On July 12, 2023, the Securities and Exchange Commission (SEC) adopted amendments (Amendments) to Rule 2a-7 governing money market funds under the Investment Company Act of 1940 (1940 Act).1 The Amendments, which are designed to “improve the resilience and transparency of money market funds,” were adopted in response to the significant outflows that some money market funds experienced in connection with the economic shock attributable to the COVID-19 pandemic in March 2020 and that contributed to stress on short-term funding markets.
The Amendments, among other things:
(i) remove a money market fund’s ability to temporarily suspend redemptions, and remove provisions that tie liquidity thresholds to the discretionary imposition of liquidity fees;
(ii) increase minimum portfolio liquidity requirements to 25% (from 10%) of the total assets in daily liquid assets and 50% (from 30%) of total assets in weekly liquid assets;
(iii) require institutional prime and institutional tax-exempt money market funds to impose a liquidity fee when the fund has net redemptions above 5% of net assets;
(iv) require a non-government money market fund2 to impose a discretionary liquidity fee if the fund’s board determines that the fee is in the best interest of the fund;
(v) remove the bright-line 10% weekly liquid assets threshold under the stress testing requirements to instead require a money market fund to determine, and periodically test, the minimum level of liquidity it seeks to maintain during periods of market stress;
(vi) allow retail and government money market funds to handle a negative interest rate environment by reducing the number of shares outstanding to maintain a stable net asset value (NAV) per share, subject to certain board determinations and disclosures to investors; and
(vii) modify certain reporting requirements on Forms N-MFP, N-CR and PF.
Effective Dates and Compliance Dates
The Amendments were published in the Federal Register on August 3, 20233 and will be effective October 2, 2023, and the amendments to Forms N-MFP, N-CR and PF have a delayed effective and compliance date of June 11, 2024.
- The compliance date for the mandatory liquidity fee framework is October 2, 2024.
- The compliance date for the discretionary liquidity fee framework, increased minimum liquidity requirements, changes to the stress testing requirements and amendments specifying the method for calculating dollar-weighted average portfolio maturity (WAM) and dollar-weighted average life maturity (WAL) is April 2, 2024.
- There is no separate compliance date for the removal of redemption gates, removal of the tie between liquidity fees and liquidity thresholds, and the new provision allowing share cancellation – compliance with these amendments will be required on October 2, 2023.
Removal of Redemption Gates and the Tie Between the Liquid Asset Threshold and Liquidity Fees
Rule 2a-7 currently allows a money market fund to temporarily suspend redemptions (i.e., impose a “gate”) or impose a liquidity fee of up to 2% of the value of the shares redeemed, if the fund’s weekly liquid assets fall below 30% of total assets and the fund’s board determines that the redemption gate or liquidity fee is in the fund’s best interests.
The Amendments remove the provisions allowing a fund to impose temporary redemption gates4 and the provisions that tie a fund’s ability to impose liquidity fees to the level of weekly liquid assets. The SEC stated in the Release that, during the market stress in March 2020, the possibility of funds imposing gates or liquidity fees “appears to have contributed to investors’ incentives to redeem,” and that the 30% threshold “contributed to incentives” for fund managers to maintain weekly liquid asset levels above the 30% threshold instead of using liquid assets to meet redemptions.
Mandatory Liquidity Fee Framework
The Amendments include a mandatory liquidity fee framework for institutional prime and institutional tax-exempt funds, which the SEC adopted instead of the proposed swing pricing requirement.5 Under this framework, institutional prime and institutional tax-exempt money market funds will be required to impose a liquidity fee on redeeming investors when daily net redemptions exceed 5% of net assets6 or such smaller amount of net redemption as the fund’s board determines. However, funds will not be required to impose this fee when liquidity costs are less than one basis point, which the SEC anticipates “will often be the case under normal market conditions.”
The amount of the liquidity fee must be based on a “good faith estimate, supported by data, of the costs the fund would incur if it sold a pro rata amount of each security in its portfolio to satisfy the amount of the net redemptions.” If such costs cannot be estimated in good faith and supported by data, the fund must impose a “default fee” of 1% of the value of the shares redeemed.
