FINAL Rule for Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A.
"Future stressed periods may be more protracted or more severe than in March 2020, particularly absent Federal Reserve action."
Effective October 2nd
Wut mean?:
- The SEC has removed the ability for fund boards to stop money take-outs when their available cash gets too low.
- Change in Liquidity Fees: Before, when the available cash in a fund dropped to a certain level, they could charge you extra fees. That's not the case anymore.
- New Fee System: Some money market funds will have a new way to charge fees, making it fairer for everyone, especially if you want to take your money out.
- Higher Cash Requirements: Funds now need to keep more cash on hand, 25% available daily and 50% available weekly.
- New Reporting Rules: There will be some changes to how funds report their actions and money.
- Handling Negative Interest: If the interest rate goes negative, certain funds can handle it by taking back some shares.
- The SEC provided clearer steps for funds to figure out the average time it takes for their investments to mature.
- Big fund advisers have to provide more details on how they operate.
- The SEC corrected mistakes in their previous rules.
- Effective October 2nd and the amendments to Forms N-CR, N-MFP, and PF are effective June 11, 2024.
Wut mean?:
Money Market Funds are mutual funds focusing on cash management. Many people like them because they try to keep your money safe and accessible. They're also vital for short-term financing needs for different entities.
- Why the Change? Back in March 2020, due to the economic shock from COVID-19, some of these funds saw a big outflow. This caused stress in short-term funding markets, and the government had to intervene.
- Main Changes:
- Liquidity Ties Removed: The SEC wants to break the link between how much liquid cash a fund has and the additional fees they might charge.
- Swing Pricing Requirement: Initially proposed, this would have managed the effects of big withdrawals from funds during market stress. However, after feedback, this isn’t being adopted.
- Liquid Asset Requirements: Funds now need to have more money on hand, with 25% available daily and 50% available weekly.
- Stable Net Asset Value (NAV) Rules: Originally, the SEC wanted to stop certain practices in a negative interest rate environment. But after feedback, they're letting funds use some of those methods, but with conditions.
- Public Reporting: Funds need to publicly report major drops in their liquidity.
- Feedback Received: Many supported parts of the proposal, like increased daily and weekly liquidity. However, some were concerned about operational challenges, especially with the swing pricing requirement. Others worried about the effects of the proposed rules in negative interest rate scenarios.
- Final Decisions: After feedback, they're tweaking rules to help money market funds be more resilient. This includes changes to how fees are charged and giving funds some flexibility in negative interest environments.
- Other Changes: Reporting requirements are being updated, ensuring transparency but considering the sensitivities around certain information.
Wut Mean?:
- Basics of Money Market Funds:
- Invest in short-term, high-quality debt like Treasury bills and commercial paper.
- Goal: provide stability, allow investors to receive dividends reflecting short-term interest rates, and ensure daily liquidity.
- Popular for retail and institutional investors for cash management.
- Essential for short-term financing needs of businesses, banks, and governments.
- Types of Money Market Funds:
- Prime Funds: Invest in taxable short-term debts from corporations and banks.
- Government Funds: Primarily hold U.S. Government obligations. Offer higher safety but usually lower yields.
- Tax-Exempt Funds: Mainly invest in state and local government obligations; their interest is often tax-free for individuals.
- Within prime and tax-exempt categories, funds can be “retail” (for individuals) or “institutional” (for broader entities like corporations).
- Pricing and Valuation:
- Government and retail funds can generally use a stable share price (like $1.00).
- Institutional prime and tax-exempt funds use a "floating" NAV, changing according to the current market value of their securities.
- Statistics as of March 2023:
- 294 money market funds registered, holding over $5.7 trillion.
- Breakdown: government funds ($4.4 trillion), prime funds ($1 trillion), and tax-exempt funds ($119 billion).
- Regulation History:
- Rule 2a-7 was adopted in 1983, with multiple amendments to address vulnerabilities.
- Past reforms introduced minimum liquid asset requirements, redemption gates, and floating NAVs for certain funds, along with enhanced transparency.
