On December 15, 2021, by a 3-2 vote, the U.S. Securities and Exchange Commission proposed a new round of rule amendments intended to “improve the resilience and transparency of money market funds.”1 The proposed amendments would remove the liquidity fee and redemption gate provisions from Rule 2a-7 under the Investment Company Act of 1940, require institutional prime and institutional tax-exempt money market funds to implement swing pricing policies and procedures, and require all money market funds to increase their daily liquid asset and weekly liquid asset minimum requirements to 25% and 50%, respectively. The SEC requests comments within 60 days of the publication of the proposed rules in the Federal Register.
Our Take. The swing pricing amendments for institutional prime and institutional tax-exempt funds will be a controversial element of the proposed changes. Swing pricing would be a significant change in investor experience and operationally complex to implement. Likewise, there are concerns with proposed preparedness terms relating to negative interest rates, in part because of high costs relative to limited perceived benefit. The remaining elements of the proposal also will generate debate but in each case represent a less fundamental level of change. Removal of fees and gates, for example, returns money market funds to the period prior to 2014 when fees and gates were first added.
I. Historical Context to the Proposed Rules
Understanding the current proposals requires a brief review of, first, the history of prior money market fund reforms and, second, market events in March 2020.
Prior Reform Initiatives. As part of a package of money market reforms adopted in 2010 in the wake of the 2008 financial crisis, all money market funds are required to hold at least 30% of their total assets in “weekly liquid assets,” and taxable money market funds are required to hold at least 10% of their total assets in “daily liquid assets.” A second round of reforms adopted in 2014 permitted a money market fund to impose a liquidity fee of up to 2%, or temporarily suspend redemptions for up to 10 business days in a 90-day period, if the fund’s weekly liquid assets fall below 30% of its total assets and the fund’s board of directors determines that imposing a fee or gate is in the fund’s best interests.
Recent Market Events. In March 2020, growing concerns about the impact of the COVID-19 pandemic disrupted short-term funding markets and prompted some institutional investors to rotate out of the prime and tax-exempt money market funds that participate in those markets. During a two-week period in mid-March, SEC data show that publicly offered institutional prime funds had a 30% redemption rate, including outflows of approximately 20% of assets during the week of March 20 alone. (In contrast, retail money market funds had lower outflows of approximately 11% of their total assets.)
The SEC also believes that data from March 2020 suggest that money market fund managers were actively managing their portfolios to avoid weekly liquid assets’ falling below 30% of total assets by, in some cases, selling other portfolio securities to meet redemptions. The SEC suggests this was tied to a desire to assuage investors’ concerns about the possibility of redemption gates and liquidity fees being imposed if a fund dropped below the 30% threshold.
II. Removal of Liquidity Fee and Redemption Gate Provisions
In other words, while fees and gates were intended to provide a “cooling off” period and better allocate the costs of providing liquidity to redeeming investors, the SEC now believes — even though no money market fund imposed a fee or gate — that the possibility of such a fee or gate appears to have contributed to incentives for investors to redeem and for money market fund managers to maintain weekly liquid asset levels above the threshold rather than use those liquid assets to meet redemptions.
In response, the SEC proposes not only to remove the tie between liquidity thresholds and fee and gate provisions, which many commentators questioned in light of the events outlined above, but to remove fee and gate provisions from Rule 2a-7 (the Rule) under the Investment Company Act of 1940, as amended (the 1940 Act), entirely. Under the proposal, a money market fund board would continue to be able to suspend redemptions to facilitate an orderly liquidation of the fund under Rule 22e-3 under the 1940 Act. (As part of this package of the proposed amendments, the SEC also proposes technical changes to the stress testing requirements for money market funds. The changes would decouple stress testing from liquidity fees.)
