February 8, 2023
Vanessa A. Countryman
Secretary
U.S. Securities and Exchange Commission
100 F Street NE
Washington, DC 20549-1090
By electronic submission
MSCI Comments on the U.S. Securities and Exchange Commission (“the Commission”)
Proposed Rule on Open-End Fund Liquidity Risk Management Programs and Swing Pricing;Form N-PORT Reporting (File Number S7-26-22) (the “Proposed Rule”)
MSCI is a leading provider of critical decision support tools and solutions for the global
investment community. Our products and services include indexes; portfolio construction andrisk management tools; environmental, social and governance (“ESG”) and climate solutions;and real estate market and transaction data and analysis. Our analytics offerings include risk
management, performance attribution and portfolio management content, applications andservices that provide clients with an integrated view of risk and return and tools for analyzing
market, credit, liquidity, counterparty, and climate risk across all major asset classes, spanning
short-, medium- and long-term time horizons.
MSCI is pleased to provide comments on the Commission’s proposed amendments to current
rules for open-end management investment companies (“open-end funds”) regarding liquidity
risk management programs and swing pricing. We understand that the Proposed Rule isdesigned to improve liquidity risk management programs to better prepare fund for stressed
conditions and improve transparency in liquidity classifications. While MSCI supports theCommission’s objectives to reduce model risk and improve transparency for investors, theproposed liquidity classification framework may have untended consequences. In particular, we
make the following observations:•

The uniform 10% stressed trade size may be too high. Our analysis indicates that manylarge equity funds may exceed the 15% illiquid holding limit. As an alternative, the current
rules for calculating the reasonably anticipated trade size, which allow funds to define
their own trade size assumptions based on fund characteristics, could be combined witha minimum stressed trade size.

•

The proposed definition of value impact is unlikely to accurately capture the changes inliquidity. During the COVID pandemic outbreak in March 2020, equity traded volumes
increased, but at the same time, so did bid-ask spread and market impacts. Applying the
proposed amendments could result in counter-intuitive classification. For example,

7 World Trade Center | 250 Greenwich Street | 49th Floor | New York, NY 10007 | United States
Client Support: +1 888 588 4567 (toll free)msci.comequity funds may have seen their share of illiquid positions decrease in March andpositions qualified as highly liquid increase.
•

Defining value impact through average daily volume for listed equities could lead tofluctuations and significant daily jumps. Traded volumes sometimes spike collectively
for many stocks, typically around quarter-ends when earnings reports are published.
These fluctuations could lead to significant daily jumps in the share of illiquid holdings
for equity funds even at smaller trade sizes. Rather than defining value based on volume
impact, we suggest defining value based on price impact, similar to fixed income
instruments.

In the attached Annex, we provide further comments consistent with these observations and in
response to specific questions included in the proposing release.
MSCI would like to thank the Commission for its consideration of our submission. Should you
have any questions, please do not hesitate to contact me through ryan.mensing@msci.com.
Sincerely,s/
Ryan Mensing
Executive Director
Government and Regulatory Affairs
MSCI Inc.

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1

Question
Should we require funds to use a stressed
trade size, as proposed? Would the change
from reasonably anticipated trade size tostressed trade size materially change theproportion of investments classified in a given
liquidity category? If yes, how? Would the
proposed stressed trade size affect certain
types of funds more than others? Would the
proposed stressed trade size be likely tooverstate or understate liquidity?

Response
Performing liquidity classification using a stressed trade size could help fundmanagers prepare for market downturns, but we suggest a Final Rule not define thisstressed size in terms of a fixed proportion of the position size.
Funds might face two types of liquidity stresses: (1) a market-wide stress, where
investors are withdrawing funds across many funds and liquidity conditions
deteriorate in entire asset classes; and (2) a more idiosyncratic stress which impacts
one (or a handful of) funds only. The volatile period around March 2020, during the
breakout of the Covid crisis, is a good example for (1), while the collapse of the
Woodford Equity Income Fund for (2).
Liquidity classification is an effective tool to prevent funds from deviating too far fromtheir peers in terms of investing in less liquid assets and hunting for yield, but it isunlikely to prepare the entire industry for truly extreme market shocks. Fixing the tradesize irrespective of investor composition, redemption history or expected investor
behavior is likely to disadvantage larger funds.
If the Commission adopts a fixed percentage rule, the 10% figure is likely to decrease
the share of investments classified as highly liquid and increase the share of illiquid
holdings for most funds, as most of our clients currently assume trade sizes that aresmaller than 10%. Our analysis of the largest equity mutual funds showed that 9 outof 9 would have exceeded the 15% illiquid holding cap more than once every 10 weeks
over the period January 2020 to November 2022, assuming weekly classification
frequency.1

