In medicine, some prescriptions may do more harm than healing. This unintended consequence unfortunately applies to the U.S. Securities and Exchange Commission’s proposed liquidity-risk management rules for open-ended mutual and exchange-traded funds.
Among the Commission’s proposal is a requirement for fund managers to classify each asset by the number of days it would take to convert the position for cash at a price “that does not materially affect the value of the asset immediately prior to sale.” Assets would fall in one of six buckets: two to three business days, four to seven calendar days, eight to 15 calendar days, 16 to 30 calendar days, and greater than 30 calendar days.
Although classifying portfolio assets in this manner would be relatively simple on paper, it likely will have the opposite effect that the Commission originally intended, as has been stated by the largest global asset managers like BlackRock and Vanguard as well as industry group Investment Company Institute.
The proposed rule’s over-prescriptive nature would require asset managers to make forecast on future market conditions on an asset-by-asset basis, which would be a very subjective exercise, according to BlackRock officials. Alternatively, if fund administrators chose not to make these estimates, it would force buy-side firms to rely on third-parting rating-service providers to accomplish the same task with the same pitfalls faced by the fund administrator.
The resulting ratings would be nothing more than a fig leaf that would provide the investment community with a false sense of equivalence between funds that have different investment strategies and different underlying assets.
This is the challenge when regulators take a 'one size fits all' approach to regulation. Not all men look good in a size-44 suit nor women in a size-14 dress.
The SEC needs to go back to its drawing board and hammer out a principle-based approach to liquidity risk management that would allow fund administrators to reach regulatory mandated goals, but in their own fashion.
Liquidity-risk management is not a new concept for the fund industry; in fact, it has more than 70 years of experience with the practice. Almost everyone in the industry agrees that committing such policies to paper is an excellent idea, just do not hamstring fund administrators by forcing them to use a novel and arbitrary method for their risk calculations.