We continue wading through the SEC's 424-page "Money Market Fund Reforms" final rules, which were published Wednesday, and we continue to like what we see. (See the MMF Reforms press release here and the Fact Sheet here.) The rule's summary explains, "The Securities and Exchange Commission is adopting amendments to certain rules that govern money market funds under the Investment Company Act of 1940. These amendments are designed to improve the resilience and transparency of money market funds. The amendments will revise the primary rule that governs money market funds to remove the ability for a fund board to temporarily suspend redemptions if the fund's liquidity falls below a threshold. In addition, the amendments will remove the tie between liquidity thresholds and the potential imposition of liquidity fees. The amendments will also require certain money market funds to implement a liquidity fee framework that will better allocate the costs of providing liquidity to redeeming investors. In addition, the Commission is increasing the daily liquid asset and weekly liquid asset minimum requirements to 25% and 50%, respectively. "
It continues, "The Commission also is amending certain reporting requirements on Form N-MFP and Form N-CR and making certain conforming changes to Form N-1A to reflect amendments to the regulatory framework for money market funds. In addition, the Commission is addressing how money market funds with stable net asset values may handle a negative interest rate environment, including by adopting amendments that will permit these funds to use share cancellation, subject to certain conditions. Further, the Commission is adopting rule amendments to specify how funds must calculate weighted average maturity and weighted average life. In addition, the Commission is adopting amendments to Form PF concerning the information large liquidity fund advisers must report for the liquidity funds they advise. Finally, the Commission is adopting two technical amendments to Form N-CSR and Form N-1A to correct errors from recent Commission rulemakings."
The Introduction states, "The Commission is adopting amendments to rule 2a-7 under the Investment Company Act of 1940. Money market funds are a type of mutual fund registered under the Act and regulated pursuant to rule 2a-7. These funds are popular cash management vehicles for both retail and institutional investors because they seek to provide investors with principal stability and access to daily liquidity. In addition, money market funds serve as an important source of short-term financing for businesses, banks, and Federal, state, municipal, and Tribal governments. In March 2020, in connection with an economic shock from the onset of the COVID-19 pandemic, certain types of money market funds had significant outflows, contributing to stress on short-term funding markets that resulted in government intervention to enhance the liquidity of such markets. Our historical experience with these funds and the events of March 2020 have led us to re-evaluate certain aspects of the regulatory framework applicable to money market funds. Accordingly, the Commission is adopting amendments to rule 2a-7 and certain reporting forms that are designed to improve the resilience of money market funds during times of market stress while preserving the benefits that investors have come to expect from these funds."
The SEC writes, "In December 2021, the Commission proposed to amend rule 2a-7 to remove the tie between weekly liquid asset thresholds and the potential imposition of liquidity fees and redemption gates, since it appears these provisions contributed to investors' incentives to redeem from certain funds in March 2020 and affected fund managers' willingness to use available liquidity in their portfolios to meet redemptions. For funds that experienced the heaviest outflows in March 2020 and in prior periods of market stress, the proposal also included a new swing pricing requirement that was designed to mitigate the dilution and investor harm that can occur when other investors redeem -- and remove liquidity -- from these funds, particularly when certain markets in which the funds invest are under stress and effectively illiquid. The Commission also proposed to increase the minimum daily and weekly liquid asset requirements to better equip money market funds to manage significant and rapid investor redemptions. In addition, we proposed certain form amendments to improve transparency and facilitate Commission monitoring of money market funds. As part of the proposal, the Commission proposed to amend rule 2a-7 to prohibit a stable net asset value ('NAV') money market fund from using share cancellation or a reverse distribution mechanism in a negative interest rate environment."
The rule continues, "The Commission received comment letters on the proposal from a variety of commenters, including funds and investment advisers, law firms, other fund service providers, investor advocacy groups, professional and trade associations, and interested individuals. As discussed in greater detail throughout this release, these commenters expressed a diversity of views. Many commenters expressed support for aspects of the proposal, including removing the link between liquidity thresholds and the imposition of redemption gates and liquidity fees; increasing the minimum daily and weekly liquid asset requirements above current minimums; and clarifying the calculation of weighted average portfolio maturity and weighted average life maturity. Many commenters, however, expressed concern about the consequences of the proposed swing pricing requirement, suggesting, among other reasons, that it would be operationally difficult and may not effectively prevent destabilizing runs during periods of stress. Separately, several commenters expressed that the Commission should adopt more modest increases to the daily and weekly liquid asset requirements than proposed. Many commenters also generally opposed the proposed clarification of how stable net asset value money market funds should handle a negative interest rate environment, stating that the proposed prohibition from using share cancellation in certain negative interest environments could be operationally burdensome and costly without clear benefits for investors. Lastly, while some commenters were supportive of the proposed modifications to the fund reporting requirements, others expressed concern about the sensitivity or burdens of reporting certain information regarding money market fund investors or portfolios, as well as significant declines in liquidity."
They tell us, "After considering the comments on the proposal, we are adopting rule and form amendments to improve the resilience and transparency of money market funds, with certain modifications. As proposed, the final amendments will remove the redemption gate provision from rule 2a-7; increase the minimum daily and weekly liquid asset requirements to 25% and 50%, respectively; specify the weighted average portfolio maturity and weighted average life maturity calculations; and require public reporting of significant declines in liquidity on Form N-CR. However, we are not adopting the proposed swing pricing requirement. Rather, the final amendments will modify the current liquidity fee framework to require institutional prime and institutional tax-exempt money market funds to impose a liquidity fee when the fund experiences net redemptions that exceed 5% of net assets, while also allowing any non-government money market fund to impose a discretionary liquidity fee if the board determines a fee is in the best interest of the fund. Similar to the proposed swing pricing requirement, the liquidity fee framework is designed to better allocate liquidity costs associated with redemptions to the redeeming investors. In addition, in a change from the proposal, the final amendments will permit retail and government money market funds to use a reverse distribution mechanism if negative interest rates occur in the future with certain conditions, including appropriate disclosure to concisely and clearly describe to shareholders the fund's use of a reverse distribution mechanism and its effect on investors."
