[Federal Register Volume 78, Number 118 (Wednesday, June 19, 2013)]
[Proposed Rules]
[Pages 36834-37030]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-13687]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 230, 239, 270, 274 and 279
[Release No. 33-9408, IA-3616; IC-30551; File No. S7-03-13]
RIN 3235-AK61
Money Market Fund Reform; Amendments to Form PF
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing two alternatives for amending rules that govern
money market mutual funds (or ``money market funds'') under the
Investment Company Act of 1940. The two alternatives are designed to
address money market funds' susceptibility to heavy redemptions,
improve their ability to manage and mitigate potential contagion from
such redemptions, and increase the transparency of their risks, while
preserving, as much as possible, the benefits of money market funds.
The first alternative proposal would require money market funds to sell
and redeem shares based on the current market-based value of the
securities in their underlying portfolios, rounded to the fourth
decimal place (e.g., $1.0000), i.e., transact at a ``floating'' net
asset value per share (``NAV''). The second alternative proposal would
require money market funds to impose a liquidity fee (unless the fund's
board determines that it is not in the best interest of the fund) if a
fund's liquidity levels fell below a specified threshold and would
permit the funds to suspend redemptions temporarily, i.e., to ``gate''
the fund under the same circumstances. Under this proposal, we could
adopt either alternative by itself or a combination of the two
alternatives. The SEC also is proposing additional amendments that are
designed to make money market funds more resilient by increasing the
diversification of their portfolios, enhancing their stress testing,
and increasing transparency by requiring money market funds to provide
additional information to the SEC and to investors. The proposal also
includes amendments requiring investment advisers to certain
unregistered liquidity funds, which can resemble money market funds, to
provide additional information about those funds to the SEC.
DATES: Comments should be received on or before September 17, 2013.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-03-13 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-03-13. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. All comments received will be posted without change; we do
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Adam Bolter, Senior Counsel; Brian
McLaughlin Johnson, Senior Counsel; Kay-Mario Vobis, Senior Counsel;
Amanda Hollander Wagner, Senior Counsel; Thoreau A. Bartmann, Branch
Chief; or Sarah G. ten Siethoff, Senior Special Counsel, Investment
Company Rulemaking Office, at (202) 551-6792, Division of Investment
Management, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment amendments to rules 419 [17 CFR 230.419] and 482 [17 CFR
230.482] under the Securities Act of 1933 [15 U.S.C. 77a--z-3]
(``Securities Act''), rules 2a-7 [17 CFR 270.2a-7], 12d3-1 [17 CFR
270.12d3-1], 18f-3 [17 CFR 270.18f-3], 22e-3 [17 CFR 270.22e-3], 30b1-7
[17 CFR 270.30b1-7], 31a-1 [17 CFR 270.31a-1], and new rule 30b1-8 [17
CFR 270.30b1-8] under the Investment Company Act of 1940 [15 U.S.C.
80a] (``Investment Company Act'' or ``Act''), Form N-1A under the
Investment Company Act and the Securities Act, Form N-MFP under the
Investment Company Act, and section 3 of Form PF under the Investment
Advisers Act [15 U.S.C. 80b], and new Form N-CR under the Investment
Company Act.\1\
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\1\ Unless otherwise noted, all references to statutory sections
are to the Investment Company Act, and all references to rules under
the Investment Company Act, including rule 2a-7, will be to Title
17, Part 270 of the Code of Federal Regulations [17 CFR 270].
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Table of Contents
I. Introduction
II. Background
A. Role of Money Market Funds
B. Economics of Money Market Funds
1. Incentives Created by Money Market Funds' Valuation and
Pricing Methods
2. Incentives Created by Money Market Funds' Liquidity Needs
3. Incentives Created by Imperfect Transparency, Including
Sponsor Support
4. Incentives Created by Money Market Funds Investors' Desire To
Avoid Loss
5. Effects on Other Money Market Funds, Investors, and the
Short-Term Financing Markets
C. The 2007-2008 Financial Crisis
D. Examination of Money Market Fund Regulation Since the
Financial Crisis
1. The 2010 Amendments
2. The Eurozone Debt Crisis and U.S. Debt Ceiling Impasse of
2011
3. Our Continuing Consideration of the Need for Additional
Reforms
III. Discussion
A. Floating Net Asset Value
1. Certain Considerations Relating to the Floating NAV Proposal
2. Money Market Fund Pricing
3. Exemption to the Floating NAV Requirement for Government
Money Market Funds
4. Exemption to the Floating NAV Requirement for Retail Money
Market Funds
5. Effect on Other Money Market Fund Exemptions
6. Tax and Accounting Implications of Floating NAV Money Market
Funds
7. Operational Implications of Floating NAV Money Market Funds
8. Disclosure Regarding Floating NAV
9. Transition
B. Standby Liquidity Fees and Gates
1. Analysis of Certain Effects of Liquidity Fees and Gates
2. Terms of the Liquidity Fees and Gates
3. Exemptions To Permit Liquidity Fees and Gates
4. Amendments to Rule 22e-3
5. Exemptions From the Liquidity Fees and Gates Requirement
6. Operational Considerations Relating to Liquidity Fees and
Gates
7. Tax Implications of Liquidity Fees
8. Disclosure Regarding Liquidity Fees and Gates
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9. Alternative Redemption Restrictions
C. Potential Combination of Standby Liquidity Fees and Gates and
Floating Net Asset Value
1. Potential Benefits of a Combination
2. Potential Drawbacks of a Combination
3. Effect of Combination
4. Operational Issues
D. Certain Alternatives Considered
1. Alternatives in the FSOC Proposed Recommendations
2. Alternatives in the PWG Report
E. Macroeconomic Effects of the Proposals
1. Effect on Current Investment in Money Market Funds
2. Effect on Current Issuers and the Short-Term Financing
Markets
F. Amendments to Disclosure Requirements
1. Financial Support Provided to Money Market Funds
2. Daily Disclosure of Daily Liquid Assets and Weekly Liquid
Assets
3. Daily Web Site Disclosure of Current NAV per Share
4. Disclosure of Portfolio Holdings
5. Daily Calculation of Current NAV per Share Under the
Liquidity Fees and Gates Proposal
6. Money Market Fund Confirmation Statements
G. New Form N-CR
1. Proposed Disclosure Requirements Under Both Reform
Alternatives
2. Additional Proposed Disclosure Requirements Under Liquidity
Fees and Gates Alternative
3. Economic Analysis
H. Amendments to Form N-MFP Reporting Requirements
1. Amendments Related to Rule 2a-7 Reforms
2. New Reporting Requirements
3. Clarifying Amendments
4. Public Availability of Information
5. Request for Comment on Frequency of Filing
6. Operational Implications
I. Amendments to Form PF Reporting Requirements
1. Overview of Proposed Amendments to Form PF
2. Utility of New Information, Including Benefits, Costs, and
Economic Implications
J. Diversification
1. Treatment of Certain Affiliates for Purposes of Rule 2a-7's
Five Percent Issuer Diversification Requirement
2. Asset-Backed Securities
3. The Twenty-Five Percent Basket
4. Additional Diversification Alternatives Considered
K. Issuer Transparency
L. Stress Testing
1. Stress Testing Under the Floating NAV Alternative
2. Stress Testing Under the Liquidity Fees and Gates Alternative
3. Economic Analysis
4. Combined Approach
M. Clarifying Amendments
1. Definitions of Daily Liquid Assets and Weekly Liquid Assets
2. Definition of Demand Feature
3. Short-Term Floating Rate Securities
4. Second Tier Securities
N. Proposed Compliance Date
1. Compliance Period for Amendments Related to Floating NAV
2. Compliance Period for Amendments Related to Liquidity Fees
and Gates
3. Compliance Period for Other Amendments to Money Market Fund
Regulation
4. Request for Comment
O. Request for Comment and Data
IV. Paperwork Reduction Act Analysis
A. Alternative 1: Floating Net Asset Value
1. Rule 2a-7
2. Rule 22e-3
3. Rule 30b1-7 and Form N-MFP
4. Rule 30b1-8 and Form N-CR
5. Rule 34b-1(a)
6. Rule 482
7. Form N-1A
8. Advisers Act Rule 204(b)-1 and Form PF
B. Alternative 2: Standby Liquidity Fees and Gates
1. Rule 2a-7
2. Rule 22e-3
3. Rule 30b1-7 and Form N-MFP
4. Rule 30b1-8 and Form N-CR
5. Rule 34b-1(a)
6. Rule 482
7. Form N-1A
8. Advisers Act Rule 204(b)-1 and Form PF
C. Request for Comments
V. Regulatory Flexibility Act Certification
VI. Statutory Authority
Text of Proposed Rules and Forms
I. Introduction
Money market funds are a type of mutual fund registered under the
Investment Company Act and regulated under rule 2a-7 under the Act.\2\
Money market funds pay dividends that reflect prevailing short-term
interest rates, generally are redeemable on demand, and, unlike other
investment companies, seek to maintain a stable net asset value per
share (``NAV''), typically $1.00.\3\ This combination of principal
stability, liquidity, and payment of short-term yields has made money
market funds popular cash management vehicles for both retail and
institutional investors. As of February 28, 2013, there were
approximately 586 money market funds registered with the Commission,
and these funds collectively held over $2.9 trillion of assets.\4\
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\2\ Money market funds are also sometimes called ``money market
mutual funds'' or ``money funds.''
\3\ See generally Valuation of Debt Instruments and Computation
of Current Price Per Share by Certain Open-End Investment Companies
(Money Market Funds), Investment Company Act Release No. 13380 (July
11, 1983) [48 FR 32555 (July 18, 1983)] (``1983 Adopting Release'').
Most money market funds seek to maintain a stable net asset value
per share of $1.00, but a few seek to maintain a stable net asset
value per share of a different amount, e.g., $10.00. For
convenience, throughout this Release, the discussion will simply
refer to the stable net asset value of $1.00 per share.
\4\ Based on Form N-MFP data. SEC regulations require that money
market funds report certain portfolio information on a monthly basis
to the SEC on Form N-MFP. See rule 30b1-7.
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Money market funds seek to maintain a stable share price by
limiting their investments to short-term, high-quality debt securities
that fluctuate very little in value under normal market conditions.\5\
They also rely on exemptions provided in rule 2a-7 that permit them to
value their portfolio securities using the ``amortized cost'' method of
valuation and to use the ``penny-rounding'' method of pricing.\6\ Under
the amortized cost method, a money market fund's portfolio securities
generally are valued at cost plus any amortization of premium or
accumulation of discount, rather than at their value based on current
market factors.\7\ The penny rounding method of pricing permits a money
market fund when pricing its shares to round the fund's net asset value
to the nearest one percent (i.e., the nearest penny).\8\ Together,
these valuation and pricing techniques create a ``rounding convention''
that permits a money market fund to sell and redeem shares at a stable
share price without regard to small variations in the value of the
securities that comprise its portfolio.\9\
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Other types of mutual funds not regulated by rule 2a-7, must calculate
their daily NAVs using market-based factors (with some exceptions) and
do not use penny rounding.\10\ We note, however, that banks and other
companies also make wide use of amortized cost accounting to value
certain of their assets.\11\
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\5\ Throughout this Release, we generally use the term ``stable
share price'' to refer to the stable share price that money market
funds seek to maintain and compute for purposes of distribution,
redemption and repurchases of fund shares.
\6\ Money market funds use a combination of the two methods so
that, under normal circumstances, they can use the penny rounding
method to maintain a price of $1.00 per share without pricing to the
third decimal point like other mutual funds, and the amortized cost
method so that they need not strike a daily market-based NAV. See
infra text accompanying nn.163, 177.
\7\ See rule 2a-7(a)(2). See also infra note 10.
\8\ See rule 2a-7(a)(20).
\9\ When the Commission initially established its regulatory
framework allowing money market funds to maintain a stable share
price through use of the amortized cost method of valuation and/or
the penny rounding method of pricing (so long as they abided by
certain risk limiting conditions), it did so understanding the
benefits that stable value money market funds provided as a cash
management vehicle, particularly for smaller investors, and focusing
on minimizing inappropriate dilution of assets and returns for
shareholders. See Proceedings before the Securities and Exchange
Commission in the Matter of InterCapital Liquid Asset Fund, Inc. et
al., 3-5431, Dec. 28, 1978, at 1533 (Statement of Martin Lybecker,
Division of Investment Management at the Securities and Exchange
Commission) (stating that Commission staff had learned over the
course of the hearings the strong preference of money market fund
investors to have a stable share price and that with the right risk
limiting conditions the Commission could limit the likelihood of a
deviation from that stable value, addressing Commission concerns
about dilution); 1983 Adopting Release, supra note 3, at nn.42-43
and accompanying text (``[T]he provisions of the rule impose
obligations on the board of directors to assess the fairness of the
valuation or pricing method and take appropriate steps to ensure
that shareholders always receive their proportionate interest in the
money market fund.''). At that time, the Commission was persuaded
that deviations to an extent that would cause material dilution
generally would not occur given the risk limiting conditions of the
rule. See id., at nn.41-42 and accompanying text (noting that
testimony from the original money market fund exemptive order
hearings alleged that the risk limiting conditions, short of
extraordinarily adverse conditions in the market, should ensure that
a properly managed money market fund should be able to maintain a
stable price per share and that rule 2a-7 is based on that
representation).
\10\ For a mutual fund not regulated under rule 2a-7, the
Investment Company Act and applicable rules generally require that
it price its securities at the current net asset value per share by
valuing portfolio instruments at market value or, if market
quotations are not readily available, at fair value as determined in
good faith by the fund's board of directors. See section 2(a)(41)(B)
of the Act and rules 2a-4 and 22c-1. The Commission, however, has
stated that it would not object if a mutual fund board of directors
determines, in good faith, that the value of debt securities with
remaining maturities of 60 days or less is their amortized cost,
unless the particular circumstances warrant otherwise. See Valuation
of Debt Instruments by Money Market Funds and Certain Other Open-End
Investment Companies, Investment Company Act Release No. 9786 (May
31, 1977) [42 FR 28999 (June 7, 1977)] (``1977 Valuation Release'').
In this regard, the Commission has stated that the ``fair value of
securities with remaining maturities of 60 days or less may not
always be accurately reflected through the use of amortized cost
valuation, due to an impairment of the credit worthiness of an
issuer, or other factors. In such situations, it would appear to be
incumbent upon the directors of a fund to recognize such factors and
take them into account in determining `fair value.' '' Id.
\11\ See FASB ASC paragraph 320-10-35-1c indicating investments
in debt securities classified as held-to-maturity shall be measured
subsequently at amortized cost in the statement of financial
position. See also Vincent Ryan, FASB Exposure Draft Alarms Bank
CFOs (June 2, 2010) available at http://www.cfo.com/article.cfm/14502294.
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In exchange for the ability to rely on the exemptions provided by
rule 2a-7, the rule imposes important conditions designed to limit
deviations between the fund's $1.00 share price and the market value of
the fund's portfolio. It requires money market funds to maintain a
significant amount of liquid assets and to invest in securities that
meet the rule's credit quality, maturity, and diversification
requirements.\12\ For example, a money market fund's portfolio
securities must meet certain credit quality requirements, such as
posing minimal credit risks.\13\ The rule also places limits on the
remaining maturity of securities in the fund's portfolio to limit the
interest rate and credit spread risk to which a money market fund may
be exposed. A money market fund generally may not acquire any security
with a remaining maturity greater than 397 days, and the dollar-
weighted average maturity of the securities owned by the fund may not
exceed 60 days and the fund's dollar-weighted average life to maturity
may not exceed 120 days.\14\ Money market funds also must maintain
sufficient liquidity to meet reasonably foreseeable redemptions, and
generally must invest at least 10% of their portfolios in assets that
can provide daily liquidity and invest at least 30% of their portfolios
in assets that can provide weekly liquidity.\15\ Finally, rule 2a-7
also requires money market funds to diversify their portfolios by
generally limiting the funds to investing no more than 5% of their
portfolios in any one issuer and no more than 10% of their portfolios
in securities issued by, or subject to guarantees or demand features
(i.e., puts) from, any one institution.\16\
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\12\ See rule 2a-7(c)(2), (3), (4), and (5).
\13\ See rule 2a-7(a)(12), (c)(3)(ii).
\14\ Rule 2a-7(c)(2).
\15\ See rule 2a-7(c)(5). The 10% daily liquid asset requirement
does not apply to tax exempt funds.
\16\ See rule 2a-7(c)(4).
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Rule 2a-7 also includes certain procedural requirements overseen by
the fund's board of directors. These include the requirement that the
fund periodically calculate the market-based value of the portfolio
(``shadow price'') \17\ and compare it to the fund's stable share
price; if the deviation between these two values exceeds \1/2\ of 1
percent (50 basis points), the fund's board of directors must consider
what action, if any, should be initiated by the board, including
whether to re-price the fund's securities above or below the fund's
$1.00 share price (an event colloquially known as ``breaking the
buck'').\18\
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\17\ See rule 2a-7(c)(8)(ii)(A).
\18\ See rule 2a-7(c)(8)(ii)(A) and (B). Regardless of the
extent of the deviation, rule 2a-7 imposes on the board of a money
market fund a duty to take appropriate action whenever the board
believes the extent of any deviation may result in material dilution
or other unfair results to investors or current shareholders. Rule
2a-7(c)(8)(ii)(C). In addition, the money market fund can use the
amortized cost or penny-rounding methods only as long as the board
of directors believes that they fairly reflect the market-based net
asset value per share. See rule 2a-7(c)(1).
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Different types of money market funds have been introduced to meet
the differing needs of money market fund investors. Historically, most
investors have invested in ``prime money market funds,'' which hold a
variety of taxable short-term obligations issued by corporations and
banks, as well as repurchase agreements and asset-backed commercial
paper.\19\ ``Government money market funds'' principally hold
obligations of the U.S. government, including obligations of the U.S.
Treasury and federal agencies and instrumentalities, as well as
repurchase agreements collateralized by government securities. Some
government money market funds limit themselves to holding only U.S.
Treasury obligations or repurchase agreements collateralized by U.S.
Treasury securities and are called ``Treasury money market funds.''
Compared to prime funds, government and Treasury money market funds
generally offer greater safety of principal but historically have paid
lower yields. ``Tax-exempt money market funds'' primarily hold
obligations of state and local governments and their instrumentalities,
and pay interest that is generally exempt from federal income tax for
individual taxpayers.
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\19\ See Investment Company Institute, 2013 Investment Company
Fact Book, at 178, Table 37 (2013), available at http://www.ici.org/pdf/2013_factbook.pdf.
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In the analysis that follows, we begin by reviewing the role of
money market funds and the benefits they provide investors. We then
review the economics of money market funds. This includes a discussion
of several features of money market funds that, when combined, can
create incentives for fund shareholders to redeem shares during periods
of stress, as well as the potential impact that such redemptions can
have on the fund and the markets that provide short-term financing.\20\
We then discuss money market funds' experience during the 2007-2008
financial crisis against this backdrop. We next analyze our 2010
reforms and their impact on the heightened redemption activity during
the 2011 Eurozone sovereign debt crisis and U.S. debt ceiling impasse.
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\20\ Throughout this Release, we generally refer to ``short-term
financing markets'' to describe the markets for short-term financing
of corporations, banks, and governments.
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Based on these analyses as well as other publicly available
analytical works, some of which are contained in the report responding
to certain questions posed by Commissioners Aguilar, Paredes and
Gallagher (``RSFI Study'') \21\ prepared by staff from the Division of
Risk, Strategy, and Financial Innovation (``RSFI''), we propose two
alternative frameworks for additional regulation of money market funds.
Each alternative seeks to preserve the ability of money market funds to
function as an effective and efficient cash management tool for
investors, but also address
[[Page 36837]]
certain features in money market funds that can make them susceptible
to heavy redemptions, provide them with better tools to manage and
mitigate potential contagion from high levels of redemptions, and
increase the transparency of their risks. We are also proposing
amendments that would apply under each alternative that would result in
additional changes to money market fund disclosure, diversification
limits, and stress testing, among other reforms.\22\
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\21\ See Response to Questions Posed by Commissioners Aguilar,
Paredes, and Gallagher, a report by staff of the Division of Risk,
Strategy, and Financial Innovation (Nov. 30, 2012), available at
http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
\22\ We note that we have consulted and coordinated with the
Consumer Financial Protection Bureau regarding this proposed
rulemaking in accordance with section 1027(i)(2) of the Dodd-Frank
Wall Street Reform and Consumer Protection Act.
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II. Background
A. Role of Money Market Funds
The combination of principal stability, liquidity, and short-term
yields offered by money market funds, which is unlike that offered by
other types of mutual funds, has made money market funds popular cash
management vehicles for both retail and institutional investors, as
discussed above. Retail investors use money market funds for a variety
of reasons, including, for example, to hold cash for short or long
periods of time or to take a temporary ``defensive position'' in
anticipation of declining equity markets. Institutional investors
commonly use money market funds for cash management in part because, as
discussed later in this Release, money market funds provide efficient
diversified cash management due both to the scale of their operations
and their expertise.\23\
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\23\ See infra notes 72-73 and accompanying text.
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Money market funds, due to their popularity with investors, have
become an important source of financing in certain segments of the
short-term financing markets, as discussed in more detail in section
III.E.2 below. Money market funds' ability to maintain a stable share
price contributes to their popularity. Indeed, the $1.00 stable share
price has been one of the fundamental features of money market funds.
As discussed in more detail in section III.A.7 below, the funds' stable
share price facilitates the funds' role as a cash management vehicle,
provides tax and administrative convenience to both money market funds
and their shareholders, and enhances money market funds' attractiveness
as an investment option.
Rule 2a-7, in addition to facilitating money market funds'
maintenance of stable share prices, also benefits investors by making
available an investment option that provides an efficient and
diversified means for investors to participate in the short-term
financing markets through a portfolio of short-term, high quality debt
securities.\24\ Many investors likely would find it impractical or
inefficient to invest directly in the short-term financing markets, and
some investors likely would not want the relatively undiversified
exposure that can result from investing in those markets on a smaller
scale or that could be associated with certain alternatives to money
market funds, like bank deposits.\25\ Although other types of mutual
funds can and do invest in the short-term financing markets, investors
may prefer money market funds because the risk the funds may undertake
is limited under rule 2a-7 (and because of the funds' corresponding
ability to maintain a stable share price).\26\
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\24\ See, e.g., Comment Letter of Harvard Business School
Professors Samuel Hanson, David Scharfstein, & Adi Sunderam (Jan. 8,
2013) (available in File No. FSOC-2012-0003) (``Harvard Business
School FSOC Comment Letter'') (explaining that prime money market
funds, by providing a way for investors to invest in the short-term
financing markets indirectly, ``provides MMF investors with a
diversified pool of deposit-like instruments with the convenience of
a single deposit-like account,'' and that, ``[g]iven the fixed costs
of managing a portfolio of such instruments, MMFs provide scale
efficiencies for small-balance savers (e.g., households and small
and mid-sized nonfinancial corporations) along with a valuable set
of transactional services (e.g., check-writing and other cash-
management functions).'').
\25\ Id. See also, e.g., Comment Letter of Investment Company
Institute (Jan. 24, 2013) (available in File No. FSOC-2012-0003)
(``ICI Jan. 24 FSOC Comment Letter'') (explaining that although bank
deposits are an alternative to money market funds, ``corporate cash
managers and other institutional investors do not view an
undiversified holding in an uninsured (or underinsured) bank account
as having the same risk profile as an investment in a diversified
short-term money market fund subject to the risk-limiting conditions
of Rule 2a-7'').
\26\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25
(``The regulatory regime established by Rule 2a-7 has proven to be
effective in protecting investors' interests and maintaining their
confidence in money market funds.'').
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Therefore, although rule 2a-7 permits money market funds to use
techniques to value and price their shares not permitted to other
mutual funds (or not permitted to the same extent), the rule also
imposes additional protective conditions on money market funds. These
additional conditions are designed to make money market funds' use of
the pricing techniques permitted by rule 2a-7 consistent with the
protection of investors, and more generally, to make available an
investment option for investors that seek an efficient way to obtain
short-term yields. These conditions thus reflect the differences in the
way money market funds operate and the ways in which investors use
money market funds compared to other types of mutual funds.
We recognize, and considered when developing the reform proposals
we are putting forward today, that money market funds are a popular
investment product and that they provide many benefits to investors and
to the short-term financing markets. Indeed, it is for these reasons
that we are proposing reforms designed to make the funds more
resilient, as discussed throughout this Release, while preserving, to
the extent possible, the benefits of money market funds. These reform
proposals may, however, make money market funds less attractive to
certain investors as discussed more fully below.
B. Economics of Money Market Funds
The combination of several features of money market funds can
create an incentive for their shareholders to redeem shares heavily in
periods of financial stress, as discussed in greater detail in the RSFI
Study. We discuss these factors below, as well as the harm that can
result from heavy redemptions in money market funds.
1. Incentives Created by Money Market Funds' Valuation and Pricing
Methods
Money market funds are unique among mutual funds in that rule 2a-7
permits them to use the amortized cost method of valuation and the
penny-rounding method of pricing. As discussed above, these valuation
and pricing techniques allow a money market fund to sell and redeem
shares at a stable share price without regard to small variations in
the value of the securities that comprise its portfolio, and thus to
maintain a stable $1.00 share price under most conditions.
Although the stable $1.00 share price calculated using these
methods provides a close approximation to market value under normal
market conditions, differences may exist because market prices adjust
to changes in interest rates, credit risk, and liquidity. We note that
the vast majority of money market fund portfolio securities are not
valued based on market prices obtained through secondary market trading
because the secondary markets for most portfolio securities such as
commercial paper, repos, and certificates of deposit are not actively
traded. Accordingly, most money market fund portfolio securities are
valued largely through ``mark-to-model'' or ``matrix pricing''
estimates.\27\
[[Page 36838]]
The market value of a money market fund's portfolio securities also may
experience relatively large changes if a portfolio asset defaults or
its credit profile deteriorates.\28\ Today differences within the
tolerance defined by rule 2a-7 are reflected only in a fund's shadow
price, and not the share price at which the fund satisfies purchase and
redemption transactions.
---------------------------------------------------------------------------
\27\ See, e.g., Harvard Business School FSOC Comment Letter,
supra note 24 (``secondary markets for commercial paper and other
private money market assets such as CDs are highly illiquid.
Therefore, the asset prices used to calculate the floating NAV would
largely be accounting or model-based estimates, rather than prices
based on secondary market transactions with sizable volumes.'');
Institutional Money Market Funds Association, The Use of Amortised
Cost Accounting by Money Market Funds, available at http://www.immfa.org/assets/files/IMMFA%20The%20use%20of%20amortised%20cost%20accounting%20by%20MMF.pdf
(noting that ``investors typically hold money market instruments to
maturity, and so there are relatively few prices from the secondary
market or broker quotes,'' that as a result most money market funds
value their assets using yield curve pricing, discounted cash flow
pricing, and amortized cost valuation, and surveying several money
market funds and finding that only U.S. Treasury bills are
considered ``level one'' assets under the relevant accounting
standards for which traded or quoted prices are generally
available).
\28\ The credit quality standards in rule 2a-7 are designed to
minimize the likelihood of such a default or credit deterioration.
---------------------------------------------------------------------------
Deviations that arise from changes in interest rates and credit
risk are temporary as long as securities are held to maturity, because
amortized cost values and market-based values converge at maturity. If,
however, a portfolio asset defaults or an asset sale results in a
realized capital gain or loss, deviations between the stable $1.00
share price and the shadow price become permanent. For example, if a
portfolio experiences a 25 basis point loss because an issuer defaults,
the fund's shadow price falls from $1.0000 to $0.9975. Even though the
fund has not broken the buck, this reduction is permanent and can only
be rebuilt internally in the event that the fund realizes a capital
gain elsewhere in the portfolio, which generally is unlikely given the
types of securities in which money market funds typically invest.\29\
---------------------------------------------------------------------------
\29\ It is important to understand that, in practice, a money
market fund cannot use future portfolio earnings to rebuild its
shadow price because Subchapter M of the Internal Revenue Code
effectively forces money market funds to distribute virtually all of
their earnings to investors. These restrictions can cause permanent
reductions in shadow prices to persist over time, even if a fund's
other portfolio securities are otherwise unimpaired.
---------------------------------------------------------------------------
If a fund's shadow price deviates far enough from its stable $1.00
share price, investors may have an economic incentive to redeem money
market fund shares.\30\ For example, investors may have an incentive to
redeem shares when a fund's shadow price is less than $1.00.\31\ If
investors redeem shares when the shadow price is less than $1.00, the
fund's shadow price will decline even further because portfolio losses
are spread across a smaller asset base. If enough shares are redeemed,
a fund can ``break the buck'' due, in part, to heavy investor
redemptions and the concentration of losses across a shrinking asset
base. In times of stress, this reason alone provides an incentive for
investors to redeem shares ahead of other investors: early redeemers
get $1.00 per share, whereas later redeemers may get less than $1.00
per share even if the fund experiences no further losses.
---------------------------------------------------------------------------
\30\ The value of this economic incentive is determined in part
by the volatility of the fund's underlying assets, which is, in
turn, affected by the volatility of interest rates, the likelihood
of default, and the maturities of the underlying assets. Since the
risk limiting conditions imposed by rule 2a-7 require funds to hold
high quality assets with short maturities, the volatility of the
underlying assets is very low (which implies that the corresponding
value of this economic incentive is low), except when the fund is
under stress.
\31\ We recognize that, absent the fund breaking the buck,
arbitraging fluctuations in a money market fund's shadow price would
require some effort and may not be compelling in many cases given
the small dollar value that could be captured. See, e.g., Money
Market Fund Reform, Investment Company Act Release No. 28807 (June
30, 2009) [74 FR 32688 (July 8, 2009)] (``2009 Proposing Release''),
at nn.304-305 and accompanying text (discussing how to arbitrage
around price changes from rising interest rates, investors would
need to sell money market fund shares for $1.00 and reinvest the
proceeds in equivalent short-term debt securities at then-current
interest rates).
---------------------------------------------------------------------------
To illustrate the incentive for investors to redeem shares early,
consider a money market fund that has one million shares outstanding
and holds a portfolio worth exactly $1 million. Assume the fund's
stable share price and shadow price are both $1.00. If the fund
recognizes a $4,000 loss, the fund's shadow price will fall below $1.00
as follows:
[GRAPHIC] [TIFF OMITTED] TP19JN13.001
If investors redeem one quarter of the fund's shares (250,000
shares), the redeeming shareholders are paid $1.00. Because redeeming
shareholders are paid more than the shadow price of the fund, the
redemptions further concentrate the loss among the remaining
shareholders. In this case, the amount of redemptions is sufficient to
cause the fund to ``break the buck.''
[GRAPHIC] [TIFF OMITTED] TP19JN13.002
This example shows that if a fund's shadow price falls below $1.00
and the fund experiences redemptions, the remaining investors have an
incentive to redeem shares to potentially avoid holding shares worth
even less, particularly if the fund re-prices its shares below $1.00.
This incentive exists even if investors do not expect the fund to incur
further portfolio losses.
As discussed in greater detail in the RSFI Study and as we saw
during the 2007-2008 financial crisis as further discussed below, money
market funds, although generally able to maintain stable share prices,
remain subject to credit, interest rate, and liquidity risks, all of
which can cause a fund's shadow price to decline below $1.00 and create
an incentive for investors to redeem shares ahead of other
investors.\32\ Although defaults are very low probability events, the
resulting losses will be most acute if the default occurs in a position
that is greater than 0.5% of the fund's assets, as was the case in the
Reserve Primary Fund's investment in Lehman Brothers commercial paper
in September 2008.\33\ As discussed further in section III.J of this
Release, we note that money market funds hold significant numbers of
such larger positions.\34\
---------------------------------------------------------------------------
\32\ See generally RSFI Study, supra note 21, at section 4.A.
\33\ See generally infra section II.C.
\34\ FSOC, in formulating possible money market reform
recommendations, solicited and received comments from the public
(FSOC Comment File, File No. FSOC-2012-0003, available at http://www.regulations.gov/#!docketDetail;D=FSOC-2012-0003), some of which
have made similar observations about the concentration and size of
money market fund holdings. See, e.g., Harvard Business School FSOC
Comment Letter, supra note 24 (noting that ``prime MMFs mainly
invest in money-market instruments issued by large, global banks''
and providing information about the size of the holdings of ``the 50
largest non-government issuers of money market instruments held by
prime MMFs as of May 2012'').
---------------------------------------------------------------------------
2. Incentives Created by Money Market Funds' Liquidity Needs
The incentive for money market fund investors to redeem shares
ahead of other investors also can be heightened
[[Page 36839]]
by liquidity concerns. Money market funds, by definition and like all
other mutual funds, offer investors the ability to redeem shares upon
demand.
A money market fund has three sources of internal liquidity to meet
redemption requests: cash on hand, cash from investors purchasing
shares, and cash from maturing securities. If these internal sources of
liquidity are insufficient to satisfy redemption requests on any
particular day, money market funds may be forced to sell portfolio
securities to raise additional cash.\35\ Since the secondary market for
many portfolio securities is not deeply liquid (in part because most
money market fund securities are held to maturity), funds may have to
sell securities at a discount from their amortized cost value, or even
at fire-sale prices,\36\ thereby incurring additional losses that may
have been avoided if the funds had sufficient liquidity.\37\ This,
itself, can cause a fund's portfolio to lose value. In addition,
redemptions that deplete a fund's most liquid assets can have
incremental adverse effects because they leave the fund with fewer
liquid assets, making it more difficult to avoid selling less liquid
assets, potentially at a discount, to meet further redemption requests.
---------------------------------------------------------------------------
\35\ Although the Act permits a money market fund to borrow
money from a bank, such loans, assuming the proceeds of which are
paid out to meet redemptions, create liabilities that must be
reflected in the fund's shadow price, and thus will contribute to
the stresses that may force the fund to ``break the buck.'' See
section 18(f) of the Investment Company Act.
\36\ Money market funds normally meet redemptions by disposing
of their more liquid assets, rather than selling a pro rata slice of
all their holdings, which typically include less liquid securities
such as certificates of deposit, commercial paper, or term
repurchase agreements (``repo''). See Harvard Business School FSOC
Comment Letter, supra note 24 (``MMFs forced to liquidate commercial
paper and bank certificates of deposits are likely to sell them at
heavily discounted, `fire sale' prices. This creates run risk
because early investor redemptions can be met with the sale of
liquid Treasury bills, which generate enough cash to fully pay early
redeemers. In contrast, late redemptions force the sale of illiquid
assets at discounted prices, which may not generate enough revenue
to fully repay late redeemers. Thus, each investor benefits from
redeeming earlier than others, setting the stage for runs.'');
Jonathan Witmer, Does the Buck Stop Here? A Comparison of
Withdrawals from Money Market Mutual Funds with Floating and
Constant Share Prices, Bank of Canada Working Paper 2012-25 (Aug.
2012) (``Witmer''), available at http://www.bankofcanada.ca/wp-content/uploads/2012/08/wp2012-25.pdf. ``Fire sales'' refer to
situations when securities deviate from their information-efficient
values typically as a result of sale price pressure. For an overview
of the theoretical and empirical research on asset ``fire sales,''
see Andrei Shleifer & Robert Vishny, Fire Sales in Finance and
Macroeconomics, 25 Journal of Economic Perspectives, Winter 2011, at
29-48 (``Fire Sales'').
\37\ The RSFI Study examined whether money market funds are more
resilient to redemptions following the 2010 reforms and notes that,
``As expected, the results show that funds with a 30 percent [weekly
liquid asset requirement] are more resilient to both portfolio
losses and investor redemptions'' than those funds without a 30
percent weekly liquid asset requirement. RSFI Study, supra note 21,
at 37.
---------------------------------------------------------------------------
3. Incentives Created by Imperfect Transparency, Including Sponsor
Support
Lack of investor understanding and complete transparency concerning
the risks posed by particular money market funds can exacerbate the
concerns discussed above. If investors do not know a fund's shadow
price and/or its underlying portfolio holdings (or if previous
disclosures of this information are no longer accurate), investors may
not be able to fully understand the degree of risk in the underlying
portfolio.\38\ In such an environment, a default of a large-scale
commercial paper issuer, such as a bank holding company, could
accelerate redemption activity across many funds because investors may
not know which funds (if any) hold defaulted securities and initiate
redemptions to avoid potential rather than actual losses in a ``flight
to transparency.'' \39\ Since many money market funds hold securities
from the same issuer, investors may respond to a lack of transparency
about specific fund holdings by redeeming assets from funds that are
believed to be holding highly correlated positions.\40\
---------------------------------------------------------------------------
\38\ See, e.g., RSFI Study, supra note 21, at 31 (stating that
although disclosures on Form N-MFP have improved fund transparency,
``it must be remembered that funds file the form on a monthly basis
with no interim updates,'' and that ``[t]he Commission also makes
the information public with a 60-day lag, which may cause it to be
stale''); Comment Letter of the Presidents of the 12 Federal Reserve
Banks (Feb. 12, 2013) (available in File No. FSOC-2012-0003)
(``Federal Reserve Bank Presidents FSOC Comment Letter'') (stating
that ``[e]ven more frequent and timely disclosure may be warranted
to increase the transparency of MMFs'' and noting that ``[d]uring
times of stress, [. . .] uncertainty regarding portfolio composition
could heighten investors' incentives to redeem in between reporting
periods [of money market funds' portfolio information], as they will
not be able to determine if their fund is exposed to certain
stressed assets''); see also infra section III.H where we request
comment on whether we should require money market funds to file Form
N-MFP more frequently.
\39\ See Nicola Gennaioli, Andrei Shleifer & Robert Vishny,
Neglected Risks, Financial Innovation, and Financial Fragility, 104
J. Fin. Econ. 453 (2012) (``A small piece of news that brings to
investors' minds the previously unattended risks catches them by
surprise and causes them to drastically revise their valuations of
new securities and to sell them. . . . When investors realize that
the new securities are false substitutes for the traditional ones,
they fly to safety, dumping these securities on the market and
buying the truly safe ones.'').
\40\ See infra notes 65-67 and accompanying text. Based on Form
N-MFP data as of February 28, 2013, there were 27 different issuers
whose securities were held by more than 100 prime money market
funds.
---------------------------------------------------------------------------
Money market funds' sponsors on a number of occasions have
voluntarily chosen to provide financial support for their money market
funds \41\ for various reasons, including to keep a fund from re-
pricing below its stable value, but also, for example, to protect the
sponsors' reputations or brands. Considering that instances of sponsor
support are not required to be disclosed outside of financial
statements, and thus were not particularly transparent to investors,
voluntary sponsor support has played a role in helping some money
market funds maintain a stable value and, in turn, may have lessened
investors' perception of the risk in money market funds.\42\ Even those
investors who were aware of sponsor support could not be assured it
would be available in the future.\43\ Instances of discretionary
sponsor support were relatively common during the financial crisis. For
example, during the period from September 16, 2008 to October 1, 2008,
a number of money market fund sponsors purchased large amounts of
portfolio securities from their money market funds or provided capital
support to the funds (or received staff no-action assurances in order
to provide
[[Page 36840]]
support).\44\ Commission staff provided no-action assurances to 100
money market funds in 18 different fund groups so that the fund groups
could enter into such arrangements.\45\ Although a number of advisers
to money market funds obtained staff no-action assurances in order to
provide sponsor support, several did not subsequently provide the
support because it was no longer necessary.\46\
---------------------------------------------------------------------------
\41\ Rule 17a-9 currently allows for discretionary support of
money market funds by their sponsors and other affiliates.
\42\ See, e.g., Comment Letter of Occupy the SEC (Feb. 15, 2013)
(available in File No. FSOC-2012-0003) (``Occupy the SEC FSOC
Comment Letter'') (``The current strategies for maintaining a stable
NAV--rounding and discretionary fund sponsor support--both serve to
conceal important market signals of mounting problems within the
fund's portfolio.''). See also Federal Reserve Bank Presidents FSOC
Comment Letter, supra note 38 (warning that ``[g]iven the perception
of stability that discretionary support creates, this practice may
attract investors that are not willing to accept the underlying
risks in MMFs and who therefore are more prone to run in times of
potential stress.'')
\43\ See, e.g., U.S. Securities and Exchange Commission,
Roundtable on Money Market Funds and Systemic Risk, unofficial
transcript (May 10, 2011), available at http://www.sec.gov/spotlight/mmf-risk/mmf-risk-transcript-051011.htm (``Roundtable
Transcript'') (Bill Stouten, Thrivent Financial) (``I think the
primary factor that makes money funds vulnerable to runs is the
marketing of the stable NAV. And I think the record of money market
funds and maintaining the stable NAV has largely been the result of
periodic voluntary sponsor support. I think sophisticated investors
that understand this and doubt the willingness or ability of the
sponsor to make that support know that they need to pull their money
out before a declining asset is sold.''); (Lance Pan, Capital
Advisors Group) (``over the last 30 or 40 years, [investors] have
relied on the perception that even though there is risk in money
market funds, that risk is owned somehow implicitly by the fund
sponsors. So once they perceive that they are not able to get that
additional assurance, I believe that was one probable cause of the
run''); see also Federal Reserve Bank Presidents FSOC Comment
Letter, supra note 38 (stating that ``[t]hough [sponsor support]
creates a perception of stability, it may not truly provide
stability in times of stress. Indeed, events of 2008 showed that
sponsor support cannot always be relied upon.''); infra section
III.F.1.
\44\ See Steffanie A. Brady et al., The Stability of Prime Money
Market Mutual Funds: Sponsor Support from 2007 to 2011, Federal
Reserve Bank of Boston Risk and Policy Analysis Unit Working Paper
No. 12-3 (Aug. 13, 2012), available at http://www.bos.frb.org/bankinfo/qau/wp/2012/qau1203.pdf. Staff in the Federal Reserve Bank
of Boston's Risk and Policy Analysis Unit examine 341 money market
funds and find that 78 of the funds disclosed sponsor support on
Form N-CSR between 2007 and 2011 (some multiple times). This
analysis excludes Capital Support Agreements and/or Letters of
Credit that were not drawn upon. Large sponsor support (in
aggregate) representing over 0.5% of assets under management
occurred in 31 money market funds, and the primary reasons disclosed
for such support include losses on Lehman Brothers, AIG, and Morgan
Stanley securities. Moody's Investors Service Special Comment,
Sponsor Support Key to Money Market Funds (Aug. 9, 2010) (``Moody's
Sponsor Support Report''), reported that 62 money market funds
required sponsor support during 2007-2008.
\45\ Our staff estimated that during the period from August 2007
to December 31, 2008, almost 20% of all money market funds received
some support (or staff no-action assurances concerning support) from
their money managers or their affiliates. We note that not all of
such support required no-action assurances from Commission staff
(for example, fund affiliates were able to purchase defaulted Lehman
Brothers securities from fund portfolios under rule 17a-9 under the
Investment Company Act without the need for any no-action
assurances). See, e.g., http://www.sec.gov/divisions/investment/im-noaction.shtml#money.
\46\ See, e.g., Comment Letter of The Dreyfus Corporation (Aug.
7, 2012) (available in File No. 4-619) (stating that no-action
relief to provide sponsor support ``was sought by many money funds
as a precautionary measure'').
---------------------------------------------------------------------------
The 2007-2008 financial crisis is not the only instance in which
some money market funds have come under strain, although it is unique
in the amount of money market funds that requested or received sponsor
support.\47\ Interest rate changes, issuer defaults, and credit rating
downgrades can lead to significant valuation losses for individual
funds. Table 1 documents that since 1989, in addition to the 2007-2008
financial crisis, 11 events were deemed to have been sufficiently
negative that some fund sponsors chose to provide support or to seek
staff no-action assurances in order to provide support.\48\ The table
indicates that these events potentially affected 158 different money
market funds. This finding is consistent with estimates provided by
Moody's that at least 145 U.S. money market funds received sponsor
support to maintain either price stability or share liquidity before
2007.\49\ Note that although these events affected money market funds
and their sponsors, there is no evidence that these events caused
systemic problems, most likely because the events were isolated either
to a single entity or class of security. Table 1 is consistent with the
interpretation that outside a crisis period, these events did not
propagate risk more broadly to the rest of the money market fund
industry. However, a caveat that prevents making a strong inference
about the impact of sponsor support on investor behavior from Table 1
is that sponsor support generally was not immediately disclosed, and
was not required to be disclosed by the Commission, and so investors
may have been unaware that their money market fund had come under
stress.\50\
---------------------------------------------------------------------------
\47\ See Moody's Sponsor Support Report, supra note 44.
\48\ The table does not comprehensively describe every instance
of sponsor support of a money market fund or request for no-action
assurances to provide support, but rather summarizes some of the
more notable instances of sponsor support.
\49\ See Moody's Sponsor Support Report, supra note 44, noting
in particular 13 funds requiring support in 1990 due to credit
defaults or deterioration at MNC Financial, Mortgage & Realty Trust,
and Drexel Burnham; 79 funds requiring support in 1994 due to the
Orange County bankruptcy and holdings of certain floating rate
securities when interest rates increased; and 25 funds requiring
support in 1999 after the credit of certain General American Life
Insurance securities deteriorated.
\50\ Note that we are proposing changes to our rules and forms
to require more comprehensive and timely disclosure of such sponsor
support. See infra sections III.F.1 and III.G.
\51\ The estimated total numbers of money market funds are from
Table 38 of the Investment Company Institute's 2013 Fact Book,
available at http://www.ici.org/pdf/2013_factbook.pdf. The numbers
of money market funds are as of the end of the relevant year, and
not necessarily as of the date that any particular money market fund
received support (or whose sponsor received no-action assurances in
order to provide support).
\52\ See Jack Lowenstein, Should the Rating Agencies be
Downgraded?, Euromoney (Feb. 1, 1990) (noting that Integrated
Resources had been rated A-2 by Standard & Poor's until two days
before default); Jonathan R. Laing, Never Say Never--Or, How Safe Is
Your Money-Market Fund?, Barron's (Mar. 26, 1990) (``Laing''), at 6;
Randall W. Forsyth, Portfolio Analysis of Selected Fixed-Income
Funds--Muni Money-Fund Risks, Barron's (July 2, 1990) (``Forsyth''),
at 33; Georgette Jasen, SEC Is Accelerating Its Inspections of Money
Funds, Wall St. J. (Dec. 4, 1990) (``Jasen''), at C1. One $630
million money market fund held a 3.5% position in Integrated
Resources when it defaulted. See Linda Sandler, Cloud Cast on `Junk'
IOUs By Integrated Resources, Wall St. J. (June 28, 1989).
\53\ See Laing, supra note 52; Forsyth, supra note 52; Jasen,
supra note 52.
\54\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 19959 (Dec. 17, 1993) [58 FR
68585 (Dec. 28, 1993)] at n.12 (``1993 Proposing Release''). See
also Leslie Eaton, Another Close Call--An Adviser Bails Out Its
Money Fund, Barron's (Mar. 11, 1991), at 42 (noting that Mercantile
Bancorp bought out $28 million of MNC Financial notes from its
affiliated money market fund, which had accounted for 3% of the
money market fund's assets).
Table 1
------------------------------------------------------------------------
Estimated number
Number of money of money market
market funds from funds supported
Year 2013 ICI mutual by affiliate or Event
fund fact book for which no-
\51\ action assurances
obtained
------------------------------------------------------------------------
1989........... 673 4 Default of
Integrated
Resources
commercial paper
(rated A-2 by
Standard &
Poor's until
shortly prior to
default).\52\
1990........... 741 11 Default of
Mortgage &
Realty Trust
commercial paper
(rated A-2 by
Standard &
Poor's until
shortly prior to
default).\53\
1990........... 741 10 MNC Financial
Corp. commercial
paper downgraded
from being a
second tier
security.\54\
1991........... 820 10 Mutual Benefit
Life Insurance
(``MBLI'')
seized by state
insurance
regulators,
causing it to
fail to honor
put obligations
after those
holding
securities with
these features
put the
obligations en
masse to
MBLI.\55\
1994........... 963 40 Rising interest
rates damaged
the value of
certain
adjustable rate
securities held
by money market
funds.\56\
1994........... 963 43 Orange County,
California
bankruptcy.\57\
1997........... 1,103 3 Mercury Finance
Corp. defaults
on its
commercial
paper.
[[Page 36841]]
1999........... 1,045 25 Credit rating
downgrade of
General American
Life Insurance
Co. triggered a
wave of demands
for repayment on
its funding
contracts,
leading to
liquidity
problems and
causing it to be
placed under
administrative
supervision by
state insurance
regulators.\58\
2001........... 1,015 6 Pacific Gas &
Electric Co. and
Southern
California
Edison Co.
commercial paper
went from being
first tier
securities to
defaulting in a
2-week
period.\59\
2007........... 805 51 Investments in
SIVs.
2008........... 783 109 Investments in
Lehman Brothers,
America
International
Group, Inc.
(``AIG'') and
other financial
sector debt
securities.
2010........... 652 3 British Petroleum
Gulf oil spill
affects price of
BP debt
securities held
by some money
market funds.
2011........... 632 3 Investments in
Eksportfinans,
which was
downgraded from
being a first
tier security to
junk-bond
status.
------------------------------------------------------------------------
It also is important to note that, as discussed above, fund
sponsors may provide financial support for a number of different
reasons. Sponsors may support funds to protect their reputations and
their brands or the credit rating of the fund.\60\ Support also may be
used to keep a fund from breaking a buck or to increase a fund's shadow
price if its sponsor believes investors avoid funds that may have low
shadow prices. We note that the fact that no-action assurances were
obtained or sponsor support was provided does not necessarily mean that
a money market fund would have broken the buck without such support or
assurances.
---------------------------------------------------------------------------
\55\ At the time of its seizure, MBLI debt was rated in the
highest short-term rating category by Standard & Poor's. See 1993
Proposing Release, supra note 54, at n.28 and accompanying text. The
money market fund sponsors either repurchased the MBLI-backed
instruments from the funds at their amortized cost or obtained a
replacement guarantor in order to prevent shareholder losses. Id.
\56\ See Money Market Fund Prospectuses, Investment Company Act
Release No. 21216 (July 19, 1995) [60 FR 38454, (July 26, 1995)], at
n.17; Investment Company Institute, Report of the Money Market
Working Group (Mar. 17, 2009), available at http://www.ici.org/pdf/ppr_09_mmwg.pdf (``ICI 2009 Report''), at 177; Leslie Wayne,
Investors Lose Money in `Safe' Fund, N.Y. Times, Sept. 28, 1994;
Leslie Eaton, New Caution About Money Market Funds, N.Y. Times,
Sept. 29, 1994.
\57\ See ICI 2009 Report, supra note 56, at 178; Tom Petruno,
Orange County in Bankruptcy: Investors Weigh Their Options: Muni
Bond Values Slump but Few Trade at Fire-Sale Prices, L.A. Times,
Dec. 8, 1994.
\58\ See Sandra Ward, Money Good? How some fund managers
sacrificed safety for yield, Barron's (Aug. 23, 1999), at F3.
\59\ See Aaron Lucchetti & Theo Francis, Parents Take on Funds'
Risks Tied to Utilities, Wall St. J. (Feb. 28, 2001), at C1; Lewis
Braham, Commentary: Money Market Funds Enter the Danger Zone,
Businessweek (Apr. 8, 2001).
\60\ See, e.g., Marcin Kacperczyk & Philipp Schnabl, How Safe
are Money Market Funds?, 128 Q. J. Econ. (forthcoming Aug. 2013)
(``Kacperczyk & Schnabl'') (``. . . fund sponsors with more non-
money market fund business expect to incur large costs if their
money market funds fail. Such costs are typically reputational in
nature, in that an individual fund's default generates negative
spillovers to the fund's sponsor['s] other business. In practice,
these costs could be outflows from other mutual funds managed by the
same sponsor or a loss of business in the sponsor's commercial
banking, investment banking, or insurance operations.''); Patrick E.
McCabe, The Cross Section of Money Market Fund Risks and Financial
Crises, Federal Reserve Board Finance and Economic Discussion Series
Paper No. 2010-51 (2010) (``Cross Section'') (``Nothing required
these sponsors to provide support, but because allowing a fund to
break the buck would have been destructive to a sponsor's reputation
and franchise, sponsors backstopped their funds voluntarily.'');
Value Line Posts Loss for 1st Period, Cites Charge of $7.5 Million,
Wall St. J. (Sept. 18, 1989) (``In discussing the charge in its
fiscal 1989 annual report [for buying out defaulted commercial paper
from its money market fund], Value Line said it purchased the fund's
holdings in order to protect its reputation and the continuing
income from its investment advisory and money management
business.''); Comment Letter of James J. Angel (Feb. 6, 2013)
(available in File No. FSOC-2012-0003) (``Angel FSOC Comment
Letter'') (``Sponsors have a strong commercial incentive to stand
behind their funds. Breaking the buck means the immediate and
catastrophic end of the sponsor's entire asset management
business.'').
---------------------------------------------------------------------------
Finally, the government assistance provided to money market funds
during 2007-2008 financial crisis, discussed in more detail below, may
have contributed to investors' perceptions that the risk of loss in
money market funds is low.\61\ If investors perceive money market funds
as having an implicit government guarantee in times of crisis, any
potential instability of a money market fund's NAV could be mis-
estimated. Investors will form expectations about the likelihood of a
potential intervention to support money market funds, either by the
U.S. government or fund sponsors. To the extent these forecasts are
based on inaccurate information, investor estimates of potential losses
will be biased.
---------------------------------------------------------------------------
\61\ See, e.g, Marcin Kacperczyk & Philipp Schnabl, Money Market
Funds: How to Avoid Breaking the Buck, in Regulating Wall St: The
Dodd-Frank Act and the New Architecture of Global Finance (Viral V.
Acharya, et al., eds., 2011), at 313 (``Given that money market
funds provide both payment services to investors and refinancing to
financial intermediaries, there is a strong case for the government
to support money market funds during a financial crisis by
guaranteeing the value of money market fund investments. As a result
of such support, money market funds have an ex ante incentive to
take on excessive risk, similarly to other financial institutions
with explicit or implicit government guarantees . . . after the
[government] guarantees were provided in September 2008 [to money
market funds], most investors will expect similar guarantees during
future financial crises. . . .''). But see Comment Letter of
Fidelity (Apr. 26, 2012) (available in File No. 4-619) (``Fidelity
April 2012 PWG Comment Letter'') (citing a survey of Fidelity's
retail customers in which 75% of responding customers did not
believe that money market funds are guaranteed by the government and
25% either believed that they were guaranteed or were not sure
whether they were guaranteed). We note that investor belief that
money market funds are not guaranteed by the government does not
necessarily mean that investors do not believe that the government
will support money market funds if there is another run on money
market funds.
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4. Incentives Created by Money Market Funds Investors' Desire To Avoid
Loss
In addition to the incentives described above, other
characteristics of money market funds create incentives to redeem in
times of stress. Investors in money market funds have varying
investment goals and tolerances for risk. Many investors use money
market funds for principal preservation and as a cash management tool,
and, consequently, these funds can attract investors who are unable or
unwilling to tolerate even small losses. These investors may seek to
minimize possible losses, even at the cost of forgoing higher
returns.\62\ Such
[[Page 36842]]
investors may be very loss averse for many reasons, including general
risk tolerance, legal or investment restrictions, or short-term cash
needs.\63\ These overarching considerations may create incentives for
money market investors to redeem and would be expected to persist, even
if valuation and pricing incentives were addressed.
---------------------------------------------------------------------------
\62\ See, e.g., Comment Letter of Investment Company Institute
(Apr. 19, 2012) (available in File No. 4-619) (``ICI Apr 2012 PWG
Comment Letter'') (enclosing a survey commissioned by the Investment
Company Institute and conducted by Treasury Strategies, Inc.
finding, among other things. that 94% of respondents rated safety of
principal as an ``extremely important'' factor in their money market
fund investment decision and 64% ranked safety of principal as the
``primary driver'' of their money market fund investment).
\63\ See, e.g., Comment Letter of County Commissioners Assoc. of
Ohio (Dec. 21, 2012) (available in File No. FSOC-2012-0003)
(``County governments in Ohio operate under legal constraints or
other policies that limit them from investing in instruments without
a stable value.'').
