On June 5, 2013, the SEC unanimously approved for public comment proposals to modify the regulation of money market funds (“MMFs”), primarily through amendments to Rule 2a-7 under the Investment Company Act of 1940, which sets forth various requirements particular to MMFs. The SEC’s two principal proposals are presented as alternatives, although the Commission is also seeking comment on whether some combination of the two might be appropriate. In addition, the SEC proposed amendments to related rules and forms that would apply under either alternative, including with respect to disclosure requirements, diversification, and stress testing for MMFs, as well as reporting obligations for MMFs and unregistered MMF-equivalents reported on SEC Form PF by registered advisers (“private liquidity funds”).
The stated goals of the SEC’s proposals are to (i) mitigate MMFs’ susceptibility to heavy redemptions during times of stress, (ii) increase the transparency of MMF risk, (iii) improve MMFs’ ability to manage and mitigate potential contagion from high levels of redemptions, and (iv) preserve as much as possible the benefits of MMFs for investors and the short-term financing markets. The proposed amendments are summarized below.
Principal Proposals – Two Alternatives
Alternative No. 1 - Floating Net Asset Value for Prime Institutional Funds
Under the first alternative, a “prime institutional MMF,” which would be any MMF that is not either a “retail MMF” or a “government MMF,” would be required to use a floating net asset value (“NAV”) and would not be permitted to penny round its prices. With a floating NAV, the daily share price of a prime institutional MMF would fluctuate along with changes, if any, in the market-based value of its portfolio securities. Under this proposal, a prime institutional MMF would be required to “basis point round” its share price to the nearest 1/100th of 1% (i.e., the fourth decimal place in the case of a fund with a $1.0000 share price).
Government and Retail MMFs. Government and retail MMFs would be allowed to continue using the current penny-rounding method of pricing and maintain a stable share price instead of converting to a floating NAV. (But, as described below, government and retail MMFs would be allowed to use the amortized cost method of valuation only to the same extent as other mutual funds.)
- A government MMF would be generally defined as any MMF that invests at least 80% of its total assets in cash, government securities, and/or repurchase agreements that are collateralized by government securities.
- A retail MMF would be generally defined as any MMF that does not permit a shareholder to redeem more than $1 million in a single business day.
Tax-Exempt MMFs. While tax-exempt MMFs could be “prime institutional MMFs,” the SEC’s proposal notes that most MMFs that invest in municipal securities (“tax-exempt MMFs”) are intended for retail investors and thereby likely would qualify for the retail MMF exemption from the floating NAV proposal. In this regard, the SEC requested comment on whether tax-exempt MMFs that wish to take advantage of the proposed retail MMF exemption should be required to also meet the 10% daily liquid asset requirements under Rule 2a-7, from which tax-exempt MMFs are currently exempt.
Omnibus Accounts. The proposal acknowledges potential difficulties associated with applying the daily redemption limitation in the context of omnibus accounts. To address this issue, the proposal would allow an MMF to qualify as a retail MMF even if it allows a shareholder of record to redeem more than $1,000,000 in a single day, if the following conditions are met: (1) the shareholder of record would have to be an “omnibus account holder” that restricts each of its beneficial owners to no more than $1,000,000 in daily redemptions; and (2) the MMF would have to have policies and procedures reasonably designed to allow it to conclude that the omnibus account holder does not permit any beneficial owner from “directly or indirectly” redeeming more than $1,000,000 in a single day.
Advance Notice Exception. The proposal requests comment on whether a retail MMF should be allowed to permit a redemption request in excess of the $1,000,000 daily limit if advance notice is provided.
Alternative No. 2 - Liquidity Fees on Redemptions and Redemption Gates
Instead of requiring certain MMFs to adopt a floating NAV, the second alternative would, under certain conditions, (i) require each MMF, other than a government MMF, to impose “liquidity fees” on redemptions and (ii) give each MMF’s board of directors the ability to impose a temporary suspension of redemptions (or a “redemption gate”).
Liquidity Fees. If an MMF’s level of “weekly liquid assets” were to fall below 15% of its total assets (which is half the 30% minimum currently required under Rule 2a-7), the MMF would be required to impose a 2% liquidity fee on all redemptions, unless its board (including a majority of its independent directors) determines that such a fee would not be in the fund’s best interest or that a lesser fee would be in the fund’s best interest.
- Weekly liquid assets would generally consist of cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert into cash within one week.
Redemption Gates. If an MMF crosses the 15% liquidity threshold, its board would also be able to impose a redemption gate if the board (including a majority of its independent directors) determines that doing so would be in the fund’s best interest.
