disadvantages of using swing pricing to manage dilution arising from
shareholder purchase and redemption activity.
---------------------------------------------------------------------------

    \560\ See proposed Item 6(d) of Form N-1A.
---------------------------------------------------------------------------

c. Request for Comment
    We request comment on all aspects of the proposed amendments to
Form N-1A.
     Would the proposed amendments regarding payment of
redemption proceeds be helpful to fund shareholders? Should we modify
the proposed disclosures, and if so, how?
     In addition to the proposed disclosure requirements,
should Form N-1A be amended to require certain funds to incorporate
enhanced disclosure regarding liquidity risk into their summary
prospectuses? If so, what funds should be subject to such enhanced
disclosure requirements (e.g., funds with certain investment
strategies, whose three-day liquid asset minimums are below a certain
threshold, or that hold above a certain percentage of their portfolio
(for instance, 5%, 10%, 20%, 30%) in assets with extremely limited
liquidity, such as assets that can only be converted to cash in over 7
days, over 15 days, over 30 days, or over 90 days at a price that does
not materially affect the value of that asset immediately prior to
sale)? What specific liquidity risk disclosure requirements should
apply to these funds?
     Are there any challenges associated with funds disclosing
when they expect to pay redemption proceeds? Should funds be required
to disclose the expected period in normal and stressed market
conditions?
     Are there any challenges associated with funds disclosing
the methods that they use to meet redemption requests and whether those
methods are used regularly or only in stressed market conditions? Would
disclosure of this information overly complicate prospectus
disclosures?
     In cases where the number of days in which a fund will pay
redemption proceeds differs by distribution channel, are there any
challenges associated with funds disclosing the number of days for each
distribution channel? Do funds pay all redemption proceeds at the same
time irrespective of distribution channel (although when the
shareholder actually receives redemption proceeds may differ by
distribution channel)?
     Would the proposed amendments provide useful information
to shareholders about how funds plan to satisfy redemption requests? Is
there any additional information about fund redemption policies that
shareholders should be aware of that is not discussed above? If so,
would such additional information already be covered under existing
Form N-1A requirements, or would we need to make any amendments to the
form or its instructions?
     Would the proposed amendment to Item 28 of Form N-1A that
would require a fund to file as exhibits to its registration statement
any agreements related to lines of credit for the benefit of the fund
be useful to fund shareholders and market participants? Why or why not?
Are there any issues associated with funds filing such credit
agreements? For example, even if specific fees paid in connection with
the credit agreements are redacted, do funds have confidentiality
concerns regarding filing such credit agreements? Should funds be
required to file credit agreements if we adopt the proposed amendments
to proposed Form N-CEN that require a fund to disclose information
regarding lines of credit available to the fund?
     Would the proposed amendments to Form N-1A regarding swing
pricing be useful to fund shareholders? Should funds be required to
disclose additional information regarding swing pricing, and if so,
what information should be disclosed?
2. Proposed Amendments to Proposed Form N-PORT
    The Commission, investors, and other market participants currently
have limited information about the liquidity of portfolio investments
of funds, and we believe that all would benefit from more detailed
reporting and disclosure of the liquidity of a fund's portfolio
investments. On May 20, 2015, we proposed requiring registered
management investment companies and ETFs organized as unit investment
trusts, other than registered money market funds or small business
investment companies, to electronically file with the Commission
monthly portfolio investment information on proposed Form N-PORT.\561\
As we discussed in the Investment Company Reporting Modernization
Release, the information that would be filed on proposed Form N-PORT
would enhance the Commission's ability to effectively oversee and
monitor the activities of

investment companies in order to better carry out its regulatory
functions. We also stated that we believe that many investors,
particularly institutional investors, as well as academic researchers,
financial analysts, and economic research firms, could use the
information reported on proposed Form N-PORT to evaluate fund
portfolios and assess the potential for returns and risks of a
particular fund.\562\
---------------------------------------------------------------------------

    \561\ Submissions on Form N-PORT would be required to be filed
no later than 30 days after the close of each month. As proposed,
only information reported for the third month of each fund's fiscal
quarter on Form N-PORT would be publicly available, and such
information would not be made public until 60 days after the end of
the third month of the fund's fiscal quarter. See Investment Company
Reporting Modernization Release, supra note 104.
    \562\ See Investment Company Reporting Modernization Release,
supra note 104.
---------------------------------------------------------------------------

    We believe that requiring funds to report information about the
liquidity of portfolio investments would assist the Commission in
better assessing liquidity risk in the open-end fund industry, which
can inform its policy and guidance, as well as in its monitoring for
compliance with proposed rule 22e-4 and identifying potential outliers
in fund liquidity classifications for further inquiry, as appropriate.
Furthermore, we believe that this information would help investors and
potential users better understand the liquidity risks in funds.
Accordingly, the Commission seeks to enhance the reporting regarding
the liquidity of fund holdings by proposing that each fund report on
Form N-PORT the fund's three-day liquid asset minimum as well as the
liquidity classification for each portfolio asset, as further described
below.
a. Liquidity Classification of Portfolio Investments
    Part C of proposed Form N-PORT would require a fund and its
consolidated subsidiaries to disclose its schedule of investments and
certain information about the fund's portfolio of investments. We
propose to add Item C.13 to Part C of proposed Form N-PORT, which would
require a fund to indicate the liquidity classification of each of the
fund's positions in a portfolio asset. Funds would be required to
indicate such liquidity classification using the following categories
as specified in proposed rule 22e-4:
     Convertible to cash within 1 business day;
     Convertible to cash within 2-3 business days;
     Convertible to cash within 4-7 calendar days;
     Convertible to cash within 8-15 calendar days;
     Convertible to cash within 16-30 calendar days; and
     Convertible to cash in more than 30 calendar days.

For portfolio assets with multiple liquidity classifications, proposed
Item C.13 would require funds to indicate the dollar amount
attributable to each classification. For example, a fund could
determine that it could convert half of a portfolio position to cash in
2-3 business days and the other half of the position in 4-7 calendar
days in order to dispose of the position without creating a market
impact and receive cash for the trade. In this case, half of the
position would be reported in the 2-3 day category and the other half
in the 4-7 day category.
    We anticipate that the enhanced reporting proposed in these
amendments would help our staff better monitor liquidity trends and
various funds' liquidity risk profiles. We also believe that making
this information available to the public quarterly, as with other
information on proposed N-PORT, is appropriate. We received several
comments to the Investment Company Reporting Modernization Release that
addressed our proposal to require funds to identify on proposed Form N-
PORT whether an investment is an illiquid asset. Specifically, several
commenters noted concern that public dissemination of a fund's
liquidity determinations could lead to misinterpretation and confusion
among investors, particularly because of the subjective nature of such
determinations.\563\
---------------------------------------------------------------------------

    \563\ See, e.g., Comment Letter of Charles Schwab Investment
Management on Investment Company Reporting Modernization Release
(Aug. 11, 2015); Comment Letter of Invesco Advisers, Inc. on
Investment Company Reporting Modernization Release (Aug. 11, 2015);
Comment Letter of the Investment Company Institute on Investment
Company Reporting Modernization Release (Aug. 11, 2015); Comment
Letter of Pioneer Investments on Investment Company Reporting
Modernization Release (Aug. 11, 2015).
---------------------------------------------------------------------------

    While we appreciate commenters' concerns and request further
comment, we believe that the liquidity-related data reported on Form N-
PORT that is made publicly available would inform investors and assist
users in assessing funds' relative liquidity and the overall liquidity
of the fund industry and of particular investment strategies and would
not be confusing to investors.\564\ For example, third-party data
analyzers could use the reported information to produce useful metrics
for investors about the relative liquidity of different funds with
similar strategies. We also anticipate that this publicly available
data would provide a resource for fund managers to compare the
liquidity classifications assigned to various portfolio assets, which
in turn could result in making the liquidity classifications assigned
to certain positions more consistent across the fund industry, to the
extent appropriate, and could provide greater market transparency as to
the liquidity characteristics of certain assets.
---------------------------------------------------------------------------

    \564\ See supra note 561 regarding public disclosure of
information submitted on Form N-PORT.
---------------------------------------------------------------------------

    We note that the liquidity classification of an asset may vary
across funds depending on the facts and circumstances relating to the
funds and their trading practices.\565\ For example, one fund may hold
a particular asset as a hedge against a risk in another portfolio
asset. In this case, that asset's liquidity profile may be tied to the
liquidity of the corresponding hedged asset. Another fund not using
that asset as a hedge could report a quite different liquidity
classification. Liquidity classifications also may vary based on the
size of fund positions in a particular portfolio asset. We also
recognize that liquidity classifications inherently involve some level
of judgment by the fund and estimation as market conditions can change,
and thus a fund may predict liquidity based on current information that
it will take a certain time period to convert a particular asset to
cash only to find that it takes longer to do so when the fund actually
sells the asset. Nevertheless, for the reasons discussed above, we
believe that the proposed reporting of liquidity classification
information will provide very valuable information to us and market
participants about current fund expectations regarding portfolio
liquidity.
---------------------------------------------------------------------------

    \565\ See, e.g., Comment Letter of the Investment Company
Institute on Investment Company Reporting Modernization Release
(Aug. 11, 2015) (``These [liquidity] judgments may differ among
personnel and certainly among fund complexes.''); Comment Letter of
Invesco Advisers, Inc. on Investment Company Reporting Modernization
Release (Aug. 11, 2015) (``Invesco and other fund complexes could
reasonably differ in their assessments of the liquidity of a
particular security, even though both complexes have a sound method
for determining liquidity and follow their own reasonable
procedures.'').
---------------------------------------------------------------------------

b. 15% Standard Assets
    As currently proposed, Form N-PORT would require that each fund
disclose whether each particular portfolio security is an ``illiquid
asset.'' \566\ The proposed form defines illiquid assets in terms of
current Commission guidelines (i.e., assets that cannot be sold or
disposed of by the fund within seven calendar days, at approximately
the value ascribed to them by the fund).\567\ In connection with
proposed rule 22e-4's requirement regarding 15% standard assets,\568\
we propose to amend the General Instructions to proposed Form N-PORT to
remove the term ``Illiquid

Asset'' from the definitions section and replace it with the term ``15%
Standard Asset,'' as such term is defined in proposed rule 22e-4.\569\
---------------------------------------------------------------------------

    \566\ See Item C.7 of proposed Form N-PORT.
    \567\ See General Instruction E of proposed Form N-PORT.
    \568\ See proposed rule 22e-4(a)(4); see also supra section
III.C.4.a.
    \569\ See Item C.7 of proposed Form N-PORT; revised General
Instructions to proposed Form N-PORT.
     The Investment Company Reporting Modernization Release also
proposed amendments to Article 12 of Regulation S-X in which funds
would be required to identify illiquid securities. See, e.g.,
proposed rule 12-12, n. 10 of Regulation S-X (requiring funds to
indicate ``by an appropriate symbol each issue of illiquid
securities''). We propose to define ``illiquid securities'' in
Regulation S-X (as well as ``illiquid investment,'' which term also
appears in Regulation S-X) by reference to the term ``15% standard
assets,'' as defined in proposed rule 22e-4(a)(4). See proposed
210.6-02(e), (f).
---------------------------------------------------------------------------

    This change would have the effect of requiring funds to report, for
each portfolio asset, whether the asset is a 15% standard asset. This
information would allow our staff and other interested parties to track
the extent that funds are holding 15% standard assets and to discern
the nature of those holdings. This information also would help these
groups in tracking the fund's exposure to liquidity risk.
c. Three-Day Liquid Asset Minimum
    We propose to add an Item B.7 to Part B of proposed Form N-PORT to
require each fund to disclose its ``three-day liquid asset minimum,''
as such term is defined in proposed rule 22e-4.\570\ Requiring
reporting of this information on Form N-PORT would allow our staff and
other interested parties to easily assess the three-day liquid asset
minimum across funds because of the interactive nature of how the
information would be reported on proposed Form N-PORT.
---------------------------------------------------------------------------

    \570\ See proposed rule 22e-4(a)(9); see also supra section
III.C.3. We also propose adding the term ``Three-Day Liquid Asset
Minimum'' to General Instruction E of proposed Form N-PORT,
referencing the definition of such term in proposed rule 22e-4.
---------------------------------------------------------------------------

