the proposed rule. In proposing rule 18f-4, the Commission noted
that, should the rule be adopted, it would rescind Release 10666 and
relevant staff no-action letters. See 2015 Derivatives Proposing
Release, supra footnote 222, at section III.I.
    \464\ See generally 2015 Derivatives Proposing Release, supra
footnote 222, at section II.B (providing background information on
the application of section 18 and Release 10666 to derivatives and
certain other transactions).
    \465\ See also Dear Chief Financial Officer Letter from Lawrence
A. Friend, Chief Accountant, Division of Investment Management (Nov.
7, 1997) (staff letter taking the position that a fund could
segregate assets by designating such assets on its books, rather
than establishing a segregated account at its custodian).
---------------------------------------------------------------------------

    Thus, we noted in the Proposing Release that, although assets used
by a fund to cover derivatives and other transactions should be liquid
when considered in isolation, when evaluating their liquidity for
purposes of proposed rule 22e-4, the fund would have to consider that
they are being used to cover other transactions and, consistent with
our position in Release 10666, are ``frozen'' and ``unavailable for
sale or other disposition.'' \466\ We stated that because these assets
are only available for sale to meet redemptions once the related
derivatives position is disposed of or unwound, a fund should classify
the liquidity of these segregated assets using the liquidity of the
derivative instruments they are covering. We also provided guidance
that, when a formerly segregated asset is no longer segregated, a fund
generally should assess, as part of the proposed ongoing liquidity
classification review requirement, whether the liquidity classification
given to the portfolio asset when it was segregated continues to be
appropriate. Finally, we noted in the Proposing Release that in
addition to the liquidity of a fund's derivatives positions themselves,
assessing a fund's liquidity risk generally may include an evaluation
of the potential liquidity demands that may be imposed on the fund in
connection with its use of derivatives, including any variation margin
or collateral calls the fund may be required to meet.\467\
---------------------------------------------------------------------------

    \466\ See Proposing Release, supra footnote 9, at section
III.B.2.i.
    \467\ See id., at n.309 and accompanying text.
---------------------------------------------------------------------------

    The Proposing Release included a request for comment on the
proposed ``relationship of [an] asset to another portfolio asset''
liquidity classification factor, which included asking whether rule
22e-4 should explicitly require a fund to classify the liquidity of a
position (or portions of a position in a particular asset) used to
cover a derivative position using the same liquidity classification
category as it assigned to the derivative, and whether the Commission
should provide additional guidance regarding the circumstances in which
a fund should consider the liquidity of a particular portfolio asset in
relation to the liquidity of another asset.\468\ Multiple commenters
raised concerns about the proposed ``relationship of [an] asset to
another portfolio asset'' liquidity classification factor and
accompanying guidance in the Proposing Release.\469\ Many stated that
the Commission's guidance as to classifying segregated assets using the
liquidity of the derivative instrument they are covering would be
unworkable and would raise costly operational burdens, because funds
currently do not identify individual liquid assets to cover specific
derivatives transactions.\470\ Instead,

commenters noted that it is common in the fund industry for a fund to
review its outstanding obligations under its derivatives positions on a
portfolio basis and determine an aggregate amount of liquid assets that
must be segregated in connection with the transactions requiring
coverage.\471\ One commenter suggested that, instead of the proposed
``relationship of [an] asset to another portfolio asset'' liquidity
classification factor, the Commission alternatively could require funds
to assign liquidity classifications to cover assets on an aggregate
portfolio basis in amounts corresponding to the aggregate amount of
derivatives exposure in each liquidity category.\472\
---------------------------------------------------------------------------

    \468\ See id., at section III.B.2.j.
    \469\ See, e.g., Dechert Comment Letter; Milliman Comment
Letter; T. Rowe Comment Letter; Vanguard Comment Letter.
    \470\ See, e.g., Dechert Comment Letter; ICI Comment Letter I;
Invesco Comment Letter; Vanguard Comment Letter. But see Nuveen
Comment Letter (suggesting that, for purposes of the alternative
liquidity classification approach that it recommends, a security
used specifically to cover a derivatives transaction that cannot be
unwound within seven days (and thus the derivative would be
classified as ``illiquid'' under the commenter's recommended
approach) also would be considered to be ``illiquid'' under that
approach).
    \471\ See Dechert Comment Letter.
    \472\ See id.; see also ICI Comment Letter I (suggesting that
the Commission add an item to Form N-PORT's Schedule of Portfolio
Investments that permits a fund to note whether an asset (or portion
thereof) is encumbered or linked to other assets as of the reporting
date, without separately tying to or identifying a ``linked''
asset).
---------------------------------------------------------------------------

    Some commenters also argued that the guidance provided in the
proposal could make an otherwise liquid but segregated asset appear to
be less liquid than it actually is when considered in isolation.\473\
For example, if a cash equivalent security were used to cover a
derivative that the fund determined to be convertible to cash within 8-
15 days, under the Commission's guidance, the cash equivalent also
would be classified as an asset that could be converted to cash within
8-15 days. However, the fund would be able to replace the cash
equivalent as a coverage asset with another liquid asset at any time,
which would immediately unencumber the cash equivalent (but would
encumber other liquid assets with the same value).
---------------------------------------------------------------------------

    \473\ See ICI Comment Letter I; T. Rowe Comment Letter.
---------------------------------------------------------------------------

    Finally, commenters generally discussed features of derivatives
transactions informing the way that their liquidity would be classified
under proposed rule 22e-4. One commenter noted that the proposal seemed
to suggest that derivatives are inherently more risky and present
greater liquidity risk than other, more traditional assets.\474\ This
commenter maintained that, in some situations, derivatives may be more
liquid than more traditional assets. Another commenter stated that,
while the liquidity of a derivatives transaction depends on the
derivative's underlying reference asset to some degree, its liquidity
also largely stems from the needs of other market participants for that
kind of derivative.\475\
---------------------------------------------------------------------------

    \474\ See T. Rowe Comment Letter.
    \475\ See Milliman Comment Letter.
---------------------------------------------------------------------------

    The requirements in rule 22e-4 regarding the classification of a
fund's derivatives transactions are meant to clarify and simplify the
application of the classification requirements to derivatives
transactions and respond to commenters' concerns. First, rule 22e-4
specifies that the liquidity classification and review requirements
apply to each of the fund's investment transactions (including
derivatives) and requires a fund to take into account relevant market,
trading, and investment-specific considerations in classifying
derivatives' liquidity.\476\ In addition, we have modified rule 22e-4
from the proposal to require a fund to classify each of the fund's
portfolio investments.\477\ We have made this change to clarify that
the classification requirement (and the other requirements of rule 22e-
4) applies to all of a fund's investment positions, regardless of
whether they are assets or liabilities, as the proposal intended.\478\
The proposed classification requirement, which would have required each
fund to classify the liquidity of its portfolio positions (or portions
of a position in a particular asset), could potentially have been read
to exclude certain derivatives and other transactions that are
classified as liabilities on the fund's balance sheet.\479\ Final rule
22e-4 thus requires the liquidity of all derivatives transactions to be
classified, regardless of if they are classified as assets or
liabilities on a fund's balance sheet, for the sake of operational
simplicity, completeness (e.g., to help reduce confusion regarding a
fund's liquidity profile as disclosed on Form N-PORT), and because all
derivatives transactions could implicate portfolio liquidity insofar as
other assets are segregated to cover these derivatives and derivatives
in a liability position involve transactions for which a fund would be
required to pay fund assets to exit the transaction.\480\
---------------------------------------------------------------------------

    \476\ Rule 22e-4(b)(1)(ii). As with other portfolio investments,
funds may classify derivatives transactions by asset class, so long
as the fund or its adviser does not have information about any
market, trading, or investment-specific considerations that are
reasonably expected to significantly affect the liquidity
characteristics of a particular derivative that would require a
different classification for that derivative. Rule 22e-
4(b)(1)(ii)(A).
    \477\ We note that in the Proposing Release, we requested
comment on whether the rule should ``focus not just on the liquidity
of the fund's assets but also more specifically and prominently on
its liabilities, such as derivatives obligations, that may affect
the liquidity of the fund.'' See Proposing Release, supra footnote
9, at text following n.155.
    \478\ We note that use of the term ``investments'' is consistent
with other reporting requirements on Form N-PORT, and reflects the
proposal's discussions of the classification requirement applying to
all of a fund's portfolio positions, not just those that are assets.
See, e.g., id., at section III.B. (``[W]e are proposing new
requirements for classifying and monitoring the liquidity of funds'
portfolio positions.''; ``The proposed liquidity categorization
process would be in addition to the existing 15% guideline (which
would be retained, as discussed below) and would require a fund to
assess the liquidity of its portfolio positions individually, as
well as the liquidity profile of the fund as a whole.'' [emphasis
added]). See also Investment Company Reporting Modernization
Adopting Release, supra footnote 120.
    \479\ We note, however, that no commenters suggested that the
proposal's use of the terms ``assets'' and ``positions''
interchangeably would lead to derivatives or other investments that
are liabilities not being subject to the rule, and that many
commenters discussed the impact of the classification requirement on
a variety of derivatives and other transactions that could be
liabilities. See, e.g., ICI Comment Letter (discussing
classifications of derivatives and TBA transactions); HSBC Comment
Letter (noting that ``[T]o the extent that this is possible, Asset
Managers should attempt to take all liabilities into account when
trying to calculate liquidity for a given fund.''). Nonetheless, to
eliminate any potential confusion, we are changing the term
``assets'' to ``investments'' throughout rule 22e-4, related
reporting items and definitions on Form N-PORT and Form N-LIQUID.
    \480\ See rule 22e-4(b)(1)(ii) (requiring funds to classify each
of the portfolio investments, including each of the fund's
derivatives transactions). We have made corresponding changes to
each of the liquidity categories to account for the classification
of all portfolio investments (i.e., the liquidity categories under
rule 22e-4 as adopted are highly liquid investments, moderately
liquid investments, less liquid investments, and illiquid
investments).
---------------------------------------------------------------------------

    Besides specifying that the liquidity of a derivatives transaction
must be classified taking into account relevant market, trading, and
investment-specific considerations, rule 22e-4 provides no derivatives-
specific factors that a fund would have to evaluate in classifying a
derivatives transactions' liquidity. We generally agree with
commenters' suggestions that the liquidity of a derivatives transaction
may depend on market demand for that kind of derivative, as well as the
liquidity of the derivative's underlying reference asset.\481\ Whether
a derivatives transaction is centrally cleared also could indicate that
the transaction is more liquid than an equivalent transaction that is
not cleared.\482\ In classifying and reviewing the liquidity of a
derivatives transaction, like classifying the liquidity of any
portfolio investment, a fund should consider the guidance factors
discussed in this Release, to the extent the factors are applicable and
the fund deems their

consideration to be appropriate.\483\ The provision in rule 22e-4
stating that a fund may generally classify its portfolio investments
according to their asset class applies to the fund's derivatives
transactions,\484\ as do the rule's market depth provisions.\485\ The
definitions of ``highly liquid investment,'' ``moderately liquid
investment,'' and ``less liquid investment'' that refer to the ability
to convert an investment to cash or dispose of an investment within a
specified period, with respect to derivatives transactions that the
fund classifies as liabilities on its balance sheet,\486\ should be
read to refer to the time period in which the fund reasonably expects
to be able to exit a transaction.
---------------------------------------------------------------------------

    \481\ See supra footnotes 474-475 and accompanying text.
    \482\ See, e.g., Deutsche Bank Research, Liquidity Is Key for
the Central Clearing of Derivatives (Mar. 12, 2015), available at
https://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000352403/Liquidity_is_key_for_the_central_clearing_of_deriv.pdf; see also
infra footnote 552.
    \483\ See infra section III.C.4.
    \484\ Rule 22e-4(b)(1)(ii)(A).
    \485\ Rule 22e-4(b)(1)(ii)(B).
    \486\ See supra footnote 480 and accompanying text.
---------------------------------------------------------------------------

