The Securities and Exchange Commission has voted to propose amendments to certain rules governing money market funds as a response to massive outflows and stress on short-term funding markets following the onslaught of COVID-19 in March 2020.
“Together these amendments are designed to reduce the likelihood of runs on money market funds during periods of stress,” SEC chairman Gary Gensler said. “They also would equip funds to better meet large redemptions, addressing concerns about redemption costs and liquidity,” he added.
“Given the broad reach of short-term funding markets, these proposals speak to our remit to maintain fair, orderly and efficient markets.”
Money market funds are purchasers of municipal bonds and municipal issuers also sometimes use them as places to invest while maintaining liquidity.
The proposed rules would remove the liquidity fee and redemption gate provisions in the existing rule in hopes of eliminating the incentive for preemptive redemptions from MMFs and encourage more funds to effectively use their existing liquidity buffers in times of stress. They also would require institutional prime and institutional tax-exempt MMFs to implement swing pricing policies and procedures requiring investors to bear the liquidity costs on redemptions.
The proposal also increases daily liquid asset and weekly liquid asset minimum liquidity requirements to 25% and 50%, respectively, in hopes of providing a more substantial buffer if rapid redemptions do occur.
The Commission also proposed amendments to reporting requirements on Forms N-MFP and N-CR in order to make more information on MMFs available, in addition to changes to Form N-1A to better reflect the Commission’s wider changes to MMFs.
The proposals also encompass amendments to rules addressing how MMFs with stable net asset values should handle environments with negative interest rates in addition to amendments to specify how funds calculate weighted average maturity and weighted average life.
Concerns about MMFs were present following the 2008 financial crisis and the 2010 reforms were largely designed to enhance liquidity and create more transparency for the public, Commissioner Alison Herren Lee said.
“Those reforms were tested in March 2020 when money funds were under stress again,” she said. “By that time, the Commission had completed additional reforms in 2014, subjecting the funds to valuation and risk-limiting regulations – such as the requirement for institutional prime and institutional tax-exempt funds to use a ‘floating’ net asset value.”
The Commission allowed funds to use liquidity fees and redemption gates, prompting then-Commissioner Kara Stein and others to express concern that introducing the possibility of a redemption gate could incentivize investors to redeem ahead of others.
“Her concerns were proved largely correct,” Herren Lee said. “As uncertainty about the pandemic loomed, investors sought stability and capital preservation by moving into cash and short-term securities.”
This created pressure in short-term funding markets and investors sought heavy redemptions. “In fact, the potential imposition of fees and gates as a result of decreases in fund liquidity to fuel redemption behavior,” Herren Lee said.
But questions about the efficacy of such policies remain. “Specifically, I’m interested in the foreseeable impact of swing pricing,” Herren Lee said. “Will it disincentivize first movers to help stem a run as contemplated? How might it impact investor choice?”
“Broadly, the idea is not to discourage the use of liquidity in times of stress, but to offer transparency once significant amounts of liquidity have been drained,” she said.
“But, is that enough? Should the Commission require reporting whenever a fund’s liquidity drops below the regulatory requirements? Are investors likely to overreact to such reporting or would the increased transparency help them make better decisions?”
The muni market is still assessing how this will affect its various players, but from an initial view, it isn’t shocking.
“It doesn't seem like it would affect the market significantly from the dealer's perspective,” said Michael Decker, senior vice president for research and public policy at the Bond Dealers of America. “But we're still reviewing.”
