On July 12, 2023, the US Securities and Exchange Commission
("SEC") voted, by a 3-2 vote, to adopt money market fund
reforms that will significantly impact the regulatory framework
governing money market funds ("money funds" or
"funds"). According to the SEC, the reforms are designed
to improve the resiliency of money funds by reducing the risk of
shareholder "runs" on money funds during periods of
market stress. The adopting release highlighted heavy outflows from
institutional prime money funds in March 2020 at the onset of the
COVID-19 pandemic. The reforms consist of amendments to Rule 2a-7
under the Investment Company Act of 1940 (the "1940
Act"), the primary rule governing the operation of money
funds, and related recordkeeping, reporting, and disclosure form
amendments (collectively, the final rules). This Client Alert
summarizes key aspects of the final rules.
As a preliminary matter, it is significant that the SEC did not
adopt certain elements of the proposed rulemaking that received
broad opposition in the comment letter process. In particular, the
SEC had initially proposed a mandatory swing pricing requirement
for institutional prime and institutional tax-exempt money funds
("institutional money funds"), but it ultimately did not
adopt this requirement in the final rules. Instead, the SEC adopted
a new liquidity fee framework, which includes a mandatory
requirement for institutional money funds to apply liquidity fees
when they experience certain large net redemptions —
specifically, if daily net redemptions exceed 5% of net assets
(subject to a de minimis exception). This alternative
resembles swing pricing in many respects while lessening, but not
eliminating, the operational challenges, feasibility concerns, and
costs that generated so much criticism in comments on the proposed
rulemaking.
Certain of the reforms apply to all categories of money funds,
while others apply only to certain categories. For ease of
reference, the following is a high-level overview of key reforms
under the final rules and their applicability to categories of
money funds:
Reform |
Government Money Funds |
Prime Money Funds |
Tax-Exempt Money Funds |
||
Institutional |
Retail |
Institutional |
Retail |
||
Removal of Ability to Impose Redemption Gates |
N/A1 |
Yes |
Yes |
Yes |
Yes |
Mandatory Liquidity Fee Requirement |
N/A1 |
Yes |
N/A |
Yes |
N/A |
Discretionary Liquidity Fee Requirement |
N/A1 |
Yes |
Yes |
Yes |
Yes |
Increase to Minimum Portfolio Liquidity Requirements |
Yes |
Yes |
Yes |
2Yes |
2Yes |
Amendments Related to Potential Negative Interest Rates |
Yes |
N/A |
Yes |
N/A |
Yes |
Amendments Related to WAM/WAL Calculations |
Yes |
Yes |
Yes |
Yes |
Yes |
Amendments to SEC Reporting Requirements |
Yes |
Yes |
Yes |
Yes |
Yes |
Mandatory Swing Pricing Requirement |
NOT ADOPTED BY THE SEC |
- Government money funds may elect to be subject to the fees and gates provisions under current Rule 2a-7. However, in practice, government money funds have rarely, if ever, opted into these provisions. Under the final rules, government money funds will continue to be permitted to opt into the discretionary liquidity fee provision but not the mandatory liquidity fee provision.
- Similar to the current rule, tax-exempt money funds will not be subject to daily liquid asset requirements under the final rules.
Amendments to Liquidity Fees and Redemption Gates Provisions
Currently, a money fund has the ability to impose liquidity fees
or temporarily suspend redemptions (i.e., impose a
"gate") after dropping below certain specified liquidity
thresholds. Specifically, Rule 2a-7 gives the board of directors of
a money fund discretion to impose liquidity fees (up to 2%) and/or
gates (for up to 10 business days during any 90-day period) if the
fund's weekly liquid assets fall below 30% of its total assets.
In addition, a non-government money fund is required to impose a
liquidity fee of 1% on all redemptions if its weekly liquid assets
fall below 10% of its total assets, unless the board determines
that imposing such a fee would not be in the best interests of the
fund.
