SEC Moves to Revive Cross Trades in Debt Securities
The SEC proposed to allow SEC-registered investment companies and business development companies to cross-trade certain fixed-income securities with affiliates, reversing a limit in place since 2022.
The proposal would amend ICA Rule 17a-7 ("Exemption of certain purchase or sale transactions between an investment company and certain affiliated persons thereof"), the cross-trading rule. Rule 2a-5 ("Fair value determination and readily available market quotations"), adopted in 2020, defined "readily available market quotations" narrowly enough that most fixed-income securities lost eligibility to be the subject of a cross trade. The proposal would allow cross trades in securities valued with observable inputs (level 2). Securities valued with significant unobservable inputs (level 3) would stay ineligible for cross trading.
Under the proposal, cross trades would be priced either (i) at the value set in a fund's next net asset value calculation that day or (ii) at a price the adviser determines reasonably reflects current market prices, using one or more unaffiliated pricing sources. Before each trade, the adviser would determine that it is in the best interest of each fund involved. The chief compliance officer would be required to review cross trades quarterly, back-test later sales of cross-traded securities at least annually, and report to the board. The rule would also permit de minimis payments to unaffiliated parties for clearing, settlement, custody, recording, or reporting. Funds would report aggregate monthly trading and cross-trading volumes by asset class on Form N-PORT and Form N-MFP.
SEC Chair Paul Atkins said the 2020 rulemaking that limits cross trading left registered funds and shareholders without a cost-saving option. Commissioner Mark Uyeda said cross trading can help funds avoid fire-sale prices in distressed markets. He asked whether transaction-level reporting to the Trade Reporting and Compliance Engine or the Real-Time Transaction Reporting System would aid price discovery. Investment Company Institute CEO Eric Pan said the proposal would reduce transaction costs while keeping strong investor protections.
Comments are due 60 days after Federal Register publication.