Skip to Content
Fund Spy

Liquidity and the Law of Unintended Consequences

Two SEC proposals that could get in each other's way.

The SEC issued two important regulatory proposals during the past several months, the first of which was released in September 2015 and is designed to "enhance effective liquidity risk management" for mutual funds and exchange-traded funds. Among other things, the proposed regulations would shine a light on the liquidity characteristics of fund holdings, while also mandating that a portion of each portfolio be easily liquidated within three days without triggering big price losses.

The second proposal was released a couple of months later and is meant to "enhance the regulation of the use of derivatives" by registered investment companies, a term that includes mutual funds, ETFs, and closed-end funds. This proposal would require funds to comply with one of two rules designed to limit the amount of leverage they can develop with derivatives. The first rule would cap a fund's exposure to certain kinds of transactions (including derivatives) at 150% of net assets. The second would allow for exposure up to 300% but would require the use of a so-called value-at-risk test that would ensure a fund was taking on less market risk than if the fund did not use derivatives.