On Wednesday afternoon, the SEC unanimously passed proposals that would aim to restructure several key operational aspects of money market funds in light of the recurrent problem of such funds"breaking the buck" in recent months. The SEC held an open meeting Wednesday to seek comment on proposed money market fund rule changes as well as other issues not yet specifically addressed by rule changes, such as holding a floating share price and making amendments to money market rules with respect to investment in asset backed securities.
While the changes may seem extensive, the commissioners concluded that the proposed changes will have little impact on the underlying utility of the money market fund as it exists today. The primary criterion for formulating the proposals was in fact to preserve the utility of such funds, and a modest impact on the nature of funds was promised. For funds that will have to make significant changes in their management in order to accommodate the new rules, the SEC projected a yield decrease of between 4 and 6 bps. However, as several of the speakers at the hearing noted, many money market funds have preemptively complied with increased liquidity measures of their own accord with the new rules and the changes will be negligible in the near future.
Money market funds currently hold over $3.8 trillion in assets, and roughly 1/5 of U.S. households' cash is held in money market funds. Disruptions in the money market arena have increased instability in the general credit markets with such events as the September 15 2008 $300 billion withdrawal from prime money market funds. The SEC proposals aimed at avoiding events such as those experienced last fall, and would enhance 2a-7 risk-limiting requirements. The commissioners expect the proposals to: enable money market funds to be well positioned to redeem shares; increase the quality of the investments; enhance the commission's ability to monitor money market funds; and promote orderly liquidation of any fund that has "broken the buck". SEC chair Mary Shapiro claimed that the new regulations will go a long way towards creating money market safeguards, saying that "the value of the rules over the long term will be very significant in the protection of investors."
The relevant changes approved include:
5% minimum cash (or readily convertible into cash) holdings for retail money market funds
10% minimum cash (or readily convertible into cash) holdings for instiutional funds
restricted maturity limits of 120 days for the weighted average life maturity (no such limit currently exists)
restricted maximum weighted average maturity limits of 60 days (down from the current 90-day limit)
investments restricted to only the highest quality securities (most funds are currently permitted to invest up to 5% in second tier securities)
periodic stress tests
"know your investor" procedures to identify liquidity pressures
monthly online posting of fund portfolio holdings
monthly reporting to the SEC on portfolio schedules
electronic processing for funds at a price other than $1 per share
ability to suspend redemptions of shares in the case that a fund does "break the buck"
expanded ability of purchase of distressed assets from a fund's affiliates in order to protect a fund from losses.
The Securities and Exchange Commission today will consider proposing rule amendments designed to significantly strengthen the regulatory requirements governing money market funds. The proposal would increase the resilience of these funds to economic stresses and reduce the risks of runs on the funds. The proposal would:
Improved Liquidity: The proposal would prohibit money market funds from purchasing illiquid securities. It also would require that funds have a minimum percentage of their assets in highly liquid securities so that those assets could be readily converted to cash:
For retail money market funds at least 5% of assets must be in cash, U.S. Treasury securities, or readily convertible into cash (collectively, “liquid”) within one day, and at least 15% must be liquid within one week.
For institutional money market funds, which have experienced greater liquidity challenges than retail funds, at least 10% of assets must be liquid within one day, and at least 30% must be liquid within one week.
Currently, rule 2a-7, the rule governing money market funds, contains no liquidity requirements. [Note: The one-day liquidity limits for retail and institutional funds would not apply to tax exempt (i.e., municipal) money market funds.]
Shortened Maturity Limits: The proposal would shorten the average maturity limits for money market funds, which would help to limit the exposure of the funds to certain risks, such as interest rate risks. It would 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 would be 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 (currently the limit is 90 days).
Higher Credit Quality: The proposal would limit money market funds to investing only in the highest quality securities – that is, not “Second Tier” securities. Currently, most funds are permitted to invest up to 5% of their assets in “Second Tier” securities.
Periodic Stress Tests: The proposal would 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.
“Know Your Investor” Procedures: The proposal would require funds to develop procedures to identify investors whose redemption requests may pose risks for funds. Such procedures would require funds to anticipate the likelihood of large redemptions.
Enhance Disclosure of Portfolio Securities
Monthly Web Site Posting: The proposal would require money market funds each month to post on their Web sites their portfolio holdings.
Monthly Reporting: The proposal would also require money market funds each month to report to the Commission detailed portfolio schedules in a format that could be used to create an interactive database through which the Commission could better oversee the activities of money market funds. This would replace the current quarterly reporting requirement.
Improve Money Market Fund Operations
Electronic Processing: The proposal would require that all money market funds and their administrators be able to process purchases and redemptions electronically at a price other than $1 per share. The requirement would facilitate share redemptions if a fund were to “break the buck.” A money market fund “breaks the buck” when its net asset value falls below $1 per share, meaning investors in that fund will lose money.
Suspension of Redemptions: The proposal would permit a money market fund’s board of directors to suspend redemptions if the fund were to break a buck and decide to liquidate. In the event of a threatened run on the fund, this would allow for an orderly liquidation of the portfolio. The fund would be required to notify the Commission when it relies on this rule.
Purchases by Affiliates: The proposal would expand the ability of affiliates of money market funds to purchase distressed assets from funds in order to protect a fund from losses. Currently, an affiliate cannot purchase securities from the fund before a ratings downgrade or a default of the securities – unless it receives individual approval. The change would permit such purchases without the need for approval under conditions that would protect the fund from transactions that disadvantage the fund. The fund would have to notify the Commission when it relies on this rule.
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In addition to the proposed rules, the Commission will consider seeking public comment on such issues as:
Floating Share Price – Should money market funds be required to sell and redeem shares at a floating share price rather than a stable share price (typically $1 per share)?
Credit Rating Agencies – What role should credit rating agencies’ ratings have in money market fund regulation? Should fund boards designate certain rating agencies that they will use to evaluate securities for purchase, and to monitor securities after purchase?
Asset-Backed Securities – Should the Commission amend the money market fund rule with respect to investment in asset‑backed securities and the attendant risks?
The proposed rule amendments and requests for comment would be subject to a 60 day public comment period following publication in the Federal Register.
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