Terminating Liquidity Fees and Redemption Gates; Limits on Redemption Gates. A liquidity fee or redemption gate would terminate automatically when the MMF’s level of weekly liquid assets reaches or exceeds 30% of its total assets, although the MMF’s board (including a majority of its independent directors) could terminate the fee or gate before then. In addition, a redemption gate could not be in place for more than 30 days, although the board (including a majority of its independent directors) could lift the gate sooner. An MMF could not impose a gate for more than 30 days in any 90-day period.
Exempting Government MMFs. Liquidity fees and redemption gates would not apply to government MMFs, but these funds could voluntarily elect to implement such measures subject to certain conditions.
Both Alternatives – Limits on Use of Amortized Cost for All MMFs
Under both alternatives, MMFs, regardless of type, would no longer be able to use amortized cost to value their portfolio securities, except to the limited extent all mutual funds are able to do so (i.e., where the fund’s board determines, in good faith, that the fair value of debt securities with remaining maturities of 60 days or less is their amortized cost, unless the particular circumstances warrant otherwise).
Amendments to Disclosure Requirements
In addition to the alternatives summarized above, the SEC’s proposal includes the following changes to MMF disclosure requirements.
- Website Disclosure. Under the proposals, an MMF would be required to disclose daily on its website (1) its market-based NAV per share (rounded to the fourth decimal place in the case of a fund with a $1.0000 share price or an equivalent level of accuracy for funds with a different share price), (2) the percentage of its portfolio invested in both “daily liquid assets” and “weekly liquid assets,” and (3) its net inflows or outflows as of the end of the previous business day.
- Disclosure of Material Events and Sponsor Support. An MMF would be required to promptly disclose certain events on new Form N-CR and, in certain cases on its website, including (a) the imposition or lifting of liquidity fees and/or redemption gates and the board’s analysis in this regard, (b) portfolio security defaults, (c) any financial support for the MMF provided by its sponsor or an affiliate, and (d) for an MMF that continues to maintain a stable share price under either alternative, a decline in the MMF’s market-based NAV per share below $0.9975. An MMF would have to disclose historical instances of financial support by its sponsor or an affiliate in the MMF’s statement of additional information.
- Form N-MFP. Form N-MFP, which MMFs currently use to report to the SEC their portfolio holdings and other information each month, would be amended to clarify existing requirements and require reporting of additional information relevant to assessing MMF risk. The proposal would make information filed on Form N-MFP available to the public immediately upon filing, eliminating the current 60-day delay on public availability.
The SEC’s proposal includes the following changes to Rule 2a-7’s requirements regarding the diversification of an MMF’s portfolio:
- Aggregation of Affiliates. An MMF would be required to aggregate affiliates for purposes of determining whether it complies with Rule 2a-7’s 5% concentration limit, which prohibits an MMF from investing any more than 5% of its assets in any one issuer.
- Removal of 25% Basket. All of an MMF’s assets would need to meet the concentration limits for guarantors and “put” providers, thereby eliminating the so-called 25% basket that permits a single institution to guarantee 25% of an MMF’s assets.
- Asset-Backed Securities. MMFs would need to aggregate all asset-backed securities vehicles sponsored by the same entity for purposes of Rule 2a-7’s 10% guarantor diversification limit. Aggregation would not, however, be required if an MMF’s board determines the fund is not relying on the guarantor’s strength or structural enhancements of the asset-backed security in determining the quality or liquidity of the asset-backed security.
Under the SEC’s proposals, the stress testing requirements adopted by the SEC in 2010 would be increased. In this regard, MMFs generally would be required to test the impact of certain market conditions on their liquidity, including the possibility that weekly liquid assets will fall below 15% of total assets. MMFs that have a stable share price would also be required to assess the risk that they will be unable to maintain a stable price, and further board reporting would be required.
Private Liquidity Fund Reporting
The SEC’s proposals include amendments to Form PF, which SEC-registered advisers use to report information about certain privately-offered unregistered funds that they advise. These amendments would require a large liquidity fund adviser, defined as an adviser with $1 billion or more in combined private liquidity fund and MMF assets under management, to report substantially the same information for the adviser’s private liquidity funds as Form N-MFP requires for MMFs.
Proposed Compliance Dates
The SEC proposes to require compliance with the various amendments as follows: (1) the floating NAV alternative - 2 years after adoption; (2) the liquidity fee and redemption gate alternative - 1 year after adoption; and (3) other proposed amendments that are not specifically related to the implementation of either alternative – 9 months after adoption.
Comments on the SEC’s proposals are due 90 days after the publication of a formal proposing release in the Federal Register.