1

See What Would the SEC’s Liquidity Proposal Mean for Equity Funds? available at https://www.msci.com/www/blog-posts/what-would-the-sec-sliquidity/03618554751 (January 27, 2023).

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2

Is the proposed stressed trade size of 10%
appropriate? If not, what minimum trade size
would be appropriate and why? For example,
should we increase or decrease the stressed
trade size to, for example, 15% or 5% or someother threshold? Is there other data thatshould factor into setting the stressed trade
size?

3

Should the stressed trade size vary for
different types of funds and, if so, how? For
instance, should the stressed trade size be afunction of the fund's flow history, such as the99th percentile highest week of the fund's
absolute or net flows over a given period (e.g.,
3 years, 5 years, 10 years, or the life of thefund)? Should the stressed trade size be thehigher of a specified value applied to each
investment or the 99th percentile highest
week of absolute flows?

Based on our analysis of large equity mutual funds, the uniform 10% stressed tradesize would be too high. Instead, the current rules for calculating the reasonably
anticipated trade size, which allows funds to define their own trade size assumptions
based on fund characteristics, could be combined with a minimum stressed tradesize. This approach was highlighted as an alternative by the Commission in the
proposing release.
The typical values that our clients determined under the current rules are smaller than10%.
As noted in response to Question 2, MSCI supports keeping the current methodology
which allows funds to calibrate their own assumed trade size values based on fundcharacteristics. This could be combined with a minimum stressed trade size, which
was highlighted as an alternative by the Commission.
Many of our clients use historical net outflows for a multi-year lookback period as oneof the components to determine the reasonably anticipated trade size. Fund flows,
however, often follow fat-tailed distributions. Our analysis showed that statisticalmeasures, such as percentiles or expected shortfall-like metrics may understate tailevents.2 We found that fitted fat-tailed distributions, such as generalized Pareto, may
capture tail events better.
Investor concentration might also be considered when determining the stressed tradesize, as the current rule suggests. It is plausible to assume that a single investor who
holds large fraction of the fund shares may want his/her investments redeemed. This
information, however, sometime only partially available for fund managers. The mostcommon approach that we saw in practice is to floor the anticipated trade size at thelargest known investor’s investment as a percentage of the fund NAV.

2

See Liquidity Risk Management for Funds: Part 2: Best Practices for Stress Testing available at https://www.msci.com/www/research-report/liquidity-riskmanagement-for/01998350696 (July 24, 2020).

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4

5

7

8

Should the method of applying the stressed
trade size to each investment vary for
different types of funds and, if so, how? Are
there types of investments that should be
excluded or use a different stressed tradesize? Are there other, more appropriate
methods of applying a stressed trade size
across different type of investments andportfolios?

The stressed trade size should take fund characteristics into account and may vary
based on the scale and complexity of the fund.

Instead of establishing a set stressed tradesize, should we set a minimum stressed tradesize and provide factors for determining if afund should have a higher stressed trade size?
If so, what factors should funds consider insetting their stressed trade size?
Should we define value impact throughaverage daily trading volume or price decline,
as proposed? Should we use a different
definition of value impact instead, and if so,should it depend on the type of investment?
Should different types of funds have different
value impact standards? If yes, whatstandards, and for what types of funds?
For shares listed on a national securities
exchange or a foreign exchange, should we
define a significant change in market value as
selling or disposing of more than 20% of theaverage daily trading volume, as proposed?
Are there other types of investments for whichan average daily trading volume test would beappropriate? For example, is there data

The combination of an established minimum stressed trade size and a fund-specificstressed trade size is a reasonable approach. To determine the fund-specific stressed
trade size, funds may consider the degree of investor concentration, the history offund flows and the investor type (if known), as the currently effective Rules prescribe.

