We continue quoting from and analyzing the SEC's 424-page "Money Market Fund Reforms," which were published a week and a half ago. Today, we excerpt from the new "Liquidity Fee Requirement," which starts with the sub-section, "Determination to Adopt a Liquidity Fee Requirement." They write, "After considering comments, we are adopting a mandatory liquidity fee framework for institutional prime and institutional tax-exempt funds instead of the proposed swing pricing requirement. We believe the mandatory liquidity fee will reduce operational burdens associated with swing pricing while still achieving many of the benefits we were seeking with swing pricing by allocating liquidity costs to redeeming investors in stressed periods. In addition, we are adopting a discretionary liquidity fee for all non-government money market funds so that liquidity fees are an available tool for such funds to manage redemption pressures when the mandatory fee does not apply." (See the MMF Reforms press release here and the Fact Sheet here.) (Note: Register for our July 27 at 2pm Eastern for a "Money Fund Wisdom Demo & Training" session, where we'll review Crane Data's product suite with a focus on our MFI Daily asset series. We'll also comment on the data disclosure changes pending from the SEC's recent Money Market Fund Reforms.)
The new rule continues, "Whether the fee is mandatory or discretionary, we are, as proposed, removing from rule 2a-7 the tie between liquidity fees and a fund's weekly liquid asset levels to avoid predictable triggers that may incentivize investors to preemptively redeem to avoid incurring fees. This liquidity fee framework, independent of a predictable threshold for its application, achieves the intended benefits of the current liquidity fee regime by allocating liquidity costs to redeeming shareholders in times of stress while, in contrast to the current rule, avoiding incentives for preemptive redemptions associated with weekly liquid asset triggers. An approach solely based on liquidity fees, as opposed to gates, does not present the same concerns about incentivizing redemptions that exist under current rule 2a-7. As discussed, money market fund investors seemingly have been more concerned about the possibility of redemption gates than the possibility of liquidity fees. This change is designed to increase the resilience of money market funds."
It says, "The Commission proposed a swing pricing requirement under which an institutional prime or institutional tax-exempt fund would downwardly adjust its current NAV per share by a swing factor when a fund has net redemptions. The swing factor adjustment would reflect spread and transaction costs and, if net redemptions exceeded 4% of the fund's net assets, then the swing factor would also include market impact costs. The Commission also proposed to remove the liquidity fee provision in rule 2a-7, which conditions the use of liquidity fees upon declines in fund liquidity below identified, predictable thresholds, and to specify that money market funds could instead impose liquidity fees under rule 22c-2 at their discretion."
The SEC writes, "Many commenters expressed broad concerns about the swing pricing proposal and its potential effect on institutional money market funds and investors. Several commenters stated that the proposed swing pricing requirement was incompatible with how money market funds operate and manage liquidity, which may limit the utility of these funds as cash management vehicles. For instance, commenters expressed concern that swing pricing may inhibit a fund's ability to offer features such as same-day settlement and multiple NAV strikes per day due to concerns that swing pricing would delay a fund's ability to determine its NAV.... In addition, some commenters indicated that the operational costs of the proposed swing pricing requirement could cause some sponsors to eliminate their institutional prime and institutional tax-exempt money market funds, particularly smaller funds, and reduce money market fund assets. In light of these considerations, some commenters suggested that swing pricing is not an appropriate tool for money market funds and stated that a liquidity fee framework would be better suited to the structure and characteristics of money market funds, if the Commission determines that an anti-dilution tool is necessary for these funds."
They then state, "Many commenters stated that liquidity fees were preferable to swing pricing. Many of these commenters stated that liquidity fees would be easier for money market funds to implement. For instance, some commenters suggested that funds would be able to build on their existing experience with liquidity fees under current rules. Similarly, some commenters raised the concern that swing pricing is ill-suited for money market funds given the general lack of experience with swing pricing in the money market fund industry."
The rule continues, "Several commenters stated that a liquidity fee framework would provide benefits to investors relative to swing pricing. Some of these commenters suggested that a liquidity fee would be less confusing and more transparent with respect to the liquidity costs redeeming investors incur because investors are more familiar with the concept of liquidity fees (which exist in the current rule) and because the size of the swing factor is not readily observable in the fund's share price. Some commenters suggested that a liquidity fee would be a more direct way to pass along liquidity costs and, unlike swing pricing, would do so without providing a discount to subscribing investors or adding volatility to the fund's NAV.... Further, one commenter indicated that a liquidity fee framework could better preserve same-day liquidity for investors than swing pricing because liquidity fees are already operationally feasible for many money market funds and present fewer implementation challenges."
It states, "After considering these comments, we are adopting a liquidity fee framework to better allocate liquidity costs to redeeming investors. The proposed swing pricing requirement was designed to address potential shareholder dilution and the potential for a first-mover advantage for institutional funds. While we continue to believe these goals are important, we are persuaded by commenters that these same goals are better achieved through a liquidity fee mechanism, particularly given that current rule 2a-7 includes a liquidity fee framework that funds are accustomed to and can build upon."
