On July 23, 2014, on a 3-2 vote, the SEC adopted amendments to certain rules under the 1940 Act, including Rule 2a-7, that govern money market funds. According to the SEC, the rule amendments seek to: (1) limit money market funds’ susceptibility to heavy redemptions during periods of market stress, (2) improve money market funds’ ability to deal with potential contagion from heavy redemptions, (3) increase risk transparency in money market funds, and (4) preserve, to the extent possible, the benefits of money market funds for investors. The primary rule changes include the requirement for certain money market funds to operate using a floating NAV rather than a stable NAV, and the ability of money market funds to impose liquidity fees and redemption gates in certain circumstances to stem redemptions. In addition, the SEC adopted other rule and form amendments applicable to money market funds, including enhanced diversification and disclosure requirements.
The rule amendments require institutional prime money market funds (i.e., those that primarily invest in corporate debt securities) and institutional municipal money market funds (i.e., those that primarily invest in tax-exempt municipal securities) to operate using a floating NAV. The amendments eliminate the valuation exemptions for these types of funds that allowed the use of amortized cost to value portfolio securities and/or permitted a fund to round its NAV to the nearest penny in order to maintain a stable share price (generally $1.00). Institutional prime money market funds and institutional municipal money market funds will be required to sell and redeem shares based on the current market value of their portfolio securities. Under the rule amendments, these funds also must round their share prices and transact in fund shares to four decimal places in the case of a $1.0000 share price or an equivalent level of accuracy for funds with a different share price (e.g., $10.000).
The floating NAV requirement does not apply to government money market funds or retail money market funds. Government money market funds are defined under the rule amendments as those funds that invest at least 99.5% of their total assets in government securities, cash and/or repurchase agreements that are collateralized by cash or government securities. (Government money market funds currently are able to invest up to 20% of total assets in non- government assets.) Retail money market funds are defined as those funds that have policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons. In the adopting release, the SEC recognized that in order to qualify as a retail money market fund, funds that currently have both retail and institutional investors would need to reorganize into separate retail and institutional money market funds or otherwise involuntarily redeem certain investors. To help facilitate these actions, the SEC, in the adopting release, provided exemptive relief from Sections 17(a), 18 and 22(e) of the 1940 Act, which might otherwise prohibit the reorganizations or redemptions, subject certain board determinations and notice requirements.
Liquidity Fees and Redemption Gates
The final rule amendments allow liquidity fees and/or redemption gates in certain circumstances for all non-government money market funds as compared to the proposed rule amendments which would have required them. Although government money market funds are not subject to the new liquidity fees and redemption gates provisions, these funds could voluntarily opt into them if previously disclosed to investors.
If a money market fund’s weekly liquid assets fall below 30% of its total assets, the fund may impose a liquidity fee of up to 2% on all redemptions upon a determination by the fund’s board of directors (including a majority of its independent directors) that imposing such a fee is in the best interests of the fund.
If a money market fund’s weekly liquid assets fall below 30% of its total assets, the fund may suspend redemptions (impose a redemption gate) for up to 10 business days in a rolling 90-day period upon a determination by the fund’s board of directors (including a majority of its independent directors) that imposing a redemption gate is in the best interests of the fund.
If a money market fund’s weekly liquid assets fall below 10% of its total assets, the fund is required to impose a liquidity fee of 1% on all redemptions unless the fund’s board of directors (including a majority of its independent directors) determines that such a fee is not in the best interests of the fund or determines that a lower or higher fee (not to exceed 2%) would be in the best interests of the fund.
If a money market fund’s weekly liquid assets fall below 10% of its total assets, the fund’s board of directors (including a majority of its independent directors) may permanently suspend redemptions and proceed to liquidate the fund.
Weekly liquid assets generally include cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert into cash within one week.
Enhanced Disclosure, Diversification and Stress Testing
The rule amendments provide several changes to money market fund disclosure requirements. Advertisements and summary prospectuses must include specific disclosure regarding risks associated with a money market fund, the use of liquidity fees or redemption gates, the use of a stable NAV or a floating NAV, as applicable, and sponsor support of the fund. Websites of money market funds must disclose, on a daily basis, the levels of daily and weekly liquid assets, net inflows and outflows, market-based NAVs per share, the use of any liquidity fees and redemption gates and any sponsor support. Form N-MFP was also amended to add new reporting requirements and to eliminate the 60-day delay on the public availability of the information filed. Finally, the rule amendments require money market funds to promptly disclose certain significant events on new Form N-CR, including security defaults, sponsor support, the use of liquidity fees or redemption gates and, for retail and government money market funds, a decline in the fund’s market-based NAV below $0.9975 or its equivalent for funds with a different share price.
The rule amendments also change the investment diversification requirements for money market funds. Currently, money market funds generally must limit their investments in (1) securities of any one issuer to no more than 5% of fund assets and (2) securities subject to a demand feature or a guarantee to no more than 10% of fund assets from any one provider; however, as much as 25% of the value of securities held in a money market fund’s portfolio may be subject to guarantees or demand features from one institution (25% basket). The rule amendments require money market funds to treat certain entities affiliated with each other as single issuers for purposes of complying with the 5% diversification limit. The rule amendments also require funds to treat the sponsors of asset-backed securities as guarantors subject to the 10% diversification limit, unless the board of directors makes certain determinations that the fund is not relying on the sponsor’s financial strength or credit support when determining the security’s quality or liquidity. Finally, the rule amendments eliminate the 25% basket for all money market funds except municipal money market funds, which may now only invest up to 15% in securities subject to guarantees or demand features from one institution.
The rule amendments also enhance the stress testing requirements applicable to money market funds. The rule amendments require money market funds to test their ability to maintain weekly liquid assets of at least 10% and to minimize principal volatility (and, for stable NAV money market funds, the ability to maintain a stable share price) in response to certain prescribed scenarios.
In connection with the SEC’s adoption of the money market fund rule amendments, the IRS adopted a revenue procedure exempting floating NAV money market funds from the wash sale rules. In addition, the IRS proposed regulations to provide a simplified method of accounting for gains and losses on shares of floating NAV money market funds.
The new rule amendments become effective 60 days after publication in the Federal Register. The compliance date for the floating NAV, liquidity fees and redemption gates amendments is two years after the effective date. The compliance date for the diversification, disclosure and stress testing amendments is 18 months after the effective date. The compliance date for reports on new Form N-CR is 9 months after the effective date.