A fund’s board is responsible for administering the mandatory liquidity fee; however, the Amendments permit the board to delegate this responsibility to the fund’s investment adviser or officers, subject to written guidelines established and reviewed by the board and ongoing board oversight.7 (In contrast, the current Rule 2a-7 does not permit the board to delegate responsibility for liquidity fee determinations.)
Discretionary Liquidity Fee
The Amendments retain the discretionary liquidity fee provisions in Rule 2a-7, except without the above-mentioned tie between liquidity fees and weekly liquid assets. In particular, the Amendments provide that a non-government money market fund must impose a discretionary liquidity fee (not to exceed 2% of the value of the shares redeemed) if the fund’s board determines that the fee would be in the best interests of the fund. Government money market funds are not subject to this provision but may choose to rely on the ability to impose discretionary liquidity fees.
Increased Portfolio Liquidity Requirements
The Amendments increase the required minimum levels of daily liquid assets and weekly liquid assets to 25% (from 10%) and 50% (from 30%), respectively, as determined at the time of security acquisition.
The Amendments require a fund to notify its board when the fund’s liquidity falls to less than half of the required levels – i.e., when the fund has invested less than 25% of its total assets in weekly liquid assets or less than 12.5% of its total assets in daily liquid assets (a “liquidity threshold event”). A fund must notify its board within one business day after a liquidity threshold event and must provide its board with a brief description of the facts and circumstances that led to the liquidity threshold event within four business days after the event.
Changes to Liquidity Metrics in Stress Testing
The Amendments revise the stress testing requirements of Rule 2a-7 to reflect related changes to the liquidity fee framework and required minimum weekly liquid assets threshold. Currently, Rule 2a-7 requires a money market fund to stress test, among other things, its ability to maintain 10% weekly liquid assets under specified hypothetical events. The Amendments replace this 10% threshold with a requirement for a money market fund to test its ability to maintain “sufficient minimum liquidity” under such hypothetical events. A fund will be permitted to determine the minimum level of liquidity that it considers sufficient in stress periods, which may differ among funds, and will be required to identify that liquidity level in its written stress testing procedures and provide the fund’s board with reports on the results of periodic testing.
Addressing Negative Interest Rates
The Amendments maintain the ability of government and retail money market funds (“stable NAV funds”) to convert to a floating NAV in the event of negative interest rates, and add the ability of stable NAV funds to engage in share cancellation in order to reduce the number of shares outstanding to maintain a stable NAV per share in the event of negative interest rates. A fund’s ability to engage in share cancellation will be subject to certain board determinations and disclosures to investors.
Calculation of Weighted Average Maturity and Weighted Average Life
The Amendments specify the method for calculating WAM and WAL.8 As some funds calculate WAM and WAL based on the percentage of each security’s market value in the portfolio and other funds base calculations on the amortized cost of each portfolio security, the amended definitions of WAM and WAL will provide more consistency across funds. Under the Amendments, funds will be required to calculate WAM and WAL based on the percentage of each security’s market value in the portfolio.
Amendments to Reporting Requirements
Form N-CR. The Amendments require a money market fund to report on Form N-CR if it experiences a liquidity threshold event, among other changes to the Form. The Amendments also require that Form N-CR be filed in a custom eXtensible Markup Language (XML)-based structured data language.
Form N-MFP. The Amendments require reporting of additional information on Form N-MFP, including information about shareholder concentration and composition, prime funds’ sales of non-maturing investments, the application of liquidity fees, and share cancellation.
Form PF. The Amendments modify Form PF to require “large liquidity fund advisers”9 to report additional information about the liquidity funds they advise.10
The Amendments are the SEC’s third attempt to safeguard money market funds in the changing investment environment since the 2008 financial crisis. The SEC added liquidity, credit quality and maturity limits in 2010, and liquidity gates and fees and floating NAV requirements in 2014. The Amendments retract some of the 2014 rule changes, because they did not operate as intended during the market stress in March 2020. Instead, the SEC has made a new effort to transfer to redeeming shareholders certain costs of satisfying redemption requests.
Seward & Kissel LLP will continue to provide insight on any related developments. If you have any questions regarding the matters covered in this memo, please contact any member of our Registered Funds Group.