While much of the focus of the SEC's recent Money Market Fund Reforms has been on institutional MMFs, the final rules also establish new guidelines -- and definitions -- for government and retail money market funds. We take a look at the key rules changes around government and retail MMFs below. On page 202 of the final rules (which were recently published in the Federal Register), it explains how the definition of government MMFs has changed, particularly with respect to the non-government basket. "The fees and gates and floating NAV reforms included in today's Release will not apply to government money market funds, which are defined as a money market fund that invests at least 99.5% of its total assets in cash, government securities, and/or repurchase agreements that are "collateralized fully" (i.e., collateralized by cash or government securities). In addition, under today's amendments, government money market funds may invest a de minimis amount (up to 0.5%) in non-government assets, unlike our proposal and under current rule 2a-7, which permits government money market funds to invest up to 20% of total assets in non-government assets." [Note: Though "government" money funds are currently allowed to buy up to 20% in non-govt assets, none do.]
On not imposing gates and fees or floating NAV on government MMFs it says, "Government money market fund will not be required to, but may, impose a fee or gate if the ability to do so is disclosed in a fund's prospectus and the fund complies with the fees and gates requirements in the amended rule. With respect to the floating NAV reform, most commenters supported a reform that does not apply to government money market funds. Commenters noted that government funds pose significantly less risk of heavy investor redemptions than prime funds, have low default risk and are highly liquid even during market stress, and experienced net inflows during the financial crisis.... Government money market funds face different redemption pressures and have different risk characteristics than other money market funds because of their unique portfolio composition. The securities primarily held by government money market funds typically have a lower credit default risk than commercial paper and other securities held by prime money market funds and are highly liquid in even the most stressful market conditions. As noted in our proposal, government funds' primary risk is interest rate risk; that is, the risk that changes in the interest rates result in a change in the market value of portfolio securities. Even the interest rate risk of government money market funds, however, is generally mitigated because these funds typically hold assets that have short maturities and hold those assets to maturity.... Most government money market funds always have at least 30% weekly liquid assets because of the nature of their portfolio (i.e., the securities they generally hold, by definition, are weekly liquid assets)."
It talks about providing investor with clear choices. "We expect that some money market fund investors may be unwilling or unable to invest in a money market fund that floats its NAV and/or can impose a fee or gate. By not subjecting government money market funds to the fees and gates and floating NAV reforms, fund sponsors will have the ability to offer money market fund investment products that meet investors' differing investment and liquidity needs. We also believe that this approach preserves some of the current benefits of money market funds for investors. Based on our evaluation of these considerations and tradeoffs, and the more limited risk of heavy redemptions in government money market funds, we believe it is preferable to tailor today's reforms and not apply the floating NAV requirement to government funds, but to permit them to implement the fees and gates reforms if they choose."
It explains in more detail why it changed the size of the non-government basket. "We agree with commenters who suggested that permitting government funds to invest potentially up to 20% of fund assets in riskier non-government securities may promote a type of hybrid money market fund that presents new risks that are not consistent with the purposes of the money market reforms adopted today. It would limit the effectiveness of our floating NAV reform, for example, to allow a hybrid government fund to develop and potentially present credit risk to institutional investors seeking greater yield, while keeping the benefit of a stable NAV. In order to evaluate an appropriate de minimis amount of non-government securities, Commission staff, using Form N-MFP data, analyzed the exposure of government money market funds to non-government securities between November 2010 and November 2013.... An analysis of the data also showed that, between November 2010 and November 2013, government money market funds generally invested between 0.5% and 2.5% of their total amortized cost dollar holdings in non-government securities and, more recently closer to 0.5% in non-government securities from November 2012 to November 2013. We expect that the 0.5% non-conforming basket is consistent with current industry practices and strikes an appropriate balance between providing government money market fund managers with adequate flexibility to manage such funds while preventing them from taking on potentially high levels of risk associated with non-government assets."
Retail MMFs also have their own new rules. "Our fees and gates reform will apply to retail money market funds, but our floating NAV reform will not. However, as discussed more below, we are revising the definition of a retail money market fund from our proposal to address concerns raised by commenters. As amended, a retail money market fund means a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons."
