Trouble Comes in Threes

Date: December 28, 2015

For people who believe in this sort of thing, numbers can be an omen. Seven is lucky. Thirteen is unlucky. All good things and certain bad things, most notably death and trouble, come in threes. And as everyone knows, the third time is the charm.

In 2015, the number three has definitely been of the bad variety for the investment company back office. While perhaps – perhaps – not as serious as death, a triumvirate of SEC-rule proposals – Investment Company Reporting Modernization (IC Mod), Liquidity Risk Management (Liquidity), and most recently the proposed Derivatives Rules for Registered Funds and Business Development Companies (Derivatives), – certainly fit the label of “trouble”. There have been many regulations proposed in 2015, but these three have the common bond of significant investment company back-office impact.

IC Mod tops the trouble list by creating Form N-PORT and Form N-CEN. While probably not as bad for the back office, Liquidity’s impact on N-PORT and N-CEN, its introduction of swing pricing and its updates to the prospectus will definitely cause plenty of problems. Both proposals also require the back office to learn new concepts. IC Mod will require the back office to develop enough of an understanding of the risk management concepts delta and duration to identify red flags. Liquidity requires understanding new SEC-created concepts like “15% asset” and “less liquid” asset.

Trouble number three came out on December 11 when the SEC released its Derivatives proposal.  Currently, the SEC uses implied leverage, implied issuance of senior securities, Section 18 of the ‘40 Act, 1979’s Release 10666 (another treat for all of you numerologists out there) and an assortment of no action letters to provide guidance on the use of derivatives by investment companies. As with most recent securities regulation, Dodd Frank says the current regulatory framework is no longer acceptable, so the SEC is formalizing their rules with the new Derivatives proposal.

Similar to the Liquidity proposal, the back office is not the direct target of the Derivatives proposal, but it still causes them trouble via the need to report more and different information to the SEC on Form N-PORT and Form N-CEN. And similar to IC Mod and Liquidity, it is not just a matter of sourcing additional data and dropping it in a form. With the Derivatives proposal, the back office will need to add the risk management concepts VaR, gamma and vega to their training lists.

Remarkably, both of the new forms, N-PORT and N-CEN, have now been modified twice during the comment period of the proposal that created them, adding trouble by requiring the back office to change the tires while the bus is moving. In isolation, any one of these three would be problematic. As three separate but interrelated proposals that keep updating the first proposal, they are even worse.

After a rough 2015, here’s to hoping that 2016 will deliver only the good kind of three, knock on wood.

To learn more about 13f-2 watch our webinar replay Part 1: Unpacking the SEC's New Disclosure Rules for Shareholders
Join us for Part 2: Operationalizing the SEC's New Disclosure Rules, for Shareholders on December 12.