Checklist for Fund Investors of Repurchase Agreement in the Event of Dealer Insolvency

This checklist is designed primarily to detail the steps that a fund investor (e.g., money market fund) (“Fund”) would take in order to liquidate securities (“Collateral”) subject to a repurchase agreement (“repo”) with a dealer (“Dealer”) that becomes insolvent after entering into the repo.

This checklist assumes that a Fund has entered into a tri-party repo with a Dealer. A tri-party repo is one where the Fund purchases securities from the Dealer subject to the Dealer’s agreement to repurchase the securities at an agreed upon date and price. During the term of the repo the Collateral is kept at a third party subcustodian (“Subcustodian”) in a custody account (“Segregated Account”). If the Fund has another custodian (“Custodian”), the Segregate Account may be maintained in the name of the Custodian for the benefit of the Fund. This checklist also assumes that the applicable bankruptcy safeharbor provisions apply that permit the Fund to liquidate the securities subject to the repo. Additionally, it assumes that there is a one-day automatic stay before the Fund is permitted to liquidate the securities subject to the repo following the appointment of the Federal Deposit Insurance Corporation but that no order has been authorized by the Securities Investor Protection Act of 1970 or any statute administered by the Securities and Exchange Commission (“SEC”) that would prevent the Fund from liquidating the Collateral after the one-day stay.

1. Preliminary Steps¹

[ ]	Review the Master Repurchase Agreement (“MRA”) and related Subcustodial Undertaking among the Fund, Dealer, and Subcustodian for the provisions relating to events of default and resulting transfers or sales of the Collateral. If using a liquidation agent to sell Collateral following a repo default event (“Liquidation Agent”), prepare and execute a contract with the Liquidation Agent.
[ ]	Discuss repo default procedures with the Subcustodian, Custodian, and any Liquidation Agent and obtain and review their forms or other templates available for such events.
[ ]	Review pricing policies and procedures and other trading, accounting, and portfolio systems to determine system capabilities to ensure ability to hold, value, and trade Collateral as necessary. If the Fund is a money market fund, confirm that systems can account for securities with remaining maturities in excess of 397 days or that are otherwise not Eligible Securities as defined by Rule 2a-7 under the Investment Company Act of 1940. If system changes are not feasible, develop manual process to work around system limitations.
[ ]	Prepare standing settlement instructions (“SSIs”) regarding various repo default events for Subcustodian, Custodian, and, if applicable, Liquidation Agent. If Collateral may be maintained at the Subcustodian after default, obtain necessary forms and authorizations to allow the Fund to clear and settle trades through the Subcustodian.
[ ]	Consider changes to the Fund’s disclosure documents (e.g., prospectus), including adding a possible risk factor regarding repos in the event of a Dealer’s insolvency or other type of default.

2. Event of Default

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Event of Default under the MRA: Under Section 11 of the MRA, an Event of Default is triggered if, among other events, an Act of Insolvency² occurs with respect to the Dealer. Under section 11(a) of the MRA an Event of Default due to an Act of Insolvency by the Dealer will be deemed to be declared automatically without notice from the Fund and the date on which the Dealer is to repurchase the Collateral, if it has not already occurred, will be deemed immediately to occur.

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Implications under Rule 2a-7: Such an event is a default and/or Event of Insolvency with respect to the repo under Rule 2a-7. In such a situation, the money market fund is required to dispose of the security “as soon as practicable consistent with an orderly disposition of the security…absent a finding by the board of directors that disposal of the portfolio security would not be in the best interests of the money market fund.”³

3. Notice and Instructions to Subcustodian

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Fund Delivers Notice of Default to Subcustodian: Generally, under the Subcustodial Undertaking, the non-defaulting party (e.g., Fund) will be required to deliver a written notice of the Event of Default (“Notice of Default”) to the Subcustodian. Upon receipt of the Notice of Default, the Subcustodian is required to act in accordance with the instructions of the non-defaulting party (e.g., Fund) with respect to its rights under the MRA.

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Fund (or Custodian) Instructs Subcustodian Regarding Collateral: The Subcustodial Undertaking generally provides that upon receipt of the Notice of Default, the Subcustodian is instructed to (i) cease transferring the Collateral or cash between the Segregated Account and the Dealer’s account; and (ii) to follow exclusively the Fund’s SSI or the Custodian’s instructions with respect to the Collateral in the Segregated Account.⁴

[ ] Fund (or Custodian) Instructs Subcustodian to Transfer Collateral to the Fund’s account at the Custodian: Using the SSI, the Fund (or Custodian) should instruct (e.g., via SWIFT) the Subcustodian to transfer (e.g., via DTCC, Fedwire⁵) the Collateral in the Segregated Account to its account at the Custodian. The Fund also should instruct the Custodian to accept/receive the Collateral into the Fund’s account at the Custodian. The Fund also may need to provide the Custodian with certain information such as the identity of the delivering party, CUSIPs of the Collateral, and the amount to be delivered. The Custodian should reconcile the Collateral received and note any pending or upcoming corporate actions.

[ ] Fund instructs Subcustodian to Continue to hold the Collateral in the Fund’s Segregated Account or Other Account at the Subcustodian: Using the SSI, the Fund (or Custodian) should instruct the Subcustodian to hold the Collateral in the Segregated Account or in a separate trading account at the Subcustodian. The Collateral can be traded from the Segregated Account or separate trading account or kept in the Segregated Account for safekeeping.