The uniform 10% stressed trade size may be too strict for larger funds. On the other
hand, for a fund with a very concentrated investor base, the 10% stressed trade size
may be too low.
The stressed trade size may also depend on the extent derivatives are used in thefund. During volatile periods, funds using derivatives more heavily may have to post
more capital to their margin accounts. This means that funds with a higher derivatives
exposure would need more cash, which may be reflected in a larger stressed tradesize used in the liquidity analysis.

As explained in further detail below in response to Question 8, MSCI would discourage
defining the value impact through average daily volume for listed equities. MSCI
considers the 1% price decline for non-listed instruments reasonable.
We believe that defining the value impact in terms of price decline for listed equities
too would be a better approach as we see potential shortcomings of the averagevolume-based market impact definition. See our response to Question 8.
Liquidity measures built solely on traded volumes cannot capture the full extent ofliquidity risk and may produce counterintuitive results in certain cases. MSCI
identified three significant challenges imposed by the proposed definition of the value
impact through average daily volume for listed stocks:
1) MSCI analysis has shown that equity trading volumes more than doubled on
average during the March 2020 COVID-19 market crisis, while bid-ask spreads andtransaction costs significantly increased. Applying the proposed amendments, equity
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available for fixed-income securities thatfunds could use objectively to analyze market
participation under a value impact standard?

funds would have seen their share of illiquid positions decrease in March and theirshare of positions categorized as highly liquid increase. We believe that accounting
for transaction costs in the definition of the market impact standard would help avoid
this.32) The volume-based metric may introduce some instability to the bucketing,especially for small cap equity funds. Many small cap stocks do not trade often, andwe observe spikes in the trading volume (e.g., a couple of days of very high tradedvolume followed by weeks of very limited activity). During the period following a daywith large traded volumes, the stock may appear very liquid, however, when that dayphases out of the averaging window, the stock may get classified as illiquid. Thismight be further amplified by events such as earnings announcements, when tradedvolumes typically spike. As our analysis has shown, some funds would often have
daily changes of the illiquid bucket percentage in the 5-10% range. Choosing a longer
averaging window could be a partial remedy, however it may also decrease thereactiveness of the classification.4
3) Trading 20% of the average daily volume may incur significant transaction costs.
Using MSCI's transaction cost model, we found that for approximately 20% of the
ACWI IMI index constituents these trading costs would exceed 1% for a trade size
equal to 20% of the daily volume. Our results may highlight the need to incorporatetransaction cost considerations into the definition of the market impact standard.
These considerations apply for other types of investments as well. For fixed income
securities, trading might be even more sporadic or scattered than for listed stocks. It
can happen that a bond was not traded because there were no sellers, however,selling the bond could be done at limited transaction costs. For example, manymunicipal bonds are held until maturity. Trading volumes usually fall significantly rightafter the issuance and might be low throughout the lifespan of the bond. Adopting a

3

See SEC Liquidity Proposal: A Better Warning Signal? available at https://www.msci.com/www/quick-take/sec-liquidity-proposal-a-better/03536057592?v=0(December 5, 2022).

4

See What Would the SEC’s Liquidity Proposal Mean for Equity Funds? available at https://www.msci.com/www/blog-posts/what-would-the-sec-sliquidity/03618554751 (January 27, 2023).

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volume-based classification for fixed income securities bears the risk of turning large
fraction of asset classes to be categorized as illiquid.
9

Should the percent of average daily trading
volume be higher or lower (e.g., 15% or 25%)?
Should the measurement period for the
average daily trading volume be longer or
shorter than the proposed 20 business days
(e.g., 10, 30, or 40 business days)? Shoulddays where shares were not traded becounted as zero volume days as proposed orin some other manner? Are there
circumstances in which the average daily
trading volume test should vary by instrument,
type of instrument, or trading venue?