    Along with classifying the liquidity of each of its derivative
transactions, final rule 22e-4 requires a fund to identify, for
derivatives transactions that a fund has classified as moderately
liquid investments, less liquid investments, and illiquid investments,
the percentage of the fund's highly liquid investments that are
segregated to cover, or pledged to satisfy margin requirements in
connection with, the transactions in each of these classification
categories.\487\ When a fund's assets are segregated or pledged in
connection with derivatives transactions, they are only available for
sale to meet redemptions once the related derivatives position is
disposed of or unwound (or if other assets are segregated or pledged in
their place). Thus, even if the segregated or pledged assets would, on
their own, be considered extremely liquid, they would effectively not
be able to be used to meet redemption requests or to rebalance or
otherwise adjust a portfolio's composition in order to manage liquidity
risk. As discussed below, we believe that it is important, for purposes
of transparency regarding a fund's portfolio liquidity, to provide
clarity that certain percentages of a fund's investments may not be
functionally available to meet redemptions or for other liquidity risk
management purposes.\488\
---------------------------------------------------------------------------

    \487\ Rule 22e-4(b)(1)(ii)(C).
    \488\ See infra section III.C.6.
---------------------------------------------------------------------------

    We believe that requiring a fund to determine the percentage of
highly liquid investments that are segregated to cover, or pledged to
satisfy margin requirements in connection with, its derivatives
transactions classified in each of the ``moderately liquid,'' ``less
liquid,'' and ``illiquid'' classification categories strikes an
appropriate balance between providing this transparency and reducing
burdens on funds. Under this approach, a fund generally would not need
to specifically identify particular assets that are segregated or
pledged to cover specific derivatives transactions, but instead a fund
will calculate the percentage of highly liquid investments segregated
or pledged to cover derivatives transactions that include derivatives
transactions classified in each of the other three classification
categories. For purposes of calculating these percentages, a fund that
has segregated or pledged non-highly liquid investments as well as
highly liquid investments to cover derivatives transactions, should
first use segregated or pledged assets that are highly liquid
investments to cover derivatives transactions classified in the three
lower liquidity classification categories.\489\ This approach should
promote consistency and comparability across funds. In the absence of
such an instruction, some funds might instead take the opposite
approach, and assume that segregated non-highly liquid investments
first cover these less liquid derivatives transactions, creating
inconsistencies between funds.
---------------------------------------------------------------------------

    \489\ See note to rule 22e-4(b)(1)(ii)(C). However, if a fund
has specifically identified individual assets that are not highly
liquid investments as being segregated to cover such derivatives
transactions, the fund may match those specific segregated assets to
specific derivatives transactions and need not assume that
segregated highly liquid assets cover those derivatives.
---------------------------------------------------------------------------

    The approach in the final rule responds to commenters' concerns
that funds rarely identify and segregate a specific liquid asset
against an individual derivative on a one-for-one relationship,\490\
and would reduce burdens that could result if the Commission's
liquidity classification rules were to require a fund to do so. It also
responds to commenters' concerns that linking the liquidity of specific
segregated assets to the liquidity of a fund's derivatives transactions
could understate the liquidity of those segregated assets, since a fund
may be able to readily substitute another liquid asset for the
segregated asset.\491\ However, the Commission's approach also would
provide the basis for needed transparency for the Commission, its
staff, and the public into the way that a fund's segregated or pledged
assets may affect the fund's overall portfolio liquidity. Rule 22e-4,
which requires a fund only to determine percentages of segregated or
pledged assets comprising the fund's highly liquid investments,
reflects our belief that this transparency is especially important with
respect to funds' highly liquid investments. As noted above, a fund's
disclosure of percentages of its highly liquid investments that are
segregated or pledged assets would permit the Commission and its staff
to understand what percentage of a fund's highly liquid investment
minimum is composed of encumbered assets, and would allow the public to
better understand that a certain percentage of a fund's highly liquid
investments may not be immediately available for liquidity risk
management purposes.
---------------------------------------------------------------------------

    \490\ See supra footnote 470 and accompanying text.
    \491\ See supra footnote 473 and accompanying paragraph. We
note, however, that the ability to substitute may not improve the
overall liquidity of the portfolio.
---------------------------------------------------------------------------

    While a fund will not need to identify which of its particular
assets are segregated in connection with particular derivatives
transactions, it will need to identify the percentage of its highly
liquid investments that are segregated or pledged with respect to
derivatives transactions classified in each of the moderately liquid,
less liquid, and illiquid classification categories. We recognize that
these requirements will likely entail additional evaluation of the
liquidity character of a fund's segregated assets compared to what a
fund might do today as part of its current asset segregation
procedures.\492\ We believe these burdens are justified, however, by
the important transparency benefits of identifying the percentages of
highly liquid investments that are segregated or pledged assets.
---------------------------------------------------------------------------

    \492\ See infra section IV.C.1.
---------------------------------------------------------------------------

    We also note that these burdens are further reduced because under
the rule a fund need not identify the percentage of segregated or
pledged assets covering derivatives that are highly liquid investments,
or the percentage of segregated or pledged assets that are moderately
liquid investments or less liquid investments.\493\ A fund would be
permitted to exclude its derivatives transactions that are classified
as highly liquid investments in determining the percentages of highly
liquid investments that are segregated or pledged assets since the fund
could dispose of or exit these derivatives transactions within three
business days and the segregated or pledged assets also would be
available to the fund for liquidity risk management purposes within
three business days. Furthermore, as described in the preceding
paragraph, the rule's requirement to identify the percentages of a
fund's highly liquid investments that are also segregated or

pledged assets reflects our belief that asset segregation or margin
transparency is most important with respect to a fund's highly liquid
investments.
---------------------------------------------------------------------------

    \493\ See rule 22e-4(b)(1)(ii)(C).
---------------------------------------------------------------------------

4. Guidance on Liquidity Classification Factors
    Unlike rule 22e-4 as proposed, final rule 22e-4 does not include an
enumerated list of factors that a fund would be specifically required
to consider in classifying and reviewing the liquidity of its portfolio
investments. The rule instead generally requires a fund to take into
account ``relevant market, trading, and investment-specific
considerations'' in classifying and reviewing its portfolio
investments' liquidity.\494\ In contrast, under the proposed rule a
fund would have been required to take the following nine factors into
account, to the extent applicable, when classifying the liquidity of
each portfolio position in a particular asset:
---------------------------------------------------------------------------

    \494\ See supra section III.C.1.b.
---------------------------------------------------------------------------

     Existence of an active market for the asset, including
whether the asset is listed on an exchange, as well as the number,
diversity, and quality of market participants;
     Frequency of trades or quotes for the asset and average
daily trading volume of the asset (regardless of whether the asset is a
security traded on an exchange);
     Volatility of trading prices for the asset;
     Bid-ask spreads for the asset;
     Whether the asset has a relatively standardized and simple
structure;
     For fixed income securities, maturity and date of issue;
     Restrictions on trading of the asset and limitations on
transfer of the asset;
     The size of the fund's position in the asset relative to
the asset's average daily trading volume and, as applicable, the number
of units of the asset outstanding; and
     Relationship of the asset to another portfolio asset.\495\
---------------------------------------------------------------------------

    \495\ Proposed rule 22e-4(b)(2)(ii).
---------------------------------------------------------------------------

    The Proposing Release requested comment generally on whether the
Commission should codify a list of liquidity classification factors (as
discussed above) \496\ and also requested comments relating to the
usefulness of the proposed factors generally, as well as specific
comments on the proposed factors.\497\ With respect to the general
usefulness of the proposed factors, multiple commenters suggested that
the proposed factors would be largely informative in assessing assets'
relative liquidity,\498\ but others advised that the proposed factors
would not be useful in assisting fund management in making liquidity
determinations.\499\ Some who objected to the proposed factors argued
that their usefulness would be limited by the fact that they would be
based on backward-looking data and thus may not reflect future
conditions.\500\ Some commenters also argued that some of the proposed
factors (e.g., frequency of trades or quotes for an asset and average
daily trading volume of an asset) are generally more appropriate for
assessing the liquidity of exchange-traded securities than securities
that are traded over-the-counter (``OTC'') and that evaluating certain
OTC securities using the proposed factors may make these securities
appear to be less liquid than they actually are.\501\ For example,
multiple commenters contended that certain fixed income securities tend
to trade infrequently on any given day, but these securities' liquidity
is nevertheless quite high because a fund would generally be able to
sell them fairly quickly.\502\ As discussed specifically below,
commenters also expressed more granular concerns about certain of the
proposed factors (specifically, frequency of trades or quotes for an
asset, trading price volatility, position size, and relationship of an
asset to another portfolio asset \503\).
---------------------------------------------------------------------------

    \496\ See supra section III.C.1.b.
    \497\ See Proposing Release, supra footnote 9, at section
III.B.2.j.
    \498\ See, e.g., CRMC Comment Letter; ICI Comment Letter I; J.P.
Morgan Comment Letter; Nuveen Comment Letter.
    \499\ See, e.g., Cove Street Comment; GFOA Comment Letter; MFS
Comment Letter; Vanguard Comment Letter.
    \500\ See, e.g., Cove Street Comment; Dodge & Cox Comment
Letter; Vanguard Comment Letter.
    \501\ See, e.g., Banks Comment Letter; LSTA Comment Letter;
Milliman Comment Letter; Wells Fargo Comment Letter.
    \502\ See, e.g., GFOA Comment Letter; MFS Comment Letter; T.
Rowe Comment Letter; Vanguard Comment Letter.
    \503\ For a discussion of commenters' concerns about this
proposed factor in the context of derivatives transactions, see
supra section III.C.3.c.
    Commenters also expressed concerns about this proposed factor in
the context of assets used for hedging or risk mitigation purposes.
In the Proposing Release, we stated that, when a fund purchases an
asset (a ``hedging asset'') in order to hedge or mitigate the risks
associated with another asset (a ``hedged asset''), the fund should
consider the liquidity of the hedged asset when evaluating the
liquidity of the hedging asset. Commenters stated that current
industry practice often involves hedging aggregate portfolio
exposures, not specific securities. See, e.g., ICI Comment Letter I;
Milliman Comment Letter; Oppenheimer Comment Letter; T. Rowe Comment
Letter. These commenters argued that the Commission's guidance
instructing a fund to classify the liquidity of hedging assets in
consideration of the hedged asset's liquidity classification would
therefore be unworkable and would raise costly operational burdens,
because funds do not currently link hedging assets and hedged assets
on a one-for-one basis.
    Unlike in the context of derivatives transactions, in which we
have stated that a fund must segregate assets to cover derivatives
transactions, and this renders the segregated assets ``frozen'' and
``unavailable for sale or other disposition'' (see supra footnote
465 and accompanying text), we have not previously stated that
purchasing assets with the intent to hedge or mitigate the risks
associated with another asset makes those hedging assets unavailable
for sale. We thus do not view the linkages between hedging and
hedged assets to be directly analogous with the linkages between
derivatives transactions and assets segregated to cover those
derivatives transactions, and we are not stating in this Release the
guidance we included in the Proposing Release regarding the proposed
``relationship of an asset to another portfolio asset'' in the
context of assets used for hedging or risk mitigation purposes.
---------------------------------------------------------------------------

    As discussed above, we are not codifying the proposed factors in
part because we understand that certain factors would be more
informative to some funds than others, depending on the fund's
investment strategy and liquidity risk profile. We also are concerned
that codifying the factors, particularly if applied in a ``check-the-
box'' fashion, could lead funds to adopt classification processes that
do not reflect the extent of a fund's ability to sell its portfolio
investments to meet redemptions within a given time period without a
market impact, or do not otherwise result in an accurate picture of a
fund's liquidity profile.\504\ However, we continue to believe that the
proposed classification factors could be useful and relevant as aspects
of the general market, trading, and investment-specific considerations
that a fund must take into account under the final rule. Thus, in this
section III.C.4, we discuss each of the factors that funds could
consider in evaluating portfolio investments' liquidity characteristics
and managing liquidity risk.\505\ Based on staff outreach across the
fund industry, we understand that certain of these factors reflect
certain common considerations that funds often take into account in
evaluating their portfolio investments' liquidity.\506\ Moreover, as
discussed above, multiple commenters stated that the proposed rule
included factors that, largely, are useful for assessing a fund's
assets' relative liquidity.\507\ For example, some

commenters agreed that factors such as those incorporated in the
proposal are generally relevant considerations to use when evaluating
asset liquidity and would help promote effective liquidity risk
assessments,\508\ and that portfolio assets' liquidity should be
evaluated using a variety of inputs such as those that the proposed
factors represent.\509\ Some suggested that the Commission discuss the
factors as guidance accompanying its adoption of rule 22e-4.\510\
Overall, we believe this approach provides flexibility that should
facilitate meaningful liquidity analyses, and encourages funds to
consider relevant information.
---------------------------------------------------------------------------

