Loan market preparing for SEC liquidity rules

September 15, 2016 10:20 AM EDT

A sign for the Securities and Exchange Commission (SEC) is pictured in the foyer of the Fort Worth Regional Office in Fort Worth, Texas June 28, 2012. REUTERS/Mike Stone


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By Kristen Haunss

NEW YORK (Reuters) - Managers of loan mutual funds are preparing for the release of final rules from the US Securities and Exchange Commission (SEC) that seek to improve the liquidity risk management of mutual funds and exchange-traded funds (ETF).

In September 2015, the SEC announced the proposal for the funds, which are typical investments of retirement and college savings plans. The regulator criticized long settlement times citing concerns that funds may not be able to meet redemption requests during volatile market conditions. In its 2016 Examination Priorities, the SEC said protecting retail investors is a priority.

Under the proposal, funds would be required to include a liquidity classification of the portfolio based on the time needed for an asset to be converted to cash, a review of the fund’s liquidity risk and establish a three-day liquid asset minimum, requiring a set percentage of assets be held in cash or invested in holdings that can be converted to cash within three business days. It is unclear what the final requirements of the rule will be.

There were US$116.81bn of assets in US loan mutual funds and ETFs in August, according to data compiled by Thomson Reuters LPC. The funds hold about 13% of the US$880bn leveraged loan market. There has been six weeks of inflows into loan mutual funds and ETFs through the week ending September 7, according to Lipper.

“Loans have performed very well over the years,” said Elliot Ganz, general counsel at the Loan Syndications and Trading Association (LSTA). “Loan mutual funds have always been able to meet redemptions, even during some of the most stressful times, and we are hopeful the SEC will recognize that.”

In January, firms including Credit Suisse Asset Management and BlackRock, as well as the LSTA, asked the SEC to reconsider parts of the proposal.

An SEC spokesperson declined to comment.

RISKY PACE

It took 17.7 days to complete a loan trade in the second quarter, according to Markit. Bond and equity markets currently settle trades in three days and efforts are underway to cut that time frame to two days.

And while the loan market is working on initiatives to improve settlement times, it still takes more than twice the seven days recommended by the LSTA to complete a trade.

The fundamental problem with liquidity mismatches – the difference between the time it takes to settle a loan and the timeframe required to meet redemptions – remains a year after the SEC released proposals for improving risk management of mutual funds and ETFs, according to Steve Tu, an analyst at Moody’s Investors Service.

“Funds have this mismatch and it poses a risk for investors,” he said.

In a September 2015 statement about the proposal, SEC Commissioner Kara Stein, who has criticized long settlement times in the loan market, stressed the importance of funds being able to meet redemptions.

“Every investor in a mutual fund or ETF expects that they will be able to get their money out of the fund quickly, if need be,” she said.

(Reporting by Kristen Huanss; Editing By Michelle Sierra)



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