In our continuing in-depth coverage of the SEC's Final Rules on Money Market Fund Reform, we take a closer look at the fees and gates provisions. Specifically, we examine the benefits, the impact on fund flows, the size of fees, when they should be imposed, and how often, among other things. Explains the final rules, "While we recognize that there is risk of pre-emptive redemptions, the benefits of having effective tools in place to address runs and contagion risk leads us to adopt the proposed fees and gates reforms, with some modifications. We believe several of the changes we are making in our final reforms will mitigate this risk and dampen the effects on other money market funds and the broader markets if pre-emptive redemptions do occur." (Note: Late Thursday, Fidelity Investments also published its most recent communication in a new "`Regulatory Reform educational series," a piece entitled, "Redemption Restrictions for Money Market Mutual Funds: Liquidity Fees and Redemption Gates.")
On the impact of imposing as fee or gate, the SEC's final rule states, "Commenters have suggested that once fees and gates are imposed, they may not be easily lifted without triggering a run. Similarly, other commenters warned that imposing a fee or gate would not help a fund recover from a crisis but rather force it into liquidation because investors would lose trust in the fund and seek to invest in a money market fund that has not imposed a fee or gate. We acknowledge that there is a risk that investors may redeem from a fund after a fee or gate is lifted. We believe this is less likely following the imposition of a fee, however, because investors will continue to have the ability to redeem while a fee is in place and, therefore, may experience less disruption and potentially less loss in trust. We think it is important to observe that whenever a fee or gate is imposed, the fund may already be under stress from heavy redemptions that are draining liquidity, and the purpose of the fees and gates amendments is to give the fund's board additional tools to address this external threat when the board determines that using one or both of the tools is in the fund's best interests.... Even if a fund ultimately liquidates, its disposition is likely to be more orderly and efficient if it previously imposed a fee or gate. In fact, imposing a fee or gate should give a fund more time to generate greater liquidity so that it will be able to liquidate with less harm to shareholders."
On the potential effects on liquidity, it states, "In our view, however, these reforms should not unreasonably impede the use of money market funds as liquid investments. First, under normal circumstances, when a fund's liquidity is not under stress, the fees and gates amendments will not affect money market funds or their shareholders. Fees and gates are tools for funds to use in times of severe market or internal stress. Second, even when a fund experiences stress, the fees and gates amendments we are adopting today do not require money market funds to impose fees and gates when it is not in the best interests of the fund."
How often will they be imposed? "We believe gates (as well as fees) will rarely be imposed in normal market conditions. In our view, in those likely rare situations where a gate would be imposed, investors would (in the absence of the gating mechanism) potentially be left in worse shape if the fund were, for example, forced to engage in the sale of assets and thus incur permanent losses; or worse, if the fund were forced to liquidate because of a severe liquidity crisis. Thus, we believe that allowing fund boards to impose gates should not be viewed as detrimental to funds, but rather should be viewed as an interim measure boards can employ in worse case scenarios where the alternative would likely be a result potentially more detrimental to investors' overall interests.... While we recognize these commenter concerns regarding liquidity, we believe that the overall benefits and protections that are provided by the fees and gates amendments to all investors in these money market funds outweigh these concerns.... Moreover, to the extent an investor wants to invest in a money market fund without the possibility of fees and/or gates, it may choose to invest in a government money market fund, which is not subject to the fees and gates requirements."
On flows out of money funds it states, "Some commenters expressed concern that the possibility of fees and gates being imposed could result in diminished investor appeal and/or utility of affected money market funds, and could cause investors to either abandon or severely restrict use of affected money market funds. For example, commenters suggested that fees and gates would drive sweep account money out of money market funds. Commenters warned that fees and gates may cause investors to shift investments into other assets, government money market funds, FDIC-insured accounts and other bank products, riskier and/or less regulated investments, or other alternative stable value products. Conversely, other commenters predicted only minor effects on investor demand and/or that investor demand would decrease less under the proposed fees and gates alternative than under the proposed floating NAV alternative. We recognize that, as suggested by certain commenters, our amendments could cause some shareholders to redeem their prime money market fund shares and move their assets to alternative products that do not have the ability to impose fees or gates because the potential imposition of a fee or gate could make investment in a money market fund less attractive due to less certain liquidity. We agree with one commenter that suggested it is difficult to estimate the extent to which assets might shift from prime funds to government funds or other alternatives."
