an open-end fund may not invest in the aggregate more than 15% of its
net assets in ``illiquid securities,'' we proposed to require funds to
report on Form N-PORT whether each portfolio asset is a ``15% standard
asset,'' as defined under the proposal,\628\ in addition to reporting
the liquidity of each of the fund's positions (or portions of a
position) in a portfolio asset using six proposed categories.\629\ One
commenter opposed requiring reporting of the 15% standard asset at the
individual portfolio asset level, raising concerns that public
disclosure could have adverse effects on funds.\630\ Another commenter
opposed reporting of the 15% standard asset at the individual portfolio
asset level if publicly disclosed in addition to the proposed six
liquidity classification categories, stating that the distinction
between the two pieces of data would make sense to industry experts but
would be confusing and potentially misleading to typical
investors.\631\
---------------------------------------------------------------------------

    \627\ See supra section III.C.2.d.
    \628\ See Proposing Release, supra footnote 9, at section
III.G.2.b.
    \629\ See Proposing Release, supra footnote 9, at section
III.G.2.a.
    \630\ See Cohen & Steers Comment Letter.
    \631\ See Federated Comment Letter.
---------------------------------------------------------------------------

    After considering these comments, we agree that presenting to the
public liquidity classification information and the 15% standard asset
designation separately could potentially confuse investors. As
discussed in more detail in section III.C previously, we believe that
it is more appropriate to harmonize the rule 22e-4 limit on illiquid
investments, referred to as 15% standard assets under the proposal,
with the rule's broader liquidity classification requirement by
incorporating an illiquid investment category into the classification
requirement. Likewise, we believe that this harmonization should be
reflected in reports on Form N-PORT. Thus, we are adopting, modified
from the proposal, an illiquid investment category into Form N-PORT
that corresponds with rule 22e-4's broader classification
requirement.\632\ By doing this, a fund's exposure to illiquid
investments may be viewed as part of the fund's overall liquidity
profile in a more clear and concise manner. Furthermore, we are
persuaded by some of the concerns raised by commenters regarding the
unintended adverse effects that public disclosure of illiquid
investment information on the portfolio position level could have on
funds and fund investors. As adopted, liquidity classification
information reported on the portfolio position level will be non-public
on Form N-PORT, as discussed in more detail above.
---------------------------------------------------------------------------

    \632\ See Item C.7. of Form N-PORT.
---------------------------------------------------------------------------

    We expect to use this information to monitor fund compliance with
the prohibition of acquiring illiquid investments if the fund would
have invested more than 15% of its net assets in illiquid investments
that are assets and analyze liquidity trends in the fund industry.
Overall, we believe that maintaining this information on illiquid
investments as part of the liquidity classification information
reported on Form N-PORT will provide the Commission with meaningful
data, including information regarding exposure to illiquid investments
across the fund industry.

D. Highly Liquid Investment Minimum

    Today we are adopting a requirement that each fund determine its
``highly liquid investment minimum,'' or the minimum amount of the
fund's net assets that the fund invests in highly liquid investments
that are assets.\633\ In determining its highly liquid investment
minimum, a fund will be required to consider the factors the fund also
has to consider, as applicable, in assessing its liquidity risk under
rule 22e-4.\634\ Additionally, in determining whether a fund is meeting
its highly liquid investment minimum, the fund will look only to its
investments that are assets of the fund.\635\ Rule 22e-4 as adopted
today also requires a fund to adopt and implement policies and
procedures for responding to a shortfall in a fund's highly liquid
investments below its highly liquid investment minimum.\636\ These
policies and procedures must include reporting to the fund's board of
directors, no later than the board's next regularly scheduled meeting,
regarding any shortfall of the fund's highly liquid investments
compared to its minimum. A fund is required to report to its board

within one business day, and submit a non-public report to the
Commission, if its highly liquid investment minimum shortfall lasts
more than seven consecutive calendar days.\637\ A fund's board of
directors is not normally required to specifically approve the fund's
highly liquid investment minimum, although during a time that a fund's
highly liquid investments are below the fund's determined minimum
level, a fund's highly liquid investment minimum can be changed only
with board approval.\638\ Additionally, a discussion of the fund's
minimum must be included in the written annual report to the board on
the adequacy and effectiveness of the fund's liquidity risk management
program. Funds whose portfolio assets consist primarily of highly
liquid investments, as well as In-Kind ETFs, are not subject to the
highly liquid investment minimum requirement.\639\
---------------------------------------------------------------------------

    \633\ Rule 22e-4(a)(7). Rule 22e-4(a)(7) refers to highly liquid
investments that are ``assets'' to make clear that when evaluating
whether a fund is meeting its highly liquid investment minimum, the
fund should look to its investments with positive values. Highly
liquid investments that have negative values should not be netted
against highly liquid investments that have positive values when
calculating whether the fund is meeting its highly liquid investment
minimum. Thus, only highly liquid investments that have positive
values (i.e., ``assets'') should be used in the numerator. Cf. infra
footnote 744 (discussing the use of the term ``assets'' in the 15%
limit on illiquid investments).
    \634\ Rule 22e-4(b)(1)(iii)(A)(1).
    \635\ Rule 22e-4(a)(7).
    \636\ Rule 22e-4(b)(1)(iii)(A)(3).
    \637\ Id. See also Item D.1 of new Form N-LIQUID.
    \638\ Rule 22e-4(b)(1)(iii)(A)(1).
    \639\ Rule 22e-4(b)(1)(iii)(A); see also rule 22e-4(a)(5)
(excluding money market funds and In-Kind ETFs from the definition
of ``fund'').
---------------------------------------------------------------------------

    As described in more detail below, this requirement is a
modification of the proposed ``three-day liquid asset minimum,'' which
also would have required a fund to determine the percentage of the
fund's net assets to be invested in relatively liquid assets (under the
proposal, ``three-day liquid assets,'' or cash and any asset
convertible to cash within three business days at a price that does not
materially affect the value of that asset immediately prior to
sale).\640\ In determining its three-day liquid asset minimum, the
proposed rule would have required a fund to consider the factors the
fund would have to consider, as applicable, in assessing its liquidity
risk under rule 22e-4.\641\ Under the proposal, a fund would have been
prohibited from acquiring any asset other than a three-day liquid asset
if, after acquisition, the fund would hold fewer three-day liquid
assets than the percentage specified under its three-day liquid asset
minimum.\642\ Also under the proposal, a fund's board would have had to
approve the fund's three-day liquid asset minimum and any changes
thereto.\643\
---------------------------------------------------------------------------

    \640\ Proposed rule 22e-4(a)(8); proposed rule 22e-
4(b)(2)(iv)(A)-(C).
    \641\ Proposed rule 22e-4(b)(2)(iv)(A).
    \642\ Proposed rule 22e-4(b)(2)(iv)(C).
    \643\ Proposed rule 22e-4(b)(3)(i).
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    The goal of the proposed three-day liquid asset minimum requirement
was to increase the likelihood that a fund would hold adequate liquid
assets to meet redemption requests without materially affecting the
fund's NAV.\644\ The proposed three-day liquid asset minimum also was
intended to be structured in a way that would foster consistency in
funds' consideration of relevant liquidity risk factors, while
permitting flexibility in implementing this liquidity risk management
tool as appropriate given the diverse range of funds it would
cover.\645\ It was intended to work together with other aspects of the
proposed liquidity risk management program designed to help ensure that
while funds would consider the spectrum of liquidity in their
portfolios (in part through the proposed classification requirement),
they would pay particular attention to the most liquid and least liquid
ends of this spectrum.\646\
---------------------------------------------------------------------------

    \644\ See Proposing Release, supra footnote 9, at section
III.C.3.
    \645\ Id.
    \646\ See id., at sections III.B.1, III.C and III.C.3.
---------------------------------------------------------------------------

    Many commenters agreed that a requirement for a fund to determine a
minimum--or, per some commenters' suggestions, a target--amount of
relatively liquid assets would assist funds in effectively meeting
redemption requests under a variety of market conditions.\647\ Some, on
the other hand, suggested that a minimum or target requirement would
not necessarily enhance a fund's ability to meet shareholder
redemptions because the amount of liquid assets a fund may need is
dynamic and unpredictable, and in extraordinary stressed market
conditions no particular amount of liquid assets may end up being
sufficient to meet redemptions.\648\ Commenters also objected to the
structure of the proposed minimum requirement, particularly the fact
that the requirement would not permit a fund to acquire relatively less
liquid assets if the fund were to fall below its minimum, arguing that
the requirement could actually increase shareholder redemptions during
times of stress.\649\ In addition, commenters expressed concerns that
the proposed requirement could prevent funds from meeting their
principal investment strategies \650\ and that it could effectively
prevent funds from holding or acquiring favorable, but relatively less
liquid, assets under certain circumstances, which could intensify
market stress as well as adversely affect a fund's NAV.\651\ Finally,
some commenters expressed concerns about the potential operational
burdens associated with the proposed three-day liquid asset minimum
requirement.\652\
---------------------------------------------------------------------------

    \647\ See, e.g., AFR Comment Letter; Charles Schwab Comment
Letter; CRMC Comment Letter; Wells Fargo Comment Letter.
    \648\ See, e.g., Dechert Comment Letter; HSBC Comment Letter;
Invesco Comment Letter; MFS Comment Letter.
    \649\ See, e.g., BlackRock Comment Letter; SIFMA Comment Letter
I.
    \650\ See, e.g., Invesco Comment Letter; Oppenheimer Comment
Letter; Cohen & Steers Comment Letter; ICI Comment Letter I.
    \651\ See, e.g., BlackRock Comment Letter; Credit Suisse Comment
Letter; ICI Comment Letter I; NYC Bar Comment Letter.
    \652\ See, e.g., Federated Comment Letter; ICI Comment Letter I.
---------------------------------------------------------------------------

    Some commenters also suggested alternatives to the proposed three-
day liquid asset minimum. As discussed further below, a number of
commenters suggested requiring funds to maintain a ``target'' or
threshold amount of certain liquid assets.\653\ Other commenters
suggested requiring funds to consider whether to maintain a target
amount of liquid assets \654\ or to adopt policies and procedures to
address shareholder redemptions, which could include targets or
ranges.\655\ As discussed below, we believe the highly liquid
investment minimum requirement we are adopting strikes an appropriate
balance in promoting the benefits intended by the proposed three-day
liquid asset minimum requirement, including consistency in funds'
consideration of certain factors relevant to their liquidity risk
management procedures, while at the same time lessening the likelihood
of certain adverse consequences identified by commenters.
---------------------------------------------------------------------------

    \653\ See, e.g., Invesco Comment Letter (suggesting that funds
be required to maintain a ``target'' range of three-day and/or
seven-day liquid assets); PIMCO Comment Letter (suggesting that a
minimum cash target could be established by the investment manager);
BlackRock Comment Letter (suggesting that funds could be required to
take several steps to ensure an appropriate level of Tier 1 and Tier
2 assets, which could be articulated as a range or target); Credit
Suisse Comment Letter.
    \654\ See, e.g., SIFMA Comment Letter I; Oppenheimer Comment
Letter.
    \655\ See, e.g., Dechert Comment Letter; IDC Comment Letter.
---------------------------------------------------------------------------

1. Anticipated Benefits of Highly Liquid Investment Minimum
    Like the proposed three-day liquid asset requirement, we believe
that the highly liquid investment minimum requirement will increase the
likelihood that a fund would be prepared to meet redemption requests
without significant dilution of remaining investors' interests in the
fund. Some commenters noted that it is common for funds to assess how
much liquidity they may need under various market conditions in order
to meet redemptions over a relatively short time horizon and suggested
that targeting a certain level of relatively liquid assets is an
appropriate way for a fund to manage its liquidity

risk.\656\ To the extent that a fund already aims to invest a specified
portion of its portfolio in relatively liquid assets, we anticipate
that such funds may already be substantially in compliance with the
highly liquid investment minimum requirement we are adopting today.
More importantly, it would require those funds that do not currently
consider what an appropriate baseline level of liquidity might be to do
so.
---------------------------------------------------------------------------

    \656\ See, e.g., supra footnote 653.
---------------------------------------------------------------------------

