SEC Proposes Amendments to Money Market Fund Rules

Investment Management Update

Date: January 10, 2022

On December 15, 2021, the Securities and Exchange Commission (SEC) proposed amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended (“Proposed Rule”). The Proposed Rule is meant to address concerns about money market funds brought to light by the events of March 2020, when investors, concerned with COVID-19’s potential impacts on the economy, allocated significant funds to cash and short-term government securities (including government money market funds), while at the same time allocating a significant amount of funds away from prime and tax-exempt money market funds. This significant reallocation and resulting heavy asset flow placed stress on short-term funding markets, which greatly impacted the operation of money market funds.

If adopted, the proposal would result in

  • the removal of liquidity fee and redemption gate provisions;
  • the adoption of a swing pricing requirement;
  • an increase in portfolio liquidity requirements;
  • a change in reporting requirements on Forms N-CR and N-MFP;
  • the prohibition of certain practices used by funds in negative interest rate environments to maintain a stable net asset value; and
  • the specification of dollar-weighted average portfolio maturity (WAM) and dollar weighted average life maturity (WAL) calculations.
Liquidity Fee and Redemption Gate Provisions

The Proposed Rule would remove the liquidity fee and redemption gate provisions from Rule 2a-7. Currently, money market funds can impose a liquidity fee or redemption gate (i.e., a temporary suspension of redemptions) after crossing a specified liquidity threshold. These provisions were originally meant to reduce the impacts of short-term investor panic and preserve liquidity. During March 2020, however, the liquidity fee and redemption gate provisions appeared to exacerbate investor panic because investors redeemed their funds in large amounts, fearing they would either be subject to a fee or otherwise prevented from redeeming their shares for a certain period of time. The proposal would not impact a fund’s ability to suspend redemptions under Rule 22e-3 in connection with a liquidation.

Swing Pricing

The Proposed Rule would institute a swing pricing requirement specifically for institutional prime and tax-exempt money market funds that would apply when a fund experiences net redemptions during a specified pricing period. Swing pricing is designed to ensure that the costs stemming from net redemptions are fairly allocated and do not give rise to a first-mover advantage or cause dilution of the remaining investors’ interests in the fund. Under the proposal, an institutional fund would be required to adjust its current net asset value (NAV) per share by a swing factor determined by calculating the costs the fund would incur when selling a pro rata amount of each security in its portfolio. This calculation method is designed to ensure that the fund’s adjusted NAV incorporates the cost of selling its less-liquid holdings. For example, without swing pricing, when a shareholder redeems and the fund meets the request using weekly liquid assets (i.e., assets that can be converted to cash in five business days or less), the fund has a higher percentage of less-liquid assets to cover future redemptions, which could result in higher costs for the fund’s remaining shareholders. The swing pricing proposal also includes requirements for administration and board oversight of swing pricing, such as the appointment of a swing pricing administrator, and a requirement that the swing pricing program is reasonably segregated from a fund’s portfolio management function.

Portfolio Liquidity Requirements

Currently, Rule 2a-7 requires that immediately after acquiring an asset, a money market fund must hold at least 10% of its total assets in daily liquid assets (i.e., assets that can be converted to cash within one business day) and at least 30% of its total assets in weekly liquid assets. Under the proposal, the requirements for holdings of daily and weekly liquid assets would be increased to 25% and 50%, respectively. The purpose of this increase is to provide a more substantial buffer if a fund experiences a series of significant and rapid redemptions. In connection with the increase in liquidity requirements, the proposal would remove the stress test required under Rule 2a-7 to test a fund’s ability to maintain 10% in weekly liquid assets under the specified hypothetical events described in the rule and replace it with one requiring the fund to test whether it can maintain “sufficient minimum liquidity,” the level of which would be determined individually by each fund.

