classifications be limited to specific types of funds or asset classes?
    15. If we permitted asset class level classifications, how should
the stressed trade size and value impact standard in the proposal apply
to asset class level classifications?
b. Amendments to Liquidity Classification Categories
    We are proposing changes to the liquidity classification categories
to improve funds' abilities to make timely payment on shareholder
redemptions, without the sale of portfolio investments resulting in the
dilution of outstanding fund shares. Section 22(e) of the Act
establishes a right of prompt redemption in open-end funds by requiring
such funds to make payments on shareholder redemption requests within
seven days of receiving the request. In March 2020, in connection with
the economic shock from the onset of the COVID-19 pandemic, open-end
funds faced a significant amount of investor redemptions, and we
believe additional changes to rule 22e-4 would assist funds in managing
investor redemptions in future stressed conditions.
    Rule 22e-4 currently allows funds to classify as less liquid
investments those that the fund reasonably expects to be able to sell
or dispose of in seven calendar days or less without significantly
changing the market value of the investment, but that are reasonably
expected to settle in more than seven calendar days.\94\ Under the
current rule, an investment is classified as illiquid if it cannot be
sold or disposed of in seven calendar days or less without
significantly changing the market value of the investment.\95\ We
propose to eliminate the less liquid classification category and amend
the definition of illiquid investment to include those investments that
a fund reasonably expects not to be convertible to U.S. dollars in
current market conditions in seven calendar days or less without
significantly changing the market value of the investment, as well as
those investments whose fair value is measured using an unobservable
input that is significant to the overall measurement.\96\ Under the
proposal to eliminate the less liquid classification category, the rule
would therefore have only three liquidity classifications: highly
liquid investments, moderately liquid investments, and illiquid
investments. We also propose to amend the term ``convertible to cash''
to ``convertible to U.S. dollars,'' codifying prior Commission
statements.\97\ Finally, we propose to specify how to count the
identified number of days an investment is convertible to U.S. dollars
for purposes of the liquidity categories.
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    \94\ See rule 22e-4(a)(10) (defining ``less liquid
investment'').
    \95\ See rule 22e-4(a)(8) (defining ``illiquid investment'').
    \96\ See proposed rule 22e-4(a).
    \97\ See Liquidity Rule Adopting Release, supra note 8, at n.848
(``Cash means cash held in U.S. dollars, and would not include, for
example, cash equivalents or foreign currency.'').
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i. Removing the Less Liquid Investment Category and Classifying These
Investments as Illiquid
    We propose to eliminate the less liquid classification category and
amend the definition of illiquid investment to include investments, in
part, that a fund reasonably expects not to be convertible to U.S.
dollars in seven calendar days or less without significantly changing
the market value of the investment. Investments that funds currently
classify as less liquid would become illiquid investments under the
proposed amendments, absent changes to shorten the settlement time of
many of those investments. Section 22(e) of the Act requires open-end
funds to make payment on shareholder redemption requests within seven
days of receiving the request. The proposed amendment to define an
investment as illiquid if it does not settle to U.S. dollars in seven
calendar days is designed to reduce the mismatch between the receipt of
cash upon the sale of assets with longer settlement periods and the
payment of shareholder redemptions. This would help prepare funds for
future stressed conditions by reducing the risk of a fund not being
able to meet shareholder redemptions. Unlike the current rule, the
proposed rule would directly limit to 15% the amount of fund assets
that are not reasonably expected to be convertible to U.S. dollars in
seven days.
    While funds may classify different types of investments as less
liquid investments today, the most common type of investment in this
category is bank loans.\98\ Fund investments make

up approximately 15% of the bank loan market.\99\ Filings on Form N-
PORT show that over 90% of bank loan investments reported by open-end
funds are classified as less liquid.\100\ In 2015, commenters
addressing concerns about liquidity in the bank loan market stated that
significant efforts were then underway to materially improve settlement
times in the bank loan market, which are typically longer than other
asset classes.\101\ Bank loans are not standardized and have
individualized legal documentation. This provides flexibility of terms
for bank loans, but also increases the time for a fund to settle a bank
loan trade and receive proceeds from the sale, thus increasing the risk
of the fund not being able to meet shareholder redemptions.\102\
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    \98\ Based on Form N-PORT data, bank loans made up 77% and 60%
of investments reported as less liquid in Feb. and Mar. 2020,
respectively. In addition to bank loans, a smaller number of fixed-
income securities, mortgage-backed securities, and equities are
categorized as less liquid investments.
    \99\ See Leveraged Loan Primer (last visited Oct. 4, 2022),
available at https://pitchbook.com/leveraged-commentary-data/leveraged-loan-primer#market-size (stating that the Morningstar LSTA
U.S. Leveraged Loan Index, which is used as a proxy for market size
in the U.S., totaled approximately $1.375 trillion as of Feb. 2022).
As of Dec. 2021, there are 746 open-end funds that classified
approximately $204 billion in bank loan interests as reported on
Form N-PORT. Using this data, we estimate that funds held
approximately 15% of the bank loan market.
    \100\ Based on Form N-PORT data, in 2021, more than 90% of the
gross value of loans reported by open-end funds were classified as
less liquid. This was also the case in Feb. and Mar. 2020.
    \101\ See, e.g., Comment Letter of the Loan Syndications and
Trading Association on 2015 Proposing Release, supra note 31, File
No. S7-16-15, available at https://www.sec.gov/comments/s7-16-15/s71615-57.pdf (``LSTA Comment Letter'') (stating the goal of
transforming syndicated loan settlement to a similar settlement
period as most other asset classes).
    \102\ See id.
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    Around the time that the Commission adopted the liquidity rule, the
median settlement time for a loan sale was about 12 days.\103\ In the
Liquidity Rule Adopting Release, the Commission stated that a fund may
need to consider re-classifying an investment as illiquid in the event
of an extended settlement period.\104\ By July 2021, the average time
to settle a bank loan par trade in the secondary market increased to a
then seven-year high of T+23, and the median was at T+15.\105\ While
median settlement time for bank loans in which funds invest has
generally increased, Form N-PORT data has not shown funds reclassifying
these investments to take into account extended settlement times.
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    \103\ See LSTA Comment Letter.
    \104\ See Liquidity Rule Adopting Release, supra note 8, at
n.380 and accompanying text.
    \105\ See LSTA, Secondary Trading & Settlement: Monthly July
Executive Summary (Aug. 19, 2021), available at https://www.lsta.org/news-resources/secondary-trading-settlement-monthly-july-executive-summary/?utm_source=rss&utm_medium=rss&utm_campaign=secondary-trading-settlement-monthly-july-executive-summary. In addition, fewer trades
settled within T+7, (just 20% of trades settled within the LSTA
guideline during July, a nine-percentage point reduction from the
previous year's monthly average) and settlements wider than T+20
increased 10-percentage points as of July 2021, to a 39% market
share, nearly double that of the T+7 distribution.
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    We are proposing changes to remove the less liquid investment
classification to reduce the risk that funds that invest significantly
in less liquid investments may not be able to meet shareholder
redemptions. While bank loan funds were able to meet redemption
requests during March 2020, a period of significant outflows, we are
concerned that they may not be able to meet shareholder redemptions in
future stressed conditions, especially as investments in this asset
class increase. During the month of March 2020, bank loan funds
experienced outflows of approximately 13% of assets, more than any
other type of fund. In addition, since March 2020, total registered
investment company investments in bank loans have increased 50% to
approximately $200 billion.\106\ We understand that in past times of
large outflows, the median buy-side settlement time for bank loans
generally decreased and funds had a degree of success in effecting
shorter settlement periods for these investments to help meet
redemptions.\107\ We are concerned, however, that in future stress
events these attempts to shorten settlement times may fail since loans
are not standardized, have individualized legal documentation, and rely
on manual processes for settlement. We also understand that funds with
significant extended settlement investments have used borrowing through
lines of credit to meet redemptions, but lines of credit may not be
available to all funds and borrowing imposes costs that can dilute the
value of the fund for remaining investors. Based on Form N-CEN filings,
several bank loan funds have accessed their lines of credit in their
most recent reporting period.\108\ We understand that the costs of
borrowing have risen and credit has become more difficult to obtain
over time.
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    \106\ This is based on Form N-PORT information as of Jan. 31,
2022.
    \107\ See LSTA Comment Letter (stating that settlement times
have decreased in periods of large outflows, for example, in Aug.
2011, when bank loan funds experienced $8 billion of outflows
(approximately 13% of assets). Similarly, in Mar. 2020, when bank
loan funds experienced $12 billion of outflows (approximately 13% of
assets), we understand that settlement times also generally
decreased.
    \108\ See infra note 459 and accompanying text (providing
information about bank loan funds' use of lines of credit as of Dec.
2021).
---------------------------------------------------------------------------

    We believe that investments that funds currently classify as less
liquid should be classified as illiquid investments and be subject to
the 15% limit on illiquid investments, so that funds may be better
prepared to satisfy redemptions in future stressed conditions without
delay and without significant dilution. Using Form N-PORT data, we
estimate that approximately 200 funds during March 2020 would have had
illiquid investments over the 15% limit if this proposed change had
been in effect, with bank loan funds being the largest type of affected
fund.\109\ As a result of the proposed amendments, more bank loan funds
may contract for expedited settlement, which would involve costs.
Alternatively, advisers with strategies that have 15% or more of assets
in investments classified as less liquid and illiquid may change those
strategies, close funds, or consider using a closed-end fund or other
investment vehicle structure that is not subject to rule 22e-4.
Further, potential additional demand for these investments could
provide incentives to shorten the settlement cycle for bank loans more
generally, which may reduce trading costs.\110\ We believe that these
amendments would reduce the risk of a fund not being able to satisfy
redemptions without diluting the interests of remaining shareholders
while waiting for the proceeds from the sale of an investment with
extended settlement.
---------------------------------------------------------------------------

    \109\ The number of funds is estimated by dividing the aggregate
gross value in the relevant categories by the aggregate gross value
reported.
    \110\ See infra section III.C.1.b.
---------------------------------------------------------------------------

ii. Additional Amendments to the Definition of Illiquid Investment
    We also propose to amend the definition of illiquid investment to
include investments whose fair value is measured using an unobservable
input that is significant to the overall measurement. U.S. GAAP
establishes a fair value hierarchy that categorizes into three levels
the inputs to valuation techniques used to measure fair value.\111\ The
fair value measurements of investments are categorized in accordance
with this three-level

hierarchy. The highest-level measurements are those developed using
quoted, observable inputs in active markets for identical assets and
liabilities (Level 1), such as prices for identical investments on a
securities exchange; the lowest are those developed using unobservable
inputs (Level 3).\112\ We acknowledge that observability is a valuation
concept and may not always correspond to liquidity. The proposed
amendment would require those funds not already classifying investments
valued using unobservable inputs that are significant to the overall
measurement as illiquid to change their classification practices and
may change the liquidity profile for those funds under the rule to be
less liquid. To the extent there is a liquid market for affected
investments, this proposed amendment would cause funds to over-estimate
the illiquidity of their portfolios. As of December 2021, 2,006 open-
end funds held investments that were valued using unobservable inputs
that are significant to the overall measurement (Level 3 investments),
comprising $76.3 billion, or 0.27% of all open-end fund assets.\113\
Among these, $16.9 billion were classified as highly liquid investments
and $2.1 billion as moderately liquid investments.\114\ Accordingly, we
estimate that approximately 0.07% of all open-end fund assets would be
affected by this amendment.
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    \111\ See FASB ASC 820-10-35-37, which sets out a fair value
hierarchy for accounting purposes, as compared to rule 2a-5, which
provides a framework for fund valuation practices and determining
fair value (including applying an appropriate methodology consistent
with the principles of FASB Accounting Standard Codification Topic
820: Fair Value Measurement (``ASC Topic 820'')) for purposes of the
Act. See Good Faith Determinations of Fair Value, Investment Company
Act Release No. 34128 (Dec. 3, 2020) [86 FR 748 (Jan. 6, 2021)
(``Valuation Adopting Release'')].
    \112\ See ASC Topic 820. U.S. GAAP requires funds to maximize
the use of relevant observable inputs and minimize the use of
unobservable inputs in valuing any asset or liability. In some
cases, the inputs used to measure fair value might be categorized
within different levels of the fair value hierarchy. In those cases,
the fair value measurement is categorized in its entirety in the
same level of the fair value hierarchy as the lowest level input
that is significant to the overall measurement. See ASC 820-10-35-
16AA and 820-10-35-37A. Examples of particular assets and
liabilities that may be measured using Level 3 inputs include long-
dated currency swaps, three-year options on exchange-traded shares,
interest rate swaps, asset retirement obligations at initial
recognition, and reporting units. See FASB ASC 820-10-55-22.
    \113\ See infra note 424 and accompanying paragraph. We observed
that the investments classified as highly liquid that were Level 3
investments primarily were mortgage-backed securities.
    \114\ We recognize that, in light of the proposed removal of the
less liquid category, only those investments valued using
unobservable inputs that are significant to the overall measurement
that are classified as highly liquid or moderately liquid would be
affected by this proposed amendment.
---------------------------------------------------------------------------