    As with the proposal, we believe that the final highly liquid
investment minimum requirement will help encourage consistency in
funds' consideration of certain factors relevant to their liquidity
risk management procedures. This is an important benefit compared to
some commenters' suggestions that funds simply be required to have
policies and procedures to address shareholder redemptions (which could
include liquid asset minimums or targets), but not to specify any
particular procedures within this general requirement.\657\ As with the
proposal, we believe that the approach we are adopting appropriately
encourages regularity and thoroughness in funds' consideration of
certain risk factors, while at the same time promoting flexibility in
funds' management of this risk. Under rule 22e-4 as adopted, a fund
will be able to determine its own highly liquid investment minimum, as
well as (within a fairly broad range) the assets it will hold to
satisfy its minimum.\658\ We believe that the requirement we are
adopting provides important additional flexibility to funds' liquidity
risk management practices in that a fund will be required to adopt
policies and procedures, but would be permitted to design them as
appropriate to respond to shortfalls in highly liquid investments
relative to the fund's minimum.
---------------------------------------------------------------------------

    \657\ See supra footnote 655; see also infra section IV
(discussing other reasonable alternatives to the highly liquid
investment minimum requirement).
    \658\ See rule 22e-4(b)(1)(iii)(A)(1).
---------------------------------------------------------------------------

    As noted above, some commenters suggested that a minimum
requirement would not necessarily enhance funds' ability to meet
shareholder redemptions. We agree that the highly liquid investment
minimum requirement we are adopting, standing alone, may not be a
sufficient safeguard for funds to manage liquidity risk under all
market conditions. However, we believe that, together with the rest of
the liquidity risk management program requirements we are adopting, it
is a central tool to help put a fund in a solid position to meet
redemption requests without significant dilution of remaining
investors' interests. The highly liquid investment minimum requirement,
together with the classification requirement and the 15% limitation on
a fund's investments in illiquid investments that are assets, is meant
to be a primary component of a fund's overall approach to liquidity
risk management. While the classification requirement would illustrate
the spectrum of a fund's portfolio liquidity, the highly liquid
investment minimum requirement and the 15% limitation on illiquid
investments would focus the fund's attention on each end of that
liquidity spectrum--the fund's most liquid and least liquid
investments, respectively.
    Based on a fund's liquidity risk assessment, the fund could
determine what additional liquidity risk management tools, if any,
together with the highly liquid investment minimum requirement and the
15% limitation on illiquid investments, would best permit the fund to
meet redemptions and help prevent significant investor dilution. We
also believe that the highly liquid investment minimum requirement will
be a useful liquidity risk management tool because we understand, based
on staff outreach and comments that we received on the proposal, that
the requirement we are adopting is similar to liquidity risk management
strategies that many funds currently use.\659\
---------------------------------------------------------------------------

    \659\ See supra footnote 656 and accompanying text.
---------------------------------------------------------------------------

    While certain commenters expressed concern that the proposed three-
day liquid asset minimum requirement could unduly encourage funds to
use only their most liquid assets in meeting redemptions (which
commenters argued could lead to additional redemptions from funds in
stressed periods),\660\ we note that the minimum requirement--both as
proposed and as adopted--was never meant to suggest that a fund should
only, or primarily, use its most liquid investments to meet shareholder
redemptions.\661\ Nor is it meant, as commenters argued, to suggest
that funds should hold cash-like buffers that investors may
inappropriately assume will eliminate funds' liquidity risk.\662\
Indeed, we noted in the Proposing Release that assets eligible for
inclusion in a fund's three-day liquid asset minimum holdings could
include a broad variety of securities, as well as cash and cash
equivalents.\663\ Moreover, because the final highly liquid investment
minimum requirement would not prohibit a fund from acquiring
investments other than highly liquid investments if a fund were to fall
below its minimum, we believe that the final requirement may convey
more effectively than the proposal that a fund is not guaranteed to
hold a certain level of cash or highly liquid investments at all times.
---------------------------------------------------------------------------

    \660\ See, e.g., BlackRock Comment Letter.
    \661\ See, e.g., Proposing Release, supra footnote 9, at section
II.B.2 (discussing how funds may choose to sell assets in ``strips''
or in a range of liquidity).
    \662\ See, e.g., CFA Comment Letter.
    \663\ See Proposing Release, supra footnote 9, at paragraph
following n.343.
---------------------------------------------------------------------------

    As with the proposed three-day liquid asset minimum requirement, we
believe an important feature of the highly liquid investment minimum
requirement we are adopting is the flexibility it provides for a fund
to determine an appropriate highly liquid investment minimum
considering its particular risk factors, as well as (within a fairly
broad range) the assets it will hold to satisfy its minimum. We
acknowledge that, for certain funds that currently have relatively less
liquid portfolios, the highly liquid investment minimum requirement
could cause a fund to modify its investment strategy if, after
consideration of the required factors, the fund were to determine it is
appropriate to invest in higher amounts of highly liquid investments.
In these circumstances, we believe such a modification would be
appropriate. We discuss the costs associated with any modifications to
funds' investment strategies that could result from the final highly
liquid investment minimum requirement in the Economic Analysis section
below.
2. Consideration of Liquidity Risk Factors
    Rule 22e-4 requires a fund to consider the liquidity risk factors
set forth in the rule, as applicable, in determining its highly liquid
investment minimum.\664\ Under the proposed rule, a fund likewise would
have been required to consider the proposed rule's liquidity risk
assessment factors in determining its three-day liquid asset
minimum.\665\ Several commenters suggested that these factors should be
guidance that funds may consider in setting a minimum or target for
relatively liquid assets, but should not be mandatory considerations a
fund would be required to assess.\666\ Commenters also objected to the
requirement that funds determine their three-day liquid asset minimum
based

on liquidity risk under both normal and reasonably foreseeable stressed
conditions, arguing that this requirement would result in funds being
forced to maintain artificially high levels of three-day liquid
assets.\667\ Some commenters also discussed more granular objections to
certain of the proposed factors to be used in determining a fund's
three-day liquid asset minimum, such as certain aspects of the proposed
requirements to consider a fund's shareholder concentration \668\ and
borrowing arrangements.\669\
---------------------------------------------------------------------------

    \664\ Rule 22e-4(b)(1)(iii)(A)(1).
    \665\ Proposed rule 22e-4(b)(2)(iv)(A)-(B).
    \666\ See, e.g., Oppenheimer Comment Letter; Charles Schwab
Comment Letter; SIFMA Comment Letter I.
    \667\ See, e.g., NYC Bar Comment Letter; SIFMA Comment Letter I.
    \668\ See SIFMA Comment Letter I.
    \669\ See Cohen & Steers Comment Letter.
---------------------------------------------------------------------------

    We continue to believe it is appropriate for a fund to be
required--not only permitted--to consider a specified set of liquidity
risk factors in determining its highly liquid investment minimum. We
believe requiring every fund to consider multiple aspects of its
history, policies, strategy, and operations in determining its highly
liquid investment minimum will lead to a general industry-wide baseline
for the minimum requirement. However, we are making certain
modifications to the proposed liquidity risk factors, including only
requiring funds to consider applicable factors, to respond to
commenters' concerns about this aspect of the requirement.
a. Modifications to Proposed Requirement To Consider Liquidity Risk
Factors
    As discussed above, the liquidity risk factors we are adopting
today incorporate certain modifications to the proposed factors,\670\
and thus these modifications flow through with respect to a fund's
consideration of these factors in determining its highly liquid
investment minimum. We believe that the guidance that we provide in
section III.B.2 regarding a fund's consideration of these factors in
assessing its liquidity risk also is appropriate for a fund to take
into account when determining its highly liquid investment minimum.
With the exception of the recommendations about specific factors or
guidance discussed below, we did not receive comments on the proposed
factors or the guidance provided in the Proposing Release regarding
these factors.
---------------------------------------------------------------------------

    \670\ See supra section III.B.2.
---------------------------------------------------------------------------

    Some commenters recommended that the Commission confirm that funds
may consider and weigh the factors as they deem appropriate and
relevant for purposes of the proposed minimum requirement,\671\ and we
agree that a fund should give the most weight to the factors that it
deems most relevant for determining its highly liquid investment
minimum. Moreover, to the extent any liquidity risk assessment factor
is not applicable to a particular fund, the fund would not be required
to consider that factor in determining its highly liquid investment
minimum. We have therefore added the words ``as applicable'' in the
rule,\672\ and we note that, in this context, the phrase ``as
applicable'' is meant to refer to those factors that are relevant to a
fund's particular facts and circumstances. For example, a fund would
not be required to consider the use of borrowings for investment
purposes, as specified under rule 22e-4(b)(1)(i)(A), if that fund does
not engage in borrowing.\673\ Conversely, however, a fund that
maintains borrowing sources for investment purposes would be required
to consider the use of borrowings for investment purposes as specified
under the rule. The addition of ``as applicable'' should help respond
to commenters' concerns that codifying a list of required factors as a
provision of the proposed minimum requirement would ``create an overly
rigid structure and a one-size-fits-all approach that may result in
unnecessary focus on factors that are irrelevant to certain funds.''
\674\
---------------------------------------------------------------------------

    \671\ See, e.g., Oppenheimer Comment Letter; SIFMA Comment
Letter I.
    \672\ See rule 22e-4(b)(1)(iii)(A)(1); see also supra footnote
192 and accompanying text.
    \673\ See supra section III.B.2.
    \674\ See SIFMA Comment Letter I; see also e.g., Charles Schwab
Comment Letter; Oppenheimer Comment Letter (suggesting that it is
critically important that funds be afforded a certain amount of
flexibility in setting the fund's three-day liquid asset minimum).
---------------------------------------------------------------------------

    We continue to believe that a fund should consider both normal and
reasonably foreseeable stressed conditions in determining the amount of
highly liquid investments it will hold, based on the liquidity risk
assessment factors. However, in a change from the proposal, the rule
specifies that only those stressed conditions that are reasonably
foreseeable during the period until the next review of the highly
liquid investment minimum (emphasis added) should be considered when a
fund determines its highly liquid investment minimum.\675\ As discussed
above, some commenters expressed concern that the requirement for funds
to consider normal and reasonably foreseeable stressed conditions in
determining their three-day liquid asset minimum could suggest that all
funds should hold a high level of cash or other highly liquid assets at
all times, which could in turn encourage funds to maintain portfolio
liquidity levels that are disproportionate relative to their liquidity
risk.\676\ We believe that requiring consideration of only those
stressed conditions that are reasonably foreseeable during the period
until the next review of the highly liquid investment minimum should
address commenters' concerns and should help ensure that the highly
liquid investment minimum requirement leads funds to hold levels of
portfolio liquidity that are appropriate in light of their reasonably
anticipated liquidity risk.
---------------------------------------------------------------------------

    \675\ See rule 22e-4(b)(1)(iii)(A)(1); see also rule 22e-
4(b)(1)(iii)(A)(2) (requiring funds to periodically review, no less
frequently than annually, the highly liquid investment minimum).
    \676\ See supra footnote 667 and accompanying text. Commenters
argued that this, in turn, could lead to declines in fund
performance, which shareholders would experience in the form of
lower returns. See, e.g., Fidelity Comment Letter; Invesco Comment
Letter; J.P. Morgan Comment Letter; Wells Fargo Comment Letter.
---------------------------------------------------------------------------

    This change also responds to commenters' concerns about perceived
ambiguity in the length of time over which the proposed rule would have
required funds to forecast the effect of stressed conditions on the
liquidity risk factors.\677\ Under the final rule, funds are required
to periodically review, no less frequently than annually, their highly
liquid investment minimum. Thus, the requirement to consider stressed
conditions only to the extent they are reasonably foreseeable during
the period until the next review of the highly liquid investment
minimum, limits consideration of stressed conditions to whatever time
frame the fund has determined for review of its highly liquid
investment minimum, but no longer than one year. We note that if a fund
encounters extremely stressed market conditions, beyond those that were
reasonably foreseeable during the period until the next review of the
highly liquid investment minimum, that could increase its liquidity
risk to unusual levels, the fund should consider adjusting its highly
liquid investment minimum at that time, and indeed a fund should
generally review its highly liquid investment minimum more frequently
than annually if circumstances warrant.
---------------------------------------------------------------------------

    \677\ See, e.g., MFS Comment Letter (noting that the proposal
fails to indicate the period of time over which the estimate of
foreseeable redemptions is to be calculated); see also SIFMA Comment
Letter I (``We do not agree, however, that in making their Highly
Liquid Asset Target determinations, funds should be required to
forecast the timing, severity or potential impact of stressed market
conditions or other events affecting the fund that have occurred in
the past but for which there is no reasonable way to accurately
predict their recurrence.'').

