Rule2023-15124
Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
August 3, 2023
Effective
October 2, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is adopting amendments to certain rules that govern money market funds under the Investment Company Act of 1940. These amendments are designed to improve the resilience and transparency of money market funds. The amendments will revise the primary rule that governs money market funds to remove the ability for a fund board to temporarily suspend redemptions if the fund's liquidity falls below a threshold. In addition, the amendments will remove the tie between liquidity thresholds and the potential imposition of liquidity fees. The amendments will also require certain money market funds to implement a liquidity fee framework that will better allocate the costs of providing liquidity to redeeming investors. In addition, the Commission is increasing the daily liquid asset and weekly liquid asset minimum requirements to 25% and 50%, respectively. The Commission also is amending certain reporting requirements on Form N-MFP and Form N-CR and making certain conforming changes to Form N-1A to reflect amendments to the regulatory framework for money market funds. In addition, the Commission is addressing how money market funds with stable net asset values may handle a negative interest rate environment, including by adopting amendments that will permit these funds to use share cancellation, subject to certain conditions. Further, the Commission is adopting rule amendments to specify how funds must calculate weighted average maturity and weighted average life. In addition, the Commission is adopting amendments to Form PF concerning the information large liquidity fund advisers must report for the liquidity funds they advise. Finally, the Commission is adopting two technical amendments to Form N-CSR and Form N-1A to correct errors from recent Commission rulemakings.
Full Text
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[Federal Register Volume 88, Number 148 (Thursday, August 3, 2023)]
[Rules and Regulations]
[Pages 51404-51549]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-15124]
[[Page 51403]]
Vol. 88
Thursday,
No. 148
August 3, 2023
Part II
Securities and Exchange Commission
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17 CFR Parts 270, 274, and 279
Money Market Fund Reforms; Form PF Reporting Requirements for Large
Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-
1A; Final Rule
Federal Register / Vol. 88 , No. 148 / Thursday, August 3, 2023 /
Rules and Regulations
[[Page 51404]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 270, 274 and 279
[Release Nos. 33-11211; 34-97876; IA-6344; IC-34959; File No. S7-22-21]
RIN 3235-AM80
Money Market Fund Reforms; Form PF Reporting Requirements for
Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and
Form N-1A
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to certain rules that govern money market funds
under the Investment Company Act of 1940. These amendments are designed
to improve the resilience and transparency of money market funds. The
amendments will revise the primary rule that governs money market funds
to remove the ability for a fund board to temporarily suspend
redemptions if the fund's liquidity falls below a threshold. In
addition, the amendments will remove the tie between liquidity
thresholds and the potential imposition of liquidity fees. The
amendments will also require certain money market funds to implement a
liquidity fee framework that will better allocate the costs of
providing liquidity to redeeming investors. In addition, the Commission
is increasing the daily liquid asset and weekly liquid asset minimum
requirements to 25% and 50%, respectively. The Commission also is
amending certain reporting requirements on Form N-MFP and Form N-CR and
making certain conforming changes to Form N-1A to reflect amendments to
the regulatory framework for money market funds. In addition, the
Commission is addressing how money market funds with stable net asset
values may handle a negative interest rate environment, including by
adopting amendments that will permit these funds to use share
cancellation, subject to certain conditions. Further, the Commission is
adopting rule amendments to specify how funds must calculate weighted
average maturity and weighted average life. In addition, the Commission
is adopting amendments to Form PF concerning the information large
liquidity fund advisers must report for the liquidity funds they
advise. Finally, the Commission is adopting two technical amendments to
Form N-CSR and Form N-1A to correct errors from recent Commission
rulemakings.
DATES: Effective dates: The rule amendments are effective October 2,
2023. The amendments to Forms N-1A and N-CSR are effective October 2,
2023 and the amendments to Forms N-CR, N-MFP, and PF are effective June
11, 2024.
Compliance dates: The applicable compliance dates are discussed in
section II.H.
FOR FURTHER INFORMATION CONTACT: Blair Burnett, Christian Corkery,
David Driscoll, or Laura Harper Powell, Senior Counsels; Angela
Mokodean, Branch Chief; or Brian M. Johnson, Assistant Director at
(202) 551-6792, Investment Company Regulation Office, Division of
Investment Management, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to the
following rules and forms:
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\1\ 15 U.S.C. 80a-1 et seq. Unless otherwise noted, all
references to statutory sections are to the Investment Company Act,
and all references to rules under the Investment Company Act are to
title 17, part 270 of the Code of Federal Regulations [17 CFR part
270].
\2\ 15 U.S.C. 77a et seq.
\3\ 15 U.S.C. 78a et seq.
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Commission reference CFR Citation (17
CFR)
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Investment Company Act of 1940 Rule 2a-7......... Sec. 270.2a-7.
(``Act'' or ``Investment
Company Act'') \1\.
Rule 31a-2........ Sec. 270.31a-2.
Form N-MFP........ Sec. 274.201.
Form N-CR......... Sec. 274.222.
Securities Act of 1933 Form N-1A......... Sec. Sec.
(``Securities Act'') \2\ and 239.15A and
Investment Company Act. 274.11A.
Securities Exchange Act of 1934 Form N-CSR........ Sec. Sec.
(``Exchange Act'') \3\ and 249.331 and
Investment Company Act. 274.128.
Investment Advisers Act of 1940 Form PF........... Sec. 279.9.
(``Advisers Act'').
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Table of Contents
I. Introduction
A. Role of Money Market Funds and Existing Regulatory Framework
B. March 2020 Market Events and Need for Reform
II. Discussion
A. Amendments To Remove the Tie Between the Weekly Liquid Asset
Threshold and Redemption Gates and Liquidity Fees
1. Unintended Effects of the Tie Between the Weekly Liquid Asset
Threshold and Liquidity Fees and Redemption Gates
2. Removal of Redemption Gates From Rule 2a-7
B. Liquidity Fee Requirement
1. Determination To Adopt a Liquidity Fee Requirement
2. Terms of the New Mandatory Liquidity Fee Requirement
3. The Continued Availability of Discretionary Liquidity Fees
4. Disclosure
5. Tax and Accounting Implications of Liquidity Fees
C. Amendments to Portfolio Liquidity Requirements
1. Increase of the Minimum Daily and Weekly Liquidity
Requirements
2. Consequences for Falling Below Minimum Daily and Weekly
Liquidity Requirements
3. Amendments to Liquidity Metrics in Stress Testing
D. Amendments Related to Potential Negative Interest Rates
E. Amendments to Specify the Calculation of Weighted Average
Maturity and Weighted Average Life
F. Amendments to Reporting Requirements
1. Amendments to Form N-CR
2. Amendments to Form N-MFP
3. Amendments to Form PF
G. Technical Amendments to Form N-CSR and Form N-1A
H. Effective and Compliance Dates
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Baseline
1. Money Market Funds
2. Large Liquidity Funds and Form PF
3. Other Affected Entities
C. Costs and Benefits of the Final Amendments
1. Removal of the Tie Between the Weekly Liquid Asset Threshold
and Liquidity Fees and Redemption Gates
2. Raised Liquidity Requirements
3. Stress Testing Requirements
4. Liquidity Fees
5. Amendments Related to Potential Negative Interest Rates
6. Disclosures
7. Calculation of Weighted Average Maturity and Weighted Average
Life
8. Form PF Requirements for Large Liquidity Fund Advisers
D. Alternatives
1. Alternatives to the Removal of Temporary Redemption Gates
[[Page 51405]]
2. Alternatives to the Removal of the Tie Between Weekly Liquid
Assets and Discretionary Liquidity Fees
3. Alternatives to the Final Increases in Liquidity Requirements
4. Alternative Stress Testing Requirements
5. Alternative Implementations of Liquidity Fees
6. Swing Pricing
7. Expanding the Scope of the Floating NAV Requirements
8. Countercyclical Weekly Liquid Asset Requirements
9. Amendments Related to Potential Negative Interest Rates
10. Amendments Related to WAL/WAM Calculation
11. Form PF Amendments for Large Liquidity Fund Advisers
12. Disclosures
13. Sponsor Support
14. Capital Buffers
15. Minimum Balance at Risk
16. Liquidity Exchange Bank Membership
17. Alternative Compliance and Filing Periods
E. Effects on Efficiency, Competition, and Capital Formation
V. Paperwork Reduction Act
A. Introduction
B. Rule 2a-7
C. Form N-MFP
D. Form N-CR
E. Form N-1A
F. Form PF
G. Rule 31a-2
VI. Regulatory Flexibility Act Certification Statutory Authority
I. Introduction
The Commission is adopting amendments to rule 2a-7 under the
Investment Company Act of 1940. Money market funds are a type of mutual
fund registered under the Act and regulated pursuant to rule 2a-7.\4\
These funds are popular cash management vehicles for both retail and
institutional investors because they seek to provide investors with
principal stability and access to daily liquidity. In addition, money
market funds serve as an important source of short-term financing for
businesses, banks, and Federal, state, municipal, and Tribal
governments. In March 2020, in connection with an economic shock from
the onset of the COVID-19 pandemic, certain types of money market funds
had significant outflows, contributing to stress on short-term funding
markets that resulted in government intervention to enhance the
liquidity of such markets.\5\ Our historical experience with these
funds and the events of March 2020 have led us to re-evaluate certain
aspects of the regulatory framework applicable to money market funds.