    \504\ Cf. supra paragraph accompanying footnote 322.
    \505\ Our discussion of factors that could be considered by
funds does not include the proposed ``relationship of [an] asset to
another portfolio asset'' factor because guidance on this factor, as
discussed above, has been replaced by requirements in rule 22e-4
regarding classification issues that arise with respect to
derivatives transactions. See supra footnotes 456-461 and
accompanying text; see also supra footnote 503 (discussing this
proposed factor in the context of assets used for hedging or risk
mitigation purposes).
    \506\ See Proposing Release, supra footnote 9, at text preceding
n.200.
    \507\ See supra footnote 498 and accompanying text.
    \508\ See, e.g., CRMC Comment Letter; Fidelity Comment Letter;
J.P. Morgan Comment Letter; Nuveen Comment Letter.
    \509\ See, e.g., HSBC Comment Letter; MSCI Comment Letter.
    \510\ See, e.g., IDC Comment Letter; Invesco Comment Letter;
J.P. Morgan Comment Letter; SIFMA Comment Letter I.
---------------------------------------------------------------------------

    We acknowledge, as stated by some commenters, that certain of these
factors may involve consideration of backward-looking data and thus may
not account for ways in which changing market conditions could affect
the liquidity of certain asset classes or investments.\511\ But we
believe analyzing past data, while considering how that data may change
in the future, is an inherent aspect of all risk management and does
not render such analysis fruitless. In addition, the review
requirements embedded in the classification framework, when combined
with the liquidity risk assessment requirement to consider portfolio
liquidity during normal and reasonably foreseeable stressed periods,
further responds to this critique. We also are cognizant that, for
certain fixed income or other OTC assets or asset classes, certain of
the proposed liquidity classification factors, if considered standing
alone, may appear to make these assets or classes to appear less liquid
than they actually are. In the guidance below, we discuss special
concerns that may be relevant to funds' consideration of the liquidity
characteristics of fixed income or other OTC assets.\512\
---------------------------------------------------------------------------

    \511\ See supra footnote 500 and accompanying text.
    \512\ See, e.g., text accompanying infra footnotes 536-538 and
545-558.
---------------------------------------------------------------------------

    As discussed above, a fund generally is permitted to classify the
liquidity of its portfolio investments according to their asset class.
Thus, a fund may wish to consider the guidance discussed below in
assessing the general liquidity characteristics of the asset classes in
which it invests. For investments that the fund determines must be
treated as an ``exception'' and classified separate from their asset
class,\513\ the guidance provided below could assist funds in
identifying and classifying those investments that may demonstrate
liquidity characteristics that are distinct from the fund's other
portfolio holdings within that same asset class.
---------------------------------------------------------------------------

    \513\ See rule 22e-4(b)(1)(ii)(A).
---------------------------------------------------------------------------

    The guidance we provide below is not meant to cover an exhaustive
list of considerations that a fund may take into account in evaluating
its portfolio investments' liquidity. Also, we recognize that specific
liquidity concerns appropriate for consideration could vary depending
on the issuer and the particular investment.\514\ Even if a fund's
liquidity classification policies and procedures were to incorporate
all of the guidance factors discussed below, a fund may decide that it
is appropriate to focus more heavily on certain factors and less on
others in evaluating its portfolio investments' liquidity.
---------------------------------------------------------------------------

    \514\ See, e.g., Fidelity Comment Letter; LSTA Comment Letter;
Nuveen Comment Letter; T. Rowe Comment Letter (each suggesting that
the Commission clarify that not every factor is required to be
considered to evaluate the liquidity of each of a fund's portfolio
assets).
---------------------------------------------------------------------------

    In the following sections, we discuss certain factors that a fund
could consider in assessing the liquidity of its portfolio investments
and provide guidance on specific issues associated with each of these
factors. We also discuss comments we received on the proposed
classification factors.
a. Existence of Active Market for an Asset Class or Investment;
Exchange-Traded Nature of an Asset Class or Investment
    We continue to believe that the manner in which a fund may sell an
asset class (or particular portfolio investment), including whether an
asset class or investment is generally listed on an exchange, may
affect the liquidity of that asset class or investment.\515\ While in
general, being listed on a developed and recognized exchange may
increase an investment's liquidity,\516\ we note, as certain commenters
mentioned,\517\ the fact that an investment is exchange-traded does not
necessarily mean that a fund would be able to sell or convert that
investment to cash within a relatively short period.\518\ For example,
a small-cap equity stock might be listed on an exchange but trade quite
infrequently, which would tend to decrease its relative liquidity.
Conversely, as commenters discuss, we agree that certain securities
that are traditionally traded in OTC markets, such as corporate bonds,
may not typically be designed to be traded frequently and instead are
more often ``bought and held,'' but certain of these securities
nevertheless may be readily saleable without the conversion to cash (or
in some cases, sale or disposition) significantly changing their market
value.\519\ Additionally, securities issued (or guaranteed as to
principal and interest) by the U.S. government do not trade on
exchanges, but are typically considered to be quite liquid.\520\
---------------------------------------------------------------------------

    \515\ See Proposing Release, supra footnote 9, at section
III.B.2.a (discussing the proposed requirement for a fund to
consider, to the extent applicable, the existence of an active
market for an asset, including whether the asset is listed on an
exchange, as well as the number, diversity, and quality of market
participants, in classifying the liquidity of each portfolio
position in a particular asset).
    \516\ See, e.g., Basel Committee on Banking Supervision, Basel
III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring
Tools (Jan. 2013), at part 1, section II.A.1, available at http://www.bis.org/publ/bcbs238.pdf; see also Nuveen FSOC Notice Comment
Letter, supra footnote 85 (``While securities that trade on
exchanges . . . or in deep principal/over-the-counter (``OTC'')
markets (e.g., U.S. Treasuries) are generally liquid even in
stressed markets, other securities that trade on an OTC basis . . .
have faced increasing liquidity challenges in normal markets and can
be subject to insufficient quality bids in times of stress as market
makers pull back their capital. This can make it not only more
difficult to sell these securities, but also to accurately value
those assets that are retained.'').
    \517\ See, e.g., ICI Comment Letter I.
    \518\ We note that in certain cases the exchange on which an
investment is listed may not be the primary market for that
security. For example, we understand that certain bonds that are
exchange listed trade predominantly in the OTC markets. See, e.g.,
Types of Bonds, How Big Is the Market, and Who Buys?, available at
http://www.investinginbonds.com/learnmore.asp?catid=5&subcatid=18&id=174 (``[T]he vast majority of
bond transactions, even those involving exchange-listed issues, take
place in [OTC] market.'').
    \519\ See id.
    \520\ See rule 15c3-1(c)(2)(vi)(A)(1) under the Exchange Act
(describing securities haircuts for securities issued or guaranteed
as to principal or interest by the United States or any agency
thereof); see also Liquidity Coverage Ratio: Liquidity Risk
Measurement Standards (Sept. 9, 2014) [79 FR 61440 (Oct. 10, 2014)]
(``Liquidity Coverage Ratio Release'') (in liquidity coverage ratio
rule adopted by the Office of the Comptroller of the Currency, Board
of Governors of the Federal Reserve System, and the Federal Deposit
Insurance Corporation, ``Level 1 Liquid Assets'' are described as
securities issued or unconditionally guaranteed as to timely payment
of principal and interest by the U.S. Department of the Treasury,
and liquid and readily-marketable securities issued or
unconditionally guaranteed as to the timely payment of principal and
interest by any other U.S. government agency (provided that its
obligations are fully and explicitly guaranteed by the full faith
and credit of the U.S. government)).
---------------------------------------------------------------------------

    In assessing the effect that being traded on an exchange could have
on an asset class's or investment's liquidity, a fund generally should
evaluate how this consideration informs the liquidity characteristics
of any ETF shares in which it invests. We understand that certain
funds, particularly funds with

investment strategies involving relatively less liquid portfolio
securities (such as micro-cap equity funds, high-yield bond funds, and
bank loan funds), may invest a portion of their assets in ETFs with
strategies similar to the fund's investment strategy because they view
ETF shares as having characteristics that enhance the liquidity of the
fund's portfolio.\521\ Specifically, in discussions with Commission
staff, funds that invest in ETF shares have suggested that they find
that these shares are more readily tradable, are less expensive to
trade, and have shorter settlement periods than other types of
portfolio investments.\522\ In addition, unlike investments in cash,
cash equivalents, and other highly liquid instruments, funds also have
suggested to Commission staff that investing in ETFs with the same (or
a similar) strategy as the fund's investment strategy permits the fund
to remain fully invested in assets that reflect the fund's investment
concentrations, risks, and performance potential.\523\
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    \521\ See, e.g., Katy Burne, Institutions Pour Cash Into Bond
ETFs, Wall Street Journal (Mar. 1, 2015), available at http://www.wsj.com/articles/institutions-pour-cash-into-bond-etfs-1425250969. Funds' investments in ETFs are subject to the Investment
Company Act's limitations on investments in shares issued by other
registered investment companies. See section 12(d)(1)(A) of the Act.
Currently, these practices do not concern ETMFs.
     The Commission's 2015 Request for Comment on Exchange-Traded
Products requested comment on whether investors' expectations of the
nature of the liquidity of an exchange-traded product (including an
ETF) holding relatively less liquid portfolio securities differ from
their expectations of the liquidity of the underlying portfolio
securities. See 2015 ETP Request for Comment, supra footnote 29, at
Question 49. Commenters expressed a range of views on the question.
See, e.g., Comment Letter of Vanguard on the 2015 ETP Request for
Comment (Aug. 17, 2015) (stating that the disclosures made by ETFs
in prospectuses, shareholder reports, and Web sites ``ensures that
investors and market participants have the necessary information to
make informed investment decisions''); Comment Letter of ETF Radar
on the 2015 ETP Request for Comment (Aug. 8, 2015) (stating that
investor expectations of liquidity depend on the skill of the
investor); Comment Letter of Danny Reich on the 2015 ETP Request for
Comment (July 2, 2015) (stating that there is a ``false assumption''
that underlying assets have the same liquidity as the ETP,
particularly with respect to bond ETPs).
    \522\ See Proposing Release, supra footnote 9, at section
III.C.6.b.
    \523\ See id.
---------------------------------------------------------------------------

    While we appreciate that ETFs' exchange-traded nature could make
these instruments useful to funds in managing purchases and redemptions
under certain conditions (for example, ETFs' settlement times could
more closely reflect the time in which a fund has disclosed that it
will typically redeem fund shares), funds should consider the extent to
which relying substantially on ETFs to manage liquidity risk is
appropriate. The liquidity of an ETF, particularly in times of
declining market liquidity, is limited by the liquidity of the market
for the ETF's underlying securities and, in fact, may be impaired based
on factors not directly related to the liquidity of the underlying
securities.\524\ Thus, shares of an ETF whose underlying securities are
relatively less liquid may not be able to be counted on to provide
liquidity to a fund investing in these shares during times of stress.
In the case of a significant decline in market liquidity, if authorized
participants were unwilling or unable to trade ETF shares in the
primary market, and the majority of trading took place among investors
in the secondary market, the ETF's shares could trade continuously at a
premium or a discount to the value of the ETF's underlying portfolio
securities. This could frustrate the expectations of secondary market
participants who count on the creation and redemption process to align
the prices of ETF shares and their underlying portfolio securities. We
therefore encourage funds to assess the liquidity characteristics of an
ETF's underlying securities, as well as the characteristics of the ETF
shares themselves, in classifying the liquidity of ETF shares under
rule 22e-4(b)(1)(ii).
---------------------------------------------------------------------------

    \524\ See ETF Proposing Release, supra footnote 27, at section
III.A.1; see also Tyler Durden, What Would Happen if ETF Holders
Sold All at Once? Howard Marks Explains, Zero Hedge (Mar. 26, 2015),
available at http://www.zerohedge.com/news/2015-03-26/what-would-happen-if-etf-holders-sold-all-once-howard-marks-explains (``Thus we
can't get away from depending on the liquidity of the underlying
high yield bonds. The ETF can't be more liquid than the underlying,
and we know the underlying can become highly illiquid.''). But see,
e.g., Shelly Antoniewicz, Plenty of Players Provide Liquidity for
ETFs, ICI Viewpoints (Dec. 2, 2014), available at http://www.ici.org/viewpoints/view_14_ft_etf_liquidity (stating that most
of the trading activity in bond ETF shares is done in the secondary
market and not through creations and redemptions with authorized
participants).
---------------------------------------------------------------------------