---------------------------------------------------------------------------

b. Role of Liquidity Risk Factors in Determining the Highly Liquid
Investment Minimum
    As noted above, rule 22e-4 requires a fund to consider the
liquidity risk factors set forth in the rule, as applicable, in
determining its highly liquid investment minimum. In summary, a fund
must consider, as applicable, its: (i) Investment strategy and
portfolio liquidity during normal conditions, and during stressed
conditions to the extent such conditions are reasonably foreseeable
during the period until the next review of the highly liquid investment
minimum; (ii) short-term and long-term cash flow projections during
normal conditions, and during stressed conditions to the extent such
conditions are reasonably foreseeable during the period until the next
review of the highly liquid investment minimum; and (iii) holdings of
cash and cash equivalents, as well as borrowing arrangements and other
funding sources.\678\ In addition to these factors, an ETF also must
consider, as applicable: (i) The relationship between the ETF's
portfolio liquidity and the way in which, and the prices and spreads at
which, ETF shares trade, including the efficiency of the arbitrage
function and the level of active participation by market participants
(including authorized participants); and (ii) the effect of the
composition of baskets on the overall liquidity of the ETF's
portfolio.\679\
---------------------------------------------------------------------------

    \678\ Rule 22e-4(b)(1)(i)(A)-(C); rule 22e-4(b)(1)(iii)(A)(1).
    \679\ Rule 22e-4(b)(1)(i)(D); rule 22e-4(b)(1)(iii)(A)(1); see
also infra section III.J. (discussing liquidity risk management
program elements tailored to ETFs).
---------------------------------------------------------------------------

    With respect to a fund's consideration of its investment strategy
and portfolio liquidity in determining its highly liquid investment
minimum, we continue to believe that the less liquid a fund's overall
portfolio investments are, the higher a fund may want to establish its
highly liquid investment minimum. Similarly, funds with certain
investment strategies that typically have had greater volatility of
flows than other investment strategies--such as alternative funds and
emerging market debt funds--would generally need highly liquid
investment minimums that are higher than funds whose strategies tend to
entail less flow volatility. For funds that use borrowings for
investment purposes and derivatives, we continue to believe that, all
else equal, a fund with a leveraged strategy (e.g., a fund with
leverage through bank borrowings or that has significant fixed
obligations to derivatives counterparties) generally would need a
highly liquid investment minimum that is higher than a fund that does
not.\680\ Similarly, when setting the fund's highly liquid investment
minimum, we believe a fund that has or expects to have a significant
amount of highly liquid investments segregated to cover derivatives
transactions or pledged to satisfy margin requirements in connection
with derivatives transactions should take into account the fact that
such segregated or pledged highly liquid investments may not be
available to meet redemptions. However, this guidance is not meant to
suggest that a fund should only, or primarily, use highly liquid
investments to meet shareholder redemptions. Rather, in the examples
provided in this paragraph, we believe that holding a relatively high
level of assets that are highly liquid investments would both support a
fund in meeting redemption requests in a manner that does not dilute
non-redeeming shareholders, and assist the fund in readjusting its
portfolio as necessary to handle stressed conditions, weathering
periods of heightened volatility, and managing its obligations to
derivatives counterparties.
---------------------------------------------------------------------------

    \680\ See Proposing Release, supra footnote 9, at paragraphs
accompanying n.339. As discussed in the Proposing Release, we
believe that a leveraged fund has an increased risk that it will be
unable to meet redemptions and an increased risk of investor
dilution compared to an equivalent fund with no leverage. For
example, a fund with leverage through bank borrowings may have to
meet margin calls if a security the fund provided to the bank to
secure the loan declines in value. Such margin calls can render
highly liquid portfolio assets unavailable to meet investor
redemptions, which can increase dilution and the risk the fund will
be unable to meet redemptions.
     Similarly, a fund that has significant fixed obligations to
derivatives counterparties (for example, from a total return swap or
writing credit default swaps) must pay out on these obligations when
due, even if it means selling the fund's more liquid, high quality
assets to raise cash. See, e.g., OppenheimerFunds Release, supra
footnote 223.
---------------------------------------------------------------------------

    Regarding a fund's cash flow projections, we continue to believe
that the Commission's cash flow guidance considerations could be useful
to a fund in setting its highly liquid investment minimum.\681\ We
generally expect that a fund would evaluate the Commission's guidance
on these considerations and determine whether each would be useful and
relevant in setting the fund's highly liquid investment minimum. In
addition, a fund may wish to consider employing some form of stress
testing \682\ or consider specific historical redemption scenarios in
determining its highly liquid investment minimum.
---------------------------------------------------------------------------

    \681\ See supra section III.B.2.b. These five guidance
considerations include: (i) The size, frequency, and volatility of
historical purchases and redemptions of fund shares during normal
and reasonably foreseeable stressed periods; (ii) the fund's
redemption policies; (iii) the fund's shareholder ownership
concentration; (iv) the fund's distribution channels; and (v) the
degree of certainty associated with the fund's short-term and long-
term cash flow projections.
    \682\ See supra footnote 196 and accompanying text.
---------------------------------------------------------------------------

    Each of the cash flow guidance considerations--either standing
alone, but especially viewed in combination with one another--are
potentially significant features that could materially affect the risk
of significant redemptions and thus could influence a fund's
determination of its highly liquid investment minimum. For example, a
fund with a concentrated shareholder base has a high risk that only one
or two shareholders deciding to redeem can cause the fund to sell a
significant amount of assets, which depending on the liquidity of the
fund's portfolio and how it meets those redemptions, can dilute
remaining shareholders. Similarly, a fund whose redemption policy is to
satisfy all redemptions on a next business day basis (T + 1) or that is
sold through distribution channels that historically attract investors
with more volatile and/or unpredictable flows also should consider
setting a higher minimum level for its assets that are highly liquid
investments than a fund that, all else equal, does not face these
risks.
    In setting a highly liquid investment minimum, a fund should
consider the degree of certainty associated with the fund's short-term
and long-term cash flow projections. Projections may only be as good as
the extent and quality of information that informs them. For example,
if a fund does not have substantial visibility into its shareholder
base (e.g., because the fund's shares are principally sold through
intermediaries that do not provide shareholder transparency) or if a
fund is uncertain about changing market conditions which are likely to
materially affect the fund's level of net redemptions, it may make
projections but be quite uncertain about the reliability of those
projections. In these circumstances, a fund should consider setting its
highly liquid investment minimum to reflect this uncertainty, for
example, by providing a cushion or multiple of its cash flow
projections in the event realized net redemptions are significantly
higher.
    One commenter objected that shareholder ownership concentration,
which is discussed in this Release as a guidance factor that could be
used in evaluating cash flows (but in the proposal would have been
required to be considered in analyzing a fund's cash flow projections),
should not be a

determinative consideration for a fund in establishing its appropriate
level of relatively liquid assets.\683\ This commenter expressed
concern that ``accentuating the significance of this sub-factor in the
context of new or recently launched funds, which may have a small
number of shareholders relative to more established funds, could have a
severe anti-competitive effect and create an unwarranted barrier to the
introduction of new funds.'' We agree that emphasizing shareholder
concentration could lead new funds to increase their holdings of
relatively liquid investments. However, we note that substantial
shareholder concentration, even for new or recently launched funds,
could give rise to significant liquidity risk, and thus this
consideration should not be discounted when a fund whose investor base
is significantly concentrated determines its highly liquid investment
minimum.\684\ New or recently launched funds that have a concentrated
shareholder base should consider disclosing the risk of redemption by
one or more such shareholders in the fund's prospectus.\685\ To the
extent that a new fund's shareholder base becomes significantly less
concentrated as the fund matures, the fund may wish to take this into
consideration in reviewing its highly liquid investment minimum and
adjusting it as it determines appropriate.
---------------------------------------------------------------------------

    \683\ See SIFMA Comment Letter I.
    \684\ As discussed above, a fund may also take into account the
types of shareholders in the fund and whether those shareholders
share common investment goals affecting redemption frequency and
timing. Additionally, a fund may take into account other liquidity
risk management tools available to it, such as redemption fees, when
determining its highly liquid investment minimum.
    \685\ See SIFMA Comment Letter I (suggesting that the Commission
encourage such prospectus disclosure). We recognize that other
factors, such as the size of a fund's positions and the liquidity of
those positions, could impact the extent to which this risk could
affect the fund.
---------------------------------------------------------------------------

    With respect to a fund's consideration of its holdings of cash and
cash equivalents in determining its highly liquid investment minimum,
we continue to believe that these holdings may provide funds with
important flexibility to manage their liquidity risks. Our staff has
observed that it is relatively common for fund complexes to target a
minimum amount of cash or cash equivalent holdings in the fund, with
the assumption that cash and cash equivalent holdings would allow the
fund to meet redemptions in a stressed period without realizing
significant discounts to its holdings' carrying values when they are
sold. Holding cash or cash equivalents also could readily permit funds
to rebalance or otherwise adjust a portfolio's composition in order to
manage liquidity risk. Similarly, the availability of a line of credit
or other funding sources to meet redemptions could assist a fund in
managing liquidity risk, although as discussed below, depending on the
nature of use, the use of a line of credit could raise other
issues.\686\ To the extent that a fund determines that any of these
considerations could indicate decreased liquidity risk, these
considerations could provide important inputs regarding the level that
the fund deems appropriate for its highly liquid investment minimum.
---------------------------------------------------------------------------

    \686\ See infra footnote 688 and accompanying text.
---------------------------------------------------------------------------

    Certain commenters indicated that the Commission should permit a
fund to reduce its required holdings of relatively liquid assets by the
amount of other sources of liquidity available to the fund, such as a
committed line of credit.\687\ Under these commenters' views, if a fund
were to determine that its highly liquid investment minimum would
typically be x% of the fund's net assets, a fund with a committed line
of credit representing y% of the fund's net assets should be able to
reduce its highly liquid investment minimum to x% minus y% of the
fund's net assets. We disagree with this approach for several reasons.
First, we believe that a mechanical subtraction of the amount of a
credit line available to a fund from the fund's highly liquid
investment minimum is inappropriate under circumstances in which all or
part of the line of credit is not guaranteed to be available to a
fund--for example, because it is a committed line of credit that may be
shared among other members of the fund family. Even if the credit
facility was committed just to the fund, the amount ultimately
available could depend on the financial health of the institution
providing the facility, as well as the terms and conditions of the
facility. Finally, as discussed in the Proposing Release, while a line
of credit can facilitate a fund's ability to meet unexpected
redemptions and can be taken into consideration when determining its
highly liquid investment minimum, we continue to believe that liquidity
risk management is better conducted primarily through construction of a
fund's portfolio.\688\
---------------------------------------------------------------------------

    \687\ See, e.g., Cohen & Steers Comment Letter; Oppenheimer
Comment Letter.
    \688\ See Proposing Release, supra footnote 9, at section
III.C.3; see also, e.g., HSBC Comment Letter (``The degree to which
a fund employs leverage can have a material impact on its liquidity
demands, particularly during periods of market stress. As such,
attempts to model liquidity risk should incorporate an assessment of
leverage and the extent to which this might intensify liquidity
demands for a given fund during different scenarios compared to
unleveraged funds.''); Nuveen FSOC Notice Comment Letter, supra
footnote 85 (``Funds without credit lines face the possibility of
not being able to sell sufficient assets to raise cash to fund
redemption requests, or having to sell assets at significantly
discounted values. To the extent that a fund draws on a credit line
to meet net redemptions (and thus temporarily leverages itself), it
increases its market risk at a time when markets are stressed. While
this can be potentially beneficial to long-term performance if the
asset class recovers, it increases the risk of loss to remaining
shareholders if markets continue to weaken.'').
---------------------------------------------------------------------------

    As with the proposed three-day liquid asset minimum requirement, a
fund would be required to maintain a written record of how its highly
liquid investment minimum was determined, including an assessment of
each of the factors.\689\ This would permit our examination staff to
ascertain that funds are indeed considering the required factors, as
applicable. As discussed in the Proposing Release, we continue to
generally believe that it would be extremely difficult to conclude,
based on the factors that a fund would be required to consider, that a
highly liquid investment minimum of zero would be appropriate.\690\
---------------------------------------------------------------------------

