Liquidity Is Out, ETFs Are In
The SEC’s stance on its not-yet-effective liquidity rule appears fluid, as commissioners push to abandon part of the rule and certain division heads move on to other topics. At the 2018 ICI Mutual Funds and Investment Management conference, Commissioner Hester Peirce and division director Dalia Blass signaled the possible end of the liquidity rule as an emphasis of the SEC.
Commissioner Hester noted that while the data collected by the liquidity rule might be interesting to the Commission’s staff, its cost to the industry was high and usefulness to investors was low. As a result, Commissioner Hester questioned whether the “bucketing” portion of the rule was even necessary. Her comments came about a week after the SEC decided to change the rule to include more qualitative disclosure instead of the requirement to provide quantitative data on a fund’s liquidity. She even suggested that the liquidity rule would not be helpful to investors because the information across funds would not be comparable; further, the information could be inconsistent within the same fund (e.g., a multi-manager fund wherein the various sub-advisers apply different liquidity determinations to the same security). Commissioner Hester also noted the need for fund families to rely on third-party vendors to provide pricing data and other services when implementing the liquidity rule’s requirements, which compounds the cost of meeting the rule's requirements. Overall, Commissioner Hester argued that Commission should abandon the “bucketing” mechanism because she sees it as an unnecessary tool that is costly and could raise the barrier to entry for newer fund families (or for smaller existing fund families).
At the same conference, Director Blass, head of the SEC’s Division of Investment Management, focused her attention on a possible new ETF rule. Director Blass' call for an ETF Rule comes ten years after the SEC first published a proposed rule on ETFs. At that time, Director Blass was a senior attorney with the SEC and one of the lead drafters of the proposed rule. Unfortunately, the Great Recession and Bernie Madoff stole resources and attention from the proposed rule. But now Director Blass is back, and she is in charge of the Division during a period of relative calm in the financial markets (despite recent increases in price volatility). She also seems to have the backing of SEC Chairman Jay Clayton who hired Director Blass in 2017 to run the Division. A few months after hiring Director Blass, Chairman Clayton put the SEC's regulatory spotlight on the rule that has lingered for a decade. (Director Blass may also have the support of high-profile professors such as Henry Hu at the University of Texas and John Morley of Yale University, who recently co-authored a paper on ETFs.)
Collectively, Commissioner Hester’s focus on killing part of the liquidity rule and Chairman Clayton and Director Blass’ focus on the ETF rule suggest the SEC has moved on from its earlier regulatory agenda. As a result, mutual fund boards and their investment advisers may have more leeway to chart a course to comply with the liquidity rule, which we will cover in a later post.