• Preliminary Evaluation. A fund may conduct a “preliminary evaluation” of certain asset classes or investments that the fund reasonably believes are likely to be illiquid, and base its determination of whether investments in such asset classes are illiquid solely on this preliminary evaluation and not engage in any further analysis under the Rule at that time. A fund could base its reasonable belief (i) on its previous trading experience (including its experience in the asset class or investment’s typical market depth⁶ and price impact when trading), (ii) on its understanding of the general characteristics of the asset classes under preliminary evaluation, or (iii) through other means. Note that this evaluation need not occur prior to a trade being placed.
• Secondary Evaluation. If a preliminary evaluation establishes a reasonable basis for believing that an investment is likely to be illiquid, but the fund wants to further evaluate the investment, the fund may instead conduct a “secondary evaluation” that would determine whether the investment is illiquid by utilizing the full classification process set forth in the Rule. Investments in asset classes a fund acquires that it does not reasonably believe are likely to be illiquid would not need to be classified when performing this preliminary analysis. 
• Automation and Periodic Testing. Funds could automate the preliminary evaluation and could base that evaluation on the general characteristics of the investments (e.g., whether an investment is a restricted security or has structural liquidity limitations, the trading history of the asset class, or whether the investment typically requires significant negotiations to trade). The Commission “expect[s] that a fund making use of preliminary evaluation would conduct periodic testing of the results of the preliminary evaluations to determine whether they continue to be accurate as part of their required review of the adequacy and effectiveness of the liquidity risk management program’s implementation.”
• Evaluation of Liquidity Status. While illiquidity of an investment is generally evaluated only upon acquisition and at least monthly thereafter, certain events may lead In-Kind ETFs or funds not yet subject to the classification requirement to re-evaluate the liquidity status of an investment more frequently. The Delay Release notes that “a reasonable approach for a fund to re-evaluate the liquidity of an investment might be by identifying in its policies and procedures in advance certain events that it reasonably expects would materially affect the investment’s classification.” Such events may include, for example, “those that are objectively determinable (e.g., a trading halt or delisting of a security, an issuer or counterparty default or bankruptcy, significant macro-economic developments (such as a sovereign default), or events like extraordinary natural disasters or political upheavals, for funds with concentrated geographic exposures).”

The Delay Release states that this intra-month review would not create a de facto ongoing review requirement for classification, but notes that “a fund generally should regularly monitor the amount of its illiquid investments to ensure that it does not exceed the limit as a result of the purchase or redemption activity of the fund or changes in the value of the fund’s holdings.”

C. Compliance Date Extension Chart

The Delay Release provides the following chart, which identifies the provisions of the Rule that are subject to delay, and those that are not:

 

Requirements Not Subject to Extension

Requirements Subject to Extension

Rule 22e–4:7 Liquidity Risk Management Program [paragraph (b)]. Assessment, management and periodic review of liquidity risk [paragraph (b)(1)(i)]. Illiquid investments [paragraph (b)(1)(iv)]. Redemptions in Kind [paragraph (b)(1)(v)]. Board Designation of Program Administrator [paragraph (b)(2)(ii)]. UIT Liquidity [paragraph (c)]. N-LIQUID Part A. General Information. Part B. Above 15% Illiquid Investments. Part C. At or Below 15% Illiquid Investments. N-CEN Item C.20. Lines of credit, interfund lending and interfund borrowing. Part E.5. In-Kind ETF.

Rule 22e–4:8 Classification [paragraph (b)(1)(ii)].9 Highly liquid investment minimum [paragraph (b)(1)(iii)]. Board Oversight. Initial approval of the liquidity risk management program [paragraph (b)(2)(i)]. Annual Board Reporting [paragraph (b)(2)(iii)]. N-LIQUID Part D. Assets that are Highly Liquid Investments Below the HLIM. N-PORT Item B.7. Highly Liquid Investment Minimum. Item B.8. Liquidity aggregate classification information. Item C.7. Liquidity Classification Information.

