The Securities and Exchange Commission voted 4:1 Wednesday to substantially raise the standards for the types of securities that money market funds may hold; to require them to disclose their holdings and net asset value every month; and to have 10% of their assets liquidly available for daily redemptions and 30% weekly.
The SEC said future changes may impose a floating NAV on the funds, disclose holdings without a 60-day delay and restrict their use of credit ratings agencies. Further, the SEC will continue to work with the industry to separate the assets of retail and institutional money market funds so that the former may be subject to less restrictive rules.
The SEC is also considering requiring institutional investors that make large redemption requests to receive in-kind securities rather than cash, and it might establish a permanent liquidity facility, much as it offered insurance to money market funds immediately following the 2008 collapse of and run on Reserve Funds’ Primary Fund.
Commissioner Kathleen Casey, who cast the sole dissenting vote on the Rule 2a-7 amendments, said the reforms “do not go far enough. Stable-NAV funds will remain susceptible to runs. They need a dedicated liquidity facility, to be regulated like banks and to provide investors with information on a more timely basis. The rule further embeds the use of NRSROs [nationally recognized statistical rating organizations] and reliance on credit ratings agencies, which is at complete odds with the current crisis.”
Casey noted that one money market fund held $640 billion in a structured investment vehicle, which proved to be an extremely risky investment even though it got the highest credit ratings. “Ratings create a false sense of comfort for due diligence,” she said.
Details of New Amendments
The SEC’s new credit quality and maturity amendments to Rule 2a-7 governing money market funds impose a 60-day weighted average, rather than a 90-day standard. For securities with interest rate resets, the weighted average life limit is 120 days.
Second-tier securities may now only comprise no more than 3% of a portfolio’s total assets, down from the previous 5%. For any single tier-two issuer, the limit is 50 basis points, with a maturity of no more than 45 days, much stricter than the current limit of 397 days.
The new liquidity standards require money market funds to meet daily requirements of 10% of assets in cash and cash equivalents and weekly liquidity requirements of 30%. “The rules impose a requirement to have ‘know your customer’ procedures in order to identify the potential for large redemptions and have sufficiently liquid securities in place to meet them,” explained SEC Chairman Mary Schapiro.
Every month, money market funds must report their holdings, risk characteristics and a “shadow” NAV with a 60-day lag on their website and in detailed reports to the SEC via Form MFP, which they must file within five business days of the end of the month. Previously, money market funds were required to report this information to the SEC, semi-annually.
“This way, we can build an interactive database of money market fund information and monitor risks in money market funds,” Schapiro said. “No such database exists today.”
The disclosure of the NAV will show investors, for the first time, that the value of the underlying holdings may waver and fall below the value of one dollar. Besides “acclimating” investors to the fact that a money market fund may not always hold a $1 NAV, the disclosure will serve as a deterrent to fund advisors from “taking undue risks,” Schapiro said.
The SEC will now require money market funds to “stress test portfolios under different scenarios: fair weather, foul weather and even the inevitable storms,” said Andrew “Buddy” Donohue, director of the division of investment management at the SEC.
Finally, the board of a directors of a money market fund has the power to close a fund to redemptions if large-scale redemptions overwhelm the fund and challenge its ability to return proceeds at a $1 NAV. “It will also eliminate the need for a failing fund to sell securities into a potentially de-stabilized market and further drive down prices,” Schapiro said. Conversely, the board can decide to process shareholder transactions at prices other than a dollar in order to facilitate redemptions and reduce delays.
Before casting their votes, several of the commissioners underscored the importance of money market funds to the capital markets. Thirty million investors hold more than $3 trillion in assets in money market funds, which comprise more than one-third of all mutual fund assets. Corporations and even state and municipal governments issue the corporate paper that money funds invest in, in order to meet such short-term capital needs as payroll, healthcare and rent.
In the days immediately following Lehman Brothers’ bankruptcy on Sept. 15 and Primary Fund’s breaking the buck, institutional investors redeemed $300 billion from taxable prime money market funds, or 14% of money funds’ total assets, and money funds reduced their holdings of commercial paper by $200.3 billion, or 29%.