---------------------------------------------------------------------------
The desire to avoid loss may cause investors to redeem from money
market funds in times of stress in a ``flight to quality.'' For
example, as discussed in the RSFI Study, one explanation for the heavy
redemptions from prime money market funds and purchases in government
money market fund shares during the financial crisis may be a flight to
quality, given that most of the assets held by government money market
funds have a lower default risk than the assets of prime money market
funds.\64\
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\64\ One study documented that investors redirected assets from
prime money market funds into government money market funds during
September 2008. See Russ Wermers et al., Runs on Money Market Funds
(Jan. 2, 2013), available at http://www.rhsmith.umd.edu/cfp/pdfs_docs/papers/WermersMoneyFundRuns.pdf (``Wermers Study''). Another
study found that redemption activity in money market funds during
the financial crisis was higher for riskier money market funds. See
Cross Section, supra note 60.
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5. Effects on Other Money Market Funds, Investors, and the Short-Term
Financing Markets
The analysis above generally describes how potential losses may
create shareholder incentives to redeem at a specific money market
fund. We now discuss how stress at one money market fund can be
positively correlated across funds in at least two ways. Some market
observers have noted that if a money market fund suffers a loss on one
of its portfolio securities--whether because of a deterioration in
credit quality, for example, or because the fund sold the security at a
discount to its amortized-cost value--other money market funds holding
the same security may have to reflect the resultant discounts in their
shadow prices.\65\ Any resulting decline in the shadow prices of other
funds could, in turn, lead to a contagion effect that could spread even
further.\66\ For example, a number of commenters have observed that
many money market fund holdings tend to be highly correlated, making it
more likely that multiple money market funds will experience
contemporaneous decreases in share prices.\67\
---------------------------------------------------------------------------
\65\ See generally Douglas W. Diamond & Raghuram G. Rajan, Fear
of Fire Sales, Illiquidity Seeking, and Credit Freezes, 126 Q. J.
Econ. 557 (May 2011); Fire Sales, supra note 36; Markus Brunnermeier
et al., The Fundamental Principles of Financial Regulation, in
Geneva Reports on the World Economy 11 (2009).
\66\ For example, supra Table 1, which identifies certain
instances in which money market fund sponsors supported their funds
or sought staff no-action assurances to do so, tends to show that
correlated holdings across funds resulted in multiple funds
experiencing losses that appeared to motivate sponsors to provide
support or seek staff no-action assurances in order to provide
support.
\67\ See, e.g., Comment Letter of Better Markets, Inc. (Feb. 15,
2013) (available in File No. FSOC-2012-0003) (``Better Markets FSOC
Comment Letter'') (agreeing with FSOC's analysis and stating that
``MMFs tend to have similar exposures due to limits on the nature of
permitted investments. As a result, losses creating instability and
a crisis of confidence in one MMF are likely to affect other MMFs at
the same time.''); Comment Letter of Robert Comment (Dec. 31. 2012)
(available in File No. FSOC-2012-0003) (``Robert Comment FSOC
Comment Letter'') (discussing correlation in money market funds'
portfolios and stating, among other things, that ``now that
bank[hyphen]issued money market instruments have come to comprise
half the holdings of the typical prime fund, the SEC should
acknowledge correlated credit risk by requiring that prime funds
practice sector diversification (in addition to issuer
diversification)''); Occupy the SEC FSOC Comment Letter, supra note
42 (discussing concentration of risk across money market funds).
---------------------------------------------------------------------------
As discussed above, in times of stress if investors do not wish to
be exposed to a distressed issuer (or correlated issuers) but do not
know which money market funds own these distressed securities at any
given time, investors may redeem from any money market funds that could
own the security (e.g., redeeming from all prime funds).\68\ A fund
that did not own the security and was not otherwise under stress could
nonetheless experience heavy redemptions which, as discussed above,
could themselves ultimately cause the fund to experience losses if it
does not have adequate liquidity.
---------------------------------------------------------------------------
\68\ See, e.g., Wermers Study, supra note 64 (based on an
empirical analysis of data from the 2008 run on money market funds,
finding that, during 2008, ``[f]unds that cater to institutional
investors, which are the most sophisticated and informed investors,
were hardest hit,'' and that ``investor flows from money market
funds seem to have been driven both by strategic externalities . . .
and information.'').
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As was experienced during the financial crisis, the potential for
liquidity-induced contagion may have negative effects on investors and
the markets for short-term financing of corporations, banks, and
governments. This is in large part because of the significance of money
market funds' role in such short-term financing markets.\69\ Indeed,
money market funds had experienced steady growth before the financial
crisis, driven in part by growth in the size of institutional cash
pools,\70\ which grew from under $100 billion in 1990 to almost $4
trillion just before the 2008 financial crisis.\71\ Money market funds'
suitability for cash management operations also has made them popular
among corporate treasurers, municipalities, and other institutional
investors, some of whom rely on money market funds for their cash
management operations because the funds provide diversified cash
management more efficiently due both to the scale of their operations
and their expertise.\72\ For example, according to
[[Page 36843]]
one survey, approximately 19% of organizations' short-term investments
were allocated to money market funds (and, according to this observer,
this figure is down from almost 40% in 2008 due in part to the
reallocation of cash investments to bank deposits following temporary
unlimited Federal Deposit Insurance Corporation deposit insurance for
non-interest bearing bank transaction accounts, which recently
expired).\73\
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\69\ See infra Panels A, B, and C in section III.E for
statistics on the types and percentages of outstanding short-term
debt obligations held by money market funds.
\70\ See Zoltan Pozsar, Institutional Cash Pools and the Triffin
Dilemma of the U.S. Banking System, IMF Working Paper 11/190 (Aug.
2011) (``Pozsar''); Gary Gorton & Andrew Metrick, Securitized
Banking and the Run on Repo, 104 J. Fin. Econ. 425 (2012) (``Gorton
& Metrick''); Jeremy C. Stein, Monetary Policy as Financial
Stability Regulation, 127 Q. J. Econ. 57 (2012); Nicola Gennaioli,
Andrei Shleifer & Robert W. Vishny, A Model of Shadow Banking, J.
Fin. (forthcoming 2013). The Pozsar paper defines institutional cash
pools as ``large, centrally managed, short-term cash balances of
global non-financial corporations and institutional investors such
as asset managers, securities lenders and pension funds.'' Pozsar,
at 4.
\71\ See Pozsar, supra note 70, at 5-6. These institutional cash
pools can come from corporations, bank trust departments, securities
lending operations of brokerage firms, state and local governments,
hedge funds, and other private funds. The rise in institutional cash
pools increased demand for investments that were considered to have
a relatively low risk of loss, including, in addition to money
market funds, Treasury bonds, insured deposit accounts, repurchase
agreements, and asset-backed commercial paper. See Ben S. Bernanke,
Carol Bertaut, Laurie Pounder DeMarco & Steven Kamin, International
Capital Flows and the Returns to Safe Assets in the United States,
2003-2007, Board of Governors of the Federal Reserve System
International Finance Discussion Paper No. 1014 (Feb. 2011); Pozsar,
supra note 70; Gorton & Metrick, supra note 70; Daniel M. Covitz,
Nellie Liang & Gustavo A. Suarez, The Evolution of a Financial
Crisis: Collapse of the Asset-Backed Commercial Paper Market, J.
Fin. (forthcoming 2013) (``Covitz''). The incentive among these cash
pools to search for alternate ``safe'' investments was only
heightened by factors such as limits on deposit insurance coverage
and historical bans on banks paying interest on institutional demand
deposit accounts, which limited the utility of deposit accounts for
large pools of cash. See Pozsar, supra note 70; Gary Gorton & Andrew
Metrick, Regulating the Shadow Banking System, Brookings Papers on
Economic Activity (Fall 2010), at 262-263 (``Gorton Shadow
Banking'').
\72\ See, e.g., Roundtable Transcript, supra note 43 (Travis
Barker, Institutional Money Market Funds Association) (``[money
market funds are] there to provide institutional investors with
greater diversification than they could otherwise achieve''); (Lance
Pan, Capital Advisors Group) (noting diversification benefits of
money market funds and investors' need for a substitute to bank
products to mitigate counterparty risk); (Kathryn L. Hewitt,
Government Finance Officers Association) (``Most of us don't have
the time, the energy, or the resources at our fingertips to analyze
the credit quality of every security ourselves. So we're in essence,
by going into a pooled fund, hiring that expertise for us . . . it
gives us diversification, it gives us immediate cash management
needs where we can move money into and out of it, and it satisfies
much of our operating cash investment opportunities.''); (Brian
Reid, Investment Company Institute) (``there's a very clear stated
demand out there on the part of investors for a non-bank product
that creates a pooled investment in short-term assets . . . banks
can't satisfy this because an undiversified exposure to a single
bank is considered to be far riskier. . . .''); (Carol A. DeNale,
CVS Caremark) (``I think that it would be very small investment [in]
deposits in banks. I don't think there's--you know, the ratings of
some of the banks would make me nervous, also; [sic] they're not
guaranteed. I'm not going to put a $20 million investment in some
banks.'').
\73\ See 2012 Association for Financial Professionals Liquidity
Survey, at 15, available at http://www.afponline.org/liquidity
(subscription required) (``2012 AFP Liquidity Survey''). The size of
this allocation to money market funds is down substantially from
prior years. For example, prior AFP Liquidity Surveys show higher
allocations of organizations' short-term investments to money market
funds: Almost 40% in the 2008 survey, approximately 25% in the 2009
and 2010 surveys, and almost 30% in the 2011 survey. This shift has
largely reflected a re-allocation of cash investments to bank
deposits, which rose from representing 25% of organizations' short-
term investment allocations in the 2008 Association for Financial
Professionals Liquidity Survey, available at http://www.afponline.org/pub/pdf/2008_Liquidity_Survey.pdf (``2008 AFP
Liquidity Survey''), to 51% of organizations' short-term investment
allocations in the 2012 survey. The 2012 survey notes that some of
this shift has been driven by the temporary unlimited FDIC deposit
insurance coverage for non-interest bearing bank transaction
accounts (which expired at the end of 2012) and the above-market
rate that these bank accounts are able to offer in the low interest
rate environment through earnings credits. See 2012 AFP Liquidity
Survey, this note. As of August 14, 2012, approximately 66% of money
market fund assets were held in money market funds or share classes
intended to be sold to institutional investors according to
iMoneyNet data. All of the AFP Liquidity Surveys are available at
http://www.afponline.org.
---------------------------------------------------------------------------
Money market funds' size and significance in the short-term
markets, together with their features that can create an incentive to
redeem as discussed above, have led to concerns that money market funds
may contribute to systemic risk. Heavy redemptions from money market
funds during periods of financial stress can remove liquidity from the
financial system, potentially disrupting the secondary market. Issuers
may have difficulty obtaining capital in the short-term markets during
these periods because money market funds are focused on meeting
redemption requests through internal liquidity generated either from
maturing securities or cash from subscriptions, and thus may be
purchasing fewer short-term debt obligations.\74\ To the extent that
multiple money market funds experience heavy redemptions, the negative
effects on the short-term markets can be magnified. Money market funds'
experience during the 2007-2008 financial crisis illustrates the impact
of heavy redemptions, as we discuss in more detail below.
---------------------------------------------------------------------------
\74\ See supra text preceding and accompanying n.35. Although
money market funds also can build liquidity internally by retaining
(rather than investing) cash from investors purchasing shares, this
is not likely to be a material source of liquidity for a distressed
money market fund experiencing heavy redemptions.
---------------------------------------------------------------------------
Heavy redemptions in money market funds may disproportionately
affect slow-moving shareholders because, as discussed further below,
redemption data from the 2007-2008 financial crisis show that some
institutional investors are likely to redeem from distressed money
market funds more quickly than other investors and to redeem a greater
percentage of their prime fund holdings.\75\ Slower-to-redeem
shareholders may be harmed because, as discussed above, redemptions at
a money market fund can concentrate existing losses in the fund or
create new losses if the fund must sell assets at a discount. In both
cases, redemptions leave the fund's portfolio more likely to lose
value, to the detriment of slower-to-redeem investors.\76\ Retail
investors--who tend to be slower moving--also could be harmed if market
stress begins at an institutional money market fund and spreads to
other funds, including funds composed solely or primarily of retail
investors.\77\
---------------------------------------------------------------------------
\75\ This likely is because some institutional investors
generally have more capital at stake, sophisticated tools, and
professional staffs to monitor risk. See 2009 Proposing Release,
supra note 31, at nn.46-48 and 178 and accompanying text.
\76\ See, e.g., RSFI Study, supra note 21, at 10 (``Investor
redemptions during the 2008 financial crisis, particularly after
Lehman's failure, were heaviest in institutional share classes of
prime money market funds, which typically hold securities that are
illiquid relative to government funds. It is possible that
sophisticated investors took advantage of the opportunity to redeem
shares to avoid losses, leaving less sophisticated investors (if co-
mingled) to bear the losses.'').
\77\ As discussed further below, retail money market funds
experienced a lower level of redemptions in 2008 than institutional
money market funds, although the full predictive power of this
empirical evidence is tempered by the introduction of the Treasury
Department's temporary guarantee program for money market funds,
which may have prevented heavier shareholder redemptions among
generally slower moving retail investors. See infra n.91.
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C. The 2007-2008 Financial Crisis
There are many possible explanations for the redemptions from money
market funds during the 2007-2008 financial crisis.\78\ Regardless of
the cause (or causes), money market funds' experience in the 2007-2008
financial crisis demonstrates the harm that can result from such rapid
heavy redemptions in money market funds.\79\ As explained in the RSFI
study, on September 16, 2008, the day after Lehman Brothers Holdings
Inc. announced its bankruptcy, The Reserve Fund announced that as of
that afternoon, its Primary Fund--which held a $785 million (or 1.2% of
the fund's assets) position in Lehman Brothers commercial paper--would
``break the buck'' and price its securities at $0.97 per share.\80\ At
the same time, there was turbulence in the market for financial sector
securities as a result of the bankruptcy of Lehman Brothers and the
near failure of American International Group (``AIG''), whose
commercial paper was held by many prime money market funds. In addition
to Lehman Brothers and AIG, there were other stresses in the market as
well, as discussed in greater detail in the RSFI Study.\81\
---------------------------------------------------------------------------
\78\ See generally RSFI Study, supra note 21, at section 3.
\79\ See generally RSFI Study, supra note 21, at section 3. See
also 2009 Proposing Release supra note 31, at section I.D; infra
section II.D.2 (discussing the financial distress in 2011 caused by
the Eurozone sovereign debt crisis and U.S. debt ceiling impasse and
money market funds' experience during that time).
\80\ See also 2009 Proposing Release, supra note 31, at n.44 and
accompanying text. We note that the Reserve Primary Fund's assets
have been returned to shareholders in several distributions made
over a number of years. We understand that assets returned
constitute approximately 99% of the fund's assets as of the close of
business on September 15, 2008, including the income earned during
the liquidation period. Any final distribution to former Reserve
Primary Fund shareholders will not occur until the litigation
surrounding the fund is complete. See Consolidated Class Action
Complaint, In Re The Reserve Primary Fund Sec. & Derivative Class
Action Litig., No. 08-CV-8060-PGG (S.D.N.Y. Jan. 5, 2010).
\81\ See generally RSFI Study, supra note 21, at section 3.
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Redemptions in the Primary Fund were followed by redemptions from
other Reserve money market funds.\82\ Prime institutional money market
funds more generally began experiencing heavy redemptions.\83\ During
the week of September 15, 2008, investors withdrew approximately $300
billion
[[Page 36844]]
from prime money market funds or 14% of the assets in those funds.\84\
During that time, fearing further redemptions, money market fund
managers began to retain cash rather than invest in commercial paper,
certificates of deposit, or other short-term instruments.\85\
Commenters have stated that money market funds were not the only
investors in the short-term financing markets that reduced or halted
investment in commercial paper and other riskier short-term debt
securities during the 2008 financial crisis.\86\ Short-term financing
markets froze, impairing access to credit, and those who were still
able to access short-term credit often did so only at overnight
maturities.\87\
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\82\ See 2009 Proposing Release, supra note 31, at Section I.D.
\83\ See RSFI Study, supra note 21, at section 3.
\84\ See INVESTMENT COMPANY INSTITUTE, REPORT OF THE MONEY
MARKET WORKING GROUP, at 62 (Mar. 17, 2009), available at http://www.ici.org/pdf/ppr_09_mmwg.pdf (``ICI REPORT'') (analyzing data
from iMoneyNet). The latter figure describes aggregate redemptions
from all prime money market funds. Some money market funds had
redemptions well in excess of 14% of their assets. Based on
iMoneyNet data (and excluding the Reserve Primary Fund), the maximum
weekly redemptions from a money market fund during the 2008
financial crisis was over 64% of the fund's assets.
\85\ See Philip Swagel, ``The Financial Crisis: An Inside
View,'' Brookings Papers on Economic Activity, at 31 (Spring 2009)
(conference draft), available at http://www.brookings.edu/economics/
bpea/~/media/Files/Programs/ES/BPEA/2009--spring--bpea--papers/
2009--spring--bpea--swagel.pdf; Christopher Condon & Bryan Keogh,
Funds' Flight from Commercial Paper Forced Fed Move, BLOOMBERG, Oct.
7, 2008, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a5hvnKFCC_pQ.
\86\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25.
\87\ See 2009 Proposing Release, supra note 31, at nn.51-53 &
65-68 and accompanying text (citing to minutes of the Federal Open
Market Committee, news articles, Federal Reserve Board data on
commercial paper spreads over Treasury bills, and books and academic
articles on the financial crisis).
---------------------------------------------------------------------------
Figure 1, below, provides context for the redemptions that occurred
during the financial crisis. Specifically, it shows daily total net
assets over time, where the vertical line indicates the date that
Lehman Brothers filed for bankruptcy, September 15, 2008. Investor
redemptions during the 2008 financial crisis, particularly after
Lehman's failure, were heaviest in institutional share classes of prime
money market funds, which typically hold securities that are less
liquid and of lower credit quality than those typically held by
government money market funds. The figure shows that institutional
share classes of government money market funds, which include Treasury
and government funds, experienced heavy inflows.\88\ The aggregate
level of retail investor redemption activity, in contrast, was not
particularly high during September and October 2008, as shown in Figure
1.\89\
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\88\ As discussed in section III.A.3, government money market
funds historically have faced different redemption pressures in
times of stress and have different risk characteristics than other
money market funds because of their unique portfolio composition,
which typically has lower credit default risk and greater liquidity
than non-government portfolio securities typically held by money
market funds.
\89\ We understand that iMoneyNet differentiates retail and
institutional money market funds based on factors such as minimum
initial investment amount and how the fund provider self-categorizes
the fund.
[GRAPHIC] [TIFF OMITTED] TP19JN13.003
On September 19, 2008, the U.S. Department of the Treasury
(``Treasury'') announced a temporary guarantee program (``Temporary
Guarantee Program''), which would use the $50 billion Exchange
Stabilization Fund to support more than $3 trillion in shares of money
market funds, and the Board of Governors of the Federal Reserve System
authorized the temporary extension of credit to banks to finance their
purchase of high-quality asset-backed commercial paper from money
market funds.\90\ These programs successfully slowed redemptions in
prime money market funds and provided additional liquidity to money
market funds. The disruptions to the short-term markets detailed above
could have continued for a longer period of time but for these
programs.\91\
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\90\ See 2009 Proposing Release, supra note 31, at nn.55-59 and
accompanying text for a fuller description of the various forms of
governmental assistance provided to money market funds during this
time.
\91\ Treasury used the $50 billion Exchange Stabilization Fund
to fund the Temporary Guarantee Program, but legislation has since
been enacted prohibiting Treasury from using this fund again for
guarantee programs for money market funds. See Emergency Economic
Stabilization Act of 2008 Sec. 131(b), 12 U.S.C. Sec. 5236 (2008).
The $50 billion Exchange Stabilization Fund was never drawn upon by
money market funds under this program and the Temporary Guarantee
Program expired on September 18, 2009. The Federal Reserve Board
also established the Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility (``AMLF''), through which credit was
extended to U.S. banks and bank holding companies to finance
purchases of high-quality asset-backed commercial paper (``ABCP'')
from money market funds, and it may have mitigated fire sales to
meet redemptions requests. See Burcu Duygan-Bump et al., How
Effective Were the Federal Reserve Emergency Liquidity Facilities?
Evidence from the Asset-Backed Commercial Paper Money Market Mutual
Fund Liquidity Facility, 68 J. Fin. 715 (Apr. 2013) (``Our results
suggest that the AMLF provided an important source of liquidity to
MMMFs and the ABCP market, as it helped to stabilize MMMF asset
flows and to reduce ABCP yields.''). The AMLF expired on February 1,
2010. Given the significant decline in money market investments in
ABCP since 2008, reopening the AMLF would provide little benefit to
money market funds today. For example, ABCP investments accounted
for over 20% of Moody's-rated U.S. prime money market fund assets at
the end of August 2008, but accounted for less than 10% of those
assets by the end of August 2011. See Moody's Investors Service,
Money Market Funds: ABCP Investments Decrease, Dec. 7, 2011, at 2.
Form N-MFP data shows that as of February 28, 2013, prime money
market funds held 6.9% of their assets in ABCP.
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[[Page 36845]]
D. Examination of Money Market Fund Regulation Since the Financial
Crisis
1. The 2010 Amendments
In March 2010, we adopted a number of amendments to rule 2a-7.\92\
These amendments were designed to make money market funds more
resilient by reducing the interest rate, credit, and liquidity risks of
fund asset portfolios. More specifically, the amendments decreased
money market funds' credit risk exposure by further restricting the
amount of lower quality securities that funds can hold.\93\ The
amendments, for the first time, also require that money market funds
maintain liquidity buffers in the form of specified levels of daily and
weekly liquid assets.\94\ These liquidity buffers provide a source of
internal liquidity and are intended to help funds withstand high
redemptions during times of market illiquidity. Finally, the amendments
reduce money market funds' exposure to interest rate risk by decreasing
the maximum weighted average maturities of fund portfolios from 90 to
60 days.\95\
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\92\ Money Market Fund Reform, Investment Company Act Release
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (``2010
Adopting Release'').
\93\ Specifically, the amendments placed tighter limits on a
money market fund's ability to acquire ``second tier'' securities by
(1) restricting a money market fund from investing more than 3% of
its assets in second tier securities (rather than the previous limit
of 5%), (2) restricting a money market fund from investing more than
\1/2 \of 1% of its assets in second tier securities issued by any
single issuer (rather than the previous limit of the greater of 1%
or $1 million), and (3) restricting a money market fund from buying
second tier securities that mature in more than 45 days (rather than
the previous limit of 397 days). See rule 2a-7(c)(3)(ii) and
(c)(4)(i)(C). Second tier securities are eligible securities that,
if rated, have received other than the highest short-term term debt
rating from the requisite NRSROs or, if unrated, have been
determined by the fund's board of directors to be of comparable
quality. See rule 2a-7(a)(24) (defining ``second tier security'');
rule 2a-7(a)(12) (defining ``eligible security''); rule 2a-7(a)(23)
(defining ``requisite NRSROs'').
\94\ The requirements are that, for all taxable money market
funds, at least 10% of assets must be in cash, U.S. Treasury
securities, or securities that convert into cash (e.g., mature)
within one day and, for all money market funds, at least 30% of
assets must be in cash, U.S. Treasury securities, certain other
Government securities with remaining maturities of 60 days or less,
or securities that convert into cash within one week. See rule 2a-
7(c)(5)(ii) and (iii).
\95\ The 2010 amendments also introduced a weighted average life
requirement of 120 days, which limits the money market fund's
ability to invest in longer-term floating rate securities. See rule
2a-7(c)(2)(ii) and (iii).
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In addition to reducing the risk profile of the underlying money
market fund portfolios, the reforms increased the amount of information
that money market funds are required to report to the Commission and
the public. Money market funds are now required to submit to the SEC
monthly information on their portfolio holdings using Form N-MFP.\96\
This information allows the Commission, investors, and third parties to
monitor compliance with rule 2a-7 and to better understand and monitor
the underlying risks of money market fund portfolios. Money market
funds are now required to post portfolio information on their Web sites
each month, providing investors with important information to help them
make better-informed investment decisions and helping them impose
market discipline on fund managers.\97\
---------------------------------------------------------------------------
\96\ See rule 30b1-7.
\97\ See rule 2a-7(c)(12).
---------------------------------------------------------------------------
Finally, money market funds must undergo stress tests under the
direction of the board of directors on a periodic basis.\98\ Under this
stress testing requirement, each fund must periodically test its
ability to maintain a stable NAV per share based upon certain
hypothetical events, including an increase in short-term interest
rates, an increase in shareholder redemptions, a downgrade of or
default on portfolio securities, and widening or narrowing of spreads
between yields on an appropriate benchmark selected by the fund for
overnight interest rates and commercial paper and other types of
securities held by the fund. This reform was intended to provide money
market fund boards and the Commission a better understanding of the
risks to which the fund is exposed and give fund managers a tool to
better manage those risks.\99\
---------------------------------------------------------------------------
\98\ See rule 2a-7(c)(10)(v).
\99\ See 2009 Proposing Release, supra note 31, at section
II.C.3.
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2. The Eurozone Debt Crisis and U.S. Debt Ceiling Impasse of 2011
One way to evaluate the efficacy of the 2010 reforms is to examine
redemption activity during the summer of 2011. Money market funds
experienced substantial redemptions during this time as the Eurozone
sovereign debt crisis and impasse over the U.S. debt ceiling unfolded.
As a result of concerns about exposure to European financial
institutions, prime money market funds began experiencing substantial
redemptions.\100\ Assets held by prime money market funds declined by
approximately $100 billion (or 6%) during a three-week period beginning
June 14, 2011.\101\ Some prime money market funds had redemptions of
almost 20% of their assets in each of June, July, and August 2011, and
one fund lost 23% of its assets during that period after articles began
to appear in the financial press that warned of indirect exposure of
money market funds to Greece.\102\ Figures 2 and 3 below show the
redemptions from prime money market funds during this time, and also
show that investors purchased shares of government money market funds
in late June and early July in response to these concerns, but then
began redeeming government money market fund shares in late July and
early August, likely as a result of concerns about the U.S. debt
ceiling impasse and possible ratings downgrades of government
securities.\103\
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\100\ See RSFI Study, supra note 21, at 32.
\101\ Id.
\102\ Id.
\103\ See also id. at 33.
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[[Page 36846]]
[GRAPHIC] [TIFF OMITTED] TP19JN13.004
While it is difficult to isolate the effects of the 2010
amendments, these events highlight the potential increased resilience
of money market funds after the reforms were adopted. Most
significantly, no money market fund had to re-price below its stable
$1.00 share price. As discussed in greater detail in the RSFI Study,
unlike September 2008, money market funds did not experience
significant capital losses that summer, and the funds' shadow prices
did not deviate significantly from the funds' stable share prices; also
unlike in 2008, money market funds in the summer of 2011 had sufficient
liquidity to satisfy investors' redemption requests, which were made
over a longer period than in 2008, suggesting that the 2010 amendments
acted as intended to enhance the resiliency of money market funds.\104\
The redemptions in the summer of 2011 also did not take place against
the backdrop of a broader financial crisis, and therefore may have
reflected more targeted concerns by investors (concern about exposure
to the Eurozone and U.S. government securities as the debt ceiling
impasse unfolded). Money market funds' experience in 2008, in contrast,
may have reflected a broader range of concerns as reflected in the RSFI
Study, which discusses a number of possible explanations for
redemptions during the financial crisis.\105\
---------------------------------------------------------------------------
\104\ Id. at 33-34.
\105\ Id. at 7-13.
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Although money market funds' experiences differed in 2008 and the
summer of 2011, the heavy redemptions money market funds experienced in
the
[[Page 36847]]
summer of 2011 appear to have negatively affected the markets for
short-term financing. Academics researching these issues have found, as
detailed in the RSFI Study, that ``creditworthy issuers may encounter
financing difficulties because of risk taking by the funds from which
they raise financing''; ``local branches of foreign banks reduced
lending to U.S. entities in 2011''; and that ``European banks that were
more reliant on money funds experienced bigger declines in dollar
lending.'' \106\ Thus, while such redemptions often exemplify rational
risk management by money market fund investors, they can also have
certain contagion effects on the short-term financing markets.
---------------------------------------------------------------------------
\106\ See id. at 34-35 (``It is important to note, however,
investor redemptions has a direct effect on short-term funding
liquidity in the U.S. commercial paper market. Chernenko and
Sunderam (2012) report that `creditworthy issuers may encounter
financing difficulties because of risk taking by the funds from
which they raise financing.' Similarly, Correa, Sapriza, and Zlate
(2012) finds U.S. branches of foreign banks reduced lending to U.S.
entities in 2011, while Ivashina, Scharfstein, and Stein (2012)
document European banks that were more reliant on money funds
experienced bigger declines in dollar lending.'') (internal
citations omitted); Sergey Chernenko & Adi Sunderam, Frictions in
Shadow Banking: Evidence from the Lending Behavior of Money Market
Funds, Fisher College of Business Working Paper No. 2012-4 (Sept.
2012); Ricardo Correa et al., Liquidity Shocks, Dollar Funding
Costs, and the Bank Lending Channel During the European Sovereign
Crisis, Federal Reserve Board International Finance Discussion Paper
No. 2012-1059 (Nov. 2012); Victoria Ivashina et al., Dollar Funding
and the Lending Behavior of Global Banks, National Bureau of
Economic Research Working Paper No. 18528 (Nov. 2012).
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3. Our Continuing Consideration of the Need for Additional Reforms
When we proposed and adopted the 2010 amendments, we acknowledged
that money market funds' experience during the 2007-2008 financial
crisis raised questions of whether more fundamental changes to money
market funds might be warranted.\107\ We solicited and received input
from a number of different sources analyzing whether or not additional
reforms may be necessary, and we began to solicit and evaluate
potential options for additional regulation of money market funds to
address these vulnerabilities. In the 2009 Proposing Release we
requested comment on certain options, including whether money market
funds should be required to move to the ``floating net asset value''
used by all other mutual funds or satisfy certain redemptions in-
kind.\108\ We received over 100 comments on this aspect of the 2009
Proposing Release.\109\ In adopting the 2010 amendments, we noted that
we would continue to explore more significant regulatory changes in
light of the comments we received.\110\ At the time, we stated that we
had not had the opportunity to fully explore possible alternatives and
analyze the potential costs, benefits, and consequences of those
alternatives.
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\107\ See 2009 Proposing Release, supra note 31, at section III;
2010 Adopting Release, supra note 92, at section I.
\108\ See 2009 Proposing Release, supra note 31, at section
III.A.
\109\ Comments on the 2009 Proposing Release can be found at
http://www.sec.gov/comments/s7-11-09/s71109.shtml.
\110\ See 2010 Adopting Release, supra note 92, at section I.
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Our subsequent consideration of money market funds has been
informed by the work of the President's Working Group on Financial
Markets, which published a report on money market fund reform options
in 2010 (the ``PWG Report'').\111\ We solicited comment on the features
of money market funds that make them susceptible to heavy redemptions
and potential options for reform both through our request for comment
on the PWG Report and by hosting a May 2011 roundtable on Money Market
Funds and Systemic Risk (the ``2011 Roundtable'').\112\
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\111\ Report of the President's Working Group on Financial
Markets, Money Market Fund Reform Options (Oct. 2010) (``PWG
Report''), available at http://www.treasury.gov/press-center/press-releases/Documents/10.21%20PWG%20Report%20Final.pdf. The members of
the PWG included the Secretary of the Treasury Department (as
chairman of the PWG), the Chairman of the Board of Governors of the
Federal Reserve System, the Chairman of the SEC, and the Chairman of
the Commodity Futures Trading Commission.
\112\ See President's Working Group Report on Money Market Fund
Reform, Investment Company Act Release No. 29497 (Nov. 3, 2010) [75
FR 68636 (Nov. 8, 2010)]. See also Roundtable Transcript, supra note
43.
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The potential financial stability risks associated with money
market funds also have attracted the attention of the Financial
Stability Oversight Council (``FSOC''), which has been tasked with
monitoring and responding to threats to the U.S. financial system and
which superseded the PWG.\113\ On November 13, 2012, FSOC proposed to
recommend that we implement one or a combination of three reforms
designed to address risks to financial companies and markets that money
market funds may pose.\114\ The first option would require money market
funds to use floating NAVs.\115\ The second option would require money
market funds to have a NAV buffer with a tailored amount of assets of
up to 1% (raised through various means) to absorb day-to-day
fluctuations in the value of the funds' portfolio securities and allow
the funds to maintain a stable NAV.\116\ The NAV buffer would be paired
with a requirement that 3% of a shareholder's highest account value in
excess of $100,000 during the previous 30 days--a ``minimum balance at
risk'' (``MBR'')--be made available for redemption on a delayed basis.
These requirements would not apply to certain money market funds that
invest primarily in U.S. Treasury obligations and repurchase agreements
collateralized with U.S. Treasury securities. The third option would
require money market funds to have a risk-based NAV buffer of 3%. This
3% NAV buffer potentially could be combined with other measures aimed
at enhancing the effectiveness of the buffer and potentially increasing
the resiliency of money market funds, and
[[Page 36848]]
thereby justifying a reduction in the level of the required NAV
buffer.\117\ Finally, in addition to proposing to recommend these three
reform options, FSOC requested comment on other potential reforms,
including standby liquidity fees and temporary restrictions on
redemptions (``gates''), which would be implemented during times of
market stress to reduce money market funds' vulnerability to runs.\118\
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\113\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (the ``Dodd-Frank Act'') established the FSOC: (A) To
identify risks to the financial stability of the United States that
could arise from the material financial distress or failure, or
ongoing activities, of large, interconnected bank holding companies
or nonbank financial companies, or that could arise outside the
financial services marketplace; (B) to promote market discipline, by
eliminating expectations on the part of shareholders, creditors, and
counterparties of such companies that the Government will shield
them from losses in the event of failure; and (C) to respond to
emerging threats to the stability of the United States financial
system. The ten voting members of the FSOC include the Treasury
Secretary (who serves as Chairman of the FSOC), the Chairmen of the
Commission, the Board of Governors of the Federal Reserve System,
the Commodity Futures Trading Commission, the Federal Deposit
Insurance Corporation, and the National Credit Union Administration
Board, the Directors of the Bureau of Consumer Financial Protection
and the Federal Housing Finance Agency, the Comptroller of the
Currency, and an independent insurance expert appointed by the
President of the United States. See Dodd-Frank Act, Public Law 111-
203, 124 Stat. 1376 Sec. Sec. 111-112 (2010).
\114\ See Proposed Recommendations Regarding Money Market Mutual
Fund Reform, Financial Stability Oversight Council [77 FR 69455
(Nov. 19, 2012)] (the ``FSOC Proposed Recommendations''). Under
section 120 of the Dodd-Frank Act, if the FSOC determines that the
conduct, scope, nature, size, scale, concentration, or
interconnectedness of a financial activity or practice conducted by
bank holding companies or nonbank financial companies could create
or increase the risk of significant liquidity, credit, or other
problems spreading among bank holding companies and nonbank
financial companies, the financial markets of the United States, or
low-income, minority or under-served communities, the FSOC may
provide for more stringent regulation of such financial activity or
practice by issuing recommendations to primary financial regulators,
like the Commission, to apply new or heightened standards or
safeguards. FSOC has proposed to issue a recommendation to the
Commission under this authority concerning money market funds. If
FSOC issues a final recommendation to the Commission, the
Commission, under section 120, would be required to impose the
recommended standards, or similar standards that FSOC deems
acceptable, or explain in writing to FSOC why the Commission has
determined not to follow FSOC's recommendation.
\115\ See FSOC Proposed Recommendations, supra note 114, at
section V.A.
\116\ See id. at section V.B.
\117\ See id. at section V.C.
\118\ See id. at section V.D.
---------------------------------------------------------------------------
In its proposed recommendation FSOC stated that the Commission,
``by virtue of its institutional expertise and statutory authority, is
best positioned to implement reforms to address the risk that [money
market funds] present to the economy,'' and that if the Commission
``moves forward with meaningful structural reforms of [money market
funds] before [FSOC] completes its Section 120 process, [FSOC] expects
that it would not issue a final Section 120 recommendation.'' \119\ We
strongly agree that the Commission is best positioned to consider and
implement any further reforms to money market funds, and we have
considered FSOC's analysis of its proposed recommended reform options
and the public comments that FSOC has received in formulating the money
market reforms we are proposing today.
---------------------------------------------------------------------------
\119\ See id. at section III.B.
---------------------------------------------------------------------------
The RSFI Study, discussed throughout this Release, also has
informed our consideration of the risks that may be posed by money
market funds and our formulation of today's proposals. The RSFI Study
contains, among other things, a detailed analysis of our 2010
amendments to rule 2a-7 and some of the amendments' effects to date,
including changes in some of the characteristics of money market funds,
the likelihood that a fund with the maximum permitted weighted average
maturity (``WAM'') would ``break the buck'' before and after the 2010
reforms, money market funds' experience during the 2011 Eurozone
sovereign debt crisis and the U.S. debt-ceiling impasse, and how money
market funds would have performed during September 2008 had the 2010
reforms been in place at that time.\120\
---------------------------------------------------------------------------
\120\ See generally RSFI Study, supra note 21, at section 4.
---------------------------------------------------------------------------
In particular, the RSFI Study found that under certain assumptions
the expected probability of a money market fund breaking the buck was
lower with the additional liquidity required by the 2010 reforms.\121\
In addition, funds in 2011 had sufficient liquidity to withstand
investors' redemptions during the summer of 2011.\122\ The fact that no
fund experienced a credit event during that time also contributed to
the evidence that funds' were able to withstand relatively heavy
redemptions while maintaining a stable $1.00 share price. Finally,
using actual portfolio holdings from September 2008, the RSFI Study
analyzed how funds would have performed during the financial crisis had
the 2010 reforms been in place at that time. While funds holding 30%
weekly liquid assets are more resilient to portfolio losses, funds will
``break the buck'' with near certainty if capital losses of the fund's
non-weekly liquid assets exceed 1%.\123\ The RSFI Study concludes that
the 2010 reforms would have been unlikely to prevent a fund from
breaking the buck when faced with large credit losses like the ones
experienced in 2008.\124\ The inferences that can be drawn from the
RSFI Study lead us to conclude that while the 2010 reforms were an
important step in making money market funds better able to withstand
heavy redemptions when there are no portfolio losses (as was the case
in the summer of 2011), they are not sufficient to address the
incentive to redeem when credit losses are expected to cause fund's
portfolios to lose value or when the short-term financing markets more
generally are expected to, or do, come under stress. Accordingly, we
preliminarily believe that the alternative reforms proposed in this
Release could lessen money market funds' susceptibility to heavy
redemptions, improve their ability to manage and mitigate potential
contagion from high levels of redemptions, and increase the
transparency of their risks, while preserving, as much as possible, the
benefits of money market funds.
---------------------------------------------------------------------------
\121\ Id. at 30.
\122\ Id. at 34.
\123\ Id. at 38, Table 5. In fact, even at capital losses of
only 0.75% of the fund's non-weekly liquid assets and no investor
redemptions, funds are already more likely than not (64.6%) to
``break the buck.'' Id.
\124\ To further illustrate the point, the RSFI Study noted that
the Reserve Primary Fund ``would have broken the buck even in the
presence of the 2010 liquidity requirements.'' Id. at 37.
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III. Discussion
We are proposing alternative amendments to rule 2a-7, and related
rules and forms, that would either (i) require money market funds
(other than government and retail money market funds) \125\ to
``float'' their NAV per share or (ii) require that a money market fund
(other than a government fund) whose weekly liquid assets fall below
15% of its total assets be required to impose a liquidity fee of 2% on
all redemptions (unless the fund's board determines that the liquidity
fee is not in the best interest of the fund). Under the second
alternative, once the money market fund crosses this threshold, the
fund's board also would have the ability to temporarily suspend
redemptions (or ``gate'') the fund for a limited period of time if the
board determines that doing so is in the fund's best interest.\126\ We
discuss each of these alternative proposals in this section, along with
potential tax, accounting, operational, and economic implications. We
also discuss a potential combination of our floating NAV proposal and
liquidity fees and gates proposal, as well as the potential benefits,
drawbacks, and operational issues associated with such a potential
combination. We also discuss various alternative approaches that we
have considered for money market fund reform.
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\125\ Our proposed exemptions for government and retail money
market funds (including our proposed definition for a retail money
market fund) are discussed in sections III.A.3 and III.A.4,
respectively. The exemptive amendments we are proposing are within
the Commission's broad authority under section 6(c) of the Act.
Section 6(c) authorizes the Commission to exempt by rule,
conditionally or unconditionally, any person, security, or
transaction (or classes of persons, securities, or transactions)
from any provision of the Act ``if and to the extent that such
exemption is necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions'' of the Act. 15 U.S.C. 80a-
6(c). For the reasons discussed throughout this Release, the
Commission preliminarily believes that the proposed amendments to
rules 2a-7, 12d3-1, 18f-3, and 22e-3 meet these standards.
\126\ In the text of the proposed rules and forms below we refer
to our floating NAV alternative as ``Alternative 1,'' and our
liquidity fees and gates alternative as ``Alternative 2.''
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In addition, we are proposing a number of other amendments that
would apply under either alternative proposal to enhance the disclosure
of money market fund operations and risks. Certain of our proposed
disclosure requirements would vary depending on the alternative
proposal adopted (if any) as they specifically relate to the floating
NAV proposal or the liquidity fees and gates proposal. In addition, we
are proposing additional disclosure reforms to improve the transparency
of risks present in money market funds, including daily Web site
disclosure of funds' daily and weekly liquid assets and market-based
NAV per share and historic instances of sponsor support. We also are
proposing to establish a new current event disclosure form that would
require funds to make prompt public disclosure of certain events,
including portfolio security defaults, sponsor support, a fall in the
funds' weekly liquid assets below 15% of total
[[Page 36849]]
assets, and a fall in the market-based price of the fund below $0.9975.
We are proposing to amend Form N-MFP to provide additional
information relevant to assessing the risk of funds and make this
information public immediately upon filing. In addition, we are
proposing to require that a large liquidity fund adviser that manages a
private liquidity fund provide security-level reporting on Form PF that
are substantially the same as those currently required to be reported
by money market funds on Form N-MFP.\127\
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\127\ See infra section III.I.
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Our proposed amendments also would tighten the diversification
requirements of rule 2a-7 by requiring consolidation of certain
affiliates for purposes of the 5% issuer diversification requirement,
requiring funds to presumptively treat the sponsors of asset-backed
securities (``ABSs'') as guarantors subject to rule 2a-7's
diversification requirements, and removing the so-called ``twenty-five
percent basket.'' \128\ Finally, we are proposing to amend the stress
testing provision of rule 2a-7 to enhance how funds stress test their
portfolios and require that money market funds stress test against the
fund's level of weekly liquid assets falling below 15% of total assets.
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\128\ The ``twenty-five percent basket'' currently allows money
market funds to only comply with the 10% guarantee concentration
limit with respect to 75% of the fund's total assets. See infra
section III.J.
---------------------------------------------------------------------------
We note finally that we are not rescinding our outstanding 2011
proposal to remove references to credit ratings from two rules and four
forms under the Investment Company Act, including rule 2a-7 and Form N-
MFP, under section 939A of the Dodd-Frank Act, and on which we welcome
additional comments.\129\ The Commission intends to address this matter
at another time and, therefore, this Release is based on rule 2a-7 and
Form N-MFP as amended and adopted in 2010.\130\
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\129\ See References to Credit Ratings in Certain Investment
Company Act Rules and Forms, Investment Company Act Release No.
29592 (Mar. 3, 2011) [76 FR 12896 (Mar. 9, 2011)] (proposing to also
eliminate references to credit ratings from rule 5b-3 and Forms N-
1A, N-2, and N-3, and establish new rule 6a-5 to replace a reference
to credit ratings in section 6(a)(5) that the Dodd-Frank Act
eliminated).
\130\ See 2010 Adopting Release, supra note 92. We note that
after enactment of the Dodd-Frank Act, our staff issued a no-action
letter assuring money market funds and their managers that, in light
of section 939A of the Dodd-Frank Act, the staff would not recommend
enforcement action to the Commission under section 2(a)(41) of the
Act and rules 2a-4 and 22c-1 thereunder if a money market fund board
did not designate NRSROs and did not make related disclosures in its
SAI before the Commission had completed its review of rule 2a-7
required by the Dodd-Frank Act and made any modifications to the
rule. See SEC Staff No-Action Letter to the Investment Company
Institute (Aug. 19, 2010). This staff guidance remains in effect
until such time as the Commission or its staff indicate otherwise.
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A. Floating Net Asset Value
Our first alternative proposal--a floating NAV--is designed
primarily to address the incentive of money market fund shareholders to
redeem shares in times of fund and market stress based on the fund's
valuation and pricing methods, as discussed in section II.B.1 above. It
should also improve the transparency of pricing associated with money
market funds. Under this alternative, money market funds (other than
government and retail money market funds \131\) would be required to
``float'' their net asset value. This proposal would amend \132\ rule
2a-7 to rescind certain exemptions that have permitted money market
funds to maintain a stable price by use of amortized cost valuation and
penny-rounding pricing of their portfolios.\133\ As a result, the money
market funds subject to this reform would sell and redeem shares at
prices that reflect the value using market-based factors of their
portfolio securities and would not penny round their prices.\134\ In
other words, the daily share prices of these money market funds would
``float,'' which means that each fund's NAV would fluctuate along with
changes, if any, in the value using market-based factors of the fund's
underlying portfolio of securities.\135\ Money market funds would only
be able to use amortized cost valuation to the extent other mutual
funds are able to do so--where the fund's board of directors
determines, in good faith, that the fair value of debt securities with
remaining maturities of 60 days or less is their amortized cost, unless
the particular circumstances warrant otherwise.\136\
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\131\ The definitions of government and retail money market
funds, as considered exempt under our proposals from certain
proposed reforms, are discussed in sections III.A.3 and III.A.4.
These funds would also price their portfolio securities using
market-based factors, but would continue to be able to maintain a
stable price per share through the use of the penny rounding method
of pricing.
\132\ References to rule 2a-7 as amended under our floating NAV
proposal will be ``proposed (FNAV) rule''; similarly, references to
rule 2a-7 as amended under our liquidity fees and gates proposal
discussed in section III.B will be ``proposed (Fees & Gates) rule.''
\133\ We also propose to amend rule 18f-3(c)(2)(i) to replace
the phrase ``that determines net asset value using the amortized
cost method permitted by Sec. 270.2a-7'' with ``that operates in
compliance with Sec. 270.2a-7'' because money market funds would
not use the amortized cost method to a greater extent than mutual
funds generally under either of our core reform proposals.
\134\ We have not previously proposed, but have sought comment
on requiring money market funds to use a floating NAV. See 2009
Proposing Release, supra note 31, at section II.A. The floating NAV
alternative on which we seek comment today is informed by the
comments we received in response to the 2009 comment request, as
well as relevant comments submitted in response to: (i) the PWG
Report and (ii) the FSOC Proposed Recommendations.
\135\ See infra note 27 for a discussion of how money market
funds generally value their portfolio securities using market-based
factors based on estimates from models rather than trading inputs.
\136\ See 1977 Valuation Release, supra note 10. In this regard,
the Commission has stated that the ``fair value of securities with
remaining maturities of 60 days or less may not always be accurately
reflected through the use of amortized cost valuation, due to an
impairment of the creditworthiness of an issuer, or other factors.
In such situations, it would appear to be incumbent on the directors
of a fund to recognize such factors and take them into account in
determining `fair value.' '' Id. Accordingly, this guidance
effectively limits the use of amortized cost valuation to
circumstances where it is the same as valuation based on market
factors. Some commenters voiced concern about allowing an exemption
for money market funds with remaining maturities of 60 days or less.
See, e.g., Federal Reserve Bank Presidents FSOC Comment Letter,
supra note 38. However, we believe that these commenters
misunderstood Commission guidance in this area, which limits the use
of amortized cost valuation for these securities to circumstances
under which the amortized cost value accurately reflects the fair
value, as determined using market factors. See 1977 Valuation
Release, supra note 10.
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Under this approach, the ``risk limiting'' provisions of rule 2a-7
would continue to apply to money market funds.\137\ Accordingly, mutual
funds that hold themselves out as money market funds would continue to
be limited to investing in short-term, high-quality, dollar-denominated
instruments. We would, however, rescind rule 2a-7's provisions that
relate to the maintenance of a stable value for these funds, including
shadow pricing, and would adopt the other reforms discussed in this
Release that are not related to the discretionary standby liquidity
fees and gates alternative, as discussed in section III.B below.
---------------------------------------------------------------------------
\137\ See proposed (FNAV) rule 2a-7(d) (risk-limiting
conditions).
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We also propose to require that all money market funds, other than
government and retail money market funds, price their shares using a
more precise method of rounding.\138\ The proposal would require that
each money market fund round prices and transact in its shares at the
fourth decimal place in the case of a fund with a $1.00 target share
price (i.e., $1.0000) or an equivalent level of precision if a fund
prices its shares at a different target level (e.g., a fund with a $10
target share price would price its shares at $10.000). Depending on the
degree of fluctuation, this precision would increase the
[[Page 36850]]
observed sensitivity of a fund's share price to changes in the market
values of the fund's portfolio securities, and should better inform
shareholders of the floating nature of the fund's value. Finally, we
propose a relatively long compliance date of 2 years to provide time
for money market funds converting to a floating NAV on a permanent
basis to make system modifications and time for funds to respond to
redemption requests. The extended compliance date would also allow
shareholders time to understand the implications of any reforms,
determine if a floating NAV money market fund is an appropriate
investment, and if not, redeem their shares in an orderly fashion.
---------------------------------------------------------------------------
\138\ See proposed (FNAV) rule 2a-7(c) (share price). We discuss
our proposed amendment to share pricing in infra section III.A.2.
---------------------------------------------------------------------------
The financial crisis of 2007-2008 had significant impacts on
investors, money market funds, and the short-term financing markets.
The floating NAV alternative is designed to respond, at least in part,
to the contagion effects from heavy redemptions from money market funds
that were revealed during that crisis. As discussed in greater detail
below, although it is not possible to state with certainty what would
have happened if money market funds had operated with a floating NAV at
that time, we expect that if a floating NAV had been in place, it could
have mitigated some of the heavy redemptions that occurred due to the
stable share price. Many factors, however, contributed to these heavy
redemptions, and we recognize that a floating NAV requirement is a
targeted reform that may not ameliorate all of those factors.
Under a floating NAV, investors would not have had the incentive to
redeem money market fund shares to benefit from receiving the stable
share price of a fund that may have experienced losses, because they
would have received the actual market-based value of their shares. The
transparency provided by the floating NAV alternative might also have
reduced redemptions during the crisis that were a result of investor
uncertainty about the value of the securities owned by money market
funds because investors would have seen fluctuations in money market
fund share prices that reflect market-based factors.
Of course, a floating NAV would not have prevented redemptions from
money market funds that were driven by certain other investing
decisions, such as a desire to own higher quality assets than those
that were in the portfolios of prime money market funds, or not to be
invested in securities at all, but rather to hold assets in another
form such as in insured bank deposits. The floating NAV alternative is
not intended to deter redemptions that constitute rational risk
management by shareholders or that reflect a general incentive to avoid
loss. Instead, it is designed to increase transparency, and thus
investor awareness, of money market fund risks and dis-incentivize
redemption activity that can result from informed investors attempting
to exploit the possibility of redeeming shares at their stable share
price even if the portfolio has suffered a loss.
1. Certain Considerations Relating to the Floating NAV Proposal
a. A Reduction in the Incentive To Redeem Shares
As discussed above, when a fund's shadow price is less than the
fund's $1.00 share price, money market fund shareholders have an
incentive to redeem shares ahead of other investors in times of fund
and market stress. Given the size of institutional investors' holdings
and their resources for monitoring funds, institutions have both the
motivation and ability to act on this incentive. Indeed, as discussed
above and in the RSFI Study, institutional investors redeemed shares
more heavily than retail investors from prime money market funds in
both September 2008 and June 2011.
Some market observers have suggested that the valuation and pricing
techniques permitted by rule 2a-7 may exacerbate the incentive to
redeem in money market funds if investors expect that the value of the
fund's shares will fall below $1.00.\139\ Our floating NAV proposal is
designed to lower this risk by reducing investors' incentive to redeem
shares in times of fund and market stress. Under our floating NAV
proposal, money market funds would transact at share prices that
reflect current market-based factors (not amortized cost or penny
rounding) and thus investor incentives to redeem early to take
advantage of transacting at a stable value are ameliorated.\140\
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\139\ See, e.g., Roundtable Transcript, supra note 43. (Bill
Stouten, Thrivent Financial) (``I think the primary factor that
makes money funds vulnerable to runs is the marketing of the stable
value.''); (Gary Gensler, U.S. Commodity Futures Trading Commission
(``CFTC'')) (``But one thing comes along with the money market
funds, which is the stable value, or if I can say as an old market
guy, it's a `free put.' You can put back an instrument and get 100
cents on the dollar. And it's that free put that I think causes some
structural challenges.''); Comment Letter of Federal Reserve Bank of
Richmond (Jan. 10, 2011) (available in File No. 4-619) (``Richmond
Fed PWG Comment Letter''). See also supra section II.B (discussing
the structural features of money market funds that can make them
vulnerable to runs); Statement 309 of the Shadow Financial
Regulatory Committee, Systemic Risk and Money Market Mutual Funds
(Feb. 14, 2011) (available in File No. 4-619), (``[I]f fund
valuations were marked to market immediately using the full NAV
approach--as required for other types of mutual funds--this type of
run [the September 2008 run on money market funds] would not have
occurred, and there would not have been a strong economic incentive
for money market mutual funds to liquidate positions.''); Gorton
Shadow Banking, supra note 71, at 269-270 (explaining that money
market funds' ability to transact at a stable $1.00 per share
distinguishes them from other mutual funds, allows them to compete
with bank demand deposits, and ``may have instilled a false sense of
security in investors who took the implicit promise as equivalent to
the explicit insurance offered by deposit accounts'').
\140\ As discussed supra in Section II, we recognize that
incentives other than those created by money market fund's stable
share price exist for money market fund shareholders to redeem in
times of stress, including avoidance of loss and the tendency of
investors to engage in flights to quality, liquidity, and
transparency.
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b. Improved Transparency
Our floating NAV proposal also is designed to increase the
transparency of money market fund risk. Money market funds are
investment products that have the potential for the portfolio to
deviate from a stable value. Although many investors understand that
money market funds are not guaranteed, survey data shows that some
investors are unsure about the amount of risk in money market funds and
the likelihood of government assistance if losses occur.\141\
Similarly, many institutional investors use money market funds for
liquidity purposes and are extremely loss averse; that is, they are
unwilling to suffer any losses on money market fund investments.\142\
Money market funds' stable share price, combined with the practice of
fund management companies providing financial support to money market
funds when necessary, may have
[[Page 36851]]
implicitly encouraged investors to view these funds as ``risk-free''
cash.\143\ However, the stability of money market fund share prices has
been due, in part, to the willingness of fund sponsors to support the
stable value of the fund. As discussed in section II.B.3 above, sponsor
support has not always been transparent to investors, potentially
causing investors to underestimate the investment risk posed by money
market funds. As a result, money market fund investors, who were not
accustomed to seeing their funds lose value, may have increased their
redemptions of shares when values fell in recent times.\144\
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\141\ See Fidelity April 2012 PWG Comment Letter, supra note 61.
For example, 41% of the retail customers surveyed said they either
would expect the government to protect money market funds' stable
values in times of crisis (10%) or were unsure about whether the
government would do so (31%). 47% of the retail customers thought
money market funds present comparable risks to ``bank products,''
which in context appears to refer to insured deposits, 12% thought
money market funds posed less risk than bank products, while 36% of
the retail customers thought money market funds posed more risk than
bank products.
\142\ See, e.g., Roundtable Transcript, supra note 43 (Lance
Pan, Capital Advisors Group) (``I would like to add that money fund
investors do view money funds as liquidity vehicles, not as
investment vehicles. What I mean by that is they will take zero
loss, and they're loss averse as opposed to risk averse. So to the
extent that they own that risk [i.e., investors, rather than fund
sponsors, may be exposed to a loss], at a certain point they started
to own that risk, then the run would start to develop.''); Comment
Letter of Treasury Strategies, Inc. (Jan. 10, 2011) (available in
File No. 4-619) (``The added risk [in The Reserve Primary Fund
resulting from its taking on more risk] produced higher yields, and
as a result attracted substantial `hot money' from highly
sophisticated, institutional investors. These investors were fully
knowledgeable of the risks they were taking, and assumed they would
be the first to be able to sell their investments if the Reserve
Fund's bet on a government bailout of Lehman Brothers failed.'').