- In 2014, reporting requirements were added for large advisers of liquidity funds to get a clearer view of the short-term financing market.
- Liquidity Funds:
- Similar to money market funds but aren't registered as investment companies.
- Important in short-term financing markets and aim to maintain stable net asset value.
- Not bound by the same risk-limiting conditions as money market funds, thus might take on higher risks and be more sensitive during market stress.
Wut mean?:
- March 2020 Context: Economic concerns due to COVID-19 drove investors to prioritize cash and short-term government securities. This led to significant outflows from institutional prime and tax-exempt money market funds and into government money market funds.
- Extent of Outflows: Between March 11-24, institutional prime funds faced a 30% redemption rate. Retail prime funds had an 11% outflow rate in the last three weeks of March. Tax-exempt funds, mainly retail, saw an 8% outflow rate from March 12-25.
- Market Stress: These outflows led to an increased selling activity in short-term funding markets, causing stress in these markets. The situation was exacerbated by the illiquidity of instruments like commercial paper, which became difficult to sell. There was also increased stress in short-term municipal markets.
- The Fed intervenes: To counteract the turmoil, on March 18, 2020, the Federal Reserve established the Money Market Mutual Fund Liquidity Facility (MMLF) to enhance liquidity in money markets. This move, combined with other Federal Reserve actions, slowed outflows from prime and tax-exempt money market funds. MMLF stopped providing loans in March 2021.
"future stressed periods may be more protracted or more severe than in March 2020, particularly absent Federal Reserve action."
Going after the Fed!
Effective dates:
- There's a tiered approach to transition which helps affected funds get enough time to comply without delaying the full scope of the amendments.
Effective Dates:
- For the final amendments to rule 2a-7, rule 31a-2, and Form N-1A, it is 60 days after publication in the Federal Register.
- The same 60-day timeline applies to the technical amendments to Form N-CSR and Form N-1A.
- For the final amendments to Forms N-MFP, N-CR, and PF, the effective and compliance date is June 11, 2024.
Forms N-MFP, N-CR, and PF Transition:
- The Commission has adopted a simultaneous delayed effective and compliance date for these forms to ensure uniformity in transition.
- This decision prevents inconsistent reporting across filers.
- The compliance date for rule 2a-7's website posting requirement will also be June 11, 2024.
Feedback from Commenters:
- Some commenters recommended longer transition periods, up to 24 months for the new amendments.
- However, due to a reduced compliance burden on some proposed requirements, the Commission believes the June 11, 2024 date is sufficient.
Liquidity Fee Frameworks:
- The compliance date for the mandatory liquidity fee framework is twelve months after the effective date of the final amendments.
- A six-month compliance date has been set for the discretionary liquidity fee framework.
- Funds can rely on the new provisions after their effective date but before the compliance date.
Liquidity and Maturity-Related Amendments:
- The compliance date for some of the amendments to rule 2a-7 is six months after their effective date. These include portfolio liquidity requirements and specifics for WAM and WAL calculations.
No Separate Compliance Date for Remaining Amendments:
- Some amendments, including the removal of redemption gates and the connection between liquidity fees and weekly liquid asset thresholds, will be effective 60 days after publication in the Federal Register without a separate compliance date.
- The aim is to prevent the drawbacks experienced from previous rules, especially seen in March 2020 with increased redemptions.
- There are also provisions about share cancellations in a negative interest rate scenario which will come into effect 60 days after publication.
Around 294 funds with a total of $5.7 trillion in net assets might be affected. As of March 2023, Prime money market funds represent about 20% of the industry's total net assets, while tax-exempt money market funds make up roughly 2%.
Wut Mean?:
- The drive to prevent loss and maintain liquidity prompts investors to exit certain money market funds during tumultuous times, like the 2008 financial crisis and March 2020 market stress.
- The risk of triggering runs is exacerbated if a fund might impose gates or fees when its weekly liquid assets drop below 30%. Evidence from March 2020 showed heightened outflows from institutional prime money market funds as these assets approached this threshold.
