Monday, March 23, 2009

SEC Investment Management Director Calls for New Money Market Fund Model

As the financial crisis continues and money market funds face the most challenging period of their history, Andrew Donohue, the SEC’s Director of Investment Management has called for a review of rule 2a-7 and the money market fund model. Reform of the rule 2a-7 model is a high priority going forward for the Division of Investment Management. With almost $4 trillion in assets, money market funds are of fundamental importance to the financial system as they serve to meet the liquidity and capital preservation needs of all types of investors, both individual and institutional. In remarks at the Investment Management Conference in Palm Desert, the SEC official endorsed the recent Investment Company Institute recommendations for strengthening money market funds as a good first step in developing changes to rule 2a-7.

The ICI recommends, for the first time, imposing daily and weekly minimum liquidity requirements for money market funds; and requiring regular stress testing of a money market fund’s portfolio. The Institute also urges a tightening of the portfolio maturity limit currently applicable to money market funds. Client risk would be addressed by requiring money market fund advisers to adopt know your client procedures; for the first time, disclosing client concentrations by type of client and the potential risks posed by a fund with a client base that is strongly concentrated. In addition, monthly website disclosure of a money market fund’s portfolio holdings would be required.

The director recognizes that the stable net asset value of $1.00 has been an integral part of the money market fund model, but is also aware of the challenges that it presents. He wants to quickly develop recommendations to the Commission for changes to rule 2a-7 to protect money market investors.

Reform has become urgent. In addition to experiencing the first breaking of the buck by a widely-held money market fund, he observed, over 120 money market funds face their own credit or liquidity challenges. To allow the asset purchase or credit support arrangements for funds facing these challenges, he noted, over 30 firms have sought and promptly received no-action relief from Division staff.

The Division has actively worked with the managers of money market funds as they cope with events during the crisis. In addition, the official listed a number of important actions taken to assist various liquidity facilities to assist money market funds, including consulting with Treasury on the implementation of the Temporary Guarantee Program.

The staff issued a no-action letter stating that it would not object under the senior security provisions of the Investment Company Act if money market funds participate in the Temporary Guarantee Program. In addition, the Commission issued a temporary rule enabling a money market fund participating in the program to immediately suspend redemptions, as contemplated by the program, if it breaks the buck. This rule allows for an orderly wind down of a fund under the program.

Further, the staff issued a no-action letter permitting money market funds to access the Federal Reserve's Asset Backed Commercial Paper Facility through affiliated banks; and issued a subsequent letter clarifying diversification analysis and other operational impacts of the Federal Reserve's Money Market Investor Funding Facility. The Division staff also issued a no-action letter providing temporary relief for money market funds to shadow price securities at amortized cost, if they have a final maturity of 60 days or less.

According to the director, this temporary relief was granted based on the assertion that the markets for short-term securities, including commercial paper, were not functioning as intended or were not resulting in the discovery of prices that properly reflected the fair value of securities that were fully expected to pay off upon maturity. That relief has now expired. As required by rule 2a-7, emphasized Mr. Donohue, all money market funds should have resumed shadow pricing their portfolio securities based on their market price.