The SEC Might Mandate Swing Pricing for Most Funds
The Securities and Exchange Commission might be about to mandate swing pricing for most open-end funds. This would fundamentally alter how investors buy and sell shares in these investments. Swing pricing is designed to help fund shareholders bear their transactions’ trading costs. Specifically, it requires funds to adjust their net asset value per share whenever they experience net redemptions or subscriptions of 2% of their NAV.
What Is Swing Pricing?
Swing pricing adjusts a fund’s net asset value (NAV) to account for transaction costs. It is commonly used in Europe and is designed to prevent “first mover” traders from pushing these fees onto long-term fundholders.
The SEC is considering requiring most funds to use swing pricing in the United States. This would require them to set a threshold for net redemptions and net purchases that would trigger the NAV to be adjusted by a designated swing factor.
This pricing method discourages panic sales and disincentivizes investors from redeeming their shares. In addition, it reduces the dilution effect on long-term fundholders.
Why Does the SEC Want to Mandate Swing Pricing?
In the wake of market turmoil in March 2020, the SEC cites a variety of fund managers’ requests for emergency rules regarding special mutual fund redemption fees, antidilution charges that ETFs might charge their authorized participants and “emergency actions to facilitate funds’ ability to operationalize swing pricing.”
The SEC’s proposed amendments would require most Open-End Funds2 to implement Swing Pricing (an optional liquidity and dilution management strategy). It also would require funds to report their Swing Factor adjustments publicly on Form N-PORT.
As noted earlier, the SEC believes that more widespread adoption of Swing Pricing would improve liquidity by assigning costs incurred when trading securities to traders rather than existing shareholders. It would also better protect investors from dilution and help avoid the risk of sizeable net asset flows that threaten financial stability.
In addition, the SEC argues that more widespread implementation of Swing Pricing will reduce the incentive for a Swing Pricing Administrator to overestimate costs to improve fund performance. The Proposal would also require a fund’s board to approve policies and procedures governing the Swing Pricing program, appoint a Swing Pricing Administrator and receive ongoing reporting.
What Does the SEC’s Proposal Mean for Funds?
The SEC is proposing to modernize the “Names Rule” (Rule 35d-1), which requires funds with names suggesting a focus on a specific type of investment, industry or geographic location to adopt an investment policy requiring an investment of 80% of the fund’s assets in investments that align with those terms.
The proposed rulemaking would extend the Names Rule to any fund name that suggests a focus on investments with, or investments whose issuers have, particular characteristics, such as ESG characteristics. This change would require funds to clearly define those terms in their fund prospectus and ensure that 80% of their assets comply.
In addition to updating the Names Rule, the SEC also proposes to enhance disclosures by certain investment advisers and investment companies about how they incorporate environmental, social and governance factors into their investment practices. The amendments would require additional disclosures on how a fund’s strategies align with its name and investment focus and requirements for funds to maintain records.
What Does the SEC’s Proposal Mean for Investors?
For investors, the SEC’s Proposal means that most funds could be required to follow a liquidity standard. This standard would limit the number of illiquid securities a fund can hold without triggering liquidity restrictions.
This liquidity standard is based on three factors: execution time horizon, trade size and price impact. It is similar to the SEC’s current rule, limiting illiquid holdings to 15% of the fund’s total assets.
In addition, the SEC’s Proposal includes new disclosure requirements in fund prospectuses, annual reports and adviser brochures. This information will assist investors understand how ESG elements are used in funds’ investing strategies and if the funds are managed in a way that meets their declared ESG goals.