SEC Approves Issuance of Money Market Fund Proposals, Seeks Feedback on Floating NAV Concept

The SEC voted unanimously to issue proposed amendments to Investment Company Act Rule 2a-7 that would enhance the regulation of money market funds. The Commission also agreed to solicit feedback on several questions regarding the funds, including whether they should, like other types of mutual funds, effect transactions at the market-based net asset value rather than maintaining a stable $1 net asset value. Chair Mary Schapiro noted that a floating NAV might better protect investors from runs on money market funds, but asked for feedback on whether the efficiency of the $1 NAV is more beneficial to investors.

The rule proposals are intended to address some of the major issues that came to light as a result of the market turbulence of the past two years, according to Director of the Division of Investment Management Andrew Donohue. Trouble in the industry was particularly evident last fall when Reserve Primary Fund's NAV fell below $1, prompting a wave of redemptions from money market funds and placing investors in the position of not being able to redeem their holdings at the expected $1 per share price. The difficulty spread to other money market funds as well, including the withdrawal by investors of $300 billion from prime money market funds over the course of one week last September.

The proposed rules would enhance the risk-limiting requirements of Rule 2a-7 by establishing new liquidity requirements for money market funds, so that funds are required to hold a certain percentage of their assets in cash or highly liquid securities. The proposed change would put funds in a better position to redeem investors' shares on a short-term basis.

The proposals also are designed to enhance the quality of money market fund investments by strengthening the credit quality and portfolio maturity requirements of Rule 2a-7. Specifically, the weighted average maturity limits for money market fund portfolios would be shortened from 90 days to 60 days. Funds also would be required to stress test their portfolios periodically to determine whether they can withstand market turbulence. Under the proposed rules, money market funds would be prevented from investing in Tier 2 securities.

Commissioner Troy Paredes supported the release of the proposals, but expressed reservations about the elimination of Tier 2 securities as an investment option. "I am not aware of a link between Tier 2 securities and the market turbulence," he said. He asked commenters to consider how this piece of the proposal might impact the ability of issuers of Tier 2 securities to raise capital, and to consider whether the SEC should reduce the use of Tier 2 securities rather than eliminate it.

The Commission also proposes to improve its ability to monitor money market funds by requiring the funds to disclose their portfolio holdings monthly rather than quarterly. A fund would have to post the information on its Web sites to give investors access to additional information about the fund and its risk characteristics.

The proposals also include a requirement that funds be able to process purchases and redemptions at a price other than $1, and would expand ability of affiliates to purchase distressed securities from money market funds. The proposed rule changes also would permit a money market fund whose NAV has fallen below $1 and that has decided to liquidate to suspend redemptions while the fund undertakes an orderly liquidation of assets.

In addition to the floating NAV question, the SEC is seeking comment on whether it should require that funds satisfy redemption requests in excess of a certain size through in-kind redemptions. The Commission also asked interested parties to suggest alternatives with respect to the role of credit rating agencies in money market fund regulation.

Although she supported the issuance of the proposed rules, Commissioner Kathleen Casey said she had reservations about the continued reliance on NRSRO ratings by money market funds. In her view, the SEC should be trying to reduce investor and regulatory reliance on NRSROs, but the proposals would further embed them in the process. On this point, the proposals move in exactly the wrong direction, she said.