The new rules build upon earlier reforms adopted by the SEC, circa March 2010, that were designed to reduce the interest rate, credit and liquidity risks present within money market fund portfolios. The SEC says that, when it adopted the 2010 amendments, it soon after recognized that the recent financial crisis raised additional questions of whether more fundamental changes to money market funds might be warranted (see “SEC Analyzes Money Market Fund Reform”).
In short, the rule amendments require providers to establish a floating net asset value (NAV) for institutional prime money market funds, which will allow the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets. The rule updates also provide non-government money market fund boards new tools, known as liquidity fees and redemption gates, to address potential runs on fund assets.
“Today’s reforms fundamentally change the way that money market funds operate,” explains SEC Chair Mary Jo White. “They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system. Together, this strong reform package will make our markets more resilient and enhance transparency and fairness of these products for America’s investors.”
As the SEC explains, money market funds are used by businesses, state and local governments, and other organizations to invest cash until it is needed. Further, money market funds are offered as an investment option in 67.1% of all defined contribution plans in the U.S., according to the 2013 PLANSPONSOR Defined Contribution Survey.
With a floating NAV, institutional prime money market funds (including institutional municipal money market funds) are now required to value their portfolio securities using market-based factors and sell and redeem shares based on a floating NAV. The SEC says these funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.00.
With liquidity fees and redemption gates (a common type of restriction that is put on an investment fund that limits the amount of withdrawals that are allowed from the fund during a specific period) money market fund boards gain the ability to better manage outflows during periods of stress. The final rules also include enhanced diversification, disclosure and stress testing requirements, as well as updated reporting by money market funds and private funds that operate like money market funds. The final rules provide a two-year transition period to enable both funds and investors time to fully adjust their systems, operations and investing practices.
Norm Champ, director of the SEC’s Division of Investment Management, says today’s adoption of final money market fund reforms represents “a significant additional step to address a key area of systemic risk identified during the financial crisis.”
“These reforms are important both to investors who use money market funds as a cash management vehicle and to the corporations, financial institutions, municipalities and others that use them as a source of short-term funding,” Champ adds.
The SEC also issued a related notice proposing exemptions from certain confirmation requirements for transactions effected in shares of floating NAV money market funds. Additionally, the SEC re-proposed amendments to the Commission’s money market fund rules and Form N-MFP to address provisions that reference credit ratings. As the SEC explains, the re-proposed amendments would implement section 939A of the Dodd-Frank Wall Street and Consumer Protection Act of 2010, which requires the Commission to review its rules that use credit ratings as an assessment of credit-worthiness, and replace those credit-rating references with other appropriate standards.
The rules will be effective 60 days after their pending publication in the Federal Register, and the re-proposal will have a 60-day public comment period following its publication in the Federal Register.
Initial industry responses to the SEC’s rule updates were generally supportive of the move, but concerns remain. Investment Company Institute (ICI) President and CEO Paul Schott Stevens, for example, issued a statement saying the SEC “has proceeded thoughtfully to craft a robust and meaningful final rule that will impose significant structural changes across the industry, particularly on money market funds used by institutional investors.”
Stevens adds, “Through six years of deliberations, the Securities and Exchange Commission has received extensive analysis and comment from the sponsors of money market funds, investors, issuers, and many other parties. … While we may question some aspects of the rule as adopted, we strongly believe that the SEC has the long regulatory experience and deep technical expertise required to strike the proper balance, making money market funds more resilient in times of financial stress while preserving the utility and value of these funds for investors.”
Stevens says the ICI will work with the SEC and its own member firms to ensure a smooth transition to the new rules as they are implemented over the next two years.
Another industry group, the Securities Industry and Financial Markets Association (SIFMA), issued a similar statement from its president and CEO, Kenneth Bentsen, Jr.
“Money market funds play a vital role in capital formation and credit availability by providing retail and institutional investors with an attractive option for cash investing and enabling businesses to access the short-term funding they need to carry out their daily operations, pay employees and spur economic growth,” Bentsen writes. “SIFMA commends Chair White's leadership in navigating the rule to completion and acknowledges the balanced, inclusive and transparent approach taken by the SEC in developing this regulation. Today's final rule will provide the marketplace with a degree of certainty regarding the future of these funds.”
Bentsen adds that, upon first review, SIFMA is “encouraged that the SEC has limited the new floating NAV requirement to institutional prime funds.”
“We agree that it is appropriate to carve out retail and government money market funds from a floating NAV requirement, as these funds have not shown susceptibility to destabilizing runs. Importantly, we also believe the SEC has appropriately reframed the determination of retail funds by looking at fund policies and procedures designed to limit investors in these funds to natural persons as opposed to redemption limits as originally proposed, as the nature of investors is a better indicator of a true retail fund. Further, we support the SEC's decision to move forward with a voluntary fees and/or gates program that relies on the expertise of fund boards, instead of generally imposing a broad fees and/or gates mandate.”
Bentsen concludes by saying SIFMA will continue its review of the final rule in concert with member firms. “While we may not agree with every provision of the final rule,” he adds, “we are committed to helping our members implement the new requirements, including necessary tax and accounting changes, so the industry can move forward and these funds can continue to provide critical capital formation and investment benefits that help grow the American economy."
The text of the SEC rule amendments is available here.