A market impact standard based solely on volume metrics may fall short in capturing
the full extent of liquidity risk. Please refer to our response to Question 8. In our view,the market impact definition should also include transaction cost considerations.
We find it reasonable to incorporate traded volumes as one of the components of themarket impact standard definition. In this case, the Commission may consider
instrument type specificities when deciding on the averaging window and thepercentage of the volumes to be considered.
For example, many small and micro-cap stocks do not trade every day and theaverage daily volume may fluctuate more over time, and a longer averaging period andhigher percentage value might be appropriate. Lack of trading often indicates that
there was just no interest in trading, not necessarily that you cannot trade. On days
where investors want to trade a larger amount, they manage to trade it (maybe at ahigh cost), and these days show up as high-volume days, increasing the ADV for the
next 20 days. But if such large trading happened 3-4 weeks ago, then likely we could
trade that amount again if we wanted, even if that large trading volume day is nolonger in the averaging window.
On the other hand, the average volume for large and mega cap stocks can be greaterthan a billion USD and, as such, a smaller percentage value could be considered.

10

For investments that are not listed on anational securities exchange or foreignexchange, should we define a significant
change in market value as any sale ordisposition that the fund reasonably expects
would result in a price decline of more than
1%, as proposed? Should the identified
percentage be higher or lower (e.g., 0.5% or2%)? Should this standard for determining asignificant change in market value apply to all

MSCI agrees generally that the 1% price impact falls into a reasonable range for mostasset classes. However, we would note three potential consequences of thisapproach.
1. The classification becomes less sensitive to holding size
Allowing 1% price decline, the bucketing rules may differentiate less between small
and relatively large holding sizes. Because, for example, developed market sovereign
bonds and investment grade credit typically trade below 50 bps bid-ask spread, evenafter accounting for the excess market impact of large order sizes, these large
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investments? Would funds need additional
guidance or parameters to measure thisstandard consistently, including what inputs orcomparable investments may be used indetermining the price decline?

positions would still be classified as highly liquid. This is shown in our recent
analysis.5
2. Assets remain highly liquid even under severe stress
Historical analysis shows that, in distressed markets, bid-ask spreads may triple oreven quadruple, see our blog post publication.6 A corporate bond that is traded at 25
bps half bid-ask spread may show up as highly liquid even in periods of severe market
stress.
3. Expected and excess transaction costs may not be considered differently
The uniform 1% price decline definition may make whole asset classes always
classified as highly liquid, irrespective of the holding size. On the other hand, parts ofother markets will always be classified illiquid. However, the half bid-ask spread is ananticipated cost by fund managers, and liquidity issues may be more likely to arise
from excess transaction costs above the typical half bid-ask spread. This may include
excess market impact resulting from a large trade size well-above the typical tradesize of the instrument, or from widening bid-ask spreads in stressed markets. Impact
limits that are defined in terms of the typical half bid-ask spread may also be ofinterest, beyond an absolute limit.

5

See Comparing Apples to Apples in Bond-Fund Liquidity available at https://www.msci.com/www/blog-posts/comparing-apples-to-applesin/03612522892 (January 24, 2023).

6

See Bond Liquidity: How Bad Was COVID? available at https://www.msci.com/www/blog-posts/bond-liquidity-how-bad-was/02090095898(September 16, 2020).

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11

Should the 1% price decline definition of value
impact be applied against the fund's last
valuation of an investment, which would
include both the effect of the fund's sale andmarket moves?

The 1% price decline should exclude the market risk component and only consider themarket impact caused by the trading.
This approach may confuse two separate sources of risk: market risk and liquidity
risk. In our view, liquidity risk management should focus on liquidity risk and not onmarket risk. That is, market prices changing due to news or global events, forexample, should not impact liquidity classifications.
On the practical side, classification based on this could also cause difficulties. In
periods where the asset's value declines by 1%, the asset will become inherently
illiquid. For example, if a large 75 bps rate increase is announced by the central bank,and subsequently the prices of many portfolio holdings decline by more than 1%, thenfor that day, a large fraction of the portfolio will become illiquid, even though the pricedecline has little to do with liquidity concerns.
Similarly, on days when there are rallies, illiquid securities may get classified as highly
liquid, purely because their prices increased due to market movements.

16

As proposed, should we eliminate the lessliquid investment category and amend theilliquid investment definition to include aninvestment that a fund reasonably expects
can be sold within seven calendar days
without significantly changing the market
value but is not convertible to U.S. dollars
within that period (i.e., investments that are
currently classified as less liquid under therule)? What effect would these proposed
amendments have and how would those
funds that significantly invest in such lessliquid investments likely change?

