SEC Issues Guidance on Fund Liquidity Risk Management Programs and Amends Forms N-PORT and N-CEN

On August 28, 2024, the SEC published a release (the “Release”) containing guidance based on the SEC staff’s monitoring of funds’ liquidity classifications and liquidity risk management programs mandated by Rule 22e-4 under the 1940 Act (the “Guidance”). The Guidance covers issues concerning:

• How frequently a fund should review the liquidity classifications of its investments;
• The meaning of the term “cash” under Rule 22e-4, which excludes foreign currencies, and the implications of this exclusion; and
• Relevant considerations when determining a fund’s highly liquid investment minimum (“HLIM”).

The Release also adopts amendments to Forms N-PORT and N-CEN (the “Amendments”) that are consistent with the amendments proposed in the SEC’s now-postponed 2022 proposals to overhaul open-end fund liquidity risk management programs and to implement mandatory swing pricing for all open-end funds, except money market funds (the “2022 Release”).¹

The Guidance and the Amendments are discussed in detail below.

I. The Guidance

The Release states that, while the SEC “is not adopting amendments to the liquidity rule at this time,” the Guidance for funds subject to Rule 22e-4 is intended to address questions regarding (i) “the frequency of classifying the liquidity of fund investments,” (ii) “the meaning of ‘cash’ in the rule,” and (iii) “determining and reviewing [HLIMs].”

Frequency of Classifications. The Guidance underscores that Rule 22e-4 already requires funds to review the liquidity classifications of their investments more frequently than monthly if changes in relevant market, trading, and investment-specific considerations are reasonably expected to materially affect one or more of the fund’s investment classifications. Rule 22e-4 additionally requires funds to adopt and implement reasonably designed policies and procedures to enable funds to conduct the required intra-month liquidity classification reviews when warranted by changed market conditions or other developments.

Citing Rule 22e-4’s adopting release,² the Guidance notes that the SEC has already provided examples of changes in market, trading, and investment-specific considerations that funds may wish to consider. In addition to those prior examples concerning the requirement to consider intra-month changes in investment-specific considerations, the Guidance states that “funds generally should consider reviewing liquidity classifications if changes in portfolio composition are reasonably expected to materially affect one or more investment classifications.” As examples, the Guidance observes that:

• A fund that substantially increases the size of its holdings of a particular investment “may reasonably anticipate trading a larger size of that investment, which could materially and adversely affect the liquidity classification of that investment” if a thinner market for larger trade sizes “makes it difficult to sell the investment within a particular time frame without the sale causing a significant change in market value;” and
• In general, funds should consider classifying newly acquired investments on an intra-month basis if an acquisition is “reasonably expected to result in material changes to the liquidity profile of a fund,” especially when changes to a fund’s liquidity profile may “cause a shortfall below a fund’s [HLIM] or cause the fund to exceed the rule’s limit on illiquid investments.”

Meaning of the Term “Cash”. To determine whether an investment can be classified as highly liquid or moderately liquid, Rule 22e-4 provides that a fund must consider the time that it reasonably expects an investment to be “convertible to cash” (i.e., sold and settled) without significantly changing the market value of the investment. In the SEC’s 2016 Investment Company Liquidity Risk Management Programs release, the SEC stated that the term “cash” in Rule 22e-4 means U.S. dollars and excludes foreign currencies or cash equivalents.

Accordingly, the Guidance states that a fund needs to contemplate conversion to U.S. dollars in connection with classifying an investment, and non-U.S. dollar currencies are themselves investments that must be classified based upon the time required to convert the currency in question to U.S. dollars. The Guidance cites two examples of scenarios where the SEC staff has observed practices that are inconsistent with these requirements:

• International funds that have been using the time in which an investment would be convertible to a non-U.S. dollar currency as the relevant period for determining when an investment is convertible to cash; and
• Funds classifying any currency as a highly liquid investment, regardless of the amount of time it would take to convert that currency to U.S. dollars.

The Guidance additionally states that when considering the time needed to convert a non-U.S. dollar currency, a fund should consider the amount of time it is reasonably expected to take to convert a reasonably anticipated trade size of the currency into U.S. dollars under current market conditions without significantly changing the currency exchange rate. Among other factors to consider are the existence of currency controls, the presence of an active market in forward or spot contracts for converting the currency into U.S. dollars, and any delays in currency conversions caused by market structure or operations.

