On December 15, 2021, by a 3-2 vote, the Securities and Exchange Commission (SEC or Commission) proposed amendments to the rules and forms relating to money market funds.1 The proposed amendments would remove the liquidity fee and redemption gate provisions from Rule 2a-7 under the Investment Company Act of 1940 (1940 Act), require certain money market funds to implement swing pricing policies and procedures, and require money market funds to increase their daily and weekly liquid asset minimum requirements. In addition, the proposed amendments would require certain money market funds to take certain actions in anticipation of a negative interest rate environment, specify that market value must be used in calculating dollar-weighted average portfolio maturity (WAM) and dollar-weighted average life maturity (WAL), and make certain related changes to stress testing, reporting and disclosure requirements for money market funds. The comment period for these proposed amendments ends 60 days after the publication of the proposal in the Federal Register.
These amendments are the latest in a series of amendments to the rules governing money market funds, the first of which were adopted in the aftermath of the 2008 financial crisis. The amendments seek to address provisions in the rules that the Commission believes contributed to investors’ incentives to redeem from certain money market funds during the economic shock resulting from the COVID-19 pandemic, to mitigate the harm to investors caused by other investors redeeming, and to better equip money market funds to manage significant and rapid investor redemptions.
Liquidity Fees and Redemption Gates
The proposed amendments would eliminate provisions that permit non-government money market funds to impose a liquidity fee of up to 2% or to temporarily suspend redemptions (i.e., a redemption gate) if the fund’s weekly liquid assets2 fall below 30%, and requires such funds to impose a liquidity fee of up to 1% if weekly liquid assets fall below 10% (unless the fund’s board determines that imposing such a fee is not in the best interests of the fund). These provisions, which were adopted in 2014, were designed to provide a “cooling off” period during times of market stress and to better allocate the costs of providing liquidity to redeeming investors. However, the Commission believes that the possibility of a fund imposing a liquidity fee or redemption gate created incentives for investors to redeem early and for managers to maintain weekly liquid asset levels above the threshold by using other assets to satisfy redemptions.3 As a result, these options failed to provide the benefits to the funds that were intended.
To address the failure of these tools to have the intended effect, the Commission proposes to no longer permit or require money market funds to impose liquidity fees or redemption gates. Money market funds will continue to be permitted to suspend redemptions of a liquidating fund under Rule 22e-3, and would be permitted to elect to impose a redemption fee under Rule 22c-2. The Commission is seeking comment on various alternatives, including decoupling liquidity fees and redemption gates from weekly liquid asset levels and/or lowering the thresholds.
In order to address shareholder dilution and potential institutional investor first-mover incentives, the Commission is proposing a swing pricing requirement for institutional prime and institutional tax-exempt money market funds. Swing pricing is a process of adjusting a fund’s net asset value such that redeeming shareholders pay the costs associated with raising the liquidity needed to satisfy their redemption, reducing the potential dilution of non-redeeming investors in the fund and reducing the first-mover advantage. The proposed requirement would apply to institutional prime and tax-exempt money market funds whenever the fund has net redemptions for a pricing period. A fund would calculate its swing factor4 based upon the estimated spread and other transaction costs of selling a vertical slice of its portfolio to meet its net redemptions. If net redemptions exceed a “market impact threshold,” defined as 4% of the fund’s net assets divided by the number of pricing periods the fund has in a business day, the fund would also be required to include a market impact factor in its calculation of the swing factor.
The proposal also requires the fund to adopt board-approved swing pricing policies and procedures, which must be implemented by a board-designated “swing pricing administrator,” and the swing pricing program must be reasonably segregated from portfolio management of the fund and may not include portfolio managers. The swing pricing administrator would be required to provide, no less frequently than annually, a written report to the fund’s board. The fund would also be subject to recordkeeping requirements designed to provide the Commission’s staff with the ability to review the fund’s swing pricing program.
Portfolio Liquidity Requirements
The proposal would increase the daily5 and weekly liquid assets thresholds from 10% and 30%, respectively, under current Rule 2a-7 to 25% and 50%, respectively. The Commission believes that increasing these thresholds will provide a more substantial buffer to help funds manage significant and rapid investor redemptions while maintaining the funds’ flexibility to invest in diverse assets during normal market conditions. As with current Rule 2a-7, these thresholds are measured at the time a security is acquired, which means that if a fund fails to satisfy these thresholds, it would not need to take any action, but would not be permitted to acquire additional assets other than daily and/or weekly liquid assets, as the case may be, until its portfolio meets the minimum thresholds. However, a fund with less than 12.5% of its total assets in daily liquid assets or less than 25% in weekly liquid assets would be required to notify its board within one business day of these events, and to provide the board with a brief description of the facts and circumstances that led to the event within four business days after its occurrence.
Impact of Negative Interest Rates on Money Market Funds
In the Proposing Release, the Commission notes the pervasive low interest rate environment and the challenges this poses for money market funds, particularly government money market funds. The Commission acknowledges that although Rule 2a-7 currently does not explicitly address how money market funds must operate when interest rates are negative, a money market fund may not be able to maintain a stable net asset value in a negative interest rate environment, and would need to convert to a floating share price. While the Commission believes that Rule 2a-7 provides sufficient flexibility for a fund to respond to negative interest rates, and it is not proposing any changes to the Rule 2a-7 pricing provisions at this time, it is proposing to expand government and retail money market funds’ obligations to confirm that they can fulfill shareholder transactions if they convert to a floating share price. Specifically, government and retail funds would be required to determine that financial intermediaries that submit orders to purchase or redeem shares have the capacity to redeem and sell the fund’s shares at a floating price and, if this determination cannot be made, those financial intermediaries would be prohibited from purchasing the fund’s shares in nominee name.
Other Proposed Amendments
The Commission also proposes to amend Rule 2a-7 to specify that calculations of WAM and WAL be calculated based on each security’s market value (as opposed to amortized cost). The Proposing Release noted that while most money market funds use market value in these calculations, other money market funds use amortized cost, which could lead to investor confusion in comparing funds’ WAM and WAL.
The Commission also proposed amendments to the money market fund stress testing requirements in light of the proposed increase in the daily liquidity threshold and the proposed elimination of the required liquidity fee that is currently triggered by falling below the 10% daily liquidity threshold. Instead, the Commission is proposing that money market funds test whether they are able to maintain sufficient minimum liquidity under the specified hypothetical events. Each money market fund will be permitted to determine the level of liquidity that it considers sufficient.
Proposed amendments to Form N-CR would require a money market fund to file a report on Form N-CR when the fund falls below half of the daily or weekly liquidity thresholds (12.5% or 25%, respectively), and to file reports in eXtensible Markup Language (XML), and would require additional information to be included in filings of Forms N-CR and N-MFP. Finally, the Commission is proposing certain amendments to Form N-1A to reflect the proposed changes to Rule 2a-7.
Proposed Implementation Dates
The Commission proposes to require institutional and tax-exempt money market funds to comply with the proposed swing pricing requirement, and to make related disclosures, 12 months after the effective date of the amended rule, and for government and retail money market funds to determine within 12 months after the effective date of the amended rule that intermediaries have the capacity to redeem at current net asset value per share.
The proposed implementation date of all other aspects of the proposal (except the removal of the liquidity fee and redemption gate provisions of the current rule, which would be effective immediately upon the effective date of the proposed new rule) would be six months after the effective date of the amendments.