In the wake of the problems experienced by money market funds following the Reserve Fund’s crash last fall, the SEC recently voted unanimously to propose rule amendments designed to significantly strengthen the regulatory framework for money market funds. The amendments would tighten the risk-limiting conditions of Rule 2a-7 by (among other things) requiring funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, reducing the average weighted average maturity of portfolio holdings and limiting funds to investing in the highest quality portfolio securities. In addition, new monthly reports of portfolio holdings would be required and a new rule would allow for an orderly liquidation of a money market fund that has “broken the buck.” Release No. IC-28807, 74 F.R. 32688, July 8, 2009. The SEC is seeking public comments on the proposals on or before September 8, 2009. A more specific summary of the proposed amendments follows.
- Allow money market funds to invest only in “First Tier Securities,” which are those securities that have received only the highest short-term debt ratings from the “requisite NSRSOs” (the ability to invest in so-called “Second Tier” securities would be eliminated). Unrated securities determined by the fund board or its delegate to be of comparable quality would still be eligible for purchase. A fund would not have to immediately dispose of a security that was downgraded, but would have to dispose of it “as soon as practicable consistent with achieving an orderly disposition of the security.”
- Limit a money market fund’s ability to invest in long-term unrated debt securities with remaining maturities of 397 days or less only if the securities have received long-term debt ratings in the two highest ratings categories.
- Shorten the weighted average maturity limit for money market fund portfolios from 90 days to 60 days. • Impose a new maturity test on a fund’s portfolio that would limit its “weighted average life” to 120 days. A fund’s “weighted average life” would be measured without regard to a security’s interest rate reset dates. Thus, adjustable-rate and floatingrate securities would be considered to have a “life” equal to their final maturity date, and not just until the next rate determination date occurs.
- Consideration is being given to shortening the maximum maturity that an individual security can have to something substantially less than the current maturity limit of 397 days.
- Prohibit a money market fund from acquiring a security unless, at the time of acquisition, the security is “liquid” (i.e., can be sold in the ordinary course of business within seven days at approximately amortized cost). The current rule of thumb, as expressed in rather informal terms in an early adopting release, is that a money market fund cannot invest more than 10% of its net assets in illiquid securities. This basket would be eliminated.
- Require that money market funds have certain minimum percentages of their assets in cash or securities that can be readily converted to cash, to pay redeeming investors. Different minimums would apply to “Taxable Retail Funds” and “Taxable Institutional Funds,” and the fund’s board would be required to determine, no less frequently than once a year, whether the fund is an institutional or retail money market fund. The proposed liquidity requirements would have a Minimum Daily Liquidity Requirement, a Minimum Weekly Liquidity Requirement and a General Liquidity Requirement. For example, a taxable retail fund would be required to invest at least 5% of its assets in cash, U.S. Treasury securities or securities that can provide daily liquidity, and all money market funds would have to comply with a weekly liquidity requirement that a fund cannot acquire any securities other than U.S. Treasury securities unless immediately after the transaction the fund has at least 15% of its total assets invested in “weekly liquid assets.”
- Require the board of each money market fund using the amortized cost method to adopt procedures providing for periodic “stress testing” of the fund’s portfolio to determine whether the fund can withstand market turbulence.
- Comments are being sought as to whether the current diversification rules (i.e., not more than 5% of a fund’s assets invested in securities of any one issuer) should be made more stringent.
- Limit money market funds to investing in repurchase agreements collateralized by cash items or Government securities in order to obtain the special “look-through” treatment provided under Rule 2a- 7(c)(4)(ii)(A). This will ensure that in the event of a counterparty default, a fund will be less likely to realize losses upon the sale of collateral that has become illiquid.
- The board of a money market fund, or its delegate, must evaluate the creditworthiness of the counterparty, regardless of whether the repo is fully collateralized.
Monthly Disclosure of Portfolio Information
- Require each money market fund to post on its Website a report of its portfolio holdings (i.e., schedule of investments) within two business days after each month end, and maintain this on the Website for at least 12 months. This report will identify, among other things, the issuer, the title of the issue, principal amount held and current amortized cost for each security held.
- Report on a new Form N-MFP on a monthly basis to SEC regarding the fund’s portfolio holdings as of the end of the previous month. This will be an electronic report and will contain more detailed information than that posted on the mutual fund’s Website. In fact, proposed Form N-MFP will require information on no less than 15 different items.
- Form N-Q would be amended to eliminate the requirement for filing a schedule of investment for money market funds that report monthly; the report would still be required with respect to controls and procedures and certification requirements.
Processing of Transactions
- The board of a money market fund must determine in good faith, at least once each calendar year, that the fund has the capacity to redeem and sell its securities at a price based on the current net asset value per share (and not amortized cost). This will require that the mutual fund’s board be conversant with the systems and procedures necessary to process purchases and redemptions and to determine current per-share net asset values.
Broader Exemption for Affiliate Transactions
- The SEC is proposing to amend Rule 17a-9 to permit affiliated persons of a money market fund to purchase distressed portfolio securities from the fund without applying for and being granted an exemptive order under Section 17(a). Currently, this is possible only if the security is no longer an “eligible security” under Rule 2a-7. In addition, the proposal would permit an affiliated person, for any reason, to purchase other portfolio securities, including eligible securities that have not defaulted, from an affiliated money market fund for cash at the greater of the amortized cost or market value, provided that any profit realized on a subsequent resale of the security is promptly remitted to the fund.
- Rule 2a-7 would also be amended to require a money market fund whose securities have been purchased by an affiliated person to promptly notify the SEC of the transaction via electronic mail.
- Permit a money market fund that has “broken the buck” and decided to liquidate to suspend redemptions while the fund undertakes an orderly liquidation of assets.
In addition, the SEC is seeking comment on other issues related to the regulation of money market funds, including whether money market funds should, like other types of mutual funds, effect shareholder transactions at the market-based net asset value (i.e., whether they should have “floating” rather than stabilized net asset values) and whether to require that funds satisfy redemption requests in excess of a certain size through in-kind redemptions. The Commission may propose further amendments after it considers the comments it receives on these matters.