The SEC also says, "Moreover, while we are adopting the amended reporting requirements for Form N-MFP largely as proposed, we are making modifications to certain aspects of the requirements in response to commenter concerns about the sensitivity of publicly reporting certain investor and portfolio information. We are also adopting, largely as proposed in a January 2022 Proposing Release, amendments to Form PF reporting requirements for large liquidity fund advisers. The final amendments to Form PF generally are designed to align with relevant revisions we are making to Form N-MFP. Finally, we are adopting two technical amendments to Form N-CSR and Form N-1A to correct errors from recent Commission rulemakings."
Discussing the "Role of Money Market Funds and Existing Regulatory Framework," they explain, "Money market funds are managed with the goal of providing principal stability by investing in high-quality, short-term debt securities -- such as Treasury bills, repurchase agreements, or commercial paper -- whose value does not fluctuate significantly in normal market conditions. Money market fund investors receive dividends that reflect prevailing short-term interest rates and have access to daily liquidity, as money market fund shares are redeemable on demand. The combination of limited principal volatility, diversification of portfolio securities, payment of short-term yields, and liquidity has made money market funds popular cash management vehicles for retail and institutional investors. Money market funds also serve as an important source of short-term financing for businesses, banks, and governments."
The rule continues, "Different types of money market funds exist to meet differing investor needs. 'Prime money market funds' hold a variety of taxable short-term obligations issued by corporations and banks, as well as repurchase agreements and asset-backed commercial paper. 'Government money market funds,' which are currently the largest category of money market fund, almost exclusively hold obligations of the U.S. Government, including obligations of the U.S. Treasury and Federal agencies and instrumentalities, as well as repurchase agreements collateralized by government securities. Compared to prime funds, government money market funds generally offer greater safety of principal but historically have paid lower yields. 'Tax-exempt money market funds' (or 'municipal money market funds') primarily hold obligations of state and local governments and their instrumentalities, and pay interest that is generally exempt from Federal income tax for individual taxpayers. Within the prime and tax-exempt money market fund categories, some funds are 'retail' funds and others are 'institutional' funds. Retail money market funds are held only by natural persons, and institutional funds can be held by a wider range of investors, such as corporations, small businesses, and retirement plans."
The SEC comments, "To some extent, different types of money market funds are subject to different requirements under rule 2a-7. One primary example is a fund's approach to valuation and pricing. Government and retail money market funds can rely on valuation and pricing techniques that generally allow them to sell and redeem shares at a stable share price, typically $1.00, without regard to small variations in the value of the securities in their portfolios. If the fund's stable share price and market-based value per share deviate by more than one-half of 1%, the fund's board may determine to adjust the fund's share price below $1.00, which is also colloquially referred to as 'breaking the buck.' Institutional prime and institutional tax-exempt money market funds, however, are required to use a 'floating' NAV per share to sell and redeem their shares, based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place (e.g., $1.0000). These institutional funds are required to use a floating NAV because their investors have historically made the heaviest redemptions in times of market stress and are more likely to act on the incentive to redeem if a fund's stable price per share is higher than its market-based value."
The SEC tells us, "As of March 2023, there were approximately 294 money market funds registered with the Commission, and these funds collectively held over $5.7 trillion of assets. The vast majority of these assets are held by government money market funds ($4.4 trillion), followed by prime money market funds ($1 trillion) and tax-exempt money market funds ($119 billion). Of prime money market funds' assets, approximately 44% are held by retail prime money market funds, with the remaining assets almost evenly split between institutional prime money market funds that are offered to the public and institutional prime money market funds that are not offered to the public. The vast majority of tax-exempt money market fund assets are held by retail funds."
They add, "The Commission adopted rule 2a-7 in 1983 and has amended the rule several times over the years, including in 2010 and 2014, in response to market events that have highlighted money market fund vulnerabilities. Among other things, these past reforms introduced minimum daily and weekly liquid asset requirements, provided for redemption gates and liquidity fees as available tools when a fund's liquidity drops below a threshold, required institutional money market funds to use floating NAVs, and improved transparency through reporting and website posting requirements."
Finally, the rule says, "In addition to reforms for money market funds, in 2014 the Commission introduced new reporting requirements for large advisers of liquidity funds on Form PF to better align reporting obligations of advisers regarding private liquidity funds to those of money market funds, in order to help the Commission have a more complete picture of the broader short-term financing market. Liquidity funds follow similar investment strategies as money market funds, but investment advisers are not required to register liquidity funds as investment companies under the Act. Liquidity funds are a relatively small but important category of private funds due to the role they play along with money market funds as sources, and users, of liquidity in markets for short-term financing. Similar to money market funds, liquidity funds are managed with the goal of maintaining a stable net asset value or minimizing principal volatility for investors. However, liquidity funds are not required to comply with the risk-limiting conditions of rule 2a-7, such as the restrictions on the maturity, diversification, credit quality, and liquidity of investments. Consequently, liquidity funds may take on greater risks and, as a result, may be more sensitive to market stress relative to money market funds."