III. Proposed Swing Pricing Requirement
In lieu of liquidity fees, the SEC now believes that requiring institutional prime and tax-exempt money market funds to implement “swing pricing” would be a more effective tool to address shareholder dilution and potential incentives for institutional investors to redeem quickly in times of liquidity stress. As proposed, the key concept underlying swing pricing is that a fund will make an adjustment to its net asset value (NAV) per share whenever the fund experiences net redemptions, with that adjustment intended to allocate costs of the redemptions to the redeeming shareholders. Note that investors will not necessarily know when a fund’s redemptions will trigger swing pricing or the magnitude of the swing factor prior to their choosing to transact (either as purchaser or redeemer) in a fund.
Important elements of this proposal include the following:
- Due to differences in observed investor behavior and liquidity costs during a crisis among the various fund types, swing pricing would not apply to government money market funds or retail money market funds.
- Boards of institutional prime and institutional tax-exempt money market funds would be required to approve the funds’ swing pricing policies and procedures.
- Swing pricing would apply only to the extent that a fund has net redemptions for a particular “pricing period,” that is, the trading period during which an order to purchase or sell fund shares must be received to be priced at the next computed NAV.
- A fund with multiple share classes must determine whether it experienced net redemption activity across all share classes in the aggregate rather than on a class-by-class basis.
- If a fund has net redemptions, it would be required to adjust its NAV by a “swing factor” reflecting spread and transaction costs, as applicable.
- If a fund has net redemptions for a pricing period that exceed the “market impact threshold,” that is, 4% (or a lower amount determined by the fund administrator) of the fund’s NAV divided by the number of pricing periods the fund has in a business day, the swing factor must also include good faith estimates of the market impact of selling securities to satisfy the amount of net redemptions for the pricing period.
- Given the difficulty in estimating market impact costs, the proposed amendments would permit a fund to estimate costs and the market impact factor for each type of security with the same or substantially similar characteristics and apply those estimates to all securities of that type in the fund’s portfolio.
- The SEC believes it would be reasonable to apply a market impact factor of zero to the fund’s daily and weekly liquid assets.
- A fund should determine the swing factor by calculating identified types of costs the fund would incur, as applicable, by selling a pro rata amount of each security in its portfolio (a “vertical slice”) to satisfy the amount of net redemptions for the pricing period. The “vertical slice” approach should be used even if the redemptions for a particular pricing period are met through daily or weekly liquid assets.
The proposing release includes the following chart to illustrate the swing pricing process:
1. Did the fund have net redemptions?
No: Do not apply a swing factor.
Yes: Proceed to next step.
2. Did the net redemptions exceed the market impact threshold?
No: Apply swing factor that includes spread costs (if the fund uses midmarket pricing) and other transaction costs of selling a vertical slice of the fund’s portfolio.
Yes: Apply swing factor that includes spread costs (if the fund uses midmarket pricing), other transaction costs, and market impact factor of selling a vertical slice of the fund’s portfolio.
Administration of the Swing Pricing Requirement and the Role of the Board. Under the proposed amendments, a fund’s swing pricing policies and procedures must be implemented by a board-designated administrator, and the administration of the swing pricing program must be reasonably segregated from portfolio management of the fund and may not include portfolio managers. The swing pricing administrator would be required to prepare, no less frequently than annually, a written report to the board describing the adequacy and effectiveness of the program. The swing pricing administrator’s report to the board would be required to describe (i) the administrator’s review of the adequacy of the fund’s swing pricing policies and procedures and the effectiveness of their implementation, (ii) any material changes to the fund’s swing pricing policies and procedures since the date of the last report, and (iii) the administrator’s review and assessment of the fund’s swing factors and market impact threshold, including the information and data supporting the determination of the swing factors and the swing pricing administrator’s determination to use a smaller market impact threshold, if applicable. The SEC states that the proposed amendments contemplate a board role in compliance oversight rather than board involvement in the day-to-day administration of a fund’s swing pricing program.
Operational Considerations of Swing Pricing. The SEC acknowledges that swing pricing would introduce new operational complexity to institutional money market funds. Potential hurdles include the following:
- Because intermediaries typically report flows with a delay, institutional funds would not be able to determine net shareholder flows in time to apply a swing factor to the fund’s NAV as needed.
- Swing pricing could make it more difficult or impossible for institutional funds to offer intraday liquidity and/or same day settlement.
