To Swing or Not to Swing?
Swing pricing for U.S. mutual funds—excluding money markets and exchange traded funds—will be permitted, but not required beginning November 19, 2018. Swing pricing allows a fund to adjust its net asset value (NAV) to pass on the associated costs to purchasing or redeeming shareholders.
Adopted in October 2016, concurrently with the Securities and Exchange Commission's Liquidity Risk Management Program (LRMP), swing pricing is intended to protect existing shareholders against dilution by attributing the estimated financial impact—trading and market impact costs—to redeeming or purchasing shareholders.
On days when the swing threshold has been reached, swing pricing allows for the fund’s NAV to be adjusted up or down by the swing factor. The swing factor is a fixed factor by which the NAV will swing up (for net purchases) or down (for net redemptions) when daily investor trading activity triggers the swing threshold. By applying the “swung” NAV to daily transactions, trading investors bear the burden of trading costs, protecting existing investors from absorbing those expenses.
The swing threshold is the level of net capital activity, as a percentage of the NAV, which triggers the application of the swing factor. In order to determine if the swing threshold has been met on a given trading day, information on that day’s transaction activity is required prior to the NAV strike.
Funds formulating their LRMPs may be considering using swing pricing. Because timing of order transmission has a significant impact on the process, funds who distribute via intermediaries must consider order timing as they evaluate the viability of swing pricing.
In order to make a swing determination, funds need to know if they’ve crossed the swing threshold. The SEC’s adopting release acknowledges that details of all orders may not be available in time to make that call, and allows for a “reasonable, high confidence estimate.”
While many intermediaries send orders during the business day on trade date, the majority of orders are still communicated from firms to funds after the 4 p.m. EST market close on the trade date. This allows investors to place fund trades up to the market close via their intermediary firm.
If your funds are distributed to defined contribution retirement plans using record-keeping firms to aggregate individual investor activity into plan level orders, orders may be transmitted overnight or in the early morning hours on T+1 (trade date plus one day). This allows the plan record keepers sufficient time to perform their order aggregation processes. In some instances, the record keepers then transmit orders via another intermediary or clearing firm, adding an additional step to the order communication process.
Key considerations when evaluating swing pricing:
The order timing challenge is not unique to specific firms, but is reflective of the overall market model. Industry groups continue to collaborate and discuss opportunities for change.
For global asset managers, understanding the nuances of U.S. market distribution and operations is key to determining whether or not swing pricing is a viable option in U.S. funds.
NORTHERN TRUST ACTIONS AND NEXT STEPS:
Northern Trust's has experience providing swing pricing client support, and is reviewing opportunities to prepare for adoption in the United States.
If you have questions about swing pricing and U.S. mutual funds distribution models, talk to your relationship manager or visit northerntrust.com.
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