After years of delays spanning two chairmen and multiple commissioners, the Securities and Exchange Commission last month enacted new rules to improve the stability of Money Market Mutual Funds and stave off potential runs that could collapse individual funds or even crash the nearly $3 trillion marketplace.
Proponents view the changes as long-overdue; but some opponents say the intended protections could harm the money market industry with compliance complexities, liquidity restrictions, and tax headaches that could drive big corporations away from the ubiquitous cash management tool. “The proposed medicine could certainly kill the patient,” says Tom Deas, vice president and treasurer at FMC Corp. The reality, others say, may take years to assess.
The new SEC rules require a floating net asset value (NAV) for institutional prime money market funds and provide non-government money market fund boards new tools—liquidity fees and redemption gates—to address runs on the funds. They require institutional prime money market funds to price shares using a more precise method so investors are more likely to see fluctuations in value. Currently, funds “penny round” share prices to the nearest one percent or to the nearest penny in the case of a fund with a $1.00 share price. Under the floating NAV amendments, they would instead be required to round share prices to the nearest 1/100th of one percent, known as “basis-point rounding.”
Fund boards will also have the ability to impose liquidity fees or to suspend redemptions temporarily, a process known as “gating,” if a fund’s level of weekly liquid assets falls below a certain threshold. If a fund’s liquid asset level falls below 30 percent of its total assets, its board can impose a liquidity fee of up to two percent on all redemptions. If weekly liquid assets fall below 10 percent, the fund would be required to impose a liquidity fee of 1 percent on all redemptions.
There are also enhanced disclosure requirements. Funds will be required to disclose on their Websites, on a daily basis, levels of daily and weekly liquid assets, net shareholder inflows or outflows, market-based NAVs per share, and imposition of fees and gates.
Throughout the rulemaking process, concerns were in large supply. “Utilities rely heavily on money market funds for short-term liquidity at attractive rates,” Jim Gilligan, assistant treasurer of Great Plains Energy, a Missouri-based utility holding company, said during a recent Chamber of Commerce-sponsored conference call. “I think the money market fund product will go away with the implementation of a floating NAV and redemption gates. Both are unnecessary and excessively burdensome.”
Aircraft manufacturer Boeing regularly keeps as much as $3 billion in money market funds, roughly 70 percent of that in prime funds. The introduction of a floating NAV would necessitate finding a better place to park cash, assuming one can be found, Verett Mims, the company’s assistant treasurer, says.
“We would have to start moving our money,” Mims says. “We use prime funds for getting the most liquidity and flexibility possible. If that flexibility is gone, we wouldn’t really want to be invested in them. We are not interested in return; principle preservation is first on our agenda.”
“The unfortunate reality is that there are no comparable cash investments in terms of the benefit of having a stable NAV money market fund,” she adds. “By floating a NAV, you are essentially changing the characteristics of those funds and why we invest in them. The costs and the complexity of a floating NAV are not worth it when what we are really looking for is same-day liquidity.”
Another issue, Mims says, is that the new rules lack clarity on the treatment of intra-day settlements and the need for corporations to access their money, perhaps all of it, at any time. “We would certainly have to place the money somewhere else,” she says. “With gates and fees we can’t guarantee that our cash can be accessed.”
Others, too, warn that the new rules could push companies to avoid money market products when they can. “The idea that, based on some not very clearly designed or clearly observable criteria, a liquidity gate could come down, after which a fee would be placed on redemptions, would deter a corporate treasurer from making that investment, because they can’t be assured of getting complete access to their money,” said Deas.
New Tax Implications
There are also tax implications, and a floating NAV could create taxable gains and losses, Deas explains. “If you buy a fund at a dollar and it goes up to a $1.01, when you go to sell it, that is a short-term capital gain that has to be recorded,” he says. This would lead to increased compliance costs as businesses need to re-program existing technology, or secure new systems, to track short-term gains and losses.
The proposed medicine could certainly kill the patient.
Tom Deas, Treasurer, FMC Corp.
“As a U.S. manufacturer, over 90 percent of our cash is actually in the United States and, of course, we are paying U.S. taxes on that,” Mims says. For a company that chooses to park funds in domestic money market mutual funds, rather than in foreign, low-tax jurisdictions, “it feels like we are being penalized for the cash that we keep in the United States,” she adds.