Beyond these modelling and conceptual considerations, there are also practicalchallenges. Market risk and liquidity risk are typically modelled separately. It may
require significant implementation burden for funds to consider drops in market pricein addition to transaction costs when classifying instruments.
The "Less liquid" category primarily includes the following:
1. assets with long settlement periods (7+ days), mostly bank loans
2. assets that have a normal settlement period (1-3 days), but the position with thespecified trade size can only be liquidated within 3-5 business days.
Consequently, the proposed changes would render illiquid all assets that have atypical settlement period (e.g., 2 business days) but take 3+ business days to sell.
Furthermore, the proposed change may create challenges for diversified fixed-income
funds that invest in moderately liquid assets and also bank loans. While bank loans
will become inherently illiquid, during volatile periods, the moderately liquid fixed-

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20

As proposed, should we remove the less liquid
category and require funds to use a three
category classification framework? Would the
proposed changes simplify classifications andreduce burdens over time, after funds updated
systems to reflect the change? Would the
proposed changes appropriately reflect theliquidity of a fund, or would the current
framework be more appropriate? Should funds
be permitted to invest above 15% in less liquid
investments if there are other methods ormechanisms to reduce the mismatch between
the receipt of cash upon the sale of assets
with longer settlement periods and thepayment of shareholder redemptions or toaddress potential dilution associated with thismismatch? If so, what other methods ormechanisms should these funds be requiredor permitted to use (for example, swing
pricing, gates to suspend redemptions,redemption fees, redemptions in kind,additional limits on less liquid investments,
notice periods, or lengthening the settlement
period for paying redemptions)?122 If wepermit (to the extent not already permitted) or
require use of one or more of these tools, howshould they be used (individually, in somecombination with each other, or with otherprotections, such as disclosure, board
approval, and Commission reporting)? Should
we amend other rules, or provide relief fromany specific rules or provisions of the Federal

income assets may also move to the illiquid bucket due to the above-mentioned
behavior.
Removal of the less liquid bucket is unlikely to significantly reduce the classification
burden.
The removal of the “less liquid” bucket requires an initial effort to modify theclassification framework as well as the liquidity reports. However, once the changes
are implemented, we would not expect to see a reduction in the computational andreporting burden as the classification still requires the same data inputs: liquidity
analytics to assess time to trade, and settlement period data to find the correct
bucket. As the data requirements are the same and the analytics requirements are thesame, we would not expect to see a meaningful reduction in the burden to produceclassification reports.

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securities laws, to expedite or permit use of
these methods and mechanisms?123

26

Should we amend the definition of convertible
to cash and other references to cash in rule22e-4 to refer to U.S. dollars, as proposed?
Would these amendments raise issues for
specific types of funds? If so, which ones andhow? Would these amendments affect funds'
investment strategies, including their
allocation to foreign investments and U.S.
dollars, or their performance?

MSCI agrees that taking FX conversion into account allows for better liquidity
assessment from a US-based investors’ perspective, but we think that this change
could involve some added implementation costs for funds and third-party service
providers.
From a U.S.-based investors’ perspective, including the FX conversion better
represents funds’ actual liquidity, especially in cases when there are restrictions on
currency conversion between a foreign currency and USD.
We would also highlight that for certain emerging market currencies, the repatriation
to U.S. dollars may take multiple days. Consequently, emerging market funds
investing in these countries may see some part of their investments shifting towards
the lower liquidity buckets.
The proposed amendment may create added implementation burdens for funds andthird-party analytics providers. Currently, the significant impact to the market value ofthe investment is typically assessed in the instrument’s own local currency.

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30

31Should we require funds to include the day ofclassification when counting the number ofdays to convert to U.S. dollars as proposed, orshould we require funds to begin to count the
number of days to convert to U.S. dollars on
the following day? What are the advantages
and disadvantages of this alternative? Would
this alternative result in less conservativeliquidity classifications for some funds orinvestments (i.e., by causing someinvestments that otherwise would have beenclassified as moderately liquid to be classified
as highly liquid) or impair a fund's ability tomeet redemptions?
Instead of using the days an investment would
be convertible to U.S. dollars in the liquidity
classifications as proposed, should we
separately set the number of days to: (1) makethe trade; and (2) settle the trade or otherwise
dispose of an investment, in determining
liquidity classifications? Why or why not? Is
there a different way the rule should measure
the period that an investment is convertible to
U.S. dollars?

