After many months of internal debate that spanned two chairmen, the Securities and Exchange Commission this week adopted money market fund reform rules intended to address the risk of investor runs.
The rules build upon reforms adopted by the SEC in March 2010 that were designed to reduce the interest rate, credit, and liquidity risks of money market fund portfolios. At the time, there was recognition the 2008 financial crisis raised questions of whether more fundamental changes to money market funds might be warranted. The new 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.
In greater detail, the amendments require institutional prime money market funds to price shares using a more precise method so that investors are more likely to see fluctuations in value. Currently, funds “penny round” share prices 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 amendments, they would instead be required to “basis point round” share prices to the nearest 1/100th of one percent (the fourth decimal place in the case of a fund with a $1.0000 share price).
Fund boards will have the ability to impose liquidity fees or to suspend redemptions temporarily, also known as “gate,” if a fund’s level of weekly liquid assets falls below a certain threshold. 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.
If a fund’s level of weekly liquid assets falls below 30 percent of its total assets, its board can now 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. Fees would not be imposed if the fund’s board of directors determines it is not in the best interests of the fund or that a lower or higher (up to two percent) liquidity fee is in the fund’s best interests.
Coinciding with the new rules, Department of the Treasury and the Internal Revenue Service will release new tax guidance and propose new regulations that allow floating NAV money market fund investors to use a simplified tax accounting method to track gains and losses.
The new rules also come with enhanced disclosure requirements. Funds will be required to disclose on their website, on a daily basis, their levels of daily and weekly liquid assets, net shareholder inflows or outflows, market-based NAVs per share, and imposition of fees and gates. The use of fees and gates will also be disclosed to the SEC using the new Form N-CR. Funds currently report detailed information about portfolio holdings to the SEC each month on Form N-MFP. The final rules remove the current 60-day delay on public availability and make the form public immediately upon filing.
The final rules also enhance the stress testing requirements adopted by the SEC in 2010. Money market funds will be required to test its ability to maintain weekly liquid assets of at least 10 percent and to minimize principal volatility in response to hypothetical scenarios.
The new rules, effective 60 days after their publication in the Federal Register, provide for a two-year transition period.
The rules were adopted by a 3-2 vote, with Commissioners Kara Stein and Michael Piwowar, a Democrat and Republican respectively, dissenting.
“While the floating NAV will not stop runs, it will impose costs on money market funds that will ultimately be borne by its shareholders in the form of higher fees and expenses, and lower returns,” Piwowar said in a statement. “It was just over four years ago that the Commission required money market funds to have the capacity to redeem and sell their securities at a price based on the funds’ current net asset value per share to the third decimal place. Now, they will be required to change their systems again to transact at a false level of precision required of no other funds.”
Stein’s primary concern was that “gates are the wrong tool.” “As the chance that a gate will be imposed increases, investors will have a strong incentive to rush to redeem ahead of others to avoid the uncertainty of losing access to their capital,” she said. “More importantly, a run in one fund could incite a system-wide run because investors in other funds likely will fear that they also will impose gates. While a gate may be good for one fund because it stops a run in that fund, it could be very damaging to the financial system as a whole.”