Statement Summary
Liquidity is crucial for effective capital markets, enabling quick buying and selling of securities at fair prices, thereby reducing transaction costs and enhancing risk management. A new proposal aims to amend Rule 17a-7 to allow registered funds to expand cross-trading practices, specifically including level 2 securities under GAAP, with safeguards to prevent misconduct. Cross-trading can mitigate market distress by providing funds an alternative to selling assets at depressed prices during volatility, ultimately helping to reduce systemic risks. Reporting requirements on Form N-PORT and potentially enhancing transparency through transaction-level reporting are proposed for better market insight and compliance. This initiative seeks to improve liquidity management and support market efficiency.
Original Statement
Liquidity is essential to well-functioning capital markets. When market participants can buy and sell securities quickly and at prices that reflect fundamental value, transaction costs decline, parties can better manage risk, and capital flows more efficiently to its most productive uses. Registered funds depend on market liquidity to meet shareholder redemptions and manage their portfolios across a wide range of market conditions.
Today’s proposal aims to enhance their ability to do so by amending Rule 17a-7 under the Investment Company Act of 1940, which permits cross-trading between a registered fund and its affiliates. The proposal would expand the scope of cross-trading to level 2 securities under GAAP, subject to appropriate guardrails such as updated pricing conditions and oversight requirements intended to mitigate misconduct like cherry-picking or dumping.
Fixed-income cross-trades are often used for purposes such as liquidity management, index rebalancing, duration adjustments, and meeting redemptions. These cross-trades are driven by continuous maturity roll-downs, credit rating changes, and extreme fund flows. While cross-trading is a routine part of ongoing portfolio management, it can be particularly useful during periods of market volatility.
For example, if a fund must sell a thinly traded bond to a third party during a period of market distress, the transaction might occur at a heavily discounted fire-sale price that reflects a temporary lack of market liquidity rather than a change in underlying fundamentals.
If that price is then used in mark-to-model valuations, the effects can reverberate throughout the market. Depressed marks can lower the net asset values of other funds holding similar securities, which may prompt further redemptions, additional forced sales, and still lower prices. Such a self-reinforcing cycle of fire sales can transmit stress from one fund to others and to the broader banking and financial system.
By giving funds an alternative to selling into a distressed market, cross-trading can help interrupt this cycle and mitigate systemic risk concerns, particularly when a fund’s adviser has reason to believe that certain funds, such as those funds in 401(k) retirement plans, are unlikely to have significant redemptions during that period. With appropriate guardrails, such as the adviser’s best interest determination and chief compliance officer (CCO) review, a cross-trade would allow the selling fund to avoid unwinding positions at distressed prices and the buying fund to avoid dealers and transaction costs while purchasing bonds that fit its investment strategy.
Today’s proposal would require registered funds to report on Form N-PORT or Form N-MFP the aggregate value of portfolio investments, by asset class, purchased or sold under Rule 17a-7. While this aggregated reporting would provide some visibility into funds’ cross-trading practices, transaction-level reporting of the agreed-upon price in a cross-trade might offer additional informational value to third parties engaged in price discovery for subsequent transactions.
For example, if a fund’s adviser executes a cross-trade of a bond at $98.0, where a prior level 2 valuation might have been $98.5, then the transaction price of $98.0 could be informative to other market participants pricing a similar bond.
Public reporting of the transaction price can also serve as a compliance backstop that supplements CCO review and board oversight, imposing more pricing discipline on the adviser. I am interested in hearing from the public whether transaction-level reporting to post-trade transparency systems such as the Trade Reporting and Compliance Engine (TRACE) or the Real-Time Transaction Reporting System (RTRS) would assist price discovery and market efficiency.
I thank the staff in the Divisions of Investment Management and Economic and Risk Analysis, the Office of the General Counsel, and the many other offices that have contributed to this rulemaking. Investment Company Cross Trading, Release No. IC-36358 (Oct. 9, 2026).