Other Trading Mechanism Considerations
    The means of trading a particular asset class or investment can
affect its liquidity regardless of whether the investment is a security
traded on an exchange. For example, whether an asset class or
investment is generally traded in a bilateral transaction with a single
dealer, or through an electronic auction mechanism where a trader can
simultaneously contact multiple counterparties, can have different
effects on its liquidity.\525\ The liquidity effects associated with
choice of trading mechanism may differ depending on the asset class or
investment being traded and other market conditions, and therefore it
is difficult to make general statements regarding the correlation
between a particular trading mechanism and the liquidity of the asset
class or investment being traded. For this reason, a fund may wish to
consider past experience in using different trading mechanisms to sell
a certain asset class or investment.
---------------------------------------------------------------------------

    \525\ See, e.g., Terrence Hendershott & Ananth Madhavan, Click
or Call? Auction versus Search in the Over-the-Counter Market., 70
J. of Fin. 419 (Feb. 2015), available at http://faculty.haas.berkeley.edu/hender/Click_Call_OTC.pdf.
---------------------------------------------------------------------------

Diversity and Quality of Market Participants
    In addition, the diversity and quality of market participants for a
particular asset class or investment also could contribute to the
liquidity of that asset class or investment. A fund may wish to
consider the number of market makers on both the buying and selling
sides of transactions. A fund also may wish to consider the quality of
market participants purchasing and selling a particular asset class or
investment, and may wish to assess, in particular: The market
participant's capitalization; the reliability of the market
participant's trading platform(s); and the market participant's
experience and reputation transacting in various types of assets. We
believe that the diversity and quality of market participants may be
meaningful in assessing a portfolio investment's liquidity because it
is common for relatively liquid asset classes and investments to have
active sale or repurchase markets at all times with diverse market
participants.\526\ The presence of multiple active market makers may be
a sign that a market is liquid.\527\ Diversity of market participants,
on both the buying and selling sides of transactions, may also be a
significant point for a fund to consider because it tends to reduce
market concentration and may facilitate a

market remaining liquid during periods of stress.\528\
---------------------------------------------------------------------------

    \526\ See, e.g., Abdourahmane Sarr & Tonny Lybek, Measuring
Liquidity in Financial Markets, IMF Working Paper (Dec. 2002),
available at http://www.imf.org/external/pubs/ft/wp/2002/wp02232.pdf
(``Liquid markets tend to exhibit five characteristics: (i)
Tightness (ii) immediacy, (iii) depth, (iv) breadth, and (v)
resiliency.'').
    \527\ See, e.g., Sunil Wahal, Entry, Exit, Market Makers, and
the Bid-Ask Spread, 10 Rev. of Fin. Stud. 871 (1997), available at
https://www.acsu.buffalo.edu/~keechung/MGF743/Readings/H1.pdf
(``Large-scale entry (exit) is associated with substantial declines
(increases) in quoted end-of-day inside spreads, even after
controlling for the effects of changes in volume and volatility. The
spread changes are larger in magnitude for issues with few market
makers; however, even for issues with a large number of market
makers, substantial changes in quoted spreads take place.'').
    \528\ See, e.g., Amir Rubin, Ownership Level, Ownership
Concentration, and Liquidity, 10 J. Fin. Markets 219 (Aug. 2007),
available at http://www.sciencedirect.com/science/article/pii/S1386418107000134 (``We examine the link between the liquidity of a
firm's stock and its ownership structure, specifically, how much of
the firm's stock is owned by insiders and institutions, and how
concentrated is their ownership. We find that the liquidity-
ownership relation is mostly driven by institutional ownership
rather than insider ownership. Importantly, liquidity is positively
related to total institutional holdings but negatively related to
institutional block holdings.'').
---------------------------------------------------------------------------

b. Frequency of Trades or Quotes; Average Daily Trading Volume
    In general, we continue to believe that a high frequency of trades
or quotes for a particular asset class or investment tends to indicate
that a particular asset class or investment has relatively high
liquidity.\529\ However, as many commenters raised and as discussed
below, low trading frequency and trading volume does not necessarily
indicate low liquidity, particularly for asset classes and investments
that are not exchange-traded.\530\ Also, we note that the frequency of
trades or quotes for a particular asset class or investment is not a
perfect or complete measure of liquidity, and a fund may wish to also
consider trade size in assessing the relationship between trade
frequency and liquidity.\531\ In evaluating the frequency of trades
(and bid and ask quotes) for an asset class or investment, a fund may
wish to generally consider, among other relevant factors, the number of
dealers quoting prices for that asset class or investment, the number
of other potential purchasers and sellers, and dealer undertakings to
make a market in the asset class or investment.
---------------------------------------------------------------------------

    \529\ See Proposing Release, supra footnote 9, at section
III.B.2.b (discussing the proposed requirement for a fund to
consider, to the extent applicable, the frequency of trades or
quotes for a particular asset, as well as the asset's average daily
trading volume (regardless of whether the asset is a security traded
on an exchange), in classifying the liquidity of each portfolio
position in a particular asset).
    \530\ See infra footnotes 536-538 and accompanying text.
    \531\ For example, 100 trades at $100 might or might not signify
greater liquidity than 50 trades at $200, although they are likely
to suggest better liquidity than one trade at $10,000. See Erik
Banks, Liquidity Risk: Managing Funding and Asset Risk (2nd ed.
2013), at 169.
---------------------------------------------------------------------------

    High average trading volume also tends to be correlated with
greater liquidity, particularly for exchange-traded asset classes and
investment. In general, high average daily trading volume for a
particular asset class or investment indicates a deep market for that
asset class or investment, which in turn indicates that a fund may be
able to convert its holdings in that asset class or investment to cash
without the conversion (or in some cases, sale or disposition)
significantly changing the market value.\532\ Especially for exchange-
traded asset classes or investments, a fund may wish to consider the
number of days of zero or very low trading volume during the prior
month, year, or other relevant period, as this could indicate
particularly limited liquidity. As one commenter suggested, and we
agree, a fund may wish to consider not only the historical average
trading volume of the asset class or assets in which its invests, but
also whether trading volume is likely to change under different or
stressed market conditions.\533\ High trading volume is not always
indicative of available liquidity for a particular asset class or
investment, however. For example, high trading volumes might be
associated with high selling pressure on the asset class or investment,
and trades at that time may have a high value impact.\534\ Also, as one
commenter suggested, even if a particular asset class or investment
were to exhibit high trading volume, the ability to convert the asset
class or investment to cash without the conversion (or in some cases,
sale or disposition) significantly changing the market value may also
depend on other factors such as investors' appetite for risk and the
perceived ``safety'' of specific securities in ``risk-off'' flight-to-
quality market conditions.\535\
---------------------------------------------------------------------------

    \532\ See id.; see also Fidelity FSOC Notice Comment Letter,
supra footnote 69 (``Liquidity management is linked to portfolio
managers' attention to market risks indicated by . . . shrinking
transaction volumes which exacerbate the impact cost for additional
trading'').
    We note that double-counting of trades is a potential issue to
consider when assessing average trading volume. Double-counting
occurs because of differences between dealer and auction markets. In
a dealer market, trades are ``double-counted'' because the dealer
buys from person A and then sells to person B. In an auction market,
person A and B trade directly. See, e.g., Anne M. Anderson & Edward
A. Dyl, Trading Volume: NASDAQ and the NYSE, 63 Fin. Analysts J. 79
(May/June 2007), available at http://www.cfapubs.org/doi/abs/10.2469/faj.v63.n3.4693.
    \533\ See Interactive Data Comment Letter (suggesting that the
Commission consider requiring a fund to consider the potential daily
trading volume of its portfolio assets instead of, as proposed, the
average daily trading volume of its assets).
    \534\ See, e.g., HSBC Comment Letter; see also e.g., Jennifer
Huang & Jiang Wang, Liquidity and Market Crashes, 22 Rev. of Fin.
Stud. 2607 (2009), available at http://rfs.oxfordjournals.org/content/22/7/2607.full (discussing how there can be high selling
pressure (and high volume) along with low liquidity and how this can
create market crashes); Mark Carlson, A Brief History of the 1987
Stock Market Crash with a Discussion of the Federal Reserve
Response, Federal Reserve Board Working Paper 2007-13 (Nov. 2006),
available at http://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdf (discussing how the 1987 stock market crash had both
high volume and low liquidity).
    \535\ See HSBC Comment Letter.
---------------------------------------------------------------------------

    Multiple commenters stressed that, particularly for fixed income
and other typically OTC asset classes and assets, relatively low
trading volume does not necessarily correlate with low liquidity. For
example, many commenters discussed the low turnover of the corporate
bond market, which is driven by factors such as the buy-and-hold nature
of bond investing, the distribution of an issuer's borrowing across
many different bond issues, and the fact that portfolio managers may
deem many bonds to be substitutes for one another based on common
characteristics such as issuer, sector, credit quality, and
maturity.\536\ Commenters argued that, despite the relatively low
turnover that is typical in the corporate bond market, these assets are
commonly considered to be readily tradable at market-clearing
prices.\537\ Commenters made similar arguments about the dynamics of
the municipal bond market, noting that municipal securities' trading
volume is not normally high, particularly during stable financial
periods, but municipal securities (especially those that are investment
grade) are commonly considered to be easily saleable.\538\ We generally
agree with commenters' concerns that the consideration of trading
volume as a liquidity indicator should not by itself imply that low
trading volume necessarily indicates low liquidity. Rather, it may
indicate that other information needs to be assessed to make a
liquidity determination. For asset classes and investments that
typically demonstrate low trading volume, funds may wish to consider
how the other liquidity characteristics of those asset classes and
investments, including but not limited to other guidance factors
discussed in this Release, may affect the time period and value impact
associated with the class's or investment's ability to be converted to
cash. Analysis of capital structure and credit quality of a particular
asset class or investment, as well as bid-ask spreads and maturity/date
of issue, may be particularly useful in considering the liquidity of
investments whose trading volume is normally low.
---------------------------------------------------------------------------

    \536\ See, e.g., Nuveen Comment Letter; Vanguard Comment Letter.
    \537\ See, e.g., Nuveen Comment Letter; Vanguard Comment Letter.
    \538\ See, e.g., GFOA Comment Letter; Nuveen Comment Letter.

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

c. Volatility of Trading Prices
    We continue to believe that trading price volatility is potentially
a valuable metric to consider in evaluating an asset class's or
investment's liquidity.\539\ In general, there is an inverse
relationship between liquidity and volatility,\540\ as lack of
liquidity in a particular investment tends to amplify price volatility
for that asset.\541\ Additionally, the Commission understands that
certain funds and fund groups have historically experienced liquidity
disruptions during periods of extreme market volatility, such as the
June 2013 ``taper tantrum'' \542\ and the October 2014 ``flash crash.''
\543\ As one commenter suggested, and we agree, if a fund holds asset
classes or investments that are thinly traded, the fund may wish to
consider volatility of evaluated pricing information in assessing the
liquidity of those asset classes or investments.\544\
---------------------------------------------------------------------------