    Where an investment is valued using unobservable inputs that are
significant to the overall measurement, this may indicate that an
active, liquid, and visible market for the investment does not exist.
Where there is no active, liquid, and visible market for an investment,
there may be a corresponding risk that the fund cannot sell the
investment in time to meet redemptions without dilution. The proposal
defines investments whose fair value is measured using unobservable
inputs that are significant to the overall measurement as illiquid for
purposes of this rule, which is intended to reduce this risk. By
classifying these investments as illiquid, the proposal would establish
a minimum standard for classifying the liquidity of an investment,
which is designed to provide more consistent guideposts for liquidity
classifications.
iii. Other Amendments Related to Liquidity Classification Categories
Amendments to the Definition of Moderately Liquid Investment
    We propose to simplify the definition of moderately liquid
investment to mean any investment that is neither a highly liquid
investment nor an illiquid investment.\115\ The moderately liquid
investment category would continue to provide information about the
portion of a fund's portfolio that is not on the most liquid end of the
spectrum, but that still is sufficiently liquid to meet redemption
requests within the statutory seven day period.
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    \115\ We also are proposing to remove a provision that addresses
how to classify an investment that could be viewed as either a
highly liquid investment or a moderately liquid investment because
the ambiguity in classification that provision addresses is no
longer present under the proposed amendments to those
classifications. See note to paragraph (b)(1)(ii) introductory text
in current rule 22e-4.
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Amendments to the Definition of Convertible to Cash and References to
Cash
    We propose to amend the term ``convertible to cash'' to
``convertible to U.S. dollars'' and to make conforming amendments to
the definition of this term to refer to the ability for a fund to sell
or dispose of an investment, and for it to settle in U.S. dollars.\116\
These amendments codify prior Commission statements. In the adopting
release for rule 22e-4, the Commission stated that cash means ``cash
held in U.S. dollars, and would not include, for example, cash
equivalents or foreign currency.'' \117\ The Commission also provided
an example in that release in which the period of time it took to
repatriate or convert a foreign currency to dollars factored into the
analysis of how quickly a foreign security could convert to cash.\118\
Some funds are classifying foreign investments as highly liquid taking
into account solely the time it would take to convert the proceeds of a
sale to the foreign currency. Similarly, some funds classify foreign
currency as highly liquid without further analysis about the time that
would be needed to convert that currency to U.S. dollars. We believe it
is important to view the liquidity of fund investments in terms of
convertibility to U.S. dollars within a specified period so that a fund
is able to satisfy redemption requests in U.S. dollars.\119\ This
amendment is intended to promote the ability of funds to meet
redemptions without diluting the interests of the remaining
shareholders and increase consistency in how funds classify the
liquidity of investments, including in foreign investments and foreign
currencies. In addition to the definition of convertible to cash, we
also propose to amend other references in rule 22e-4 to refer to U.S.
dollars instead of cash for consistency and clarity.\120\
---------------------------------------------------------------------------

    \116\ See proposed rule 22e-4(a) (defining ``convertible to U.S.
dollars'' as the ability to be sold or disposed of, with the sale or
disposition settled in U.S. dollars) (emphasis added). We also
propose to amend the definition of convertible to U.S. dollars to
refer to disposition of an investment, and not only sales. This is a
conforming amendment, as current rule 22e-4 classifications
otherwise refer to the ability to sell or dispose of an investment.
    \117\ See Liquidity Rule Adopting Release, supra note 8, at
n.848.
    \118\ See id., at paragraph accompanying n.379 (providing an
example where certain foreign securities may be able to be sold in
seven calendar days or less, but may be subject to capital controls
that would limit the extent to which the foreign currency could be
repatriated or converted to dollars within this time frame and
explaining that these securities would be considered to be less
liquid investments because they would be reasonably expected to
settle in more than seven calendar days).
    \119\ See id., at n.105 and accompanying text (noting concerns
about the potential mismatch between the timing of receipt of cash
for sales of fund assets and the payment of cash for shareholder
redemptions).
    \120\ See proposed rule 22e-4(a) (defining ``highly liquid
investment'' and ``in-kind exchange traded fund''); and proposed
rule 22e-4(b)(1)(i)(C) (listing liquidity risk factors).
---------------------------------------------------------------------------

Method for Counting the Number of Days
    We propose to specify when a fund must start to measure the
identified number of days in which it reasonably expects a stressed
trade size of an investment would be convertible to U.S. dollars
without significantly changing its market value. Currently, the rule
does not directly specify when to begin counting the number of days an
investment would be convertible to U.S. dollars, and funds have
inconsistent practices as to when they begin this measurement. This
inconsistency may lead certain funds to overestimate their liquidity
classifications, and reduce

their ability to meet redemptions. This also detracts from
comparability when analyzing trends across funds. For example, some
funds may consider an investment highly liquid if it could be converted
to U.S. dollars three business days after the date of the
classification analysis, while others include the date of
classification when counting the number of days. Those funds that begin
counting after the date of the classification would have the advantage
of counting an additional day as compared to those funds that include
the date of classification, and their liquidity classifications may
appear to be more liquid than a similar fund that begins counting on
the date of classification. Therefore, we propose to specify that funds
must count the day of classification when determining the period in
which an investment is reasonably expected to be convertible to U.S.
dollars.\121\ For example, in order for a fund to classify an
investment as highly liquid on Monday, it would need to reasonably
expect that the investment could be sold and settled to U.S. dollars by
Wednesday at the latest.
---------------------------------------------------------------------------

    \121\ See proposed rule 22e-4(b)(1)(ii)(A).
---------------------------------------------------------------------------

    We request comment on the proposed amendments to the liquidity
classification categories:
    16. As proposed, should we eliminate the less liquid investment
category and amend the illiquid investment definition to include an
investment that a fund reasonably expects can be sold within seven
calendar days without significantly changing the market value but is
not convertible to U.S. dollars within that period (i.e., investments
that are currently classified as less liquid under the rule)? What
effect would these proposed amendments have and how would those funds
that significantly invest in such less liquid investments likely
change?
    17. Would the proposed amendment cause funds that currently hold
less liquid investments to contract for expedited settlement for such
investments? What are the advantages or limitations of contracting for
expedited settlement? Would the proposed amendments provide an
incentive to reduce settlement times in bank loan and other relevant
markets more generally? If so, how long might it take to reduce
settlement times in response to the rule and what would be the burdens
associated with this change? Are there certain categories of bank loans
or other investments for which market participants may be unable to
reduce the settlement time to seven calendar days or less? Which
investments and why? What other effects may occur, for example, would
some funds change their strategies, liquidate, or choose to be
structured as a different investment vehicle, such as a closed-end
fund? If some funds would convert to closed-end funds, what type of
closed-end fund would they likely choose (e.g., interval fund, or a
closed-end fund listed on an exchange)? Should we amend other rules, or
provide relief from any specific rules or provisions of the Federal
securities laws, to expedite changes to strategies or conversions to
closed-end funds or other investment vehicles?
    18. Some funds classify certain bank loans as highly liquid or
moderately liquid today. What characteristics of these bank loans lead
to a reasonable expectation that they will be convertible to cash in
seven days or less without significantly changing the market value? Are
funds considering contracts for expedited settlement? Would funds need
additional guidance on how to assess the period in which a bank loan or
other investment is reasonably expected to be convertible to U.S.
dollars? For example, should we revise the proposed rule to require
that funds consider, or provide guidance suggesting that funds may wish
to consider: settlement time history for the individual or similar
investments, average settlement times for the market, and guarantees
for settlement or expedited settlement, as well as the contractual
settlement period?
    19. Have the costs of borrowing risen and has credit become more
difficult to obtain over time for bank loan funds, particularly during
stressed periods?
    20. As proposed, should we remove the less liquid category and
require funds to use a three category classification framework? Would
the proposed changes simplify classifications and reduce burdens over
time, after funds updated systems to reflect the change? Would the
proposed changes appropriately reflect the liquidity of a fund, or
would the current framework be more appropriate? Should funds be
permitted to invest above 15% in less liquid investments if there are
other methods or mechanisms to reduce the mismatch between the receipt
of cash upon the sale of assets with longer settlement periods and the
payment of shareholder redemptions or to address potential dilution
associated with this mismatch? If so, what other methods or mechanisms
should these funds be required or permitted to use (for example, swing
pricing, gates to suspend redemptions, redemption fees, redemptions in
kind, additional limits on less liquid investments, notice periods, or
lengthening the settlement period for paying redemptions)? \122\ If we
permit (to the extent not already permitted) or require use of one or
more of these tools, how should they be used (individually, in some
combination with each other, or with other protections, such as
disclosure, board approval, and Commission reporting)? Should we amend
other rules, or provide relief from any specific rules or provisions of
the Federal securities laws, to expedite or permit use of these methods
and mechanisms? \123\
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    \122\ With a notice period, an investor's redemption request
would not be processed until the end of a notice period (e.g., after
2 to 5 days). The investor would receive the next calculated price
after the notice period ends, with payment occurring at the end of a
settlement period. With a lengthened settlement period, a redeeming
investor would receive the price next calculated after submitting
the redemption order but would not receive payment until the end of
a lengthened settlement period (e.g., 5 to 7 days after trade date).
    \123\ See, e.g., section 22(e) of the Act (providing the
conditions under which a registered investment company may suspend
the right, or postpone the date, of redemption for more than seven
days).
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    21. Should we provide that an investment is illiquid if it is not
reasonably expected to be convertible to U.S. dollars in a shorter or
longer period than seven calendar days? How would a shorter or longer
period align with the requirement in section 22(e) of the Act for a
fund to satisfy redemptions within seven days? If we provided a longer
period of time to convert to U.S. dollars before an investment is
classified as illiquid, how would funds prepare for the potential
mismatch during stressed situations between the amount of available
cash and the size of shareholder redemptions? Should we provide
additional exemptions to allow funds to delay redemptions to
shareholders under certain limited circumstances and conditions, such
as independent director approval?
    22. Are there circumstances in which an investment is fair valued
using an unobservable input that is significant to the overall
measurement, but the investment should not be treated as illiquid for
purposes of the rule? Please explain and provide supporting data.
Should we permit a fund to classify certain types of investments that
are fair valued using unobservable inputs that are significant to the
overall measurement as highly liquid or moderately liquid and, if so,
which types? Should we instead treat investments that are fair valued
using unobservable inputs that are significant to the overall
measurement as presumptively illiquid, but permit funds to rebut this
presumption? If so, what process should we require for rebutting the
presumption? For example, should

