Money Market Funds
Money market funds originated as an alternative to traditional bank deposits during the late 1970s and early 1980s in reaction to increasing inflation and regulations that capped the interest rates payable by depository institutions. Today, money market funds represent a significant part of the asset management industry and provide an important service to the financial system. By intermediating between investors who seek liquid investments and borrowers who seek short-term credit, money market funds play an important role in funding the short-term credit market.
Money market funds are subject to comprehensive regulation under the federal securities laws, primarily Rule 2a-7 under the Investment Company Act of 1940, as amended (the “Investment Company Act”). The Securities and Exchange Commission (SEC) has, over a period of approximately forty years, developed and refined a complex regulatory scheme designed to limit a money market fund’s underlying portfolio risk and impose strict operational and procedural requirements. Money market funds are also subject to specific disclosure, advertising and reporting rules that differ from those that apply to other registered investment companies.
For much of their history, money market funds were defined by their ability to sell and redeem their shares at a stable $1.00 share price. But events during the 2008 financial crisis called into question whether all money market funds should continue to be able to offer a stable $1.00 share price. In response to these events, the SEC adopted three rounds of sweeping amendments to Rule 2a-7 and the other rules that govern money market funds, which were adopted in February 2010 (the “2010 Amendments”), July 2014 (the “2014 Amendments”) and September 2015 (the “2015 Amendments”). Together, these amendments were primarily intended to:
- reduce the volatility of money market fund share prices and enhance the ability of certain money market funds to maintain a stable $1.00 share price in the face of severe market events, such as the market illiquidity in the fall of 2008 that threatened the ability of many money market funds to meet redemptions;
- limit the systemic risk that money market funds are alleged to pose to the financial system because of certain features that may incentivize investors to redeem their shares during periods of market stress and thus challenge the functioning of the short-term credit market; and
- remove any requirement for a money market fund to assess the creditworthiness of its portfolio securities in reliance on credit ratings issued by nationally recognized statistical rating organizations (NRSROs).
This chapter describes the laws and regulations governing money market funds, taking into account the 2010, 2014, and 2015 Amendments. Please note that the last provisions of the 2014 and 2015 Amendments became effective on October 14, 2016.
For more information, please visit the Practising Law Institute's website.