On July 12, 2023, in a closely-watched meeting, the Securities and Exchange Commission approved new requirements on the $5.8 trillion money market fund (MMF) industry, a popular class of mutual funds that balance high liquidity, stable value, and returns that out-pace cash deposits.[1]
The new regulations, issued under the Investment Company Act of 1940,[2] aim to “improve the resilience and transparency” of MMFs by:
- Increasing minimum liquidity requirements;
- Doing away with fund gating and liquidity level-triggered redemption fees;
- Requiring certain MMFs to implement an improved liquidity-fee framework; and
- Enhancing reporting requirements to better allow the SEC to monitor MMF data.[3]
These changes, adopted by the five-member board in a three-to-two vote, represent the first major revisions to the operations of MMFs since the 2014 revamp in the wake of the 2008 liquidity crisis, which saw the Reserve Primary Fund, a MMF with $65 billion in assets under management, “break the buck,” or fail to maintain their $1-per-share value, when confronted with a wave of redemptions just as the markets for the funds’ fixed income assets froze up.[4] Later research would show that at least 28 other MMFs faced similar or worse risks by the time the federal government stepped in to backstop the MMF industry.[5]
Although MMFs are not banks but rather investment funds that issue shares (hence the SEC’s oversight), MMFs can suffer from similar effects as a bank run because both banks and MMFs are exposed to maturity and liquidity mismatch risk. That is, under normal circumstances, both banks and MMFs allow customers to withdraw funds immediately while lending out funds over longer periods. Consequently, both banks and MMFs rely on orderly financial markets to both allow the sale of debt securities and avoid waves of customer withdrawals.
Today’s new regulations stem from a more recent bank run-like episode that occurred in early 2020, as financial markets were roiled by the uncertainty surrounding the spreading COVID-19 pandemic in the United States and the resulting lockdowns’ effects on the economy.[6] Notably, a February 2023 Government Accountability Office analysis found that the 2014 reforms not only failed to prevent the wave of redemptions, but actually exacerbated it.[7]
In 2020, institutional MMF investors rushed to exit funds, fearing “the possibility of incurring a liquidity fee or losing access to their funds under a redemption gate” despite no MMF actually imposing either of the two restrictions, first made available in 2014.[8] As one industry group analysis found, the scale and effect of the COVID-driven outflows from institutional MMFs were both sharper and deeper than in 2008 (until the SEC again stepped in) as institutions recognized the risks of fees and gating:[9]
In May, SEC Chair Gary Gensler previewed some of his thoughts on MMF regulation:
There’s a saying in the woods: You don’t need to outrun the bear; you just have to outrun one of your fellow campers. I know it’s a bit gruesome, yet I think it helps explain why investors might try to cash out of investments before the proverbial bear of dilution and illiquidity catches them. … Well-regulated collective investment vehicles are among the great financial innovation of the last 90 years. … We know from history that financial fires can spread from regulatory gaps as well as herding and network interconnectedness.[10]
Voting against today’s proposal, Commissioner Mark Uyeda noted concerns that the SEC’s rules may “repeat the errors of the past,” referring to the role the 2014 regulations played in 2020:
Key questions, such as whether remaining shareholders of money market funds were disadvantaged as a result of redemption activity in March 2020 and, if so, whether and to what extent a mandatory liquidity fee would solve that problem, remain unanswered.[11]
Chair Gensler detailed his support for the new guardrails, noting:
[W]hen markets enter times of stress, some investors—fearing dilution or illiquidity—may try to escape the bear. This can lead to large amounts of rapid redemptions. We have observed this play out in times of stress, including during the 2008 financial crisis and the “dash for cash” in March 2020. Left unchecked, such stress can undermine these critical funds.
…
Today’s adoption will enhance money market funds’ liquidity, anti-dilution practices, and transparency in a number of ways.
…
Taken together, the rules will make money market funds more resilient, liquid, and transparent, including in times of stress. That benefits investors.[12]
Absent from the new rules was perhaps the most controversial proposal, a “swing pricing” requirement on MMFs. Swing pricing is a practice in which a fund’s value – and therefore an investor’s redemption value – is adjusted based on trading activity as well as underlying asset values. The goal of swing pricing is to ensure investors who make destabilizing trades (e.g., selling into a falling market) bear a more appropriate amount of the cost of those trades.[13]
Commenting on this change, Chair Gensler noted:
Based upon public feedback, today’s final rules will require liquidity fees instead of the originally proposed swing pricing requirement. I believe that liquidity fees, compared with swing pricing, offer many of the same benefits and fewer of the operational burdens.[14]
The new rules will become effective 60 days after publication in the Federal Register. The reporting form amendments will become effective June 11, 2024, and the SEC has stated that it plans a tiered approach to the transition periods for the other final amendments. Transition periods of six to twelve months are also under consideration.[15]
The rule as voted on is available on the SEC’s website, and the final regulations will be published in the Federal Register.
[1] Secs. & Exchg. Comm’n, SEC Adopts Money Market Fund Reforms and Amendments to Form PF Reporting Requirements for Large Liquidity Fund Advisers (July 12, 2023), available at https://www.sec.gov/news/press-release/2023-129.
[2] 15 U.S.C. §§ 80a-1 et seq.; 17 CFR Part 270 et seq.
[3] Secs. & Exchg. Comm’n, Fact Sheet; Money Market Reforms (July 12, 2023), available at https://www.sec.gov/files/33-11211-fact-sheet.pdf.
[4] M. Cipriani et al., Money Market Funds and Systemic Risk, Liberty Street Economics (June 11, 2012), available at https://libertystreeteconomics.newyorkfed.org/2012/06/money-market-funds-and-systemic-risk/.
[5] M. Ciprianiet al., Twenty-Eight Money Market Funds That Could Have Broken the Buck: New Data on Losses during the 2008 Crisis, Liberty Street Economics (Oct. 9, 2013), available at https://libertystreeteconomics.newyorkfed.org/2013/10/twenty-eight-money-market-funds-that-could-have-broken-the-buck-new-data-on-losses-during-the-2008-c/.
[6] Investment Company Institute, Experiences of US Money Market Funds During the COVID-19 Crisis (2020) at 17, available at www.ici.org/pdf/20_rpt_covid3.pdf
[7]See Government Accountability Office, Money Market Mutual Funds: Pandemic Revealed Unresolved Vulnerabilities, (Feb. 2023) at 16, available at https://www.gao.gov/assets/gao-23-105535.pdf.
[8] Id. at 17.
[9] Investment Company Institute, supra, at 18.
[10] Investment Company Institute, The Regulatory Landscape with SEC Chair Gary Gensler at the 2023 Leadership Summit (May 23, 2023) available at https://vimeo.com/830432511/94e585bbcd.
[11] M. Uyeda, Statement on Final Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A, Secs. & Exchg. Comm’n (July 12, 2023), available at https://www.sec.gov/news/statement/uyeda-final-money-market-fund-reforms-07-12-2023.
[12] G. Gensler, Statement on Money Market Funds, Secs. & Exchg. Comm’n (July 12, 2023), available at https://www.sec.gov/news/statement/gensler-statement-money-market-funds-07122023.
[13] S. Tanna, U.S. S.E.C. Removes ‘Swing Pricing’ from Money Market Fund Overhaul Plan, Reuters (July 11, 2023) available at https://www.reuters.com/markets/us/us-sec-removes-swing-pricing-money-market-fund-overhaul-plan-bloomberg-news-2023-07-12.
[14] G. Gensler (supra).
[15] SEC, Fact Sheet (supra) at 2.