we require funds to maintain records describing why they did not
classify such an investment as illiquid? Should we require funds to
disclose on Form N-PORT any circumstances in which they did not
classify such an investment as illiquid?
    23. Are there other types or characteristics of investments that we
should include in the definition of illiquid investment? If so, which
ones?
    24. Should we amend the definition of moderately liquid investment,
as proposed? Alternatively, should we retain the details in the current
definition that specify the number of days in which a fund must
reasonably expect an investment to be convertible to U.S. dollars in
order to classify it as moderately liquid?
    25. Would the proposed changes to the liquidity classifications
affect investment options available to investors? For example, would
bank loan funds only be available in non-open-end investment vehicles?
What effect would these proposed changes have on those asset classes
that are less available for investment by open-end funds for liquidity
reasons, the availability of credit to borrowers, and more generally,
on capital formation?
    26. Should we amend the definition of convertible to cash and other
references to cash in rule 22e-4 to refer to U.S. dollars, as proposed?
Would these amendments raise issues for specific types of funds? If so,
which ones and how? Would these amendments affect funds' investment
strategies, including their allocation to foreign investments and U.S.
dollars, or their performance?
    27. Are there circumstances in which a fund would pay redemptions
in a different currency than U.S. dollars? If so, would it be
appropriate for that fund to be able to assess the time in which an
investment could convert to that other currency for purposes of the
rule?
    28. In addition to sale and disposition, are there other ways an
investment may be converted to U.S. dollars that should be included in
the definition of convertible to U.S. dollars? If so, what are they?
    29. Would the amendment to refer to U.S. dollars instead of cash in
the definitions of highly liquid investment and convertible to cash
materially change how funds classify highly liquid investments
currently? If so, how?
    30. Should we require funds to include the day of classification
when counting the number of days to convert to U.S. dollars as
proposed, or should we require funds to begin to count the number of
days to convert to U.S. dollars on the following day? What are the
advantages and disadvantages of this alternative? Would this
alternative result in less conservative liquidity classifications for
some funds or investments (i.e., by causing some investments that
otherwise would have been classified as moderately liquid to be
classified as highly liquid) or impair a fund's ability to meet
redemptions?
    31. Instead of using the days an investment would be convertible to
U.S. dollars in the liquidity classifications as proposed, should we
separately set the number of days to: (1) make the trade; and (2)
settle the trade or otherwise dispose of an investment, in determining
liquidity classifications? Why or why not? Is there a different way the
rule should measure the period that an investment is convertible to
U.S. dollars?
c. Frequency of Classifications
    Rule 22e-4 currently requires that funds review their liquidity
classifications at least monthly in connection with reporting on Form
N-PORT, and more frequently if changes in relevant market, trading, and
investment-specific considerations are reasonably expected to
materially affect one or more of their investments'
classifications.\124\ The current rule also requires a fund to monitor
and take timely actions related to the liquidity of its investments,
including changes to its liquidity profile. Specifically, the rule
prohibits a fund from acquiring any illiquid investment if, immediately
after the acquisition, the fund would have invested more than 15% of
its net assets in illiquid investments that are assets.\125\ In
addition, the rule requires a fund to provide timely notice to its
board, and to the Commission on Form N-RN, if the fund exceeds the 15%
limit on illiquid investments, or if there is a shortfall of the fund's
highly liquid investments below its highly liquid investment minimum
for seven consecutive calendar days.\126\
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    \124\ See rule 22e-4(b)(1)(ii).
    \125\ See rule 22e-4(b)(1)(iv).
    \126\ See rule 22e-4(b)(1)(iv)(A) and rule 22e-
4(b)(1)(iii)(A)(3); Form N-RN Parts B through D.
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    We propose amendments to require a fund to classify all of its
portfolio investments each business day instead of at least
monthly.\127\ Daily classification would reflect current market
conditions more accurately and would provide funds with more data for
analysis to prepare for future stressed conditions. We believe that
daily classifications would assist liquidity risk program
administrators in better monitoring of a fund's liquidity and enhance a
fund's ability to more rapidly respond to changes that affect the
liquidity of the fund's portfolio, reflecting more effective practices
we have observed. In addition, daily classifications would help ensure
that funds timely report shortfalls below the highly liquid investment
minimum or breaches of the 15% limit on illiquid investments to the
fund's board and to the Commission, which would better achieve the
goals of the current provisions to provide board and Commission
oversight of the fund's liquidity risk management program and its
effectiveness.
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    \127\ See proposed rule 22e-4(b)(1)(ii). Although rule 22e-4
currently requires funds to classify each of the fund's portfolio
investments (including each of the fund's derivatives transactions),
we have observed that some funds are not classifying all investments
in their portfolios, such as positions in to-be-announced (TBA)
contracts to trade mortgage-backed securities or the reinvestment of
cash collateral received in securities lending arrangements.
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    Most funds did not report reclassifications of their portfolio
investments despite extraordinary liquidity constraints in March
2020.\128\ Based on the liquidity classification practices we observed
in March 2020 and on filings covering this period, we are concerned
that some funds effectively are equipped to classify their investments
primarily on a monthly basis to meet reporting requirements and are not
prepared to review classifications intra-month. Because intra-month
analyses for these funds would be out of the ordinary and only occur
when a fund determines that changes in relevant market, trading, and
investment-specific considerations are reasonably expected to
materially affect one or more of their investments' classifications, it
may be especially challenging during stressed conditions for these
funds to reclassify their investments intra-month. Requiring daily
classification, while involving costs, may ultimately lead to a more
efficient classification process for funds than monitoring trading
conditions to determine if and when intra-month classifications are
required. For

example, a daily classification requirement, in combination with the
minimum standards we propose for trade size and value impact, may lead
funds to modify their liquidity classification processes, which would
make the process more standardized, timely, and efficient.
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    \128\ Despite the liquidity constraints in Mar. 2020, we
observed through Form N-PORT filings that roughly 75% of funds did
not reclassify any investment held in both Feb. and Mar. 2020.
Specifically, roughly 80% of U.S. equity funds did not reclassify
any holding that was held in both Feb. and Mar. 2020, while roughly
10% reclassified at least one investment into a more liquid category
and roughly 13% reclassified at least one investment into a less
liquid category. Roughly 55% of taxable bond funds reclassified on
average 4% of their portfolios, with the median fund reclassifying
1% of its portfolio. Of the funds that reclassified, roughly 30%
reclassified at least one investment into a more liquid category and
roughly 44% reclassified at least one investment into a less liquid
category. More funds did, however, reclassify in Mar. 2020 period
than for either Feb. or Apr. 2020.
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    We request comment on the proposed amendments to require funds to
classify the liquidity of their investments on a daily basis.
    32. Should we require funds to classify all portfolio investments
on a daily basis, as proposed? Would this proposed amendment result in
a material change to how funds are currently classifying? To what
extent do funds already classify the liquidity of their investments on
a daily basis or collect the information they would need to classify
daily? Would this proposed amendment better integrate liquidity risk
management and portfolio management systems?
    33. We also are proposing that funds use a stressed trade size and
a defined value impact standard in determining liquidity
classifications. Would those changes affect the burdens of classifying
on a daily basis? Would those effects be different for different types
of funds? For example, would it be easier to determine on a daily basis
whether the sale of a stressed trade size of shares listed on an
exchange would exceed 20% of the average daily trading volume for those
shares than to determine whether the sale of a stressed trade size of
other investments would result in a price decline of more than 1%?
    34. Instead of classifying on a daily basis, should we require
funds to classify the liquidity of their investments at some other
frequency (e.g., weekly, biweekly, or monthly)? If so, should we
maintain the requirement for a fund to classify 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? Is there a different approach we
should use effectively to require a fund to classify its investments in
response to changing conditions? Are there certain types of funds that
should be excluded from daily classifications? If so, which funds?
    35. If we require funds to classify on a non-daily frequency, how
would they monitor for compliance with the 15% limit on illiquid
investments and the highly liquid investment minimum? How are those
limits monitored for compliance now?
2. Highly Liquid Investment Minimums
a. Proposed Scope of the Requirement and Determination of the Minimum
    Rule 22e-4 currently requires a fund to determine a highly liquid
investment minimum if it does not primarily hold assets that are highly
liquid investments. Funds that are subject to the highly liquid
investment minimum requirements must determine a highly liquid
investment minimum considering several factors, review the minimum at
least annually, and adopt policies and procedures to respond to a
shortfall of the fund's highly liquid investments below the minimum
required.\129\ We propose to require all funds to determine and
maintain a highly liquid investment minimum of at least 10% of the
fund's net assets, which is equivalent to the stressed trade size. In
connection with this proposed requirement, we would remove the
exclusion for funds that primarily invest in highly liquid investments
(the ``primarily exclusion''). The proposed amendments are designed to
ensure that funds have sufficient liquid investments for managing
stressed conditions and heightened levels of redemptions.
---------------------------------------------------------------------------

    \129\ See rule 22e-4(b)(1)(iii).
---------------------------------------------------------------------------

    We assessed liquidity-related data reported on Forms N-PORT, as
well as the development of liquidity risk management programs, through
staff outreach to funds and advisers. Based on Form N-PORT filings,
most funds do not determine a highly liquid investment minimum and
instead rely on the primarily exclusion.\130\ For those funds that have
highly liquid investment minimums, the rule currently requires that
they consider various liquidity factors, such as their investment
strategy and cash-flow projections, in both normal and reasonably
foreseeable stressed conditions.\131\ We understand that those funds
additionally consider factors such as asset class, market volatility,
and shareholder concentration in their determinations.
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    \130\ Approximately 83% of funds holding 85% of net assets do
not report setting a highly liquid investment minimum on Form N-
PORT.
    \131\ For these purposes, funds are required to consider certain
factors during stressed conditions only to the extent they are
reasonably foreseeable during the period until the next review of
the highly liquid investment minimum. See rule 22e-
4(b)(1)(iii)(A)(1).
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    As discussed above, by requiring fund liquidity classifications to
assume the sale or disposition of a set stressed trade size, the
proposal is intended to better prepare all funds for future stressed
conditions.\132\ To help further prepare a fund for heightened levels
of redemptions in stressed conditions, we are proposing to require the
highly liquid investment minimum to be equal to or higher than the
assumed stressed trade size. In setting the highly liquid investment
minimum to be at least the stressed trade size, we considered data on
fund flows for setting the stressed trade size as well as data reported
on Form N-PORT on funds' current highly liquid investment minimums. As
of March 2020, for funds that had determined a highly liquid investment
minimum, the majority of those funds reported setting a highly liquid
investment minimum of less than 10% of the fund's net assets. In
contrast, approximately 8% of those funds reported setting a highly
liquid investment minimum of more than 50% of the fund's net assets.
Thus, while there is a wide divergence in highly liquid investment
minimums, most of these funds have a minimum that is lower than the
proposed 10% level. Given the level of weekly outflows some funds have
experienced and the difficulty in predicting future stress events, we
believe that a regulatory minimum of 10% for the highly liquid
investment minimum would benefit investors by improving the ability of
funds to meet shareholder redemptions in stressed scenarios.
---------------------------------------------------------------------------

    \132\ See supra section II.A.1.a.i for discussion of the
stressed trade size and of fund flow data.
---------------------------------------------------------------------------

    In addition, the proposal's requirement for funds to both assume a
stressed trade size to determine liquidity classifications and also
maintain an equal or higher minimum of highly liquid investments is
intended to work together to better prepare them for future stressed
conditions and to reduce the risk of dilution. Not only would funds
have highly liquid investments in an amount needed to meet the stressed
trade size, they would also have more highly liquid assets to meet
redemptions without having to sell less liquid investments at
discounted prices. Funds would continue to be required to periodically
review the highly liquid investment minimum and have policies and
procedures to address any shortfall in highly liquid investments below
the minimum.
    While the proposed minimum of 10% of a fund's net assets may be a
suitable highly liquid investment minimum for most funds, certain funds
may find a higher amount appropriate depending on a fund's liquidity
risk factors and investment objectives. Consistent with the current
rule, a fund would be required to consider a specified set of liquidity
risk factors to determine whether its highly liquid investment

minimum should be above 10%.\133\ We continue to believe that the
liquidity risk factors funds must consider in determining a highly
liquid investment minimum under the current rule and the associated
guidance the Commission provided in the Liquidity Rule Adopting Release
regarding these factors are appropriate for a fund to take into account
for these purposes.\134\
---------------------------------------------------------------------------

    \133\ See Liquidity Rule Adopting Release, supra note 8, at
paragraph following n.669.
    \134\ See id., at section III.B.2.
---------------------------------------------------------------------------

