Alert October 28, 2008

Update on the Federal Government Support for Money Market Funds

Federal Reserve Bank of New York’s Money Market Investor Funding Facility. 

As discussed in the October 21, 2008 edition of the Alert, the FRB-NY has created a money market investor funding facility (the “MMIFF”) to provide senior secured funding to a series of special purpose vehicles (the “PSPVs”) to finance until April 30, 2009 the purchase of certain instruments from money market funds.  Since the announcement of that program (the “MMIFF Program”), the FRB-NY has published a “Questions & Answers” (the “Q&A”) in which it has provided additional information about the MMIFF Program, the MMIFF and the PSPVs. 

Among other things, the Q&A states:

  • A money market fund that transfers an eligible asset to the PSPVs will receive (a) cash representing 90 percent of the amortized cost of the eligible asset and (b) asset-backed commercial paper (“ABCP”) issued by the relevant PSPV representing 10 percent of the amortized cost of the eligible asset and having a stated interest rate of 25 basis points less than the stated interest rate applicable to the eligible asset.  Each ABCP investor will receive a contingent distribution of funds up to 25 basis points above the yield on the assets it sold to the PSPV, to the extent there is available accumulated income in the PSPV.  Each PSPV will have a short‑term rating of at least A-1/P-1/F-1 by at least two nationally recognized statistical rating organizations (“NRSROs”).
  • All ABCP held by investors will be subordinated to the FRB-NY loans to the PSPVs.
  • There will be five PSPVs, each holding assets issued by ten issuers.  Each issuer will have a short‑term debt rating of at least A-1/P-1/F-1 by at least two NRSROs, and be among the largest issuers of highly rated short-term liabilities held generally by money market funds.  Issuers are expected to include European in addition to U.S.‑based global financial institutions.
  • There will be limitations on how much an investor may sell to a PSPV.  As discussed below, the SEC has issued to J.P. Morgan Securities Inc. (“JPMorgan Securities”), the sponsor and manager of the PSPVs, a no-action letter that describes those limits (the “JPMorgan No-Action Letter”).

In addition, in conversations with the Investment Company Institute and others, we have learned the following about the MMIFF Program:

  • The MMIFF Program is intended to cover any fund that is registered as an investment company under the Investment Company Act of 1940 (the “1940 Act”), and that holds itself out as a money market fund (i.e., it meets the requirements of Rules 2a-7(c)(2), (c)(3) and (c)(4)), not just those money market funds that maintain a stable net asset value.
  • The PSPVs maximum liability at any one time is intended to be $600 billion in eligible assets.  As acquired instruments mature and are paid off, the principal amounts of such instruments are intended to be reapplied to the original $600 billion limit.
  • The FRB-NY expects to publish the list of the 50 issuers of the eligible assets within the next two weeks.

Separately, the Staff of the SEC’s Division of Investment Management (the “Staff”) issued to JPMorgan Securities no-action relief with respect to money market fund participation in the MMIFF Program in which, among other things, the Staff stated that:

  • It would not recommend enforcement action to the SEC under Sections 2(a)(41), 34(b) and 35(d) of the 1940 Act, and Rules 2a-4 and 22c-1 thereunder (which relate to the calculation of an investment company’s net asset value) if a money market fund treated the PSPV-issued ABCP as “Asset Backed Securities” for purposes of Rule 2a-7 under the 1940 Act;
  • It would not recommend enforcement action to the SEC under Sections 2(a)(41), 34(b) and 35(d) of the 1940 Act, and Rules 2a-4 and 22c-1 thereunder if a money market fund investing in ABCP complied with Rule 2a-7’s diversification requirements by adhering to the following conditions instead of the “look through” provisions of Rule 2a-7(c)(4)(ii)(D)(1)(i):
    • The fund may not acquire any ABCP if such acquisition would result in all ABCP representing more than 2.5 percent of the fund’s total assets;
    • At the time of its acquisition by the fund, ABCP must be a First Tier Security (as defined in Rule 2a-7(a)(12));
    • If a fund makes additional purchases of securities issued by an issuer that is one of the ten issuers the securities of which may be held by a PSPV, for diversification purposes, the fund must add the entire value of its ABCP issued by that PSPV to the value of all of its other holdings of securities of the issuer; and
    • If a fund acquires in the secondary market ABCP issued by a PSPV, for diversification purposes, the fund must add the entire value of the such ABCP to the value of all of its holdings of the securities of each of the ten issuers the securities of which may be held by the PSPV in addition to the value of all of its holdings of the securities of that issuer.
  • It would not recommend enforcement action to the SEC under Section 12(d)(3) of the 1940 Act if a money market fund participating in the MMIFF Program acquires PSPV-issued ABCP even though the PSPVs are advised by affiliated persons of financial institutions that that have significant securities-related businesses and are issuers of securities that are eligible for purchase by the PSPVs.  Section 12(d)(3) generally prohibits an investment company from purchasing a security issued by a broker, dealer, a person engaged in the business of underwriting, an investment adviser to an investment company, or a registered investment adviser.

Treasury Guarantee Program.

As discussed in the September 30, 2008 and October 14, 2008 editions of the Alert, the U.S. Treasury is providing a temporary guaranty program for certain money market funds (the “Treasury Program”), which guarantees the value of the shares of participating money market funds that were owned by beneficial owners as of the close of business on September 19, 2008.   FINRA has issued a notice to its members in which it announced that member communications with the public that are covered by NASD Rule 2210, when discussing the Treasury Program, should provide in substance the following information:

  • The Treasury Program provides a guarantee to participating money market fund shareholders based on the number of shares invested as of the close of business on September 19, 2008;
  • Any increase in the number of shares an investor holds after the close of business on September 19, 2008 will not be covered;
  • If a customer closes his or her account with the fund or broker-dealer, any future investment will not be covered;
  • If the number of shares a customer holds fluctuates over the period, the investor will be covered for the lesser of the number of shares held as of the close of business on September 19, 2008 or the current amount; and
  • The Treasury Program expires on December 18, 2008, unless extended by the Treasury.

In addition, FINRA expects that when a customer transfers an account from one brokerage firm to another, and the customer owns shares of a money market fund that is participating in the Treasury Program, the receiving brokerage firm should refer to the guarantee and inform the customer that he or she could lose the benefit of the guarantee upon the closure of the account in the account transfer or upon the transfer of the account to the receiving firm.