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Working Through Liquidity Rule Bucketing Methods

Working Through Liquidity Rule Bucketing Methods

As a firm dedicated to helping funds and distributors “stay ahead of the change,” we’ve been following the liquidity rule closely over the past year. Starting in the late fall of last year when ICI sent a letter to the SEC urging the regulator to delay the compliance date, to February of 2018 when the SEC did elect to grant firms a one-year extension, and continuing to present day where fund shops are in the midst of formalizing the processes needed to comply.

New Liquidity Rule

A large feature of the new liquidity rule compliance process involves determining how to classify how liquid your investments are – or what “bucket” they best fall into. It’s proving to be an industry-wide challenge.

Firms are currently working through different methods of bucketing, including how they classify liquidity, and how frequently they will set bucket classifications. The rule mandates funds classify their securities at least monthly, but also expects due diligence to be performed when certain events occur that make a more frequent classification necessary. As a result, a consensus on the best approach has yet to be seen. This is demonstrated in a recent industry survey where 59% of fund complexes reported that they planned to classify investments monthly, 13% plan to classify weekly, and 25% plan to classify daily. Results were similar for advisors, with 62%, 8%, and 24% respectively.

Our View

Recently, our own Tim Dowling spoke with Ignites on the liquidity rule and the factors firms must consider when implementing appropriate compliance programs.

First, the size of the fund should factor into a firm’s classification strategy. For smaller funds with blue-chip stocks, a monthly classification is suitable. However, when it comes to larger funds invested in less liquid assets, more frequent bucketing may be required or “you’re going to be violating the spirit of the rule,” as Dowling told Ignites.

In addition to size, firms must also look at the complexity of the portfolio in question. The SEC is looking for firms to put thoughtful and cautious processes in place around bucketing methodology. Dowling explained, “If your portfolio becomes more complex, no matter what the rule says about being allowed to classify monthly or by asset type, you’re going to need to classify each line item individually every day.”

Finally, firms holding fixed instruments will have to dedicate extra time to deciding how to classify investments such bonds and CDs. In these instances, a “true liquidity indicator” may not be possible, shared Mr. Dowling, and a detailed methodology should be instituted.

What’s Next?

As the industry marches towards the June 1, 2019 compliance date (December 1, 2019, for firms under $1 billion), we are continuing to monitor development in the space as we work with clients on implementing projects addressing the liquidity rule.

To read Mr. Dowling’s comments in full, below are the Ignites article we’ve referenced in this post:

Contact us for more information about how we can help you stay ahead of the change in preparation for the liquidity rule.

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