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    \118\ Rule 22e-4(b)(2).
    \119\ Rule 22e-4(b)(1)(iii)(A)(3) and rule 22e-4(b)(1)(iv).
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    Rule 22e-4, by requiring funds to limit illiquidity and manage
liquidity, should reduce the potential likelihood and extent of
dilution of non-transacting shareholders that otherwise could result
from redemptions effected at prices determined in accordance with rules
22c-1 and 2a-4. Thus, rule 22e-4, although it is numbered with
reference to section 22(e), has a broader scope and also should
separately help rule 22c-1 operate so as to reduce dilution, as
contemplated by sections 22(a) and (c).
    Second, we are adopting certain public disclosure- and confidential
reporting-related rules and amendments to provide shareholders and
other users with additional information with respect to funds'
liquidity risk profile as well as assist the Commission in its
monitoring efforts. Specifically, we are adopting reporting
requirements on Form N-PORT that will require a fund to report monthly
position-level liquidity classification information and its highly
liquid investment minimum to the Commission on a confidential
basis.\120\ Form N-PORT will also require a fund to publicly disclose
the aggregated percentage of its portfolio representing each of the
four classification categories adopted by the Commission as of the end
of each of its fiscal quarters.\121\
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    \120\ We are adopting Form N-PORT today in a companion release.
See Investment Company Reporting Modernization, Investment Company
Act Release No. 32314 (October 13, 2016) (``Investment Company
Reporting Modernization Adopting Release'') We discuss the Form N-
PORT reporting requirements related to rule 22e-4 in this Release,
including the requirements that a fund report: (i) The liquidity
classification assigned to each portfolio position (which may be
based on asset type to the extent discussed below); (ii) the asset
type label that the fund has assigned to each portfolio position,
using any asset type labeling scheme the fund employs in its own
portfolio management systems; and (iii) the fund's highly liquid
investment minimum.
    \121\ This information will be reported monthly on Form N-PORT,
but it will be disclosed to the public only for the third month of
each fiscal quarter with a 60-day delay.
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    We are adopting new rule 30b1-10 and Form N-LIQUID to require a
fund to confidentially notify the Commission when the fund's illiquid
investment holdings exceed 15% of its net assets or if its amount of
highly liquid investments declines below its highly liquid investment
minimum for more than a brief period of time. We also are adopting
amendments to Form N-1A to require a fund to publicly disclose certain
information regarding the fund's redemption procedures. Finally, we are
adopting requirements for funds to provide information on Form N-CEN
about funds' use of lines of credit and interfund lending.
    We anticipate that these new requirements will facilitate the
Commission's risk and compliance monitoring efforts by providing
greater transparency regarding the liquidity characteristics of fund
portfolio holdings, as well as its ability to monitor and assess
compliance with rule 22e-4. While Form N-PORT and Form N-CEN are
primarily designed to assist the Commission, we believe that the
requirements to publicly disclose certain information will also help
investors and other potential users utilize information on particular
funds' liquidity-related risks and redemption policies, which in turn
may assist investors in making more informed investment choices.\122\
As further discussed below, we believe that these reporting
requirements strike the right balance between protecting the funds from
certain adverse effects that could arise from public disclosure of
detailed portfolio liquidity information with the need to provide
shareholders and other users with improved information about funds'
liquidity risk profile.
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    \122\ See, e.g., Comment Letter of Markit on the Notice Seeking
Comment on Asset Management Products and Activities, Docket No.
FSOC-2014-0001 (Mar. 25, 2015) (``[W]e believe that liquidity and
redemption risk contained in asset management products can be
mitigated by providing risk managers or investors of pooled
investment vehicles better information about the liquidity risk
associated with pool investments so that they can price it more
accurately. This could be done through, among other things,
disclosures of the `prudent valuation' (accounting for pricing
uncertainty) of the fund's investments and the implementation of
appropriate liquidity risk management policies and procedures.'').
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III. Discussion

A. Program Requirement and Scope of Rule 22e-4

    Today the Commission is adopting rule 22e-4 under the Investment
Company Act. This rule will require each registered open-end management
investment company, including open-end ETFs but not including money
market funds, to establish a written liquidity risk management program.
Rule 22e-4 will not apply to closed-end funds, and will apply to UITs
only to a limited degree, as discussed further below.
1. Liquidity Risk Management Program
    Rule 22e-4 generally will require each registered open-end
management investment company to establish a written liquidity risk
management program. The majority of commenters generally supported the
proposed requirement for each fund to adopt a formal, written liquidity
risk management program,\123\ although many commenters objected to
certain aspects of the proposal and suggested modifications to certain
proposed program elements, as discussed in more detail below. Other
commenters opposed the proposed written program requirement, asserting
that funds have a history of successfully managing their liquidity and
that the proposed requirement was thus unnecessary.\124\ We continue to
believe, as discussed in the Proposing Release, that the program
requirement will produce significant investor protection benefits, in
light of the fact that funds are not currently subject to specific
requirements under

the federal securities laws or Commission rules obliging them to manage
their liquidity risk. Outreach by Commission staff has identified
practices at some funds that raise concerns regarding funds' ability to
meet their redemption obligations and lessen the effects of
dilution.\125\ The Commission is thus adopting, as proposed, a
requirement for each fund to adopt and implement a written liquidity
risk management program.\126\ However, we note that the program
requirement we are adopting incorporates modifications to most of the
proposed program elements.\127\
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    \123\ See, e.g., Comment Letter of Alternative Investment
Management Association (Jan. 13, 2016) (``AIMA Comment Letter'');
Comment Letter of Capital Research and Management Company (Jan. 13,
2016) (``CRMC Comment Letter''); Comment Letter of Cohen & Steers
(Jan. 13, 2016) (``Cohen & Steers Comment Letter''); Comment Letter
of Dechert LLP (Jan. 13, 2016) (``Dechert Comment Letter''); Comment
Letter of Fidelity Management & Research Company (Jan. 13, 2016)
(``Fidelity Comment Letter''); Comment Letter of Association of the
Bar of the City of New York (Jan. 13, 2016) (``NYC Bar Comment
Letter''); Comment Letter of Securities Industry and Financial
Markets Association (Jan. 13, 2016) (Comments on Proposal to Require
Liquidity Risk Management Programs and Related Liquidity
Disclosures) (``SIFMA Comment Letter I''); Comment Letter of T. Rowe
Price (Jan. 13, 2016) (``T. Rowe Comment Letter'').
    \124\ See Comment Letter of Cove Street Capital (Oct. 8, 2015)
(``Cove Street Comment Letter''); Comment Letter of Jim H. Francis
(Nov. 4, 2015); Comment Letter of Jordana Keefer (Jan. 7, 2016)
(``Keefer Comment Letter''); Comment Letter of Don G. Powell (Oct.
5, 2015); Comment Letter of John Wahh (Oct. 1, 2015) (``Wahh Comment
Letter'').
    \125\ See Proposing Release, supra footnote 9, at section
IV.C.1.b.
    \126\ See rule 22e-4(b).
    \127\ As discussed throughout this Release, we believe that
these modifications respond appropriately to specific concerns noted
by commenters and help to increase the effectiveness of the program
requirement in advancing the Commission's goals, while at the same
time reducing associated burdens.
---------------------------------------------------------------------------

    A fund may, as it determines appropriate, expand its liquidity risk
management procedures and related disclosure concerning liquidity risk
beyond the required program elements.\128\ While a fund would be
required to adhere to certain requirements--such as the requirement to
classify the liquidity of a fund's portfolio investments and determine
a highly liquid investment minimum \129\--in other respects, the
proposed program requirements would permit each fund to tailor its
liquidity risk management program to the fund's particular risks and
circumstances. Commenters stressed that many funds are currently
engaged in operational practices that are designed to support fund
liquidity and the redeemability of fund shares.\130\ Commenters also
noted that funds' approaches to liquidity risk management should, and
currently do, differ markedly depending on their individual risks.\131\
We believe that the program requirement will permit funds that already
have programs that satisfy the rule requirements to continue to engage
in the liquidity risk management practices that they have found to be
effective. However, the program requirement's common obligations should
strengthen liquidity risk management across the fund industry, while
also providing important transparency into funds' liquidity profiles
and risk management practices.
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    \128\ See supra footnotes 113-115 and accompanying text for a
description of the required program elements.
    \129\ In-Kind ETFs are excepted from the classification and
highly liquid investment minimum requirements. See infra section
III.J. In addition, funds whose portfolios consist primarily of
highly liquid investments would not be required to determine a
highly liquid investment minimum. See infra section III.D.5.
    \130\ See, e.g., ICI Comment Letter I; BlackRock Comment Letter;
Invesco Comment Letter; Vanguard Comment Letter.
    \131\ See, e.g., ICI Comment Letter I; Dechert Comment Letter;
Vanguard Comment Letter.
---------------------------------------------------------------------------

2. Scope of Rule 22e-4 and Related Disclosure and Reporting
Requirements
    The liquidity risk management program requirements of rule 22e-4,
as well as related disclosure and reporting requirements, will apply to
all registered open-end funds, except money market funds.\132\ Rule
22e-4 will apply to open-end ETFs, but incorporates tailored program
requirements to reflect their particular liquidity-related risks.\133\
The final rule also excludes from the highly liquid investment minimum
requirement funds whose portfolios consist primarily of highly liquid
investments. Closed-end funds are excluded from the scope of rule 22e-
4,\134\ and UITs are not subject to the rule's general program
requirement, although each UIT's principal underwriter or depositor
will be required to determine, on or before the date of the initial
deposit of portfolio securities into the UIT, that the portion of
illiquid investments that the UIT holds or will hold at the date of
deposit that are assets is consistent with the redeemable nature of the
securities it issues.\135\ We discuss these scope determinations in
more detail below.
---------------------------------------------------------------------------

    \132\ Although money market funds are excluded from the scope of
rule 22e-4, they will be subject to the amendments to Form N-1A and
Form N-CEN. See infra section III.A.2.a (``Inclusion of Funds with
All Investment Strategies and Inclusion of ETFs within the Scope of
Rule 22e-4''); section III.A.2.b (``Inclusion of Funds of All Sizes
within the Scope of Rule 22e-4''); and section III.A.2.e
(``Exclusion of Money Market Funds from the Scope of Rule 22e-4'').
    \133\ See infra section III.J.
    \134\ See infra section III.A.2.c (``Exclusion of Closed-End
Funds from the Scope of Rule 22e-4'').
    \135\ See infra section III.K.
---------------------------------------------------------------------------

a. Inclusion of Funds With All Investment Strategies and Inclusion of
ETFs Within the Scope of Rule 22e-4
    We are not excluding funds with any particular strategies from the
scope of rule 22e-4.\136\ We proposed to apply rule 22e-4 to all open-
end funds (except money market funds) regardless of the fund's
investment strategy, stating that even funds with investment strategies
that have historically entailed little liquidity risk could experience
liquidity stresses in certain environments.\137\ We also stated that
different types of funds within the same broad investment strategy
could demonstrate different levels of liquidity and relatedly,
different levels of liquidity risk.
---------------------------------------------------------------------------

    \136\ But see infra section III.D.5 (discussing exclusion of In-
Kind ETFs as well as funds that primarily hold highly liquid
investments from the highly liquid investment minimum requirement).
    \137\ See Proposing Release, supra footnote 9, at nn.123-125 and
accompanying text.
---------------------------------------------------------------------------

    Some commenters expressed concern about the costs of some of the
proposed requirements relative to the liquidity risks typically
associated with certain investment strategies,\138\ as well as concerns
about burdensome effects of some particular requirements for certain
strategies.\139\ Other commenters, however, generally supported a
program requirement that applies to all registered open-end funds,
regardless of the fund's investment strategy.\140\ We believe the
modifications to the proposal we are adopting (in particular, changes
to the classification requirement and the proposed three-day liquid
asset minimum requirement) appropriately address commenters' concerns
and reflect support that some commenters provided for a program
requirement that applies to all registered open-end funds.
---------------------------------------------------------------------------