- During stressful periods, money market fund managers might opt to sell less liquid securities to avoid hitting the 30% threshold.
- Investor behavior during stress can vary based on the type of money market fund. Institutional investors, who monitor economic shifts more closely, may exit faster. Prime funds, known to invest in riskier assets, have faced losses during crises, like the Lehman Brothers default in 2008.
- Tax-exempt funds can also feel redemption pressures during stress, while government money market funds usually experience the opposite, with inflows during crises like the 2008 global financial crisis, the Euro debt crisis in 2011, the Covid-19 pandemic in 2020, and the 2023 banking stress, as they offer investments with perceived higher security and liquidity.
- Between February and April 2023, the money market fund sector saw significant inflows due to stress in the banking sector. Specifically, from February 1 to March 15, $201 billion left bank deposits, with $191 billion entering money market funds. This trend accelerated in March, with $362 billion entering money market funds by April 5, mainly going into various Treasury and government agency funds. This movement suggests a potential interlinked run risk between money market funds and the banking system, emphasizing the need to reduce run risk in money market funds.
Wut Mean?:
Money market fund investors face potential dilution costs, which means that the value of their shares might be reduced if other investors transact at prices that don't truly represent the fund's actual value due to various factors:
- Trading Costs: Transaction-related costs, like those associated with meeting redemptions, can cause dilution. If these costs are realized after the fund's net asset value (NAV) is set (as is currently the U.S. practice), non-transacting shareholders can bear a disproportionate share of these costs, especially during large redemptions. This is illustrated by a stylized example.
- Stale Prices: During market stress, some assets become illiquid, leading to reliance on outdated or 'stale' prices. Using these stale prices can further dilute the value for remaining shareholders, especially in floating NAV funds. While this is known to occur in fixed income funds, money market funds may also be susceptible due to holding assets that are challenging to price accurately during stress.
- First-Mover Advantage: Anticipating potential dilution, investors might rush to redeem their shares before others, amplifying the impact of stress events. This behavior resembles traditional bank runs.
Regardless of the redemption reason, such redemptions can impose costs on those who stay in the fund if trading costs aren't considered. Money market fund operations, in terms of both managing redemptions and their portfolio composition, can influence the stability of underlying securities markets.
Wut Mean?:
- Advisers of liquidity funds with assets between $150 million and $1 billion must file Form PF annually with general fund details.
- Larger advisers with $1 billion or more in assets linked to liquidity and money market funds must file Form PF quarterly, giving in-depth data (under section 3 of Form PF).
By Q3 2022:
- 79 liquidity funds were reported on Form PF, accounting for $336 billion in assets.
- 51 of these were large liquidity funds, holding about 99% ($331 billion) of the total liquidity fund assets.
Liquidity funds are like money market funds but are not registered as such under the Act. Their goal is to maintain stability or minimize principal volatility, achieved by investing in stable, short-term debt securities. They are sensitive to market conditions and can suffer during market stress. Notably, they might be riskier than money market funds because they don't have to adhere to specific risk-reducing regulations (like rule 2a-7) that apply to the latter.
Wut Mean?:
These changes might lead money market funds to:
- Need quicker flow information.
- Streamline the process of assessing fees to end investors down the line.
- This could affect a variety of market participants involved with these funds, such as broker-dealers, investment advisers, banks, retirement plan managers, and TRANSFER AGENTS. The changes related to stable NAV money market funds in negative rate situations could also impact intermediaries dealing with these funds.
- The amendments might influence the funds' willingness to hold certain securities, potentially affecting the issuers of these securities, like those who issue certificates of deposit or commercial paper. This could impact how these issuers raise debt financing, the terms of the financing, or their investor base.
The new amendments:
- Decouple liquidity fees from money market funds' weekly liquid assets and eliminate gate provisions in rule 2a-7.
- Most commenters agreed with these changes.
- Benefits for money market fund investors:
- Reduces liquidity costs for remaining investors.