    A broad variety of investments, as well as cash, may qualify
towards the highly liquid investment minimum.\135\ Since approximately
83% of funds currently rely on the primarily exclusion, we would not
expect this proposal to affect their strategies. We recognize, however,
that imposing a highly liquid investment minimum of at least 10% would
require some other funds to hold a larger amount of highly liquid
assets than they currently do, and thus may affect these funds'
performance or strategies.\136\ For funds with strategies focused on
investments that would not be considered highly liquid, they would have
to determine how to constitute a portfolio of investments that would
allow the fund to meet its strategy and investing parameters while
maintaining a highly liquid investment minimum of at least 10%. All
funds would be subject to the same highly liquid investment minimum of
at least 10%, which would minimize any competitive advantage for
similar funds associated with the proposed highly liquid investment
minimum requirements. We believe it is important that all funds be
prepared to meet redemptions in future stressed scenarios, and that
funds would be better able to do so with the proposed highly liquid
investment minimum requirements.
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    \135\ See id., at n.663 and accompanying text.
    \136\ As recognized above, being unprepared for higher than
normal redemptions also can affect a fund's performance when such
redemptions occur. See supra note 81. For instance, although less
liquid assets generally offer a higher return, the trading costs
associated with selling these assets during periods of increased
redemptions may offset this risk premium, potentially resulting in a
lower overall return for fund investors. See infra note 351 and
accompanying text.
---------------------------------------------------------------------------

    In establishing a uniform floor for the highly liquid investment
minimum, we are also proposing to remove the exclusion for funds that
invest primarily in highly liquid investments. The Commission adopted
the primarily exclusion because it believed the benefits associated
with requiring such funds to determine and review a highly liquid
investment minimum, or to adopt shortfall procedures, would not justify
the associated burdens.\137\ Since that time, however, we have observed
that a fund relying on the primarily exclusion may experience
significant declines in its liquidity that result in the fund holding
less than 50% of its portfolio in highly liquid investments for a
period of time. For example, a fund that invests significantly in a
given foreign market and that generally classifies those investments as
highly liquid can experience substantial declines in the amount of its
highly liquid investments if, for example, there is political or
economic turmoil in or an extended holiday closure of that foreign
market. Funds that currently use the primarily exclusion instead of
determining and maintaining a highly liquid investment minimum do not
have the benefit of shortfall procedures, including board oversight, to
respond to events or market conditions that may cause the fund to fall
under its previously determined level of primarily held highly liquid
investments. By requiring a highly liquid investment minimum for all
funds, investors would enjoy the benefit of policies and procedures
that are designed to ensure not only oversight by the liquidity risk
program administrator but also the fund's board.
---------------------------------------------------------------------------

    \137\ Liquidity Rule Adopting Release, supra note 8, at
paragraph accompanying n.724.
---------------------------------------------------------------------------

    Moreover, the burdens of complying with highly liquid investment
minimum requirements for funds that currently use the primarily
exclusion may be reduced because many fund complexes already have
experience developing highly liquid investment minimum shortfall
policies and procedures. It may be possible for funds in the same
complex to leverage this experience to reduce the burdens of developing
these policies and procedures for funds that previously qualified for
the primarily exclusion. As liquidity risk management programs have
matured, and continue to mature, many fund complexes continue to gain
experience with highly liquid investment minimum shortfall policies and
procedures, which may also reduce burdens. By requiring all funds to
adopt a highly liquid investment minimum, we are seeking to help ensure
that funds would be better prepared to handle future stressed
conditions, which may occur suddenly and unexpectedly, as they would
have sufficient liquid investments for managing heightened levels of
redemptions.
    We request comment on the proposed amendments to highly liquid
investment minimum requirements.
    36. Should we require all funds to determine and maintain a highly
liquid investment minimum, as proposed? What effect would this proposal
have on funds? For example, would some funds have to change their
strategies or expect effects on performance?
    37. Should some types of funds be excluded from the requirement to
have a highly liquid investment minimum? If yes, which ones and why?
For example, should we preserve the exclusion for funds that primarily
hold highly liquid assets? Alternatively, should funds currently using
the primarily exclusion have a higher highly liquid investment minimum
requirement? Would funds using the primarily exclusion be as prepared
to meet redemptions in stressed scenarios without a highly liquid
investment minimum and its corresponding policies and procedures?
    38. If the primarily exclusion is kept, should we define the amount
of highly liquid assets a fund must maintain under this standard (e.g.,
investing at least 51% of the fund's net assets in highly liquid
assets, or a higher or lower amount)?
    39. Should we establish a regulatory minimum for the amount of
highly liquid investments of 10%, as proposed, or should it be set at
15% or 5% (or some other higher or lower amount)? Would establishing a
regulatory minimum reduce the burdens associated with determining and
periodically reviewing the fund's highly liquid investment minimum?
    40. Rather than propose a regulatory minimum with factors that a
fund must consider to determine whether its own highly liquid
investment minimum should be higher, should we require all funds to use
the same highly liquid investment minimum? Would this set a level
playing field for all funds and diminish any competitive advantage for
a fund with a lower highly liquid investment minimum? If so, what
amount would be appropriate for a uniform highly liquid investment
minimum for all funds (e.g., 5%, 10%, 15%, or a higher or lower
amount)?
    41. Would providing more detail or guidance on the liquidity risk
factors be helpful? If so, which factors?
    42. Would funds that do not currently have a highly liquid
investment minimum be able to leverage policies and procedures already
developed for highly liquid investment minimums, for example by other
funds in the same complex, to reduce the burdens of developing these
policies and procedures? If not, what costs would funds incur to adopt
and implement highly liquid investment minimum policies and procedures?

b. Calculation of the Highly Liquid Investment Minimum
    We are proposing amendments to rule 22e-4 that are designed to help
ensure that the highly liquid investments a fund holds to meet its
highly liquid investment minimum are available to support the fund's
ability to meet redemptions. A key aim of the highly liquid investment
minimum requirement is to decrease the likelihood that funds would be
unable to meet their redemption obligations.\138\ Building on existing
aspects of rule 22e-4, the proposed amendments would require that, when
determining the amount of assets a fund has classified as highly liquid
that count toward the highly liquid investment minimum, the fund
account for limitations in its ability to use some of those assets to
meet redemptions.\139\ Specifically, in assessing compliance with the
fund's highly liquid investment minimum, the fund would be required to:
(1) subtract the value of any highly liquid assets that are posted as
margin or collateral in connection with any derivatives transaction
that is classified as moderately liquid or illiquid; and (2) subtract
any fund liabilities.\140\
---------------------------------------------------------------------------

    \138\ See Liquidity Rule Adopting Release, supra note 8, at text
following n.117.
    \139\ As the Commission explained at the time it adopted rule
22e-4, this is not meant to suggest that a fund should only, or
primarily, use highly liquid investments to meet shareholder
redemptions. Instead, we believe that a fund holding sufficient
highly liquid assets will support the fund in meeting redemption
requests in a non-dilutive manner, and assist it in readjusting its
portfolio in times of market stress, heightened volatility, and
managing its obligations to derivatives counterparties. See
Liquidity Rule Adopting Release, supra note 8, at n.680 and
accompanying text.
    \140\ Proposed rule 22e-4(b)(1)(iii)(B)(1); 22e-
4(b)(1)(iii)(B)(2). Rule 22e-4 currently refers to a ``pledge'' of
margin or collateral, rather than ``posting.'' We are proposing to
use the term ``post'' because we believe this term is more commonly
used within the industry and by other regulators to refer to
instances where a party provides margin or collateral to its
counterparty to meet the performance of its obligation under one or
more derivatives transactions as a result of a change in the value
of such obligations since the trade was executed or the last time
such collateral was provided (commonly referred to as variation
margin) or is provided to secure potential future exposure following
default of a counterparty (commonly referred to as initial margin).
See, e.g., Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 86 FR 6850 (Jan. 25, 2021).
---------------------------------------------------------------------------

i. Margin or Collateral of Moderately Liquid and Illiquid Derivatives
    The requirement for a fund to reduce the value of its highly liquid
assets by the amount posted as margin or collateral in connection with
a non-highly liquid derivatives transaction reflects that this amount
of highly liquid assets is not available for the fund to use to meet
redemptions.\141\ This is because, where a fund enters into a
moderately liquid or illiquid derivative and posts highly liquid assets
as margin or collateral, the posted collateral is highly liquid, but
the fund cannot access the value of posted assets unless the fund exits
the derivatives transaction. Since the fund has classified the
derivative as moderately liquid or illiquid, it does not reasonably
expect to be able to exit the derivatives transaction within three
business days. We recognize that the fund may be able to access the
specific assets posted as margin or collateral by replacing them with
other assets acceptable to the fund's counterparty. But regardless of
the specific assets posted, the value of collateral posted in
connection with a moderately liquid or illiquid derivative would not be
convertible to U.S. dollars within three business days or less.
---------------------------------------------------------------------------

    \141\ See Liquidity Rule Adopting Release, supra note 8, at
nn.727-730 and accompanying text. This aspect of the proposed rule
would only require an adjustment to the amount of a fund's highly
liquid investments that are assets, since investments that are in a
liability position are unable to be used to meet redemption
requests. See proposed rule 22e-4(b)(1)(iii)(B)(1).
---------------------------------------------------------------------------

    Under the current rule, a fund is required to identify the
percentage of the fund's highly liquid investments that it has posted
as margin or collateral in connection with derivatives transactions
that the fund has classified as less than highly liquid.\142\ The
Commission believed that this approach struck an appropriate balance
between providing transparency and reducing burdens on funds.\143\ The
Commission observed that a fund generally would not need to
specifically identify particular assets that are posted as margin or
collateral to cover particular derivatives transactions, but instead
would calculate the percentage of highly liquid investments posted as
margin or collateral for derivatives transactions classified in each of
the other classification categories.\144\ Under the rule, a fund that
has posted both highly liquid investments and non-highly liquid
investments as margin or collateral in connection with a non-highly
liquid derivatives transaction should reduce its highly liquid
investments, rather than assume that posted non-highly liquid
investments would first cover the derivatives transaction, unless the
fund specifically identifies non-highly liquid investments as margin or
collateral in connection with a derivatives transaction.\145\ Finally,
the Commission observed that the current approach responds to
commenters' concerns that linking the liquidity of specific assets
posted as margin or collateral to the liquidity of a fund's derivatives
transactions could understate the liquidity of those assets, since a
fund may be able to readily substitute another liquid asset for the
asset posted as margin or collateral.\146\
---------------------------------------------------------------------------

    \142\ Rule 22e-4(b)(1)(ii)(C). In addition, funds currently also
are required to exclude highly liquid assets that are posted as
margin or collateral in connection with non-highly liquid
derivatives transactions when determining whether the fund primarily
holds highly liquid assets. Rule 22e-4(b)(1)(iii)(B).
    \143\ See Liquidity Rule Adopting Release, supra note 8, at
n.476 and accompanying text.
    \144\ Id. at n.489 and accompanying text.
    \145\ Note 1 to proposed rule 22e-4(b)(1)(iii)(B)(1). Cf. Note 1
to rule 22e-4(b)(1)(ii)(C). See also Liquidity Rule Adopting
Release, supra note 8, at nn.489-490 and accompanying text
(explaining that in the absence of such an instruction, some funds
might instead take the opposite approach, and assume that posted
non-highly liquid investments first cover these less liquid
derivatives transactions, creating inconsistencies between funds).
    \146\ We recognize that margin or collateral may be determined
and paid by funds on the basis of a group of derivatives
transactions, with the fund posting or receiving a net amount of
margin or collateral. When a fund pays margin or collateral in
connection with a group that includes derivatives transactions that
are highly liquid and non-highly liquid, funds already must
determine the amount of margin or collateral attributable to the
non-highly liquid derivatives under the current rule. For example, a
fund must perform this attribution in order to identify the
percentage of the fund's highly liquid investments that it has
posted as margin or collateral in connection with derivatives
transactions that are not themselves highly liquid.
---------------------------------------------------------------------------

