Once again, we feature excerpts from the SEC's Money Market Fund Reforms, the new changes to money fund regulations, or Rule 2a-7 of the Investment Company Act of 1940. Today, we look at the Rule's new "Stress Testing" mandate.
The SEC writes, "We are adopting amendments to rule 2a-7 to require the board of directors of each money market fund to adopt procedures providing for periodic stress testing of the money market fund's portfolio. Almost all of the commenters who addressed this matter supported requiring stress testing of fund portfolios, although several suggested changes from our proposal. Under the amended rule, a fund must adopt procedures that provide for the periodic testing of the fund's ability to maintain a stable net asset value per share based upon certain hypothetical events. These include an increase in short-term interest rates, an increase in shareholder redemptions, a downgrade of or default on portfolio securities, and widening or narrowing of spreads between yields on an appropriate benchmark selected by the fund for overnight interest rates and commercial paper and other types of securities held by the fund."
They continue, "Commenters differed on whether we should specify details for stress testing in addition to these hypothetical events. Because different tests may be appropriate for different market conditions and different money market funds, we believe that the funds are better positioned to design and modify their stress testing systems and have not included more specific criteria in the rule."
The SEC explains, "The amendment requires the testing to be done at such intervals as the fund board of directors determines appropriate and reasonable in light of current market conditions. This is the same approach that rule 2a-7 takes with respect to the frequency of shadow pricing. The rule does not, however, specifically require the board to design the portfolio stress testing, as may have been suggested by our proposing release. We agree with the many commenters that asserted that the board may not have sufficient expertise to construct appropriate stress tests for a fund. Each board may, of course, consider the extent to which it wishes to become involved in design of the stress tests."
They explain, "The rule also requires that the board receive a report of the results of the stress testing at its next regularly scheduled meeting, as proposed, and more frequently, if appropriate, in light of the results. We have added the requirement for more frequent reporting in light of results because we believe that the board should be apprised of test results when they indicate that the magnitude of hypothetical events required to cause the fund to break a buck (such as changes in interest rates or shareholder redemptions or a combination of factors) is slight when compared with actual conditions."
Finally, the SEC writes, "As proposed, the report must include: (i) the date(s) on which the fund portfolio was tested; and (ii) the magnitude of each hypothetical event that would cause the money market fund to break the buck. The report also must include an assessment by the fund's adviser of the fund's ability to withstand the events (and concurrent occurrences of those events) that are reasonably likely to occur within the following year. Finally, as proposed, funds are required to maintain records of the stress testing for six years, the first two years in an easily accessible place."