Removal of Ability to Impose Redemption Gates
The final rules remove the ability of a money fund to impose a
temporary redemption gate. According to the SEC, this removal will
eliminate the incentive under the current rule for investors to
preemptively redeem to avoid the possibility of a board using its
discretion to impose a redemption gate if the 30% threshold under
the current rule is reached. Money funds will continue to be able
to impose redemption gates to facilitate an orderly fund
liquidation pursuant to Rule 22e-3 under the 1940 Act.
New Liquidity Fee Framework
In lieu of adopting mandatory swing pricing for institutional money
funds, the SEC adopted a new liquidity fee framework that includes
elements of both mandatory liquidity fees for institutional money
funds and discretionary liquidity fees for all non-government money
market funds, as discussed in further detail below. Whether the fee
is mandatory or discretionary, the imposition of a liquidity fee
under the final rules will not be tied to a fund's weekly
liquid assets.
The SEC had initially proposed mandatory swing pricing for
institutional money funds with the goals of ensuring that the costs
stemming from net redemptions are fairly allocated to redeeming
shareholders and do not give rise to redemptions motivated by a
"first mover advantage." After receiving many comment
letters expressing broad concerns about the swing pricing proposal
and its potential effects on institutional money funds and
investors, the SEC stated that it was "persuaded by commenters
that these same goals are better achieved through a liquidity fee
mechanism, particularly given that current rule 2a-7 includes a
liquidity fee framework that funds are accustomed to and can build
upon."
While the final rules demonstrate that the SEC can be persuaded to
refrain from adopting a proposed mandatory swing pricing regime for
money funds, it remains to be seen whether the SEC will follow a
similar approach in the context of the pending proposal to mandate
swing pricing for open-end mutual funds (other than money funds).
In his public statement supporting the final rules, SEC Chair Gary
Gensler addressed the new liquidity fee framework, stating that he
"believe[s] that liquidity fees, compared with swing pricing,
offer many of the same benefits and fewer of the operational
burdens." Also, as noted by the two dissenting SEC
commissioners, the new liquidity fee framework was not included in
the proposed rulemaking, which precluded the SEC from having the
benefit of receiving and considering informed public comments to
guide the design of this aspect of the final rules.
Mandatory Liquidity Fees
Under the mandatory liquidity fee requirement, institutional money
funds will be required to apply a liquidity fee to redeeming
shareholders when net redemptions for the business day exceed 5% of
net assets (or such lower threshold as may be determined by the
fund board or its delegate), unless the liquidity fee amount is
de minimis. In determining whether a fund has crossed the
5% threshold, the fund must use flow information that is available
within a reasonable period of time after the last pricing time of
that day. The SEC recognized that there will be circumstances in
which the flow information a fund uses to determine whether it has
crossed the 5% threshold does not reflect the fund's full flows
for that day.
The amount of the liquidity fee will be determined by making a
good-faith estimate, supported by data, of the costs the fund would
incur if it sold a pro rata amount of each security in its
portfolio (a "vertical slice") to satisfy the amount of
net redemptions, including (1) spread costs and any other charges,
fees, and taxes associated with portfolio security sales, and (2)
market impacts for each security. There is no cap on the mandatory
liquidity fee amount, but the SEC recognized that, as a general
matter, it is unlikely a fund's calculated liquidity costs
would exceed 2% of the value of shares redeemed.
The SEC acknowledged commenters' concerns that market impact
factors may be difficult or costly to estimate and stated that it
specifically tailored the final rules to address these concerns.
For example, if a fund cannot make a good-faith estimate of
liquidity costs, the final rules require the fund to apply a
default liquidity fee of 1%. The SEC also provided guidance in the
adopting release on one method that funds could use to implement
its market impact calculations, which involves using pricing grids
that rely on historical data. In addition, the final rules provide
that funds will be able to pool similar securities into categories
for purposes of the market impact analysis rather than analyzing
each security separately and that a fund may assume a market impact
of zero for its daily and weekly liquid assets.