    The proposed approach is intended to enhance investor protection
while continuing to strike an appropriate balance with the potential
increased burdens on funds. The proposed approach would not require
funds to identify and reclassify specific assets posted as margin or
collateral, but rather to reduce the value of the fund's highly liquid
assets available to meet the fund's highly liquid investment minimum by
the value of the assets posted as margin or collateral. We also propose
to maintain, with conforming changes, the explanatory note discussed
above guiding the allocation of amounts posted as margin or
collateral.\147\ By reducing the fund's highly liquid investments by
the value of amounts posted as margin or collateral, the proposed
approach would avoid burdens associated with tracking specific
securities posted as margin or collateral and reclassifying investments
as they are posted as margin or collateral and recalled. It also would
not

understate the liquidity of specific securities that are posted as
margin or collateral because each security would continue to be
classified based on its own characteristics, and instead the
adjustments would only be made at the aggregate level.\148\ Moreover,
many of the operational concerns commenters raised when rule 22e-4 was
proposed, which led the Commission to adopt the current approach,
related to the treatment of assets segregated under the Commission's
Investment Company Act Release 10666, which the Commission has since
rescinded, effective August 19, 2022.\149\ We therefore believe the
proposed amendments would enhance investor protections by helping to
ensure a fund's highly liquid assets are in fact available to meet
redemptions, while continuing to balance the value of the provision
against the operational burdens to implement it.
---------------------------------------------------------------------------

    \147\ See supra note 145. In connection with the proposed
amendments to the rule's highly liquid investment minimum
provisions, we propose to re-number certain existing paragraphs and
to add paragraphs to the rule. As a result, we propose to update
cross-references to the highly liquid investment minimum provisions
within the rule. See proposed rule 22e-4(b)(1)(iii)(C) through (E)
and proposed rule 22e-4(b)(3)(iii).
    \148\ See Liquidity Rule Adopting Release, supra note 8, at
n.491 and accompanying text.
    \149\ See Liquidity Rule Adopting Release, supra note 8, at
nn.468-472 and accompanying text (operational concerns); Derivatives
Adopting Release, supra note 21, at section II.L (withdrawal of
Investment Company Act Release 10666).
---------------------------------------------------------------------------

ii. Fund Liabilities
    Under the proposal, a fund would also be required to reduce the
amount of highly liquid assets that count toward the fund's highly
liquid investment minimum by the amount of the fund's liabilities. This
proposed change is intended to result in a more accurate calculation of
the highly liquid investment minimum.\150\ The proposed approach would
include any liabilities, as defined in 17 CFR 210.6-04 (rule 6.04 of
Regulation S-X). For example, this would include investment liabilities
and amounts payable for investment advisory, management, and service
fees. Reducing the amount of highly liquid assets by fund liabilities
reflects that fund liabilities are generally paid in cash, meaning that
highly liquid assets may need to be liquidated in order to satisfy
those liabilities rather than to meet redemptions.
---------------------------------------------------------------------------

    \150\ The highly liquid investment minimum is the percentage of
a fund's net assets that it invests in highly liquid assets that are
eligible to count toward the minimum under the rule. See rule 22e-
4(a)(7) (defining highly liquid investment minimum). Because this
calculation uses net assets as the denominator (which reflects the
amount of assets less any liabilities), we believe the numerator of
eligible highly liquid assets similarly should be net of
liabilities.
---------------------------------------------------------------------------

    Based on staff outreach, it is our understanding that the proposal
reflects many funds' existing practices. For example, when a fund has
significant liabilities, they generally will be incurred in connection
with derivatives transactions or other investments that give rise to a
fund liability. Because funds are required to classify all investments,
including liabilities, investments such as highly liquid derivatives in
a liability position will reduce the value of the fund's highly liquid
investments that are assets. To enhance investor protection by
preventing assets that a fund may in the future use to pay liabilities
from also being counted toward the fund's highly liquid investment
minimum, and to promote consistency in how funds calculate their highly
liquid investment minimum, we are proposing to require that all funds
reduce their highly liquid assets used to satisfy their highly liquid
investment minimum by the amount of the fund's liabilities.\151\
---------------------------------------------------------------------------

    \151\ Depending on the rules of any applicable exchange and
local law, a variation margin payment with respect to a derivatives
transaction may be deemed to settle the fund's liability for the
daily mark-to-market loss on the transaction. In that case or any
other case where a fund does not have a liability in connection with
a given transaction, the fund would not be required to reduce its
highly liquid investments in connection with that transaction under
the proposal.
---------------------------------------------------------------------------

    We request comment on these aspects of the proposal, including:
    43. Should we, as proposed, require a fund to reduce the amount of
its highly liquid investments computed for the purposes of determining
compliance with its highly liquid investment minimum by the value of
any highly liquid assets that are posted as margin or collateral in
connection with any derivatives transaction that is classified as
moderately liquid or illiquid? Why or why not? Should we also require
that amounts posted as margin or collateral in connection with
derivatives transactions that are classified as highly liquid be
treated in this way? Alternatively, should we exempt amounts posted as
margin or collateral in connection with certain types or categories of
derivatives transactions from this requirement?
    44. How frequently do funds calculate the percentage of their
highly liquid assets posted as margin or collateral in connection with
non-highly liquid derivatives transactions today? Would the proposed
requirement to calculate this value on a daily basis present new
challenges?
    45. Should we, as proposed, require a fund to reduce the amount of
its highly liquid assets computed for the purpose of determining
compliance with its highly liquid investment minimum by the value of
any liabilities? Do funds already make this reduction when determining
compliance with highly liquid investment minimums? Should we instead
require a fund to reduce the amount of its highly liquid assets by a
different amount, such as the percentage of the fund's total assets
that its liabilities represent? Are there certain classes or types of
fund liabilities that should not be counted? For example, should we
provide an exception for liabilities associated with fund borrowings
that are used to meet redemptions in order to avoid a disincentive for
funds to borrow for this purpose under appropriate circumstances?
    46. We propose that, for these purposes, the amount of a fund's
liabilities would be computed in the same manner as a fund computes its
liabilities for purposes of rule 6-04 of Regulation S-X. If we use this
standard, as proposed, would the amount by which funds should reduce
their highly liquid assets be clear? Are there any issues that may
arise from using the standard funds use to prepare their balance
sheets? Would a different definition of ``liabilities'' be more
appropriate?
3. Limit on Illiquid Investments
    Rule 22e-4 currently limits a fund's ability to acquire illiquid
investments. Specifically, the rule prohibits a fund from acquiring any
illiquid investment if, immediately after the acquisition, the fund
would have invested more than 15% of its net assets in illiquid
investments that are assets.\152\ We are proposing to amend the rule's
limitation on illiquid investments to provide that the value of margin
or collateral that a fund could only receive upon exiting an illiquid
derivatives transaction would itself be treated as illiquid for these
purposes.\153\ As the Commission stated in 2016, the potential effects
of a fund's use of derivatives are relevant to assessing, managing, and
periodically reviewing a fund's liquidity risk.\154\ The potential
effects may be heightened when the derivatives transaction is itself
illiquid, and thus may be difficult for a fund to exit quickly enough
to use the associated margin or collateral to meet redemption requests,
or at all. Funds' use of illiquid derivatives is subject to several
limitations but, for open-end funds, the risks associated with illiquid
derivatives may be heightened as a result of the funds'
redeemability.\155\
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    \152\ See rule 22e-4(b)(1)(iv). A fund also must notify its
board, and report confidentially to the Commission on Form N-RN, if
its illiquid investments that are assets exceed 15% of net assets.
    \153\ See proposed rule 22e-4(b)(1)(iv).
    \154\ See Liquidity Rule Adopting Release, supra note 8, at text
accompanying nn.218-223.
    \155\ The limitations on funds' issuance of senior securities,
which include derivatives creating certain payment or delivery
obligations, in section 18 of the Act and 17 CFR 270.18f-4 (rule
18f-4) provide certain protections to investors, and the proposed
amendments are designed to complement those protections. See
Derivatives Adopting Release, supra note 21 (stating that a fund's
derivatives risk management program would be part of an adviser's
overall management of portfolio risk and would complement--but would
not replace--a fund's other risk management activities, such as a
fund's liquidity risk management program adopted under rule 22e-4).

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

    Under the proposal, for purposes of determining whether the fund is
in compliance with the limitation on illiquid investments, the fund
would treat as illiquid the amount of margin or collateral it has
posted in connection with a derivatives transaction that is classified
as an illiquid investment and that the fund would receive if it exited
the derivatives transaction (``excess collateral'').\156\ This proposed
requirement recognizes that, because a fund does not reasonably expect
to be able to convert an illiquid derivatives investment to U.S.
dollars within seven days, the fund likewise would not be able to
convert to U.S. dollars the value of excess collateral posted as margin
or collateral in connection with the derivatives transaction within
seven days. Therefore, the proposal would require a fund to include the
value of the excess collateral or margin when it determines the amount
of illiquid assets it holds for purposes of the 15% limit on illiquid
investments.
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    \156\ This does not mean that the investment acting as margin or
collateral would need to be classified as an illiquid investment
under the rule. A fund would classify the relevant investment
according to the rule's classification framework. In order to aid
understanding of the reported data, we propose to require a fund to
report the value of investments treated as illiquid as a result of
this provision. See section II.E.1.d, infra and Item B.8.b of
proposed Form N-PORT.
---------------------------------------------------------------------------

    As with the proposed amendments related to the amounts posted as
margin or collateral for non-highly liquid derivatives, a fund would
not be required to specifically identify particular assets that it
posted as margin or collateral to cover specific derivatives
transactions. Instead, a fund would calculate the value of its assets
posted as margin or collateral in connection with illiquid derivatives
transactions and treat that value of assets as illiquid.\157\
---------------------------------------------------------------------------

    \157\ See Item B.8.b of proposed Form N-PORT.
---------------------------------------------------------------------------

    We request comment on this aspect of the proposal, including:
    47. Should we, as proposed, require funds to treat as illiquid
investments the value of excess collateral the fund has posted in
connection with a derivatives transaction that is classified as an
illiquid investment? Are there circumstances where a fund would have
ready access to the value of such collateral even though the associated
derivatives transaction is illiquid?
    48. Are there challenges to identifying and monitoring the amount
of excess collateral a fund has posted in connection with a derivatives
transaction that is classified as an illiquid investment? If so, are
there ways to address those challenges?
    49. Are there other instances where we should treat an investment
as illiquid for purposes of the rule's limit on illiquid investments
that the current rule and the proposal do not contemplate?
    50. Should we amend any other aspects of the illiquid investment
limitations in the rule? For example, should we change the amount of
the limit on illiquid investments from 15% to a lower amount, such as
10% or 5%, or a higher amount, such as 20% or 25%?