    \138\ See, e.g., infra footnote 1107 and accompanying text.
    \139\ For example, some commenters expressed concerns about the
extent to which the proposed liquidity classification factors were
applicable to certain investment strategies, particularly funds that
invest in fixed income or other OTC assets (see, e.g., Comment
Letter of Federated Investors, Inc. (Jan. 13, 2016) (``Federated
Comment Letter''); Comment Letter of Government Finance Officers
Association (Jan. 13, 2016) (``GFOA Comment Letter''); Comment
Letter of Nuveen Fund Advisors, LLC (Jan. 13, 2016) (``Nuveen
Comment Letter''); Comment Letter of OppenheimerFunds (Jan. 13,
2016) (``Oppenheimer Comment Letter'')). Commenters also expressed
concerns about the extent to which a three-day liquid asset minimum
requirement could impede an index fund's ability to track its index
(see, e.g., BlackRock Comment Letter; HSBC Comment Letter; Invesco
Comment Letter; SIFMA Comment Letter I).
    \140\ See, e.g., CRMC Comment Letter; Comment Letter of Eaton
Vance Investment Managers (Jan. 13, 2016) (``Eaton Vance Comment
Letter I'').
---------------------------------------------------------------------------

    As noted above, rule 22e-4 will apply to open-end ETFs, although we
are adopting certain tailored program requirements for ETFs.\141\ Some
commenters objected to all or certain proposed program requirements
applying to ETFs.\142\ We respond in detail to these comments in
section III.J below. We note, however, that while ETFs' liquidity risks
can differ from the liquidity risks faced by other open-end funds, ETFs
still have liquidity-related risks that could affect their
shareholders, as well as the broader markets in which they operate. The
tailored requirements that we are

adopting for ETFs respond to commenters' suggestions that the
Commission tie these funds' liquidity risk management obligations to
the particular risks that they face, as well as our assessment of how
these funds' risks could most appropriately be addressed.\143\
---------------------------------------------------------------------------

    \141\ We note that rule 22e-4 only applies to ETFs that are
structured as open-end funds. For ease of reference, however, unless
indicated otherwise, when we refer to ETFs we mean open-end ETFs
only.
    \142\ See infra footnotes 839-841 and accompanying text.
    \143\ See infra section III.J.
---------------------------------------------------------------------------

b. Inclusion of Funds of All Sizes Within the Scope of Rule 22e-4
    Also, as proposed, we are not excluding any fund from the scope of
rule 22e-4 on the basis of size or adopting different liquidity
requirements for relatively small funds. As discussed in the Economic
Analysis section below, smaller funds tend to demonstrate relatively
high flow volatility, and thus we believe they should be subject to the
same liquidity risk management requirements as other funds.\144\
Conversely, some commenters argued that the proposed classification
requirement could unduly burden larger funds by inappropriately making
these funds appear to be less liquid than they actually are, and we
have incorporated certain modifications to the proposed classification
requirement that we believe respond to these concerns, as discussed
below.\145\
---------------------------------------------------------------------------

    \144\ See infra footnote 1160 and accompanying text.
    \145\ See infra section III.C.3.b.
---------------------------------------------------------------------------

c. Exclusion of Closed-End Funds From the Scope of Rule 22e-4
    As proposed, rule 22e-4 would have excluded closed-end investment
companies from the scope of rule 22e-4. As discussed in detail in the
Proposing Release, closed-end funds' liquidity needs are different from
those of open-end funds, because closed-end funds generally do not
issue redeemable securities and are not subject to sections 22(c) and
22(e) of the Investment Company Act.\146\ Although closed-end interval
funds do have to comply with certain liquidity standards under rule
23c-3 and therefore must manage their liquidity risk, we are not
subjecting them to rule 22e-4 because they are already required to
adopt written liquidity procedures under rule 23c-3(b)(10)(iii).\147\
Closed-end interval funds may be better able to anticipate their
liquidity needs than open-end funds because closed-end interval funds
do not permit daily redeemability, closed-end interval funds must limit
the size and timing of repurchase offers, and rule 23c-3 requires
shareholders who wish to tender their shares pursuant to a repurchase
offer to provide advance notice thereof to such funds.\148\ Commenters
uniformly agreed that closed-end funds should be excluded from the
scope of rule 22e-4 and we continue to believe that closed-end funds
(including closed-end interval funds) should be excluded from the
rule's scope.
---------------------------------------------------------------------------

    \146\ See Proposing Release, supra footnote 9, at nn.132-135 and
accompanying text. Certain closed-end funds (``closed-end interval
funds'') do elect to repurchase their shares at periodic intervals
pursuant to rule 23c-3 under the Investment Company Act.
    \147\ See Proposing Release, supra footnote 9, at n.134.
    \148\ See id., at text following n.135.
---------------------------------------------------------------------------

d. Separate Requirements for UITs Under Rule 22e-4
    As proposed, the scope of rule 22e-4 did not include UITs.\149\ As
adopted today, the rule will require a limited liquidity review under
which the UIT's principal underwriter or depositor determines, on or
before the date of the initial deposit of portfolio securities into the
UIT, that the portion of the illiquid investments that the UIT holds or
will hold at the date of deposit that are assets is consistent with the
redeemable nature of the securities it issues.\150\ UITs and their
principal underwriters and depositors will not, however, be subject to
any of the rule's other liquidity risk management program requirements.
---------------------------------------------------------------------------

    \149\ See Proposing Release, supra footnote 9, at section
III.A.2.
    \150\ See rule 22e-4(c). The rule also requires UITs to maintain
a record of that determination for the life of the UIT and for five
years thereafter.
---------------------------------------------------------------------------

    While one commenter supported excluding UITs from the scope of rule
22e-4,\151\ several other commenters argued that ETFs structured as
UITs should be subject to the same rule requirements as ETFs structured
as open-end funds.\152\ We respond in detail to these comments in
section III.K below, including discussing how we believe the
requirement to determine that a UIT's illiquid investment holdings are
consistent with the redeemable nature of the UIT's securities responds
to commenters' concerns.
---------------------------------------------------------------------------

    \151\ See ICI Comment Letter I.
    \152\ See, e.g., Comment Letter of Anonymous (Jan. 13, 2016)
(``Anonymous Comment Letter I''); BlackRock Comment Letter.
---------------------------------------------------------------------------

e. Exclusion of Money Market Funds From the Scope of Rule 22e-4
    Finally, as proposed, money market funds are excluded from the
scope of rule 22e-4. Money market funds are currently subject to
extensive requirements concerning the liquidity of their portfolio
assets that are more stringent in many respects than the requirements
of rule 22e-4, due to the historical redemption patterns of money
market fund investors and the characteristics of the assets held by
money market funds.\153\ Money market funds also are already subject to
broad liquidity-related disclosure and reporting requirements,\154\ and
they have certain tools at their disposal to manage heavy redemptions
that are not available to other open-end funds.\155\ For these reasons,
we did not include money market funds within the scope of the proposed
rule, and commenters uniformly agreed that money market funds should be
excluded from the rule's scope.\156\ We continue to believe that money
market funds should be excluded from the scope of rule 22e-4.
---------------------------------------------------------------------------

    \153\ See Proposing Release, supra footnote 9, at nn.145-150 and
accompanying text.
    \154\ See id., at nn.151-152 and accompanying text.
    \155\ See id., at nn.153-155 and accompanying text.
    \156\ See, e.g., CRMC Comment Letter; Eaton Vance Comment Letter
I; ICI Comment Letter I; Comment Letter of Voya Investment
Management (Jan. 12, 2016) (``Voya Comment Letter'').
---------------------------------------------------------------------------

B. Assessment, Management, and Review of Liquidity Risk

    Section 22(e) of the Investment Company Act requires a registered
investment company \157\ to make payment to shareholders for securities
tendered for redemption within seven days of their tender.\158\ The
legislative history of the Act indicates that shareholder dilution was
a significant concern of the Act's framers.\159\ An open-end fund's
ability to pay redeeming shareholders within this seven-day period
without significant dilution is directly related to its liquidity.
Thus, assessing and managing liquidity risk in a comprehensive manner
is critical to an open-end fund's capacity to honor redemption requests
within this seven-day period, as well as within any shorter time period
disclosed in the fund's prospectus or advertising materials, while
mitigating dilution.
---------------------------------------------------------------------------

    \157\ See supra footnote 4 and accompanying text.
    \158\ See supra footnote 36.
    \159\ See supra footnote 7 and accompanying text.
---------------------------------------------------------------------------

    Today we are adopting a new liquidity risk assessment and
management framework for funds. Specifically, rule 22e-4 requires a
fund to assess, manage, and periodically review its liquidity risk,
considering certain factors as applicable. As discussed in more detail
below, the requirements we are adopting incorporate a definition of
``liquidity risk'' that focuses on whether a fund can meet redemption
requests without significant dilution of remaining investors' interests
rather than, as proposed, whether the fund can meet redemption requests
without materially

affecting the fund's NAV.\160\ We are also adopting certain changes to
the proposed factors that a fund would consider in assessing and
managing its liquidity risk. These changes aim to simplify and
streamline the proposed liquidity risk assessment and management
factors, and reflect additional considerations that the Commission,
along with certain commenters, believes could entail heightened
liquidity risk. Notably, the proposed requirement to consider a fund's
investment strategy and portfolio liquidity in assessing and managing
liquidity risk now incorporates the instruction that this consideration
includes whether the investment strategy is appropriate for an open-end
fund, as well as whether the strategy involves a relatively
concentrated portfolio or large positions in particular issuers.\161\
Additionally, the proposed requirement to consider a fund's short-term
and long-term cash flow projections has been simplified to eliminate
the five separate sub-considerations relevant to this factor that were
incorporated in the proposed rule, but which now are discussed as
guidance in this Release.\162\
---------------------------------------------------------------------------

    \160\ See infra section III.B.1.a.
    \161\ See infra section III.B.2.a.
    \162\ See infra section III.B.2.b.
---------------------------------------------------------------------------

    We proposed liquidity risk assessment and management program
requirements with the primary goals of reducing the risk that funds
would be unable to meet redemption and other legal obligations,
minimizing dilution, and elevating the overall quality of liquidity
risk management across the fund industry while at the same time
providing funds with reasonable flexibility to adopt policies and
procedures that would be most appropriate to assess and manage their
liquidity risk.\163\ As we discuss throughout this section, we believe
that the modified requirements we are adopting today continue to
reflect these goals, while promoting a more efficient and workable
framework.
---------------------------------------------------------------------------

    \163\ See Proposing Release, supra footnote 9, at paragraph
following n.261.
---------------------------------------------------------------------------

1. Definition of ``Liquidity Risk''
    Rule 22e-4, as adopted today, defines ``liquidity risk'' as the
risk that a fund could not meet requests to redeem shares issued by the
fund without significant dilution of remaining investors' interests in
the fund.\164\ This definition is largely similar to the proposed
definition of ``liquidity risk,'' that is, the risk that a fund could
not meet requests to redeem shares issued by the fund that are expected
under normal conditions, or are reasonably foreseeable under stressed
conditions, without materially affecting the fund's NAV.\165\ However,
in response to comments, the revised definition substitutes the phrase
``without significant dilution of remaining investors' interests in the
fund'' for the phrase ``without materially affecting the fund's net
asset value.'' The definition also does not include references to
redemption requests that are expected under normal conditions or
reasonably foreseeable under stressed conditions. Instead, the final
definition simply refers to ``requests to redeem.'' We believe our
modifications to the liquidity risk factors used to assess a fund's
liquidity risk, as discussed below, make any reference to market
conditions within the definition of liquidity risk unnecessary,
confusing, and duplicative.\166\
---------------------------------------------------------------------------

    \164\ When determining whether a fund's liquidity risk will
cause significant dilution for purposes of this definition, a fund
should consider the impact of liquidity risk on the total net assets
of the fund and the adverse consequences such dilution will have on
all the fund's remaining shareholders. Furthermore, as discussed
above, a fund's inability to meet redemption requests may cause harm
to shareholders. See, e.g., supra footnotes 81-84 and accompanying
text for a discussion of the suspension of shareholder redemptions
in the Third Avenue Focused Credit Fund following a period of heavy
redemptions that the fund stated reduced the fund's portfolio
liquidity.
    \165\ See proposed rule 22e-4(a)(7); see also Proposing Release,
supra footnote 9, at text accompanying n.255.
    \166\ See rule 22e-4(b)(1)(i).
---------------------------------------------------------------------------

a. Evaluating Risk of Significant Dilution of Remaining Investors'
Interests
    Multiple commenters objected to the proposed inclusion of any NAV-
impact standard in the definition of ``liquidity risk.'' One commenter
argued that including the concept of ``without materially affecting the
fund's net asset value'' in the definition of liquidity risk would
inappropriately merge liquidity and valuation, which are subject to
different regulatory and compliance controls.\167\ Many commenters also
objected that including such a price concept in the definition of
``liquidity risk'' would incorrectly indicate that market impact can be
accurately identified and measured separate from market price movements
generally.\168\ These commenters argued that many factors (including
market volatility, portfolio composition, and trade execution and
activity) influence the price at which a fund transacts in a security
as well as the levels of cash the fund holds, and thus it is difficult
to identify the effects of the fund's transaction activity on the
fund's NAV. Finally, some commenters argued that the inclusion of a
NAV-impact standard in the definition of ``liquidity risk'' could lead
investors to believe that appropriate liquidity risk management will
protect their investments from declining in value.\169\
---------------------------------------------------------------------------