On the differences between retail and institutional investors it says, "Retail investors historically have behaved differently from institutional investors in a crisis, being less likely to make large redemptions quickly in response to the first sign of market stress. During the financial crisis, institutional prime money market funds had substantially larger redemptions than prime money market funds that self-identify as retail. As noted in the Proposing Release, for example, approximately 4-5% of retail prime money market funds had outflows of greater than 5% on each of September 17, 18, and 19, 2008, compared to 22-30% of institutional prime money market funds."
It also discusses why fees and gates are imposed on retail funds. "Although, as discussed above, the evidence suggests that retail investors historically have exhibited much lower levels of redemptions or a slower pace of redemptions in times of stress, we cannot predict future investor behavior with certainty and, thus, we cannot rule out the potential for heavy redemptions in retail funds in the future. Empirical analyses of retail money market fund redemptions during the financial crisis show that at least some retail investors eventually began redeeming shares. Similarly, we note that when the Reserve Primary Fund, which was a mixed retail and institutional money market fund, "broke the buck" as a result of the Lehman Brothers bankruptcy, almost all of its investors ran -- retail and institutional alike.... Moreover, as we recognized in the Proposing Release, retail prime money market funds, unlike government money market funds, generally are subject to the same credit and liquidity risks as institutional prime money market funds."
The rules continue, "As such, absent fees and gates, there would be nothing to help manage or prevent a run on retail prime money market funds in the future. While retail investors are unlikely to be motivated to a substantial degree by the first-mover advantage created by money market funds' stable pricing convention, they may be motivated to redeem heavily in flights to quality, liquidity, and transparency (even if they may do so somewhat slower than institutional investors). Fees and gates are designed to address these types of redemptions... Further, while we recognize that a retail money market fund may be less likely to experience strained liquidity (and thus less likely to need to impose a fee or gate), we believe there is still a sufficient risk of this occurring that we should allow such funds to impose a fee or gate to manage any related heavy redemptions when the weekly liquid assets fall below 30% and doing so is in the fund's best interests. For the same reasons, we believe requiring a fund to impose a liquidity fee when weekly liquid assets fall below 10% is also appropriate, unless the board determines otherwise based on the fund's best interests. Accordingly, retail money market funds will be subject to the fees and gates reform."
Retail funds are not subject to floating NAV, however. "We are not imposing the floating NAV reform on retail money market funds. For purposes of the floating NAV reform, we are defining a retail money market fund to mean a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons. We continue to believe that the significant benefits of providing an alternative stable NAV fund option justify the risks associated with the potential for a shift in retail investors' behavior in the future, particularly given that retail money market funds will be able to use fees and gates as tools to stem heavy redemptions should they occur. We also note that, as discussed below, our revised approach to defining a retail fund based on shareholder characteristics should minimize the potential for gaming behavior by institutional investors."
On the "natural persons" definition it says, "Drawing a distinction between retail and institutional investors is complicated by the extent to which shares of money market funds are held by investors through omnibus accounts and other financial intermediaries. We also recognize that any distinction between retail and institutional funds could result in "gaming behavior" whereby investors having the general attributes of an institution might attempt to fit within the confines of whatever retail fund definition we craft. We believe, however, that defining a retail fund using the natural person test will, as a practical matter, significantly reduce opportunities for gaming behavior because we believe that most funds will use social security numbers as part of their compliance process to limit beneficial ownership to natural persons, and institutional investors are not issued social security numbers. We expect that a fund that intends to qualify as a retail money market fund would disclose in its prospectus that it limits investments to accounts beneficially owned by natural persons. Funds will have flexibility in how they choose to comply with the natural person test. As noted by commenters, we expect that many funds will rely on social security numbers to confirm beneficial ownership by a natural person.... Funds that intend to satisfy the retail fund definition will be required to adopt and implement policies and procedures reasonably designed to restrict beneficial ownership to natural persons."
Finally, on costs it says, "The Commission estimates that based on those money market funds that self-report as "retail," approximately 195 money market funds are likely to seek to qualify as a retail money market fund under our amended rules. Based on staff experience and review of the comments received, as well as the changes to the retail definition in the final amendments, we estimate that the one-time costs necessary to implement policies and procedures and/or for a fund to qualify as a retail money market fund under our amended rules, including the various organizational, operational, training, and other costs discussed above, will range from $830,000 to $1,300,000 per entity."