- Systems required to accommodate swing pricing could carry significant costs and burdens.
The SEC believes many of these hurdles can be overcome simply by institutional funds’ imposing earlier order cutoff times to ensure that they receive flow data prior to striking their NAV and/or reducing the number of NAV strikes per day. The SEC also acknowledges that swing pricing could lead to additional variation in a fund’s NAV, reducing the appeal of these institutional money market funds as cash management tools
Comparison to Previous Swing Pricing Rule. In 2016, the SEC adopted rules2 permitting registered open-end funds (except money market funds and exchange-traded funds) to use swing pricing on a voluntary basis. Although both these rules and the proposed swing pricing rules for money market funds are designed to mitigate dilution of a fund’s NAV per share due to shareholder trading activity, there are some key differences between the two sets of rules:
- The 2016 rules require a “swing threshold” (that is, a certain amount of net purchases or net redemptions, expressed as a percentage of the fund’s NAV) to be crossed to trigger the application of swing pricing. The proposed amendments do not have a swing threshold; rather, they require institutional funds to impose swing pricing upon any amount of net redemptions during the pricing period.
- The 2016 rules contemplate that a fund adjust its NAV upward when net purchases exceed the swing threshold and downward when net redemptions exceed the swing threshold. The proposed amendments contemplate only a downward NAV adjustment when a money market fund experiences net redemptions, regardless of their magnitude.
- The 2016 rules require that the fund’s board establish an upper limit on the swing factor(s) used (which may not exceed 2% of NAV per share). The proposed amendments do not impose any limit on a money market fund’s swing factor.
It is perhaps telling that we are not aware of any funds that have voluntarily implemented the SEC’s 2016 swing pricing rules. Nor does the SEC cite any statistics in this regard.
Money Funds as Cash Equivalents. The SEC states its belief that the adoption of swing pricing would not preclude shareholders from classifying their investments in money market funds as “cash equivalents” for purposes of U.S. generally accepted accounting practices.
Amendments to Form N-1A. The proposed amendments would require institutional money market funds to respond to the swing-pricing-related items on Form N-1A that were not historically applicable to these funds. Specifically, the form requires a fund to include a general description of the effects of swing pricing on the fund’s annual total returns as a footnote to its risk/return bar chart and table. The form also requires a fund that uses swing pricing to explain the fund’s use of swing pricing, including its meaning, the circumstances under which the fund will use it, and the effects of swing pricing on the fund and investors.
Website Disclosure. The proposed amendments would require institutional funds to use swing-factor-adjusted NAVs when such funds report on their websites their NAVs per share as of the end of each business day during the preceding six months.
Amendments to Recordkeeping Requirements. The proposed amendments would add a number of recordkeeping requirements. Most involved would be keeping schedules supporting each computation of a fund’s adjustment to NAV based on its swing pricing policies and procedures.
IV. Amendments to Portfolio Liquidity Requirements
The proposed amendments would increase the daily and weekly liquid asset requirements for money market funds as follows:
Current Minimum Requirement
Proposed Minimum Requirement
Daily Liquid Assets
Weekly Liquid Assets
The SEC believes that these increased thresholds will provide a substantial buffer that would better equip money market funds to manage significant and rapid investor redemptions like those experienced in March 2020. Historically, many prime money market funds have maintained levels of liquidity that are close to, or that exceed, the proposed thresholds. The SEC believes that this demonstrates that funds have the ability to operate with the proposed minimum liquidity levels while continuing to serve as an efficient and diversified cash management tool for investors. Further, while the proposed levels do not reduce a fund’s liquidity risk to zero, the SEC believes, based on its analysis, that the proposed thresholds would be sufficiently high to allow most money market funds to manage their liquidity risk in a market crisis. The proposed thresholds would apply to all types of money market funds except tax-exempt money market funds, which will continue to be exempt from the daily liquid asset requirements.
