Challenges in Mutual Fund Liquidity Risk Management WEBINAR 13 TH JUNE PM EST

Challenges in Mutual Fund Liquidity Risk Management WEBINAR 13 TH JUNE 2017 4PM EST

Agenda Introduction Ian Blance Managing Director, Voltaire Advisors 2 1610 1620 New SEC Liquidity Rules: Next Steps and Some Open Questions Nathan Greene, Partner, Shearman & Sterling 1620 1630 Liquidity Management: A Unified Framework Stefano Pasquali, Head of Liquidity Research, BlackRock 1630 1640 Data Challenges in Mutual Fund Liquidity Risk Management Reporting Tom Stock, SVP Product Management, GoldenSource 1640 1650 Liquidity Measurement & Classification Tools/Analytics Ian Blance, Voltaire Advisors 1650 1700 Audience Q&A 1700 Close of Webinar

3 Introduction Ian Blance Managing Director Voltaire Advisors

Introduction 4 New rule 22e-4 comes into force December 2018 for most funds Some of the most complex operational challenges ever to face open-ended mutual funds April Flash Poll at JP Morgan conference: o Completed 8% o Fairly Advanced 8% o Around Half Way 29% o Early Stages 55% Requirement for board approval dictates planning timeframe? This Webinar looks at some of these issues and the attempts to resolve them

Introduction 5 Shearman & Sterling will review the rule and some of the outstanding issues and next steps BlackRock will comment on their approach to asset liquidity in general and their plans to comply with 22e-4 in particular GoldenSource will look specifically at some of the data management issues associated with the rule and the new reporting requirements in N-PORT and N-CEN Voltaire Advisors will assess the vendor response to the issue and evaluate how useful these products might be to fund managers Questions can be submitted throughout the sessions and will be addressed at the end

6 New SEC Liquidity Rules: Next Steps and Some Open Questions Nathan Greene Partner Shearman & Sterling

New SEC Liquidity Rules: Next Steps and Some Open Questions Nathan J. Greene ngreene@shearman.com June 2017

Liquidity Rule Phased effective dates start Dec. 2018 SEC requires all mutual funds have a liquidity risk management program There is a related (but optional) Swing Pricing rule, with its own complications we re not covering that rule here; also not covering elements of the liquidity rule specific to ETFs PROGRAM ASSESSMENT BUCKETING HIGHLY LIQUID MINIMUM Goal is package of programs to avoid significant dilution associated with liquidity risk What does that mean? How to measure and record? Classify all assets on four point convert to cash timetable, in each case without significant impact What does that mean? What info to collect and analyze? Can it be systematized? To what degree is market impact fund-specific? Each fund sets its own highly liquid investment minimum made up of 3-day convert to cash assets If a fund is primarily highly liquid in the ordinary course, then no minimum is required What does that mean? How to measure and record? 8

Liquidity Rule Where are firms with the rule today? WORKING GROUPS FUND BOARD REPORTING VENDORS AND CONSULTANTS Nearly all firms have a project group tasked with taking liquidity compliance forward Typically cross-functional (accounting, IT, PM/trader, legal/compliance, etc.) One part of what the group is doing is simply educating peers across the firm about what s coming Pros/cons of group model versus single leader Most firms have reported to their fund board on where they are in the process Boards largely at the keep us posted stage Some boards want advance testing / strategizing around particular products Board education sessions to come Firms have to assess what they can do internally and what they can t Vendor roles generally focused on bucketing Consultant roles generally focused on conceptual thinking about liquidity or project management How to diligence vendors? Will vendor products be customized? 9

More on bucketing BUCKETING BY ASSET CLASS? FREQUENCY? Option of making classification at asset class level instead of position level What is an asset class? How will exception positions be identified within asset classes? How do you monitor for when asset class bucketing becomes inappropriate in the moment? At least monthly, or more frequently if needed SEC reporting of bucketing data is monthly (and is only partially made public and then only quarterly) How do you monitor for when morethan-monthly bucketing becomes appropriate? 10

More on the highly liquid minimum HOW TO PICK A MINIMUM? FREQUENCY? What information is needed? How will it be collected and analyzed? Liquidity mix? Market volatility? Cash flows? Shareholder base and expected behavior? What s reasonably foreseeable for the coming year? Should be set annually, or more frequently if needed How do you monitor for when morethan-annually revisiting of the minimum becomes appropriate? 11

