The U.S. Securities and Exchange Commission (SEC) proposed on Friday to expand the scope of direct bond trading between funds under the same manager. While relaxing restrictions on tradable securities, the proposal requires managers to determine that such transactions are in the best interest of each participating fund and not to favor one party over another.

This adjustment is still in the stage of soliciting opinions. SEC plans to include securities that are primarily valued based on observable information, and will also incorporate pricing, compliance reviews, and board of directors supervision into the revisions.

Cross-trading allows affiliated funds to execute transactions directly, reducing the costs associated with portfolio rebalancing through the public market. Bloomberg reports that fund managers can use this to adjust their portfolios and meet the requirements of fund regulations; the Investment Company Association of America (ICI) estimates that cross-trading in fixed income saved funds nearly $330 million in 2020.

Restrictions on the fund valuation rules adopted in 2020. These rules define "market quotes that can be obtained at any time," effectively excluding most fixed-income securities and affecting the internal trading methods that funds could previously use.

A study released last month by the Economics and Risk Analysis Department of SEC utilized fund filing data from March 2019 to July 2024. It was found that after the valuation rules came into effect in September 2022, the indicators for internal cross-trading of corporate bonds significantly declined, while municipal bonds remained relatively stable.

The study identifies potential trading opportunities based on changes in positions at the end of the month, rather than directly counting each transaction; it does not account for overlaps that may arise from the same fund group buying and selling in different external markets. The research also finds that opportunities related to corporate bonds are concentrated among a few large fund groups, with investment-grade bonds being the main focus in terms of amount invested.

ICI President and CEO Eric Pan ( Eric J . Pan ) supported the principle-oriented approach of the proposal on Friday. The reform requirements previously proposed by the association included expanding the scope of transactions, adjusting pricing regulations, adopting risk-based procedures, as well as board supervision and summarization of transaction declarations.

According to Bloomberg, the proposal allows for valuation using directly or indirectly observable information, such as quotes for similar securities in active markets, or quotes for the same and similar securities in inactive markets. Assets that are most difficult to value and lack trading are still not included in this relaxation of regulations.

There are proposed to be two pricing methods: one is to use the value of securities determined at the next calculation of the fund's net asset value on the day of the cross-trading, and the other is for the investment advisor to determine the current market price based on unrelated pricing sources. If the latter method is adopted, it is also necessary to regularly check whether the price is reasonable.

The best interest judgment before a transaction must cover each participating fund individually, and the transaction must also comply with the fund's policies and investment strategies. SEC The Chief Compliance Officer is proposed to review cross-trades on a quarterly basis and conduct annual backtesting of the final selling prices of purchased securities to identify any signs that the fund may be in a disadvantaged position over the long term, and to report these findings to the board of directors.

Committee member Mark Uehara ( Mark T . Uyeda ) stated in his declaration that the fund was forced to sell bonds with infrequent trading during market tensions, and the discounted transactions may be due to a temporary lack of liquidity rather than fundamental changes. If other funds lower their valuations based on this, it could trigger redemptions and further selling pressure.

Ueda believes that after setting appropriate constraints, transactions between affiliated funds can provide another channel for sellers to realize cash, while allowing buyers to purchase bonds that fit their strategies and reduce transaction costs.

The proposal requires funds to report cross-trades by asset category. Ueda also raised the question of whether each transaction price should be reported to the bond trading transparency system to assist in price discovery and pricing constraints, and still wishes to hear public opinions on this matter.

SEC will set the public comment period to 60 days after the proposal is published in the Federal Register.