    This should facilitate comparisons between funds as well as the
observation of trends over time in this indicator of fund liquidity.
d. Request for Comment
    We seek comment on each of the Commission's proposed amendments to
proposed Form N-PORT.
     Is there different or other information associated with
liquidity that we should require funds to report on proposed Form N-
PORT? If so, please describe the information.
     Would the proposed liquidity classification disclosure
assist investors, fund boards, and other users in analyzing liquidity
among portfolio assets within the fund and across the fund industry?
What challenges, if any, may arise in reporting the liquidity
classification information, and how could we address those challenges?
What concerns are raised with public disclosure of liquidity
classification information and how could we address those concerns?
     Should we require that the liquidity classification
information on proposed Form N-PORT only be reported to the Commission
and not be publicly disclosed? If so, how would we achieve our goal of
allowing investors to become better informed, through information
provided by third-party information providers or otherwise, about the
liquidity of the funds in which they invest? Would public disclosure of
liquidity classification information facilitate predatory trading
practices or exacerbate first mover incentives? If so, how?
     Proposed Form N-PORT has a section in which a fund can
provide explanatory notes with any information that it believes would
be helpful in understanding the information reported on Form N-
PORT.\571\ Would this allow funds to explain any methodologies,
assumptions, or estimations used in determining liquidity
classifications?
---------------------------------------------------------------------------

    \571\ See Part E of proposed Form N-PORT.
---------------------------------------------------------------------------

3. Proposed Amendments to Proposed Form N-CEN
    As proposed, all registered investment companies, including money
market funds but excluding face amount certificate companies, would be
required to file Form N-CEN annually.\572\ Form N-CEN would require
these registered investment companies to provide census-type
information that would assist our efforts to modernize the reporting
and disclosure of information by registered investment companies and
enhance the staff's ability to carry out its regulatory functions,
including risk monitoring and analysis of the industry.\573\
---------------------------------------------------------------------------

    \572\ See Investment Company Reporting Modernization Release,
supra note 104.
    \573\ Id.
---------------------------------------------------------------------------

a. Lines of Credit, Interfund Lending, Interfund Borrowing and Swing
Pricing
    We are proposing to amend proposed Form N-CEN to allow the
Commission and other users to track certain liquidity risk management
practices that we expect funds to use on a less frequent basis than the
day-to-day portfolio construction techniques captured by proposed Form
N-PORT. More specifically, we propose amending Part C of proposed Form
N-CEN to add an item that would include certain questions regarding the
use of lines of credit, interfund lending, interfund borrowing, and
swing pricing.
    The proposed amendments would add a new Item 44 to Part C of
proposed Form N-CEN requiring a fund to disclose if it has available a
committed line of credit, and, if so, the size of the line of credit in
U.S. dollars, the name of the institution(s) with which the fund has
the line of credit, and whether the line of credit is for that fund
alone or is shared among multiple funds.\574\ If the line of credit is
shared among multiple funds, the fund would be required to disclose the
names and SEC File numbers of the other funds (including any series)
that may use the line of credit.\575\ If the fund responds
affirmatively to having available a committed line of credit, the fund
would be required to disclose whether it drew on the line of credit
during the reporting period.\576\ If the fund drew on that line of
credit during the reporting period, Item 44 would require the fund to
disclose the average dollar amount outstanding when the line of credit
was in use and the number of days that line of credit was in use.\577\
This information would allow our staff and other potential users to
assess how often and to what extent funds rely on certain external
sources of liquidity, rather than relying on the liquidity of fund
portfolio assets alone, for liquidity risk management. It also would
allow monitoring of whether such lines of credit are concentrated in
particular financial institutions.
---------------------------------------------------------------------------

    \574\ See proposed Item 44(a)(i)-(iii) of Part C of proposed
Form N-CEN.
    \575\ See proposed Item 44(a)(iii)(1) of Part C of proposed Form
N-CEN. Under proposed Form N-CEN, ``SEC File number'' means the
number assigned to an entity by the Commission when that entity
registered with the Commission in the capacity in which it is named
in Form N-CEN. See General Instruction F to proposed Form N-CEN.
    \576\ See proposed Item 44(a)(iv) of Part C of proposed Form N-
CEN.
    \577\ See proposed Item 44(a)(v) and (vi) of Part C of proposed
Form N-CEN.
---------------------------------------------------------------------------

    Proposed Item 44 also would require a fund to report whether it
engaged in interfund lending or interfund borrowing during the
reporting period, and, if so, the average amount of the interfund loan
when the loan was outstanding and the number of days that the interfund
loan was outstanding.\578\ This information would provide some
transparency regarding the extent to which funds use interfund lending
or interfund borrowing. We understand that one reason that funds have
sought exemptive relief to engage in interfund

lending and borrowing is to meet redemption obligations if necessary.
---------------------------------------------------------------------------

    \578\ See proposed Item 44(b) and (c) of Part C of proposed Form
N-CEN.
---------------------------------------------------------------------------

    Finally, Item 44 would require a fund other than a money market
fund to disclose whether it engaged in swing pricing during the
reporting period. This disclosure would inform our staff and potential
users about whether funds use swing pricing as a tool to mitigate
dilution of the value of outstanding redeemable securities through
shareholder purchase and redemption activity.\579\
---------------------------------------------------------------------------

    \579\ As part of the proposed revisions to proposed Form N-CEN,
we propose renumbering previously proposed Items 44 through 79 to 45
through 80.
---------------------------------------------------------------------------

b. Additional Information Concerning ETFs
    Proposed Form N-CEN includes a section related specifically to
ETFs.\580\ Some of the proposed reporting requirements on Form N-CEN
relate to an authorized participant's interaction with the ETF (or its
service provider), as these entities play a significant role in the
marketplace.\581\ We believe collection of such information would allow
us to better assess the size, capacity, and concentration of the
authorized participant framework and may allow the Commission staff to
monitor how ETF purchase and redemption activity is distributed across
authorized participants and, for example, the extent to which a
particular ETF--or ETFs as a group--may be reliant on one or more
particular authorized participants.\582\
---------------------------------------------------------------------------

    \580\ See Part E of proposed Form N-CEN. We note that the
reporting requirements of proposed Form N-CEN that are tailored for
ETFs also apply to UITs organized as ETFs, as well as exchange-
traded managed funds. See General Instruction A to proposed Form N-
CEN. The additional proposed reporting requirement discussed below
would apply to the same group of entities.
    \581\ Specifically, proposed Form N-CEN would require an ETF to
provide identifying information about each of its authorized
participants, as well as the dollar value of the ETF's shares that
each authorized participant purchased or redeemed from the ETF
during the reporting period. See proposed Item 60(g) of proposed
Form N-CEN.
    \582\ See Investment Company Reporting Modernization Release,
supra note 104, at section II.E.4.
---------------------------------------------------------------------------

    Specifically, we are proposing to add Item 60(g) \583\ to Form N-
CEN, which would require an ETF to report whether it required that an
authorized participant post collateral to the ETF or any of its
designated service providers in connection with the purchase or
redemption of ETF shares during the reporting period.\584\ We
understand that some ETFs (or their custodians), particularly ETFs that
invest in non-U.S. securities, require authorized participants
transacting primarily on an in-kind basis to post collateral when
purchasing or redeeming shares, most often for the duration of the
settlement process. This can protect the ETF in the event, for example,
that the authorized participant fails to deliver the basket
securities.\585\ The requirement to post collateral for creating or
redeeming ETF shares impacts the authorized participant's operating
capital, which could, in turn, affect the ability and willingness of
authorized participants to serve such ETFs or serve other market makers
on an agency basis. Accordingly, we believe that information about
required posting of collateral by authorized participants when
purchasing or redeeming shares--alongside the information we previously
proposed to require in Form N-CEN--would be helpful in understanding
whether, and to what extent, there may be concentration in the
authorized participant framework for such ETFs.
---------------------------------------------------------------------------

    \583\ In the Reporting Modernization Release, information
requirements related to authorized participants for ETFs were in
Item 59 of Proposed Form N-CEN; however, because this release
proposes to add additional items to proposed Form N-CEN, Item 59 of
proposed Form N-CEN would be renumbered to Item 60. See infra Text
of Rules and Forms.
    \584\ Proposed Item 60(g) of proposed Form N-CEN.
    \585\ See, e.g., Investment Company Institute, The Role and
Activities of Authorized Participants of Exchange-Traded Funds,
(Mar. 2015), available at https://www.ici.org/pdf/ppr_15_aps_etfs.pdf. In addition to ETFs that invest in non-U.S.
securities, Commission staff understands that there are other ETFs
that have collateral requirements for purchases and redemptions,
such as ETFs that invest in debt securities.
---------------------------------------------------------------------------

c. Request for Comment
    We seek comment on each of the Commission's proposed amendments to
proposed Form N-CEN.
     Would the proposed reporting on the availability and use
of lines of credit, interfund lending, interfund borrowing and the use
of swing pricing assist investors, Commission staff, and market
participants in assessing liquidity and liquidity risks within a fund
and across the fund industry? Would this information be readily
available to funds? If not, please explain why.
     Do the proposed questions collect all sources of liquidity
outside the liquidity of fund portfolio assets? If not, what are these
other sources?
     Is the annual reporting time period under Form N-CEN
appropriate for this requested information? Should it be collected more
frequently? If so, should we require funds to disclose any or all of
the requested information on Form N-PORT instead of Form N-CEN?
     Is there different or other information associated with
liquidity that we should require funds to report on proposed Form N-
CEN? If so, please describe the information.
     Should funds be required to report information on
uncommitted lines of credit? Please explain why or why not.
     What types of ETFs tend to require posting of collateral
for purchases or redemptions and why? Please provide data on the size
of such collateral deposits, and how this deposit requirement can
affect an authorized participant's operating capital? How common is it
for an authorized participant or market maker to contract with another
authorized participant to post such collateral on its behalf? Are there
situations where one authorized participant contracts with another
authorized participant to purchase or redeem ETF shares on an agency
basis rather than purchase or redeem the shares directly with the ETF
because of the ETF's requirement that the purchase or redemption be
collateralized for the duration of the settlement period?

H. Compliance Dates

1. Liquidity Risk Management Program
    Proposed rule 22e-4 would require that each registered open-end
management investment company, including open-end ETFs but not
including money market funds, adopt and implement a written liquidity
risk management program, approved by a fund's board of directors, that
meets certain minimum requirements outlined in the rule. Given the
nature of the liquidity risk management program, including the
classification and ongoing review of the liquidity of each of a fund's
positions in an asset (or portion thereof) required under proposed rule
22e-4(b)(2)(i) and the three-day liquid asset minimum determination
required under proposed rule 22e-4(b)(2)(iv)(A), we expect to provide
for a tiered set of compliance dates based on asset size for proposed
rule 22e-4.
    Specifically, for larger entities--namely, funds that together with
other investment companies in the same ``group of related investment
companies'' \586\ have net assets of $1

billion or more as of the end of the most recent fiscal year--we are
proposing a compliance date of 18 months after the effective date to
comply with proposed rule 22e-4. For these larger entities, we expect
that 18 months would provide an adequate period of time for funds to
prepare internal processes, policies and procedures and implement
liquidity risk management programs that meet the requirements of the
rule.
---------------------------------------------------------------------------

    \586\ For these purposes, we expect that the threshold would be
based on the definition of ``group of related investment
companies,'' as such term is defined in rule 0-10 under the
Investment Company Act. Rule 0-10 defines the term in part as ``two
or more management companies (including series thereof) that: (i)
Hold themselves out to investors as related companies for purposes
of investment and investor services; and (ii) Either: (A) Have a
common investment adviser or have investment advisers that are
affiliated persons of each other; or (B) Have a common
administrator. . . .'' We believe that this broad definition would
encompass most types of fund complexes and therefore is an
appropriate definition for compliance date purposes.
---------------------------------------------------------------------------

    For smaller entities (i.e., funds that together with other
investment companies in the same ``group of related investment
companies'' have net assets of less than $1 billion as of the end of
the most recent fiscal year),\587\ we are proposing to provide for an
extra 12 months (or 30 months after the effective date) to comply with
proposed rule 22e-4.\588\ We believe that smaller entities would
benefit from this extra time to establish and implement the
requirements outlined in the rule.
---------------------------------------------------------------------------

    \587\ Based on staff analysis of data obtained from Morningstar
Direct, as of June 30, 2015, we estimate that a $1 billion threshold
would provide an extended compliance period to approximately 66% of
the fund groups, but only 0.6% of all fund assets. We therefore
believe that the $1 billion threshold would appropriately balance
the need to provide smaller groups of investment companies with more
time to prepare internal processes, policies and procedures and
implement liquidity risk management programs that meet the
requirements of proposed rule 22e-4, while still including the vast
majority of fund assets in the initial compliance period.
    \588\ See proposed rule 22e-4(b)(2)(i), (ii) and (iv)(A)-(C).
---------------------------------------------------------------------------

