Below, we again look at the SEC's Proposed Rules on "Money Market Fund Reform, in particular the section on "Standby Liquidity Fees and Gates (starting on page 153)." Given previous feedback following the November 2010 President's Working Group Report on Money Market Fund Reform and the November 2012 Financial Stability Oversight Council's "Proposed Recommendations Regarding Money Market Mutual Fund Reform", we again expect near unanimous opposition to any floating NAV and widespread support of the liquidity fees and gates option (we expect the fees and gates proposal to be the one eventually adopted too). (Note that comments have begun appearing on the SEC's Proposed Rule page, though none substantial, even though the SEC proposal has yet to be published in the Federal Register. Interested parties will have 90 days following this publication to comment on the current proposal.)
The SEC writes on emergency liquidity fees and gates, "As an alternative to the floating NAV proposal discussed above, we are proposing to continue to allow money market funds to transact at a stable share price under normal conditions but to (1) require money market funds to institute a liquidity fee in certain circumstances and (2) permit money market funds to impose a gate in certain circumstances. In particular, this fees and gates alternative proposal would require that if a money market fund's weekly liquid assets fell below 15% of its total assets (the "liquidity threshold"), the fund must impose a liquidity fee of 2% on all redemptions unless the board of directors of the fund (including a majority of its independent directors) determines that imposing such a fee would not be in the best interest of the fund. The board may also determine that a lower fee would be in the best interest of the fund."
They explain, "We also are proposing that when a money market fund's weekly liquid assets fall below 15% of total assets, the money market fund board would also have the ability to impose a temporary suspension of redemptions (also referred to as a "gate") for a limited period of time if the board determines that doing so is in the fund's best interest. Such a gate could be imposed, for example, if the liquidity fees were not proving sufficient in slowing redemptions to a manageable level."
The proposal continues, "Under this option, rule 2a-7 would continue to permit money market funds to use the penny rounding method of pricing so long as the funds complied with the conditions of the rule, but would not permit use of the amortized cost method of valuation. We would eliminate the use of the amortized cost method of valuation for money market funds under the fees and gates alternative for the same reasons we are proposing to do so under the retail and government exemptions to the floating NAV alternative. We do not believe that allowing continued use of amortized cost valuation for all securities in money market funds' portfolios is appropriate given that these funds will already be valuing their securities using market factors on a daily basis due to new website disclosure requirements and given that penny rounding otherwise achieves the same level of price stability."
It adds, "As previously discussed, the financial crisis of 2007-2008 exposed contagion effects from heavy redemptions in money market funds that had significant impacts on investors, funds, and the markets. We have designed the fees and gates alternative to address certain of these issues. Although it is impossible to know what exactly would have happened if money market funds had operated with fees and gates at that time, we expect that if money market funds were armed with such tools, they would have been able to better manage the heavy redemptions that occurred and to limit the spread of contagion, regardless of the reason for the redemptions."
The proposal states, "Based on the level of redemption activity that occurred during the crisis, we expect that many money market funds would have faced liquidity pressures sufficient to cross the liquidity thresholds we are proposing today that would trigger the use of fees and gates. If funds therefore had imposed fees, this might have caused some investors to choose not to redeem because the direct costs of the liquidity fee may have been more tangible than the uncertain possibility of potential future losses. In addition, funds that imposed fees would likely have been able to better manage the impact of the redemptions that investors submitted, and any contagion effects may have been limited, because the fees would have helped offset the costs of the liquidity provided to redeeming shareholders, and any excess could have been used to repair the NAV of the fund, if necessary. Regardless of the incentives to redeem, a liquidity fee would make redeeming investors pay for the costs of liquidity and, even if investors redeem from a fund, gates can directly respond to a run by halting redemptions."
It tells us, "If a fund had been able to impose a redemption gate at the time, it also would have been able to stop mounting redemptions and possibly generate additional internal liquidity in the fund while the gate was in place. However, fees and gates do not address all of the factors that may lead to heavy redemptions in money market funds. For example, they do not eliminate the incentive to redeem in times of stress to receive the $1.00 stable share price before the fund breaks the buck, or prevent investors from seeking to redeem to obtain higher quality securities, better liquidity, or increased transparency. Nonetheless, for the reasons discussed above, they provide tools that should serve to address many of the types of issues that arose during the crisis by allocating more explicitly the costs of liquidity and stopping runs."
Finally, the Commission's proposal says, "As discussed in section III.C, we also request comment on whether we should combine this option with our floating NAV alternative. This reform would be intended to achieve our goals of preserving the benefits of stable share price money market funds for the widest range of investors and the availability of short-term financing for issuers, while enhancing investor protection and risk transparency, making funds more resilient to mass redemptions, and improving money market funds' ability to manage and mitigate potential contagion from high levels of redemptions, as further discussed below."
