Regulatory Advisory on Money Market Funds
Details to Rule Changes
In January 2009, the Securities and Exchange Commission (SEC) voted to adopt new rules to strengthen money market funds. The new rules focus on limiting risks associated with money market funds, increasing protection of investors, improving fund operations, and enhancing fund disclosures. Responding to a tumultuous year in the money market fund world, SEC Chairman Mary Schapiro stressed that these rules changes were "just the first step" in efforts to improve money funds' ability to withstand market turmoil and future crises.
The amendments are designed to increase the resilience of money market funds to economic stresses, reduce the risks of runs on funds, facilitate the orderly liquidation of a money market fund (MMF) that breaks, or is about to break, the buck, and improve the SEC's oversight of money market funds. The Amendments seek these goals by:
- tightening liquidity requirements
- imposing higher credit-quality requirements
- shortening portfolio maturity limits
- addressing reliance on rating agencies
- enhancing disclosure of portfolio holdings, and
- addressing issues that arise when money market funds experience market challenges.
Some of the new rules passed by the SEC have mandatory compliance dates as early as May 5, 2010. In the specific instance that a fund has an existing fundamental policy that is less restrictive than the amendments as adopted by the SEC (and does not conflict with those amendments), the fund would not need to hold a shareholder vote in order to comply.
The compliance date for amendments to rule 2a-7 related to portfolio quality, maturity, liquidity, and repurchase agreements, is May 28, 2010. A fund is not required to dispose of securities owned, or to terminate repurchase agreements entered into, as of the time of adoption of the amendments to comply with the new requirements.
Summary of the Rules
The new rules adopted by the Commission will amend Rule 2a7 under the Investment Company Act. They impose minimum liquidity requirements, implement daily and weekly liquidity requirements, and restrict the ability of funds to purchase illiquid and lower quality securities. The SEC voted to implement liquidity standards forcing funds to have enhanced reserves of cash and securities that can readily be converted to cash, should investors make requests for redemptions. Further, the Commission voted to impose requirements on credit ratings which relate to fund investments. They require that funds designate at least four nationally recognized statistical rating organizations (NRSROs) whose ratings are seen as reliable.
The SEC also implemented new rules for tier-2 securities, and set additional limits on the amounts that funds can invest. The SEC voted that money market funds can invest up to 3 percent of total fund assets in tier-2 securities. This is down from the previous level of 5 percent but not the 0 percent that was originally proposed. Additionally, the SEC enacted rules that limit funds to investing 0.5% of fund assets in each tier-2 issuer. This is down from the previous level of 1%. Finally, the term for investing in tier-2 securities is limited to a maximum maturity of 45 days.
The Commission also passed rules that enhanced disclosure requirements for money market funds. According to the new rules, money funds will have to provide monthly disclosures of detailed fund information to include holdings in each fund. These reports must be made and published on their websites within 5 days after the end of the month. Additionally, money funds will also be required to include the funds' shadow net asset value (NAV). The SEC believes this new requirement will make funds less vulnerable to runs. It also will force MMFs to disclose if they are processing, or can process, transactions at prices other than $1. SEC staff will collect and maintain all of this information in a newly created database that will be used for all money market funds and will be available to the public after 60 days.
Compliance Date: May 28, 2010
The amendments limit the purchase of illiquid securities to no more than 5 percent of a fund's portfolio (down from the current 10 percent limit). An illiquid security is defined as one that cannot be sold or disposed of within seven days at carrying value. There also is a new requirement that requires taxable money market funds to have a minimum of 10 percent of assets in cash (including demand deposits), U.S. Treasury securities and securities (including repurchase agreements) that convert to cash (e.g., mature) within one day. The amendments also require all money market funds to have a minimum of 30 percent of assets in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert to cash within one week.
Additionally, the rules require a fund to hold sufficient liquid securities to meet reasonably foreseeable redemptions. In order to meet this requirement, funds would need to develop procedures to identify investors whose redemption requests could pose risks for the fund. As a part of these procedures, a fund would need to anticipate the likelihood of large redemptions.
Finally, the amendments require fund managers to examine the fund's ability to maintain a stable net asset value (NAV) per share in the event of shocks such as interest rate changes, higher redemptions, changes in credit quality of the portfolio and changes to credit spreads. Stress testing should be carried out at such intervals as the board of directors determines appropriate and reasonable in light of current market conditions. The fund must report to its board the magnitude of the hypothetical events (or concurrent events) that would cause the fund's shadow price to deviate from its amortized cost value by 1/2 of 1 percent, as well as an assessment by the investment adviser of the fund's ability to withstand the events (and concurrent occurrences of those events) that are reasonably likely to occur within the following year. This approach echoes the approach of many money market funds to shadow pricing, where shadow prices are calculated more frequently as the deviation between the market value and amortized cost of a fund share increases. The SEC said that funds should incorporate into their stress testing procedures their evaluation of the liquidity needs of their shareholder base. The fund's board must receive a report on the stress testing at their next regularly scheduled meeting and more frequently, if appropriate, in light of the results.
Compliance Date: May 28, 2010
Under the amendments, the SEC has tightened its current requirement by restricting a fund from investing no more than 3 percent of assets in second tier securities (securities rated in the second-highest short-term rating category by rating agencies), rather than the current limit of 5 percent. Further, a fund cannot invest more than 1/2 of 1 percent of its assets in second tier securities of any single issuer, rather than the current limit of the greater of 1 percent or $1 million. Finally, funds may not purchase any second tier security that matures in more than 45 days (rather than the current 397 days, which is the generally applicable maximum under the previous Rule). The amendments forbid a fund from investing more than 2 1/2 percent of assets (reduced from 5 percent) in securities issued by or subject to demand features or guarantees from the provider of the demand feature or guarantee.