What might be still to come from the SEC FAQ GUIDANCE DELAY? Trade groups are assembling industry questions and engaged with the SEC around possible regulator FAQs Some in the industry are lobbying for a delay in implementation But all are at the same time treating the current implementation dates as their targets wait and see not an option 12

Resources Liquidity Rule SEC Release: https://www.sec.gov/rules/final/2016/33-10233.pdf Liquidity Rule Shearman & Sterling Friends and Clients Note: http://www.shearman.com/en/newsinsights/publications/2016/11/sec-liquidity-riskmanagement-rule 1 3

As one of the first law firms to establish a presence in key international markets, Shearman & Sterling has led the way in serving clients wherever they do business. This innovative spirit and the experience we have developed over more than 140 years make us the go-to law firm. These materials provide general information on our firm and the legal developments described above. They are intentionally summary in nature and do not represent legal advice. From major financial centers to emerging markets, we have the reach, depth and global perspective necessary to advise our clients on their most complex worldwide business needs. ABU DHABI BEIJING BRUSSELS DUBAI FRANKFURT HONG KONG LONDON MENLO PARK MILAN NEW YORK PARIS ROME SAN FRANCISCO SÃO PAULO SAUDI ARABIA* SHANGHAI SINGAPORE TOKYO TORONTO WASHINGTON, DC Copyright 2017 Shearman & Sterling LLP. Shearman & Sterling LLP is a limited liability partnership organized under the laws of the State of Delaware, with an affiliated limited liability partnership organized for the practice of law in the United Kingdom and Italy and an affiliated partnership organized for the practice of law in Hong Kong. *Dr. Sultan Almasoud & Partners in association with Shearman & Sterling LLP shearman.com

15 Liquidity Management: A Unified Framework Stefano Pasquali Head of Liquidity Research BlackRock

Liquidity Risk Management Unified framework June 13 th 2017 For professional clients / qualified investors only

Liquidity Risk Management Pillars Unified Liquidity Risk Framework Portfolio Liquidity Optimization Aladdin Risk Model Integration Risk Management Transaction Cost Redemption Forecast Model Portfolio Aggregation Model Use cases Trading Support Regulatory Reporting Machine Learning / Big Data / News Data Enhancements Portfolio Construction Data For professional clients / qualified investors only 17

Liquidity Classification (Sec 22e-4) Tiers definition 1 : Highly liquid, convertible to cash in 3 or less business days 2 : Moderately liquid, convertible to cash in 3-7 calendar days 3 : Less Liquid, sold or disposed but not settled in 7 or less calendar days 4 : Illiquid, not reasonably expected to be sold or disposed in 7 or less calendar days Additional Implication Consider Position Sizes and Value Impact Position Size Sizes the fund would reasonably trading (Expected Redemptions) Value Impact Without significant change of market value The final rule implicitly refers to liquidity classification factors (LCF). LCF are considered (directly or indirectly) in the current framework What do we need Classification based on data Interpretability Stability of the tiering Exception Engine For professional clients / qualified investors only 18

US HIGH YIELD SECTOR Training Data : Until 12/31/2015 Test Data : 01/01/2016 12/31/2016 This chart shows the out-of-sample performance of the model on the entire US High Yield sector Fund Threshold # of Extreme Events AUC Extreme Red. Accuracy US High Yield Sector -0.00153 18 70% 83%

Original proof of concept (portfolio of 10 simulated bonds) TCOST constrain = 0.3% As shown above, the lower the cross tracking error, the closer the liquidation profile is to pro-rata. If average t-costs are assumed to be 0.3%, the entire portfolio can be liquidated over 16 days, but only by taking the highest level of cross tracking error (35 basis points). Time constrain = 8 days For low values of allowed tcost and low allowed TE the percentage is low (71%) If we allow higher tracking error and TCOST the percentage raise to 91 % 20

21 Data Challenges in Mutual Fund Liquidity Risk Management Reporting Tom Stock SVP Product Management GoldenSource

22E-4 IMPACT ON ASSET MANAGERS Asset Managers of eligible funds must: Adopt and implement a written liquidity risk management program, under board oversight, designed to assess and manage the fund s liquidity risk Establish liquidity risk management programs, including classifying and monitoring each portfolio asset s level of liquidity and designating a minimum amount of highly liquid investments Track the ratio of liquid and illiquid holdings as percentage of the overall net asset value of the fund; funds are limited in holding no more than 15% of illiquid securities within a fund and variances must be reported to board and SEC if threshold breach persists Provide additional reporting related to fund liquidity to SEC (Forms N-CEN, N-PORT, N-LIQUID, N-1A) Enhance disclosure to investors regarding the liquidity of fund portfolios and how funds manage liquidity risk and redemption obligations 2016 ALL RIGHTS RESERVED 23

