On Wednesday, Jan. 27, 2010, the Securities and Exchange Commission voted 4-1 to adopt amendments to
Many of the rule amendments were adopted as originally proposed in June 2009. However, the final rule amendments include certain new requirements, one of which, notably, is a requirement for money market funds to disclose publicly the mark-to-market value of their net assets on a monthly basis (with a 60-day lag).
The text of the amendments to Rule 2a-7 and new rules has not yet been made publicly available. The following summarizes those portions of the rule amendments discussed by the Commission and its staff during Wednesday’s meeting:
Quality of Portfolio Investments. Money market funds will be required to meet three new portfolio quality requirements, although the Commission did not adopt its original proposal to limit money market funds to investment only in first-tier securities. First, money market fund investments in second-tier securities will be limited to three percent of the fund’s total assets. Second, a fund will not be permitted to invest more than one-half of one percent of its total assets in second-tier securities issued by any single issuer. (Currently, a money market fund may hold up to five percent of its total assets in second-tier securities and up to one percent in second-tier securities issued by any single issuer.) Third, money market funds will not be permitted to invest in second-tier securities that have a maturity of more than 45 days. The Commission’s decision to scale back its proposal appears to recognize that, as several industry participants have observed, investments in second-tier securities did not significantly contribute to the money market turmoil that began in mid- to late 2007.
Maturity of Portfolio Investments. Money market funds will be required to meet new portfolio maturity requirements. The maximum dollar-weighted average maturity of a money market fund’s portfolio will be shortened to 60 days from the current 90 days. A new limitation of 120 days for the “weighted average life” of a money market fund’s portfolio also will be imposed. This new maturity test will limit the ability of a money market fund to invest in long-term floating rate securities. This new “weighted average life” requirement follows from the Investment Company Institute’s March 2009 report, which suggested that a variable- or floating-rate security generally is more sensitive to credit and interest rate spreads than a short-term security with a final maturity equal to the former’s reset date. Accordingly, it appears that the weighted average life of a portfolio will now be measured without regard to a security’s interest rate reset dates.
Liquidity. Money market funds will be required to meet certain minimum daily and weekly liquidity requirements. For the daily requirement, money market funds will be required to invest at least 10 percent of their assets in “daily liquid assets,” i.e., cash or highly liquid securities that may be converted into cash within one day. To comply with the weekly requirement, a money market fund will be prohibited from acquiring securities other than “weekly liquid assets” if, immediately after the acquisition, the fund would have invested less than 30 percent of its total assets in cash or liquid securities that may be converted into cash within one week.
The Commission’s original proposal included different liquidity requirements for retail and institutional money market funds, and provided lower daily and weekly liquidity requirements for retail money market funds from those adopted by the Commission. However, in adopting uniform liquidity requirements for all types of money market funds, the Commission acknowledged the difficulty in distinguishing between retail and institutional money market funds.
A money market fund also will be restricted from purchasing illiquid securities if, after purchase, more than 5 percent of the fund’s portfolio will be illiquid securities. Currently, a money market fund is restricted from purchasing illiquid securities if, after purchase, more than 10 percent of the fund’s portfolio will be illiquid securities.
Disclosure of Portfolio Holdings and Shadow NAV. Money market funds will be required to post portfolio holdings information on their websites. Money market funds also will be required to provide detailed information to the Commission on a monthly basis. This information will include the mark-to-market value of the money market fund’s net assets. This information will be available to the public with a 60-day lag. Money market funds are currently required to disclose the mark-to-market value of their net assets semi-annually on Form N-SAR. The Commission staff explained that more frequent public disclosure of the mark-to-market value of money market funds’ net assets will permit investors and the Commission to better judge the risk profile of a fund, and will also help investors to understand that a money market fund’s mark-to-market net asset value fluctuates slightly even though the fund maintains a stable net asset value of $1.00.
Stress Tests and “Know Your Investor” Requirements. Money market funds will be required to conduct periodic stress tests of their investment portfolios. Money market funds also will be required to adopt “know your investor” procedures to identify those shareholders that appear likely to pose a risk of making significant redemptions.
Nationally Recognized Statistical Ratings Organizations. As further means to ensure the quality of fund investments, a money market fund’s board of directors will be required to designate at least four nationally recognized statistical ratings organizations (“NRSROs”) to which the fund would look for all purposes under Rule 2a-7 and to evaluate annually whether those NRSROs have issued sufficiently reliable credit ratings. The rule amendments also eliminate the current requirement that money market funds invest only in those asset-backed securities that have been rated by an NRSRO. While the rule release will shed more light on the matter, it appears that, with this change, the Commission has abandoned its earlier proposal to remove other references to NRSRO ratings from Rule 2a-7.
Procedures for Processing Fund Transactions at Prices Other Than $1.00. Money market funds will be required to adopt procedures to facilitate the processing of purchases and redemptions of money market fund shares at different prices than $1.00 per share.
Permitting Suspension of Redemptions. The board of directors of a money market fund will have the ability to suspend redemptions in circumstances where the fund has “broken the buck” and plans to liquidate. This rule would be an exemption from the requirement, found in Section 22(e) of the Investment Company Act, that a mutual fund must redeem shares within seven days of a redemption request.
Permitting Affiliates to Purchase Distressed Assets From Money Market Funds. The ability of affiliates of money market funds to purchase distressed assets from a fund in order to protect the fund from losses will be expanded, and, under certain conditions, such purchases will be permitted without first obtaining no-action relief (e.g., from the prohibitions on affiliated and joint transactions contained in Section 17 of the Investment Company Act).
The Commission did not consider at Wednesday’s meeting whether money market funds should no longer be permitted to use the amortized cost method of valuation or maintain a stable net asset value of $1.00 in favor of a floating net asset value. However, Commissioner Schapiro and the Commission staff noted that the Commission would continue to pursue more fundamental changes to money market regulation, including the possible adoption of a floating net asset value and mandatory redemptions in-kind. In voting against adoption of the proposed rule amendments, Commissioner Casey noted her concern that more fundamental reform of money market fund regulation is required.
The Commission did not comment on when the formal rules would be released, nor when they would take effect.
For assistance, please contact the following lawyers:
Lea Anne Copenhefer, Partner, Investment Management
leaanne.copenhefer@bingham.com, 617.951.8515
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615
Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620
This article was originally published by Bingham McCutchen LLP.