B. Swing Pricing

    We are proposing amendments to rule 22c-1 that would require all
registered open-end management investment companies to engage in swing
pricing under certain conditions, except for money market funds and
ETFs (the latter, ``excluded funds'').\158\ Swing pricing is a process
of adjusting a fund's current NAV when certain conditions are met, such
that the transaction price effectively passes on costs stemming from
shareholder inflows or outflows to the shareholders engaged in that
activity. Trading activity and other changes in portfolio holdings
associated with purchases and redemptions may impose costs, including
trading costs and costs of depleting a fund's liquidity. These costs,
which currently are borne by the non-transacting shareholders in the
fund, can dilute the interests of these shareholders. In addition, this
can create incentives for shareholders to redeem quickly to avoid
losses, particularly in times of market stress. If shareholder
redemptions are motivated by this first-mover advantage, they can lead
to increasing outflows, and as the level of outflows from a fund
increases, the incentive for remaining shareholders to redeem may also
increase.\159\ By imposing the costs associated with net purchases or
net redemptions on the shareholders who are purchasing or redeeming
from the fund at that time, swing pricing can more fairly allocate
costs, reduce the potential for dilution of investors who are not
currently transacting in the fund's shares, and reduce any potential
first-mover advantages.
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    \158\ See proposed rule 22c-1(b). We refer to registered open-
end management investment companies other than excluded funds as
``funds'' or ``open-end funds'' when discussing the swing pricing
requirement. We continue to believe it is appropriate to limit swing
pricing to these funds and to not include other fund types, such as
unit investment trusts or closed-end funds. See Swing Pricing
Adopting Release, supra note 8, at nn.62-72 and accompanying text.
With respect to excluded funds, the Commission recently proposed to
require certain money market funds to engage in swing pricing under
rule 2a-7, but those money market funds would not be subject to the
proposed swing pricing requirement under rule 22c-1(b). See Money
Market Fund Reforms, Investment Company Act Release No. 34441 (Dec.
15, 2021) [87 FR 7248 (Feb. 8, 2022)] (``Money Market Fund Proposing
Release''). ETFs, including an ETF share class of any fund that
issues multiple classes of shares representing interests in the same
portfolio, would not be subject to the swing pricing requirement, as
discussed below. See definition of ``Exchange-traded fund'' in
proposed rule 22c-1(d).
    \159\ Some research suggests that a first-mover advantage in
open-end funds may lead to cascading anticipatory redemptions akin
to traditional bank runs. This research generally models an
exogenous response to negative fund returns and not trading costs.
However, these results may extend to trading costs to the degree
that cost based dilution may reduce subsequent fund returns, which
would trigger runs in these models. See, e.g., Chen, Qi, Itay
Goldstein, and Wei Jiang. 2010. ``Payoff Complementarities and
Financial Fragility: Evidence from Mutual Fund Outflows.'' Journal
of Financial Economics 97(2): 239-262. See also Goldstein, Itay, Hao
Jiang, and David Ng. 2017. ``Investor Flows and Fragility in
Corporate Bond Funds.'' Journal of Financial Economics 126(3):592-
613. See also Morris, Stephen, Ilhyock Shim, and Hyun Song Shin.
2017. ``Redemption Risk and Cash Hoarding by Asset Managers.''
Journal of Monetary Economics 89: 71-87. See also Zeng, Yao. 2017.
``A Dynamic Theory of Mutual Fund Runs and Liquidity Management.''
Working Paper. See also Ma, Yiming, Kairong Xiao, and Yao Zeng.
2021. ``Mutual Fund Liquidity Transformation and Reverse Flight to
Liquidity.'' Working Paper. See also Ma, Yiming, Kairong Xiao, and
Yao Zeng. 2021. ``Bank Debt versus Mutual Fund Equity in Liquidity
Provision.'' Working Paper. See also Christof W. Stahel. 2022.
``Strategic Complementarity Among Investors with Overlapping
Portfolios'', available at https://ssrn.com/abstract=3952125
(positing that investors behave similarly regardless of whether they
hold assets indirectly through a fund or directly through a
separately managed account and the general explanation for investor
decisions to sell assets is that all market participants compete for
finite market liquidity).
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1. Proposed Swing Pricing Requirement
    Under the proposal, every open-end fund other than an excluded fund
would be required to establish and implement swing pricing policies and
procedures that adjust the fund's current NAV per share by a swing
factor either if the fund has net redemptions or if it has net
purchases that exceed an identified threshold.\160\ We are proposing to
require these funds to use swing pricing as an anti-dilution tool, in
contrast to the optional framework that currently exists in rule 22c-1.
Based on our observations from the events in March 2020, including in
other jurisdictions where swing pricing is a common tool, requiring
funds to use

swing pricing could result in benefits for investors, as discussed
below.\161\ However, at present no U.S. funds have implemented swing
pricing. One reason funds have not implemented swing pricing is that
they lack timely flow information to operationalize this anti-dilution
tool. However, even if all funds had access to sufficient flow
information in order to implement swing pricing, some may nonetheless
choose not to implement it due to implementation costs or because
investors in U.S. funds are unfamiliar with swing pricing. Therefore,
funds may not be incentivized to be the first to adopt swing pricing.
We believe that a regulatory requirement, rather than a permissive
framework, would accrue benefits to investors that justify the
implementation costs and would overcome these collective action
problems that may have prevented swing pricing implementation. In
addition, we continue to believe the information a fund that uses swing
pricing must disclose in its prospectus will improve public
understanding regarding a fund's use of swing pricing.\162\
---------------------------------------------------------------------------

    \160\ See proposed rule 22c-1(b)(1) and definition of ``Inflow
swing threshold'' in proposed rule 22c-1(d).
    \161\ See supra notes 59 to 63 and accompanying text (stating
that some fund managers with both U.S. and European operations
indicated to the staff that swing pricing would have been a useful
tool for U.S. funds to have had to combat dilution in Mar. 2020).
    \162\ See Swing Pricing Adopting Release, supra note 11, at
n.360 and accompanying text. In 2016, when the Commission adopted
the optional swing pricing rule for open-end funds that are not
excluded funds, it also adopted certain amendments to Form N-1A to
enhance disclosure related to a fund's use of swing pricing, if
applicable. Among other things, these amendments required that a
fund that uses swing pricing explain the fund's use of swing
pricing, including its meaning, the circumstances under which the
fund will use it, the effects of swing pricing on the fund and
investors, and the upper limit it has set on the swing factor. See
Item 6(d) of Form N-1A. Although no funds currently use swing
pricing, and therefore do not provide swing pricing disclosures to
their investors, under the proposed rule all funds other than
excluded funds would be required to provide these disclosures, other
than the swing factor upper limit disclosure, to their investors.
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    Some academics and market participants have suggested that swing
pricing has provided significant benefits to long-term investors in
funds in other jurisdictions, reducing dilution attributable to the
transaction costs associated with shareholder activity.\163\ As an
example, one foreign fund industry group has suggested that funds using
swing pricing exhibit superior performance returns over time compared
to funds with identical investment strategies and trading patterns that
do not employ anti-dilution measures.\164\ In terms of performance
benefits, one study found that, for a 10% rise in monthly outflows, the
associated decline in monthly returns relative to a fund's benchmark
was double the amount for a fund that does not use swing pricing in
comparison to a fund that uses swing pricing (a 6 basis point decline
versus a 3 basis point decline, respectively).\165\ And one investment
manager reviewed the effects of swing pricing for twenty of its
European funds in 2019 and found that the anti-dilution effect of swing
pricing improved annual performance for these funds by around 10 to
more than 60 basis points.\166\
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    \163\ See, e.g., Dunhong Jin, Marcin Kacperczyk, Bige Kahraman,
and Felix Suntheim, Swing Pricing and Fragility in Open-end Mutual
Funds, The Review of Financial Studies, 35(1) (2022), available at
https://academic.oup.com/rfs/article/35/1/1/6162183 (``Jin, et
al.''); BlackRock, Swing Pricing--Raising the Bar (Sept. 2021),
available at https://www.blackrock.com/corporate/literature/whitepaper/spotlight-swing-pricing-raising-the-bar-september-2021.pdf (``BlackRock Swing Pricing Paper'').
    \164\ See Association of the Luxembourg Fund Industry, Swing
Pricing Brochure (July 2022), available at https://www.alfi.lu/getattachment/3154f4f7-f150-4594-a9e3-fd7baaa31361/app_data-import-alfi-alfi-swing-pricing-brochure-2022.pdf.
    \165\ See CSSF Paper, supra note 61.
    \166\ See BlackRock Swing Pricing Paper, supra note 163.
---------------------------------------------------------------------------

    In addition, in March 2020, many European funds that used swing
pricing lowered their swing thresholds and increased the size of their
swing factors, suggesting there was a need to make more frequent and
significant adjustments to the funds' NAVs at that time to avoid
substantial dilution that otherwise would have occurred.\167\ One study
found that surveyed funds using swing pricing during a three week
period of elevated redemptions in March 2020 recouped roughly 6 basis
points of total net assets on average from redeeming investors.\168\
The swing pricing policies that the proposed rule would require, which
are similar to those used by some foreign funds, are designed to
mitigate dilution arising from shareholders' purchase and redemption
activity, particularly during times of stress when those dilution costs
may increase. In addition to reducing dilution, some studies also
suggest that swing pricing dampens redemption pressure, although some
have found this effect to be minimal or nonexistent during certain
periods of market stress.\169\
---------------------------------------------------------------------------

    \167\ See notes 59 to 63 and accompanying text.
    \168\ See Claessens and Lewrick, supra note 61.
    \169\ See CSSF Paper, supra note 61 (stating that funds applying
swing pricing are less exposed to redemption pressure during
episodes of elevated market volatility, but this dampening effect
appears to vanish during episodes of severe market volatility, such
as in Mar. 2020); see also infra notes 354 to 355 and accompanying
text.
---------------------------------------------------------------------------

    Consistent with our current optional swing pricing framework, the
proposed swing pricing requirement for open-end funds would apply to
both net purchases and net redemptions. Although liquidity and
transaction costs associated with meeting net redemptions can present
heightened risks of dilution, particularly in stress periods, we
continue to believe that net purchases also may cause shareholder
dilution.\170\ However, when a fund has net purchases, we propose to
require swing pricing only if the amount of net purchases exceeds a
specified threshold.
---------------------------------------------------------------------------

    \170\ See Swing Pricing Adopting Release, supra note 13, at
paragraph accompanying n.166.
---------------------------------------------------------------------------

    While the proposed swing pricing requirement generally would apply
to all registered open-end funds other than excluded funds, we propose
to retain the current provision that does not permit feeder funds in a
master-feeder fund structure to use swing pricing.\171\ The use of
swing pricing would generally be inappropriate for feeder funds,
because that level of a fund structure does not actually transact in
underlying portfolio assets as a result of net purchase or net
redemption activity. A master fund, however, generally would be subject
to the swing pricing requirement. The master fund may purchase
portfolio assets to invest purchasing shareholders' cash (as
transferred through the feeder fund) or sell portfolio assets to pay
redemption proceeds (reducing the feeder fund's interest in the master
fund). Thus, to the extent that net purchases into or redemptions from
the master fund by one or more feeder funds, or any other investors in
the master fund, would trigger the application of swing pricing under
the proposed rule, the swing factor would be applied at the level of
the master fund.
---------------------------------------------------------------------------

    \171\ See proposed rule 22c-1(b)(5) and current rule 22c-
1(a)(3)(iv).
---------------------------------------------------------------------------

    Consistent with current rule 22c-1, we propose to exclude ETFs from
the swing pricing requirement because ETFs often impose fees in
connection with the purchase or redemption of creation units that are
intended to defray operational processing and brokerage costs to
prevent possible shareholder dilution.\172\ We also are not including
ETFs within the scope of the proposed requirement because we believe
that swing pricing could impede the effective functioning of an ETF's
arbitrage mechanism. Additionally, notwithstanding section 18(f)(1) of
the Act, a fund with a share class that is an exchange-traded fund is
subject to the swing pricing requirement only with respect to any share
classes that are not

exchange-traded funds.\173\ The proposed rule provides this exemption
to allow funds with both mutual fund and ETF share classes to apply
swing pricing to only their mutual fund share classes. Absent an
exemption, differences between the ETF and mutual fund share classes
created by swing pricing could result in a fund being deemed to issue a
senior security, which would otherwise be prohibited under the
Act.\174\ Thus, a fund with an ETF share class would exclude the ETF
share class's flow information when determining whether and how to
apply swing pricing, and would not adjust the NAV of the ETF share
class by the swing factor in computing the share price of that class.
---------------------------------------------------------------------------

    \172\ See Swing Pricing Adopting Release, supra note 13, at
paragraph accompanying n.68.
    \173\ See proposed rule 22c-1(b)(6).
    \174\ Section 18(f)(1) of the Act generally makes it unlawful
for any registered open-end company to issue any class of senior
security. Section 18(g) defines senior security to include any stock
of a class having a priority over any other class as to distribution
of assets or payment of dividends.
---------------------------------------------------------------------------