The Guidance notes that funds should not base liquidity determinations on the ability to sell, dispose of, or settle an investment into the local currency without also considering the ability to convert the local currency into U.S. dollars for purposes of meeting shareholder redemption requests. That is, when considering the time in which an international, non-currency investment would be convertible to U.S. dollars, funds should consider reasonable expectations of the periods of time in which an international (i) non-currency investment can be sold and settled in the local market without significantly changing the market value of the investment and (ii) currency received upon settlement can be converted to U.S. dollars without significantly changing the currency exchange rate. For purposes of step (ii), the Guidance states that it would be reasonable for a fund to assume that it initiates a hypothetical currency conversion at the same time as the hypothetical sale of the international investment under step (i). In other words, Rule 22e-4 does not require a fund to assume that a currency is converted only after the sale and settlement of the international investment.

If a fund does not reasonably expect to be able to convert the local currency into U.S. dollars within seven calendar days, then the local currency should be classified as an illiquid investment. Any other investments in that jurisdiction that would be sold or disposed of in exchange for the illiquid local currency also should be classified as illiquid investments.

The Guidance notes that when a fund’s investments, including currency investments, in a jurisdiction are illiquid, the fund might exceed Rule 22e-4’s 15% limit on illiquid investments. If this occurs, selling the underlying illiquid investment may be required to reduce the illiquidity of the fund’s portfolio, but such a sale would cause the fund to hold a currency that is an illiquid investment.

Nonetheless, if upon the receipt of the illiquid currency the fund takes reasonable steps to convert that illiquid currency to U.S. dollars (or to purchase investments that will be convertible to U.S. dollars), the fund’s actions reduce the illiquidity of the fund’s portfolio. Accordingly, the Guidance states, when a fund converts an illiquid international investment into an illiquid local currency as a step toward reducing the fund’s illiquid investments, the SEC would not consider the fund as acquiring the illiquid currency in violation of Rule 22e-4’s prohibition on acquiring illiquid investments that exceed the rule’s 15% limit. In general, funds that exceed Rule 22e-4’s 15% limit due to holding illiquid currencies should consider taking reasonable steps such that an illiquid currency received from the sale of an investment will not be used for purposes of a fund’s investment strategy or to acquire illiquid investments.

Particular Funds’ HLIMs. This portion of the Guidance reiterates and highlights existing SEC guidance, with a particular focus on funds with portfolios that are on the lower end of the liquidity spectrum.

The Guidance underscores the importance of a fund having an HLIM that considers the fund’s particular risk factors. For example, when considering a fund’s investment strategy and portfolio liquidity, a fund that invests significantly in less liquid or illiquid investments, such as a bank loan fund, generally should consider establishing an HLIM that is higher than that of a fund with a more liquid portfolio.

More generally, funds with investment strategies that have (or can reasonably expect to have) greater volatility of flows than other investment strategies would generally need HLIMs that are higher than funds whose strategies tend to entail less flow volatility. In addition, while a line of credit or similar arrangement can help a fund meet unexpected redemptions and can be taken into consideration when determining its HLIM, the Guidance states that liquidity risk management is better conducted primarily through construction of a fund’s portfolio.

The Guidance states that the SEC is not dictating how a portfolio manager meets redemptions, highlighting, for example, that the SEC has previously stated that the HLIM requirement does not mean that a fund should only, or primarily, use its most liquid investments to meet shareholder redemptions. Moreover, the HLIM requirement, according to the Guidance, does not mean that a fund must continuously maintain a specific level of highly liquid assets and cannot use those assets to meet redemptions. The Guidance underscores that the sole consequence under Rule 22e-4 of a fund dropping below its HLIM is that the fund’s shortfall policies and procedures are triggered, including notifying the fund’s board of the shortfall at the board’s next regularly scheduled meeting (or, if the shortfall continues for more than seven consecutive calendar days, notifying the board and filing a confidential Form N-RN with the SEC within one business day).

II. Amendments to Form N-PORT

N-PORT Filing Frequency. As proposed in the 2022 Release, the Amendments apply to Rule 30b1-9 under the 1940 Act and Form N-PORT, requiring funds to file Form N-PORT reports more frequently and within a shorter period. Currently, funds are required to file Form N-PORT within 60 days after the end of each quarter (containing month-end data for the three months in the quarter). The Amendments require funds to file Form N-PORT reports monthly. These monthly filings will be due within 30 days after the end of the month to which they relate.³

The SEC’s justification for this change is that “[m]ore frequent and timely reporting of portfolio holdings information to the Commission will enable us to further our mission to protect investors by assisting the Commission and its staff in carrying out its regulatory responsibilities.” As examples, the Release cites “recent market stress events, such as the beginning of the COVID-19 pandemic and Russia’s invasion of Ukraine” as reinforcing the SEC’s need for timely data regarding funds’ portfolios and the liquidity of those portfolios. The Release states that the existing “months-long delay . . . has limited the Commission staff’s ability to develop a more complete understanding of the market on a timely basis, which is particularly important during major market events.”