22E-4 IMPACT ON ASSET MANAGERS Liquidity Bucketing Classifying Liquidity: SEC now require funds to use a methodology to classify liquidity of securities in their portfolio into 4 liquidity buckets Liquidity Bucketing considers time to liquidation and a definition of acceptable market impact where a position can be converted to cash within 3 business days or cannot be sold or disposed of in 7 calendar days Not limited to Fixed Income products all securities including equities will also require liquidity classification Highly Liquid - Convert to cash in less than 3 business days Moderately Liquid - Convert to cash in 3-7 calendar days Bid-ask spread is not sufficient and changes with notional size of trade Primary challenge - no universally agreed upon and adopted measure or model that adequately captures cost and time to liquidation in bond markets SEC proposal to permit funds (except money market funds and ETFs) to use swing pricing which transfers the market impact or dilution costs of trade activity caused by redeeming shareholders Less Liquid Sold within 7 calendar days Illiquid More than 7 calendar days to sell 2017 ALL RIGHTS RESERVED

CHALLENGES TO LIQUIDITY CLASSIFICATION Definitions Highly Liquid Investment Minimum considering cash flow and investment strategy Position Size and what fund would normally be trading Dilution Impact and a significant negative impact of redemptions Classification of liquidity of individual assets vs. asset class Frequency of determination of liquidity of individual instruments/asset classes Market conditions and volatility BCBS239 FRTB HQLA CRS 22E-4 2016 ALL RIGHTS RESERVED 25

26 Liquidity Measurement & Classification Tools/Analytics Ian Blance Managing Director Voltaire Advisors

Liquidity & Valuation 27 Interaction of Liquidity and Valuation an illiquid investment is one that cannot be sold or disposed of within seven days at approximately the value at which the fund has valued the investment Value Impact Standard funds must: determine the time period in which an investment would be reasonably expected to be converted to cash (or in some cases, sold or disposed of) in current market conditions without the conversion to cash (or in some cases, sale or disposition) significantly changing the market value of the investment. Note - Lack of trading does not necessarily mean illiquid!

Data Challenges 28 # Trades Bid-Ask Spread Market Depth / # Dealers or Quotes Historical Data Asset Class vs Individual Instruments Settlement Conventions Outstanding Issuance vs Position Size Normal Trading Volume vs Position Size Liquidity Scores

Vendor Tools Bloomberg LQA https://data.bloomberglp.com/solutions/sites/8/2015/10/bloomberg-lqa_sell-sheet.pdf ICE Data Services https://www.theice.com/market-data/pricing-and-analytics/analytics/liquidity IHS Markit https://www.markit.com/product/file?cmsid=00bd57831a874fd1b1333717b563f77d MSCI https://www.msci.com/documents/10199/514892f6-ce50-40cd-80ea-73dce685c7e9 Thomson Reuters https://www.thomsonreuters.com/content/dam/openweb/documents/pdf/tr-comfinancial/fact-sheet/valuation-navigator.pdf 29

Conclusion 30 Liquidity Risk Factors required by SEC in a program: o o o o short-term and long-term cash flow projections the fund s investment strategy and liquidity of portfolio investments use of borrowings and derivatives for investment purposes holdings of cash and cash equivalents, as well as borrowing arrangements and other funding sources Clear that these are fund specific factors To be effective under this scenario, a vendor solution will need to be highly customizable maybe so much that it ceases to be a product? Most likely outcome is vendor data and analytics as inputs into the process?

Audience Q&A 31

Thank You! 32 Participants will receive a copy of the slide deck and a recording of the Webinar tomorrow. This Webinar is part of our VIVA program of fund valuation initiatives throughout 2017 more details can be found here: http://www.voltaireadvisors.com/viva.html The next event is our Webinar on MBS & Securitized Credit Valuations on June 21 st

33 Contact Us Voltaire Advisors LLP 14 Wall Street No.1 Poultry New York London NY 10002 EC2R 8JR USA UK 1-800-317-1932 info@voltaireadvisors.com www.voltaireadvisors.com