ETF Trends
ETF Trends

The Securities and Exchange Commission will have a heavy hand in the mutual fund industry, potentially adding new regulations that could raise costs for fund companies and setting up liquidity rules that may affect bond-related exchange traded funds.

The SEC is will enact greater regulation over the $60 trillion money-management business, reports Daisy Maxey for the Wall Street Journal.

Some analysts have warned that the increased red tape will add on costs for fund companies. The fund industry may even have to go through “stress tests,” similar to what banks have to undergo. In the end, the new regulations should protection investors.

So far, the SEC has required fund firms to disclose greater data on holdings, such as potentially risky derivatives. Additionally, a recent proposal requires funds to prove they can handle extreme stress. Consequently, funds would have o set up programs to classify “liquidity risks” for trading positions.

Funds will have to hold a minimum percentage of assets that can be converted to cash in three business days and will be barred from acquiring assets that can’t be sold within seven calendar days.

Dave Nadig, director of ETF research at FactSet, argues that it will be difficult for some funds to meet the seven-day liquidity requirement. [How ETFs Are Traded]

“Folks in the ETF industry are shaking their heads trying to figure out how they’re going to stay in the junk-bond ETF business if these proposals are put in place without modification,” Nadig told the WSJ.

The liquidity rules would be especially hard to meet for bond ETFs, such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), that track notoriously illiquid fixed-income markets. [Reviewing the Liquidity of Junk Bond ETFs]

Some market observers have already warned of the impending liquidity issues that junk bond ETFs may face. For instance, Michael Contopoulos, head of high-yield strategy at Bank of America, called high yield credit a “big, big problem,” reports Michael Newberg for CNBC.

The excess liquidity from the Fedederal Reserve’s massive bond buying program and near-zero interest rates “have created an environment where high yield corporates have been able to gather funding at incredibly cheap levels,” Contopoulos said. “At some point, unless you have meaningful earnings, you can’t sustain incredibly high leverage indefinitely.”

For more information on the speculative-grade debt market, visit our junk bonds category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.