Publication of N-PORT Information. At present, Form N-PORT reports for the third month of every fiscal quarter – due 60 days after the end of quarter – are made public upon filing. After giving effect to the Amendments, the SEC will make funds’ monthly Form N- PORT reports public 60 days after the end of the month. This change was proposed in the 2022 Release.

Certain information within a Form N-PORT report is currently not reported publicly.⁴ The Amendments do not affect the treatment of this information.

Miscellaneous N-PORT Changes. The Amendments to Form N-PORT include miscellaneous changes to reflect the shift from quarter-end public reporting to monthly public reporting. Thus, after giving effect to the Amendments, funds:

• Must report certain return and flow information only for the month that the Form N-PORT report covers (instead of the current requirement to report this information for the preceding three months); and
• Are permitted to report in Part C of Form N-PORT the aggregate amount of miscellaneous securities held and, on a nonpublic basis, to report more detailed information in Part D about these individual holdings in the miscellaneous securities category.⁵

In addition, the Amendments affect certain items and definitions related to entity identifiers used in Form N-PORT.⁶

III. Amendments to Form N-CEN

As proposed in the 2022 Release, the Form N-CEN Amendments require funds that are subject to Rule 22e-4 to identify and provide certain information about the service providers a fund uses to fulfill the rule’s requirements. In addition, the Amendments include the proposed changes related to entity identifiers.

Specifically, the Amendments require a fund to (i) name each liquidity service provider, (ii) provide identifying information, including the LEI, if available, and location, for each liquidity service provider, (iii) identify if the liquidity service provider is affiliated with the fund or its investment adviser, (iv) identify the asset classes for which that liquidity service provider provided classifications and (v) indicate whether the service provider was hired or terminated during the reporting period. According to the Release, this information will allow the SEC and other participants “to track certain liquidity risk management practices.”

In addition, consistent with the Amendments to the definition of LEI in Form N-PORT, the Amendments revise Form N-CEN to separate the concepts of LEIs and RSSD IDs.⁷

IV. Compliance Dates

Form N-PORT. Fund complexes with aggregate fund net assets of at least $1 billion will be required to comply with the Form N-PORT Amendments for reports filed on or after November 17, 2025. Smaller fund complexes will be required to comply with the Form N-PORT Amendments for reports filed on or after May 18, 2026.

Form N-CEN. For Form N-CEN, all funds will be required to comply with the Form N-CEN Amendments for reports filed on or after November 17, 2025.

V. Observations

1. The Release’s Limited Scope. The SEC’s public notice and agenda for its August 28, 2024 meeting resulted in some press reports suggesting that the SEC would be moving forward with some or all of the 2022 Release’s proposals to overhaul open-end fund liquidity risk management programs and to implement mandatory swing pricing. As described above, and consistent with the SEC’s public notice and agenda, the Release contains only the less controversial Guidance and the Amendments. Nonetheless, the SEC’s most recent Regulatory Agenda, published in July 2024, indicated that the 2022 Release’s proposals were merely being deferred by the SEC, with a reproposal expected by April 2025. Thus, the 2022 Release’s proposals are not dead letters.⁸

2. Front-Running and Predatory Practices. The SEC reported that it had received comments in response to the 2022 Release to the effect that publicizing each month’s Form N-PORT information, rather than every third month’s information, “could increase the risk of predatory trading by other market participants and ultimately harm funds and their shareholders” and “could result in other market participants being able to use automated tools to reverse-engineer portfolio decisions to engage in predatory behavior such as front-running or free-riding.” In their respective public statements in connection with the Release, Commissioner Peirce (here) and Commissioner Uyeda (here) (who both voted against adopting the Release) raised similar concerns.

   The Release acknowledges that monthly Form N-PORT data “may result in a higher risk of predatory trading for certain kinds of funds as compared to other funds; for example, funds that are more likely to build or liquidate their positions over a longer time horizon.” Nonetheless, the Release states that, after considering the comments, the SEC has determined that “publication of information collected on Form N-PORT with a 60-day delay appropriately balances the benefits to investors of receiving additional data on portfolio holdings while mitigating the concerns raised by commenters about predatory trading.” Time will tell whether the concerns of the commenters and the two commissioners were warranted and which types of funds are most affected, if any.

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