Securities and Exchange Commission (SEC) Releases Money Market Fund Reform Proposals
SEC Chair Mary Jo White announced that the SEC will consider proposals that would reform the way money market funds operate in order to make them less susceptible to significant redemptions. As Chairman White explained:
Money market funds . . . have become an important provider of short-term financing to corporations, banks and governments. All told, money market funds hold nearly $3 trillion in assets.
While money market funds have thus long served as an important investment vehicle, the financial crisis of 2008 highlighted the susceptibility of these products to runs. In September of that year -- at the height of the financial crisis -- a money market fund called the Reserve Primary Fund "broke the buck" -- a term used when the value of a fund drops and investors are no longer able to get back the full dollar they put in.
Within the same week of that occurrence, investors pulled approximately $300 billion from other institutional prime money market funds. The contagion effect was rapid. The short term credit market dried up, and corporations had trouble borrowing to run their businesses. This reaction contributed to the significant disruption that already was consuming the financial system.
To stop this run, the government stepped in with unprecedented support in the form of the Treasury temporary money market fund guarantee program and Federal Reserve liquidity facilities.
In the aftermath of that experience, the Commission - in 2010 - adopted a series of reforms that increased the resiliency of money market funds. But, as the Commission stated at that time, those reforms were only a first step. Today's proposal takes the critical additional step of addressing the stable value pricing of institutional prime funds - at the heart of the 2008 run - and proposing methods to stop a money market fund run before such a run becomes a systemically destabilizing event.
The SEC's proposal contains two alternative reforms that could be adopted separately or combined into a single reform package. The reforms are designed to:
- mitigate money market funds' susceptibility to heavy redemptions during times of stress;
- improve money market funds' ability to manage and mitigate potential contagion from high levels of redemptions;
- preserve as much as possible the benefits of money market funds for investors and the short-term financing markets; and
- increase the transparency of risk in money market funds.
Alternative One: Floating NAV.
Under the first alternative, prime institutional money market funds would be required to transact at a floating net asset value (NAV), not at a $1.00 stable share price. The floating NAV alternative is designed primarily to address the heightened incentive shareholders have to redeem shares in times of financial stress. It also is intended to improve the transparency of money market fund risks through more visible valuation and pricing methods.
- Floating NAV. Prime institutional money market funds would no longer be able to use amortized cost to value their portfolio securities except to the limited extent all mutual funds are able to do so (i.e., fixed income securities maturing in less than 60 days). Daily share prices of these money market funds would fluctuate along with changes, if any, in the market-based value of their portfolio securities.
- Showing Fluctuations in Price. Prime institutional money market funds would be required to price their shares using a more precise method so that investors are more likely to see fluctuations in value. Currently, money market funds "penny round" their share price to the nearest one percent (to the nearest penny in the case of a fund with a $1.00 share price). Under the floating NAV proposal, prime institutional money market funds instead would be required to "basis point round" their share price to the nearest 1/100th of one percent (the fourth decimal place in the case of a fund with a $1.00 share price, i.e., $1.0000).
- Exempting Government and Retail Money Market Funds. Government and retail money market funds would be allowed to continue using the penny rounding method of pricing and maintain a stable share price. A government money market fund would be defined as any money market fund that holds at least 80% of its assets in cash, government securities, or repurchase agreements collateralized with government securities. A retail money market fund would be defined as a money market fund that limits a shareholder's redemptions to no more than $1 million per business day.
Alternative Two: Liquidity Fees and Redemption Gates.
Under the second alternative, money market funds would continue to transact at a stable share price, but would be able to use liquidity fees and redemption gates in times of stress.
- Liquidity Fees. If a money market fund's level of "weekly liquid assets" were to fall below 15% of its total assets (half the required amount), the money market fund would have to impose a 2% liquidity fee on all redemptions. However, such a fee would not be imposed if the fund's board of directors determines that such a fee is not in the best interest of the fund or that a lesser liquidity fee is in the best interest of 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.
- Redemption Gates. Once a money market fund had crossed the 15% weekly liquid asset threshold, its board of directors also would be able to impose a temporary suspension of redemptions (or gate). A money market fund that imposes a gate would need to lift that gate within 30 days, although the board of directors could determine to lift the gate earlier. Money market funds would not be able to impose a gate for more than 30 days in any 90-day period.