4. Valuation and Liquidation of Collateral/Accounting Issues

[ ]	An Event of Default under the MRA by the Dealer and Notice of Default under the Subcustodial Undertaking would, under generally accepted accounting principles, require the Fund to derecognize the repo and recognize the Collateral on its books at fair value (FASB ASC 860-30-25-5). Where the fair value of the Collateral exceeds the repo price, the difference would be recognized as a liability (reflecting the Fund’s obligation under bankruptcy law to return the excess to the Dealer). Where the fair value of the Collateral is less than the repo price, the deficiency is a realized loss. In this instance, the Fund also would have a bankruptcy claim against the Dealer for the deficiency, which would be recognized at fair value.
[ ]	In accordance with the MRA, determine whether to: [ ] immediately sell the Collateral (through a Liquidation Agent, if applicable) and apply the proceeds to the aggregate unpaid repo price and any other amounts owed by the Dealer (such as interest or expenses incurred as a result of the Event of Default), or [ ] in lieu of selling the Collateral, give the Dealer credit against the aggregate unpaid repo price and any other amounts owed by the Dealer, in an amount equal to the fair value of the Collateral.
[ ]	If the Fund continues to hold the Collateral, the fair value of the Collateral should be included in calculating the Fund’s shadow net asset value, as should any liability under bankruptcy law to turn over any value in excess of the Repurchase Price. Under these circumstances, the Fund would be likely to calculate its shadow net asset value on a daily basis, so the Collateral would need to be marked to market daily. A Fund should ensure that a board approved pricing vendor can provide prices in time for the Fund’s shadow net asset value calculation. The Fund would accrue income on the Collateral at the effective interest rate (reflecting any premiums/discounts) beginning at the time it recognizes the Collateral on its books.
[ ]	Where the fair value of the Collateral is less than the repurchase price, a Fund that is a money market fund should closely monitor the fund’s shadow net asset value.

5. Board Notifications, Submissions and Actions

[ ]	For Funds that are money market funds, prepare submissions to Board of Directors (“Board”) regarding: Repo default and/or Event of Insolvency and whether deviation of the money market fund’s amortized cost price per share from its market-based net asset value per share exceeds 0.50% [Rule 2a-7(c)(7)(ii)(B)]; Nature of the Collateral and current market value; The Fund’s dollar-weighted average maturity after taking the Collateral into account; Collateral liquidity plan (e.g., sell Collateral promptly to reduce size of defaulted position and mitigate the loss to the money market fund); and Other actions required by the Fund’s procedures.
[ ]	If the current market value of the Collateral would create a significant deviation of a money market fund’s amortized cost price per share from its market-based net asset value per share, determine what additional notifications to the Board are necessary.
[ ]	Call and give notice of a Board meeting in accordance with organizational documents.
[ ]	If it is determined that shareholder notification is necessary (e.g., the Board has determined to suspend redemptions and liquidate the money market fund), authorize the filing of a prospectus supplement.
[ ]	Dispose of any Collateral that is not an Eligible Security as soon as practicable consistent with an orderly disposition of the security absent a finding by the Board that disposal of the security would not be in the best interests of the money market fund.⁶
[ ]	Contact SEC’s Division of Investment Management if the defaulted repo accounted for 0.50% or more of a money market fund's total assets immediately prior to the default [Rule 2a‑7(c)(7)(iii)].

6. Form N-MFP/Website Portfolio Disclosure/Financial Statements

[ ]	If a Fund that is a money market fund crosses a month end, it should be prepared to report the Collateral in its monthly website posting required under Rule 2a-7 and in Form N-MFP required under Rule 30b1-7.
[ ]	Funds that cross a financial reporting period end should be prepared to report the Collateral in the schedule of investments in their financial statements.

7. Follow-up Items

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endnotes

¹ We recommend taking these steps as part of the contingency planning process, so that procedures can be developed and implemented in short order.

² See Section 2(a) of the MRA for the definition of an “Act of Insolvency.” Such definition includes the “commencement by such party as debtor of any case or proceeding under the bankruptcy, insolvency, reorganization, liquidation, moratorium, dissolution, delinquency or similar law."

³ The SEC has cautioned money market funds and their boards about the risk of repo defaults. “Fund directors should be aware of the risks of investing in repurchase agreements that are collateralized by instruments with remaining maturities of greater than one year. If the fund were required to realize on the collateral underlying the repurchase agreement, these instruments would have to be taken into account in calculating the fund’s dollar-weighted average portfolio maturity. The fund would have to dispose of the collateral as soon as possible if the instruments constituting the collateral caused the fund’s average portfolio maturity to exceed ninety days or did not satisfy the remaining maturity condition of the rule.” See Revisions to Rules Regulating Money Market Funds, SEC Release No. IC-18005 (February 20, 1991), 56 FR 8113 (February 27, 1991), at note 33 and accompanying text.; see also Valuation of Debt Instruments and Computation of Current Price Per Share by Certain Open-End Investment Companies (Money Market Funds), SEC Release No. IC-13380 (July 11, 1983), 48 FR 32555 (July 18, 1983), at note 29 (noting that long-term instruments, including Government securities, expose a fund to greater interest rate risk than short-term instruments). Under the 2010 amendments to Rule 2a-7, money market funds are required to maintain a weighted average maturity limit of 60 days.

⁴ Upon receipt of a Notice of Default and SSI or other accompanying instructions regarding the Collateral, the Subcustodian may conduct a review of the Collateral to ensure that the Collateral in the Fund's account is the same as was previously reported to the Fund. The Subcustodian’s legal department also may authenticate the Notice of Default and SSI or other accompanying instruction and review the terms of the MRA, Subcustodial Undertaking or other such contracts.

⁵ There may be charges associated with this transfer.

⁶ See supra note 3.