Introduction
Thank you, Paul [Stevens], for your kind introduction. Today marks my
fourth appearance here in as many years as Chair of the SEC, which should come
as no surprise. The Commission is the primary regulator of the mutual fund
industry, and it is vital that we all work continuously to protect and serve the
broad spectrum of America’s investors who depend on your products every day for
retirement, for college tuition, and for so many other financial goals.
When we first met in 2013, the industry was anxiously awaiting the SEC’s
actions on money market fund reform, the question of how to address potential
systemic risk in the asset management industry was still nascent, and the
Commission had not yet embarked on its latest effort to enhance its regulatory
regime for asset management. Much has happened since, including the
adoption of final rules for money market funds and a public statement by the
Financial Stability Oversight Council (FSOC), issued last month, updating its
review of the potential systemic risks in certain asset management products and
activities. Today, the Financial Stability Board (FSB) is working toward
issuing a second consultative draft analyzing similar issues. And the SEC
staff is, at my direction, working hard to finalize recommendations for the
rules we proposed last year on fund reporting, liquidity risk management, and
the use of derivatives, as well as advancing other proposals and
initiatives.
So, there indeed have been many significant issues to discuss with you in
the last few years and the spotlight on the asset management industry has been
bright. I expect that will continue to be the case, in 2017 and beyond,
which is what I want to focus on today. In that future, I believe the
asset management industry will continue to evolve and to be of vital importance
to investors, providing them a diversity of investment opportunities to meet
their financial goals. Dynamic and robust regulation will also be needed
that adapts and evolves to meet all of the current and future risks and
challenges, while preserving the features that have served investors so well
over more than seven decades.
Fostering this kind of dynamic regulation for asset management has been one
of the critical responsibilities of the SEC since 1940, and it has been no small
task. The 436 registered management companies with 300,000 accounts that
had a little more than $2 billion in assets in 1940,[1]
has grown to 8,131 mutual funds with approximately $15 trillion in assets held
by 54 million U.S. households as of March 2016.[2]
The current and future health of our markets and the financial security of
investors depend on the success of both our regulatory efforts and how well all
of you and other industry participants do your jobs as fiduciaries and
responsible leaders of the marketplace.
The SEC is keenly focused on our share of that weighty
responsibility. In 2014, we fundamentally reformed the way that money
market funds operate to both make our financial system more resilient and to
enhance the transparency and fairness of these funds for America’s investors.[3]
Then, building on a series of regulatory initiatives I announced in December
2014,[4]
last year we proposed rules to modernize reporting,[5]
to strengthen liquidity risk management requirements,[6]
and to address the use of derivatives by registered funds.[7]
And the staff has been closely focused on developing recommendations for
transition plans and annual stress testing for certain funds and investment
advisers.
Today, as we consider what the future will demand of investment company
regulation, I will briefly discuss these current efforts and then share my
vision for the next steps in the evolution of regulation for the asset
management industry. Our current regulatory initiatives will, of course,
continue to be a key element of that vision, but so too are addressing issues
like disclosure effectiveness, the oversight of exchange-traded funds (ETFs),
accurate portfolio pricing, and cybersecurity, to name a few. You, too,
have major responsibilities in all of these areas.
Asset Management Initiatives
Three of the most significant areas of regulation for the asset management
industry are: controls on conflicts of interest; a robust registration,
reporting and disclosure regime; and controls on specific fund portfolio
composition risks and operational risks.
[8]
During my tenure as Chair, our rulemaking program has been primarily
focused on the third area to address important developments in the industry over
the last several years.
Recent Rulemaking on Liquidity and Derivatives
Key among our efforts are the Commission’s 2015 proposals focused on
liquidity and derivatives. These initiatives are critical: they will
position the SEC to better monitor and protect America’s investors and the
integrity of the industry. And it is our responsibility to promptly
finalize these rules, which I expect to move forward on this year.
For an investor, a fundamental feature of a mutual fund is that it will
promptly honor a redemption request.
[9]
One of the challenges in managing funds is maintaining sufficient
liquidity to meet redemptions while also minimizing the impact of redemptions on
the fund’s remaining shareholders. Last December, when a mutual fund
focused on investments in high yield and distressed debt could not meet its
redemption obligations, we witnessed a demonstration of the impact on fund
investors from an illiquid fund portfolio.
[10]
And FSOC and the FSB have been examining how such a risk in open-end funds
could also impact the stability of the broader financial system.
[11]
In developing and managing the portfolio of a mutual fund in a changing and
competitive environment, funds and their advisers must use all of the tools
necessary to effectively fulfill their legal responsibility to meet shareholder
redemptions while minimizing the impact on remaining shareholders. Mutual
funds need to be developed and managed in a manner that ensures that this core
requirement is met, which includes a consideration of the kinds of products and
strategies that are appropriate for mutual fund investments and investors.
The SEC has the responsibility to see that this is done.
In September 2015, we therefore proposed rules requiring liquidity risk
management programs for open-end funds.
