WASHINGTON – Members of the Government Finance Officers Association raised concerns with the Securities and Exchange Commission's proposed rule changes that would require open-end mutual funds and exchange traded funds to take steps to manage liquidity risks so they could handle redemptions during periods of financial stress.
They made their comments during a panel at the GFOA debt committee's Winter Meeting that included members of the SEC's investment management division, which proposed the rule changes. The division's senior special counsel Sarah ten Siethoff and counsel Sarah Buescher, were joined by SEC Office of Municipal Securities director Jessica Kane and deputy director Rebecca Olsen.
The SEC's proposed rule would ensure liquidity by requiring funds to have specific liquidity risk management programs that would classify the liquidity of a fund's portfolio assets into six different categories based on how quickly the assets could be converted to cash. The categories would include: one business day; two to three business days; four to seven calendar days; eight to 15 calendar days; 16 to 30 calendar days; and more than 30 calendar days.
The fund's board would be tasked with approving the program and reviewing a written annual or more frequent report of the program's adequacy. The fund would additionally have to periodically monitor its liquidity risk, maintain no more than 15% of illiquid assets, and report the liquidity classifications for their assets by category to the SEC on a revised form. Fund managers would have flexibility in choosing which of a number of factors, like volatility of trading price and the asset bid-ask spread, are best to consider when determining the liquidity of their unique holdings.
The SEC is also proposing to require funds to determine the minimum percentage of their net assets that can be converted into cash within three business days.
Nancy Winkler, outgoing Philadelphia treasurer and the debt committee's chair, suggested that this may be a case where there may be a "corporate bond paradigm" in which people assess the muni market using assumptions they have from how the corporate bond market functions. GFOA members said they are concerned that the new rule would require fund managers to consider municipal issuances, whose bonds often have serial maturities and many CUSIPs. This is very different from the corporate market, where bonds usually have only one maturity date. If this is the case, fund managers may consider individual CUSIPs and would miss that a municipal security debt portfolio is best compared to a corporate portfolio when all of an issuer's CUSIPs that have similar characteristics and the same underlying debt are considered together, they said.
Ellen Evans, the deputy treasurer for debt management for the state of Washington, used a study from her state as an example of the need for the rule to prevent a fund manager from using a CUSIP-by-CUSIP strategy.
Washington had $18.4 billion of general obligation bonds with 1,244 individual Cusips outstanding as of July 2015, according to the study. However, the state identified a group of 40 and a group of 51 CUSIPs that shared similar coupons, maturities and call features. If fund managers did not look at the similar CUSIPs, which are all GO bonds, as a whole, Evans and others argued, the state's bonds would appear much less liquid than they actually are.
Matt Posner, a public finance consultant who attended part of Thursday's meeting, recently laid out his own concerns about the rule in a commentary piece for The Bond Buyer.
"While it is not clear how these liquidity risk-management programs will fully play out or how the SEC will treat municipals as it pertains to the three-day minimums, this new set of rules would likely force many portfolio managers to change the composition of their portfolios and make future investments with increased prudence," Posner said in the commentary. "It is safe to say fund managers will be more likely to favor higher-rated credits, larger-volume issuers, shorten the duration of their portfolios, and keep more cash on hand."
He added that the proposed changes will likely increase the cost of issuance for smaller issuers, which make up a large part of the issuer community.
The SEC representatives encouraged any GFOA members with concerns to comment on the proposal by the Jan. 13 deadline.
Buescher and ten Siethoff explained that the proposal is a step the commission is taking after going more than 20 years without providing guidance on liquidity with regard to open end funds.
"The framework is just meant to, for the first time, put in place risk management requirements and to set a higher minimum baseline for those practices," ten Siethoff said. "This is not to move everybody to the gold standard. This is just to bring up the floor."
The SEC representatives also said the framework under the rule is designed to be flexible and allow the fund manager to take the appropriate considerations into account when reviewing the specific securities contained in the fund.
GFOA members said they will carefully read through the proposal and consider what comments to provide the SEC by the deadline. The SEC representatives said they will take the comments into account as they continue to consider the rule and how it applies to the muni market.—
