The SEC Proposed Money Market Fund Reforms

On Wednesday, June 5, 2013, the Securities and Exchange Commission (the “SEC”) voted unanimously to propose rules that would reform the way that certain money market funds operate in order to make them less susceptible to runs that could harm investors.  The SEC’s proposal includes two principal alternative reforms that could be adopted alone or in combination.  One alternative would require a floating net asset value per share (NAV) for prime institutional money market funds.  The other alternative would allow the use of liquidity fees and redemption gates in times of stress.  The proposal also includes additional diversification and disclosure measures that would apply under either alternative.

Under the floating NAV alternative, prime institutional money market funds would be required to sell and redeem shares  at a floating NAV, not at a stable share price of $1.00.  The main features of this alternative are:     

• Floating NAV — Prime institutional money market funds would no longer be able to use the amortized cost method of accounting to value their portfolio securities, except to the limited extent that all mutual funds are able to do so.  Daily share prices of these money market funds would fluctuate along with changes in the market-based value of their portfolio securities.
  
  
• Showing fluctuations in price — Prime institutional money market funds would also be required to price their shares using a more precise method.  Currently, money market funds use an arithmetic convention to “penny round” their share price to the nearest one percent (to the nearest penny in the case of a fund with a $1.00 share price).  Under the floating NAV proposal, prime institutional money market funds would instead be required to “basis point round” their share price to the nearest 1/100th of one percent (the fourth decimal place in the case of a fund with a $1.0000 share price).
  
  
• Government and retail money market funds exempt — Government and retail money market funds would be allowed to continue using the amortized cost method of accounting and “penny rounding” method of pricing to maintain a stable share price of $1.00.  A government money market fund would be defined as any money market fund that holds at least 80 percent of its assets in cash, government securities, or repurchase agreements collateralized with government securities.  A retail money market fund would be defined as a money market fund that limits each shareholder’s redemptions to no more than $1 million per business day.

Under the liquidity fees and redemption gates alternative, money market funds would continue to sell and redeem shares at a stable share price, but would be able to use liquidity fees and redemption gates in times of stress.  The main features of this alternative are:

• Liquidity fees — if a money market fund’s level of “weekly liquid assets” were to fall below 15 percent of its total assets (half the required amount), the money market fund would have to impose a 2 percent liquidity fee on all redemptions.  However, such a fee would not be imposed if the fund’s board of directors determines that such a fee is not in the best interest of the fund or that a lesser liquidity fee is in the best interest of the fund.  Weekly liquid assets generally include cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert into cash within one week.
  
  
• Redemption gates — once a money market fund had crossed the 15 percent weekly liquid asset threshold, its board of directors also would be able to impose a temporary suspension of redemptions (or “gate”).  A money market fund that imposes a redemption gate would need to lift that gate within 30 days, although the board of directors could determine to lift the gate earlier.  Money market funds would not be able to impose a gate for more than 30 days in any 90-day period.
  
  
• Prompt public disclosure — Money market funds would be required to promptly and publicly disclose the crossing of the 15 percent weekly liquid asset threshold, or the imposition and removal of any liquidity fee or gate, and include a discussion of the board’s analysis in determining whether or not to impose a fee or gate.
  
  
• Exemption for government money market funds — Government money market funds would be exempt from the fees and gates requirement, although these funds could voluntarily opt into this new requirement.

The SEC is also considering whether to combine the floating NAV and the liquidity fees and gates proposals into a single reform package.  If adopted in a combined form, prime institutional money market funds would be required to sell and redeem shares at a floating NAV and all non-government money market funds would be able to impose liquidity fees or gates in certain circumstances.

Beyond the principal alternative reforms, the SEC’s proposal includes:

• Enhanced disclosure requirements — In addition to requiring certain disclosures relating to the floating NAV and fees and gates proposals, the proposal would require:
  • Website disclosure — Money market funds would be required to disclose on their website, on a daily basis, their levels of daily and weekly liquid assets and market-based NAVs.
    
    
  • New material event disclosure — Money market funds would be required to promptly disclose certain events on a new form (Form N-CR).  These events would include the imposition or lifting of fees or gates, portfolio security defaults, sponsor support, and, for funds that would continue to maintain a stable share price of $1.00 under either alternative, a fall in the fund’s market based NAV below $0.9975.
    