    On or before the applicable compliance date(s), a fund must have
adopted and implemented compliance policies and procedures that satisfy
the requirements of the new rule. These policies and procedures must
have been approved by the board on or before the applicable compliance
date(s).
2. Swing Pricing
    Proposed rule 22c-1(a)(3), if adopted, would permit (but not
require) a fund (with the exception of a money market fund or ETF) to
adopt swing pricing policies and procedures. Related proposed
amendments to rule 31a-2 (regarding the preservation of books and
records evidencing and supporting adjustments to NAV based on swing
pricing policies and procedures), Item 13 of Form N-1A and Regulation
S-X (regarding financial reporting), and Item 11(c) of Form N-1A
(regarding a fund's use of swing pricing) would apply only to funds
that elect to use swing pricing. As reliance on rule 22c-1(a)(3) would
be optional, we believe a compliance period would not be necessary.
Therefore, we expect that a fund would be able to rely on the rule
after the effective date as soon as the fund could comply with proposed
rule 22c-1(a)(3) and related records, financial reporting and
prospectus disclosure requirements.
3. Amendments to Form N-1A
    Except with respect to the proposed amendments to Form N-1A related
to swing pricing (discussed above), if the other proposed amendments to
Form N-1A are adopted, we expect to require all initial registration
statements on Form N-1A, and all post-effective amendments that are
annual updates to effective registration statements on Form N-1A, filed
six months or more after the effective date, to comply with the
proposed amendments to Form N-1A. We do not expect that funds would
require significant amounts of time to prepare additional disclosures
in accordance with our proposed amendments regarding redemptions.
4. Amendments to Form N-PORT
    Similar to the tiered compliance dates for the liquidity
classification requirements for fund liquidity risk management programs
under proposed rule 22e-4 (discussed above), we expect to provide for a
tiered set of compliance dates based on asset size for the proposed
amendments to proposed Form N-PORT. Specifically, for larger entities
we are proposing a compliance date of 18 months after the effective
date to comply with the new reporting requirements. For these larger
entities, we expect that 18 months would provide an adequate period of
time for funds, intermediaries, and other service providers to conduct
the requisite operational changes to their systems and to establish
internal processes to prepare, validate, and file reports containing
the additional information requested by the proposed amendments to Form
N-PORT. For smaller entities, we are proposing to provide for an extra
12 months (or 30 months after the effective date) to comply with the
new reporting requirements. We believe that smaller groups would
benefit from this extra time to comply with the filing requirements for
Form N-PORT and would potentially benefit from the lessons learned by
larger investment companies and groups of investment companies during
the adoption period for Form N-PORT.
5. Amendments to Form N-CEN
    If Form N-CEN and the amendments we propose to the form are
adopted, we are proposing a compliance date of 18 months after the
effective date to comply with the new reporting requirements.\589\ We
expect that 18 months would provide an adequate period of time for
funds, intermediaries, and other service providers to conduct the
requisite operational changes to their systems and to establish
internal processes to prepare, validate, and file reports containing
the additional information requested by the proposed amendments to Form
N-CEN.
---------------------------------------------------------------------------

    \589\ Unlike Form N-PORT, we do not expect to provide a tiered
compliance date based on asset size because we believe that it is
less likely that smaller fund complexes would need additional time
to comply with the amendments we propose on Form N-CEN. This 18-
month compliance period is consistent with the compliance period for
proposed Form N-CEN. See Investment Company Reporting Modernization
Release, supra note 104.
---------------------------------------------------------------------------

6. Request for Comment
    We request comment on the compliance dates discussed above.
     How, if at all, should the proposed compliance dates be
modified? What factors should we consider when setting the compliance
dates for the proposed rule and amendments to the rules and forms? To
the extent that a fund would decide to reallocate certain portions of
its portfolio in order to correlate its portfolio holdings with its
three-day liquid asset minimum, would the proposed compliance dates
provide adequate time to do so in a way that would cause the fund to
incur relatively few portfolio reallocation-related costs (i.e., by
permitting sufficient time to purchase and sell portfolio assets when
it is relatively advantageous to do so)?
     We request comment on our proposed 18-month compliance
date for proposed rule 22e-4. Is our 18-month compliance period
appropriate? If not, what length of time (e.g., 12 months or 24 months)
would be appropriate for compliance with the new rule?
     We also request comment on our proposed tiered compliance
dates for proposed rule 22e-4 and related reporting requirements under
our proposed amendments to proposed Form N-PORT. Is a threshold of $1
billion based on the net assets of funds together with other investment
companies in the same ``group of related investment companies'' as of
the end of the most recent fiscal year appropriate? Should the
threshold be higher or lower? \590\ Should the threshold include
aggregation of net assets with other investment companies in the same
``group of related investment companies?'' Why or why not? Is our

12-month extension of the compliance period for smaller entities
appropriate? If not, what length of time (e.g., 6 months or 18 months)
would be adequate and why?
---------------------------------------------------------------------------

    \590\ Based on staff analysis of data obtained from Morningstar
Direct, as of June 30, 2015, we estimate that a threshold of $100
million would include approximately 38% of fund firms and 0.1% of
all fund assets. A threshold of $3 billion would include
approximately 77% of fund firms and 1.6% of fund assets.
---------------------------------------------------------------------------

     With respect to our proposed amendments to Form N-PORT, is
our compliance date of 18 months for larger filers appropriate? If not,
what length of time would be appropriate for compliance with the
proposed amendments? Would a shorter or longer compliance date be
appropriate? Is our 12-month extension of the compliance period for
smaller entities appropriate? If not, what length of time would be
appropriate for compliance with the additional reporting requirements
under the proposed amendments?
     Is our 18-month compliance period for our proposed
amendments to Form N-CEN appropriate? If not, what length of time would
be appropriate? Would a shorter or longer compliance date be
appropriate?
     We are proposing to not have a compliance period for
proposed amendments to rule 22c-1 regarding swing pricing policies
procedures and related amendments to rule 31a-2, Form N-1A and
Regulation S-X. Is this appropriate?
     Is our six-month compliance period for our proposed
amendments to Form N-1A disclosure requirements regarding the
redemption of fund shares adequate? If not, what length of time would
be adequate and why?

IV. Economic Analysis

A. Introduction and Primary Goals of Proposed Regulation

    The Commission is sensitive to the economic effects that could
result from the proposed liquidity risk management program requirement,
the ability for funds to use swing pricing under proposed rule 22c-
1(a)(3), and the proposed new disclosure and reporting requirements
regarding liquidity risk and liquidity risk management (such proposed
rule and proposed amendments to certain rules and forms, the ``proposed
liquidity regulations''). These economic effects include the benefits
and costs of the proposed liquidity regulations, as well as the effects
on efficiency, competition, and capital formation. The economic effects
of the proposed liquidity regulations are discussed below in the
context of the primary goals of the proposed regulation.
    In summary, and as discussed in greater detail in section III
above, the proposed liquidity regulations include the following:
    [cir] Proposed new rule 22e-4 would require that each fund
establish a written liquidity risk management program. A fund's
liquidity risk management program would be required to include the
following elements: (i) Classification and ongoing review of the
classification of the liquidity of each of the fund's positions in a
portfolio asset (or portions of a position in a particular asset),
taking into account certain specified factors; (ii) assessment and
periodic review of its liquidity risk; and (iii) management of the
fund's liquidity risk, including limitations on the fund's acquisition
of less liquid assets or 15% standard assets in certain circumstances.
    [cir] Under proposed rule 22c-1(a)(3), a fund (except a money
market fund or ETF) would be permitted (but not required) to establish
and implement swing pricing policies and procedures that would, under
certain circumstances, require the fund to use swing pricing to adjust
its current NAV to lessen potential dilution of the value of
outstanding redeemable securities caused by shareholder purchase and
redemption activity. A fund that engages in swing pricing would be
subject to certain disclosure and reporting requirements.
    [cir] Proposed amendments to Form N-1A, Regulation S-X, proposed
Form N-PORT, and proposed Form N-CEN would require enhanced fund
disclosure and reporting regarding position liquidity, shareholder
redemption practices, and swing pricing.
    The proposed liquidity regulations are designed to promote
effective liquidity risk management throughout the open-end fund
industry and thereby reduce the risk that funds will be unable to meet
redemption obligations and mitigate dilution of the interests of fund
shareholders in accordance with, among other provisions, section 22(e)
and rule 22c-1 under the Investment Company Act. The proposed liquidity
regulations also seek to enhance disclosure regarding fund liquidity
and redemption practices. In addition, these proposed reforms are
intended to address the liquidity-related developments in the open-end
fund industry discussed above and are a part of a broader set of
initiatives to address the impact of open-end fund investment
activities on financial markets and the risks associated with the
increasingly complex portfolio composition and operations of the asset
management industry. We provide an overview of these rulemaking goals
in the following paragraphs, and the goals are discussed in more detail
below as we describe the prospective benefits and costs of each aspect
of the proposal.\591\
---------------------------------------------------------------------------

    \591\ See infra sections IV.C.1, IV.C.2, and IV.C.3.
---------------------------------------------------------------------------

    A primary goal of the proposed liquidity regulations is to promote
investor protection by reducing the risk that funds will be unable to
meet their redemption obligations, elevating the overall quality of
liquidity risk management across the fund industry, increasing
transparency of funds' liquidity risks and risk management practices,
and mitigating potential dilution of existing shareholders' interests.
Funds are not currently subject to requirements under the federal
securities laws or Commission rules that specifically require them to
maintain a minimum level of portfolio liquidity (with the exception of
money market funds), and follow Commission guidelines (not rules) that
generally limit their investment in illiquid assets.\592\ Additionally,
funds today are only subject to limited disclosure requirements
concerning a fund's liquidity risk and risk management.\593\ Staff
outreach has shown that funds today engage in a variety of different
practices--ranging from comprehensive and rigorous to minimal and
basic--for classifying the liquidity of their portfolio assets,
assessing and managing liquidity risk, and disclosing information about
their liquidity risk, redemption practices, and liquidity risk
management practices to investors.\594\ We believe that the proposed
enhanced requirements for funds' assessment, management, and disclosure
of liquidity risk could decrease the chance that funds would be unable
to meet their redemption obligations and mitigate potential dilution of
non-redeeming shareholders' interests.
---------------------------------------------------------------------------

    \592\ See supra section II.D; infra section IV.B.1.a.
    \593\ See supra section II.D; infra section IV.B.1.c.
    \594\ See supra section II.D; infra sections IV.B.1.a, IV.B.1.c.
---------------------------------------------------------------------------

    The proposed liquidity regulations are also intended to lessen the
possibility of early redemption incentives (and investor dilution)
created by insufficient liquidity risk management, as well as the
possibility that investors' share value will be diluted by costs
incurred by the fund as a result of other investors' purchase or
redemption activity. When a fund experiences significant redemption
requests, it may sell portfolio securities or borrow funds in order to
obtain sufficient cash to meet redemptions.\595\ However, sales of a
fund's portfolio assets conducted in order to meet shareholder
redemptions could result in significant adverse consequences to non-
redeeming

shareholders when a fund fails to adequately manage liquidity. For
example, if a fund sells portfolio assets under unfavorable
circumstances, this could create negative price pressure on those
assets and decrease the value of any of those assets still held by the
fund.\596\ Funds also may borrow from a bank or use interfund lending
facilities to meet redemption requests, but there are costs associated
with such borrowings. Both selling of portfolio assets and borrowing to
meet redemption requests could cause funds to incur costs that would be
borne at least partially by non-redeeming shareholders.\597\ These
factors could result in dilution in the value of non-redeeming
shareholders' interests in a fund,\598\ and also could create
incentives for early redemptions in times of liquidity stress, which
could result in further dilution of non-redeeming shareholders'
interests.\599\ There also is a potential for adverse effects on the
markets when open-end funds fail to adequately manage liquidity. For
example, the sale of less liquid portfolio assets at discounted or even
fire sale prices can produce significant negative price pressure on
those assets and correlated assets, which can impact other investors
holding these assets and may transmit stress to other funds or portions
of the markets.\600\ For reasons discussed in detail below, we believe
that the liquidity risk management program requirement and the ability
for a fund to adopt swing pricing policies and procedures would
mitigate the risk of potential shareholder dilution and decrease the
incentive for early redemption in times of liquidity stress.
---------------------------------------------------------------------------