Reporting Requirements
Form N-CR

A money market fund is required to file Form N-CR when a portfolio security defaults or experiences an event of insolvency, an affiliate provides financial support to the fund, the fund experiences a deviation between current NAV per share and intended stable price per share, or liquidity fees or redemption gates are imposed or lifted. Under the proposal, a fund would also be required to file Form N-CR if a liquidity threshold event occurs – meaning the fund has less than 25% of its total assets in weekly liquid assets or less than 12.5% of its total assets in daily liquid assets. A fund would also need to notify its board of such a liquidity threshold event within one business day and provide the board with a description of the relevant facts and circumstances within four business days after the liquidity threshold event.

The Proposed Rule, if adopted, would also remove the requirement to file Form N-CR if liquidity fees or redemption gates are imposed or lifted, provide other clarifying amendments, and require the form to be filed in a structured data format.

Form N-MFP

Money market funds use Form N-MFP to report their portfolio holdings and other key information each month. Under the proposal, Form N-MFP would require a money market fund to disclose the name and percent of ownership of each person who owns of record or is known by the fund to own beneficially 5% or more of its shares outstanding. Further, any money market fund that is not a government or retail money market fund would be required to disclose the percentage of shareholders within the following categories: non-financial corporation, pension plan, nonprofit, state or municipal government entity (excluding governmental pension plans), registered investment company, private fund, depository institution or other banking institution, sovereign wealth fund, broker-dealer, insurance company, and other. Additionally, under the proposal, a money market fund that is not a government or retail money market fund would be required to report the number of times it applied a swing factor over the course of the reporting period and each swing factor applied. The Proposed Rule would also add a new Part D to Form N-MFP, which would require disclosure regarding the amount of portfolio securities a prime money market fund sold or disposed of during the reporting period.

Negative Interest Rates

Another concern for the SEC stemming from the events of March 2020 was how stable NAV funds (including government and retail money market funds) should operate in a negative interest rate environment. In its current form, Rule 2a-7 does not explicitly address how a money market fund must operate when interest rates are negative; however, it states that a stable NAV fund may seek to maintain a stable share price by using amortized cost and/or penny-rounding accounting methods, provided the fund’s board believes a stable share price fairly reflects the fund’s market-based NAV per share. If the board believes the stable share price does not fairly reflect the market-based NAV per share, the fund is not be permitted to use amortized cost and/or penny-rounding accounting methods, and instead would need to convert to a floating share price.

Under the Proposed Rule, to aid in the management of a negative interest rate environment, a government or retail money market fund (or the fund’s principal underwriter or transfer agent on its behalf) would be required to determine that financial intermediaries that submit orders to purchase or redeem the fund’s shares have the capacity to redeem and sell the fund’s shares at prices that do not correspond to a stable price per share. If this determination cannot be made, the fund must prohibit the financial intermediary from purchasing the fund’s shares in nominee name. The fund would be required to maintain records identifying the intermediaries it has determined have the capacity to transact at non-stable share prices and the intermediaries for which it was unable to make this determination. Further, the proposal would prohibit a money market fund from operating a reverse distribution mechanism, routine reverse stock split, or other device that would periodically reduce the number of the fund’s outstanding shares to maintain a stable share price.

WAM and WAL

WAM and WAL are calculations of the average maturities of all securities in a portfolio, weighted by each security’s percentage of net assets. The SEC has found that, under the current definitions in Rule 2a-7, funds use different approaches when calculating WAM and WAL. For example, some funds base calculations on the market value of portfolio securities, while others use the amortized cost of each portfolio security. Under the proposal, a money market fund would be required to calculate WAM and WAL based on the percentage of each security’s market value in the portfolio.

Requests for Comment

The Proposed Rule will be published on SEC.gov and in the Federal Register. The comment period will remain open for 60 days after publication in the Federal Register.

FOR MORE INFORMATION

For more information, please contact:

Krisztina Nadasdy
614.469.3243
Krisztina.Nadasdy@ThompsonHine.com

Andrew J. Davalla
614.469.3353
Andrew.Davalla@ThompsonHine.com

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