Mutual Fund Modernization and Liquidity Risk Management

On October 13, 2016, the SEC formalized their new Forms N-PORT and N-CEN, which require mutual funds to report and disclose additional information, such as a fund’s derivate holdings, liquidity position information and census information, in a compressed timeline.

“Fund sponsors and service providers are challenging themselves to source and map the required data, deal with a new relatively short compliance and filing timeline, and consider required staffing and budget impacts for significantly more workload—all while maintaining an effective compliance risk management program,” Bruce Treff, Managing Director at Deloitte, said to members during the latest #WebinarWednesday.

Notably, the SEC recently delayed the Form N-PORT filing requirement by nine months. Filing a Form N-PORT through the EDGAR system will now begin in April 2019 for larger fund complexes (those with greater than $1B in assets under management) and in April 2020 for smaller fund complexes (those with less than $1B).

“During the nine-month filing delay, fund complexes will be required to maintain Form N-PORT information in their records to make this information available to the SEC upon request,” Treff, who moderated the January 24 discussion, said. “During this interim period, fund groups will also be required to continue filing Form N-Q, which is filed after a fund’s first and third fiscal quarters until the fund begins filing Form N-PORT using EDGAR. It’s also important to note that there were no modifications made to the June 1, 2018, compliance date for Form N-CEN.”

But what does the delay really mean for the industry? “The delay is not driven by the industry’s concerns, and it’s not overly helpful for readiness efforts,” Treff said. “The 1,000+ data elements across Forms N-PORT and N-CEN still need to be captured from multiple internal and external sources and validated for accuracy, quality and timeliness.”

On the other hand, Treff said many firms view the fund modernization reporting requirements as a strategic opportunity to reconsider their operating models, including data sourcing, maintenance strategies, reporting, advance analytic capabilities and enhanced oversight strategies.

Karl Ehrsam, Principal at Deloitte, outlined four operating model challenges currently faced by industry participants:

1) Finalizing the operating model decision. “N-PORT and N-CEN are new; they require new technologies, capabilities and service delivery models that are being built,” Ehrsam said. “Much of the environment is being developed and tested, and the solutions are not mature enough for many sponsors to finalize decisions on how they plan to operate from an end-to-end perspective.” Without these decisions finalized, the fund’s board cannot approve new service agreements, supporting processes or pricing.

2) Enhancing the oversight and interaction model. “The oversight model, including the internal processes it controls to perform the due diligence and operational assessments of the service providers, are becoming a secondary priority until operating model decisions are finalized,” Ehrsam said. He also observed that many managers have not yet settled on ongoing interactions with service providers, and the technology needed to manage those interactions hasn’t been deployed.

3) Managing internal and external data requirements. According to Ehrsam, filing solution providers and the service providers leveraging them are still developing an appropriate schema for the creation of the structured data format that is required by the filing. In addition, Ehrsam said, “we are finding that organizations may incur additional data costs for data that is already received, because some providers consider data used for purposed of N-PORT as a new use under existing contracts.”

4) Identifying resourcing needs. “Both managers and service providers are unclear as to the amount of additional resources that may be required to support new filings,” Ehrsam said. “Firms will be challenged to identify and acquire the appropriate resources who understand the regulatory, fund accounting and technology aspects of the rule.”

Lisa Shea, Senior Vice President, Northern Trust, said Northern Trust has been actively working with technology providers to enhance existing capabilities to support the new requirements. “We are looking at the data we already have access to, we’re talking with our clients about the data that they have access to, and we’re marrying those data points together,” Shea said.

The challenge, as Ehrsam noted, is that those systems are still a work in progress. “The good news on that development process is that a collaborative effort between the fund sponsor and service provider allows for a design of technology and process that meets the needs of an efficient operation, and allows us to turnaround this large amount of data in the required timeframe.”

Shea encouraged fund sponsors to communicate with providers to understand the nuances of the far-reaching process in a truly collaborative effort. “Don’t set it and forget it, and expect that you’re going to have a fully formed model put in front of you on the last day,” she said. “You need to be communicating now.”

Robert Zakem, Managing Director, Deloitte, focused on the Liquidity Rule, which requires funds and ETFs to implement liquidity risk management programs.

The rule requires monthly classification of fund investments into one of four liquidity classes, or “buckets.”

“There are two that really have consequences, and we encourage clients as they look into their program to bear this in mind—the highly liquid investment minimum and the iliquid security percentage,” Zakem said. “Breaching those [buckets] has consequences; however, some folks are misguidedly of the view that ‘we’re [only] going to focus on bucket one and bucket four.’”

However, Zakem pointed out, much like any element of mutual fund data, this information may be used by investment consultants and 401K administrators. “You want to be as precise as possible in classifying your securities so as to not put your funds in a competitive disadvantage when this information starts surfacing in the public domain; which I believe it undoubtedly will,” Zakem said.

Zakem outlined challenges faced when implementing effective liquidity risk management programs, which have been elevated to require board-level attention and cross-functional involvement in the face of global regulatory changes.

The SEC recently published a set of frequently asked questions regarding liquidity risk management programs in which two issues were especially prominent: ETFs (and the determinations of the de minimus cash amount for cash redemptions by an ETF that classifies itself as in-kind) and sub-adviser challenges, including delegation of responsibilities across multiple sub-advisers.

Zakem also highlighted challenges in program governance, data management and technology, as well as the importance of parametrization when implementing a program. “There are a lot of elements throughout this rule that require some defining as you go through and construct the program. Without those definitions, you’re shooting at a moving target,” he said.

To view the archived webinar for additional insight, visit here and be sure to share your thoughts with us.

Note: Although the observations contained in this work represent the best thoughts of the individuals comprising the NICSA webinar panel, they do not necessarily reflect the views of NICSA or any of its member organizations. Matters addressed in this work may touch upon legal or regulatory matters, however nothing herein is intended to be or should be construed as legal advice. You should contact your own counsel in order to obtain legal advice regarding these or any other matters.


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