    \689\ See rule 22e-4(b)(3)(iii); see also infra section III.I.
    \690\ See Proposing Release, supra footnote 9, at paragraphs
accompanying and following n.341.
---------------------------------------------------------------------------

3. Highly Liquid Investment Minimum Shortfall Policies and Procedures
    Under rule 22e-4, a fund will be required to adopt specific
policies and procedures for responding to a shortfall in the fund's
assets that are highly liquid investments below its highly liquid
investment minimum (for purposes of this section, a fund's ``shortfall
policies and procedures''). A fund's shortfall policies and procedures,
as described in more detail below, must include reporting to the fund's
board of directors no later than the board's next regularly scheduled
meeting with a brief explanation of the causes of the shortfall, the
extent of the shortfall, and any actions taken in response.\691\ Also,
a fund's shortfall policies and procedures must include reporting
within one business day to the fund's board if a shortfall lasts more
than seven consecutive calendar days, including an explanation of how
the fund plans to restore its minimum within a reasonable period of
time.\692\
---------------------------------------------------------------------------

    \691\ See rule 22e-4(b)(1)(iii)(A)(3).
    \692\ See id.
---------------------------------------------------------------------------

a. Shortfall Policies and Procedures Requirement
    Rule 22e-4 as proposed did not include the requirement for a fund
to adopt shortfall policies and procedures. This requirement replaces
the proposed prohibition against acquiring any asset

other than a three-day liquid asset if a fund's holdings of three-day
liquid assets were to drop below its three-day liquid asset minimum
(for purposes of this section, the ``proposed acquisition
limit'').\693\ As discussed above, commenters expressed concerns that
the proposed acquisition limit could have adverse effects on funds,
their shareholders, and the markets in which funds operate.
Specifically, commenters cautioned that shareholder redemptions could
increase if shareholders observe that a large redemption has taken
place and assume that the fund will not be able to effectively employ
its investment strategy due to the proposed prohibition on acquiring
any assets that are not three-day liquid assets.\694\ Commenters
suggested that this, in turn, could incentivize shareholders to redeem
quickly in times of stress, which could spark additional redemptions
from funds in stressed periods. Some commenters also argued that the
proposed acquisition limit could lead index funds to hold a level of
relatively liquid assets that causes them to deviate from the
construction of their indices \695\ and could cause funds that are
managed relative to a benchmark to experience higher tracking
error.\696\ Commenters also maintained that the proposed acquisition
limit could impair actively managed funds to the extent that it could
limit portfolio managers' discretion to purchase assets that they
believe would maximize funds' returns.\697\
---------------------------------------------------------------------------

    \693\ See proposed rule 22e-4(b)(2)(iv)(C).
    \694\ See, e.g., BlackRock Comment Letter.
    \695\ See, e.g., Invesco Comment Letter; Dechert Comment Letter;
Oppenheimer Comment Letter.
    \696\ See, e.g., HSBC Comment Letter; ICI I Comment Letter.
    \697\ See, e.g., PIMCO Comment Letter; ICI I Comment Letter;
Federated Comment Letter.
---------------------------------------------------------------------------

    In addition, commenters argued that the proposed acquisition limit
could effectively prevent funds from holding or acquiring favorable,
but relatively less liquid, assets under certain circumstances, which
could intensify market stress as well as adversely affect a fund's
NAV.\698\ For example, some commenters suggested that a fund whose
three-day liquid asset holdings were to fall below its minimum could
feel pressure to sell less liquid assets in order to replenish its
three-day liquid assets, which could lead to excessive sales of less
liquid assets during times of market stress that could adversely affect
the fund's NAV.\699\ Relatedly, commenters suggested that the proposed
acquisition limit could produce harmful market effects if it were to
significantly increase the demand for relatively liquid assets, which
could conversely decrease demand for other asset types (making them
less liquid) and exacerbate market volatility.\700\ Commenters
expressed concern that any ``herding'' behavior that could result from
the proposed acquisition limit could become especially pronounced
during stressed periods.\701\ Commenters also argued that the proposed
acquisition limit could prevent a fund manager from purchasing certain
investments that it views as undervalued in a downturn, when the fund's
holdings of three-day liquid assets are at or below the fund's
minimum.\702\ They contended that this in turn could reduce the fund's
universe of potential investments and ability to invest in contrarian
and countercyclical ways,\703\ which could eliminate a potential pool
of buyers and thus could exacerbate an already stressed
environment.\704\
---------------------------------------------------------------------------

    \698\ See, e.g., BlackRock Comment Letter; SIFMA I Comment
Letter; Wells Fargo Comment Letter.
    \699\ See, e.g., Oppenheimer Comment Letter.
    \700\ See, e.g., Invesco Comment Letter; Cohen & Steers Comment
Letter; ICI Comment Letter I; Wells Fargo Comment Letter.
    \701\ See, e.g., ICI Comment Letter I; Wellington Comment Letter
II.
    \702\ See, e.g., ICI Comment Letter I.
    \703\ See, e.g., BlackRock Comment Letter; ICI Comment Letter I;
Wells Fargo Comment Letter.
    \704\ See, e.g., SIFMA Comment Letter I; Invesco Comment Letter
---------------------------------------------------------------------------

    A significant number of commenters suggested that the Commission
adopt a liquid asset target in lieu of the proposed three-day liquid
asset minimum requirement--indeed, this was the most common alternative
suggestion to the proposed three-day liquid asset minimum
requirement.\705\ One primary distinction between the target
requirements that commenters recommended and the proposed three-day
liquid asset minimum requirement is that a target requirement would not
prohibit a fund from acquiring certain assets if a fund's holdings of
relatively liquid assets were to fall below the target. Instead, some
commenters stated that a fund should have a reasonable period to
respond to a shortfall of relatively liquid assets below the fund's
target, and/or that any such shortfalls must be reported to the fund's
board.\706\
---------------------------------------------------------------------------

    \705\ See, e.g., supra footnote 653 and accompanying text; see
also infra section IV.C (discussing other reasonable alternatives to
the highly liquid investment minimum requirement).
    \706\ See, e.g., Invesco Comment Letter; PIMCO Comment Letter;
Federated Comment Letter; J.P. Morgan Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that fund shareholders' interests are
generally best served when the percentage of a fund's assets invested
in relatively liquid investments is at (or above) the level deemed
appropriate by the fund.\707\ The highly liquid investment minimum
requirement we are adopting would not prohibit a fund from acquiring
assets other than highly liquid investments when a fund's highly liquid
investments fall below its minimum. However, we believe that the
shortfall policies and procedures requirement we are adopting--which
replaces the proposed acquisition limit--provides flexibility while
also promoting effective liquidity management practices. We believe
this requirement also responds to concerns about a flat prohibition
against purchasing certain assets when the fund's assets that are
highly liquid investments drop below a certain level.
---------------------------------------------------------------------------

    \707\ See Proposing Release, supra footnote 9, at n.346 and
accompanying text.
---------------------------------------------------------------------------

    Additionally, we believe that the shortfall policies and procedures
requirement responds appropriately to commenters' concerns that there
could be appropriate reasons for a fund to acquire an investment other
than a highly liquid investment if a fund were to fall below its
minimum. The final highly liquid investment minimum requirement will
require that funds determine a level of assets that are highly liquid
investments designed to help them manage the fund through stressed
conditions or opportunistically readjust their portfolios, while
permitting a fund's portfolio liquidity to fall below this level when
determined appropriate from a risk management perspective or on account
of extenuating circumstances. The shortfall policies and procedures
requirement, including the reporting requirement, is meant to foster
discussion among the fund's management (and board) if its assets that
are highly liquid investments fall below the level the fund determined
to be an appropriate minimum. We further believe that the final highly
liquid investment minimum requirement appropriately responds to
commenters' concerns that the proposed acquisition limit could restrict
funds' ability to meet their principal investment strategies, to the
detriment of fund investors. The final requirement provides fund
managers more leeway than the proposed requirement to structure and
modify their portfolios because--as would be the case in the target
requirement commenters suggested--fund managers would not be prevented
from purchasing certain assets when a fund's holdings of assets that
are highly liquid investments drop below its highly liquid investment
minimum.
    The highly liquid investment minimum requirement we are adopting,
together with the shortfall policies and

procedures requirement, also responds to commenters' concerns that the
proposed acquisition limit could exacerbate potential market stresses
and lead to other harmful market effects. Under the final rule, a fund
that falls below its highly liquid investment minimum would not be
restricted to acquiring only highly liquid investments, if acquiring
other investments were consistent with the fund's shortfall policies
and procedures. Also, as discussed above, the requirement that a fund
determine its highly liquid investment minimum taking into account only
those stressed conditions that are reasonably foreseeable during the
period until the next review of the highly liquid investment minimum
should decrease the probability that a fund could overweight its assets
that are highly liquid investments relative to its liquidity risk. This
also, in turn, should lessen demand for highly liquid investments
compared to the possible market effects of the proposed requirement.
    Finally, we believe that the final highly liquid investment minimum
requirement, in conjunction with the shortfall policies and procedures
requirement, will help to mitigate some of the operational burdens that
commenters argued would accompany the proposal,\708\ while continuing
to advance the Commission's goals. We note that the highly liquid
investment minimum requirement will involve monitoring a fund's
portfolio investments' liquidity for compliance. We recognize that this
monitoring may result in operational costs, which could be greater for
funds with multiple sub-advisers to the extent that these funds would
need to build or otherwise implement systems to coordinate portfolio
liquidity information provided by each sub-adviser.\709\ However, we
expect that the operational costs associated with the final highly
liquid investment minimum requirement would be significantly less
compared to the proposal, which would have entailed the additional
costs of building systems that would bar the purchase of less liquid
investments if the fund were to fall below its minimum. We understand
that some fund complexes today already track a liquid asset minimum or
target, and for these funds, operational costs associated with the
final minimum requirement would only entail adjustments to their
current processes and not the costs of an entirely new systems build-
out.
---------------------------------------------------------------------------

    \708\ See, e.g., Federated Comment Letter (suggesting that the
proposed requirement could present significant operational and
technological challenges because a fund's trade order management
system would need to maintain the liquidity classification for each
security in order to accurately monitor compliance with the fund's
three-day liquid asset minimum); ICI Comment Letter I (noting that
the proposed requirement would raise operational difficulties for
funds with multiple sub-advisers because compliance would
necessitate consideration of portfolio assets' liquidity at the fund
level, and thus the proposal would require a significant amount of
coordination among sub-advisers).
    \709\ See also infra paragraph accompanying footnote 818
(discussing the coordination of liquidity risk management efforts
undertaken by various service providers, including a fund's sub-
adviser(s)).
---------------------------------------------------------------------------

b. Operation of Shortfall Policies and Procedures Requirement
    Rule 22e-4 provides flexibility as to the particular shortfall
policies and procedures a fund may adopt because we believe that
different facts and circumstances could result in different funds
taking different approaches to address a decline in assets that are
highly liquid investments.\710\ We also recognize that it may be
difficult to contemplate or specify all appropriate factors to consider
(or their weighting) in advance of a shortfall, and that part of the
decision process requires an evaluation of the current stress event and
a determination of whether it is likely to persist (and for how long).
Nonetheless, a fund's shortfall policies and procedures could specify
some of the actions that a fund could consider taking to respond to a
highly liquid investment minimum shortfall under different conditions,
as well as market- and fund-specific circumstances that could shape a
fund's response to a particular shortfall occasion. For example, the
policies and procedures could outline some of the circumstances under
which it could be appropriate for a fund to purchase assets that are
not highly liquid investments, despite being below its minimum. If, for
example, the fund reasonably expected inflows in the near future (e.g.,
from a retirement plan platform), it may determine it is acceptable to
pursue an attractive buying opportunity despite a decline below the
fund's highly liquid investment minimum that it expects to be short-
term. It also could be appropriate, for example, for a fund to consider
selling certain relatively less liquid holdings over a period of time
and investing some of the proceeds in highly liquid investments.
---------------------------------------------------------------------------

    \710\ For example, a fund may handle a shortfall due to changes
in market conditions differently than a shortfall due to increased
redemptions.
---------------------------------------------------------------------------

