On December 15, the SEC voted to propose reforms that would significantly affect the regulatory framework governing money market funds (MMFs). According to the SEC, the proposed reforms are designed to improve the resiliency of MMFs by reducing the risk of shareholder “runs,” especially during times of liquidity stress. The SEC indicated that the proposed rulemaking is informed by the experiences of MMFs during March 2020 in connection with the market volatility from the onset of the COVID-19 pandemic, which included heavy outflows from institutional prime MMFs. The public comment period for the proposed reforms will remain open until 60 days after the date of publication in the Federal Register.
The key aspects of the proposed reforms consist of amendments to Rule 2a-7 under the Investment Company Act of 1940 (1940 Act), the primary rule governing the operation of MMFs, and related form amendments that would, if adopted, cover the following:
- Remove the Liquidity Fees and Redemption Gates Provisions. The reforms would remove the ability of a MMF to impose liquidity fees or redemption gates once the fund falls below certain liquidity thresholds. However, the reforms would not preclude a MMF from utilizing provisions of the 1940 Act and rules thereunder (other than Rule 2a-7) that permit a MMF to suspend redemptions or impose redemption fees in certain limited circumstances. For example, a MMF would still be permitted to suspend redemptions to facilitate an orderly fund liquidation pursuant to Rule 22e-3 or impose redemption fees up to 2% of the value of the shares redeemed to mitigate dilution arising from shareholder transaction activity pursuant to Rule 22c-2.
- Impose a “Swing Pricing” Requirement. The reforms would require an institutional prime and institutional tax-exempt MMF, but not a government or retail MMF, to use “swing pricing” on each day it has net redemptions. Swing pricing is the process of adjusting the fund’s NAV to effectively pass on the costs stemming from redemption activity to the redeeming shareholders (such costs are currently borne by the remaining shareholders in the fund), which the SEC believes will help mitigate the risk of redemptions motivated by a perceived “first-mover advantage.” The reforms also would require the board of directors of an institutional prime and institutional tax-exempt MMF to: (i) approve the fund’s swing pricing policies and procedures; (ii) designate a “swing pricing administrator” to administer the policies and procedures on a day-to-day basis (the administrator would have to be reasonably segregated from the fund’s portfolio management); and (iii) review, at least annually, a written report prepared by the swing pricing administrator describing the adequacy and effectiveness of the swing pricing program.
- Amend the Portfolio Liquidity Requirements. The reforms would increase the minimum liquidity requirements for a MMF by raising the “daily liquid asset” minimum from 10% to 25% of the fund’s total assets and raising the “weekly liquid asset” minimum from 30% to 50%. If a fund’s portfolio does not meet the minimum daily or weekly liquid asset threshold, the fund may not acquire any assets other than “daily liquid assets” or “weekly liquid assets,” respectively, until it meets these minimum thresholds. In addition, when a money market fund’s “daily liquid assets” fall below 12.5% or its “weekly liquid assets” fall below 25%, the fund would be required, within one business day after the occurrence, to notify its board of directors and file a public report with the SEC. The reforms also would replace the current aspect of the stress testing provisions in which a MMF must test its ability to maintain 10% “weekly liquid assets” under specified hypothetical events with a requirement to test its ability to maintain “sufficient minimum liquidity” under such specified hypothetical events, where each fund would be permitted to determine the level of liquidity that it considers sufficient instead of using a bright-line threshold of 10% “weekly liquid assets” for this purpose.
- Affect How Stable-NAV MMFs Must Operate When Interest Rates are Negative. The reforms would prohibit a government and retail MMF, which have a stable NAV, from implementing a so-called “reverse distribution mechanism,” a reverse stock split or any other device that would reduce the number of the fund’s outstanding shares as a means of maintaining the fund’s stable NAV. This prohibition effectively would require a government or retail money market fund that has to apply a negative yield, which may occur, for example, in a negative interest rate environment, to convert from a stable NAV (based on the amortized cost and/or penny-rounding methods) to a “floating” NAV (based on the current market-based value of the securities in the portfolio and rounded to the fourth decimal place).
- Specify the Calculation of WAM and WAL. The reforms would require each MMF to calculate its “dollar-weighted average portfolio maturity” (WAM) and “dollar-weighted average life maturity” (WAL), which are important determinants of interest rate risk in a fund’s portfolio, based on the percentage of each security’s market value in the portfolio. This specificity would eliminate a discrepancy that currently exists as a result of some MMFs choosing to base these calculations on the amortized cost of each portfolio security.
- Amend Certain Reporting Requirements. The reforms would amend Form N-MFP, which is a monthly portfolio holdings report that is used to assist the SEC in monitoring MMFs, to provide certain new information about a fund’s shareholders and disposition of non-maturing portfolio investments, to improve the accuracy and consistency of currently reported information, and to increase the frequency of certain data points.
The SEC Commissioners voted 3-2 to propose the MMF reforms. SEC Chairman Gary Gensler, who voted in favor of the proposal, has experience with the prior rounds of MMF reforms that the SEC adopted in 2010 and 2014 in response to the 2007-2008 financial crisis. As then-Chair of the CFTC, Gensler served as a member of FSOC, which was established by Congress in 2010 to identify risks to the United States’ financial stability. Following the 2010 reforms, while the SEC was considering the potential for additional measures, FSOC explored resiliency issues around MMFs and solicited and received public comments on various proposed recommendations for structural MMF reforms.
In their public remarks, the two SEC Commissioners who dissented in the vote (Commissioners Hester Peirce and Elad Roisman) cited concerns that the proposed reforms would be “too much regulatory prescription” and a “one-size-fits-all” approach in certain respects and questioned whether it would be more prudent to propose a more “principles-based” approach that allows MMFs to decide for themselves the best approach (or combination of approaches) to increase MMF resilience, which could include, for example, the use of swing pricing, liquidity fees and gates and/or other ways to reward non-redeeming shareholders. In dissenting, Peirce and Roisman generally observed that investors have different needs for liquidity and different risk tolerances and that the heterogeneity resulting from a more principles-based approach could allow for more investor choice in the market. Peirce also highlighted that commenters have pointed to real operational difficulties and complexities associated with swing pricing, and she questioned whether swing pricing’s effect on an institutional prime or institutional tax-exempt MMFs’ NAV would be large enough to move the needle on an investor’s decision to redeem. She also stated that the proposal, if finalized in its current form, “likely would continue the trend of driving more money into government funds.”
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