- Removal of weekly liquid asset-linked liquidity fees and the elimination of redemption gates might make money market funds more appealing as a low-risk tool for risk-averse investors.
- Benefits for money market funds:
- Reduces the risk of large-scale withdrawals.
- Present structures can pressure investors to withdraw funds early as funds near a 30% liquid asset threshold.
- Many institutional investors, fearing restricted access to their investments, closely watched daily and weekly liquid asset balances.
- The new amendments might reduce this early withdrawal incentive, especially during market stress.
- The link between the 30% threshold and possible fees or gates wasn't effective in March 2020. Funds were seemingly more focused on keeping their weekly liquid assets rather than addressing redemptions.
- By removing this link, funds might be more motivated to handle large redemptions efficiently.
- The outcome is that funds can better use their liquid assets to address redemptions during stressful times without the threat of runs. This is especially significant for funds with liquid assets near the minimum threshold.
- Investors benefit as they won't face potential imposition gates except in liquidations, making money market funds seem like a more fluid investment product.
SEC throws the Fed under the bus again!
Wut Mean?:
Amendments have been made to increase daily and weekly liquid asset requirements in money market funds to 25% and 50%, respectively. The purpose is to reduce the potential for rapid, large-scale withdrawals/runs from these funds.
- Supporters believe that the amendments will bolster the resilience of money market funds, especially during periods of financial stress.
- This is because funds with more liquid assets can more easily fulfill redemption requests without needing to sell less liquid assets in a potentially unfavorable market environment.
- Higher liquidity can deter runs by reducing trading costs and making it less appealing for early investors to withdraw their assets during a rush of redemptions.
Research has shown that less-liquid funds experienced more significant outflows during financial crises.
- For instance, during the COVID-19 crisis, less-liquid funds saw redemptions sooner than their more liquid counterparts.
- Critics argue that increasing the liquid asset threshold may not necessarily enhance fund liquidity, as fund managers could treat these thresholds as regulatory minimums and not necessarily use them for redemptions.
- Before the new rule, a drop in liquid assets below a 30% threshold only meant a fund couldn't acquire other than a weekly liquid asset. Now, with the removal of some ties to liquidity fees and redemption gates, funds may be more comfortable using their weekly liquid assets.
- Some believe the current obligation of funds to maintain adequate liquidity may not be sufficient, especially during unpredictable market stress events.
- The SEC acknowledges that the potential benefits of the new rule might be offset if money market funds already exceed the new minimum liquidity thresholds, either due to other regulations or current market conditions.
- Data from March 2023 shows that some funds already exceed the new thresholds: 43% for daily and 56% for weekly liquid assets. As such, the amendments might have a more limited impact on current funds.
- Detractors argue that the new requirements are based on false assumptions, like the idea that the failure of one fund will cascade and affect all money market funds.
The SEC states the main benefits of the raised liquidity requirements include reducing the risk of runs in money market funds, enhancing the resilience of such funds, and minimizing reliance on government backups. After the financial turbulence in March 2020, some funds shifted towards more liquid assets like Treasuries, preparing them better for potential future redemption needs.
- The actual economic benefits will depend on how funds adjust to these new requirements. Some might lengthen the maturity of their remaining portfolios, which could affect their overall liquidity.
TLDRS:
- FINAL Rule for Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A.
Main Changes:
- Liquidity Ties Removed: The SEC wants to break the link between how much liquid cash a fund has and the additional fees they might charge.
- Swing Pricing Requirement: Initially proposed, this would have managed the effects of big withdrawals from funds during market stress. However, after feedback, this isn’t being adopted.
- Liquid Asset Requirements: Funds now need to have more money on hand, with 25% available daily and 50% available weekly.
- Stable Net Asset Value (NAV) Rules: Originally, the SEC wanted to stop certain practices in a negative interest rate environment. But after feedback, they're letting funds use some of those methods, but with conditions.
- Public Reporting: Funds need to publicly report major drops in their liquidity.