    \595\ See supra section II.B.2; infra sections IV.C.1, IV.C.2.
    \596\ See supra notes 46-48 and accompanying text.
    \597\ See supra notes 49-53 and accompanying text.
    \598\ See supra notes 46-48 and accompanying text; infra
sections IV.C.1, IV.C.2.
    \599\ See supra notes 49-53 and accompanying text; infra
sections IV.C.1, IV.C.2.
    \600\ See supra note 54 and accompanying text.
---------------------------------------------------------------------------

    Finally, the proposed liquidity regulations are meant to address
recent industry developments that have underscored the significance of
funds' liquidity risk management practices. In recent years, there has
been significant growth in the assets managed by funds with strategies
that focus on holding relatively less liquid assets, such as fixed
income funds (including emerging market debt funds), open-end funds
with alternative strategies, and emerging market equity funds.\601\
There also has been considerable growth in assets managed by funds that
exhibit characteristics that could give rise to increased liquidity
risk, such as relatively high investor flow volatility.\602\
Additionally, as discussed in detail above, standard fund redemption
and securities settlement periods have tended to become significantly
shorter over the last several decades, which has caused funds to
satisfy redemption requests within relatively short time periods (e.g.,
within T+3, T+2, and next-day periods).\603\ But while fund redemption
periods have become shorter, certain funds have increased their
holdings of portfolio securities with relatively long settlement
periods, which could result in a liquidity mismatch between when a fund
plans or is required to pay redeeming shareholders, and when any asset
sales that the fund has executed in order to pay redemptions will
settle.\604\ Collectively, these industry trends have emphasized the
importance of effective liquidity risk management among funds and
enhanced disclosure regarding liquidity risk and risk management.
---------------------------------------------------------------------------

    \601\ See supra section II.C.1; infra section IV.B.3; see also
DERA Study, supra note 39, at pp. 6-9.
    \602\ See infra section IV.B.3.
    \603\ See supra notes 73-77 and accompanying text.
    \604\ See supra notes 78-79 and accompanying text.
---------------------------------------------------------------------------

B. Economic Baseline

    The proposed liquidity regulations would affect all funds and their
investors, investment advisers and other service providers, all issuers
of the portfolio securities in which funds invest, and other market
participants potentially affected by fund and investor behavior. The
effects of the proposed liquidity regulations on all of these parties
are analyzed in detail below in the discussion of the costs and
benefits of the proposed regulations. The economic baseline of the
proposed liquidity regulations includes funds' current practices
regarding liquidity risk management, swing pricing, and liquidity risk
disclosure, as well as the economic attributes of funds that affect
their portfolio liquidity and liquidity risk. These economic attributes
include industry-wide trends regarding funds' liquidity and liquidity
risk management, as well as industry developments highlighting the
importance of robust liquidity risk management by funds.
1. Funds' Current Practices Regarding Liquidity Risk Management, Swing
Pricing, and Liquidity Risk Disclosure
a. Funds' Current Liquidity Risk Management Requirements and Practices
    Under section 22(e) of the Investment Company Act, an open-end fund
is required to make payment to shareholders for securities tendered for
redemption within seven days of their tender.\605\ In addition to the
seven-day redemption requirement in section 22(e), open-end funds that
are sold through broker-dealers are required as a practical matter to
meet redemption requests within three business days because broker-
dealers are subject to rule 15c6-1 under the Exchange Act, which
establishes a three-day (T+3) settlement period for security trades
effected by a broker or a dealer. Furthermore, rule 22c-1 under the
Act, the ``forward pricing'' rule, requires funds, their principal
underwriters, and dealers to sell and redeem fund shares at a price
based on the current NAV next computed after receipt of an order to
purchase or redeem fund shares, even though cash proceeds from
purchases may be invested or fund assets may be sold in subsequent days
in order to satisfy purchase requests or meet redemption obligations.
---------------------------------------------------------------------------

    \605\ See section 22(e) of the Investment Company Act. Section
22(e) of the Act provides, in part, that no open-end fund shall
suspend the right of redemption or postpone the date of payment upon
redemption of any redeemable security in accordance with its terms
for more than seven days after tender of the security absent
specified unusual circumstances.
---------------------------------------------------------------------------

    With the exception of money market funds subject to rule 2a-7 under
the Act, the Commission has not promulgated rules requiring open-end
funds to invest in a minimum level of liquid assets.\606\ The
Commission historically has taken the position that open-end funds
should maintain a high degree of portfolio liquidity to ensure that
their portfolio securities and other assets can be sold and the
proceeds used to satisfy redemptions in a timely manner in order to
comply with section 22(e).\607\ The Commission also has stated that
open-end funds have a ``general responsibility to maintain a level of
portfolio liquidity that is appropriate under the circumstances,'' and
to engage in ongoing portfolio liquidity monitoring to determine
whether an adequate level of portfolio liquidity is being maintained in
light of the fund's redemption obligations.\608\ Open-end funds also
are required by rule 38a-1 under the Act to adopt and implement written
compliance policies and procedures reasonably designed to prevent
violations of the federal securities laws, and such policies and
procedures should be appropriately tailored to reflect each fund's
particular compliance risks.\609\ An open-end fund

holding a significant portion of its assets in securities with long
settlement periods or with infrequent trading, for instance, may be
subject to relatively greater liquidity risks than other open-end
funds, and should have relatively more robust policies and procedures
to comply with its redemption obligations.
---------------------------------------------------------------------------

    \606\ See supra note 85 and accompanying text.
    \607\ See Restricted Securities Release, supra note 86.
    \608\ See supra note 87 and accompanying text.
    \609\ See Rule 38a-1 Adopting Release, supra note 90.
---------------------------------------------------------------------------

    Additionally, long-standing Commission guidelines generally limit
an open-end fund's aggregate holdings of ``illiquid assets'' to 15% of
the fund's net assets (the ``15% guideline'').\610\ Under the 15%
guideline, a portfolio security or other asset is considered illiquid
if it cannot be sold or disposed of in the ordinary course of business
within seven days at approximately the value at which the fund has
valued the investment.\611\ The 15% guideline has generally limited
funds' exposure to particular types of securities that cannot be sold
within seven days and that the Commission and staff have indicated may
be illiquid, depending on the facts and circumstances.
---------------------------------------------------------------------------

    \610\ See supra note 92 and accompanying text.
    \611\ See supra note 93 and accompanying text.
---------------------------------------------------------------------------

    Staff outreach has shown that funds currently employ a diversity of
practices with respect to classifying portfolio assets' liquidity, as
well as managing liquidity risk. Section II.D.3 above provides an
overview of these practices, which include, among others: Assessing the
ability to sell particular assets within various time periods, taking
into account relevant market, trading, and other factors; monitoring
initial liquidity determinations for portfolio assets (and modifying
these determinations, as appropriate); holding certain amounts of the
fund's portfolio in highly liquid assets or cash equivalents;
establishing committed back-up lines of credit or interfund lending
facilities; and conducting stress testing relating to the extent the
fund has liquid assets to cover possible levels of redemptions.\612\ We
have observed that some of the funds with relatively more thorough
liquidity risk management practices have appeared to be able to meet
periods of high redemptions without significantly altering the risk
profile of the fund or materially affecting the fund's performance, and
thus with few dilutive impacts. It therefore appears that these funds
have generally aligned their portfolio liquidity with their liquidity
needs, and that their liquidity risk management permits them to
efficiently meet redemption requests. Other funds, however, employ
liquidity classification and liquidity risk management practices that
are substantially less rigorous. As discussed above in section II.D.3,
some funds do not take different market conditions into account when
evaluating portfolio asset liquidity, and do not conduct ongoing
liquidity monitoring. Likewise, some funds do not have independent
oversight of their liquidity risk management outside of the portfolio
management process. As a result, funds' procedures for classifying the
liquidity of their portfolio securities, as well as the
comprehensiveness and independence of their liquidity risk management,
vary significantly.
---------------------------------------------------------------------------

    \612\ See also e.g., Nuveen FSOC Notice Comment Letter, supra
note 45 (discussing stress tests of a fund's ability to meet
redemptions over certain periods); BlackRock FSOC Notice Comment
Letter, supra note 50 (discussing several overarching principles
that provide the foundation for a prudent market liquidity risk
management framework for collective investment vehicles, including
an independent risk management function, compliance checks to ensure
portfolio holdings do not exceed regulatory limits, a risk
management function that is independent from portfolio management,
and measuring levels of liquid assets into ``tiers of liquidity'');
Invesco FSOC Notice Comment letter, supra note 35, at 11 (discussing
liquidity analysis).
---------------------------------------------------------------------------

b. Funds' Current Swing Pricing Practices
    Commission rules and guidance do not currently address the ability
of an open-end fund to use swing pricing to mitigate potential dilution
of fund shareholders, and U.S. registered funds do not currently use
swing pricing. However, as discussed above, certain foreign funds
currently do use swing pricing.\613\ We understand that some fund
complexes that include U.S. registered funds also include foreign-
domiciled funds that currently use swing pricing.
---------------------------------------------------------------------------

    \613\ See supra notes 417-420 and accompanying text.
---------------------------------------------------------------------------

c. Funds' Current Liquidity Risk Disclosure Requirements and Practices
    Items 4 and 9 of Form N-1A require a fund to disclose the principal
risks of investing in the fund.\614\ A fund currently must disclose the
risks to which the fund's portfolio as a whole is expected to be
subject and the circumstances reasonably likely to adversely affect the
fund's NAV, yield, or total return.\615\ Some funds currently disclose
that liquidity risk is a principal risk of investing in the fund.
---------------------------------------------------------------------------

    \614\ Item 4(b)(1)(i) and Item 9(c) of Form N-1A.
    \615\ Id.
---------------------------------------------------------------------------

    Item 11 of Form N-1A requires a fund to describe its procedure for
redeeming fund shares, including restrictions on redemptions, any
redemption charges, and whether the fund has reserved the right to
redeem in kind.\616\ Disclosure regarding other redemption information,
such as the timing of payment of redemption proceeds to fund
shareholders, varies across funds as there are currently no specific
requirements for this disclosure. Some funds disclose that they will
redeem shares within a specific number of days after receiving a
redemption request, other funds disclose that they will honor such
requests within seven days (as required by section 22(e) of the Act),
and others provide no specific time periods. Additionally, some funds
disclose differences in the timing of payment of redemption proceeds
based on the distribution channel through which the fund shares are
redeemed, while others do not.
---------------------------------------------------------------------------

    \616\ Item 11(c) of Form N-1A.
---------------------------------------------------------------------------

    Funds are not currently required to disclose information about the
liquidity of their portfolio assets. However, Form N-PORT, as proposed
earlier this year, would require that each fund disclose whether each
particular portfolio security is an ``illiquid asset'' and defines
illiquid assets in terms of current Commission guidelines (i.e., assets
that cannot be sold or disposed of by the fund within seven calendar
days, at approximately the value ascribed to them by the fund).\617\
Also, some funds voluntarily disclose in their registration statements
any specific limitations applicable to the fund's investment in 15%
guideline assets, as well as types of assets considered by the fund to
be subject to the 15% guideline.
---------------------------------------------------------------------------

    \617\ See General Instruction E of proposed Form N-PORT.
---------------------------------------------------------------------------

    Form N-1A does not currently require funds to disclose information
about liquidity risk management practices such as the establishment (or
use) of committed back-up lines of credit. A fund is, however, required
to disclose information regarding the amount and terms of unused lines
of credit for short-term financing, as well as information regarding
related party transactions in its financial statements or notes
thereto.\618\
---------------------------------------------------------------------------

    \618\ See Regulation S-X 210.5-02.19(b); 210.4-08(k).
---------------------------------------------------------------------------

2. Economic Trends Regarding Funds' Liquidity and Liquidity Risk
Management
a. Overview
    While the liquidity of a fund's portfolio assets, and the fund's
overall liquidity risk, depend on a variety of factors and are unique
to the particular circumstances facing the fund,\619\ analysis by staff
economists has revealed trends that are useful for

providing an overview of the liquidity of funds exhibiting certain
characteristics.\620\ These trends are useful in estimating the
relative level of liquidity of certain types of funds, and have thus
helped to shape the scope and substance of the proposed liquidity
regulations and to estimate the benefits and costs of the proposed
liquidity regulations, as discussed below. Staff economists have also
analyzed how fund portfolios change in response to decreases in market
liquidity and large net outflows. These trends may be useful in
examining how redemption requests could give rise to investor
protection and potential market impact concerns.
---------------------------------------------------------------------------

