Commission Strengthens Money Market Regulations

The SEC adopted new rules designed to significantly strengthen the regulatory requirements governing money market funds. The new rules are intended to increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds by tightening the maturity and credit quality standards and imposing new liquidity requirements. The Commission acted after a review of the money market regulatory scheme prompted by the Reserve Primary Fund's "breaking the buck" in September 2008. A money market fund "breaks the buck" when its net asset value falls below $1.00 per share, meaning investors in that fund will lose money.

The new rules require money market funds to have a minimum percentage of their assets in highly liquid securities so that those assets can be readily converted to cash to pay redeeming shareholders. There are currently no minimum liquidity mandates. For all taxable money market funds, at least 10 percent of assets must be in cash, U.S. Treasury securities, or securities that convert into cash within one day. For all money market funds, at least 30 percent of assets must be in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, or securities that convert into cash within one week.

The rules would further restrict the ability of money market funds to purchase illiquid securities by 1) restricting money market funds from purchasing illiquid securities if, after the purchase, more than 5 percent of the fund's portfolio will be illiquid securities (the current limit is 10 percent); and 2) redefining as "illiquid" any security that cannot be sold or disposed of within seven days at carrying value.

The new rules also place new limits on a money market fund's ability to acquire lower quality, or "Second Tier," securities. Under the new rules, funds may not 1) invest more than three percent of their assets in Second Tier securities (the current limit is five percent); 2 ) invest more than one-half of one percent of their assets in Second Tier securities issued by any single issuer (the current limit is the greater of one percent or $1 million) or 3) buy Second Tier securities that mature in more than 45 days (the current limit is 397 days).

Money market funds will also face shorter maturity limits, in order to limit the exposure of funds to certain risks such as sudden interest rate movements. The maximum "weighted average life" maturity of a fund's portfolio will be 120 days. Currently, there is no such limit. The effect of the restriction is to limit the ability of the fund to invest in long-term floating rate securities. In addition, the rules shorten the maximum weighted average maturity of a fund's portfolio to 60 days. The current limit is 90 days.

Measures described as "know your investor" procedures rules require funds to hold sufficiently liquid securities to meet foreseeable redemptions. Currently, there are no such requirements. In order to meet this new requirement, funds would need to develop procedures to identify investors whose redemption requests may pose risks for funds. As part of these procedures, funds would need to anticipate the likelihood of large redemptions. The rules also will require fund managers to examine the fund's ability to maintain a stable net asset value per share in the event of shocks, such as interest rate changes, higher redemptions, and changes in credit quality of the portfolio. Previously, there were no such stress test requirements.

The new rules continue to limit a money market fund's investment in rated securities to those securities rated in the top two rating categories, or to unrated securities of comparable quality. At the same time, the new rules also continue to require money market funds to perform an independent credit analysis of every security purchased. As such, the credit rating serves as a screen on credit quality, but can never be the sole factor in determining whether a security is appropriate for a money market fund. In addition, the new rules improve the way that funds evaluate securities ratings provided by NRSROs. Funds must designate at least four NRSROs each year whose ratings the fund's board considers to be reliable. This permits a fund to disregard ratings by NRSROs that the fund has not designated, for purposes of satisfying the minimum rating requirements, while promoting competition among NRSROs. The rules also will eliminate the current requirement that funds invest only in those asset backed securities that have been rated by an NRSRO.

With regard to repurchase agreements, the new rules strengthen the requirements for allowing a money market fund to "look through" the repurchase issuer to the underlying collateral securities for diversification purposes. Collateral must be cash items or government securities, as opposed to the current requirement of highly rated securities. The fund must also evaluate the creditworthiness of the repurchase counterparty.

Each month, money market funds must post on their Web sites their portfolio holdings. Currently, there is no Web site posting requirement. Portfolio information must be maintained on the fund's Web site for no less than six months after posting. The new rules also require money market funds each month to report to the Commission detailed portfolio schedules in a format that can be used to create an interactive database through which the Commission can better oversee the activities of money market funds. The information reported to the Commission would be available to the public 60 days later. This information would include a money market fund's "shadow" NAV, or the mark-to-market value of the fund's net assets, rather than the stable $1.00 NAV at which shareholder transactions occur. Currently a money market fund's "shadow" NAV is reported twice a year with a 60-day lag.

Funds and their administrators must be able to process purchases and redemptions electronically at a price other than $1.00 per share. This requirement facilitates share redemptions if a fund were to "break the buck." Fund boards may also to suspend redemptions if the fund is about to break the buck and the board decides to liquidate the fund. Ccurrently the board must request an order from the SEC to suspend redemptions. In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule.

The Commission also expanded the ability of affiliates of money market funds to purchase distressed assets from funds in order to limit losses. Currently, an affiliate cannot purchase securities from the fund before a ratings downgrade or a default of the securities unless it receives individual approval. The rule change permits such purchases without the need for approval under conditions that protect the fund from transactions that disadvantage the fund. The fund must notify the Commission when it relies on this rule.

The adopted are effective 60 days after publication in the Federal Register. We will provide a link to the release when it becomes available.


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