D. New Compliance Dates

The following table lists the requirements of the Rule, along with the updated compliance dates; changed dates are highlighted.

Rule Requirement	Rule Provision	Larger Fund Groups	Smaller Fund Groups
Assessment, management, and periodic review of a fund’s liquidity risk	22e-4(b)(1)(i)	Dec. 1, 2018	June 1, 2019
Limiting the fund’s investment in illiquid investments that are assets to no more than 15% of the fund’s net assets (the 15% illiquid investment limit)	22e-4(b)(1)(iv)	Dec. 1, 2018	June 1, 2019
For funds that engage in, or reserve the right to engage in, redemptions in-kind, the establishment of policies and procedures regarding how they will engage in such redemptions in-kind	22e-4(b)(1)(v)	Dec. 1, 2018	June 1, 2019
Board approval of person(s) designated to administer the program	22e-4(b)(2)(ii)	Dec. 1, 2018	June 1, 2019
Classification of the liquidity of each of the fund’s portfolio investments, as well as at least monthly reviews of the fund’s liquidity classifications*	22e-4(b)(1)(ii)	June 1, 2019	Dec. 1, 2019
Determining and periodically reviewing a highly liquid investment minimum*	22e-4(b)(1)(iii)	June 1, 2019	Dec. 1, 2019
Board initial approval of program and annual review of written report	22e-4(b)(2)(i), (iii)	June 1, 2019	Dec. 1, 2019

*The related reporting requirements of Forms N-PORT and N-LIQUID, and the related recordkeeping requirements under subsections (b)(3)(i), (ii) and (iii) of the Rule, will be subject to the same delayed compliance dates.

The Commission originally scheduled an open meeting for Feb. 21, 2018, to consider both the extension of the Rule’s compliance dates and proposed amendments to Form N-PORT and Form N-1A related to disclosures of liquidity risk management for open-end funds. On the eve of the meeting, however, the Commission canceled the meeting without explanation; the Commissioners subsequently approved the compliance date delay by seriatim action (i.e., acting unanimously without a meeting). The Commission later held an open meeting on March 14, at which the Commissioners voted 3 – 2 to propose reporting and disclosure changes. Comments on the proposal are due on or before May 18, 2018.

A. Proposed Disclosure Changes

1. Proposed Elimination of Bucketing Disclosures

Form N-PORT currently requires each fund to report monthly the aggregate percentage of its portfolio investments that is in each of the four buckets, and these percentages are to be publicly disclosed by the Commission for the third month of each fiscal quarter, 60 days after the end of the quarter.

The Disclosure Release acknowledges three issues regarding this requirement. First, variations in methodologies and assumptions used to conduct liquidity classification can significantly affect the classification information reported on Form N-PORT in ways that investors may not understand. Second, Form N-PORT may not be the most accessible and useful way to communicate information about liquidity risk and may not provide the necessary context for investors to understand how the fund’s classification results relate to its liquidity risk and risk management. Third, because this reporting item singles out liquidity risk and does not place it in a broader context of the risks and factors affecting a fund’s risk, returns and performance, it may inappropriately focus investors on one investing risk over others. In light of these concerns, the Commission proposed to eliminate the requirement to report and disclose aggregate classification information.

Form N-PORT also requires a fund to report and disclose the percentages of the fund’s highly liquid investments that it has segregated to cover or pledged to satisfy margin requirements in connection with derivatives transactions that are classified as moderately liquid, less liquid, or illiquid investments. The Commission proposed that these percentages would continue to be reported, but no longer disclosed.

2. Proposed Annual Report Disclosures

The Commission stated that it is important for investors to understand the liquidity risks of the funds they hold and how those risks are managed. The Commission therefore proposed to replace the Form N-PORT aggregate classification disclosures with a new disclosure requirement in the fund’s annual report to shareholders as part of its management discussion of fund performance.