    Similarly, as part of its shortfall policies and procedures, a fund
could set forth how it would set out a time frame by which it plans to
bring its assets that are highly liquid investments back up to the
level of its highly liquid investment minimum.\711\ If a fund
encounters highly liquid investment minimum shortfalls regularly, a
fund's liquidity risk management program administrator, potentially
together with the fund's broader risk management function, should
consider whether the fund's risk management policies and procedures
should be modified. We note that a fund's shortfall policies and
procedures could, but will not be required to, specify the persons who
will typically determine how, if at all, to respond to a shortfall (for
example, the person designated by the board to administer the fund's
liquidity risk management program, in conjunction with the fund's risk
managers and portfolio managers).
---------------------------------------------------------------------------

    \711\ If a fund's highly liquid investment minimum shortfall
lasts more than seven consecutive calendar days, reporting to the
fund's board within one business day is required, including an
explanation of how the fund plans to restore its minimum within a
reasonable period of time. See rule 22e-4(b)(1)(iii)(A)(3).
---------------------------------------------------------------------------

    As discussed below, although we are not requiring a fund's board to
specifically approve its highly liquid investment minimum, we continue
to believe that the board should play an oversight role with respect to
the minimum.\712\ A requirement to inform the board when a fund drops
below its highly liquid investment minimum, as well as the
circumstances leading to the fund's highly liquid investment minimum
shortfall and actions taken in response, will permit the board better
to understand circumstances that may give rise to heightened liquidity
risk. It also will provide important context for the board in
evaluating the effectiveness of the fund's highly liquid investment
minimum and the fund's liquidity risk management program generally.
Many commenters suggested that the Commission should adopt a board
reporting requirement when a fund's holdings of relatively liquid
assets drop below the level that the fund has generally targeted as
appropriate.\713\ Rule 22e-4 as adopted generally reflects these
suggestions.
---------------------------------------------------------------------------

    \712\ See infra section III.H.3.
    \713\ See, e.g., J.P. Morgan Comment Letter (suggesting a breach
would necessitate a report to the board); SIFMA I Comment Letter
(suggesting a ``highly liquid asset target'' and noting that
``[i]nstances where a fund dipped below its target percentage
[could] be reported to the fund board with an explanation from
management as to why the fund dipped below its target and any
resulting impact on the fund's liquidity risk profile''); Invesco
Comment Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

    As fund boards are charged with oversight and not day-to-day
management of funds' liquidity risk, we

believe that it is appropriate not to require that the fund's board be
informed that the fund has dropped below its highly liquid investment
minimum immediately when this occurs. Thus, rule 22e-4 requires that a
fund's board be informed of a highly liquid investment minimum
shortfall at the board's next regularly scheduled meeting.\714\ If a
fund were to drop below its highly liquid investment minimum multiple
times prior to the next regularly scheduled board meeting, fund
management could provide a single report to the board at that meeting
discussing each of these occurrences.
---------------------------------------------------------------------------

    \714\ See rule 22e-4(b)(1)(iii)(A)(3).
---------------------------------------------------------------------------

    However, we believe that when a fund's assets that are highly
liquid investments are below its minimum for an extended period of
time, this could indicate especially heightened liquidity risk, and
thus under these circumstances it is appropriate to report a highly
liquid investment minimum shortfall to the board within a shorter time
frame. We are therefore adopting the requirement for a fund to report
to its board of directors within one business day if its shortfall
lasts longer than seven consecutive calendar days. Rule 22e-4 requires
that this accelerated reporting include an explanation of how the fund
plans to restore the fund's highly liquid investment minimum within a
``reasonable'' period of time. Fund management generally should take
into account the fund's level of liquidity risk, as well as the facts
and circumstances leading to the highly liquid investment minimum
shortfall, in determining a reasonable time for returning the fund's
assets that are highly liquid investments to the fund's minimum level.
4. Periodic Review of Highly Liquid Investment Minimum
    Rule 22e-4 requires a fund to periodically review, no less
frequently than annually, the fund's highly liquid investment
minimum.\715\ The proposed rule also included a periodic review
requirement with respect to the proposed three-day liquid asset
minimum, but instead of an annual minimum review requirement, the
proposed rule would have required that the periodic review be conducted
at least semi-annually.\716\ We requested comment on this proposed
review requirement generally, including the proposed minimum frequency
of a fund's review. We received few comments on the proposed review
requirement separate from general comments on the proposed three-day
liquid asset minimum, although we received general support for a review
requirement concerning a fund's target level of liquid assets.\717\
---------------------------------------------------------------------------

    \715\ See rule 22e-4(b)(1)(iii)(A)(2).
    \716\ See proposed rule 22e-4(b)(2)(iv)(B).
    \717\ See, e.g., Oppenheimer Comment Letter.
---------------------------------------------------------------------------

    We continue to believe, as discussed in the Proposing Release, that
a periodic review is a central component of the highly liquid
investment minimum requirement we are adopting.\718\ Although we
proposed a minimum semi-annual review requirement, we are adopting a
minimum annual review requirement primarily in order to correlate the
minimum period for a fund's highly liquid investment minimum review
with the minimum period in which a fund's board would be required to
review a written report describing the adequacy of the fund's liquidity
risk management program, as described in more detail below.\719\ The
minimum annual review period also would correlate with the requirement
for a fund to review its liquidity risk periodically, but no less
frequently than annually.\720\ We believe that correlating the time
periods for each review requirement in rule 22e-4 will reduce
compliance burdens and mitigate potential confusion that could arise
from disparate review periods.
---------------------------------------------------------------------------

    \718\ See Proposing Release, supra footnote 9, at paragraph
following n.352.
    \719\ See infra section III.H.2.
    \720\ See supra section III.B.3.
---------------------------------------------------------------------------

    We also do not believe that extending the highly liquid investment
minimum review period from a minimum of semi-annually to annually will
adversely affect funds or investors as a fund generally should review
its highly liquid investment minimum more frequently if circumstances
warrant. Additionally, as discussed above, a fund's board will be
regularly informed of any highly liquid investment minimum shortfalls.
Thus, the board will be aware of any liquidity risk management issues
that might warrant reconsideration of the fund's risk management
procedures or its highly liquid investment minimum.
    Like the requirement for a fund to periodically review its
liquidity risk, the highly liquid investment minimum review requirement
will permit each fund to develop and adopt its own procedures for
conducting this review, taking into account the fund's particular facts
and circumstances. Additionally, we believe that in developing
comprehensive review procedures, a fund should generally consider
including procedures for evaluating regulatory, market-wide, and fund-
specific developments affecting the fund's liquidity risk. A fund also
may wish to adopt procedures specifying any circumstances that would
prompt more frequent review of the fund's highly liquid investment
minimum in addition to the annual minimum review required by the rule
(as well as the process for conducting more frequent reviews).\721\
---------------------------------------------------------------------------

    \721\ See, e.g., supra footnote 273 and accompanying paragraph;
see also supra section III.D.2.a.
---------------------------------------------------------------------------

5. Exclusion for Funds Primarily Holding Assets That Are Highly Liquid
Investments
    Rule 22e-4, as adopted, excludes a fund that primarily holds assets
that are highly liquid investments (a ``primarily highly liquid fund'')
from the requirements to determine and review a highly liquid
investment minimum, and to adopt shortfall policies and
procedures.\722\ We sought comment in the Proposing Release about
whether we should exclude certain funds from the proposed three-day
liquid asset minimum, such as funds that only invest in three-day
liquid assets. Commenters argued that a requirement for a fund to
determine a minimum portion of assets that it will invest in relatively
liquid assets is not suitable for funds that primarily invest in highly
liquid investment classes, given that a significant portion of the
fund's portfolio would be composed of such assets, and thus the
benefits associated with the three-day liquid asset minimum requirement
would not justify the burdens.\723\ After considering these comments
and reevaluating the costs and benefits of the proposal, we agree that
a primarily highly liquid fund should not be required to determine and
review a highly liquid investment minimum, or adopt shortfall policies
and procedures. We agree with commenters that the benefits associated
with these requirements as applied to

primarily highly liquid funds would not justify the associated
burdens.\724\
---------------------------------------------------------------------------

    \722\ See rule 22e-4(b)(1)(iii)(A).
    \723\ See, e.g., FSR Comment Letter (``[T]he Commission should
consider alternative regulatory approaches for index funds that seek
to track the performance of indices that are comprised of highly
liquid assets . . . .''); Dechert Comment Letter (citing Statement
on Open-End Fund Liquidity Risk Management Programs and Swing
Pricing, Commissioner Daniel M. Gallagher, Securities and Exchange
Commission (Sept. 22, 2015) (``Furthermore, for funds that invest
solely in assets that can be settled in three days or less--for
example, a fund that limits its investments to equity securities of
S&P 500 companies--the `three-day bucket' has no functional value.
Requiring such a fund to set its three-day bucket--whether it be at
1%, or 20% or even 90%--would be a meaningless exercise given that
the entire portfolio would be comprised of assets settled in three
days or less.'')).
    \724\ For more discussion about the costs and burdens associated
with the highly liquid investment minimum requirement, see infra
section IV.C.
---------------------------------------------------------------------------

    Under rule 22e-4, a fund whose portfolio consists primarily of
assets that are highly liquid investments would be excluded from the
highly liquid investment minimum requirement.\725\ Thus, we anticipate
that a primarily highly liquid fund would address in its liquidity risk
management program how it determines that it primarily holds assets
that are highly liquid investments, including, for example, how it
defines ``primarily.'' \726\ If a fund were to modify its investment
strategy or encounter strategy ``drift'' such that it no longer
primarily held assets that were highly liquid investments, it would be
required to adopt and review a highly liquid investment minimum, as
well as adopt and implement policies and procedures for responding to a
shortfall of the fund's assets that are highly liquid investments below
its minimum. We therefore believe that if a fund's investment strategy
is such that it cannot generally be predicted whether the fund would
primarily hold assets that are highly liquid investments (for example,
if the strategy were to entail a significant amount of volatility in
terms of the fund's portfolio liquidity), it would be difficult for the
fund's management to conclude that the fund should appropriately be
excluded from the highly liquid investment minimum requirement.
---------------------------------------------------------------------------

    \725\ See rule 22e-4(b)(1)(iii)(A). Money market funds and In-
Kind ETFs also would be excluded from the highly liquid investment
minimum requirement. See rule 22e-4(a)(5) (defining ``fund,'' for
purposes of the rule as excluding money market funds and In-Kind
ETFs).
    \726\ As noted by commenters, a highly liquid index fund would
be one example of a fund whose portfolio consists primarily (in the
case of these index funds, almost entirely) of assets that are
highly liquid investments. See supra footnote 723. In our view, if a
fund held less than 50% of its assets in highly liquid investments
it would be unlikely to qualify as ``primarily'' holding assets that
are highly liquid investments.
---------------------------------------------------------------------------

    For purposes of determining whether a fund primarily holds assets
that are highly liquid investments, a fund must exclude from its
calculations the percentage of the fund's assets that are highly liquid
investments that it has segregated to cover derivatives transactions
that the fund has classified as moderately liquid investments, less
liquid investments, and illiquid investments, or pledged to satisfy
margin requirements in connection with those derivatives transactions,
as determined pursuant to rule 22e-4(b)(1)(ii)(C).\727\ As discussed
above, when a fund's assets are segregated or pledged in connection
with derivatives transactions, they may not be immediately available
for liquidity risk management purposes.\728\ Thus, a fund whose assets
that are highly liquid investments that are segregated or pledged in
connection with derivatives transactions may not have the same level of
liquidity risk management flexibility as a fund whose assets are highly
liquid investments that are not similarly segregated or pledged. While
we believe that the benefits associated with the highly liquid
investment minimum requirements as applied to primarily highly liquid
funds would not justify associated burdens,\729\ we believe that this
consideration is appropriate only to the extent a fund primarily holds
assets that are highly liquid investments that are not segregated or
pledged in connection with derivatives transactions. As an extreme
example, if a fund were to hold only assets that were highly liquid
investments that were segregated or pledged in connection with
derivatives transactions and that were not themselves classified as
highly liquid investments, none of its assets that were highly liquid
investments would be available to meet redemptions or otherwise manage
liquidity risk. Thus, we believe that such fund's assets that were
highly liquid investments would likely not be commensurate with its
liquidity risk profile as determined with reference to the liquidity
risk factors it would be required to consider under rule 22e-4.\730\
---------------------------------------------------------------------------

