A proposal by the Securities and Exchange Commission to alter the way open-end funds operate could have a detrimental impact on retirement savers if implemented.
Among other things, under this requirement, an order to purchase or redeem a fund’s shares would be executed at the current day’s price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order BEFORE the pricing time as of which the fund calculates its net asset value (NAV). That would be a significant change from current practices that permit that receipt by a qualifying intermediary—like a recordkeeper. Little wonder that the Investment Company Institute (ICI) cautioned that the “SEC’s proposed 'hard close' …is likely to make it impossible for 401(k) plans to place trade orders for their participants.” Well, certainly not at the market close timing currently employed by most.
According to the SEC, the rule and form amendments would:
- enhance how open-end funds—other than money market funds (MMFs) and certain ETFs—classify the liquidity of their investments and require a minimum amount of highly liquid assets of at least 10% of net assets; and
- provide for more detailed public reporting of fund information, including information about funds’ liquidity and use of swing pricing.
Why This, Why Now?
If you’re wondering what problem the SEC is attempting to solve with this proposal, the SEC points to March 2020, noting that in connection with the economic shock from the onset of the COVID-19 pandemic, U.S. open-end funds faced a significant volume of investor redemptions. As investors sought to redeem fund investments to free up cash during a time of market uncertainty, open-end funds faced significant redemptions and liquidity concerns, the SEC maintains.
The ICI, however, notes that it presented extensive research regarding the experiences of funds during March 2020, showing that there is strong evidence that funds did not amplify problems in the financial markets during that period.
“The proposal to mandate swing price is unnecessary. Its rationale is built on minimizing dilution—yet the SEC’s assertions lack detail or supporting evidence,” ICI President and CEO Eric Pan said in a statement. “The swing pricing proposal faces insurmountable operational hurdles, risks confusing investors, and upending mutual funds’ longstanding and equitable share pricing methodology.”
The Proposal
Under the proposal, an open-end fund, other than an MMF or ETF, would be required to adjust its net asset value (NAV) so that the transaction price effectively passes on costs stemming from inflows or outflows to the investors engaged in that activity, rather than diluting other shareholders.
The proposal would require funds to adopt policies and procedures to adjust a fund’s NAV per share by a swing factor when the fund experiences net redemptions or when net purchases exceed a threshold. The swing factor would reflect bid-ask spread and certain other costs of selling or purchasing a vertical slice of the fund’s portfolio. It would also include an estimate of market impact costs when net redemptions or net purchases exceed a threshold.
Further, the proposal would require a “hard close” for these funds. An investor’s order to purchase or redeem a fund’s shares would be eligible for a given day’s price only if the fund, its transfer agent, or a registered clearing agency receives the order before the time as of which the fund calculates its NAV, typically 4 p.m. ET.
Cascading Consequences
In a statement opposing the release, SEC Commissioner Hester Peirce likens the proposal to more of a Greek tragedy than a regulatory initiative.
Peirce explains that swing pricing is dependent upon the fund or one of its service providers—such as a transfer agent or a registered clearing agency—receiving order flow information prior to the establishment of that day’s share price to allow the fund to determine whether to implement the swing factor, and if so, how large it should be. Yet, a fund might not receive the order flow information until as late as the next morning. The proposal, however, specifies that “[i]ntermediaries would need to reengineer their systems to ensure disseminated order information reaches the transfer agent or Fund/SERV before 4 p.m.”
Such a hard close, Peirce emphasizes, would have “cascading consequences,” as some intermediaries likely would set their own internal cut-off times—including adopting a blanket policy of processing orders at the next day’s price.
The proposal even admits that retirement plan recordkeepers could have a particularly rough transition, Peirce notes. In fact, the proposal acknowledges that retirement plan recordkeepers would need to substantially update or alter their processes and systems to accommodate the proposed hard close requirement to submit orders more quickly.
“It would not just be fund administrators and intermediaries who would have to alter their current practices and expectations, investors interested in securing same-day pricing would have to adjust too, but the Commission thinks it’s worth it,” the SEC Commissioner states, in arguing against the proposal.
Comments Requested
At this point, the proposal is just that—and the SEC is asking for comments on the proposed amendments, including whether the Commission should require funds to implement the proposed hard close requirement and whether there are alternatives to the proposed hard close requirement that should be implemented.
Moreover, the SEC also asks whether its efforts to modernize fund order processing are supported by the proposed hard close requirement; what steps would intermediaries be required to take to operationalize the proposed hard close requirement; and whether there are any operational impediments for intermediaries, transfer agents, and/or registered clearing agencies in implementing the proposed hard close requirement.
To that end, the SEC also seeks comments on whether retirement plan providers would need to make changes to plan rules in order to accommodate compliance with a hard close. “Are plan rules able to be altered for plans that are currently owned, or would alterations only be feasible on a going forward basis? If a change in plan rules would be necessary, how would plan rules need to be altered? How would plan participants be affected by changes to plan rules?,” the SEC asks.
Among the many other questions the SEC asks is whether the proposed hard close requirement would help retirement plan recordkeepers to reduce their batch processing cycles and, if so, how.
A comment period will remain open for 60 days after publication in the Federal Register.
