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The SEC on Feb. 4, 2021, said it is seeking the public’s comment on potential commission action to reform money market funds because the market experienced volatility caused by the COVID-19 pandemic, as highlighted in the President’s Working Group on Financial Markets’ (PWG) December report.

The short-term funding markets in March 2020 experienced significant stress from the economic downturn because of concerns related to the pandemic. And there was an overall flight to liquidity among investors.

According to PWG report about the pandemic’s effect on money markets, government money market funds had significant inflows during that time, but the prime and tax-exempt money market funds experienced significant outflows and increasingly illiquid markets for the funds’ assets. As a result, prime and tax-exempt money market funds contributed to the general stress in the short-term private debt markets and short-term municipal markets.

After the Federal Reserve implemented programs to support the short-term funding markets, the market stress and related pressure on market funds subsided fairly quickly.

“Money market funds play a significant role in our short-term funding markets, and they are utilized by both large institutions and individual retail investors,” SEC Acting Chair Allison Herren Lee said in a statement. “Comments received will assist the SEC and other relevant financial regulators in further analysis of potential reforms.”

The preliminary rulemaking document is in Release No. IC-34188, Request for Comment on Potential Money Market Fund Reform Measures in President’s Working Group Report.

Comments are due 60 days after publication in the Federal Register. The release notes that the SEC will conduct discussions with various interested parties about the options described in the PWG report and the comments the commission gets.

The SEC in 2010 and 2014 implemented money market fund reforms, and the PWG report describes how different types of money market funds have evolved since the 2008 financial crisis. The report said that prime and tax-exempt money market funds experienced pressure in March despite previous reforms to make the funds more resilient to credit and liquidity stresses and less susceptible to runaway redemptions.

“The report concludes that more work is needed to reduce the risk that structural vulnerabilities in prime and tax-exempt money market funds will lead to or exacerbate stresses in short-term funding markets,” the SEC said.

The report lays out various steps that regulators could consider in strengthening the resilience of prime and tax-exempt money market funds and the larger short-term funding markets:

  • removal of tie between MMF liquidity and fee and gate thresholds;
  • reform of conditions for imposing redemption gates;
  • minimum balance at risk;
  • MMF liquidity management changes;
  • countercyclical weekly liquid asset requirements;
  • floating NAVs for all prime and tax-exempt MMFs;
  • swing pricing requirement;
  • capital buffer requirements;
  • require liquidity exchange bank membership; and
  • new requirements governing sponsor support

2010 reforms

In February 2010, the SEC issued Release No. IC-29132, Money Market Fund Reform, to implementing one of the agency's main responses to the credit crisis of 2008. It required funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, reducing the maximum weighted average maturity of portfolio holdings and improving the quality of portfolio securities.

Funds will have to report their portfolio holdings monthly to the SEC. Fund that have repriced below $1 per share, or, in industry parlance broken the buck, will be permitted to suspend shareholder redemptions.

The SEC at the time said it was trying to make money market funds ride out short-term upheavals in the financial markets, such as the rout that hit the segment in the fall of 2008 after Lehman Brothers Holdings Inc. filed for bankruptcy and the Treasury Department and Federal Reserve had to keep American International Group afloat.

2014 reforms

Then in July 2014, the SEC issued Release No. 33-9616, Money Market Fund Reform; Amendments to Form PF, which significantly changed the way money market funds operate. The reforms included a requirement that prime institutional funds float their share prices and are intended to reduce the risk of investor runs during market sell-offs. Funds have permission to limit investors’ ability to redeem shares during downturns. Government and retail money funds are allowed to continue using the amortized cost method of pricing to maintain a stable share price.

A government fund invests 99.5% or more of its total assets in cash, government securities, or repurchase agreements. The previous threshold was 80%.

Money fund boards are able to impose liquidity fees and suspend redemptions temporarily or “gate” them for non-government funds if the level of weekly liquid assets falls below 30% of total assets. If a fund’s level of weekly liquid assets falls below 10%, it will have to impose a liquidity fee of 1% on all redemptions. However, the fund’s board will have the discretion not to impose a fee or lower it if it’s in the fund's interests. The board can also impose a fee as high as 2%.

For more information on this topic, or to learn how Baker Tilly SEC accounting specialists can help, contact our team.

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