Yesterday, the Securities and Exchange Commission (SEC) approved new rules and amended existing rules under the Investment Company Act of 1940 that govern money market funds. These new rules and rule amendments aim to increase protection of investors by restricting the risks posed by money market funds, enhance fund disclosure and improve fund operations.
The new rules and rule amendments seek to limit the risk associated with investments in money market funds by:
- reducing the amount of assets that a money market fund is permitted to invest in second-tier securities from 5% of its total holdings to 3%;
- limiting a money market fund’s exposure to any single second-tier issuer to 0.5%;
- limiting investments in second-tier securities to those securities that have a maturity of no more than 45 days rather than the current 397 day limit;
- reducing the maximum weighted average maturity limit of a money market fund’s portfolio from 90 days to 60 days;
- imposing a new weighted average life limit of 120 days for portfolio securities;
- imposing a new daily liquidity requirement mandating that 10% of assets held by taxable money market funds be in cash, U.S. Treasury securities or securities that can be converted into cash within one day;
- imposing a new weekly liquidity requirement mandating that 30% of the assets of all money market funds be in cash, U.S. Treasury securities, certain other government securities with remaining maturities of no more than 60 days or securities that can be converted into cash within one week;
- restricting money market funds from having more than 5% of their portfolios invested in illiquid securities, down from the current 10% limit, and redefining “illiquid” as any security that cannot be sold or disposed of within seven days at carrying value;
- imposing a new requirement that money market funds have in place “know your customer” procedures that will enable them to identify the potential for large redemptions and have enough liquid securities on hand to satisfy them;
- imposing a new requirement that money market fund managers conduct periodic stress tests of their funds to evaluate the ability of the funds to maintain a stable net asset value (NAV) in the wake of potentially disruptive events;
- imposing a new requirement that the board of directors of a money market fund designate each year at least four nationally recognized statistical rating organizations (NRSROs) whose ratings the fund’s board considers reliable;
- eliminating the current requirement that funds invest only in those asset-backed securities that have been rated by an NRSRO; and
- permitting money market funds to “look through” issuers of repurchase agreements to the underlying collateral securities for diversification purposes only if the collateral for such agreements is cash or government securities and the money market fund has evaluated the creditworthiness of the repurchase counterparty.
The new rules and rule amendments also mandate increased disclosure on the part of money market funds by requiring funds to:
- post their portfolio holdings on their websites and maintain such information for at least six months; and
- file reports with the SEC, within 5 days of the end of the month, detailing the composition of their portfolios and disclosing the mark-to-market value, or “shadow NAV,” of their assets.
Finally, the new rules and rule amendments introduce several reforms aimed at improving fund operations. These changes include:
- requiring money market funds and their administrators to be able to process transactions at prices other than $1 per share to facilitate redemptions should a fund break the buck;
- permitting boards of directors of money market funds to suspend redemptions if a fund is about to break the buck and decides to liquidate; and
- expanding the ability of affiliates of money market funds to purchase distressed assets from the funds in order to protect the funds from suffering losses without having to seek individual exemptive relief from the SEC.
The SEC also announced that additional reforms related to money market funds are still be considering and are possible in the future, including:
- a move from the use of a stable NAV of $1 per share to a floating NAV;
- a requirement that large redemption requests be satisfied in-kind;
- “real time” disclosure of shadow NAV;
- the establishment of a private liquidity facility to provide liquidity to money market funds in times of stress; and
- the implementation of a “two-tiered” system of money market funds that requires a stable NAV for those funds that are subject to greater risk-limiting conditions and possible liquidity facility requirements.