Significantly, institutional money funds will not be required to
impose a liquidity fee when the estimated costs are de
minimis. Estimated costs will be de minimis if they
are less than one basis point (0.01%) of the value of the shares
redeemed. This de minimis exception is designed to reduce
the frequency of triggering mandatory liquidity fees when
institutional funds may cross the 5% threshold under normal market
conditions and outside of stress. The SEC stated that it
anticipates that a fund's estimated liquidity costs generally
will be de minimis under normal market conditions and, therefore,
institutional money funds typically will not impose mandatory
liquidity fees under those circumstances under this de
minimis exception.
Discretionary Liquidity Fees
Recognizing that a discretionary liquidity fee provides money fund
boards with an additional tool to manage liquidity in times of
stress, the SEC decided to largely retain the discretionary
liquidity fee provision in the current rule, but without the tie
between liquidity fees and weekly liquid assets. Under the final
rules, all non-government money funds will be permitted to impose
liquidity fees on redeeming shares of up to 2% of the value of
shares redeemed. Like the current rule, the discretionary liquidity
fee provision under the final rules will not apply to government
money funds, but a government money fund will be permitted to opt
into this provision, giving it the ability to impose discretionary
liquidity fees.
Instead of tying discretionary liquidity fees to a weekly liquid
asset threshold, the final rules give the fund's board (or its
delegate) the flexibility to determine when a fee is necessary
based on current market conditions and the specific circumstances
of the fund. Irrespective of weekly liquid asset levels or
redemption levels, a non-government money fund may apply a
discretionary liquidity fee if the board (or its delegate)
determines that such fee is in the best interests of the fund. Once
imposed, the liquidity fee must remain in effect until the board
(or its delegate) determines that imposing such fee is no longer in
the best interests of the fund.
Institutional money funds, which will be subject to both the
mandatory and discretionary liquidity fee provisions, may impose
discretionary liquidity fees on days with net redemptions at or
below 5% of net assets. On days when net redemptions exceed 5%,
institutional money funds cannot impose discretionary liquidity
fees and must apply only the mandatory liquidity fee
provision.
Board Oversight of Liquidity Fee
Determinations
A money fund's board will be responsible for making liquidity
fee determinations under the mandatory and discretionary liquidity
fee requirements. However, in contrast to the current rule, a board
will be permitted to delegate this responsibility to the fund's
investment adviser or officers, subject to certain board oversight
requirements. The board will be required to adopt and periodically
review written guidelines (including guidelines for determining the
application and size of liquidity fees) and procedures under which
a delegate makes liquidity fee determinations. According to the
SEC, such written guidelines generally should specify the manner in
which the delegate is to act with respect to any discretionary
aspect of the liquidity fee mechanism. The board will also need to
periodically review the delegate's liquidity
determinations.
Recordkeeping
The final rules amend the recordkeeping rule under the 1940 Act
(Rule 31a-2) to require money funds to preserve records that
document how they determine the amount of any liquidity fee.
Increases to Minimum Portfolio Liquidity Requirements
Money funds are subject to minimum liquidity requirements
designed to support a money fund's ability to meet redemptions
even in market conditions in which the money fund cannot rely on a
secondary or dealer market to provide liquidity. The final rules
increase the minimum liquidity requirements for a money fund by
raising the daily liquid asset minimum from 10% to 25% of the
fund's total assets and raising the weekly liquid asset minimum
from 30% to 50% of the fund's total assets. These liquidity
requirements will continue to apply immediately following
"acquisitions" of portfolio assets, meaning that a money
fund that passively falls below a minimum would not be able to
acquire any assets other than daily or weekly liquid assets, as
applicable, until the fund meets the minimum threshold.
If a money fund's daily liquid assets fall below 12.5% or its
weekly liquid assets fall below 25%, the fund will be required to
notify its board and file a public report with the SEC (Form N-CR)
within one business day after the occurrence. In addition, within
four business days after the occurrence, the board must receive a
brief description of the facts and circumstances that led to the
liquidity threshold event.