    \539\ See Proposing Release, supra footnote 9, at section
III.B.2.c (discussing the proposed requirement for a fund to
consider, to the extent applicable, the volatility of trading prices
for its portfolio assets, in classifying the liquidity of each
portfolio asset).
    \540\ See, e.g., Tarun Chordia, Asani Sarkar & Avanidhar
Subrahmanyam, An Empirical Analysis of Stock and Bond Market
Liquidity, Federal Reserve Bank of New York Staff Reports, No. 164
(Mar. 2003), available at http://www.newyorkfed.org/research/staff_reports/sr164.pdf (finding that unexpected liquidity and
volatility shocks are positively and significantly correlated across
stock and bond markets).
    \541\ See, e.g., Prachi Deuskar, Extrapolative Expectation:
Implications for Volatility and Liquidity (Aug. 2007), available at
https://business.illinois.edu/pdeuskar/Deuskar_Extrapolative_Liquidity_Volatility.pdf (``Illiquidity
amplifies supply shocks, increasing realized volatility of prices,
which feeds into subsequent volatility forecasts.''); see also
Fidelity FSOC Notice Comment Letter, supra footnote 69, at 21
(``Liquidity management is linked to portfolio managers' attention
to market risks indicated by . . . increasing market- and security-
specific volatility.'').
    \542\ In May 2013, Ben Bernanke, then Chairman of the Federal
Reserve Board, announced that the Federal Reserve may start scaling
back its asset purchase program--in which the Federal Reserve
purchased approximately $85 billion worth of bonds and mortgage-
backed securities each month--sooner than investors expected. This
caused interests rates on fixed income products to spike, and bond
prices to fall dramatically. This market dislocation came to be
known as the ``taper tantrum. See Christopher Condon & Jeff Kearns,
Fed Worried About Triggering Another `Taper Tantrum', Bloomberg
(Oct. 8, 2014), available at http://www.bloomberg.com/news/articles/2014-10-08/fed-worried-about-triggering-another-taper-tantrum-.
    \543\ See Joint Staff Report: The U.S. Treasury Market on
October 15, 2014 (July, 13, 2015), available at https://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf (``On October 15, 2014,
the market for U.S. Treasury securities, futures, and other closely
related financial markets experienced an unusually high level of
volatility and a very rapid round-trip in prices. Although trading
volumes were high and the market continued to function, liquidity
conditions became significantly strained.'').
    \544\ See Interactive Data Comment Letter (suggesting that the
Commission consider replacing the proposed ``volatility of trading
prices for the asset'' classification factor with ``volatility of
traded or evaluated pricing information,'' to make this proposed
factor more applicable to fixed income assets and other asset
classes that may be thinly traded).
---------------------------------------------------------------------------

d. Bid-Ask Spreads
    Bid-ask spreads--the difference between bid and offer prices for a
particular investment--have historically been viewed as a useful
measure for assessing the liquidity of assets,\545\ and we continue to
believe that a fund may consider this factor useful in classifying the
liquidity of a particular asset class or investment.\546\ The bid-ask
spread of a particular investment is related to the riskiness of that
investment, as well as the length of time that a broker-dealer believes
it will have to hold the investment before selling it.\547\ In general,
high bid-ask spreads for a particular asset class or investment
correlate with a lack of liquidity in that asset class or investment.
For example, when liquidity was significantly constricted during the
2007-2009 financial crisis, bid-ask spreads on U.S. investment grade
bonds were notably elevated.\548\ However, bid-ask spreads alone do not
necessarily provide a comprehensive understanding of an investment's
liquidity. For instance, bid-ask spreads are often constrained by the
increments in which prices are quoted.\549\ Additionally, as one
commenter noted, bid-ask spreads do not take into account the volume
and scale of a portfolio manager's intended buy and sell
transactions.\550\
---------------------------------------------------------------------------

    \545\ See, e.g., Michael J. Fleming, Measuring Treasury Market
Liquidity, Federal Reserve Bank of New York Economic Policy Review
(Sept. 2003), available at https://www.newyorkfed.org/medialibrary/media/research/epr/03v09n3/0309flempdf.pdf (providing a literature
review of studies analyzing bid-ask spreads in relation to Treasury
market liquidity); see also Fidelity FSOC Notice Comment Letter,
supra footnote 69, at 21 (``Liquidity management is linked to
portfolio managers' attention to market risks indicated by . . .
heightened market impact costs (as indicated by widening bid/ask
spreads)'').
    \546\ See Proposing Release, supra footnote 9, at section
III.B.2.d (discussing the proposed requirement for a fund to
consider, to the extent applicable, its portfolio assets' bid-ask
spreads when assessing its portfolio assets' liquidity).
    \547\ See MarketAxess, The MarketAxess Bid-Ask Spread Index
(BASI): A More Informed Picture of Market Liquidity in the U.S.
Corporate Bond Market (2013), available at http://www.marketaxess.com/pdfs/research/marketaxess-bid-ask-spread-index-BASI.pdf (discussing methodology for developing an index that tracks
bid-ask spreads of U.S. corporate bonds).
    \548\ See, e.g., Got Liquidity?, supra footnote 452, at 7; see
also Rich Estabrook, Diminished Liquidity in the Corporate Bond
Market: Implications for Fixed Income Investors, Oppenheimer (Mar.
16, 2015), at 1, available at http://www.opco.com/trend-analysis/final_liquidity_report-031615.pdf.
    \549\ See, e.g., Michael A. Goldstein & Kenneth A. Kavajecz,
Eighths, Sixteenths, and Market Depth: Changes in Tick Size and
Liquidity Provision on the NYSE, 56 J. Fin. Econ. 125 (2000),
available at https://www.researchgate.net/publication/4978467_Eighths_Sixteenths_and_Market_Depth_Changes_in_Tick_Size_and_Liquidity_Provision_on_the_Nyse (``Using limit order data provided
by the NYSE, we investigate the impact of reducing the minimum tick
size on the liquidity of the market. While both spreads and depths
(quoted and on the limit order book) declined after the NYSE's
change from eighths to sixteenths, depth declined throughout the
entire limit order book as well. The combined effect of smaller
spreads and reduced cumulative limit order book depth has made
liquidity demanders trading small orders better off; however,
traders who submitted larger orders in lower volume stocks did not
benefit, especially if those stocks were low priced.''); Hendrik
Bessembinder, Tick Size, Spreads, and Liquidity: An Analysis of
Nasdaq Securities Trading Near Ten Dollars, 9 J. of Fin.
Intermediation 213 (July 2000), available at http://
www.acsu.buffalo.edu/~keechung/MGF743/Readings/G4.pdf (``There is no
evidence of a reduction in liquidity with the smaller tick size. The
largest spread reductions occur for stocks whose market makers avoid
odd-eighth quotes. This finding provides support for models implying
that changes in the tick size can affect equilibrium spreads on a
dealer market and indicates that the relation between tick size and
market quality is more complex than the imposition of a constraint
on minimum spread widths.'').
    \550\ See HSBC Comment Letter.
---------------------------------------------------------------------------

e. Standardization and Simplicity of Asset Class's or Investment's
Structure
    We continue to believe that whether an asset class or investment
has a relatively standardized and simple structure is generally
relevant to a fund's evaluation of an asset class's or investment's
liquidity.\551\ Investments that trade OTC with terms set at issuance
such as sizes, maturities, coupons, and payment dates may be relatively
more liquid compared to similarly situated investments without
standardized terms. Standardization can increase liquidity by
simplifying the ability to quote and trade securities, enhancing
operational efficiency to execute and settle trades, and improving
secondary market transparency. Some types of OTC-traded securities
exhibit a relatively high level of standardization, such as government
and agency bonds, futures contracts, and certain swap contracts.
Central clearing of certain OTC-traded securities, which generally
requires the terms of these securities to be highly standardized, has
been associated with an increase in these investments' liquidity, as
measured by factors such as the bid-ask spreads for these investments
and the number of dealers providing quotes for these

investments.\552\ However, standardization alone may not be indicative
of an investment's liquidity. For example, corporate bond issuers
commonly have large numbers of bonds outstanding, and trading can be
fragmented among that universe of bonds.\553\ However, as discussed
above, we understand that market participants may consider many
corporate bonds to be highly comparable and substitutable from a
liquidity perspective, to the extent that they share common
characteristics such as issuer, sector, credit quality, and
maturity.\554\
---------------------------------------------------------------------------

    \551\ See Proposing Release, supra footnote 9, at section
III.B.2.e (discussing the proposed requirement for a fund to
consider, to the extent applicable, the standardization and
simplicity of structure of its portfolio assets when assessing its
portfolio assets' liquidity).
    \552\ See, e.g., Yee Cheng Loon & Zhaodong (Ken) Zhong, The
Impact of Central Clearing on Counterparty Risk, Liquidity, and
Trading: Evidence from the Credit Default Swap Market, 112 J. of
Fin. Econ. 91 (Apr. 2014), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2176561 (analyzing the impact of central
clearing on credit default swaps and finding that cleared reference
entities experience an improvement in both liquidity and trading
activity relative to non-cleared entities); Joshua Slive, Jonathan
Witmer & Elizabeth Woodman, Liquidity and Central Clearing: Evidence
from the CDS Market, Bank of Canada Working Paper 2012-38 (Dec.
2012), available at http://www.bankofcanada.ca/wp-content/uploads/2012/12/wp2012-38.pdf (analyzing ``the relationship between
liquidity and central clearing using information on credit default
swap clearing at ICE Trust and ICE Clear Europe,'' and finding that
``the introduction of central clearing is associated with a slight
increase in the liquidity of a contract'' (but noting that the
effects of central clearing on liquidity must be viewed in light of
the fact that the central counterparty chooses the most liquid
contracts for central clearing, consistent with liquidity
characteristics being important in determining the safety and
efficiency of clearing)). But see Manmohan Singh, Collateral,
Netting and Systemic Risk in the OTC Derivatives Market, IMF Working
Paper 10/99 (Apr. 1, 2010), available at https://www.imf.org/external/pubs/cat/longres.cfm?sk=23741.0 (arguing that large
increases in collateral posted for the centrally cleared trades
negatively affect market liquidity given that most large banks will
be reluctant to offload their positions to central counterparties).
    \553\ For example, while each of the top ten largest issuers in
the United States had one common equity security outstanding as of
April 2014, these issuers collectively had more than 9,000 bonds
outstanding. See BlackRock, Corporate Bond Market Structure: The
Time for Reform Is Now, Viewpoint (Sept. 2014), at 7, available at
https://www.blackrock.com/corporate/en-mx/literature/whitepaper/viewpoint-corporate-bond-market-structure-september-2014.pdf.
    \554\ See supra footnote 536 and accompanying text.
---------------------------------------------------------------------------

f. Maturity and Date of Issue of Fixed Income Securities
    We continue to believe that, with respect to the fixed income
investments a fund holds in its portfolio, those investments' maturity,
as well as their date of issue, are significant indicators of their
liquidity.\555\ In general, a fixed income asset trades most frequently
in the time directly following issuance, and its trading volume
decreases in the asset's remaining time to maturity.\556\ Thus ``on-
the-run'' securities (that is, bonds or notes of a particular maturity
that were most recently issued) tend to trade significantly more
frequently than their ``off-the-run'' counterparts (that is, bonds or
notes issued before the most recently issued bond or note of a
particular maturity).\557\ Because high trading volume generally
suggests relatively high liquidity,\558\ a fixed income asset's date of
issuance and maturity, which in turn are generally correlated with the
trading volume of a fixed income asset, together are important
liquidity indicators. We understand, based on staff outreach and
industry knowledge, that remaining time to maturity is a key factor
that fixed income funds commonly consider in assessing the liquidity of
their portfolio positions.
---------------------------------------------------------------------------

    \555\ See Proposing Release, supra footnote 9, at section
III.B.2.f (discussing the proposed requirement for a fund to
consider, with respect to fixed income assets, these assets'
maturity and date of issue when assessing their liquidity).
    \556\ See, e.g., Sugato Chakravarty & Asani Sarkar, Liquidity in
U.S. Fixed Income Markets: A Comparison of the Bid-Ask Spread in
Corporate, Government and Municipal Bond Markets, Federal Reserve
Board of New York Staff Report No. 73 (Mar. 1999), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=163139.
    \557\ The on-the-run phenomenon refers to the fact that, in
fixed income markets, securities with nearly identical cash flows
trade at different yields and with different liquidity. In
particular, most recently issued (i.e., on-the-run) government bonds
of a certain maturity are generally more liquid than previously
issued (i.e., off-the-run or old) bonds maturing on similar dates.
See, e.g., Paolo Pasquariello & Clara Vega, The on-the-run liquidity
phenomenon, 92 J. of Fin. Econ. 1-24 (Apr. 2009), available at
http://webuser.bus.umich.edu/ppasquar/onofftherun.pdf (analyzing the
liquidity differentials of on-the-run and off-the-run U.S. Treasury
bonds and finding, among other things, that on-the-run and off-the-
run liquidity differentials are economically and statistically
significant--showing that on-the-run bonds tend to be more liquid
than their off-the-run counterparts--even after controlling for
certain intrinsic characteristics of the bonds); Michael Barclay,
Terrence Hendershott & Kenneth Kotz, Automation versus
Intermediation: Evidence from Treasuries Going Off the Run, 61 J. of
FIN. 2395 (Oct. 2006), available at http://faculty.haas.berkeley.edu/hender/on-off.pdf (discussing how ``when
Treasury securities go `off the run' their trading volume drops by
more than 90%'').
    \558\ See supra section III.C.4.b.
---------------------------------------------------------------------------

g. Restrictions on Trading; Limitations on Transfer
    We continue to believe that restrictions on trading certain
investments, as well as limitations on an investment's transfer, may
adversely affect those investments' liquidity.\559\ For example,
although we are replacing existing Commission guidance on identifying
illiquid assets (including the specific factors listed in the Rule 144A
Release regarding the liquidity of a rule 144A security) \560\ with new
regulatory requirements regarding the process for determining that
certain investments are illiquid, we believe that the restricted nature
of a rule 144A security is one factor that generally should be
considered by a fund in evaluating the liquidity of a rule 144A
security.\561\ Regardless of whether a portfolio investment is a
restricted security, it may nevertheless be subject to other
limitations on transfer. For example, for securities that are traded in
certain foreign markets, government approval may be required for the
repatriation of investment income, capital, or the proceeds of sales of
securities by foreign investors.\562\ Portfolio investments furthermore
may be subject to certain contractual limitations on transfer.\563\
Securities subject to transfer limitations in general are less liquid
than securities without such limitations.
---------------------------------------------------------------------------

