Alert February 02, 2010

SEC Adopts Amendments to Money Market Fund Rules

The SEC announced that it has adopted amendments (the “Amendments”) to its rules relating to money market funds, principally to Rule 2a-7 under the Investment Company Act of 1940, as amended.  The Amendments were proposed in June 2009, as discussed in the July 7, 2009 Alert.  The Amendments have not yet been published.  The following description of the Amendments is based on the SEC’s announcement regarding the Amendments and related statements prepared by the Staff of the SEC’s Division of Investment Management.

Changes to Rule 2a-7’s Risk-Limiting Conditions

The Amendments make several significant changes to the risk-limiting conditions in Rule 2a-7:

Maturity Calculations

  • The Amendments decrease a money market fund portfolio’s maximum permissible weighted average maturity from 90 days to 60 days; and
  • A money market fund portfolio’s weighted average maturity, determined without consideration to Rule 2a-7’s maturity shortening provisions (what the Staff refers to as “weighted average maturity life”), may not exceed 120 days; this requirement is new.

Second Tier Securities

  • The limit on a money market fund’s holdings of “second tier” securities (generally, securities that have received short-term ratings in the second highest ratings categories, or their equivalent) is decreased from 5 percent of total assets to 3 percent of total assets;
  • The maximum amount a money market fund may hold in second tier securities of any one issuer is decreased from 1 percent of the fund’s total assets to ½ of 1 percent of the fund’s total assets; and
  • The maximum permissible remaining maturity for a second tier security is reduced from 397 days to 45 days.

Minimum Liquidity Standard

  • Each money market fund is subject to a new minimum liquidity requirement (there are none currently) under which it must maintain (a) at least 10 percent of its portfolio in cash, U.S. Treasuries and securities that convert to cash in one business day, and (b) at least 30 percent of its portfolio in cash, U.S. Treasuries, certain government securities with remaining maturities of 60 business days or less, and securities that convert to cash in one week; and
  • The current 10 percent limit on illiquid securities articulated by the SEC staff is replaced by an express provision in Rule 2a-7 that prohibits a money market fund from purchasing any illiquid security if, after the purchase, more than 5 percent of the fund’s portfolio consists of illiquid securities.

Changes on Treatment of Certain Types of Securities

The Amendments also make several important changes to the treatment of certain types of securities in which money market funds typically invest:

  • Ratings on Asset Backed Securities.  Money market funds will be permitted to invest in asset backed securities that are not rated by a Nationally Recognized Statistical Ratings Organization (“NRSRO”); currently, Rule 2a-7 allows a money market fund to invest in asset backed securities only if they have been rated by an NRSRO; and
  • Repurchase Agreements.  In order for a repurchase agreement to be fully collateralized, which, for diversification purposes, permits the fund to look through the repurchase agreement and treat the underlying collateral as the securities held by the fund, (a) the repurchase agreement must be collateralized only with cash and government securities (currently, a repurchase agreement may be deemed to be fully collateralized if it is collateralized with cash, government securities, securities rated in the highest rating category by the requisite number of NRSROs and unrated but comparable securities), and (b) the fund has evaluated the creditworthiness of the counterparty.

Operational and Disclosure Changes

The Amendments also add certain new operational and disclosure requirements:

  • “Know Your Customers.”  In addition to complying with the new minimum liquidity standard, a money market fund will be required to hold securities that are sufficiently liquid to meet reasonably foreseeable redemptions.  As a result, funds will be required to adopt procedures to identify investors whose redemptions may pose a risk to the fund.
  • Stress Testing.  A money market fund’s investment manager will be required to examine the fund’s ability to maintain a stable net asset value in the event of market actions, large redemptions and other significant events.
  • NRSROs.  A money market fund’s board must designate at least four NRSROs whose ratings the board deems reliable.  The board is then entitled to disregard ratings from other NRSROs when determining that an investment meets Rule 2a-7’s minimum ratings requirements.
  • Disclosure of Portfolio Holdings and Shadow Prices.  Each month, a money market fund must (a) disclose its portfolio holdings on its web site and (b) make a filing with the SEC (which will be publicly available) that reports (i) the “shadow price” of the fund’s shares, which is calculated using the market prices of its portfolio securities rather than their amortized cost, and (ii) information relating to the fund’s portfolio holdings.
  • Calculation of a Fund’s Share Price at a Price Other than its Stable Net Asset Value.  A money market fund and its administrator must be able to process purchases and redemptions of fund shares at prices other than the fund’s stable net asset value.
  • Certain Purchases of Portfolio Holdings by an Affiliate without SEC Approval.  Affiliates of a money market fund will have more flexibility to purchase distressed securities held by a money market fund without express SEC approval.
  • Suspension of Redemptions.  The board of a money market fund will be able to suspend redemptions of fund shares without express SEC approval and liquidate the fund if the board determines that the fund is about to “break the buck.”

The Alert will provide more detailed coverage of this development once the SEC publishes the formal release describing the Amendments.