Accordingly, the Commission is adopting amendments to rule 2a-7 and
certain reporting forms that are designed to improve the resilience of
money market funds during times of market stress while preserving the
benefits that investors have come to expect from these funds.
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\4\ Money market funds are also sometimes called ``money market
mutual funds'' or ``money funds.''
\5\ See infra section I.B (discussing these events in more
detail).
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In December 2021, the Commission proposed to amend rule 2a-7 to
remove the tie between weekly liquid asset thresholds and the potential
imposition of liquidity fees and redemption gates, since it appears
these provisions contributed to investors' incentives to redeem from
certain funds in March 2020 and affected fund managers' willingness to
use available liquidity in their portfolios to meet redemptions.\6\ For
funds that experienced the heaviest outflows in March 2020 and in prior
periods of market stress, the proposal also included a new swing
pricing requirement that was designed to mitigate the dilution and
investor harm that can occur when other investors redeem--and remove
liquidity--from these funds, particularly when certain markets in which
the funds invest are under stress and effectively illiquid. The
Commission also proposed to increase the minimum daily and weekly
liquid asset requirements to better equip money market funds to manage
significant and rapid investor redemptions. In addition, we proposed
certain form amendments to improve transparency and facilitate
Commission monitoring of money market funds. As part of the proposal,
the Commission proposed to amend rule 2a-7 to prohibit a stable net
asset value (``NAV'') money market fund from using share cancellation
or a reverse distribution mechanism in a negative interest rate
environment.
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\6\ Money Market Fund Reforms, Investment Company Act Release
No. 34441 (Dec. 15, 2021) [87 FR 7248 (Feb. 8, 2022)] (``Proposing
Release'').
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The Commission received comment letters on the proposal from a
variety of commenters, including funds and investment advisers, law
firms, other fund service providers, investor advocacy groups,
professional and trade associations, and interested individuals.\7\ As
discussed in greater detail throughout this release, these commenters
expressed a diversity of views. Many commenters expressed support for
aspects of the proposal, including removing the link between liquidity
thresholds and the imposition of redemption gates and liquidity fees;
increasing the minimum daily and weekly liquid asset requirements above
current minimums; and clarifying the calculation of weighted average
portfolio maturity and weighted average life maturity.\8\ Many
commenters, however, expressed concern about the consequences of the
proposed swing pricing requirement, suggesting, among other reasons,
that it would be operationally difficult and may not effectively
prevent destabilizing runs during periods of stress.\9\ Separately,
several commenters expressed that the Commission should adopt more
modest increases to the daily and weekly liquid asset requirements than
proposed.\10\ Many commenters also generally opposed the proposed
clarification of how stable net asset value money market funds should
handle a negative interest rate environment, stating that the proposed
prohibition from using share cancellation in certain negative interest
environments could be operationally burdensome and costly without clear
benefits for investors.\11\ Lastly, while some commenters were
supportive of the proposed modifications to the fund reporting
requirements, others expressed concern about the sensitivity or burdens
of reporting certain information regarding money market fund investors
or portfolios, as well as significant declines in liquidity.\12\
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\7\ The comment letters on the Proposing Release (File No. S7-
22-21) are available at <a href="https://www.sec.gov/comments/s7-22-21/s72221.htm">https://www.sec.gov/comments/s7-22-21/s72221.htm</a>.
\8\ See, e.g., Comment Letter of Investment Company Institute
(Apr. 11, 2022) (``ICI Comment Letter''); Comment Letter of
Americans for Financial Reform Education Fund (Apr. 11, 2022)
(``Americans for Financial Reform Comment Letter'').
\9\ See, e.g., Comment Letter of The Asset Management Group of
the Securities Industry and Financial Markets Association (Apr. 11,
2022) (``SIFMA AMG Comment Letter''); Comment Letter of State Street
Global Advisors (Apr. 11, 2022) (``State Street Comment Letter'').
\10\ See, e.g., Comment Letter of Western Asset Management
Company, LLC (Apr. 11, 2022) (``Western Asset Comment Letter'');
Comment Letter of Healthy Markets Association (Apr. 12, 2022)
(``Healthy Markets Association Comment Letter'').
\11\ See, e.g., Comment Letter of Federated Hermes Inc. (Apr.
11, 2022) (``Federated Hermes Comment Letter I''); Comment Letter of
Allspring Funds Management, LLC (Apr. 11, 2022) (``Allspring Funds
Comment Letter''); Comment Letter of Fidelity Management Research
Company LLC (Apr. 11, 2022) (``Fidelity Comment Letter'').
\12\ See infra section II.F.
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After considering the comments on the proposal, we are adopting
rule and form amendments to improve the resilience and transparency of
money market funds, with certain modifications.\13\ As proposed, the
final amendments will remove the redemption gate provision from rule
2a-7; increase the minimum daily and
[[Page 51406]]
weekly liquid asset requirements to 25% and 50%, respectively; specify
the weighted average portfolio maturity and weighted average life
maturity calculations; and require public reporting of significant
declines in liquidity on Form N-CR. However, we are not adopting the
proposed swing pricing requirement. Rather, the final amendments will
modify the current liquidity fee framework to require institutional
prime and institutional tax-exempt money market funds to impose a
liquidity fee when the fund experiences net redemptions that exceed 5%
of net assets, while also allowing any non-government money market fund
to impose a discretionary liquidity fee if the board determines a fee
is in the best interest of the fund. Similar to the proposed swing
pricing requirement, the liquidity fee framework is designed to better
allocate liquidity costs associated with redemptions to the redeeming
investors. In addition, in a change from the proposal, the final
amendments will permit retail and government money market funds to use
a reverse distribution mechanism if negative interest rates occur in
the future with certain conditions, including appropriate disclosure to
concisely and clearly describe to shareholders the fund's use of a
reverse distribution mechanism and its effect on investors.
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\13\ We have consulted and coordinated with the Consumer
Financial Protection Bureau regarding this final rulemaking in
accordance with section 1027(i)(2) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
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Moreover, while we are adopting the amended reporting requirements
for Form N-MFP largely as proposed, we are making modifications to
certain aspects of the requirements in response to commenter concerns
about the sensitivity of publicly reporting certain investor and
portfolio information. We are also adopting, largely as proposed in a
January 2022 Proposing Release, amendments to Form PF reporting
requirements for large liquidity fund advisers.\14\ The final
amendments to Form PF generally are designed to align with relevant
revisions we are making to Form N-MFP. Finally, we are adopting two
technical amendments to Form N-CSR and Form N-1A to correct errors from
recent Commission rulemakings.
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\14\ Amendments to Form PF to Require Current Reporting and
Amend Reporting Requirements for Large Private Equity Advisers and
Large Liquidity Fund Advisers, Investment Advisers Act Release No.
5950 (Jan. 26, 2022) [87 FR 9106 (Feb. 17, 2022)] (``Form PF
Proposing Release'').
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A. Role of Money Market Funds and Existing Regulatory Framework
Money market funds are managed with the goal of providing principal
stability by investing in high-quality, short-term debt securities--
such as Treasury bills, repurchase agreements, or commercial paper--
whose value does not fluctuate significantly in normal market
conditions. Money market fund investors receive dividends that reflect
prevailing short-term interest rates and have access to daily
liquidity, as money market fund shares are redeemable on demand. The
combination of limited principal volatility, diversification of
portfolio securities, payment of short-term yields, and liquidity has
made money market funds popular cash management vehicles for retail and
institutional investors. Money market funds also serve as an important
source of short-term financing for businesses, banks, and governments.
