SEC Proposes Amendments to Rules Governing Money Market Funds
On December 15, 2021, the Securities and Exchange Commission, by a party-line vote of three-to-two, proposed for public comment amendments (Proposed Amendments) to Rule 2a-7 and other rules that govern money market funds (money funds) under the Investment Company Act of 1940.1 According to the SEC’s proposing release (Release), the Proposed Amendments are “designed to improve the resiliency and transparency of money market funds” following the liquidity stresses experienced in March 2020 in connection with the COVID-19 coronavirus pandemic and the associated stresses in the short-term credit markets. The Proposed Amendments include the following key reforms:
- Increase in daily and weekly liquid asset requirements and related reporting requirements;
- Removal of required and permissive liquidity fee and redemption gate provisions;
- Swing pricing requirement for institutional prime and institutional tax-exempt money funds; and
- Amendments to address potential negative interest rates.
Each of these proposals is briefly summarized below:
Increase in Daily and Weekly Liquid Asset Requirements; Reporting of Liquidity Threshold Events
For all money funds, the Proposed Amendments would increase: minimum daily liquid asset requirements from 10% to 25%; and weekly liquid asset requirements from 30% to 50%. Consistent with the existing regulatory requirement that, if a money fund’s portfolio does not meet the minimum daily liquid asset or weekly liquid asset thresholds, in the event the Proposed Amendments are adopted, the fund would not be able to acquire any assets other than daily liquid assets or weekly liquid assets, respectively, until it meets these minimum thresholds. However, a money fund would be required to notify its board and publicly file a report on Form N-CR if the percentage of its total assets in daily liquid assets or weekly liquid assets falls below 12.5% or 25%, respectively. The money fund would be required to file a report on Form N-CR within one business day of such a “liquidity threshold event.” This report would include: the date on which the fund’s assets fell below the specified thresholds; and the level of both weekly and daily liquid assets on that date. Within four business days after the event, the fund would be required to file an updated report that includes a brief description of the circumstances that led to the fund’s assets falling below the applicable thresholds.
Removal of Required and Permissive Liquidity Fee and Redemption Gate Provisions
The Proposed Amendments would remove provisions in Rule 2a-7 that permit (or under certain circumstances require) a money fund to impose liquidity fees. The Proposed Amendments also would remove provisions in Rule 2a-7 that permit a money fund to impose a redemption gate. In the Release, the SEC noted that, in March 2020, the possibility of the imposition of liquidity fees and/or redemption gates “appears to have contributed to investors’ incentives to redeem from prime money market funds and for money market fund managers to maintain weekly liquid asset levels above the threshold, rather than use those assets to meet redemptions.”
The removal of the liquidity fee and redemption gate provisions from Rule 2a-7 was supported to a certain extent by all of the Commissioners. However, Commissioners Hester M. Peirce and Elad L. Roisman questioned whether a money fund’s board of directors should be allowed to consider imposing fees and gates voluntarily as an additional tool to stem redemptions during times of market stress.
Swing Pricing Requirement for Institutional Prime and Institutional Tax-Exempt Money Funds
The Proposed Amendments would impose a mandatory swing pricing regime on institutional prime and institutional tax-exempt money funds (i.e., money funds that are not a government money fund or retail money fund) that experience net redemptions. Specifically, the Proposed Amendments would require an institutional prime or institutional tax-exempt money fund to implement policies and procedures that require the fund to adjust its NAV per share downward by a “swing factor” when it experiences net redemptions during a “pricing period.” In determining the “swing factor,” the “swing pricing administrator” (which could be the fund’s investment adviser or officer(s) responsible for administering the fund’s swing pricing policies and procedures) would make good faith estimates, supported by data, of the costs the fund would incur if it sold a pro rata amount of each security in the fund’s portfolio (i.e., a “vertical slice” of its portfolio) to satisfy the amount of net redemptions for the “pricing period.” A “pricing period” would be defined for this purpose as the period of time in which an order to purchase or sell securities issued by the fund must be received to otherwise be priced at the next-computed NAV.
Further, if net redemptions for a pricing period exceed the “market impact threshold,” which would be defined as an amount of net redemptions for a pricing period that equals the value of 4% of the fund’s NAV divided by the number of pricing periods the fund has in a business day (or such smaller amount of net redemptions as the fund’s swing pricing administrator determines), then the good faith estimates also must include, for each security in the fund’s portfolio, market impacts.
Under the Proposed Amendments, institutional prime and institutional tax-exempt money funds would be required to develop and adopt swing pricing policies and procedures that would need to be approved by the fund’s board. The fund’s board also would be required to designate the swing pricing administrator and review, no less frequently than annually, a written report prepared by the swing pricing administrator.
The SEC requests feedback on the proposed swing pricing requirement, including, most notably, the potential operational difficulties in implementing swing pricing. Commissioner Roisman, in particular, questioned whether money fund intermediaries that serve investors might have preferences with respect to implementing swing pricing or one of the alternative structures described in the Release. Additionally, Commissioner Allison Herren Lee questioned whether the use of swing pricing would actually be effective in disincentivizing redeeming investors from engaging in run-like behavior.
Amendments to Address Potential Negative Interest Rates
In face of questions concerning how stable NAV money funds (which include government money funds and retail money funds) might continue to operate in a potential negative interest rate environment, the Release indicates that, as a general matter, it may be inappropriate under the existing provisions of Rule 2a-7 for a money fund with a gross negative yield to continue to maintain a stable NAV. In particular, the Release states that “if negative interest rates turn a stable NAV fund’s gross yield negative, the board may reasonably believe the stable share price does not fairly reflect the market-based price per share, as the fund would be unable to generate sufficient income to support a stable share price.” Under these circumstances, “the fund would need to convert to a floating share price.” Additionally, “the board of a stable NAV fund could reasonably require the fund to convert to a floating share price to prevent material dilution or other unfair results to investors or current shareholders.”
To codify the SEC’s view with respect to addressing negative fund yields for stable NAV money funds, the SEC proposes to amend Rule 2a-7 to prohibit money funds from implementing: a reverse distribution mechanism; routine reverse stock split; or other device that periodically would reduce the number of the fund’s outstanding shares in order to maintain a stable share price. Relatedly, the Proposed Amendments would require a stable NAV money fund to determine that its financial intermediaries are able to process share transactions if the fund converts to a floating NAV. Otherwise, the money fund would be required to prohibit the relevant financial intermediaries from purchasing its shares in nominee name.
The Proposed Amendments begin a new phase in the ongoing debate over the regulation of money funds; this debate has been reignited following the market stresses experienced in connection with the COVID-19 coronavirus pandemic. Unfortunately, the comment period for the Proposed Amendments – which, if adopted, would significantly impact money funds and likely would prompt many comments from the industry – is only 60 days after their publication in the Federal Register. This relatively short comment period was described as “a major shortcoming” by Commissioner Roisman. For context, the SEC provided a 90-day comment period in connection with its proposed money market reforms in 2013. An upcoming Dechert OnPoint will provide a more detailed analysis of the Proposed Amendments, as well as potential issues raised for money funds, their boards of directors, service providers and intermediaries.
1) Money Market Fund Reforms, Release No. IC-34441 (Dec. 15, 2021).