Two years have quickly passed since the Securities and Exchange Commission (“SEC”) first issued new regulations in July 2014 revising previous money market rules under the Investment Company Act of 1940 and Rule 2a-7. As previously reported, the new money market provisions strive to manage fund outflows in periods of market distress, enhance the funds’ control over heavy redemptions and improve transparency for investors. The multi-year implementation period has nearly concluded and key components of these money market amendments require full compliance by no later than October 14, 2016. With just over two months remaining, we recommend institutional investors thoroughly review current money market holdings, including any cash sweep vehicles utilized in custodian accounts, and evaluate the following money market impacts.
Floating Net Asset Value
Institutional prime money market funds will soon be required to report a floating net asset value (“NAV”) or price per share. Money funds historically applied amortized cost accounting to the underlying bond securities, however the new floating NAV requirement will reflect the actual market value of the fund’s underlying securities. In other words, the fund’s price, now calculated to the fourth decimal place under the floating NAV structure, will fluctuate above or below the stable $1.0000 value money market funds maintained in the past.
Importantly, government and Treasury only money market funds will continue to support a fixed $1 NAV and will not adopt the floating NAV. Money markets with at least 99.5% of their portfolio in cash, government securities and repurchase agreements solely collateralized by government securities or cash fall under the government money market classification. Furthermore, retail money market funds will also maintain a stable NAV. Based on the SEC’s definition, retail includes “funds that have policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons.”1
Gates and Liquidity Fees
In the event a prime money market fund’s weekly liquid assets fall below 30%, the fund may experience a temporary suspension of redemptions, also referred to as gating. Gates may be applied to investor redemptions for up to 10 business days in any 90-day window. Additionally, a maximum 2% liquidity fee could be imposed if weekly liquid assets fall below the same 30% threshold. A fund would also be required to assess a 1% liquidity fee should a fund’s weekly liquid assets fall below 10%.
Each fund’s Board of Directors will assume discretion over gating and liquidity fees and will act in the best interest of the fund, taking into account the current bond portfolio, market environment and redemption activity. Funds will be required to submit formal filings with the SEC should gates or liquidity fees be imposed on investors. Similar to the floating net asset value rules above, government and retail money market funds are exempt from the gating and liquidity fee provisions.
Enhanced Disclosures and Diversification Requirements
Finally, the money market amendments mandate improved website disclosures, including daily and weekly liquidity levels, cash flow activity, market-based NAV data and transparency into any gating and liquidity fee events. Further diversification requirements, tax and accounting guidelines and revisions to Rule 2a-7 were also adopted as part of the amendments.
The passage of these reforms marked a significant shift for institutional-based money market funds as they have long provided the stable $1 share price even if the underlying bond portfolio experiences market declines. While the SEC vote was not unanimous and many in the industry aggressively lobbied against money market legislation, the new provisions are designed to protect funds should a run occur like in 2008 when the Reserve Primary fund broke the buck, prompting mass redemptions out of money market funds. The chart below summarizes the key details outlined above.
