SEC Money Market Funds Regulation
A perspective on the implications and challenges for the firms
Overview
The SEC has proposed key reforms to the regulatory framework governing the money market funds from 2016, which consists of amendments to Rule 2a-7 under the Investment company act of 1940. The key driver of the proposed reforms is to improve the
resiliency of the money market funds which faced heavy outflows during the 2020 pandemic period. The reforms also aims to maintain the liquidity during market stress scenarios like high volatility, thereby offering investor protection. The point of view provides
a brief on the proposed amendments, the business implications and challenges for the impacted firms and the next steps.
Proposed Amendments
The key aspects of the proposed amendments are
Liquidity Requirements
- To provide sufficient liquidity, the fund’s minimum liquid asset requirements is proposed to increase from 10% daily liquid assets to 25%, and from 30% weekly liquid assets to 50%
- The fund would need to notify the board within 1 business day of the liquidity threshold breach event along with a brief description of the event and circumstances
- The reforms propose to eliminate stress testing at the current 10% weekly liquid asset level, and it would be the prerogative of the fund to determine the minimum level of liquidity it seeks to maintain during stress periods, periodically be able to test
its ability to maintain liquidity, and report to the board the results of the testing
Weighted average maturity/life calculations
The amendments require the weighted average maturity/life calculations to be based on the each security’s weighted market price in a fund’s portfolio instead of the amortized cost of each portfolio security
Liquidity fees and redemption gates
The provisions of Rule 2a-7 that were added in the 2014 rule amendments to permit liquidity fees and redemption gates when a fund’s weekly liquid assets fall below certain thresholds would be removed as per the proposed amendments
Swing pricing requirements
- When the fund has net redemptions, the proposed changes require institutional money market funds to adopt swing pricing procedures to adjust a fund’s current NAV per share by a “swing factor” that effectively passes portfolio transaction costs
arising from shareholder redemptions (but not subscriptions) on to the redeeming shareholders, instead of the transaction costs being borne by the fund’s remaining shareholders.
- The fund’s board needs to designate the swing pricing administrator who decides the swing factor application and also approve the policies and procedures for the swing pricing requirements.
Amendments for negative interest rate scenarios
- The proposed amendments state that if interest rates turn negative, the fund’s board could decide to convert to a floating share price from the offered stable NAV, to prevent material v dilution or other unfair results to investor or current shareholders
- The amendments also prohibit the fund from utilizing a “reverse distribution mechanism” where the fund reduces the number of outstanding shares to maintain a stable NAV
Reporting requirements
The proposed reforms are directed at amendments to existing and new reporting requirements on forms N-MFP, N-CR and changes to Form N-1A
- Form N-CR - The proposal requires funds to file reports on Form N-CR in a custom structured data format—XML—and make certain other reporting modifications, such as by removing the reporting events that relate to liquidity fees and redemption gates.
Liquidity threshold events reported to the board would also need to be reported on Form N-CR.
- Form N-MFP – The proposed amendments mandate various new disclosure requirements pertaining to the composition and concentration of the fund’s shareholders, portfolio securities sold and imposition of swing pricing during the reporting period.
- Form N-1A. The proposal requires institutional funds to: (i) include a general description of the effects of swing pricing on the fund’s annual total returns as a footnote to its risk/return bar chart and table; (ii) include a description of swing
pricing in its disclosure regarding procedures for pricing fund shares; and (iii) explain the fund’s use of swing pricing, including its meaning, the circumstances under which the fund will use it, and the effects of swing pricing on the fund and investors.
Key business implications
The impacted entities of the regulations include investment firms offering money market funds, asset managers, broker dealers, registered independent advisors, transfer agents and retirement plan administrators.The key impacted funds are prime money
market funds (Institutional and Retail), Tax exempt money market fund (Institutional and Retail) and Govt money market funds.The swing pricing requirements are applicable only to the institutional prime money market funds and the govt money market funds are
exempt from the removal of liquidity fees and redemption gates.
The key business areas and implications are shown in the below picture.
As inferred from the picture, the Liquidity risk management area has minimal impact as the proposed amendments are aimed at minimal modifications to the current liquidity threshold management and governance. Due to the introduction of swing
pricing requirements and amendments to the current NAV calculations, we envisage a high business impact to the fund pricing and fund management areas in terms of managing the relevant data feeds and cut off timings from various intermediaries, core changes
to the floating NAV calculations which is bound to impact the other related functions like Tax & Accounting, Client Servicing etc. Similarly, the regulatory reporting areas will require significant modifications and new features, given the new requirement
for reporting in structured data format combined with swing pricing disclosures. Since majority of the functions are interlinked via interfaces and data feeds, there would be application related modifications required for data feeds across applications and
need to build new application interfaces with business intermediaries.
Key challenges for the firms
While majority of the asset managers have supported the proposed amendments on increasing the liquidity threshold requirements, removal of liquidity fees and redemption gates and WAM/WAL calculations, they have highlighted the challenges for implementation
of swing pricing, negative interest rate scenario handling and regulatory reporting requirements, which could potentially lead the investors to reduce investments in money market funds and move towards other short term funding instruments.
The key challenges for swing pricing requirements stem around operational complexities, costs, complexities around multi strike NAVs and with no regard to actual liquidity impact, it could render the swing factor determination completely irrelevant. There
are also concerns around amendments for negative interest rate environment, given that it is a hypothetical scenario which is highly unlikely to occur, will require substantial operational and technology changes from the intermediaries for calculation of floating
NAVs. As per the industry feedback, firms would also have to face additional reporting overhead for implementing the proposed amendments and firms see a potential risk of trading strategies being revealed via the reporting disclosures.
The way forward
The SEC has proposed a twelve-month compliance period for swing pricing and six months for liquidity requirements. As the US asset managers are pushing back on certain proposed amendments citing operational complexities and costs as major factors,
the SEC is expected to analyze the industry feedback and publish the final amendments within six months and expect the money market funds to be compliant with the new regulations by 2023.