The Securities and Exchange Commission (SEC) has proposed two rules that would require swing pricing for different types of products.
Swing pricing uses a “swing factor,” expressed as a percentage of the fund’s net asset value (NAV) and intended to represent an estimate of the transaction costs, to adjust the NAV per share. Funds could use this mechanism to change the NAV for redeeming shares during periods of market stress, where the cost is borne by shareholders that decide to redeem, not those that remain invested in the fund.
The SEC claims swing pricing is necessary because it would protect investors during periods of mass redemptions, but mutual fund industry leaders say implementing the mechanism would be an operational burden.
Two Proposed Rules
In 2021, the SEC proposed a rule that would require swing pricing for money market funds before following up with the most recent proposal that would require most other open-end funds to adopt swing pricing, as well.
The November 2022 swing pricing proposal for open-end funds is similar to the mandatory requirements that the SEC proposed for institutional money market funds in 2021, but they also differ in important ways. Those differences would make it difficult for fund managers and intermediaries to comply with both rules.
The money market fund swing pricing proposal relates only to net reductions, whereas the swing pricing proposal for open-end funds relates to both purchases and reductions. In addition, the money market fund proposal has different thresholds than the open-end fund proposal.
In any event, implementing the swing pricing procedures in the SEC’s November 2022 proposal in its current form would require daunting fundamental changes in fund companies’ operating procedures.
Different Requirements and Different Implementations
If the SEC finalizes its two proposed rules requiring swing pricing, companies that offer products impacted by both rules, along with their intermediaries, will have to establish processes to comply with the different requirements set forth in the proposals, which will require different implementation.
Data is a central element of swing pricing that companies must consider, and the flow of information presents an operational challenge. Speaking to Ignites, John Randall, director of operations and distribution at the Investment Company Institute, said companies need to know trading volume and activity to effectively calculate swing pricing.
“The main reason that it’s operationally a challenge is because you need a certain amount of data, and that data is not available in the time frame you would need it,” Randall told the publication. “So, it makes it very difficult to swing a price.”
“Fund companies would need trade volume details in order to price accordingly,” explained Jason Davenport, Delta Data Sales Director. “However, that detail comes from an intermediary who needs the pricing before they can send over the trade details.”
Hard Close Brings Bigger Operational Challenge
There are numerous concerns with the swing pricing proposal, including investor confusion and the operational and informational issues that the SEC is attempting to fix simultaneously with the implementation of a hard close.
Under the proposal, all open-end funds required to implement swing pricing (which would exclude money market funds and ETFs) would also be required to implement a hard close of trading for open-end funds at 4 p.m. ET.
Currently, if an investor submits an order to an intermediary to purchase or redeem fund shares, that order will be executed at the current day’s price if the intermediary receives that order before the time the fund has established for determining the value of its NAV.
However, the fund may not receive information about that order until after it calculates its NAV, which presents issues for implementation of swing pricing due to funds lacking sufficient flow information.
To comply with the proposed hard close requirement, funds and intermediaries would need to make significant changes to their business practices, including altering processes and integrating new technologies to facilitate faster order submission.
“The hard close portion of the rule is a real sticking point for intermediaries, given their current processing timelines,” said Colt Younger, Delta Data’s Senior Vice President of Product. “It seems like people might be able to find paths, while not ideal, to get through swing pricing. The hard close component is harder to get around operationally.”
Industry Pushes Back with Comments Letters
During the public comment period for the swing pricing proposal, the mutual fund industry came out swinging against it, with the SEC receiving more than 245 distinct comments.
“The SEC’s proposal would fundamentally disrupt funds’ current practices, upend long-standing approaches to calculating share prices, and ultimately make investing more confusing for everyday Americans,” read a comment letter advanced by the Investment Company Institute and duplicated more than 2,000 times to the Commission.
Many commenters pushed back on the proposed Investment Company Act Rule 22c-1 (pricing of redeemable securities for distribution, redemption, and repurchase) for its call for swing pricing and a hard 4 p.m. ET close.
A hard close “would also negatively impact or entirely eliminate the ability of investors who transact in mutual funds through intermediaries or retirement plans to purchase or sell shares at the net asset value (NAV) of a fund on the same day they submit their orders,” said SIFMA.
Even the Consumer Federation of America, which does support the SEC’s liquidity risk management proposal, cautioned against the use of swing pricing in the U.S.
“In Europe, funds are able to obtain [sufficient flow] data before striking their NAV, whereas in the U.S., funds are able to obtain this data before striking their NAV,” the group wrote.
“The fact that some investors would be able to execute their orders on the same day while others would be forced to wait an extra day to execute their orders would also make swing pricing less effective,” the CFA added.
Without substantial changes to the way funds and intermediaries transact purchases and redemptions, the implementation of swing pricing by funds presents significant challenges and operational changes by open-end funds and intermediaries. If adopted in their proposed form, these new rules would have a far-reaching impact on the mutual funds industry.
As the industry awaits the SEC’s next action on the swing pricing proposal, contact Delta Data to learn more about how these rules could affect your firm.