Different types of money market funds exist to meet differing
investor needs. ``Prime money market funds'' hold a variety of taxable
short-term obligations issued by corporations and banks, as well as
repurchase agreements and asset-backed commercial paper.\15\
``Government money market funds,'' which are currently the largest
category of money market fund, almost exclusively hold obligations of
the U.S. Government, including obligations of the U.S. Treasury and
Federal agencies and instrumentalities, as well as repurchase
agreements collateralized by government securities.\16\ Compared to
prime funds, government money market funds generally offer greater
safety of principal but historically have paid lower yields. ``Tax-
exempt money market funds'' (or ``municipal money market funds'')
primarily hold obligations of state and local governments and their
instrumentalities, and pay interest that is generally exempt from
Federal income tax for individual taxpayers.\17\ Within the prime and
tax-exempt money market fund categories, some funds are ``retail''
funds and others are ``institutional'' funds. Retail money market funds
are held only by natural persons, and institutional funds can be held
by a wider range of investors, such as corporations, small businesses,
and retirement plans.\18\
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\15\ Commission staff regularly publish comprehensive data
regarding money market funds on the Commission's website, available
at <a href="https://www.sec.gov/divisions/investment/mmf-statistics.shtml">https://www.sec.gov/divisions/investment/mmf-statistics.shtml</a>.
This data includes information about the monthly holdings of prime
money market funds by type of security. Staff reports and other
staff documents (including those cited herein) represent the views
of Commission staff and are not a rule, regulation, or statement of
the Commission. The Commission has neither approved nor disapproved
the content of these documents and, like all staff statements, they
have no legal force or effect, do not alter or amend applicable law,
and create no new or additional obligations for any person.
\16\ Some government money market funds generally invest at
least 80% of their assets in U.S. Treasury obligations or repurchase
agreements collateralized by U.S. Treasury securities and are called
``Treasury money market funds.''
\17\ In this release, we also use the term ``non-government
money market fund'' to refer to prime and tax-exempt money market
funds.
\18\ A retail money market fund is defined as a money market
fund that has policies and procedures reasonably designed to limit
all beneficial owners of the fund to natural persons. See 17 CFR
270.2a-7(a)(21) (rule 2a-7(a)(21)).
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To some extent, different types of money market funds are subject
to different requirements under rule 2a-7. One primary example is a
fund's approach to valuation and pricing. Government and retail money
market funds can rely on valuation and pricing techniques that
generally allow them to sell and redeem shares at a stable share price,
typically $1.00, without regard to small variations in the value of the
securities in their portfolios.\19\ If the fund's stable share price
and market-based value per share deviate by more than one-half of 1%,
the fund's board may determine to adjust the fund's share price below
$1.00, which is also colloquially referred to as ``breaking the buck.''
\20\ Institutional prime and institutional tax-exempt money market
funds, however, are required to use a ``floating'' NAV per share to
sell and redeem their shares, based on the current market-based value
of the securities in their underlying portfolios rounded to the fourth
decimal place (e.g., $1.0000). These institutional funds are required
to use a floating NAV because their investors have historically made
the heaviest redemptions in times of market stress and are more likely
to act on the incentive to redeem if a fund's stable price per share is
higher than its market-based value.\21\
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\19\ See Proposing Release, supra note 6, at n.10 (discussing
amortized cost method and penny rounding cost method); see also 17
CFR 270.2a-7(c)(1)(i) and (g)(1) and (2). Throughout this release,
we generally use the term ``stable share price'' or ``stable NAV''
to refer to the stable share price that these money market funds
seek to maintain and compute for purposes of distribution,
redemption, and repurchases of fund shares.
\20\ These funds must compare their stable share price to the
market-based value per share of their portfolios at least daily.
\21\ See Proposing Release, supra note 6, at n.12.
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As of March 2023, there were approximately 294 money market funds
registered with the Commission, and these funds collectively held over
$5.7 trillion of assets.\22\ The vast majority of these assets are held
by government money market funds ($4.4 trillion), followed by prime
money market funds ($1 trillion) and tax-exempt money
[[Page 51407]]
market funds ($119 billion).\23\ Of prime money market funds' assets,
approximately 44% are held by retail prime money market funds, with the
remaining assets almost evenly split between institutional prime money
market funds that are offered to the public and institutional prime
money market funds that are not offered to the public.\24\ The vast
majority of tax-exempt money market fund assets are held by retail
funds.
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\22\ Money Market Fund Statistics, Form N-MFP Data, period
ending Mar. 2023, available at: <a href="https://www.sec.gov/files/mmf-statistics-2023-03.pdf">https://www.sec.gov/files/mmf-statistics-2023-03.pdf</a>. This data excludes ``feeder'' funds to avoid
double counting assets.
\23\ Id.
\24\ Some asset managers establish privately offered money
market funds to manage cash balances of other affiliated funds and
accounts.
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The Commission adopted rule 2a-7 in 1983 and has amended the rule
several times over the years, including in 2010 and 2014, in response
to market events that have highlighted money market fund
vulnerabilities.\25\ Among other things, these past reforms introduced
minimum daily and weekly liquid asset requirements, provided for
redemption gates and liquidity fees as available tools when a fund's
liquidity drops below a threshold, required institutional money market
funds to use floating NAVs, and improved transparency through reporting
and website posting requirements.\26\
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\25\ See Proposing Release, supra note 6, at n.16 and
accompanying text (providing more detail related to previous
Commission actions and government intervention following the 2008
financial crisis).
\26\ Money Market Fund Reform, Investment Company Act Release
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (``2010
Adopting Release''); Money Market Fund Reform; Amendments to Form
PF, Investment Company Act Release No. 31166 (July 23, 2014) [79 FR
47735 (Aug. 14, 2014)] (``2014 Adopting Release'').
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In addition to reforms for money market funds, in 2014 the
Commission introduced new reporting requirements for large advisers of
liquidity funds on Form PF to better align reporting obligations of
advisers regarding private liquidity funds to those of money market
funds, in order to help the Commission have a more complete picture of
the broader short-term financing market.\27\ Liquidity funds follow
similar investment strategies as money market funds, but investment
advisers are not required to register liquidity funds as investment
companies under the Act. Liquidity funds are a relatively small but
important category of private funds due to the role they play along
with money market funds as sources, and users, of liquidity in markets
for short-term financing.\28\ Similar to money market funds, liquidity
funds are managed with the goal of maintaining a stable net asset value
or minimizing principal volatility for investors. However, liquidity
funds are not required to comply with the risk-limiting conditions of
rule 2a-7, such as the restrictions on the maturity, diversification,
credit quality, and liquidity of investments. Consequently, liquidity
funds may take on greater risks and, as a result, may be more sensitive
to market stress relative to money market funds.
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\27\ Generally, investment advisers registered (or required to
be registered) with the Commission with at least $150 million in
private fund assets under management must file Form PF.
\28\ As of Sept. 2022, there were 79 liquidity funds reported on
Form PF with $336 billion in gross assets under management.
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B. March 2020 Market Events and Need for Reform
As discussed in the Proposing Release, in March 2020, growing
economic concerns about the impact of the COVID-19 pandemic led
investors to reallocate their assets into cash and short-term
government securities.\29\ Institutional investors, in particular,
sought highly liquid investments, including government money market
funds.\30\ In contrast, institutional prime and institutional tax-
exempt money market funds experienced outflows beginning the week of
March 9, 2020, which accelerated the following week.\31\ Outflows from
retail prime and retail tax-exempt funds began the week of March 16, a
week after outflows in institutional funds began.
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\29\ See SEC Staff Report on U.S. Credit Markets
Interconnectedness and the Effects of the COVID-19 Economic Shock
(Oct. 2020) (``SEC Staff Interconnectedness Report''), at 2,
available at <a href="https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf">https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf</a>.
\30\ More specifically, government money market funds had record
inflows of $838 billion in Mar. 2020 and an additional $347 billion
of inflows in Apr. 2020. See id. at 25.
\31\ Id.