\143\ See also, e.g., Better Markets FSOC Comment Letter, supra
note 67, at 11-12 (``a fluctuating NAV would correct the basic
misconception among many investors that their investment is
guaranteed'').
\144\ See, e.g., PWG Report, supra note 111, at 10 (``Investors
have come to view MMF shares as extremely safe, in part because of
the funds' stable NAVs and sponsors' record of supporting funds that
might otherwise lose value. MMFs' history of maintaining stable
value has attracted highly risk-averse investors who are prone to
withdraw assets rapidly when losses appear possible.''); Comment
Letter of Capital Advisers (Apr. 2, 2012) (available in File No. 4-
619) (stating that institutional money market fund investors
``derive their risk-free assumptions from the fact that very few (a
total of two) funds have experienced losses and in all other `near
miss' instances fund sponsors have provided voluntary capital or
liquidity support to cover potential losses'' and that the
``Treasury Department further reinforced these assumptions when it
announced the Temporary Guarantee Program for Money Market Funds on
September 29, 2008'') (emphasis in original).
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Our floating NAV proposal is designed to increase the transparency
of risks present in money market funds. By making gains and losses a
more regular and observable occurrence in money market funds, a
floating NAV could alter investor expectations by making clear that
money market funds are not risk free and that the funds' share price
will fluctuate based on the value of the funds' assets.\145\ Investors
in money market funds with floating NAVs should become more accustomed
to, and tolerant of, fluctuations in money market funds' NAVs and thus
may be less likely to redeem shares in times of stress. The proposal
would also treat money market fund shareholders more equitably than the
current system by requiring redeeming shareholders to receive the fair
value of their shares.\146\
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\145\ For a more detailed discussion of a floating NAV and
investors' expectations, see PWG Report, supra note 111, at 19-22;
2009 Proposing Release, supra note 31, at section III.A.
\146\ See, e.g., Comment Letter of Deutsche Investment
Management Americas Inc. (Jan. 10, 2011) (available in File No. 4-
619) (``Deutsche PWG Comment Letter'') (noting that a ``variable NAV
fund . . . will treat all investors fairly during times of stress'';
that ``large and sudden redemptions runs [are] a phenomenon
exacerbated by the fact that amortized cost accounting rules can
embed realized losses in the fund that are not reflected in the
NAV''; and that ``[t]o avoid having to absorb these embedded losses,
investors have the incentive to redeem early''); Comment Letter of
TDAM USA Inc. (Sept. 8, 2009) (available in File No. S7-11-09)
(agreeing that ``requiring money market funds to issue and redeem
their shares at market value, or to float their NAVs, would in
certain respects advance shareholder fairness'').
---------------------------------------------------------------------------
To further enhance transparency, we also are proposing to require a
number of new disclosures related to fund sponsor support (see section
III.F below). As discussed further in section III.E below, investors
unwilling to bear the risk of a floating NAV would likely move to other
products, such as government or retail money market funds (which we
propose would be exempt from our floating NAV proposal and permitted to
maintain a stable price).
We seek comment on this aspect of our proposal.
Do commenters agree that floating a money market fund's
NAV would lessen the incentive to redeem shares in times of fund and
market stress that can result from use of amortized cost valuation and
penny rounding pricing by money market funds today?
What would be the effect of the other incentives to redeem
that would remain under a floating NAV with basis point pricing
requirement?
Would floating a money market fund's NAV provide
sufficient transparency to cause investors to estimate more accurately
the investment risks of money market funds? Do commenters believe that
daily disclosure of shadow prices on fund Web sites would accomplish
the same goal without eliminating the stable share price at which fund
investors purchase and redeem shares? Why or why not? Is daily
disclosure of a fund's shadow price without transacting at that price
likely to lead to higher or lower risks of large redemptions in times
of stress? If the enhanced disclosure requirements proposed elsewhere
in this Release were in place, what would be the incremental benefit of
the enhanced transparency of a floating NAV?
Are there other places to disclose the shadow price that
would make the disclosure more effective in enhancing transparency?
If the fluctuations in money market funds' NAVs remained
relatively small even with a $1.0000 share price, would investors
become accustomed only to experiencing small gains and losses, and
therefore be inclined to redeem heavily if a fund experienced a loss in
excess of investors' expectations?
Would investors in a floating NAV money market fund that
appears likely to suffer a loss be less inclined to redeem because the
loss would be shared pro rata by all shareholders? Would a floating NAV
make investors in a fund more likely to redeem at the first sign of
potential stress because any loss would be immediately reflected in the
floating NAV?
Would floating NAV money market funds treat non-redeeming
shareholders, and particularly slower-to-redeem shareholders, more
equitably in times of stress?
To the extent that some investors choose not to invest in
money market funds due to the prospect of even a modest loss through a
floating NAV, would the funds' resiliency to heightened redemptions be
improved?
Would money market fund sponsors voluntarily make cash
contributions or use other available means to support their money
market funds and thereby prevent their NAVs from actually floating?
\147\ Would larger fund sponsors or those sponsors with more access to
capital have a competitive advantage over other fund sponsors?
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\147\ In section III.A.5.a we discuss the economic implications
of sponsor support under our floating NAV proposal. We are not
proposing any changes that would prohibit fund sponsors from
supporting money market funds under our floating NAV proposal. Our
proposal also includes new disclosure requirements related to
sponsor support. See infra section III.F.
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c. Redemptions During Periods of Illiquidity
We recognize that a floating NAV may not eliminate investors'
incentives to redeem fund shares, particularly when financial markets
are under stress and investors are engaging in flights to quality,
liquidity, or transparency.\148\ As discussed above, the RSFI Study
noted that the incentive for investors to redeem ahead of other
investors is heightened by liquidity concerns-when liquidity levels are
insufficient to meet redemption requests, funds may be forced to sell
portfolio securities into illiquid secondary markets at
[[Page 36852]]
discounted or even fire-sale prices.\149\ Because the potential cost of
liquidity transformation is not reflected in market-based pricing until
after the redemption has occurred, this liquidity pressure may create
an additional incentive for investors to redeem shares in times of fund
and market stress.\150\ In addition, market-based pricing does not
capture the likely increasing illiquidity of a fund's portfolio as it
sells its more liquid assets first during a period of market stress to
defer liquidity pressures as long as possible. As discussed in section
II.D.1 above, our 2010 amendments, including new daily and weekly
liquid asset requirements, strengthened the resiliency of money market
funds to both portfolio losses and investor redemptions as compared
with 2008. We note, however, that other financial intermediaries that
engage in maturity transformation, including banks, also have liquidity
mismatches to some degree.
---------------------------------------------------------------------------
\148\ See, e.g., PWG Report, supra note 111, at 20 (``To be
sure, a floating NAV itself would not eliminate entirely MMFs'
susceptibility to runs. Rational investors still would have an
incentive to redeem as fast as possible the shares of any MMF that
is at risk of depleting its liquidity buffer before that buffer is
exhausted, because subsequent redemptions may force the fund to
dispose of less-liquid assets and incur losses.''); 2009 Proposing
Release, supra note 31, at 106 (``We recognize that a floating net
asset value would not necessarily eliminate the incentive to redeem
shares during a liquidity crisis--shareholders still would have an
incentive to redeem before the portfolio quality deteriorated
further from the fund selling securities into an illiquid market to
meet redemption demands.''). See also supra notes 36-37 and
accompanying text.
\149\ See RSFI Study, supra note 21, at 4 (noting that most
money market fund portfolio securities are held to maturity, and
secondary markets in these securities are not deeply liquid).
\150\ Although we recognize that managers of certain other
mutual funds, and not just money market funds, generally sell the
most liquid portfolio securities first to satisfy redemptions that
exceed available cash, non-money market mutual funds generally are
not as susceptible to heightened redemptions as are money market
funds for a variety of reasons, including that non-money market
mutual funds generally are not used for cash management.
---------------------------------------------------------------------------
We request comment on the incentive to redeem that exists in a
liquidity crisis.
Do commenters believe that a floating NAV is sufficient to
address the incentive to redeem caused by liquidity concerns in times
of market stress? Would other tools, such as redemption gates or
liquidity fees, also be necessary?
Do commenters believe that money market funds as currently
structured present unique risks as compared with other mutual funds,
all of which may face some degree of liquidity pressure during times of
market stress? Would the floating NAV proposal suffice to address those
risks?
Did the 2010 amendments, including new daily and weekly
liquid asset requirements, address sufficiently the incentive to redeem
in periods of illiquidity?
d. Empirical Evidence in Other Floating NAV Cash Management Vehicles
Commenters have cited to the fact that some floating value money
market funds in other jurisdictions and U.S. ultra-short bond mutual
funds also suffered heavy redemptions during the 2007-2008 financial
crisis.\151\ These commenters suggest, therefore, that money market
fund floating NAVs would likely not stop investors from redeeming
shares. One qualification in considering these experiences is that many
of the European floating NAV products that experienced heavy
shareholder redemptions were priced and managed differently than our
proposal and that U.S. ultra-short bond mutual funds are not subject to
rule 2a-7's risk-limiting conditions.\152\
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\151\ See, e.g., Statement of the Investment Company Institute,
SEC Open Meeting of the Investor Advisory Committee, May 10, 2010,
at 4, available at www.ici.org/pdf/24289.pdf (stating that
``[u]ltra-short bond funds lost more than 60% of their assets from
mid-2007 to the end of 2008, and French floating NAV dynamic money
funds lost about 40% of their assets in a three-month time span from
July 2007 to September 2007'' and that ``[s]hareholders in fixed-
income funds [including those with floating NAVs] also tend to be
more risk adverse and more likely to redeem shares quickly when
fixed-income markets show any signs of distress''); Comment Letter
of the European Fund and Asset Management Association (Jan. 10,
2011) (available in File No. 4-619) (``EFAMA PWG Comment Letter'')
(noting that ``[i]n a matter of weeks, EUR 70 billion were redeemed
from these [enhanced money market] funds, predominantly by
institutional investors; around 15-20 suspended redemptions for a
short period, and 4 of them were [definitively] closed.'').
\152\ Many European floating NAV money market funds, not all of
which suffered heavy redemptions, price their shares differently
than floating NAV money market funds would under our proposal by
accumulating rather than distributing dividends. The shares of
accumulating dividend funds therefore generally will exceed one
euro, and a loss in these funds would be a small reduction in the
excess value above one euro as opposed to a drop in value below a
single euro. This kind of floating NAV money market fund may not
have affected shareholders' expectations of and tolerance for losses
to the same extent as would our proposal. See, e.g., Deutsche PWG
Comment Letter, supra note 146 (stating that ``drawing parallels to
the return or redemption experiences within [European money market
funds and ultra-short bond funds] and those in the proposed variable
NAV rule 2a-7 money market funds is not entirely accurate due to the
differences in the duration of time and the magnitude of the
redemption experiences'' and noting that (i) ``the variable NAV
structure prevalent in many European money market funds is based on
a system of accumulating dividends, not the use of a mark to market
accounting system'' and (ii) ``one of the weaknesses addressed
through the European Fund and Asset Management Association
(``EFAMA'') and the Committee of European Securities Regulators
(``CESR'') in the European style of money market funds was the lack
of standardization in the definition of money market funds and the
broad investment policies across EU member states''). See also
Witmer, supra note 36.
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Europe, for example, has several different types of money market
funds, all of which can take on more risk than U.S. money market funds
as they are not currently subject to regulatory restrictions on their
credit quality, liquidity, maturity, and diversification as stringent
as those imposed under rule 2a-7, among other differences in
regulation.\153\ One commenter observed that the financial crisis was
first felt in Europe when ``so-called `enhanced money market funds,'
which used the `money market' fund label in their marketing strategies
while taking on more risk than traditional money market funds, [ran]
into problems.'' \154\ The difficulties experienced by these funds, the
commenter asserted, ``created confusion for investors about the
definition, classification and risk characteristics of money market
funds.'' \155\ In contrast, French mon[eacute]taire funds, which are
managed more conservatively than ``enhanced money market funds'' and
thus resemble more closely the floating NAV money market funds
contemplated by our proposal, generally did not experience heavy
redemptions.\156\ The experience of French mon[eacute]taire funds would
be consistent with another commenter's observation that ``one could
reach the opposite conclusion that a variable NAV structure can, and in
fact has, operated as intended during times of market stress in a
manner consistent with minimizing systemic risk.'' \157\
---------------------------------------------------------------------------
\153\ For a discussion of the regulation of European money
market funds, see infra Table 2, notes E and H; Common Definition of
European Money Market Funds (Ref. CESR/10-049).
\154\ See EFAMA PWG Comment Letter, supra note 151 (emphasis in
original).
\155\ Id. (noting that ``[i]n a matter of weeks, EUR 70 billion
were redeemed from these [enhanced money market] funds,
predominantly by institutional investors; around 15-20 suspended
redemptions for a short period, and 4 of them were [definitively]
closed'').
\156\ See Comment Letter of HSBC Global Asset Management on the
European Commission's Green Paper on Shadow Banking (May 28, 2012)
(``HSBC EC Letter''), available at http://ec.europa.eu/internal_market/consultations/2012/shadow/individual-others/hsbc_en.pdf
(comparing inflows and outflows of European money market funds);
EFAMA PWG Comment Letter, supra note 151 (describing the outflows
from European enhanced money market funds).
\157\ Deutsche PWG Comment Letter, supra note 146 (emphasis in
original).
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U.S ultra-short bond funds also experienced redemptions in this
period. U.S. ultra-short bond funds are not subject to rule 2a-7's
risk-limiting conditions and although their NAVs float, pose more risk
of loss to investors than most U.S. money market funds, including
floating NAV money market funds under our proposal.\158\ One reason
that investors redeemed shares in ultra-short bond funds during the
2007-2008 financial crisis may have been because they did not fully
understand the riskiness or liquidity of ultra-short
[[Page 36853]]
bond funds. That some ultra-short bond funds experienced heavy
redemptions during the financial crisis, therefore, does not
necessarily suggest that investors in the floating NAV money market
funds contemplated by our proposal also would experience redemptions in
a financial crisis. Empirical analysis in this area also yields
different opinions.\159\
---------------------------------------------------------------------------
\158\ See, e.g., Witmer, supra note 36, at 23 (noting that
ultra-short bond funds in the U.S. and enhanced money market funds
in Europe both maintain a floating NAV structure, but are not
subject to the same liquidity, credit, and maturity restrictions as
money market funds).
\159\ See, e.g., Witmer, supra note 36 (empirically testing
whether floating NAVs (as compared with constant NAVs) provide a
benefit in reducing run-like behavior by examining flow and
withdrawal behavior (from 2006 through 2011) of money market mutual
funds in the United States and Europe and concluding that the
variable NAV fund structure is less susceptible to run-like behavior
relative to constant NAV money market funds). But see Comment Letter
of Jeffrey Gordon (Feb. 28, 2013) (available in File No. FSOC-2012-
0003) (``Gordon FSOC Comment Letter'').
---------------------------------------------------------------------------
Having pointed out these differences, we recognize that the data is
consistent with certain commenters' view that other incentives may lead
to heavy redemptions of floating NAV funds in times of stress.\160\ We
seek comment on the performance of other floating NAV investment
products during the 2007-2008 financial crisis.
---------------------------------------------------------------------------
\160\ See, e.g., Comment Letter of Treasury Strategies, Inc.
(Alternative One: Floating Net Asset Value) (Jan. 15, 2013)
(available in File No. FSOC-2012-0003).
---------------------------------------------------------------------------
Do commenters agree with the preceding discussion of what
may have caused investors to heavily redeem shares in some floating
value money market funds in other jurisdictions and in U.S. ultra-short
bond funds during the 2007-2008 financial crisis? Are there other
possible factors that we should consider?
Do commenters agree with the distinctions we identified
between money market funds under our proposed floating NAV and money
market funds in other jurisdictions and U.S. ultra-short bond funds?
Are there similarities or differences we have not identified?
Do commenters believe that the risk limiting requirements
of rule 2a-7 would deter heavy redemptions in money market funds with a
floating NAV because of the restrictions on the underlying assets?
Do commenters believe that money market funds attract very
risk averse investors? If so, are these investors more or less likely
to rapidly redeem in times of stress to avoid even small losses?
2. Money Market Fund Pricing
We are proposing that money market funds, other than government and
retail money market funds, price their shares using a more precise
method of valuation that would require funds to price and transact in
their shares at an NAV that is calculated to the fourth decimal place
for shares with a target NAV of one dollar (e.g., $1.0000). Funds with
a current share price other than $1.00 would be required to price their
shares at an equivalent level of precision (e.g., a fund with a $10
target share price would price its shares at $10.000).\161\ The
proposed change to money market fund pricing under our floating NAV
proposal would change the rounding convention for money market funds--
from penny rounding (i.e., to the nearest one percent) to ``basis
point'' rounding (to the nearest 1/100th of one percent).\162\ ``Basis
point'' rounding is a significantly more precise standard than the 1/
10th of one percent currently required for most mutual funds.\163\ For
the reasons discussed below, we believe that our proposal provides the
level of precision necessary to convey the risks of money market funds
to investors.
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\161\ See proposed (FNAV) rule 2a-7(c). In its proposed
recommendations the FSOC proposed that money market funds re-price
their shares to $100.00, which is the mathematical equivalent of our
$1.0000 proposed share price. See FSOC Proposed Recommendations,
supra note 114, at 31. FSOC commenters generally opposed the $100.00
per share re-pricing, stating that the Investment Company Act does
not require that a registered investment company offer its shares at
a particular price. See, e.g., Comment Letter of Federated
Investors, Inc. (Re: Alternative One) (Jan. 25. 2013) (available in
File No. FSOC-2012-0003) (``Federated Investors Alternative 1 FSOC
Comment Letter''); ICI Jan. 24 FSOC Comment Letter, supra note 25.
While our proposed pricing is mathematically the same as that
proposed by the FSOC, pricing fund shares using $1.00 extended to
four decimal places reduces other potential costs, including, for
example, the possibility that funds would require corporate actions
(e.g., reverse stock splits) to re-price their shares at $100.00.
Our proposed pricing does not mandate that funds establish a
particular share price, but rather amends the precision by which a
fund prices its shares.
\162\ Money market funds are permitted to use penny rounding
under rule 2a-7(c) and therefore, a money market fund priced at
$1.00 per share may round its NAV to the nearest penny.
\163\ Currently, money market funds priced at $1.00 may round
their NAV to the nearest penny ($1.00). See rule 2a-7(c). Mutual
funds other than money market funds must calculate the fund's NAV to
the nearest 1/10th of 1% (i.e., for funds with shares priced at
$1.00, the funds should price their shares to the third decimal
place, or $1.000). See 1977 Valuation Release, supra note 10. Many
mutual funds typically price their shares at an initial NAV of $10
and round their NAV to the nearest penny. See rule 2a-4. Because
floating NAV money market funds, under our proposal, would continue
to adhere to rule 2a-7s's risk-limiting conditions and generally
seek principal stability, we are proposing that money market funds
with a floating NAV value their shares to the nearest 1/100th of 1%,
a more precise standard than that required of most mutual funds
today.
---------------------------------------------------------------------------
Market-based valuation with penny rather than ``basis point''
rounding effectively provides the same rounding convention as exists in
money market funds today--the underlying valuation based on market-
based factors may deviate by as much as 50 basis points before the fund
breaks the buck. Accordingly, it is unlikely to change investor
behavior.
A $1.0000 share price, however, would reflect small fluctuations in
value more than a $1.00 price, which may more effectively inform
investor expectations. For example, the value of a $1.00 per share
fund's portfolio securities would have to change by 50 basis points for
investors to currently see a one-penny change in the NAV; under our
proposal, the share price at which investors purchase and redeem shares
would reflect single basis point variations.\164\ We do not anticipate
significant operational difficulties or overly burdensome costs arising
from funds pricing shares using ``basis point'' rounding: A number of
money market funds recently elected to voluntarily report daily shadow
NAVs at this level of precision.\165\
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\164\ We expect that floating $100.00 NAVs (which is the
mathematical equivalent of our proposed $1.0000 NAV) would change by
a penny or more during all but the shortest investment horizons.
Commission staff compared reported shadow prices on Form N-MFP
between November 2010 and March 2012 over consecutive one-, three-,
and six-month periods. Staff estimated that there would have been no
penny change over a one-month period in 98% of the months using a
$10.00 NAV but only 69% of the months using a $100 NAV. Staff
estimated that there would have been no penny change over a three-
month period in 98% of the time using a $10 NAV but only 59% of the
time using a $100.00 NAV. Staff estimates that there would have been
no penny change over a six-month period in 96% of the time using a
$10 NAV but only 43% of the time using a $100.00 NAV. No money
market fund had a support agreement in place during this time
period.
\165\ Many large fund complexes have begun (or plan) to disclose
daily money market fund market valuations (i.e., shadow prices) of
at least some of their money market funds, rounded to four decimal
places (``basis point'' rounding), for example, BlackRock, Fidelity
Investments, and J.P. Morgan. See, e.g., Money Funds' New Openness
Unlikely to Stop Regulation, Wall St. J. (Jan. 30, 2013).
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``Basis point'' rounding should enhance many of the potential
advantages of having a floating NAV. It should allow funds to reflect
gains and losses more precisely. In addition, it should help reduce
incentives for investors to redeem shares ahead of other investors when
the shadow price is less than $1.0000 as investors would sell shares at
a more precise and equitable price than under the current rules. At the
same time, it should help reduce penalties for investors buying shares
when shadow prices are less than $1.0000. ``Basis point'' rounding
should therefore help stabilize funds in times of market stress by
deterring redemptions from investors that would otherwise seek to take
advantage of less precise pricing to redeem at a higher value than a
more precise valuation would provide
[[Page 36854]]
and thus dilute the value of the fund for remaining shareholders.
Our proposed amendment to require that money market funds use
``basis point'' rounding should provide shareholders with sufficient
price transparency to better understand the tradeoffs between risk and
return across competing funds, and become more accustomed to
fluctuations in market value of a fund's portfolio securities.\166\ It
should allow them to appreciate that some money market funds may
experience greater price volatility than others, and thus that there
are variations in the risk profiles of different money market funds.
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\166\ Similar to other mutual funds, our proposed pricing of
money market fund shares would continue to allow shareholders to
purchase and redeem fractional shares, and therefore would not
affect the ability of shareholders to purchase and redeem shares
with round or precise dollar amounts as they do today.
---------------------------------------------------------------------------
We also considered whether to require that money market funds price
to three decimal places (for a fund with a target share price of
$1.000), as other mutual funds do. We are concerned, however, that such
``10 basis point'' rounding may not be sufficient to ensure that
investors do not underestimate the investment risks of money market
funds, particularly if funds manage themselves in such a way that their
NAVs remain constant or nearly constant. Fund investment managers may
respond to a floating NAV with ``10 basis point'' rounding by managing
their portfolios more conservatively to avoid volatility that would
require them to price fund shares at something other than $1.000. It is
possible that managers would be able to avoid this volatility for quite
some time, even with a floating NAV.\167\ Although a floating NAV with
``basis point'' rounding may discourage risk taking in funds, a
floating NAV with ``10 basis point'' rounding may mask small deviations
in the market-based value of the fund's portfolio securities.
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\167\ See, e.g., PWG Report, supra note 111, at 22 (``Investors'
perceptions that MMFs are virtually riskless may change slowly and
unpredictably if NAV fluctuations remain small and rare. MMFs with
floating NAVs, at least temporarily, might even be more prone to
runs if investors who continue to see shares as essentially risk-
free react to small or temporary changes in the value of their
shares.''); Comment Letter of Federated Investors, Inc. (May 19,
2011) (available in File No. 4-619) (stating that ``managers would
employ all manners of techniques to minimize the fluctuations in
their funds' NAVs'' and, therefore, ``[i]nvestors would then expect
the funds to exhibit very low volatility, and would redeem their
shares if the volatility exceeded their expectations'').
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We seek comment on this aspect of our proposal.
What level of precision in calculating a fund's share
price would best convey to investors that floating NAV funds are
different from stable price funds? Is ``basis point'' rounding too
precise? Would ``10 basis point rounding'' ($1.000 for a fund with a
$1.00 target share price) provide sufficient price transparency? Or
another measure?
Would requiring funds to price their shares at $1.0000 per
share effectively alter investor expectations regarding a fund's NAV
gains and losses? Would this in turn make investors less likely to
redeem heavily when faced with potential or actual losses?
Would ``basis point'' rounding better reflect gains and
losses? Would it help eliminate incentives for investors to redeem
shares ahead of other investors when prices are less than $1.0000?
Should we require that all money market funds price their
shares at $1.0000, including those funds that currently price their
shares at an initial value other than $1.00? Do commenters agree that,
regardless of a fund's initial share price, under our proposal all
money market funds would be required to price fund shares to an
equivalent level of precision (e.g., ``basis point'' rounding)?
What would be the cost of implementing ``basis point''
rounding? Would funds require corporate actions or shareholder approval
to price fund shares at $1.0000? What operational changes and related
costs would be involved?
3. Exemption to the Floating NAV Requirement for Government Money
Market Funds
We are proposing an exemption to the floating NAV requirement for
government money market funds-money market funds that maintain at least
80% of their total assets in cash, government securities, or repurchase
agreements that are collateralized fully.\168\ We believe that a
government money market fund that maintains 80% of its total assets in
cash and government securities fits within the typical risk profile of
government money market funds as understood by investors, and is the
portfolio holdings test used today for determining the accuracy of a
fund's name.\169\ Under the proposal, government money market funds
would not be subject to the basis point rounding aspect of the floating
NAV requirement and instead would be permitted to use the penny
rounding method of pricing fund shares to maintain a stable price.\170\
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\168\ Proposed (FNAV) rule 2a-7(c)(2).
\169\ For example, some government money market funds limit
themselves to holding mostly Treasury securities and Treasury repos
and are referred to as ``Treasury money market funds.'' To comply
with the investment company names rule, funds that hold themselves
out as Treasury money market funds must hold at least 80% of their
portfolio assets in U.S. Treasury securities and for Treasury repos.
See rule 35d-1 (a materially deceptive and misleading name of a fund
(for purposes of section 35(d) of the Investment Company Act
(Unlawful representations and names)) includes a name suggesting
that the fund focuses its investments in a particular type of
investment or in investments in a particular industry or group of
industries, unless, among other requirements, the fund has adopted a
policy to invest, under normal circumstances, at least 80% of the
value of its assets in the particular type of investments or
industry suggested by the fund's name).
\170\ As discussed in greater detail below, money market funds
that take advantage of an exemption to the floating NAV requirement
would not be able to use the amortized cost method of valuation, but
would instead be required to only use the penny rounding method of
pricing to facilitate a stable price per share.
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As discussed above, government money market funds face different
redemption pressures and have different risk characteristics than other
money market funds because of their unique portfolio composition.\171\
The securities primarily held by government money market funds
typically have even a lower credit default risk than commercial paper
and are highly liquid in even the most stressful market scenario.\172\
The primary risk that these funds bear is interest rate risk; that is,
the risk that changes in interest rates result in a change in the
market value of portfolio securities. Even the interest rate risk of
government money market funds, however, is generally mitigated because
they typically hold assets that have short maturities and hold those
assets to maturity.\173\
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\171\ See, e.g., Comment Letter of Charles Schwab (Jan. 17,
2013) (available in File No. FSOC-2012-0003) (``Schwab FSOC Comment
Letter''); FSOC Proposed Recommendations, supra note 114, at 9.
\172\ See, e.g., RSFI Study, supra note 21, at 8-9; Comment
Letter of Vanguard (Jan. 15, 2013) (available in File No. FSOC-2012-
0003) (``Vanguard FSOC Comment Letter'').
\173\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25
(``Given the short duration of [government] money market fund
portfolios, any interest rate movements have a modest and temporary
effect on the value of the fund's securities'').
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Nonetheless, it is possible that a government money market fund
could undergo such stress that it results in a significant decline in a
fund's shadow price. Government money market funds may invest up to 20%
of their portfolio in non-government securities, and a credit event in
that 20% portion of the portfolio or a shift in interest rates could
trigger a drop in the shadow price, thereby creating incentives for
shareholders to redeem shares ahead of other investors.
[[Page 36855]]
Despite these risks, we believe that requiring government money
market funds to float their NAV may be unnecessary to achieve policy
goals.\174\ As discussed below, shifting to a floating NAV could impose
potentially significant costs on both a fund and its investors. In
light of the evidence of investor behavior during previous crises, it
does not appear that government money market funds are as susceptible
to the risks of mass investor redemptions as other money market
funds.\175\ Investors have frequently noted the benefits of having a
stable money market fund option, and exempting government money market
funds from a floating NAV would allow us to preserve this option at a
minimal risk.\176\ On balance, we believe the benefits of retaining a
stable share price money market fund option and the relative safety in
a government money market fund's 80% bucket appropriately
counterbalances the risks associated with the 20% portion of a
government money market fund's portfolio that may be invested in
securities other than cash, government securities, or repurchase
agreements.
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\174\ Many commenters have agreed with this position, suggesting
that a floating NAV proposal should exempt government money market
funds. See, e.g., Comment Letter of The Dreyfus Corporation (Feb.
11, 2013) (available in File No. FSOC-2012-0003) (``Dreyfus FSOC
Comment Letter''); Comment Letter of Northern Trust (Feb. 14, 2013)
(available in File No. FSOC-2012-0003) (``Northern Trust FSOC
Comment Letter''); ICI Jan. 24 FSOC Comment Letter, supra note 25.
\175\ See RSFI Study, supra note 21, at 12-13 (examining the
change in daily assets of different types of money market funds and
highlighting abnormally large inflows into institutional and retail
government funds during September 2008).
\176\ See, e.g., Comment Letter of Allegheny Conference on
Community Development (Jan. 4, 2013) (available in File No. FSOC-
2012-0003) (``Many nonprofit institutions are required, by law or by
investment policy, to invest cash only in products offering a stable
value''); Comment Letter of New Jersey Association of Counties (Dec.
21, 2012) (available in File No. FSOC-2012-0003) (``We thus strongly
support maintaining the ability of money market funds to offer a
stable $1.00 per-share value'').
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Under the proposal, funds taking advantage of the government fund
exemption (as well as funds using the retail exemption discussed in the
next section) would no longer be permitted to use the amortized cost
method of valuation to facilitate a stable NAV, but would continue to
be able to use the penny rounding method of pricing. While today
virtually all money market funds use both amortized cost valuation and
penny rounding pricing together to maintain a stable value, either
method alone effectively provides the same 50 basis points of deviation
from a fund's shadow price before the fund must ``break the buck'' and
re-price its shares. Accordingly, today the principal benefit from
money market funds being able to use amortized cost valuation in
addition to basis point rounding is that it alleviates the burden of
the money market fund having to value each portfolio security each day
using market factors.\177\ However, as described in section III.F.3
below, we are proposing that all money market funds be required to
disclose on a daily basis their share price with portfolios valued
using market factors and applying basis point rounding. As a result,
money market funds--including those exempt from the floating NAV
requirement--would have to value their portfolio assets using market
factors instead of amortized cost each day. Accordingly, in line with
this increased transparency on the valuation of money market funds'
portfolios, and in light of the fact that this increased transparency
renders penny rounding alone an equal method of achieving price
stability in money market funds, we are proposing that the government
exemption permit penny rounding pricing alone and not also amortized
cost valuation for all portfolio securities.
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\177\ Rule 2a-7 currently requires a money market fund's board
of directors to review the amount of deviation between the fund's
market-based NAV per share and the fund's amortized cost per share
``periodically.'' Rule 2a-7(c)(8)(ii)(A)(2).
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The government money market fund exemption to the floating NAV
requirement would not be limited solely to Treasury money market funds,
but also would extend to money market funds that invest at least 80% of
their portfolio in cash, ``government securities'' as defined in
section 2(a)(16) of the Act, and repurchase agreements collateralized
with government securities. Allowable securities would include
securities issued by government-sponsored entities such as the Federal
Home Loan Banks, government repurchase agreements, and those issued by
other ``instrumentalities'' of the U.S. government.\178\ It would
exclude, however, securities issued by state and municipal governments,
which do not generally share the same credit and liquidity traits as
U.S. government securities.\179\
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\178\ Section 2(a)(16) of the Investment Company Act.
\179\ See, e.g., RSFI Study, supra note 21; Schwab FSOC Comment
Letter, supra note 171 (``There may be slightly higher risk in
municipal money market funds, but these funds tend to be more liquid
than most prime funds.'').
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Today, government money market funds hold approximately $910
billion in assets, or around 40% of all money market fund assets.\180\
Fund groups that wish to focus on offering stable price products could
offer government and retail money market funds. We also note that our
proposed retail money market fund exemption discussed in the next
section would likely cover most municipal (or tax-exempt) funds,
because the tax advantages that these funds offer are only enjoyed by
individuals and thus most of these funds could continue to offer a
stable share price.\181\ Similarly, investors who prefer a stable price
fund or are unable to invest in a floating NAV fund could choose to
invest in government money market funds. These investors could continue
to use these money market funds as a cash management tool without
incurring any costs or other effects associated with floating NAV
investment vehicles.
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\180\ Based on iMoneyNet data.
\181\ We note that there are some tax-exempt money market funds
that self-classify as institutional funds to private reporting
services such as iMoneyNet. We understand that these funds'
shareholder base typically is comprised of omnibus accounts, with
underlying individual investors.
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We request comment on this aspect of our proposal.
Do commenters agree with our assumption that money market
funds with at least 80% of their total assets in cash, government
securities, and government repos are unlikely to suffer losses due to
credit quality problems correct? Is our assumption that they are
unlikely to be subject to significant shareholder redemptions during a
financial crisis correct?
Should government money market funds be exempt from the
floating NAV requirement? Why or why not? Are there other risks, such
as interest rate or liquidity risks, about which we should be concerned
if we adopt this proposed exemption to the floating NAV requirement? If
so, what are they and how should they be addressed?
Would the costs imposed on government money market funds
if we required them to price at a floating NAV be different from the
costs discussed below?
Are the proposed criteria for qualifying for the
government money market funds exemption to the floating NAV requirement
appropriate? Should government money market funds be required to hold
more or fewer than 80% of total assets in cash, government securities,
and government repos? If so, what should it be and why?
What kinds of risks are created by exempting government
money market funds from a floating NAV requirement where the funds are
permitted to maintain 20% of their portfolio in securities other than
cash, government securities, and government repos? Should there be
additional limits or
[[Page 36856]]
requirements on the 20%? Would investors have incentives to redeem
shares ahead of other investors if they see a material downgrade in
securities held in the 20% basket? Would such an incentive create a
significant risk of runs?
Is penny rounding sufficient to allow government money
market funds to maintain a stable price? Should we also permit these
funds to use amortized cost valuation? If so, why? Should we permit
money market funds to continue using amortized cost valuation for
certain types of securities, such as government securities? Why?
If the Commission does not adopt this exemption, how many
investors in government money market funds might reallocate assets to
non-government money market fund alternatives? How many assets in
government money market funds might be reallocated to alternatives? To
what non-government money market fund alternatives are these investors
likely to reallocate their investments?
Should we provide other exemptions to the floating NAV
requirement based on the characteristics of a fund's portfolio assets,
such as funds that hold heightened daily or weekly liquid assets? If
so, why and what threshold should we use?
Should money market funds that invest primarily in
municipal securities be exempted from the floating NAV requirement? Why
or why not? To what extent would such funds expect to qualify for the
retail exemption?
4. Exemption to the Floating NAV Requirement for Retail Money Market
Funds
a. Overview
We are also proposing to exempt money market funds that are limited
to retail investors from our floating NAV proposal by allowing them to
use the penny rounding method of pricing instead of basis point
rounding.\182\ Under this proposal, retail funds would still generally
be required to value portfolio securities using market-based factors
rather than amortized cost. As discussed in detail below, retail
investors historically have behaved differently from institutional
investors in a crisis, being much less likely to make large redemptions
quickly in response to the first sign of market stress. Thus, prime
money market funds that are limited to retail investors in general have
not been subject to the same pressures as institutional or mixed
funds.\183\ Under the proposed exemption, we would define a retail fund
as a money market fund that does not permit a shareholder to redeem
more than $1 million in a single business day. We would permit retail
funds to continue to maintain a stable price. As of February 28, 2013,
funds that self-report as retail money market funds currently hold
nearly $695 billion in assets, which is approximately 26% of all assets
held in money market funds.\184\
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\182\ Much like under the government fund proposal, funds that
take advantage of the retail exemption would not be able to use the
amortized cost method of valuation to facilitate a stable NAV for
the same reasons as discussed in section III.A.3 above.
\183\ See, e.g., Comment Letter of United Services Automobile
Association (Feb. 15. 2013) (available in File No. FSOC-2012-0003)
(``USAA FSOC Comment Letter'') (``Retail MMFs do not need additional
or more stringent regulation to prevent runs because retail
investors are inherently (and historically) less likely to cause
runs.'').
\184\ Based on iMoneyNet data. Of these assets, approximately
$497 billion are held by prime money market funds and another $198
billion are in government funds. Because we are proposing to exempt
government funds from the floating NAV requirement, the proposed
retail exemption would only be relevant to the investors holding the
$497 billion in retail prime funds.
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As noted above in section II, during the 2007-2008 financial
crisis, institutional prime money market funds had substantially
greater redemptions than retail prime money market funds.\185\ For
example, approximately 4-5% of prime retail money market funds had
outflows of greater than 5% on each of September 17, 18, and 19, 2008,
compared to 22-30% of prime institutional money market funds.\186\
Similarly, in late June 2011, institutional prime money market funds
experienced heightened redemptions in response to concerns about their
potential exposure to the Eurozone debt crisis, whereas retail prime
money market funds generally did not experience a similar
increase.\187\ Studies of money market fund redemption patterns in
times of market stress also have noted this difference.\188\ As
discussed above, institutional shareholders tend to respond more
quickly than retail shareholders to potential market stresses because
generally they have greater capital at risk and may be better informed
about the fund through sophisticated tools to monitor and analyze the
portfolio holdings of the funds in which they invest.
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\185\ See RSFI Study, supra note 21, at 8. We note that the RSFI
Study used a definition of retail fund based on fund self-
classification, which does not entirely correspond with the
definition of retail fund that we are proposing today.
\186\ Based on iMoneyNet data. iMoneyNet classifies retail and
institutional money market funds according to who is eligible to
purchase fund shares, minimum initial investment amount in the fund,
and to whom the fund is marketed. However, as discussed infra, there
is currently no regulatory distinction that reliably distinguishes
these types of investors, and the iMoneyNet method uses a different
method of classification than the method we are proposing.
\187\ Based on iMoneyNet data. Retail money market funds
suffered net redemptions of less than 1% between June 14, 2011 and
July 5, 2011, and only 27 retail money market funds had redemptions
in excess of 5% during that period (and of these funds only 7 had
redemptions in excess of 10% during this period), far fewer
redemptions than those incurred by institutional funds.
\188\ See, e.g., RSFI Study, supra note 21, at 8; Cross Section,
supra note 60, at 9 (noting that institutional prime money market
funds suffered net redemptions of $410 billion (or 30% of assets
under management) in the four weeks beginning September 10, 2008,
based on iMoneyNet data, while retail prime money market funds
suffered net redemptions of $40 billion (or 5% of assets under
management) during this same time period); Kacperczyk & Schnabl,
supra note 60, at 31; Wermers Study, supra note 64.
---------------------------------------------------------------------------
Given the tendency of retail investors to continue to hold money
market fund shares in times of market stress, it appears to be
unnecessary to impose a floating NAV requirement on retail funds to
address the risk that a fund would be unable to manage heavy
redemptions in times of crisis.\189\ We understand that funds designed
for retail investors generally do not have a concentrated shareholder
base and are therefore less likely to experience large and unexpected
redemptions that would put a strain on the fund's liquidity.\190\ Some
commenters have therefore suggested providing an exemption for retail
funds to preserve the current benefits of money market funds for these
investors, and as a consequence, reduce the macroeconomic effects that
may be associated with a floating NAV requirement.\191\ A retail
exemption may also reduce the operational burdens of implementing a
floating NAV, because retail funds and their intermediaries may not
need to undertake the operational costs of transitioning
[[Page 36857]]
systems or managing potential tax and accounting issues associated with
a floating NAV. However, other commenters have opposed a retail
exemption, citing the difficulty of distinguishing retail and
institutional investors, operational issues, and other concerns.\192\
---------------------------------------------------------------------------
\189\ See Comment Letter of Reich & Tang (Feb. 14, 2013)
(available in File No. FSOC-2012-0003) (``Reich & Tang FSOC Comment
Letter'') (``As a general rule, retail investors' use of money
market funds tends to be stable and countercyclical. . . . This is
in direct contrast to the general behavior of institutional
investors.'').
\190\ See Comment Letter of John M. Winters (Dec. 18, 2012)
(available in File No. FSOC-2012-0003) (``Winters FSOC Comment
Letter'') (``Retail MMFs and institutional government MMFs do not
have a liquidity problem due to the nature of the investor type or
portfolio securities. . . .'').
\191\ See, e.g., USAA FSOC Comment Letter, supra note 183
(``Bifurcation would allow retail MMFs to continue to play the same
vital role they do today, provide retail investors with professional
investment management services, portfolio diversification and
liquidity, while also acting as a key provider of financing in the
broader capital markets''); Reich & Tang FSOC Comment Letter, supra
note 189 (``A departure of this nature would diminish and endanger
the benefits [of MMFs] to retail investors and cause these same
individuals to seek potentially less appropriate or riskier
alternatives.''). See also infra section III.E.
\192\ See, e.g., Comment Letter of Invesco Ltd. (Feb. 15, 2013)
(available in File No. FSOC-2012-0003) (``Invesco FSOC Comment
Letter'') (``While we acknowledge that the disruptions experienced
by MMFs during the 2008 financial crisis were largely attributable
to prime MMF redemptions by large investors, we believe that efforts
to characterize MMFs or their investors as either ``institutional''
or ``retail'' are misplaced and impractical due to the difficulty of
establishing a litmus test that can be used consistently to identify
those investors most likely to trigger a MMF run.''); Comment Letter
of Federated Investors, Inc. (Feb. 15. 2013) (available in File No.
FSOC-2012-0003) (``Federated Investors Feb. 15 FSOC Comment
Letter'').
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In 2009, similar considerations led us to propose lower
requirements for the amount of daily and weekly liquid assets that
retail money market funds would need to hold compared with
institutional funds.\193\ We noted that retail prime money market funds
experienced significantly fewer outflows when compared with
institutional prime money market funds in the fall of 2008.\194\
Although we have not adopted that proposal, in part because we
recognize significant difficulties in distinguishing retail from
institutional funds for purposes of that reform, we continue to
consider whether retail and institutional money market funds should be
subject to different requirements.
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\193\ In 2009, we proposed to define a retail money market fund
as a money market fund that was not an institutional fund, and to
define an institutional fund as a money market fund whose board of
directors, considering a number of factors, determines that is
``intended to be offered to institutional investors.'' See 2009
Proposing Release, supra note 31, at section II.C.2.
\194\ Id. at n.185 and accompanying text.
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It is important to note that some commenters on our 2009 money
market fund reforms proposal suggested that not all retail and
institutional shareholders behave the same way as their peers.\195\
Also, although retail shareholders during recent financial crises have
not redeemed from money market funds in large numbers in response to
market stress, this does not necessarily mean that in the future they
will not eventually exhibit increased redemption activity if stress on
one or more money market funds persists.\196\ Empirical analyses of
retail money market fund redemptions during the 2007-2008 financial
crisis show that at least some retail investors eventually began
redeeming shares.\197\ The introduction of the Treasury Temporary
Guarantee Program on September 19, 2008 (a few days after institutional
prime money market funds experienced heavy redemptions) may have
prevented shareholder redemptions from accelerating in retail money
market funds. Commenters on the FSOC Proposed Recommendations also have
questioned whether the behavior of retail investors during the 2008
crisis should be regarded as definitive.\198\
---------------------------------------------------------------------------
\195\ See, e.g., Comment Letter of Invesco Aim Advisors, Inc.
(Sept. 4, 2009) (available in File No. S7-11-09) (``Invesco 2009
Comment Letter''); Comment Letter of Federated Investors, Inc.
(Sept. 8, 2009) (available in File No. S7-11-09).
\196\ See, e.g., Comment Letter of HSBC Global Asset Management
Ltd (Feb. 15, 2013) (available in File No. FSOC-2012-0003) (``HSBC
FSOC Comment Letter'') (``Whilst the credit crisis of 2008 is an
important data point to compare investor behavior, there are other
data points in history that show that retail investors do ``run''
from investments (banks, other types of mutual fund) during times of
market crisis.'').
\197\ See, e.g., Cross Section, supra note 60, at 25-26 (finding
that net redemptions from retail prime money market funds in
September 2008 indicates that higher risk money market funds did
have greater net outflows but only late in the run and that outflows
from retail money market funds peaked later than those from
institutional funds); Wermers Study, supra note 64, at 3 (analysis
of money market fund redemption data from the 2007-2008 financial
crisis showed that ``prime institutional funds exhibited much larger
persistence in outflows than retail funds, although retail investors
also exhibited some run-like behavior.'').
\198\ See, e.g., Federated Investors Feb 15 FSOC Comment Letter,
supra note 192 (``The oft-repeated point that some funds labeled
``institutional'' experienced higher redemptions than some funds
labeled ``retail'' during the financial crisis is not sufficient.
Many so-called institutional funds experienced the same or even
lower levels of redemptions as so-called [retail money market] funds
during the period of high redemptions during the financial crisis,
and many funds included both retail and institutional investors.'').
---------------------------------------------------------------------------
The evidence, however, suggests that retail investors tend to
redeem shares slowly in times of fund and market stress or do not
redeem shares at all. As indicated in the RSFI study, such lower
redemptions may be more readily managed without adverse effects on the
fund, in part because of the Commission's enhanced liquidity
requirements adopted in 2010.\199\ However, we recognize that by
providing a retail exemption to the floating NAV, we would be leaving
in place for those investors the existing incentive to redeem that can
result from the use of a stable price, and some retail investors could
potentially benefit from redeeming shares ahead of other retail
investors in times of fund and market stress.\200\
---------------------------------------------------------------------------
\199\ See supra section II.D.2 for a discussion of how these
enhanced liquidity requirements were more effective in providing
stability in the face of the slower pace of redemptions in
institutional prime money market funds in June and July of 2011 in
response to the Eurozone debt crisis compared with the very rapid
heavy redemptions that occurred in September 2008. But see RSFI
study, supra at note 21, at 37 (noting that The Reserve Primary Fund
would have broken the buck even in the presence of the 2010
liquidity requirements).
\200\ See Dreyfus FSOC Comment Letter, supra note 174 (``Thus
while it can be expected that different kinds of prime money market
funds may experience different levels of redemption activity, it may
not be the case that different kinds of prime money market funds
have different credit risk profiles.'').
---------------------------------------------------------------------------
The retail exemption would take the same form as the government
exemption in allowing these money market funds to price using penny
rounding instead of basis point rounding. For the reasons described in
section III.A.3 above, we do not believe that allowing continued use of
amortized cost valuation for all securities in these funds' portfolios
is appropriate given that these funds will be required to value their
securities using market factors on a daily basis due to new Web site
disclosure requirements described in section III.F.3 and given that
penny rounding otherwise achieves the same level of price stability.
We request comment on whether we should provide a retail money
market fund exemption to the floating NAV.
Are we correct in our understanding that retail investors
are less likely to redeem money market fund shares in times of market
stress than institutional investors? Or are they just slower to
participate in heavy redemptions?
Does the evidence showing that retail investors behave
differently than institutional investors justify a retail exemption? Is
this difference in behavior likely to continue in the future?
Would a retail exemption reduce the operational effects of
implementing the floating NAV requirement, such as systems changes and
tax and accounting issues? If so, to what extent and how?
If the Commission does not adopt an exemption to the
floating NAV requirement for retail funds, how many investors in retail
prime money market funds might reallocate assets to non-prime money
market fund alternatives? How many assets in retail prime money market
funds might be reallocated to alternatives? To what non-prime money
market alternatives are retail investors likely to reallocate their
investments? \201\
---------------------------------------------------------------------------
\201\ See infra section III.E.
---------------------------------------------------------------------------
Are we correct that retail investors would prefer an
exemption from the floating NAV requirement? Would they instead prefer
to invest in floating NAV funds? If so, why?
Is penny rounding sufficient to allow retail money market
funds to maintain a stable price? Should we also permit these funds to
use amortized cost valuation? If so, why?
Should we consider requiring retail funds that rely on an
exemption from
[[Page 36858]]
the floating NAV requirement to be subject to the liquidity fees and
gates requirement described in section III.B?
b. Operation of the Retail Fund Exemption
The operational challenges of implementing an exemption for retail
investor funds are numerous and complex. Currently, many money market
funds are owned by both retail and institutional investors, although
many are separated into retail and institutional share classes.\202\
With the retail exemption to the floating NAV requirement, funds with
separate share classes for different types of investors (as well as
funds that mix different types of investors together) that wish to
offer a stable price would need to reorganize, offering separate money
market funds to retail and institutional investors.\203\ We recognize
that any distinction could result in ``gaming behavior'' whereby
investors having the general attributes of an institution might attempt
to fit within the confines of whatever retail exemption we craft.\204\
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\202\ Several of the largest prime money market funds have both
institutional and retail share classes. For example, see Vanguard
Money Market Reserves, Vanguard Prime Money Market Fund Investor
Shares (VMMXX), Registration Statement (Form N-1A) (Dec. 28, 2012);
Vanguard Money Market Reserves, Vanguard Prime Money Market Fund
Institutional Shares (VMRXX), Registration Statement (Form N-1A)
(Dec. 28, 2012); J.P. Morgan Money Market Funds, JPMorgan Prime
Money Market Fund Institutional Class Shares (JINXX), Registration
Statement (Form N-1A) (July 1, 2012); J.P. Morgan Money Market
Funds, JPMorgan Prime Money Market Fund Morgan Class Shares (VMVXX),
Registration Statement (Form N-1A) (July 1, 2012).
\203\ Alternatively, funds might choose to be treated as
institutional (and not eligible for the proposed retail exemption to
the floating NAV requirement).
\204\ See Comment Letter of BlackRock, Inc. (Dec. 13, 2012)
(available in File No. FSOC-2012-0003) (``BlackRock FSOC Comment
Letter'') (``A two-tiered approach to MMFs based on a distinction
between ``retail'' and ``institutional'' funds would be difficult to
implement and may lead to gaming behavior by investors.''); HSBC
FSOC Comment Letter, supra note 196 (``There are also practical
challenges such as defining and identifying different types of
investors and preventing the ``gaming'' of any regulation.'').
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It can be difficult to distinguish objectively between retail and
institutional money market funds, given that funds generally self-
report this designation, there are no clear or consistent criteria for
classifying funds and there is no common regulatory or industry
definition of a retail investor or a retail money market fund.\205\
Many of the issues that we discuss below regarding distinguishing
between types of investors were raised by our 2009 proposed money
market fund reforms in which we proposed to establish different
liquidity requirements for institutional and retail money market
funds.\206\ Many commenters then asserted that distinguishing between
retail and institutional money market funds would be difficult given
the extent to which shares of money market funds are held by investors
through omnibus accounts and other financial intermediaries.\207\
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\205\ Commenters have suggested a number of ways to distinguish
retail funds from institutional funds. See, e.g., Comment Letter of
Fidelity Investments, Comments on Response to Questions Posed by
Commissioners Aguilar, Paredes, and Gallagher, (Jan. 24, 2013),
available at http://www.sec.gov/comments/mms-response/mms-response.shtml (``Fidelity RSFI Comment Letter''); Schwab FSOC
Comment Letter, supra note 171. All of these methods involve some
degree of subjectivity and risk of over or under inclusion.
\206\ We proposed but did not adopt a requirement that a money
market fund's board determine at least once each calendar year
whether the fund is an institutional fund based on the nature of the
record owner of the fund's shares, minimum initial investment
requirements, and cash flows from purchases and redemptions. See
2009 Proposing Release, supra note 31, at nn.195-197 and
accompanying text.
\207\ See 2010 Adopting Release, supra note 92, at nn.220-228
and accompanying text. Many commenters also expressed concern with
requiring fund boards to make such a determination. See 2010
Adopting Release, supra note 92, at n.222 and accompanying text. See
also section III.A.4.b of this Release.
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Some commenters at the time, however, suggested possible approaches
we might take.\208\ We have since received more comments suggesting
other methods for distinguishing between investor types.\209\ The daily
redemption limit method we are proposing today is an objective
criterion intended to encourage self-identification of retail
investors, because we understand that institutional investors generally
would not be able to tolerate such redemption limits and they would
accordingly self-select into institutional money market funds designed
for them, while we anticipate that the limit would not constrain how
most retail investors typically use money market funds. We also discuss
several alternate methods we could use to make such a distinction
below.
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\208\ For example, one commenter suggested that we treat as
institutional a fund that has any class that offers same-day
liquidity to shareholders. Comment Letter of Fidelity Investments
(Aug. 24, 2009) (available in File No. S7-11-09) (``Fidelity 2009
Comment Letter''). We expressed concern regarding this proposal and
whether institutional investors would be willing to migrate to funds
that offer next-day liquidity to avoid the more restrictive
requirements. See 2010 Adopting Release, supra note 92. We expressed
similar concerns about others' suggestion that retail funds be
distinguished based on minimum initial account sizes or maximum
expense ratios. See, e.g., Comment Letter of HighMark Capital
Management, Inc. (Sept. 8, 2009) (available in File No. S7-11-09);
Comment Letter of T. Rowe Price Associates, Inc. (Sept. 8, 2009)
(available in File No. S7-11-09) (``T. Rowe Price 2009 Comment
Letter'').
\209\ See, e.g., Fidelity RSFI Comment Letter, supra note 205;
Schwab FSOC Comment Letter, supra note 171.
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i. Daily Redemption Limit
We are proposing to define a retail money market fund as a money
market fund that restricts a shareholder of record from redeeming more
than $1,000,000 in any one business day.\210\ We believe that this
approach would be relatively simple to implement, since it would only
require a retail money market fund to establish a one-time, across-the-
board redemption policy,\211\ and unlike other approaches discussed
below, it would not depend on a fund's ability to monitor the dollar
amounts invested in shareholders' accounts, shareholder concentrations,
or other shareholder characteristics. A daily redemption limitation
approach also should reduce the risk that a retail fund will experience
heavier redemption requests than it can effectively manage in a crisis,
because it will limit the total amount of redemptions a fund can
experience in a single day, allowing the fund time to better predict
and manage its liquidity.\212\
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\210\ See proposed (FNAV) rule 2a-7(c)(3).
\211\ The proposed retail exemption would provide exemptive
relief from the Investment Company Act and its rules to permit a
retail money market fund to restrict daily redemptions as provided
for in the proposed rule. See proposed (FNAV) rule 2a-7(c)(3)(iii).
\212\ See USAA FSOC Comment Letter, supra note 183 (``This
approach would reduce large money movement from retail MMFs in any
given day, and therefore retail MMFs would be less likely to
experience large scale runs resulting from a lack of liquidity.'').
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A redemption limitation approach to defining retail funds should
also lead institutions to self-select into institutional floating money
market funds, since retail money market funds with redemption
limitations would typically not meet their operational needs.\213\ This
incentive to self-select may help mitigate (but cannot eliminate)
``gaming'' by investors with institutional characteristics who
otherwise might be tempted to try and invest in stable price retail
funds, compared to the other methods of distinguishing investors
discussed below. Even if an institutional investor purchased shares in
a stable price fund, the institutional investor would be subject to the
$1 million daily redemption limit. Retail investors rarely need the
ability to redeem such a significant amount on a daily basis, and if
they do anticipate needing to make
[[Page 36859]]
large redemptions quickly, they would be able to choose to invest in a
government money market fund, a floating NAV fund, or plan to make
several redemptions over time.
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\213\ See id. (noting that if the Commission were to define a
fund as retail through a daily redemption limitation approach
``[l]arge individual investors and institutions will self-select
into institutional MMFs because retail MMFs will not meet their
operational needs.'').