    
  • Disclosure of sponsor support — Money market funds would be required to disclose historic instances of sponsor support for money market funds (in addition to the current event disclosures required on Form N-CR).
    
    
• Immediate reporting of fund portfolio holdings — Money market funds currently report detailed information about their portfolio holdings to the SEC each month on Form N-MFP.  Under the proposal, Form N-MFP would be amended to clarify existing requirements and require reporting of additional information relevant to assessing money market fund risk.  In addition, the proposal would eliminate the current 60-day delay on public availability of the information filed on the form and would make it public immediately upon filing.
  
  
• Improved private liquidity fund reporting — To better monitor whether substantial assets migrate to liquidity funds in response to money market fund reforms, the proposal would amend Form PF, which private fund advisers use to report information about certain private funds they advise.
  
  
• Reporting by large liquidity fund advisers — The proposed changes would require a “large liquidity fund adviser” (a liquidity fund adviser managing at least $1 billion in combined money market fund and liquidity fund assets) to report substantially the same portfolio information on Form PF as registered money market funds would report on Form N-MFP.  A liquidity fund is essentially an unregistered money market fund.
  
  
• Stronger diversification requirements — The proposal includes the following proposed changes to the diversification requirements of the portfolios of money market funds:
  
  
  • Aggregation of affiliates — Money market funds would be required to aggregate affiliates for purposes of determining whether they are complying with money market funds’ 5 percent concentration limit.  Under this limitation, a fund may not invest any more than 5 percent of its assets in any one issuer.
    
    
  • Removal of the 25 percent basket — all of a money market fund’s assets would need to meet the concentration limits for guarantors and ‘put’ providers, thereby removing the so-called 25 percent basket that permitted a single guarantor to guarantee 25 percent of a money market fund’s assets.
    
    
  • Asset-backed securities — Money market funds would need to aggregate all of the asset-backed securities vehicles sponsored by the same entity for purposes of the 10 percent guarantor diversification limit imposed by Rule 2a-7 of the Investment Company Act of 1940.  This aggregation would not be necessary if a money market fund’s board of directors determines the fund is not relying on the sponsor’s strength or structural enhancements of the asset-backed security in determining the quality or liquidity of the asset-backed security.
    
    
• Enhanced stress testing — under the proposal, the stress testing requirements adopted by the SEC in 2010 would be further enhanced.  In particular, a money market fund would be required to stress test against the fund’s level of weekly liquid assets falling below 15 percent of total assets.  In addition, the SEC is proposing to strengthen how money market funds stress test their portfolios and report the result of their stress tests to their boards of directors.

Read the SEC press release

The Fed Approves Interim Final Rule Regarding the Application of Swaps Push-Out Provision to Uninsured Banks

On Wednesday, June 5, 2013, the Federal Reserve Board (the “Fed”) approved an interim final rule clarifying the treatment of uninsured U.S. branches and agencies of foreign banks under Section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the so-called swaps push-out provision.  Set to become effective on July 16, 2013, Section 716 generally prohibits the provision of certain types of federal assistance, such as discount window lending and deposit insurance, to swaps entities.

Insured depository institutions that are swaps entities are eligible for a transition period of up to 24 months to comply and for certain statutory exceptions.  The interim final rule clarifies that, for purposes of Section 716, uninsured U.S. branches and agencies of foreign banks will be treated as insured depository institutions.  Thus, they will be eligible to apply for a transition period and will be treated as insured depository institutions for purposes of the other provisions of Section 716.  The interim final rule also establishes the process for state member banks and uninsured state branches or agencies of foreign banks to apply to the Fed for the transition period.

Read the Fed press release

The FDIC Publishes Final Rule Determining Criteria for Entities Predominantly Engaged in Financial Activities

On Monday, June 10, 2013, the Federal Deposit Insurance Corporation (the “FDIC”) published in the Federal Register a final rule that establishes the criteria for determining if a company is predominantly engaged in “activities that are financial in nature or incidental thereto” for purposes of Title II of the Dodd-Frank Act.  A company that is predominantly engaged in such activities is a “financial company” for purposes of Title II unless it is one of the few entities specifically excepted.  A financial company, other than an insured depository institution, may be subject to Title II’s orderly liquidation provisions if, among other things, it is determined that the failure of the company and its resolution under otherwise applicable law would have serious adverse effects on financial stability in the United States.

Read the FDIC rule

© 2013 Perkins Coie LLP