NATIONWIDE: An Introduction to Registered Funds

How the Biden Administration Will Impact Asset Management

With the first 100 days of the Biden administration in the rear-view mirror and Chair Gensler newly installed at the Securities and Exchange Commission (“SEC”), policy priorities for the asset management industry are becoming clearer. Our analysis begins with the two most pressing priorities – climate change disclosure and repercussions of the pandemic. We then turn to what to expect from the Divisions of Examinations (“Examinations”) and Enforcement (“Enforcement”). Finally, we highlight other issues that we anticipate the SEC or the Division of Investment Management likely will address.

Climate Change and ESG 

The Biden administration has announced a “government-wide” approach to the climate crisis and environmental justice. Chair Gensler’s testimonies before Congress signaled strong support for regulation relating to corporate issuer climate risk disclosures, and during her tenure as acting chair, Commissioner Lee highlighted disclosure as the “most fundamental role” the SEC must play with respect to climate risk and ESG more generally. While ESG regulatory plans for asset managers and funds are not as clear, we anticipate amended rules or guidance related to one or more of the following: Rule 35d-1; proxy voting guidance; amendments to Form N-PX. In addition, we already have seen the Biden administration forcefully re-engage globally. While it is unlikely that the SEC would adopt regulation substantially similar to Europe’s (e.g., Sustainable Finance Disclosure Regulation), efforts to harmonize ESG-related regulation globally could influence SEC policy choices. In any event, increased asset manager and product disclosure under European regulations, especially as it becomes more detailed next year, will inevitably have an impact on US asset managers.

COVID-19 and Financial Stability 

One priority of the SEC in 2021 will be to consider appropriate policy responses to the market volatility of 2020. Federal regulators implemented a number of programs in March 2020 in an effort to calm jittery markets, including stepping in with emergency measures to assist money market funds and instituting a liquidity facility to purchase corporate bond ETFs. The SEC has been studying what occurred, and we expect that they will develop policy responses intended to address what they learn. In particular, SEC staff already are signaling that prior regulatory actions for money market funds may not have operated as intended, such that further policy changes may be warranted. Will those changes be supported by the banking regulators, FSOC, and international bodies such as the FSB? Stay tuned. More broadly, the SEC also is considering whether changes should be made in the fixed income markets. Needless to say, the Fed will be very interested in these choices, including specifically as they relate to fixed income ETFs, after its intervention with respect to these products.

Examinations and Enforcement 

Examinations priorities for asset managers for 2021 include, in light of COVID-19, plans to review information security risks, including cyber-attack-related risks and business continuity and disaster recovery plans. Consistent with the “government-wide” focus on climate, Examinations plans to increase its scrutiny of investment strategies that incorporate ESG, particularly whether the firms’ practices are in line with their disclosures. Examinations also will focus on compliance with the fiduciary duty rulemaking and guidance - Pete Driscoll recently stated that Form CRS will be the “number one” document that examiners will read as they prepare for an examination. Other priorities include ETFs, digital assets, fund anti-money laundering programs, LIBOR transition, and fund liquidity risk management.

Enforcement was down significantly in 2020 – there were 17% fewer cases brought than in 2019. We expect Chair Gensler to be aggressive in the enforcement arena, including a shift in focus from Main Street to Wall Street, significant corporate penalties, and efforts to enforce new rules like Regulation Best Interest. Enforcement recently announced the creation of a Climate and ESG Task Force, which will focus on disclosure gaps. With respect to funds and asset managers, the existence of the Asset Management Unit ensures continued focus on our industry.

Other IM priorities  

Cryptocurrency 

The SEC has consistently rejected applications for a bitcoin ETF. We believe Chair Gensler’s arrival may be the catalyst for change. At his confirmation hearing, Chair Gensler referred to teaching courses on cryptocurrencies at MIT and indicated: “Bitcoin and other cryptocurrencies have brought new thinking to payments and financial inclusion, but they’ve also raised new issues of investor protection that we still need to attend to.” While IM previously has raised concerns related to custody, excessive volatility and fraud, the crypto space has matured. Regulated entities are entering the custody space, and the crypto futures markets are seeing higher volumes.

Cross Trading 

In adopting the valuation rule, the prior administration left an unexploded land mine relating to cross trades under Rule 17a-7. The definition of the term “readily available market quotations” generally means that any security classified as Level 2 under GAAP, including most fixed income securities, will no longer will be eligible to cross trade once the valuation rule goes into effect on September 8, 2022. IM issued a request for feedback on this issue, and potential revisions to Rule 17a-7 are on the SEC’s most recent rulemaking agenda. The industry has urged the SEC to scrap the requirement that cross trades require a “readily available market quotation” and replace it with a new principles-based approach.

Registered Fund Boards 

Registered fund boards historically have met in person based, in part, on certain statutory requirements. In 2020, in response to the pandemic, boards successfully transitioned to virtual meetings consistent with temporary relief from the in-person meeting requirements provided by the SEC. As boards start planning the return to in-person meetings, the SEC is considering whether to make this relief permanent and, if so, under what conditions. Boards of public operating companies have had the flexibility to meet virtually for many years. Based on the successful experience with virtual meetings during the pandemic, we expect the SEC to provide fund boards with at least some flexibility to continue in-person meetings going forward.

Antitrust 

Under the prior administration, the Federal Trade Commission proposed amendments to the Hart-Scott Rodino Act (“the Act”) that would expand the definition of “person” under the Act to include “associates,” and require the aggregation of acquisitions in the same issuer across those entities (“the Aggregation Rule”). The industry has expressed concerns that the Aggregation Rule effectively would result in the elimination of exemptions for ordinary course transactions made solely for the purpose of investments, which, among other concerns, will lead to increased filings, the costs of which will ultimately be borne by investors.

Conclusion 

2021 will be a busy year for asset managers. As the former administration wrapped up in 2020, the SEC finalized a number of major rules impacting advisers and registered funds, including funds-of-funds, derivatives and valuation. Funds and advisers will spend significant resources in 2021 gearing up to comply with these complex rules. As Chair Gensler settles into his new role and fills out his senior staff, many factors, including the other Commissioners, Congress, the industry and market events, will impact his agenda. Asset management is only one piece of the SEC’s broad mission and responsibility, so priorities in this space will have stiff competition for SEC time and attention from important issues in other areas under the agency’s jurisdiction. Nonetheless, as his agenda begins to take shape, we can expect action on those outlined above, and the asset management industry would be wise to keep a close eye on these developments.