Upcoming Compliance Deadlines for Registration Statement and Shareholder Report Disclosures under Liquidity Risk Management and Reporting Modernization Reforms
May 05, 2017
The initial compliance dates are rapidly approaching for new disclosure requirements adopted by the U.S. Securities and Exchange Commission (SEC) for registered investment company (funds)1. All initial registration statement filings and post-effective amendments to an effective registration statement must comply with the new requirements if filed on or after the specified compliance dates. In addition, shareholder reports filed after the applicable compliance date must comply with the amendments to Regulation S-X. In particular, funds will be required to include the following:
- New prospectus disclosure regarding the timing of redemption payments and methods to satisfy redemptions – compliance date: June 1, 2017. Open-end funds must disclose additional information in their prospectuses included in initial registration statement filings on Form N-1A.
- New disclosure requirements regarding securities lending activities – compliance date: August 1, 2017. Open-end funds must disclose certain information in their Statement of Additional Information (SAI) included in initial registration statement filings and post-effective amendments thereto. Closed-end funds must disclose such information in their shareholder reports.
- New shareholder report disclosure regarding derivatives and certain other investments – compliance date: August 1, 2017. All registered funds must disclose certain additional information in their shareholder reports.
Funds and their advisers and service providers will need to begin preparing updated disclosures to address these requirements in advance of the applicable compliance dates.2 This OnPoint provides an overview of these requirements and highlights issues funds and their advisers and service providers may wish to take into consideration.
Timing of Redemption Payments and Methods to Satisfy Redemptions – Compliance Date: June 1, 2017
Form N-1A currently requires open-end funds to include a description of their policies and procedures for redeeming fund shares, as well as any related restrictions or redemption charges. In the Liquidity Program Adopting Release, the SEC adopted amendments to Item 11 of Form N-1A, which will require open-end funds to disclose additional information regarding redemption payments and the methods used to satisfy redemption requests.3 In particular, an open-end fund will be required to:
- Disclose the number of days typically expected, or an estimated range of days, in which the fund anticipates that it will pay redemption proceeds. The disclosed pay-out timing must be based on the method of payment (e.g., by check, wire or automated clearing house) chosen by the redeeming shareholder, but need not be based on the distribution channel through which the redeeming shareholder generally transacts; and
- Describe the methods the fund typically expects to use to satisfy redemption requests (e.g., sale of portfolio securities, cash reserves, lines of credit, interfund lending or redemptions in kind), as well as whether such methods will be used regularly or only in stressed market conditions.
With respect to the timing of redemption payments, the SEC noted that a fund is required to disclose the typical number of days (or estimated range of days) in which the fund anticipates that it will pay redemption proceeds. However, the SEC noted that a fund might wish to consider also disclosing whether the payment of redemption proceeds may take longer than the typical number of days disclosed for such payment. In this regard, the SEC stated that a fund might wish to disclose that redemption payments may take up to seven days, as provided under the Investment Company Act of 1940.
Some fund prospectuses currently have disclosures relating to redemptions based on whether the shareholder holds shares directly with the fund (direct accounts) or through an intermediary (intermediary accounts). While the SEC does not require a fund to disclose the number of days (or range of days) it typically expects to pay redemption proceeds by distribution channel, a fund may disclose different information with respect to direct accounts and intermediary accounts, if this approach better aligns with the format of the fund’s prospectus.
In the Fund Disclosure Adopting Release, the SEC noted several examples of methods a fund may typically expect to use to satisfy redemption requests. The SEC stated that a fund that imposes a redemption fee might also disclose that the use of such fee is designed to help reduce dilution and offset transaction costs associated with shareholder redemption activity. In addition to the methods identified by the SEC, a fund may wish to disclose that it employs other methods to meet redemptions, including (among others) overdraft facilities with its custodian bank, reverse repurchase agreement arrangements and sale/buyback transactions.
Funds and their advisers and service providers will need to review current policies and procedures for the timing related to redemption payments and the methods used to satisfy redemption requests. This may include, for example, discussions with the fund’s transfer agent to determine the timing for redemption payments and, in connection with a fund’s methods to satisfy redemption requests, discussions with portfolio management. It is important to note that certain funds (for example, money market funds) may have approaches that differ from other open-end funds with respect to the timing of redemption payments and methods to satisfy redemptions. Funds offered as funding vehicles for variable annuity contracts and variable life insurance policies offered by the separate accounts of insurance companies, or through other channels (e.g., funds offered exclusively to retirement plans or separately managed accounts), may have different redemption payment arrangements or methods to satisfy redemptions. As a result, disclosures in response to these new requirements may vary across a fund complex.