    \619\ See supra section III.B.2 (discussing factors relevant to
an assessment of the liquidity of a fund's portfolio assets); supra
section III.C.1 (discussing factors relevant to an assessment of a
fund's liquidity risk).
    \620\ The analysis discussed in this section reflects an
evaluation of data on U.S. funds (primarily, U.S. equity funds and
U.S. municipal bond funds) from the years 1999-2014, conducted by
economists in the Commission's Division of Economic and Risk
Analysis. DERA Study, supra note 39.
---------------------------------------------------------------------------

b. Trends in the Relationship Between Liquidity of Portfolio Assets,
Market Capitalization of Portfolio Assets, and Fund Assets
    Staff economists have examined how the liquidity of U.S. equity
funds' portfolios is influenced by both the market capitalization of a
fund's portfolio assets, as well as the size of the fund in terms of
assets. As described in more detail below, among U.S. equity funds, the
average liquidity of a fund's equity positions is correlated with the
market capitalization of a fund's portfolio assets, as well as the
level of the fund's assets.\621\ The staff's analysis with respect to
these trends is, at this point, limited to an analysis of U.S. equity
funds, on account of limitations in the availability of current data
with respect to the holdings of funds that are not U.S. equity
funds.\622\ To the extent that Form N-PORT is adopted, we anticipate
that the fund portfolio data filed on this form would significantly
assist the staff in conducting similar liquidity-related analyses in
the future.\623\
---------------------------------------------------------------------------

    \621\ For these purposes, ``average liquidity of a fund's equity
positions'' is defined as the asset-weighted average liquidity of
the individual equity positions held by the fund. Liquidity for
individual equity positions is calculated using the Amihud liquidity
measure because it is a widely accepted liquidity measure. See id.,
section 4.1. See also Yakov Amihud, Illiquidity and Stock Returns:
Cross-Section and Time-Series Events, 5 J. of Fin. Markets (2002) 31
(``Amihud'').
    \622\ DERA Study, supra note 39, at pp. 31-32.
    \623\ See infra section IV.C.3.b.
---------------------------------------------------------------------------

    Fund liquidity tends to be highest for large cap U.S. equity funds
and lowest for small cap U.S. equity funds.\624\ As a U.S. equity
fund's assets increase, fund liquidity also tends to increase. Among
U.S. equity funds with less than $100 million in assets, the median
price impact of ten million dollars in trading volume on the average
portfolio asset is about 69 basis points; among U.S. equity funds with
greater than $1 billion in assets, the same amount of trading volume
has a median price impact of about 46 basis points.\625\
---------------------------------------------------------------------------

    \624\ DERA Study, supra note 39, at pp. 29-30.
    \625\ Id.
---------------------------------------------------------------------------

    To the extent that a fund invests in portfolio assets that are
relatively less liquid, the fund may experience greater liquidity risk
than a fund that invests in portfolio assets that are highly liquid.
Based in part on our empirical analysis, we have decided not to propose
any modification of or exclusion from the proposed liquidity
requirements for smaller funds, since smaller funds tend to demonstrate
relatively high flow volatility (and thus possibly greater liquidity
risk).\626\ Also, based in part on staff analysis finding that
different types of funds within the same broad investment strategy
demonstrate different levels of liquidity (and thus, presumably,
different levels of liquidity risk), we have decided not to propose to
exclude certain investment strategies from the scope of the proposed
rule.\627\ Our cost estimates associated with the proposed liquidity
risk management program requirement reflect staff analysis showing that
certain types of funds tend to have relatively more liquid portfolios
than others.\628\
---------------------------------------------------------------------------

    \626\ See infra section VI; infra note 727 and accompanying
text.
    \627\ See infra notes 726-727 and accompanying text.
    \628\ See infra section IV. C.1. and accompanying text.
---------------------------------------------------------------------------

    We do note, however, that the staff's analysis discussed in the
previous two paragraphs may overstate the difference in liquidity risk
between funds with differing levels of asset liquidity for two reasons.
First, the analysis performed by the staff does not reflect the fact
that smaller funds will have smaller positions in the underlying
equities, and sales of relatively small positions should result in less
price impact than sales of larger positions (although the sale of
smaller positions should have greater transaction costs as a percentage
of sale proceeds). However, with respect to U.S. equity funds, staff
analysis indicates that, on average, smaller funds hold assets that are
relatively less liquid, which may at least partially offset that
fact.\629\ Second, the analysis does not reflect the fact that less
liquid funds, regardless of style or size, may have larger cash and
cash equivalent holdings or liquid asset buffers that may offset their
less liquid holdings. Staff analysis does show that cash and cash
equivalent holdings vary, on average, according to the funds' strategy,
but cash and cash equivalent holdings also vary significantly among
funds within a particular strategy.\630\ That result implies that, even
within a relatively less liquid strategy, certain funds within the
strategy hold relatively little cash and cash equivalents.
---------------------------------------------------------------------------

    \629\ DERA Study, supra note 39, at pp. 29-30.
    \630\ DERA Study, supra note 39, at pp. 10-12. The DERA Study
describes how cash and cash equivalents are defined for these
purposes.
---------------------------------------------------------------------------

c. Trends in the Manner in Which Funds' Portfolio Management Responds
to Changes in Flow Volatility and Decreases in Market Liquidity
    While portfolio managers consider a variety of factors when
constructing a fund's portfolio (including the fund's investment
strategies, economic and market trends, portfolio asset credit quality,
and tax considerations), meeting daily redemption obligations is
fundamental for open-end funds, and funds need to manage liquidity in
order to meet obligations. We understand, based on statements from
members of the fund industry and staff outreach, that funds generally
consider the portfolio management process to be of central importance
in managing funds' liquidity risk.\631\ Commission staff has analyzed
whether the liquidity of funds' portfolio holdings, as well as funds'
holdings of cash and cash equivalents, is correlated with certain
events that could affect a fund's liquidity risk--that is, increased
flow volatility, and decreased market liquidity. As described in more
detail below, staff analysis shows empirical results indicating that
funds' portfolio holdings tend to be less liquid, and their holdings of
cash and cash equivalents tend to be lower, when funds encounter
periods of decreased flow volatility. These results indicate that
certain funds' portfolio construction takes liquidity risk management
into account and, as discussed below, the details comprising these
results have both reinforced our understanding of the benefits of the
proposed regulations and have shaped certain of the provisions of the
proposed regulations.
---------------------------------------------------------------------------

    \631\ See, e.g., ICI FSOC Notice Comment Letter, supra note 16,
at 14 (``For mutual funds, the central importance of meeting
redemptions means that liquidity management is a key element of
regulatory compliance, investment risk management, and portfolio
management--and a constant area of focus.'').
---------------------------------------------------------------------------

    The results of the staff's analysis demonstrate that, with respect
to U.S. equity funds, the liquidity of funds' holdings of equity
securities is higher

when flow volatility is higher.\632\ As discussed above, staff's
analysis with respect to trends that reflect the liquidity of funds'
non-cash (or cash equivalent) holdings is limited to an analysis of
U.S. equity funds, on account of limitations in the availability of
current data with respect to the holdings of funds that are not U.S.
equity funds.\633\ However, the staff was able to conduct similar
analyses regarding the relationship between flow volatility and
portfolio liquidity with respect to U.S. municipal bond funds, which
are unique in that their holdings typically consist only of U.S.
municipal bonds and cash and cash equivalents. Because U.S. municipal
bonds are less liquid than cash, any change in the relative holdings of
municipal bonds and cash and cash equivalents indicates a change in the
fund's portfolio liquidity. Unlike U.S. municipal bond funds, other
types of funds tend to hold portfolio assets that are not as
homogenous, and thus staff would not be able to assume that changes in
relative holdings across asset classes could indicate a change in the
fund's portfolio liquidity. With respect to U.S. municipal bond funds,
the holdings of municipal bonds (as opposed to these funds' holdings of
cash and cash equivalents) are relatively lower when flow volatility is
higher; holdings of municipal bonds are higher and holdings of cash and
cash equivalents are lower when flow volatility is lower.\634\ Thus,
like U.S. equity funds, U.S. municipal bond funds' portfolio liquidity
tends to be higher when flow volatility is higher. Likewise, staff
analysis of the cash and cash equivalent holdings of all funds
(regardless of strategy) shows that funds with more volatile flows tend
to hold more cash and cash equivalents.\635\
---------------------------------------------------------------------------

    \632\ DERA Study, supra note 39, at p. 37.
    \633\ See supra notes 622-623 and accompanying text.
    \634\ DERA Study, supra note 39, at pp. 39-40.
    \635\ DERA Study, supra note 39, at pp. 41-42.
---------------------------------------------------------------------------

    The results of staff's analysis on the relationship between
portfolio liquidity and fund flow volatility are significant for
several reasons. First, these results suggest that, as indicated by
funds in the course of staff outreach and in funds' statements
regarding their liquidity risk management, some funds actively manage
their portfolio liquidity to respond to events that could challenge
funds' ability to plan to meet redemption requests. These results also
emphasize that flow volatility is a relevant factor that a fund should
consider when assessing liquidity risk and managing the liquidity
profile of its portfolio. Rule 22e-4 as proposed reflects this by
requiring a fund to consider its cash flow projections in assessing its
liquidity risk (and determining its three-day liquid asset minimum),
including the volatility of historical purchases and redemptions of
fund shares during normal and stressed periods.\636\
---------------------------------------------------------------------------

    \636\ See proposed rule 22e-4(b)(2)(iii)(A)(1).
---------------------------------------------------------------------------

    While increased flow volatility could make a fund less certain as
to the extent of redemption requests it will be required to meet,
changes in market liquidity (that is, the extent to which market
factors affect the liquidity of a fund's portfolio holdings) could make
a fund less certain that the assets its holds are sufficient to meet
redemption requests, or meet such requests in a way that minimizes
dilution of non-redeeming shareholders. Thus, both increased flow
volatility and decreased market liquidity could increase a fund's
liquidity risk. While staff analysis shows that U.S. equity fund
liquidity decreased sharply during the 2007-2009 financial crisis, the
cause of this decrease in liquidity is initially unclear.\637\ Fund
liquidity could have decreased because of a general decrease in the
liquidity of all assets in the market, or fund liquidity could have
decreased as a result trading activity--for instance, if the fund were
to sell its most liquid assets to pay redeeming shareholders or if the
fund were to buy less liquid assets because of perceived profit
opportunities. Staff analysis, however, suggests that decreases in the
liquidity of U.S. equity funds are generally driven by changes in
market liquidity and that funds do limited trading to offset such
decreases.\638\ For the average U.S. equity fund, when market liquidity
decreases by 1% from the previous quarter, fund liquidity decreases by
0.93% from the previous quarter. Conversely, when market liquidity
increases by 1% from the previous quarter, fund liquidity increases by
0.82% from the previous quarter.\639\ So, while the results are
consistent with the view that U.S. equity funds actively manage their
portfolio liquidity, funds appear to make only minor adjustment to
their portfolio in response to changes in market liquidity.\640\
---------------------------------------------------------------------------

    \637\ DERA Study, supra note 39, at pp. 30-31.
    \638\ DERA Study, supra note 39, at Section 6. As discussed
above, staff's analysis with respect to trends that reflect the
liquidity of funds' non-cash (or cash equivalent) holdings is
limited to an analysis of U.S. equity funds, on account of
limitations in the availability of current data with respect to the
holdings of funds that are not U.S. equity funds. See also supra
notes 622-623 and accompanying text.
    \639\ DERA Study, supra note 39, at pp. 34-35.
    \640\ Funds may be unable to fully offset decreases in market
liquidity because of their investment mandate. A small cap mutual
fund cannot simply begin buying only large cap stocks just because
the liquidity of small cap stocks has decreased.
---------------------------------------------------------------------------

    This analysis demonstrates that fund portfolio liquidity tends to
be lower during periods of decreased market liquidity. Based on this
analysis, if a shareholder were to redeem shares during a period of
decreased market liquidity, funds would likely have a less liquid
portfolio of assets available to sell to meet redemptions. To the
extent that selling those relatively less liquid assets requires the
fund to accept a discount from the assets' market value, the value of
the fund's shares would be negatively affected. Our staff's analysis
thus highlights a source of potential concern regarding investor
protection, reinforcing our motivation to propose regulations to better
protect investors by enhancing funds' liquidity risk management. A
primary benefit of the proposed liquidity risk management program
requirement, discussed below, is the potential for the requirement to
improve investor protection by decreasing the likelihood that a fund
would be unable to meet its redemption obligations, or meet such
obligations by materially affecting the fund's NAV.\641\
---------------------------------------------------------------------------

