SEC Replaces Requirement To Disclose Liquidity Buckets With Requirement To Disclose Effectiveness Of Liquidity Risk Management Program

Author:Mr Jay Baris, Andrew (Buddy) J. Donohue, Nathan J. Greene, Paul S. Schreiber, Thomas M. Majewski and Matthew Kutner
Profession:Shearman & Sterling LLP

In a split vote on June 28, 2018, the Securities and Exchange Commission adopted a new rule to require certain open-end investment companies to disclose in their annual or semi-annual shareholder reports information about the operation and effectiveness of their liquidity risk management program. The new rule replaces a requirement for funds to disclose a snapshot of the fund's historic aggregate liquidity classification data on Form N-PORT.

The SEC also amended Form N-PORT to give funds more flexibility in reporting liquidity classifications. The amendments will allow funds to split their portfolio holdings into more than one "bucket" when split reporting more accurately reflects the liquidity of the investment or eases cost burdens. Finally, the SEC amended Form N-PORT to require funds to disclose holdings of cash and cash equivalents that are not reported elsewhere.

Disclosure of Liquidity Information

Rule 22e-4 requires open-end funds (other than money market funds and "in-kind" exchange-traded funds) to classify portfolio investments into one of four "buckets" and report those classifications on Form N-PORT. (Funds were required to report the aggregate percentage of investments in each bucket, although investment-level buckets remained non-public.) In eliminating this reporting requirement, the SEC acknowledged that the quarterly public disclosure of the liquidity information may sometimes mislead investors and lack objectivity. The Form N-PORT disclosure, it said, did not provide investors with necessary context about the liquidity risk, methodologies and assumptions used to conduct liquidity classification. In short, the SEC said that shareholder report and prospectus disclosure of liquidity risks will better serve the purpose of tailoring information necessary for particular liquidity risks and management practices of the specific fund.

In place of the bucket reporting requirement, the SEC now requires funds to briefly discuss the operation and effectiveness of their liquidity risk management program in a new section of the fund's report to shareholders (annual or semi-annual). The disclosure is intended to complement the existing liquidity risk disclosure in prospectus and the fund's discussion of the factors that materially affected performance in the MDFP section of the shareholders report. Notably, the SEC refused to exempt highly liquid funds and in-kind ETFs from the requirement to include this new narrative disclosure, noting...

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