Compliance Date
The compliance date for this disclosure is June 1, 2017. Funds will need to disclose this new information in initial registration statements on Form N-1A and post-effective amendments thereto, filed on or after June 1, 2017.
Disclosure regarding Securities Lending Activities – Compliance Date: August 1, 2017
In the Fund Reporting Adopting Release, the SEC adopted amendments to Item 19 of Form N-1A and Item 21 of Form N-3, which will require open-end funds to disclose certain information regarding their securities lending activities in their SAI. The SEC also adopted new Item 12 of Form N-CSR, which will require closed-end funds to disclose such information in their Form N-CSR. A fund will be required to disclose the following information (in dollars) regarding the fund’s securities lending activities during its most recent fiscal year:
The reporting modernization amendments also require a fund to describe the services provided by the fund’s securities lending agent. The SEC specified that this description should be based on the services actually furnished to the fund in its most recent fiscal year. As set forth in the Fund Reporting Adopting Release, examples of the types of securities lending services a fund may wish to disclose include, but are not limited to:
- Locating borrowers;
- Monitoring daily the value of the loaned securities and collateral;
- Requiring additional collateral as necessary;
- Managing cash collateral;
- Managing qualified dividends;
- Negotiating loan terms;
- Selecting securities to be loaned;
- Recordkeeping and account servicing;
- Monitoring dividend activity and material proxy votes relating to loaned securities; and
- Arranging for return of loaned securities to the fund at loan termination.
Funds and their advisers and service providers will need to compile the data and information required to respond to the new securities lending disclosure. This may involve working with a fund’s securities lending agent to categorize the fees paid by the fund to the securities lending agent in the manner set forth above. It also may include implementing a process to review the actual services performed by the securities lending agent during the past fiscal year (as opposed to the services listed in the securities lending agreement). In addition, it is important to note that the services provided by the securities lending agent may include services not identified in the Fund Reporting Adopting Release, as noted above. As a result of these new requirements, funds may wish to adopt a protocol to review the securities lending disclosure as part of the annual update process to ensure the information that the fund discloses is accurate each year.
Public disclosure of securities lending fees throughout the industry may provide funds with additional data for use in negotiating securities lending arrangements.
Compliance Date
The compliance date for this disclosure is August 1, 2017. We understand that, based on informal discussions with the SEC staff, these disclosure changes will apply to registration statements (or shareholder reports with respect to closed-end funds) for funds with fiscal periods ending after August 1, 2017, as opposed to registration statements (or shareholder reports) filed on or after August 1, 2017.8
Disclosure regarding Derivatives and Certain Other Investments– Compliance Date: August 1, 2017
Regulation S-X prescribes the content and form of financial statements to be included in registration statements and shareholder reports for registered investment companies and business development companies (referred to as “funds” for purposes of the discussion in this section).9 In the Fund Reporting Adopting Release, the SEC adopted amendments to Regulation S-X that will require additional disclosures in a fund’s shareholder report regarding the fund’s derivative investments. These disclosures must be placed prominently in a schedule in the fund’s financial statements (rather than included as a schedule in the notes to the financial statements).
The amendments to Article 12 of Regulation S-X set forth new, standardized schedules for reporting position-level information as to open futures contracts, open forward foreign currency contracts, and open swap contracts.10 The amendments also modify the current disclosure requirements applicable to the schedule of purchased and written options contracts.11 Further, the amendments implement new instructions regarding the format and display of disclosures regarding derivative contracts; these instructions are consistent with the instructions for Rules 12-12 and 12-13.
The Fund Reporting Adopting Release implements several further amendments to Regulation S-X, including (among others):
- Adding an instruction to Rule 12-12 that will require a fund to indicate the interest rate or preferential dividend rate and maturity date, as applicable, for certain enumerated debt instruments;12
- Revising instruction 4 to Rule 12-13 and Rule 12-13C to no longer require disclosure of the counterparty for both exchange-traded options and swaps and centrally cleared options and swaps;
- Amending the instructions to Rule 12-12 to require funds to indicate whether any portion of a security held in connection with open put or call option contracts, or loans for short sales, is on loan; and
- Amending Rule 12-14 to require funds to disclose additional information regarding their investments in, and advances to, affiliates.