    We request comment on our proposal to require any fund that is not
an excluded fund to implement swing pricing.
    51. As proposed, should we require any fund that is not an excluded
fund to implement swing pricing? Should we provide any additional
exclusions from the swing pricing requirement? For example, should
funds that invest solely or primarily in highly liquid investments be
permitted, but not required, to use swing pricing? If we provide an
exclusion for funds that primarily invest in highly liquid investments,
how should we define primarily for these purposes (e.g., more than 50%,
66%, or 75%)? Should we use the same definition of highly liquid
investment as the liquidity rule for these purposes? If not, how should
we define highly liquid investments for purposes of an exclusion from
the swing pricing requirement? If a fund primarily invested in highly
liquid investments were to no longer qualify for this exclusion, when
should it be required to adopt swing pricing (e.g., immediately or
within a certain grace period)? Alternatively, should we limit the
exclusion from swing pricing to funds that do not invest more than a
certain percentage of assets in illiquid investments? What maximum
level of illiquid investments would be appropriate to qualify for the
exclusion (e.g., 1%, 2%, 5%, or 10%)? When should a fund be required to
adopt swing pricing if it no longer complies with this exclusion (e.g.,
immediately or within a certain grace period)? Should we use the same
definition of illiquid investments as the liquidity rule for these
purposes?
    52. Should we limit the swing pricing requirement to only certain
types of mutual funds and retain an optional framework for other mutual
funds? If so, how should we identify by rule the types of mutual funds
that would most benefit from a swing pricing requirement? As an
example, would it be appropriate to require swing pricing for fixed-
income mutual funds only, and to retain an optional approach for other
funds? If so, how would a fixed-income fund be defined for this purpose
(e.g., a mutual fund that invests at least a certain percentage in
fixed-income investments, such as 50%, 75%, or 80%)? How would fixed-
income investments, or any other type of portfolio investment, be
defined for this purpose?
    53. Should we adopt swing pricing as a default tool, with a
requirement that an open-end fund, other than an excluded fund,
implement swing pricing unless certain conditions are met? For example,
should a fund be required to implement swing pricing unless its board
of directors makes certain determinations (e.g., that the fund and its
shareholders are unlikely to experience significant dilution in
connection with investor purchases and redemptions) and the fund
maintains records of such determinations? Should a fund be required to
report information about the reasons for such a determination publicly?
    54. Should swing pricing remain an optional tool for all mutual
funds, other than excluded funds? If so, how likely are funds to use
the tool if we adopt the proposed hard close requirement or take other
steps to facilitate a fund's ability to determine its daily flows
before the NAV is finalized? Are certain types of funds more likely to
use swing pricing if it remained an optional tool? If so, why are these
funds more likely to use swing pricing than others? Are the funds that
would use swing pricing if it remained optional the same funds that
would benefit most from addressing dilution associated with shareholder
transactions?
    55. As proposed, should we retain the current provision in the rule
that does not allow feeder funds in a master-feeder structure to engage
in swing pricing?
    56. Under the proposal, ETFs, the shares of which are listed and
traded on a national securities exchange, and that are formed and
operate under an exemptive order under the Investment Company Act or in
reliance on rule 6c-11, would not be subject to swing pricing. Is the
proposed definition of ETF appropriate? If we adopt the swing pricing
requirement, would mutual funds seek to convert to an ETF structure?
Are there any actions or exemptive relief that the Commission should
take or grant to facilitate the conversion of mutual funds to ETFs? If
ETFs were to become the predominant form of open-end fund under the
Investment Company Act, would that affect the need to impose swing
pricing? And likewise, if ETFs were to become the predominant form of
open-end fund, would that benefit or harm investors, and if so, how and
to what extent?
    57. Should we provide that funds with an ETF share class must
exclude the ETF share class from the application of swing pricing, as
proposed? What, if any, operational challenges would exist for such
funds under this approach? Should we instead require that ETF share
classes be subject to the swing pricing requirement, which would result
in authorized participant purchases and redemptions being effected at
an adjusted NAV?
    58. Should we require swing pricing for both net redemptions and
net purchases, as proposed, or only for net redemptions? Do dilution
and liquidity concerns exist for open-end funds in both scenarios?
    59. What would be the operational challenges and costs for funds to
adopt and implement swing pricing, as proposed? If funds
operationalized swing pricing in March 2020, would it have been an
effective tool to address dilution during that period? To what extent
were funds selling portfolio assets and incurring transaction costs to
meet redemptions, or in anticipation of future redemptions, during that
period?
    60. Will the existing swing pricing disclosures required in Form N-
1A be sufficient to help investors understand swing pricing? How
familiar are U.S. investors with swing pricing? Are there any
amendments we should make to the swing pricing disclosure requirements
in Form N-1A that would help investors better understand the concept of
swing pricing? For example, should funds be required to disclose in
their registration statements the frequency they have applied, or would
have applied, a swing factor over a specified period of time (e.g., 1,
3, or 5 years) based on historical flow information? Should we require
a fund to provide additional disclosure about swing pricing to
investors outside of the registration statement? For example, should we
require funds to disclose the effects of swing pricing in shareholder
reports (e.g., in management's discussion of fund performance)?

    61. Is the experience with swing pricing in certain foreign
jurisdictions relevant to an analysis of whether swing pricing would be
an effective tool for U.S. funds? Beyond the operational differences
identified in this release, are there differences in regulatory
frameworks, markets, fund investors, or other factors between the U.S.
and these other jurisdictions that might cause U.S. funds' experiences
with swing pricing to differ? \175\
---------------------------------------------------------------------------

    \175\ See infra note 225 (discussing that European jurisdictions
in which funds use swing pricing generally already have a hard
close, which results in European funds receiving order flow much
earlier than U.S. funds).
---------------------------------------------------------------------------

    62. Rule 2a-4 under the Act requires a fund, when determining its
current NAV, to reflect changes in holdings of portfolio securities and
changes in the number of outstanding shares resulting from
distributions, redemptions, and repurchases no later than the first
business day following the trade date. Are there any changes we should
make to rule 2a-4 to address dilution? For example, should we amend
that rule to require that funds reflect these changes on trade date?
2. Amendments to Swing Threshold Framework
    The current rule permits a fund to determine its own swing
threshold for net purchases and net redemptions, based on a
consideration of certain factors the rule identifies.\176\ We are
proposing to specify when a fund must use swing pricing to adjust its
current NAV, which would differ depending on whether the fund has any
net redemptions or has net purchases above a specified threshold on a
given day.
---------------------------------------------------------------------------

    \176\ The factors a fund currently must consider in determining
the size of its swing threshold are: (1) the size, frequency, and
volatility of historical net purchases or net redemptions of fund
shares during normal and stressed periods; (2) the fund's investment
strategy and the liquidity of the fund's portfolio investments; (3)
the fund's holdings of cash and cash equivalents, and borrowing
arrangements and other funding sources; and (4) the costs associated
with transactions in the markets in which the fund invests. See rule
22c-1(a)(3)(i)(B).
---------------------------------------------------------------------------

    When the Commission adopted the swing pricing provisions in 2016,
it determined to require a swing threshold and not to prescribe a swing
threshold floor applicable to all funds because it believed that
different levels of net purchases and net redemptions would create
different risks of dilution for funds with different strategies,
shareholder bases, and other liquidity-related characteristics.\177\ At
that time, the Commission believed consideration of the swing threshold
factors--which took into account these different liquidity-related
characteristics--would lead a fund to set a threshold at a level that
would trigger the fund's investment adviser to trade portfolio assets
in the near term to a degree or of a type that may generate material
liquidity or transaction costs for the fund. We further believed that
after considering these factors, a fund would be unable to set the
swing threshold at zero. Thus the current rule does not contemplate
full swing pricing, but assessment of the swing threshold factors could
lead certain funds to set low swing thresholds approximating full swing
pricing.
---------------------------------------------------------------------------

    \177\ For considerations relating to the swing threshold in the
current rule, see generally Swing Pricing Adopting Release, supra
note 11, at nn.150-155 and accompanying text.
---------------------------------------------------------------------------

    In the intervening period, however, we have observed that the size
of funds' swing thresholds in certain other jurisdictions has depended
more on uniform decisions by the manager of a fund complex than on an
individual fund's liquidity-related circumstances.\178\ In addition, we
considered our experience with the liquidity rule discussed above,
where currently allowed discretion has led to favorable liquidity
assessments that tend to over-estimate funds' liquidity during stressed
market conditions and that fail to change dynamically during stressed
market conditions. A similar experience translated to swing pricing
could cause high swing thresholds set during calm market conditions
that do not adjust downward as may be appropriate in some cases during
stressed market conditions. As a result of these experiences, we are
concerned that retaining the principles-based framework for setting
swing thresholds under the current rule would not result in the level
of fund-specific tailoring the Commission contemplated and, instead,
would simply result in undue variation among similarly situated funds
and, in some cases, swing thresholds high enough that swing pricing
does not adequately address dilution.
---------------------------------------------------------------------------

    \178\ See Bank of England Survey, supra note 60 (``In most cases
we observed that funds with different primary strategies and assets,
but managed by the same fund manager, used both the same thresholds
for applying swing pricing, and the same calculation of the
standardised swing factor. This appears to indicate that managers
may not be fully considering specific factors such as in the
investor base or asset-specific factors for individual funds.'').
---------------------------------------------------------------------------

    In the case of net redemptions, the proposed rule would require a
fund to apply swing pricing always (i.e., without a swing
threshold).\179\ Because every net redemption can potentially involve
trading or borrowing costs that dilute the value of the fund, as well
as depletion of a fund's liquidity for remaining shareholders that
increases the likelihood of future dilution, the proposal, in setting a
uniform approach to triggering swing pricing in all circumstances,
would require a fund to apply a swing factor regardless of the size of
its net redemptions, which is intended to fairly allocate costs and
reduce dilution. Applying swing pricing regardless of the size of net
redemptions may help reduce any potential first-mover advantage
associating with redeeming before other investors. However, the types
of costs the swing factor must take into account would depend on the
size of net redemptions. Specifically, the proposed rule would require
a fund to include market impacts in its swing factor only if net
redemptions exceed 1% of the fund's net assets (the ``market impact
threshold'').\180\ Market impact costs are the costs incurred when the
price of a security changes as a result of the effort to purchase or
sell the security.\181\
---------------------------------------------------------------------------

    \179\ See proposed rule 22c-1(b)(1)(i).
    \180\ See proposed rule 22c-1(b)(2)(i)(C) and definition of
``Market impact threshold'' in proposed rule 22c-1(d).
    \181\ Market impact costs reflect price concessions (amounts
added to the purchase price or subtracted from the selling price)
that are required to find the opposite side of the trade and
complete the transaction.
---------------------------------------------------------------------------

    We understand that there may be operational challenges and
complexities to estimating market impact costs. Recognizing these
difficulties, and that market impacts are likely to be minimal or even
negligible when redemptions are not significant, the proposal sets a
market impact threshold below which estimates of market impact would
not be necessary. Based on our analysis of historical daily flow data
over a period of more than 10 years for equity and fixed-income mutual
funds, a given fund had daily outflows of more than 1% on slightly more
than 1% of trading days.\182\ We propose a 1% market impact threshold
to balance the operational challenges of frequently estimating market
impacts with the goal of reducing dilution, particularly in times of
stress (i.e., when a fund is more likely to experience redemptions of
more than 1% of net assets and market impacts are likely to be larger).
We recognize that smaller funds may be less likely than larger ones to
have market impacts at a 1% threshold, because they generally would be
selling smaller investment sizes than larger funds would at that
threshold. However, there are circumstances in which smaller funds may
also experience market impact costs at the 1% threshold; for example,
if the fund holds substantial

illiquid investments or during periods of market stress. Therefore, the
proposal requires all funds to assess whether market impact costs would
occur when net redemptions exceed a 1% threshold and, if they do occur,
to include such costs in the swing factor. A uniform market impact
threshold for all funds would provide a consistent and objective
threshold for all funds to consider market impacts.
---------------------------------------------------------------------------

    \182\ Based on Morningstar data for the period of Jan. 2009
through Dec. 2021.
---------------------------------------------------------------------------

