October 6, 2023 - At next week’s LSTA Annual Conference, Charles Carter (State Street), Elliot Ganz (LSTA), Mary Heath (Voya Investment Mgt.), Ellen Hefferan (LSTA), Michael Schuster (Brown Brothers Harriman) and Sarah Wagner (S&P Global) will unpack that topic in connection with the proposed rules for Outsourcing, Safeguarding Advisory Client Assets, and Open-End Fund Liquidity Risk Management Programs.

One thing we definitively know is that if these rules are finalized as written, there will be changes in the market as it currently operates.  The Outsourcing Proposal would establish a prescriptive antifraud rule governing the standards and methods used by investment advisors to evaluate and contract with certain service providers, as well as corresponding disclosure and recordkeeping requirements.  Investment Managers already perform oversight on outsourced functions and have processes in place to select outsourced providers.  Outsourced providers already face scrutiny from investment managers who measure their performance.  Would (or wouldn’t) the proposed level of oversight be helpful?  Will smaller outsourced providers be disproportionately impacted by these new requirements?  Does this create barriers to entry for start-up companies?

In the Open-End Fund Liquidity Risk Management Programs, the SEC proposes eliminating the Category 3 “Less Liquid Investments” classification and reclassifying those investments, which would include leveraged loans, as Category 4, “Illiquid Investments”.  This reclassification would be unsustainable for open-end funds which can only hold 15% of illiquid investments.  While acknowledging the misfit between redemptions and settlements, that doesn’t mean that there are problems meeting redemptions.  Instead of assuming, we’ll discuss how open-end funds currently manage cash and liquidity.  But will 10% invested in Highly Liquid investments, lines of credit and the addition of expedited settlement arrangements satisfy the SEC? Speaking of expedited settlement, there will be operational impacts in utilizing Master Participation Agreements.  How should dealers, investment managers, fund administrators, custodians and software providers prepare? 

Turning to the Safeguarding Proposed Rule, the definition of “possession and control” is unrealistic as written; however, will this have an impact on the role of the agent bank?  How could this affect the responsibilities of the custodian?  The proposal, if adopted, would impose impractical protocols and significant costs on advisors (which likely would be passed on to the clients) by establishing a requirement that an independent public accountant verify each trade as it occurs.  Does this requirement substantially reduce the risk – or have any real value to investors?  While a loan is not a DVP (delivery vs. payment) asset, there are tools that largely ensure that cash cannot be misappropriated.  Better make sure that your firm implements them!

Join us at our Annual Conference next Thursday as our panelists peel the operational onion on these proposed rules and help determine what this means for you and your institution.  The agenda (and registration) are available here.

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