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Applying the daily redemption limitation method to omnibus accounts
may pose difficulties. In order for the fund to impose its redemption
limit policies on the underlying shareholders, intermediaries with
omnibus accounts would need to provide some form of transparency
regarding underlying shareholders, such as account sizes of underlying
shareholders (showing that each was below the $1 million redemption
limit). Alternatively, the fund could arrange with the intermediary to
carry out the fund's policies and impose the redemption limitation, or
else impose redemption limits on the omnibus account as a whole. We
discuss omnibus account issues further below.
We have selected $1,000,000 as the appropriate daily redemption
threshold because we expect that such a daily limit is high enough that
it should continue to make money market funds a viable and desirable
cash management tool for retail investors,\214\ but is low enough that
it should not suit the operational needs of institutions. We recognize
that typical retail investors rarely make redemptions that approach
$1,000,000 in a single day. Nonetheless, retail investors' net worth
and investment choices can differ significantly, and they may on
occasion engage in large transactions. For example, a retail investor
may make large redemption requests when closing out their account,
rebalancing their investment portfolio, paying their tax bills, or
making a large purchase such as the down payment on a house. In
selecting the appropriate redemption limit, we sought to find a
threshold that is low enough that institutions would self-select out of
retail funds, but high enough that it would not impose unnecessary
burdens on retail investors, even when they engage in atypical
redemptions. One commenter suggested a lower redemption threshold of
$250,000,\215\ but we are concerned that such a threshold may be too
low to meet the cash management needs of retail investors that engage
in occasional large transactions. We also considered a higher
threshold, such as a $5,000,000 daily redemption limit instead, but are
concerned that such a higher limit might not provide sufficient
limitation on heightened redemptions in times of stress.
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\214\ The staff understands that for at least one large fund
group, significantly less than 1% of the number of redemption
transactions in money market funds intended for retail investors
exceed $1,000,000, and that more than 97% of retail transactions
were under $25,000. Nonetheless, the fund group received redemption
request exceeding $250,000 from some retail investors on a daily
basis.
\215\ See USAA FSOC Comment Letter, supra note 183 (suggesting
that a $250,000 cap on daily redemptions is a natural dollar limit
because it is consistent with rule 18f-1 (exemption for mutual funds
that allows funds to commit to pay certain redemptions in cash,
rather than in-kind) and the current FDIC account guarantee limit).
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As mentioned previously, setting an appropriate redemption
threshold for retail money market funds is complicated by the fact that
retail investors may, however, on occasion need to redeem relatively
large amounts from a money market fund, for example, in connection with
the purchase of a home, and that some institutions may have small
enough cash balances that they may find that a $1,000,000 daily
redemption threshold still suits their operational needs. A retail
fund's prospectus and advertising materials would need to provide
information to shareholders about daily redemption limitations to
shareholders.\216\ This should provide sufficient information to
potential investors, both retail and institutional, to allow them to
make informed decisions about whether investing in the fund would be
appropriate. Any money market fund that takes advantage of the retail
exemption would also need to effectively describe that it is intended
for retail investors. Retail investors who may need to make large
(i.e., in excess of $1,000,000) immediate redemptions would thus know
that they should not invest in a retail money market fund with daily
redemption limitations, and that they should instead use an alternate
cash management tool. Alternatively, since it is likely that retail
investors would have advance notice of the need to redeem in excess of
the fund's limits, they could manage the redemption request over a
period of several days.
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\216\ Prospectus disclosure regarding any restrictions on
redemptions is currently required by Form N-1A, and we do not
believe that any amendments to the current disclosure requirements
would be necessary to require additional fund disclosure regarding
the daily redemption restrictions of the proposed retail exemption.
See Item 6 and Item 11(c)(1) of Form N-1A.
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We request comment on our proposed method of distinguishing between
retail and institutional money market funds based on a daily redemption
limitation of $1,000,000.
Would a daily redemption limit effectively distinguish
retail from institutional money market funds? Are we correct in
assuming that institutional investors would self-select out of retail
funds with such redemption limits? Would a daily redemption limit help
reduce the risk that a fund might not be able to manage heavy
shareholder redemptions in times of stress? Would this method of
distinguishing between retail and institutional money market funds
appropriately reflect the relative risks faced by these two types of
funds?
If we classify funds as retail or institutional based on
an investor's permitted daily redemptions, should we limit a retail
fund investor's daily redemptions to $1,000,000, or some other dollar
amount such as $250,000 or $5,000,000? Should we provide a means to
increase the dollar amount limit to keep pace with inflation? If so,
what method should we use?
How large are institutional investors' typical account
balances and daily redemptions? Would institutional investors be
willing to break large investments into smaller pieces so they can
spread them across multiple retail funds?
Are current disclosure requirements sufficient to inform
current and potential shareholders of the operations and risks of
redemption limitations? Should we consider additional disclosure
requirements? If so, what kinds of disclosures should be required?
We ask commenters to provide empirical justification for
any comments on a redemption limitation approach to distinguishing
retail and institutional money market funds. We also request that
commenters with access to shareholder redemption data provide us with
detailed information about the size of individual redemptions in normal
market periods but especially in September 2008 and summer 2011.
In particular, we request that commenters submit data on
the size and frequency of retail and institutional redemptions in money
market funds today, including breakdowns of the typical number and
dollar volume of transactions in funds intended for retail and
institutional shareholders. We also request empirical data on the size
and frequency of retail investors outlier redemption activity, such as
when closing out their accounts or making other atypical transactions.
Should the exemption have a weekly redemption limit as an
alternative to, or in addition to, the daily redemption limit? If so,
what should that limit be?
We have discussed above why we believe a daily redemption limit may
effectively distinguish between retail and institutional investors and
may also serve to help a retail fund manage the redemption requests it
receives. In some cases, retail investors may still want to
[[Page 36860]]
redeem more than $1 million in a single day. To help accommodate such
requests, but at the same time allow a retail fund to effectively
manage its redemptions, a retail exemption also could include a
provision permitting an investor to redeem in excess of the fund's
daily redemption limit, provided the investor gives advance notice of
their intent to redeem in excess of the limit. Permitting higher
redemptions with advance notice may serve the interests of retail
investors, while also giving a fund manager sufficient time to prepare
to meet the redemption request without adverse consequences to the
fund. We request comment on whether we should include a provision
allowing retail funds to permit redemption requests in excess of their
daily limit if the investor provides advance notice.
Should we include a provision permitting retail investors
to redeem more than the daily redemption limit if they gave advance
notice? How frequently are retail investors likely to need to redeem
more than the daily redemption limit, and also know that they would
need to make such a redemption in advance? Would such an advance notice
provision encourage ``gaming behavior,'' for example if an institution
invested in a retail fund and gave notice that every Friday it would
redeem a large position to make payroll? Should we be concerned with
such ``gaming behavior'' provided that the fund was given sufficient
notice that it could effectively manage the redemptions?
If we were to include an advance notice provision, what
should the terms be? Should a retail investor be permitted to redeem
any amount provided that they gave sufficient notice? A limited amount,
such as $5 or $10 million? How much advance notice would be required, 2
days, 5 days, more or less? Should the amount that an investor be
permitted to redeem be tied to the amount of advance notice given? For
example, should an investor be permitted to redeem $3 million in a
single day if they give 3 days' notice, but $10 million in a single day
if they gave 10 days' notice?
Should an advance notice provision include requirements
regarding the method of how the notice is submitted to the fund, or for
fund recordkeeping of the notices it receives? Should such a provision
include requirements on intermediary communications, (for example, if
the notice is provided to the intermediary rather than the fund, should
we require that the advance notice clock begin counting once the fund
receives the notice, not when it is given to the intermediary) or
should it leave such details to be worked out between the parties?
What operational costs would be associated with providing
such an advance notice provision? Would funds be able to effectively
communicate to investors the terms of such an advance notice provision?
We note that most money market funds that invest in municipal
securities (tax-exempt funds) are intended for retail investors,
because the tax advantages of those securities are only applicable to
individual investors, and accordingly, a retail exemption would likely
result in most such funds seeking to qualify for the proposed
exemption. Our 2010 reforms exempted tax-exempt funds from the
requirement to maintain 10% daily liquid assets because, at the time,
we understood that the supply of tax-exempt securities with daily
demand features was extremely limited.\217\ Because tax-exempt money
market funds are not required to maintain 10% daily liquid assets,
these funds may be less liquid than other retail money market funds,
which could raise concerns that tax-exempt retail funds might not be
able to manage even the lower level of redemptions expected in a retail
fund. Based on information received through Form N-MFP, we now
understand that many tax-exempt funds can and do maintain more than 10%
of their portfolio in daily liquid assets, and thus complying with a
10% daily liquid asset requirement may be feasible for these
funds.\218\ We request comment on whether we should require tax-exempt
funds that wish to take advantage of the proposed retail exemption to
also meet the 10% daily liquid asset requirements.
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\217\ See 2010 Adopting Release, supra note 92, at nn.240-243
and accompanying text; rule 2a-7(c)(5)(ii).
\218\ Based on a review of Form N-MFP filings, we understand
that as of the end of February 2013, 51% of tax-exempt funds
maintain daily liquid assets in excess of 10%, and that another 29%
maintain daily liquid assets of between 5% and 10% of their
portfolios. The average daily liquid assets held across all tax-
exempt funds was approximately 9.9% of their total portfolios.
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Would tax-exempt funds that rely on the proposed retail
exemption be able to manage redemptions in time of stress without such
a daily liquid asset requirement? What level of daily liquid assets do
tax-exempt money market funds typically maintain today? Should we
require tax-exempt money market funds to meet the daily liquid asset
requirement if they are to rely on the proposed retail exemption to the
floating NAV?
There are different ways a money market fund could comply with the
exemption's daily redemption limitation if a shareholder seeks to
redeem more than $1 million on any given day notwithstanding the fund's
policy not to honor such requests. The fund could treat the entire
order as not in ``good order'' and reject the order in its entirety.
Alternatively, the fund could treat the order as a request to redeem $1
million and reject the remainder of the order (or treat it as if it
were received on the next business day). Any of those approaches would
allow the money market fund to meet the daily redemption limitation and
neither would provide an incentive for a shareholder to submit a
redemption request in excess of $1 million on any one day. A fund would
also need to disclose how it handles such excessive redemption requests
in its prospectus.\219\ We request comment on these approaches.
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\219\ See Item 6 and Item 11(c)(1) of Form N-1A.
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Should we specify in rule 2a-7 the way that a money market
fund must comply with the exemption's daily redemption limitation? Is
either of the ways we discuss above easier or less costly to implement
than the other?
Are there any other approaches, other than the ones
discussed above, that funds may use to meet the daily redemption
limitation? If so, what are the benefits and costs of those
alternatives?
ii. Omnibus Account Issues
Today, most money market funds do not have the ability to look
through omnibus accounts to determine the characteristics and
redemption patterns of their underlying investors. An omnibus account
may consist of holdings of thousands of small investors in retirement
plans or brokerage accounts, just one or a few institutional accounts,
or a mix of the two. Omnibus accounts typically aggregate all the
customer orders they receive each day, net purchases and redemptions,
and they often present a single buy and single sell order to the fund.
Because the omnibus account holder is the shareholder of record, to
qualify as a retail fund under a direct application of our daily
redemptions limitation proposal, a fund would be required to restrict
daily redemptions by omnibus accounts to no more than $1,000,000.
Because omnibus accounts can represent hundreds or thousands of
beneficial owners and their transactions, they would often have daily
activity that exceeds this limit. This combined activity would result
in omnibus accounts often having daily redemptions that exceed the
limit even though no one beneficial owner's
[[Page 36861]]
transaction exceeds the limit.\220\ Accordingly, to implement a retail
exemption, our proposal needs to also address retail investors that
purchase money market shares through omnibus accounts.
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\220\ See, e.g., Invesco FSOC Comment Letter, supra note 192
(``These [omnibus] accounts, due to their size, might well be
regarded as `institutional' despite the fact that the aggregate of
assets belong largely to investors who would be considered `retail'
if they invested in the MMF directly.'').
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To address this issue, the proposed retail exemption would also
permit a fund to allow a shareholder of record to redeem more than
$1,000,000 in a single day, provided that the shareholder of record is
an ``omnibus account holder'' \221\ that similarly restricts each
beneficial owner in the omnibus account to no more than $1,000,000 in
daily redemptions.\222\ Under the proposed exemption, a fund would not
be required to impose its redemption limits on an omnibus account
holder, provided that the fund has policies and procedures reasonably
designed to allow the conclusion that the omnibus account holder does
not permit any beneficial owner from ``directly or indirectly''
redeeming more than $1,000,000 in a single day.\223\
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\221\ Omnibus account holder would be defined in the proposed
rule as ``a broker, dealer, bank, or other person that holds
securities issued by the fund in nominee name.'' See proposed (FNAV)
rule 2a-7(c)(3) (ii).
\222\ See proposed (FNAV) rule 2a-7(c)(3) (ii).
\223\ See id.
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The restriction on ``direct or indirect'' redemptions is designed
to manage issues related to ``chains of intermediaries,'' such as when
an investor purchases fund shares through one intermediary, for
example, an introducing broker or retirement plan, which then purchases
the fund shares through a second intermediary, such as a clearing
broker.\224\ The proposed exemption would require that a retail fund's
policies and procedures be reasonably designed to allow the conclusion
that the fund's redemption limit is applied to beneficial owners all
the way down any chain of intermediaries. If a fund cannot reasonably
conclude that such policies are enforced by intermediaries at each step
of the chain, then the fund must apply its redemption limit at the
aggregate omnibus account holder level (or rely on a cooperating
intermediary to apply the fund's redemption limits to any uncooperative
intermediaries further down the chain). Accordingly, to redeem more
than $1,000,000 daily, a fund's policies and procedures must be
designed to conclude that an omnibus account holder that is the
shareholder of record with the fund reasonably concludes that all
beneficial owners in the omnibus account, even if invested through
another intermediary, comply with the redemption limit. If the fund
cannot reasonably conclude that intermediaries that have omnibus
accounts with it also do not permit beneficial owners to redeem more
than $1,000,000 in a single day, the fund's policies must be reasonably
designed to allow the conclusion that the omnibus account holder
applies the fund's redemption limit to the other intermediaries'
transactions on an aggregate level.\225\
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\224\ For purposes of imposing redemption limitations on
beneficial owners, we would expect that funds seek to ensure as part
of their policies and procedures that an intermediary would make
reasonable efforts consistent with applicable regulatory
requirements to aggregate multiple accounts held with it that are
owned by a single beneficial owner. We would not expect that a fund
would seek to ensure that an intermediary reasonably be able to
identify that a single beneficial owner owns fund shares through
multiple accounts if the shareholder has an account with the
intermediary, and also owns shares through another intermediary that
does not already share account information with the first
intermediary.
\225\ See proposed (FNAV) rule 2a-7(c)(3)(ii).
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We note that the challenges of managing implementation of fund
policies through omnibus accounts are not unique to a retail exemption.
For example, funds frequently rely on intermediaries to assess,
collect, and remit redemption fees charged pursuant to rule 22c-2 on
beneficial owners that invest through omnibus accounts. Funds and
intermediaries face similar issues when managing compliance with other
fund policies, such as account size limits, breakpoints, rights of
accumulation, and contingent deferred sales charges.\226\ Service
providers also offer services designed to facilitate compliance and
evaluation of intermediary activities.
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\226\ Under rule 38a-1, funds are required to have policies and
procedures reasonably designed to prevent violation of the federal
securities laws by the fund and certain service providers.
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The proposed rule would not require retail money market funds to
enter into explicit agreements or contracts with omnibus account
holders at any stage in the chain, but would instead allow funds to
manage these relations in whatever way that best suits their
circumstances. We would expect that in some cases, funds may enter into
agreements with omnibus account holders to reasonably conclude that
their policies are complied with. In other cases, funds may have
sufficient transparency into the activity of omnibus account holders,
or use other verification methods (such as certifications), that funds
could reasonably conclude that their policies are being followed
without an explicit agreement. If a fund could not verify or reasonably
conclude that an omnibus account holder is applying the redemption
limit to underlying beneficial owner transactions, we would expect that
a fund would treat that omnibus account holder like any other
shareholder of record, and impose the $1,000,000 daily redemption limit
on that omnibus account. Retail money market funds will need to monitor
compliance and implement policies and procedures to address the
implications of potential exceptions, for example, if an intermediary
improperly permitted a redemption in excess of the fund's limits.
Finally, the rule would also prohibit a fund from allowing an omnibus
account holder to redeem more than $1,000,000 for its own account in a
single day.\227\ This restriction is intended to prevent an omnibus
account holder from exceeding the fund's redemption limits under the
exemption when trading for its own account.
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\227\ See proposed (FNAV) rule 2a-7(c)(3)(ii).
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As proposed, the omnibus account holder provision does not provide
for any different treatment of intermediaries based on their
characteristics and instead applies the redemption limits equally to
all beneficial owners. However, in some circumstances such treatment
may not be consistent with the intent of the exemption. For example, an
intermediary with investment discretion, such as a defined-contribution
pension plan that allows the plan sponsor to remove a money market fund
from its offerings, could unilaterally liquidate in one day a quantity
of fund shares that greatly exceeds the fund's redemption limit, even
if no one beneficial owner had an account balance that exceeds the
limit. Intermediaries might also pose different risks, for example, the
risks associated with a sweep account might be different than the risks
posed by a retirement plan. Also, certain intermediaries may not be
able to offer funds with redemption restrictions to investors, even if
the underlying beneficial owners are retail investors. We understand
that identical treatment of intermediaries under the proposal may not
precisely reflect the risks of intermediaries with different
characteristics, but recognize that this is a cost of our attempt to
keep the retail exemption simple to implement.
A shareholder may own fund shares through multiple accounts, either
directly with a fund, or through an intermediary. In some cases, such
as when one account is held directly with
[[Page 36862]]
a fund and another account is held through an intermediary, the fund
would not be able to identify that the same shareholder has multiple
accounts with the fund, and may not be able to effectively restrict
that shareholder from redeeming fund shares from those accounts, that
in aggregate, may exceed the proposed daily redemption limit. The
proposed retail exemption would not restrict such redemptions, because
the shareholder with multiple accounts would not be a ``shareholder of
record'' for all of the accounts.\228\ In other cases, a fund may be
able to identify that a shareholder holds multiple accounts with the
fund, such as if a shareholder owns fund shares in an account held
directly with the fund, and also owns shares through an individual
retirement account (``IRA'') held with the fund. In those cases, the
shareholder with multiple accounts would be the shareholder of record
for both accounts, and the fund should be able to identify the
shareholder as such.\229\ If a fund receives redemption orders
exceeding the $1,000,000 limit from a shareholder of record through
multiple accounts in a single day, the fund would need to aggregate the
redemption requests from all accounts held by that shareholder of
record, and impose the daily redemption limit on the shareholder of
record's total redemptions, not just on an account-by-account
basis.\230\
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\228\ See id.. An intermediary would be the shareholder of
record for the omnibus accounts they hold.
\229\ We note that we do not expect funds to collapse such
accounts, but rather match such accounts where there is reasonably
available identifying information on hand at the fund or its
transfer agent that the accounts have the same record owner.
\230\ Similar issues may arise if a shareholder holds an account
jointly with another person, such as a spouse. A fund's policies and
procedures should establish methods of managing redemptions from
joint accounts.
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We request comment on the proposed treatment of omnibus account
holders under the retail exemption to the floating NAV alternative.
Does our proposed treatment of omnibus accounts under the
retail exemption appropriately address the operation of such accounts?
What types of policies and procedures would funds develop to confirm
that omnibus account holders are able to reasonably prevent beneficial
owners that invest through the account from violating a retail money
market fund's redemption limit policies and procedures?
The proposed rule does not require funds to enter into
agreements with omnibus account holders, nor does it prescribe any
other mechanism for requiring a fund to verify that its redemption
limits are effectively enforced. Should we require such agreements?
What difficulties would arise in implementing such agreements? Instead
of agreements, should we consider prescribing some other type of
verification or compliance procedure to prevent a fund's limit from
being breached, such as certifications from omnibus account holders?
Should the rule require a fund to obtain periodic
certifications regarding the redemptions of beneficial owners in an
omnibus account? If so, should we require a specific periodicity of
certifications, such as every month, or every quarter?
Should we differentiate between intermediaries that invest
through omnibus accounts? For example, should we require that an
intermediary that has investment discretion over a number of beneficial
owners' accounts be treated as a single beneficial owner for purposes
of the daily redemption limit? Should we treat certain intermediaries
differently than others, perhaps allowing higher or unlimited
redemptions for investors who invest through certain types of
intermediaries such as retirement plans? What operational difficulties
would arise if we were to provide for such differential treatment of
intermediaries?
Can funds accurately identify multiple accounts in a fund
that are owned by a single shareholder of record? If not, what costs
would be incurred in building such systems? How should the redemption
limit apply to accounts that are owned by multiple investors? Should we
be concerned about investors opening accounts through multiple
intermediaries and multiple accounts in an attempt to circumvent the
daily redemption limits?
As discussed above, we understand that today many money market
funds are unable to determine the characteristics or redemption
patterns of their shareholders that invest through omnibus accounts.
This lack of transparency can not only hinder a fund from effectively
applying a retail exemption but can also lead to difficulties in
managing the liquidity levels of a fund's portfolio, if a fund cannot
effectively anticipate when it is likely to receive significant
shareholder redemptions through examination of its shareholder base. We
request comment on whether we should consider requiring additional
transparency into money market fund omnibus accounts to enable funds to
understand better their respective shareholder base and relevant
redemption patterns.
Should we consider any other methods of generally
providing more transparency into omnibus accounts for money market
funds so that funds could better manage their portfolios in light of
their respective shareholder base? If so, what methods should we
consider?
c. Consideration of Other Distinguishing Methods
As discussed above, as part of the retail exemption that we are
proposing today, we are proposing a method of distinguishing between
retail and institutional money market funds based on daily redemption
limits. This is not the only method by which we could attempt to
distinguish types of funds. Below we discuss several alternate methods
of making such a distinction, and request comment on whether we should
adopt one of these methods instead.
i. Maximum Account Balance
A different method of distinguishing retail funds would be to
define a retail fund as a fund that does not permit account balances of
more than a certain size. For example, we could define a fund as retail
if the fund does not permit investors to maintain accounts with a
balance that exceeds $250,000, $1,000,000, $5,000,000, or some other
amount.\231\ If an investor's account balance were to exceed the
threshold dollar amount, the fund could automatically direct additional
investments to shares of a government money market fund or a fund
subject to the floating NAV requirement.\232\ Such an approach would
require a retail fund to update the disclosure in its prospectus and
advertising materials to inform investors how their investments would
be handled in such circumstances. Much like the redemption limitation
method, omnibus accounts may pose difficulties that would need to be
addressed through certifications, transparency, or some other
manner.\233\ A maximum account balance approach may also create
operational issues in other ways, such
[[Page 36863]]
as managing what happens if a buy and hold investor's account exceeded
the limits due to appreciation in value. Determining the proper maximum
account balance that would effectively distinguish between retail and
institutional investors may also prove difficult.
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\231\ A variation on this approach might prohibit further
investment in a retail fund at the end of a calendar quarter if the
average account size exceeds a threshold dollar amount during the
quarter.
\232\ If a fund were part of a fund group that does not include
an affiliated institutional fund, the fund would not allow further
investments from an investor whose account balance reaches (or, if
the account receives dividends or otherwise increases in value,
exceeds) the threshold amount.
\233\ We also expect that there may be significant differences
in costs depending on how such an exemption was structured, and that
it could be significantly less costly to test whether an investor
investing through an omnibus account has exceeded a maximum account
balance periodically rather than on a trade-by-trade basis. See also
infra section III.A.4.d for a discussion of operational costs of the
retail exemption.
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Defining a retail fund based on the maximum permitted account
balance would be relatively simple to explain to investors through
disclosure in the fund's prospectus and advertising materials. This
approach could, however, disadvantage funds that do not have an
affiliated government or institutional money market fund into which
investors' ``spillover'' investments in excess of the maximum amount
could be directed and could encourage ``gaming behavior,'' if
institutional investors were to open multiple accounts through
different intermediaries with balances under the maximum amount in
order to evade any maximum investment limit we might set.\234\
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\234\ See BlackRock FSOC Comment Letter, supra note 204;
Federated Investors Feb. 15 FSOC Comment Letter, supra note 192.
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We request comment on the approach of distinguishing between retail
and institutional money market funds based on investors' account
balances:
If we were to classify funds as retail or institutional
based on an investor's account balance, what maximum account size would
appropriately distinguish a retail account from an institutional
account: $250,000, $1,000,000, $5,000,000, or some other dollar amount?
Would this method of distinguishing between retail and institutional
money market funds appropriately reflect the relative risks faced by
these two types of funds? How would funds or other parties, such as
intermediaries and omnibus accountholders, be able to enforce account
balance limitations?
Would shareholders with institutional characteristics be
likely to open multiple retail money market fund accounts under the
maximum amount, for example by going through intermediaries, to
circumvent the account size requirement, and if so, would retail funds
be subject to greater risk during periods of stress? What disclosure
would be necessary to inform current and potential shareholders of the
operations and risks of account balance limitations?
We ask commenters to provide empirical justification for
any comments on an account balance approach to distinguishing retail
and institutional money market funds. We also request information on
composition and distribution of individual account sizes to assist the
Commission in considering this approach.
ii. Shareholder Concentration
Another approach to distinguishing retail and institutional money
market funds might be to base the distinction on the fund's shareholder
concentration characteristics. Under this approach, a fund would be
able to qualify for a retail exemption if the fund's largest
shareholders owned less than a certain percentage of the fund. This
type of ``concentration'' method of distinguishing funds would be a
test for identifying funds whose shareholders are more concentrated,
and thus have a limited number of shareholders whose redemption choices
could affect the fund more significantly during periods of stress. A
heavily concentrated fund may indicate that the fund has a smaller
number of large shareholders, who are likely institutions. In addition,
funds whose shareholders are less concentrated, and thereby that are
less subject to heavy redemption pressure from a limited number of
investors, may be able to withstand stress more effectively and thus
could maintain a stable price.
Commenters have suggested several methods for defining the
appropriate concentration level for a fund. One test for determining if
a fund is institutional might be whether the top 20 shareholders own
more than 15% of the fund's assets,\235\ or the top 100 shareholders
own more than 25% of fund assets, or some other similar measure.
Another method to test concentration might be to define a fund as
institutional if any shareholder owns more than 0.1% of the fund,\236\
or 1% of the fund, or some other percentage.
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\235\ See Fidelity RSFI Comment Letter, supra note 205. This
commenter suggested that the test would apply regardless of whether
underlying shareholders are individuals or institutions.
\236\ See Schwab FSOC Comment Letter, supra note 171.
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Distinguishing between retail and institutional money market funds
based on shareholder concentration could more accurately reflect the
relative risks that funds face than distinguishing retail and
institutional money market funds based on the maximum balance of
shareholders' accounts, since an individual shareholder's account value
does not necessarily reflect the risks of concentrated heavy
redemptions. However it may be less accurate at distinguishing types of
investors (and at reducing the risks of heavy redemptions associated
with certain types of investors) than the redemption limitation
discussed above, because the redemption limitation would likely cause
investors to self-select into the appropriate fund.
One benefit of the concentration method of distinguishing retail
funds is that it may lessen operational issues related to omnibus
accounts. If funds were required to count an intermediary with omnibus
accounts as one shareholder for concentration purposes (e.g., like any
other shareholder), there may be no need for transparency into omnibus
accounts.\237\ However, if we did not require such treatment of omnibus
accounts, this concentration method would raise the same issues
associated with managing omnibus accounts as the other methods
discussed above.
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\237\ See supra note 235.
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This concentration method of distinguishing retail funds would also
pose a number of difficulties in implementation and operation. For
example, it may be over-inclusive and a fund may be wrongly classified
as an institutional money market fund if many of its large shareholders
of record are intermediaries or sweep accounts,\238\ even though the
underlying beneficial owners may be retail investors. The method may
also create difficulties for funds that have limited assets or
investors (for example, new funds with only a few investors), because
those small and start-up funds may have a concentrated investor base
even though their investors may be primarily retail.\239\ Similarly,
this method may not effectively distinguish retail and institutional
money market funds if the fund is so large that even institutional
accounts do not trigger the concentration limits. An institutional fund
that is not heavily concentrated may be subject to the same risks as a
more concentrated fund, because institutional investors tend to be more
sensitive to changing market conditions.
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\238\ See, e.g., Dreyfus FSOC Comment Letter, supra note 174
(noting that sweep accounts behaved more like retail accounts rather
than institutional ones during the 2008 financial crisis).
\239\ See Invesco FSOC Comment Letter, supra note 192
(``Proposals to designate as ``institutional'' any account holding
more than a given percentage of a MMF would provide an unfair
competitive advantage to larger funds, which could continue to
classify larger investors as ``retail.'').
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Finally, this method could create significant operational issues
for funds if shareholder concentration levels were to change
temporarily, or to fluctuate periodically.\240\ For example, if we were
to provide a retail exemption that
[[Page 36864]]
depended on a fund's top 20 investors not owning more than 15% of the
fund, this would require a fund to constantly monitor the size of its
investor base and reject investments that would push the fund over the
concentration limit in real time. Constant monitoring and order
rejection may be costly and difficult to implement, not only for the
fund but also for the affected shareholders who may have their purchase
orders rejected unexpectedly by the fund. Shareholders may also have
issues understanding whether a fund is institutional or retail, and
because concentration may frequently change, it may be difficult to
provide clear guidelines regarding whether a shareholder could or could
not invest in a fund.
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\240\ See Schwab FSOC Comment Letter, supra note 171 (discussing
issues related to temporary changes in ownership percentages that
may cause violations of such a concentration test).
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We request comment on the approach of distinguishing between retail
and institutional money market funds based on shareholder
concentration:
If we classify funds as retail or institutional based on
shareholder concentration, what thresholds should we use? Would
criteria such as whether the top 20 investors make up more than 15% of
the fund, or some other threshold, effectively distinguish between
types of funds? Would such a concentration test pose operational
difficulties? How would funds enforce such limits? How should funds
treat omnibus accounts if they were to use such a test?
Would investors who are likely to redeem shares when
market-based valuations fall below the stable price per share be
willing and able to spread their investment across enough funds to
avoid being too large in any one of them?
Would shareholder concentration limits result in further
consolidation in the industry, as funds seek to grow in order to
accommodate large investors?
We ask commenters to provide empirical justification for
any comments on a shareholder concentration approach to distinguishing
retail and institutional money market funds.
iii. Shareholder Characteristics
Money market funds could also look at certain characteristics of
the investors, such as whether they use a social security number or a
taxpayer identification number to register their accounts or whether
they demand same-day settlement, to distinguish between retail and
institutional money market funds. Such a characteristics test could be
used either alone, or in combination with one of the other methods
discussed above to distinguish retail funds. However, this approach
also has significant drawbacks. While institutional money market funds
primarily offer same-day settlement and retail money market funds
primarily do not, this is not always the case.\241\ Likewise, social
security numbers do not necessarily correlate to an individual, and
taxpayer identification numbers do not necessarily correlate to a
business. For instance, many businesses are operated as pass-through
entities for tax purposes. In addition, funds may not be aware of
whether their investors have a SSN or a TIN if the investments are held
through an omnibus account.
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\241\ Some institutional money market funds do not offer same-
day settlement. See, e.g., Money Market Obligations Trust, Federated
New York Municipal Cash Trust (FNTXX), Registration Statement (Form
N-1A) (Feb. 28, 2013) (stating that redemption proceeds normally are
wired or mailed within one business day after receiving a request in
proper form). Some retail money market funds do offer same-day
settlement. See, e.g., Dreyfus 100% U.S. Treasury Money Market Fund
(DUSXX), Registration Statement (Form N-1A) (May 1, 2012) (stating
that if a redemption request is received in proper form by 3:00
p.m., Eastern time, the proceeds of the redemption, if transfer by
wire is requested, ordinarily will be transmitted on the same day).
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The Commission requests comment on shareholder characteristics that
could effectively distinguish between types of investors, as well as
other methods of distinguishing between retail and institutional money
market funds.
What types of shareholder characteristics would
effectively distinguish between types of investors? Social security
numbers and/or taxpayer identification numbers? Whether the fund
provides same-day settlement? Some other characteristic(s)?
Besides the approaches discussed above, are there other
ways we could effectively distinguish retail from institutional money
market funds? Should we combine any of these approaches? Should we
adopt more than one of these methods of distinguishing retail funds, so
that a fund could use the method that is lowest cost and best fits
their investor base?
We ask commenters to provide empirical justification for
any comments on a shareholder characteristics approach to
distinguishing retail and institutional money market funds.
d. Economic Effects of the Proposed Retail Exemption
In addition to the costs and benefits of a retail exemption
discussed above, implementing any retail exemption to the floating NAV
requirement may have effects on efficiency, competition, and capital
formation. A retail exemption to the floating NAV requirement could
make retail money market funds more attractive to investors than
floating NAV funds without a retail exemption, assuming that retail
investors prefer such funds. If so, we anticipate a retail exemption
could reduce the impact we expect on the number of funds and assets
under management, discussed in section III.E below. However, these
positive effects on capital formation could be reversed to the extent
that the costs funds incur in implementing a retail exemption are
passed on to shareholders, or shareholders give up potentially higher
yields. As discussed above, a retail exemption to the floating NAV
requirement could involve operational costs, with the extent of those
costs likely being higher for funds sold primarily through
intermediaries than for funds sold directly to investors. These
operational costs, depending on their magnitude, might affect capital
formation and also competition (depending on the different ability of
funds to absorb these costs).
A retail exemption to the floating NAV requirement could have
negative effects on competition by benefitting fund groups with large
percentages of retail investors, especially where those retail
investors invest directly in the funds rather than through
intermediaries, relative to other funds.\242\ A retail exemption could
have a negative effect on competition to the extent that it favors fund
groups that already offer separate retail and institutional money
market funds and thus might not need to reorganize an existing money
market fund into two separate funds to implement the exemption. On the
other hand, as discussed above, we believe that the majority of money
market funds currently are owned by both retail and institutional
investors (although many funds are separated into retail and
institutional classes), and therefore relatively few funds would
benefit from this competitive advantage. Fund groups that can offer
multiple retail funds will have a competitive advantage over those that
cannot if investors with large liquidity needs are willing to spread
their investments across multiple retail funds to avoid the redemption
threshold.
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\242\ Fund groups with large percentages of retail investors,
and in particular, direct investors, may be better positioned to
satisfy growing demand if we were to adopt the proposed retail
exemption to our floating NAV proposal. See Invesco FSOC Comment
Letter, supra note 192 (``Imposing a distinction between `retail'
versus `institutional' funds would therefore unduly favor those MMF
complexes with a preponderance of direct individual investors or
affiliated omnibus account platforms over those with a more diverse
investor basis and those with using unaffiliated intermediaries.'').
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[[Page 36865]]
A retail exemption may promote efficiency by tying the floating NAV
requirement to the shareholders that are most likely to redeem from a
fund in response to deviations between its stable share price and
market-based NAV per share. However, to the extent that a retail
exemption fails to distinguish effectively institutional from retail
shareholders, it may have negative effects on efficiency by permitting
``gaming behavior'' by shareholders with institutional characteristics
who nonetheless invest in retail funds. It may also negatively affect
fund efficiency to the extent that, to take advantage of a retail
exemption, a fund that currently separates institutional and retail
investors through different classes instead would need to create
separate and distinct funds, which may be less efficient. The costs of
such a re-organization are discussed in this Release below.
We request comment on the effects of a retail exemption to the
floating NAV proposed on efficiency, competition, and capital
formation.
Would implementing a retail exemption have an effect on
efficiency, competition, or capital formation? Which methods of
distinguishing retail and institutional investors discussed above, if
any, would result in the most positive effects on efficiency,
competition, and capital formation?
Would the floating NAV proposal have less of a negative
impact on capital formation with a retail exemption than without? Would
it provide competitive advantages to fund groups that have large
percentages of retail investors, especially where those retail
investors invest directly in the funds rather than through
intermediaries, relative to other funds that have lower percentages of
retail investors?
Would a retail exemption better promote efficiency by
tying the floating NAV requirement to institutional shareholders
instead of retail shareholders? Why or why not?
The qualitative costs and benefits of any retail exemption to the
floating NAV proposal are discussed above. Because we do not know how
attractive such funds would be to retail investors, we cannot quantify
these qualitative benefits or costs. However, we can quantify the
operational costs that money market funds, intermediaries, and money
market fund service providers might incur in implementing and
administering the retail exemption to the floating NAV requirement that
we are proposing today.\243\
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\243\ The costs estimated in this section would be spread
amongst money market funds, intermediaries, and money market fund
service providers (e.g., transfer agents). For ease of reference, we
refer only to money market funds and intermediaries in our
discussion of these costs. As with other costs we estimate in this
Release, our staff has estimated the costs that a single affected
entity would incur. We anticipate, however, that many money market
funds and intermediaries may not bear the estimated costs on an
individual basis. The costs of systems modifications, for example,
likely would be allocated among the multiple users of the systems,
such as money market fund members of a fund group, money market
funds that use the same transfer agent, and intermediaries that use
systems purchased from the same third party. Accordingly, we expect
that the cost for many individual entities may be less than the
estimated costs.
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Although we do not have the information necessary to provide a
point estimate \244\ of the potential costs associated with a retail
exemption, our staff has estimated the ranges of hours and costs that
may be required to perform activities typically involved in making
systems modifications, implementing fund policies and procedures, and
performing related activities. These estimates include one-time and
ongoing costs to establish separate funds if necessary, modify systems
and related procedures and controls, update disclosure in a fund's
prospectus and advertising materials to reflect any investment or
redemption restrictions associated with the retail exemption, as well
as ongoing operational costs. All estimates are based on the staff's
experience and discussions with industry representatives. We first
discuss the different categories of operational costs that might be
incurred in implementing a retail exemption, and then we provide a
total cost estimate that captures all of the categories of costs
discussed below. We expect that only funds that determine that the
benefits of taking advantage of the proposed retail exemption would be
justified by the costs would take advantage of it and bear these costs.
Otherwise, they would incur the costs of implementing a floating NAV
generally.
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\244\ We are using the term ``point estimate'' to indicate a
specific single estimate as opposed to a range of estimates.
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Many money market funds are currently owned by both retail and
institutional investors, although they are often separated into retail
and institutional share classes. A fund relying on the proposed retail
exemption would need to be structured to accept only retail investors
as determined by the daily redemption limit, and thus any money market
fund that currently has both retail and institutional shareholders
would need to be reorganized into separate retail and institutional
money market funds. One-time costs associated with this reorganization
would include costs incurred by the fund's counsel to draft appropriate
organizational documents and costs incurred by the fund's board of
directors to approve such documents. One-time costs also would include
the costs to update the fund's registration statement and any relevant
contracts or agreements to reflect the reorganization, as well as costs
to update prospectuses and to inform shareholders of the
reorganization. Funds and intermediaries may also incur one-time costs
in training staff to understand the operation of the fund and
effectively implement the redemption restrictions.
The daily redemption limitation method of distinguishing retail and
institutional investors that we are proposing today would also require
funds to have policies and procedures reasonably designed to allow the
conclusion that omnibus account holders apply the fund's redemption
limits to beneficial owners invested through the omnibus accounts.
Adopting such policies and procedures and building systems to implement
them would also involve one-time costs for funds and intermediaries.
Funds could either conclude that their policies are enforced by
obtaining information regarding underlying investors in omnibus
accounts (transparency), or use some other sort of method to reasonably
verify that omnibus account holders are implementing the fund's
redemption policies, such as entering into an agreement or getting
certifications from the omnibus account holder. In preparing the
following cost estimates, the staff assumed that funds would generally
rely on financial intermediaries to implement redemption policies
without undergoing the costs of entering into an agreement, because
funds and intermediaries would typically take the approach that is the
least expensive. However, some funds may undertake the costs of
obtaining an explicit agreement despite the expense. Our staff
estimates that the one-time costs necessary to implement the retail
exemption to the floating NAV proposal, including the various
organizational, operational, training, and other costs discussed above,
would range from $1,000,000 to $1,500,000 for each fund that chooses to
take advantage of the retail exemption.\245\
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\245\ Staff estimates that these costs would be attributable to
the following activities: (i) Planning, coding, testing, and
installing system modifications; (ii) drafting, integrating, and
implementing related procedures and controls; and (iii) preparing
training materials and administering training sessions for staff in
affected areas. Our staff's estimates of these operational and
related costs, and those discussed throughout this Release, are
based on, among other things, staff experience implementing, or
overseeing the implementation of, systems modifications and related
work at mutual fund complexes, and included analyses of wage
information from SIFMA's Management & Professional Earnings in the
Securities Industry 2012, see infra note 996, for the various types
of professionals staff estimates would be involved in performing the
activities associated with our proposals. The actual costs
associated with each of these activities would depend on a number of
factors, including variations in the functionality, sophistication,
and level of automation of existing systems and related procedures
and controls, and the complexity of the operating environment in
which these systems operate. Our staff's estimates generally are
based on the use of internal resources because we believe that a
money market fund (or other affected entity) would engage third-
party service providers only if the external costs were comparable,
or less than, the estimated internal costs. The total operational
costs discussed here include the costs that are ``collections of
information'' that are discussed in section IV of this Release.
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[[Page 36866]]
Funds that choose to take advantage of the retail exemption would
also incur ongoing costs. These ongoing costs would include the costs
of operating two separate funds (retail and institutional) instead of
separate classes of a single fund, such as additional transfer agent,
accounting, and other similar costs. Funds and intermediaries would
also incur ongoing costs related to enforcing the daily redemption
limitation on an ongoing basis and monitoring to conclude that the
limits are being effectively enforced. Other ongoing costs may include
systems maintenance, periodic review and updates of policies and
procedures, and additional staff training. Accordingly, our staff
estimates that money market funds and intermediaries administering a
retail exemption likely would incur ongoing costs of 20%-30% of the
one-time costs, or between $200,000 and $450,000 per year.\246\
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\246\ We recognize that adding new capabilities or capacity to a
system (including modifications to related procedures and controls
and related training) will entail ongoing annual maintenance costs
and understand that those costs generally are estimated as a
percentage of the initial costs of building or modifying a system.
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Are the staff's cost estimates too high or too low, and,
if so, by what amount and why? Are there operational or other costs
associated with segregating retail investors other than those discussed
above?
Do commenters believe that the proposed retail exemption
would involve expenses beyond those estimated? To what extent would the
costs vary depending on how a retail exemption is structured? Which of
the staff's assumptions would most significantly affect the costs? Has
our staff identified the assumptions that most significantly influence
the cost of a retail exemption?
What kinds of ongoing activities would be required to
administer the proposed retail exemption to the floating NAV
requirement, and to what extent? Would it be less costly for some funds
(e.g., those that are directly sold to investors) to make use of a
retail investor exemption? If so, how much would those funds save?
5. Effect on Other Money Market Fund Exemptions
a. Affiliate Purchases
Rule 17a-9 provides an exemption from section 17(a) of the Act to
permit affiliated persons of a money market fund to purchase portfolio
securities from the fund under certain circumstances, and it is
designed to provide a means for an affiliated person to provide
liquidity to the fund and prevent it from breaking the buck.\247\ Under
our floating NAV proposal, however, money market funds' share prices
would ``float,'' and funds thus could not ``break the buck.''
Notwithstanding the inability of funds to ``break the buck'' under our
floating NAV proposal, for the reasons discussed below, we propose to
retain rule 17a-9 with the amendments, discussed below, for all money
market funds (including government and retail money market funds that
would be exempt from our floating NAV proposal).
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\247\ Absent a Commission exemption, section 17(a)(2) of the Act
prohibits any affiliated person or promoter of or principal
underwriter for a fund (or any affiliated person of such a person),
acting as principal, from knowingly purchasing securities from the
fund. For convenience, in this Release, we refer to all of the
persons who would otherwise be prohibited by section 17(a)(2) from
purchasing securities of a money market fund as ``affiliated
persons.'' ``Affiliated person'' is defined in section 2(a)(3) of
the Act.
Rule 17a-9, as adopted in 1996, provides an exemption from
section 17(a) of the Act to permit affiliated persons of a money
market fund to purchase a security from a money market fund that is
no longer an eligible security (as defined in rule 2a-7), provided
that the purchase price is (i) paid in cash; and (ii) equals the
greater of amortized cost of the security or its market price (in
each case including accrued interest). See Revisions to Rules
Regulating Money Market Funds, Investment Company Act Release No.
21837 (Mar. 21, 1996) [61 FR 13956 (Mar.28, 1996)] (the ``1996
Adopting Release''). As part of the 2010 money market fund reforms
(discussed in supra section II.D.1), we expanded the exemptive
relief in rule 17a-9 to permit affiliates to purchase from a money
market fund (i) a portfolio security that has defaulted, but that
continues to be an eligible security (subject to the purchase
conditions described); and (ii) any other portfolio security
(subject to the purchase conditions described above), for any
reason, provided the affiliated person remits to the fund any profit
it realizes from the later sale of the security (``clawback
provision''). See rule 17a-9(a), (b).
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Funds with a floating NAV would still be required to adhere to rule
2a-7's risk-limiting conditions to reduce the likelihood that portfolio
securities experience losses from credit events and interest rate
changes. Even with a floating NAV and limited risk, as specified by the
provisions of rule 2a-7, money market funds face potential liquidity,
credit and reputational issues in times of fund and market stress and
the resultant incentives for shareholders to redeem shares.
In normal market conditions, that shareholders may request
immediate redemptions from a fund with a portfolio that does not hold
securities that mature in the same time frame generally is no cause for
concern because funds typically can sell portfolio securities to
satisfy shareholder redemptions without negatively affecting prices. In
times of crisis when the secondary markets for portfolio assets become
illiquid, funds might be unable to sell sufficient assets without
causing large price movements that affect not only the non-redeeming
shareholders but also investors in other funds that hold similar
assets. Therefore, to provide fund sponsors with flexibility to protect
shareholder interests, we are proposing to allow fund sponsors to
continue to support money market fund operations through, for example,
affiliate purchases (in reliance on rule 17a-9), provided such support
is thoroughly and consistently disclosed.\248\
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\248\ Commenters have noted the importance of sponsor support
under rule 17a-9 as a tool that funds can use as a support
mechanism. See, e.g., Comment Letter of U.S. Chamber of Commerce
(Jan. 23, 2013) (available in File No. FSOC-2012-0003) (``U.S.
Chamber Jan. 23, 2013 FSOC Comment Letter''), Federated Investors
Alternative 1 FSOC Comment Letter, supra note 161. We are proposing
amendments to require that money market funds disclose the
circumstances under which a fund sponsor may offer any form of
support to the fund (e.g., capital contributions, capital support
agreements, letters of indemnity), any limits on such support, past
instances of support provided to the fund, and public notification
to the Commission regarding current instances of support provided.
See infra section III.F for a more detailed discussion.
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As exists today, money market fund sponsors that have a greater
capacity to support their funds may have a competitive advantage over
other fund sponsors that do not. The value of this competitive
advantage depends on the extent to which fund sponsors choose to
support their funds and may be reduced by the proposed enhanced
disclosure requirements discussed in this Release which may
disincentivize fund sponsors from supporting their funds. The value of
potential sponsor support also will depend on whether investors view
support as good news (because, for example, the sponsor stands behind
the fund) or bad news (because, for
[[Page 36867]]
example, the sponsor does not adequately monitor the portfolio
manager). The decision to leave rule 17a-9 in place should not, in our
opinion, impose any additional costs on money market funds, their
shareholders, or others, or change the effects on efficiency or capital
formation. We recognize, however, that permitting sponsor support
(through rule 17a-9 transactions) may allow money market fund sponsors
to prevent their fund from deviating from its stable share price,
potentially undercutting our goal to increase the transparency of money
market fund risks.
We request comment on retaining the rule 17a-9 exemption.
Do commenters believe affiliated person support is
important to funds, investors, or the securities markets even under our
floating NAV proposal? Do commenters agree with our assumptions that
liquidity concerns are likely to remain significant even with a
floating NAV and that fund sponsors should continue to have this
flexibility to protect shareholder interests? We note that rule 17a-9
was established and then expanded in 2010, in the context of stable
values. If money market funds are required to float their NAVs, should
we limit further the circumstances under which fund sponsors or
advisers can use rule 17a-9? If so, how?
Does permitting affiliated purchases for floating NAV
money market funds reduce the transparency of fund risks that our
floating NAV proposal is designed, in part, to achieve? If so, does the
additional disclosure we are proposing mitigate such an effect? Are
there additional ways we can mitigate such an effect?
Should we allow only certain types of support or should we
prohibit certain types of support? For example, should we allow
sponsors to purchase under rule 17a-9 only liquidity-impaired assets,
or should we prohibit sponsors from purchasing defaulted securities?
Why or why not? If yes, what types of support should be permitted and
what types should be prohibited? Why?
Would the ability of fund sponsors to support the NAV of
floating funds affect the way in which money market funds are
structured and marketed? If so, how? Would it affect the competitive
position of fund sponsors that are more or less likely to have
available capital to support their funds?
Do commenters agree that our proposed amendment would not
impose additional costs on funds or shareholders or impact efficiency
or capital formation?
Instead of retaining 17a-9, should we instead repeal the
rule and thereby prohibit certain types of sponsor support of money
market funds? If so, why?
b. Suspension of Redemptions
Rule 22e-3 exempts money market funds from section 22(e) of the Act
to permit them to suspend redemptions and postpone payment of
redemption proceeds to facilitate an orderly liquidation of the
fund.\249\ Rule 22e-3 replaced temporary rule 22e-3T.\250\ Rule 22e-3
is designed to allow funds to suspend redemptions before actually
breaking the buck, reduce the vulnerability of investors to the harmful
effects of heavy redemptions on funds, and minimize the potential for
disruption to the securities markets.\251\ Rule 22e-3 currently
requires that a fund's board of directors, including a majority of
disinterested directors, determine that the deviation between the
fund's amortized cost price per share and the market-based net asset
value per share may result in material dilution or other unfair results
before it suspends redemptions.\252\ We recognize that, under our
floating NAV proposal, money market funds (including those exempt from
the floating NAV requirement) generally would no longer be able to use
amortized cost valuation for their portfolio holdings.\253\ Instead,
government and retail money market funds would use the penny rounding
method of pricing to maintain a stable share price and other money
market funds would have a floating NAV per share. Accordingly, for all
money market funds, the current threshold under rule 22e-3 for
suspending redemptions would need modification to conform to the new
regulatory regime.
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\249\ Rule 22e-3(a)(1).
\250\ Rule 22e-3 was first adopted as an interim final temporary
final shortly after the Temporary Guarantee Program was established.
See Temporary Exemption for Liquidation of Certain Money Market
Funds, Investment Company Act Release No. 28487 (Nov. 20, 2008) [73
FR 71919 (Nov. 26, 2008)] (establishing rule 22e-3T to facilitate
compliance for those money market funds that elected to participate
in the Temporary Guarantee Program and were therefore required to
promptly suspend redemptions if the fund broke the buck). The
temporary rule expired on expired October 18, 2009. Id. See also
infra section II.C (discussing the Temporary Guarantee Program).
\251\ See 2010 Adopting Release, supra note 92, at section II.H
(noting that the rule is designed only to facilitate the permanent
termination of the fund in an orderly manner). See also rule 22e-
3(a)(2) (requiring the fund's board to irrevocably approve the
fund's liquidation).
\252\ Rule 22e-3(a)(1).
\253\ As discussed above, money market funds would continue to
be permitted to use amortized cost to value portfolio securities
with a remaining maturity of 60 days or less.
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As discussed above, we recognize that our floating NAV proposal, in
conjunction with our other proposals, may not be sufficient to
eliminate the incentive for shareholders to redeem shares in times of
fund and market stress. As such, floating NAV money market funds may
still face liquidity issues that could force them to want to suspend
redemptions and liquidate. Commenters have noted the benefits of rule
22e-3, including that the rule prevents a lengthy and disorderly
liquidation process, like that experienced by the Reserve Primary
Fund.\254\ Therefore, despite a floating NAV fund's inability to break
a buck, we believe the benefits of rule 22e-3 should be preserved.
Accordingly, under our proposed amendment, all floating NAV money
market funds would be permitted to suspend redemptions, when, among
other requirements, the fund, at the end of a business day, has less
than 15% of its total assets in weekly liquid assets.\255\ As discussed
below in our discussion of the liquidity fees and gates alternative
proposal, we believe that when a fund's weekly liquid assets are at
least 50% below the minimum required weekly liquidity (i.e., weekly
liquid assets have fallen from 30% to 15%), the fund is under
sufficient stress to warrant that the fund's board be permitted to
suspend redemptions in light of a decision to liquidate the fund (and
therefore facilitate an orderly liquidation).
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\254\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25;
Comment Letter of Federated Investors, Inc. (Re: Alternative 2)
(Jan. 25. 2013) (available in File No. FSOC-2012-0003) (``Federated
Alternative 2 FSOC Comment Letter'').
\255\ See proposed (FNAV) rule 22e-3(a) (requiring that the
fund's board, including a majority of directors who are not
interested persons of the fund, irrevocably has approved the
liquidation of the fund).
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Government money market funds and retail money market funds, which
would be exempt from the floating NAV requirement, would be able to
suspend redemptions and liquidate if either (1) the fund, at the end of
a business day, has less than 15% of its total assets in weekly liquid
assets or (2) the fund's price per share as computed for purposes of
distribution, redemption, and repurchase is no longer equal to its
stable share price or the fund's board (including a majority of
disinterested directors) determines that such a change is likely to
occur.\256\ This would allow those funds to suspend redemptions and
liquidate if the fund came under liquidity stress or if the fund was
about to ``break the buck.''
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\256\ See id.
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Because money market funds already comply with rule 22e-3, we do
not believe that retaining the rule in the
[[Page 36868]]
context of our floating NAV proposal would impose any additional costs
on money market funds, their shareholders, or others, nor have any
effects on competition, efficiency, or capital formation.\257\
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\257\ The Commission considered rule 22e-3's costs, benefits,
and effects on competition, efficiency, and capital formation, which
this amendment would preserve, when it adopted the rule. See 2010
Adopting Release, supra note 92, at sections II.H, V, and VI.
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We request comment on this proposed amendment.
Do commenters believe that the ability to suspend
redemptions (under the circumstances we propose) would be important to
floating NAV funds, their investors, and the securities markets?
Would this ability be important to a retail or government
money market fund even though we are proposing to exempt these funds
from the floating NAV requirement, in part, because they are less
likely to face heavy redemptions in times of stress?
Is it appropriate to allow a money market fund to suspend
redemptions and liquidate if its level of weekly liquid assets falls
below 15% of its total assets? Is there a different threshold based on
daily or weekly assets that would better protect money market fund
shareholders? What is that threshold, and why is it better? Is there a
threshold based on different factors that would better protect money
market fund shareholders? What are those factors, and why are they
better? If so, is such suspension then appropriate only in connection
with liquidation, or should it be broader?
Is our conclusion correct that it will impose no costs nor
have any effects on competition, efficiency, or capital formation?
6. Tax and Accounting Implications of Floating NAV Money Market Funds
a. Tax Implications
Money market funds' ability to maintain a stable value per share
simplifies tax compliance for their shareholders. Today, purchases and
sales of money market fund shares at a stable $1.00 share price
generate no gains or losses, and money market fund shareholders
therefore generally need not track the timing and price of purchase and
sale transactions for capital gains or losses.
i. Realized Gains and Losses
If we were to require some money market funds to use floating NAVs,
taxable investors in those money market funds, like taxable investors
in other types of mutual funds, would experience gains and losses.
Shareholders in floating NAV money market funds, therefore, could owe
tax on any gains on sales of their money market fund shares, could have
tax benefits from any losses, and would have to determine those
amounts.\258\ Because it is not possible to predict the timing of
shareholders' future transactions and the amount of NAV fluctuations,
we are not able to estimate the amount of any increase or decrease in
shareholders' tax burdens. But, given the relatively small fluctuations
in value that we anticipate would occur in floating NAV money market
funds and our proposed exemption of certain funds from the floating NAV
requirement, any changes in tax burdens likely would be minimal.
