“Changes in the modern asset management industry call on us to now look anew at liquidity management in funds and propose reforms that will better protect investors and maintain market integrity,” SEC Chair Mary Jo White said.

Mutual funds, which are held by 53 percent of all U.S. households, already face a legal requirement to return cash to investors within seven days. In search of higher returns, many fixed-income funds have migrated into riskier debt that doesn’t trade often and could be difficult to sell at fair value during a period of market stress.

A key concern is that any problems will be exacerbated when the Fed raises interest rates, causing bond prices to plunge and prompting fund investors to run for the exits.

The SEC’s plan would force funds, including exchange traded funds, to adopt liquidity-management plans and classify how long it would take to convert positions to cash. Funds would have to hold a minimum amount of cash or cash equivalents, meaning the assets could be sold within three days. A fund’s board of directors would decide what percentage of a portfolio must be easily liquidated.

Eoin Treacy's view

The extraordinarily low interest rate environment that has prevailed for almost a decade has led to a situation where investors are unfamiliar with convexity in bond portfolios. After all why would anyone worry about interest rate risk when rates are zero and have not moved in years? 

During the credit crisis there were simply no bids for a large number of bond issues which created a situation where funds could not price their securities. Mark to market only works when the market functions as expected. Liquidity in the bond markets has been deteriorating as the Fed has come to dominate whole sections of the market and pension funds refuse to trade their holdings. As I pointed out yesterday a number of bond ETFs are now very large and any change to how much they need to invest in cash or cash equivalents is likely to have a knock-on effect for the wider bond market. 

At the present moment that is not what the market is worried about, preferring the relative safe haven of bonds against a background where equities remain under pressure.