Tuesday, October 22, 2013

Big Four Line Up Behind Position That Floating NAV for Money Market Funds Would Not Imperil Their US GAAP Cash Equivalent Status

In comments to the SEC, the Big Four accounting firms have lined up behind the position that in normal circumstances the existence of a floating NAV for money market funds as proposed by the Commission would not imperil the cash equivalent status of a money market fund investment. U.S. GAAP defines cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and that are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates; and includes a money market fund as an example of a cash equivalent.

In its proposed Release on money market fund 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.

GAAP and cash equivalents. In its letter to the SEC, PricewaterhouseCoopers said that it would be appropriate for a registrant to classify an investment in a money market fund that invests in assets in accordance with Rule 2a-7 as a cash equivalent in normal economic conditions, even if the money market fund does not maintain a perfectly stable value at all times. PwC went on to note that it may be prudent, however, to reiterate that independent of any rules adopted under the SEC proposal, registrants would typically re-evaluate this classification if either the underlying investments deviate from the requirements in Rule 2a-7 or other factors indicate that classification as a cash equivalent is no longer appropriate.

Under current practice, registrants generally consider open-end money market funds that maintain $1.00 per share to be cash equivalents, and would re-evaluate that conclusion if the fund's NAV falls below a rounded $1.00 per share. Under the proposal, registrants would be required to exercise judgment to assess at which point a meaningful decrease below $1.00 per share should trigger a change in the classification, in the rare instance this may occur. PwC urged the SEC to provide guidance on how to evaluate the magnitude of changes in the NAV in assessing whether the investment in the fund continues to qualify as a cash equivalent

The floating NAV could also have certain financial reporting implications, said PwC. Thus, if enacted, the Commission should address the transition in the financial highlights from amortized cost in prior periods to a floating net asset value in both a fund's financial statements, and its Form N-1A filing. As the change in methodology could also affect comparability with prior periods for certain disclosures such as advertisements and SEC yield, the firm similarly recommended that the Commission provide transition guidance in these areas.

In its comment letter, KPMG said that under normal market conditions U.S. GAAP would not preclude a money market fund with a floating NAV from being classified as a cash equivalent. Similarly, the ability to impose liquidity fees and gates combined with a floating NAV would not preclude such fund from being classified as a cash equivalent under U.S. GAAP. Consistent with the current reporting requirements for the classification of investments in money market funds under U.S. GAAP, continued KPMG, there may be circumstances, such as instability in the financial markets and defaults on underlying securities, where the money market fund may not be highly liquid and may not meet the criteria to be classified as a cash equivalent. KPMG reminded that the classification of any financial instrument as a cash equivalent requires judgment and is based on a variety of facts and circumstances present as of the date of the financial statements.

Echoing these views in its comment letter, Deloitte said that a money market fund would still qualify, under normal market conditions, as a cash equivalent in an investor’s financial statements if its NAV floats and it has the ability, as determined by the board of directors of the fund, to impose liquidity fees and gates.

In an earlier letter, Ernst & Young agreed 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.”

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