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Mutual Fund Modernization and Liquidity Risk Management

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Mutual fund sponsors and their service providers are reevaluating their operating models to support compliance with the SEC’s Mutual Fund Modernization reporting requirements and Liquidity Rule. This discussion explores the challenges that fund sponsors and administrators are facing, as well as insights on how they are responding to each of these emerging regulatory requirements.

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Mutual Fund Modernization and Liquidity Risk Management

  1. 1. 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:
  2. 2. www.nicsa.org | #WebinarWednesdays 2 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
  3. 3. www.nicsa.org | #WebinarWednesdays 3 Today’s Speakers Bruce Treff Managing Director Deloitte & Touche LLP Boston, MA +1 617 437 3087 btreff@deloitte.com Robert Zakem Managing Director Deloitte & Touche LLP Atlanta, GA +1 404 220 1369 rzakem@deloitte.com Lisa Shea Senior Vice President Northern Trust Corporation Chicago, IL +1 312 444 4214 ls70@ntrs.com Karl Ehrsam Principal Deloitte & Touche LLP Parsippany, NJ +1 212 436 3153 kehrsam@deloitte.com
  4. 4. www.nicsa.org | #WebinarWednesdays 4 Investment Company Reporting Modernization
  5. 5. www.nicsa.org | #WebinarWednesdays 5 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
  6. 6. www.nicsa.org | #WebinarWednesdays 6 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 Identifying Resourcing 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
  7. 7. www.nicsa.org | #WebinarWednesdays 7 Representative data challenges and considerations What the Industry Is Facing? What Can the Industry Do? Sourcing Derivative Return 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)
  8. 8. www.nicsa.org | #WebinarWednesdays 8 Perspective on service provider readiness Technology Product Offering Implementation Timeline Service Model Support Representative Strengths • 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 experience in 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 Representative Challenges • 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
  9. 9. www.nicsa.org | #WebinarWednesdays 9 Liquidity Risk Management
  10. 10. www.nicsa.org | #WebinarWednesdays 10 ‫‏‬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 purposes Increase transparency through standardization 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
  11. 11. www.nicsa.org | #WebinarWednesdays 11 LRM Program Governance Data Management Parametrization 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 risk management have elevated liquidity risk to board-level attention which requires cross-functional involvement
  12. 12. www.nicsa.org | #WebinarWednesdays 12 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
  13. 13. www.nicsa.org | #WebinarWednesdays 13 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 minimus test 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
  14. 14. www.nicsa.org | #WebinarWednesdays 14 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
  15. 15. Q&AQUESTIONS & ANSWERS SESSION www.nicsa.org | #WebinarWednesdays 15
  16. 16. www.nicsa.org | #WebinarWednesdays 16 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. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see www.deloitte.com/about to learn more about our global network of member firms.

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