Changes to Liquidity Metrics in Stress Testing
Under the current stress test provisions of Rule 2a-7, a money fund is required to test, among other things, its ability to maintain 10% weekly liquid assets under specified hypothetical events. The final rules replace this bright-line 10% threshold with a requirement for a money fund to test its ability to maintain "sufficient minimum liquidity" under such hypothetical events. Each fund will be permitted to determine the minimum level of liquidity that it considers sufficient in stress periods, which the SEC acknowledged may differ among money funds for a variety of reasons.
Amendments Related to Negative Interest Rates
In a negative interest environment, the gross yield for
government and retail money funds ("stable NAV funds")
that seek to maintain a stable share price (e.g., $1.00 share
price) likely would turn negative. Without a mechanism to
distribute or account for the negative yield, it would cause the
stable NAV fund's market-based shadow price to deviate from its
stable share price, as the fund would begin to lose money. This
deviation could cause the fund to re-price its securities below the
$1.00 share price (an event known as "breaking the
buck"). The current rule was amended to explicitly address the
options available to a stable NAV fund when interest rates are
negative.
Conversion to Floating NAV
Under the final rules, if a stable NAV fund has negative gross
yield, the fund will retain the ability it has under the current
rule to convert to a floating NAV, which would enable the fund to
absorb the negative yield into its share price. A floating NAV is
based on the current market-based value of the securities in the
portfolio and is rounded to the fourth decimal place (e.g.,
$1.0000).
Reverse Distribution Mechanism
In a change from the SEC's proposal, the final rules will also
permit a stable NAV fund to use a reverse distribution mechanism
("0RDM" or "share cancellation"), subject to
board oversight and disclosure requirements. An RDM involves
offsetting the daily negative yield accrued through the
proportional reduction of the total number of outstanding fund
shares. As contrasted with a conversion to a floating NAV, which
would result in the stable NAV fund's losses being reflected
through a declining share price, the use of an RDM will maintain
the stable share price, despite losing value, by reducing the
number of its outstanding shares. Shareholders in such a stable NAV
fund would observe a stable share price but a declining number of
shares for their investment.
Although the SEC initially proposed a prohibition on the use of an
RDM, the SEC ultimately chose to expressly permit the use of an
RDM, noting that it was "persuaded by commenters that the
concern that investors may find share cancellation misleading or
confusing can be addressed by establishing conditions for a
fund's use of share cancellation, including required
disclosures" and that the RDM "may be less disruptive or
costly than converting to a floating NAV in some cases." Prior
to the proposed rulemaking, the money fund industry, with input
from the Investment Company Institute, had generally identified the
RDM as among the most operationally feasible options available in a
negative yield environment.
The final rules permit a stable NAV fund to use an RDM only if the
fund has negative gross yield as a result of negative interest
rates and only if the fund's board determines that reducing the
number of the fund's shares outstanding is in the best
interests of the fund and its shareholders. This board
responsibility will not be delegable. In making this best interest
determination, the SEC stated that it believes a board generally
should consider: (1) the capabilities of the fund's service
providers and intermediaries to support the equitable application
of the RDM across the fund's shareholders, including
considerations of whether the operational and recordkeeping systems
of the service providers and intermediaries are able to process and
apply a pro rata reduction of shares in shareholder
accounts on a daily basis; and (2) any state law limitations on
share cancellation. In addition, the SEC stated that it believes a
board will also need to devote particular attention to questions
concerning the applicable tax rules and generally should consider
the tax implications of the RDM for the fund and its
shareholders.
If a stable NAV fund plans to use share cancellation, the final
rules require the fund's prospectus to contain disclosure
providing advance notice about these plans and their potential
effects on shareholders. When an RDM is activated and the fund is
canceling shares, the fund must provide information in each account
statement (or in a separate writing accompanying each statement)
identifying that such practice is in use and explaining its effects
on shareholders.
SEC Guidance on Preparing for the Possibility of a
Conversion to a Floating NAV
Given that the final rules permit the use of an RDM, the SEC
decided not to adopt its initial proposal that would have required
stable NAV funds to make determinations related to
intermediaries' capabilities of transacting at a floating NAV.