Consequences for Falling Below Minimum Daily and Weekly Liquidity Requirements. The daily and weekly liquid asset requirements currently are measured at the time each security is acquired. Therefore, a money market fund’s portfolio does not fail to satisfy the conditions if it drops below the minimum liquidity thresholds; the fund simply may not acquire any assets other than daily liquid assets or weekly liquid assets, respectively, until it meets those minimum thresholds. This approach will be maintained in the proposed amendments. However, if the fund has invested less than 25% of its total assets in weekly liquid assets or less than 12.5% of its total assets in daily liquid assets (a “liquidity threshold event”), the proposed rules would require the fund to notify its board within one business day of the liquidity threshold event. The proposed amendments also would require the fund to provide the board with a brief description of the facts and circumstances that led to the liquidity threshold event within four business days after its occurrence.
V. Amendments Related to Potential Negative Interest Rates
Although interest rates on government debt securities have been negative in countries outside the United States, the Federal Reserve (Fed) has never established a lower bound of the target range for the federal funds rate below 0%. However, twice during the past 15 years, the Fed has established that lower bound at 0% to spur borrowing and other economic activity (in the face of the 2008 and 2020 economic crises).
The SEC explains that while stable NAV money market funds can still maintain a non-negative stable share price when investing in instruments that yield a low but positive interest rate, if interest rates turn negative, it would be challenging or impossible for a fund to maintain a non-negative stable share price. Such a fund would begin to lose money. If this were to occur, the board of a stable NAV fund could reasonably require the fund to convert to a floating share price to prevent material dilution or other unfair results to investors or current shareholders. While the SEC is not proposing changes to the Rule’s pricing provisions in relation to negative interest rates, the proposed amendments would require a government or retail money market fund (or the fund’s principal underwriter or transfer agent on its behalf) to determine that financial intermediaries that submit orders to purchase or redeem the fund’s shares have the capacity to redeem and sell the fund’s shares at prices that do not correspond to a stable price per share or, if this determination cannot be made, to prohibit the relevant financial intermediaries from purchasing the fund’s shares in nominee name. The SEC suggests that absent this capability, a money market fund would not actually be able to process transactions at a floating NAV, as required by the current Rule.
The proposed amendments also would prohibit money market funds from operating a reverse distribution mechanism, routine reverse stock split, or other device that would periodically reduce the number of a fund’s outstanding shares to maintain a stable share price. These mechanisms are, in the SEC’s view, potentially misleading or confusing to shareholders, who may assume that their investment in a fund with a stable share price is holding its value while, in fact, the investment is losing value over time.
VI. Amendments to Specify the Calculation of Weighted Average Maturity and Weighted Average Life
The SEC recognized that a majority of money market funds calculate weighted average maturity (WAM) and weighted average life (WAL) based on the percentages of each security’s market value in the portfolio, while other money market funds base calculations on the amortized cost of each portfolio security. Because this discrepancy can create an inconsistency of WAM and WAL calculations across funds, including in data reported to the SEC and on fund websites, the proposed amendments would require that money market funds calculate WAM and WAL based on the percentage of each security’s market value in the portfolio (not amortized cost).
VII. Amendments to Form N-CR
The proposed amendments would make certain changes affecting money market funds’ reports on Form N-CR, including the following:
- add a requirement to file a Form N-CR report when a liquidity threshold event occurs (that is, when the fund has invested either less than 25% of its total assets in weekly liquid assets or less than 12.5% of its total assets in daily liquid assets)
- add a requirement to include the registrant name, series name, and legal entity identifiers (LEIs) for the registrant and series
- remove the reporting events that relate to liquidity fees and gates
- with respect to the reporting requirement in Form N-CR relating to the provision of financial support to a money market fund, when the support involves the purchase of a security from the fund, add a requirement to provide the date the fund acquired the security
The proposed amendments would require money market funds to file reports on Form N-CR in a custom eXtensible Markup Language (XML)-based structured data language created specifically for reports on Form N-CR (N-CR-specific XML). The SEC believes use of an N-CR-specific XML language would make it easier for money market funds to prepare and submit the information required by Form N-CR accurately and would make the submitted information more useful to investors and the SEC.
