The staff of the Division of Investment Management (Staff) of the U.S. Securities and Exchange Commission has issued guidance in the form of frequently asked questions (FAQs or guidance) related to the SEC’s investment company liquidity risk management rule adopted in October 2016. As discussed in our October 2016 memorandum, the SEC adopted new Rule 22e-4 (Rule) under the Investment Company Act of 1940, as amended,1 which requires each registered open-end management investment company, including mutual funds and exchange-traded funds (ETFs) but excluding money market funds, to adopt and implement a written liquidity risk management (LRM) program reasonably designed to assess and manage the fund’s liquidity risk.
The FAQs specifically address questions on LRM program requirements regarding administration and investment classification by sub-advised funds and the de minimis cash redemption exception for in-kind ETFs.2 The FAQs also contain information regarding LRM programs for entities that are not sub-advised funds (or their advisers or sub-advisers) or in-kind ETFs.
The guidance notes, among other things, that an adviser does not have an independent obligation to adopt and implement an LRM program, and that the Rule requires funds – not advisers – to adopt and implement LRM programs. While funds have ultimate responsibility for compliance with the Rule, the guidance underscores that the Rule and the Adopting Release contemplate a role for advisers and their personnel in handling responsibilities under funds’ LRM programs (e.g., administering a fund’s LRM program or, in certain circumstances, handling specific LRM program responsibilities delegated by the LRM program administrator).
The guidance also notes that the Staff recognizes that an adviser may provide advisory services to multiple funds, and that the Adopting Release acknowledges the need for each fund’s LRM program to be appropriately tailored to that fund’s risks and circumstances. Accordingly, the guidance indicates that an adviser of more than one fund may have responsibilities under various funds’ respective LRM programs, each of which may differ from another, including multiple programs for funds within the same fund complex. In such circumstances, the Staff believes that such an adviser would not be obligated to reconcile (i) the varying elements of the funds’ LRM programs; (ii) the programs’ underlying methodologies, assumptions, or practices; or (iii) the program outputs (e.g., liquidity classifications of fund investments).
The guidance also references the statement in the Adopting Release that funds (even those in the same fund complex) may classify the liquidity of similar investments differently based on the facts and circumstances pertaining to each fund, and appropriately arrive at different classifications for the same investment. In this regard, funds could use varying methodologies and assumptions with respect to relevant market, trading, and investment-specific considerations, as well as market depth and reasonably anticipated trade size, and thereby appropriately arrive at different classifications for the same instrument.3
If you have any questions regarding the matters covered in this memorandum, please contact one of the attorneys listed below.
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1 See Investment Company Liquidity Risk Management Programs, Investment Company Act Release No. 32315 (Oct. 13, 2016) (Adopting Release).
2 ETFs that qualify as “in-kind ETFs” are excluded from certain requirements of the Rule.
3 Under the Rule, a fund must take into account “relevant market, trading, and investment-specific considerations” in classifying its portfolio investments’ liquidity, as well as the investments’ market depth, based on trades of the size that a fund would “reasonably anticipate trading.”