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\258\ In its proposed recommendation, the FSOC recognized the
potential increased tax-compliance burdens associated with a
floating NAV for both money market funds and shareholders. FSOC
Proposed Recommendations, supra note 114, at 33-34.
---------------------------------------------------------------------------
Commenters also have asserted that taxable investors in floating
NAV money market funds, like taxable investors in other types of mutual
funds, would be required to track the timing and price of purchase and
sale transactions to determine the amounts of gains and losses
realized.\259\ For mutual funds other than stable-value money market
funds, tax rules now generally require the funds or intermediaries to
report to the IRS and the shareholders certain information about sales
of shares, including sale dates and gross proceeds.\260\ If the shares
sold were acquired after January 1, 2012, the fund or intermediary must
also report cost basis and whether any gain or loss is long or short
term.\261\ These new basis reporting requirements and the pre-2012
reporting requirements are collectively referred to as ``information
reporting.'' Mutual funds and intermediaries, however, are not
currently required to make reports to certain shareholders (including
most institutional investors). The regulations call these shareholders
``exempt recipients.'' \262\
---------------------------------------------------------------------------
\259\ See, e.g., Comment Letter of Investment Company Institute
(Feb. 16, 2012) (available in File No. 4-619) (``ICI Feb. 2012 PWG
Comment Letter'') (enclosing a submission by the Investment Company
Institute Working Group on Money Market Fund Reform Standing
Committee on Investment Management International Organization of
Securities Commissions) (``To be sure, investors already face these
burdens [tracking purchases and sales for tax purposes] in
connection with investments in long-term mutual funds. But most
investors make fewer purchases and sales from long-term mutual funds
because they are used for long-term saving, not cash management.'').
\260\ Regulations exclude sales of stable-value money market
funds from this reporting obligation. See 26 CFR 1.6045-1(c)(3)(vi).
\261\ The new reporting requirements (often referred to as
``basis reporting'') were instituted by section 403 of the Energy
Improvement and Extension Act of 2008 (Division B of Pub. L. 110-
343) (codified at 26 U.S.C. 6045(g), 6045A, and 6045B); see also 26
CFR 1.6045-1; Internal Revenue Service Form 1099-B.
\262\ See 26 CFR 1.6045-1(c)(3).
---------------------------------------------------------------------------
We understand, based on discussions by our staff with staff at the
Treasury Department and the IRS, that, by operation of the current tax
regulations, if our floating NAV proposal is adopted, money market
funds that float their NAV per share would no longer be excluded from
the information reporting requirements currently applicable to mutual
funds and intermediaries.\263\ Because retail money market funds would
not be required to use floating NAVs, the vast majority of floating NAV
money market fund shareholders are expected to be exempt recipients
(with respect to which information reporting is not required). Such
exempt recipients would thus be required to track gains and losses,
similar to the current treatment of exempt recipient holders of other
mutual fund shares. If there are any money market fund shareholders for
which information reporting is made, those shareholders would be able
to make use of such reports in determining and reporting their tax
liability. We also understand that the Treasury Department and the IRS
are considering alternatives for modifying forms and guidance (1) to
include net information reporting by the funds of realized gains and
losses for sales of all mutual fund shares; and (2) to allow summary
income tax reporting by shareholders.\264\
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\263\ See supra note 260.
\264\ For 2012, the IRS allowed certain taxpayers to include
summary totals in their Federal income tax returns, adding
``Available upon request'' where transaction details might otherwise
have been required. See 2012 Instructions for Form 8949--Sales and
Other Dispositions of Capital Assets, p. 3, col. 1, ``Exception 2,''
available at http://www.irs.gov/pub/irs-pdf/i8949.pdf.
---------------------------------------------------------------------------
We anticipate that these modifications, if effected, could reduce
burdens and costs to shareholders when reporting annual realized gains
or losses from transactions in a floating NAV money market fund. We
recognize that if these modifications are not made, the tax reporting
effects of a floating NAV could be quite burdensome for money market
fund investors that typically engage in frequent transactions.
Regardless of the applicability of net information reporting or of
summary income tax reporting, however, all shareholders of floating NAV
money market funds would be required to recognize and report taxable
gains and losses with respect to redemptions of fund shares, which does
not occur today
[[Page 36869]]
with respect to shares of stable-value money market funds.\265\
---------------------------------------------------------------------------
\265\ Money market funds also would incur costs in gathering and
transmitting this information to money market fund shareholders that
they would not incur absent our proposal, but these costs are
discussed in the operational costs discussed below.
---------------------------------------------------------------------------
We request comment on the burdens of tax compliance for money
market fund shareholders (the impact on funds is discussed in the
operational costs section below).
If any shareholders of a floating NAV money market fund
are not exempt recipients (and thus receive the information reporting
that other non-exempt-recipient shareholders of other mutual funds
currently receive), how difficult would it be for those shareholders to
use that information to determine and report taxable gains and losses?
Would it be any more difficult for floating NAV money market fund
shareholders than other mutual fund shareholders? What kinds of costs,
by type and amount, would be involved?
In the case of floating NAV fund shareholders that are
exempt recipients (which are not required recipients of information
reporting), what types and amounts of costs would those shareholders
incur to track their share purchases and sales and report any taxable
gains or losses?
As discussed above, mutual funds and intermediaries are
not required to provide information reporting for exempt recipients,
including virtually all institutional investors. Do mutual funds and
intermediaries provide this information to shareholders even if tax law
does not require them to do so? If not, would money market funds and
intermediaries be able to use their existing systems and processes to
access this information if investors request it as a result of our
floating NAV proposal? Would doing so involve systems modifications or
other costs in addition to those we estimate in section III.A.7, below?
Would institutions or other exempt recipients find it useful or more
efficient to receive this information from funds rather than to develop
it themselves?
Would exempt-recipient investors continue to invest in
floating NAV funds if there continues to be no information reporting
with respect to them?
Would exempt-recipient investors invest in floating NAV
money market funds if there is no administrative relief related to
summary reporting of capital gains and losses, as discussed above? What
would be the effect on the utility of floating NAV money market funds
if the anticipated administrative relief is not provided? Would
investors be able to use floating NAV money market funds in the same
way or for the same purposes absent the anticipated administrative
relief?
ii. Wash Sales
In addition to the tax obligations that may arise through daily
fluctuations in purchase and redemption prices of floating NAV money
market funds (discussed above), special ``wash sale'' rules apply when
shareholders sell securities at a loss and, within 30 days before or
after the sale, buy substantially identical securities.\266\ Generally,
if a shareholder incurs a loss from a wash sale, the loss cannot be
deducted, and instead must be added to the basis of the new,
substantially identical securities, which effectively postpones the
loss deduction until the shareholder recognizes gain or loss on the new
securities.\267\ Because many money market fund investors automatically
reinvest their dividends (which are often paid monthly), virtually all
redemptions by these investors would be within 30 days of a dividend
reinvestment (i.e., purchase). Under the wash sale rules, the losses
realized in those redemptions would be disallowed in whole or in part
until an investor disposed of the replacement shares (or longer, if
that disposition is also a wash sale). We understand that the Treasury
Department and IRS are actively considering administrative relief under
which redemptions of floating NAV money market fund shares that
generate losses below a de minimis threshold would not be subject to
the wash sale rules. We recognize, however, that money market funds
would still incur operational costs to establish systems with the
capability of identifying wash sale transactions, assessing whether
they meet the de minimis criterion, and adjusting shareholder basis as
needed when they do not.\268\
---------------------------------------------------------------------------
\266\ See 26 U.S.C. 1091.
\267\ Id.
\268\ These operational costs are discussed in infra section
III.A.7.
---------------------------------------------------------------------------
We request comment on the tax implications related to our floating
NAV proposal.
Would investors continue to invest in floating NAV money
market funds absent administrative relief from the Treasury Department
and IRS relating to wash sales? What would be the effect on the utility
of floating NAV money market funds if the anticipated administrative
relief is not provided? Would investors be able to use floating NAV
money market funds in the same way or for the same purposes absent the
anticipated administrative relief?
b. Accounting Implications
If we were to adopt our floating NAV proposal, some money market
fund shareholders may question whether they would be able to treat
their fund shares as ``cash equivalents'' on their balance sheets. We
understand that classifying money market fund investments as cash
equivalents is important because, among other things, investors may
have debt covenants that mandate certain levels of cash and cash
equivalents.\269\
---------------------------------------------------------------------------
\269\ In addition, some corporate investors may perceive cash
and cash equivalents on a company's balance sheet as a measure of
financial strength.
---------------------------------------------------------------------------
Current U.S. GAAP defines cash equivalents as ``short-term, highly
liquid investments that are readily convertible to known amounts of
cash and that are so near their maturity that they present
insignificant risk of changes in value because of changes in interest
rates.'' \270\ In addition, U.S. GAAP includes an investment in a money
market fund as an example of a cash equivalent.\271\ Notwithstanding,
some shareholders may be concerned given this guidance came before
money market funds using floating NAVs.\272\
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\270\ See Financial Accounting Standards Board Accounting
Standards Codification (``FASB ASC'') paragraph 305-10-20.
\271\ Id.
\272\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25.
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Except as noted below, the Commission believes that an investment
in a money market fund with a floating NAV would meet the definition of
a ``cash equivalent.'' We believe the adoption of floating NAV alone
would not preclude shareholders from classifying their investments in
money market funds as cash equivalents because fluctuations in the
amount of cash received upon redemption would likely be insignificant
and would be consistent with the concept of a `known' amount of cash.
The RSFI Study supports our belief by noting that floating NAV money
market funds are not likely to experience significant fluctuations in
value.\273\ The floating NAV requirement is also not expected to change
the risk profile of money market fund portfolio investments. Rule 2a-
7's risk-limiting conditions should result in fluctuations in value
from changes in interest rates and credit risk being insignificant.
---------------------------------------------------------------------------
\273\ See RSFI Study, supra note 21.
---------------------------------------------------------------------------
As is the case today with stable share price money market funds,
events may occur that give rise to credit and liquidity issues for
money market funds and shareholders would need to reassess if their
investments continue to meet the definition of a cash equivalent. For
example, during the financial crisis,
[[Page 36870]]
certain money market funds experienced unexpected declines in the fair
value of their investments due to deterioration in the creditworthiness
of their assets and as a result, portfolios of money market funds
became less liquid. Investors in these money market funds would have
needed to determine whether their investments continued to meet the
definition of a cash equivalent. If events occur that cause
shareholders in floating NAV money market funds to determine their
shares are not cash equivalents, the shares would need to be classified
as investments, and shareholders would have to treat them either as
trading securities or available-for-sale securities.\274\
---------------------------------------------------------------------------
\274\ See FASB ASC paragraph 320-10-25-1.
---------------------------------------------------------------------------
Do commenters believe using a floating NAV would preclude money
market funds from being classified as cash equivalents under GAAP?
Would shareholders be less likely to invest in floating
NAV money market funds if the shares held were classified for financial
statement purposes as an ``investment'' rather than ``cash and cash
equivalent?''
Are there any other accounting-related costs or burdens
that money market fund shareholders would incur if we require money
market funds to use floating NAVs?
c. Implications for Local Government Investment Pools
We also recognize that many states have established local
government investment pools (``LGIPs''), money market fund-like
investment pools that invest in short-term securities,\275\ that are
required by law or investment policies to maintain a stable NAV per
share.\276\ The Government Accounting Standards Board (``GASB'') states
that LGIPs that are operated in a manner consistent with rule 2a-7
(i.e., a ``2a7-like pool'') may use amortized cost to value securities
(and presumably, facilitate maintaining a stable NAV per share).\277\
Our floating NAV proposal, if adopted, may have implications for LGIPs.
In order to continue to manage LGIPs, state statutes and policies may
need to be amended to permit the operation of investment pools that
adhere to rule 2a-7 as we propose to amend it.\278\ Because we are
unable to predict how various state legislatures and other market
participants will react to our floating NAV proposal, we do not have
the information necessary to provide a reasonable estimate of the
impact on LGIPs or the potential effects on efficiency, competition,
and capital formation. We note, however, that it is possible that
states could amend their statutes or policies to permit the operation
of LGIPs that comply with rule 2a-7 as we propose to amend it. We
request comment on this aspect of our proposal.
---------------------------------------------------------------------------
\275\ LGIPs tend to emulate typical money market funds by
maintaining a stable NAV per share through investments in short-term
securities. See infra III.E.1, Table 2, note N.
\276\ See, e.g., U.S. Chamber of Commerce Letter to the Hon.
Elisse Walter (Feb. 13, 2013), available at http://www.centerforcapitalmarkets.com/wp-content/uploads/2010/04/2013-2.13-Floating-NAV-Qs-Letter.pdf. See also, e.g., Virginia's Local
Government Investment Pool Act, which sets certain prudential
investment standards but leaves it to the state treasury board to
formulate specific investment policies for Virginia's LGIP. See Va.
Code Ann. Sec. 2.2-4605(A)(3). Accordingly, the treasury board
instituted a policy of managing Virginia's LGIP in accordance with
``certain risk limiting provisions to maintain a stable net asset
value at $1.00 per share'' and ``GASB `2a-7 like' requirements.''
Virginia LGIP's Investment Circular, June 30, 2012, available at
http://www.trs.virginia.gov/cash/lgip.aspx. Not all LGIPs are
currently managed to maintain a stable NAV, however, see infra
section III.E.1, Table 2, note N.
\277\ See GASB, Statement No. 31, Accounting and Financial
Reporting for Certain Investments and for External Investment Pools
(Mar. 1997).
\278\ See, e.g., Comment Letter of American Public Power Assoc.,
et al., File No. FSOC-2012-0003 (Feb. 13, 2013) (``If the SEC rules
are changed to adopt a daily floating NAV, states would have to
alter their own statutes in order to comply, as many state statues
cite rule 2a-7 as the model for their management of the LGIPs'').
---------------------------------------------------------------------------
Would our floating NAV proposal affect LGIPs as described
above? Are there other ways in which LGIPs would be affected? If so,
please describe.
Are there other costs that we have not considered?
How do commenters think states and other market
participants would react to our floating NAV proposal? Do commenters
believe that states would amend their statutes or policies to permit
LGIPs to have a floating NAV per share provided the fund complies with
rule 2a-7, as we propose to amend it? If so, what types and amounts of
costs would states incur? If not, would there be any effect on
efficiency, competition, or capital formation?
7. Operational Implications of Floating NAV Money Market Funds
Money market funds (or their transfer agents) are required under
rule 2a-7 to have the capacity to redeem and sell fund shares at prices
based on the funds' current net asset value per share pursuant to rule
22c-1 rather than $1.00, i.e., to transact at the fund's floating
NAV.\279\ Intermediaries, although not subject to rule 2a-7, typically
have separate obligations to investors with regard to the distribution
of proceeds received in connection with investments made or assets held
on behalf of investors.\280\ Prior to adopting these amendments to rule
2a-7, the ICI submitted a comment letter detailing the modifications
that would be required to permit funds to transact at the fund's
floating NAV.\281\ Accordingly, we expect that money market funds and
transfer agents already have laid the foundation required to use
floating NAVs.
---------------------------------------------------------------------------
\279\ See rule 2a-7(c)(13). See also 2010 Adopting Release,
supra note 92, at nn.362-363.
\280\ See, e.g., 2010 Adopting Release, supra note 92, at
nn.362-363. Examples of intermediaries that offer money market funds
to their customers include broker-dealers, portals, bank trust
departments, insurance companies, and retirement plan
administrators. See Investment Company Institute, Operational
Impacts of Proposed Redemption Restrictions on Money Market Funds,
at 13 (2012), available at http://www.ici.org/pdf/ppr_12_operational_mmf.pdf (``ICI Operational Impacts Study'').
\281\ See, e.g., Comment Letter of the Investment Company
Institute (Sept. 8, 2009) (available in File No. S7-11-09) (``ICI
2009 Comment Letter'') (describing the modifications that would be
necessary if the Commission adopted the requirement, currently
reflected in rule 2a-7(c)(13), that money market funds (or their
transfer agents) have the capacity to transact at a floating NAV,
to: (i) Fund transfer agent recordkeeping systems (e.g., special
same-day settlement processes and systems, customized transmissions,
and reporting mechanisms associated with same-day settlement systems
and proprietary systems used for next-day settlement); (ii) a number
of essential ancillary systems and related processes (e.g., systems
changes for reconciliation and control functions, transactions
accepted via the Internet and by phone, modifying related
shareholder disclosures and phone scripts, education and training
for transfer agent employees and changes to the systems used by fund
accountants that transmit net asset value data to fund transfer
agents); and (iii) sub-transfer agent/recordkeeping arrangements
(explaining that similar modifications likely would be needed at
various intermediaries).
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We recognize, however, that funds, transfer agents, intermediaries,
and others in the distribution chain may not currently have the
capacity to process transactions at floating NAVs constantly, as would
be required under our proposal.\282\ Accordingly, we expect that sub-
transfer agents, fund accounting departments, custodians,
intermediaries, and others in the distribution chain would need to
develop and overlay additional controls and procedures on top of
existing systems in order to implement a floating NAV on a continual
basis. In each case, the controls and procedures for the accounting
systems at these entities would have to be modified to permit those
systems to calculate a money
[[Page 36871]]
market fund's floating NAV each business day and to communicate that
value to others in the distribution chain on a permanent basis. In
addition, we understand that, under our floating NAV proposal, money
market funds and other recordkeepers would incur additional costs to
track portfolio security gains and losses, provide ``basis reporting,''
and monitor for potential wash-sale transactions, as discussed above in
section III.A.6. We believe, however, that funds, in many cases, should
be able to leverage existing systems that track this information for
other mutual funds.
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\282\ Even though a fund complex's transfer agent system is the
primary recordkeeping system, there are a number of additional
subsystems and ancillary systems that overlay, integrate with, or
feed to or from a fund's primary transfer agent system, incorporate
custom development, and may be proprietary or vendor dependent
(e.g., print vendors to produce trade confirmations). See ICI
Operational Impacts Study at 20, supra note 280. The systems of sub-
transfer agents and other parties may also require modifications
related to our floating NAV proposal.
---------------------------------------------------------------------------
We understand that the costs to modify a particular entity's
existing controls and procedures would vary depending on the capacity,
function and level of automation of the accounting systems to which the
controls and procedures relate and the complexity of those systems'
operating environments.\283\ Procedures and controls that support
systems that operate in highly automated operating environments would
likely be less costly to modify while those that support complex
operations with multiple fund types or limited automation or both would
be more costly to change.\284\ Because each system's capabilities and
functions are different, an entity would likely have to perform an in-
depth analysis of our proposed rules to calculate the costs of
modifications required for its own system. While we do not have the
information necessary to provide a point estimate of the potential
costs of modifying procedures and controls, we expect that each entity
would bear one-time costs to modify existing procedures and controls in
the functional areas that are likely to be impacted by our proposal.
Our staff has estimated that the one-time costs of implementation for
an affected entity would range from $1.2 million (for entities
requiring less extensive modifications) to $2.3 million (for entities
requiring more extensive modifications).\285\ Staff also estimates that
the annual costs to keep procedures and controls current and to provide
continuing training would range from 5% to 15% of the one-time
costs.\286\
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\283\ See, e.g., ICI Operational Impacts Study at 37, supra note
280 (noting that the modifications necessary to transact at a
floating NAV would ``require in some cases minor and other instances
major modifications--depending on the complexity of the systems and
the types of intermediaries and investors'' involved).
\284\ See, e.g., id. at 41 (reporting that half of the
respondents in its survey reported that their transfer agent systems
``already had the capability to process money market trades'' at a
floating value, while the other respondents would need to modify
their transfer agent systems to comply with the requirement to have
the capacity to transact at a floating NAV).
\285\ Staff estimates that these costs would be attributable to
the following activities: (i) Drafting, integrating, and
implementing procedures and controls; (ii) preparation of training
materials; and (iii) training. See also supra note 245 (discussing
the bases of our staff's estimates of operational and related
costs).
\286\ As noted throughout this Release, we recognize that adding
new capabilities or capacity to a system (including modifications to
related procedures and controls) will entail ongoing annual
maintenance costs and understand that those costs generally are
estimated as a percentage of initial costs of building or expanding
a system.
---------------------------------------------------------------------------
We anticipate, however, that many money market funds, transfer
agents, custodians, and intermediaries in the distribution chain may
not bear the estimated costs on an individual basis and therefore
experience economies of scale. For example, the costs would likely be
allocated among the multiple users of affected systems, such as money
market funds that are members of a fund group, money market funds that
use the same transfer agent or custodian, and intermediaries that use
systems purchased from the same third party. Accordingly, we expect
that the cost for many individual entities that would have to process
transactions at floating NAVs may be less than the estimated costs.
We request comment on this analysis and our range of estimated
costs to money market funds, transfer agents, custodians, and
intermediaries.
To what extent would transfer agents, fund accounting
departments, custodians, and intermediaries need to develop and
implement additional controls and procedures or modify existing ones
under our floating NAV proposal?
To what extent do intermediaries, as a result of their
separate obligations to investors regarding distribution of proceeds,
have the capacity to process (on a continual basis) transactions at a
fund's floating NAV?
Do money market funds and others expect they would incur
costs in addition to those we estimate above or that they would incur
different costs? If so, what are these costs?
Would the costs incurred by money market funds and others
in the distribution chain discussed above be passed on to retail (and
other) investors in the form of higher fees?
If a number of money market funds already report daily
shadow prices using ``basis point'' rounding, are there additional
operational costs that funds would incur to price their shares to four
decimal places? If so, please describe. Are there means by which these
operational costs can be reduced while still providing sufficient price
transparency?
Do all funds have the ready capability to price their
shares to four decimal places? For those funds that do so already, we
seek comment on the costs involved in developing this capability. For
funds that do not have the capability, what types and amounts of costs
would be incurred?
What type of ongoing maintenance and training would be
necessary, and to what extent? Do commenters agree that such costs
would likely range between 5% and 15% of one-time costs? If not, is
there a more accurate way to estimate these costs?
To what extent would money market funds or others
experience economies of scale?
We request that intermediaries and others provide data to
support the costs they expect they would incur and an explanation of
the work they have already undertaken as a result of rule 2a-7's
current requirement that money market funds (or their transfer agents)
have the capacity to transact at a floating NAV.
In addition, funds would incur costs to communicate with
shareholders the change to a floating NAV per share. Although funds
(and their intermediaries that provide information to beneficial
owners) already have the means to provide shareholders the values of
their money market fund holdings, our staff anticipates that they would
incur additional costs associated with programs and systems
modifications necessary to provide shareholders with access to that
information online, through automated phone systems, and on shareholder
statements under our floating NAV proposal and to explain to
shareholders that the value of their money market funds shares will
fluctuate.\287\
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\287\ Staff expects these costs would include software
programming modifications, as well as personnel costs that would
include training and scripts for telephone representatives to enable
them to respond to investor inquiries.
---------------------------------------------------------------------------
Our staff anticipates that these communication costs would vary
among funds (or their transfer agents) and fund intermediaries
depending on the current capabilities of the entity's Web site,
automated or manned phone systems, systems for processing shareholder
statements, and the number of investors. We believe that money market
funds themselves would need to perform an in-depth analysis of our
proposed rules in order to estimate the necessary systems
modifications. While we do not have the information necessary to
provide a point estimate of the potential costs of systems
modifications, our staff
[[Page 36872]]
has estimated that the costs for a fund (or its transfer agent) or
intermediary that may be required to perform these activities would
range from $230,000 to $490,000.\288\ Staff also estimates that funds
(or their transfer agents) and their intermediaries would have ongoing
costs to maintain automated phone systems and systems for processing
shareholder statements, and to explain to shareholders that the value
of their money market fund shares will fluctuate, and that these costs
would range from 5% to 15% of the one-time costs.\289\ We request
comment on this aspect of our proposal.
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\288\ Staff estimates that these costs would be attributable to
the following activities: (i) Project assessment and development;
(ii) project implementation and testing; and (iii) written and
telephone communication. See also supra note 245 (discussing the
bases of our staff's estimates of operational and related costs).
\289\ As noted throughout this Release, we recognize that adding
new capabilities or capacity to a system will entail ongoing annual
maintenance costs and understand that those costs generally are
estimated as a percentage of initial costs of building or expanding
a system.
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Do commenters agree with our estimated range of costs to
funds (or their transfer agents) and fund intermediaries to communicate
with shareholders the change to a floating NAV per share? If not, we
request detailed estimates of the types and amounts of costs.
Money market funds' ability to maintain a stable value also
facilitates the funds' role as a cash management vehicle and provides
other operational efficiencies for their shareholders.\290\ Money
market fund shareholders generally are able to transact in fund shares
at a stable value known in advance. This permits money market fund
transactions to settle on the same day that an investor places a
purchase or sell order, and allows a shareholder to determine the exact
value of his or her money market fund shares (absent a liquidation
event) at any time.\291\ These features have made money market funds an
important component of systems for processing and settling various
types of transactions.\292\
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\290\ See, e.g., Federated Investors Alternative 1 FSOC Comment
Letter, supra note 161; Comment Letter of Steve Fancher, et al.
(Jan. 22, 2013) (available in File No. FSOC-2012-0003); Comment
Letter of Steve Morgan, et al. (Jan. 22, 2013) (available in File
No. FSOC-2012-0003) (``Steve Morgan FSOC Comment Letter''); Comment
Letter of Edward Jones (Feb. 15, 2013) (available in File No. FSOC-
2012-0003) (``Edward Jones FSOC Comment Letter'') (citing cash
management benefits for individual investors in particular); Comment
Letter of T. Rowe Price (Jan. 30, 2013) (available in File No. FSOC-
2012-0003) (``T. Rowe Price FSOC Comment Letter'').
\291\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25
(noting how same-day settlement is vitally important to many
investors and describing how such same-day settlement is facilitated
by a stable NAV). We note, however, that not all money market fund
transactions settle on the same day. See, e.g., ICI 2009 Comment
Letter, supra note 281 (describing the systems and processes
involved to permit same-day settlement and those involved for next-
day settlement).
\292\ See, e.g., Comment Letter of John D. Hawke (Dec. 15, 2011)
(available in File No. 4-619) (``Hawke Dec 2011 PWG Comment
Letter'') (identifying various types of systems, including among
others trust accounting systems at bank trust departments; corporate
payroll processing systems and processing systems used to manage
corporations' cash balances; processing systems used by federal,
state, and local governments to manage their cash balances; and
municipal bond trustee cash management systems).
---------------------------------------------------------------------------
Commenters have asserted that money market funds with floating NAVs
would be incompatible with these systems because, among other things,
transactions in shares of these money market funds, like other types of
mutual fund transactions, would generally not settle on the same day
that an order is placed, and the value of the shares of these money
market funds could not be determined precisely before that day's NAV
had been calculated.\293\ Requiring money market funds to use floating
NAVs, the commenters assert, would require money market fund
shareholders and service providers to reprogram their systems or
manually reconcile transactions, increasing staffing costs.\294\ Others
have asserted that similar considerations could affect features that
are particularly appealing to retail investors, such as ATM access,
check writing, electronic check payment processing services and
products, and U.S. Fedwire transfers.\295\ We note that we are
proposing an exemption for retail funds which we expect would
significantly alleviate any such concerns about the costs of altering
those features, because funds that take advantage of the retail
exemption would be able to maintain a stable price, and accordingly,
such features would be unaffected. Nonetheless, not all funds with
these features may choose to take advantage of the proposed retail
exemption, and therefore, some funds may need to make additional
modifications to continue offering these features. We have included
estimates of the costs to make such modifications below. We seek
comment on the extent to which these features may be affected by our
proposal and the proposed retail exemption.
---------------------------------------------------------------------------
\293\ Hawke Dec 2011 PWG Comment Letter, supra note 292 (``The
net result of a floating NAV would be to make Money Funds not useful
to hold the large, short-term cash balances used in these automated
transaction processing systems across a wide variety of businesses
and applications.''); Comment Letter of Cachematrix Holdings LLC
(Dec. 12, 2011) (available in File No. 4-619) (``Cachematrix PWG
Comment Letter'') (``A stable share price is critical to same-day
and next-day processing, shortened settlement times, float
management, and mitigation of counterparty risk among firms.'');
Comment Letter of State Street Global Advisors (Sept. 8, 2009)
(available in File No. S7-11-09) (``[T]he stable NAV simplifies
transaction settlement, which permits money market funds to offer
shareholders same day settlement options, as well as ATM access,
check writing, and ACH/FedWire transfers.'').
\294\ See, e.g., Hawke Dec 2011 PWG Comment Letter, supra note
292 (stating that ``[m]anual processing [required to reconcile the
day-to-day fluctuations in the value of money market funds with a
floating NAV] would mean more staffing requirement, more costs
associated with staffing the function, and errors and delays in
completing the process'' and that reprogramming systems would ``take
many years and hundreds of millions of dollars to complete across a
wide range of businesses and applications for which stable value
money funds currently are used to hold short-term liquidity'');
Cachematrix PWG Comment Letter, supra note 293 (``[A]n entire
industry has programmed accounting, trading and settlement systems
based on a stable share price. The cost for each bank to retool
their sub-accounting systems to accommodate a fluctuating NAV could
be in the millions of dollars. This does not take into account the
costs that each bank would then pass on to the thousands of
corporations that use money market trading systems.'').
\295\ See, e.g., Comment Letter of Fidelity Investments (Feb.
14, 2013) (available in File No. FSOC-2012-0003) (``Fidelity FSOC
Comment Letter''). ([B]roker-dealers offer clients a variety of
features that are available generally only to accounts with a stable
NAV, including ATM access, check writing, and ACH and Fedwire
transfers. A floating NAV would force MMFs that offer same day
settlement on shares redeemed through wire transfers to shift to
next day settlement or require fund advisers to modify their systems
to accommodate floating NAV MMFs.''); Edward Jones FSOC Comment
Letter, supra note 290; ICI Feb 2012 PWG Comment Letter, supra note
259 (``[E]limination of the stable NAV for money market funds would
likely force brokers and fund sponsors to consider how or whether
they could continue to provide such services to money market fund
investors.'').
---------------------------------------------------------------------------
Would money market funds and financial intermediaries
continue to provide the retail-focused services discussed above if we
were to require money market funds to use floating NAVs? If not, why
not?
Would investors reduce or eliminate their money market
fund investments if these services were no longer available or if the
cost of these services increases?
Commenters also assert that requiring money market funds to use
floating NAVs would extend the settlement cycle from same-day
settlement to next-day settlement, which would expose parties to
transactions to increased risk (e.g., during a day in which a
transaction to be paid by proceeds from a sale of money market fund
shares is still open, one party to the transaction could default).\296\
But a money market
[[Page 36873]]
fund with a floating NAV could still offer same-day settlement. The
fund could price its shares each day and provide redemption proceeds
that evening. Indeed, we are aware of two floating NAV money market
funds that normally operate this way.\297\ Alternatively, funds could
price their shares periodically (e.g., at noon and 4 p.m. each day) to
provide same-day settlement.\298\ We recognize that pricing services
may incur operational costs to modify their systems (and pass these
costs along to funds) to provide pricing multiple times each day and
seek comment on the nature and amounts of these costs.
---------------------------------------------------------------------------
\296\ See, e.g., Hawke Dec 2011 PWG Comment Letter, supra note
292 (``Both parties would carry the unsettled transaction as an open
position for one extra day and each party would be exposed for that
time to the risk that its counterparty would default during the
extra day, or that the bank holding the cash overnight (or over the
weekend) would fail. For a bank involved in making a payment in
anticipation of an incoming funds transfer as part of these
processing systems, this change from same-day to next-day processing
of money fund redemptions would turn intra-day overdrafts into
overnight overdrafts, resulting in much greater default and funding
risks to the bank. This extra day's float would mean more risk in
the system and a larger average float balance that each party must
carry and finance.''); Cachematrix PWG Comment Letter, supra note
293 (``A stable share price is critical to same-day and next-day
processing, shortened settlement times, float management, and
mitigation of counterparty risk among firms.'').
\297\ See, e.g., the prospectus for the DWS Variable NAV Money
Fund, dated December 1, 2011, available at http://www.sec.gov/Archives/edgar/data/863209/000008805311001627/nb120111ict-vnm.txt
(``If the fund receives a sell request prior to the 4:00 p.m.
Eastern time cut-off, the proceeds will normally be wired on the
same day. However, the shares sold will not earn that day's
dividend.''); prospectus for the Northern Funds, dated December 7,
2012, available at http://www.sec.gov/Archives/edgar/data/916620/000119312512495705/d449473d485apos.htm (``Redemption proceeds
normally will be sent or credited on the next Business Day or, if
you are redeeming your shares through an authorized intermediary, up
to three Business Days, following the Business Day on which such
redemption request is received in good order by the deadline noted
above, unless payment in immediately available funds on the same
Business Day is requested.'').
\298\ We understand that pricing vendors may not provide
continual pricing throughout the day. Instead, money market funds
could establish periodic times at which the fund would price its
shares.
---------------------------------------------------------------------------
Do commenters expect to incur the types of costs described
above (e.g., increased staffing costs to manually reconcile
transactions)? Are there additional costs we have not identified?
What kinds of costs, specifically, do commenters expect to
incur? What kinds of employee costs would be involved?
Would an extended settlement cycle impose costs on money
market fund investors? If so, what kinds of costs and how much?
Would money market funds extend the settlement cycle or
would they exercise either of those other options?
Would exercising either of the two options discussed above
impose costs on money market funds? If so, how much? Are there options
that we have not identified that money market funds could use to
provide same-day settlement?
Would extending the settlement cycle cause investors to
leave or not invest in money market funds?
Do commenters agree that a delay in settlement for some
money market fund transactions could expose parties to the transactions
to increased counterparty risk? To what extent would this occur, and
how does the nature of this risk differ from counterparty risk that
arises in other aspects of a money market fund shareholder's business?
Do commenters agree that money market funds generally
could still offer same-day settlement if required to use a floating
NAV?
Do fund pricing services have the capacity to provide
pricing multiple times each day? If not, what types and amounts of
costs would pricing services incur to develop this capacity? Would
pricing services pass these costs down to funds?
Are the money market funds that currently same-day settle
with a floating NAV representative of what a broader industry of
floating NAV money market funds could achieve? Are there additional
costs or complications in conducting such same-day settlement for
larger funds than smaller funds?
In addition to money market funds and other entities in the
distribution chain, each money market fund shareholder would also
likely be required to perform an in-depth analysis of our floating NAV
proposal and its own existing systems, procedures, and controls to
estimate the systems modifications it would be required to undertake.
Because of this, and the variation in systems currently used by
institutional money market fund shareholders, we do not have the
information necessary to provide a point estimate of the potential
costs of systems modifications. Nevertheless, our staff has attempted
to describe the types of activities typically involved in making
systems modifications and estimated a range of hours and costs that may
be required to perform these activities. In addition, the Commission
requests from commenters information regarding the potential costs of
system modifications for money market fund shareholders.
Our staff has prepared ranges of estimated costs, taking into
account variations in the functionality, sophistication, and level of
automation of money market fund shareholders' existing systems and
related procedures and controls, and the complexity of the operating
environment in which these systems operate.\299\ In deriving its
estimates, our staff considered the need to modify systems and related
procedures and controls related to recordkeeping, accounting, trading,
cash management, and bank reconciliations, and to provide training
concerning these modifications.
---------------------------------------------------------------------------
\299\ Some money market fund shareholders do not use systems and
would not use them under this proposal (e.g., many retail
investors), and these shareholders of course would not incur any
systems modifications costs.
---------------------------------------------------------------------------
Staff estimates that a shareholder whose systems (including related
procedures and controls) would require less extensive or labor-
intensive modifications would incur one-time costs ranging from
$123,000 to $253,000.\300\ Staff estimates that a shareholder whose
systems (including related procedures and controls) would require more
extensive or labor-intensive modifications would incur one-time costs
ranging from $1.4 million to $2.9 million.\301\ In addition, staff
estimates the annual maintenance costs to these systems and procedures
and controls, and the costs to provide continuing training, would range
from 5% to 15% of the one-time implementation costs.\302\ We request
comment on our analysis and the nature and extent of the costs money
market fund shareholders anticipate they would incur as a result of our
floating NAV proposal.
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\300\ Staff estimates that these costs would be attributable to
the following activities: (i) Planning, coding, testing, and
installing system modifications; (ii) drafting, integrating,
implementing procedures and controls; (iii) preparation of training
materials; and (iv) training. See also supra note 245 (discussing
the bases of our staff's estimates of operational and related
costs).
\301\ Id.
\302\ See supra note 286.
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Are shareholder systems in fact unable to accommodate a
floating NAV, even if the NAV typically fluctuates very little (a
fraction of a penny) on a day-to-day basis?
If shareholder systems are unable to accommodate a
floating NAV, what kinds of programming costs would shareholders incur
in reprogramming the systems and how do they compare to our staff's
estimates above?
Do shareholders have other systems they use to manage
their investments that fluctuate in value? If so, could these systems
be used for money market funds? If not, why not?
How much would it cost to adapt existing shareholder
systems (currently used to accommodate investments that fluctuate in
value) to accommodate money market funds with floating NAVs and how do
these costs compare to our staff's estimates above?
[[Page 36874]]
8. Disclosure Regarding Floating NAV
We are proposing disclosure-related amendments to rule 482 under
the Securities Act \303\ and Form N-1A in connection with the floating
NAV alternative. We anticipate that the proposed rule and form
amendments would provide current and prospective shareholders with
information regarding the operations and risks of this reform
alternative. In keeping with the enhanced disclosure framework we
adopted in 2009,\304\ the proposed amendments are intended to provide a
layered approach to disclosure in which key information about the
proposed new features of money market funds would be provided in the
summary section of the statutory prospectus (and, accordingly, in any
summary prospectus, if used) with more detailed information provided
elsewhere in the statutory prospectus and in the statement of
additional information (``SAI'').
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\303\ Rule 482 applies to advertisements or other sales
materials with respect to securities of an investment company
registered under the Investment Company Act that is selling or
proposing to sell its securities pursuant to a registration
statement that has been filed under the Investment Company Act. See
rule 482(a). This rule describes the information that is required to
be included in an advertisement, including a disclosure statement
that must be used on money market fund advertisements. See rule
482(b).
Our proposal would also affect fund supplemental sales
literature (i.e., sales literature that is preceded or accompanied
by a statutory prospectus). Rule 34b-1 under the Investment Company
Act prescribes the requirements for supplemental sales literature.
Because rule 34b-1(a) cross-references the requirements of rule
482(b)(4), any changes made to that provision will affect the
requirements for fund supplemental sales literature.
\304\ See Enhanced Disclosure and New Prospectus Delivery Option
for Registered Open-End Management Investment Companies, Investment
Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26,
2009)] (``Summary Prospectus Adopting Release'') at paragraph
preceding section III (adopting rules permitting the use of a
summary prospectus, which is designed to provide key information
that is important to an informed investment decision).
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a. Disclosure Statement
The move to a floating NAV would be designed to change the
investment expectations and behavior of money market fund investors. As
a measure to achieve this change, we propose to require that each money
market fund, other than a government or retail fund, include a bulleted
statement disclosing the particular risks associated with investing in
a floating NAV money market fund on any advertisement or sales material
that it disseminates (including on the fund Web site). We also propose
to include wording designed to inform investors about the primary risks
of investing in money market funds generally in this bulleted
disclosure statement. While money market funds are currently required
to include a similar disclosure statement on their advertisements and
sales materials,\305\ we propose amending this disclosure statement to
emphasize that money market fund sponsors are not obligated to provide
financial support, and that money market funds may not be an
appropriate investment option for investors who cannot tolerate
losses.\306\
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\305\ See supra note 303. Rule 482(b)(4) (which currently
requires a money market fund to include the following disclosure
statement on its advertisements and sales materials: An investment
in the Fund is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the
Fund seeks to preserve the value of your investment at $1.00 per
share, it is possible to lose money by investing in the Fund).
\306\ See infra note 607 and accompanying text (discussing the
extent to which discretionary sponsor support has the potential to
confuse money market fund investors); supra note 141 and
accompanying text (noting that survey data shows that some investors
are unsure about the amount of risk in money market funds and the
likelihood of government assistance if losses occur).
---------------------------------------------------------------------------
Specifically, we would require floating NAV money market funds to
include the following bulleted disclosure statement on their
advertisements and sales materials:
You could lose money by investing in the Fund.
You should not invest in the Fund if you require your
investment to maintain a stable value.
The value of shares of the Fund will increase and decrease
as a result of changes in the value of the securities in which the Fund
invests. The value of the securities in which the Fund invests may in
turn be affected by many factors, including interest rate changes and
defaults or changes in the credit quality of a security's issuer.
An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency.
The Fund's sponsor has no legal obligation to provide
financial support to the Fund, and you should not expect that the
sponsor will provide financial support to the Fund at any time.\307\
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\307\ See proposed (FNAV) rule 482(b)(4)(i). If an affiliated
person, promoter, or principal underwriter of the fund, or an
affiliated person of such person, has entered into an agreement to
provide financial support to the fund, the fund would be permitted
to omit the last bulleted sentence from the disclosure statement for
the term of the agreement. See Note to paragraph (b)(4), proposed
(FNAV) rule 482(b)(4).
---------------------------------------------------------------------------
We also propose to require a substantially similar bulleted
disclosure statement in the summary section of the statutory prospectus
(and, accordingly, in any summary prospectus, if used).\308\
---------------------------------------------------------------------------
\308\ See proposed (FNAV) Item 4(b)(1)(ii)(A) of Form N-1A. Item
4(b)(1)(ii) currently requires a money market fund to include the
following statement in its prospectus: An investment in the Fund is
not insured or guaranteed by the Federal Deposit Insurance
Corporation or any other government agency. Although the Fund seeks
to preserve the value of your investment at $1.00 per share, it is
possible to lose money by investing in the Fund.
---------------------------------------------------------------------------
With respect to money market funds that are not government or
retail funds, we propose to remove current requirements that money
market funds state that they seek to preserve the value of shareholder
investments at $1.00 per share.\309\ This disclosure, which was adopted
to inform investors in money market funds that a stable net asset value
does not indicate that the fund will be able to maintain a stable
NAV,\310\ will not be relevant once funds are required to ``float''
their net asset value.
---------------------------------------------------------------------------
\309\ See Item 4(b)(1)(ii) of Form N-1A; proposed (FNAV) Item
4(b)(1)(ii)(A) of Form N-1A.
\310\ See Registration Form Used by Open-End Management
Investment Companies, Investment Company Act Release No. 23064 (Mar.
13, 1998) [63 FR 13916 (Mar. 23, 1998)] (release amending
disclosure) (``Registration Statement Adopting Release''); Revisions
to Rules Regulating Money Market Funds, Investment Company Act
Release No. 18005 (Feb. 20, 1990) [56 FR 8113 (Feb. 27, 1991)]
(adopting release); Revisions to Rules Regulating Money Market
Funds, Investment Company Act Release No. 17589 (July 17, 1990) [55
FR 30239 (July 25, 1990)] (``1990 Proposing Release'').
---------------------------------------------------------------------------
As discussed above, the floating NAV proposal would provide
exemptions to the floating NAV requirement for government and retail
money market funds.\311\ Accordingly, the proposed amendments to rule
482 and Form N-1A would require government and retail money market
funds to include a bulleted disclosure statement on the fund's
advertisements and sales materials and in the summary section of the
fund's statutory prospectus (and, accordingly, in any summary
prospectus, if used) that does not discuss the risks of a floating NAV,
but that would be designed to inform investors about the risks of
investing in money market funds generally.\312\ We propose to require
each government and retail fund to include the following bulleted
disclosure statement in the summary section of its statutory prospectus
(and, accordingly, in any summary prospectus, if used), and on any
advertisement or sales material that it disseminates (including on the
fund Web site):
---------------------------------------------------------------------------
\311\ See supra sections III.A.3 and III.A.4 and proposed (FNAV)
rules 2a-7(c)(2) and (c)(3).
\312\ See supra notes 305-306 and accompanying text.
---------------------------------------------------------------------------
You could lose money by investing in the Fund.
The Fund seeks to preserve the value of your investment at
$1.00 per
[[Page 36875]]
share, but cannot guarantee such stability.
An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency.
The Fund's sponsor has no legal obligation to provide
financial support to the Fund, and you should not expect that the
sponsor will provide financial support to the Fund at any time.\313\
---------------------------------------------------------------------------
\313\ See proposed (FNAV) rule 482(b)(4)(ii) and proposed (FNAV)
item 4(b)(1)(ii)(B) of Form N-1A; see also supra notes 305 and 308
(discussing the current corresponding disclosure requirements for
money market funds). If an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
entered into an agreement to provide financial support to the fund,
the fund would be permitted to omit the last bulleted sentence from
the disclosure statement that appears on a fund advertisement or
fund sales material, for the term of the agreement. See Note to
paragraph (b)(4), proposed (FNAV) rule 482(b)(4).
Likewise, if an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
entered into an agreement to provide financial support to the fund,
and the term of the agreement will extend for at least one year
following the effective date of the fund's registration statement,
the fund would be permitted to omit the last bulleted sentence from
the disclosure statement that appears on the fund's registration
statement. See Instruction to proposed (FNAV) item 4(b)(1)(ii) of
Form N-1A.
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The proposed disclosure statements are intended to be one measure
to change the investment expectations and, therefore, the behavior of
money market fund investors. The risk-limiting conditions of rule 2a-7
and past experiences of money market fund investors have created
expectations of a stable, cash-equivalent investment. As discussed
above, one reason for such expectation may have been the role of
sponsor support in maintaining a stable net asset value for money
market funds.\314\ In addition, we are concerned that investors, under
the floating NAV proposal, will not be fully aware that the value of
their money market fund shares will increase and decrease as a result
of the changes in the value of the underlying portfolio
securities.\315\ In proposing the disclosure statement, we have taken
into consideration investor preferences for clear, concise, and
understandable language.\316\ We also considered whether language that
was stronger in conveying potential risks associated with money market
funds would be effective for investors.\317\ In addition, we considered
whether the proposed disclosure statement should be limited to only
money market fund advertisements and sales materials, as discussed
above. Although we acknowledge that the summary section of the
prospectus must contain a discussion of key risk factors associated
with a floating NAV money market fund, we believe that the importance
of the disclosure statement merits its placement in both locations,
similar to how the current money market fund legend is required in both
money market fund advertisements and sales materials and the summary
section of the prospectus.\318\
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\314\ See supra section II.B.3.
\315\ See Fidelity FSOC Comment Letter, supra note 295 (finding,
from its study, that 81% of its retail money market fund investors
understood that securities held by these funds have some small day-
to-day fluctuations). However, the study did not address the extent
to which these investors understood that these fluctuations could
impact the value of their shares of money market funds, rather than
the value of the underlying portfolio securities.
\316\ See Study Regarding Financial Literacy Among Investors, a
study by staff of the U.S. Securities and Exchange Commission (Aug.
2012), available at http://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf, at vi.
\317\ See Molly Mercer et al., Worthless Warnings? Testing the
Effectiveness of Disclaimers in Mutual Fund Advertisements, 7 J.
Empirical Legal Stud. 429 (2010) (evaluating the usefulness of
legends in mutual fund advertisements regarding performance
advertising).
\318\ See supra notes 305 and 308.
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We request comment on the disclosure statements \319\ proposed to
be required on any money market fund advertisements or sales materials,
as well as in the summary section of a fund's statutory prospectus
(and, accordingly, in any summary prospectus, if used).
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\319\ In the questions that follow, we use the term ``disclosure
statement'' to mean the new disclosure statement that we propose to
require floating NAV funds to incorporate into their prospectuses
and advertisements and sales materials or, alternatively and as
appropriate, the new disclosure statement that we propose to require
government or retail funds to incorporate into their prospectuses
and advertisements and sales materials.
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Would the disclosure statement proposed to be used by
floating NAV funds adequately alert investors to the risks of investing
in a floating NAV fund, and would investors understand the meaning of
each part of the proposed disclosure statement? Will investors be fully
aware that the value of their money market fund shares will increase
and decrease as a result of the changes in the value of the underlying
portfolio securities? If not, how should the proposed disclosure
statement be amended?
Would the disclosure statement proposed to be used by
government and retail money market funds, which are not subject to the
floating NAV requirement, adequately alert investors to the risks of
investing in those types of funds, and would investors understand the
meaning of each part of the proposed disclosure statement? If not, how
should the proposed disclosure statement be amended?
Would different shareholder groups or different types of
funds benefit from different disclosure statements? For example, should
retail and institutional investors receive different disclosure
statements, or should funds that offer cash management features such as
check writing provide different disclosure statements from funds that
do not? Why or why not? If yes, how should the disclosure statement be
tailored to different shareholder groups and fund types?
Will the proposed disclosure statement respond effectively
to investor preferences for clear, concise, and understandable
language?
Would the following variations on the proposed disclosure
statement be any more or less useful in alerting shareholders to the
risks of investing in a floating NAV fund (as applicable) and/or the
risks of investing in money market funds generally?
[cir] Removing or amending the following bullet point in the
proposed disclosure statement: ``The Fund's sponsor has no legal
obligation to provide financial support to the Fund, and you should not
expect that the sponsor will provide financial support to the Fund at
any time.''
[cir] Removing or amending the following bullet point in the
proposed disclosure statement: ``The value of the securities in which
the Fund invests may in turn be affected by many factors, including
interest rate changes and defaults or changes in the credit quality of
a security's issuer.''
[cir] Amending the final bullet point in the proposed disclosure
statement to read: ``Your investment in the Fund therefore may
experience losses.''
[cir] Amending the final bullet point in the proposed disclosure
statement to read: ``Your investment in the Fund therefore may
experience gains or losses.''
Would investors benefit from requiring the proposed
disclosure statement also to be included on the front cover page of a
money market fund's prospectus (and on the cover page or beginning of
any summary prospectus, if used)?
Would investors benefit from any additional types of
disclosure in the summary section of the statutory prospectus or on the
prospectus' cover page? If so, what else should be included?
Should we provide any instruction or guidance in order to
highlight the proposed disclosure statement on fund advertisements and
sales materials (including the fund's Web site) and/or lead investors
efficiently to the
[[Page 36876]]
disclosure statement? \320\ For example, with respect to the fund's Web
site, should we instruct that the proposed disclosure statement be
posted on the fund's home page or be accessible in no more than two
clicks from the fund's home page?
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\320\ Such instruction or guidance would supplement current
requirements for the presentation of the disclosure statement
required by rule 482(b)(4). See supra note 305; rule 482(b)(5).
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b. Disclosure of Tax Consequences and Effects on Fund Operations
The proposed requirement that money market funds transition to a
floating NAV would entail certain additional tax- and operations-
related disclosure, which disclosure requirements would not necessitate
rule and form amendments.\321\ As discussed above, if we were to
require certain money market funds to use a floating NAV, taxable
investors in money market funds, like taxable investors in other types
of mutual funds, may experience taxable gains and losses.\322\
Currently, funds are required to describe in their prospectuses the tax
consequences to shareholders of buying, holding, exchanging, and
selling the fund's shares.\323\ Accordingly, we expect that, pursuant
to current disclosure requirements, floating NAV money market funds
would include disclosure in their prospectuses about the tax
consequences to shareholders of buying, holding, exchanging, and
selling the shares of the floating NAV fund. In addition, we expect
that a floating NAV money market fund would update its prospectus and
SAI disclosure regarding the purchase, redemption, and pricing of fund
shares, to reflect any procedural changes resulting from the fund's use
of a floating NAV.\324\ As discussed below, if we were to adopt the
floating NAV alternative, the compliance date would be 2 years after
the effective date of the adoption with respect to any amendments
specifically related to the floating NAV proposal, including related
amendments to disclosure requirements.\325\
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\321\ Prospectus disclosure regarding the tax consequences of
these activities is currently required by Form N-1A. See Item 11(f)
of Form N-1A.
\322\ See supra section III.A.6 (discussing the tax and economic
implications of floating NAV money market funds).
\323\ See Item 11(f) of Form N-1A.
\324\ We expect that a money market fund would include this
disclosure (as appropriate) in response to, for example, Item
11(``Shareholder Information'') and Item 23 (``Purchase, Redemption,
and Pricing of Shares'') of Form N-1A.
\325\ See infra section III.N.1.
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We request comment on the disclosure that we expect floating NAV
money market funds would include in their prospectuses about the tax
consequences to shareholders of buying, holding, exchanging, and
selling the shares of the fund, as well as the effects (if any) on fund
operations resulting from the transition to a floating NAV.
Should Form N-1A or its instructions be amended to more
explicitly require any of the disclosure we discuss above, or any
additional disclosure, to be included in a fund's prospectus and/or
SAI?
Is there any additional information about a floating NAV
fund's operations that shareholders should be aware of that is not
discussed above? If so, would such additional information already be
covered under existing Form N-1A requirements, or would we need to make
any amendments to the form or its instructions?
c. Disclosure of Transition to Floating NAV
A fund must update its registration statement to reflect any
material changes by means of a post-effective amendment or a prospectus
supplement (or ``sticker'') pursuant to rule 497 under the Securities
Act.\326\ We would expect that, to meet this requirement, at the time
that a stable NAV money market fund transitions to a floating NAV (or
adopts a floating NAV in the course of a merger or other
reorganization),\327\ it would update its registration statement to
include relevant related disclosure, as discussed in this section of
the Release, by means of a post-effective amendment or a prospectus
supplement. We request comment on this requirement.
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\326\ See 17 CFR 230.497.
\327\ See infra section III.N.
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Besides requiring a fund that transitions to a floating
NAV to update its registration statement by filing a post-effective
amendment or prospectus supplement, should we also require that, when a
fund transitions to a floating NAV, it must notify shareholders
individually about the risks and operational effects of a floating NAV
on the fund, such as a separate mailing or email notice? Would
shareholders be more likely to understand and appreciate these risks
and operational effects (disclosure of which would be included in the
fund's registration statement, as discussed above) if they were to
receive such individual notification? If so, what information should
this individual notification include? What would be an appropriate time
frame for this notification? How would such notification be
accomplished, and what costs would be incurred in providing such
notification?
d. Request for Comment on Money Market Fund Names
As discussed above, our floating NAV proposal would provide
exemptions to the floating NAV requirements for government money market
funds and retail money market funds. We request comment on whether we
should require new terminology in money market fund names \328\ to
reduce the risk of investor confusion that might result from permitting
some types of funds to maintain a stable price, while requiring others
types of funds to use a floating NAV.
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\328\ See rule 2a-7(b)(3) (setting forth the conditions for a
fund to use a name that suggests that it is a money market fund or
the equivalent, including using terms such as ``cash,'' ``liquid,''
``money,'' ``ready assets,'' or similar terms in a fund's name).
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Given that, under our floating NAV proposal, some funds'
share prices would increase and decrease as a result of changes in the
value of the securities in which the fund invests, should we require
new terminology in money market fund names to reduce any risk of
investor confusion that might result from both stable price money
market funds and floating NAV money market funds using the same term
``money market fund'' in their names? For example, should we require
money market funds to use either the term ``stable money market fund''
or ``floating money market fund,'' as appropriate, in their names? Why
or why not?
e. Economic Analysis
The floating NAV proposal makes significant changes to the nature
of money market funds as an investment vehicle. The proposed disclosure
requirements in this section are intended to communicate to
shareholders the nature of the risks that follow from the floating NAV
proposal. In section III.E, we discussed how the floating NAV proposal
might affect shareholders' use of money market funds and the resulting
effects on the short-term financing markets. The factors and uncertain
effects of those factors discussed in that section would influence any
estimate of the incremental effects that the proposed disclosure
requirements might have on either shareholders or the short-term
financing markets. However, we believe that the proposed disclosure
will better inform shareholders about the changes, which should result
in shareholders making investment decisions that better match their
investment preferences. We expect that this will have similar effects
on efficiency, competition, and capital formation as those that are
outlined in
[[Page 36877]]
section III.E rather than introduce new effects. We further believe
that the effects of the proposed disclosure requirements will be small
relative to the effects of the floating NAV proposal. The Commission
staff cannot estimate the quantitative benefits of these proposed
requirements at this time because of uncertainty about how increased
transparency may affect different investors' understanding of the risks
associated with money market funds.\329\ We request additional data
from commenters below to enable us to effectively calculate these
effects.
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\329\ Likewise, uncertainty regarding how the proposed
disclosure may affect different investors' behavior would make it
difficult for the SEC staff to measure the quantitative benefits of
the proposed requirements. With respect to the proposed disclosure
statement, there are many possible permutations on specific wording
that would convey the specific concerns identified in this Release,
and the breadth of these permutations makes it difficult for SEC
staff to test how investors would respond to each wording variation.