Compliance Date: June 30, 2010
The SEC voted to amend the rules to reduce the maximum weighted average maturity (WAM) for a fund from 90 days to 60 days.The amendments also restrict the maximum weighted average life (WAL) of a fund to 120 days. WAL is a new, more restrictive method of calculating average portfolio maturity, intended to ensure that funds can maintain stability even during volatile markets. Under the current rule, a fund is permitted to deem the maturity of certain variable rate instruments to be shortened to less than their face maturity, based on, among other things, the next date the interest rate on the instruments is readjusted. In effect, for purposes of calculating maturity, the security is treated as if it were a series of short-term obligations that each matures on the next succeeding interest rate reset date. But, the SEC explains, a security with a deemed shorter maturity is more volatile than a security that actually matures on the interest reset date. Therefore, they have concluded that the shortened maturity is not an accurate measure of the volatility of the security. Further, while the interest rate adjustment may offer some protection against interest rate changes in the marketplace, permitting maturity shortening does not protect against liquidity risk to the portfolio.
The new WAL calculation excludes that type of maturity shortening approach when calculating weighted average portfolio maturity. As a result, the maturity of a portfolio calculated under the WAL method is longer than it would be using the customary WAM methodology.
This amendment does not affect a money market fund's existing ability under the rule to shorten maturity based on the period until principal can be recovered by demand under a demand feature. A demand feature is a right to demand payment of amortized cost plus accrued interest during the life of the security.
Finally, Rule 2a-7 previously permitted a fund that relied exclusively on the penny-rounding method of pricing to acquire government securities with remaining maturities of up to 762 days. The amendments eliminate this provision, requiring that the fund meet the generally applicable maximum within 397 days.
Designation of NRSROs
Compliance Date: December 31, 2010
Under the new amendment , money market funds will be limited to investing in securities that are determined by the adviser to present minimal credit risk, and rated in the top two rating categories by rating agencies (or unrated securities that are of comparable quality to securities with such ratings). The amendments require a fund's board to annually designate at least four rating agencies whose ratings the board considers to be reliable to be used by the fund to determine whether a security meets the rule's rating criteria. The board also will be responsible at least once each calendar year to determine that the ratings by those agencies are sufficiently reliable for that use. The fund must identify the designated rating agencies in the fund's statement of additional information by no later than December 31, 2010. The fund may disregard ratings by rating agencies that have not been designated, for purposes of assessing quality of a security and monitoring for downgrades that may require the fund to reassess or dispose of a security.
Currently there are 10 rating agencies registered with the SEC, though not all of them rate securities held by all money market funds. The SEC stated that the amendments are intended to foster competition among rating agencies to develop a specialized service of providing short-term ratings to money market funds and hopefully will improve the quality of ratings. The SEC also said that when the fund's board designates rating agencies, it should have the benefit of the adviser's evaluation of the quality of the rating agencies' ratings. Various rating agency information currently is publicly available, including statistics showing downgrades and defaults on securities rated by the agency as well as the agency's policies and procedures to address conflicts of interest (which may arise, for example, because ratings are paid for by the issuer of the security).
Currently, Rule 2a-7 requires that all asset backed securities be rated (other than asset backed securities backed by municipal securities). The new amendments eliminate this requirement allowing funds to acquire unrated asset backed securities that otherwise meet the requirements of the Rules.
Disclosure and Reporting
Compliance Date: October 7, 2010 & December 7, 2010
The amendments require money market funds to report to the SEC, on a monthly basis, detailed portfolio schedules in a format that can be used to create an interactive database. This will allow the SEC to better oversee the activities of money market funds (Form N-MFP). This information would include the money market fund's shadow or market-based price, and the market value of each of the fund's securities. Information reported to the SEC would be available to the public after a 60-day delay. All money market funds must begin filing information on Form N-MFP no later than Dec. 7, 2010. Filing is required by five business days after month end, with information as of the end of the preceding month. SEC staff will be able to receive nonpublic trial data beginning Oct. 7, 2010. Currently, the SEC has no such database of money market fund information.
The amendments require funds to post their portfolio holdings on their Web site each month and to maintain the information on their Web site for six months. The compliance date for public Web site disclosure is Oct. 7, 2010. Web site posting is required by five business days after month end, with information as of the end of the preceding month. Money market funds must continue to report more detailed holdings to the SEC four times a year on Form N-Q and Form N-CSR no earlier than 60 days after the close of the quarter. The disclosures must include the following information for each security:
- Name of the issuer
- Category of investment (e.g., Treasury Debt, Asset Backed Commercial Paper, etc.)
- CUSIP (if any)
- Principal amount
- Maturity date
- Final legal maturity (i.e., without benefit of the interest rate maturity reset provisions for floating-rate and variable-rate securities;
- Coupon or yield and
- Amortized cost value.
In addition the posting must include, for each class of the fund, the WAM and the WAL as of the last business day of the prior month. The fund must also include a link to the SEC's web site where the user may find the most recent 12 months of filings of the its Form N-MFP. Each posting must remain on the fund's Web site for at least six months.