The Chairman of the Securities and Exchange Commission defended the commission’s swing pricing proposal at an annual conference hosted by the Investment Company Institute. The SEC’s proposal would require most open-end funds to keep at least 10% of their net assets in highly liquid assets, would impose a hard close at 4 p.m. eastern time, update liquidity classifications, and implement swing pricing.
Swing pricing is a pricing mechanism which requires the NAV of a fund to adjust to account for trading costs and thereby passes those costs to the traders in the form of a reduced redemption price, instead of absorbing the costs back into the fund and effectively forcing remaining fundholders to bear the cost. The proposal is intended to reduce dilution of the fund and disincentivize additional redemptions.
The motivation for this proposal is primarily the stress placed on mutual funds in 2020, early in the pandemic, which required intervention from the Federal Reserve. Gensler has emphasized that the SEC should use its authority to reduce the necessity of emergency Fed intervention. In his remarks at ICI, he noted the Fed was intended to be a lender of last resort to banks and not to funds.
Gensler explained that there have been many policy changes in U.S. history that were designed to reduce the damage done by financial panics and market runs. He cited President Woodrow Wilson creating the Federal Reserve after the Panic of 1907, and President Franklin Roosevelt creating the SEC and Federal Deposit Insurance Company in response to the Great Depression.
When describing the risk of economic panics, Gensler turned to a metaphor he cites often: the camper who escapes the hungry bear, not because he was the fastest camper, but because he was not the slowest. In other words, the last investor to sell is the one who gets eaten (by the market), and the urge to not be last encourages panic selling.
Eric Pan, the president and CEO of ICI and moderator of the conversation with Gensler, responded by asking if the threat of dilution was “really a bear or is it a cub?” Pan argued that investor dilution, even during the pandemic was relatively small, or at least manageable; and that in any case, the “knock on effects” of dilution are not a threat to financial stability on a national level.
Gensler answered that fund dilution from large redemption volume is not “an unsubstantiated hypothesis.” The chairman explained that many mutual funds requested liquidity from the Fed in 2020 so that they could meet the large number of redemption requests that were coming in due as Covid lockdowns began.
The Fed providing liquidity to funds in 2020 was a theme that Gensler would come back to during his address to the conference. He noted that many of the same fund managers were in the conference audience, telling them “you recall who you were,” and saying that some audience members should “look in the mirror.” When Pan expressed skepticism that dilution is a major problem, Gensler recommended that he “ask your members who were making those phone calls in 2020.”
The key goal of the swing pricing proposal, according to Gensler, is that “redeeming shareholders bear the appropriate costs associated with their redemptions, particularly in times of stress” and that the proposal was an important element of “liquidity risk management.” Investors should be protected from dilution so that they can get a price that reflects the value of the underlying portfolio, he said.
Other market participants and observers have raised concerns about the proposal that include its potential negative effect on those saving for retirement and on investors based in states on Pacific Time, who could struggle to get trades in on time in Eastern Time in order to get that day’s price.