    \559\ See Proposing Release, supra footnote 9, at section
III.B.2.g (discussing the proposed requirement for a fund to
consider restrictions on trading and limitations on transfer in
classifying the liquidity of each portfolio asset).
    \560\ See Rule 144A Release, supra footnote 37, at text
following n.62.
    \561\ See id. While we are withdrawing the guidance in the Rule
144A Release, including the guidance that boards are responsible for
determining if a security is liquid or illiquid, we note that the
guidance factors discussed in the Rule 144A Release are consistent
with certain of the guidance factors discussed in this Release.
    \562\ See, e.g., HSBC Comment Letter; HSBC Global Research,
Emerging Markets Currency Guide 2012 (Dec. 2011), available at
https://www.hsbcnet.com/gbm/attachments/rise-of-the-rmb/currency-guide-2012.pdf?WT.ac=CIBM_gbm_pro_rmbrise_pbx01_On; see also
Liquidity Coverage Ratio Release, supra footnote 520, at section
II.B.3.iv (discouraging banking entities from holding a
disproportionate amount of their eligible highly qualified liquid
assets in locations outside the United States where unforeseen
impediments may prevent timely repatriation of such assets during a
liquidity crisis).
    \563\ See, e.g., Stephen H. Bier, Julien Bourgeois & Joseph
McClain, Mutual Funds and Loan Investments, The Investment Lawyer:
Covering Legal and Regulatory Issues of Asset Management, Vol. 22,
No. 3 (Mar. 2015), at 2, available at http://www.dechert.com/files/Uploads/Documents/FSG/Mutual%20Funds%20and%20Loan%20Investments%20-%20The%20Investment%20Lawyer.pdf (``[M]any loans and assignment
trades remain bespoke transactions that require consents from
borrowers or key syndicate members, and loan documents are still
negotiated written documents that require human review. As a result
. . . the mechanics of loan trades and certain trade settlement
times cause funds to carefully monitor liquidity considerations
surrounding loan investments. . . . [In making such determinations,
funds] typically consider factors common to general liquidity
determinations, as well as factors specific to the loan markets,
which can include: (i) The legal limitations on the transferability
or sale of a loan including the requirement to obtain consents from
borrowers or syndicate agents and members prior to assignment; (ii)
the existence of a trading market for the loans and the estimated
depth of the market; (iii) the frequency of trades or quotes for the
loan; (iv) the estimated length of the settlement period; and (v)
the borrower's health.'').

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

5. Liquidity Classification Review Requirement
    Under rule 22e-4 as adopted today, a fund would be required to
review its portfolio investments' classifications at least monthly in
connection with reporting the liquidity classification for each
portfolio investment on Form N-PORT, as well as more frequently if
changes in relevant market, trading, and investment-specific
considerations are reasonably expected to materially affect one or more
of its investments' classifications.\564\ A fund generally could
classify and review the liquidity classifications of its portfolio
investments according to their asset class; however, the fund must
separately classify and review any investment within an asset class if
the fund or its adviser, after reasonable inquiry, has information
about any market, trading, or investment-specific considerations that
are reasonably expected to significantly affect the liquidity
characteristics of that investment as compared to other securities
within that asset class.\565\
---------------------------------------------------------------------------

    \564\ See rule 22e-4(b)(1)(ii).
    \565\ See rule 22e-4(b)(1)(ii)(A).
---------------------------------------------------------------------------

    As discussed in the Proposing Release, the Commission has
previously stated that it ``expects funds to monitor portfolio
liquidity on an ongoing basis to determine whether, in light of current
circumstances, an adequate level of liquidity is being maintained.''
\566\ Some have interpreted this statement to mean that the Commission
does not intend for a fund to reassess the liquidity status of
individual securities on an ongoing basis, but instead to monitor
whether a fund portfolio's overall liquidity profile is appropriate in
light of its redemption obligations.\567\ While we agree that a fund
should monitor the liquidity of its portfolio holistically, we note
that the decreased liquidity of individual portfolio components can
directly affect the ability of a fund to meet its redemption
obligations without significant dilution of remaining investors'
interests in the fund.\568\ We thus believe that specifically requiring
a fund to review the classifications of its portfolio investments made
under rule 22e-4 would reduce the risk that a fund would be unable to
meet its redemption obligations without significant investor dilution.
---------------------------------------------------------------------------

    \566\ See Proposing Release, supra footnote 9, at nn.246-248 and
accompanying text (citing Guidelines Release, supra footnote 38, at
section II).
    \567\ See id., at n.247 (citing Investment Company Institute,
Valuation and Liquidity Issues for Mutual Funds (Feb. 1997), at 45).
    \568\ See, e.g., Third Avenue Temporary Order, supra footnote 12
(``On December 9, 2015, after considering the environment the Fund
was in and the likelihood that incremental sales of portfolio
securities to satisfy additional redemptions would have to be made
at prices that would unfairly disadvantage all remaining
shareholders, the Board determined that the fairest action on behalf
of all shareholders would be to adopt a plan of liquidation.''); see
also Heartland Release, supra footnote 80.
---------------------------------------------------------------------------

    As proposed, rule 22e-4 would have required a fund to review its
liquidity classifications on an ongoing basis.\569\ Also, like the
proposed classification requirement, the proposed review requirement
would have required a fund to take into account a list of specified
factors, as the fund determines applicable, in reviewing its portfolio
assets' liquidity.\570\ In the Proposing Release, we stated that a fund
may wish to determine the frequency of ongoing review of portfolio
positions' liquidity classifications based in part on the liquidity of
its portfolio holdings, as well as the timing of its portfolio
acquisitions and turnover.\571\ In addition, we noted in the Proposing
Release that, at a minimum, a fund would review its liquidity
classifications at least monthly in order to accurately report this
information on proposed Form N-PORT.\572\ Proposed rule 22e-4 did not
include provisions that would permit a fund to review its portfolio
assets' liquidity on an asset-class basis.
---------------------------------------------------------------------------

    \569\ Proposed rule 22e-4(b)(2)(i).
    \570\ Proposed rule 22e-4(b)(2)(ii).
    \571\ See Proposing Release, supra footnote 9, at text
accompanying n.252.
    \572\ See id., at n.253.
---------------------------------------------------------------------------

    We sought comment in the Proposing Release about the proposed
ongoing review requirement. Several commenters suggested that the
Commission adopt a general liquidity classification review requirement,
without incorporating specific factors that a fund would be required to
consider during the course of its review.\573\ One commenter argued
that the frequency of the proposed review requirement was unclear and
recommended that the Commission adopt more specific standards
associated with review frequency.\574\ Multiple commenters expressed
concerns about the potential burden associated with an ``ongoing''
review requirement \575\ and suggested that these concerns could be
mitigated by replacing the proposed requirement to classify the
liquidity of each portfolio position with a ``top-down'' requirement
permitting funds to classify their portfolio assets' liquidity on an
asset-class basis.\576\
---------------------------------------------------------------------------

    \573\ See, e.g., CFA Comment Letter; Vanguard Comment Letter.
    \574\ See Better Markets Comment Letter.
    \575\ See, e.g., Dechert Comment Letter; ICI Comment Letter I;
LSTA Comment Letter; T. Rowe Comment Letter.
    \576\ See, e.g., LSTA Comment Letter.
---------------------------------------------------------------------------

    We believe that the review requirement we are adopting, together
with the rule provision specifying that a fund would generally be
permitted to review its liquidity classifications with reference to its
holdings' asset classes, advances our goal of requiring funds to
appropriately re-evaluate the liquidity of their portfolio holdings,
while responding to commenters' concerns. As discussed in the Proposing
Release, we understand that some funds currently may not review the
liquidity of their portfolio investments on a continuing basis after
they are acquired.\577\ In particular, we understand that certain funds
may initially determine that certain investments are liquid or illiquid
but will not regularly re-evaluate these initial classifications, even
in light of changing market conditions. We understand that some funds,
on the other hand, currently reassess the liquidity of their portfolio
investment regularly based on market-wide developments, as well as
events affecting particular securities or asset classes.\578\
---------------------------------------------------------------------------

    \577\ See Proposing Release, supra footnote 9, at paragraph
accompanying n.250.
    \578\ See id., at n.250 and accompanying text; see also ICI
Comment Letter I.
---------------------------------------------------------------------------

    Rule 22e-4 as adopted requires a fund to review its liquidity
classifications at least monthly, in connection with reporting its
liquidity classifications monthly on Form N-PORT.\579\ This requirement
responds to the recommendation that the Commission adopt more specific
standards associated with review frequency. Moreover, in order to
determine whether its holdings are consistent with the fund's highly
liquid investment minimum, as well as the rule 22e-4 limitation on
illiquid investments, a fund would have to determine whether its
initial classification determinations have changed based on market
conditions or other developments. Therefore, rule 22e-4 also includes
the requirement for a fund to review its liquidity classifications more
frequently than monthly if changes in relevant market, trading, and
investment-specific considerations are reasonably expected to
materially affect one or more of its investment classifications.\580\
For example, relevant market-wide developments could include changes in
interest rates or other macroeconomic events, market-wide volatility,
market-wide flow changes, dealer inventory or capacity changes, and
extraordinary

events such as natural disasters or political upheaval.\581\ Asset-
class and investment-specific developments that a fund may wish to
consider include, among others, regulatory changes affecting certain
asset classes and corporate events (such as bankruptcy, default,
pending restructuring, or delisting, as well as reputational events).
We believe that the rule's requirement that a fund review its liquidity
classifications at least monthly, as well as more frequently in light
of market-related and other changes that could materially affect a
fund's investment classifications, will provide funds with more
direction as to the frequency of their classification reviews, as well
as circumstances that could lead to a classification review, than the
proposed ongoing review requirement.
---------------------------------------------------------------------------

    \579\ See rule 22e-4(b)(1)(ii).
    \580\ See id.
    \581\ See, e.g., 2014 Fixed Income Guidance Update, supra
footnote 94.
---------------------------------------------------------------------------

    We believe that the review requirement we are adopting, as opposed
to the proposed ongoing review requirement, permits funds to tailor
their review of liquidity classifications in light of the liquidity
character of a fund's portfolio investments. The modifications to rule
22e-4 clarify that we do not expect a fund to constantly reassess all
of its portfolio investments' liquidity. Also, the review requirement
that we are adopting would not require a fund to consider a detailed
list of specific factors in the course of conducting its liquidity
classification reviews. Instead, as discussed above, it would require a
fund to take into account ``relevant market, trading, and investment-
specific considerations'' in reviewing its investments' liquidity.\582\
---------------------------------------------------------------------------

    \582\ See rule 22e-4(b)(1)(ii).
---------------------------------------------------------------------------

    Finally, the review requirement that we are adopting, like the rule
22e-4 classification requirement, would permit a fund to generally
review its portfolio investments' liquidity according to their asset
class (provided that the fund must identify, and separately review, any
investment within an asset class that the fund determines should be
reviewed separately based on its liquidity characteristics).\583\ We
believe that this approach will permit funds to increase their
efficiency in classifying and reviewing portfolio investments'
liquidity.
---------------------------------------------------------------------------

    \583\ See rule 22e-4(b)(1)(ii)(A).
---------------------------------------------------------------------------

