SEC cross-trading proposal restores Level 2 fixed income, excludes Level 3 assets

The SEC proposed on Oct. 9 to amend Rule 17a-7 of the Investment Company Act so registered funds can again cross trade most fixed-income securities valued with observable inputs, or Level 2. Level 3 assets and non-leveled holdings such as private fund shares valued at net asset value would remain ineligible. The SEC asked for comment on whether some Level 3 securities should be eligible.

Registered closed-end funds held about $242 billion, or roughly 38%, of their $637 billion in gross investments in Level 3 or non-leveled assets as of September 2025, according to SEC data. The figure comes from the SEC Division of Investment Management's Registered Fund Statistics report covering filings received through Jan. 29, 2026. Mutual funds held about 1.4% of investments in those categories and ETFs less than 0.1%, so the carve-out lands almost entirely on the closed-end category that includes interval funds and tender-offer funds.

Most fixed-income securities have been ineligible for cross trading since Sept. 8, 2022, the compliance date of Rule 2a-5. The 2020 valuation rule's definition of "readily available market quotations" in practice excluded most fixed-income securities; the new proposal would undo that for Level 2 names.

The SEC estimates the amended rule would produce about $173 million a year in transaction-cost savings. In 2020, on a different population and period, fund complexes cross traded more than $204 billion of fixed-income securities, saving nearly $329 million, according to a 2021 Investment Company Institute report. That works out to roughly 16 basis points of the traded value; the SEC's forward estimate rests on an unspecified base, so the two figures are not directly comparable.

"When executed appropriately, cross trades allow registered funds to avoid costs associated with open market trades and to then pass those savings on to investors," SEC Chair Paul S. Atkins said. The ICI asked Atkins in an August 2025 letter to revise the rule so registered funds could resume crossing fixed-income securities.

A cross trade moves a position to an affiliated fund instead of through the dealer market; the savings are the spread and market impact the fund avoids. For an interval fund, that lowers the cost of repositioning the book. Funding a repurchase offer is a separate problem from pricing a cross trade.

BDCs are not registered funds, but they may rely on Rule 17a-7 under a provision of the '40 Act until the SEC adopts BDC-specific rules. The proposal notes that BDCs generally hold significant level 3 assets and that the amendments may not materially expand the set of transactions available to them.