The SEC Might Mandate Swing Pricing for Most Funds
The Securities and Exchange Commission (SEC) recently proposed amendments that would mandate swing pricing for most funds. While this is an interesting concept that could benefit shareholders, it poses some challenges. Under the proposed amendments, a purchase or redemption order would be eligible for a given day’s price only if received by an Open-End Fund, its transfer agent, or a registered clearing agency before the pricing time. This could change how funds interact with their intermediaries, potentially affecting how investors buy and sell shares of mutual funds.
Liquidity fees
The SEC has suggested that Open-End Funds implement “Swing Pricing Policies,” which change a fund’s NAV per share by a “swing factor” based on net redemptions (no threshold) or net acquisitions beyond a threshold (2% of net assets). With few exclusions, Rule 22c-1 would compel these funds to utilize swing pricing to calculate their swing factor.
Swing pricing may present operational challenges for Open-End Funds since intermediaries may receive investor orders later in the day or the next day. After calculating NAV, a fund can know the investor’s order. To overcome this issue, the SEC recommends that relevant Open-End Funds implement a “hard closure” rule in which an intermediary must receive investor orders, a registered clearing agency, or the fund itself by the time it calculates its NAV, often 4 p.m.
Hard close
Swing pricing assigns inflow and outflow expenses to investors rather than diluting fund owners. The SEC’s proposed amendments would mandate swing pricing for all open-end funds other than money market funds and exchange-traded funds (Open-End Funds).
Proposed Rule 22c-1 requires a fund’s board to approve its Swing Pricing Policies and designate an Administrator who administers the Swing Pricing process. The board also must review, at least annually, a written report prepared by the Administrator.
In addition, the SEC proposes a hard close for Open-End Funds that must receive investor orders by the fund’s pricing time, typically 4 p.m. ET, for those investors to receive that day’s price. The SEC explains that this is necessary to ensure that the information needed to apply swing pricing is timely.
Transition periods
The SEC might mandate swing pricing for most funds, which would be a boon to investors and fund managers. However, several impediments should be watched closely.
One of the biggest issues is that, under swing pricing, investors will only know when they can redeem or buy shares much later than the fund’s NAV calculation time. This could result in mismatches between trades and NAV calculations, leading to problems for a fund.
The SEC proposes introducing a “hard close” requirement for fund share transactions to deal with this problem. This will require that only trades received by the fund firm at its firm’s trade cutoff time (presumably, 4 p.m. for most funds) receive that day’s price and trade date.
Compliance
Compliance costs – the ongoing price of following the rules – are one of the biggest expenses for hedge funds. A survey of managers in Asia Pacific showed that up to half of management fees, including compliance officers and consultants, are spent on regulatory compliance.
This would require the fund to adjust NAV by a “swing factor,” which reflects at least spread and transaction costs. The swing factor must incorporate good-faith estimates of the market impact of selling securities to fulfill net redemptions above 1% of NAV (unless the swing pricing administrator specifies a lower threshold). Market effect cost estimates can be applied to all assets or individual investments.