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SEC (Securities and Exchange Commission) Guidance on Risk Management in Changing Fixed Income Market

The Division of Investment Management issued an Investment Management Guidance Update suggesting certain steps that fund advisers should consider when evaluating their risk management and disclosure practices in light of the changing market conditions and the Federal Reserve Board’s decision to slow quantitative easing. The SEC guidance also indicates that mutual fund boards should use the guidance as a discussion topic when reviewing fund advisers as part of their oversight obligations.

In June 2013, the net assets of bond mutual funds reached near-historic heights of $3.6 trillion. While the bond markets are growing, primary dealer capacity in the market remains at levels similar to those in 2001, reducing the market-making capacity. The combination of decreased market-making capacity, increased interest rates due to slowing quantitative easing, and significant increases in bond mutual fund assets have the potential to decrease liquidity and increase volatility in the fixed income market. Understanding the potential increase in volatility, the Division of Investment Management suggested that fund advisers should consider taking the following steps:

  • Assess and Stress Test Liquidity. Consistent with the redemption requirements under Section 22(e) of the Investment Company Act, fund advisers should assess their ability to meet redemption requests over varying periods of time. The guidance suggests that advisers should undertake such testing in normal market environments, in addition to stressed environments, and assess their sources of liquid assets that would be least impacted by increases in market stress.

  • Conduct More General Stress-Tests/Scenario Analyses. The guidance prompts advisers to consider how they could use stress-testing beyond making liquidity assessments. For example, advisers could analyze interest rate hikes or widening spreads.

  • Risk Management Evaluation. Advisers should consider the outcomes of risk management assessments and determine what actions are most appropriate for individual funds or fund complexes.

  • Communication with Fund Boards. Advisers should keep fund boards apprised of a fund’s risk exposure and liquidity position and should consider whether the board would benefit from additional information regarding relevant topics.

  • Shareholder Communications. Funds should review and assess the adequacy of their existing fixed income risk disclosure, including the potential for increased volatility and redemptions in response to tapering of quantitative easing and rising interest rates.

Copyright © 2020 Godfrey & Kahn S.C.National Law Review, Volume IV, Number 120



About this Author

Chris Cahlamer Investment Management Attorney

Chris Cahlamer is the team leader of the firm’s Investment Management Practice Group, where he practices in investment management and securities law, focusing on investment companies, investment advisers, regulatory examinations, new product development, SEC compliance and reporting obligations, CCO support, private fund formation and operation, investment company reorganizations, investment advisor mergers and acquisitions, and general corporate and board fiduciary issues.

Chris earned his law degree, summa cum laude, at Marquette University Law School. While there, he...

Susan Hoaglund, Investment Management Attorney, Godfrey Kahn law firm

Susan Hoaglund is a member of the Investment Management Practice Group. Susan provides advice to investment advisers, investment companies, broker-dealers and banks regarding legal, regulatory and compliance matters.