Federal Reserve Releases Report on Liquidity Tools for Open-End Funds
As part of the FEDS notes series (a series from the Federal Reserve staff reflecting their own views on certain issues), Federal Reserve Board staff offer their views in an article titled, “New Insights from N-CEN: Liquidity Management at Open-End Funds and Primary Market Concentration of ETFs.” The paper sources data on mutual funds, ETFs, and money market funds through Form N-CEN, to determine which liquidity tools these fund types take advantage of. The paper focuses on three specific tools that are currently available to funds: swing pricing, bank funded lines of credit, and interfund lending. The study noted, however, that ETFs are generally less susceptible to liquidity issues than mutual funds because of the in-kind redemption features of ETFs.
The study observed that zero U.S. based funds implemented swing pricing likely because “funds, intermediaries, and service providers have not yet been able to work through operational issues in the current infrastructure.” Regarding the tapping of lines of credit with banking entities, the study found that between Q1 of 2018 and Q2 of 2021 approximately half of all open-end funds had access to at least one credit line facility. Broken down by fund type, the study noted that during this period 55% of mutual funds, 42% of money market funds, and 15% of ETFs had an established line of credit. The study observed that “mutual funds were the largest borrowers while ETFs borrowed for the longest period, at 106 days.” While open-end funds are generally prohibited from interfund lending under the Investment Company Act of 1940, individual fund families can apply for exemption to the SEC after meeting certain conditions. The Federal Reserve staff found “only two and three percent of all open-end funds lent and borrowed via these arrangements during our sample period, and an average loan lent was about $15 million with three outstanding days.” The study highlights that money market funds tend to be the “largest and the most patient lenders in interfund lending,” while mutual funds tend to borrow greater amounts more frequently.
The authors conclude by noting the pending rule proposal at the SEC that would mandate swing pricing at all mutual funds while carving out ETFs and money market funds (although the Commission has a similar swing pricing proposal pending in the money market fund space). The authors write that “the SEC's recent proposal, if adopted, would be an important step to enhance the timeliness and transparency of fund reporting and disclosure.” Additionally, the authors’ state “closing the data gaps would enable regulators to better monitor funds' liquidity mismatch and their risk management from a financial stability perspective.”