    \167\ See SIFMA Comment Letter I.
    \168\ See, e.g., Comment Letter of Credit Suisse (Jan. 13, 2016)
(``Credit Suisse Comment Letter''); Comment Letter of Dodge & Cox
(Jan. 21, 2016) (``Dodge & Cox Comment Letter''); Comment Letter of
MFS Investment Management (Jan. 13, 2016) (``MFS Comment Letter'');
SIFMA Comment Letter I; Comment Letter of Investment Company
Institute (May 17, 2016) (``ICI Comment Letter III'') (encouraging
the Commission to adopt a definition of liquidity risk that
incorporates language related directly to dilution rather than value
impact on the NAV).
    \169\ See, e.g., ICI Comment Letter I; MFS Comment Letter; SIFMA
Comment Letter I.
---------------------------------------------------------------------------

    While we agree that liquidity and valuation are distinct concepts,
we consider these concepts as having certain inter-relationships.
First, liquidity risk in an open-end fund inherently involves an
assessment of the liquidity of the fund's investments. Common
definitions of investment liquidity include consideration of the value
impact or costs from trading that investment.\170\ Second, our staff
has observed in its outreach many occasions when a fund was unwilling
to transact

in certain portfolio investments when such sales would yield a price
that the fund considered unacceptable.\171\ This relationship is clear
in the Commission guidelines limiting a fund's investment in illiquid
investments. These guidelines specify that an illiquid investment is
one that cannot be sold or disposed of within seven days at
approximately the value at which the fund has valued the investment''
(emphasis added).\172\ We continue to believe that the inclusion of a
conceptual relationship between liquidity and sale price in the
definition of ``liquidity risk'' is appropriate.\173\ Such a
relationship indicates that liquidity risk involves the risk that a
fund will not be able to meet redemption requests under any
circumstances, as well as the risk that a fund could meet redemption
requests, but only in a manner that adversely affects the fund's non-
redeeming shareholders through significant dilution.\174\
---------------------------------------------------------------------------

    \170\ See, e.g., Radhakrishnan Gopalan, et al., Asset Liquidity
and Stock Liquidity, 47 J. Fin & Quant. Anal. 333 (2012), available
at http://apps.olin.wustl.edu/faculty/gopalan/asset_stock_liquidity.pdf (``An asset is liquid if it can be
converted into cash quickly and at a low cost.''); Yakov Amihud &
Haim Mendelson, Liquidity, Asset Prices, and Financial Policy, 47
Fin. Anal. J. 56 (1991), available at http://www.jstor.org/stable/4479488?seq=1#page_scan_tab_contents (``An asset is liquid if it can
be bought or sold at the current market price quickly and at low
cost.'').
    In addition, we note that many funds disclose liquidity risk as
a principal investment risk in their prospectuses, and these
disclosures often reference possible adverse value impacts from
selling fund investments under certain conditions. See, e.g., Schwab
Strategic Trust rule 485(b) Registration Statement (June 30, 2016),
available at https://www.sec.gov/Archives/edgar/data/1454889/000119312516632635/d203200d485bpos.htm (``Liquidity Risk. The fund
may be unable to sell certain securities, such as illiquid
securities, readily at a favorable time or price, or the fund may
have to sell them at a loss.''); Voya Variable Funds rule 485(b)
Registration Statement (May 1, 2016), available at https://www.sec.gov/Archives/edgar/data/2664/000119312516562669/d124096d485bpos.htm (``Liquidity: If a security is illiquid, the
[fund] might be unable to sell the security at a time when the
[fund's] manager might wish to sell, or at all. Further, the lack of
an established secondary market may make it more difficult to value
illiquid securities, exposing the [fund] to the risk that the price
at which it sells illiquid securities will be less than the price at
which they were valued when held by the [fund]. The prices of
illiquid securities may be more volatile than more liquid
investments. The risks associated with illiquid securities may be
greater in times of financial stress. The [fund] could lose money if
it cannot sell a security at the time and price that would be most
beneficial to the Portfolio.'').
    \171\ That is, the price that a portfolio manager could
realistically receive for certain portfolio investments could, in
effect, render such investments de facto illiquid if these pricing
considerations cause the portfolio manager to refrain from selling
them. See, e.g., Third Avenue Temporary Order, supra footnote 12
(``On December 9, 2015, after considering the environment the Fund
was in and the likelihood that incremental sales of portfolio
securities to satisfy additional redemptions would have to be made
at prices that would unfairly disadvantage all remaining
shareholders, the Board determined that the fairest action on behalf
of all shareholders would be to adopt a plan of liquidation.'').
    \172\ See supra footnote 39 and accompanying text.
    \173\ We also note that several commenters favorably discussed
foreign and international regulators' liquidity risk management
regimes, including ones that define the concepts of liquid (or
illiquid) portfolio assets, as well as funds' liquidity risk, with
reference to value impact or a discount that the fund may incur upon
sale. See, e.g., Dechert Comment Letter (favorably discussing
certain liquidity risk management requirements, including the
definition of ``liquidity risk,'' under the UCITS Directive); ICI
Comment Letter I (noting that the Commission could look to other
jurisdictions, including the European Union, for support for a
principles-based program rule); Invesco Comment Letter (also noting
that the UCITS Directive provides a framework for a principles-based
liquidity risk management program requirement); see also Commission
Directive 2010/43/EU, OJ L 176 (2010), at Ch. 1, Art. 3(8) (defining
``liquidity risk'' as ``the risk that a position in the UCITS
portfolio cannot be sold, liquidated or closed at limited cost in an
adequately short time frame and that the ability of the UCITS to
comply at any time with its redemption obligation is thereby
compromised''); Ontario Securities Commission, Report on Staff's
Continuous Disclosure Review of Mutual Fund Practices Relating to
Portfolio Liquidity, OSC Staff Notice 81-727 (June 25, 2015)
(definition of ``illiquid asset'' refers to the ``ability to readily
dispose of a portfolio asset through a market facility on which
public quotations are available at a price that approximates the
amount at which the portfolio asset is valued'').
     We note as well that U.S. banking regulators have defined
``liquidity'' as ``a financial institution's capacity to meet its
cash and collateral obligations at a reasonable cost.'' Interagency
Policy Statement on Funding and Liquidity Risk Management, 75 FR
13656 (Mar. 22, 2010), available at http://www.occ.gov/news-issuances/federal-register/75fr13656.pdf.
    \174\ See supra footnote 79 and accompanying text.
---------------------------------------------------------------------------

    We believe a definition of ``liquidity risk'' that includes a
reference to the value impact from trading portfolio investments should
not imply that mutual fund shareholders are guaranteed a protected NAV
or that the fund cannot sell investments at a loss due to market risk,
credit deterioration, or liquidity risk. Indeed, funds' narrative risk
disclosure in their registration statements and other shareholder
communications generally should make clear those risks that could
adversely affect the fund's NAV, yield, and total return, including
liquidity-related risks.\175\ However, we believe defining liquidity
risk clarifies what funds must manage under rule 22e-4, and, for the
reasons discussed above, we believe impacts on valuation may play a
significant role in evaluating the ability to effectively meet
shareholder redemptions while lessening the effects of dilution.
---------------------------------------------------------------------------

    \175\ See, e.g., Item 4(b) of Form N-1A.
---------------------------------------------------------------------------

    Nonetheless, we agree with commenters that using the proposed
specific standard of ``materially affecting the fund's NAV'' may pose
certain challenges. We recognize that it may be difficult to calculate
the particular market impact that a fund's transactions in an
investment will have on that investment's price, which some commenters
suggested was inherent to the proposed standard. There could be other
reasons for a fund's NAV fluctuating, separate from the fund's sales of
portfolio investments to meet redemption requests as well.
    Accordingly, in the final rule we have modified the NAV-impact
standard in the definition of ``liquidity risk'' to substitute the
phrase ``without significant dilution of remaining investors' interests
in the fund'' for the phrase ``without materially affecting the fund's
net asset value.'' This revised standard more directly corresponds to
the concerns of the Act \176\ and rule 22e-4 by focusing on meeting
investor redemptions without dilution.
---------------------------------------------------------------------------

    \176\ See supra footnote 32and accompanying text for a
discussion of the liquidity concerns of the Act.
---------------------------------------------------------------------------

    We also note that commenter interpretations of the term
``materially'' varied, with some commenters adopting very narrow
interpretations \177\ of the term and others taking a more broad
view.\178\ We note that, for purposes of this definition, the term
``significant'' is not meant to reference slight NAV movements, the
causes of which may not be easily distinguishable, nor is it limited
only to fire-sale situations. Instead, a fund's liquidity risk
management program should focus on the fund's ability to meet
redemptions in a manner that does not harm shareholders.\179\ In
particular, ``significant'' dilution of remaining investors' interests
in the fund can occur at much lower levels of dilution than what would
occur in a fire sale situation. We believe ``significant'' conveys more
effectively than ``materially'' that the definition is not meant to
reference slight NAV movements, while avoiding the confusion around the
term ``materially'' evident in the comment letters and better focusing
the rule on the level of dilution that would harm remaining investors'
interests even in the absence of a fire sale.
---------------------------------------------------------------------------

    \177\ See Comment Letter of Interactive Data Pricing and
Reference Data (Dec. 18, 2015) (``Interactive Data Comment Letter'')
(noting that there are several possible interpretations of the term,
including an NAV price impact based on a one penny movement, among
others.).
    \178\ See SIFMA Comment Letter I (proposing the Commission
substitute the phrase ``assuming no fire-sale discounting'' for the
phrase ``without materially affecting the fund's net assets'' and
arguing that a fire-sale standard is a more appropriate outer
boundary for price movements.). We believe that adopting a fire-sale
standard as the outer boundary for price movements would be
inappropriate because such an extreme outer boundary would fail to
capture a fund's liquidity risk exposure during normal and stressed
conditions and would, thus, inadequately address the liquidity risk
management concerns of rule 22e-4.
    \179\ The classification requirements under rule 22e-4 include a
value impact standard as well, which is based on the number of days
within which it is determined that an investment would be
convertible to cash (or, in the case of the less-liquid and illiquid
categories, sold or disposed of) without the conversion (or, in the
case of the less-liquid and illiquid categories, sale or
disposition) significantly changing the market value of the
investment. See infra section III.C and accompanying text.
---------------------------------------------------------------------------

    Under rule 22e-4, a fund would be required to adopt a liquidity
risk management program that is ``reasonably designed to assess and
manage the fund's liquidity risk.'' A fund's liquidity risk management
program should be appropriately tailored to reflect that fund's
particular liquidity risks. Therefore, while a fund is required to
consider certain liquidity risk factors specified in rule 22e-4 as
applicable, a fund may also, as it determines appropriate, expand its
liquidity risk management program beyond the required program elements,
and must do so to the extent it would be necessary to effectively
assess and manage its liquidity risk.\180\ This

requirement, however, requires a fund to assess and manage liquidity
risk and does not require a fund to eliminate all adverse impacts of
liquidity risk, which would be incompatible with an investment product
such as a mutual fund or ETF, whose NAV may fluctuate for a variety of
reasons, including changing liquidity conditions.
---------------------------------------------------------------------------

    \180\ Rule 22e-4(b) requires that a fund ``adopt and implement a
written liquidity risk management program that is reasonably
designed to assess and manage its liquidity risk,'' and identifies
certain specific elements that a fund must consider in doing so.
---------------------------------------------------------------------------

b. Expected and Reasonably Foreseeable Redemption Requests
    As proposed, the definition of ``liquidity risk'' would have
required funds to consider redemption requests that are expected under
normal conditions, as well as those that are reasonably foreseeable
under stressed conditions. Some commenters stated that the concept of
redemption requests that are reasonably foreseeable under stressed
conditions was vague and could subject funds to ex-post second
guessing.\181\ One commenter suggested that the Commission clarify: (i)
Whether funds should address both normal and reasonably foreseeable
stressed conditions (or select one set of conditions) in assessing
liquidity risk; and (ii) the level of market stress that funds should
assume in conducting a liquidity risk assessment.\182\
---------------------------------------------------------------------------