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During the two-week period of March 11 to 24, publicly offered
institutional prime funds had a 30% redemption rate (about $100
billion), which included outflows of approximately 20% of assets during
the week of March 20 alone.\32\ In contrast, privately offered
institutional prime funds had redemptions of 3% of assets during the
week of March 20, and lost approximately 6% of their total assets ($17
billion) from March 9 through 20. Retail prime funds had outflows of
approximately 11% of their total assets ($48 billion) in the last three
weeks of March 2020. Outflows from tax-exempt money market funds, which
are mostly retail funds, were approximately 8% of their total assets
($12 billion) from March 12 through 25.
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\32\ See Proposing Release, supra note 6, at n.30.
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The Proposing Release discussed the potential factors that
incentivized investors to redeem from certain money market funds in
March 2020.\33\ These factors included concerns about the potential
imposition of redemption gates or liquidity fees based on observed
declines in some funds' weekly liquid assets, general concerns about
declining fund liquidity, general uncertainty related to a global
health crisis and fears of associated economic downturns, and the need
to meet near-term cash needs unrelated to the market stress. The
Proposing Release also discussed data regarding the relationship
between a fund's weekly liquid asset levels and the amount of outflows
it experienced in March 2020. The data showed that funds with lower
weekly liquid asset levels were more likely to have significant
outflows in March 2020, but some funds with higher levels of liquidity
also experienced large outflows.\34\
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\33\ Id., at n.42 and accompanying discussion.
\34\ Id., at n.44.
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These outflows caused some money market funds to engage in greater
than normal selling activity in short-term funding markets which, when
combined with similar selling activity from other market participants
such as hedge funds and bond mutual funds, both contributed to, and was
impacted by, stress in short-term funding markets.\35\ In markets for
private short-term debt instruments, such as commercial paper and
certificates of deposit, conditions significantly deteriorated in the
second week of March 2020. These markets, in which prime money market
funds and other participants invest, essentially became ``frozen'' in
March 2020, making it more difficult to sell these instruments, which
have limited secondary trading even in normal market conditions.\36\
Similarly, stresses in short-term municipal markets contributed to
pricing pressures and outflows for tax-exempt money market funds which,
in turn, contributed to increased stress in municipal markets.\37\ One
factor that appears to have contributed to money market funds' sales of
long-term portfolio securities is the incentive fund managers had to
maintain weekly liquid assets above 30% in an effort to avoid
investors' concerns about the possibility of redemption gates or
liquidity fees under our current rule.\38\
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\35\ See Proposing Release, supra note 6, at n.54 and
accompanying discussion.
\36\ Id.
\37\ Id.
\38\ Id., at n.77 and accompanying discussion.
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[[Page 51408]]
On March 18, 2020, the Federal Reserve, with the approval of the
Department of the Treasury, broadened its program of support for the
flow of credit to households and businesses by taking steps to enhance
the liquidity and functioning of money markets with the establishment
of the Money Market Mutual Fund Liquidity Facility (``MMLF''). The MMLF
provided loans to financial institutions on advantageous terms to
purchase securities from money market funds that were raising
liquidity, thereby helping enhance overall market functioning and
credit provisions to the broader economy.\39\ MMLF utilization reached
a peak of just over $50 billion in early April 2020, or about 5% of net
assets in prime and tax-exempt money market funds at the time.\40\
Along with other Federal Reserve actions and programs to support the
short-term funding markets, the MMLF had the effect of significantly
slowing outflows from prime and tax-exempt money market funds.\41\ The
MMLF ceased providing loans in March 2021.
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\39\ Information about the MMLF is available on the Federal
Reserve's website at <a href="https://www.federalreserve.gov/monetarypolicy/mmlf.htm">https://www.federalreserve.gov/monetarypolicy/mmlf.htm</a>. The Federal Reserve Bank of Boston operated the MMLF.
\40\ See Proposing Release, supra note 6, at n.36.
\41\ Id., at n.37.
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Commenters generally agreed that the growing economic concerns
related to the impact of the COVID-19 pandemic led investors to seek
liquidity in the form of cash and short-term government securities in
March 2020, leading to outflows from prime money market funds and
significant inflows to government money market funds.\42\ Commenters
also acknowledged that the markets for private short-term debt
instruments, such as commercial paper and certificates of deposit,
significantly deteriorated during this period.\43\ However, some
commenters questioned the nexus between the liquidity crisis in the
short-term funding markets and the outflows from prime money market
funds, asserting that events in the money market fund market were not a
significant cause of the liquidity issues in the short-term funding
markets in March 2020.\44\ Accordingly, some commenters suggested that
any reform exclusive to money market funds by themselves will likely
not address the broader liquidity challenges in the short-term funding
markets.\45\ Going further, a few commenters expressed that the
proposed reforms would have negative impacts to the short-term funding
markets because they would reduce the demand for prime money market
funds, thereby reducing capacity in the short-term funding markets.\46\
Some of these commenters encouraged the Commission, and policymakers
more generally, to re-examine the short-term funding markets and the
various events surrounding the volatility in March 2020, and to
consider available tools other than reforms to the money market fund
regulatory framework, that would improve resiliency in this segment of
our markets.\47\ Conversely, other commenters asserted that liquidity
issues with money market funds served as a source of significant
contagion that imperiled the short-term markets broadly and forced
government intervention.\48\ Some of these commenters suggested that
the Commission should consider more aggressive reforms to solve the
unique problems presented by money market funds, mainly that they are
hybrid instruments that embody elements of both securities investments
and banking products that are treated as cash-like by investors.\49\
---------------------------------------------------------------------------
\42\ See, e.g., ICI Comment Letter; Comment Letter of The
Vanguard Group, Inc. (Apr. 11, 2022) (``Vanguard Comment Letter'');
Comment Letter of Professors Samuel G. Hanson, David S. Scharfstein,
and Adi Sunderam, Harvard Business School (Apr. 11, 2022) (``Prof.
Hanson et al. Comment Letter''); Comment Letter of Blackrock (Apr.
11, 2022) (``BlackRock Comment Letter''); Comment Letter of the CFA
Institute (Apr. 11, 2022) (``CFA Comment Letter'').
\43\ See, e.g., Comment Letter of Invesco Ltd. (Apr. 11, 2022)
(``Invesco Comment Letter''); Vanguard Comment Letter; BlackRock
Comment Letter (asserting that they struggled to find bids from
dealer banks in the secondary market for much of the commercial
paper, bank certificates of deposits, or municipal debt they were
holding).
\44\ See, e.g., ICI Comment Letter; Federated Hermes Comment
Letter I; Invesco Comment Letter; Vanguard Comment Letter; BlackRock
Comment Letter; Healthy Markets Association Comment Letter.
\45\ See, e.g., ICI Comment Letter; Federated Hermes Comment
Letter I; Invesco Comment Letter; Vanguard Comment Letter; BlackRock
Comment Letter.
\46\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of J.P.
Morgan Asset Management (Apr. 11, 2022) (``JP Morgan Comment
Letter'').
\47\ See, e.g., JP Morgan Comment Letter; Federated Hermes
Comment Letter I; ICI Comment Letter (recommending adjusting bank
regulations to enable banks and their dealers to expand their
balance sheets to provide market liquidity during periods of market
stress without materially reducing the overall resilience of those
firms).
\48\ See, e.g., Comment Letter of Better Markets (Apr. 11, 2022)
(``Better Markets Comment Letter''); CFA Comment Letter.
\49\ See, e.g., Better Markets Comment Letter; Prof. Hanson et
al. Comment Letter.
---------------------------------------------------------------------------
We understand that money market funds are not the totality of the
short-term funding markets and that the reforms discussed in this
adopting release may not solve all future issues connected to the
short-term funding markets. However, we believe the events of March
2020 evidence that money market funds need better functioning tools for
managing through stress while mitigating harm to shareholders.
Specifically, in addition to requiring higher liquidity minimums to
prepare for significant and rapid investor redemptions, funds need to
be able to use that liquidity when such redemptions occur. In addition,
to prevent redeeming shareholders from diluting the interests of
remaining shareholders by removing liquidity from the fund in times of
market stress, when liquidity in underlying short-term funding markets
is scarce and costly, funds need tools to ensure that liquidity costs
are fairly allocated to redeeming investors. Moreover, while the period
of market stress in March 2020 was relatively brief, it is important to
consider that future stressed periods--whether specific to certain
money market funds or the short-term funding markets more generally--
may be more protracted or more severe than in March 2020, particularly
absent Federal Reserve action. We believe that these needs for better
functioning tools to manage through stress while mitigating harm to
shareholders can be met while preserving the benefits that investors
have come to expect from money market funds. Accordingly, we are
adopting amendments to rule 2a-7 and related reporting and registration
forms that are designed to achieve these key objectives and to reflect
our experience with the rule since it was initially adopted in
1983.\50\
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\50\ See generally Valuation of Debt Instruments and Computation
of Current Price Per Share by Certain Open-End Investment Companies
(Money Market Funds), Investment Company Act Release No. 13380 (July
11, 1983) [48 FR 32555 (July 18, 1983)].