The proposed amendment would require a fund to “briefly discuss the operation and effectiveness of the Fund’s liquidity risk management program during the most recently completed fiscal year.” To satisfy this requirement, a fund generally should provide information about the operation and effectiveness of the program, and insight into how the program functioned over the past year. This discussion should provide investors with enough detail to appreciate the manner in which a fund manages its liquidity risk. It could, but would not be required to, include discussion of the role of the classification process, the 15 percent illiquid investment limit, and the HLIM in the fund’s liquidity risk management process.

B. Proposed Reporting Changes

1. Proposed Optional Use of Multiple Buckets

Form N-PORT currently requires a fund, in connection with the nonpublic reports of each portfolio investment’s liquidity classification, to classify each holding into a single liquidity bucket. The Commission proposed to allow funds the option of splitting a portfolio holding into more than one bucket under three specified circumstances. A fund attributing multiple classification categories to a single holding would be required to indicate which of the three circumstances is applicable.

• When a fund has multiple subadvisers that each manage a different portion or “sleeve” of the fund’s portfolio, and differences arise between subadvisers as to their views of the liquidity classification of a single holding that may be held in multiple sleeves. The fund effectively would treat the portions of the holding managed by different subadvisers as if they were separate and distinct securities, each with its own reasonably anticipated trade size, and bucketing them accordingly. The Commission’s staff (the Staff) previously provided guidance in the FAQ released in January 2018 that such a fund may use the subadvisers’ classifications and does not have to reconcile them for compliance purposes. 
• When there are liquidity-affecting features that justify the fund treating the holding as two or more separate investments for liquidity purposes. For example, a fund might hold a put option on a portion of a position, giving it more liquidity, or part of a position might consist of restricted shares that are illiquid. Each portion of the holding that exhibits different liquidity characteristics would be treated as a separate investment, with its own reasonably anticipated trade size. 
• When a fund wishes to classify holdings proportionally across buckets, based on an assumed sale of the entire position. Under this voluntary approach, a fund would not use sizes that it reasonably anticipates trading when engaging in this analysis, but instead would assume liquidation of the whole position. For example, a fund holding $100 million in an asset might determine that it would be able to convert $30 million of the asset to cash in one to three business days, while the remaining $70 million would require up to seven calendar days for conversion to cash. This fund could choose to split the liquidity classification of the holding on Form N-PORT and report an allocation of 30 percent of the asset in the highly liquid bucket and 70 percent of the asset in the moderately liquid bucket.

2. Proposed Reporting of Cash and Cash Equivalents

Form N-PORT requires registered management investment companies (other than money market funds and small business investment companies) to make monthly filings of their schedules of portfolio investments; filings for the third month of each fiscal quarter are disclosed to the public, 60 days after the end of the quarter. Cash and certain cash equivalents are not considered investments for this purpose and are not reported on Form N-PORT. The Commission proposed to amend Form N-PORT to include a new requirement to disclose cash and cash equivalents (other than cash equivalents that are otherwise reported).

C. Commissioner Concerns

Of the five Commissioners, only Chairman Jay Clayton fully supported the proposal.¹⁰ Commissioners Kara Stein and Robert Jackson opposed it because of the proposal not to disclose aggregate liquidity classification information, which Stein called a roll-back of transparency¹¹ and Jackson said would give mutual fund investors less, not more, information about the risks that they face.¹² Commissioners Michael Piwowar and Hester Peirce both supported the proposal, but criticized the failure to consider rescinding the liquidity classification requirement, which they called a missed opportunity.¹³  

D. Directions for the Future

The Commission’s proposal is not necessarily intended to be the last word. The Staff will conduct a review of the granular fund-specific liquidity classification data that the Commission will begin receiving on a confidential basis in June 2019. The Staff will provide an analysis of the data to the Commission and present to the Commission by June 2020 a recommendation addressing whether and, if so, how there should be public dissemination of fund-specific liquidity classification information.

