Mary Jo White Securities and Exchange Commission Chairman
They did it.
The five commissioners of the SEC have unanimously approved regulatory proposals that would, among other things, allow money funds for institutional clients float their NAV, as well as impose fees and liquidity gates in the face of redemption panics.
According to USA Today, the regulations now face a 90-day public comment period. The newspaper also reports that they could be enacted individually or combined together in a "hybrid oversight package."
Elisse B. Walter Securities and Exchange Commission Commissioner, Former Chairman
The NAV proposal only applies to prime funds, which are directed to large institutional investors. Retails that cap investor redemptions to $1 million per business day are exempt, as well as funds with at least 80 percent of their assets in cash or government securities.
The second rule institutes a 2 percent fee for investor withdrawals at ends with liquid assets that have fallen below their required amount. Fund directors also are given the option to set temporary liquidity gates blocking redemptions for up to 30-days within an 90-day period.
Luis A. Aguilar Securities and Exchange Commission Commissioner
Her speech earlier today in favor of the proposals can be found here.
The ICI released a statement expressing its support of the proposals here.
Troy A. Paredes Securities and Exchange Commission Commissioner
The ICI statement, from president and chief executive Paul Schott Stevens, included the declarations that “we are particularly pleased that the Commission recognized the effectiveness of liquidity fees and gates in addressing risks that might arise in a widespread crisis. We also welcome the inclusion of fees and gates as a standalone option in the proposal."
“We look forward to providing our analysis and industry expertise in response to the SEC’s proposals,” Stevens also stated.
Daniel M. Gallagher Securities and Exchange Commission Commissioner
Here is White's comment from today's SEC meeting:
Opening Statement at the SEC Open Meeting
Chairman Mary Jo White
June 5, 2013
This is an open meeting of the Securities and Exchange Commission on June 5, 2013.
Today, the Commission will consider proposals that would reform the way money market funds operate in order to make them less susceptible to runs.
As many people know, money market funds are investment vehicles that hold a pool of high-quality, short-term securities. In the early 1980s, the Commission provided money market funds with an exemption making them distinct from mutual funds and certain other investment products. That exemptive rule (Rule 2a-7) allowed these funds generally to maintain a stable share price of $1.00 instead of changing their share prices according to the market value of the securities held by the fund.
The industry has changed substantially since that time. Money market funds are now a significant piece of the nation’s financial system. Over the years, money market funds have become a popular investment product for both retail and institutional investors. They also have become an important provider of short-term financing to corporations, banks and governments. All told, money market funds hold nearly $3 trillion in assets, the majority of which are in institutional funds.
While money market funds have thus long served as an important investment vehicle, the financial crisis of 2008 highlighted the susceptibility of these products to runs. In September of that year – at the height of the financial crisis – a money market fund called the Reserve Primary Fund “broke the buck” – a term used when the value of a fund drops and investors are no longer able to get back the full dollar they put in.
Within the same week of that occurrence, investors pulled approximately $300 billion from other institutional prime money market funds. The contagion effect was rapid. The short term credit market dried up, and corporations had trouble borrowing to run their businesses. This reaction contributed to the significant disruption that already was consuming the financial system.
To stop this run, the government stepped in with unprecedented support in the form of the Treasury temporary money market fund guarantee program and Federal Reserve liquidity facilities.
In the aftermath of that experience, the Commission – in 2010 – adopted a series of reforms that increased the resiliency of money market funds. But, as the Commission stated at that time, those reforms were only a first step. Today’s proposal takes the critical additional step of addressing the stable value pricing of institutional prime funds – at the heart of the 2008 run – and proposing methods to stop a money market fund run before such a run becomes a systemically destabilizing event.
It has been a journey to get to this point. Commission staff has spent literally years studying different reform alternatives and performing extensive economic analysis in arriving at these recommendations.
These proposals are important in and of themselves and because they advance the public debate that will shape the final rules to address one of the most prominent events arising from the financial crisis.
