed in May, would make fund firms give up more data on their holdings, such as potentially risky derivatives products. Then last month came proposals requiring funds to prove they can handle the roof caving in. The funds would have to set up programs to classify “liquidity risks” for each of their trading positions. ETFs and exchange-traded managed funds, the hybrids that have been approved by the SEC but not yet launched, will also have to do it, but not money-market funds.
What spurred this? Politicians, policy makers and industry participants questioned if funds are vulnerable to stresses that could destabilize the financial system. Funds are using more-complex strategies, focusing on asset classes that might take time to sell.
How would the proposed programs manage funds’ liquidity risks? It gets pretty specific. For example, funds would be required to classify the liquidity of each of their holdings into one of six liquidity categories. The categories would indicate the number of days in which a holding or a portion of a holding could be sold at a price that wouldn’t move the asset’s price in the market. Funds would also be prohibited from acquiring any asset that couldn’t be sold within seven calendar days if it would mean that such assets would account for more than 15% of their net assets.
Funds would be required to invest a minimum percentage of their net assets in positions that could be converted to cash in three business days.
Funds with illiquid assets will incur more rules-compliance costs. And the downside of carrying more “liquid” assets is that they could be easier to trade but produce weaker investment results, Moody’s Investors Service warned.
Do fairer costs result? Ideally. The rules permit mutual funds, except money funds and ETFs, to voluntarily use European-style “swing pricing.” That adjusts the net asset value of a fund’s shares to pass on more trading costs to the shareholders responsible for that activity. The flexible pricing would be good for some fund companies and the funds’ long-term performance, Moody’s says.
How have the funds reacted? The Investment Company Institute trade group has said it supports the SEC on addressing risks. After the new proposal, however, it pointedly noted that mutual funds have successfully done this “for 75 years.”
Dave Nadig, director of ETF research at FactSet, says it will be complex for some funds to meet the seven-day liquidity test. “Folks in the ETF industry are shaking their heads trying to figure out how they’re going to stay in the junk-bond ETF business if these proposals are put in place without modification,” he says. Interestingly, small funds might be better off, since they have smaller positions to sell.
What other regulatory changes might affect the asset-management business? Aside from annual stress tests, the SEC might require asset-management firms to detail how they could be dismantled in a crisis.
How will the rules proceed from here? Here is a link to the most recent 415-page proposed rule at sec.gov. Investors can weigh in with comments. Regulators have also reopened the comment period for new forms it has proposed; here is that link on thewebsite.
Ms. Maxey is a reporter for The Wall Street Journal in New York. Email her firstname.lastname@example.org.