    When a fund has net purchases, we propose to only require swing
pricing--including market impact--if the amount of net purchases
exceeds 2% of the fund's net assets (the ``inflow swing
threshold'').\183\ We recognize that smaller levels of net purchases
are less likely to result in dilution than net redemptions. This is
because funds, while required to pay redemptions within seven days, are
not required to invest cash inflows within a specified period.
Therefore, if bid-ask spreads have widened on a day that the fund
receives the cash inflows, the fund manager generally can wait to
invest the cash to reduce transaction costs.\184\ In addition, while
investing the cash inflows could decrease the liquidity of the fund,
particularly if the cash is used to purchase illiquid investments, the
liquidity rule curbs this possibility by limiting the amount of
illiquid investments a fund can acquire.
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    \183\ See definition of ``Inflow swing threshold'' in proposed
rule 22c-1(d).
    \184\ Regardless of bid-ask spreads, a fund manager also may
choose to use cash inflows to invest in derivatives to obtain market
exposure quickly while strategizing where to invest that cash on a
longer-term basis. Funds may be incentivized to invest promptly in
an effort to avoid reduced returns and tracking error.
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    For these reasons, the proposal sets a swing threshold for net
purchases but not one for net redemptions. We also recognize that low
levels of net purchases are less likely to result in dilution, but that
higher levels of net purchases are more likely to result in dilution
absent appropriate tools for mitigating it. Based on our analysis of
historical daily flow data over a period of more than 10 years for
equity and fixed-income mutual funds, a given fund had daily inflows of
approximately 2% on about 1% of trading days.\185\ Therefore, similar
to the proposed market impact threshold, we propose an inflow swing
threshold of 2% to balance the operational challenges of frequently
implementing swing factors for net purchases with the goal of reducing
dilution, particularly when a fund has significant inflows.
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    \185\ Based on Morningstar data for the period of Jan. 2009
through Dec. 2021.
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    Although the proposed rule would identify a market impact threshold
that would apply to net redemptions and an inflow swing threshold for
net purchases, the rule would permit the fund's swing pricing
administrator to use smaller thresholds than the rule identifies in
either of these instances as the administrator determines is
appropriate to mitigate dilution.\186\ Flexibility to use a smaller
threshold is designed to recognize that there may be circumstances in
which a smaller threshold than the rule requires would help reduce
dilution, such as when the fund holds a larger amount of investments
that are less liquid, in times of market stress, or in the case of a
large fund (i.e., because a large fund is selling or purchasing a
larger amount of instruments than a small fund at a 1% market impact
threshold for net redemptions or a 2% inflow swing threshold for net
purchases). For example, a fund might elect to implement swing pricing
if the fund experiences net purchases of any amount.
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    \186\ See definitions of ``Inflow swing threshold'' and ``Market
impact threshold'' in proposed rule 22c-1(d). Under the proposed
rule, the term ``swing pricing administrator'' has the same meaning
as the term ``person(s) responsible for administering swing
pricing'' under the current rule. See proposed rule 22c-1(d);
current rule 22c-1(a)(3)(ii)(C). The swing pricing administrator is
the fund's investment adviser, officer, or officers responsible for
administering the fund's swing pricing policies and procedures. The
proposed rule specifies that the swing pricing administrator may
consist of a group of persons. As with the current rule, the fund's
board of directors must designate this person or group of persons.
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    We understand that in having the option to set a lower market
impact threshold for net redemptions and inflow swing threshold for net
purchases, the swing pricing administrator would have discretion that
it potentially could use to enhance fund performance in a misleading
manner by adjusting the fund's NAV more frequently or more
substantially than is needed to address dilution. To help address this
risk, under the proposal the administrator would be required to include
in its written reports to the board the information and data supporting
its determination to use lower thresholds.\187\ Additionally,
consistent with the current rule, a fund's portfolio manager could not
be designated as the swing pricing administrator.\188\
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    \187\ See proposed rule 22c-1(b)(3)(iii)(C). Consistent with the
current rule, a fund would be required to maintain a written copy of
the report provided to the board for six years, the first two years
in an easily accessible place. See rule 22c-1(a)(3)(iii); proposed
rule 22c-1(b)(4).
    \188\ See rule 22c-1(a)(3)(ii)(C) and proposed rule 22c-
1(b)(3)(ii). See also Swing Pricing Adopting Release, supra note 11,
at n.269 and accompanying text.
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    We request comment on our proposed amendments to the swing pricing
threshold.
    63. Should we adopt a framework that, in the case of net
redemptions, requires a fund to adjust its NAV by a swing factor only
when those net redemptions exceed an identified threshold (i.e., as we
propose for net purchases)? If so, should that threshold be the same
size as the 1% market impact threshold, or a lower or higher amount
(e.g., 0.5%, 1.5%, or 2%)?
    64. Should we require the application of the swing factor
regardless of the size of net purchases or net redemptions, or only
when they exceed a certain percentage of a fund's net assets? Should
funds have discretion to set their own thresholds? If so, should that
discretion be based on the swing threshold factors currently in the
rule or should we adjust those factors?
    65. Should we include a market impact threshold for net
redemptions, as proposed? Is 1% an appropriate level for the market
impact threshold? Should it be a lower or higher amount (e.g., 0.5%,
1.5%, or 2%)? Is there different data or analysis that we should take
into account to determine the market impact threshold?
    66. Should we include an inflow swing threshold for net purchases,
as proposed? Is 2% an appropriate level for the inflow swing threshold?
Should it be a lower or higher amount (e.g., 0.5%, 1%, 1.5%, or 3%)? Is
there different data or analysis that we should take into account to
determine the inflow swing threshold?
    67. Would the proposed inflow swing threshold, or a requirement to
use swing pricing in the case of net purchases more generally, cause a
fund to limit the total amount an investor can invest in the fund? If
so, what effects would this have on investors?
    68. Should we permit the swing pricing administrator to use
discretion to establish a smaller market impact threshold for net
redemptions or a smaller inflow swing threshold for net purchases if
the administrator determines a smaller threshold is appropriate to
mitigate dilution, as proposed? Should we prescribe the circumstances
in which a smaller threshold would be permitted, the timing of such a
determination by the swing pricing administrator (e.g., if a swing
pricing administrator must formally establish a smaller threshold that
will remain in place for a period of time), disclosure of such a
determination to the fund's investors, and recordkeeping requirements
in support of the determination? Should we require the fund's board,
instead of

the swing pricing administrator, to approve use of a smaller threshold?
Should we permit the swing pricing administrator to exclude certain
types of costs from the swing factor if it uses a lower-than-required
threshold? For example, should a swing pricing administrator be
permitted to exclude market impact estimates from the swing factor if
it uses an inflow swing threshold that is lower than 2%, and instead
only include market impact estimates when inflows also exceed 2%?
    69. Should the swing pricing administrator or the board have
flexibility to establish larger thresholds than proposed (i.e., to
apply a swing factor only when net redemptions exceed a specified
percentage, to include market impacts in the swing factor when net
redemptions are an identified amount that is greater than 1%, or to
apply a swing factor only when net purchases exceed an identified
amount that is greater than 2%)? If so, what are the circumstances in
which a fund board or the swing pricing administrator should have
flexibility to use larger thresholds that the proposed rule identifies?
    70. Should we allow certain types of funds to use different
thresholds than those the proposed rule identifies? For example, should
we permit or require smaller funds to use larger thresholds? If so, how
should we identify smaller funds for these purposes? Should the rule
identify larger thresholds for smaller funds, or should smaller funds
have flexibility to determine their own thresholds? As another example,
should we permit or require funds that hold significant amounts of
highly liquid investments to use larger thresholds? If so, how should
we identify funds that hold significant amounts of highly liquid
investments for these purposes? Should the rule identify larger
thresholds for these funds, or should they have flexibility to
determine their own thresholds?
3. Determining Flows
    Consistent with the current rule, the swing pricing administrator
must review investor flow information to determine if the fund has net
purchases or net redemptions and the amount of net purchases or net
redemptions.\189\ For these purposes, investor flow information means
information about the fund investors' daily purchase and redemption
activity. Investor flow information may consist of individual,
aggregated, or netted eligible orders, and excludes any purchases or
redemptions that are made in kind and not in cash.\190\ Currently it
would be difficult to determine investor flow information on a given
day because some intermediaries do not provide order flow until after
the fund has finalized its NAV. In recognition of these challenges, the
current rule permits a swing pricing administrator to make swing
pricing determinations based on receipt of sufficient investor flow
information to allow the fund to estimate reasonably whether it has
crossed a swing threshold with high confidence.\191\ While the hard
close provision in the proposed rule is intended to result in funds
generally having flow information in a timely manner, and therefore
greatly reduce the need for estimation, we recognize some estimation
may still be required. The proposed rule would, therefore, continue to
permit the swing pricing administrator to make swing pricing
determinations based on reasonable, high confidence estimates of
investor flows.\192\
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    \189\ See rule 22c-1(a)(3)(i)(A) and proposed rule 22c-
1(b)(1)(i).
    \190\ See definition of ``Investor flow information'' in
proposed rule 22c-1(d). See also infra section II.C.2 (discussing
the proposed definition of ``eligible order'' for purposes of the
hard close requirement).
    \191\ See rule 22c-1(a)(3)(i)(A).
    \192\ Under the current rule, the swing pricing administrator is
permitted to make swing threshold determinations based on receipt of
sufficient flow information ``to allow the fund to reasonably
estimate whether it has crossed the swing threshold(s) with high
confidence.'' See rule 22c-1(a)(3)(i)(A).
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    Under our proposal, the swing pricing administrator would be
required to review investor flow information on a daily basis to
determine: (1) if the fund experiences net purchases or net
redemptions; and (2) the amount of net purchases or net redemptions. We
propose to permit the swing pricing administrator to make these
determinations based on ``reasonable, high confidence estimates.''
While there would be less of a need to estimate flows under the
proposed hard close requirement, we understand that a swing pricing
administrator still would need to use estimates in some cases. For
instance, if an investor submits an exchange order to redeem its shares
from Fund A and simultaneously invest the proceeds in Fund B, the swing
pricing administrator for Fund B may need to estimate the incoming cash
by multiplying the number of shares redeemed from Fund A by an estimate
of Fund A's NAV, which may be the prior day's transaction price. In
this situation, we recognize it will not be possible for the swing
pricing administrator to determine the exact size of the related flow
information until a later time. Therefore, we propose to permit the use
of reasonable, high confidence estimates to make swing pricing
determinations. Furthermore, some funds groups with both U.S. and
European operations may already have experience with this type of
estimation, because European funds that have adopted swing pricing
generally use the prior day's price to estimate today's flows.
    We request comment on our proposal requirements related to
shareholder flow information.
    71. Should we permit a swing pricing administrator to make
reasonable, high confidence estimates of investor flows, as proposed?
Are there operational complexities to this approach? Is the rule's
reference to reasonable, high confidence estimates of investor flows
sufficiently clear? If not, how should we revise the rule to provide
greater clarity about permitted estimates?
    72. As proposed, should we remove references to receipt of
sufficient investor flow information in the rule in light of the
proposed hard close requirement?
    73. Is the proposed definition of ``investor flow information''
clear and understandable? Should the rule continue to exclude any
purchases or redemptions that are made in kind and not in cash, as
proposed?
    74. Should we provide additional guidance about circumstances in
which a swing pricing administrator may need to use estimates in
connection with arriving at a reasonable, high confidence estimate of
the fund's investor flow information and how the administrator should
arrive at those estimates? Are there other types of investor orders,
beyond orders that identify the number of shares to be purchased or
sold and exchanges, that would still require estimation under a hard
close approach? Should funds be able to use the prior day's transaction
price for purposes of estimating flows where the amount of such flows
are dependent on having a transaction price? Should funds be permitted
to make adjustments to the prior day's price for these purposes (e.g.,
to reflect market movements relative to fund benchmarks that occurred
after the prior day's NAV was struck)? If so, under what circumstances
should we permit such adjustments?
    75. If we adopt the proposed hard close requirement, would there be
scenarios in which a swing pricing administrator would be unable to
arrive at a reasonable, high confidence estimate of investor flows? If
so, when would this occur? How should a fund comply with the swing
pricing requirement if the administrator is unable to arrive at a
reasonable, high

confidence estimate of investor flows on a given day?
    76. Would the use of reasonable, high confidence estimates of
investor flows subject swing pricing determinations to abuse? Should
the use of estimates be limited to specific circumstances? Are there
other ways for the swing pricing administrator to make swing pricing
determinations without the use of reasonable, high confidence estimates
of investor flows?
    77. Do fund groups with both U.S. and European operations already
have experience with investor flow estimation? If so, would experience
with European operations help these fund groups use estimates in their
U.S. funds? What changes to the proposed rule, if any, would help fund
groups without prior experience with investor flow estimation?
4. Swing Factors
    In determining the swing factor, the proposed rule would require a
fund's swing pricing administrator to make good faith estimates,