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II. Discussion
A. Amendments To Remove the Tie Between the Weekly Liquid Asset
Threshold and Redemption Gates and Liquidity Fees
1. Unintended Effects of the Tie Between the Weekly Liquid Asset
Threshold and Liquidity Fees and Redemption Gates
Following amendments to rule 2a-7 in 2014, a money market fund has
the ability to impose liquidity fees or redemption gates (generally
referred to as ``fees and gates'') after crossing a specified liquidity
threshold.\51\ A money market fund may impose a liquidity fee of up to
2%, or temporarily suspend redemptions for up to 10 business days in a
90-day period, if the
[[Page 51409]]
fund's weekly liquid assets fall below 30% of its total assets and the
fund's board of directors determines that imposing a fee or gate is in
the fund's best interests.\52\ Additionally, a non-government money
market fund is required to impose a liquidity fee of 1% on all
redemptions if its weekly liquid assets fall below 10% of its total
assets, unless the board of directors of the fund determines that
imposing such a fee would not be in the best interests of the fund.\53\
Separately, a money market fund is required to provide daily disclosure
of the percentage of its total assets invested in weekly liquid assets
(as well as daily liquid assets) on its website to provide transparency
to investors and increase market discipline.\54\
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\51\ Government funds are permitted, but not required, to impose
fees and gates, as discussed below. See 17 CFR 270.2a-7(c)(2); 2014
Adopting Release, supra note 26.
\52\ If, at the end of a business day, a fund has invested 30%
or more of its total assets in weekly liquid assets, the fund must
cease charging the liquidity fee (up to 2%) or imposing the
redemption gate, effective as of the beginning of the next business
day. See 17 CFR 270.2a-7(c)(2)(i).
\53\ The board also may determine that a lower or higher fee
would be in the best interests of the fund. See 17 CFR 270.2a-
7(c)(2)(ii)(A).
\54\ 17 CFR 270.2a-7(h)(10)(ii); 2014 Adopting Release, supra
note 26, at section III.E.9.a.
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Money market fund fees and gates below these thresholds were
intended to serve as redemption restrictions that would provide a
``cooling off'' period to temper the effects of a short-term investor
panic and preserve liquidity levels in times of market stress, as well
as better allocate the costs of providing liquidity to redeeming
investors.\55\ However, these provisions did not achieve these
objectives during the period of market stress in March 2020. As
discussed in the Proposing Release, evidence suggests that in March
2020, even though no money market fund imposed a liquidity fee or gate,
the possibility of their imposition after crossing the publicly
disclosed 30% weekly liquid asset threshold appears to have contributed
to investors' incentives to redeem from prime money market funds.\56\
The presence of this threshold appears to have increased investor
redemption activity as prime and tax-exempt money market funds
approached the 30% weekly liquid asset level.\57\ Further, this
liquidity threshold also appeared to affect money market fund managers'
behavior in March 2020 and contributed to incentives for money market
fund managers to maintain weekly liquid asset levels above a 30% weekly
liquid asset threshold, rather than use those assets to meet
redemptions.\58\ Thus, contrary to its intended benefit, this threshold
appeared to heighten prime and tax-exempt money market funds'
susceptibility to heavy redemptions as funds' publicly disclosed weekly
liquid assets approached it and increased the lack of liquidity in
underlying short-term funding markets in March 2020.
---------------------------------------------------------------------------
\55\ See 2014 Adopting Release, supra note 26, at section III.A.
\56\ See Proposing Release, supra note 6, at section I.B.
\57\ See id.
\58\ See id. See also ICI Comment Letter; SIFMA AMG Comment
Letter.
---------------------------------------------------------------------------
In addition, as discussed in the Proposing Release, it appears that
money market fund investors are more sensitive to the possibility of
redemption gates than the possibility of liquidity fees.\59\ While
liquidity fees impose a cost for an investor to redeem, gates outright
stop redemptions for the duration of the gate. Money market fund
investors--who typically invest in money market funds for cash
management purposes--are generally sensitive to being unable to access
their investments for a period of time and have a tendency to redeem
from such funds preemptively if they fear a gate may be imposed.
---------------------------------------------------------------------------
\59\ See Proposing Release, supra note 5, at nn. 75-76 and
accompanying text (discussing comment letters that expressed views
that the possibility of redemption gates was a greater concern for
investors, particularly institutional investors, in Mar. 2020 than
the possibility of liquidity fees and that retail investors appeared
less sensitive to fees and gates than institutional investors).
---------------------------------------------------------------------------
Many commenters agreed with the Commission's assessment that the
regulatory link between a known liquidity threshold and the imposition
of fees and gates contributed to investors' incentives to redeem from
money market funds in March 2020.\60\ Many commenters also agreed with
the Commission's assessment that the weekly liquid asset threshold also
contributed to incentives for managers to avoid falling below this
threshold.\61\ One commenter suggested that removing the regulatory
link between weekly liquid assets and redemption gates (and liquidity
fees) would free up an additional 30% of liquidity that funds could use
in a crisis similar to March 2020.\62\
---------------------------------------------------------------------------
\60\ See, e.g., Comment Letter of Morgan Stanley Investment
Management Inc. (Apr. 8, 2022) (``Morgan Stanley Comment Letter'');
ICI Comment Letter; Comment Letter of Northern Trust Asset
Management (Mar. 24, 2022) (``Northern Trust Comment Letter'');
Fidelity Comment Letter; see also Proposing Release, supra note 6,
at section II.A.1 (``Available evidence, supported by many comment
letters in response to the Commission's request for comment [ ]
suggested that funds' incentives to maintain weekly liquid assets
above the 30% threshold were directly tied to investors' concerns
about the possibility of redemption gates and liquidity fees under
our rules if a fund drops below that threshold.'').
\61\ See, e.g., ICI Comment Letter, Comment Letter of T. Rowe
Price (Apr. 11, 2022) (``T. Rowe Comment Letter''); JP Morgan
Comment Letter.
\62\ See Federated Hermes Comment Letter I.
---------------------------------------------------------------------------
Several commenters stated that the potential imposition of
redemption gates in particular, as opposed to liquidity fees, drove
instability and redemptions in March 2020.\63\ For example, one
commenter suggested that the mere possibility that fund boards may
impose gates was a key factor that contributed significantly to the
stresses experienced by publicly offered institutional prime funds in
March 2020.\64\ Another commenter stated that, based on a survey of
institutional investor clients, investors were particularly concerned
about gates and perceived the 30% weekly liquid asset threshold as a
``bright line'' not to be crossed.\65\ An additional commenter stated
that, based on data and discussions with its member funds, the
possibility of a gate especially caused investors in March 2020 to
redeem heavily.\66\
---------------------------------------------------------------------------
\63\ See, e.g., Fidelity Comment Letter; Northern Trust Comment
Letter; Comment Letter of the Institute of International Finance
(Apr. 11, 2022) (``IIF Comment Letter''); ICI Comment Letter.
\64\ See Fidelity Comment Letter.
\65\ See JP Morgan Comment Letter.
\66\ See ICI Comment Letter.
---------------------------------------------------------------------------
Thus, based on available evidence and as suggested by many
commenters, the weekly liquid asset threshold for consideration of fees
and gates appear to have potentially increased the risks of investor
runs without providing benefits to money market funds as intended by
the Commission. In addition, money market fund investors have
demonstrated particular sensitivity to the possibility of gates and the
corresponding lack of access to their investments, and these concerns
appear to have incentivized redemptions in March 2020 more so than any
concerns about the possibility of fees. Accordingly, after considering
the comments received, we are adopting amendments to the fee and gate
provisions in rule 2a-7 to remove the regulatory link between weekly
liquid assets and fees and gates. As discussed below, we are amending
rule 2a-7 to remove gate provisions altogether and amending the
liquidity fee structure to remove weekly liquid asset-linked thresholds
and implement a modified liquidity fee framework that will provide for
both mandatory and discretionary liquidity fees. We believe these
changes will provide more effective tools for money market funds to use
to mitigate short-term investor panic and preserve liquidity levels in
times of market stress, as well as better
[[Page 51410]]
allocate the costs of providing liquidity to redeeming investors.