MSCI does not think that the proposed change would move assets from themoderately liquid to the highly liquid bucket.
This is because the current rule classifies holdings based on the number of days it
takes to convert it to cash. This can be interpreted in the local currency of the asset.
Then converting the local currency proceeds to USD, as the amendments prescribe,
may take additional time. As such, the conversion to USD may take longer than tolocal currency and assets may move towards lower liquidity bucket.

From the perspective of a fund's liquidity management, what matters most is the total
time it takes to receive the cash after the sale of an asset. As such, we see little
benefit in separately defining time to sell and time to settle and this requirement
would pose some added implementation burden for classification (and also forreporting if the settlement period would need to be separately reported to theCommission).

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58

Should we require swing pricing for both net
redemptions and net purchases, as proposed,or only for net redemptions? Do dilution andliquidity concerns exist for open-end funds inboth scenarios?

63

Should we adopt a framework that, in the caseof net redemptions, requires a fund to adjust
its NAV by a swing factor only when those net
redemptions exceed an identified threshold(i.e., as we propose for net purchases)? If so,should that threshold be the same size as the
1% market impact threshold, or a lower orhigher amount (e.g., 0.5%, 1.5%, or 2%)?

If swing pricing is adopted in a Final Rule, then both asset sales and purchases should
be included.
As the Commission noted, investor dilution may also occur for net subscriptions. Twopotential sources of investor dilution are: (1) transaction costs; and (2) change in
portfolio composition.
For large net subscriptions, the fund may decide between spreading the investment of
the cash inflow over multiple days and keeping transaction costs lower or invest it
relatively fast to preserve the portfolio composition. Even though funds do not havetime limits to invest cash inflows, slower investment of capital may dilute the interestof existing investors since only smaller fraction of their portfolio would generate
returns.
While MSCI agrees with the Commission that swing pricing can be one effective
mitigant to investor dilution,7 we would also note potential side effects of total swing
pricing.
If a fund adjusts its NAV downwards for any net redemptions, it may introduce
additional volatility to the fund's reported NAV. This volatility may result in an increaseof the tracking error that comes solely from capital flows.
Our second observation is related to the treatment of subscribers vs redeemers. On
days of net redemptions, both the subscribers and the redeemers trade fund units atthe swing NAV. For subscribers, it means that they could purchase fund shares at alower price than the mid-NAV, even if the redeemers only slightly outsize subscribers.
In this case redeemers effectively subsidize subscribers.

7

See also Section 4 of Liquidity Risk Management for Funds: Part 1: Dilution Effects (July 2020) available athttps://www.msci.com/documents/10199/ec49c6f3-149e-e806-c049-85770693b012.

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134 If we adopt a liquidity fee framework insteadof a swing pricing framework, should a fundbe required to apply a liquidity fee under thesame circumstances in which a fund would be
required to adjust its net asset value under the
proposed swing pricing requirement? Should afund be required to use the same approach to
calculating a liquidity fee as the proposed
approach to calculating a swing factor?
Should the same board oversight framework
apply under this approach as the proposedswing pricing requirement (e.g., with the board
approving the fund's liquidity fee policies andprocedures and designating a liquidity fee
administrator, and such administrator would
report periodically to the board)?

246 Would these amendments cause a fund or any
third-party service providers assessing
liquidity to have new or unforeseen burdens?
Would this increase the cost of third-party
services?

