Mutual Fund Modernization and Liquidity Risk Management

www.nicsa.org | #WebinarWednesdays

Investment Company Reporting Modernization and

Liquidity Risk Management

Perspectives on Industry Readiness For Regulatory Change

January 24, 2018 2:00-3:00pm EST

Sponsored by:


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Agenda

Introductions and Opening Remarks All

Investment Company Reporting Modernization (MFM)• Rule background and modification to filing requirements• Operating model challenges and perspective• Data aggregation and governance concerns• Service provider readiness

• Bruce Treff, Managing Director, Deloitte & Touche LLP

• Karl Ehrsam, Principal, Deloitte & Touche LLP

• Lisa Shea, Senior Vice President, Northern Trust Corporation

Liquidity Risk Management (LRM)• Overview of the Liquidity Rule• Industry challenges and perspective• Compliance strategy considerations• Summary of representative Liquidity Rule FAQ’s• Interconnectivity between MFM and LRM rules

• Bob Zakem, Managing Director, Deloitte & Touche LLP

Questions and Answer All


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Today’s Speakers

Bruce TreffManaging DirectorDeloitte & Touche LLPBoston, MA+1 617 437 [email protected]

Robert ZakemManaging Director Deloitte & Touche LLP Atlanta, GA+1 404 220 [email protected]

Lisa SheaSenior Vice PresidentNorthern Trust CorporationChicago, IL+1 312 444 [email protected]

Karl EhrsamPrincipalDeloitte & Touche LLPParsippany, NJ+1 212 436 [email protected]


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Investment Company Reporting Modernization


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Rule background and the modification to filing requirements

SEC’s Modified Approach

The SEC has now modified the approach for RICs to file Form N-PORT while the agency continues the review and uplift of the Electronic Data Gathering, Analysis and Retrieval (“EDGAR”) and other systems

Filing of Form N-PORT through the EDGAR system will begin in April 2019 for larger fund groups and April 2020 for smaller fund groups

Fund groups will be required to maintain Form N-PORT information in their records and make this information available to the SEC upon request in lieu of filing the Form N-PORT on EDGAR

Fund groups will be required to continue filing Form N-Q until the fund begins filing Form N-PORT using EDGAR

No modifications were made to the June 1, 2018 compliance date for Form N-CEN

Impact to the Industry

Demonstrate June 1, 2018 Compliance• Large fund complexes and their service

providers will be encouraged to implement systems and/or modified processes by June 1, 2018 to evidence Form N-PORT information within the fund’s records upon SEC request

Finalize Data Sourcing and Aggregation• The 1,000+ data elements across Form N-

PORT and N-CEN will still need to be captured via multiple sources and validated for accuracy, quality and timeliness

Consider Impact To Implementation Planning• Plans may need to be re-evaluated to

consider the need to evidence Form N-PORT information by June 2018, and implement solutions to submit Form N-CEN by June 2018 and submit Form N-PORT via EDGAR by April 2019

Background

On October 13, 2016, the US Securities and Exchange Commission1 (SEC) finalized new Forms N-PORT and N-CEN that require certain Registered Investment Companies (RICs) to report and disclose additional information such as a fund’s derivatives holdings, liquidity position, and census-type information in a more compressed timeline

1https://www.sec.gov/news/pressrelease/2016-215.html


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Operating model challenges and perspectives

Challenges Industry Perspective

Finalizing Operating Model Decision

Evaluating Filing Solution Options – Filing solution offerings are not yet mature enough to finalize

decisions on the future operating model

Securing Board Approval – Without a finalized decision, the fund’s Board cannot provide approval on

new service agreements, processes and pricing

Enhancing Oversight /

Interaction Models

Performing Service Provider Oversight – Oversight models, including internal processes and controls

to perform due diligence and operational assessments of service providers, are becoming a secondary

priority until operating model decisions are finalized

Managing Ongoing Service Provider Interactions – Fund sponsors and service providers will be

encouraged to establish or enhance third party risk programs to manage the multiple layers of

cascading dependencies between service providers

Managing Internal and External Data

Requirements

Creating Structured Data Format – Filing solution providers are still actively developing the

appropriate schema that allows for the creation of the structured data format required by the filing

Leveraging Existing Data Subscriptions – Organizations may incur additional data costs on data that is

already received because some data providers consider data used for purposes of Form N-PORT a new,

customized service

IdentifyingResourcing Needs

“Crashing” Staff Resources – Organizations are unclear as to the of amount additional resources that

may be required to support new filings and the impact of these costs to the fund and/or sponsor

Obtaining Required Expertise – Firms may be challenged in identifying the appropriate resources who

understand the regulatory interpretive, fund accounting and technology aspects of the rule


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Representative data challenges and considerations

What the Industry Is Facing? What Can the Industry Do?

