According to an SEC announcement, the financial crisis and the weaknesses revealed by the Reserve Primary Fund’s “breaking the buck” in September 2008 precipitated a full-scale review of the money market fund regulatory regime by the SEC.
A money market fund “breaks the buck” when its net asset value (NAV) falls below $1.00 per share, meaning investors in that fund will lose money.
The SEC’s new rules are intended to “increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds by tightening the maturity and credit quality standards and imposing new liquidity requirements,” according to an update on the agency’s web site.
“These new rules will have substantial benefits for investors and are an important first step in our efforts to strengthen the money market regime,” said SEC Chairman Mary L. Schapiro. “These rules will help reduce risks associated with money market funds, so that investor assets are better protected and money market funds can better withstand market crises. The rules also will create a substantial new disclosure regime so that everyone from investors to the SEC itself can better monitor a money market fund’s investments and risk characteristics.”
The new rules require money market funds to have a minimum percentage of their assets in highly liquid securities so that those assets can be readily converted to cash to pay redeeming shareholders (currently, there are no minimum liquidity mandates). Additionally, for all taxable money market funds, at least 10% of assets must be in cash, U.S. Treasury securities, or securities that convert into cash (e.g., mature) within one day.
For all money market funds, at least 30% of assets must be in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, or securities that convert into cash within one week, according to the SEC. The rules would further restrict the ability of money market funds to purchase illiquid securities by:
- Restricting money market funds from purchasing illiquid securities if, after the purchase, more than 5% of the fund’s portfolio will be illiquid securities (rather than the current limit of 10%).
- Redefining as “illiquid” any security that cannot be sold or disposed of within seven days at carrying value.
Higher Credit Quality
The new rules place new limits on a money market fund's ability to acquire lower quality (second tier) securities. They do this by:
- Restricting a fund from investing more than 3% of its assets in second tier securities (rather than the current limit of 5%).
- Restricting a fund from investing more than ½ of 1% of its assets in second tier securities issued by any single issuer (rather than the current limit of the greater of 1% or $1 million).
- Restricting a fund from buying second tier securities that mature in more than 45 days (rather than the current limit of 397 days).
The SEC said the new rules shorten the average maturity limits for money market funds, which helps to limit the exposure of funds to certain risks such as sudden interest rate movements.
They do this by:
- Restricting the maximum "weighted average life" maturity of a fund's portfolio to 120 days. Currently, there is no such limit. The effect of the restriction is to limit the ability of the fund to invest in long-term floating rate securities.
- Restricting the maximum weighted average maturity of a fund's portfolio to 60 days (the current limit is 90 days).
The new rules require fund managers to examine the fund's ability to maintain a stable net asset value per share in the event of shocks - such as interest rate changes, higher redemptions, and changes in credit quality of the portfolio (previously, there were no stress test requirements), and they continue to limit a money market fund's investment in rated securities to those securities rated in the top two rating categories (or unrated securities of comparable quality). The new rules also continue to require money market funds to perform an independent credit analysis of every security purchased.
The SEC said that in order to meet the new liquidity requirements (to meet foreseeable redemptions), “funds would need to develop procedures to identify investors whose redemption requests may pose risks for funds. As part of these procedures, funds would need to anticipate the likelihood of large redemptions.”
In addition, the new rules improve the way that funds evaluate securities ratings provided by Nationally Recognized Statistical Rating Organizations (NRSROs).
The new rules require money market funds each month to post on their Web sites their portfolio holdings (there is no current Web site posting requirement), and portfolio information must now be maintained on the fund's Web site for no less than six months after posting.
The new rules require money market funds and their administrators to be able to process purchases and redemptions electronically at a price other than $1.00 per share. This requirement facilitates share redemptions if a fund were to break the buck, according to the SEC.
The new rules permit a money market fund's board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio, according to the SEC. The fund is now required to notify the Commission prior to relying on this rule.
The new rules adopted today are effective 60 days after their publication in the Federal Register, and mandatory compliance with some of the rules will be phased in during the year, according to the SEC. The final rules, including compliance dates, will be posted on the SEC Web site as soon as possible.
More information is available at http://www.sec.gov/news/press/2010/2010-14.htm.