    \181\ See Federated Comment Letter; NYC Bar Comment Letter.
    \182\ See AFR Comment Letter.
---------------------------------------------------------------------------

    The final definition of liquidity risk eliminates references to
redemption requests that are expected under normal conditions or
reasonably foreseeable under stressed conditions. The final definition
simply refers to ``requests to redeem.'' We believe our modifications
to the liquidity risk factors used to assess a fund's liquidity risk,
including the clarification that a fund must consider certain liquidity
risk factors both during normal and reasonably foreseeable stressed
conditions, makes any reference to market conditions within the
definition of liquidity risk unnecessary, confusing and duplicative. We
believe the revised definition also addresses commenters' concerns that
the proposed definition was unclear. We have provided guidance below
regarding each liquidity risk factor and the need to consider normal
and reasonably foreseeable stressed market conditions.
2. Liquidity Risk Factors
    Rule 22e-4 will require each fund to assess, manage, and
periodically review (with such review occurring no less frequently than
annually) its liquidity risk, considering the following factors as
applicable:
     Investment strategy and liquidity of portfolio investments
during both normal and reasonably foreseeable stressed conditions
(including whether the investment strategy is appropriate for an open-
end fund, the extent to which the strategy involves a relatively
concentrated portfolio or large positions in particular issuers, and
the use of borrowings for investment purposes and derivatives);
     Short-term and long-term cash flow projections during both
normal and reasonably foreseeable stressed conditions; and
     Holdings of cash and cash equivalents, as well as
borrowing arrangements and other funding sources.\183\
---------------------------------------------------------------------------

    \183\ See rule 22e-4(b)(1)(i). We note that rule 22e-4 as
adopted also includes two additional factors that an ETF will have
to consider as applicable in assessing, managing, and periodically
reviewing its liquidity risk, which reflect potential liquidity-
related concerns that could arise from the structure and operation
of ETFs (including In-Kind ETFs). These are: (i) The relationship
between the ETF's portfolio liquidity and the way in which, and the
prices and spreads at which, ETF shares trade, including, the
efficiency of the arbitrage function and the level of active
participation by market participants (including authorized
participants); and (ii) the effect of the composition of baskets on
the overall liquidity of the ETF's portfolio. These factors are
discussed in more detail below. See infra section III.J.
---------------------------------------------------------------------------

    A fund may incorporate other considerations, in addition to these
factors, in evaluating its liquidity risk.
    Like the rule we are adopting today, rule 22e-4 as proposed would
have required each fund to assess its liquidity risk, taking certain
specified factors into account.\184\ Specifically, the proposed rule
would have required each fund to take the following factors into
account in assessing the fund's liquidity risk: (i) Short-term and
long-term cash flow projections, considering size, frequency, and
volatility of historical purchases and redemptions of fund shares
during normal and stressed periods; the fund's redemption policies; the
fund's shareholder ownership concentration; the fund's distribution
channels; and the degree of certainty associated with the fund's short-
term and long-term cash flow projections; (ii) the fund's investment
strategy and liquidity of portfolio investments; (iii) use of
borrowings and derivatives for investment purposes; and (iv) holdings
of cash and cash equivalents, as well as borrowing arrangements and
other funding sources.\185\ The person(s) designated to administer the
liquidity risk management program must also conduct reviews of the
adequacy and effectiveness of the implementation of the liquidity risk
management program, and such reviews must occur no less frequently than
annually.\186\ Commenters generally supported the requirement for a
fund to assess its liquidity risk.\187\ Additionally, some commenters
expressed support for the proposed liquidity risk factors, as well as
the proposed requirement to consider these factors in assessing
liquidity risk.\188\ However, several commenters objected to the
proposed requirement for a fund to consider certain specified factors
and suggested instead that consideration of the factors be permissive
instead of mandatory.\189\
---------------------------------------------------------------------------

    \184\ See Proposing Release, supra footnote 9, at section
III.C.1.
    \185\ See proposed rule 22e-4(b)(2)(iii).
    \186\ See id.
    \187\ See, e.g., AFR Comment Letter; Comment Letter of CFA
Institute (Jan. 12, 2016) (``CFA Comment Letter''); FSR Comment
Letter; ICI Comment Letter I.
    \188\ See, e.g., AFR Comment Letter; CRMC Comment Letter; ICI
Comment Letter I; Invesco Comment Letter.
    \189\ See, e.g., CFA Comment Letter; MFS Comment Letter; Voya
Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that the factors are central to evaluating
and managing a fund's liquidity risk and that requiring each fund to
consider, as a baseline, a standard set of factors for assessing and
managing liquidity risk would promote effective and thorough liquidity
risk management across the fund industry. However, we recognize that
some of the proposed factors may not be applicable in assessing and
managing the liquidity risk of certain funds or types of funds.\190\
One commenter requested that we clarify that a fund only needs to
consider factors relevant to its operations, which may include some or
all of the factors outlined in rule 22e-4, and others not
enumerated.\191\ We agree, and to the extent any liquidity risk factor
specified in rule 22e-4 is not applicable to a particular fund, the
fund will not be required to consider it in assessing and managing its
liquidity risk. We have therefore added the words ``as applicable'' in
the rule's instruction to consider the specified factors.\192\ For
example, a fund will not be required to consider the use of borrowings
for investment purposes and derivatives, as specified under rule 22e-
4(b)(1)(i)(A), if that fund does not engage in borrowing

or use derivatives. Similarly, a fund that maintains borrowing sources
for investment purposes will be required to consider the use of
borrowings for investment purposes as specified under the rule. We also
believe that condensing and simplifying the proposed factors helps
respond to commenters' concerns that the proposed factors were overly
complex \193\ and potentially inapplicable to certain funds.\194\
---------------------------------------------------------------------------

    \190\ See Proposing Release, supra footnote 9, at section
III.C.1.
    \191\ See ICI Comment Letter I.
    \192\ See rule 22e-4(b)(1)(i) (requiring a fund to consider,
``as applicable,'' certain factors); see also FSR Comment Letter
(supporting the proposed liquidity risk assessment requirement and
agreeing with the Commission's position in the proposal that a fund
would not be required to consider those factors that are not
applicable to that particular fund).
    \193\ See, e.g., Comment Letter of Better Markets, Inc. (Jan.
13, 2016) (``Better Markets Comment Letter'').
    \194\ See, e.g., ICI Comment Letter I; MFS Comment Letter.
---------------------------------------------------------------------------

    As noted above, this list of liquidity risk factors is not meant to
be exhaustive. In assessing, managing, and periodically reviewing its
liquidity risk, a fund may take into account considerations in addition
to the factors set forth in rule 22e-4 and must do so to the extent
necessary to adequately assess and manage the fund's liquidity
risk.\195\ For example, as discussed in the Proposing Release, if a
fund elects to conduct stress testing to determine whether it has
sufficient liquid investments to cover different levels of redemptions,
a fund may wish to incorporate the results of this stress testing into
its liquidity risk assessment and management.\196\ We continue to
believe that stress tests that analyze the proposed factors could be
particularly useful to a fund in evaluating its liquidity risk.
---------------------------------------------------------------------------

    \195\ See note 180 and accompanying text.
    \196\ See Proposing Release, supra footnote 9, at paragraph
accompanying n.266.
---------------------------------------------------------------------------

    Below we provide guidance on specific issues associated with each
of the liquidity risk factors and also discuss the Commission's
decision to adopt each of these factors (some with modifications).
a. Investment Strategy and Portfolio Liquidity
    We are adopting the proposed requirement for a fund to consider its
investment strategy and portfolio liquidity in assessing, managing, and
periodically reviewing its liquidity risk, but with certain
modifications in response to commenters.\197\ The principal changes
include a requirement to consider whether the investment strategy is
appropriate for an open-end fund, as well as the extent the strategy
involves a relatively concentrated portfolio or large positions in
particular issuers, and a clarification that this factor should be
assessed both during normal and reasonably foreseeable stressed
conditions.
---------------------------------------------------------------------------

    \197\ See rule 22e-4(b)(1)(i)(A).
---------------------------------------------------------------------------

    We continue to believe that various aspects of a fund's investment
strategy--including whether the fund is actively or passively managed
\198\ and a fund's portfolio management decisions that are meant in
part to decrease an undesirable tax impact on the fund \199\-- could
significantly affect the fund's liquidity risk. Also the extent to
which the fund is diversified, including a fund's status as a regulated
investment company under Subchapter M of the Internal Revenue Code, as
well as its principal investment strategies as disclosed in its
prospectus, could affect its liquidity risk in that the fund could be
limited by its diversification obligations in its ability to sell
certain portfolio securities.\200\ We note, for example, that the Third
Avenue Focused Credit Fund stated that its status as a regulated
investment company under Subchapter M limited the fund's ability to
return cash to its shareholders after it suspended redemptions because
of its need to comply with certain asset diversification tests to
maintain its regulated investment company status.\201\ As discussed in
the Proposing Release, we also continue to caution that while a fund's
investment strategy is an important factor in evaluating a fund's
liquidity risk, different types of funds within the same broad
investment strategy may demonstrate different levels of liquidity, (and
thus, presumably, different levels of liquidity risk).\202\
---------------------------------------------------------------------------

    \198\ See Proposing Release, supra footnote 9, at paragraph
accompanying nn.292-295 (discussing factors that could increase or
decrease the liquidity risk associated with index-based strategies
versus actively-managed strategies).
    \199\ See Proposing Release, supra footnote 9, at paragraph
accompanying n.299 (detailing the ways in which a fund's tax
management strategy could make its portfolio managers unwilling to
sell certain portfolio assets in order to meet redemptions, which
could in turn increase the fund's liquidity risk compared to a
similarly situated fund).
    \200\ See Proposing Release, supra footnote 9, at paragraph
accompanying nn.296-298 (discussing the extent to which a fund's
portfolio is diversified (or, relatedly, a fund's concentration in
certain types of portfolio assets) could have ramifications on the
fund's potential liquidity risk, including the ways that various
diversification requirements could constrain its ability to sell
certain portfolio securities in order to meet redemptions).
    \201\ See Third Avenue Focused Credit Fund Update (Mar. 8,
2016), available at http://thirdave.com/wp-content/uploads/2016/04/03-09-16-FCF-Call-Transcript-1.pdf (noting that, because one of the
diversification tests under Subchapter M would require the fund to
have less than 50% of its assets in concentrated positions, the fund
needed to retain cash in order not to violate this test, in light of
the manner in which it chose to manage the fund's liquidation of its
other assets).
    \202\ See Proposing Release, supra footnote 9, at n.301 and
accompanying text.
---------------------------------------------------------------------------

Consideration of Strategy Appropriateness for Open-End Fund Structure
    We are adopting several modifications to the proposed requirement
to consider a fund's investment strategy and portfolio liquidity in
assessing, managing, and periodically reviewing its liquidity risk.
First, we clarify in final rule 22e-4 that consideration of investment
strategy must take into account whether the fund's strategy is
appropriate for an open-end fund. This clarification reflects several
commenters' suggestions that a fund's liquidity risk management program
could (or should) involve a consideration of whether the fund's
investment strategy and permissible holdings are suitable for the open-
end structure.\203\
---------------------------------------------------------------------------

    \203\ See BlackRock Comment Letter (``[W]e recommend that the
Commission consider whether funds should be required to explicitly
address the level of position concentration that is appropriate for
the fund's investment strategy and investor profile in [liquidity
risk management] policies and procedures''); ICI Comment Letter I
(``A risk-based liquidity management program could require a fund
manager, when launching a new mutual fund, to assess whether the
fund's investment strategy and permissible holdings are suitable for
the open-end structure in light of [its] liquidity
characteristics.''); see also CRMC Comment Letter (encouraging the
Commission to consider whether certain funds may be inappropriate
for the open-end fund structure).
---------------------------------------------------------------------------

    We agree with this suggestion raised by commenters. As discussed
above, all open-end funds are subject to section 22(e) of the
Investment Company Act, which requires a fund to pay redemption
proceeds within seven days after receipt of a redemption request, and
hold themselves out at all times as being able to meet redemptions (in
many cases within an even shorter period of time).\204\ To the extent
that a fund's investment strategy involves investing in securities
whose liquidity is limited, or otherwise entails a significant degree
of liquidity risk, the fund may not be able to meet its redemption and
other legal obligations, or may not meet redemptions without diluting
its shareholders' interests in the fund. We understand that it is a
common best practice for a fund and its management to consider the
appropriateness of a fund's investment strategy in the context of
launching an open-end fund, and then for an open-end fund to continue
to manage its liquidity risk such that its strategy and holdings remain
appropriate for the open-end structure. However, not all funds appear
to consider this. Also, as we have observed funds beginning to pursue
more complex investment

strategies,\205\ we believe it is appropriate to require that each
open-end fund consider whether it has a liquidity risk management
framework in place that corresponds with the liquidity risks inherent
in its strategy and its structure as a fund that offers redeemable
securities.
---------------------------------------------------------------------------