6. Liquidity Classification Reporting and Disclosure Requirements
    In connection with the liquidity classification requirement of rule
22e-4, we are requiring, largely as proposed and with certain
modifications in response to comments, a fund to report the liquidity
classification assigned to each of the fund's portfolio investments on
Form N-PORT.\584\ Position-level liquidity classification information
will be reported to the Commission in a structured data format on a
confidential basis rather than released every three months to the
public.\585\ Under the final rules, a fund will also be required to
publicly report on Form N-PORT the aggregated percentage of its
portfolio investments that falls into each of the four liquidity
classification categories outlined above.\586\ This aggregate
information will be disclosed to the public only for the third month of
each fiscal quarter with a 60-day delay. While we acknowledge that
liquidity classification determinations may be to some extent
subjective and that such information reported on Form N-PORT may be
non-standardized, we believe that, on balance, our staff, investors,
and other potential users would benefit from the information that will
be reported on Form N-PORT that currently may not be reported or
disclosed by funds. We believe that this greater transparency about
liquidity at the fund-level will provide our staff, investors, and
other potential users with a helpful picture of the general liquidity
characteristics of funds and help them better understand the liquidity
risks associated with a particular fund. We also believe that this
information will help investors make more informed investment
decisions.
---------------------------------------------------------------------------

    \584\ Rather than report the liquidity classification among six
categories as under the proposal, funds will be required to report
liquidity classifications among four liquidity categories, which may
be based on asset type to the extent discussed above. See Item C.7.
of Form N-PORT. We have modified the numbering convention for items
within Form N-PORT from the proposal to be consistent with Form N-
PORT as adopted in the Investment Company Reporting Modernization
Adopting Release.
    \585\ See General Instruction F of Form N-PORT.
    \586\ Item B.8.a. of Form N-PORT. We note that such reporting is
designed to serve as a snapshot of a fund's liquidity on the last
business or calendar day of the month. See rule 30b1-9 under the
Investment Company Act (requiring reporting on Form N-PORT to be
current as of the last business day, or last calendar day, of the
month). Accordingly, the aggregate percentage of portfolio
investments in each of the four liquidity classification categories
need not reflect pending transactions, but instead should reflect
the balance of investments in each category on the last business or
calendar day of the month.
---------------------------------------------------------------------------

    As part of this public disclosure, a fund would publicly disclose
the percentages of its highly liquid investments that are segregated to
cover, or pledged to satisfy margin requirements in connection with,
the fund's derivatives transactions that the fund has classified in the
moderately liquid, less liquid, and illiquid investments classification
categories in light of the requirement in rule 22e-4 that the liquidity
classification cover each of the fund's derivatives transactions,
discussed above.\587\ This derivatives transactions information will
also be made public for the third month of each fiscal quarter with a
60-day delay.
---------------------------------------------------------------------------

    \587\ Item B.8.b. of Form N-PORT. This derivatives transactions
reporting requirement corresponds to the modification in rule 22e-
4(b)(1)(ii)(C), discussed above.
---------------------------------------------------------------------------

    Most commenters opposed the proposed Form N-PORT reporting
requirement, and particularly objected to having position-level
liquidity information reported on Form N-PORT made public.\588\ We
believe that the additions to Form N-PORT adopted today in this Release
address many of these concerns. We discuss these additions, the
comments we received on the proposal, as well as modifications we made
to the proposal in response to comments, in more detail below.
---------------------------------------------------------------------------

    \588\ See, e.g., Cohen & Steers Comment Letter; NYC Bar Comment
Letter; SIFMA Comment Letter I; Wellington Comment Letter.
---------------------------------------------------------------------------

a. Reporting Liquidity Classification of Portfolio Investments
    We proposed to require a fund to report on Form N-PORT the
liquidity classification of each of the fund's positions (or portions
of a position) in a portfolio asset using the proposed classification
system of rule 22e-4.\589\ As discussed above, most commenters opposed
the proposed classification regime, and many offered varied
classification alternatives for fund liquidity risk management and
reporting purposes. As discussed previously, we are today adopting a
liquidity classification requirement under rule 22e-4 based on a
``days-to-cash'' framework as proposed, but with a number of
modifications informed by commenter recommendations that we believe
address many commenters' concerns about the classification process
itself.
---------------------------------------------------------------------------

    \589\ See Proposing Release, supra footnote 9, at section
III.G.2.a.
---------------------------------------------------------------------------

    A number of commenters supported reporting liquidity
classifications to the Commission on Form N-PORT, provided that it was
not publicly disclosed.\590\ For example, one

commenter expressed support for reporting position-level liquidity
classifications to the Commission, noting that the Commission should
have the data it needs to monitor fund holdings and liquidity
determinations, examine potential outliers, and, if an unexpected
market event occurs (e.g., the default of a significant institution),
quickly assess the potential impact on mutual funds it supervises.\591\
Another commenter expressed the belief that the proposed liquidity
classifications data could be appropriate for Commission oversight
purposes.\592\
---------------------------------------------------------------------------

    \590\ See, e.g., Dechert Comment Letter; Interactive Data
Comment Letter; J.P. Morgan Comment Letter; Nuveen Comment Letter.
Some commenters suggested that the Commission evaluate reported
classification data for a period of time to determine whether the
information is appropriate for public disclosure. See BlackRock
Comment Letter; Fidelity Comment Letter; SIFMA Comment Letter III.
    \591\ See J.P. Morgan Comment Letter.
    \592\ See State Street Comment Letter.
---------------------------------------------------------------------------

    On the other hand, a few commenters objected to reporting liquidity
classifications, as proposed, even if such information is disclosed
only to the Commission.\593\ Some commenters stated that there is
limited utility in the proposed classification information for the
Commission since the information would be subjective and methodology-
specific, which would lead to results that would preclude comparisons
across funds, limiting the utility of this information for the
Commission's monitoring of industry-wide data.\594\ In addition, one
commenter expressed concerns about the security of sensitive
information filed with the Commission due to recent high-profile
cybersecurity breaches both in the governmental and private
sectors.\595\
---------------------------------------------------------------------------

    \593\ See Federated Comment Letter; Fidelity Comment Letter;
Invesco Comment Letter; SIFMA Comment Letter I.
    \594\ See, e.g., BlackRock Comment Letter; Fidelity Comment
Letter; Wellington Comment Letter.
    \595\ See Invesco Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that requiring funds to report the liquidity
classification of their portfolio investments is vital to our ongoing
monitoring and oversight efforts. A key goal of the rulemaking is to
allow us to monitor funds' liquidity profiles (both on a fund-by-fund
basis and across funds) over time, and respond as appropriate. Absent
the required reporting on Form N-PORT, our ability to engage in such
efforts would be limited and less efficient. We believe that the
changes made to the classification system discussed above should serve
to mitigate commenters' concerns about the difficulties of making
comparisons across the industry, in light of the reduced number of
categories for classification. We recognize that there is still likely
to be variation between funds in how they classify certain asset
classes and investments, and believe that despite any variations, this
liquidity information will be useful and valuable to us. We will be
able to identify different fund liquidity classification practices, and
use that information to gain insight into how different funds view
liquidity in the market, and whether there are any identifiable
liquidity concerns. We also note that despite any concerns about
variation of practices across funds limiting comparability, we expect
that the reported information will allow us to generally monitor
specific funds' liquidity on a consistent basis across time, and
identify how their views of the liquidity of their investments change.
    We believe that such information will assist us in better assessing
liquidity risk in the open-end fund industry, which can inform our
policy and guidance. We also believe that this information will assist
us in monitoring for compliance with rule 22e-4 and identifying
potential outliers in fund liquidity classifications for further
inquiry, as appropriate. We recognize that liquidity classifications,
similar to valuation- and pricing-related matters, inherently involve
judgment and estimations by funds. We also understand that the
liquidity classification of an asset class or investments may vary
across funds depending on the facts and circumstances relating to the
funds and their trading practices.\596\ We do not believe that data
based on estimations of market conditions on a fund-by-fund basis is
uninformative or of limited utility because of the information's
sometimes fund-specific, subjective nature.\597\ Rather, we believe
that even with potential variances in determinations, the liquidity
information reported will be informative to the Commission.
Furthermore, we believe that members of the fund industry are generally
in the best position to provide current information on the conditions
of fund liquidity since they are in the markets every day trading
securities and observe how markets are evolving and related liquidity
characteristics are changing.
---------------------------------------------------------------------------

    \596\ 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.'').
    \597\ See supra footnote 594 and accompanying text.
---------------------------------------------------------------------------

    In sum, we believe that the modified reporting requirements on Form
N-PORT will provide the Commission with meaningful data concerning the
liquidity of portfolio investments across the fund industry and at the
same time lessen burdens on funds classifying and reporting liquidity
information (compared to the proposal). Accordingly, we are adopting
the requirement for funds to report the liquidity classification of
their portfolio investments to the Commission.
b. Non-Public Disclosure of Liquidity Classification Information
Reported on Form N-PORT
    We proposed that liquidity classification information reported on
Form N-PORT at the portfolio position level be disclosed to the public
for the third month of each fiscal quarter with a 60-day delay. One
commenter expressed general support for regulatory initiatives aimed at
improving transparency.\598\ Several commenters expressed support for
public disclosure of liquidity information if the framework for
classification was modified from the proposed six-category liquidity
classification framework to alternative frameworks proposed by
commenters that generally measured the liquidity of portfolio positions
based on asset type and included less classification categories.\599\
---------------------------------------------------------------------------

    \598\ See Interactive Data Comment Letter.
    \599\ See, e.g., Charles Schwab Comment Letter; FSR Comment
Letter; Nuveen Comment Letter; Vanguard Comment Letter.
---------------------------------------------------------------------------

    On the other hand, most commenters opposed the proposed public
disclosure of the liquidity classification. Some commenters expressed
concerns that the value to the public of the position-level liquidity
classification information on Form N-PORT, as proposed, would be
limited.\600\ Many other commenters expressed concerns that the public
disclosure of the position-level liquidity classification information
could be potentially misleading to investors for various reasons. For
example, many commenters contended that, while the position-by-position
information reported would be subjective, the numeric days-to-
settlement presentation proposed on Form N-PORT could imply a false
sense of precision of the data to

fund investors.\601\ Many of these commenters also argued that
providing subjective, position-level liquidity classification
information to the public could potentially result in misleading
comparisons across funds,\602\ with some commenters noting that such
comparisons could disadvantage certain funds over others.\603\ While
reports on Form N-PORT would be submitted to the Commission within 30
days after month end, some commenters voiced concerns that the
liquidity data presented on Form N-PORT would be stale for the public
given that the reports, as proposed, would be available every third
month of a fund's fiscal quarter with a 60-day delay, adding to the
risk of misleading investors about the real-time state of a portfolio's
liquidity.\604\
---------------------------------------------------------------------------

    \600\ See, e.g., Better Markets Comment Letter (expressing
concerns that the proposal's three-day liquid asset minimum and 15%
standard assets are determined by the fund and that the liquidity
classifications reported on Form N-PORT would be stale information
for the public); Morningstar Comment Letter (also stating concerns
that the information available to the public under the proposal
would be stale and expressing the belief that investors could find
it difficult to compare the liquidity characteristics of portfolios
from different funds).
    \601\ See, e.g., Dechert Comment Letter; Eaton Vance Comment
Letter I; Federated Comment Letter; LSTA Comment Letter; Morningstar
Comment Letter.
    \602\ See, e.g., BlackRock Comment Letter; IDC Comment Letter;
J.P. Morgan Comment Letter; Voya Comment Letter.
    \603\ See, e.g., BlackRock Comment Letter; IDC Comment Letter;
ICI Comment Letter I; Wellington Comment Letter.
    \604\ See, e.g., FSR Comment Letter; LSTA Comment Letter;
Morningstar Comment Letter (noting that given public disclosure on
N-PORT would be provided infrequently, the information might well be
very out of date when an investor reviews it, thereby providing
little benefit to investors); NYC Bar Comment Letter.
---------------------------------------------------------------------------