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We anticipate that all money market funds would incur costs to
update their registration statements, as well as their advertising and
sales materials (including the fund Web site), to include the proposed
disclosure statement, and that floating NAV funds additionally would
incur costs to update their registration statements to incorporate tax-
and operations-related disclosure relating to the use of a floating
NAV. We expect these costs generally would be incurred on a one-time
basis. Our staff estimates that the average costs for a floating NAV
money market fund to comply with these proposed disclosure amendments
would be approximately $1,480 and that the compliance costs for a
government or retail money market fund would be approximately
$592.\330\ Each money market fund in a fund group might not incur these
costs individually.
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\330\ Staff estimates that these costs would be attributable to
amending the fund's disclosure statement and updating the fund's
advertising and sales materials. See supra note 245 (discussing the
bases of our staff's estimates of operational and related costs).
The costs associated with these activities are all paperwork-related
costs and are discussed in more detail in infra section IV.A.7.
We expect the new required disclosure would add minimal length
to the current required prospectus disclosure, and thus would not
increase the number of pages in, or change the printing costs of, a
fund's prospectus. Based on conversations with fund representatives,
the Commission understands that, in general, unless the page count
of a prospectus is changed by at least four pages, printing costs
would remain the same.
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We request comment on this economic analysis:
Are any of the proposed disclosure requirements unduly
burdensome, or would they impose any unnecessary costs?
We request comment on the staff's estimates of the
operational costs associated with the proposed disclosure requirements.
We request comment on our analysis of potential effects of
these proposed disclosure requirements on efficiency, competition, and
capital formation.
9. Transition
The PWG Report suggests that a transition to a floating NAV could
itself result in significant redemptions.\331\ Money market fund
investors could seek to redeem shares ahead of other investors to avoid
realizing losses when their money market funds switch to a floating
NAV. Investors may anticipate their funds' NAVs per share being less
than $1.00 when the switch occurs or they may fear their funds might
incur liquidity costs from heavy redemptions resulting from the
behavior of other investors.
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\331\ PWG Report, supra note 111, at 22. Other commenters have
voiced additional concern that redemptions as a result of the
transition to a floating NAV could be destabilizing to the financial
markets. See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25;
Comment Letter from American Association of State Colleges and
Universities (Jan. 21, 2011) (available in File No. 4-619).
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To avoid large numbers of preemptive redemptions by shareholders
and allow sufficient time for funds and intermediaries to cost-
effectively adapt to the new requirements, we propose to delay
compliance with this aspect of the proposed rules for a period of 2
years from the effective date of our proposed rulemaking. Accordingly,
money market funds subject to our floating NAV proposal could continue
to price their shares as they do today for up to 2 years following this
date. On or before the compliance date, all stable value money market
funds not exempted from the floating NAV proposal would convert to a
floating NAV. However, we note that, under our floating NAV proposal,
investors who prefer a stable price product also could invest in a
government or retail money market fund. We request comment on the
proposed transition.
If we were to adopt the floating NAV proposal, money market funds
and their shareholders would have 2 years to understand the
implications of and implement our reform. We believe this would benefit
money market funds and their shareholders by allowing money market
funds to make this transition at the optimal time and potentially not
at the same time as all other money market funds (which may be more
likely to have a disruptive effect on the short-term financing markets,
and thus not be perceived as optimal by funds). It would also provide
time for investors such as corporate treasurers to modify their
investment guidelines or seek changes to any statutory or regulatory
constraints to which they are subject to permit them to invest in a
floating NAV money market fund or other investments as appropriate.
Giving fund shareholders ample time to dispose of their investments
in an orderly fashion also should benefit money market funds and their
other shareholders because it would give funds additional time to
respond appropriately to the level and timing of redemption
requests.\332\ We recognize, however, that shareholders might still
preemptively redeem shares at or near the time that the money market
fund converts from a stable value to a floating NAV if they believe
that the market value of their shares will be less than $1.00. We
expect, however, that money market fund sponsors would use the
relatively long compliance period to select an appropriate conversion
date that would minimize this risk. We therefore expect that providing
shareholders, funds, and others a relatively long time to assess the
effects of the regulatory change if adopted would mitigate the risk
that the transition to a floating NAV, itself, could prompt significant
redemptions.\333\
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\332\ Comment Letter of Thrivent Mutual Funds (Jan. 10, 2011)
(available in File No. 4-619) (``Any change [to a floating NAV]
could be implemented with sufficient advanced notice to allow
institutional investors to modify their investment guidelines to
permit investment in a floating NAV fund, where appropriate. A mass
exodus assumes that investors have a clear alternative, which they
do not, and come to the same conclusion in tandem, which is
improbable given the lack of clear alternatives.''); Richmond Fed
PWG Comment Letter, supra note 139 (``If informed well ahead of a
change [to a floating NAV], investors are more likely to move
gradually, mitigating the disruption.''). In addition, a relatively
long compliance period would provide money market funds sufficient
time to modify and/or establish the systems necessary to transact
permanently at a floating NAV.
\333\ In its proposal, FSOC suggested a transition period of 5
years. FSOC Proposed Recommendations, supra note 114, at 31.
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We considered an even longer transition period, including the 5-
year period in FSOC's proposed floating NAV recommendation.\334\ FSOC's
[[Page 36878]]
proposed recommendation, however, would have required money market
funds to re-price their shares at $100 per share, and would have
grandfathered existing money market funds (which could continue to
maintain a stable value) but required investments after a specified
date to be made in floating NAV money market funds. Money market fund
sponsors therefore would have had to take a corporate action to re-
price their shares and, if they chose to rely on the grandfathering, to
form new floating NAV money market funds to accept new investments
after the specified date. Money market funds and others in the
distribution chain may be better able to implement basis point rounding
as we propose, and therefore may not need a 5-year transition period.
Indeed, some commenters on FSOC's proposed recommendation, which could
require a longer transition period than our proposal, supported a 2-
year transition period.\335\
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\334\ See FSOC Proposed Recommendations, supra note 114, at 31
(``To reduce potential disruptions and facilitate the transition to
a floating NAV for investors and issuers, existing MMFs could be
grandfathered and allowed to maintain a stable NAV for a phase-out
period, potentially lasting five years. Instead of requiring these
grandfathered funds to transition to a floating NAV immediately, the
SEC would prohibit any new share purchases in the grandfathered
stable-NAV MMFs after a predetermined date, and any new investments
would have to be made in floating-NAV MMFs.'').
\335\ See BlackRock FSOC Comment Letter, supra note 204 (``We
agree that a transition period is extremely important to avoid
market disruption. Assuming existing funds are grandfathered as CNAV
funds and no new shares are purchased, a transition period of two
years from the effective date of a new rule should suffice.''); HSBC
FSOC Comment Letter, supra note 196 (``[W]e believe a 2-3 year
transition period should be sufficient for the industry, investors
and regulators to prepare for any required changes to products,
systems etc.''). But see U.S. Chamber Jan. 23, 2013 FSOC Comment
Letter, supra note 248 (suggesting a transition period of up to 5
years could be necessary).
---------------------------------------------------------------------------
We request comment on our proposed compliance date.
Would our proposed transition period mitigate operational
or significant redemption risks that could result from requiring money
market funds to use floating NAVs?
If not, how much time would be sufficient to allow money
market fund shareholders that do not wish to remain in a money market
fund with a floating NAV to identify alternatives without posing
operational or significant redemption risk?
Do commenters agree that a compliance period of 2 years is
sufficient to address operational issues associated with converting
funds to floating NAVs? Should the compliance period be shorter or
longer? Why? Would a 5-year transition period, consistent with FSOC's
proposed floating NAV recommendation, be more appropriate?
Do fund sponsors anticipate converting (at an appropriate
time) existing stable value money market funds to floating NAV funds or
would sponsors establish new funds? If sponsors expect to establish new
funds, are there costs other than those we describe below (related to a
potential grandfathering provision)?
Are there other measures we could take that would minimize
the risks that could arise from investors seeking preemptively to
redeem their shares in advance of a fund's adoption of a floating NAV?
Should we provide a grandfathering provision, in addition
to, or in lieu of, a relatively long compliance date? If we adopted a
grandfathering provision, how long should the grandfathering period
last? Would a grandfathering provision better achieve our objective of
facilitating an orderly transition?
B. Standby Liquidity Fees and Gates
As an alternative to the floating NAV proposal discussed above, we
are proposing to continue to allow money market funds to transact at a
stable share price under normal conditions but to (1) require money
market funds to institute a liquidity fee in certain circumstances and
(2) permit money market funds to impose a gate in certain
circumstances. In particular, this fees and gates alternative proposal
would require that if a money market fund's weekly liquid assets fell
below 15% of its total assets (the ``liquidity threshold''), the fund
must impose a liquidity fee of 2% on all redemptions unless the board
of directors of the fund (including a majority of its independent
directors) determines that imposing such a fee would not be in the best
interest of the fund. The board may also determine that a lower fee
would be in the best interest of the fund.\336\
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\336\ We would not require, but would permit, government funds
to impose fees and gates, as discussed below. Unlike under the
floating NAV alternative, we are not proposing to exempt retail
funds from our fees and gates proposal. See infra section III.B.5 of
this Release.
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We also are proposing that when a money market fund's weekly liquid
assets fall below 15% of total assets, the money market fund board
would also have the ability to impose a temporary suspension of
redemptions (also referred to as a ``gate'') for a limited period of
time if the board determines that doing so is in the fund's best
interest. Such a gate could be imposed, for example, if the liquidity
fees were not proving sufficient in slowing redemptions to a manageable
level.
Under this option, rule 2a-7 would continue to permit money market
funds to use the penny rounding method of pricing so long as the funds
complied with the conditions of the rule, but would not permit use of
the amortized cost method of valuation. We would eliminate the use of
the amortized cost method of valuation for money market funds under the
fees and gates alternative for the same reasons we are proposing to do
so under the retail and government exemptions to the floating NAV
alternative.\337\ We do not believe that allowing continued use of
amortized cost valuation for all securities in money market funds'
portfolios is appropriate given that these funds will already be
valuing their securities using market factors on a daily basis due to
new Web site disclosure requirements and given that penny rounding
otherwise achieves the same level of price stability.
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\337\ See section III.A.3 and III.A.4 of this Release.
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As previously discussed, the financial crisis of 2007-2008 exposed
contagion effects from heavy redemptions in money market funds that had
significant impacts on investors, funds, and the markets. We have
designed the fees and gates alternative to address certain of these
issues. Although it is impossible to know what exactly would have
happened if money market funds had operated with fees and gates at that
time, we expect that if money market funds were armed with such tools,
they would have been able to better manage the heavy redemptions that
occurred and to limit the spread of contagion, regardless of the reason
for the redemptions.
During the crisis, some investors redeemed at the first sign of
market stress, and could do so without bearing any costs even if their
actions imposed costs on the fund and the remaining shareholders. As
discussed in greater detail below, if money market funds had imposed
liquidity fees during the crisis, it could have resulted in those
investors re-assessing their redemption decisions because they would
have been required to pay for the costs of their redemptions. Based on
the level of redemption activity that occurred during the crisis, we
expect that many money market funds would have faced liquidity
pressures sufficient to cross the liquidity thresholds we are proposing
today that would trigger the use of fees and gates. If funds therefore
had imposed fees, this might have caused some investors to choose not
to redeem because the direct costs of the liquidity fee may have been
more tangible than the uncertain possibility of potential future
losses. In addition, funds that imposed fees would likely have been
able to better manage the impact of the redemptions that investors
submitted, and any contagion effects may have been limited, because the
fees would have helped offset the costs of the liquidity provided to
redeeming
[[Page 36879]]
shareholders, and any excess could have been used to repair the NAV of
the fund, if necessary. Regardless of the incentives to redeem, a
liquidity fee would make redeeming investors pay for the costs of
liquidity and, even if investors redeem from a fund, gates can directly
respond to a run by halting redemptions.
If a fund had been able to impose a redemption gate at the time, it
also would have been able to stop mounting redemptions and possibly
generate additional internal liquidity in the fund while the gate was
in place. However, fees and gates do not address all of the factors
that may lead to heavy redemptions in money market funds.\338\ For
example, they do not eliminate the incentive to redeem in times of
stress to receive the $1.00 stable share price before the fund breaks
the buck, or prevent investors from seeking to redeem to obtain higher
quality securities, better liquidity, or increased transparency.
Nonetheless, for the reasons discussed above, they provide tools that
should serve to address many of the types of issues that arose during
the crisis by allocating more explicitly the costs of liquidity and
stopping runs.
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\338\ See infra nn 361 and 362 and accompanying text.
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As discussed in section III.C, we also request comment on whether
we should combine this option with our floating NAV alternative. This
reform would be intended to achieve our goals of preserving the
benefits of stable share price money market funds for the widest range
of investors and the availability of short-term financing for issuers,
while enhancing investor protection and risk transparency, making funds
more resilient to mass redemptions, and improving money market funds'
ability to manage and mitigate potential contagion from high levels of
redemptions, as further discussed below.
1. Analysis of Certain Effects of Liquidity Fees and Gates
As discussed in the RSFI Study and in section II above,
shareholders may redeem money market fund shares for several reasons
under stressed market conditions.\339\ One of these incentives relates
to the current rounding convention in money market fund valuation and
pricing that can allow early redeeming shareholders to redeem for $1.00
per share, even when the market-based NAV per share of the fund is
lower than that price. As discussed in section III.A above, the
floating NAV proposal is principally focused on mitigating this
incentive by causing redeeming shareholders to receive the market value
of redeemed shares. However, as the RSFI Study details, there are a
variety of other factors that may motivate shareholders to redeem
assets from money market funds in times of stress. Adverse economic
events or financial market conditions can cause shareholders to engage
in flights to quality, liquidity, or transparency (or combinations
thereof).\340\ When money market funds may have to absorb, suddenly,
high levels of redemptions that are expected to be in excess of the
fund's internal sources of liquidity, investors may expect that fund
managers will deplete the fund's most liquid assets first to meet
redemptions and may have to sell securities at a loss (because of
transitory liquidity costs) or even ``fire sale'' prices.\341\
Accordingly, shareholder redemptions during such periods can impose
expected future liquidity costs on the money market fund that are not
reflected in a $1.00 share price based on current amortized cost
valuation.
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\339\ See RSFI Study, supra note 21, at 2-4.
\340\ See id. at 7-14; Qi Chen et al., Payoff Complementarities
and Financial Fragility: Evidence from Mutual Fund Outflows, 97 J.
Fin. Econ. 239-262 (2010). Prime money market funds can be
particularly susceptible to redemptions in a flight to quality,
liquidity or transparency because they hold similar portfolios and
thus can present a correlated risk of loss of quality or loss of
liquidity (and particularly when the financial system is strained
because most of their non-governmental assets are short-term debt
obligations of large banks.) See infra section III.J. See also
Harvard Business School FSOC Comment Letter, supra note 24; Angel
FSOC Comment Letter, supra note 60.
\341\ See, e.g., Comment Letter of Americans for Financial
Reform (Feb. 20, 2012) (available in File No. FSOC-2012-0003);
BlackRock FSOC Comment Letter, supra note 204; Philip E. Strahan &
Basak Tanyeri, Once Burned, Twice Shy: Money Market Fund Responses
to a Systemic Liquidity Shock, Boston College Working Paper (July
2012) (finding that in response to the September 2008 run on money
market funds, the funds first responded by selling their safest and
most liquid holdings). See also Stephan Jank & Michael Wedow, Sturm
und Drang in Money Market Funds: When Money Market Funds Cease to be
Narrow, Deutsche Bundesbank Discussion Paper No. 20/2008 (finding
that German money market funds enhanced their yield by investing in
less liquid securities in the lead up to the 2007-2008 subprime
crisis, but then experienced runs during the crisis, while more
liquid money market funds functioned as a safe haven). We note that
other mutual funds also may tend to deplete their most liquid assets
first to meet redemptions, but the incentive to redeem because of
the potential for declining fund liquidity may be stronger in money
market funds because of their use as a cash management vehicle and
the resulting heightened sensitivity to potential losses.
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Because the circumstances under which liquidity becomes expensive
historically have been infrequent, we expect that liquidity fees only
will be imposed when the fund's board of directors considers the fund's
liquidity costs to be at a premium and the liquidity fee, if imposed,
will apply only to those shareholders who redeem and cause the fund to
incur that cost. Under normal market conditions, fund shareholders
would continue to enjoy unfettered liquidity for money market fund
shares.\342\ As such, liquidity fees are designed to preserve the
current benefits of principal stability, liquidity, and a market yield
under most market conditions, but reduce the likelihood that ``when
markets are dislocated, costs that ought to be attributed to a
redeeming shareholder are externalized on remaining shareholders and on
the wider market.'' \343\
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\342\ See Comment Letter of J.P. Morgan Asset Management (Jan.
14, 2013) (available in File No. FSOC-2012-0003) (``J.P. Morgan FSOC
Comment Letter'') (``the standby character of [fees and gates]
proposals appropriately balances the goal of allowing MMFs to
operate normally when not under stress, yet promote stability,
flexibility and reasonable fairness when stressed.''); Comment
Letter of Wells Fargo Funds Management, LLC (Jan. 17, 2013)
(available in File No. FSOC-2012-0003) (``Wells Fargo FSOC Comment
Letter'') (stating that standby fees and gates are narrowly
tailored, ``imposed to address [run risk] while preserving money
market funds' key attributes'').
\343\ HSBC Global Asset Management, Liquidity Fees; a proposal
to reform money market funds (Nov. 3, 2011) (``HSBC 2011 Liquidity
Fees Paper'').
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In addition to liquidity fees, our proposal also would allow money
market funds to impose redemption gates after the liquidity threshold
is reached. Our proposal on liquidity fees and gates, however, could
affect shareholders by potentially limiting the full, unfettered
redeemability of money market fund shares under certain conditions, a
principle embodied in the Investment Company Act.\344\ Currently, a
money market fund generally can suspend redemptions only \345\ after
obtaining an exemptive order from the Commission or in accordance with
rule 22e-3, which requires the fund's board of directors to determine
that the fund is about to ``break the buck''
[[Page 36880]]
(specifically, that the extent of deviation between the fund's
amortized cost price per share and its current market-based net asset
value per share may result in material dilution or other unfair results
to investors).\346\ Under our proposal, a money market fund board could
decide to temporarily suspend redemptions once it had crossed the same
thresholds that can trigger the imposition of a liquidity fee.\347\ The
fund could use such a gate to assess the viability of the fund, to
create a ``circuit breaker'' giving time for a market panic to subside,
or to create ``breathing room'' to permit more fund assets to mature
and provide internal liquidity to the fund.\348\ In the 2009 Proposing
Release, we requested comment on whether we should include a provision
in rule 22e-3 that would permit fund directors to temporarily suspend
redemptions during certain exigent circumstances.\349\ Many commenters
on our 2009 Proposing Release supported our permitting such a temporary
suspension of redemptions.\350\
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\344\ Section III.B.3 infra discusses the rationale for the
exemptions from the Investment Company Act and related rules
proposed to permit money market funds to impose standby liquidity
fees and gates.
\345\ There are limited exceptions specified in section 22(e) of
the Act in which a money market fund (and any other mutual fund) may
suspend redemptions, such as (i) for any period (A) during which the
New York Stock Exchange is closed other than customary week-end and
holiday closings or (B) during which trading on the New York Stock
Exchange is restricted, or (ii) during any period in which an
emergency exists as a result of which (A) disposal by the fund of
securities owned by it is not reasonably practical or (B) it is not
reasonably practical for the fund to determine the value of its net
assets. The Commission also has granted orders in the past allowing
funds to suspend redemptions. See, e.g., In the Matter of The
Reserve Fund, Investment Company Act Release No. 28386 (Sept. 22,
2008) [73 FR 55572 (Sept. 25, 2008)] (order); Reserve Municipal
Money-Market Trust, et al., Investment Company Act Release No. 28466
(Oct. 24, 2008) [73 FR 64993 (Oct. 31, 2008)] (order).
\346\ Rule 22e-3(a)(1).
\347\ See proposed (Fees & Gates) rule 2a-7(c)(2)(ii).
\348\ See, e.g., Angel FSOC Comment Letter, supra note 60
(``gates that limit MMMF redemptions to the natural maturity of the
MMMF portfolios can prevent the forced selling of assets and
transform a disorderly run into an orderly walk to quality''); ICI
Jan. 24 FSOC Comment Letter, supra note 25 (noting that a gate
provides time for the fund to rebuild its liquidity as portfolio
securities mature).
\349\ Being able to impose a temporary suspension of redemptions
to calm instances of heightened redemptions had been recommended by
an industry report. ICI 2009 Report, supra note 56, at 85-89
(recommending that the Commission permit a fund's directors to
suspend temporarily the right of redemption if the board, including
a majority of its independent directors, determines that the fund's
net asset value is ``materially impaired'').
\350\ See, e.g., Comment Letter of Charles Schwab Investment
Management, Inc. (Sept. 4, 2009) (available in File No. S7-11-09)
(``Schwab 2009 Comment Letter''); Comment Letter of the Dreyfus
Corporation (Sept. 8, 2009) (available in File No. S7-11-09)
(``Dreyfus 2009 Comment Letter''); Comment Letter of Federated
Investors, Inc. (Sept. 8, 2009) (available in File No. S7-11-09); T.
Rowe Price 2009 Comment Letter, supra note 208. One commenter
opposed the Commission permitting a temporary suspension of
redemptions. See Comment Letter of Fund Democracy and the Consumer
Federation of America (Sept. 8, 2009) (available in File No. S7-11-
09) (stating that such a ``free time-out provision would increase
incentives to run for the exits before the fund is closed and
virtually guarantee that, once the fund was reopened, a flood of
redemptions will follow. The provision provides a potential escape
valve that will reduce fund managers' incentives to protect the
fund's NAV. The provision provides virtually no benefit to
shareholders while serving primarily to protect fund managers'
interests.'').
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We are proposing a combination of liquidity fees and gates because
we believe that liquidity fees and gates, while both aimed at helping
funds better and more systematically manage high levels of redemptions,
do so in different ways and thus with somewhat different tradeoffs.
Liquidity fees are designed to reduce shareholders' incentives to
redeem when it is abnormally costly for the fund to provide liquidity
by requiring redeeming shareholders to bear at least some of the
liquidity costs of their redemption (rather than transferring those
costs to remaining shareholders).\351\ To the extent that liquidity
fees paid exceed such costs, they also can help increase the fund's net
asset value for remaining shareholders which would have a restorative
effect if the fund has suffered a loss. As one commenter has said, a
liquidity fee can ``provide a strong disincentive for investors to make
further redemptions by causing them to choose between paying a premium
for current liquidity or delaying liquidity and benefitting from the
fees paid by redeeming investors.'' \352\ This explicit pricing of
liquidity costs in money market funds could offer significant benefits
to such funds and the broader short-term financing market in times of
potential stress by lessening both the frequency and effect of
shareholder redemptions.\353\ Unlike liquidity fees, gates are designed
to halt a run by stopping redemptions long enough to allow (1) fund
managers time to assess the appropriate strategy to meet redemptions,
(2) liquidity buffers to grow organically as securities mature, and (3)
shareholders to assess the level of liquidity in the fund and for any
shareholder panic to subside. We also note that gates are the one
regulatory reform discussed in this Release and the FSOC Proposed
Recommendations that definitively stops a run on a fund (by blocking
all redemptions).
---------------------------------------------------------------------------
\351\ See, e.g., Wells Fargo FSOC Comment Letter, supra note 342
(stating that a standby liquidity fee would ``provide an affirmative
reason for investors to avoid redeeming from a distressed fund'' and
``those who choose to redeem in spite of the liquidity fee will help
to support the fund's market-based NAV and thus reduce or eliminate
the potential harm associated with the timing of their redemptions
to other remaining investors'').
\352\ See ICI Jan. 24 FSOC Comment Letter, supra note 25.
\353\ We note that investors owning securities directly--as
opposed to through a money market fund--naturally bear these
liquidity costs. They bear these costs both because they bear any
losses if they have to sell a security at a discount in times of
stress to obtain their needed liquidity and because they directly
bear the risk of a less liquid investment portfolio if they sell
their most liquid holdings first to obtain needed liquidity.
---------------------------------------------------------------------------
Fees and gates also may have different levels of effectiveness
under different stress scenarios. For example, we expect that liquidity
fees will be able to reduce the harm to non-redeeming shareholders and
the broader markets when a fund faces heavy redemptions during periods
in which its true liquidity costs are less than the fund's imposed
liquidity fee. Redemptions during this time will increase the value of
the fund, which, in turn, will stabilize the fund to the extent
remaining shareholders' incentive to redeem shares is decreased.
However, it is possible that liquidity fees might not be fully
effective during periods of systemic crises because, for example,
shareholders might choose to redeem from money market funds
irrespective of the level of a fund's true liquidity costs and
imposition of the liquidity fee.\354\ In those cases, gates could
function as useful circuit breakers, allowing the fund time to rebuild
its own internal liquidity and shareholders to pause to reconsider
whether a redemption is warranted.
---------------------------------------------------------------------------
\354\ See RSFI Study, supra note 21, at 7-14 (discussing
different possible explanations for why shareholders may redeem from
money market funds in times of stress).
---------------------------------------------------------------------------
Finally, research in behavioral economics suggests that liquidity
fees may be particularly effective in dampening a run because, when
faced with two negative options, investors tend to prefer possible
losses over certain losses, even when the amount of possible loss is
significantly higher than the certain loss.\355\ Unlike gates, when a
liquidity fee is imposed, investors would make an economic decision
over whether to redeem. Therefore, under this behavioral economic
theory, investors fearing that a money market fund may suffer losses
may prefer to stay in the money market fund and avoid payment of the
liquidity fee (despite the possibility that the fund might suffer a
future loss) rather than redeem and lock in payment of the liquidity
fee.
---------------------------------------------------------------------------
\355\ See, e.g., Daniel Kahneman, Thinking, Fast and Slow
(2011), at 278-288.
---------------------------------------------------------------------------
We are proposing a combination of fees and gates, with a fee as the
initial default but with an optional ability for a fund's board to
replace the fee with a gate, or impose a gate immediately, in each case
as the board deems best for the fund.\356\ We are proposing this
structure as the initial default (rather than imposing a gate as the
default) because we believe that a fee has the potential to be less
disruptive to fund shareholders and the short-term financing markets
because a fee allows fund shareholders to continue to transact in times
of stress (although at a cost).\357\ At the same time, if the board
[[Page 36881]]
determines that a fee is insufficient to protect the interests of non-
redeeming shareholders, it still has the option of imposing a gate (and
perhaps later lifting the gate, but keeping in place the fee).
---------------------------------------------------------------------------
\356\ See proposed (Fees & Gates) rule 2a-7(c)(2).
\357\ See, e.g., Comment Letter of UBS on the IOSCO Consultation
Report on Money Market Fund Systemic Risk Analysis and Reform
Options (May 25, 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf) (``UBS IOSCO Comment Letter'') (``we are
convinced that [partial single swinging pricing] is more efficient
than gates as prices are more efficient signals of scarcity than
quantitative rationing''); Comment Letter of BNP Paribas on the
IOSCO Consultation Report on Money Market Fund Systemic Risk
Analysis and Reform Options (May 25, 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf (``BNP Paribas
IOSCO Comment Letter'') (``It would not make sense to restrict the
redeemer willing to pay the price of liquidity.'').
---------------------------------------------------------------------------
Many participants in the money market fund industry have expressed
support for imposing some form of a liquidity fee or gate on redeeming
money market fund investors when the fund comes under stress as a way
of reducing, in a targeted fashion, the fund's susceptibility to heavy
redemptions.\358\ Liquidity fees and gates are known to be able to
reduce incentives to redeem,\359\ and they have been used successfully
in the past by certain non-money market fund cash management pools to
stem redemptions during times of stress.\360\
---------------------------------------------------------------------------
\358\ See, e.g., BlackRock FSOC Comment Letter, supra note 204;
J.P. Morgan FSOC Comment Letter, supra note 342; Northern Trust FSOC
Comment Letter, supra note 174; Comment Letter of the Securities
Industry and Financial Markets Association (``SIFMA'') (Jan. 14,
2013) (available in File No. FSOC-2012-0003) (``SIFMA FSOC Comment
Letter''); Vanguard FSOC Comment Letter, supra note 172. See also
David M. Geffen & Joseph R. Fleming, Dodd-Frank and Mutual Funds:
Alternative Approaches to Systemic Risk, Bloomberg Law Reports (Jan.
2011) (``The alternative suggested here is that, during a period of
illiquidity, as declared by a money market fund's board (or,
alternatively, the SEC or another designated federal regulator), a
money market fund may impose a redemption fee on a large share
redemption approximately equal to the cost imposed by the redeeming
shareholder and other redeeming shareholders on the money market
fund's remaining shareholders. . . . The redemption fee causes the
large redeeming shareholder to internalize the cost of the negative
externality that the redemption otherwise would impose on non-
redeeming shareholders.''). But see, e.g., Comment Letter of the
U.S. Chamber of Commerce on the IOSCO Consultation Report on Money
Market Fund Systemic Risk Analysis and Reform Options (May 24,
2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf (``Imposing a liquidity fee is akin to implementing a
variable NAV, and as such, would preclude a number of companies from
investing in money market mutual funds. Although the liquidity fee
may not be imposed until the fund's portfolio falls below a
specified threshold or when there is a high volume of redemptions,
corporate treasurers have an obligation to ensure that ``a dollar in
will be a dollar out'' and therefore, will not risk investing cash
in an investment product that may not return 100 cents on the
dollar.''); Comment Letter of Federated Investors, Inc. on the IOSCO
Consultation Report on Money Market Fund Systemic Risk Analysis and
Reform Options (May 25, 2012) available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf (``Federated IOSCO Comment
Letter'') (``Federated believes that liquidity fees . . . are simply
a different way to break the dollar . . . and would generate large
preemptive redemptions from MMFs'').
\359\ Cf. G.W. Schwert & P.J. Seguin, Securities Transaction
Taxes: An Overview of Costs, Benefits and Unresolved Questions, 49
Financial Analysts Journal 27 (1993); K.A. Froot & J. Campbell,
International Experiences with Securities Transaction Taxes, in The
Internationalization of Equity Markets (J. Frankel, ed., 1994), at
277-308.
\360\ A Florida local government investment pool experienced a
run in 2007 due to its holdings in SIV securities. The fund
suspended redemptions and ultimately reopened but after the fund
(and each shareholder's interest) had been split into two separate
funds: One holding the more illiquid securities previously held by
the pool (called ``Fund B'') and one holding the remaining
securities of the fund. Fund B reopened with a 2% redemption fee and
did not generate a run upon its reopening. See David Evans and
Darrell Preston, Florida Investment Chief Quits; Fund Rescue
Approved, Bloomberg (Dec. 4, 2007); Helen Huntley, State Wants Fund
Audit, Tampa Bay Times (Dec. 11, 2007). Some European enhanced cash
funds also successfully used fees or gates during the financial
crisis to stem redemptions. See Elias Bengtsson, Shadow Banking and
Financial Stability: European Money Market Funds in the Global
Financial Crisis (2011) (``Bengtsson''), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1772746&download=yes;
Julie Ansidei, et al., Money Market Funds in Europe and Financial
Stability, European Systemic Risk Board Occasional Paper No. 1, at
36 (June 2012), available at http://www.esrb.europa.eu/pub/pdf/occasional/20120622_occasional_paper.pdf.
---------------------------------------------------------------------------
We recognize that the prospect of a fund imposing a liquidity fee
or gate could raise a concern that shareholders will engage in
preemptive redemptions if they fear the imminent imposition of fees or
gates (either because of the fund's situation or because such
redemption restrictions have been triggered in other money market
funds).\361\ We expect the opportunity for preemptive redemptions will
decrease as a result of the amount of discretion fund boards would have
in imposing liquidity fees and gates, because shareholders would not be
able to accurately predict when, and under what circumstances, fees and
gates may be imposed.\362\ Shareholders also might rationally choose to
follow other shareholders' redemptions even when those other
shareholders' decisions are not necessarily based on superior private
information.\363\ General stress in the short-term markets or fears of
stress at a particular fund could trigger redemptions as shareholders
try to avoid the fee.
---------------------------------------------------------------------------
\361\ See, e.g., FSOC Proposed Recommendations, supra note 114,
at 62-63; Harvard Business School FSOC Comment Letter, supra note 24
(``news that one MMF has initiated redemption restrictions could set
off a system-wide run by panic-stricken investors who are anxious to
redeem their shares before other funds also initiate
restrictions''); Comment Letter of The Systemic Risk Council (Jan.
18, 2013) (available in File No. FSOC 2012-0003) (``Systemic Risk
Council FSOC Comment Letter'') (stating that temporary gates or fees
that come down in a crisis do not address the structural problem of
the $1.00 NAV and would move up a run on money market funds).
Empirical evidence in the equity and futures markets demonstrates
that investors may trade in advance of circuit breakers being
triggered so as to not be left in temporarily illiquid positions.
Investors have been found to trade ahead of predictable market
closings and price limit hits. Empirical studies document trading
pressure before trading halts. See Y. Amihud & H. Mendelson, Trading
Mechanisms and Stock Returns: An Empirical Investigation, 42 J. Fin.
533-553 (1987); Y. Amihud & H. Mendelson, Volatility, Efficiency and
Trading: Evidence from the Japanese Stock Market, 46 J. Fin. 1765-
1789 (1991); H.R. Stoll & R. E. Whaley, Stock Market Structure and
Volatility, 3 Review of Financial Studies 37-71 (1990); M.S. Gerety
& J.H. Mulherin, Trading Halts and Market Activity: An Analysis of
Volume at the Open and the Close, 47 J. Fin. 1765-1784 (1992).
Empirical studies show trading volume accelerates before a price
limit hits. See Y. Du, et al., An Analysis of the Magnet Effect
under Price Limits, 9 International Review of Fin. 83-110 (2009);
G.J. Kuserk & P.R. Locke, Market Making With Price Limits, 16 J.
Futures Markets 677-696 (1996). An experimental study finds that
mandated market closures accelerate trading activity when an
interruption is imminent. See L.F. Ackert, et al., An Experimental
Study of Circuit Breakers: The Effects of Mandated Market Closures
and Temporary Halts on Market Behavior, 4 J. Financial Markets 185-
208 (2001). Empirical studies report trading volume increases
following trading halts and price limit hits. See, e.g., S.A. Corwin
& M.L. Lipson, Order Flow and Liquidity around NYSE Trading Halts,
55 J. Fin. 1771-1801 (2000); W.G. Christie, et al., Nasdaq Trading
Halts: The Impact of Market Mechanisms on Prices, Trading Activity,
and Execution Costs, 57 J. Fin. 1443-1478 (2002); and C.M.C. Lee, et
al., Volume, Volatility, and New York Stock Exchange Trading Halts,
49 J. Fin. 183-213 (1994). See also K.A. Kim & S.G. Rhee, Price
Limit Performance: Evidence from the Tokyo Stock Exchange, 52 J.
Fin. 885-901 (1997).
\362\ See A. Subrahmanyam, On Rules Versus Discretion in
Procedures to Halt Trade, 47 J. Economics and Business 1-16 (1995);
A. Subrahmanyam, The Ex-Ante Effects of Trade Halting Rules on
Informed Trading Strategies and Market Liquidity, 6 Rev. Financial
Economics 1-14 (1997).
\363\ Theoretical models show investors may rationally follow
others' actions, even though these other investors' decisions are
not necessarily based on superior private information. See S.
Bikhchandani, et al., A Theory of Fads, Fashion, Custom, and
Cultural Change as Informational Cascades, 100 J. Pol. Econ. 992-
1026 (1992); I. Welch, Sequential Sales, Learning, and Cascades, 47
J. Fin. 695-732 (1992). Experimental data demonstrates investors may
overreact to uninformative trades. See C. Camerer & K. Weigelt,
Information Mirages in Experimental Asset Markets, 64 J. Bus. 463-
493 (1991). Price limits, which are loosely akin to trading
suspensions, may help to protect markets from destabilizing trades.
See F. Westerhoff, Speculative markets and the effectiveness of
price limits, 28 J. Econ. Dynamics and Control 493-508 (2003).
---------------------------------------------------------------------------
While we acknowledge that liquidity fees may not always preclude
redemptions, fees are designed so that as redemptions begin to
increase, if liquidity costs exceed the prescribed threshold for
imposing a fee and the fund imposes a fee, the run will be halted. The
fees, once imposed, should both curtail the level of redemptions, and
fees paid by those that do redeem should, at least partially, cover
liquidity costs incurred by funds and may even potentially repair the
NAV of any funds that have suffered losses. One
[[Page 36882]]
circumstance under which liquidity fees would not self-correct is if
the amount of the fee is less than or exactly equal to the fund's
realized liquidity costs. Gates would not be self-correcting in the
event of realized portfolio losses, but they can help the fund preserve
assets and generate more internal liquidity as assets mature. Some
commenters have considered whether liquidity fees and gates might
precipitate a run. For example, some commenters have expressed their
view that a liquidity fee or gate would not accelerate a run, stating
that such redemptions would likely trigger the fee or gate and that,
once triggered, the fee or gate would then lessen or halt
redemptions.\364\ Even if investors have an incentive to redeem, their
redemptions eventually will cause a fee or gate to come down and halt
the run.
---------------------------------------------------------------------------
\364\ See, e.g., HSBC EC Letter, supra note 156 (``Some
commentators have objected that a trigger-based liquidity fee would
cause investors to seek to redeem prior to the imposition of the
fee. We disagree with this argument, which misunderstands the cause
of investor redemptions. . . . A liquidity fee would be imposed as a
consequence of investors' loss of confidence/flight to quality. It
could not, therefore, be the cause of investors' loss of confidence/
flight to quality.'') (emphasis in original); J.P. Morgan FSOC
Comment Letter, supra note 342 (standby liquidity fees ``do not
prevent an initial run, but they do provide a useful tool to slow a
run after one has begun''); SIFMA FSOC Comment Letter, supra note
358 (``the operation of the proposed gate and liquidity fee
themselves will stem any exodus and damper its effect''); Wells
Fargo FSOC Comment Letter, supra note 342 (``To the extent that
investor redemptions made for the purpose of avoiding a liquidity
fee have the effect of accelerating a run . . . the redemption gate
and liquidity fee apply an equally strong countermeasure. First, the
redemption gate would halt the run, and second, the ensuing
imposition of liquidity fees would either cause further redemption
activity to cease or monetize further redemptions into transactions
that are accretive, rather than dilutive, to a fund's market-to-
market NAV. The redemption gate and liquidity fee operate to
effectively reverse and repair any accelerated redemption activity
the existence of the liquidity fee might otherwise induce.
Redemption gates and liquidity fee mechanisms applying to all other
money market funds would also mitigate any contagion risk.'').
---------------------------------------------------------------------------
Under this proposal, money market funds would have the benefit of
being able to use the penny rounding method of pricing for their
portfolios. As discussed further below in section III.F.4 and III.F.5,
they would also have to provide much fuller transparency of the market-
based NAV per share of the funds and the marked-based value of the
funds' portfolio securities. This increased transparency is designed to
allow better shareholder understanding of deviations between the fund's
value using market-based factors and its stable price. It also is aimed
at helping investors better understand any risk involved in money
market fund investments as a result of rule 2a-7's rounding convention.
However, retaining these valuation and pricing methods for money market
funds does not eliminate the ability of investors to redeem ahead of
other investors from a money market fund that is about to ``break the
buck'' and consequently may permit those early redeemers to receive
$1.00 per share instead of its market value as discussed in section
III.A above. Nevertheless, in times of fund or market stress the fund
is likely to impose either liquidity fees or gates, which will limit
the ability of redeeming shareholders to receive more than their pro-
rata share of the market-based value of the fund's assets.
Requiring that boards impose liquidity fees absent a finding that
the fee is not in the best interest of the fund, and permitting them to
impose gates once the fund has crossed certain thresholds could offer
advantages to the fund in addition to better and more systematically
managing liquidity and redemption activity. They could provide fund
managers with a powerful incentive to carefully monitor shareholder
concentration and shareholder flow to lessen the chance that the fund
would have to impose liquidity fees or gates in times of market stress
(because larger redemptions are more likely to cause the fund to breach
the threshold). Such a requirement also could encourage portfolio
managers to increase the level of daily and weekly liquid assets in the
fund, as that would tend to lessen the likelihood of a liquidity fee or
gate being imposed.\365\ Further, because our proposal provides the
board discretion not to impose the liquidity fee (or to impose a lower
liquidity fee) and gives boards the option to impose gates, the boards
of directors can impose fees or gates when the board determines that it
is in the best interest of the fund to do so.
---------------------------------------------------------------------------
\365\ See, e.g., Vanguard FSOC Comment Letter, supra note 172 (a
standby liquidity fee along with daily disclosure of the fund's
liquidity levels ``will serve as an effective tool to force
investment advisors, particularly those managing funds with highly
concentrated shareholder bases, to manage their funds with adequate
liquidity to prevent the [standby liquidity fee] from ever being
triggered'').
---------------------------------------------------------------------------
The prospect of facing fees and gates when a fund is under stress
serves to make the risk of investing in a money market fund more
transparent and to better inform and sensitize investors to the
inherent risks of investing in money market funds. Fees and gates also
could encourage shareholders to monitor and exert market discipline
over the fund to reduce the likelihood that either the imposition of
fees or gates will become necessary in that fund.\366\ An additional
benefit to the board's determination of liquidity fees and gates is
that they create an incentive for money market fund managers to better
and more systemically manage redemptions in all market conditions.\367\
---------------------------------------------------------------------------
\366\ See, e.g., Vanguard FSOC Comment Letter, supra note 172 (a
standby liquidity fee ``will encourage advisors and investors to
self-police to avoid triggering the fee'').
\367\ See, e.g., HSBC 2011 Liquidity Fees Letter, supra note 343
(a liquidity fee ``will result in more effective pricing of risk (in
this case, liquidity risk) . . . [and] act as a market-based
mechanism for improving the robustness and fairness'' of money
market funds); BlackRock FSOC Comment Letter, supra note 204 (``A
fund manager will focus on managing both assets and liabilities to
avoid triggering a gate. On the liability side, a fund manager will
be incented to know the underlying clients and model their behavior
to anticipate cash flow needs under various scenarios. In the event
a fund manager sees increased redemption behavior or sees reduced
liquidity in the markets, the fund manager will be incented to
address potential problems as early as possible.'')
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Our proposal on liquidity fees and gates, however, could affect
shareholders by potentially limiting the full, unfettered redeemability
of money market fund shares under certain conditions, a principle
embodied in the Investment Company Act.\368\ Thus, this alternative, if
adopted, could result in some shareholders redeeming their money market
fund shares and moving their assets to alternative products (or
government money market funds) out of concern that the potential
imposition of a liquidity fee or gate could make investment in a money
market fund less attractive due to less certain liquidity.\369\ We also
recognize that the imposition of a gate may affect the efficiency of
money market fund shareholders' investment allocations and have
corresponding impacts on capital formation if the redemption
[[Page 36883]]
restriction prevents shareholders from moving cash invested in money
market funds to other investment alternatives that might be preferable
at the time.
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\368\ Section III.B.3 infra discusses the rationale for the
exemptions from the Investment Company Act and related rules
proposed to permit money market funds to impose standby liquidity
fees and gates.
\369\ See infra section III.E for a discussion of the potential
effects on money market fund investments and capital formation as a
result of this alternative, if adopted. See also Comment Letter of
Fidelity (Feb. 3, 2012) (available in File No. 4-619) (finding in a
survey of their retail money market fund customers that 43% would
stop using a money market fund with a 1% non-refundable redemption
fee charged if the fund's NAV per share fell below $0.9975 and 27%
would decrease their use of such a fund); Federated IOSCO Comment
Letter, supra note 358 (stating that they anticipate ``that many
investors will choose not to invest in MMFs that are subject to
liquidity fees, and will redeem existing investments in MMFs that
impose a liquidity fee'' but noting that ``[s]hareholder attitudes
to redemption fees on MMFs are untested''). But see HSBC EC Letter,
supra note 156 (``A liquidity fee [triggered by a fall in the fund's
market-based NAV] should also be acceptable to investors, because it
can be rationalized in terms of investor protection. (When we've
presented the case for a liquidity fee in these terms to our
investors, they have generally been receptive.)'').
---------------------------------------------------------------------------
We request comment on our discussion of the economic basis and
tradeoffs for this alternative.
Would our proposal on liquidity fees and gates achieve our
goals of preserving the benefits of stable share price money market
funds for the widest range of investors and the availability of short-
term financing for issuers while enhancing investor protection and risk
transparency, making funds more resilient to mass redemptions and
improving money market funds' ability to manage and mitigate potential
contagion from high levels of redemptions? Are there other benefits
that we have not identified and discussed?
Would a liquidity fee provide many of the same potential
benefits as the proposed floating NAV? If not, what are the differences
in potential benefits? Would it result in a more effective pricing of
liquidity risk into the funds' share prices and a fairer allocation of
that cost among shareholders? Would a liquidity fee that potentially
restores the fund's shadow price reduce some remaining shareholders
incentive to redeem?
Would the prospect of a fee or gate encourage investors to
limit their concentration in a particular fund? Would an appropriately
structured threshold for liquidity fees and gates provide an incentive
for fund managers to monitor shareholder concentration and flows as
well as portfolio composition to minimize the possibility of a fund
applying a fee or gate? Would it encourage better board monitoring of
the fund? Would it encourage shareholders to monitor and exert
appropriate discipline over the fund? Would shareholders underestimate
whether a fee or gate would ever be imposed by the board? How would the
prospect of a fee or gate affect shareholder behavior?
How will the liquidity fees or gates affect the fund's
portfolio choices? Will it affect the way funds manage their weekly
liquid assets?
Funds currently have the ability to delay the payment of
redemption proceeds for up to seven days.\370\ Are there considerations
that make funds hesitant to impose this delay that would also make
funds hesitant to impose fees or gates? What are those factors?
---------------------------------------------------------------------------
\370\ See section 22(e) of the Investment Company Act.
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Would the expected imposition of a liquidity fee or gate
increase redemption activity as the fund's liquidity levels near the
threshold? Would the prospect of a liquidity fee or gate create an
incentive to redeem during times of potential stress by shareholders
fearing that such a fee or gate might be imposed, thus inciting a run?
If so, do commenters agree that in such a case the redemptions would
trigger a fee or gate and slow or halt redemptions? If not, are there
ways in which we could modify our proposed threshold for liquidity fees
and gates such that a run could not arise without triggering fees or
gates? What information would be needed for investors to reliably
predict that a fund is on the verge of imposing fees or gates? Would
the necessary information be readily available under our proposal?
Are some types of shareholders more likely than other
types of shareholders to attempt to redeem in anticipation of the
imposition of the fee or gate? Are there ways that we could reduce the
risk of pre-emptive redemptions? Would imposition of a fee or gate as a
practical matter lead to liquidation of that fund? If so, should this
be a concern?
Is penny rounding sufficient to allow government money
market funds to maintain a stable price? Should we also permit these
funds to use amortized cost valuation? If so, why?
Should we prohibit advisers to money market funds from
charging management fees while the fund is gated? How might this affect
advisers' incentives to make recommendations to the board when it is
considering whether to not impose a liquidity fee or gate?
We note that we are not proposing to repeal or otherwise modify
rule 17a-9 (permitting sponsors to support money market funds through
portfolio purchases in some circumstances) under this proposal.
Therefore, money market fund sponsors would be able to continue to
support the money market funds they manage by purchasing securities
from money market fund portfolios at their amortized cost value (or
market price, if greater). Instead, we are requiring greater and more
timely disclosure of any sponsor support of a money market fund, as
further described in section III.F.1 below. We note that some sponsors
could use such support to prevent a money market fund from breaching a
threshold that would otherwise require the board to consider imposition
of a liquidity fee. Such support could benefit fund shareholders by
preventing them from incurring the costs or loss of liquidity that a
liquidity fee or gate may entail. However, because such support would
be discretionary, its possibility may create uncertainty about whether
fund investors will have to bear the costs and burdens of a liquidity
fee or gate in times of stress, which could lead to unpredictable
shareholder behavior and inefficient shareholder allocation of
investments if their expectations of risk turn out to be misplaced. Our
continuing to permit sponsor support of money market funds, albeit with
greater transparency,\371\ also could favor money market fund groups
with a well-capitalized sponsor that is better able to provide
discretionary support to its affiliated money market funds and thus
avoid the imposition of fees or gates. Nonetheless, even the
expectation of possible discretionary sponsor support may tend to slow
redemptions. We request comment on the retention of rule 17a-9 under
this proposal.
---------------------------------------------------------------------------
\371\ See infra section III.F.
---------------------------------------------------------------------------
Should we continue to allow this type of sponsor support
of money market funds, given the enhanced transparency requirements?
Would allowing sponsor support prevent or limit this proposal from
achieving the goal of enhancing investor protection and improving money
market funds' ability to manage high levels of redemptions? If so, how?
Should we instead prohibit sponsor support under this option? If so,
why? If we prohibited sponsor support, how would this advance investor
protection if such support would protect the value or liquidity of the
fund? Should we modify rule 17a-9 to limit or condition sponsor
support?
Would sponsors provide support to prevent a money market
fund from breaching a liquidity threshold? Would sponsors be more
willing and able to provide support to stabilize the fund under the
liquidity fees and gates proposal than they were to support money
market funds before the 2007-2008 financial crisis? Why or why not?
As discussed further below, we also are proposing to require that
money market funds disclose their market-based NAVs and levels of daily
and weekly liquid assets on a daily basis on the funds' Web sites.\372\
---------------------------------------------------------------------------
\372\ See infra section III.F.
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2. Terms of the Liquidity Fees and Gates
We are proposing that if a money market fund's weekly liquid assets
fall or remain below 15% of its total assets at the end of any business
day, the next business day it must impose a 2% liquidity fee on each
shareholder's redemptions, unless the fund's board of directors
(including a majority of its independent directors) determines that
[[Page 36884]]
such a fee would not be in the best interest of the fund or determines
that a lower fee would be in the best interest of the fund.\373\ Any
fee imposed would be lifted automatically once the money market fund's
level of weekly liquid assets had risen to or above 30%, and it could
be lifted at any time by the board of directors (including a majority
of its independent directors) if the board determines to impose a
different fee or if it determines that imposing the fee is no longer in
the best interest of the fund.\374\
---------------------------------------------------------------------------
\373\ Proposed (Fees & Gates) rule 2a-7(c)(2)(i). A ``business
day,'' defined in rule 2a-7 as ``any day, other than Saturday,
Sunday, or any customary business holiday,'' would end after 11:59
p.m. on that day. See rule 2a-7(a)(4). If the shareholder of record
making the redemption was a direct shareholder (and not a financial
intermediary), we would expect the fee to apply to that
shareholder's net redemptions for the day. In order to provide the
money market fund flexibility, if a liquidity fee were in place for
more than one business day, the fund's board could vary the level of
the liquidity fee (subject to the 2% limit) if the board determined
that a different fee level was in the best interest of the fund.
Proposed (Fees & Gates) rule 2a-7(c)(2)(i)(A). The new fee level
would take effect the next business day following the board's
determination. Id.
\374\ Proposed (Fees & Gates) rule 2a-7(c)(2)(i)(B).
---------------------------------------------------------------------------
In addition, once the fund had crossed below the 15% threshold, the
fund's board of directors (including a majority of its independent
directors) would be able to temporarily suspend redemptions and gate
the fund if the board determines that doing so is in the best interest
of the fund.\375\ Any gate imposed also would be automatically lifted
once the fund's weekly liquid assets had risen back to or above 30% of
its total assets (although the board of directors (including a majority
of its independent directors) could lift the gate earlier.\376\ Any
money market fund that imposes a gate would need to lift that gate
within 30 days and a money market fund could not impose a gate for more
than 30 days in any 90-day period.\377\ Under this proposal, we also
would amend rule 22e-3 to permit the suspension of redemptions and
liquidation of a money market fund if the fund's level of weekly liquid
assets falls below 15% of its total assets.\378\
---------------------------------------------------------------------------
\375\ The fund must reject any redemption requests it receives
while the fund is gated. See proposed (Fees & Gates) rule 2a-
7(c)(2)(ii).
\376\ Proposed (Fees & Gates) rule 2a-7(c)(2)(ii).
\377\ Proposed (Fees & Gates) rule 2a-7(c)(2)(ii). We also note
that an adviser to a money market fund could seek an exemptive order
from the Commission to allow for continued gating beyond 30 days if
such gating would be necessary or appropriate in the public interest
and consistent with the protection of investors and the purposes
fairly intended by the policy and provisions of the Investment
Company Act.
\378\ See proposed (Fees & Gates) rule 22e-3.
---------------------------------------------------------------------------
a. Discretionary Versus Mandatory Liquidity Fees and Gates
We are proposing a default liquidity fee that the money market
fund's board of directors can modify or remove if it is in the best
interest of the fund, because this structure offers the possibility of
achieving many of the benefits of both fully discretionary and
automatic (regulatory mandated) redemption restriction triggers. A
purely discretionary trigger allows a fund board the flexibility to
determine when a restriction is necessary, and thus allows tailoring of
the triggering of the fee to the market conditions at the time, and the
specific circumstances of the fund. However, a purely discretionary
trigger creates the risk that a fund board may be reluctant to impose
restrictions, even when they would benefit the fund and the short-term
financing markets. They may not impose such restrictions out of fear
that doing so signals trouble for the individual fund or fund complex
(and thus may incur significant business and reputational effects) or
could incite redemptions in other money market funds in anticipation
that fees may be imposed in those funds as well. Fully discretionary
triggers also provide shareholders with little advance knowledge of
when such a restriction might be triggered and fund boards could end up
applying them in a very disparate manner. Fully discretionary triggers
also may present operational difficulties for fund managers who
suddenly may need to implement a liquidity fee and may not have systems
in place that can rapidly institute a fee whose trigger and size was
previously unknown.
Automatic triggers set by the Commission may mitigate these
potential concerns, but they create a risk of imposing costs on
shareholders when funds are not truly distressed or when liquidity is
not abnormally costly. Establishing thresholds that result in the
imposition of a fee, unless the board makes a finding that such a fee
is not in the best interest of the fund, balances these tradeoffs by
providing some transparency to shareholders on potential fee or gate
triggers and giving some guidance to boards on when a fee or gate might
be appropriate. At the same time, it also allows boards to avoid
imposing a fee or gate when it would be inappropriate in light of the
circumstances of the fund and the conditions in the market.
Our proposed rule essentially creates a default liquidity fee of a
pre-determined size, imposed when the fund's weekly liquid assets have
dropped below a certain threshold. However, it provides the fund's
board flexibility to alter the default option--for example, by imposing
a gate instead of a fee or by imposing a fee at a different threshold
or imposing a lower percentage fee--as long as it determines that doing
so is in the best interest of the fund.
We request comment on our proposed default structure for the
liquidity fees and gates.
Should the imposition of a liquidity fee or gate be fully
discretionary or should it have a completely automatic trigger? Why?
Would a money market fund's board of directors impose a
fully discretionary fee or gate during times of stress on the money
market fund despite its possible unpopularity with investors and
potential competitive disadvantage for the fund or fund group if other
funds are not imposing a liquidity fee or gate? On the other hand,
would a fund's board of directors be able to best determine when a fee
or gate should be imposed rather than an automatic trigger?
What operational complexities would be involved in a fully
discretionary liquidity fee? Would fund complexes and their
intermediaries be able to program systems in advance to accommodate the
immediate imposition of a liquidity fee whose trigger and size were
unknown in advance?
b. Threshold for Liquidity Fees and Gates
We are proposing that a liquidity fee automatically be imposed on
money market fund redemptions if the fund's weekly liquid assets fall
below 15% of its total assets, unless the fund's board of directors
(including a majority of its independent directors) determines that a
fee would not be in the best interest of the fund.\379\ We also are
proposing that, once the fund has crossed below this threshold, the
money market fund board also would have the ability to impose a
temporary gate for a limited period of time provided that the board of
directors (including a majority of its independent directors)
determines that imposing a gate is in the fund's best interest.\380\
Any fee or gate imposed would be automatically lifted when the fund's
weekly liquid assets had risen back to or above 30% of its total assets
(although the board of directors (including a majority of its
independent directors) could lift the fee or gate earlier if the board
determined it was in the best interest of the fund.\381\
---------------------------------------------------------------------------
\379\ See proposed (Fees & Gates) rule 2a-7(c)(2)(i).
