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Money Market Fund Reform: 2010 SEC Amendments
The Securities and Exchange Commission (SEC) in January 2010 approved amendments to Rule 2a-7 under the Investment Company Act of 1940, the rule that governs the operations of money market funds. 1 The amendments tighten fund liquidity requirements, impose stricter quality requirements, address reliance on rating agencies, impose stricter maturity limits, require enhanced disclosure of portfolio holdings and address issues that arise when a money market fund experiences market challenges. The amendments are designed to make money market funds more resilient to certain short-term market risks, and to provide greater protections for investors in a money market fund that is unable to maintain a stable net asset value (NAV) per share.
Further Restricts Risks by Money Market Funds
Improved Liquidity: The rules require money market funds to hold sufficiently liquid securities to meet foreseeable redemptions (currently there are no such requirements). In order to meet this requirement, funds need to develop procedures to identify investors whose redemption requests may pose risks for funds. As part of these procedures, funds need to anticipate the likelihood of large redemptions. The rules also require that funds have a minimum percentage of their assets in highly liquid securities so that those assets can be readily converted to cash to pay redeeming shareholders (currently there are no minimum liquidity mandates):
Daily Requirement: For all taxable money market funds, at least 10 percent of assets must be in cash, U.S. Treasury securities, or securities that convert into cash (e.g., mature) within one day.
Weekly Requirement: For all money market funds, at least 30 percent of assets must be in cash, U.S. treasury securities, certain other government securities with remaining maturities of 60 days or less (which appear to include agency securities), or securities that convert into cash within one week.
The rule further restricts the ability of money market funds to purchase illiquid securities by:
Restricting money market funds from purchasing illiquid securities if, after the purchase, more than 5 percent of the fund’s portfolio will be illiquid securities (rather than the current limit of 10 percent).
Redefining as “illiquid” any security that cannot be sold or disposed of within seven days at approximately the market value ascribed to it by the fund.
Higher Credit Quality: The rules place new limits on a money market fund’s ability to acquire lower quality (Second Tier) securities. They do this by:
Restricting a fund from investing more than 3 percent of its assets in Second Tier securities (rather than the current limit of 5 percent).
Restricting a fund from investing more than 0.5 percent of its assets in Second Tier securities issued by any single issuer (rather than the current limit of the greater of 1 percent or $1 million).
Restricting a fund from buying Second Tier securities that mature in more than 45 days (rather than the current limit of 397 days).
Shorter Maturity Limits: The rules shorten the average maturity limits for money market funds, which would help to limit the exposure of funds to certain risks such as sudden interest rate movements. They 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 is 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).
Periodic Stress Tests: The rules require fund managers to examine the fund’s ability to maintain a stable NAV per share in the event of shocks—such as interest rate changes, higher redemptions, and changes in credit quality of the portfolio (currently there are no stress test requirements).
Nationally Recognized Statistical Rating Organizations (NRSROs): The rules continue to limit a money market funds’ investment in rated securities to those securities rated in the top two rating categories (or unrated securities of comparable quality). At the same time, the rules also continue to require money market funds to perform an independent credit analysis of every security purchased. As such, the credit rating continues to serve as a screen (or a floor) on credit quality, but can never be the sole factor in determining whether a security is appropriate for a money market fund.
In addition, the rules improve the way that funds evaluate securities ratings provided by NRSROs. They do this by:
Requiring funds to designate each year at least four NRSROs whose ratings the fund’s board considers to be reliable. This will permit a fund to disregard ratings by NRSROs that the fund has not designated, for purposes of satisfying the minimum rating requirements, while promoting competition among NRSROs.
Eliminating the current requirement that funds invest only in those asset backed securities that have been rated by an NRSRO.
Repurchase Agreements: The rules strengthen the requirements for allowing a money market fund to “look through” the repurchase issuer to the underlying collateral securities for diversification purposes:
Collateral must be cash items or government securities (as opposed to the current requirement of highly rated securities).
The fund must evaluate the creditworthiness of the repurchase counterparty.
Enhances Disclosure of Portfolio Securities
Monthly Website Posting: The rules require money market funds each month to post on their Web sites their portfolio holdings (currently there is no website posting requirement). Portfolio information must be maintained on the fund’s website for no less than six months after posting.
Monthly Reporting: The rules also require money market funds each month to report to the SEC detailed portfolio schedules in a format that can be used to create an interactive database through which the SEC can better oversee the activities of money market funds (currently the SEC has no such database of money market fund information). Information reported to the SEC will be available to the public on a 60-day delay. Most significantly, this information includes a money market fund’s “shadow” NAV, or the mark-to-market value of the fund’s net assets, rather than the stable $1.00 NAV at which shareholder transactions occur (currently a money market fund’s “shadow” NAV is reported twice a year, with a 60-day delay).
Improves Money Market Fund Operations
Processing of Transactions: The rules require that all money market funds and their administrators be able to process purchases and redemptions electronically at a price other than $1.00 per share (currently there is no such explicit requirement). This requirement facilitates share redemptions if a fund were to “break the dollar.”
Suspension of Redemptions: The rules permit a money market fund’s board of directors to suspend redemptions if the fund is about to break the dollar and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund will be required to notify the SEC prior to relying on this rule.
Purchases of Affiliates: The rules 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 permits such purchases without the need for approval under conditions that protect the fund from transactions that disadvantage the fund. The fund will have to notify the commission when it relies on this rule.
1 Money Market Reform, SEC Release No. IC-29132 (January 27, 2010)