2. Removal of Redemption Gates From Rule 2a-7
We are adopting, as proposed, the removal of money market funds'
ability through rule 2a-7 to temporarily suspend redemptions (i.e.,
impose a ``gate'').\67\ In the Proposing Release, we discussed our
concern that gates may not be an effective tool for money market funds
to stem heavy redemptions in times of stress due to money market fund
investors' general sensitivity to being unable to access their
investments for a period of time and tendency to redeem from funds
preemptively if they fear a gate may be imposed. We believe that
removing gate provisions altogether from rule 2a-7 will reduce the risk
of investor runs on money market funds during periods of market stress.
Money market funds will continue to be able to impose permanent gates
to facilitate an orderly liquidation of a fund pursuant to 17 CFR
270.22e-3 (``rule 22e-3''), and we are not adopting any changes to that
rule.\68\
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\67\ See Proposing Release, supra note 6, at section II.A.2.
\68\ See 17 CFR 270.22e-3. Rule 22e-3 under the Act permits
money market funds to suspend redemptions and postpone the payment
of proceeds in connection with a liquidation upon certain declines
in liquidity or deviations between market-based and stable prices,
board approval of liquidation, and notice to the Commission.
---------------------------------------------------------------------------
Many commenters generally supported the proposal to remove
redemption gates in rule 2a-7.\69\ Several of these commenters stated
that use of rule 22e-3 to suspend redemptions in connection with a fund
liquidation would be sufficient to address scenarios in which a fund
may need to suspend redemptions.\70\ One such commenter suggested that
any money market fund that needed to impose a gate would likely need to
fully liquidate, making rule 22e-3 sufficient for these purposes.\71\
---------------------------------------------------------------------------
\69\ See, e.g., Western Asset Comment Letter; Morgan Stanley
Comment Letter; Vanguard Comment Letter; CFA Comment Letter; SIFMA
AMG Comment Letter; Comment Letter of the Committee on Capital
Markets Regulation (Apr. 11, 2022) (``CCMR Comment Letter''); T.
Rowe Comment Letter.
\70\ See Allspring Funds Comment Letter; CFA Comment Letter; IIF
Comment Letter; Northern Trust Comment Letter; SIFMA AMG Comment
Letter.
\71\ See Invesco Comment Letter.
---------------------------------------------------------------------------
Some commenters supported removing the tie between the weekly
liquid asset threshold and a fund's ability to impose a gate but
suggested that gates could still be a useful tool outside of a fund
liquidation. These commenters suggested that fund boards should have
broader discretion to impose gates without linkage to a weekly liquid
asset threshold.\72\ Some commenters suggested that the rule should
permit fund boards to impose a gate if the board determines a gate is
in the best interests of the fund and its shareholders, subject to
certain policies and procedures, disclosure, and reporting
requirements.\73\ Another commenter suggested that fund boards should
have complete discretion with respect to imposing gates but that the
SEC should require relevant disclosures.\74\
---------------------------------------------------------------------------
\72\ See Federated Hermes Comment Letter I; Comment Letter of
Federated Hermes Funds Board of Trustees (Apr. 11, 2022)
(``Federated Hermes Fund Board Comment Letter''); Comment Letter of
the Cato Inst. (Feb. 10, 2022) (``Cato Inst. Comment Letter'').
\73\ See Federated Hermes Comment Letter I (stating that funds
should be required to report the basis for imposing temporary gates
to the Commission); Federated Hermes Fund Board Comment Letter.
\74\ See Cato Inst. Comment Letter.
---------------------------------------------------------------------------
After considering these comments, we continue to believe that the
removal of money market funds' ability to impose gates through rule 2a-
7 is appropriate.\75\ By removing the gate provision, either with or
without an associated liquidity threshold, we seek to limit the
potential for investor uncertainty and de-stabilizing preemptive
investor redemption behavior related to the potential use of gates
during stress events as well as to better encourage funds to more
effectively use their existing liquidity buffers in times of stress. As
discussed above, rather than providing an effective tool for money
market funds to manage redemption pressures during a period of stress,
the potential availability of gates under prescribed parameters
exacerbated the redemption pressures experienced by some funds during
March 2020.
---------------------------------------------------------------------------
\75\ As proposed, in addition to removing the gate provisions
from rule 2a-7, we are also removing associated disclosure and
reporting requirements about a fund's potential or actual imposition
of gates. See Items 4(b)(1)(ii) and 16(g) of current Form N-1A;
Parts F and G of current Form N-CR.
---------------------------------------------------------------------------
Retaining a gate provision under rule 2a-7 without an associated
liquidity threshold, as suggested by some commenters, could result in
continuing investor uncertainty and may contribute to preemptive
investor redemption behavior during stress events. In normal and
stressed markets, shareholders may need or want to access their funds
for various reasons, including to meet near-term cash needs. When in
place, a gate fully inhibits the redeemability of the money market fund
shares for the duration of the gate, thereby blocking shareholders'
access to their shares. We believe this complete halt to redemptions,
even if temporary, has the potential to significantly incentivize
preemptive redemptions. As discussed above, several commenters stated
that fear of gates in particular contributed to redemptions in March
2020. Removing the link to a publicly disclosed liquidity threshold
seemingly would expand the current gate provisions under rule 2a-7,
potentially increasing investor uncertainty regarding when a fund may
impose a gate. Even if such action by a money market fund board is
unlikely to occur, as suggested by some commenters,\76\ the mere
possibility of a gate would persist and thus investor uncertainty and
fear may remain, particularly when there are signs that a fund or
short-term funding markets are under stress. Accordingly, we are
removing the gate provision from rule 2a-7 to avoid this unintended
outcome.
---------------------------------------------------------------------------
\76\ See, e.g., Comment Letter of Mutual Fund Directors Forum
(Apr. 11, 2022) (``Mutual Fund Directors Forum Comment Letter'').
---------------------------------------------------------------------------
In light of the proposed removal of gates under rule 2a-7, some
commenters suggested additional amendments to rule 22e-3. This rule
generally allows a money market fund to suspend redemptions if, among
other conditions, (1) the fund has invested less than 10% of its total
assets in weekly liquid assets or, in the case of a government or
retail money market fund, the fund's market-based price per share has
deviated or is likely to deviate from its stable price, and (2) the
fund's board has approved the fund's liquidation. Some commenters
suggested that the SEC remove the weekly liquid asset threshold
enumerated in rule 22e-3 and give fund boards more flexibility to
approve liquidations.\77\ One of these commenters suggested that the
weekly liquid asset threshold in rule 22e-3 would not remain meaningful
because of the Commission's proposal to remove the liquidity fee
provisions from rule 2a-7, including the default liquidity fee
provision for non-government money market funds with weekly liquid
assets that fall below 10%.\78\
---------------------------------------------------------------------------
\77\ See Allspring Funds Comment Letter; Comment Letter of
Dechert LLP (Apr. 11, 2022) (``Dechert Comment Letter'').
\78\ See Dechert Comment Letter.
---------------------------------------------------------------------------
We do not agree that expanding the availability of rule 22e-3 is
appropriate. Rule 22e-3 provides a mechanism for a money market fund to
permanently suspend redemptions when the fund is under significant
stress to facilitate an orderly liquidation. While the amendments in
this release include the removal of a default liquidity fee provision
for non-government money market funds linked to a 10% weekly liquid
asset threshold, we do not agree
[[Page 51411]]
with the contention that the significance of the 10% weekly liquid
asset threshold is thereby meaningfully reduced with respect to rule
22e-3. Due to the absolute and significant nature of a permanent
suspension of redemptions and liquidation, the conditions in rule 22e-
3, including the 10% weekly liquid asset threshold, limit the fund's
ability to permanently suspend redemptions to circumstances that
present a significant risk of a run on the fund and potential harm to
shareholders.\79\ We continue to believe that where a fund's weekly
liquid assets fall below 10%, the fund is reasonably understood to be
experiencing significant stress and circumstances may present a
significant risk of a run on the fund and potential harm to
shareholders. In these circumstances, the ability of the board of
directors of such fund to suspend redemptions in light of a decision to
liquidate can help address the significant run risk and reduce
potential harm to shareholders. Where a money market fund is unable to
avail itself of a permanent suspension of redemptions under rule 22e-3,
the fund may suspend redemptions after obtaining an exemptive order
from the Commission.\80\ Accordingly, we are not adopting amendments to
rule 22e-3.
