The Staff of the SEC’s Division of Investment Management recently wrote to the Investment Company Institute (the “ICI”) and stated that a money market fund may treat a short-term floating rate security (“STFRS”) that is subject to an unconditional demand feature as a short‑term variable rate security (“STVRS”) for the purpose of calculating the fund’s dollar‑weighted average life to maturity (“WAL”). Rule 2a-7 under the 1940 Act, which regulates all registered investment companies that hold themselves out as money market funds or which use the term “money market” or a similar term in their names, requires among other things that each money market fund maintain a WAL of 120 days or less. Rule 2a-7(c)(2)(iii) provides that WAL is calculated without reference to the maturity shortening provisions in Rule 2a‑7(d) regarding interest rate readjustments.
Under Rule 2a-7, a security’s maturity generally is determined as the period remaining until (a) the date on which, in accordance with the terms of the security, the principal amount must be unconditionally be paid or (b) in the case of a security called for redemption, the date on which the redemption payment must be made. Rule 2a-7(d) provides several exceptions to that general rule, including exceptions for STVRSs and STFRSs. An STVRS is a security, the principal amount of which, in accordance with its terms, must unconditionally be paid within 397 calendar days and which has an interest rate that adjusts on specified dates. Like an STVRS, an STFRS is a security, the principal amount of which, in accordance with its terms, must unconditionally be paid within 397 calendar days; however, the interest rate for an STFRS adjusts whenever a specified interest rate changes.
Under Rule 2a-7(d)(2), an STVRS generally is deemed to have a maturity equal to the earlier of the period remaining until the next readjustment of the interest rate, or the period remaining until the principal amount may be recovered through demand. For purposes of calculating a fund’s WAL, however, a security’s remaining maturity is the period remaining until the principal amount may be recovered through demand because under Rule 2a‑7(c)(2)(iii), any maturity shortening provision based on an interest rate readjustment must be disregarded. Under Rule 2a‑7(d)(4), an STFRS generally is deemed to have a remaining maturity equal to one day. According to the ICI, in the context of an STFRS, Rule 2a‑7(c)(2)(iii) could be interpreted as requiring a fund to use a remaining maturity equal to the period until the security is unconditionally paid in accordance with its terms, even if the security has an unconditional demand feature that permits the fund to recover the principal amount earlier. A fund could not use the one-day period in calculating its WAL because of the prohibition of using the rule’s maturity shortening provisions based on interest rate readjustments.
According to the ICI, nothing in the adopting release to the recent amendments to Rule 2a‑7, which added the WAL requirement to the rule, indicated that for the purposes of calculating a fund’s WAL, the SEC intended to calculate the remaining maturities of an STFRS without reference to a demand feature and an STVRS with reference to a demand feature. The Staff agreed, and thus, would permit a money market fund to treat an STFRS that is subject to an unconditional demand feature as an STVRS for the purpose of calculating the fund’s WAL.