On July 23, 2014 the US Securities and Exchange Commission (SEC) adopted a Final Rule that amends Rule 2a-7 of the Investment Company Act of 1940, which governs money market funds. These long anticipated amendments are designed to provide both structural and operational reform addressing an investor run on funds during a financial crisis, as was seen in 2008. The Final Rule becomes effective sixty days after publication in the Federal Register and provides for a two-year implementation period.
Below are key takeaways from the Final Rule.
Floating net asset value (NAV)
The amendments require institutional prime and institution municipal money market funds to transact with a floating NAV, which will be based on the current market value of the securities in the fund’s underlying portfolio rounded to four decimal places. The funds will no longer be able to use the amortized cost method to maintain a $1.00 NAV. Tax-exempt money market funds will also be required to transact at a floating NAV, unless they meet the definition of retail funds as stated below.
The amendments do allow for some funds to be exempt from the floating NAV. Specifically retail and government money market funds will be allowed to continue using the amortized cost method. Retail money market funds have been defined as funds that have policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons. Government money market funds must have 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements collateralized solely by government securities or cash.
Subsequent to the final rule, the Treasury Department and Internal Revenue Service issued proposed tax guidance related to the floating NAV. The proposal will allow floating NAV money market fund investors to use a simplified tax accounting method for capital gains and losses when shares of these funds are purchased and sold. Additionally, a new revenue procedure was proposed that provides relief from the wash sale rules for investors of floating NAV money market funds.
Liquidity fees and redemption gates
The liquidity fees and redemption gates amendment specifically applies to all non-government money market funds, however government money market funds may opt to use them.
- Liquidity fees: A fund’s board of directors, if they feel it’s in the best interest of the fund, will have the ability to impose a liquidity fee of up to two percent on all redemptions if the fund’s weekly liquid assets (as defined in Rule 2a-7) fall below thirty percent of the fund’s total assets. A one percent liquidity fee would be required if a fund’s level of weekly liquid assets falls below ten percent of total assets, unless the fund’s board of directors determines that imposing the fee would not be in the fund’s best interest, or conversely, imposing a higher fee (up to 2 percent) would be in the fund’s best interest.
- Redemption gates: In addition to liquidity fees, when a fund’s weekly liquid assets fall below thirty percent of total assets, the board of directors has the ability to temporarily suspend redemptions for up to ten business days in a ninety-day period.
On top of these significant amendments to Rule 2a-7, the Final Rule also seeks to enhance disclosure and reporting requirements through the following:
- Beginning nine months following the Final Rule’s publication in the Federal Register, funds will be required to implement new material event disclosures on the Form N-CR.
- Beginning eighteen months following the Final Rule’s publication in the Federal Register, funds will be required to comply with amendments to diversification requirements, enhanced stress testing, additional disclosures, and reporting changes to Form PF and Form N-MFP.
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