[12]
Although commenters have been generally supportive of enhanced liquidity risk
management for funds, many expressed concerns about the liquidity classification
framework and operational challenges for swing pricing. We appreciated
receiving comments from the industry and other interested parties that provided
constructive suggestions focused on our shared goal of eliminating the adverse
consequences of ineffective liquidity management. This is a critically
important area, and I continue to welcome your input as staff works toward
finalizing recommendations for these reforms this year.
In December, we proposed another vital rule to enhance the regulation of
the use of derivatives by registered investment companies (including mutual
funds and ETFs) by limiting the amount of leverage that funds may obtain through
use of derivatives and requiring funds to implement derivatives risk management
measures.
[13]
One core purpose of the Investment Company Act is to protect investors from the
potential adverse effects of leveraging a fund’s assets, and the Act
specifically limits the ability of funds to borrow money or otherwise issue
senior securities. The proposed rule would provide an updated and more
comprehensive approach to regulating funds’ use of derivatives in light of the
significant growth in the volume and complexity of derivatives over the past two
decades and the increased use of derivatives by certain funds.
There has again been support for the Commission to act to provide an
updated and more comprehensive approach to the regulation of a fund’s use of
derivatives. Many commenters, however, are not in favor of the proposal’s
portfolio limitations and some have provided a range of suggested modifications
and alternatives. Here, too, I continue to welcome your views as staff
works to finalize the recommendations on the rulemaking.
A Look Toward the Future
As we build on the significant actions we have already taken and those I
expect to come this year, we are also actively engaged in many other areas where
important work remains to be done. And that work is a shared
responsibility for the Commission and for fund managers and boards. I will
first touch on two of the areas where we are taking the initiative – disclosure
effectiveness and ETFs –and then highlight some of the other emerging challenges
where your role is front and center.
Disclosure Effectiveness in the Fund Industry
One important area we are focused on is whether the disclosure regime for
registered funds has evolved sufficiently in response to the changing types of
funds and strategies, as well as the evolving needs of investors.
Registration is a core regulatory tool that enables the Commission to
identify, monitor, and regulate funds and advisers, and the periodic disclosure
about their business arrangements, related conflicts, and compliance practices
is a key requirement of registration that provides essential information to
investors. The Commission has already taken significant steps to modernize
our registered fund disclosure regime, including adopting the summary prospectus
to better focus mutual fund investors on the fees and risks of a fund.
[14]
But more is needed.
Consequently, as we look forward past 2016, I have directed IM staff to
undertake a disclosure effectiveness initiative of their own to consider ways to
improve the form, content, and delivery of funds’ disclosures. Staff is in
the early stages of prioritizing areas of focus, but I expect they will include
ways to leverage advances in technology to improve the presentation and delivery
of disclosures and ways to enhance disclosure about fund strategies,
investments, risks, and fees.
In particular, a fund’s disclosure of fees and expenses plays a pivotal
role in informing investors about their fund investments. The staff will,
for example, consider whether improvements could be made to the fee table to
facilitate investor comprehension of the information it presents and whether the
most helpful information is required. The SEC’s Investor Advisory
Committee, at its meeting in April, also recommended that the Commission
identify ways to improve mutual fund cost disclosure.
[15]
I also encourage you to provide your insights to IM staff.
Other areas of staff focus include how funds can present risks most
effectively
[16]
and whether the requirement that a fund disclose certain factors that materially
affected the fund’s performance can be improved.
[17]
And there continues to be concern about whether all of the information in a
prospectus or statement of additional information continues to be necessary or
helpful to investors. The summary prospectus has helped, but the staff is
considering whether further improvements could be made.
IM’s disclosure effectiveness initiative will seek to aid funds and their
managers in preparing their disclosure materials. But do not forget that
it is a fund’s ultimate responsibility to provide investors with the
information they need to make informed investment decisions. You should be
continuously reevaluating the purpose and value of all of your funds’
disclosures. Avoid boilerplate and tailor your disclosure as appropriate
for each fund. Ask yourselves regularly: What can I do to improve
investors’ understanding of the fund’s strategies, risks, and costs? These
features of your funds change continuously and so should your disclosures.
Need for Further Review of ETFs
Clearer and more robust disclosures are only part of the current and future
picture. The SEC’s authority and focus go considerably beyond disclosure
[18]
and so should your focus and fiduciary decision-making. We regulate funds’
practices as well as their disclosures, and certain events over the last decade
have sharpened our focus on particular types of funds that we believe require
our enhanced attention. ETFs are a prime example, and they are the second
challenge for the future of investment company regulation that I want to focus
on today.
As you know, the evolution and growth of the ETF industry have been
astounding. The number of ETFs has grown from 359 in 2006 to 1,594 in
2015, with a corresponding growth in the amount of net assets from $408 billion
in 2006 to more than $2 trillion in 2015.
[19]
Despite the popularity and broad success of these funds, their history is
not without some turbulence. Take, for example, the May 2010 Flash Crash,
which highlighted the need to review disparities in prices for index ETFs and a
decline in prices of U.S. equity securities.
[20]
Similar issues appeared on August 24, 2015, when the markets again experienced
unusual price volatility, including a lack of liquidity in certain securities.