    \204\ See supra footnotes 34-36, 42-47 and accompanying text.
    \205\ See supra footnote 11 and accompanying text.
---------------------------------------------------------------------------

    We believe that specifically requiring an open-end fund to consider
whether its investment strategy is appropriate for the open-end
structure would supplement existing practices and provide an important
additional layer of shareholder protection. For example, this
requirement will likely cause funds to evaluate the suitability of
investment strategies that will be permitted under the 15% illiquid
investment requirement, but still could entail significant liquidity
risk--such as strategies involving highly concentrated portfolios, or
strategies involving investment in portfolio investments that are so
sensitive to stressed conditions that funds may not be able to find
purchasers for those investments during stressed periods.\206\
Furthermore, funds that have significant holdings of securities with
extended settlement periods may face challenges operating as open-end
funds and should take these holdings into account when determining
whether the fund's portfolio is appropriate for an open-end fund.\207\
For example, primarily holding securities with extended settlement
periods beyond seven days may not be appropriate for an open-end fund,
as primarily having such extended settlement holdings may raise
concerns with the fund's ability to meet redemptions within seven days,
particularly if the fund has not established adequate other sources of
liquidity.
---------------------------------------------------------------------------

    \206\ We note that, when a fund files its initial registration
statement and post-effective amendments thereto with the
Commission's Division of Investment Management for review,
Commission staff could request information from the fund regarding
the fund's basis for determining that its investment strategy is
appropriate for the open-end structure, just as staff currently may
request information from a fund to support its disclosure reflecting
the fund's compliance with various provisions of the Investment
Company Act and rules thereunder.
    \207\ See infra footnote 378 and accompanying text.
---------------------------------------------------------------------------

    Because a fund will be required to consider the liquidity risk
factors (as applicable) in periodically reviewing its liquidity risk,
the final rule requires a fund's periodic liquidity risk review to
include a consideration of whether the fund's investment strategy is
appropriate for an open-end fund.\208\ For example, if a fund's
illiquid investments exceed 15% of net assets, this could indicate that
the fund is encountering liquidity pressures that could significantly
impair the fund's ability to meet its redemption and other legal
obligations. In this case, we believe it would be appropriate for a
fund to review and potentially update its liquidity risk management
procedures for handling the fund's high levels of illiquid investment
holdings. In circumstances in which it appears unlikely that the fund
will be able to reduce its illiquid investment holdings to or below 15%
within a period of time commensurate with its redemption obligations, a
fund's periodic liquidity risk review could lead the fund to reconsider
its continued operation as an open-end fund.\209\
---------------------------------------------------------------------------

    \208\ See infra section III.B.3.
    \209\ Moreover, we note that actions that either directly or
indirectly extinguish the rights of shareholders to redeem their
shares could, depending on the facts and circumstances, involve
violations of section 22(e) and other provisions of the Act, such as
section 48(a) (prohibiting a person from doing indirectly, through
another person, what that person is prohibited by the Act from doing
directly).
---------------------------------------------------------------------------

Consideration of Portfolio Concentration, and Holdings of Large
Portfolio Positions
    We also are adopting a modification to the proposed liquidity risk
factors to clarify that consideration of a fund's investment strategy
must include an evaluation of whether the strategy involves a
relatively concentrated portfolio or large positions in particular
issuers. Some commenters suggested that funds with extraordinarily
concentrated portfolios may have particular liquidity risks that could
make redeemability from these funds especially challenging.\210\ Our
evaluation of these comments, together with recent events discussed
below, have led us to revise the proposed ``investment strategy''
liquidity risk factor to focus on fund concentration issues.
---------------------------------------------------------------------------

    \210\ See, e.g., BlackRock Comment Letter; CRMC Comment Letter;
ICI Comment Letter I; Invesco Comment Letter.
---------------------------------------------------------------------------

    We believe that this component of a fund's investment strategy is a
particularly significant factor in evaluating the extent to which
investment strategy contributes to liquidity risk. As we noted in the
Proposing Release, while a fund with a relatively more diversified
portfolio that needs to sell portfolio investments to build liquidity
may be able to select investments for sale based on whether the markets
for those investments are favorable, a relatively less diversified fund
may have fewer options (i.e., because it has less choice of investments
to sell or because the markets for its portfolio investments are
uniform or correlated) and could thus be compelled to transact in
unfavorable markets.\211\ In addition, as discussed below, holding a
large portion of a particular issue could adversely affect a fund's
ability to convert the position to cash without a value impact, and
this can hamper a fund's portfolio management flexibility due to the
higher liquidity risk in its positions.\212\ Thus, we believe that
investment strategies that involve holding large portions of a
particular issue--particularly if the market for these securities is
thinly traded \213\ or if the fund's strategy involves investment in a
relatively small number of holdings--could notably increase a fund's
liquidity risk. As discussed above, the recent suspension of
redemptions by Third Avenue Focused Credit Fund, which had a
concentrated portfolio and large holdings of particular issues,
illustrates how these methods of concentration directly affect
liquidity risk, which in turn could adversely affect shareholders to
the extent that they are not able to redeem their shares, or redeem
their shares only at a significant discount.\214\
---------------------------------------------------------------------------

    \211\ See Proposing Release, supra footnote 9, at paragraph
accompanying nn.296-298.
     However, as also discussed above, the extent to which a fund is
required to be diversified, including a fund's status as a regulated
investment company under Subchapter M of the Internal Revenue Code,
could affect its liquidity risk in that the fund could be limited by
its diversification obligations in its ability to sell certain
portfolio securities. See supra footnotes 200-201 and accompanying
text.
    \212\ See infra footnote 440 and accompanying text; infra
paragraph accompanying footnote 450.
    \213\ See infra footnote 544 and accompanying text.
    \214\ See, e.g., Jeffrey Ptak & Sarah Bush, Third Avenue Focused
Credit Abruptly Shuttered, Morningstar (Dec. 11, 2015), available at
http://ibd.morningstar.com/article/article.asp?id=733021&CN=brf295,http://ibd.morningstar.com/archive/archive.asp?inputs=days=14;frmtId=12,%20brf295 (noting that ``Third
Avenue Focused Credit stood out for its large, concentrated
allocation to distressed and other low-quality fare''); see also
Third Avenue Temporary Order, supra footnote 12 (noting that
``Applicants further state that relief permitting the Fund to
suspend redemptions in connection with its liquidation would permit
the Fund to liquidate its assets in an orderly manner and prevent
the Fund from being forced to sell assets at unreasonably low prices
to meet redemptions.'').
---------------------------------------------------------------------------

Use of Borrowings for Investment Purposes and Derivatives
    We have incorporated the proposed requirement to consider a fund's
use of borrowings for investment purposes and derivatives within the
requirement to consider investment strategy in assessing, managing, and
periodically reviewing a fund's liquidity risk.\215\ As

proposed, this consideration was not included within the investment
strategy factor, but instead was a stand-alone liquidity risk factor.
However, we believe that including this consideration within the
general investment strategy factor is clearer, because a fund's use of
borrowings for investment purposes and derivatives may be viewed as a
component of its investment strategy. We note that we have also revised
the phrase ``use of borrowings and derivatives for investment
purposes'' that was used in the Proposing Release, and instead are
using the term, ``use of borrowings for investment purposes and
derivatives'' in the final rule. We have made this revision in order to
clarify that funds should consider all derivatives, including those
used for hedging purposes. As proposed, this provision could
potentially have been read to exclude the consideration of derivatives
used for hedging, which was not the intent of the proposed requirement.
We believe this clarification will make clear that the requirement is
for a fund to consider both use of borrowings for investment purposes
and use of derivatives in general. One commenter stated that it agreed
that funds should consider the use of derivatives when assessing
liquidity risk, including the extent and types of derivatives used, as
well as the structure and terms of a fund's derivatives
transactions.\216\ No commenters suggested that a fund's use of
borrowings for investment purposes and derivatives is inapplicable to a
fund's liquidity risk (provided that the fund engages in borrowing or
uses derivatives \217\).
---------------------------------------------------------------------------

    \215\ See proposed rule 22e-4(b)(2)(iii)(C); rule 22e-
4(b)(1)(i)(A).
    \216\ See CFA Comment Letter.
    \217\ See supra footnotes 191-192 and accompanying text
(clarifying that, to the extent one of the factors specified in rule
22e-4(b)(1)(i) is not applicable to a particular fund, the fund
would not be required to consider that factor in assessing its
liquidity risk).
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    We continue to believe that the potential effects of the use of
borrowings for investment purposes and derivatives are relevant to
assessing, managing, and periodically reviewing a fund's liquidity
risk.\218\ As we noted in the Proposing Release, borrowing for
investment purposes, whether from a bank \219\ or through financing
transactions such as reverse repurchase agreements and short
sales,\220\ may affect a fund's liquidity risk.\221\ Similarly, a
fund's use of derivatives such as futures, forwards, swaps and written
options may affect a fund's liquidity risk as well.\222\ We note that
in addition to the liquidity of the derivatives positions themselves,
assessing, managing, and periodically reviewing liquidity risk
generally may include an evaluation of the potential liquidity demands
that may be imposed on the fund in connection with its use of
derivatives, including any variation margin or collateral calls the
fund may be required to meet.\223\ To the extent the fund is required
to make payments to a derivatives counterparty, those assets would not
be available to meet shareholder redemptions.
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    \218\ See Proposing Release, supra footnote 9, at section
III.C.1.c.
    \219\ See id., at n.303 and accompanying text (noting that, in
addition to the asset coverage limitations imposed by section 18 of
the Investment Company Act, any borrowing from a bank would be
subject to the terms agreed between a fund and the bank, including
terms relating to the maturity date of the borrowing and any
circumstances under which the borrowing may be required to be
repaid).
    \220\ See id., at nn.304-305 and accompanying text (noting that
funds that borrow for investment purposes, for example through
financing transactions such as reverse repurchase agreements and
short sales, generally do so in reliance on certain Commission
guidance, under which funds cover their obligations under such
transactions by segregating certain liquid assets, and discussing
the effects of asset segregation on funds' liquidity risk).
    Segregated assets are considered to be unavailable for sale or
disposition, including for redemptions, unless replaced by other
appropriate non-segregated assets of equal value. See Securities
Trading Practices of Registered Investment Companies, Investment
Company Act Release No. 10666 (Apr. 18, 1979) [44 FR 25128 (Apr. 27,
1979)] (``Release 10666''). This means that a fund that receives
significant redemption requests may need to exit a portion of its
financing transactions in order make more liquid investments
available for sale to fulfill such requests. Furthermore, if a fund
seeks to exit its financing transactions in a declining market, it
may need to dispose of a greater amount of its more liquid holdings
in order to repay its borrowings, thereby reducing the amount of
liquid investments it has available to meet redemptions.
Consequently, a fund's assessment and management of its liquidity
risk must include an evaluation of the nature and extent of its
borrowings and the potential impact of borrowings on the fund's
overall liquidity profile.
    \221\ We note that borrowings for investment purposes pose a
variety of liquidity risks, including the risk that redemptions may
require the sale of securities in amounts exceeding the amount of
the redemption, resulting in a reduction of the fund's borrowings.
Additionally, even without redemptions, the fund may need to sell
securities and reduce borrowings if its investment values decline,
which may have negative effects on the fund's liquidity.
    \222\ See Proposing Release, supra footnote 9, at paragraph
accompanying nn.306-307 (discussing how the use of derivatives may
affect a fund's liquidity risk). Funds that use derivatives under
which they have an obligation to pay typically do so in reliance on
the guidance we provided in Release 10666 and in related no-action
letters issued by our staff, and therefore segregate liquid assets
in respect of their obligations under derivatives transactions. See
generally Use of Derivatives by Investment Companies under the
Investment Company Act of 1940, Investment Company Act Release No.
29776 (Aug. 31, 2011) [76 FR 55237 (Sept. 7, 2011)], at 13-17; see
also Use of Derivatives by Registered Investment Companies and
Business Development Companies, Investment Company Act Release No.
31933 (Dec. 1, 2015) [80 FR 80884 (Dec. 28, 2015)] (``2015
Derivatives Proposing Release''), at n.47 and accompanying text; see
also supra footnote 220. Derivatives may therefore raise concerns
that are similar to those discussed at footnote 220 in the context
of borrowings. Funds also may be required to dispose of assets in
order to post required margin with respect to their short sale
transactions. In addition, some derivatives transactions--
particularly those that are complex or entered into OTC--may be less
liquid, have longer settlement periods, or be more difficult to
price than other types of investments, which potentially increases
the amount of time required to exit such transactions.
    \223\ See In re OppenheimerFunds, Inc., et al., Investment
Company Act Release No. 30099 (June 6, 2012) (settled action)
(``OppenheimerFunds Release'') (alleging the adviser made misleading
statements regarding two fixed income mutual funds that suffered
significant losses during the 2008 financial crisis primarily due to
their use of total return swaps to obtain exposure to commercial
mortgage-backed securities and noting that the funds ``had to raise
cash for anticipated [total return swap] contract payments by
selling depressed bonds into an increasingly illiquid market.'').
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Consideration of Investment Strategy and Portfolio Liquidity During
Normal and Reasonably Foreseeable Stressed Conditions
    Finally, we also are modifying the proposed liquidity risk
assessment requirement to clarify that certain liquidity risk factors
must be considered during both normal and reasonably foreseeable
stressed conditions. As proposed, rule 22e-4 did not specify whether a
consideration of these factors should consider normal conditions,
stressed conditions, or both. One commenter stated that the proposed
rule's treatment of stressed conditions was unclear,\224\ and another
said that the proposed rule was unclear about what needed to be
considered in assessing ``stress.'' \225\ For those liquidity risk
factors that could vary depending on market conditions (i.e., a fund's
portfolio liquidity and cash flow projections), we believe that it is
appropriate to require a fund to evaluate those factors in normal and
reasonably foreseeable stressed conditions. Thus, if a fund's portfolio
strategy involves investing in securities whose liquidity is likely to
decline in stressed conditions, a fund should take this into account in
determining how its portfolio liquidity could contribute to its overall
liquidity risk. For example, a fund's portfolio liquidity could
decrease in stressed conditions if such conditions led to market
participants pulling back on transacting in the fund's portfolio
securities, or if stressed conditions affecting other assets or asset
classes were to have correlated effects on the fund's portfolio
securities. In considering normal and reasonably foreseeable stressed
conditions, funds should consider historical experience but should
recognize that such

