SEC proposes amendments to money market fund rules - Ernst & Young - United States

SEC proposes amendments to money market fund rules

In June 2009, the Securities and Exchange Commission (SEC) issued its much-anticipated proposals to amend money market rules. The 197-page document discussed in detail the events leading up to the economic crisis and the issues directly impacting the money market fund industry.

As expected, the proposals focus on tightening credit risk and maturity limits, enhancing risk analysis and improving liquidity, as well as expanding board oversight responsibilities and periodic disclosures. In many respects, the proposals have taken into account several of the recommendations for money market reform made by the Investment Company Institute (ICI) in March.

Here are several things to keep in mind:

• Proposed changes in portfolio liquidity standards will require fund management to change their daily operations and monitoring procedures to meet new portfolio liquidity standards. For example, daily and weekly liquidity requirements will have to be measured for each security at the time of purchase. Compliance and trading systems will need to be modified to accommodate pre-and post-trade analysis.
  
• The proposals require funds to maintain minimum levels of cash and securities readily convertible to cash based on the characteristics of their shareholder base to evaluate anticipated redemption activity. The liquidity requirements in the proposal distinguish between taxable retail, taxable institutional and tax-exempt fund categories. Therefore, boards will have to establish an annual process to determine which money market funds meet the criteria for each category based on the underlying shareholder profile. These “know your shareholder” requirements may present significant challenges, for example, in a multi-class fund containing both retail and institutional shareholder classes.
  
• The SEC has proposed mandatory stress-testing that would require funds to prepare for hypothetical events (e.g., an increase in short term interest rates, an increase in redemptions, downgrades in securities, changing spreads). Management and boards of directors would have to analyze and document their assessments of the effect these events might have on the funds and develop responses for each scenario.
  
• In addition to expanding board oversight responsibilities for stress testing, additional proposals would require the board to at least annually determine a fund’s capacity to redeem and sell its securities at a price based on the current net asset value per share.  This would require a fund to have the capacity to process transactions at other than a stable NAV.
  
• Expanded disclosure is a significant element of the SEC’s proposed amendments. Detailed monthly reporting to the SEC and monthly postings to a public website, including the possibility of providing a market, in addition to amortized cost, based NAV and market prices of portfolio securities, were included in the proposals. 

Additional proposals focus on the ability of affiliated persons to purchase portfolio securities and the permissibility of suspending redemptions when a fund has “broke the buck” to facilitate an orderly liquidation.

Seeking input
The SEC is also looking for input on several possible regulatory changes. It has requested comments on whether money market rules should be amended to allow funds to have a floating net asset value (NAV). The industry has previously commented (through the ICI) that a stable NAV ($1.00) is a critical characteristic of money market funds and that allowing funds to float would, in effect, be the end of the money market fund industry.

The SEC also is requesting comment on the use of in-kind redemptions to satisfy redemption requests. Although many funds disclose their ability to pay in kind, the SEC is considering whether to impose a threshold or requirement for in-kind redemptions, and how to calculate that threshold (e.g., amortized cost vs. market value). Industry and other public comments received related to the proposals are expected to be considered when the President’s Working Group (PWG) issues its report on money market funds to the Obama administration in September (The SEC is a member of the PWG). 

Overall, the proposals will require a review of substantially all systems and procedures currently supporting money market fund operations (including transfer agents). Fund management and boards will most likely have to modify many existing controls and procedures as well as develop new ones. Fund management and boards should start thinking now about how best to respond in order to operate in a much different regulatory environment. The proposals’ comment period ended on 8 September 2009.

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