Four of the money fund industry's leading industry attorneys took to the dais on day 2 of Crane's 5th Annual Money Fund University a week-and-a-half ago in Stamford, Conn., to talk about regulations -- primarily the reforms adopted by the Securities & Exchange Commission in July 2014. (Three of the four will also be presenting tomorrow at ICI's one-day seminar, "Will You Be Ready? Implementing the New Money Market Fund Rules".) In the opening MFU session, Joan Ohlbaum Swirsky, Counsel at Stradley Ronon and author of the book, "The Guide to Rule 2a-7: A Map Through the Maze for the Money Market Professional," and John Hunt, Partner at Nutter, McLennan & Fish, set the stage by discussing the history and particulars of 2a-7 and touched on the first round of reforms in 2010. During the two sessions that followed, Stephen Keen, Counsel, Reed Smith, and Jack Murphy, Partner, Dechert LLP, dove into the 2014 reforms, highlighting the major changes and the questions that remain unanswered. Below, we excerpt from these sessions. (Note: For more on Fidelity's Major Money Fund Changes, see yesterday's "News and see J.P. Morgan Securities' update, "Fidelity announces major changes to its MMF lineup".)
Explaining the long road to reform, Keen said, "First, I want to talk about how we got here and the fact that we're still somewhat on the road. In September 2008, the financial crisis hit and within 6 months, ICI had established a working group, which came up with a set of reforms that [were] basically the genesis of the 2010 amendments. That was the first step, but there was more to come, and there was a long process of getting that more worked out. It culminated in July 2014 with the adoption of new reforms. But there's still a little unfinished business. There are a lot of unanswered questions about the reforms; ICI and SIFMA have sent the SEC a set of frequently asked questions to basically see if we can some interpretive responses from them. (This Q&A has not been made public yet). Also, the SEC has proposed additional amendments to get rid of credit ratings as required by Dodd-Frank, so those ... are going to change."
Keen explained, "What happened was we invented new types of money market funds. We've talked about prime, government, tax-exempt -- those are all categories that came from people like Peter [Crane], who started to classify funds. But those are not technically legal terms -- until now. The rule now defines what a government money market fund is, what a retail money market fund is, and then anything that isn't those things is going to have a fluctuating NAV, so we are going to call that an FNAV fund. Only government and retail will have stable values, and only retail and FNAV funds are required to have fees and gates. Then there are a set of general reforms that apply to all 3 categories, although at different levels of impact, depending on the fund."
On FNAV funds, Keen said, "Let's start off with the FNAV funds. This is a money market fund that unlike all money market funds today, cannot use the amortized cost method or penny rounding to stabilize its NAV. Now the caveat for that is, you can still use amortized cost for securities with remaining maturities of 60 days or less. The other thing that's different is they have to round not to the nearest penny but to the nearest basis point; the fourth digit in a one dollar price. This is 10 times the accuracy that's required of a mutual fund. Government funds and retail funds can still penny round but FNAV funds cannot -- they have to add these extra digits and that's intended to make their NAV move. One of the problems with FNAV was the fact that you have to track the changes in the NAV for accounting and tax purposes. What the SEC did in connection with this was coordinate with Treasury and IRS to eliminate some of those problems. The IRS also adopted a provision that exempts these types of funds from what are called wash sale rules."
Keen added. "Retail funds sustain their stable NAV, but they restrict its beneficial owners to natural persons.... Retail funds have to have procedures that are reasonably designed to keep your beneficial owner as natural persons. This is one of the things that we've asked the SEC to give us more insight on." Keen continued, "If you have non-natural beneficial owners, then you're going to have a fluctuating NAV. The simple answer so far appears to be that it's beneficially owned by a natural person if you have a social security number -- only natural persons have social security numbers. An estate account should be beneficially owned by a natural person. Only people retire, only people go to college, only people get sick, so retirement plans, college savings plans, health savings plans should all qualify."
Murphy added, "The last thing you want here is to add any ambiguity. It would be great if the SEC would draw lines so that everyone is on the same page. If not, then the industry will have to try to draw its own lines." Keen commented, "For government funds, it's a very simple requirement -- 99.5% of your total assets have to be in government securities or repurchase agreements backed solely by government securities, or cash. If you meet these qualifications you can maintain stable NAV and you have no restrictions on whom your investors can be." Murphy added, "Historically, government funds have had to have at least 80% in government securities."
On Fees and Gates, Keen explained, "With government funds, you're also not going to be subject to fees and gates. So now we are going to talk about retail and FNAV funds [which are subject to gates and fees]. The board has an option to impose a liquidity fee or a gate on redemptions if weekly liquid assets are below 30%. The liquidity fee can't be higher than 2%; the redemptions suspension cannot be for more than 10 days. You don't have to disclose the liquidity fee on the fee table because it's an emergency measure, so it's not a normal cost. And you have to remove it if you get back over 30%. When you're back over 30% it has to come off the next day. There's also a default liquidity fee if you are below 10% weekly liquid assets and the default fee is 1%. It's a default in the sense that if the board doesn't meet to impose a different liquidity fee, or impose a gate, or decide not to do anything even though the fund is down to that level of weekly liquid assets, then it will take effect. Basically, the board still has the ability to call off any fee or gate. It's not required to ever put it on. At 30%, it's totally optional; at 10%, unless you act, you are going to have to put it in play."
Keen added, "The point I keep making on this is, no one is going to operate at 30% weekly liquid assets -- they are going to operate at 40%, or 35%. They are going to have a margin for error. The real question is: What's the reason [you breached 30%]? If the reason is you have a defaulted security in the portfolio, then these will be tools to deal with that circumstance. What will drive the decision is not the fact that you're at 22% weekly liquid assets, or 8%, or whatever, it'll be that you have a defaulted security in the fund. Or the market has melted down and there's no liquidity. Those are the circumstances that you need to keep your eye on because that's going to drive what the fund and board should do."
Murphy added, "The notion is: if you are going to have a run on the bank, how do you stop it? You close the doors of the bank. How do you stop a run on the money fund -- you close the doors. Only, funds have never had the authority to do this. No one knows if this is going to be a nuclear event."
They then discussed Disclosure Requirements. Keen said, "You're going to need to report your weekly liquid assets everyday on the web site." Murphy commented, "We're seeing funds either putting in place or thinking about putting in place procedures like that, whereby, at a certain level, notice is given to the Chairman of the Board before it's posted on the web site. The SEC came up with a new form ... Form N-CR would be required to be filed upon certain material events -- a default or event of insolvency, a provision of financial support by the sponsor, a stable NAV fund that's shadow price drops below 99.75 cents, or weekly liquid assets that drop below 10% at the end of a business day. Also, any time a fund imposes or removes a liquidity fee or gate. This is the first thing you'll have to comply with (July 2015)."
Murphy continued, "Currently, the fund has to disclose its month-end WAM and portfolio holdings as of the end of each month. This has been amended. The fund will now be required to disclose its WAL, the maturity date for each portfolio holdings, as well as each holding's fair value. With respect to daily website reporting, funds are going to be required to disclose for the end of each business day during the preceding 6 months the percentage of total assets in daily and weekly liquid assets, net inflows and outflows, and the shadow NAV rounded to the nearest basis point.... You need to post 6 months' worth of data as of April 14, 2016, so you need to start thinking about this." In closing, Keen commented, "It's been amazing to me that almost $3 trillion has stayed in the funds with effectively no return. That testifies to the need for money market funds."