experience may not necessarily be indicative of future outcomes,
depending on changes in market conditions and the fund's particular
circumstances.
---------------------------------------------------------------------------

    \224\ See BlackRock Comment Letter.
    \225\ See AFR Comment Letter.
---------------------------------------------------------------------------

    We note that ``stressed'' conditions will likely entail different
scenarios for different types of funds. For example, differing levels
of changes in interest rates and/or interest rates' implied volatility
could affect two bond funds very differently, depending on factors such
as the maturity, coupon rates and other characteristics of the funds'
portfolio holdings. Assessment of stressed conditions also should take
into account stresses originating outside of market stress. For
example, certain funds could be significantly affected by geopolitical
stresses, such as an emerging markets debt fund whose holdings'
liquidity is affected by factors such as economic uncertainty in the
holdings' countries of issuance. The extent to which stressed
conditions are reasonably foreseeable will vary depending on the fund's
facts and circumstances.
b. Cash Flow Projections
    We are adopting the requirement for a fund to consider its short-
term and long-term cash flow projections, during both normal and
reasonably foreseeable stressed conditions, in assessing and managing
its liquidity risk.\226\ The proposed rule also included the
requirement for a fund to consider its cash flow projections in
assessing its liquidity risk. However, we are adopting some
modifications to this proposed requirement. Most significantly,
although the proposed rule specified five separate considerations a
fund would have to take into account in evaluating the extent to which
its cash flow projections contribute to its liquidity risk, rule 22e-4
as adopted today does not enumerate these five considerations. Instead,
we are discussing these five considerations as guidance that funds
should generally take into account in evaluating their cash flow
projections, as discussed in more detail below.
---------------------------------------------------------------------------

    \226\ See rule 22e-4(b)(1)(i)(B).
---------------------------------------------------------------------------

    We continue to believe, as discussed in the Proposing Release, that
understanding a fund's cash flows is important in determining whether
the fund will have sufficient cash to satisfy redemption requests.\227\
We also continue to believe that the better a fund's portfolio and risk
managers are able to predict the fund's net flows, the better they will
be able to measure and manage the fund's liquidity risk.\228\
Predictability about whether periods of market stress or declines in
fund performance generally lead to increased redemptions of fund shares
is particularly significant, as careful liquidity risk management
during these periods could prevent the need to sell less-liquid
portfolio assets under unfavorable circumstances. This type of selling,
in turn, could create significant negative price pressure on the assets
and, to the extent the fund continues to hold a portion of those
assets, decrease the value of the assets still held by the fund at
least temporarily.\229\ To the extent a fund understands the
composition of its shareholder base (for example, among retirement
investors, other individual investors, or discretionary accounts), it
may be able to better predict fund flows in response to market events
or fund performance.
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    \227\ See Proposing Release, supra footnote 9, at nn.267-268 and
accompanying text.
    \228\ See id., at n.269 and accompanying text. See also Fidelity
Comment Letter (noting that the predictability of fund cash flows
varies depending on the predictability of the redemption behavior of
the fund's shareholder base. ``[F]unds whose shareholders include
investors who purchased shares distributed through a retirement
program or other planned savings program may exhibit redemption
patterns that are relatively more predictable.''); BlackRock Comment
Letter (noting that funds may need additional data from their
distributors and transfer agents regarding shareholder redemption
activity to allow funds to make short-term and long-term cash
projections).
    \229\ See Proposing Release, supra footnote 9, at n.270 and
accompanying text.
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Consideration of Cash Flow Projections During Normal and Reasonably
Foreseeable Stressed Periods
    We also are revising the rule to require a fund to consider its
short-term and long-term cash flow projections during both normal and
reasonably foreseeable stressed conditions.\230\ As discussed above,
proposed rule 22e-4 would have required a fund, in evaluating short-
term and long-term cash flow projections, to consider the size,
frequency, and volatility of historical purchases and redemptions of
fund shares during normal and stressed periods.\231\ Although we are
not including a specific requirement for a fund to consider historical
purchases and redemptions in considering its cash flow projections, we
believe continuing to incorporate the concept of normal and reasonably
foreseeable stressed conditions within the requirement to consider cash
flow projections is critical for a fund to obtain a complete picture of
how its cash flows may affect its liquidity risk, particularly because
greater, more frequent, or more volatile outflows during stressed
conditions could exacerbate a fund's liquidity risk.\232\ A fund and
its portfolio and/or risk managers should review the guidance we
provide below regarding funds' evaluation of the size, frequency, and
volatility of historical purchases and redemptions of fund shares
during normal and reasonably foreseeable stressed circumstances, as
well as similar funds' purchases and redemptions, in determining how
normal and reasonably foreseeable stressed market conditions could
affect a fund's cash flows and contribute to the fund's liquidity
risk.\233\
---------------------------------------------------------------------------

    \230\ See rule 22e-4(b)(1)(i)(B).
    \231\ See proposed rule 22e-4(b)(2)(iii)(A)(1).
    \232\ See Proposing Release, supra footnote 9, at text
accompanying and following n.273.
    \233\ See infra footnotes 236-239 and accompanying text.
---------------------------------------------------------------------------

Guidance on Evaluating a Fund's Cash Flow Projections
    As discussed above, rule 22e-4 as adopted today requires a fund to
consider its short-term and long-term cash flow projections during both
normal and reasonably foreseeable stressed conditions in assessing,
managing, and periodically reviewing liquidity risk. This liquidity
risk factor simplifies the rule as proposed, which would have codified
five separate considerations that would comprise a fund's consideration
of its cash flow projections--namely, (i) the size, frequency, and
volatility of historical purchases and redemptions of fund shares
during normal and reasonably foreseeable stressed periods, (ii) the
fund's redemption policies, (iii) the fund's shareholder ownership
concentration, (iv) the fund's distribution channels, and (v) the
degree of certainty associated with the fund's short-term and long-term
cash flow projections. Instead of enumerating these five considerations
in the text of rule 22e-4, we are discussing each of them as guidance
in this Release (together, the ``cash flow guidance considerations'').
    We are not codifying the cash flow guidance considerations to
simplify the rule 22e-4 liquidity risk factors and to alleviate certain
commenter concerns about the complexity of the proposed factors.
Commenters argued that the requirement to consider a specified list of
multiple liquidity risk factors is overly complex--making compliance
more difficult for funds, and oversight more difficult for the
Commission.\234\ Commenters discussed the dangers of an analysis that
mandates consideration of multiple factors becoming a generic
``checklist'' approach to liquidity risk management that does not fully
capture

the business practices, strategies, and risks that are germane to
certain funds.\235\ We agree that requiring an overly complex liquidity
risk assessment analysis could lead to this result, to the detriment of
investors. Such procedures could appear to be robust, but in actuality
may not reflect (or may underweight) a fund's most significant risk
factors because of the perceived requirement to focus on enumerated
factors that may not be particularly important to a fund's operations
and risks. Thus, we believe that simplifying the cash flow liquidity
risk factor in rule 22e-4 will benefit funds and their shareholders and
continue to advance the Commission's goal of promoting meaningful
liquidity risk analysis.
---------------------------------------------------------------------------

    \234\ See, e.g., Better Markets Comment Letter.
    \235\ See, e.g., MFS Comment Letter.
---------------------------------------------------------------------------

    With respect to the size, frequency, and volatility of historical
purchases and redemptions of fund shares, we continue to believe, as
discussed in the Proposing Release, that funds whose historical net
flows are relatively less volatile in terms of size and frequency will
likely entail less liquidity risk than similar funds with more volatile
net flows.\236\ A fund should generally review historical purchases and
redemptions of fund shares across a variety of market conditions in
order to determine how the fund's flows may differ during normal and
reasonably foreseeable stressed periods (keeping in mind that
historical experience may not necessarily be indicative of future
outcomes).\237\ In addition to considering its own historical flow
data, a fund, particularly a fund without substantial operating
history, should consider purchase and redemption activity in funds with
similar investment strategies.\238\ A fund may wish to evaluate whether
the size, frequency, and volatility of its shareholder flows follow any
discernible patterns (for example, patterns relating to seasonality,
shareholder tax considerations, fund advertising, changes in fund
performance ratings provided by third-party rating agencies, and the
fund's investment strategy and size).\239\
---------------------------------------------------------------------------

    \236\ See Proposing Release, supra footnote 9, at nn.272 and
accompanying text.
    \237\ See supra footnotes 230-233 and accompanying text. A fund
may find it instructive to understand when its highest, lowest, most
frequent, and most volatile purchases and redemptions occurred
within various time horizons, such as the past one, five, ten, and
twenty years (as applicable, considering the fund's operating
history).
    \238\ See Proposing Release, supra footnote 9, at text following
n.273. We note that consideration of similar funds' purchases and
redemptions could show whether the fund's historical flows are
typical or aberrant compared to those seen in similar funds and
assist new funds in predicting flow patterns.
    \239\ See Proposing Release, supra footnote 9, at nn.274-279 and
accompanying text (discussing how a fund's investment strategy could
contribute to its shareholder flows and noting that smaller funds
may experience greater flow volatility). For instance, we understand
that certain investors tend to trade in and out of ETFs with index-
based strategies frequently because they invest in these ETFs for
hedging and/or short-term trading purposes.
---------------------------------------------------------------------------

    We also continue to believe that a fund generally should consider
its normal redemption policies and practices in evaluating the extent
to which its cash flow projections may contribute to its liquidity
risk. Specifically, as discussed in the Proposing Release, a fund
should generally consider its disclosed or advertised time period for
paying (or endeavoring to pay) redemption proceeds and whether this
time period varies based on the payment method the fund employs.\240\
For example, a fund whose policies require it to typically pay
redeeming shareholders on a next-day basis may have fewer options for
managing high levels of redemptions than a fund whose policies require
it to typically pay redeeming shareholders on a T + 3 basis.\241\
---------------------------------------------------------------------------

