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NEW YORK (Reuters) - US investment firms are assessing whether their mutual funds, which help investors to save for college and retirement, are meeting regulations designed to curb risk in the asset management industry.
The Securities and Exchange Commission (SEC) released liquidity rules in October 2016 to improve the information available to mutual fund investors and make sure that firms can convert their investments to cash and meet redemption requests during market volatility.
The regulator specifically criticized leveraged loans, as trades can take six times longer to settle than bonds, which puts the asset in a ‘less liquid’ investment category.
Loan settlement times rose to 18.9 days in the first quarter of 2017, from 17.8 days in the fourth quarter of 2016, according to IHS Markit data. The Loan Syndications & Trading Association recommends seven-day settlement, while bond and stock trades will be completed in two days from September.
Firms are running their funds through simulations to see if they comply, sources said. Third-party service providers are also developing programs to classify investments into four buckets as required by the rule, based on times that it would take to convert holdings to cash without significantly changing their value.
Managers need to ask: “What does the portfolio look like when bucketed; what do you think a reasonably stressed version of your portfolio looks like; what do you think redemption pressures might be?” said Nathan Greene, co-head of the asset management group at law firm Shearman & Sterling.
Firms have also set up internal working groups with members from their compliance, legal, operations and portfolio management teams to assess the rule and develop their strategy, he said.
Mutual funds are preparing for the regulations but are hoping that trade associations will convince the SEC to delay the December 2018 compliance date and release a frequently-asked-questions document to give further clarity.
Funds need more time because new compliance systems are time consuming to build, and their resources are stretched trying to meet multiple regulations at the same time.
Investment Company Institute (ICI) then General Counsel, David Blass, said on March 13 that the SEC should keep an open mind about revisiting some regulations, including the liquidity risk management rule, to “prevent any negative unintended consequences or unnecessary costs.”
“The SEC’s liquidity rule is quite complex, and is proving enormously expensive, time-consuming, and challenging to implement,” according to an ICI statement. “For those reasons, we are exploring with members ways to make the rule more workable and implementation less burdensome.”
An SEC spokesperson declined to comment.
Several third-party service providers and mutual fund administrators are developing software programs that could help with compliance as managers consider their options.
IHS Markit is expanding its existing liquidity services to include a data field for the number of days it will take to liquidate a position, an estimate of the pricing impact and the SEC bucket that the asset would fall into, Dan Huscher, director of fixed-income pricing at the firm, said.
The firm discussed the rule at a roundtable with more than 100 participants in San Francisco on April 28 and plans to have the new information available in the third quarter of this year, he said.
Long settlement times are not curbing investors’ interest in loans. Loan funds experienced 28 straight weeks of inflows through May 24 on the back of rising interest rates, according to Lipper.
“The market has begun to head in the right direction with efforts being made to improve the loan cycle on both the buy- and sell-sides,” said Adrian Marshall, head of the loan portfolio management desk at BlackRock.
BlackRock is also beginning work on the rule’s classification and reporting requirements.
“The market understands what regulators are saying and how to adapt, but more work needs to be done in terms of continuing to improve loan settlement times,” he said.
Reporting by Kristen Haunss; Editing by Tessa Walsh