    \727\ Rule 22e-4(b)(1)(iii)(B). As described above, a fund would
be permitted to exclude its derivatives transactions that are
classified as highly liquid investments in determining the
percentage of highly liquid investments that are segregated or
pledged assets because, since the fund could dispose of or exit
these derivatives transactions within three business days, the
associated segregated or pledged assets also would be available to
the fund for liquidity risk management purposes within three
business days. See supra text following footnote 493.
    \728\ See supra section III.C.3.c.
    \729\ See supra footnote 724 and accompanying text.
    \730\ See supra section III.D.2 (discussing the rule 22e-4
requirement for a fund to consider certain liquidity risk factors in
determining its highly liquid investment minimum).
---------------------------------------------------------------------------

6. Highly Liquid Investment Minimum Reporting and Disclosure
Requirements
    We proposed to amend Form N-PORT to add a new item that would
require each fund to disclose its three-day liquid asset minimum, as
such term was proposed to be defined in proposed rule 22e-4. One
commenter supported reporting the three-day liquid asset minimum in a
structured data format to the public as proposed.\731\ Certain other
commenters supported reporting the three-day liquid asset minimum in a
structured data format as proposed but to the Commission only.\732\ One
commenter did not support public disclosure of a fund's three-day
liquid asset minimum, as proposed, but said it would support public
disclosure of a fund's three-day liquid asset minimum if the Commission
adopted a recommended alternative to such definition.\733\
---------------------------------------------------------------------------

    \731\ See Charles Schwab Comment Letter (noting that information
about the fund's liquidity risk management program will be
particularly helpful to investors, as will disclosure of a fund's
overall liquidity picture and a fund's three-day liquid asset
minimum).
    \732\ See, e.g., CFA Comment Letter; Voya Comment Letter.
    \733\ See Vanguard Comment Letter.
---------------------------------------------------------------------------

    Some commenters, however, opposed public disclosure of both the
three-day liquid asset minimum as proposed and recommended alternatives
to the three-day liquid asset minimum. Commenters expressed concerns
that public disclosure could be misleading to investors, arguing that
any minimum reported on Form N-PORT would be subjective, presented
without context, and may not reflect a fund's actual portfolio
management approach at the time the data is being relied upon by
investors.\734\ Other commenters contended that public disclosure could
interfere with a fund's investment strategy and promote unwarranted,
and potentially destabilizing, redemption activity by fund
shareholders, especially during times of stress.\735\ One commenter
stated that public disclosure of a liquidity minimum would also give
undue emphasis to a single element of a fund's liquidity risk
management program and could potentially encourage third parties to use
a single numerical figure as a basis for comparing funds, further
encouraging undue reliance on the liquidity minimum figure by
investors.\736\ Certain other commenters expressed concern that public
disclosure could potentially expose a fund to predatory trading
activity if the fund is seen as vulnerable to liquidity risks or is
under stress.\737\ In addition, one commenter contended that
comparisons of three-day liquid asset minimums could result in
competitive pressures for relatively

uniform minimums among funds with similar investment strategies,
ultimately harming fund investors.\738\
---------------------------------------------------------------------------

    \734\ See, e.g., Eaton Vance Comment Letter I; J.P. Morgan
Comment Letter; NYC Bar Comment Letter; Voya Comment Letter.
    \735\ See, e.g., Eaton Vance Comment Letter I; J.P. Morgan
Comment Letter; Wells Fargo Comment Letter.
    \736\ See SIFMA Comment Letter I.
    \737\ See, e.g., Eaton Vance Comment Letter I; SIFMA Comment
Letter.
    \738\ See NYC Bar Comment Letter.
---------------------------------------------------------------------------

    We are persuaded by some of the concerns expressed by commenters
regarding the potential risks to funds and fund investors of public
reporting of a fund's three-day liquid asset minimum, as proposed, or
any alternative formulation, including a fund's highly liquid
investment minimum, as adopted today. In response to comments, we are
adopting amendments to require a fund to report its highly liquid
investment minimum on Form N-PORT to the Commission on a non-public
basis.\739\ We believe that the requirement that a fund report to its
board when the fund's assets that are highly liquid investments fall
below the fund's highly liquid investment minimum, discussed above, is
a more appropriate tool to assist fund boards in their oversight of
fund liquidity risks, thereby ultimately protecting shareholder
interests in the fund.\740\
---------------------------------------------------------------------------

    \739\ See General Instruction F of Form N-PORT.
    \740\ See supra section III.D.3.
---------------------------------------------------------------------------

    In light of the changes we are making to the way the highly liquid
investment minimum is established, the final modifications to Form N-
PORT require that if a fund's minimum has changed during the reporting
period, any prior minimums established by the fund during the reporting
period also be reported.\741\ Because, as discussed previously, we are
not requiring the fund's board to approve changes to the highly liquid
asset minimum, we believe it is important that any changes to the
minimum during a reporting period be included in Form N-PORT to help
mitigate the possibility of window dressing a fund's highly liquid
asset minimum at the end of the reporting period, and allow us to
monitor for changes to a fund's minimum. In addition, considering the
changes we have made to the way the minimum works from the proposal,
and consistent with the board and Commission reporting requirements we
are adopting relating to shortfalls of a fund's minimum, the final
amendments to Form N-PORT also require that if a fund is below its
minimum during the reporting period, a fund needs to report the number
of days it is below its minimum during the reporting period.\742\ We
believe that this reporting requirement will enhance our monitoring of
fund's compliance with the minimum and the board and Commission
reporting requirements contained elsewhere in rule 22e-4. These
additional reporting requirements also would be non-public, for the
same reasons discussed above.
---------------------------------------------------------------------------

    \741\ See Item B.7.c. of Form N-PORT.
    \742\ See Item B.7.b. of Form N-PORT.
---------------------------------------------------------------------------

    Overall, we believe that such board oversight together with
confidential reporting to the Commission is a regulatory approach that
balances commenters' concerns about certain adverse effects that could
arise from public reporting of liquid investment minimums with the need
for enhanced investor protections and meaningful information for
Commission regulatory oversight responsibilities. We believe that it is
neither necessary nor appropriate in the public interest or for the
protection of investors to make information regarding a fund's highly
liquid investment minimum publicly available at this time.\743\
---------------------------------------------------------------------------

    \743\ See section 45 of the Act, which provides, in summary,
that the information contained in any report or other document filed
with the Commission pursuant to the Act shall be made available to
the public, unless by rules and regulations upon its own motion, or
by order upon application, the Commission finds that public
disclosure is ``neither necessary nor appropriate in the public
interest or for the protection of investors.''
---------------------------------------------------------------------------

E. Limitation on Funds' Illiquid Investments

    Rule 22e-4 includes a limit on a fund's ability to acquire illiquid
investments. Specifically, the rule prohibits a fund from acquiring any
illiquid investment if, immediately after the acquisition, the fund
would have invested more than 15% of its net assets in illiquid
investments that are assets.\744\ The rule's 15% limit on funds'
illiquid investments applies to all funds (including In-Kind
ETFs).\745\ Additionally, as discussed below, a fund will be required
to notify its board, and confidentially the Commission, when its
illiquid investments that are assets exceed 15% of its net assets.
Moreover, the person(s) designated to administer the liquidity risk
management program must explain in a report to the board the extent and
causes of the occurrence, and how the fund plans to bring its illiquid
investments that are assets to or below 15% of its net assets within a
reasonable period of time.\746\ If the amount of the fund's illiquid
investments that are assets is still above 15% of its net assets 30
days from the occurrence (and at each consecutive 30 day period
thereafter), the board of directors, including a majority of its
independent directors,\747\ must assess whether the plan presented to
it continues to be in the best interest of the fund.
---------------------------------------------------------------------------

    \744\ Rule 22e-4(b)(1)(iv). Rule 22e-4(b)(1)(iv) refers to
investments that are ``assets'' to make clear that the 15% limit on
illiquid investments applies to investments with positive values.
Illiquid investments that have negative values should not be netted
against illiquid investments that have positive values when
calculating compliance with the 15% limit. Thus, only illiquid
investments that have positive values (i.e., ``assets'') should be
used in the numerator.
    \745\ See id.; see also rule 22e-4(a)(5) and (9) (defining the
terms ``fund'' and ``In-Kind ETF'' for purposes of the rule).
    \746\ Rule 22e-4(b)(1)(iv)(A).
    \747\ ``Independent directors'' as used herein refers to
directors who are not ``interested persons'' of a fund or In-Kind
ETF, as applicable, as that term is defined in section 2(a)(19) of
the Investment Company Act.
---------------------------------------------------------------------------

    The limitation on funds' illiquid investments is similar to the
limitation on ``15% standard assets'' in proposed rule 22e-4,\748\ in
that both requirements would limit the acquisition of assets that
cannot be sold or disposed of within seven days. However, there are
several key differences between the proposed and adopted requirements.
Specifically, the proposed rule would have had a fund identify 15%
standard assets in a process separate from the requirement to classify
portfolio assets' liquidity, whereas rule 22e-4 as adopted today
generally incorporates classification of portfolio investments as
illiquid into the process for classifying the liquidity of a fund's
portfolio investments generally. As discussed in sections III.C.1.b and
III.C.3.b above, a fund is required to take into account ``relevant
market, trading, and investment-specific considerations,'' and also is
required to consider market depth, in classifying an investment as
illiquid. Also as discussed above in section III.C.2.d, rule 22e-4
incorporates a modified value impact standard in the definition of
``illiquid investment'' from the value impact standard reflected in

the proposed definition of ``15% standard asset.''
---------------------------------------------------------------------------

    \748\ See Proposing Release, supra footnote 9, at section
III.C.4. Under the proposed rule, ``15% standard asset'' was defined
as ``an asset that may not be sold or disposed of in the ordinary
course of business within seven calendar days at approximately the
value ascribed to it by the fund.'' Proposed rule 22e-4(a)(4). For
purposes of this definition, a fund would not have needed to
consider the size of the fund's position in the asset or the number
of days associated with receipt of proceeds of sale or disposition
of the asset. Id.
    We note that, as proposed, the text of rule 22e-4 would have
limited the acquisition of 15% standard assets if, immediately after
the acquisition, the fund would have invested more than 15% of its
total assets (as opposed to net assets) in 15% standard assets. See
proposed rule 22e-4(b)(2)(iv)(D). This reference to ``total assets''
in the proposed rule text was intended to read ``net assets,'' as
was evident in the discussion of this rule provision in Proposing
Release, section III.C.4 (and elsewhere in the Proposing Release),
which consistently discussed the provision as limiting a fund's
acquisition of 15% standard assets if, immediately after the
acquisition, the fund would have invested more than 15% of its net
assets in 15% standard assets. Rule 22e-4 as adopted refers to ``net
assets'' instead of ``total assets.''
---------------------------------------------------------------------------

    The majority of commenters supported the codification of the
Commission's 15% guideline as proposed. Many commenters stated that the
15% guideline is an important investor protection measure and posited
that the guideline has proven to be a highly effective safeguard
against liquidity risk.\749\ One commenter specifically noted that
assets of open-end funds should be predominantly liquid and replacing
the guideline with a formal regulatory mandate would promote investor
protection.\750\ Another commenter viewed the 15% guideline as a clear
safeguard against liquidity risk that has the benefits of simplicity,
clarity, and easy administration.\751\ One commenter stated that
setting reasonable controls on, and monitoring the use of, illiquid
asset classes to ensure that they do not compromise the liquidity
offered to investors within the fund is an important element of
properly managing open-end funds.\752\ Finally, one commenter suggested
that the proposed codification of the 15% guideline would both increase
the likelihood that funds hold adequate liquid assets to meet
redemption requests without significant dilution and increase the
likelihood that a fund's portfolio is not concentrated in assets whose
liquidity is limited.\753\
---------------------------------------------------------------------------

    \749\ See, e.g., Cohen & Steers Comment Letter; Eaton Vance
Comment Letter I; FSR Comment Letter; LSTA Comment Letter.
    \750\ See State Street Comment Letter.
    \751\ See Better Markets Comment Letter.
    \752\ See BlackRock Comment Letter.
    \753\ See CRMC Comment Letter.
---------------------------------------------------------------------------

