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From Securities Regulation Daily, July 23, 2014

Split Commission gives thumbs-up to money market fund reforms

By Amy Leisinger, J.D.

By a 3-2 vote at today’s SEC open meeting, the Commission approved money market fund (MMF) reform measures years in the making. Along with disclosure, reporting, and diversification enhancements, the approved amendments address floating net asset values (NAVs) for institutional prime and tax-exempt MMFs, exempt equivalent retail and government funds, and permit MMF boards to impose liquidity fees and temporary redemption gates to prevent investor runs. The dissenting commissioners opposed the combination of these two approaches and the related changes, but the Commission unanimously approved related exemptive relief and a reproposal of rules to address references to credit ratings in relation to MMFs.

Background. In June 2013, the SEC proposed to require prime institutional MMFs to use a floating NAV to reduce run risk and to improve transparency by requiring a greater degree of precision (1/100th of 1 percent, or 4 decimal places, for some funds). Government and retail MMFs would be exempted from the floating NAV requirement and would continue to use penny rounding to calculate stable NAVs. The SEC also proposed liquidity fees and redemption gates to allow an MMF to require all redeeming shareholders to pay a liquidity fee for redemption if the fund’s weekly liquid assets (WLA) fall below a certain level. Gated-redemption rules would give MMF boards authority to temporarily suspend redemptions, which would automatically cease after required WLA is restored; government MMFs would also be exempt from the fee/gate rules but could opt in to them.

The SEC also provided stress-test enhancements and proposed a number of new disclosure obligations for MMFs, including requiring disclosure of material events on a new form and amending MMFs’ reporting obligations on Form N-MFP to eliminate a time lag. Other proposals addressed MMFs’ concentration limits, including removal of the 25-percent basket regarding a single guarantor.

With only some adjustments in light of commenters’ suggestions, the proposal was presented to the Commission for a vote.

Commissioner remarks. According to a statement by Chair Mary Jo White, these reforms will nullify the “first mover” advantage by preventing unfair benefits to those investors who redeem at the first sign of risk. She noted that providing for a floating NAV for institutional prime MMFs will address the true value of MMF assets and underscore the fact that these investments are not guaranteed and that the use of liquidity fees and redemption gates will mitigate the risk of widespread runs and contagion effects. The approaches address risk in different ways that could result in issues if either is adopted alone, she said. Together with the enhancements to reporting and disclosure obligations and diversification and stress-testing requirements, these recommendations, including the lowered liquidity fee, address potential operational costs and effectively balance the need to preserve the benefits of MMFs while enhancing investor protection, according to Chair White. The 2010 MMF reforms were effective but did not provide all of the tools necessary to stem runs on MMFs, she opined. The two-year transition period for the new rules coupled with pledges by Treasury and the IRS to concurrently address the tax costs associated with floating NAV will alleviate commenters’ concerns, she concluded.

Although opposed to the first MMF reform proposal based on its lack of research and support data, Commissioners Luis A. Aguilar and Daniel M. Gallagher echoed the chair’s sentiments that a floating NAV and liquidity fees as discussed in the current amendments would likely slow investors’ rush to redeem in times of stress and that redemption gates would provide MMFs with time to address a potential crisis situation. Commissioner Aguilar stated that the floating NAV makes even more transparent that MMFs hold no guarantee and that the fees and gates, while lower and shorter, respectively, than what was proposed, will serve to prevent preemptive efforts to get out ahead of fees and gates. Further, the enhanced disclosure obligations on new Form N-CR and Forms N-MFP and PF will provide the Commission with additional information to monitor the industry, he said.

Commissioner Gallagher noted that market-based pricing in the form of a floating NAV will serve to clarify risks by valuing assets in a manner more similar to others in the financial markets and to put investors on notice of the distinction between federally insured accounts and MMFs. The regulatory enhancements concerning fees and gates will eliminate the incentive to preemptively redeem shares and provide fund boards with the ability to stave off runs, he said. This targeted and measured regulatory response represents an acknowledgement that a “one-size-fits-all” approach may not be effective, and, with the pledged tax and accounting changes and the parallel transparency reforms, the commissioner expressed his support for the proposed changes.

Stein dissent. Commisssioner Kara M. Stein declined to vote in favor of the MMF reform measures, noting that, given the sizable role these funds play and the features that make them susceptible to runs, further efforts must be made to prevent other aspects of overreliance on short-term investment activities. To really support the goal of enhancing MMF resiliency, regulators need to work together with a broader focus on interconnectedness in economic stability, she explained. While the floating NAV could potentially address investor confusion, she said, the redemption gates represent a regulatory shortcoming. According to the commissioner, investors still have an incentive to redeem in a crisis, and MMFs are likely to stop reinvesting matured securities during a gate period; as such, a gate may stop a run in one fund but have an adverse effect on the system as a whole. This issue has not been adequately addressed, she said.

Piwowar dissent. In dissent, Commissioner Michael Piwowar stated that he remains unable to support the adoption of the combined floating NAV/fee/gate approach, noting that it does not serve the goal of preserving the benefits of MMF investments. While acknowledging the possibility the fee/gate approach has the potential to prevent MMF runs, he said that requiring a floating NAV would not serve this purpose or eliminate the “first mover” advantage. Sophisticated investors with large investments would still have incentive, and likely the ability, to redeem ahead of other shareholders, and to require the floating NAV calculation may limit the usefulness of MMFs as cash management tools, the commissioner explained. If we think even the sophisticated investors require a floating NAV to understand the risk of loss, then all our disclosure obligations are “dubious at best,” he opined. As an alternative to the adopted approach, the commissioner suggested providing investors with the choice as to whether to invest in an MMF with floating NAV or fees and gates to fit their respective investment objectives.

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