The rules also commented on factors that a fund's board should consider when deciding whether or not to impose a fee or gate. "The "best interests" standard in today's amendments recognizes that each fund is different and that, once a fund's weekly liquid assets have dropped below the minimum required by rule 2a-7, a fund's board is best suited, in consultation with the fund's adviser, to determine when and if a fee or gate is in the best interests of the fund.... We agree with the commenter who suggested an exclusive list of factors could be counter-productive.... Instead, we believe a fund board should consider any factors it deems appropriate when determining whether fees and/or gates are in the best interests of a fund. Nonetheless, we believe it is appropriate to provide certain guideposts that boards may want to keep in mind, as applicable and appropriate, when determining whether a fund should impose fees or gates and are providing such guidance in this Release.... These may include, but are not limited to: relevant indicators of liquidity stress in the markets and why the fund's weekly liquid assets have fallen (e.g., Have weekly liquid assets fallen because the fund is experiencing mounting redemptions during a time of market stress or because a few large shareholders unexpectedly redeemed shares for idiosyncratic reasons unrelated to current market conditions or the fund?); the liquidity profile of the fund and expectations as to how the profile might change in the immediate future, including any expectations as to how quickly a fund's liquidity may decline and whether the drop in weekly liquid assets is likely to be very short-term (e.g., Will the decline in weekly liquid assets be cured in the next day or two when securities currently held in the fund's portfolio qualify as weekly liquid assets?); for retail and government money market funds, whether the fall in weekly liquid assets has been accompanied by a decline in the fund's shadow price; the make-up of the fund's shareholder base and previous shareholder redemption patterns; and/or the fund's experience, if any, with the imposition of fees and/or gates in the past.... Other commenters proposed that boards should be permitted to reasonably determine and commit themselves in advance to a policy to not allow a fee or gate to ever be imposed on a fund. We disagree. A blanket decision on the part of a fund board to not impose fees or gates, without any knowledge or consideration of the particular circumstances of a fund at a given time, would be flatly inconsistent with the fees and gates amendments we are adopting today, which, at a minimum, require a fund to impose a liquidity fee when its weekly liquid assets have dropped below 10%, unless the fund's board affirmatively finds that such fee is not in the best interests of the fund."
Regarding the size of fees, the rules say, "Today's amendments will permit a money market fund to impose a discretionary liquidity fee of up to 2% after its weekly liquid assets drop below 30% of its total assets. We are also adopting a default liquidity fee of 1% that must be imposed if a fund drops below 10% weekly liquid assets, unless a fund's board determines not to impose such a fee, or to impose a lower or higher fee (not to exceed 2%) because it is in the best interests of the fund. As proposed, the amendments would have required funds to impose a default liquidity fee of 2% after a fund's weekly liquid assets dropped below 15% of its total assets, although (as under our final amendments) fund boards could have determined not to impose the fee or to lower the fee.... We note that fund boards should not consider our 1% default liquidity fee as creating the presumption that a liquidity fee should be 1%. If a fund board believes based on market liquidity costs at the time or otherwise that a liquidity fee is more appropriately set at a lower or higher (up to 2%) level, it should consider doing so.... The amendments we are adopting today incorporate substantial flexibility for a fund board to determine when and how it imposes liquidity fees. As long as funds' weekly liquid assets are above the regulatory threshold (i.e. 30%), fund shareholders should continue to enjoy unfettered liquidity for money market fund shares. The likely limited and infrequent use of liquidity fees leads us to believe exemptions are generally unnecessary."
On the duration of gates and fees it says, "We are adopting, as proposed, a requirement that any fee or gate be lifted automatically once the fund's weekly liquid assets have risen to or above 30% of the fund's total assets. We are also adopting, with certain modifications from the proposal as discussed below, a requirement that a money market fund must lift any gate it imposes within 10 business days and that a fund cannot impose a gate for more than 10 business days in any 90-day period.... We also recognize commenters' concerns regarding the application of fees and gates in the context of sweep accounts. We note that during normal market conditions, fees and gates should not impact sweep accounts' (or any other investor's) investment in a money market fund. We also note that, unlike our proposal, the amendments we are adopting today will allow a fund boards to institute a fee or gate at any time of the days. To the extent a sweep account's daily investment is made at the end of the day, we believe this change should reduce concerns that the sweep account holder will find out about a redemption restriction only after it has made its daily investment and may lessen the difficulty and costs related to developing a trading system that can ensure an account has sufficient funds to cover the trade itself plus the possibility of a liquidity fee."
Finally, the SEC writes, "We believe the floating NAV requirement may encourage those investors who are least able to bear risk of loss to redirect their investments to other investment opportunities (e.g., government money market funds), and this may have the secondary effect of removing from the funds those investors most prone to redeem should a liquidity event occur for which fees or gates could be imposed."