Today’s proposal contains two alternative reforms that could be adopted separately or combined into a single reform package to address run risk in money market funds.
The first proposed alternative would require that all institutional prime money market funds operate with a floating net asset value (NAV). That is, they could no longer value their entire portfolio at amortized cost and they could not round their share prices to the nearest penny. The set “dollar” would be replaced by a share price that actually fluctuates, reflecting the changing values in these money market funds.
This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds.
Retail and government money market funds – which have not historically faced runs in even the worst of times – would be exempt from the proposed floating NAV requirement.
This approach would thus preserve the stable value fund product for those retail investors who have found it to be convenient and beneficial. It also would allow municipal and corporate investors to have access to government money market funds – a stable value product – if they need it, although it would be a product that holds federal government securities as opposed to the higher-yielding investments of a prime fund.
We are soliciting commenters’ views regarding the impact of targeting the floating NAV reform to institutional prime funds and whether government and retail money market funds also should operate with a floating NAV, as well as commenters’ views regarding whether today’s proposal would effectively differentiate retail funds from institutional funds by imposing a $1 million redemption limit. These and other important questions are specifically posed in the proposal.
I believe the floating NAV reform proposal is important for a number of reasons:
First, by eliminating the ability of early redeemers to receive $1.00 – even when the fund has experienced a loss and its shares are worth somewhat less – this proposal should reduce incentives for shareholders to redeem from institutional prime money market funds in times of stress.
Second, the proposal increases transparency and highlights investment risk because shareholders would experience price changes as an institutional prime money market fund’s value fluctuates.
And, third, the proposal is targeted, by focusing reform on the segment of the market that experienced the run in the financial crisis.
Fees & Gates
The second proposed alternative seeks to directly counter potentially harmful redemption behavior during times of stress.
Under this alternative, non-government money market funds would be required to impose a 2 percent liquidity fee if the fund’s level of weekly liquid assets fell below 15 percent of its total assets, unless the fund’s board determined that it was not in the best interest of the fund. That determination would be subject to the board’s fiduciary duty, and we believe it would be a high hurdle. After falling below the 15 percent weekly liquid assets threshold, the fund’s board would also be able to temporarily suspend redemptions in the fund for up to 30 days – or “gate” the fund.
This “fees and gates” alternative potentially could enhance our regulation in several ways:
First, it could more equitably allocate liquidity risk by assigning liquidity costs in times of stress (when liquidity is expensive) to redeeming shareholders – the ones who create the liquidity costs and disruption.
Second, this alternative would provide new tools to allow funds to better manage redemptions in times of stress, and thereby potentially prevent harmful contagion effects on investors, other funds, and the broader markets. If the beginning of a run or significantly heightened redemptions occur, they would no longer continue unchecked, potentially spiraling into a crisis. The imposition of liquidity fees or gates would be an available tool to directly counteract a run.
And, third, this approach also is targeted, focusing the potential limitations on a money market fund investor’s experience to times of stress when unfettered liquidity can have real costs.
The two alternative approaches in today’s proposal target the common goal of reducing the incentive to redeem in times of stress, albeit in different ways. Accordingly, the proposal requests comment on whether a better reform approach would be to combine the two alternatives into a single reform package – requiring that prime institutional funds have a floating NAV and be able to impose fees and gates in times of stress, and that retail funds be able to impose fees and gates. We specifically solicit and I am interested in commenters’ views on this combined approach.
Greater Diversification, Disclosure and Reporting
Importantly, the staff’s recommendations also contain a number of other significant reform proposals – tightening diversification requirements, enhancing disclosure requirements, strengthening stress testing and improving reporting on both money market funds and unregistered liquidity funds that could serve as alternatives to money market funds for some investors. These proposed reforms should further enhance the resiliency and transparency of this important product and are significant complements to the other proposals.
Today’s proposal is the product of very hard work by all those who have sought to meaningfully reform this investment product that is such a critical piece of the nation’s financial fabric.
