May 1, 2023 - Last week Senator Tim Scott (R. SC), Ranking Member of the Senate Banking Committee, and Congressman Patrick McHenry, Chairman of the House Financial Services Committee, sent a joint letter to Gary Gensler, Chair of the Securities and Exchange Commission (SEC) expressing their concern about the SEC’s proposed rule on Open-End Fund Liquidity Risk Management and Swing Pricing. The letter specifically called out the SEC’s treatment of open-end loan funds, noting that the proposed rule would effectively prohibit open-end loan funds which they described as a critical and growing investment strategy used by investors, including many retired savers, in times of rising interest rates. They explained that “this would have a direct and negative impact on small public companies that rely on the bank loan market for financing, as well as their employees and the communities they support”. Scott and McHenry also charged that the SEC has not adequately considered the impact of the proposed rule, noting that the SEC itself acknowledged that it lacked the data necessary to adequately quantify the associated costs.
The Scott/McHenry letter echoes concerns the LSTA has raised in its comment letter and subsequent advocacy. In particular, the SEC proposed eliminating “Level 3, Less Liquid Investments” (which is where nearly all loan investments sit) and shifting those assets into the “Illiquid Investments”. Open-end funds can only have 15% invested in illiquid assets, so, as Scott and McHenry warned, this would be the de facto end of open-end loan funds. In our letter, we pushed back on the proposal and offered a more reasonable and more workable counterproposal. First, we noted that there were no problems in meeting redemptions, including in the Covid-stressed environment of March 2020. We flagged the many tools – such as liquidity risk management plans, lines of credit and highly liquid investment minimums (“HLIMs”) that can be converted into cash in three days – that managers used to meet redemption requests. And we offered an alternative that the SEC staff should appreciate: In addition to all the existing tools available to loan managers to meet redemptions, we offered an industry level 10% HLIM and noted that the industry continues to work on expedited settlement arrangements. The 10% HLIM – which must be met every day – is a particularly robust offer. There are only three times in history where the monthly redemption rate topped 10%, so a daily 10% HLIM – in conjunction with all the other liquidity management tools – would make open-end loan funds even more robust. Ultimately, the SEC’s proposal to reclassify loans as Illiquid Investments is an attempt to resolve a problem that doesn’t exist at a great cost to both retail investors (whom the rule purports to protect) and corporate borrowers.
In addition to submitting the comment letter, the LSTA’s policy team has met with the SEC staff and two Commissioners and made its case about open-end loan funds to several members of Congress. The policy team has also coordinated closely with LSTA member firms and other financial trade associations that are concerned about the proposed rule’s potential impact on open-end loan funds. We hope that the SEC will listen – if not to us, then at least to Senator Scott and Representative McHenry.