\380\ See proposed (Fees & Gates) rule 2a-7(c)(2)(ii).
\381\ Proposed (Fees & Gates) rule 2a-7(c)(2).
---------------------------------------------------------------------------
[[Page 36885]]
Our proposed 15% weekly liquid asset threshold is a default for
money market funds imposing liquidity fees that requires the board to
consider taking action. Fund boards of directors have the flexibility
to impose a liquidity fee or gate if weekly liquid assets fall below
this threshold (or they may determine not to impose a liquidity fee or
gate at all), and can continue to reconsider their decision in light of
new events as long as the fund is below this liquidity threshold.\382\
Several industry commenters have recommended basing imposition of a
liquidity fee on the money market fund's level of weekly liquid assets,
with their proposed thresholds ranging from 7.5% to 15% of weekly
liquid assets.\383\ As shown in the chart below, our staff's analysis
of Form N-MFP data shows that, between March 2011 and October 2012,
there were two months in which funds reported weekly liquid assets
below 15% (one fund in May 2011, and four funds in June 2011) and there
were two months in which funds reported weekly liquid assets of at
least 15% but below 20% (one fund in March 2011, and one fund in
February 2012).
---------------------------------------------------------------------------
\382\ See infra text preceding n.385.
\383\ See, e.g., BlackRock FSOC Comment Letter, supra note 204
(recommending an automatic trigger of 15% weekly liquid assets); ICI
Jan. 24 FSOC Comment Letter, supra note 25 (recommending an
automatic trigger of between 7.5% and 15% weekly liquid assets);
Vanguard FSOC Comment Letter, supra note 172 (recommending an
automatic trigger of 15% weekly liquid assets).
---------------------------------------------------------------------------
Fees and gates are a tool to mitigate problems in funds, so we
selected a threshold that would indicate distress in a fund, but also
one that few funds would cross in the ordinary course of business,
allowing funds and their boards to avoid the costs of frequent
unnecessary consideration of fees and gates. The analysis below shows
that if the triggering threshold was between 25-30% weekly liquid
assets, funds would have crossed this threshold every month except one
during the period, and if it was set at between 20-25% weekly liquid
assets, some funds would have crossed it nearly every other month.
However, the analysis shows that funds rarely cross the threshold of
between 15-20% weekly liquid assets during normal operations, and that
during the time period analyzed, there were only 2 months that had any
funds below the 15% weekly liquid assets threshold.
Distribution of Weekly Liquid Assets in Prime Money Market Funds, March 2011--October 2012 \384\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Date [0.00-0.05] [0.05-0.10] [0.10-0.15] [0.15-0.20] [0.20-0.25] [0.25-0.30] Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mar-11.................................. .............. .............. .............. 1 1 11 259
Apr-11.................................. .............. .............. .............. .............. .............. 3 261
May-11.................................. .............. 1 .............. .............. 2 9 260
Jun-11.................................. .............. .............. 4 .............. 2 25 257
Jul-11.................................. .............. .............. .............. .............. .............. 3 257
Aug-11.................................. .............. .............. .............. .............. 3 10 256
Sep-11.................................. .............. .............. .............. .............. .............. 5 256
Oct-11.................................. .............. .............. .............. .............. 1 6 258
Nov-11.................................. .............. .............. .............. .............. .............. 4 257
Dec-11.................................. .............. .............. .............. .............. .............. 7 256
Jan-12.................................. .............. .............. .............. .............. .............. 3 256
Feb-12.................................. .............. .............. .............. 1 .............. 2 255
Mar-12.................................. .............. .............. .............. .............. .............. 5 251
Apr-12.................................. .............. .............. .............. .............. .............. .............. 248
May-12.................................. .............. .............. .............. .............. .............. 7 247
Jun-12.................................. .............. .............. .............. .............. 1 4 245
Jul-12.................................. .............. .............. .............. .............. 1 3 245
Aug-12.................................. .............. .............. .............. .............. .............. 4 244
Sep-12.................................. .............. .............. .............. .............. 1 6 241
Oct-12.................................. .............. .............. .............. .............. .............. 2 241
--------------------------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------
\384\ For purposes of our analysis, the monthly distribution of
prime money market funds with weekly liquid assets above 30% is not
shown.
---------------------------------------------------------------------------
Because the data on liquidity is reported at the end of the month,
it could be the case that more than four money market funds' level of
weekly liquid assets fell below 15% on other days of the month during
our period of study. However, this number may overestimate the
percentage of funds that are expected to impose a fee or gate because
we expect that funds would increase their risk management around their
level of weekly liquid assets in response to the fees and gates
requirement to avoid breaching the liquidity threshold. Using this
information to inform our choice of the appropriate level for a weekly
liquid asset threshold, we are proposing a 15% weekly liquid assets
threshold to balance the desire to have such consideration triggered
while the fund still had liquidity reserves to meet redemptions but
also not set the trigger at a level that frequently would be tripped by
normal fluctuations in liquidity levels that typically would not
indicate a fund under stress.
We are proposing to require that any fee or gate be lifted
automatically once the fund's weekly liquid assets have risen back
above 30% of the fund's assets--the minimum currently mandated under
rule 2a-7--and thus a fee or gate would appear to be no longer
justified. We considered whether a fee or gate should be lifted
automatically before the fund's weekly liquid assets were completely
restored to their required minimum--for example, once they had risen to
25%. However, we preliminarily believe that automatically removing such
a restriction before the fund's level of weekly liquid assets was fully
replenished may result in a fund being unable to maintain a liquidity
fee or gate to protect the fund even when the fund is still under
stress and before stressed market conditions have fully subsided. We
note that a fund's board can always determine to lift a fee or gate
before the fund's level of weekly liquid assets is restored to 30% of
its assets.
There are a number of factors that a fund's board of directors may
consider in determining whether to impose a liquidity fee once the
fund's weekly liquid assets have fallen below 15% of its total assets.
For example, it may want to consider why the level of weekly
[[Page 36886]]
liquid assets has fallen. Is it because the fund is experiencing
mounting redemptions during a time of market stress or is it because a
few large shareholders unexpectedly redeemed for idiosyncratic reasons
unrelated to current market conditions? Another relevant factor to the
fund board may be whether the fall in weekly liquid assets has been
accompanied by a fall in the fund's shadow price. The fund board also
may want to consider whether the fall in weekly liquid assets is likely
to be very short-term. For example, will the fall in weekly liquid
assets be cured in the next day or two when securities currently in the
fund's portfolio qualify as weekly liquid assets? Many money market
funds ``ladder'' the maturities of their portfolio securities, and thus
it could be the case that a fall in weekly liquid assets will be
rapidly cured by the portfolio's maturity structure.
We considered instead proposing a threshold based on the shadow
price of the money market fund. For example, one money market fund
sponsor has suggested that we require money market funds' boards of
directors to consider charging a liquidity fee on redeeming
shareholders if the shadow price of a fund's portfolio fell below a
specified threshold.\385\ This commenter asserted that such a trigger
would ensure that shareholders only pay a fee when redemptions would
actually cause the fund to suffer a loss and thus redemptions clearly
disadvantage remaining shareholders. However, we are concerned that a
money market fund being able to impose a fee only when the fund's
shadow price has fallen by some amount below $1.00 in certain cases may
come too late to mitigate the potential consequences of heavy
redemptions and to fully protect investors. Heavy redemptions can
impose adverse economic consequences on a money market fund even before
the fund actually suffers a loss. They can deplete the fund's most
liquid assets so that the fund is in a substantially weaker position to
absorb further redemptions or losses. In addition, our proposed
threshold is a default trigger for the liquidity fee--the board is not
required to impose a liquidity fee when the fund's weekly liquid assets
have fallen below 15%. Thus, a board can take into account whether the
money market fund's shadow price has deteriorated in determining
whether to impose a liquidity fee or gate when the fund's weekly liquid
assets have fallen below the threshold. A threshold based on shadow
prices also raises questions about whether and to what extent
shareholders differentiate between realized (such as those from
security defaults) and market-based losses (such as those from market
interest rate changes) when considering a money market fund's shadow
price. If shareholders do not redeem in response to market-based losses
(as opposed to realized losses), it may be inappropriate to base a fee
on a fall in the fund's shadow price if such a fall is only temporary.
On the other hand, a temporary decline in the shadow price using
market-based factors can lead to realized losses from a shareholder's
perspective if redemptions cause a fund with an impaired NAV to ``break
the buck.''
---------------------------------------------------------------------------
\385\ HSBC FSOC Comment Letter, supra note 196 (suggesting
setting the market-based NAV trigger at $0.9975).
---------------------------------------------------------------------------
We also considered proposing a threshold based on the level of
daily liquid assets rather than weekly liquid assets. We expect that a
money market fund would meet heightened shareholder redemptions first
by depleting the fund's daily liquid assets and next by depleting its
weekly liquid assets, as daily liquid assets tend to be the most
liquid. Accordingly, basing this threshold on weekly liquid assets thus
provides a deeper picture of the fund's overall liquidity position, as
a fund whose weekly liquid assets have fallen to 15% has likely
depleted all of its daily liquid assets. In addition, a fund's levels
of daily liquid assets may be more volatile because they are one of the
first assets used to satisfy day-to-day shareholder redemptions, and
thus more difficult to use as a gauge of true fund distress. Finally,
as noted above, funds are able under the Investment Company Act to
delay payment of redemption requests for up to seven days. Thus,
substantial depletion of weekly liquid assets may be a better indicator
of true fund distress. We also considered a trigger that would combine
liquidity and market-based NAV thresholds but have preliminarily
concluded that a single threshold would accomplish our goals without
undue complexity and would be easier for investors to understand.
We request comment on our default threshold for liquidity fees and
our threshold on when a money market fund's board may impose a gate.
What should be the trigger either for a default liquidity
fee or for a board's ability to impose a gate? Rather than our proposed
trigger based on a fund's level of weekly liquid assets, should it be
based on the fund's shadow price or its level of daily liquid assets?
Should it be based on a certain fall in either the fund's weekly liquid
assets or shadow price? Why and what extent of a fall? Should it be
based on some other factor? Should it be based on a combination of
factors?
If we considered a threshold based on the fund's shadow
price, do shareholders differentiate between realized and market-based
losses (such as those from security defaults versus those from market
interest rate changes) when considering a money market fund's shadow
price? If so, how does it affect their propensity to redeem shares when
one or more funds have losses?
Should we permit a fund board to impose a liquidity fee or
gate even before a fund passes the trigger requiring the default fee to
be considered if the board determines that an early imposition of a
liquidity fee or gate would be in the best interest of the fund? Would
that reduce the benefits discussed above of having an automatic default
trigger? What concerns would arise from permitting imposition of a fee
or gate before a fund passes the thresholds we may establish?
What extent of decline in weekly liquid assets should
trigger consideration of a fee or gate and why? Should it be more or
less than 15% weekly liquid assets, such as 10% or 20%?
How do fund holdings of weekly liquid assets vary within
the calendar month, between Form N-MFP filing dates? How do net
shareholder redemptions vary within the calendar month, between Form N-
MFP filing dates? How accurately can the fund forecast the net
redemptions of its shareholders? When is the fund more likely to make
forecasting errors?
Should a liquidity fee or gate not be required until the
fund suffers an actual loss in value? Why or why not and if so, how
much of a loss in value?
Is one type of threshold less susceptible to preemptive
runs? If so, why?
Are there other factors that a board might consider in
determining whether to impose a fee or gate? Should we require that
boards consider certain factors? If so, which factors and why?
c. Size of Liquidity Fee
We are proposing that the liquidity fee be set at a default rate of
2%, although a fund's board could impose a lower liquidity fee (or no
fee at all) if it determines that a lower level is in the best interest
of the fund.\386\ Commenters have suggested that liquidity fee levels
ranging from 1% to 3% could be effective.\387\ We selected a default
fee of
[[Page 36887]]
2% because we believe that a liquidity fee set at this level is high
enough that it may impose sufficient costs on redeeming shareholders to
deter redemptions in a crisis, but is low enough to permit investors
who wish to redeem despite the cost to receive their proceeds without
bearing unwarranted costs.\388\ A 2% level should also permit a fund to
recoup the costs of liquidity it may bear, while repairing the fund if
it has incurred losses.\389\ We recognize that establishing any fixed
fee level may not precisely address the circumstances of a particular
fund in a crisis, and accordingly are proposing to make this 2% level a
default, which a fund board may lower or eliminate in accordance with
the circumstances of any individual fund.
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\386\ See proposed (Fees & Gates) rule 2a-7(c)(2)(i)(A).
\387\ See, e.g., Vanguard FSOC Comment Letter, supra note 172
(recommending a fee of between 1 and 3%); BlackRock FSOC Comment
Letter, supra note 204 (recommending a standby liquidity fee of 1%);
ICI Jan. 24 FSOC Comment Letter, supra note 25 (recommending a 1%
fee).
\388\ See, e.g., Vanguard FSOC Comment Letter, supra note 172
(``We believe a fee in this amount [1-3%] will serve as an adequate
deterrent to investors who may attempt to flee a fund out of fear,
but would still allow those investors who have a need to access
their cash the ability to redeem a portion of their holdings.'');
ICI Jan. 24 FSOC Comment Letter, supra note 25 (``A liquidity fee
set at this level [1%] would discourage redemptions, but allow the
fund to continue to provide liquidity to investors. . . . Investors
truly in need of liquidity would have access to it, but at a pre-
determined cost.'').
\389\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25
(``Insofar as investors choose to redeem, the fee would benefit
remaining shareholders by mitigating liquidation costs and
potentially rebuilding NAVs.'').
---------------------------------------------------------------------------
We also considered whether we should require a liquidity fee with
an amount explicitly tied to market indicators of changes in liquidity
costs for money market funds. For example, one fund manager suggested
that the amount of the liquidity fee charged could be based on the
anticipated change in the market-based NAV of the fund's portfolio from
the redemption, assuming a horizontal slice of the fund's portfolio was
sold to meet the redemption request.\390\ This firm asserted that such
a liquidity fee would proportionately target the extent that the
redemption was causing a material disadvantage to remaining investors
in the fund and it would be clear to investors how the fee would
advance investor protection.
---------------------------------------------------------------------------
\390\ HSBC FSOC Comment Letter, supra note 196.
---------------------------------------------------------------------------
There may be a number of drawbacks to such a ``market-sized''
liquidity fee, however. First, it does not provide significant
transparency in advance to shareholders of the size of the liquidity
fee they may have to pay in times of stress. It could also reduce the
fees' efficacy in stemming redemptions if investors fear that the fee
might go up in the future. This lack of transparency may hinder
shareholders' ability to make well-informed decisions. It also may be
difficult for money market funds to rapidly determine precise liquidity
costs in times of stress when the short-term financing markets may be
generally illiquid. Indeed, our staff gave no-action assurances to
money market funds relating to valuation during the 2008 financial
crisis because determining pricing in the then-illiquid markets was so
difficult.\391\ We also understand that a liquidity fee that is not
fixed in advance and indeed may change from day-to-day may be
considerably more difficult and expensive for money market funds to
implement and administer from an operational perspective. Such a fee
would require real-time inputs of pricing factors into fund systems
that would need to be rapidly disseminated through chains of financial
intermediaries in order to apply to daily redemptions from the large
number of beneficial owners that hold money market fund shares through
omnibus accounts. A floating fee would assume sale of a horizontal
cross section of assets but we do not think that is how portfolio
securities would be sold to meet redemptions.
---------------------------------------------------------------------------
\391\ See Investment Company Institute, SEC Staff No-Action
Letter (Oct. 10, 2008) (not recommending enforcement action through
January 12, 2009, if money market funds used amortized cost to
shadow price portfolio securities with maturities of 60 days or less
in accordance with Commission interpretive guidance and noting:
``You state that under current market conditions, the shadow pricing
provisions of rule 2a-7 are not working as intended. You believe
that the markets for short-term securities, including commercial
paper, may not necessarily result in discovery of prices that
reflect the fair value of securities the issuers of which are
reasonably likely to be in a position to pay upon maturity. You
further assert that pricing vendors customarily used by money market
funds are at times not able to provide meaningful prices because
inputs used to derive those prices have become less reliable
indicators of price.'').
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These factors have led us to propose a default liquidity fee of a
fixed size, but to allow the board of directors (including a majority
of its independent directors) to impose a smaller-sized liquidity fee
if it determines that such a smaller fee would be in the best interest
of the fund.\392\ We preliminarily believe that such a default may
provide the best combination of directing boards of directors to a
liquidity fee size that may be appropriate in many stressed market
conditions, but providing flexibility to boards to lower the size of
that liquidity fee if it determines that a smaller fee would better and
more fairly estimate and allocate liquidity costs to redeeming
shareholders. Some factors that boards of directors may want to
consider in determining whether to impose a smaller-sized liquidity fee
than 2% include the shadow price of the money market fund at the time,
relevant market indicators of liquidity stress in the markets, changes
in spreads for portfolio securities (whether based on actual sales,
dealer quotes, pricing vendor mark-to-model or matrix pricing, or
otherwise), changes in the liquidity profile of the fund in response to
redemptions and expectations regarding that profile in the immediate
future, and whether the money market fund and its intermediaries are
capable of rapidly putting in place a fee of a different amount. We are
not proposing to allow fund boards to impose a larger liquidity fee
than 2% because we understand that, even in ``fire sales'' or other
crisis situations, money market funds typically have not realized
haircuts greater than 2% when selling portfolio securities, and believe
that investors should not face unwarranted costs when redeeming their
shares. In addition, the staff has noted in the past that fees greater
than 2% raise questions regarding whether a fund's securities remain
``redeemable.'' \393\ If a fund continues to be under stress even with
a 2% liquidity fee, the fund board may consider imposing a redemption
gate or liquidating the fund pursuant to rule 22e-3.
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\392\ See proposed (Fees & Gates) rule 2a-7(c)(2)(i).
\393\ Section 2(a)(32) of the Act [15 U.S.C. 80a-2(a)(32)]
defines the term ``redeemable security'' as a security that entitles
the holder to receive approximately his proportionate share of the
fund's net asset value. The Division of Investment Management
informally took the position that a fund may impose a redemption fee
of up to 2% to cover the administrative costs associated with
redemption, ``but if that charge should exceed 2 percent, its shares
may not be considered redeemable and it may not be able to hold
itself out as a mutual fund.'' See John P. Reilly & Associates, SEC
Staff No-Action Letter (July 12, 1979). This position is currently
reflected in our rule 23c-3(b)(1) under the Act [17 CFR 270.23c-
3(b)(1)], which permits a maximum 2% repurchase fee for interval
funds and rule 22c-2(a)(1)(i) [17 CFR 270.22c-2(a)(1)(i)] which
similarly permits a maximum 2% redemption fee to deter frequent
trading in mutual funds.
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We request comment on our proposed default size for the liquidity
fee.
What should be the amount of the liquidity fee? Should it
be a default amount, a fixed amount, or an amount directly tied to the
cost of liquidity in times of stress? If as proposed, we adopt a
default fee, should it be 2%, 1%, or some other level? Should we give
boards discretion to impose a higher fee if the board determines that
it is in the best interest of the fund? Commenters are requested to
please provide data to support your suggested fee level.
If the amount of the liquidity fee is tied to the cost of
liquidity at the time of the redemption, how would that
[[Page 36888]]
amount be determined? Would a liquidity fee that changes depending on
market circumstances provide shareholders with sufficient transparency
on the size of the fee to be able to affect their purchase and
redemption behavior? If the size of the liquidity fee changed depending
on market circumstances, would money market funds be able to determine
readily the amount of the liquidity fee during times of market
dislocation? Would such a fee affect one type of investor more than
another type of investor?
Is a flat, fixed liquidity fee preferable to a variable
fee that might be higher than the flat fee? Will the fund's ability to
choose a lower liquidity fee result in any conflicts of interest
between redeeming shareholders, non-redeeming shareholders, and the
investment adviser?
How should we weigh the risk that a flat liquidity fee may
be higher or lower than the actual liquidity costs to the money market
fund from the redemption, against the risk that a market-based
liquidity fee may not provide sufficient advance transparency to
shareholders and may be difficult to set appropriately in a crisis?
How difficult would it be for money market funds and
various intermediaries in the distribution chain of money market fund
shares to handle from an operational perspective a liquidity fee that
varied?
d. Default of Liquidity Fees
Our proposal provides that a liquidity fee be imposed once a non-
government money market fund's weekly liquid assets has fallen below
15% of its total assets (which is one-half of its required 30%
minimum), unless the board of directors determines that such a fee
would not be in the best interest of the fund. After the fund has
crossed that 15% liquidity threshold, the board could also impose a
gate. Based on this default choice, the implicit ordering of redemption
restrictions thus would be a liquidity fee, and if that fee is not
sufficiently slowing redemptions, a gate (although once the liquidity
fee threshold was crossed, a board would be able to immediately impose
a gate instead of a fee). We proposed a liquidity fee, rather than a
gate, as the default because we believe that a fee has the potential to
be less disruptive to fund shareholders and the short-term financing
markets because a fee allows fund shareholders to continue to transact
in times of stress (although at a cost). Some industry commenters
instead have suggested that money market funds impose a gate
first.\394\ Such a pause in redemption activity could provide time for
any spike in redemptions to subside before redemptions were allowed
with a fee. We request comment on liquidity fees being the default
under this proposal.
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\394\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25;
Vanguard FSOC Comment Letter, supra note 172.
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Should the implicit ordering in the proposed rule be
reversed, with a default of the fund imposing a gate once the fund has
crossed the weekly liquid asset threshold, unless or until the board
determines to re-open with a liquidity fee? Why?
Should there be a different threshold for consideration of
a gate if we adopted a gate as the default? Why or why not? Should a
gate be mandatory under certain circumstances? If so, under what
circumstances? Should any mandatory gate have a pre-specified window?
If so, how long should that gate be imposed?
e. Time Limit on Gates
We are proposing that a money market fund board must lift any gate
it imposes within 30 days and that a board could not impose a gate for
more than 30 days in any 90-day period. As noted above, a fund board
could only impose a gate if it determines that the gate is in the best
interest of the fund, and we would expect the board would lift the gate
as soon as it determines that a gate is no longer in the best interest
of the fund. This time limitation for the gate is designed to balance
protecting the fund in times of stress while not unduly limiting the
redeemability of money market fund shares, given the strong preference
embodied in the Investment Company Act for the redeemability of open-
end investment company shares.\395\ We understand that investors use
money market funds for cash management, and that lack of access to
their money market fund investment for a long period of time can impose
substantial costs and hardships.\396\ Indeed, many shareholders in The
Reserve Primary Fund informed us about these costs and hardships during
that fund's lengthy liquidation.\397\
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\395\ See Investment Trusts and Investment Companies: Hearings
on S. 3580 Before a Subcomm. of the Senate Comm. on Banking and
Currency, 76th Cong., 3d Sess. 291-292 (1940) (statement of David
Schenker, Chief Counsel, Investment Trust Study, SEC).
\396\ See, e.g., Comment Letter of Thrivent Financial for
Lutherans (Feb. 15, 2013) (available in File No. FSOC-2012-0003)
(``Thrivent FSOC Comment Letter'') (``The proposed liquidity fees
reduce the simplicity, reduce the liquidity for the majority of
shareholders, increase the potential for losses, and as a result,
dramatically alter the product. Money market funds' intended purpose
is to be a liquidity product, but if the product is only liquid for
the first 15% of investors that redeem, then it is no longer a
liquidity product for the remaining 85%.'').
\397\ See Kevin McCoy, Primary Fund Shareholders Put in a Bind,
USA Today, Nov. 11, 2008, available at http://usatoday30.usatoday.com/money/perfi/funds/2008-11-11-market-fund-side_N.htm (discussing hardships faced by Reserve Primary Fund
shareholders due to having their shareholdings frozen, including a
small business owner who almost was unable to launch a new business,
and noting that ``Ameriprise has used `hundreds of millions of
dollars' of its own liquidity for temporary loans to clients who
face financial hardships while they await final repayments from the
Primary Fund''); John G. Taft, Stewardship: Lessons Learned from the
Lost Culture of Wall Street (2012), at 2 (``Now that the Reserve
Primary Fund had suspended redemptions of Fund shares for cash, our
clients had no access to their cash. This meant, in many cases, that
they had no way to settle pending securities purchase and therefore
no way to trade their portfolios at a time of historic market
volatility. No way to make minimum required distributions from
retirement plans. No way to pay property taxes. No way to pay
college tuition. It meant bounced checks and, for retirees,
interruption of the cash flow distributions they were counting on to
pay their day-to-day living expenses.'').
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These concerns motivated us to propose a time period that would not
freeze shareholders' money market fund investments for an excessively
long period of time. On the other hand, we do want to provide some time
for stressed market conditions to subside, for portfolio securities to
mature and provide internal liquidity to the fund, and for potentially
distressed fund portfolio securities to recover or be held to maturity.
As of February 28, 2013, 43% of prime money market fund assets had a
maturity of 30 days or less.\398\ Accordingly, within a 30-day window
for a gate, a substantial amount of a money market fund's assets could
mature and provide cash to the fund to meet redemptions when the fund
re-opened. We also note that some commenters suggested a 30-day time
limit on any gate.\399\ Balancing all of these factors led us to
propose a 30-day time limit for any gate imposed. So that this 30-day
time limit could not be circumvented, for example, by reopening the
fund on the 29th day for a day before re-imposing the gate for
potentially another 30-day period, we also are proposing that the fund
cannot impose a gate for more than 30 days in any 90-day period. The
30-day limit is a maximum, and a money market fund board likely would
need to meet regularly during any period in which a redemption gate is
in place and would lift the gate promptly when it
[[Page 36889]]
determines that the gate is no longer in the best interest of the
fund.\400\
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\398\ Based on Form N-MFP data, with maturity determined in the
same manner as it is for purposes of computing the fund's weighted
average life.
\399\ See, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25.
\400\ The fund's board may also consider permanently suspending
redemptions in preparation for fund liquidation under rule 22e-3 if
the fund approaches the 30 day gating limit.
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Does a 30-day limit appropriately balance these
objectives? Should there be a shorter time limit, such as 10 days?
Should there be a longer time limit, such as 45 days? Why?
Will our proposed limit on the number of days a fund can
be gated in any 90-day period effectively prevent ``gaming'' of the 30-
day gate limitation? Should it be a shorter window or larger window? 60
days? 120 days?
Should we impose additional restrictions on a money market
fund's use of a gate? Should we, for example, require the board of
directors of a money market fund that has imposed a gate to meet each
day or week that the gate is in place, and permit the gate to remain in
place only if the board makes specified findings at these meetings? We
could provide that a gate may only remain in place if the board,
including a majority of the independent directors, finds that lifting
the gate and meeting shareholder redemptions could result in material
dilution or other unfair results to investors or existing shareholders.
Would requiring the board to make such a finding to continue to use a
gate help to prevent a fund from imposing a gate for longer than is
necessary or appropriate? Would a different required finding better
achieve this goal? Would fund boards be able to make such findings
accurately, particularly during a crisis when a board may be more
likely to impose a gate? Would such a requirement deter fund boards
from keeping a gate in place when doing so may be in the best interest
of the fund?
f. Application of Liquidity Fees to Omnibus Accounts
For beneficial owners holding mutual fund shares through omnibus
accounts, we understand that, with respect to redemption fees imposed
to deter market timing of mutual fund shares, financial intermediaries
generally impose any redemption fees themselves to record or beneficial
owners holding through that intermediary.\401\ We understand that they
do so often in accordance with contractual arrangements between the
fund or its transfer agent and the intermediary. We would expect any
liquidity fees to be handled in a similar manner, although we
understand that some money market fund sponsors will want to review
their contractual arrangements with their funds' financial
intermediaries and service providers to determine whether any
contractual modifications would be necessary or advisable to ensure
that any liquidity fees are appropriately applied to beneficial owners
of money market fund shares. We also understand that some money market
fund sponsors may seek certifications or other assurances that these
intermediaries and service providers will apply any liquidity fees to
the beneficial owners of money market fund shares. We also recognize
that money market funds and their transfer agents and intermediaries
will need to engage in certain communications regarding a liquidity
fee.
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\401\ See rule 22c-2. Our understanding of how financial
intermediaries handle redemption fees in mutual funds is based on
Commission staff discussions with industry participants and service
providers.
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We request comment on the application of liquidity fees and gates
to shares held through omnibus accounts.
Do commenters agree with our view that liquidity fees
likely will be handled by intermediaries in a manner similar to how
they currently impose redemption fees? If not, how would liquidity fees
be applied to shares held through financial intermediaries? Is our
understanding correct that financial intermediaries generally apply any
liquidity fees themselves to record or beneficial owners holding
through that intermediary? Would they do so based on existing
contractual arrangements or would funds make contractual modifications?
What cost would be involved in any contractual modifications?
Would funds in addition or instead seek certifications
from financial intermediaries that they will apply any liquidity fees?
What cost would be involved in any such certifications?
What other methods might money market funds use to gain
assurances that financial intermediaries will apply any liquidity fees
appropriately? At what costs? Will some intermediaries not offer prime
money market funds to avoid operational costs involved with fees and
gates?
3. Exemptions To Permit Liquidity Fees and Gates
The Commission is proposing exemptions from various provisions of
the Investment Company Act to permit a fund to institute liquidity fees
and gates.\402\ In the absence of an exemption, imposing gates could
violate section 22(e) of the Act, which generally prohibits a mutual
fund from suspending the right of redemption or postponing the payment
of redemption proceeds for more than seven days, and imposing liquidity
fees could violate rule 22c-1, which (together with section 22(c) and
other provisions of the Act) requires that each redeeming shareholder
receive his or her pro rata portion of the fund's net assets. The
Commission is proposing to exercise its authority under section 6(c) of
the Act to provide exemptions from these and related provisions of the
Act to permit a money market fund to institute liquidity fees and gates
notwithstanding these restrictions.\403\ As discussed in more detail
below, we believe that such exemptions do not implicate the concerns
that Congress intended to address in enacting these provisions, and
thus they are necessary and appropriate in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the Act.
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\402\ See proposed (Fees & Gates) rule 2a-7(c).
\403\ 15 U.S.C. 80a-6(c). In order to clarify the application of
liquidity fees and gates to variable contracts, we also would amend
rule 2a-7 to provide that, notwithstanding section 27(i) of the Act,
a variable contract sold by a registered separate account funding
variable insurance contracts or the sponsoring insurance company of
such account may apply a liquidity fee or gate to contract owners
who allocate all or a portion of their contract value to a
subaccount of the separate account that is either a money market
fund or that invests all of its assets in shares of a money market
fund. See proposed (Fees & Gates) rule 2a-7(c)(2)(iv). Section
27(i)(2)(A) makes it unlawful for any registered separate account
funding variable insurance contracts or the sponsoring insurance
company of such account to sell a variable contract that is not a
``redeemable security.''
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We do not believe that gates would conflict with the purposes
underlying section 22(e), which was designed to prevent funds and their
investment advisers from interfering with the redemption rights of
shareholders for improper purposes, such as the preservation of
management fees.\404\ The board of a money market fund would impose
gates to benefit the fund and its shareholders by making the fund
better able to handle substantial redemptions, as discussed above.
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\404\ See 2009 Proposing Release, supra note 31, at n.281 and
accompanying text.
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We also propose to provide exemptions from rule 22c-1 to permit a
money market fund to impose liquidity fees because a money market fund
would impose liquidity fees to benefit the fund and its shareholders by
providing a more systematic allocation of liquidity costs.\405\
Remaining shareholders also may benefit if the fees help repair any
decline in the fund's shadow price or lead to an increased
[[Page 36890]]
dividend paid to remaining fund shareholders. The amount of additional
fees that the fund might collect in this regard would be only to
further the purpose of the provision and could only be imposed under
circumstances of stress on the fund.
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\405\ See proposed (Fees & Gates) rule 2a-7(c) (providing that,
notwithstanding rule 22c-1, among other provisions, a money market
fund may impose a liquidity fee under the circumstances specified in
the proposed rule).
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A gate would also be similarly limited. It could only be imposed
for a limited period of time and only under circumstances of stress on
the fund. This aspect of gates, therefore, is akin to rule 22e-3, which
also provides an exemption from section 22(e) to permit money market
fund boards to suspend redemptions of fund shares in order to protect
the fund and its shareholders from the harmful effects of a run on the
fund, and to minimize the potential for disruption to the securities
markets.\406\ We are proposing to permit money market funds to be able
to impose fees and gates because they may provide substantial benefits
to money market funds and the short-term financing markets for issuers,
as discussed above. However, because we recognize that fees and gates
may impose hardships on investors who rely on their ability to freely
redeem shares (or to redeem shares without paying a fee), we also have
proposed limitations on when and for how long money market funds could
impose these restrictions.\407\
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\406\ See 2010 Adopting Release, supra note 92, at text
following n.379.
\407\ See proposed (Fees & Gates) rule 2a-7(c)(2). Cf. 2010
Adopting Release, supra note 92, at text following n.379 (``Because
the suspension of redemptions may impose hardships on investors who
rely on their ability to redeem shares, the conditions of [rule 22e-
3] limit the fund's ability to suspend redemptions to circumstances
that present a significant risk of a run on the fund and potential
harm to shareholders.'')
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We request comment on our proposed amendments allowing money market
funds to institute fees and gates.
Would the proposed amendments to rule 2a-7 provide
sufficient exemptive relief to permit a money market fund to institute
fees or gates with both the requirements of rule 2a-7 and the
Investment Company Act? Are there other provisions of the Investment
Company Act from which the Commission should consider providing an
exemption?
4. Amendments to Rule 22e-3
Under this proposal, we also would amend rule 22e-3 to permit (but
not require) the permanent suspension of redemptions and liquidation of
a money market fund if the fund's level of weekly liquid assets falls
below 15% of its total assets.\408\ This will allow a money market fund
that imposes a fee or a gate, but determines that it would not be in
the best interest of the fund to continue operating, to permanently
suspend redemptions and liquidate. As such, it will provide an
additional tool to fund boards of directors to manage a fund in the
best interest of the fund when that fund comes under stress regarding
its liquidity buffers. It will allow fund boards to suspend redemptions
and liquidate a fund that the board determines would be unable to stay
open (or, if gated, re-open) without further harm to the fund, and
prevents such a fund from waiting until its shadow price has declined
so far that it is about to ``break the buck.''
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\408\ See proposed (Fees & Gates) rule 22e-3.
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We considered whether a money market fund's level of weekly liquid
assets should have to fall further than the 15% threshold that allows
the imposition of fees and gates for the fund to be able to permanently
suspend redemptions and liquidate. A permanent suspension of
redemptions could be considered more draconian because there is no
prospect that the fund will re-open--instead the fund will simply
liquidate and return money to shareholders. Accordingly, one could
consider a lower weekly liquid asset threshold than 15% justified.
However, we believe such considerations must be balanced against the
risk that might be caused by establishing a lower threshold for
enabling a permanent suspension of redemptions. For example, a fund
with a fee or gate in place might know (based on market conditions or
discussions with its shareholders or otherwise) that upon lifting the
fee or gate it will experience a severe run. We would not want to force
such a fund to lift the fee or re-open and weather enough of that run
to deplete its weekly liquid assets below a lower threshold. We
preliminarily believe this risk is great enough to warrant allowing
money market funds to suspend redemptions permanently once the fund's
weekly liquid assets fall below 15% of its total assets.
As under existing rule 22e-3, a money market fund also would still
be able to suspend redemptions and liquidate if it determines that the
extent of the deviation between its shadow price and its market-based
NAV per share may result in material dilution or other unfair results
to investors or existing shareholders.\409\ Accordingly, a money market
fund that suffers a default would still be able to suspend redemptions
and liquidate before that credit loss lead to redemptions and a fall in
its weekly liquid assets.
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\409\ See proposed (Fees & Gates) rule 22e-3.
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We request comment on our proposed amendments to rule 22e-3 under
this proposal.
Is it appropriate to allow a money market fund to suspend
redemptions and liquidate if its level of weekly liquid assets falls
below 15% of its total assets? Is there a different threshold based on
daily or weekly assets that would better protect money market fund
shareholders?
Should a fund's ability to suspend redemptions and
liquidate be tied only to adverse deviations in its shadow price? If
so, is our current standard under rule 22e-3 appropriate or is there a
different level of shadow price decline that should trigger a money
market fund's ability to suspend redemptions and liquidate?
5. Exemptions From the Liquidity Fees and Gates Requirement
We are proposing that government money market funds (including
Treasury money market funds) be exempt from any fee or gate requirement
but that these funds be permitted to impose such a fee or gate under
the regime we have described above if the ability to impose such fees
and gates were disclosed in the fund's prospectus.\410\ This exemption
is based on a similar analysis to our proposed exemption of government
money market funds from the floating NAV proposal and also on our
desire to facilitate investor choice by providing a money market fund
investment option for an investor who was unwilling or unable to invest
in a money market fund that could impose liquidity fees or gates in
times of stress.
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\410\ See proposed (Fees & Gates) rule 2a-7(c)(2)(iii).
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As discussed in the RSFI Study, government money market funds
historically have experienced inflows, rather than outflows, in times
of stress due to flights to quality, liquidity, and transparency.\411\
The assets of government money market funds tend to appreciate in value
in times of stress rather than depreciate.\412\ Accordingly,
[[Page 36891]]
the portfolio composition of government money market funds means that
these funds are less likely to need to use these restrictions. We also
expect that some money market fund investors may be unwilling or unable
to invest in a money market fund that could impose a fee or gate. For
example, there could be some types of investors, such as sweep
accounts, that may be unwilling or unable to invest in a money market
fund that could impose a gate because such an investor requires the
ability to immediately redeem at any point in time, regardless of
whether the fund or the markets are distressed. Accordingly, exempting
government money market funds from the fees and gates requirement would
allow fund sponsors to offer a choice of money market fund investment
products that meet differing liquidity needs, while minimizing the risk
of adverse contagion effects from heavy money market fund redemptions.
Based on our evaluation of these considerations and tradeoffs, and the
more limited risk of heavy redemptions in government money market
funds, we preliminarily believe that on balance it is preferable to
exempt these funds from this potential requirement, but permit them to
use liquidity fees and gates if they choose.
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\411\ See RSFI Study, supra note 21, at 6-13.
\412\ Government money market funds tend to attract significant
inflows of investments during times of broader market distress,
which can appreciate their value. See, e.g., figure 1 in supra
section I.B (showing that during the 2008 Lehman crisis
institutional share classes of government money market funds, which
include Treasury and government funds, experienced heavy inflows).
Also see, e.g., ICI Jan. 24 FSOC Comment Letter, supra note 25
(noting government money market funds attracted an inflow of $192
billion during the week following the Lehman bankruptcy in September
2008); HSBC FSOC Comment Letter, supra note 196 (``As evidenced
during the credit crisis of 2008, Treasury and government funds
benefitted from a ``flight to quality'' during these systemic
events''); Dreyfus FSOC Comment Letter, supra note 174 (noting its
institutional government and institutional Treasury money market
funds generally experienced high levels of net inflows during 2008).
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We note that Treasury money market funds generally would be exempt
from any liquidity fees and gates requirement because at least 80% of
their assets generally must be Treasury securities and overnight
repurchase agreements collateralized with Treasury securities, each of
which is a weekly liquid asset. Accordingly, it is highly unlikely for
a Treasury money market fund to breach the 15% weekly liquid asset
threshold that would allow imposition of a fee or gate. Most government
money market funds similarly always would have at least 15% weekly
liquid assets because of the nature of their portfolio, but it is
possible to have a government money market fund with below 15% weekly
liquid assets. We also note that government money market funds and
Treasury money market funds do not necessarily have the same risk
profile. For example, government money market funds generally have a
much higher portion of their portfolios invested in securities issued
by the Federal Home Loan Mortgage Corporation (Freddie Mac), the
Federal National Mortgage Association (Fannie Mae), and the Federal
Home Loan Banks and thus a higher exposure to the home mortgage market
than Treasury money market funds. We note that this exemption would not
apply to tax-exempt (or municipal) money market funds. As discussed
above, because tax-exempt money market funds are not required to
maintain 10% daily liquid assets, these funds may be less liquid than
other money market funds, which could raise concerns that tax-exempt
retail funds might not be able to manage even the lower level of
redemptions expected in a retail money market fund. In addition,
municipal securities typically present greater credit and liquidity
risk than government securities and thus could come under pressure in
times of stress.
We request comment on our proposed exemption of government money
market funds from the proposed liquidity fees and gates requirement.
Is this exemption appropriate, particularly in light of
the redemptions from government funds in late June and early July 2011?
Why or why not?
Is it appropriate to give government money market funds
the option to have the ability to impose fees and gates so long as they
disclose the option to investors? Why or why not? What factors might
lead a government fund to exercise this option?
Should the exemption for government money market funds be
extended to municipal money market funds? Why or why not?
We also considered whether there should be other exemptions from
the proposed liquidity fees and gates requirement. For example, as
discussed in section III.A.4 above, we are proposing an exemption for
retail money market funds from any floating NAV requirement. We noted
in that section how retail money market funds experienced fewer
redemptions during the 2007-2008 financial crisis and thus may be less
likely to suffer heavy redemptions in the future. However, unlike with
government money market funds, a retail prime money market fund
generally is subject to the same credit and liquidity risk as an
institutional prime money market fund. In addition, a floating NAV
requirement affects a shareholder's experience with a money market fund
on a daily basis. Given the costs and burdens associated with a
floating NAV requirement, and the potential limited benefit to retail
shareholders on an ongoing basis given that they are less likely to
engage in heavy redemptions, a retail exemption might be more
appropriate on balance under a floating NAV requirement than under a
liquidity fees and gates requirement. In contrast, a fee or gate
requirement would not affect a money market fund unless the fund's
weekly liquid assets fell below 15% of its total assets--i.e., unless
it came under stress. Exempting retail money market funds from this
requirement thus could leave only institutional (and not retail)
shareholders protected when the money market fund in which they have
invested comes under stress. Given that such an exemption would merely
relieve them in normal times of the costs and burden on those investors
created by the prospect that the fund could impose a fee or gate if
someday it came under stress, we preliminarily believe that a retail
exemption may not be warranted for this alternative. We also considered
methods of exempting some retail investors from a fee or gate
requirement. For example, we could exempt small redemption requests,
such as those below $10,000, or $100,000 per day, from any fee or gate
requirement. Such small redemptions are less likely to materially
impact the liquidity position of the fund. This type of exemption could
retain the benefits of fees and gates for retail money market funds
generally while providing some relief from the burdens for investors
with smaller redemption needs. However, we are concerned that granting
such exemptions could complicate the fees and gates requirement both as
an operational matter and in terms of ease of shareholder understanding
without providing substantial benefits.
We also have considered whether irrevocable redemption requests
submitted at least a certain period in advance should be exempt as the
fund should be able to plan for such liquidity demands and hold
sufficient liquid assets. However, we are concerned that shareholders
could try to ``game'' the fee or gate requirement through such
exemptions, for example, by redeeming a certain amount every week and
then reinvesting the redemption proceeds immediately if the cash is not
needed. We also are concerned that allowing such an exception would add
significantly to the cost and complexity of this requirement, as fund
groups would need to be able to separately track which shares are
subject to a fee or gate and which are not.
We request comment on other potential exemptions from the proposed
liquidity fees and gates requirement.
Should retail money market funds (including tax-exempt
money market funds) or retail investors be exempt from any liquidity
fee or gate provision? Should there be an exemption for small
redemption requests, such as redemptions below $10,000? If so, below
what level? If a retail money
[[Page 36892]]
market fund crossed the thresholds we are proposing for board
consideration of a fee or gate, is there a reason not to allow the
fund's board to protect the fund and its shareholders through the use
of a liquidity fee or gate? Would investors ``game'' such exemptions?
Should we create an exemption for shareholders that submit
an irrevocable redemption request at least a certain period in advance
of the needed redemption? Why or why not? With what period of advance
notice? For each of these exemptions, could funds track the shares that
are not subject to the fee or gate? What operational costs would be
involved in including such an exemption? Would shareholders ``game''
such exemptions?
Would further exemptions undermine the goal of the
liquidity fee or gate in deterring or stopping heavy redemptions? Why
or why not? Would exemptions from the fee or gate proposal make it more
difficult or costly to implement or operationalize? How would any such
difficulties compare to the benefits that could be obtained from such
exemptions?
6. Operational Considerations Relating to Liquidity Fees and Gates
Money market funds and others in the distribution chain (depending
on how they are structured) likely would incur some operational costs
in establishing or modifying systems to administer a liquidity fee or
gate. These costs likely would be incurred by, or spread amongst, a
fund's transfer agents, sub-transfer agents, recordkeepers,
accountants, portfolio accounting departments, and custodian. Money
market funds and others also may be required to develop procedures and
controls, and may incur other costs, for example to update systems
necessary for confirmations and account statements to reflect the
deduction of a liquidity fee from redemption proceeds. Money market
funds and their intermediaries may need to establish new, or modify
existing, systems or procedures that would allow them to administer
temporary gates. Money market fund shareholders also might be required
to modify their own systems to prepare for possible future liquidity
fees, or manage gates, although we expect that only some shareholders
would be required to make these changes.\413\ They also may modify
contracts or seek certifications from financial intermediaries that
they will apply any liquidity fee.
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\413\ Many shareholders use common third party-created systems
and thus would not each need to modify their systems.
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These costs would vary depending on how a liquidity fee or gate is
structured, including its triggering event, as well as on the
capabilities, functions, and sophistication of the fund's and others'
current systems. These factors will vary among money market funds,
shareholders, and others, and particularly because we request comment
on a number of ways in which we could structure a liquidity fee or gate
requirement, we cannot ascertain at this stage the systems and other
modifications any particular money market fund or other affected entity
would be required to make to administer a liquidity fee or manage a
gate. Indeed, we believe that money market funds and other affected
entities themselves would need to engage in an in-depth analysis of
this alternative in order to estimate the costs of the necessary
systems modifications. While we do not have the information necessary
to provide a point estimate of the potential costs of systems
modifications needed to administer a liquidity fee or gate, our staff
has estimated a range of hours and costs that may be required to
perform activities typically involved in making systems
modifications.\414\ In estimating these hours and costs, our staff
considered the need to modify the systems described above.
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\414\ Staff estimates that these costs would be attributable to
the following activities: (i) Planning, coding, testing, and
installing system modifications; (ii) drafting, integrating, and
implementing related procedures and controls; and (iii) preparing
training materials and administering training sessions for staff in
affected areas. See also supra note 245 (discussing the bases of our
staff's estimates of operational and related costs).
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If a money market fund determines that it would only impose a flat
liquidity fee of a fixed percentage known in advance (e.g., it would
only impose the default 2% liquidity fee) and have the ability to
impose a gate, our staff estimates that a money market fund (or others
in the distribution chain) would incur one-time systems modification
costs (including modifications to related procedures and controls) that
ranges from $1,100,000 to $2,200,000.\415\ Our staff estimates that the
one-time costs for entities to communicate with shareholders (including
systems costs related to communications) about the liquidity fee or
gate would range from $200,500 to $340,000.\416\ In addition, we
estimate that the costs for a shareholder mailing would range between
$1.00 and $3.00 per shareholder.\417\ We also recognize that adding new
capabilities or capacity to a system will entail ongoing annual
maintenance costs and understand that those costs generally are
estimated as a percentage of initial costs of building or expanding a
system. Our staff estimates that the costs to maintain and modify these
systems required to administer a liquidity fee and the ability to
administer a standby gate (to accommodate future programming changes),
to provide ongoing training, and to administer the liquidity fee or
gate on an ongoing basis would range from 5% to 15% of the one-time
costs. Our staff understands that if a fund board imposes a liquidity
fee whose amount could vary, the cost could exceed this range, but
because such costs depend on to what extent the fee might vary, we do
not have the information necessary to provide a reasonable estimate of
how much more a varying fee might cost to implement.
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\415\ Staff estimates that these costs would be attributable to
the following activities: (i) Project planning and systems design;
(ii) systems modification, integration, testing, installation, and
deployment; (iii) drafting, integrating, implementing procedures and
controls; and (iv) preparation of training materials. See also supra
note 245 (discussing the bases of our staff's estimates of
operational and related costs).
\416\ Staff estimates that these costs would be attributable to
the following activities: (i) modifying the Web site to provide
online account information and (ii) written and telephone
communications with investors. See also supra note 245 (discussing
the bases of our staff's estimates of operational and related
costs).
\417\ Total costs of the mailing for individual funds would vary
significantly depending on the number of shareholders that receive
information from the fund by mail (as opposed to electronically).
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Although our staff has estimated the costs that a single affected
entity would incur, we anticipate that many money market funds,
transfer agents, and other affected entities may not bear the estimated
costs on an individual basis. Instead, the costs of systems
modifications likely would be allocated among the multiple users of the
systems, such as money market fund members of a fund group, money
market funds that use the same transfer agent or custodian, and
intermediaries that use systems purchased from the same third party.
Accordingly, we expect that the cost for many individual entities may
be less than the estimated costs due to economies of scale in
allocating costs among this group of users.
Moreover, depending on how a liquidity fee or gate is structured,
mutual fund groups and other affected entities already may have systems
that could be adapted to administer a liquidity fee or gate at minimal
cost, in which case the costs may be less than the range we estimate
above. For example, some money market funds may be part of mutual fund
groups in which one or more funds impose deferred sales loads or
redemption fees
[[Page 36893]]
under rule 22c-2, both of which require the capacity to administer a
fee upon redemptions and may involve systems that could be adapted to
administer a liquidity fee.
Our staff estimates that a money market fund shareholder whose
systems (including related procedures and controls) required
modifications to account for a liquidity fee or gate would incur one-
time costs ranging from $220,000 to $450,000.\418\ Our staff estimates
that the costs to maintain and modify these systems and to provide
ongoing training would range from 5% to 15% of the one-time costs.
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\418\ Staff estimates that these costs would be attributable to
the following activities: (i) Project planning and systems design;
(ii) systems modification, integration, testing, installation; and
(iii) drafting, integrating, implementing procedures and controls.
See also supra note 245 (discussing the bases of our staff's
estimates of operational and related costs).
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We request comment on our estimate of operational costs associated
with the liquidity fees and gates alternative.
Do commenters agree with our estimates of operational
costs?
Are there operational costs in addition to those we
estimate above? What systems would need to be reprogrammed and to what
extent? What types of ongoing maintenance, training, and other
activities to administer the liquidity fee or gate would be required,
and to what extent?
Are our estimates too high or too low and, if so, by what
amount? To what extent would the estimate vary based on the event that
would trigger the imposition of a liquidity fee or the manner in which
the fee would be calculated once triggered? To what extent would the
estimate vary based on how the gate is structured?
To what extent would money market funds or others
experience the economies of scale that we identify?
7. Tax Implications of Liquidity Fees
We understand that liquidity fees may have certain tax implications
for money market funds and their shareholders. Similar to the liquidity
fee we are proposing today, rule 22c-2 allows mutual funds to recover
costs associated with frequent mutual fund share trading by imposing a
redemption fee on shareholders who redeem shares within seven days of
purchase. We understand that for tax purposes, shareholders of these
mutual funds generally treat the redemption fee as offsetting the
shareholder's amount realized on the redemption (decreasing the
shareholder's gain, or increasing the shareholder's loss, on
redemption).\419\ Consistent with this characterization, funds
generally treat the redemption fee as having no associated tax effect
for the fund. We understand that our proposed liquidity fee, if
adopted, would be treated for tax purposes consistently with the way
that funds and shareholders treat redemption fees under rule 22c-
2.\420\
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\419\ Cf. 26 CFR 1.263(a)-2(e) (commissions paid in sales of
securities by persons who are not dealers are treated as offsets
against the selling price). See also Investment Income and Expenses
(Including Capital Gains and Losses), IRS Publication 550, at 44
(``fees and charges you pay to acquire or redeem shares of a mutual
fund are not deductible. You can usually add acquisition fees and
charges to your cost of the shares and thereby increase your basis.
A fee paid to redeem the shares is usually a reduction in the
redemption price (sales price).''), available at http://www.irs.gov/pub/irs-pdf/p550.pdf.
\420\ Referring to IRS guidance in a different context, one
commenter suggested that our proposed liquidity fee also might be
characterized for tax purposes as an investment expense for the
shareholder and income to the fund. See ICI Jan. 24 FSOC Comment
Letter, supra note 25. This commenter noted that, if the fund were
required to treat the liquidity fee as ordinary income, the fund
would have to distribute the income to avoid liability for the
corporate level income tax and a 4% excise tax on the amount
retained. In that case, the fund would not realize all of the
benefit the liquidity fee is designed to provide. Id. (citing IRS
Revenue Procedure 2009-10 as supporting the position that the fee
received by the fund should be treated as a capital gain because it
is being used to offset capital losses incurred by the fund on its
portfolio in order to pay the redeeming shareholder and noting that
because the capital gain would offset the capital loss, the fund
would not have an additional distribution requirement). This
commenter suggests that the IRS provide guidance to this effect
(noting that in Revenue Procedure 2009-10, which provided only
temporary administrative guidance, the IRS took this position with
respect to amounts paid to a money market fund by the fund's adviser
to prevent the fund from breaking the buck). Id. See also Arrowsmith
et al. v. Commissioner of Internal Revenue, 344 U.S. 6 (1952).
---------------------------------------------------------------------------
If, as described above, a liquidity fee has no direct tax
consequences for the money market fund, that tax treatment would allow
the fund to use 100% of the fee to repair a market-based price per
share that was below $1.0000. If redemptions involving liquidity fees
cause the money market fund's shadow price to reach $1.0050, however,
the fund may need to distribute to the remaining shareholders
sufficient value to prevent the fund from breaking the buck (and thus
rounding up to $1.01 in pricing its shares).\421\ We understand that
any such distribution would be treated as a dividend to the extent that
the money market fund has sufficient earnings and profits. Both the
fund and its shareholders would treat these additional dividends the
same as they treat the fund's routine dividend distributions. That is,
the additional dividends would be taxable as ordinary income to
shareholders and would be eligible for deduction by the funds.
---------------------------------------------------------------------------
\421\ See proposed (Fees & Gates) rule 2a-7(g)(2).
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In the absence of sufficient earnings and profits, however, some or
all of these additional distributions would be treated as a return of
capital. Receipt of a return of capital would reduce the recipient
shareholders' basis (and thus could decrease a loss, or create or
increase a gain for the shareholder in the future when the shareholder
redeems the affected shares).\422\ Thus, in the event of any return of
capital distributions, the shareholders, the fund, and other
intermediaries might become subject to tax-payment or tax-reporting
obligations that do not affect stable NAV funds currently operating
under rule 2a-7.\423\
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\422\ If the payment of liquidity fees forces a money market
fund to make a return of capital distribution to avoid re-pricing
its shares above $1.00, this could also create tax consequences for
remaining shareholders in the fund.
\423\ See the discussion above of the additional obligations
that would be created by gains and losses recognized with respect to
floating NAV funds.
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Finally, we understand that the tax treatment of a liquidity fee
may impose certain operational costs on money market funds and their
financial intermediaries and on shareholders. Either fund groups or
their intermediaries would need to track the tax basis of money market
fund shares as the basis changed due to any return of capital
distributions, and shareholders would need to report in their annual
tax filings any gains \424\ or losses upon the sale of affected money
market fund shares. We are unable to quantify any of the tax and
operational costs discussed in this section because we are unable to
predict how often liquidity fees will be imposed by money market funds
and how often redemptions subject to liquidity fees would cause the
funds to make return of capital distributions to the remaining
shareholders.
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\424\ Redemptions subject to a liquidity fee would almost always
result in losses, but gains are possible if a shareholder received a
return of capital distribution with respect to some shares and the
shareholder later redeemed the shares for $1.0000 each.
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We request comment on this aspect of our proposal.
If liquidity fees cause the fund's shadow price to exceed
$1.0049, will that result cause the fund to make a special distribution
to current shareholders?
Do money market funds and other intermediaries already
have systems in place to track and report the variations in basis, and
the gains and losses that might result from imposing liquidity fees? If
not, what costs would be
[[Page 36894]]
expected to be incurred to establish this capability? In light of the
fact that it may be necessary to establish new systems to track this
information, how does the cost of these new systems compare with the
costs that would be incurred to accommodate floating NAVs?