There have been important and thoughtful comments throughout this process, including suggestions and recommendations from investors, the industry, and fellow regulators. We have given them all very careful consideration and they have proven invaluable to us formulating the important proposals we are voting on today.
In this regard I especially would like to thank all of my fellow Commissioners for their contributions and the spirit of cooperation in which we worked leading up to today’s meeting.
I want to reiterate that our goal is to implement an effective reform that decreases the susceptibility of money market funds to run risk and prevents money market fund events similar to those that occurred in 2008 from repeating themselves. With this goal in mind, I very much look forward to the comments and am very pleased that, with my fellow Commissioners, we are moving this reform process forward.
Before I ask Norm Champ, Director of the Division of Investment Management, to discuss the proposed reforms, I would like to thank Norm and his team: Diane Blizzard, Sarah ten Siethoff, Thoreau Bartmann, Brian Johnson, Adam Bolter, Amanda Wagner, Kay Vobis, Jaime Eichen, and Megan Monroe for their tireless work on this rule making.
This rulemaking was a true team effort between the Division of Investment Management and the Division of Risk, Strategy and Financial Innovation, so I want to also express my gratitude for the work of Craig Lewis, Kathleen Hanley, Jennifer Marietta-Westberg, Woodrow Johnson, Jennifer Bethel, Virginia Meany, Dan Hiltgen, and Mila Sherman. I also would like to acknowledge the critical work and analysis included in the staff’s economic study published late last year, which was highly influential in developing today’s proposed reforms.
Thanks as well to Anne Small, Meridith Mitchell, Lori Price, Cathy Ahn, Jill Felker, and Kevin Christy from the Office of the General Counsel; Jim Burns, David Blass, Haime Workie, and Natasha Greiner from the Division of Trading and Markets; and Paul Beswick, Rachel Mincin, and Jeff Minton from the Office of the Chief Accountant.
And now I’ll turn the meeting over to Norm Champ to provide a fuller explanation of the proposed reforms we are considering today.
SEC PROPOSES MONEY MARKET FUND REFORMS
Washington D.C., June 5, 2013 – The Securities and Exchange Commission today voted unanimously to propose rules that would reform the way that 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 (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.
The SEC began evaluating the need for money market fund reform after the Reserve Primary Fund “broke the buck” at the height of the financial crisis in September 2008.
“Our goal is to implement effective reform that decreases the susceptibility of money market funds to runs and prevents events like what occurred in 2008 from repeating themselves,” said Mary Jo White, Chair of the SEC.
The public comment period for the proposal will last for 90 days after its publication in the Federal Register.
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Reforming Money Market Funds
SEC Open Meeting
June 5, 2013
The History of Money Market Funds – Money market funds are a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts. They have since grown significantly and currently hold more than $2.9 trillion in assets, the majority of which is in institutional funds.
Under Investment Company Act Rule 2a-7, these funds must limit their portfolio investments to high-quality, short-term debt securities. Unlike other mutual funds, money market funds seek to maintain a stable share price (typically $1.00) through the use of certain valuation and pricing methods permitted under Rule 2a-7. The typical experience for a money market fund investor is that when they invest a dollar, they are able to get back a dollar on demand (plus the yield that was earned during the course of the investment). As a result, money market funds have become popular cash management vehicles for retail and institutional investors.
When a money market fund’s market-based value deviates more than 0.5 percent ($0.005) from its stable $1.00 share price, a money market fund generally re-prices at its market value. At these times, investors will no longer get back their full dollar – a phenomenon known as “breaking the buck.”
There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate debt securities. Money market funds that primarily invest in corporate debt securities are referred to as prime funds.
Funds are often structured to cater to different types of investors. Some funds are marketed to individuals and intended for retail investors, while other funds that typically require very high minimum investments are intended for institutional investors.