Although the final rules do not include these requirements, the SEC
stated that it believes stable NAV funds generally should engage
with their distribution networks in considering how they would
handle a negative interest rate environment, as intermediaries'
ability to apply a floating NAV or to process share cancellations
in an RDM is an important consideration in determining an approach
that is in the best interests of the fund and its shareholders.
Amendments Related to Calculations of WAM and WAL
Each money fund is currently required to calculate and publicly report its dollar-weighted average portfolio maturity (WAM) and dollar-weighted average life maturity (WAL), which are important determinants of interest rate risk in a fund's portfolio. Money funds currently use different approaches when calculating WAM and WAL, with some basing these calculations on the percentage of each security's market value and others basing them on the amortized cost of each security. The final rules require each money fund to make WAM and WAL calculations based on the percentage of each security's market value in the portfolio.
Amendments to Certain SEC Reporting Requirements
The final rules modify certain reporting forms that are applicable to money funds, including the public report required to be promptly filed with the SEC upon the occurrence of certain specified events (Form N-CR), as well as the public monthly portfolio holdings report that is used to assist the SEC in monitoring and analyzing money funds (Form N-MFP). The final rules also modify a confidential reporting form applicable to certain private fund advisers (Form PF) to require additional information about liquidity funds they advise — i.e., unregistered private funds that seek to maintain a stable NAV and thus can resemble money funds.
Amendments to Prospectus/SAI Disclosure Requirements
The final rules amend the disclosure requirements for a money fund's registration statement on Form N-1A to require disclosure reflecting the new liquidity fee framework and new disclosure regarding the potential use of an RDM.
Compliance Deadlines
Effective Dates
The final rules will become effective 60 days after publication in
the Federal Register (which has not yet occurred as of the date of
this Client Alert), with the exception of the amendments to Forms
N-MFP, N-CR, and PF, which have a delayed effective date of June
11, 2024.
Compliance Dates
The SEC adopted a tiered transition period for money funds to
comply with the final rules, which is summarized in the chart
below. Affected money funds may voluntarily choose to begin to rely
on the mandatory and discretionary liquidity fee provisions at any
time between the amendment's effective date and the applicable
compliance date.
For the amendments to Forms N-MFP, N-CR, and PF, the SEC adopted a
simultaneous effective and compliance date of June 11, 2024, to
provide for a uniform transition to the updated reporting
requirements. Accordingly, all reports filed on or after June 11,
2024 must comply with the amendments, and filers will not be
permitted to voluntarily provide the newly required information
prior to then.
In addition, there is no separate compliance date for certain
amendments to the final rules. As a result, funds must be in full
compliance with these amendments by 60 days after publication in
the Federal Register. In light of the extremely short period before
these amendments become mandatory, money funds and their advisers
should promptly begin to consider what actions would be necessary
or appropriate to take prior to the effective date. The amendments
subject to this short transition period include the removal of
redemption gates, the removal of the tie between liquidity fees and
liquidity thresholds, the new provision allowing the use of RDM in
certain circumstances, the amendments to the registration statement
disclosure requirements on Form N-1A, and the amendments to the
recordkeeping rule to require money funds to preserve records
regarding their liquidity fee computations.
Reform |
Effective Date |
Compliance Date |
All Reforms under the Final Rules Not Listed Below, Including:
|
60 days After Publication in the Federal Register |
Immediately Upon Effective Date (i.e., 60 days After Publication in the Federal Register) |
Amendments to Portfolio Liquidity Requirements, Including Increase to Minimum Portfolio Liquidity Requirements |
6 Months After Effective Date |
|
Amendments Related to WAM/WAL Calculations |
6 Months After Effective Date |
|
Discretionary Liquidity Fee Requirement |
6 Months After Effective Date |
|
Mandatory Liquidity Fee Requirement |
12 Months After Effective Date |
|
Amendments to SEC Reporting Requirements (Forms N-MFP, N-CR, PF) |
June 11, 2024 |
June 11, 2024 |
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.