Help on the taxation front will come from the Internal Revenue Service and Treasury Department when the new rules take effect. When formulating its new rules, the SEC reached an agreement with the agencies to streamline accounting and alleviate the potential tax burden. Investors will not be required to track and report the cost or tax basis and redemption price of all shares they purchase and redeem. Rather, they may calculate their taxable gain or loss on an aggregate basis at the end of the tax year, based on information already provided in their year-end statements.
SEC Commissioner Daniel Gallagher, who initially expressed similar tax concerns, says that the IRS will also waive its “wash-sale” rule, which could have penalized investors who frequently move cash in and out of money funds. The IRS will exempt fund investors subject to a floating NAV from rules, which prohibit taxpayers from recognizing a loss on the sale of a security if the investor buys a substantially identical security within 30 days, a common occurrence with short-term cash management securities such as money market funds. This revenue procedure will provide “full and immediate relief to taxpayers who otherwise would have had to track the timing of individual purchases and redemptions for compliance with the wash sale rules,” he said in a statement.
What the New Rules Mean
The following is from a “fact sheet” issues by the Securities and Exchange Commission on new rules governing Money Market Funds.
Require certain money market funds to maintain a floating net asset value (NAV) for sales and redemptions based on the current market value of the securities in their portfolios rounded to the fourth decimal place (e.g., $1.0000). The requirement, which would apply to institutional prime money market funds (including institutional municipal money market funds), would result in the daily share prices of the money market funds fluctuating along with changes in the market-based value of the funds’ investments.
Fees and Gates
Under the rules, if a money market fund’s level of “weekly liquid assets” falls below 30 percent of its total assets (the regulatory minimum), the money market fund’s board would be allowed to impose a liquidity fee of up to two percent on all redemptions. Such a fee could be imposed only if the money market fund’s board of directors determines that such a fee is in the best interests of the fund. If a money market fund’s level of weekly liquid assets falls below 10 percent, the money market fund would be required to impose a liquidity fee of one percent 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 interests of the fund or that a lower or higher (up to two percent) liquidity fee is in the best interests of the fund.
If a money market fund’s level of weekly liquid assets falls below 30 percent, a money market fund’s board could in its discretion temporarily suspend redemptions (gate). To impose a gate, the board of directors would find that imposing a gate is in the money market fund’s best interests. A money market fund that imposes a gate would be required to lift that gate within 10 business 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 10 business days in any 90-day period.
“This is not an insubstantial rule. The big question is will it accomplish what it was supposed to? I think the jury is still out on that,” says Jay Baris, a partner at law firm Morrison & Foerster and chairman of its investment management practice. “No matter what the SEC did, there would still be people who didn’t like it. Some will say it goes too far; others will say it doesn’t go far enough.”
The final rule ballooned to 869 pages with more than 2,500 footnotes. Baris describes the added bulk as indicative of the many compromises that went into the drafting, a necessary step to secure needed votes from commissioners (Kara Stein, a Democrat, and Republican Michael Piwowar nevertheless voted against it).
“All of these rules are going to require more compliance and changes to systems,” Baris says. “The rule will require more oversight by the board of directors. There are costs embedded in complying with the new rules, the question is how much?”
Among the SEC’s compromises: The floating NAV requirement does not apply to retail funds, only institutional funds and the pending tax guidance is also especially welcomed. “The IRS’ allowance for trades to be accounted on a gross basis, rather than a trade-by-trade basis, “will go a long way toward easing” fears of “a recordkeeping and tax accounting nightmare,” Baris says.
Scott Weisman, a managing director in PwC’s financial services regulatory practice, advises a wait-and-see approach. “SEC staff has tried to come up with a solution that it believes isn’t going to be too onerous operationally and compliance-wise for institutional prime funds, while at the same time balancing the need for controlling runs and bringing more soundness to money market funds in general,” he says. A two-year transition period and the creation of a working group that will assess implementation problems and make recommendations for fresh guidance or rule amendments are both positives for all parties.
Other concerns, such as those voiced by the SEC’s Stein, are that liquidity fees and gates may encourage runs, rather than prevent them. It is a trickier situation to assess at this moment, Weisman says. On one hand, fund boards were given flexibility in deciding when, and to what degree liquidity fees will be assessed and when gates are triggered. That flexibility, however, creates some uncertainty as to what those parameters will be on a fund-by-fund basis.
His advice: let the rule play out. “All predictions are really out the window and people need time to digest what this is going to mean,” he says.