While many funds may already incorporate the information contemplated by these amendments in their shareholder reports, funds and their advisers and service providers will need to be prepared to present the required information in an appropriate format in the schedule of investments section of the fund’s financial statements (rather than in the notes to those financial statements). Funds will also need to evaluate the amendments to Regulation S-X to determine whether the funds have the necessary data and information to respond to the new disclosure requirements, including the following characteristics of debt and derivative investments, as applicable: counterparties; notional amounts; upfront payments/receipts; and interest rates or preferential dividend rates and maturity dates. For funds that invest in derivatives with an underlying investment that is a nonpublic index, funds will need to adopt a process to compile multiple components of that index.
Compliance Date
The compliance date for this disclosure is August 1, 2017. As noted above, we understand that, based on informal discussions with the SEC staff, the compliance date applies to shareholder reports for funds with fiscal periods ending after August 1, 2017, as opposed to shareholder reports filed on or after August 1, 2017.13
Conclusion
The initial compliance deadlines for new registration statement and shareholder report disclosures are fast approaching. Funds and their advisers and service providers should consider the necessary updates to, and implement processes to verify the accuracy of, the disclosures relating to redemption information, securities lending activities and derivatives.
Footnotes
1) Investment Company Liquidity Risk Management Programs, Rel. No. IC-32315 (Oct. 13, 2016) (Liquidity Program Adopting Release); for further information, please refer to Dechert OnPoint, SEC Adopts New Rules and Rule Amendments to Require Registered Open-End Investment Companies to Establish Liquidity Risk Management Programs and Permit Them to use “Swing Pricing.” Investment Company Reporting Modernization, Release No. IC-32314 (Oct. 13, 2016) (Fund Reporting Adopting Release); for further information, please refer to Dechert OnPoint, SEC Adopts Rules and Forms to Modernize Reporting Requirements for Registered Investment Companies.
2) The compliance dates for the remaining new liquidity risk management requirements adopted by the SEC are December 1, 2018 for fund complexes with net assets of $1 billion or more, and June 1, 2019 for fund complexes with net assets below $1 billion. The compliance dates for the remaining reporting modernization requirements are: (i) Form N-PORT, June 1, 2018 for fund complexes with net assets below $1 billion, and June 1, 2019 for fund complexes with net assets of $1 billion or more; and (ii) Form N-CEN, June 1, 2018 for all fund complexes.
3) These amendments apply to open-end funds, including money market funds but excluding exchange-traded funds that issue or redeem shares in creation units of not less than 25,000 shares.
4) The SEC noted that this would include income from cash collateral reinvestment, and clarified that gross income may also include: negative rebates; loan fees paid by borrowers when collateral is noncash; management fees from a pooled cash collateral reinvestment vehicle that are deducted from the vehicle’s assets before income is distributed; and any other income.
5) If a fee for a service listed in the sub-bullets under this row is included in the revenue split, the SEC included an instruction to state that the fee is “included in the revenue split.”
6) This represents the sum of the values of the items listed under Row 2 of the table.
7) This represents the value in Row 1 minus the value in Row 3 of the table.
8) Due to ambiguity in the Fund Reporting Adopting Release regarding the application of the compliance dates, it is our understanding that the industry is seeking from the SEC staff written confirmation of this approach in the form of a response to frequently asked questions.
9) Certain limited amendments apply to unit investment trusts and face-amount certificate companies.
10) For open futures contracts, funds will be required to disclose the notional amount and value of the contracts. For open forward foreign currency contracts, funds will be required to disclose the counterparty to the contract. For open swap contracts, funds will be required to disclose the counterparty and upfront payments or receipts to the contract, as well as the value of the contract.
11) Funds will be required to include a description of the contract and to disclose the counterparty to the contract, as well as the notional amount and value of the contract.
12) When disclosing the interest rate for variable rate securities, a fund must describe the reference rate and spread as well as provide the end of period interest rate for each investment, or include disclosure of each reference rate at the end of the period.
13) Similar to the compliance date for the securities lending disclosure, it is our understanding that the industry is seeking from the SEC staff written confirmation of this approach in the form of a response to frequently asked questions.
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