Both swing pricing and liquidity fees could provide protection against dilution.
However,
there is an important difference between calculating the swing factor and the fee
amount. Transaction costs are due only for the net flows, since redemptions andsubscriptions can be netted, and no trading is required for their overlap. We see one
main difference between the two mitigants on how these costs are distributed
between redeemers and subscribers.
Let us assume a day with net redemptions. With swing pricing, subscribers maypurchase fund units at a discount. Redeemers (majority flow) effectively are not only
paying the transaction costs for the net flows but also subsidizing subscribers(minority flow) by the discount amount. On the other hand, dynamic fees may charge
only the transaction cost amount on redeemers, without financing the discounted
purchases. As such, generally, fees may result in lower cost for the majority flow thanapplying the swing factor.
We agree, however, that the operational costs of dynamic fees may be relatively high.
In recently published MSCI research,8 we proposed an approach for the calculation of
simplified liquidity fees which, on average, may effectively mitigate investor dilution.
The proposal makes some modelling aspects easier which simplifies some
calculations, but the changes would impose some initial implementation burden as
well as operational burden due to daily classifications.
The proposed approach would make modelling easier in some respects, especially as
funds used to spend significant effort to determine their reasonably anticipated tradesize, which would now be fixed at 10%. However, this approach also may havedrawbacks with respect to the quality of results (as explained in responses to
Questions 2 and 8), especially now that funds have already invested into building out
their reporting systems for the current rules. In this sense, this would be a step back.
On the other hand, the changes require some initial implementation burden, as well as
ongoing operational burden due to the increased number of analytics runs due to therequirement to classify daily. It is likely that these would involve additional costs as

8

Id.

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many funds do not currently classify daily. The exact scale of cost increases for funds
is difficult to quantify as of now.

249 What price impact models do funds currently
use for liquidity classifications of theirinvestments? Are there advantages of using
one model over another? Are there priceimpact models available to use only throughcertain third-party service providers assessing
liquidity? Do service providers assessing
liquidity vary in costs for their services?

250 What would be the costs of obtaining daily
pricing and liquidity information for the
purposes of daily liquidity classifications?
What are the current costs related to obtaining
such information?

MSCI's LiquidityMetrics formalizes the concept of liquidity using liquidity surfaces.
Liquidity surfaces model the relationship between traded size, transaction cost andexecution time horizon. For calculating the liquidation horizon, users need to specify
the trade amount and their assumption for significant price impact limit. This defines
a point on the liquidity surface, and we can read off the liquidation horizon. Liquidity
surfaces are calibrated on observed market data.
Transaction cost estimates can be broken down into two components: the half bidask spread and the market impact component. The bid-ask spread is the minimum
cost of a roundtrip trade, so half of it may be attributed to the buy and sell sides of a
trade, respectively. The market impact component is the cost incurred by larger trades
on top of the half bid-ask spread.
One advantage of such model that it explicitly takes transaction costs into account.
For example, two stocks may have similar trading characteristics and comparable
average daily volumes, still, may differ in terms of bid-ask spread and market impact.
Daily model calibrations would marginally improve liquidity classifications but may
come with additional costs as it would increase computational effort.
Most data sources that MSCI uses in liquidity analytics are daily, although some data
comes with a weekly frequency. For model calibration, we use large datasets and, assuch, the calibration of the models is computationally intensive. Technologically, we
could increase the calibration frequency of the MSCI models, but this is likely to resultin higher costs for users of the analytics.
MSCI models rely on historical observations. We tailored the length of the lookback
period to strike balance between reactiveness of the model (i.e., how quickly it picks
up changes in the market) and the stability of the model (i.e., how stableclassifications are over time if there are no significant changes in the market). As a15

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consequence, daily model calibrations may have limited effect on the accuracy of theclassification.

251 Do funds currently monitor their liquidity
classifications on a daily basis? Are there
specific types of funds that do not currently
evaluate their classifications more frequently
than monthly?
254 Which components of trading costs contributethe most to fund dilution? How significant aremarket impact costs? If we adopted analternative that excluded market impact fromswing factor calculations, would the rule's
effectiveness at mitigating dilution besignificantly reduced?

Around half of MSCI U.S.-based clients are already classifying on a daily basis, while
the other half classify monthly.

If swing pricing was introduced, both bid-ask spreads and market impact should beconsidered.
As described in our response to Question 249, MSCI's LiquidityMetrics breaks
transaction costs down into two components: the half bid-ask spread and the market
impact component. The market impact component can be as large or evensignificantly larger than the half bid-ask spread component, especially for large tradesizes and in stressed markets. Hence, both bid-ask spreads and market impact costs
may contribute significantly to fund dilution.
The whole transaction cost should be taken into account. An alternative that excludes
the market impact component from swing factor calculations is likely underestimatetransaction costs and reduce its effectiveness against fund dilution.

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