    \641\ See infra section IV.C.1.b.
---------------------------------------------------------------------------

d. Trends in Fund Strategies To Meet Redemption Requests
    A fund may meet redemption requests in a variety of ways, including
by using available cash to pay all redemptions. If a fund were to sell
portfolio assets in order to meet redemption requests, the fund's
portfolio liquidity will be affected by the choice of which assets will
be sold. Subsequent rebalancing of the fund's portfolio after
redemptions are met will also affect portfolio liquidity. For example,
a fund facing a large redemption request can lessen the price impact of
selling assets by selling the most liquid portion of the
portfolio.\642\ That choice benefits non-redeeming investors by
minimizing the loss in fund value due to the price impact of selling,
but it also could increase the liquidity risk of the fund
portfolio.\643\ If the fund instead were to

sell a ``strip'' of the portfolio (i.e., a cross-section or
representative selection of the fund's portfolio assets), the impact on
fund value may be greater, but the liquidity of the fund portfolio
would be unchanged as a result of the sale. Funds also could choose to
meet redemptions by selling a range of assets in between its most
liquid, on one end of the spectrum, and a perfect pro rata strip of
assets, on the other end of the spectrum. Additionally, funds could
choose to opportunistically pare back or eliminate holdings in a
particular asset or sector to meet redemptions.
---------------------------------------------------------------------------

    \642\ We note that in some instances, selling only the most
liquid assets to meet a large redemption could be inconsistent with
the fund's investment mandate. For example, if a fund's investment
mandate required it to hold a certain percentage of its portfolio in
equities, the fund might not be able to sell a large portion of its
equity holdings to meet redemption requests and still hold the
required percentage of its portfolio in equities.
    \643\ See, e.g., supra note 37 (discussing recent circumstances
in which, during a year of heavy redemptions that caused a high
yield bond fund's assets to shrink 33% in this period, the fund's
holdings of bonds rated triple-C or below grew to 47% of assets,
from 35% before the redemptions).
---------------------------------------------------------------------------

    Staff analysis of the impact of large redemptions on portfolio
liquidity suggests that the typical U.S. equity fund does not sell a
strip of its portfolio assets to meet redemptions, but instead
appears--based on changes in funds' portfolio liquidity following net
outflows--to disproportionately sell the more liquid portion of its
portfolio for this purpose.\644\ Similarly, staff analysis shows that
when a U.S. municipal bond fund encounters net outflows, the typical
U.S. municipal bond fund will experience an increase in its holdings of
municipal bonds (and a decrease in its holdings of cash and cash
equivalents), thus decreasing the fund's overall portfolio
liquidity.\645\ This suggests that U.S. municipal bond funds tend to
satisfy redemption requests with cash, and not by selling a strip of
the fund's portfolio assets.
---------------------------------------------------------------------------

    \644\ DERA Study, supra note 39, at pp. 43-46.
    \645\ DERA Study, supra note 39, at pp. 47-49; see also supra
notes 633-634 and accompanying text (discussing the staff's
assumptions that a decrease in the holdings of municipal bonds by a
U.S. municipal bond fund would increase the fund's liquidity, as
well as the reasons that the staff does not make similar assumptions
about funds other than U.S. municipal bond funds).
---------------------------------------------------------------------------

    Holding all else equal, as the liquidity of a U.S. equity fund
portfolio decreases, the price impact of selling a strip of that
portfolio increases.\646\ As a result, we would expect less liquid U.S.
equity funds to have greater incentive to meet redemption requests by
selling their most liquid assets rather than a strip of their
portfolio. Staff analysis suggests that, as initial liquidity
decreases, U.S. equity funds do become more likely to
disproportionately sell their relatively more liquid assets, rather
than strips of their portfolio, to meet redemptions.\647\ That choice
has the effect of decreasing the liquidity of the portfolio, which
could potentially disadvantage non-redeeming shareholders by increasing
the fund's liquidity risk.\648\ As discussed below, we believe that a
significant benefit of the liquidity risk management program
requirement is the decreased possibility that a fund's actions taken in
order to pay redemptions would result in negative effects on the fund's
liquidity profile that could ultimately harm non-redeeming
shareholders.\649\
---------------------------------------------------------------------------

    \646\ DERA Study, supra note 39, at pp. 25-26. The Amihud
liquidity measure used in this analysis measures price impact. When
using this measure, price impact increases when liquidity decreases,
by definition. However, using alternative measures of liquidity,
this statement would not necessarily be true. See supra note 621.
    \647\ DERA Study, supra note 39, at pp. 45-46 and Table 19.
    \648\ While a holder of an illiquid asset receives compensation
in the form of an illiquidity premium (see, e.g., Amihud, supra note
621, at 31), non-redeeming investors might not be aware of the
change in portfolio liquidity and would therefore maintain an
allocation that does not reflect their liquidity risk preference.
    \649\ See infra section IV.C.1.b.
---------------------------------------------------------------------------

3. Fund Industry Developments Highlighting the Importance of Funds'
Liquidity Risk Management
a. Overview
    Along with staff analysis of economic relationships regarding
funds' portfolio liquidity, evaluating recent fund industry
developments also point to concerns about the need for funds to have
liquidity risk management programs that will reduce the risk that funds
will be unable to meet redemption obligations without materially
affecting the fund's NAV or risk profile and mitigate dilution of
interests of fund shareholders.\650\ These developments include the
growth in assets managed by funds with strategies that are generally
viewed as concentrating in relatively less liquid asset holdings, as
well as the growth in assets managed by funds with strategies that tend
to exhibit relatively high portfolio flow volatility, which could give
rise to increased liquidity risk. This section provides details about
these industry trends.
---------------------------------------------------------------------------

    \650\ See supra section IV.A.
---------------------------------------------------------------------------

    Below we discuss the size and growth of the U.S. fund industry
generally, as well as the growth of various investment strategies
within the industry. We show that the fund industry has grown
significantly in the past two decades, and during this period, funds
with international strategies, fixed income funds, and funds with
alternative strategies have grown particularly quickly. We also examine
trends regarding the volatility and predictability of fund flows,
discussing in particular those types of funds that demonstrate notably
volatile and unpredictable flows. Because volatility and predictability
in a fund's flows can affect the extent to which the fund is able to
meet expected and reasonably foreseeable redemption requests without
materially affecting a fund's NAV or dilution of the interests of fund
shareholders, assessing trends regarding these factors can provide
information about sectors of the fund industry that could be
particularly susceptible to liquidity risk.
    While we believe that these trends are relevant from the
perspective of addressing potential liquidity risk in the fund industry
(and in funds' underlying portfolio assets), we emphasize that
liquidity risk is not confined to certain types of funds or investment
strategies. Although we recognize that certain fund characteristics
could make a fund relatively more prone to liquidity risk, we believe
that all types of funds entail liquidity risk to some extent.\651\
Thus, while in this section we discuss certain types of funds and
strategies that are generally considered to exhibit increased liquidity
risk, we are not asserting that only these types of funds and
strategies involve liquidity risk, or that a fund of the type and with
the strategy discussed below necessarily demonstrates greater liquidity
risk than a fund that does not have these same characteristics.
---------------------------------------------------------------------------

    \651\ See supra section III.A.2.
---------------------------------------------------------------------------

b. Size and Growth of the U.S. Fund Industry and Various Investment
Strategies Within the Industry
    Open-end funds and ETFs manage a significant and growing amount of
assets in U.S. financial markets. As of the end of 2014, there were
8,734 open-end funds (excluding money market funds, but including
ETFs), as compared to 5,279 at the end of 1996.\652\ The assets of
these funds were $15.05 trillion in 2014, having grown from about $2.63
trillion in 1996.\653\ Within these figures, the number of ETFs and
ETFs' assets have increased notably in the past decade. There were
1,411 ETFs in 2014, as opposed to a mere 119 in 2003, and ETFs' assets
have increased from $151 billion in 2003 to $1.9 trillion in 2014.\654\
---------------------------------------------------------------------------

    \652\ See 2015 ICI Fact Book, supra note 3, at 177, 184.
    \653\ See 2015 ICI Fact Book, supra note 3, at 175, 183.
    \654\ See 2015 ICI Fact Book, supra note 3, at 60.
---------------------------------------------------------------------------

    U.S. equity funds represent the greatest percentage of U.S. open-
end fund industry assets.\655\ Excluding ETFs, money market funds and
variable annuities, open-end U.S. equity funds held 44.5% of U.S. fund
industry assets as of the end of 2014. The investment

strategies with the next-highest percentages of U.S. fund industry
assets are foreign equity funds (15.4%), mixed strategy funds (13.7%),
and general bond funds (13.3%).\656\ Funds with alternative strategies
only represent a small percentage of the U.S. fund industry assets, but
as discussed below, the number of alternative strategy funds and the
assets of this sector have grown considerably in recent years.\657\
---------------------------------------------------------------------------

    \655\ DERA Study, supra note 39, at Table 1.
    \656\ Id. The figure for general bond funds does not include
assets attributable to foreign bond funds (2.0%), U.S. corporate
bond funds (0.8%), U.S. government bond funds (1.3%), and U.S.
municipal bond funds (4.5%).
    \657\ DERA Study, supra note 39, at pp. 7-8.
---------------------------------------------------------------------------

    While the overall growth rate of funds' assets has been generally
high (about 8.0% per year, between the years 2000 and 2014 \658\), it
has varied significantly by investment strategy.\659\ U.S. equity
funds' assets grew substantially in terms of dollars from the end of
2000 to 2014,\660\ but this sector's assets as a percentage of total
U.S. fund industry assets decreased from about 65% to about 45% during
that same period.\661\ Like U.S. equity funds, the assets of U.S.
corporate bond funds, government bond funds, and municipal bond funds
also increased in terms of dollars from 2000 to 2014, but each of these
sectors' assets as a percentage of the fund industry decreased during
this period.\662\ On the other hand, the assets of foreign equity
funds, general bond funds, and foreign bond funds increased steadily
and substantially as a percentage of the fund industry over the same
period.\663\ For example, foreign equity funds increased steadily from
10.6% of total industry assets in 2000 to 15.4% in 2014. And within
these three investment strategies, certain investment subclasses
(emerging market debt and emerging market equity) have grown
particularly quickly from 2000 to 2014.\664\
---------------------------------------------------------------------------

    \658\ DERA Study, supra note 39, at Table 2.
    \659\ The figures in this paragraph and the following paragraph,
discussing the variance in growth rate of funds' assets by
investment strategy, exclude ETF assets.
    \660\ U.S. equity funds held about $5.6 trillion as the end of
2014, compared to about $2.9 trillion at the end of 2000. DERA
Study, supra note 39, at Table 2.
    \661\ DERA Study, supra note 39, at Table 2.
    \662\ Id. U.S. corporate bond funds held about $99 billion at
the end of 2014, as opposed to $66 billion in 2000; these funds'
assets as a percentage of the U.S. fund industry decreased from 1.5%
in 2000 to 0.8% in 2014. U.S. government bond funds held about $166
billion at the end of 2014, as opposed to $91 billion in 2000; these
funds' assets as a percentage of the U.S. fund industry decreased
from 2.1% in 2000 to 1.3% in 2014. U.S. municipal bond funds held
about $565 billion at the end of 2014, as opposed to $278 billion in
2000; these funds' assets as a percentage of the U.S. fund industry
decreased from 6.3% in 2000 to 4.5% in 2014.
    \663\ Id. Foreign equity funds held about $1.9 trillion in 2014,
as opposed to $465 billion in 2000; these funds' assets as a
percentage of the U.S. fund industry increased from 10.6% in 2000 to
15.4% in 2014. U.S. general bond funds held about $1.7 trillion at
the end of 2014, as opposed to $240 billion in 2000; these funds'
assets as a percentage of the U.S. fund industry increased from 5.4%
in 2000 to 13.3% in 2014. Foreign bond funds held about $259 billion
at the end of 2014, as opposed to $19 billion in 2000; these funds'
assets as a percentage of the U.S. fund industry increased from 0.4%
in 2000 to 2.0% in 2014.
    \664\ DERA Study, supra note 39, at p. 9. Emerging market debt
and emerging market equity funds held about $334 billion at the end
of 2014, as opposed to $20 billion in 2000. The assets of emerging
market debt funds and emerging market equity funds grew by an
average of 20.8% and 22.7%, respectively, each year from 2000
through 2014.
     These investment subclasses represent a small portion of the
U.S. mutual fund industry (the combined assets of these investment
subclasses as a percentage of the U.S. fund industry was 2.6% at the
end of 2014).
---------------------------------------------------------------------------