---------------------------------------------------------------------------
\79\ See 2010 Adopting Release, supra note 26, at section II.H.
\80\ 15 U.S.C. 80a-22(e).
---------------------------------------------------------------------------
B. Liquidity Fee Requirement
1. Determination To Adopt a Liquidity Fee Requirement
After considering comments, we are adopting a mandatory liquidity
fee framework for institutional prime and institutional tax-exempt
funds instead of the proposed swing pricing requirement. We believe the
mandatory liquidity fee will reduce operational burdens associated with
swing pricing while still achieving many of the benefits we were
seeking with swing pricing by allocating liquidity costs to redeeming
investors in stressed periods. In addition, we are adopting a
discretionary liquidity fee for all non-government money market funds
so that liquidity fees are an available tool for such funds to manage
redemption pressures when the mandatory fee does not apply. Whether the
fee is mandatory or discretionary, we are, as proposed, removing from
rule 2a-7 the tie between liquidity fees and a fund's weekly liquid
asset levels to avoid predictable triggers that may incentivize
investors to preemptively redeem to avoid incurring fees.\81\ This
liquidity fee framework, independent of a predictable threshold for its
application, achieves the intended benefits of the current liquidity
fee regime by allocating liquidity costs to redeeming shareholders in
times of stress while, in contrast to the current rule, avoiding
incentives for preemptive redemptions associated with weekly liquid
asset triggers. An approach solely based on liquidity fees, as opposed
to gates, does not present the same concerns about incentivizing
redemptions that exist under current rule 2a-7. As discussed, money
market fund investors seemingly have been more concerned about the
possibility of redemption gates than the possibility of liquidity
fees.\82\ This change is designed to increase the resilience of money
market funds.
---------------------------------------------------------------------------
\81\ By ``predictable,'' we mean that an investor can use
available information to predict whether a fee will apply on a given
day or on future days. In the case of weekly liquid assets, an
investor can observe the weekly liquid asset level disclosed for the
prior day and use that information to predict whether the fund will
cross the weekly liquid asset threshold in the near term. In the
case of the net redemption threshold we are adopting for mandatory
liquidity fees, while an investor can observe net flows for the
prior day, that flow information does not necessarily predict the
fund's flows for that day or future days, as net flows depend on
independent investment decisions made by a large number of investors
with differing needs and considerations. See infra section
IV.C.4.a.i.
\82\ See supra section II.A.1.
---------------------------------------------------------------------------
The Commission proposed a swing pricing requirement under which an
institutional prime or institutional tax-exempt fund would downwardly
adjust its current NAV per share by a swing factor when a fund has net
redemptions. The swing factor adjustment would reflect spread and
transaction costs and, if net redemptions exceeded 4% of the fund's net
assets, then the swing factor would also include market impact costs.
The Commission also proposed to remove the liquidity fee provision in
rule 2a-7, which conditions the use of liquidity fees upon declines in
fund liquidity below identified, predictable thresholds, and to specify
that money market funds could instead impose liquidity fees under 17
CFR 270.22c-2 (``rule 22c-2'') at their discretion.\83\
---------------------------------------------------------------------------
\83\ See 17 CFR 270.22c-2 (rule 22c-2 under the Investment
Company Act) (providing that an open-end fund may impose a
redemption fee, not to exceed 2% of the value of the shares
redeemed, upon the determination by the fund's board of directors
that such fee is necessary or appropriate to recoup for the fund the
costs it may incur as a result of those redemptions or to otherwise
eliminate or reduce so far as practicable any dilution of the value
of the outstanding securities issued by the fund).
---------------------------------------------------------------------------
Many commenters expressed broad concerns about the swing pricing
proposal and its potential effect on institutional money market funds
and investors. Several commenters stated that the proposed swing
pricing requirement was incompatible with how money market funds
operate and manage liquidity, which may limit the utility of these
funds as cash management vehicles.\84\ For instance, commenters
expressed concern that swing pricing may inhibit a fund's ability to
offer features such as same-day settlement and multiple NAV strikes per
day due to concerns that swing pricing would delay a fund's ability to
determine its NAV.\85\ Some commenters suggested that swing pricing may
assume a greater degree of liquidity costs than funds incur to meet
redemptions because money market funds generally satisfy redemptions
through maturing assets, rather than secondary market selling activity,
and are equipped to handle relatively large redemptions with available
liquidity.\86\ Some commenters stated that swing pricing would
introduce greater volatility in fund share prices and performance,
which they asserted would reduce investor demand for institutional
money market funds.\87\ In addition, some commenters indicated that the
operational costs of the proposed swing pricing requirement could cause
some sponsors to eliminate their institutional prime and institutional
tax-exempt money market funds, particularly smaller funds, and reduce
money market fund assets.\88\ In light of these considerations, some
commenters suggested that swing pricing is not an appropriate tool for
money market funds and stated that a
[[Page 51412]]
liquidity fee framework would be better suited to the structure and
characteristics of money market funds, if the Commission determines
that an anti-dilution tool is necessary for these funds.\89\
---------------------------------------------------------------------------
\84\ See, e.g., Comment Letter of Independent Directors Council
(Apr. 11, 2022) (``IDC Comment Letter''); Mutual Fund Directors
Forum Comment Letter; Comment Letter of The Bank of New York Mellon
(Apr. 11, 2022) (``BNY Mellon Comment Letter''); Fidelity Comment
Letter; Comment Letter of State Street Global Advisors (Apr. 11,
2022) (``State Street Comment Letter''); Comment Letter of Federated
Hermes, Inc. (Apr. 11, 2022) (``Federated Hermes Comment Letter
II'') (letter primarily focused on the proposed swing pricing
requirement).
\85\ See, e.g., Comment Letter of Capital Group Companies, Inc.
(Apr. 11, 2022) (``Capital Group Comment Letter''); State Street
Comment Letter; ICI Comment Letter; Federated Hermes Comment Letter
II; SIFMA AMG Comment Letter; BNY Mellon Comment Letter.
\86\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of
American Bankers Association (Apr. 11, 2022) (``ABA Comment Letter
I''); Invesco Comment Letter; Fidelity Comment Letter; Allspring
Funds Comment Letter.
\87\ See SIFMA AMG Comment Letter; Western Asset Comment Letter;
see also Northern Trust Comment Letter; Federated Hermes Comment
Letter II.
\88\ See, e.g., JP Morgan Comment Letter; BlackRock Comment
Letter; IDC Comment Letter; Comment Letter of U.S. Chamber of
Commerce, Center for Capital Markets Competitiveness (Apr. 11, 2022)
(``US Chamber of Commerce Comment Letter''); CCMR Comment Letter;
Comment Letter of Americans for Tax Reform (Apr. 9, 2022)
(``Americans for Tax Reform Comment Letter''); Northern Trust
Comment Letter.
\89\ See, e.g., ICI Comment Letter (suggesting that, if data and
analysis show that an anti-dilution mechanism is necessary for
public institutional prime and tax-exempt funds, modifying and
leveraging the existing fee framework would be less problematic than
swing pricing and could serve the Commission's goals in a way that
avoids imposing unnecessary operational costs); Invesco Comment
Letter; SIFMA AMG Comment Letter (suggesting that, to the extent the
Commission continues to believe, based on data driven findings and
analysis, that an additional anti-dilution tool is necessary, the
Commission consider liquidity fees instead of swing pricing);
Federated Hermes Comment Letter I; Federated Hermes Comment Letter
II; Invesco Comment Letter; Comment Letter of The Charles Schwab
Corporation (Apr. 11, 2022) (``Schwab Comment Letter''); Morgan
Stanley Comment Letter; JP Morgan Comment Letter; BlackRock Comment
Letter; State Street Comment Letter; Western Asset Comment Letter;
IIF Comment Letter; Allspring Funds Comment Letter. Some of the
comments received with respect to the swing pricing proposal are
also relevant to issues implicated by the liquidity fee mechanism
that we are adopting. We primarily discuss those comments below in
the relevant sections addressing the amended liquidity fee
framework.
