The Securities and Exchange Commission is asking market participants to help it craft a definition of retail money market funds as part of a set of reforms that it proposed Wednesday.
The definition is crucial to one of two requirements the SEC proposed to prevent runs on money market funds such as those that occurred during the 2008 financial crisis. The commission proposed requiring prime institutional money market funds operate with a floating net asset value (NAV), instead of the current stable NAV of $1.00 per share. Retail funds would be exempt from this requirement, as would funds primarily investing in U.S. government securities.
In the proposed rules, the SEC defines a retail money market fund as one that limits each shareholder's redemptions to no more than $1 million per business day. Funds that invest in municipal securities would need to apply this restriction on redemptions in order to continue using a stable NAV.
But the 698-page SEC rulemaking proposal requests comment on whether muni funds should be exempted from having to maintain a floating NAV. The SEC said it expects most tax-exempt money market funds would seek the retail exemption.
The SEC's definition of a retail money market fund is new and differs from those used by industry statistics compilers. Companies such as iMoneyNet define retail funds by considering such factors as a shareholder's minimum initial investment amount and how the fund provider categorizes and markets the fund.
The SEC asks for comment on other ways, besides the daily redemption limit, that it could differentiate between the institutional funds it wants to reign in and the retail funds that historically have not had problems with runs.
Another approach would be to restrict account balances to a certain size, the SEC said. That approach would require the cap to set forth in the fund's prospectus. The fund manager would also have to detail the actions it would take in the event that an investor's holdings exceeded the cap.
"For example, we could define a fund as retail if the fund does not permit investors to maintain accounts with a balance that exceeds $250,000, $1 million, $5 million, or some other amount," the SEC wrote in the proposed rules. "If an investor's account balance were to exceed the threshold dollar amount, the fund could automatically direct additional investments to shares of a government money market fund or a fund subject to the floating NAV requirement."
The SEC requested comments on that approach, but worried that it would not work for all funds or that it could be skirted by savvy institutional investors.
Two other ideas for drawing a line between institutional and retail money market funds would focus on the makeup of the shareholders themselves, rather than on the structural requirements of the fund.
Under a shareholder concentration definition, a fund could qualify for the retail exemption from a floating NAV if the largest shareholders owned less than a certain percentage of the fund's total assets.
"A heavily concentrated fund may indicate that the fund has a smaller number of large shareholders, who are likely institutions," the SEC wrote. "In addition, funds whose shareholders are less concentrated, and thereby less subject to heavy redemption pressure from a limited number of investors, may be able to withstand stress more effectively and thus could maintain a stable price."
That approach, however, could be over-inclusive and catch retail funds that happen to have a smaller concentration of investors, the commission worried. The SEC is also considering defining retail based on shareholder characteristics, such as whether investors use a social security number or a taxpayer identification number to register their accounts or whether they demand same-day settlement. These characteristics are not always indicative of one type of fund or the other, and the SEC is soliciting comment on other investor characteristics that could be helpful in crafting a definition.
Regardless of whether they become subject to a floating NAV requirements, muni money market funds would have to comply with another proposal, if it is adopted, which would require them to have liquidity fees and redemption gates.
The proposal will be open for comment for 90 days after its publication in the Federal Register, which could be next week.