The Financial Crisis – At the height of the financial crisis in September 2008, a money market fund named the Reserve Primary Fund “broke the buck” and re-priced its shares below its $1.00 stable share price, leading many investors to pull their money out of the fund. That same week, prime institutional money market funds experienced rapid heavy redemptions, with investors withdrawing approximately $300 billion (14 percent of their assets). These redemptions, which halted after the U.S. Treasury provided a government guarantee, prompted the SEC to evaluate the need for money market fund reform.
The 2010 Amendments – In March 2010, the Commission adopted a series of amendments to its rules on money market funds. The amendments were designed to make money market funds more resilient by reducing the interest rate, credit, and liquidity risks of their portfolios. Although these reforms improved money market fund resiliency, the Commission said at the time that it would continue to consider whether further, more fundamental changes to money market fund regulation might be warranted.
Study by the Division of Risk, Strategy, and Financial Innovation – In December 2012, staff from the SEC’s Division of Risk, Strategy, and Financial Innovation published a study relating to money market funds. The study contained, among other things, a detailed analysis of the possible causes of investor redemptions in prime money market funds during the 2008 financial crisis, certain characteristics of money market funds before and after the Commission’s 2010 reforms, and how future reforms of money market fund regulation might affect investor demand for money market funds and alternative investments.
The study indicated that government money market funds generally are not susceptible to heavy redemptions or runs due to the nature of their portfolio assets. Retail investors have historically been less likely to redeem heavily from such funds in times of financial stress.
The study informed the Commission’s consideration of the risks that may be posed by money market funds and provided a foundation for this proposal.
The SEC’s proposed reforms are designed to:
Mitigate money market funds’ susceptibility to heavy redemptions during times of stress.
Improve money market funds’ ability to manage and mitigate potential contagion from high levels of redemptions.
Preserve as much as possible the benefits of money market funds for investors and the short-term financing markets.
Increase the transparency of risk in money market funds.
Alternative One: Floating NAV – Under the first alternative, prime institutional money market funds would be required to transact at a floating net asset value (NAV), not at a $1.00 stable share price. The floating NAV alternative is designed primarily to address the heightened incentive shareholders have to redeem shares in times of financial stress. It also is intended to improve the transparency of money market fund risks through more visible valuation and pricing methods.
Floating the NAV – Prime institutional money market funds would no longer be able to use amortized cost to value their portfolio securities except to the limited extent all mutual funds are able to do so. Daily share prices of these money market funds would fluctuate along with changes, if any, in the market-based value of their portfolio securities.
Showing Fluctuations in Price – Under the first alternative, prime institutional money market funds would be required to price their shares using a more precise method so that investors are more likely to see fluctuations in value. Currently, money market funds “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 instead would 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).
Exempting Government and Retail Money Market Funds – Government and retail money market funds would be allowed to continue using the penny rounding method of pricing and maintain a stable share price. 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.
Alternative Two: Liquidity Fees and Redemption Gates – Under the second alternative, money market funds would continue to transact at a stable share price, but would be able to use liquidity fees and redemption gates in times of stress.
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 this 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 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 fund crossing of the 15 percent weekly liquid asset threshold, the imposition and removal of any liquidity fee or gate, and 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. However, these funds could voluntarily opt into this new requirement.
Potential Combination of Both Proposals – The Commission is considering whether to combine the floating NAV and the liquidity fees and gates proposals into a single reform package. If adopted in that form, prime institutional money market funds would be required to transact at a floating NAV and all non-government money market funds would be able to impose liquidity fees or gates in certain circumstances. The Commission requests public comments on the benefits and drawbacks of a single reform approach.
Enhanced Disclosure Requirements – In addition to requiring certain disclosures relating to the floating NAV and fees and gates proposals, the proposal seeks to improve the transparency of money market fund operations and risks by:
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 per share.
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 under either alternative – a fall in the fund’s market based NAV per share 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.
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 money market funds’ portfolios:
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. However, this 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 Commission 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 Commission 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.