Unpredictable circumstances can cause the liquidity of traded financial instruments to almost disappear. In the US, the role of the SEC’s Rule 22e-4 could be helping prevent such cases.
In a recent post by Confluence, the company detailed the role of the regulation as well as its pros and cons.
The company said, “Securities regulators worldwide have developed rules that require fund managers to both measure and report on the actual liquidity of the instruments in their portfolios and the length of time it might take to sell them.
“In the U.S., this has taken the form of SEC Rule 22e-4, which requires that a minimum percentage of the investments comprising a fund’s portfolio be highly liquid.”
According to Confluence, Rule 22e-4 is specifically aimed at quantifying liquidity risk in most mutual fund and ETF portfolios. The regulation requires funds to classify their positions as being in one of four buckets: highly liquid investments, moderately liquid investments, less liquid investments and illiquid investments1
The firm continued, “Rule 22e-4 has created a number of potential compliance problems for fund managers. To thrive amid these requirements, investment managers must have a quick and simple way to assess the true liquidity of their portfolios.
“This is made more complicated by the simple fact that not all assets or markets are created equal. Compared to bond trading, which is often sporadic, for example, most public equities trade at a fairly high frequency. In many cases, performing the extensive analysis required for fund managers to maintain Rule 22e-4 compliance in bond markets necessitates working with third parties that have the expertise to navigate these new regulatory waters.”
The company said it expects the rules issued across a different regulatory framework to take some time to get aligned. The same can go for market depth requirements that call for managers to assess the degree to which selling a proportion of the position would impact the liquidity characteristics of the remaining holding, as well as the potential impact to investors.
Confluence concluded, “Clearly, the ability to liquidate any asset depends on three things – how much of it is to be sold, how quickly it can be sold and the price that firms are willing (or required) to take – and then systemically tracking such exposure. Rule 22e-4 continues to represent a major step forward in this area, and by leveraging compliance expertise and robust technology, funds can meet the moment with precision, efficiency and peace of mind.”
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