Compliance : Investment Company Act : Money Markets :
Reforming Money Market Funds
The Securities and Exchange Commission will consider whether to propose rules that would reform the way that money market funds operate.
The History of Money Market Funds
Under Investment Company Act Rule 2a-7, these funds must limit their portfolio investments to high-quality, short-term debt securities. Unlike other mutual funds, money market funds seek to maintain a stable share price (typically $1.00) through the use of certain valuation and pricing methods permitted under Rule 2a-7. The typical experience for a money market fund investor is that when they invest a dollar, they are able to get back a dollar on demand (plus the yield that was earned during the course of the investment). As a result, money market funds have become popular cash management vehicles for retail and institutional investors.
When a money market fund’s market-based value deviates more than 0.5 percent ($0.005) from its stable $1.00 share price, a money market fund generally re-prices at its market value. At these times, investors will no longer get back their full dollar – a phenomenon known as “breaking the buck.”
There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate debt securities. Money market funds that primarily invest in corporate debt securities are referred to as prime funds.
Funds are often structured to cater to different types of investors. Some funds are marketed to individuals and intended for retail investors, while other funds that typically require very high minimum investments are intended for institutional investors.
The Financial Crisis – At the height of the financial crisis in September 2008, a money market fund named the Reserve Primary Fund “broke the buck” and re-priced its shares below its $1.00 stable share price, leading many investors to pull their money out of the fund. That same week, prime institutional money market funds experienced rapid heavy redemptions, with investors withdrawing approximately $300 billion (14 percent of their assets). These redemptions, which halted after the U.S. Treasury provided a government guarantee, prompted the SEC to evaluate the need for money market fund reform.
The 2010 Amendments – In March 2010, the Commission adopted a series of amendments to its rules on money market funds. The amendments were designed to make money market funds more resilient by reducing the interest rate, credit, and liquidity risks of their portfolios. Although these reforms improved money market fund resiliency, the Commission said at the time that it would continue to consider whether further, more fundamental changes to money market fund regulation might be warranted.
Study by the Division of Risk, Strategy, and Financial Innovation – In December 2012, staff from the SEC’s Division of Risk, Strategy, and Financial Innovation published a study relating to money market funds. The study contained, among other things, a detailed analysis of the possible causes of investor redemptions in prime money market funds during the 2008 financial crisis, certain characteristics of money market funds before and after the Commission’s 2010 reforms, and how future reforms of money market fund regulation might affect investor demand for money market funds and alternative investments.
The study indicated that government money market funds generally are not susceptible to heavy redemptions or runs due to the nature of their portfolio assets. Retail investors have historically been less likely to redeem heavily from such funds in times of financial stress.
The study informed the Commission’s consideration of the risks that may be posed by money market funds and provided a foundation for this proposal.
The Commission is considering a proposal that would include two principal alternative reforms that could be adopted alone or in combination. The proposal also includes additional diversification and disclosure measures that would apply under either alternative.
The proposed reforms are designed to:
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.
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.
Potential Combination of Both Proposals – The Commission 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 non-government money market funds would be able to impose liquidity fees or gates in certain circumstances. The Commission requests public comments on the benefits and drawbacks of a single reform approach.
Enhanced Disclosure Requirements – In addition to requiring certain disclosures relating to the floating NAV and fees and gates proposals, the proposal seeks to improve the transparency of money market fund operations and risks by:
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 of money market funds’ portfolios:
Enhanced Stress Testing – Under the proposal, the stress testing requirements adopted by the Commission 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 percent of total assets. In addition, the Commission 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.