Thursday, September 19, 2013

Big Four Firm Seeks Guidance from SEC and FASB on Audit Implications of SEC Money Market Fund Proposals

In a letter to the SEC, the Ernst & Young firm commented on the accounting and auditing implications of the Commission’s proposed reform of the regulation of money market funds. US GAAP explicitly states that money market funds are commonly considered cash equivalents. The main characteristics for an investment to be classified as a cash equivalent is that it is short term, highly liquid, readily convertible to known amounts of cash and presents insignificant risk of changes in value because of changes in interest rates

The audit firm urged the SEC to inventory a number of practice-related questions that have been raised by auditors, and users and preparers of financial statements on the cash equivalent topic and consider issuing, along with FASB, guidance to address these questions, perhaps through the Emerging Issues Task Force (EITF). One key question is whether an unexpected deterioration in the value or liquidity of a money market investment after the balance sheet date would be treated as a non-recognized subsequent event. Another question being raised by auditors is whether the occurrence of an event triggering fees and gates would preclude the continued classification of an investment in a money market fund as a cash equivalent.

In its proposed Release on money market reform, the SEC is considering two alternatives that could be adopted alone or in combination: 1) Floating NAV—Prime institutional money market funds would be required to transact at a floating NAV, while Government and retail money market funds would be allowed to continue using stable NAV. 2) Liquidity fees and redemption gates—Non-government money market funds would be permitted to use liquidity fees and redemption gates to reduce run risks in times of stress.

The audit firm agrees with the Commission that investments in money market funds with a floating NAV under amended SEC Rule 2a-7 would continue to meet the definition of a cash equivalent because the fluctuations in value would be expected to be insignificant. Ernst & Young also concurred with the Commission that the evaluation of whether an investment in a money market fund meets the requirements of a cash equivalent should be performed periodically

The firm also agreed with the Commission that investments in money market funds with both a floating NAV and fees and gates under the proposed amendments would continue to meet the definition of a cash equivalent. The potential suspension of redemptions for up to 30 days in contingent circumstances would not violate the requirement that a cash equivalent be “readily convertible to known amounts of cash.” Moreover, the potential imposition of a liquidity fee of up to 2 percent in contingent circumstances would not violate the requirement that a cash equivalent present “insignificant risk of changes in value.”

The proposal requests comment on whether sponsors of money market funds should be required to publicly disclose their financial statements in order to permit an evaluation of the sponsor’s capacity to provide support. The audit firm noted that the Commission has existing rules and practices that address the provision of financial statements when a guarantee or explicit credit enhancement exists. When there is merely implied or potential financial support, reasoned the firm, there should be no reason to require financial statements of the sponsor unless it is required to consolidate the money market fund as a variable interest entity under US GAAP. Otherwise, requiring sponsors to provide financial statements would not appear to be cost-justified when their financial support is not legally enforceable.

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