[21]
The staff has been focused on analyzing these events and any broader
implications they may have for how we regulate ETFs. They are also
analyzing the role that authorized participants and market makers play in the
operation and trading of ETFs and how much they impact the liquidity in the
markets.
[22]
Staff is looking closely at the interconnectedness of the prices of ETF shares
and their portfolio holdings and the impact on investors when the ETF’s
arbitrage mechanism does not function efficiently. And staff is
considering the sales practices of broker-dealers in the market and how
investors understand and use ETFs, particularly as the product landscape
continues to diversify. The SEC has taken a number of initial actions to
share our thinking on these issues,
[23]
and further regulatory steps beyond additional disclosures may be needed to
address some of these issues. I welcome the input of ETFs, investors, and
other market participants as we continue to consider the unique and pressing
challenges that arise from the ETF structure.
Use of Technology and Service Providers
While the Commission is very actively engaged in enhancing disclosure
effectiveness and the regulation of ETFs, there are other emerging challenges
that are Commission priorities where your focus, expertise and initiative are
particularly essential. One such challenge is the risk in using technology
and service providers. This challenge was clearly illustrated for you
during the events of August 24
th when a fund service provider was
unable to timely process system-generated NAV calculations for certain ETFs and
mutual funds or to produce current baskets for ETF in-kind creation and
redemption orders.
[24]
The incident created significant issues for funds and highlighted the challenges
that can arise from the technology and interdependencies that drive the modern
securities market. It is important that a fund is adequately prepared to
promptly and effectively respond to risks that may be triggered by service
providers and its own use of technology, including implementing alternative and
reliable means to satisfy the fund’s regulatory requirements.
Cybersecurity is a particularly critical element of this challenge – as I
have said before, it is one of the greatest risks facing the financial services
industry. Cyber risks can produce far-reaching impacts, and robust and
responsible safeguards for funds and for their investors must be
maintained. The Commission has been very active in drawing attention to
the issue and examining and enforcing the rules we oversee that relate to
cybersecurity.
[25]
Our regulatory efforts are focused primarily on ensuring that our
registered entities have policies and procedures to address the risks posed to
systems and data by cyberattacks. In the asset management space, IM staff
issued guidance that discussed a number of measures that funds and advisers
should consider.
[26]
While no one can prevent all disruptions from cybersecurity events, you should
consider the full range of cybersecurity risks to your funds and consider
appropriate tools and procedures to prevent breaches, detect attacks and limit
harm.
Portfolio Pricing
Another challenge for funds is pricing portfolio holdings and determining
per share net asset values (NAV) accurately. Increasingly, funds have
acquired portfolio investments that make it difficult to accurately determine
their value, especially in a timely manner each day. Many of these
portfolio investments may have legal or contractual restrictions on their sale,
others may be complex instruments, and still others may not trade that
often. As portfolio strategies and permissible investments for a fund are
being developed, it is essential that the accurate pricing of the portfolio
holdings and NAV calculations are carefully considered. It is also
important that the services used to assist funds with pricing do so accurately,
in the manner disclosed in the fund’s prospectus and consistent with the
law. This is of high importance to everyone. I, along with your
investors, expect that you will get it right.
Of course, these are not the only challenges for funds. Fund
governance is another, as are valuation, performance advertising, and issues
that may arise when funds make payments to intermediaries for the distribution
of fund shares. I encourage you to continue to work to address these
challenges and identify others that may impact your funds and their
investors.
Conclusion
With all of the developments in the fund industry that I have discussed
today, one thing that has not changed since 1940 is the SEC’s duty to ensure
that all investors, whether they are investing in mutual funds or other types of
investment companies, are protected. The Commission’s work over the
decades demonstrates how deeply we hold this responsibility, and our current
initiatives, while quite consequential, are just the latest example of the
agency carrying out its mission.
At the same time, you too bear a weighty responsibility as stewards of the
assets of America’s investors. While the SEC regulates investment
companies, you, as asset management executives, are the standard bearers for
your industry and must foster a culture in your organizations that prioritizes
responsibility and fairness and asks first – and last – what is in the best
interest of investors. As you develop new products and new strategies,
your focus should be on helping to ensure that those products and strategies are
designed to best meet investors’ needs and that America’s investors are strongly
protected.
Thank you for listening and for all you do, and will do, for your
investors.
[6]
Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening
of Comment Period for Investment Company Reporting Modernization Release,
Release No. 33-9922 (Sep. 22, 2015),
available at https://www.sec.gov/rules/proposed/2015/33-9922.pdf
(“Liquidity Management Proposal”).
[8]
See Chair White Dec. 2014 Speech,
supra note 4.
[9]
See Section 22(e) of the Investment Company Act.
[12]
Liquidity Management Proposal, supra note 6.
[13]
Derivatives Proposal, supra note 7.
[17]
See Form N-1A, Item 27(b)(7) (requiring that a fund’s (other than a
money market fund) annual report to shareholders “discuss the factors that
materially affected the Fund’s performance during the most recently completed
fiscal year, including the relevant market conditions and the investment
strategies and techniques used by the Fund’s investment adviser.”)
[22]
Remarks to the Investor Advisory Committee,
supra note 21.