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U.S. Regulators Said to Step Up Scrutiny of Fund Liquidity

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U.S. financial regulators are stepping up inquiries into whether funds that buy debt are prepared for an exodus of investors as the central bank moves closer to raising interest rates for the first time in nine years.

The U.S. Securities and Exchange Commission and the Federal Reserve have been asking money managers about their ability to meet daily redemption requests from investors, said three people with direct knowledge of the matter who asked not to be identified discussing private conversations.

The increased scrutiny comes during a seventh year of suppressed interest rates that have pushed investors into higher-yielding assets such as corporate debt and emerging-market bonds. The worry now is that funds that invest in the most difficult-to-sell securities may struggle if the bond rally ends and investors seek to withdraw their money all at once.

Regulators are particularly concerned about debt markets where trades take longer to complete, the people said. That includes leveraged loans, which often take seven days or more to settle, they said. Regulators have asked funds to detail their plans for meeting a requirement that clients be able to pull their cash daily.

U.K. Inquiries

Fund managers are expecting regulators to make recommendations on the subject in the coming months, after discussions that have taken place during much of the past year, the people said.

Fixed-income managers have already been loading up on cash and securities they can sell easily -- such as Treasuries and bank bonds -- and arranging credit lines to fund redemptions in the event of a debt-market sell-off. The heightened scrutiny may prompt more efforts to fortify funds.

The queries by the Fed and SEC mirror a similar project undertaken in the U.K., where both the Bank of England and the Financial Conduct Authority have been requesting more information on how funds might handle liquidity and redemption risk.

Bank of England Governor Mark Carney warned in a speech in June that some market participants had continued to “take liquidity for granted and crowd into trades.” That same month in the U.S., SEC Commissioner Kara Stein said regulators are increasingly paying attention to funds that buy hard-to-sell assets.

Eric Kollig, a spokesman for the Fed, declined to comment. SEC spokesman John Nester didn’t immediately respond to a request for comment.

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