    \240\ See Item 6(b) of Form N-1A (requiring a fund to briefly
identify the procedures for redeeming shares); infra section III.M.1
(discussing amendments to Item 11 of Form N-1A).
    \241\ To illustrate, when a fund that pays redemption proceeds
within one day receives a large redemption request and a fund that
pays redemption proceeds within three business days receives a
redemption request of the same size, the first fund must satisfy the
full request within one day, whereas the second fund has more time
to satisfy the redemption request. Even though the shareholder flows
of the first and second fund are identical, the redemption policies
of the first fund magnify its liquidity risks by requiring that the
fund pay redemptions quickly. See, e.g., Proposing Release, supra
footnote 9, at n.270.
---------------------------------------------------------------------------

    A fund's shareholder ownership concentration also could affect its
cash flow projections, as a fund that has a concentrated set of
beneficial owners could experience considerable cash outflows from
redemptions by a single or small number of shareholders, or by the
decisions of an intermediary that has discretionary power over a
significant number of shareholder accounts.\242\ This in turn could
hamper a fund's management of liquidity risk if the fund does not have
procedures in place to manage large redemptions. For these reasons, we
believe a fund should consider the extent to which its shareholder
concentration affects its liquidity risk, particularly taking into
account other factors that could magnify shareholder concentration-
related liquidity risk (e.g., if a fund has an investment strategy that
attracts shareholders who trade based on short-term price movements).
---------------------------------------------------------------------------

    \242\ We note that a relatively concentrated fund shareholder
base may make it easier for funds to communicate with those
shareholders or intermediaries about anticipated future redemptions,
and thus plan liquidity demands. However, those shareholders are
under no legal obligation to forewarn the fund of their redemptions
and, particularly in times of stress, may not do so.
---------------------------------------------------------------------------

    We also continue to believe that a fund should consider how its
distribution channels could affect its cash flows, including the
predictability of its cash flows. For example, a fund may wish to
consider the extent to which its redemption practices could depend on
its distribution channels,\243\ as well as whether its distribution
channels (particularly, whether the fund's shares are held through
omnibus accounts) could make it difficult for a fund to be fully aware
of the composition of its underlying investor base,\244\ including
investor characteristics that could affect the fund's short-term and
long-term flows.\245\ A fund's distribution channels could affect its
cash flow predictions because certain distribution channels are
generally correlated with particular purchase and redemption
patterns.\246\ Additionally, we note that investors in mutual funds
distributed through certain channels also may have similar purchase and
redemption characteristics relating to their financial and tax-related
needs.\247\
---------------------------------------------------------------------------

    \243\ For example, mutual funds that are sold through broker-
dealers will generally have to meet redemption requests within three
business days, because rule 15c6-1 under the Exchange Act
effectively establishes a T+3 settlement period for purchases and
sales of securities (other than certain types of securities exempted
by the rule) effected by a broker or dealer, unless a different
settlement period is expressly agreed to by the parties at the time
of the transaction.
    \244\ See, e.g., Comment Letter of Coalition of Mutual Fund
Investors (Jan. 18, 2016) (``CMFI Comment Letter'') (raising
concerns regarding omnibus account transparency).
    \245\ These investor characteristics could include whether
ownership in the mutual fund is relatively concentrated, as well as
whether the types of underlying investors in the fund typically
share common investment goals affecting redemption frequency and
timing.
    \246\ For instance, investors in mutual funds distributed
through a retirement plan channel or other planned savings channel
(such as a qualified tuition plan authorized by section 529 of the
Internal Revenue Code) may be more likely to be long-term investors
who do not trade based on short-term price movements, and their
purchase and redemption patterns thus may be relatively predictable
compared to those of other investors.
    \247\ For example, taxable investors who are considering
purchasing mutual fund shares around capital gains distribution
dates have an incentive to delay their purchases until after the
distribution, but non-taxable shareholders (such as those who invest
through IRAs and other tax-deferred accounts) face no such incentive
for delaying purchases. See Woodrow T. Johnson & James M. Poterba,
Taxes and Mutual Fund Inflows around Distribution Dates, NBER
Working Paper 13884 (Mar. 2006, rev'd Mar. 2008), available at
http://economics.mit.edu/files/2512; see also supra footnote 239 and
accompanying text (discussing seasonality in mutual fund flows).

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

    Finally, we continue to believe that a fund should consider the
degree of certainty surrounding its short-term and long-term cash flow
projections. A fund could consider the length of its operating history
(including the fund's experience during points of market instability,
illiquidity, or volatility) and any purchase and redemption patterns. A
fund may use ranges in considering cash flow projections and their
relationship to liquidity risk. If a fund has implemented policies to
encourage certain shareholders (e.g., large shareholders or
institutional shareholders) to provide advance notification of their
intent to redeem a significant number of shares of the fund, this could
increase the degree of probability surrounding its cash flow
projections.\248\
---------------------------------------------------------------------------

    \248\ We understand, based on staff outreach, that advance
notification procedures are a relatively common liquidity risk
management tool that funds currently employ. See Comment Letter of
Invesco on the Notice Seeking Comment on Asset Management Products
and Activities, Docket No. FSOC-2014-0001 (Mar. 25, 2015), at 11
(``Invesco FSOC Notice Comment Letter'') (noting that Invesco has
advance notification arrangements regarding anticipated redemptions
above certain levels in place with certain distribution partners).
---------------------------------------------------------------------------

c. Holdings of Cash and Cash Equivalents, Borrowing Arrangements, and
Other Funding Sources
    We are adopting the requirement for a fund to consider its holdings
of cash and cash equivalents, as well as its borrowing arrangements and
other funding sources, in assessing, managing, and periodically
reviewing its liquidity risk, as proposed.\249\ As discussed in the
Proposing Release, current U.S. Generally Accepted Accounting
Principles (``GAAP'') define cash equivalents as short-term, highly
liquid investments that are readily convertible to known amounts of
cash and that are so near their maturity that they present
insignificant risk of changes in value because of changes in interest
rates.\250\ While we understand based on staff outreach and the
comments we received on the proposal that many asset managers establish
minimum cash and cash equivalent targets as part of their liquidity
risk management practices,\251\ commenters stated that significant cash
and cash equivalent holdings are not necessarily appropriate for all
funds and as a stand-alone tool do not necessarily entirely mitigate
liquidity risk.\252\ We agree with commenters that the amount of cash
and cash equivalent holdings appropriate for liquidity risk management
depends on a particular fund's facts and circumstances. Similarly, we
agree with commenters that significant holdings of cash and cash
equivalents could still be insufficient to protect a fund with large
holdings of illiquid investments (or investments whose liquidity
decreases significantly during stressed periods) if the fund were faced
with heavy redemptions.\253\ But we continue to believe that holdings
of cash and cash equivalents can be a valuable liquidity risk
management tool because these holdings tend to remain very liquid under
nearly all market conditions.\254\ Thus, a fund could use its cash and
cash equivalent holdings in normal and stressed conditions to meet some
redemption requests without significant dilution of remaining
investors' interests. Holdings of cash and cash equivalents also could
provide a fund's portfolio manager with flexibility to readjust its
portfolio as it deems advantageous (either in terms of performance or
risk management) under changing market circumstances. We therefore
believe it is appropriate for a fund to consider its holdings of cash
and cash equivalents as part of its liquidity risk assessment.
---------------------------------------------------------------------------

    \249\ See rule 22e-4(b)(1)(i)(C).
    \250\ See Proposing Release, supra footnote 9, at n.311 and
accompanying text.
    \251\ See, e.g., Comment Letter of Pacific Investment Management
Company LLC (Jan. 13, 2016) (``PIMCO Comment Letter'').
    \252\ See, e.g., ICI Comment Letter I (noting that fund
complexes that specialize in U.S. equity funds, especially those
focusing on large-cap stocks, are likely to be able to meet
redemptions with only modest holdings of cash or cash equivalents
because the U.S. equity market is so liquid); see also infra
footnote 662 and accompanying text (discussing commenters' concerns
that the proposed three-day liquid asset minimum requirement would
be construed to require a fund specifically to hold cash and cash
equivalents, which commenters argued could prevent funds from
meeting their principal investment strategies and could give
investors a false sense of security that cash buffers will eliminate
liquidity risk).
    \253\ We also note that a substantial investment in cash and
cash equivalents could decrease a fund's total return and/or cause
the fund to diverge from its investment strategy, and thus a fund
may wish to calibrate its holdings of these instruments to manage
its liquidity risk while taking these concerns into consideration.
    \254\ We note that cash and cash equivalent holdings and
borrowing arrangements are just two of several liquidity management
tools that are at a fund's disposal. Though we are requiring funds
to consider these tools, the rule neither creates a substantive
obligation on funds to maintain specific levels of cash and cash
equivalents nor requires funds to procure any specific borrowing
arrangements.
---------------------------------------------------------------------------

    Several commenters discussed the extent to which a fund's borrowing
arrangements and other funding sources could shape the fund's liquidity
risk. Some commenters strongly supported the use of borrowing
arrangements to help mitigate liquidity risk, asserting that funds
historically have generally succeeded in managing liquidity risk,
partly due to lines of credit and interfund lending.\255\ Commenters
also asserted that obtaining access to backup sources of liquidity like
lines of credit, interfund lending arrangements, and repurchase
agreements should be considered beneficial as the flexibility to use
these liquidity sources has value to a fund's shareholders.\256\
However, another commenter argued that asset managers should not meet
redemptions through the use of borrowing facilities other than to meet
short-term settlement mismatches, as this could potentially
disadvantage non-redeeming investors.\257\
---------------------------------------------------------------------------

    \255\ See, e.g., Comment Letter of Independent Directors Council
(Jan. 13, 2016) (``IDC Comment Letter'').
    \256\ See, e.g., BlackRock Comment Letter; Oppenheimer Comment
Letter.
    \257\ See HSBC Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that entering into borrowing or other
funding arrangements could assist a fund in meeting redemption requests
in certain cases (for example, by bridging any timing mismatches
between when a fund is required to pay redeeming shareholders and when
any asset sales that the fund has executed in order to pay redemptions
will settle).\258\ However, we have concerns that, in some situations,
borrowing arrangements may not be beneficial to a fund's liquidity risk
management to the extent that the fund's use of borrowings to meet
redemptions leverages the fund at the expense of non-redeeming
investors. In such a case, non-redeeming shareholders would effectively
bear the costs of borrowing and the increased risk to the fund created
by leverage.\259\ Thus, we believe that funds should consider the
likely overall benefits and risks in including such borrowing or other
funding arrangements within a liquidity risk management program.
---------------------------------------------------------------------------

    \258\ See Proposing Release, supra footnote 9, at n.314 and
accompanying text.
    \259\ See Heartland Release, supra footnote 80.
---------------------------------------------------------------------------

    In evaluating the extent to which a fund's borrowing arrangements
could help the fund manage its liquidity risk, a fund may wish to
consider any aspects of those arrangements that could limit the fund's
ability to borrow. For instance, a fund generally may wish to consider
the terms of the credit facility (e.g. whether the credit facility is
committed or uncommitted), as well as the financial health of the
institution(s) providing the facility. A fund also generally should
consider whether a credit facility would be shared among multiple funds
within a fund family.