    In addition, several commenters supported a limit on the amount of
illiquid assets that can be held by a fund generally, but suggested
alternatives to how the 15% standard would operate or the proposed
definition of 15% standard assets.\754\ In fact, most commenters who
expressed concerns regarding the proposed 15% limit did so in the
context of suggesting alternatives to the proposal or the proposed
definition of ``15% standard asset.'' Multiple commenters who discussed
the proposed limit suggested that the Commission should harmonize its
codification of the existing 15% guideline with the proposed
requirement for a fund to classify the liquidity of its portfolio
assets generally (i.e., they suggested that illiquid assets be the
least liquid classification category).\755\ Some commenters suggested
that any limit on illiquid assets should not just limit the acquisition
of illiquid assets, but also should require the fund to adjust its
portfolio if it exceeds the 15% limit.\756\ Finally, some commenters
suggested that a fund be required to notify its board and the
Commission if it exceeds the 15% limit.\757\ All other comments on the
proposed limit were comments regarding the definition of ``15% standard
asset'' and are discussed above in section III.C.2.d.
---------------------------------------------------------------------------

    \754\ See, e.g., AFR Comment Letter; Blackrock Comment Letter;
Keefer Comment Letter; Wahh Comment Letter. In general, the comments
we received on the 15% standard did not specifically address the
amount of the limit; cf. footnote 761 and accompanying text.
    \755\ See, e.g., Eaton Vance Comment Letter I; Federated Comment
Letter; SIFMA Comment Letter I; Markit Comment Letter.
    \756\ See, e.g., Fidelity Comment Letter; Keefer Comment Letter;
Wahh Comment Letter. But see HSBC Comment Letter (arguing that
imposing a fixed time period in which holdings above the 15%
threshold must be divested would not be appropriate because it may
force sales at depressed prices to the detriment of investors).
    \757\ See BlackRock Comment Letter; ICI Comment Letter I; SIFMA
Comment Letter III.
---------------------------------------------------------------------------

    We agree with commenters who stated that codifying a limit on
funds' illiquid investments should be a central element of managing
open-end funds' liquidity risk, which in turn would further the
protection of investors. While we believe that the highly liquid
investment minimum requirement will increase the likelihood that each
fund holds adequate liquid assets to meet redemption requests without
significant dilution of remaining investors' interests in the fund, the
limit on illiquid investments also should increase the likelihood that
a fund's portfolio is not concentrated in investments whose liquidity
is extremely limited, and thus will serve as an across-the-board limit
on fund illiquidity. As discussed above, the Commission and staff have
in the past provided guidance in connection with the 15% guideline.
Today we are withdrawing this guidance along with the 15% guideline and
replacing it with new requirements for determining that an investment
is illiquid, as well as new guidance in this Release regarding these
requirements. We believe that the limit on illiquid investments that
are assets that we are adopting, together with the new definition of
``illiquid investments'' that encompasses additional elements for
determining that an investment is illiquid,\758\ provides a more
comprehensive framework for funds to evaluate the liquidity of their
investments.
---------------------------------------------------------------------------

    \758\ See supra section III.C.2.d.
---------------------------------------------------------------------------

    We also agree, as discussed in more detail in section III.C.2.d
above, that it is appropriate to harmonize the rule 22e-4 limit on
illiquid investments with the rule's broader liquidity classification
requirement by incorporating an illiquid investment category into the
classification requirement. We believe that this harmonization will
reduce confusion that could arise if we were to adopt requirements for
identifying illiquid investments that differed from the requirements
for classifying the liquidity of investments that are not
illiquid.\759\ Additionally, we believe the harmonization responds to
commenter concerns that, in practice, many funds believe very few of
their portfolio investments are subject to the 15% limit on illiquid
securities, since funds will be required to take into account
``relevant market, trading, and investment-specific considerations'' in
identifying illiquid investments and incorporate market depth
considerations as part of the rule's liquidity classification
requirement.\760\ A fund also will be required to consider a modified
value impact standard in determining if an investment is illiquid,
which as discussed above, we believe will help funds make more accurate
liquidity assessments, particularly for asset classes or investments
that are subject to intra-day price volatility.
---------------------------------------------------------------------------

    \759\ See supra footnotes 392-395 and accompanying text.
    \760\ See supra footnotes 399-401 and accompanying text.
---------------------------------------------------------------------------

    One commenter suggested that, if the Commission adopts requirements
that would expand the set of assets that is subject to the 15% limit on
illiquid assets, it could consider extending the limit beyond 15%, or
extending the time-to-sale period associated with the definition of
``illiquid asset'' beyond seven days, in order to limit market
disruptions.\761\ We have considered this suggestion and have decided
that it is not necessary.\762\ We continue to believe that 15% is an
appropriate limit on illiquid investments that are assets. The
compliance period we are adopting for rule 22e-4 will permit funds to
come into compliance with the revised 15% illiquid investment limit
while minimizing market disruptions.\763\
---------------------------------------------------------------------------

    \761\ See AFR Comment Letter.
    \762\ As noted above, no other commenters specifically addressed
the amount of the limit.
    \763\ See infra section III.M.1.
---------------------------------------------------------------------------

    In the proposal, we requested comment as to whether we should
require a fund to divest its assets in excess of the 15% limit or
whether we should limit the time period in which a fund can exceed the
15% limit. As noted above, some commenters suggested that the 15% limit
should be a maintenance test, rather than an acquisition test,
requiring the fund to adjust its portfolio if it exceeds the 15%

limit.\764\ Another commenter argued that imposing a fixed time period
in which holdings above the 15% threshold must be divested would not be
appropriate because it may force sales at depressed prices to the
detriment of investors.\765\ In addition, one commenter noted the
importance of ensuring oversight once a fund breaches the 15% limit and
that efforts are made to reduce the fund's illiquid asset holdings
(when possible).\766\
---------------------------------------------------------------------------

    \764\ See supra footnote 756 and accompanying text.
    \765\ See HSBC Comment Letter.
    \766\ See BlackRock Comment Letter; cf. PIMCO Comment Letter
(suggesting that, with respect to the proposed three day liquid
asset minimum, if a fund breaches the minimum, its manager should be
afforded a reasonable period of time to reposition the portfolio).
---------------------------------------------------------------------------

    We believe that requiring a fund to divest illiquid investments if
the fund's holdings of illiquid investments that are assets exceed 15%
of net assets--which, as suggested by a commenter, could result in the
fund needing to sell the illiquid investments at prices that
incorporate a significant discount to the investments' stated value, or
even at fire sale prices--could adversely affect shareholders and could
potentially negate the liquidity risk management benefits of the
illiquid investment limit. Therefore, under the final rule, a fund will
be prohibited from acquiring any illiquid investment if, immediately
after the acquisition, its illiquid investments that are assets would
exceed 15% of its net assets.\767\
---------------------------------------------------------------------------

    \767\ We recognize that some index funds currently implement
their strategies by using a full replication technique--i.e., by
investing in all of the component securities of an index. To the
extent an index tracked by an index fund would require a fund using
a full replication technique to invest more than 15% of its net
assets in illiquid investments that are assets, such fund could not
make those investments and would need to consider whether it should
continue to seek to track the performance of such index or whether
it should use a different investment technique, such as sampling, to
track the index.
---------------------------------------------------------------------------

    We further believe, however, that a fund should not be permitted to
exceed the 15% limit on illiquid investments for an extended period of
time without board oversight. Therefore, because we believe that if a
fund's illiquid investments that are assets exceed the 15% limit it
could indicate that the fund is encountering harmful liquidity
pressures, the final rule requires, as suggested by commenters,\768\
that a fund promptly report such occurrence to its board and the
Commission.\769\ Specifically, the final rule requires funds that hold
more than 15% of their net assets in illiquid investments that are
assets to report such an occurrence to their boards of directors within
one business day, including an explanation of the extent and causes of
the occurrence and how they plan to bring their illiquid investments
that are assets to or below 15% of their net assets within a reasonable
period of time.\770\ We also anticipate that if a fund exceeds the 15%
limit on illiquid investments that are assets at any point during the
year, the written report to the board of directors regarding the
adequacy and effectiveness of the liquidity risk management program
would discuss the breach of the limit and, if the fund is still
breaching the 15% limit at the time of the report, the plan to bring
the fund's illiquid investments that are assets to or below 15% of its
net assets within a reasonable period of time.\771\ In addition, if the
amount of the fund's illiquid investments that are assets is still
above 15% of its net assets 30 days from the occurrence (and at each
consecutive 30 day period thereafter), the fund's board of directors,
including a majority of directors who are not interested persons of the
fund, must assess whether the plan presented to it, as described above,
continues to be in the best interest of the fund or in kind ETF.\772\
We believe these requirements appropriately balance our concerns
regarding the overall liquidity of the fund's portfolio with the
potential adverse effects that the forced sale of illiquid investments
could have on a fund and its shareholders. These requirements should
not result in funds selling their illiquid investments at fire sale
prices or at inopportune times because such a sale would likely not be
in the best interests of a fund and its shareholders. However, we
believe that board oversight is important when a fund's illiquid
investments exceed 15% of its net assets for an extended period of
time.
---------------------------------------------------------------------------

    \768\ See supra footnote 757.
    \769\ See infra section III.H.4 (discussing board oversight of
the illiquid investment limit).
    \770\ Rule 22e-4(b)(1)(iv)(A); see also infra section III.H.4.
    \771\ See infra section III.H.2 (discussing the written report
to the board on the adequacy and effectiveness of the liquidity risk
management program); see also rule 22e-4(b)(2)(iii).
    \772\ See rule 22e-4(b)(1)(iv)(A) and (B).
---------------------------------------------------------------------------

    We acknowledge that requiring a board assessment of the
appropriateness of the fund's plan to decrease its level of illiquid
investments every 30 days a fund holds illiquid assets in excess of 15%
of its net assets may impose burdens on boards and funds. Nonetheless,
we believe that such a requirement is appropriate in light of the
serious consequences that can result when a fund's liquidity becomes
impaired or further deteriorates, particularly for extended periods of
time.\773\ We expect that this requirement will appropriately focus
boards and funds on resolving liquidity impairments in a reasonable
period of time and in the best interests of the fund and its
shareholders. In light of the risks attendant in holding larger
proportions of illiquid investments, we believe it is important that
the board is provided sufficient information and regular updates so
that it can make an informed judgment. Accordingly, we believe this
periodic reassessment requirement in the rule is appropriate.
---------------------------------------------------------------------------

    \773\ See, e.g., Discussion of liquidity issues associated with
the Third Avenue Focused Credit fund at n. 81.
---------------------------------------------------------------------------

    Additionally, as discussed in section III.M.2 below, a fund will be
required to confidentially notify the Commission when its illiquid
investments that are assets exceed 15% of its net assets. As discussed
below, reporting of this information will assist Commission staff in
its monitoring efforts of liquidity, including monitoring not only the
reporting fund but also funds that may have comparable characteristics
to the reporting fund and may be similarly affected by market events.
The percentage of the fund's holdings invested in illiquid investments
that are assets also will be disclosed on Form N-PORT to the public on
a quarterly basis, with a 60-day delay, as discussed in section III.C.6
above, which will lead to increased transparency of the fund's profile
regarding holdings of illiquid investments at particular points in
time.

