Stradley Ronon published a "Fund Alert" yesterday, written by Joan Swirsky, entitled, "Money Market Fund Reform: SEC Proposes Fundamental Reform and Other Significant Rule Amendments. It says, "At an open meeting (the Open Meeting) on June 5, the SEC proposed fundamental reform of money market funds that operate under Rule 2a-7 (the Rule) under the Investment Company Act of 1940, along with additional significant proposals that would expand money market funds' required disclosures, constrain their portfolio management and broaden stress testing. If adopted, the reforms will increase operational and compliance demands on money market funds and their advisers and enhance board responsibilities. In addition, the reforms could dampen yields on money market funds if operational and compliance costs are passed on to shareholders or if managers invest conservatively in response to the reforms. The SEC offers the candid assessment that the reforms "may come at a cost to fund yield and profitability as managers shift to shorter dated or more liquid securities"."
Swirsky explains, "The fundamental reforms are set forth in the proposing release (the Release) as two alternative versions of Rule 2a-7, with the second alternative consisting of two separate features -- (1) a floating net asset value (NAV), and (2) a liquidity fee and redemption gate. However, the SEC makes clear that the two alternatives (and the two separate features in the second alternative) could be adopted together or in any combination. The proposed fundamental reforms would do the following: A. Floating NAV - Require a floating NAV for money market funds other than U.S. government money market funds and retail money market funds. This requirement would apply to prime money market funds and tax-exempt money market funds unless the funds satisfy the proposed description of a retail money market fund. The SEC acknowledges the operational and other costs that would be required to transition to a floating NAV. The Rule as amended under this alternative is referred to as the "Proposed FNAV Rule."
The piece continues, "The proposal exempts from the requirement to float the NAV funds that do not permit any shareholder of record to redeem more than $1 million on any one business day. The SEC acknowledges the significant operational and compliance burdens of implementing the retail exemption. The SEC estimates that the cost for each fund to implement the retail exemption would range from $1 million to $1.5 million per fund. Omnibus exception to $1 million redemption limit – fund needs procedures that "allow conclusion" that intermediary imposes $1 million daily redemption limit."
The Stradley Alert says, "The floating NAV must be calculated to the nearest hundredth of a percent (the fourth decimal place on a $1.00 share). Money market funds currently calculate NAV to the nearest one percent, and non-money market funds with a $1.00 NAV are required to calculate NAV to the nearest tenth of a percent under existing SEC precedent.... Money market funds that maintain a stable NAV would do so only by using the penny-rounding method of pricing. Under penny-rounding, a fund calculates the market value of its share and rounds the market value to the nearest penny on a $1.00 share."
It tells us, "Amortized cost valuation permitted only for securities maturing within 60 days. The SEC will permit an exception to the prohibition on amortized cost valuation for securities with maturities within 60 days unless the particular circumstances warrant otherwise. The permission to value very short-term securities at amortized cost reflects current SEC requirements for non-money market funds. This exception may cover a significant portion of money market fund holdings because money market funds are required to maintain an average weighted portfolio maturity of no more than 60 days."
On the "Liquidity Fee and Redemption Gate" option, the Alert states, "Impose two provisions that apply when the weekly liquid assets of a money market fund other than a U.S. government money market fund have fallen to less than 15 percent of total assets (referred to below as "depleted"). (U.S. government money market funds could voluntarily abide by these requirements. Tax-exempt money market funds are subject to these requirements.) The Rule as amended under this two-part alternative is referred to as the "Proposed FG Rule." The Proposed FG Rule essentially grants the board5 the authority to impose or not impose the liquidity fee (in the amount the board desires) and/or the gate for the period the board desires while weekly liquid assets are depleted."
Swirsky writes under the section "Commissioners Prefer Combination?, "At the Open Meeting, one of the commissioners voiced support for adopting the Proposed FG Rule as a stand-alone measure, two commissioners indicated a preliminary preference for combining the measures, and the two remaining commissioners did not clearly indicate their preference on this issue. The less fundamental reforms could be adopted without regard to the approach to the fundamental reforms. If both the Proposed FNAV Rule and the Proposed FG Rule are adopted as proposed, the only money market funds that would be required neither to adopt a floating NAV nor to operate with a liquidity fee or gate would be U.S. government money market funds. Retail money market funds could continue to have a stable NAV but would be required to operate with a liquidity fee and gate unless the funds were U.S. government money market funds. Non-U.S. government institutional money market funds would be required to comply with both proposals."
She adds, "The Release raises important challenges and uncertainties regarding the floating NAV, including: how to transition to the floating NAV without triggering pre-emptive redemptions by shareholders who anticipate that the NAV may be less than $1.00 at the conversion date; compliance with tax rules for a floating NAV share; purchasers of money market fund shares concluding that a floating NAV share is a "cash equivalent" (the SEC believes that it is under normal circumstances); and determining whether certain funds can qualify as "retail" funds, which are exempt from the floating NAV requirement. Funds that raise particular challenges are those that include both retail and institutional shareholders, funds with shareholders who are omnibus accounts, funds in master-feeder structures, and tax-exempt funds."
The Stradley piece says, "The proposals are likely to draw a wide variety of reactions from industry participants, which may include the following, among others: Some may be relieved that the fundamental reforms do not include capital buffers or minimum balance requirements. These alternatives were included as proposed recommendations to the SEC by the Financial Stability Oversight Council (FSOC) in its report issued on Nov. 13, 2012 (the "FSOC Recommendations"), to widespread objection by industry participants. Some may be pleased that the Proposed FG Rule could be a stand-alone measure. Some have argued that the floating NAV for any money market funds will not stem runs and will greatly reduce the value of the money market funds to investors. On the other hand, others may believe that a gate is not a practical solution, because when it is lifted the fund will experience a run, even if a liquidity fee is imposed.
Finally, Swirsky tells us, "The Release poses myriad questions on every aspect of the proposals, giving the impression that the proposals remain a work in progress despite the detailed analysis in the Release and copious comments already provided on prior money market fund reform proposals. Even if reforms are finalized, implementation is a distant goal -- by some estimates, no earlier than late 2014 for less fundamental reforms, early 2015 for fees and gates, and early 2016 for a floating NAV. These estimates are based on the following possible timeline: September 17 – comments are due on the proposal; Early 2014 – the SEC could issue a final rule release, assuming that it will need several months to analyze comments and finalize rules; Late 2014 – non-fundamental reforms implemented (the SEC has proposed a nine-month compliance period); Early 2015 – fees and gates implemented (the SEC has proposed a one-year compliance period); Early 2016 – floating NAV implemented (the SEC has proposed a two-year compliance period)."
