Today, the U.S. Securities and Exchange Commission (“SEC”), by a vote of 3 to 2, approved amendments to Rule 2a-7 and other rules that govern money market funds under the Investment Company Act of 1940 (the “Amendments”).1 The Amendments generally combine the two alternatives set forth in the proposing release issued in 2013 (the “Proposal”)2 – (1) requiring institutional money market funds to operate with a floating net asset value (“NAV”), rounded to the fourth decimal place and (2) allowing the imposition of “liquidity fees” and “redemption gates.” In her opening remarks, SEC Chair White stated that the Amendments “fundamentally change the way most money market funds operate…will reduce the risk of runs in money market funds and provide important new tools that will help protect investors and the financial system in a crisis.”
The Amendments require that certain money market funds operate with a floating NAV, rounded to the fourth decimal place (e.g., $1.0000). Specifically, the floating NAV requirement applies to those money market funds that do not meet the definition of a “government” or “retail” money market funds (i.e., “institutional” money market funds).3 Under the Amendments, government money market funds are defined as funds that invest 99.5% or more of their assets in cash, government securities and/or repurchase agreements that are collateralized solely by government securities or cash.4 Retail money market funds are defined as funds that have policies and procedures reasonably designed to limit allbeneficial owners of the money market fund to natural persons.5
In adopting the Amendments, several SEC Commissioners noted the importance of mitigating the tax and accounting requirements relating to a floating NAV requirement on money market funds operating with a floating NAV and their investors. This afternoon, in conjunction with the SEC approving the Amendments, the Internal Revenue Service and Treasury Department issued guidance that would exclude any losses on the redemption of shares in a money market fund operating with a floating NAV from the application of the so-called wash sale rules in section 1091 of the Code. Proposed Treasury Regulations were also issued that would allow a simplified method of computing gains and losses in transactions in shares of a money market fund operating with a floating NAV. The proposed method would determine the increase or decrease in the aggregate value of shares during a computation period. Such amount would then be reduced by the net investment in shares during the computation period and the resulting amount would be treated as short-term capital gain or loss (without regard to actual realization of gains and losses).
Liquidity Fees and Redemption Gates
In addition to the floating NAV requirement, the Amendments empower a board of directors of a non-government money market fund to impose a liquidity fee of up to 2% if the level of the fund’s “weekly liquid assets” falls below 30% of the fund’s total assets. The Amendments also require that a non-government money market fund impose a 1% liquidity fee if the fund’s level of weekly liquid assets falls below 10% of total assets, unless the fund’s board of directors determines that it would not be in the fund’s best interest to impose the fee or determines to impose a lower or higher (up to 2%) liquidity fee. In addition, if the level of the fund’s weekly liquid assets falls below 30% of the fund’s total assets, the fund’s board of directors is empowered to temporarily suspend shareholder redemptions for up to 10 business days in a 90 day period (i.e., “redemption gates”). Government money market funds are permitted, but not required, to impose liquidity fees and redemption gates.
Other Notable Changes in the Amendments
Lastly, the Amendments contain other notable changes, such as tightening the diversification requirements under Rule 2a-7, enhancing disclosure requirements, strengthening stress testing and increasing reporting obligations on both registered money market funds and unregistered liquidity funds that could serve as alternative investments to money market funds. These include the adoption of Form N-CR and amendments to Form PF and Form N-MFP.
In addition to the Amendments, the SEC proposed exemptive relief from Rule 10b-10 of the Securities Exchange of Act 1934. The proposed relief would exempt broker-dealers from the written notification requirements of Rule 10b-10(a), with respect to transactions effected in shares of floating NAV money market funds. The SEC also re-proposed amendments to Rule 2a-7 in order to eliminate the use of credit ratings in Rule 2a-7.
The Amendments will be become effective 60 days after publication in the Federal Register, although the floating NAV requirements and liquidity fees and gates amendments will become effective two years after publication in the Federal Register. The compliance date for (i) Form N-CR and (ii) amendments to diversification, stress testing, disclosure, Form PF, Form N-MFP and other clarifying amendments will be nine months and eighteen months, respectively, after publication in the Federal Register.
The Amendments begin a new phase of the regulation of money market funds that has permeated the investment management industry since the 2008 financial crisis. An upcoming DechertOnPoint will provide more analysis of the Amendments, as well as their potential impact on the money market fund industry.