Following a turbulent week in the financial markets, the U.S. Treasury Department (the “Treasury”) and Federal Reserve took a series of steps in an attempt to stabilize the financial system. Among other measures, they propose to support the price stability of money market mutual funds (“MMF”).
Two key measures were adopted: (1) the Treasury established a Guarantee Program for Money Market Funds; and (2) the Federal Reserve extended loans to banks to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market funds. These measures were announced at the end of a difficult week in the financial market and specifically for MMFs, in which Putnam Investments closed and liquidated the Putnam Prime Money Market Fund, and the Primary Fund’s (part of Reserve Fund) net asset value (“NAV”) fell below $1 (“broke the buck”), leading the Reserve to impose redemption limits on several MMFs it operates. Each of these measures is discussed in detail below.
Treasury Establishes Guarantee Program for Money Market Funds
On September 19, 2008 the Treasury announced the establishment of a Temporary Guarantee Program for Money Market Mutual Funds (“the Program”). The Program will assist participating MMFs that break the buck to pay shareholders $1.00 per share upon liquidation of the funds. MMFs will be insured for up to $50 billion with assets from the Treasury’s Exchange Stabilization Fund (“ESF”). ESF was established by the Gold Reserve Act of 1934, and its funds have traditionally been used to purchase or sell foreign currencies, to hold U.S. foreign exchange and Special Drawing Rights assets, and to provide financing to foreign governments.
The following are the core elements of the Program:
- The Program protects investors’ accounts. It provides a guarantee to shareholders with respect to shares held by them as of the close of business on September 19, 2008. MMFs that broke the buck before September 19 are not covered by the Program. Later share purchases, made after September 19, are also not covered. This means that any increase in the number of shares held in an account after the close of business on September 19, 2008 will not be guaranteed. Further, if the number of shares held in an account fluctuates over the period, investors will be covered for either the number of shares held as of the close of business on September 19, 2008 or the current amount, whichever is less.
- Participation in the Program is voluntary and is done on a fund-by-fund basis. Investors cannot sign up for the Program individually. A MMF that chooses to participate is required to complete a Guarantee Agreement Form and pay an upfront fee, which covers the first three months of participation in the Program. Participation in the program and the Guarantee Agreement must be approved by the fund’s board of directors. There are two fee levels:
- MMFs with NAV per share greater than or equal to $0.9975 as of the close of business on September 19, 2008 will pay an upfront fee of 0.01 percent, 1 basis point, based on the number of shares outstanding on that date.
- Funds with net asset value per share of greater than or equal to $0.995 and below $0.9975 as of the close of business on September 19, 2008 will be required to pay an upfront fee of 0.015 percent, 1.5 basis points, based on the number of shares outstanding on that date.
- The Program will exist for an initial three-month term and may be renewed, at the decision of the Secretary of the Treasury, for up to one year. If the Program is extended, MMF participation will not be automatically renewed. Funds that wish to renew their participation will be required to pay an additional fee at the extension point.
- The Program is available to MMFs that are regulated under Rule 2a-7 of the Investment Company Act of 1940, maintain a stable share price of $1, are publicly offered, and are registered with the Securities and Exchange Commission.
- Eligible funds include both taxable and tax- exempt MMFs. Participation in the Program will not be treated as a federal guarantee that jeopardizes the tax-exempt treatment of payments by tax-exempt MMFs. Shareholders in tax-exempt MMFs will continue to receive dividends that are free from federal income tax when paid as exempt-interest dividends.
- The Program is triggered when a participating fund’s NAV falls below $0.995 (“triggering event”). Once a triggering event occurs, the fund must provide the Treasury with a Guarantee Event Notice and is required to begin liquidation promptly and no later than five business days of the triggering event. Liquidation must be effectuated within 30 days of the triggering event. Only once the fund liquidates can it provide a Payment Request Notice to the Treasury. Upon the Treasury’s receipt of a Payment Request Notice, the shortfall between the proceeds of the liquidation and $1 per share will be covered by the Treasury.
- Prior to notifying the Treasury of a triggering event, under the Program a participating MMF is required to report by email to the SEC and the Treasury once its Market-Based NAV is less than $0.9975.
- Once a participating MMF breaks the buck, liquidates, and provides the Treasury with a Payment Request Notice, the Treasury will remit the Guarantee Payment on the following business day, subject to possible extensions at the discretion of the Treasury.