Sourcing DerivativeReturn and Reference

Information

• Many derivative transactions and positions are recorded in offline spreadsheets and are not at the granular level Form N-PORT requires

• Fund administrators or custodians often may not have readily available access to a derivative’s reference instrument information

Develop a uniform approach to:

• classify derivatives for ongoing fund reporting and accounting purposes

• calculate profit and loss for those N-PORT’s classification levels

Engage upstream parties (i.e., brokers) for reference instrument information

Reconcile internal and external security master databases

Establishing New Data Processes and Controls

• Fund sponsors have more access to a majority of the ~500 Form N-CEN requirements such as Legal Entity Identifiers, SEC File Numbers, and Central Registration Depository numbers than fund administrators

Develop a data governance model across multiple functions (e.g. Legal, Compliance, Operations, external) to confirm their acknowledgment and responsibility in providing data into the reporting process

Finalizing Data Strategy and

Warehousing Needs

• Data warehouse requirements have not been fully explored / vetted as fund sponsors and administrators are still finalizing N-PORT and N-CEN sources

Leverage technology professionals to identify and evaluate a data strategy not only for ongoing regulatory reporting, but for other business uses(e.g., internal analytics and data visualization)


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Perspective on service provider readiness

TechnologyProductOffering

ImplementationTimeline

Service Model Support

RepresentativeStrengths

• Developed initial user interfaces and workflows tools / capabilities

• Contemplating a data model used for multiple reporting purposes and not only Form N-PORT / N-CEN filings

• Previous experiencein offering and providing services to support similar reporting requirements

• Fully mobilized teams that have been working through the rule for months

• Existing relationships with fund reporting / administration teams that may assist in the resolution of future escalation issues

RepresentativeChallenges

• Not yet demonstrated a comprehensive Form N-PORT and N-CEN filing solution

• Developing the appropriate XML schema to support the new filings is an ongoing exercise

• Articulating additional services and associated pricing (e.g., data sourcing / enrichment, data warehousing)

• Accommodating a comprehensive time period for testing due to approaching compliance date

• Not yet finalized a plan for service level agreements, help desk structure, and new processes

• Supporting multiple initiatives related to mutual fund servicing

The evolution of new tools and service models to support MFM should be an iterative process between service providers and fund sponsors. Both parties should seek to engage each other in the development and advancement of their respective operating models


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Liquidity Risk Management


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Rule 22e-41‏ (the “Liquidity Rule”) requires funds and Exchange Traded Funds (“ETFs”) to adopt, implement, and manage a written liquidity risk management program that involves the following:

Periodic review of a newly established liquidity risk management program and its components

Monthly classification of fund investments into one of four liquidity classes

For certain funds, determination of a ‘highly liquid investment minimum’ – failure to maintain requires a subsequent report to the Fund Board and—in some cases—to the SEC

Adoption of related written policies and procedures, including record-keeping requirements

Limiting illiquid investments to 15% of net assets

Reporting certain liquidity events to the SEC via form N-LIQUID within one business day of occurrence

Adjusting responses to form N-1A, N-PORT and N-CEN based on new liquidity reporting requirements

Elements of the Liquidity Rule

Classify assets into liquidity groups

Establish liquidity thresholds to

quantify liquidity for monitoring

purposesIncrease

transparency throughstandardization of

reporting

Formalize liquidity program, policies and procedures

Liquidity Rule Summary

Overview of the Liquidity Rule

1https://www.sec.gov/rules/final/2016/33-10233.pdf


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LRM Program

GovernanceData

ManagementParametrization Technology

• Establishing guiding principles

• Process formalization

• Global v. jurisdictional approach

• Delineating roles & responsibilities across the three lines of defense

• Articulating LRM practices

• Enriching portfolio holding data

• Internal & external data aggregation and analysis

• Potential release of confidential data

• Defining security-level liquidity assumptions

• Determining the fund assessment methodology

• Centralizing fund flow data

• Establishing the highly liquid investment minimum

• Build v. buy solutions

• Automating pre-and post-trade liquidity monitoring

• Creating dashboard reporting

• Connectivity to fund reporting requirements

Common challenges when implementing effective LRM Programs

ETF Challenges

• Testing the de minimus exemption for ETFs with infrequent basket redemption activity