The SEC explains, "The mandatory liquidity fee framework we are adopting is designed to address concerns with the prior liquidity fee framework -- namely the incentives for preemptive redemptions associated with predictable weekly liquid asset triggers. At the same time it continues to seek to ensure that the costs stemming from redemptions in stressed market conditions are more fairly allocated to redeeming investors. Specifically, institutional prime and institutional tax-exempt money market funds will be subject to a mandatory liquidity fee when net redemptions exceed 5% of net assets. Funds will not be required to impose this fee, however, when liquidity costs are less than one basis point, which we anticipate will often be the case under normal market conditions. As discussed in more detail throughout this section, the mandatory liquidity fee we are adopting will broadly address the concerns commenters raised about the swing pricing proposal while still generally achieving the goals we sought in that proposal. Separately, similar to the statements in the proposal that money market funds can impose discretionary liquidity fees under rule 22c-2, amended rule 2a-7 will provide a discretionary liquidity fee tool to all non-government money market funds, which a fund will use if its board (or the board's delegate, in accordance with board-approved guidelines) determines that such fee is in the best interests of the fund."
They say, "The mandatory liquidity fee approach that we are adopting will require redeeming investors to pay the cost of depleting a fund's liquidity, particularly under stressed market conditions and when net redemptions are sizeable. As discussed in the proposal, trading activity and other changes in portfolio holdings associated with meeting redemptions may impose costs, including trading costs and costs of depleting a fund's daily or weekly liquid assets. These costs, which currently are borne by the remaining investors in the fund, can dilute the interests of non-redeeming shareholders and create incentives for shareholders to redeem quickly to avoid losses, particularly in times of market stress. If shareholder redemptions are motivated by this first-mover advantage, they can lead to increasing outflows, and as the level of outflows from a fund increases, the incentive for remaining shareholders to redeem may also increase. Regardless of the motive for investor redemptions, there can be significant, unfair adverse consequences to remaining investors in a fund in these circumstances, including material dilution of remaining investors' interests in the fund. The mandatory liquidity fee mechanism is designed to reduce the potential for such dilution."
The Reforms continue, "After considering comments, we continue to believe that in periods of market stress, when liquidity in underlying short-term funding markets is scarce and costly, redeeming investors should bear liquidity costs associated with sizeable redemption activity. While we recognize that a fund may not incur immediate costs to meet those redemptions if the fund can satisfy redemptions using daily liquid assets, the fund is likely to face costs to rebalance the liquidity of its portfolio over time. Moreover, if redemptions are large and ongoing, there is an increased likelihood that the fund will need to sell less liquid assets to satisfy redemptions, which involves greater costs. Thus, there is a timing misalignment between an investor's redemption activity and when the fund, and its remaining shareholders, incur liquidity costs. The liquidity fee requirement we are adopting is designed to protect remaining shareholders from dilution under these circumstances and to more fairly allocate costs so that redeeming shareholders bear the costs of removing liquidity from the fund when liquidity in underlying short-term funding markets is costly."
The SEC then states, "We understand that future stress periods may not look exactly the same as March 2020, and, as some commenters suggested, in future periods funds may feel more comfortable drawing on available liquidity to meet redemptions because we are removing the tie between liquidity thresholds and fees and gates. Funds also may begin future stressed periods with higher levels of daily and weekly liquid assets than in March 2020, although at that time some funds had liquidity above the minimums we are adopting. However, it is also possible that future stress periods will be longer or otherwise more severe than March 2020, that future stress events will have no Federal intervention to alleviate those stresses, or that a particular fund or group of funds will come under stress due to factors idiosyncratic to the fund(s). It is important for funds to be able to manage through various types of stress events and not to rely solely on liquidity buffers to manage stress. As discussed below and in the Proposing Release, while liquidity minimums are an important tool for managing redemptions, our analysis suggests that some funds would run out of liquidity if faced with the redemptions rates experienced in March 2020. Thus, we do not agree with commenters who suggested that amendments to enhance money market fund liquidity, and the useability of that liquidity, would be sufficient on their own, without an available anti-dilution tool."
The section concludes, "As discussed, we are adopting a mandatory liquidity fee framework in lieu of the proposed swing pricing requirement. Table 1 (see pages 42-45) below compares the key elements of the current rule's default liquidity fee, the proposed swing pricing requirement, and the mandatory liquidity fee provision we are adopting. In addition, Table 2 below compares the key elements of the current rule's discretionary liquidity fee, the redemption fee approach contemplated by the proposal, and the discretionary liquidity fee provision we are adopting. We discuss these aspects of the final rule and how they relate to comments on the proposal in the following sections."
