February 15, 2024 - This week the LSTA submitted its third comment letter in response to the SEC’s proposed amendments to its liquidity risk management rule for open-end funds. In the 2022 proposal the SEC intends, among other things, to eliminate one of the four liquidity categories that must be selected by the open-end fund for each of its portfolio investments.  This category – the “less liquid” investment category – is largely where loan assets fall. Therefore, the elimination of this category effectively shuts down open-end loan funds. As described in our first letter, the consequences of the SEC’s proposal would be disastrous (and unwarranted). The commentary in the proposal makes clear that this is intentional because the Commission is concerned that open-end loan funds can meet redemptions in all circumstances – despite the fact that open-end loan funds have never missed a redemption, including in the atypical  month of March 2020, and have (and use) a suite of liquidity management tools to address a settlement mismatch between the redemption of fund shares and the sale of a loan asset. These tools include active cash management and modeling, maintaining highly liquid investment minimums (“HLIMs”), using committed lines of credit, and interfund lending. In addition, in response to this proposed rulemaking, the LSTA worked with interested members to develop a standardized expedited settlement arrangement (“ESA”) that could be implemented by a dealer and open-end loan fund. The ESA would allow for settlement certainty by the third business day after the trade (T+3).

In this third letter, the LSTA continues to advocate for retention of the “less liquid” category. The LSTA proposes that this is possible while still addressing the Commission’s concerns by requiring a 10% HLIM for open-end loan funds and in light of the additional tool in the liquidity toolbox that will be available in the ESA. (The LSTA documents supporting the ESA are currently available as exposure drafts.) While the LSTA strongly believes that the above proposal should adequately address the Commission’s concerns, the third letter includes an additional proposal to further allay them. The LSTA recommends that Rule 22e-4 be amended so that the less liquid category remains available for loan assets that an open-end fund reasonably expects can be converted into U.S. dollars by T+10 business days. This recommendation builds upon the current definition of “less liquid” that requires that “an asset can be sold or disposed of within seven calendar days but takes longer to settle,” and adds an outer bound on expected settlement time. Importantly, the LSTA notes that funds would need a substantial amount of time, 24 months, to prepare for compliance. (More detail can be found here.)

In support of this proposal, the LSTA surveyed 11 members representing 75% of the open-end loan fund universe on the settlement times of their open-end loan fund sales. The conclusions show the feasibility of the additional proposal – so long as certain considerations are kept in mind. To illustrate how long it takes for open-end loan funds to settle their loan sales, the LSTA analyzed settlement data across two distinct time periods, March 2020 (a period of extremely high trading volumes and massive fund outflows), and October 2023 (a period of normal trade volume and minimal outflows). During March 2020, the median time to settle their sales came in at T+6, meaning that 50% of trades settled within six business days after the trade date.  Furthermore, 83% of trades settled within the aforementioned T+10 settlement period. Results looked very similar in October 2023, when the median time to settle came in at T+7, with 74% of trades settled within T+10.  As previously mentioned, these statistics support the feasibility of this proposal while also highlighting 1) that a shorter settlement timeframe than what is proposed is not feasible and 2) the substantial time that market participants will need to comply.

The LSTA will continue to engage with the Commission on this very important issue and update members on those efforts.