    Many commenters also expressed concerns that public disclosure of
the proposed position-level liquidity classification information would
ultimately harm fund shareholders and the fund market for a variety of
reasons. Some commenters argued that public reporting would facilitate
predatory trading practices, particularly during periods of liquidity
stress, ultimately harming fund investors.\605\ Commenters expressed
the belief that public reporting of liquidity classifications at the
position-level exacerbates these concerns, noting, for example, that in
the event a fund experiences a liquidity issue, public information
about its portfolio-level liquidity classifications may expose the fund
to predatory trading.\606\ In addition, several commenters expressed
concern that public reporting of position-level liquidity
classifications could be harmful to the fund market, arguing that such
reporting would incentivize homogenized liquidity determinations and
comparative liquidity ``ratings'' from third-party service
providers,\607\ as well as ``window dressing'' at period ends prior to
disclosure, increasing the potential for systemic risks in the fund
industry. \608\ Other commenters suggested that the Commission evaluate
reported classification data for a period of time to determine whether
the information is appropriate for public disclosure.\609\
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    \605\ See BlackRock Comment Letter (stating that publicly
available position-level data exacerbated Third Avenue's troubles as
other market participants knew of the holdings of the Focused Credit
Fund and used that information to the detriment of the fund). See
also e.g., Federated Comment Letter; ICI Comment Letter I; SIFMA
Comment Letter I; Voya Comment Letter.
    \606\ See, e.g., SIFMA Comment Letter I.
    \607\ See, e.g., Charles Schwab Comment Letter; Wellington
Comment Letter; Comment Letter of Wellington Management Company LLP
(June 10, 2016) (``Wellington Comment Letter II''); Wells Fargo
Comment Letter.
    \608\ See, e.g., Dechert Comment Letter; LSTA Comment Letter;
NYC Bar Comment Letter; Oppenheimer Comment Letter.
    \609\ See, e.g., BlackRock Comment Letter; Fidelity Comment
Letter; SIFMA Comment Letter I.
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    While many of these commenters objected to the proposed position-
level public disclosure of liquidity classifications, several
commenters did not object to making more aggregated portfolio-level
disclosure of liquidity data available to the public.\610\ These
commenters suggested that, while position-level liquidity data may pose
concerns as discussed above, providing the public a portfolio-level
``roll up'' of the liquidity levels of the fund may provide useful data
and would be unlikely to raise the same kind of issues.\611\
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    \610\ See, e.g., Nuveen Comment Letter; T. Rowe Comment Letter.
    \611\ See, e.g., Nuveen Comment Letter; T. Rowe Comment Letter.
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    We recognize that the level of position-level detail necessary for
the Commission and our staff to effectively monitor fund liquidity may
not be necessary for other users. We understand that some data
collectors would prefer to use information reported on Form N-PORT
proposed under the Investment Company Reporting Modernization proposal
(which we are adopting concurrently), such as monthly portfolio
holdings data, rather than the classification information proposed in
the liquidity proposal.\612\ Furthermore, we understand that for many
investors, the proposed specific position-level liquidity data would be
likely unnecessarily detailed, and that aggregated or ``rolled up''
portfolio-level information about fund liquidity may be more easily
understandable and usable. As discussed below, such aggregated
information will likely result in more user friendly and digestible
portrayals of fund liquidity, and at the same time we expect will avoid
many of the potential harms suggested by commenters that might result
from position-level disclosure to the public. Such a layered reporting
and disclosure regime should allow the Commission and investors each to
access the liquidity information likely most useful for their purposes.
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    \612\ See Morningstar Comment Letter.
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    We also appreciate the limitations and subjectivity of the
liquidity classification process, and thus understand the risks of
investors potentially giving too much weight to a fund manager's
individual liquidity classification choices. The classification of
portfolio investments at the position-level under the days-to-cash
framework involves a number of assumptions and methodologies that could
result in classifications that vary from fund to fund. As a result, the
liquidity classification information reported for the same or similar
asset classes and investments could vary because of complex differences
in methodologies and assumptions that may not be reported on Form N-
PORT nor easily explained to investors but would be available to the
Commission in inspections.\613\
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    \613\ A fund has the option of providing explanatory notes
related to its filing to explain any of its methodologies, including
related assumptions, in Part E of Form N-PORT. See Instruction G to
Form N-PORT.
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    We appreciate the concerns raised by commenters that reporting
publicly position-level data could imply a false sense of precision
about the liquidity profile of a fund and that, given the delay in the
public reporting of portfolio-level classification information (60 days
after quarter-end), the position-level information will likely be out
of date when reviewed by investors. While we can take these potential
variances in liquidity classifications of assets into account in
evaluating and using the data for the Commission's purposes in
observing potential trends in liquidity profiles across the fund
industry, it may be more difficult to explain them to investors.
Furthermore, the Commission would receive portfolio-level
classification information within 30 days of month-end, thereby
increasing the utility of the classification information for Commission
purposes. We expect that providing only aggregated liquidity
classification information on the funds' portfolio assets publicly may
mitigate some of these concerns. This level of detail should
appropriately focus investors on the fund's general liquidity profile
and general trends in fund liquidity rather than individual security-
level liquidity decisions, in light of the concerns discussed above.
    Some commenters also raised concerns that public reporting of

liquidity classifications at the position level could potentially
expose investors to harm, including, for example, potentially exposing
a fund to predatory trading, particularly during periods of liquidity
stress.\614\ We believe, however, that the aggregated public disclosure
on Form N-PORT once each quarter with a 60-day lag would alleviate
these predatory trading concerns given that those engaged in predatory
trading would not have information about a fund's own assessment of its
liquidity characteristics in real-time and would not have the detailed
position-level information in real time necessary to pursue such
strategies.
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    \614\ See, e.g., ICI Comment Letter; Cohen and Steers Comment
Letter; Dechert Comment Letter; Nuveen Comment Letter.
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    For these reasons, we find that it is neither necessary nor
appropriate in the public interest or for the protection of investors
to make liquidity classification information for each portfolio
investment publicly available.\615\ We also are adopting amendments to
Form N-PORT to require a fund to publicly disclose the aggregated
percentage of its portfolio assets representing each of the four
classification categories outlined in Form N-PORT and related rule 22e-
4,\616\ as discussed in more detail below. We believe that providing
liquidity classification data attributable to each portfolio investment
to the Commission and fund-level data to investors is an efficient
approach to present liquidity information in a manner that both
satisfies the Commission's need for position-level liquidity data for
its regulatory oversight purposes and provides useful fund liquidity
information to investors.
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    \615\ See section 45(a) of the Investment Company Act, which
requires information in investment company forms to be made
available to the public, unless we find that public disclosure is
neither necessary nor appropriate in the public interest or for the
protection of investors. See also General Instruction F of Form N-
PORT.
    \616\ See Item B.8. of Form N-PORT.
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    In addition, the Commission recognizes the importance of sound data
security practices and protocols for non-public information, including
information that may be competitively sensitive. The Commission has
substantial experience with storage and use of non-public information
reported on Form PF and delayed public disclosure of information on
Form N-MFP (although the Commission no longer delays public disclosure
of reports on Form N-MFP), as well as other non-public information that
the Commission handles in its ordinary course of business. Commission
staff is carefully evaluating the data security protocols that will
apply to non-public data reported on Form N-PORT in light of the
specific recommendations and concerns raised by commenters. Drawing on
its experience, the staff is working to design controls and systems for
the use and handling of Form N-PORT data in a manner that reflects the
sensitivity of the data and is consistent with the maintenance of its
confidentiality.\617\ In advance of the compliance date, we expect that
the staff will have reviewed the controls and systems in place for the
use and handling of non-public information reported on Form N-PORT.
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    \617\ See Reporting by Investment Advisers to Private Funds and
Certain Commodity Pool Operators and Commodity Trading Advisors on
Form PF, Investment Advisers Act Release No. 3308 (Oct. 31, 2011)
[76 FR 71228 (Nov. 16, 2011)]. We recognize that there are
differences between the N-PORT reporting requirements and the Form
PF reporting requirements, such as frequency, granularity, and
registration status, and our recognition of these differences guides
our evaluation of appropriate measures for preservation of data
security for reported information.
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c. Public Fund-Level Aggregate Liquidity Profile Reporting
    As previously discussed, we are adopting, with modifications, the
proposed requirement that funds report to the Commission on a non-
public basis the liquidity classification assigned to each portfolio
position on Form N-PORT. Some commenters expressed concerns that the
value to the public of the position-level liquidity classification
information on Form N-PORT, as proposed, would be limited.\618\ Other
commenters recommended that, as an alternative to the proposal, the
Commission make available to the public a general assessment of the
liquidity of the portfolio at the fund level, rather than the
individual security level,\619\ with more detailed information,
including the fund's assessment of the liquidity of each asset at the
individual security level, provided to the Commission but kept
confidential.\620\
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    \618\ See, e.g., Better Markets Comment Letter; Morningstar
Comment Letter.
    \619\ See, e.g., Dechert Comment Letter; Federated Comment
Letter; LSTA Comment Letter; NYC Bar Comment Letter.
    \620\ See, e.g., SIFMA Comment Letter I; Charles Schwab Comment
Letter.
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    We appreciate these comments and recognize that position-level
liquidity classification data, while valuable for Commission purposes,
may be of limited use for everyday investors. We find persuasive
commenters' recommendations to provide the public with a general
assessment of the liquidity of a portfolio at the fund level as an
approach to provide everyday investors useful information on fund
liquidity. As a result, we are adopting amendments to Form N-PORT to
require a fund to publicly report for the third month of each fiscal
quarter with a 60-day delay the aggregate percentage of its portfolio
representing each of the four classification categories outlined in
Form N-PORT and related rule 22e-4.\621\ For purposes of this reporting
item, a fund would report the aggregate percentage of investments that
are assets in each liquidity category compared to total portfolio
investments that are assets (not including liabilities) of the
fund.\622\
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    \621\ See Item B.8.a. of Form N-PORT.
    \622\ See id.
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    In order to avoid misleading investors about the actual
availability of highly liquid investments to meet redemptions, a fund
also will be required to publicly report on Form N-PORT the percentage
of its highly liquid investments that it has segregated to cover, or
pledged to satisfy margin requirements in connection with, derivatives
transactions that are classified as moderately liquid, less liquid, or
illiquid investments.\623\ As discussed above, we proposed to require a
fund to consider the relationship of an asset to another portfolio
asset in classifying the liquidity of its portfolio assets reported on
Form N-PORT and to consider guidance that a fund should classify the
liquidity of assets segregated to cover derivatives obligations using
the liquidity of the derivative instruments such assets are
covering.\624\ One commenter suggested that the Commission add an item
to the Schedule of Portfolio Investments on Form N-PORT that permits a
fund to note whether an asset (or portion thereof) is encumbered or
linked to other assets as of the reporting date.\625\ Another commenter
suggested that the Commission require funds to assign liquidity
classifications to cover assets on an aggregate portfolio basis in
amounts corresponding to the aggregate amount of derivatives exposure
in each liquidity category.\626\
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    \623\ See Item B.8.b. of Form N-PORT; see also supra section
III.C.3.c.
    \624\ See Proposing Release, supra footnote 9, at section
III.B.2; see also supra section III.C.3.c.
    \625\ See ICI Comment Letter I; see also supra section
III.C.3.c.
    \626\ See Dechert Comment Letter; see also supra section
III.C.3.c.
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    In consideration of the commenters' recommendations, we believe
that our modification to the proposal to require a fund to report
publicly the percentage of the fund's highly liquid investments that
are segregated to cover, or pledged to satisfy margin requirements in
connection with, the fund's derivatives

transactions that are classified in each liquidity category strikes an
appropriate balance between providing investors with useful information
about the impact of derivatives coverage obligations on the percentage
of a fund's highly liquid investments and lessening operational burdens
associated with classifying investments. Since the public will only
receive asset liquidity classification information on an aggregate
level and only the Commission will receive liquidity classifications on
an investment-by-investment basis, we believe that the suggested
alternative to add an item to the Schedule of Portfolio Investments on
Form N-PORT linking an asset encumbered to other assets in connection
with derivatives transactions would not be a helpful means to inform
investors about the connection between derivatives obligations and the
availability of highly liquid investments to meet redemptions. We
believe that without public reporting of the percentage of a fund's
highly liquid investments that are segregated to cover, or pledged to
satisfy margin requirements in connection with, a fund's derivatives
transactions that are not themselves highly liquid investments, the
reported percentage of a fund's highly liquid investments could be
potentially misleading to investors if a portion of highly liquid
investments are not available to meet redemptions due to derivatives
transactions obligations.
    Overall, we continue to believe that investors currently have
limited information about the liquidity of fund investments and would
benefit from enhanced information to evaluate funds and assess the
potential for returns and risks of a particular fund. We expect that
many investors will use liquidity reporting information to better
understand the liquidity risks associated with a particular fund for
purposes of making more informed investment decisions and will benefit
from aggregate information about a fund's overall liquidity. Moreover,
we believe that requiring a fund to publicly disclose only the
aggregate percentage of its portfolio assets representing each of the
four classification categories balances commenters' concerns about
certain adverse effects that could arise from public reporting of
detailed portfolio liquidity information with investors' need for
improved information about funds' liquidity risk profiles.
d. Illiquid Investments
    As discussed above, rule 22e-4, as adopted, combines a fund's
illiquid investment determinations with the general liquidity
classification framework reported on Form N-PORT.\627\ In the Proposing
Release, in connection with the codification of the 15% guideline that