- Prompt Public Disclosure. Money market funds would be required to promptly and publicly disclose that the fund crossed the 15% weekly liquid asset threshold, the imposition and removal of any liquidity fee or gate, and a discussion of the board's analysis in determining whether or not to impose a fee or gate.
- Exemption for Government Money Market Funds. Government money market funds would be exempt from the liquidity fees and gates requirement. However, these funds could voluntarily opt into this new requirement.
Potential Combination of Both Proposals.
The SEC is considering whether to combine the floating NAV and the liquidity fees and gates proposals into a single reform package. If adopted in that form, prime institutional money market funds would be required to transact at a floating NAV and all other non-government money market funds would be able to impose liquidity fees or gates in certain circumstances. Certain of the SEC's other proposals discussed below would vary depending on whether one or the other, or both, major reform proposals are adopted.
Enhanced Disclosure Requirements.
In addition to requiring certain disclosures relating to the floating NAV and liquidity fees and gates proposals, the proposal seeks to improve the transparency of money market fund operations and risks as follows:
- Website Disclosure. Money market funds would be required to disclose on their website, on a daily basis, their levels of daily and weekly liquid assets and market-based NAV per share.
- New Material Event Disclosure. Money market funds would be required to promptly disclose certain events on a new form (Form N-CR). These events would include the imposition or lifting of liquidity fees or gates, portfolio security defaults, sponsor support, and, for funds that would continue to maintain a stable share price under either alternative, a decline in the fund's market based NAV per share below $0.9975.
- Disclosure of Sponsor Support. Money market funds would be required to disclose in their SAIs historic instances of sponsor support for money market funds.
Immediate Reporting of Fund Portfolio Holdings.
Money market funds currently report detailed information about their portfolio holdings to the SEC each month on Form N-MFP. Under the proposal, Form N-MFP would be amended to clarify existing requirements and require reporting of additional information relevant to assessing money market fund risk. In addition, the proposal would eliminate the current 60-day delay on public availability of the information filed on the form and would make it public immediately upon filing.
Improved Private Liquidity Fund Reporting.
To better monitor whether substantial assets migrate to liquidity funds in response to money market fund reforms, the proposal would amend Form PF, which private fund advisers use to report information about certain private funds they advise. The proposed changes would require a "large liquidity fund adviser" (a liquidity fund adviser managing at least $1 billion in combined money market fund and liquidity fund assets) to report substantially the same portfolio information on Form PF as registered money market funds would report on Form N-MFP. A liquidity fund is essentially an unregistered money market fund.
Stronger Diversification Requirements.
The proposal includes the following proposed changes to the diversification requirements for money market funds' portfolios:
- Aggregation of Affiliates. Money market funds would be required to aggregate affiliates for purposes of determining whether they are complying with money market funds' 5% concentration limit. Under this limitation, a fund may not invest any more than 5% of its assets in any one issuer or affiliated group of issuers (based on 50% ownership).
- Asset-Backed Securities. Money market funds would need to aggregate all of the asset-backed securities vehicles sponsored by the same entity for purposes of the 10% guarantor diversification limit. However, this would not be necessary if a money market fund's board of directors determines the fund is not relying on the sponsor's strength or structural enhancements of the asset-backed security in determining the quality or liquidity of the asset-backed security.
- Removal of the 25% Basket. All of a money market fund's assets would need to meet the concentration limits for guarantors and 'put' providers, thereby removing the so-called 25% basket that permitted a single guarantor to guarantee up to 25% of a money market fund's assets.
Enhanced Stress Testing.
Under the proposal, the stress testing requirements adopted by the SEC in 2010 would be further enhanced. In particular, a money market fund would be required to stress test against the fund's level of weekly liquid assets falling below 15% of total assets. In addition, the SEC is proposing to strengthen how money market funds stress test their portfolios and report the result of their stress tests to their boards of directors. The SEC was critical of the industry's compliance with the 2010 stress testing requirements. It stated explicitly that the additional requirements being proposed were "minimum" requirements and not an exhaustive list.
Comments on the money market fund proposals are due September 17, 2013.
Sources: SEC Proposes Money Market Fund Reforms, SEC Press Release 2013-101 (June 5, 2013); Money Market Fund Reform; Amendments to Form PF, SEC Release No. IC-30551 (June 5, 2013).