When a credit facility is shared, a fund should assess the extent the
facility mitigates its liquidity risk given the liquidity risk
associated with the other funds sharing the facility.\260\ Similarly,
with respect to interfund lending within a family of funds, the terms
of an interfund lending arrangement and any conditions required under
exemptive relief permitting the arrangement \261\ (including
limitations on the circumstances in which interfund lending may be
used) will shape the role that interfund lending has in a fund's
overall liquidity risk management.\262\
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    \260\ See Proposing Release, supra footnote 9, at paragraph
accompanying nn.314-317.
    \261\ See, e.g., Nationwide Mutual Fund, et al., Investment
Company Act Release No. 32115 (May 16, 2016) [81 FR 31988 (May 20,
2016)] (notice of application) (``Nationwide Exemptive Relief'');
TCW Alternative Funds, et al., Investment Company Act Release No.
32113 (May 11, 2016) [81 FR 30585 (May 17, 2016)] (notice of
application) (``TCW Exemptive Relief''); see also Proposing Release,
supra footnote 9, at paragraph accompanying nn.318-319.
    \262\ For example, it is common for such exemptive orders to
permit interfund lending in circumstances in which there is a timing
mismatch between when a fund is required to pay redeeming
shareholders and when any asset sales that the fund has executed in
order to pay redemptions will settle (e.g., a fund may be required
to pay redeeming shareholders within three business days, but the
portfolio transactions the fund has executed in order to pay these
shareholders may not settle for seven days). A fund can reasonably
predict that it will repay borrowed money relatively quickly and
reliably under these circumstances. Under these conditions, this
type of borrowing would tend to be low risk, and thus entail less
liquidity risk than borrowing money to pay redemptions without
already having secured a price at which the assets used to cover the
borrowing will be sold.
     Funds may only engage in interfund lending when it is in the
best interests of both the lending and the borrowing fund. The
exemptive relief anticipates a fund family's interfund lending
arrangements include an assessment of: (i) If the fund participates
as a lender, any effect its participation may have on the fund's
liquidity risk; and (ii) if the fund participates as a borrower,
whether the fund's portfolio liquidity is sufficient to satisfy its
obligation to repay the loan along with its other liquidity needs.
See Nationwide Exemptive Relief, supra footnote 261; TCW Exemptive
Relief, supra footnote 261. For example, the relief is not intended
to permit a fund to act as lender of last resort to a borrowing
fund.
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3. Periodic Review of a Fund's Liquidity Risk
    Rule 22e-4 as adopted includes the requirement for a fund to
periodically review the fund's liquidity risk, taking into account the
same liquidity risk factors a fund would have to consider in initially
assessing and managing its liquidity risk.\263\ The proposed rule also
included the requirement for a fund to periodically review its
liquidity risk, considering those factors it would evaluate in
initially assessing its liquidity risk.\264\ Commenters generally
supported the proposed liquidity risk review requirement.\265\
Specifically, some commenters agreed that this requirement will help
further the Commission's goals,\266\ expressed support for the proposed
liquidity risk review factors,\267\ and agreed with the Commission's
general approach of permitting funds to develop their own policies and
procedures for conducting periodic liquidity risk reviews.\268\ Other
commenters objected to the requirement for a fund to consider certain
specified liquidity risk review factors and suggested instead that
consideration of the factors be made permissive instead of
mandatory.\269\ Still another commenter argued that the proposed
liquidity risk review approach gives funds too much discretion and
recommended that the Commission adopt a baseline standard for the
frequency of funds' liquidity risk reviews (i.e., adopt an annual or
quarterly review requirement).\270\
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    \263\ See rule 22e-4(b)(1)(i).
    \264\ See proposed rule 22e-4(b)(2)(iii).
    \265\ See, e.g., CRMC Comment Letter; CFA Comment Letter;
Fidelity Comment Letter; ICI Comment Letter I.
    \266\ See CRMC Comment Letter.
    \267\ See, e.g., CRMC Comment Letter; ICI Comment Letter I.
    \268\ See, e.g., CFA Comment Letter; Fidelity Comment Letter.
    \269\ See, e.g., MFS Comment Letter; Voya Comment Letter.
    \270\ See Better Markets Comment Letter.
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    We are adopting a periodic review requirement substantially as
proposed. As discussed above, we have revised the liquidity risk
factors that a fund must consider in assessing, managing, and
periodically reviewing its liquidity risk. A fund will not have to
consider any factor that is not applicable to a particular fund.\271\
This requirement is principles-based, and thus each fund may develop
and adopt procedures to review the fund's liquidity risk tailored as
appropriate to reflect the fund's particular facts and circumstances.
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    \271\ See supra footnote 192 and accompanying text.
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    After evaluating commenters' concerns about the liquidity risk
assessment factors, we continue to believe that these factors, modified
as discussed above, are central to reviewing a fund's liquidity risk.
We also continue to believe that requiring each fund to consider a
baseline set of factors, as applicable, in reviewing liquidity risk
would promote effective liquidity risk management across the fund
industry. As discussed above,\272\ we believe that our changes to the
proposed liquidity risk factors--which highlight particular risks but
also condense and simplify some proposed factors--strike an appropriate
balance between promoting consistency in funds' consideration of a
standard set of liquidity risk factors and easing burdens associated
with this analysis.
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    \272\ See supra footnotes 193-194 and accompanying text.
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    We considered a commenter's suggestion that the Commission adopt a
minimum frequency for funds' liquidity risk review, and we have
modified the proposed rule to clarify that a fund's periodic review of
its liquidity risk must occur no less frequently than annually.\273\ As
discussed below, we are adopting a requirement that a fund periodically
review, no less frequently than annually its highly liquid investment
minimum (as determined considering the same factors that a fund would
reference in periodically reviewing its liquidity risk).\274\ Because
this review of a fund's highly liquid investment minimum would, de
facto, necessitate a fund's review of its liquidity risk, we believe it
is appropriate to align the minimum periods for these reviews.
Similarly, as discussed further below, we also are adopting a
requirement that a fund's board must review, no less frequently than
annually, a written report that describes a review of the adequacy of
the fund's liquidity risk management program.\275\ Accordingly, the
minimum period for the liquidity risk review will be aligned with the
period in which this report will be presented to the fund's board,
creating further synergies. We note, however, that a fund may determine
that it is appropriate for its liquidity risk to be reviewed more
frequently than annually, depending on the extent to which the required
review factors could vary based on market- or sector-wide developments,
as well as changes to the fund's operations or other fund-specific
circumstances.
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    \273\ See rule 22e-4(b)(1)(i).
    \274\ See infra section III.D.4.
    \275\ See infra section III.H.2.
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C. Classifying the Liquidity of a Fund's Portfolio Investments, and
Disclosure and Reporting Requirements Regarding Portfolio Investments'
Liquidity Classifications

    Today we are adopting requirements for each fund, with the
exception of In-Kind ETFs, to classify the liquidity of its portfolio
investments. Rule 22e-4 as adopted today requires a fund to classify
the liquidity of each portfolio investment based on the number of days
within which it determined that it reasonably expects an investment
would be convertible to cash (or, in the case of the less-liquid and
illiquid categories, sold or disposed of) without the conversion (or,
in the case of the less-

liquid and illiquid categories, sale or disposition) significantly
changing the market value of the investment. Specifically, rule 22e-4
will require a fund to classify each of its portfolio investments,
including its derivatives transactions,\276\ into one of four liquidity
categories:
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    \276\ See rule 22e-4(b)(1)(ii). The final rule requires a fund
to classify all portfolio investments, including investments that
are liabilities of the fund. See infra section III.C.3.c.
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     Highly liquid investments, defined as cash and any
investment reasonably expected to be convertible to cash in current
market conditions in three business days or less without the conversion
to cash significantly changing the market value of the investment.
     Moderately liquid investments, defined as any investment
reasonably expected to be convertible to cash in current market
conditions in more than three calendar days but in seven calendar days
or less without the conversion to cash significantly changing the
market value of the investment.
     Less liquid investments, defined as any investment
reasonably expected to be sold or disposed of in current market
conditions in seven calendar days or less without the sale or
disposition significantly changing the market value of the investment,
but where the sale or disposition is reasonably expected to settle in
more than seven calendar days.
     Illiquid investments, defined as any investment that may
not reasonably be expected to be sold or disposed of in current market
conditions in seven calendar days or less without the sale or
disposition significantly changing the market value of the investment.
    This determination must be based on information obtained after
reasonable inquiry; the term ``convertible to cash'' in the category
definitions refers to the ability to be sold, with the sale settled.
The final rule requires a fund to take into account relevant ``market,
trading, and investment-specific considerations'' in classifying its
portfolio investments' liquidity, but the rule does not detail a list
of factors comprising these considerations.\277\ This Release does
include, however, guidance on certain considerations that a fund may
wish to evaluate in taking into account relevant market, trading, and
investment-specific considerations when classifying the liquidity of
its portfolio investments.\278\ The fund may classify portfolio
investments based on asset class, so long as the fund or its
adviser,\279\ after reasonable inquiry, does not have information about
any market, trading, or investment-specific considerations that are
reasonably expected to significantly affect the liquidity
characteristics of an investment that would suggest a different
classification for that investment.\280\ As discussed in more detail
below, the fund also must consider the investment's market depth in
classifying the investment.\281\ The fund also must review its
portfolio investments' classifications at least monthly and 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.\282\ Finally, the fund
must take into account certain considerations for highly liquid
investments that it has segregated to cover certain derivatives
transactions.\283\
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    \277\ See rule 22e-4(b)(1)(ii).
    \278\ See infra section III.C.4.
    \279\ The term ``adviser'' as used in this Release and rule 22e-
4 generally refers to any person, including a sub-adviser, that is
an ``investment adviser'' of an investment company as that term is
defined in section 2(a)(20) of the Investment Company Act. See infra
paragraph accompanying footnote 818 (discussing the coordination of
liquidity risk management efforts undertaken by various service
providers, including a fund's sub-adviser(s)).
    \280\ See rule 22e-4(b)(1)(ii)(A).
    \281\ More specifically, the fund must determine whether trading
varying portions of a position in a particular investment, in sizes
that the fund would reasonably anticipate trading, is reasonably
expected to significantly affect the liquidity of that investment,
and if so, the fund must take this determination into account when
classifying the liquidity of that investment. See rule 22e-
4(b)(1)(ii)(B).
    \282\ See rule 22e-4(b)(1)(ii); see also rule 22e-4(b)(1)(i)
(imposing an ongoing responsibility on the fund to assess and manage
its liquidity risk).
    \283\ More specifically, with respect to the fund's derivatives
transactions that it has classified as moderately liquid
investments, less liquid investments, and illiquid investments, it
must identify the percentage of the fund's highly liquid investments
that it has segregated to cover, or pledged to satisfy margin
requirements in connection with, derivatives transactions in each of
these classification categories. See rule 22e-4(b)(1)(ii)(C); see
also rule 22e-4(b)(1)(iii)(B) (addressing such percentage of highly
liquid investments in connection with determining whether a fund
primarily holds highly liquid investments).
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    Rule 22e-4 as proposed would have required each fund to classify
the liquidity of its portfolio positions (or portions of a position in
a particular asset) and review the liquidity classification of each
position on an ongoing basis.\284\ In classifying and reviewing the
liquidity of portfolio assets, proposed rule 22e-4 would have required
a fund to consider the number of days within which a fund's position in
a portfolio asset (or portions of a position in a particular asset)
would be convertible to cash at a price that does not materially affect
the value of that asset immediately prior to sale.\285\ Based on this
determination, made using information obtained after reasonable
inquiry, the proposed rule would have required a fund to classify each
of its positions in a portfolio asset (or portions thereof) into one of
six liquidity categories: (i) Convertible to cash within 1 business
day; (ii) convertible to cash within 2-3 business days; (iii)
convertible to cash within 4-7 calendar days; (iv) convertible to cash
within 8-15 calendar days; (v) convertible to cash within 16-30
calendar days; and (vi) convertible to cash in more than 30 calendar
days.\286\ The proposed rule would have required a fund to consider
certain specified factors, to the extent applicable, in determining the
time period in which a portfolio position (or portion thereof) would be
convertible to cash.\287\
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    \284\ See Proposing Release, supra footnote 9, at section III.B.
    \285\ Proposed rule 22e-4(b)(2)(i).
    \286\ Proposed rule 22e-4(b)(2)(i).
    \287\ Proposed rule 22e-4(b)(2)(ii); see also infra section
III.C.4.
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    Although some commenters acknowledged potential benefits to the
proposed classification requirement, most commenters were generally
opposed to the proposed six-category liquidity classification
framework. As discussed further below, commenters' primary objections
were concerns that the proposed classification framework would: (i) Not
reflect current liquidity risk management practices or industry ``best
practices''; (ii) require funds to make overly subjective projections
about asset liquidity, particularly to the extent that they would have
to project a fund's ability to sell and settle a position well into the
future; (iii) place undue reliance on third-party data vendors and
analysts; (iv) incorporate a materiality standard that is unclear and
impractical to apply; and (v) inappropriately require funds to take
position size and settlement timing into account when classifying the
liquidity of a portfolio position.
    Commenters suggested many alternatives to the proposed
classification requirement--both changes to the structure of the
proposed classification requirement, as well as suggestions about more
granular aspects of the proposed requirement. Although the details
vary, commenters raised three primary structural alternatives to the
proposed classification requirement: (i) A ``principles-based''
liquidity classification approach, where each fund would have to
classify the liquidity of its portfolio assets, but the Commission
would not require any

specific classification scheme; \288\ (ii) a simplified version of the
proposed classification system, with fewer classification categories
based on shorter time projections than the proposal; \289\ and (iii) an
approach with new classification categories based on qualitative
distinctions in the market- and trading-related characteristics of
different asset classes under different market conditions, which
generally would rely on the Commission mapping different asset classes
to each of these new classification categories.\290\
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    \288\ See, e.g., AIMA Comment Letter; Comment Letter of the Loan