F. Policies and Procedures Regarding Redemptions in Kind

    Many funds reserve the right to redeem their shares in-kind instead
of with cash.\774\ Mutual funds that reserve the right to redeem in
kind may use such redemptions to manage liquidity risk under
exceptional circumstances.\775\ While many funds

disclose that they have reserved the right to redeem in kind, most
funds often consider redemptions in kind to be a last resort or
emergency measure, and thus many do not have specific policies or
procedures in place governing such in-kind redemptions.\776\ Like the
proposal, the final rule requires a fund that engages in or reserves
the right to engage in in-kind redemptions to adopt and implement
written policies and procedures regarding in-kind redemptions as part
of the management of its liquidity risk.\777\ These policies and
procedures generally should address the process for redeeming in kind,
as well as the circumstances under which the fund would consider
redeeming in kind.
---------------------------------------------------------------------------

    \774\ See, e.g., Rule 18f-1 and Form N-18F-1 Adopting Release,
supra footnote 24 (stating that the definition of ``redeemable
security'' in section 2(a)(32) of the Investment Company Act ``has
traditionally been interpreted as giving the issuer the option of
redeeming its securities in cash or in kind.'').
    \775\ See Karen Damato,  `Redemptions in Kind' Become Effective
for Tax Management, Wall Street Journal (Mar. 10, 1999), available
at http://www.wsj.com/articles/SB921028092685519084 (```Redemptions
in kind' are typically viewed by fund managers as an emergency
measure, a step they could take to meet massive redemptions in the
midst of a market meltdown.''). Besides using in-kind redemptions as
an emergency measure to manage liquidity risk, funds may also use
in-kind redemptions for other reasons. For example, funds may wish
to redeem certain investors (particularly, large, institutional
investors) in kind, because in-kind redemptions could have a lower
tax impact on the fund than selling portfolio securities in order to
pay redemptions in cash. This, in turn, could benefit the remaining
shareholders in the fund. See, e.g., id. (``If a fund has to sell
appreciated stocks to pay a redeeming shareholder, it realizes
capital gains. Unless the fund has offsetting capital losses, those
gains are distributed as taxable income to all remaining fund
holders. By contrast, when funds distribute stocks from their
portfolios, there is no tax event for the continuing holders.'').
    \776\ See Proposing Release, supra footnote 9, at section
III.C.5
    \777\ Rule 22e-4(b)(v). This requirement also applies to In-Kind
ETFs that are subject to the tailored regime discussed below. Id.
---------------------------------------------------------------------------

    Multiple commenters welcomed efforts by the Commission to
facilitate funds' ability to use redemptions in kind and stated that
they considered redemptions in kind an important liquidity risk
management tool for allocating the cost of selling securities to meet
redemptions to redeeming investors.\778\ These commenters also
generally agreed that as part of a fund's management of its liquidity
risk, a fund should adopt and implement written policies and procedures
regarding in-kind redemptions.\779\ Commenters noted that there are
often logistical issues associated with paying in-kind redemptions, and
that this limits the availability of in-kind redemptions under many
circumstances.\780\ Commenters also noted that some shareholders are
generally unable or unwilling to receive in-kind redemptions, which may
limit its utility.\781\ These commenters agreed that requiring funds to
implement policies and procedures on in-kind redemptions in advance
would promote a focus on addressing any legal or operations issues
before the fund's use of redemptions in kind, thus making such
redemptions a more practical and effective liquidity management
tool.\782\
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    \778\ BlackRock Comment Letter (noting that redemptions in kind
allow costs to be externalized from the fund without the use of
mechanisms such as swing pricing).
    \779\ See, e.g., BlackRock Comment Letter; Invesco Comment
Letter.
    \780\ See, e.g., Invesco FSOC Notice Comment Letter, supra
footnote 248 (noting that while ``Invesco has on occasion exercised
rights to redeem in kind, in practice such rights are exercised
infrequently'').
    \781\ See Peter Fortune, Mutual Funds, Part I: Reshaping the
American Financial System, New England Econ. Rev. (July/Aug. 1997)
(``Fortune'') at 47 (``A fund redeeming in kind does so at the risk
of its reputation and future business . . .''), available at http://www.bostonfed.org/economic/neer/neer1997/neer497d.htm; Invesco
Comment Letter.
    \782\ ICI Comment Letter I; BlackRock Comment Letter.
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    Commenters also suggested that the Commission provide guidance on
the appropriate use of in-kind redemptions for funds.\783\ We expect
that effective fund policies and procedures on in-kind redemptions
would contemplate a variety of issues and circumstances. Well-designed
policies and procedures would likely address the particular
circumstances in which a fund might employ in-kind redemptions, for
example, detailing whether a fund would use in-kind redemptions at all
times, or only under stress, and what types of events may lead the fund
to use them. Such policies and procedures would also likely address
whether a fund would use in-kind redemptions for all redemption
requests or only for requests over a certain size.\784\
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    \783\ See, e.g., BlackRock Comment Letter.
    \784\ One commenter suggested that fund sponsors should consider
redemptions in kind if withdrawal requests exceed a certain
percentage of a fund's total assets. See BlackRock Comment Letter.
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    Funds may also wish to consider having policies and procedures that
address the ability of investors to receive in-kind redemptions,
potentially including different procedures for different shareholder
types. For example, the policies and procedures might provide that
retail shareholders (who may not be operationally equipped to receive
in-kind redemptions) may be provided cash redemptions, but that
institutional investors who may be able to receive such securities,
would be paid out in-kind under certain circumstances. These procedures
may also consider whether holdings through omnibus accounts pose any
unique issues that should be addressed. Well-designed policies and
procedures would likely also address potential operational issues with
providing in-kind redemptions to various kinds of investors, and plan
out methods for addressing such operational issues. These might include
notifying large shareholders that may be subject to redemptions in kind
and setting up securities transfer processes for those shareholders in
advance.
    Effective policies and procedures would also likely address how the
fund would determine which securities it would use in an in-kind
redemption (for example would it use illiquid or restricted
securities), or whether it plans to redeem securities in kind as a pro
rata ratio of the fund's securities holdings, or whether it would
redeem in a non-pro rata manner. For a fund that redeems pro rata,
policies and procedures might address how the fund plans in-kind
redemptions of odd lots or small lots of securities, and if a fund were
to do such odd lot transactions, how to process such transactions. They
may also consider how they would accomplish in-kind redemptions of
illiquid securities or securities that have restrictions on their
transferability, and the extent to which these securities would not be
redeemed in kind.
    If a fund chooses not to redeem in a pro rata manner, effective
policies and procedures would likely address that securities redeemed
are selected and distributed in a manner that is fair and does not
disadvantage either the redeeming shareholder or the remaining
investors in the fund. We caution that if a fund redeems an investor's
interests in a fund by transferring an unrepresentative set of
securities to the investor, this may raise questions of shareholder
discrimination and unfairness (as well as potentially cherry picking
and favoritism), which should be addressed in the fund's policies and
procedures. For example, policies and procedures could address how to
ensure that any securities that are redeemed in kind in a non-pro rata
manner are valued properly, to ensure that the securities transferred
represent the proportionate share of the fund NAV.\785\ They might also
address how the fund would determine that shareholders are treated
fairly, and are not redeemed with securities the fund deems undesirable
or securities that have significant tax consequences. Relatedly, the
policies and procedures may also address how the fund evaluates the tax
consequences to the fund and the redeeming shareholder of distributing
certain securities, for example, whether distributing certain
securities that have significant capital gains or losses built in would
have inequitable results.
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    \785\ See section 2(a)(32) (definition of redeemable security).
Such a transaction may have significant negative consequences to the
redeeming recipient, particularly if the security provided was fair
valued improperly, was restricted, or was in other ways impaired.
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    Because the management and personnel capacity of funds facing heavy
redemptions and other liquidity stresses will likely be strained as
funds attempt to manage these pressures, the Commission believes that
requiring funds to have policies and procedures

dictating how fund's will implement in-kind redemptions will increase
the likelihood that in-kind redemptions will be a feasible risk
management tool, and may address any potential fund or shareholder
inequities. Accordingly, we are adopting this requirement largely as
proposed.\786\
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    \786\ The rule text has been slightly modified to make clear
that redemption in kind policies and procedures must address not
just how the fund will engage in redemptions in kind, but also when
it will do so. Rule 22e-4(b)(1)(v).
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G. Cross-Trades

    Today, under rule 17a-7, funds may make certain affiliated
securities transactions between funds and certain affiliates (``cross
trades''), provided they meet certain protective conditions.\787\ Rule
17a-7 includes conditions that limit the portfolio assets that may be
cross-traded, and, as discussed below, cross-trades involving certain
less liquid assets may not be eligible to rely on the rule. As
discussed in the Proposing Release, some funds may consider engaging in
cross-trades to be a useful liquidity risk management tool. Cross-
trading can benefit funds and their shareholders by allowing funds that
are mutually interested in a securities transaction that is consistent
with the investment strategies of each fund to conduct the transaction
without incurring transaction costs and without generating a market
impact.\788\ However, cross-trades also have significant potential for
abuse. For example, as the Commission has previously stated, ``an
unscrupulous investment adviser might `dump' undesirable securities on
a registered investment company or transfer desirable securities from a
registered investment company to another more favored advisory client
in the complex. Moreover the transaction could be effected at a price
which is disadvantageous to the registered investment company.'' \789\
Cross-trade transactions also may be inconsistent with the investment
objectives, investment strategies, or risk profiles of participating
investment companies and other advisory clients.\790\
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    \787\ Section 17 of the Act restricts transactions between an
``affiliated person of a registered investment company or an
affiliated person of such affiliated person'' and that investment
company--for example, transactions between a fund and another fund
managed by the same adviser. A fund must therefore obtain exemptive
relief from the Commission before entering into purchase or sale
transactions with an affiliated fund, or execute such transactions
subject to the provisions of rule 17a-7 under the Investment Company
Act (permitting purchase and sale transactions among affiliated
funds and other accounts, under certain circumstances).
    \788\ As noted above, rule 17a-7 requires that each cross-trade
be consistent with the policy of each fund participating in the
transaction and that no brokerage commissions, fees or other
remuneration be paid in connection with the transaction. Because
cross-trades are conducted privately between funds, they are not
transparent to market trading reporting systems and thus are
unlikely to generate a market impact.
    \789\ Exemption of Certain Purchase or Sale Transactions Between
a Registered Investment Company and Certain Affiliated Persons
Thereof, Investment Company Act Release No. 11136 (Apr. 21, 1980)
[45 FR 29067 (May 1, 1980)]. See also Evergreen Order, supra
footnote 46 (fund's adviser failed to seek best execution in trading
fund securities and favored one client over another, thereby
engaging in transactions that operated as a fraud or deceit upon its
client in violation of section 206(2) of the Advisers Act).
    \790\ A fund that provided a non-pro rata distribution of cash,
securities or other property to a shareholder that owns 5% or more
of the fund and/or gives any election to the shareholder about which
assets to receive may also raise affiliated transaction concerns
under section 17(a) and rule 17a-5, as such a transaction would fall
outside the exemption provided by rule 17a-5 and thus might be
viewed as a sale to or purchase from the fund by an affiliated
person.
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    Accordingly, rule 17a-7 requires that any cross-trades satisfy
certain conditions designed to prevent such abuses, including the
requirement that market quotations be readily available for each traded
security and that if the security is only traded over the counter, the
cross-trade be conducted at the average of the highest current
independent bid and lowest current independent offer determined on the
basis of reasonable inquiry.\791\ In requiring market quotations for
cross-traded securities, the Commission has stated that ``[r]eliance
upon such market quotations provides an independent basis for
determining that the terms of the transaction are fair and reasonable
to each participating investment company or other advisory client and
do not involve overreaching.'' \792\ Rule 17a-7 also requires that a
cross-trade transaction be ``consistent with the policy of each
registered investment company and separate series of a registered
investment company participating in the transaction, as recited in its
registration statement and reports filed under the Act.'' \793\
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    \791\ See rule 17a-7(b).
    \792\ Exemption of Certain Purchase or Sale Transactions Between
a Registered Investment Company and Certain Affiliated Persons
Thereof, Investment Company Act Release No. 11676 (Mar. 10, 1981)
[45 FR 17011 (Mar. 17, 1981)]. The Commission has historically
declined to expand rule 17a-7 to cross-trades for which market
quotations were not readily available and where independent current
market prices were not available because these conditions increase
the potential for abuse through cross-trades. See id.
    \793\ See rule 17a-7(c).
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    We noted in the Proposing Release that less liquid assets are less
likely to satisfy rule 17a-7 than highly liquid investments.\794\ Some
commenters expressed concern that this assertion would prohibit funds
from, or create a presumption against, cross-trading any assets deemed
less liquid,\795\ or directly incorporate liquidity classification
decisions into rule 17a-7 eligibility determinations.\796\ One
commenter, disagreeing with the assertion that less liquid assets are
less likely to satisfy rule 17a-7 than highly liquid assets, stated ``a
less actively traded security may be less liquid, but nonetheless have
readily available market quotations, and a fund may determine that
independent bid and offer prices are available in the market. The
relative illiquidity of the security itself will not alone be
determinative of whether prices are available for Rule 17a-7
purposes.'' \797\
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    \794\ See Proposing Release, supra footnote 9, at n.396 and
accompanying text.
    \795\ See ICI Comment Letter I.
    \796\ See Comment Letter of Simpson Thacher & Bartlett LLP (Jan.
14, 2016) (``Simpson Thacher Comment Letter'').
    \797\ See Fidelity Comment Letter.
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    We note that less liquid assets, by definition, are less likely to
trade in highly active markets that produce readily available market
quotations, which may make it more difficult to ensure that the terms
of a cross-trade transaction are fair and reasonable to each
participating investment company or other advisory client and do not
involve overreaching. As one commenter noted, ``rule 17a-7 broadly
requires the availability of accurate valuation information with