- add a requirement that all money market funds disclose the name and percentage of ownership for each person who owns of record or is known by the fund to own beneficially 5% or more of the shares outstanding in the relevant class
- add a requirement that money market funds that are not government or retail money market funds identify the percentage of investors within certain specified category types
- add a requirement that prime money market funds disclose the aggregate amount of portfolio securities they sold or disposed of in different investment categories during the reporting period (excluding securities held until maturity)
- add a requirement that money funds that are not government or retail money market funds report the number of times they applied a swing factor over the course of the reporting period and each swing factor applied
- regarding the schedule of portfolio securities reported on Form N-MFP, add a requirement that filers must report each security individually by lot rather than in the aggregate
- regarding repurchase agreements (repos), add requirements that funds identify (i) the name of the counterparty to a repo transaction, (ii) whether a repo is centrally cleared and the name of the central clearing counterparty, (iii) if a repo was settled on a triparty platform, and (iv) the CUSIP number of the securities involved in the repo
- include “cash” as a category of investment that most clearly represents the collateral in repos
- remove the ability for funds to aggregate certain information if multiple securities of an issuer are subject to the repo
- remove the three categories “Treasury,” “Government/Agency,” and “Exempt Government” to describe a money market fund and replace them with one “Government” category, then add a new subsection that requires government money market funds to indicate whether they typically invest at least 80% of the value of their assets in U.S. Treasury securities
- add a requirement that a fund indicate whether it is established as a cash management vehicle for affiliated funds and accounts
- add a requirement that funds report only the amount of any fee waiver or expense reimbursement during the reporting period and not the name of any person who paid for or waived fund operating expenses or management fees
- add a new category of investment that distinguishes between U.S. government agency notes that are coupon-paying and those that are no-coupon discount notes
- add a requirement that a fund provide daily and weekly liquid assets, NAV per share, and net shareholder flow for each business day of the month rather than on a weekly basis
- add a requirement that funds report seven-day gross and net yields for each business day instead of as of the end of the reporting period
- add a requirement that funds must provide the name and LEI for both the fund registrant and its series
- add a requirement that funds must respond to the item requesting the LEI for a portfolio security with “N/A” if the portfolio company does not have an LEI
- add RSSD ID assigned by the National Information Center of the Fed’s Board of Governors as an additional category of “other identifiers” that a fund can use to identify a financial institution rather than defining “LEI” to include an RSSD ID if a financial institution does not have an assigned LEI
IX. Compliance Dates
The release includes the following proposed compliance periods:
Proposed Compliance Date
Swing pricing requirements for institutional prime and institutional tax-exempt funds
12 months after the effective date
Swing pricing amendments to Forms N-MFP and N-1A
12 months after the effective date
Government and retail money market funds must determine that financial intermediaries that submit orders to purchase or redeem the funds’ shares have the capacity to redeem and sell the funds’ shares at prices that do not correspond to a stable price per share
12 months after the effective date
Increased daily and weekly minimum asset requirements
6 months after the effective date
Amendments to Forms N-CR and N-MFP, except the swing-pricing-related disclosure on Form N-MFP
6 months after the effective date
Removal of the liquidity fee and redemption gate provisions from the Rule and associated disclosure requirements in Form N-1A and Form N-CR
Effective on the effective date of the final rule
In our view, a 12-month compliance period may not be enough for money market funds to work through operational aspects of swing pricing. We note that when the SEC adopted its swing pricing rules for non-money-market funds in 2016, it delayed the effective date of those rules for 24 months.
X. Comment Period
Comments are due within 60 days after publication of the release in the Federal Register. We expect the SEC to receive comments from numerous stakeholders, including money market fund sponsors, shareholders of money market funds, and issuers of short-term debt securities such as corporations and banks.
The dissenting opinions of the two commissioners who voted against the proposals may provide a roadmap for at least some commenters who will oppose the rulemaking. The dissenting commissioners argue that swing pricing is too complex and should not be mandatory but a voluntary tool that funds can choose to implement among other possible fee options. They also express concern that swing pricing would cause investors to favor government money market funds over prime money market funds. They also object to applying higher liquidity thresholds to non-institutional funds.
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