    The assets of funds with alternative strategies \665\ also have
grown rapidly in recent years. From 2005 to 2014, the assets of
alternative strategy funds grew from $366 million to $334 billion, and
from the end of 2011 to the end of 2013, the assets of alternative
strategy funds grew by almost 80% each year. However, as discussed
above, funds with alternative strategies remain a relatively small
portion of the U.S. fund industry as a percentage of total assets.\666\
While growth in funds with alternative strategies has slowed over the
past year, a rising interest rate environment could cause inflows to
these funds to increase once again, as investors look to reduce their
interest rate risk and/or increase income by investing in alternative
strategies.\667\
---------------------------------------------------------------------------

    \665\ See supra note 64 for a discussion of the primary
investment strategies practiced by ``alternative strategy'' funds.
    \666\ See supra note 657 and accompanying text.
    \667\ See supra note 66.
---------------------------------------------------------------------------

c. Significance of Fund Industry Developments
    The industry developments discussed above are notable for several
reasons. The growth of funds generally over the past few decades
demonstrates that investors have increasingly come to rely on
investments in funds to meet their financial needs.\668\ As investments
in funds increase, the need for continued effective regulations to
protect investors is paramount. Initiatives such as the proposed
liquidity regulations, which aim to promote shareholder protection by
enhancing funds' liquidity risk management, are important to decrease
the risk that funds will be unable to meet redemption obligations and
reduce potential dilution of the interests of fund shareholders.
---------------------------------------------------------------------------

    \668\ See supra note 6 and accompanying text.
---------------------------------------------------------------------------

    These trends also demonstrate growth in particular types of funds
that may entail increased liquidity risk. In particular, there has been
significant growth in high-yield bond funds, emerging market debt
funds, and funds with alternative strategies. Commissioners and
Commission staff have previously spoken about the need to focus on
potential liquidity risks relating to fixed income assets and fixed
income funds,\669\ and within this sector, funds that invest in high-
yield bonds could be subject to greater liquidity risk as they invest
in lower-rated bonds that tend to be less liquid than investment grade
fixed income securities.\670\ Emerging market debt funds may invest in
relatively illiquid securities with lengthy settlement periods.\671\
Likewise, funds with alternative strategies may invest in portfolio
assets that are relatively illiquid.\672\ Moreover, Commission staff
economists have found that both foreign bond funds (including emerging
market debt funds) and alternative strategy funds have historically
experienced relatively more volatile and unpredictable flows than the
average mutual fund,\673\ which could increase these funds' liquidity
risk by making it more difficult to plan to meet fund redemptions (and
thus, more likely that a fund may need to sell portfolio assets in a
manner that creates a market impact in order to pay redeeming
shareholders).\674\ On account of these characteristics of high-yield
bond funds, emerging market debt

funds, and funds with alternative strategies, we are concerned that the
growth in these strategies could give rise to increased concerns
regarding these funds' liquidity risk.
---------------------------------------------------------------------------

    \669\ See supra note 62 and accompanying text.
    \670\ The Commission and Commission staff have cautioned that
high yield securities may be considered to be illiquid, depending on
the facts and circumstances. See Interval Fund Proposing Release,
supra note 83; see also SEC Investor Bulletin, What Are High-Yield
Corporate Bonds?, available at http://www.sec.gov/investor/alerts/ib_high-yield.pdf (noting that high-yield bonds may be subject to
more liquidity risk than, for example, investment-grade bonds). But
see BlackRock, Viewpoint, Who Owns the Assets?, supra note 79
(discussing the liquidity characteristics of high-yield bond funds
in depth, and noting that these funds have weathered multiple market
environments, and are generally managed with multiple sources of
liquidity).
    \671\ See, e.g., supra note 197 and accompanying text
(discussing the settlement cycles associated with transactions in
certain foreign securities); see also Reuters, ``Fitch: Close Look
at EM Corporate Bond Trading Reveals Liquidity Risks'' (Apr. 16,
2015), available at http://www.reuters.com/article/2015/04/16/idUSFit91829620150416. But see BlackRock, Viewpoint, Who Owns the
Assets?, supra note 79 (discussing the liquidity characteristics of
emerging market debt funds in depth, and noting that these funds
tend to hold a portion of their assets in developed market
government bonds (providing further liquidity), generally establish
limits on less liquid issuers, and generally maintain allocations to
cash for liquidity and rebalancing purposes).
    \672\ See supra notes 68-72 and accompanying text.
    \673\ DERA Study, supra note 39, at pp. 16-24.
    \674\ See supra notes 269-270 and accompanying text.
---------------------------------------------------------------------------

C. Benefits and Costs, and Effects on Efficiency, Competition, and
Capital Formation

    Taking into account the goals of the proposed liquidity regulations
and the economic baseline, as discussed above, this section explores
the benefits and costs of the proposed liquidity regulations, as well
as the potential effects of the proposed liquidity regulations on
efficiency, competition, and capital formation. This section also
discusses reasonable alternatives to proposed rule 22e-4, proposed rule
22c-1(a)(3), and the proposed disclosure and reporting requirements
regarding funds' liquidity risk and liquidity risk management and swing
pricing.
1. Proposed Rule 22e-4
a. Requirements of Proposed Rule 22e-4
    Proposed rule 22e-4 would require each fund to establish a written
liquidity risk management program. The proposed rule specifies that a
fund's liquidity risk management program shall include the following
required program elements: (i) Classification and ongoing review of the
classification of the liquidity of each of the fund's positions in a
portfolio asset (or portions of a position in a particular asset),
taking into account certain specified factors set forth in the rule;
\675\ (ii) assessment and periodic review of the fund's liquidity risk
taking into account certain specified factors set forth in the rule;
\676\ and (iii) management of the fund's liquidity risk.\677\ A fund's
policies and procedures for managing liquidity risk, in turn, must
incorporate the determination and periodic review of the adequacy of a
fund's three-day liquid asset minimum (that is, the percentage of the
fund's net assets that must be invested in three-day liquid
assets).\678\ Proposed rule 22e-4 would also prohibit a fund from
acquiring any: (i) Less liquid asset, if immediately after the
acquisition, the fund would have invested less than its three-day
liquid asset minimum in three-day liquid assets; \679\ or (ii) 15%
standard asset, if immediately after the acquisition, the fund would
have invested more than 15% of its net assets in 15% standard
assets.\680\ In addition, proposed rule 22e-4 would require a fund to
establish policies and procedures regarding redemptions in kind, to the
extent that the fund engages in or reserves the right to engage in
redemptions in kind.\681\
---------------------------------------------------------------------------

    \675\ Proposed rule 22e-4(b)(2)(i)-(ii).
    \676\ Proposed rule 22e-4(b)(2)(iii).
    \677\ Proposed rule 22e-4(b)(2)(iv).
    \678\ Proposed rule 22e-4(b)(2)(iv)(A)-(B).
    \679\ Proposed rule 22e-4(b)(2)(iv)(C).
    \680\ Proposed rule 22e-4(b)(2)(iv)(D).
    \681\ Proposed rule 22e-4(b)(2)(iv)(E).
---------------------------------------------------------------------------

    A fund's board, including a majority of the fund's independent
directors, would be required to approve the fund's liquidity risk
management program (including the fund's three-day liquid asset
minimum), as well as any material change to the program.\682\ The fund
would be required to designate the fund's adviser or officers
responsible for administering the program, and such designation is
required to be approved by the fund's board of directors.\683\ The
fund's board would also be required to review, at least annually, a
written report prepared by the fund's investment adviser or officers
administering the liquidity risk management program reviewing the
adequacy of the fund's liquidity risk management program, including the
fund's three-day liquid asset minimum, and the effectiveness of its
implementation.\684\
---------------------------------------------------------------------------

    \682\ Proposed rule 22e-4(b)(3)(i).
    \683\ Proposed rule 22e-4(b)(3)(iii).
    \684\ Proposed rule 22e-4(b)(3)(ii).
---------------------------------------------------------------------------

    Proposed rule 22e-4 also includes certain recordkeeping
requirements. A fund would be required to keep a written copy of its
liquidity risk management policies and procedures, as well as copies of
any materials provided to the fund's board in connection with the
approval of the initial liquidity risk management program and any
material changes to the program and annual board reporting
requirement.\685\ A fund also would be required to keep a written
record of how its three-day liquid asset minimum, and any adjustments
thereto, were determined.\686\
---------------------------------------------------------------------------

    \685\ Proposed rule 22e-4(c)(1) and (2).
    \686\ Proposed rule 22e-4(c)(3).
---------------------------------------------------------------------------

b. Benefits
    We believe that proposed rule 22e-4 is likely to produce benefits
for current and potential fund investors. Specifically, we believe that
the proposed program requirement is likely to improve investor
protection by decreasing the chance that a fund would be unable to meet
its redemption obligations, would meet such obligations only by
materially affecting the fund's NAV, or would meet such obligations
through methods that would have other adverse impacts on non-redeeming
investors (e.g., increased risk exposure and decreased liquidity).
Funds are not currently subject to specific requirements under the
federal securities laws or Commission rules obliging them to manage
their liquidity risk.\687\ Also, with the exception of money market
funds, funds are currently guided by Commission guidelines (not rules)
that generally limit their investment in illiquid assets.\688\ As
discussed above, funds today employ notably different practices for
assessing and classifying the liquidity of their portfolio assets, as
well as for assessing and managing fund liquidity risk. Some of these
practices take into account multiple aspects relating to portfolio
assets' liquidity (including relevant market, trading, and asset-
specific factors), involve comprehensive assessment and robust
management of fund liquidity risk, and incorporate ongoing review of
both portfolio liquidity and fund liquidity risk. Outreach by
Commission staff has found that practices of some funds raise concerns
regarding various funds' ability to meet their redemption obligations
and lessen the effects of dilution. Also, while some funds have
independent oversight of their liquidity risk outside of the portfolio
management process, others do not. While a fund's portfolio management
has access to a great deal of information relevant to the liquidity of
the fund's portfolio assets, and thus pertinent to the fund's liquidity
risk, a portfolio manager may have conflicts of interest that could
impede effective liquidity risk management.\689\ For example, because
investments in relatively less liquid assets may result in higher total
returns for a fund, fund managers may have incentive to increase their
funds' investment in illiquid assets levels in a manner that is
potentially inconsistent with the funds' expected and reasonably
foreseeable redemptions. Consequently, to the extent that some funds do
not currently meet the minimum baseline requirements for fund
assessment and management of liquidity risk proposed in this rule,
investor protection would be enhanced by reducing the risk that funds
will be unable to meet redemption obligations and mitigating dilution
of fund shareholders.
---------------------------------------------------------------------------

    \687\ See supra section IV.B.1.a.
    \688\ See id.
    \689\ See text accompanying supra note 258.
---------------------------------------------------------------------------

