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Journal entry — SEC adopts money market fund reforms

Published on: Jul 24, 2014

The SEC voted 3–2 yesterday to adopt a final rule on money market fund (MMF) reform, after analyzing feedback from over 1,400 respondents to its June 2013 proposed rule. The final rule gives MMFs a two-year transition period to prepare to implement the new requirements.

In her remarks before the vote, SEC Chair Mary Jo White stated, "Today's reforms will fundamentally change the way that [MMFs] operate. They will reduce the risk of runs in [MMFs] and provide important new tools that will help further protect investors and the financial system in a crisis. Together, this strong reform package will make our financial system more resilient and enhance the transparency and fairness of these products for America’s investors.”

The final rule retains the SEC's proposal to eliminate the use of penny rounding for institutional nongovernment MMFs and establishes a current net asset value (NAV) — or floating NAV — like that used in other mutual funds.1 In addition, government2 and retail MMFs may continue using amortized cost to value a fund’s investments instead of calculating the fund’s value by using a floating NAV (i.e., they may continue to use a stable NAV, which is typically $1). Municipal money market funds are not exempt from the floating rate requirement unless they meet the definition of a “retail” MMF. However, unlike the proposed rule, the final rule notes that MMFs with floating NAVs will be permitted to “continue to use amortized cost to value debt securities with remaining maturities of 60 days or less if fund directors, in good faith, determine that the fair value of the debt securities is their amortized cost value, unless the particular circumstances warrant otherwise.” 

The final rule also includes provisions related to redemption gates and liquidity fees. Under the final rule, an MMF will be permitted to "impose a liquidity fee of up to 2%, or temporarily suspend redemptions (also known as “gate”) for up to 10 business days in a 90-day period, if the fund’s weekly liquid assets fall below 30% of its total assets and the fund’s board of directors (including a majority of its independent directors) determines that imposing a fee or gate is in the fund’s best interests. [However, an MMF] will be required to impose a liquidity fee of 1% on all redemptions if its weekly liquid assets fall below 10% of its total assets, unless the board of directors of the fund (including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund.”3

In addition, the final rule includes requirements related to enhanced portfolio diversification, stress testing, disclosures, and financial reporting obligations.

Editor’s Note: In feedback on the proposed rule, many respondents had expressed concerns about the potential accounting and tax reporting implications resulting from the proposed requirements. In a statement about the final rule’s adoption, Commissioner Daniel Gallagher noted, “As we make abundantly clear in today’s release, the accounting issues have been completely addressed: money funds are cash equivalents [and] concurrently with today’s rulemaking, the Department of the Treasury and the IRS have issued a revenue procedure, that is, an official IRS statement of procedure that may be relied on by taxpayers under the Internal Revenue Code.” The guidance issued by the IRS and Treasury Department (1) allows an MMF relief from tracking individual sales for purposes of complying with “wash sales” rules and (2) simplifies the basis for calculating gains and losses.

In addition, the final rule conveys the SEC’s belief that under normal market conditions, an investment in an MMF “that has the ability to impose a fee or gate” qualifies as a cash equivalent under U.S. GAAP. It also clarifies that if events occur that cause an MMF to impose liquidity fees or gates, “shareholders would need to reassess if their investments in [such an MMF continues] to meet the definition of a cash equivalent” under U.S. GAAP but does not provide guidance regarding how such a reassessment might be performed. The final rule also notes that the SEC declined to issue a “more formal pronouncement (as requested by some commenters) to confirm [its] position . . . because the federal securities laws provide the Commission with plenary authority to set accounting standards, and [the SEC does so in the final rule].”4

The SEC also unanimously voted to issue proposed and reproposed rules related to (1) MMF communications to investors and (2) the replacement of credit rating references in Rule 2a-7 and Form N-MFP with other factors a fund would use to assess liquidity and credit worthiness of investments to comply with Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Comments on the proposals are due 60 days after their publication in the Federal Register.

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1 As noted in the final rule, “all registered mutual funds must price and transact in their shares at the current NAV, calculated by valuing portfolio instruments at market value or, if market quotations are not readily available, at fair value as determined in good faith by the fund’s board of directors (i.e., use a floating NAV).”

2 The final rule defines a government MMF as “a money market fund that invests at least 99.5% of its total assets in cash, government securities, and/or repurchase agreements that are ‘collateralized fully’ (i.e., collateralized by cash or government securities)” (footnote omitted).

3 As the final rule also notes, “[t]hese amendments differ in some respects from the fees and gates that [were initially] proposed, which would have required funds to impose a 2% liquidity fee on all redemptions, and would have permitted the imposition of redemption gates for up to 30 days in a 90-day period, after a fund’s weekly liquid assets fell below 15% of its total assets. In addition . . . a fund’s board (including a majority of independent directors) could have determined not to impose the liquidity fee or to impose a lower fee.”

4 See Section VI of the final rule for additional information.

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