The Disclosure Release also notes that the Department of the Treasury recently recommended that the Commission embrace a principles-based approach to liquidity risk management rulemaking and any associated bucketing requirements.¹⁴ The Commission states that it “note[s] that market participants will continue to gather insights as liquidity risk management programs are implemented, and can provide comments to the Commission as they do so. The staff will monitor the information received and report to the Commission what steps, if any, the staff recommends in light of commenter experiences.”

The Disclosure Release also indicates that the Staff anticipates publishing aggregated and anonymized information about the fund industry’s liquidity, along the lines of the periodic reports on private fund industry statistics derived from Form PF data. The Commission expects that the Staff will publish the report periodically and that the report will discuss aggregated and anonymized liquidity data of all funds or funds in certain categories, but will not identify the specific liquidity profile of any individual fund.

In October 2016, the Commission adopted the Rule and other rule and form amendments designed to promote effective liquidity risk management throughout the open-end investment company industry; the amendments were effective Jan. 17, 2017, although, as discussed above, the compliance dates for most of the amendments have not yet been reached.¹⁵ The Rule requires each registered open-end fund, other than money market funds, to adopt and implement a written liquidity risk management program that is reasonably designed to assess and manage the fund’s liquidity risk. Each liquidity risk management program is required to incorporate the following elements:

1. Assessment, Management, and Periodic Review of Liquidity Risk. Each fund and In-Kind ETF must assess, manage, and periodically review (at least annually) its liquidity risk.
2. Classification of Portfolio Holdings. Each fund must classify each of its portfolio investments (including derivatives) into one of the following four categories, based on the number of days reasonably expected to convert the investment to cash (or, in the case of less liquid and illiquid investments, to sell the investment) without the conversion to cash or sale significantly changing its market value, under current market conditions:
   
   
   • Highly liquid investments: Cash and investments convertible into cash in three business days or less.
   • Moderately liquid investments: Investments convertible into cash in more than three business days but in seven calendar days or less.
   • Less liquid investments: Investments that can be sold or disposed of in seven calendar days or less, but where the sale or disposition is reasonably expected to settle in more than seven calendar days.
   • Illiquid investments: Investments that cannot be sold or disposed of in current market conditions in seven calendar days or less.
3. Highly Liquid Investment Minimum (HLIM). Each fund, other than funds primarily holding highly liquid investments, must determine and periodically review an HLIM (the percentage of the fund’s assets held in highly liquid investments). A fund must adopt and implement policies and procedures for responding to a shortfall of the fund’s highly liquid investments below its HLIM. The fund may not change the HLIM during any period when the fund is below the minimum without approval from the fund’s board, and it must report shortfalls to the fund’s board.
4. 15 Percent Illiquid Investment Limit. No fund or In-Kind ETF may acquire any illiquid investment if, immediately after the acquisition, it would have invested more than 15 percent of its net assets in illiquid investments.
5. Redemptions in Kind. Funds that engage in (or reserve the right to engage in) redemptions in kind, including In-Kind ETFs, must establish policies and procedures regarding how and when they will engage in redemptions in kind.

The Rule also requires each fund’s board to (i) approve the fund’s liquidity risk management program, (ii) approve an administrator for the program (the program administrator), and (iii) review annual reports from the program administrator on the operation of the program and the program’s adequacy and effectiveness of implementation, including, if applicable, the operation of the HLIM and any material changes to the program.

In the adopting release for the Rule, the Commission also adopted certain public disclosure requirements and nonpublic reporting requirements, including:

• adoption of rule 30b1-10 and related Form N-LIQUID to provide nonpublic notification to the Commission whenever a fund’s illiquid investments exceed 15 percent of its net assets and if its amount of highly liquid investments declines below its HLIM for more than seven days; and 
• amendments to Form N-PORT to generally require a fund to report monthly to the Commission, on a nonpublic basis, the portfolio investments in each of the defined buckets, as well as the fund’s HLIM, and to disclose publicly the aggregated percentage of its portfolio representing each of the four liquidity classification categories as of the end of each of its fiscal quarters.