Subadvisor Challenges

• Divergent classifications

• Delegation of responsibilities across multiple subadvisors

• Reconciliation of data and security classifications

Potential Challenges Based on Recent SEC FAQ

LRM has historically been a portfolio management process, however, global regulatory changes and a focus on reputational riskmanagement have elevated liquidity risk to board-level attention which requires cross-functional involvement


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Quantitative and qualitative considerations

for the liquidity risk program

Amount of excess liquidity available and

monitoring under the Rule

Cash-flow projections

under normal and stressed conditions

Maturity profiles of available funding sources

Price volatility and correlation trends

with respect to certain asset

classes

Usage and limits of secured and unsecured lines

of credit

Funding and position

concentrations at each counterparty

Position concentrations

in related asset classes

Liquidation and mark-down assumptions for positions

Compliance strategy considerations


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Summary of representative Liquidity Rule FAQ’s

Roles and Responsibilities

• The Funds' LRM Program Administrator may delegate specific responsibilities to one or more subadvisers, subject to oversight by the LRM Program Administrator

Subadvisers to multiple funds and that are subject to multiple LRM programs are not obligated to reconcile the various elements of multiple LRM programs

The Funds' LRM program should control how an adviser/subadviser carries out its responsibilities under the Liquidity Rule

Security Classification

If there are multiple subadviser for the same fund, and each reach a different conclusion as to the liquidity of a security, neither the fund, adviser, or subadvisers are obligated to reconcile the classification differences for compliance purposes

The Fund's LRM program should have procedures to reconcile different classification conclusions for purposes of Form N-PORT filing

Subadvised Fund

Redemption In-kind ETF Exemptions

The In-kind status of an ETF is ultimately facts and circumstances based, and an ETF that lost its status could decide to avail itself of the in-kind exemption as soon as reasonably practicable

For new ETF's (i.e., those with no or limited operating history to test historical redemptions), an ETF could determine that it qualifies as an in-kind ETF based on its policies and procedures

An ETF that loses its status under the in-kind exemption does not have to wait for a defined period (e.g., 2 years) before claiming the exemption

Defining De minimus for purposes of classifying an in-kind ETF

If an ETF issues a redemption in cash proportionate to the ETF's cash position, such redemption will be considered an in-kind redemption

A cash redemption exceeding 10% of the redemption proceeds is unlikely to qualify as a de minimus amount of cash for purposes of qualifying as an in-kind ETF

For the purposes of testing whether an ETF meets the de minimustest for qualifying as an in-kind ETF, ETF's should adopt a consistent testing methodology that can include:

Back testing

Proven ability to facilitate redemption baskets under varied market conditions

ETF’s


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Interconnectivity between MFM and LRM Rules

• The Liquidity Rule provides the foundation for reporting on the liquidity of a fund’s portfolio position including Form N-LIQUID and new liquidity classifications, which would be required on Form N-PORT

• Form N-PORT requires reporting of monthly liquidity classifications and highly liquid investment minimums, which will be made public on the third month of each fiscal quarter with a 60-day delay

• Form N-CEN requires reporting of a fund’s use of lines of credit, interfund lending / borrowing and whether the fund qualifies as an In-Kind ETF

Investment Company Reporting Modernization

Liquidity Risk Management Program

N-PORT• Highly Liquid Investment

Minimum• Liquidity Classifications (both at

aggregate and the security level)

N-CEN• Lines of credit, Interfund lending

and interfund borrowing• In-Kind ETFs

N-LIQUID• Above 15% Illiquid Threshold• At or Below 15% Illiquid

Investments• Highly Liquid Investments

Below Highly Liquid Investment Minimum

Q&AQUESTIONS & ANSWERS SESSION


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This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting,business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

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Mutual Fund Modernization and Liquidity Risk Management

Economy & Finance

Transcript of Mutual Fund Modernization and Liquidity Risk Management