On July 23, 2014, the Securities and Exchange Commission (“SEC”) released an 869-page document adopting amendments to the rules that govern money market mutual funds. The amendments passed by a narrow 3-to-2 margin and, similar to previous amendments adopted in 2010, are designed to address money market funds’ susceptibility to heavy redemptions in times of stress such as those seen during the 2008 financial crisis.
The new amendments include three key mechanisms to accomplish the SEC’s goals: floating net asset values, liquidity fees, and redemption gates. The measures are designed to provide additional transparency into the risks inherent in money market funds, and also to provide disincentives for investors to withdraw their money market fund assets at times of stress. The SEC has also introduced a new distinction between “Retail” and “Institutional” money market funds. The table1 below summarizes how new stabilization mechanisms will apply to various money market fund types:
|Money Market Fund Type||Floating Net Asset Value Required?||New Liquidity Fee Rules Required?||New Redemption Gate Rules Required?|
|Government||No||No (but a fund can opt in if disclosed in prospectus)||No (but a fund can opt in if disclosed in prospectus)|
|Retail (including municipal & prime)||No||Yes||Yes|
|Institutional (including municipal & prime)||Yes||Yes||Yes|
Importantly, compliance with the key provisions noted in the table above is not required for two years. This will provide fund companies with plenty of time to incorporate the new rules and update their prospectuses. Given the two-year implementation window, we recommend that clients take sufficient time to work with their Consultant to evaluate which money market fund type will best meet their needs going forward.
- Government Money Market Fund – invests at least 99.5% of its total assets in cash, government securities backed by the full faith and credit of the U.S. government and/or repurchase agreements that are collateralized fully by cash or government securities (previous rules allowed government funds to have up to 20% in non-government assets).
- Retail Money Market Fund – has policies and procedures reasonably designed to limit all beneficial owners (those with voting or investment power) to natural persons (individuals).
- Institutional Money Market Fund – for purposes of these regulations, includes any money market fund that does not meet the definition of a government or retail money market fund.
- Floating Net Asset Value – requires daily share price to fluctuate along with changes in the market-based value of the funds’ investments instead of remaining stable at $1.00 per share. Floating net asset value money market funds will report to the fourth decimal point (e.g., $1.0001).
- New Liquidity Fee Rules – if fund’s weekly liquid assets fall below 30%, fund board can impose a fee of up to 2% on redemptions; if fund’s weekly liquid assets fall below 10%, fund is required to impose a fee of 1% on redemptions (unless board determines alternative from 0-2% is in fund’s best interest).
- New Redemption Gate Rules – if fund’s weekly liquid assets fall below 30%, fund board can suspend redemptions at its discretion (maximum 10 business day gate in 90-day period).
- Weekly Liquid Assets – 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.
Currently, money market funds are valued, by rule2, at $1 per share. Historically, this rule was based on the presumption that their assets are very stable and therefore their underlying net asset value (“NAV”) should always remain very close to the $1 per share price. Money market fund risks were exposed in 2008 when the Reserve Primary Fund, the nation’s oldest and largest money market fund, saw its NAV fall to 97 cents per share after writing off debt issued by the bankrupt Lehman Brothers. Investors in money market funds panicked and significant outflows ensued. Ultimately, the U.S. Department of the Treasury was forced to rush to market a program, similar to FDIC insurance for bank deposits, to temporarily insure the NAV of money market funds.
By requiring a floating NAV for certain types of money market mutual funds, the SEC is seeking “to reduce the first mover advantage inherent in a stable NAV fund, by disincentivizing redemption activity that can result from investors attempting to exploit the possibility of redeeming shares at the stable share price even if the portfolio has suffered a loss. [Floating NAVs] are also intended to reduce the chance of unfair investor dilution and make it more transparent to certain of the impacted investors that they, and not the fund sponsors or the Federal government, bear the risk of loss.”3
The SEC is also adopting “exemptions from various provisions of the Investment Company Act to permit a fund to institute liquidity fees and redemption gates. In the absence of an exemption, imposing gates could violate section 22(e) of the Act, which generally prohibits a mutual fund from suspending the right of redemption or postponing the payment of redemption proceeds for more than seven days, and imposing liquidity fees could violate rule 22c-1, which (together with section 22(c) and other provisions of the Act) requires that each redeeming shareholder receive his or her pro rata portion of the fund’s net assets.”4 Liquidity fees and redemption gates provide additional tools for money market funds to directly address a run on a fund that could occur at times of stress.
A floating NAV will add additional tax and accounting complexity for taxable investors, liquidity fees could make accessing money market fund assets more expensive in a period of market stress, and redemption gates could force investors to wait up to 10 business days to obtain liquidation proceeds. However, the new SEC rules do not materially alter the basic investment characteristics of money market funds. While it remains to be seen whether the new SEC measures will have their desired effect in a market panic, we view them as measured and reasonable steps.
1. Source: SEC release #33-9616 and press release #2014-143.
2. Rule 2a-7 of the 1940 Act allows a fund to value its investments at amortized cost rather than market value if certain conditions are met. A money market fund maintains the $1 NAV by paying dividends to shareholders equal to the fund’s net income.