    We believe that the proposed liquidity risk management program
requirement would promote improved alignment of the liquidity of the
fund's portfolio with the fund's expected (and reasonably foreseeable)
levels of redemptions. As discussed above, proposed rule 22e-4 would
require each fund to consider a

standard set of factors, as applicable, in classifying the liquidity of
its portfolio assets and in assessing its liquidity risk, and to
determine a three-day liquid asset minimum to increase the likelihood
that the fund will hold adequate liquid assets to meet redemption
requests without materially affecting the fund's NAV. Each fund would
have flexibility to determine the particular assets that it holds in
connection with its three-day liquid asset minimum. 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. While one fund may conclude that it is appropriate to hold
a significant portion of its three-day liquid assets in cash and cash
equivalents, another could decide it is appropriate to hold assets that
are convertible to cash within longer periods (but not exceeding three
business days) as the majority of its three-day liquid asset minimum
holdings. We believe that the proposed three-day liquid asset minimum
requirement would allow funds to continue to meet a wide variety of
investors' investment needs by obliging funds to maintain appropriate
liquidity in their portfolios, while permitting funds to remain
substantially invested in portfolio assets that conform to their
investment strategies. The limitation on acquisition of 15% standard
assets would complement the three-day liquid asset minimum requirement
to increase the likelihood that a fund's portfolio is not overly
concentrated in assets whose liquidity is extraordinarily limited.
    We believe that the proposed rule also would decrease the
probability that a fund will be able to meet redemption requests only
through activities that can materially affect the fund's NAV or risk
profile or dilute the interests of fund shareholders. For example, when
a fund does not effectively manage liquidity and is faced with
significant redemptions, it may be forced to sell portfolio assets
under unfavorable circumstances, which could create significant
negative price pressure on those assets.\690\ This, in turn, could
disadvantage non-redeeming shareholders by decreasing the value of
those shareholders' interests in the fund.\691\ Even if a fund were to
sell the most liquid portion of its portfolio to meet redemption
requests, which would minimize the loss in fund value due to the price
impact of selling, these asset sales could decrease the liquidity of
the fund portfolio, potentially creating increased liquidity risk for
non-redeeming shareholders. As discussed above, staff analysis suggests
that U.S. equity funds may dispose of relatively more liquid assets
first, as opposed to selling a pro rata ``strip'' of the fund's
portfolio assets, which minimizes price impact on a fund in the short
term, but ultimately decreases the liquidity of the fund's
portfolio.\692\ Short-term borrowings by a fund to meet redemption
requests also could disadvantage non-redeeming shareholders by
leveraging the fund and requiring the fund to pay interest on the
borrowed funds (although, in some instances, the costs of borrowing may
be less than the costs of selling assets to meet redemptions). For
example, in a settled enforcement action, the Commission found that
certain high-yield bond funds experienced liquidity problems and as a
result, the funds borrowed heavily against a line of credit to meet
fund redemption requests, which permitted shareholders to redeem fund
shares at prices above the fair value of the fund's holdings. The
result was a benefit to redeeming shareholders at the expense of
remaining and new shareholders.\693\ Moreover, the costs of borrowing
(that is, the costs associated with maintaining a committed line of
credit, as well as interest expenses associated with drawing on a
credit line) could be passed on to fund shareholders in the form of
fund operating expenses, which could adversely affect a fund's NAV. It
is possible that such costs could exceed any price impact caused by
asset sales conducted to generate liquidity, particularly since the
costs of maintaining a committed line of credit are ongoing costs,
whereas the price impact caused by asset sales could be only temporary.
To the extent that the proposed program requirement results in
liquidity risk assessment and management that enhance funds' ability to
meet redemption obligations, it would be less likely that a fund takes
actions to pay redemptions that would materially affect the fund's NAV
or have other adverse impacts on non-redeeming shareholders.
---------------------------------------------------------------------------

    \690\ See Coval & Stafford, supra note 51 (discussing how mutual
fund fire sales impact asset prices).
    \691\ While the impact of fire sales on asset prices may be
short lived in some instances, Coval and Stafford show that the
impact of fire sales can often take many months to dissipate. Id.
    \692\ See supra note 39 and accompanying discussion.
    \693\ Heartland Release, supra note 47.
---------------------------------------------------------------------------

    The potential negative consequences of asset sales effected to pay
fund redemptions could create incentives in times of liquidity stress
in the markets for early redemptions, or a ``first-mover advantage.''
\694\ For example, recent academic studies have suggested that an
incentive exists for market participants to front-run trades conducted
by a fund in response to significant changes in fund flows.\695\ This
suggests that sophisticated fund investors could anticipate that
significant fund outflows could lead a fund to conduct trades that
would disadvantage non-redeeming shareholders, which could create an
incentive to redeem ahead of such trades. Among U.S. equity funds,
staff analysis suggests that, as a fund's liquidity decreases, a fund
will become more likely to sell its relatively more liquid assets to
pay redemptions (thus resulting in decreased liquidity in the fund's
portfolio).\696\ Thus, if investors' redemptions are motivated by a
first-mover advantage, this could lead to increasing levels of
redemptions, and as the level of outflows from a fund increases, the
incentive to redeem also increases. Any negative effects on non-
redeeming shareholders thus could be magnified by a first-mover
advantage to the extent that this dynamic produces growing redemptions
and decreased portfolio liquidity. While we understand that fund
investors may not have historically been motivated to redeem on account
of a perceived (or actual) first-mover advantage during previous
periods of stress,\697\ we cannot predict how investors may behave in
the future. The first-mover advantage is more commonly referenced with
respect to money market funds, but the incentives that have been argued
to create the first-mover advantage among those funds exist (in
possibly weaker form) among other open-end funds. To the extent that
economic incentives exist to redeem fund shares prematurely, this could
lead to investor dilution as discussed above, and the possibility of
protecting against this potential dilution is one motivating aspect
(but not the only or key

motivating aspect \698\) of the overall goal of investor protection
that we believe the proposed rule 22e-4 would accomplish.
---------------------------------------------------------------------------

    \694\ See supra note 49 and accompanying text (discussing the
possibility of a first-mover advantage with respect to the timing of
shareholder redemption from funds). But see supra note 50
(discussing arguments that such a first-mover advantage does not
exist in funds, as well as arguments that even if incentives to
redeem ahead of other shareholders do exist, this does not
necessarily imply that investors will in fact redeem en masse in
times of market stress).
    \695\ See Coval & Stafford, supra note 51; Dyakov & Verbeek,
supra note 51.
    \696\ See supra section II.B.2.
    \697\ See, e.g., Comment Letter of Wellington Management Group
LLP on the FSOC Notice (Mar. 25, 2015), at 4; ICI FSOC Notice
Comment Letter, supra note 16, at 7; Nuveen FSOC Notice Comment
Letter, supra note 45, at 10 (all arguing that evidence shows that
fund shareholders' redemptions are largely driven by other concerns
rather than a theoretical first-mover advantage).
    \698\ See supra notes 690-693 and accompanying text.
---------------------------------------------------------------------------

    We recognize that certain funds already engage in fairly
comprehensive liquidity risk management practices, and the proposed
program requirement would likely benefit these funds' shareholders less
than it would benefit the shareholders of funds that do not employ
equally rigorous practices. The proposed program requirement aims to
promote a minimum baseline in the fund industry, both in the assessment
of portfolio assets' liquidity and the evaluation of factors relevant
to liquidity risk management. This, in turn, we believe would promote
investor protection by elevating the overall quality of liquidity risk
management across the fund industry, reducing the likelihood that funds
will meet redemption obligations only through activities that could
materially affect fund NAVs or risk profiles, and mitigating dilution
of shareholder interests. We cannot quantify the total benefits to fund
operations and investor protection that we discuss above, but to the
extent that staff outreach has noted that some funds currently have no
(or very limited) formal liquidity risk management programs in place,
proposed rule 22e-4 would enhance current liquidity risk management
practices.
    We also believe that the liquidity risk management program
requirement, as proposed, would not adversely impact fund diversity and
investor choice. While the proposed liquidity risk management program
requirement would include certain required elements, and would require
a fund to consider certain specified factors in classifying the
liquidity of its portfolio assets and assessing its liquidity risk, it
would not produce a de facto prohibition against certain investment
strategies. We anticipate that the proposed three-day liquid asset
minimum requirement would be sufficiently flexible to permit funds with
different investment strategies, and whose cash flow and liquidity
needs vary notably from one fund to the next, to manage their
individual levels of liquidity risk. This proposed requirement would
not mandate a standard level of minimum liquid asset holdings across
the fund industry. Proposed rule 22e-4 thus would allow a fund with a
relatively less liquid investment strategy to continue operating under
that strategy, so long as the fund determines a three-day liquid asset
minimum that takes into account the factors required to be considered
under the proposed rule, and invests its assets in compliance with its
three-day liquid asset minimum. (We recognize, however, that the
proposed rule could result in a fund modifying its portfolio
composition if it determines that the three-day liquid asset minimum
that it should hold, as a result of its consideration of the required
factors specified in the proposed rule, does not correspond with the
fund's current portfolio composition.\699\) The proposed requirement
would not adversely impact the diversity of investment strategies
within the fund industry and would permit a fund investor to choose
appropriate investment options for his or her risk tolerance and risk
preferences.\700\
---------------------------------------------------------------------------

    \699\ See infra section IV.C.1.c.
    \700\ We also believe that investor choice would be facilitated
by the proposed enhanced disclosure requirements, as discussed below
at section IV.C.3.b.
---------------------------------------------------------------------------

    Finally, to the extent that the proposed program requirement
results in funds less frequently needing to sell portfolio assets in
unfavorable market conditions in order to meet redemptions, the
proposed requirement also could lower potential spillover risks that
funds could pose to the financial markets generally. For example, the
proposed approach could decrease the risk that all investors holding an
asset would be affected if a fund facing heavy redemptions were forced
to sell portfolio assets under unfavorable circumstances, which in turn
could create significant negative price pressure on those assets. If,
as a result of the proposed program requirement, a fund was prepared to
meet redemption requests in other ways, the proposed rule could
decrease the risk that the fund might indirectly transmit stress to
other market sectors and participants. While there have been examples
of funds' liquidity risk management preventing spillover market effects
that could have arisen in the face of significant shareholder
redemptions, this prevention of larger market effects has occurred
because of funds' organic liquidity risk management practices, and not
because of any specific liquidity risk management requirements. It is
unclear whether such organic practices will be sufficient to prevent
future spillover market events of similar or greater magnitude. The
proposed rule should help all funds, not just funds with liquidity risk
management practices currently in place, operate in a manner that
lessens the chance of spillover risks. We are unable to quantify this
potential benefit because we cannot predict the extent to which funds
would enhance their current liquidity risk management practices as a
result of proposed rule 22e-4, or predict the precise circumstances
that could entail negative spillover effects in light of less-
comprehensive liquidity risk management by funds.\701\
---------------------------------------------------------------------------

    \701\ The ability of the Commission to perform such analysis is
limited by difficulties in both gathering data about funds'
liquidity risk management practices and quantifying such data.
---------------------------------------------------------------------------

c. Costs
One-Time and Ongoing Costs Associated With Program Establishment and
Implementation
    Funds would incur one-time costs to establish and implement a
liquidity risk management program in compliance with proposed rule 22e-
4, as well as ongoing program-related costs. As discussed above, funds
today employ a range of different practices, with varying levels of
comprehensiveness, for assessing and classifying the liquidity of their
portfolio assets, as well as for assessing and managing fund liquidity
risk. Accordingly, funds whose practices regarding portfolio asset
liquidity classification and liquidity risk assessment and management
most closely align with the proposed liquidity risk management program
requirements would incur relatively lower costs to comply with proposed
rule 22e-4. Funds whose practices for classifying the liquidity of
their portfolio assets and for assessing and managing liquidity risk
are less comprehensive or not closely aligned with our proposals, on
the other hand, may incur relatively higher initial compliance costs.
    Our staff estimates that the one-time costs necessary to establish
and implement a liquidity risk management program would range from $1.3
million to $2.25 million \702\ per fund complex,

depending on the particular facts and circumstances and current
liquidity risk management practices of the funds comprising the fund
complex.\703\ These estimated costs are attributable to the following
activities, as applicable to each of the funds within the complex: (i)
Developing policies and procedures relating to each of the required
program elements,\704\ and the related recordkeeping requirements of
the proposed rule; (ii) planning, coding, testing, and installing any
system modifications relating to each of the required program elements;
(iii) integrating and implementing policies and procedures relating to
each of the required program elements (including classifying the
liquidity of each of the fund's positions in a portfolio asset (or
portions of a position in a particular asset) in a portfolio asset
pursuant to proposed rule 22e-4(b)(2)(i)), as well as the recordkeeping
requirements of the proposed rule; (iv) preparing training materials
and administering training sessions for staff in affected areas; and
(v) board approval of the program. We anticipate that if there is
demand to develop policies and procedures relating to each of the
required program elements, third parties may develop programs that fund
complexes could purchase for less than our estimated cost to develop
the programs themselves. Indeed, we understand that third parties have
already developed programs to classify the liquidity of portfolio
assets, which are currently available for purchase.\705\ Because the
proposed requirement for a fund to limit acquisition of 15% standard
assets under certain circumstances is similar to existing Commission
guidelines, we assume that a fund complex would incur minimal costs
associated with implementing the proposed requirement to limit
acquisition of 15% standard assets with respect to each of its
respective funds.\706\
---------------------------------------------------------------------------

    \702\ These cost estimates are based in part on the staff's
recent estimates of the one-time systems costs associated with
implementing the fees and gates provisions of the 2014 amendments to
rule 2a-7 under the 1940 Act. See 2014 Money Market Fund Reform
Adopting Release, supra note 85, at section III.A.5.b. Although the
substance and content of systems associated with establishing and
implementing a liquidity risk management program (including any
systems changes associated with classifying the liquidity of funds'
portfolio positions) would be different from the substance and
content of systems associated with implementing the rule 2a-7 fees
and gates provisions, the one-time costs associated with proposed
rule 22e-4, like the one-time costs associated with the fees and