- Guarantee payments to participants in the Program will not exceed the amount available within the ESF on the date of payment. Currently ESF assets are approximately $50 billion.
- The Guarantee may be transferred in the event of reorganization provided that: (1) no Guarantee Event has occurred with respect to the merging fund prior to the reorganization; (2) each other fund that is a party to the reorganization is operating in compliance with Rule 2a-7 and has a policy of maintaining a stable NAV of $1.00 per share; and (3) each other fund has a market-based NAV immediately prior to the reorganization of not less than $0.995. The surviving fund is required to agree in writing to be bound by the terms of the Guarantee Agreement and assume all of the obligations of the merging fund under the Guarantee Agreement, and the investment advisers of the surviving fund must agree to be bound by the Guarantee Agreement and assume all of the obligations of the investment adviser of the merging fund.
MMFs interested in participating in the Guarantee Program need to apply by October 8 by completing a Guarantee Agreement Form and paying the fee discussed above. The form and other required corresponding documents are available on the Program’s web page.
Federal Reserve Extends Loans to Banks to Finance Their Purchases of High-Quality Asset-Backed Commercial Paper (ABCP) from Money Market Mutual Funds
On September 19, 2008 the Federal Reserve announced that it will extend non-recourse loans at primary credit rate to U.S. depository institutions and bank holding companies to finance purchases of high-quality asset backed commercial paper (“ABCP”) from money market mutual funds (“MMF”). The special lending facility, called Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (“AMLF”), is designed to foster liquidity in ABCP markets and assist MMFs that hold such paper to meet investors’ redemption demands. The facility offers eligible borrowers advances from the Federal Reserve Bank of Boston on a non-recourse basis if they use the proceeds of the loan to purchase certain ABCP from eligible MMFs. Under the program, the borrower is at no risk of loss on the eligible ABCP . Currently, there are no specific details on how many such purchases will be financed. All U.S. depository institutions, bank holding companies, and U.S. branches and agencies of foreign banks are eligible to participate in the program (“eligible borrowers”). The facility commenced on September 19, 2008 and will be in place until January 30, 2009.
In order to facilitate ABCP purchases from MMFs by depository institutions and bank holding companies, the Federal Reserve temporarily adopted regulatory exemptions from its leverage and risk-based capital rules for ABCP held by such companies as a result of participation in the AMLF. Further regulatory exemptions adopted by the Federal Reserve include a temporary limited exemption from sections 23A and 23B of the Federal Reserve Act, which establish certain restrictions on and requirements for transactions between a bank and its affiliates. The latter change is designed to increase the capacity of a member bank to purchase ABCP from affiliated MMF in connection with the ABCP lending facility.
Under the program, eligible borrowers can borrow money from the lending facility to purchase ABCP from a MMF under the following conditions:
- The MMFs must be regulated under Rule 2a-7 of the Investment Company Act of 1940.
- Eligible issues of ABCP are only U.S.dollar- denominated issues from a U.S. issuer, and rated First-Tier Securities under Rule 2a-7 (rated no less than A1, F1, or P1 by at least two nationally recognized rating agencies). The ABCP must be issued by an entity organized under U.S. laws, or a political subdivision of such entity, and under a program that was in existence on September 18, 2008.
- To be eligible, a borrower must have OC-10 documentation on file with their local Reserve Bank, or complete a resolution signed by the borrower’s board of directors and have an official authorized under that resolution to sign FRB Boston’s Letter of Agreement governing the program. The rest of the borrowing documents required to acquire the loan will be posted at http://www.discountwindow.org.
- Borrowers must purchase ABCP from a MMF at amortized cost (MMF’s acquisition cost of the ABCP as adjusted for amortization of premium or accretion of discount).
- Loans will be given only against ABCP purchased on or after September 19, 2008.
- Borrowers are not required to pledge and borrow against the ABCP on the same day of their purchase from a qualified MMF. However, until an advance is made and the ABCP pledged to secure the advance, borrowers would retain credit and interest rate risks.
To enable the effective implementation of the AMLF described above, on September 25, 2008 the staff of the SEC’s Division of Investment Management issued a no-action letter to the Investment Company Institute (“ICI”) stating that it will not recommend enforcement action under Section 17(a) of the Investment Company Act of 1940 or the rules thereunder if an eligible borrower purchases ABCP from an affiliated MMF, at the amortized cost value of the ABCP , with cash borrowed through the AMLF.1
1) Investment Company Institute, SEC No-Action Letter (Sept. 25, 2008).
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