8. Disclosure Regarding Liquidity Fees and Gates
In connection with the liquidity fees and gates alternative, we are
also proposing alternate disclosure-related amendments to rule 2a-7,
rule 482 under the Securities Act,\425\ and Form N-1A. We anticipate
that the proposed rule and form amendments would provide current and
prospective shareholders with information regarding the operations and
risks of this reform alternative, as well as current and historical
information regarding the imposition of fees and gates. In keeping with
the enhanced disclosure framework we adopted in 2009,\426\ the proposed
amendments are intended to provide a layered approach to disclosure in
which key information about the proposed new features of money market
funds would be provided in the summary section of the statutory
prospectus (and, accordingly, in any summary prospectus, if used) with
more detailed information provided elsewhere in the statutory
prospectus and in the SAI.
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\425\ See supra note 303.
\426\ See Summary Prospectus Adopting Release, supra note 304,
at paragraph preceding section III.
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a. Disclosure Statement
The Commission's liquidity fees and gates alternative proposal
would permit funds to charge liquidity fees and impose redemption
restrictions on money market fund investors. As a measure to achieve
this reform, we propose to require that each money market fund (other
than government money market funds that have chosen to rely on the
proposed rule 2a-7 exemption for government money market funds from any
fee or gate requirements), include a bulleted statement, disclosing the
particular risks associated with investing in a fund that may impose
liquidity fees or redemption restrictions, on any advertisement or
sales material that it disseminates (including on the fund Web site).
We also propose to include wording designed to inform investors about
the primary general risks of investing in money market funds in this
bulleted disclosure statement. While money market funds are currently
required to include a similar disclosure statement on their
advertisements and sales materials,\427\ we propose amending this
disclosure statement to emphasize that money market fund sponsors are
not obligated to provide financial support, and that money market funds
may not be an appropriate investment option for investors who cannot
tolerate losses.\428\
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\427\ See id. Rule 482(b)(4) currently requires a money market
fund to include to following disclosure statement on its
advertisements and sales materials: An investment in the Fund is not
insured or guaranteed by the Federal Deposit Insurance Corporation
or any other government agency. Although the Fund seeks to preserve
the value of your investment at $1.00 per share, it is possible to
lose money by investing in the Fund.
\428\ See infra note 607 and accompanying text (discussing the
extent to which discretionary sponsor support has the potential to
confuse money market fund investors); supra note 141 and
accompanying text (noting that survey data shows that some investors
are unsure about the amount of risk in money market funds and the
likelihood of government assistance if losses occur).
---------------------------------------------------------------------------
Specifically, we would require each money market fund (other than
government money market funds that have chosen to rely on the proposed
rule 2a-7 exemption for government money market funds from any fee or
gate requirements) to include the following bulleted disclosure
statement on their advertisements and sales materials:
You could lose money by investing in the Fund.
The Fund seeks to preserve the value of your investment at
$1.00 per share, but cannot guarantee such stability.
The Fund may impose a fee upon sale of your shares when
the Fund is under considerable stress.
The Fund may temporarily suspend your ability to sell
shares of the Fund when the Fund is under considerable stress.
An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency.
The Fund's sponsor has no legal obligation to provide
financial support to the Fund, and you should not expect that the
sponsor will provide financial support to the Fund at any time.\429\
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\429\ See proposed (Fees & Gates) rule 482(b)(4)(i). Rule
482(b)(4) currently requires a money market fund to include to
following disclosure statement on its advertisements and sales
materials: An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency. Although the Fund seeks to preserve the value of your
investment at $1.00 per share, it is possible to lose money by
investing in the Fund.
If an affiliated person, promoter, or principal underwriter of
the fund, or an affiliated person of such person, has entered into
an agreement to provide financial support to the fund, the fund
would be permitted to omit this bulleted sentence from the
disclosure statement for the term of the agreement. See Note to
paragraph (b)(4), proposed (Fees & Gates) rule 482(b)(4).
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We also propose to require a substantially similar bulleted disclosure
statement in the summary section of the statutory prospectus (and,
accordingly, in any summary prospectus, if used).\430\
---------------------------------------------------------------------------
\430\ See proposed (Fees & Gates) Item 4(b)(1)(ii)(A) of Form N-
1A. Item 4(b)(1)(ii) currently requires a money market fund to
include the following statement in its prospectus: An investment in
the Fund is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the
Fund seeks to preserve the value of your investment at $1.00 per
share, it is possible to lose money by investing in the Fund.
---------------------------------------------------------------------------
As discussed above, the liquidity fees and gates proposal would
exempt government money market funds from any fee or gate requirement,
but a government money market fund would be permitted to charge
liquidity fees and impose gates if the ability to charge liquidity fees
and impose gates were disclosed in the fund's prospectus. Accordingly,
the proposed amendments to rule 482 and Form N-1A would require
government money market funds that have chosen to rely on this
exemption to include a bulleted disclosure statement on the fund's
advertisements and sales materials and in the summary section of the
fund's statutory prospectus (and, accordingly, in any summary
prospectus, if used) that does not include disclosure of the risks of
liquidity fees and gates, but that includes additional detail about the
risks of investing in money market funds generally. We propose to
require each government money market fund that relies on the exemption
to include the following bulleted disclosure statement in the summary
section of its statutory prospectus (and, accordingly, in any summary
prospectus, if used), and on any advertisement or sales material that
it disseminates (including on the fund Web site):
You could lose money by investing in the Fund.
The Fund seeks to preserve the value of your investment at
$1.00 per share, but cannot guarantee such stability.
An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency.
The Fund's sponsor has no legal obligation to provide
financial support to the Fund, and you should not expect that the
sponsor will provide financial support to the Fund at any time.\431\
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\431\ See proposed (Fees & Gates) rule 482(b)(4)(ii) and
proposed (Fees & Gates) Item 4(b)(1)(ii)(B) of Form N-1A. If an
affiliated person, promoter, or principal underwriter of the fund,
or an affiliated person of such person, has entered into an
agreement to provide financial support to the fund, the fund would
be permitted to omit this bulleted sentence from the disclosure
statement that appears on a fund advertisement or fund sales
material, for the term of the agreement. See Note to paragraph
(b)(4), proposed (Fees & Gates) rule 482(b)(4).
Likewise, if an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
entered into an agreement to provide financial support to the fund,
and the term of the agreement will extend for at least one year
following the effective date of the fund's registration statement,
the fund would be permitted to omit this bulleted sentence from the
disclosure statement that appears on the fund's registration
statement. See Instruction to proposed (Fees & Gates) Item
4(b)(1)(ii) of Form N-1A.
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[[Page 36895]]
The proposed disclosure statements are intended to be one measure
to change the investment expectations of money market fund investors,
including the expectation that a money market fund is a stable,
riskless investment.\432\ In addition, we are concerned that investors,
under the liquidity fees and gates proposal, will not be fully aware of
potential restrictions on fund redemptions. In proposing the disclosure
statement, we have taken into consideration investor preferences for
clear, concise, and understandable language and have also considered
whether language that was stronger in conveying potential risks
associated with money market funds would be effective for
investors.\433\ In addition, we considered whether the proposed
disclosure statement should be limited to only money market fund
advertisements and sales materials, as discussed above. Although we
acknowledge that the summary section of the prospectus must contain a
discussion of key risk factors associated with a money market fund, we
believe that the importance of the disclosure statement merits its
placement in both locations, similar to how the current money market
fund legend is required in both money market fund advertisements and
sales materials and the summary section of the prospectus.\434\
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\432\ See supra section II.B.3.
\433\ See supra notes 316 and 317.
\434\ See supra notes 429 and 430.
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We request comment on the proposed disclosure statement.\435\
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\435\ In the questions that follow, we use the term ``disclosure
statement'' to mean the new disclosure statement that we propose to
require money market funds other than those exempted from the fees
and gates requirements to incorporate into their prospectuses and
advertisements and sales materials or, alternatively and as
appropriate, the new disclosure statement that we propose to require
government funds (that choose to rely on the rule 2a-7 exemption
from the fees and gates requirements) to incorporate into their
prospectuses and advertisements and sales materials.
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Would the proposed disclosure statement adequately alert
investors to the risks of investing in a money market fund, including a
fund that could impose liquidity fees or gates under certain
circumstances? Would investors understand the meaning of each part of
the proposed disclosure statement? If not, how should the proposed
disclosure statement be amended? Would the following variations on the
proposed disclosure statement be any more or less useful in alerting
shareholders to potential investment risks?
[cir] Removing or amending the following bullet in the proposed
disclosure statement: ``The Fund's sponsor has no legal obligation to
provide financial support to the Fund, and you should not expect that
the sponsor will provide financial support to the Fund at any time.''
[cir] Including additional disclosure of the possibility that a
temporary suspension of redemptions could become permanent if the board
determines that the fund should liquidate.
[cir] Including additional disclosure to the effect that retail
shareholders should not invest all or most of the cash that they might
need for routine expenses (e.g., mortgage payments, credit card bills,
etc.) in any one money market fund, on account of the possibility that
the fund could impose a liquidity fee or suspend redemptions.
[cir] Amending the final bullet in the proposed disclosure
statement to read: ``Your investment in the Fund therefore may
experience losses.''
Will the proposed disclosure statement respond effectively
to investor preferences for clear, concise, and understandable
language?
Would investors benefit from requiring this disclosure
statement also to be included on the front cover page of a non-
government money market fund's prospectus (and on the cover page or
beginning of any summary prospectus, if used)?
Should we provide any instruction or guidance in order to
highlight the proposed disclosure statement on fund advertisements and
sales materials (including the fund's Web site) and/or lead investors
efficiently to the disclosure statement? \436\ For example, with
respect to the fund's Web site, should we instruct that the proposed
disclosure statement be posted on the fund's home page or be accessible
in no more than two clicks from the fund's home page?
---------------------------------------------------------------------------
\436\ Such instruction or guidance would supplement current
requirements for the presentation of the disclosure statement
required by rule 482(b)(4). See supra note 429; rule 482(b)(5).
---------------------------------------------------------------------------
b. Disclosure of the Effects of Liquidity Fees and Gates on Redemptions
Currently, funds are required to disclose any restrictions on fund
redemptions in their registration statements.\437\ We expect that, to
comply with these requirements, money market funds (besides government
money market funds that have chosen to rely on the proposed rule 2a-7
exemption from the fees and gates requirements) would disclose in the
registration statement the effects that the potential imposition of
fees and/or gates may have on a shareholder's ability to redeem shares
of the fund. We believe that this disclosure would help investors
understand the potential effect of their redemption decisions during
periods that the fund experiences stress, and to evaluate the full
costs of redeeming fund shares--one of the goals of this
rulemaking.\438\ Specifically, we would expect money market funds to
briefly explain in the prospectus that if the fund's weekly liquid
assets have fallen below 15% of its total assets, the fund will impose
a liquidity fee of 2% on all redemptions, unless the board of directors
of the fund (including a majority of its independent directors)
determines that imposing such a fee would not be in the best interest
of the fund or determines that a lesser fee would be in the best
interest of the fund. We also would expect money market funds to
briefly explain in the prospectus that if the fund's weekly liquid
assets have fallen below 15% of its total assets, the fund board would
be able to impose a temporary suspension of redemptions for a limited
period of time and/or liquidate the fund. We also would expect money
market funds to disclose in the prospectus that information about the
historical occasions on which the fund's weekly liquid assets have
fallen below 15% of its total assets, or the fund has imposed liquidity
fees or redemption restrictions, appears in the funds' SAI (as
applicable).\439\
---------------------------------------------------------------------------
\437\ See Item 11(c)(1) and Item 23 of Form N-1A.
\438\ See supra note 351 and accompanying text (discussing the
extent to which standby liquidity fees can provide a disincentive
for money market fund investors to redeem their shares during times
of stress).
\439\ See infra section III.B.8.d.
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In addition, we would expect money market funds to incorporate
additional disclosure in the prospectus or SAI, as the fund determines
appropriate, discussing the operations of fees and gates in more
detail.\440\ This could
[[Page 36896]]
include disclosure regarding the following:
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\440\ Prospectus disclosure regarding any restrictions on
redemptions is currently required by Item 11(c)(1) of Form N-1A.
However, we believe that funds could determine that more detailed
disclosure about the operations of fees and gates, as further
discussed in this section, would appropriately appear in a fund's
SAI, and that this more detailed disclosure is responsive to Item 23
of Form N-1A (``Purchase, Redemption, and Pricing of Shares''). In
determining whether to include this disclosure in the prospectus or
SAI, money market funds should rely on the principle that funds
should limit disclosure in prospectuses generally to information
that is necessary for an average or typical investor to make an
investment decision. Detailed or highly technical discussions, as
well as information that may be helpful to more sophisticated
investors, dilute the effect of necessary prospectus disclosure and
should be placed in the SAI. See Registration Form Used by Open-End
Management Investment Companies, Investment Company Act Release No.
23064 (Mar. 13, 1998) [63 FR 13916 (Mar. 23, 1998)], at section I.
Based on this principle, we anticipate that funds would generally
consider the disclosure topics covered by the first two bullets on
the above list (means of notifying shareholders of fees and gates
and the timing of the imposition and removal of fees and gates) to
be appropriate prospectus disclosure.
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Means of notifying shareholders about the imposition and
lifting of fees and/or gates (e.g., press release, Web site
announcement);
Timing of the imposition and lifting of fees and gates,
including an explanation that if a fund's weekly liquid assets fall
below 15% of its total assets at the end of any business day, the next
business day it must impose a 2% liquidity fee on shareholder
redemptions unless the fund's board of directors determines otherwise,
and an explanation of the 30-day limit for imposing gates;
Use of fee proceeds by the fund, including any possible
return to shareholders in the form of a distribution;
The tax consequences to the fund and its shareholders of
the fund's receipt of liquidity fees; and
General description of the process of fund liquidation
\441\ if the fund's weekly liquid assets fall below 15%, and the fund's
board of directors determines that the fund would be unable to stay
open (or, if gated, re-open) without further harm to the fund.
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\441\ See supra note 408 and accompanying text.
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We request comment on the disclosure that we expect funds to
include in their registration statements regarding the operations and
effects of liquidity fees and redemption gates.
Would the disclosure that we discuss above adequately
assist money market fund investors in understanding the potential
effect of their redemption decisions, and in evaluating the full costs
of redeeming fund shares? Should we require funds to include this
disclosure in their prospectuses and/or SAIs? Should we require funds
to include any additional prospectus and SAI disclosure discussing, in
detail, the operations and effects of fees and redemption gates? In
particular, should we require funds to include any additional details
about the fund's liquidation process? \442\ Alternatively, should any
of the proposed prospectus and SAI disclosure not be required, and if
so, why not?
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\442\ Disclosure about the process of fund liquidation might
include, for example, disclosure regarding any fees, including
advisory fees, that the adviser will collect during the liquidation
process.
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Should we require any information about the basic
operations and effects of fees and redemption gates to be disclosed in
the summary section of the statutory prospectus (and any summary
prospectus, if used)?
Should we require disclosure to investors of the
particular risks associated with buying fund shares when the fund or
market is stressed, especially when the fund is imposing either a
liquidity fee or a gate?
Should Form N-1A or its instructions be amended to more
explicitly require any of the proposed disclosure to be included in a
fund's prospectus and/or SAI? If so, how should it be amended?
c. Disclosure of the Imposition of Liquidity Fees and Gates
If we were to adopt a reform alternative involving liquidity fees
and gates, we believe that it would be important for money market funds
(other than government money market funds that have chosen to rely on
the proposed rule 2a-7 exemption from the fees and gates requirements)
to inform existing and prospective shareholders when: (i) The fund's
weekly liquid assets fall below 15% of its total assets; (ii) the
fund's board of directors imposes a liquidity fee pursuant to rule 2a-
7; or (iii) the fund's board of directors temporarily suspends the
fund's redemptions pursuant to rule 2a-7 or permanently suspends
redemptions pursuant to rule 22e-3. This information would be important
for shareholders to receive, as it could influence prospective
shareholders' decision to purchase shares of the fund, as well as
current shareholders' decision or ability to sell fund shares. To this
end, we are proposing an amendment to rule 2a-7 that would require a
fund to post prominently on its Web site certain information that the
fund would be required to report to the Commission on Form N-CR \443\
regarding the imposition of liquidity fees, suspension of fund
redemptions, and the removal of liquidity fees and/or resumption of
fund redemptions.\444\ The amendment would require a fund to include
this Web site disclosure on the same business day as the fund files an
initial report with the Commission in response to any of the events
specified in Parts E, F, and G of Form N-CR,\445\ and, with respect to
any such event, to maintain this disclosure on its Web site for a
period of not less than one year following the date on which the fund
filed Form N-CR concerning the event.\446\
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\443\ See infra section III.G.
\444\ See proposed (Fees & Gates) rule 2a-7(h)(10)(v); proposed
(Fees & Gates) Form N-CR Parts E, F, and G; see also infra section
III.G (discussing the proposed Form N-CR requirements). With respect
to the events specified in Part E of Form N-CR (imposition of a
liquidity fee) and Part F of Form N-CR (suspension of fund
redemptions), a fund would be required to post on its Web site only
the preliminary information required to be filed on Form N-CR on the
first business day following the triggering event. See Instructions
to proposed (Fees & Gates) Form N-CR Parts E and F.
\445\ A fund must file an initial report on Form N-CR in
response to any of the events specified in Parts E, F, or G within
one business day after the occurrence of any such event. We believe
that funds should disclose these events within one business day
following the event because it is particularly important to provide
shareholders with information that could directly affect their
redemption of fund shares, and that could be a material factor in
determining whether to purchase or redeem fund shares, as soon as
reasonably possible.
\446\ See proposed (Fees & Gates) rule 2a-7(h)(10)(v). We
believe that the one-year minimum time frame for Web site disclosure
is appropriate because this time frame would effectively oblige a
fund to post the required information in the interim period until
the fund files an annual post-effective amendment updating its
registration statement, which update would incorporate the same
information. See infra notes 450 and 451 and accompanying text.
Although a fund would inform prospective investors of any redemption
fee or gate currently in place by means of a prospectus supplement
(see infra note 449 and accompanying text), the prospectus
supplement would not inform shareholders of any fees or gates that
were imposed, and then were removed, during the previous 12 months.
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We believe that this Web site disclosure would provide greater
transparency to shareholders regarding occasions on which a fund's
weekly liquid assets drop below 15% of the fund's total assets, as well
as the imposition of liquidity fees and suspension of fund redemptions,
because many investors currently obtain important information about the
fund on the fund's Web site.\447\ We understand that investors have, in
past years, become accustomed to obtaining money market fund
information on funds' Web sites.\448\ While we believe
[[Page 36897]]
that it is important to have a uniform, central place for investors to
access the required disclosure, we note that nothing in this proposal
would prevent a fund from supplementing its Form N-CR filing and Web
site posting with complementary shareholder communications, such as a
press release or social media update disclosing a fee or gate imposed
by the fund.
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\447\ For example, fund investors may access the fund's proxy
voting guidelines, and proxy vote report, as well as the fund's
prospectus, SAI, and shareholder reports if the fund uses a summary
prospectus, on the fund Web site.
\448\ See, e.g., 2010 Adopting Release, supra note 92 (adopting
amendments to rule 2a-7 requiring money market funds to disclose
information about their portfolio holdings each month on their Web
sites); SIFMA FSOC Comment Letter, supra note 358 (noting that some
industry participants now post on their Web sites portfolio
holdings-related information beyond that which is required by the
money market reforms adopted by the Commission in 2010, as well as
daily disclosure of market value per share); see also infra note 659
(discussing recent decisions by a number of money market fund firms
to begin reporting funds' daily shadow prices on the fund Web site).
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A fund currently must update its registration statement to reflect
any material changes by means of a post-effective amendment or a
prospectus supplement (or ``sticker'') pursuant to rule 497 under the
Securities Act.\449\ We would expect that, to meet this requirement,
promptly after a money market fund imposes a redemption fee or gate, it
would inform prospective investors of any fees or gates currently in
place by means of a prospectus supplement.
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\449\ See 17 CFR 230.497.
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We request comment on the proposed requirement for money market
funds to inform existing and prospective shareholders, on the fund's
Web site and in the fund's registration statement, of any present
occasion in which the fund's weekly liquid assets fall below 15% of its
total assets, the fund's board imposes a liquidity fee, or the fund's
board temporarily suspends the fund's redemptions.
Should any more, any less, or any other information be
required to be posted on the fund's Web site than that disclosed on
Form N-CR?
As proposed, should we require this information to be
posted ``prominently'' on the fund's Web site? Should we provide any
other instruction as to the presentation of this information, in order
to highlight the information and/or lead investors efficiently to the
information, for example, should we require that the information be
posted on the fund's home page or be accessible in no more than two
clicks from the fund's home page?
Should this information be posted on the fund's Web site
for a longer or shorter period than one year following the date on
which the fund filed Form N-CR to disclose any of the events specified
in Part E, F, or G of Form N-CR?
Besides requiring a money market fund that imposes a
liquidity fee or gate to file a prospectus supplement and include
related disclosure on the fund's Web site, should we also require the
fund to notify shareholders individually about the effects of the fee
or gate? Should we require a fund to engage in any other supplemental
shareholder communications, such as issuing a press release or
disclosing the fee or gate on any form of social media that the fund
uses?
How will the disclosure of the imposition of a fee or gate
affect the willingness of current or prospective investors to purchase
shares of the fund? How will this disclosure affect investors'
purchases and redemptions in other funds? How will it affect other
market participants? Will these effects differ based on the number of
funds that concurrently impose fees and/or gates?
d. Historical Disclosure of Liquidity Fees and Gates
We also believe that money market funds' current and prospective
shareholders should be informed of post-compliance-period historical
occasions in which the fund's weekly liquid assets have fallen below
15% or the fund has imposed liquidity fees or redemption gates. While
we recognize that historical occurrences are not necessarily indicative
of future events, we anticipate that current and prospective fund
investors could use this information as one factor to compare the risks
and potential costs of investing in different money market funds.
We are therefore proposing an amendment to Form N-1A to require
money market funds (other than government money market funds that have
chosen to rely on the proposed rule 2a-7 exemption from the fees and
gates requirements) to provide disclosure in their SAIs regarding any
occasion during the last 10 years (but not before the compliance
period) on which the fund's weekly liquid assets have fallen below 15%,
and with respect to each such occasion, whether the fund's board of
directors determined to impose a liquidity fee and/or suspend the
fund's redemptions.\450\ With respect to each occasion, we propose
requiring funds to disclose: (i) The length of time for which the
fund's weekly liquid assets remained below 15%; (ii) the dates and
length of time for which the fund's board of directors determined to
impose a liquidity fee and/or temporarily suspend the fund's
redemptions; and (iii) a short discussion of the board's analysis
supporting its decision to impose a liquidity fee (or not to impose a
liquidity fee) and/or temporarily suspend the fund's redemptions.\451\
We would expect that this disclosure could include (as applicable, and
taking into account considerations regarding the confidentiality of
board deliberations) a discussion of the following factors relating to
the board's decision to impose a liquidity fee and/or suspend
redemptions: The fund's shadow price; relevant market indicators of
liquidity stress in the markets; changes in spreads for portfolio
securities; the fund's future liquidity profile (taking into account
predicted redemptions and other expectations); the fund's ability to
apply any collected fees quickly to rebuild fund liquidity; and the
predicted time for portfolio securities to mature and provide internal
liquidity to the fund, and for potentially distressed portfolio
securities to mature or recover. The required disclosure would permit
current and prospective shareholders to assess, among other things, any
patterns of stress experienced by the fund, as well as whether the
fund's board has previously imposed fees and/or redemption gates in
light of significant drops in portfolio liquidity. This disclosure also
would provide investors with historical information about the board's
past analytical process in determining how to handle liquidity issues
when the fund experiences stress, which could influence an investor's
decision to purchase shares of, or remain invested in, the fund. In
addition, the required disclosure may encourage portfolio managers to
increase the level of daily and weekly liquid assets in the fund, as
that would tend to lessen the likelihood of a liquidity fee or gate
being needed, and the fund being required to disclose the fee or gate
to current and prospective investors.\452\
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\450\ See proposed (Fees & Gates) Item 16(g)(1) of Form N-1A. We
believe that the proposed 10-year look-back period would provide
shareholders and the Commission with a historical perspective that
would be long enough to provide a useful understanding of past
events, and to analyze patterns with respect to fees and gates, but
not so long as to include circumstances that may no longer be a
relevant reflection of the fund's management or operations.
\451\ See instructions to proposed (Fees & Gates) Item 16(g)(1)
of Form N-1A.
\452\ See supra note 365.
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We request comment on the proposed requirement for money market
funds to include SAI disclosure regarding the historical occasions in
which the fund's weekly liquid assets have fallen below 15% or the fund
has imposed liquidity fees or redemption gates.
Would the proposed disclosure requirement assist current
and prospective fund investors in comparing the risks and potential
costs of investing in different money market funds, and would retail
investors as well as
[[Page 36898]]
institutional investors benefit from the proposed disclosure? Would the
proposed requirement to include a short discussion of the board's
analysis supporting its decision whether to impose a fee or suspend
redemptions result in meaningful and succinct disclosure? Should any
more, any less, or any other disclosure be required to be included in
the fund's SAI? Should the disclosure instead be required in the
prospectus?
Keeping in mind the compliance period we propose,\453\
should the ``look-back'' period for this historical disclosure be
longer or shorter than 10 years?
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\453\ See infra section III.N.
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Should the proposed SAI disclosure be permitted to be
incorporated by reference in a fund's registration statement, on
account of the fact that funds will have previously disclosed the
information proposed to be required in this SAI disclosure on Form N-
CR? \454\
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\454\ See proposed (Fees & Gates) Form N-CR Parts E, F, and G.
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Should we require this historical disclosure to be
included anywhere else, for example, on the fund's Web site?
e. Prospectus Fee Table
Under the proposed liquidity fees and gates alternative, a
liquidity fee would only be imposed when a fund experiences stress
(i.e., we believe that shareholders would not pay the liquidity fee in
connection with their typical day-to-day transactions with the fund
under normal conditions and many funds may never need to impose the
fee). Because funds are anticipated to rarely, if at all, impose this
fee,\455\ we do not believe that the prospectus fee table, which is
intended to help shareholders compare the costs of investing in
different mutual funds, should include the proposed liquidity fee.\456\
Therefore, we propose clarifying in the instructions to Item 3 of Form
N-1A (``Risk/Return Summary: Fee Table'') that the term ``redemption
fee,'' for purposes of the prospectus fee table, does not include a
liquidity fee that may be imposed in accordance with rule 2a-7.\457\ As
discussed above, we do believe that shareholders should be able to
compare the extent to which money market funds have historically
imposed liquidity fees, and to this end, we have proposed SAI
amendments requiring this disclosure.\458\ Also, as previously
discussed, funds would disclose in the summary section of the statutory
prospectus (and, accordingly, any summary prospectus, if used) that
they may impose a liquidity fee, and also would include a detailed
description of the size of the fees, and when the fees might be
imposed, elsewhere in the statutory prospectus.\459\
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\455\ See supra text following note 383.
\456\ Instruction 2(b) to Item 3 of Form N-1A currently defines
``redemption fee'' to include any fee charged for any redemption of
the Fund's shares, but does not include a deferred sales charge
(load) imposed upon redemption.
\457\ See instruction 2(b) to proposed (Fees & Gates) Item 3 of
Form N-1A.
\458\ See supra notes 450 and 451 and accompanying text.
\459\ See supra notes 429, 431 and 440 and accompanying text.
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We request comment on the proposed Form N-1A instruction that would
clarify that, for purposes of the prospectus fee table, the term
``redemption fee'' does not include a liquidity fee imposed in
accordance with rule 2a-7.
Would shareholders find it instructive for funds to
disclose the proposed liquidity fee in the prospectus fee table? Why or
why not? If we were to require money market funds to include liquidity
fees in the fee table, how should the fee table account for the
contingent nature of liquidity fees and inform investors that liquidity
fees will only be imposed in certain circumstances? Should the
possibility of a liquidity fee be disclosed in a footnote of the fee
table? Should a cross-reference to the fund's SAI disclosure regarding
historical occasions on which the fund has imposed liquidity fees be
disclosed in a footnote of the fee table?
Would the proposed SAI amendments requiring disclosure of
the historical occasions on which the fund has imposed liquidity fees
be an effective way for shareholders to compare the extent to which
money market funds have historically imposed liquidity fees, and
analyze the probability that a fund will impose such fees in the
future?
f. Economic Analysis
The liquidity fees and gates proposal makes significant changes to
the nature of money market funds as an investment vehicle. The proposed
disclosure requirements in this section are intended to communicate to
shareholders the nature of the risks that follow from the liquidity
fees and gates proposal. In section III.B, we discussed why we are
unable to estimate how the liquidity fees and gates proposal will
affect shareholders' use of money market funds or the resulting effects
on the short-term financing markets because we do not have the
information necessary to provide a reasonable estimate. For similar
reasons, we are unable to estimate the incremental effects that the
proposed disclosure requirements will have on either shareholders or
the short-term financing markets. However, we believe that the proposed
disclosure will better inform shareholders about the changes, which
should result in shareholders making investment decisions that better
match their investment preferences. We expect that this will have
similar effects on efficiency, competition, and capital formation as
those outlined in section III.E rather than to introduce new effects.
We further believe that the effects of the proposed disclosure
requirements will be small relative to the liquidity fees and gates
proposal. The Commission staff has not measured the quantitative
benefits of these proposed requirements at this time because of
uncertainty about how increased transparency may affect different
investors' understanding of the risks associated with money market
funds.\460\ Where it is relevant, we request the data needed to make
these calculations below.
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\460\ Likewise, uncertainty regarding how the proposed
disclosure may affect different investors' behavior makes it
difficult for the SEC staff to measure the quantitative benefits of
the proposed requirements. With respect to the proposed disclosure
statement, there are many possible permutations on specific wording
that would convey the specific concerns identified in this Release,
and the breadth of these permutations makes it difficult for SEC
staff to test how investors would respond to each wording variation.
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We anticipate that money market funds would incur costs to amend
their registration statements, and to update their advertising and
sales materials (including the fund Web site), to include the proposed
disclosure statement. We also anticipate that money market funds
(besides government money market funds that have chosen to rely on the
proposed rule 2a-7 exemption from the fees and gates requirements)
would incur costs to (i) amend their registration statements to
incorporate disclosure regarding the effects of fees and gates on
redemptions; (ii) include disclosure of the post-compliance-period
historical occasions in which the fund's weekly liquid assets have
fallen below 15% or the fund has imposed liquidity fees or gates; and
(iii) update the prospectus fee table. These funds also would incur
costs to disclose current instances of liquidity fees or gates on the
fund's Web site. These costs would include initial, one-time costs, as
well as ongoing costs. Our staff estimates that the average one-time
costs for a money market fund (except government money market funds
that have chosen to rely on the proposed rule 2a-7 exemption from the
fees and
[[Page 36899]]
gates requirements) to comply with these proposed disclosure amendments
would be approximately $1,480, and that the average one-time compliance
costs for a government money market fund that has chosen to rely on the
proposed rule 2a-7 exemption from the fees and gates requirements would
be approximately $592.\461\
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\461\ Staff estimates that these costs would be attributable to
amending the fund's disclosure statement and updating the fund's
advertising and sales materials. See supra note 245 (discussing the
bases of our staff's estimates of operational and related costs).
The costs associated with these activities are all paperwork-related
costs and are discussed in more detail in infra section IV.B.7.
We expect the new required disclosure would add minimal length
to the current required registration statement disclosure, and thus
would not increase the number of pages in, or change the printing
costs of, a fund's registration statement. Based on conversations
with fund representatives, the Commission understands that, in
general, unless the page count of a registration statement is
changed by at least four pages, printing costs would remain the
same.
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Ongoing compliance costs include the costs for money market funds
periodically to update disclosure in their registration statements
regarding historical occasions in which the fund's weekly liquid assets
have fallen below 15% or the fund has imposed fees or gates, and also
to disclose current instances of any of these events on the fund's Web
site. Because the required registration statement and Web site
disclosure overlaps with the information that a fund must disclose on
Form N-CR when the fund's weekly liquid assets fall below 15%, or the
fund imposes or removes a fee or gate,\462\ we anticipate that the
costs a fund will incur to draft and finalize the disclosure that will
appear in its registration statement and on its Web site will largely
be incurred when the fund files Form N-CR, as discussed below in
section III.G.3. In addition, we estimate that a fund (besides a
government money market fund that has chosen to rely on the proposed
rule 2a-7 exemption from the fees and gates requirements) would incur
average annual costs of $296 \463\ to review and update the historical
disclosure in its registration statement (plus printing costs), and
costs of $207 \464\ each time that it updates its Web site to include
the required disclosure.
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\462\ See proposed (Fees & Gates) Form N-CR Parts E, F, and G.
\463\ The costs associated with updating the fund's registration
statement are paperwork-related costs and are discussed in more
detail in infra section IV.B.7.
\464\ The costs associated with updating the fund's Web site are
paperwork-related costs and are discussed in more detail in infra
section IV.B.1.g.iv.
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We request comment on this economic analysis:
Are any of the proposed disclosure requirements unduly
burdensome, or would they impose any unnecessary costs?
We request comment on the staff's estimates of the
operational costs associated with the proposed disclosure requirements.
We request comment on our analysis of potential effects of
these proposed disclosure requirements on efficiency, competition, and
capital formation.
9. Alternative Redemption Restrictions
a. Stand-Alone Liquidity Fees or Stand-Alone Gates
We are proposing that money market fund boards of directors be
permitted to institute liquidity fees or gates (and potentially one
followed by the other). This proposal is designed to provide money
market funds with multiple tools to manage heightened redemptions in
the best interest of the fund and to mitigate potential contagion
effects on the short-term financing markets for issuers.
We also have considered whether we should permit these money market
funds to institute only liquidity fees or only gates. As discussed
above, fees and gates can accomplish somewhat different objectives and
have somewhat different tradeoffs and effects on shareholders and the
short-term financing markets for issuers. For shareholders valuing
principal preservation in their evaluation of money market fund
investments, a gate may be preferable to a liquidity fee particularly
if the fund expects to rebuild liquidity through maturing assets. In
contrast, shareholders preferring liquidity over principal preservation
may prefer a liquidity fee because it allows full liquidity of that
investor's money market fund shareholdings--it just imposes a greater
cost for that liquidity if the fund is under stress.\465\
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\465\ See, e.g., Comment Letter of BlackRock, Inc. on the IOSCO
Consultation Report on Money Market Fund Systemic Risk Analysis and
Reform Options (May 28, 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf. (stating their preference for
liquidity fees over gates ``because clients with an extreme need for
liquidity can choose to pay for that liquidity in a crisis''); BNP
Paribas IOSCO Comment Letter, supra note 357 (stating that it
``would not make sense to restrict the redeemer willing to pay the
price of liquidity'').
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Because fees and gates can accomplish somewhat different objectives
and one may be better suited to one set of market circumstances than
the other, we preliminarily believe that providing funds with the
ability to use either tool, as the board determines is in the best
interest of the fund, is a better approach to preserve the benefits of
money market funds for investors and the short-term financing markets
for issuers, enhance investor protection, and improve money market
funds' ability to manage and mitigate high levels of redemptions. It
also may better allow funds to tailor the redemption restrictions they
employ to their experience with the preferences and behavior of their
particular shareholder base and to adapt the restriction they institute
as they or the industry gains experience over time employing such
restrictions. We request comment on stand-alone liquidity fees or
stand-alone gates.
Should we adopt rule amendments that would just permit
money market funds to institute liquidity fees or just permit these
money market funds to institute a gate? Why might it be preferable to
allow only a fee or only a gate? If we allowed only a fee or only a
gate, should there be different parameters or restrictions around when
the fee or gate could be imposed or lifted than what we have proposed?
If so, what should they be and why?
b. Partial Gates
We are proposing to permit money market funds to institute a
complete gate in certain circumstances--a temporary suspension of
redemptions. Some have suggested that we allow money market funds to
impose partial gates in times of stress.\466\ For example, once the
money market fund had crossed the 15% weekly liquid asset threshold, we
could permit the board of directors (including a majority of its
independent directors) to limit redemptions by any particular
shareholder to a certain percentage of their shareholdings, to a
certain percentage of the fund's outstanding shares, or to a certain
dollar amount per day. Those limited redemptions would not be charged a
liquidity fee.
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\466\ See, e.g., HSBC EC Letter, supra note 156 (stating that a
money market fund should be able to limit the total number of shares
that the fund is required to redeem on any trading day to 10% of the
shares in issue, that any such gate be applied pro rata to
redemption requests, and that any redemption requests not met be
carried over to the next business day and so forth until all
redemption requests have been met).
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A partial gate can operate to prevent ``fire sales'' of assets in
the fund and provide some liquidity to investors while allowing time
for the fund to satisfy the remaining portion of redemptions requests
under better market conditions or with internally generated liquidity.
It can act as a gradual brake on redemptions, reducing
[[Page 36900]]
them to the extent that they no longer impact the fund's value or
liquidity. In doing so, they can have a less severe impact on fund
shareholders because they know they will be able to redeem without cost
at least a certain portion of their investment on any particular day,
even in times of stress. A partial gate could be imposed in lieu of a
liquidity fee or could be combined with a liquidity fee (e.g., once the
fund imposed a partial gate, a shareholder could redeem 10% of their
shareholdings at no cost and the rest of their shareholdings by paying
a liquidity fee). Similarly, we could consider adopting a partial gate
in lieu of our full gate proposal or as an additional tool that would
be available to fund boards on the same terms as a full gate is
available.
On the other hand, a partial gate may not impose a substantial
enough deterrent on redemption activity in times of stress to
effectively reduce the contagion impact of heavy redemptions on
remaining investors and the short-term financing markets. For example,
in 2007 when a Florida local government investment pool suspended
redemptions in response to a run, it re-opened with a combined partial
gate and liquidity fee--local governments could take out the greater of
15% of their holdings or $2 million without penalty, and the remainder
of any redemptions were subject to a 2% redemption fee.\467\ We
understand that only a few investors redeemed more than what was
allowed without a fee, but that investors redeemed most of what was
allowed under the partial gate without triggering the redemption
fee.\468\ We also are concerned that a partial gate would operate in
substantially the same manner as an exemption from the fee or gate
requirement for small withdrawals, discussed above in section III.B.5,
and thus may be subject to many of the same drawbacks in terms of
operational costs and added complexity compared to our liquidity fees
and gates proposal.
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\467\ See David Evans and Darrell Preston, Florida Investment
Chief Quits; Fund Rescue Approved, Bloomberg (Dec. 4, 2007).
\468\ See, e.g., Neil Weinberg, Florida Fund Meltdown: Bad to
Worse, Forbes (Dec. 6, 2007) (noting that investors withdrew $1.2
billion from the $14 billion pool after it re-opened, while
depositing only $7 million, but that only 3 out of about 1,700
participants in the pool chose to pay the redemption fee to withdraw
additional assets).
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We request comment on whether we should require or permit partial
gates in certain circumstances.
Should we allow partial gates? If so, why? Under what
conditions and of what nature? Should they limit each shareholder's
redemptions to a certain percentage of his or her shareholdings (e.g.,
10% or 25%), to a certain percentage of the fund's outstanding shares
(e.g., 1% or 5%), or to a certain dollar amount per day (e.g., $10,000
or $50,000)? If so, what percentage or dollar amount and why?
How would partial gates affect shareholder redemption
decisions compared to our proposal of liquidity fees and full gates?
Would they achieve our goals of preserving the benefits of money market
funds for investors and the short-term financing markets for issuers,
while mitigating the risk of runs, enhancing investor protection and
improving money market funds' ability to manage and mitigate high
levels of redemptions to the same extent as our proposed liquidity fees
and gates? Why or why not?
If we allowed partial gates, should they be allowed in
addition to liquidity fees and full gates or in lieu of fees or full
gates? What operational and other costs would be involved if we allowed
partial gates in addition to or in lieu of fees and/or full gates?
c. In-Kind Redemptions
In 2009, we requested comment on requiring that funds satisfy
redemption requests in excess of a certain size through in-kind
redemptions.\469\ We also requested comment on this type of redemption
restriction when we requested comment on the PWG Report.\470\ In-kind
redemptions might lessen the effect of large redemptions on remaining
money market fund shareholders, and they would ensure that the
redeeming investors bear part of the cost of their liquidity needs.
During the 2008 financial crisis, one money market fund stated that it
would honor certain large redemptions in-kind in an attempt to decrease
the level of redemptions in that fund.\471\
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\469\ See 2009 Proposing Release, supra note 31, at section
III.B. An in-kind redemption occurs when a shareholder's redemption
request to a fund is satisfied by distributing to that shareholder
portfolio assets of that fund instead of cash.
\470\ See PWG Report, supra note 111, at section 3.c (discussing
requiring that money market funds satisfy certain redemptions in-
kind).
\471\ See 2009 Proposing Release, supra note 31, at n.309.
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In both instances, almost all commenters addressing this potential
reform option opposed it.\472\ Most commenters believed that requiring
in-kind redemptions would be technically unworkable due to the complex
valuation and operational issues that would be imposed on both the fund
and on investors receiving portfolio securities.\473\ They also
asserted that required in-kind redemptions could result in disrupting,
rather than stabilizing, markets if redeeming shareholders needing
liquidity were forced to sell into declining markets.\474\ Several
commenters stated that investors would dislike the prospect of
receiving redemptions in-kind and would structure their holdings to
avoid the requirement, but would nevertheless still collectively engage
in redemptions if the money market funds were to come
[[Page 36901]]
under stress with similar adverse consequences for the funds and the
short-term financing markets.\475\
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\472\ But see Comment Letter of Forward Management (Aug. 21,
2009) (available in File No. S7-11-09) (supporting in-kind
redemption requirement); Comment Letter of the American Bar
Association (Committee on Federal Regulation of Securities) (Sept.
9, 2009) (available in File No. S7-11-09) (same). In addition, two
PWG Report commenters expressed concern that redemptions in-kind
would be technically unworkable, but were open to further
examination of this option. See Comment Letter of Invesco Advisers,
Inc. (Jan. 10, 2011) (available in File No. 4-619) (``We have
previously expressed our concern that requiring money market funds
to satisfy redemptions in-kind under certain circumstances would
likely be technically unworkable and could result in disrupting,
rather than stabilizing, markets. While we continue to harbor these
concerns, we would be supportive in principle of a mandatory in-kind
redemption requirement if these technical challenges could be
addressed successfully in a partnership with regulatory
authorities.''); Comment Letter of Federated Investors, Inc. (Jan.
7, 2011) (available in File No. 4-619) (``Federated Jan 2011 PWG
Comment Letter'') (``we have identified some of the major problems
associated with redemption in-kind and included these in our comment
letter to the Commission on the recent money market fund reforms. .
. . At the appropriate time, we would be willing to meet with the
Commission or its staff to review our analysis of the issues raised
in responding to such events and to discuss approaches to resolving
these issues.'').
\473\ See, e.g., Comment Letter of BlackRock Inc. (Jan. 10,
2011) (available in File No. 4-619) (``BlackRock PWG Comment
Letter''); Comment Letter of The Dreyfus Corporation (Jan. 10, 2011)
(available in File No. 4-619) (``Dreyfus PWG Comment Letter'');
Comment Letter of Investment Company Institute (Jan. 10, 2011)
(available in File No. 4-619) (``ICI Jan 2011 PWG Comment Letter'');
Comment Letter of Fidelity Investments (Jan. 10, 2011) (available in
File No. 4-619) (``Fidelity Jan 2011 PWG Comment Letter''). For
example, the BlackRock PWG Comment Letter stated that some
shareholders cannot receive and hold direct investments in money
market assets and some portfolio securities, such as repurchase
agreements and Eurodollar time deposits, are OTC contracts and
cannot be transferred to retail or to multiple investors. The
Fidelity Jan 2011 PWG Comment Letter added that advisers may only be
able to transfer the most liquid securities, leaving a less liquid
portfolio for non-redeeming shareholders and with odd-lot positions
that are more difficult and expensive to trade.
\474\ See, e.g., Comment Letter of Goldman Sachs Asset
Management, L.P. (Jan. 10, 2011) (available in File No. 4-619) (``a
potential result of forced in-kind redemptions is simply to transfer
the selling responsibility from presumably sophisticated and
experienced asset managers to a disparate group of investors who do
not necessarily have any reason to know how to dispose of these
securities effectively''); Comment Letter of SVB Asset Management
(Jan. 10, 2011) (available in File No. 4-619); Comment Letter of T.
Rowe Price Associates, Inc. (Jan. 10, 2011) (available in File No.
4-619).
\475\ See, e.g., ICI Jan 2011 PWG Comment Letter, supra note
473; Richmond Fed PWG Comment Letter, supra note 139; Comment Letter
of Wells Fargo Funds Management, LLC (Jan. 10, 2011) (available in
File No. 4-619) (``Wells Fargo PWG Comment Letter'').
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These comments led us to believe that requiring in-kind redemptions
would create operational difficulties that could prevent funds from
operating fairly to investors in practice and that it would not
necessarily mitigate money market funds' susceptibility to runs and
related adverse effects on the short-term financing markets and capital
formation. Thus, we expect that the liquidity fees and gates approach
described above would better achieve our goals of preserving the
benefits of money market funds for investors and the short-term
financing markets for issuers while enhancing investor protection and
improving money market funds' ability to manage and mitigate potential
contagion from high levels of redemptions. Liquidity fees and gates
also may be easier to implement than required in-kind redemptions. We
request comment on whether we are correct in our analysis of the
relative merits and costs of in-kind redemptions as compared to the
other forms of redemption restrictions described in this Release as
well as any others that money market funds could seek to impose.
We also request comment on all the redemption restriction
alternatives discussed in this Release.
Are there other alternatives that we should consider? Do
commenters agree with our discussion about the advantages and
disadvantages of the various alternatives? Do commenters agree with our
discussion of their potential benefits and costs and other economic
effects?
C. Potential Combination of Standby Liquidity Fees and Gates and
Floating Net Asset Value
Today, we are proposing two alternative methods of reforming money
market funds. Although these two proposals are designed to achieve many
of the same goals, by their nature they would do so to different
degrees and with different tradeoffs. As discussed above, our first
alternative would require money market funds (other than government and
retail funds) to adopt floating NAVs. This proposal is designed
primarily to address the incentive for shareholders to redeem shares
ahead of other investors in times of fund and market stress. It also is
intended to improve the transparency of funds' investment risks through
more transparent valuation and pricing methods. It makes explicit the
risk and reward relation for money market funds. We recognize, however,
that the proposal does not necessarily address shareholders' incentive
to redeem from money market funds due to their liquidity risk or for
other reasons as discussed below. In times of severe market stress when
the secondary markets for funds' assets become illiquid, investors may
still have incentives to redeem shares before their fund's liquidity
dries up. It also may not alter money market fund shareholders'
incentive to redeem in times of market stress when investors are
engaging in flights to quality, liquidity, and transparency and the
related contagion effects from such high levels of redemptions.
Our second proposal, which requires funds to impose liquidity fees
unless the fund's board determines that it would not be in the best
interest of the fund and permits them to impose gates in certain
circumstances, is primarily focused on helping money market funds
manage heightened redemptions and reducing shareholders' incentive to
redeem under stress. It also could improve the transparency of funds'
liquidity risks through a more transparent and systematic allocation of
liquidity costs. In doing so, it addresses a principal drawback of our
floating NAV proposal by imposing a cost on redemptions in times of
market stress that may incorporate not just investment risk but also
liquidity risk. The prospect of facing liquidity fees and gates will
give the additional benefit of better informing and sensitizing
investors to the risks of investing in money market funds. We
recognize, however, that our liquidity fees and gates proposal does not
entirely eliminate the incentive of shareholders to redeem when the
fund's shadow price falls below a dollar. Moreover, it does not
eliminate the lack of valuation transparency in the pricing of money
market funds and any corresponding lack of shareholder appreciation of
money market fund valuation risks.
We are considering addressing the limitations of the two proposals
by combining them into a single reform package; that is, requiring
money market funds (other than government money market funds and,
regarding the floating NAV, retail money market funds) to both use a
floating NAV and potentially impose liquidity fees or gates in times of
fund and market stress.\476\ Doing so would address some of the
drawbacks of each proposal individually, but would present other
tradeoffs, as further discussed below.
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\476\ As discussed in supra section III.A.4, retail money market
funds would also be exempt from our proposed floating NAV
requirement.
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1. Potential Benefits of a Combination
A combined reform approach could reduce investors' incentive to
quickly redeem assets from money market funds in a crisis, improve the
transparency of funds' investment and liquidity risks, and enhance
money market funds' ability to manage and mitigate potential contagion
from high levels of redemptions relative to either proposal alone.
Under a combined approach, the floating NAV should reduce investors'
incentive to redeem early to avoid a market-based loss embedded in the
fund's portfolio because the fund would be transacting at the fair
value of its portfolio at all times. Doing so should reduce the
likelihood that investors engage in preemptive redemptions that could
trigger the imposition of fees and gates.\477\ Requiring a fund to
operate with a floating NAV with potential imposition of fees and gates
in times of fund or market stress should thus reduce the risk that
funds would face heavy redemptions. Early redeeming shareholders would
be less likely to be able to exit the fund without bearing the cost of
their redemptions, and thereby it will be less likely to concentrate
losses for the remaining shareholders. At the same time, requiring a
floating NAV fund to consider imposing liquidity fees or impose gates
when the fund's liquidity buffer comes under strain should enhance its
ability to manage its liquidity risk before it results in portfolio
losses.
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\477\ See supra section III.B.1 (discussing shareholders'
potential incentive to engage in preemptive redemptions in a stable
price money market fund that can impose fees or gates).
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The combination would provide a broader range of tools to a
floating NAV money market fund to manage redemptions in a crisis,
thereby avoiding ``fire sales'' of assets that would affect all
shareholders and potentially the short-term financing markets for
issuers. The combined approach also should further enhance the ability
of money market funds to treat shareholders equitably, and could allow
better management of funds' portfolios in a crisis to minimize
shareholder losses.
Requiring funds that can impose liquidity fees and gates to have a
floating NAV provides fuller transparency of fund valuation and
[[Page 36902]]
liquidity risk. This enhanced transparency may better inform investors
to the risk profile of their money market fund investment, and may make
investors less sensitive to fluctuations in a money market fund's NAV.
As a result of this familiarity with money market fund NAV
fluctuations, investors may be less likely to redeem shares in times of
fund and market stress because of the possibility that a fund's NAV
might change, and correspondingly reducing the chances that fees or
gates may be triggered.\478\ Liquidity fees also can encourage funds to
better and more systematically manage liquidity and redemption activity
and encourage shareholders to monitor and exert market discipline over
the fund to reduce the likelihood that the imposition of fees or gates
will become necessary in that fund.
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\478\ See supra section III.A.1.
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We request comment on the potential benefits of combining our two
alternatives into a single proposal.
Would combining the floating NAV alternative with the
liquidity fees and gates alternative have the benefits we discuss
above? Are there any other benefits that we have not discussed? If so,
what would they be?
Would combining the floating NAV alternative with only
liquidity fees or only gates provide different benefits?
2. Potential Drawbacks of a Combination
Some drawbacks may result from combining the two proposals.\479\
One potential drawback is that combining a floating NAV with liquidity
fees and gates does not preserve the benefits of stable price money
market funds for investors as our liquidity fees and gates alternative
does. Although any combination likely would include an exemption to the
floating NAV requirement for government and retail money market
funds,\480\ most other money market funds would have a floating NAV,
thereby incurring the costs and operational issues associated with that
proposal. As discussed more fully in the section on that alternative,
some investors may be deterred from investing in a floating NAV fund
for a variety of reasons. We have designed our liquidity fees and gates
alternative in large part to preserve the benefits of stable price
funds for those investors while enhancing investor protection and
improving money market funds' ability to manage and mitigate potential
contagion from high levels of redemptions. Combining the proposals thus
may not fully accomplish our goal of preserving the current benefits of
money market funds.
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\479\ One commenter noted their opposition to combining
redemption gates with a floating NAV, arguing that such a
combination ``acknowledges that the floating NAV does not resolve
such first mover advantage.'' See Dreyfus FSOC Comment Letter, supra
note 174.
\480\ See supra sections III.A.3 and III.A.4. In any
combination, retail funds would likely be subject to fees and gates,
although exempt from the floating NAV, and thus would not be exempt
from both provisions as government funds likely would.
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Another drawback of combining the two proposals is that if a
floating NAV significantly changes investor expectations regarding
money market fund risk and their prospect of suffering losses,
requiring funds with a floating NAV to also be able to impose standby
liquidity fees and gates may be unnecessary to manage the risks of
heavy redemptions in times of crisis. Because of the unique features of
stable price money market funds, liquidity fees and gates may be
necessary for a fund to ensure that all of its shareholders are treated
the same, while also managing the risks of contagion from heavy
redemptions. A fund with a floating NAV may not face these same risks
and thus providing those funds with the ability to impose fees or gates
may not be justified, particularly in light of the Investment Company
Act's expressed preference for full redeemability of open-end fund
shares.\481\
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\481\ See 15 U.S.C. 80a-2(a)(32) and 80a-22(e); see also supra
note 395.
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A last potential drawback is that although some investors may be
comfortable investing in a money market fund that has either a floating
NAV or liquidity fees and gates, some investors may not wish to invest
in a fund that has both features because a fund that does not have a
stable price and also may restrict redemptions may not be suitable as a
cash management tool for such investors. The combination of our
proposals may result in these investors looking to other investment
alternatives that offer principal stability or that do not also have
potential restrictions on redemptions. We discuss the potential effects
of such a shift in section III.E below.
We request comment on the potential drawbacks of combining our two
alternatives into a single proposal.
Would combining the floating NAV alternative with the
liquidity fees and gates alternative have the drawbacks we discuss
above? Are there any other drawbacks that we have not discussed? If so,
what would they be?
Would combining the floating NAV alternative with only
liquidity fees or only gates impose different costs?
3. Effect of Combination
As discussed above, each of the alternatives that we are proposing
today achieves similar goals, in different ways, but they bear distinct
costs. Accordingly, if we were to combine the two proposals, while
there is the likelihood that a combination may in some ways improve on
each alternative standing alone, the combination would impose two
separate sets of costs on funds, investors, and the markets. We request
comment on whether the benefit of combining the two alternatives into a
single reform would justify the drawbacks of imposing two distinct sets
of costs and economic impacts.
Should we combine the two alternatives as a single reform?
What would be the advantages and drawbacks of such a combination? Would
the benefits of combining the proposals justify requiring the two
individual sets of costs associated with implementing the combined
alternatives? Would the imposition of two sets of costs materially
impact the decisions of money market fund sponsors on whether or not
they would continue to offer the product?
4. Operational Issues
Combining the two alternatives into a single approach could pose
certain operational issues and raise questions about how we should
structure such a reform. These issues are discussed below.
a. Fee Structure
Under our liquidity fees and gates proposal, the board of directors
of a money market fund would be required to impose a liquidity fee
(unless they find that not doing so would be in the best interest of
the fund) if the fund's weekly liquid assets fell below 15% of its
total assets. The default liquidity fee would be 2% unless the board
determined that a lesser fee would be in the best interest of fund
shareholders.
The liquidity fees imposed by a floating NAV fund may serve
different purposes than those of a stable price fund. A stable price
fund board, for example, might use liquidity fees to recoup the costs
associated with selling assets at distressed prices in an illiquid
market to meet redemptions, as well as to help repair the fund's NAV.
In contrast, a floating NAV fund board might choose to impose liquidity
fees only to recoup the costs associated with selling assets at
distressed prices. This difference in the purpose served by liquidity
fees raises questions about the appropriate default size of a liquidity
fee for the combined proposal, the
[[Page 36903]]
appropriate thresholds for triggering imposition of the fee, and the
thresholds for removing it.
We request comment on the structure of the default liquidity fee if
applied to a floating NAV money market fund.
Should we alter the default liquidity fee for the combined
proposal? Should we specify a default fee for the combined proposal or
merely require that a fee be based on the costs incurred by the fund
selling assets to meet redemptions? We previously noted issues that can
arise with variable liquidity fees.\482\ Would these issues be of
concern in the context of a floating NAV fund?
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\482\ See supra section III.B.2.c.
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