---------------------------------------------------------------------------
Commenters expressed different views on whether the proposed swing
pricing requirement would achieve the Commission's goal of ensuring
that the costs stemming from net redemptions are fairly allocated and
do not give rise to dilution or a potential first-mover advantage,
particularly in times of stress. A few commenters were supportive of
swing pricing and suggested that it would enhance the resilience of
money market funds.\90\ Many commenters, however, expressed concern
that swing pricing would not achieve the Commission's goals of
allocating liquidity costs and reducing dilution and potential first-
mover advantages. Some commenters suggested that redemptions are not
motivated by a first-mover advantage and that liquidity, rather than
avoiding dilution from other shareholders' redemptions, was the
motivation for redemptions in March 2020.\91\ Some commenters suggested
that swing pricing would not address first-mover issues because
investors would not know at the time they submitted redemptions orders
if a swing factor would apply for that pricing period.\92\ Similarly,
another commenter suggested that small adjustments to a fund's NAV
would be unlikely to affect a shareholder's decision to redeem, even
with a market impact factor.\93\ Some other commenters suggested that
uncertainty regarding the application of swing pricing may in fact
increase incentives for investors to redeem ahead of others.\94\
---------------------------------------------------------------------------
\90\ See, e.g., Americans for Financial Reform Comment Letter;
CFA Comment Letter; Comment Letter of Systemic Risk Council (Apr.
15, 2022) (``Systemic Risk Council Comment Letter''); Better Markets
Comment Letter; Comment Letter of Chris Barnard (Oct. 19, 2022)
(``Chris Barnard Comment Letter'').
\91\ See, e.g., Fidelity Comment Letter; Capital Group Comment
Letter; BlackRock Comment Letter; Americans for Tax Reform Comment
Letter; see also Federated Hermes Comment Letter I (suggesting that
the 2014 amendments that imposed a floating NAV on institutional
funds sufficiently addressed first-mover issues).
\92\ See, e.g., Capital Group Comment Letter; Dechert Comment
Letter; Schwab Comment Letter; Allspring Funds Comment Letter;
Federated Hermes Comment Letter II; JP Morgan Comment Letter;
BlackRock Comment Letter; ICI Comment Letter; SIFMA AMG Comment
Letter; see also US Chamber of Commerce Comment Letter.
\93\ See Fidelity Comment Letter.
\94\ See, e.g., CCMR Comment Letter (suggesting that swing
pricing could incentivize runs as investors seek to redeem before a
market impact factor is applied); Comment Letter of Institutional
Cash Distributors (Apr. 11, 2022) (``ICD Comment Letter''); Prof.
Hanson et al. Comment Letter; State Street Comment Letter.
---------------------------------------------------------------------------
As discussed in the Proposing Release, swing pricing and liquidity
fees can be economically equivalent in terms of charging redeeming
investors for the liquidity costs they impose on a fund.\95\ Both
approaches allow funds to recapture the liquidity costs of redemptions
to make non-redeeming investors whole. The Commission considered both
approaches in the Proposing Release and, after acknowledging that each
approach has certain advantages and disadvantages over the other, the
Commission expressed the view that swing pricing appeared to have
operational benefits relative to liquidity fees. For example, as
discussed in the proposal, the Commission believed swing pricing would
require less involvement by intermediaries in applying a charge to
redeeming investors than liquidity fees.\96\
---------------------------------------------------------------------------
\95\ See Proposing Release, supra note 6, at sections II.B.1 and
III.D.5.
\96\ See id. at paragraph accompanying n.149 and section
III.D.5.
---------------------------------------------------------------------------
Many commenters stated that liquidity fees were preferable to swing
pricing.\97\ Many of these commenters stated that liquidity fees would
be easier for money market funds to implement.\98\ For instance, some
commenters suggested that funds would be able to build on their
existing experience with liquidity fees under current rules.\99\
Similarly, some commenters raised the concern that swing pricing is
ill-suited for money market funds given the general lack of experience
with swing pricing in the money market fund industry.\100\
---------------------------------------------------------------------------
\97\ See, e.g., Invesco Comment Letter; SIFMA AMG Comment Letter
(stating that liquidity fees offer many advantages as compared to
swing pricing); Federated Hermes Comment Letter I (suggesting that a
discretionary liquidity fee would be less onerous than swing
pricing); Federated Hermes Commenter Letter II; Invesco Comment
Letter; Schwab Comment Letter; Morgan Stanley Comment Letter; JP
Morgan Comment Letter; BlackRock Comment Letter; State Street
Comment Letter; Western Asset Comment Letter; IIF Comment Letter;
Allspring Funds Comment Letter; see also Dechert Comment Letter; CFA
Comment Letter.
\98\ See, e.g., Federated Hermes Comment Letter II; Invesco
Comment Letter; SIFMA AMG Comment Letter; Schwab Comment Letter; IIF
Comment Letter; BlackRock Comment Letter.
\99\ See, e.g., Federated Hermes Comment Letter II; Invesco
Comment Letter; SIFMA AMG Comment Letter; Schwab Comment Letter; IIF
Comment Letter.
\100\ See Morgan Stanley Comment Letter; SIFMA AMG Comment
Letter; IIF Comment Letter; Federated Hermes Comment Letter I;
Federated Hermes Comment Letter II; Comment Letter of Senator Pat
Toomey (Apr. 12, 2022) (``Senator Toomey Comment Letter''); Mutual
Fund Directors Forum Comment Letter; see also Comment Letter of
Professor Stephen G. Cecchetti, Brandeis International Business
School, and Professor Kermit L. Schoenholtz, Leonard N. Stern School
of Business, New York University (Feb. 1, 2022) (``Profs. Ceccheti
and Schoenholtz Comment Letter'').
---------------------------------------------------------------------------
Several commenters stated that a liquidity fee framework would
provide benefits to investors relative to swing pricing.\101\ Some of
these commenters suggested that a liquidity fee would be less confusing
and more transparent with respect to the liquidity costs redeeming
investors incur because investors are more familiar with the concept of
liquidity fees (which exist in the current rule) and because the size
of the swing factor is not readily observable in the fund's share
price.\102\ Some commenters suggested that a liquidity fee would be a
more direct way to pass along liquidity costs and, unlike swing
pricing, would do so without providing a discount to subscribing
investors or adding volatility to the fund's NAV.\103\ Some commenters
suggested that the changes in a fund's
[[Page 51413]]
NAV caused by application of the swing factor may cause investors to
time their purchases of money market shares to attain a pricing
advantage during predictable seasonal redemption activity such as tax
payment dates or month-end.\104\ Further, one commenter indicated that
a liquidity fee framework could better preserve same-day liquidity for
investors than swing pricing because liquidity fees are already
operationally feasible for many money market funds and present fewer
implementation challenges.\105\
---------------------------------------------------------------------------
\101\ See, e.g., ICI Comment Letter; Invesco Comment Letter;
SIFMA AMG Comment Letter; Federated Hermes Comment Letter I;
Federated Hermes Commenter Letter II; Invesco Comment Letter; Schwab
Comment Letter; Morgan Stanley Comment Letter; JP Morgan Comment
Letter; BlackRock Comment Letter; State Street Comment Letter;
Western Asset Comment Letter; IIF Comment Letter; Allspring Funds
Comment Letter; see also Dechert Comment Letter; CFA Comment Letter.
\102\ See, e.g., Morgan Stanley Comment Letter (expressing the
belief that investors understand and are more comfortable with a
fee-based regime, as compared to swing pricing, because of previous
efforts of money market fund sponsors to educate fund investors on
liquidity fees, as well as investors' experiences with redemption
fees under rule 22c-2 and sales charges and deferred sales charges);
SIFMA AMG Comment Letter; Federated Hermes Comment Letter II.
\103\ See, e.g., ICI Comment Letter; Federated Hermes Comment
Letter II (``Shareholders who subscribe on days when price is swung
down will receive a windfall profit.''); JP Morgan Comment Letter
(``[R]emaining investors will not experience additional NAV
volatility as with swing pricing.'').
\104\ See Federated Hermes Comment Letter I; Federated Hermes
Comment Letter II (expressing concern about other scenarios in which
swing pricing may incentivize trading to take advantage of
fluctuations in the fund's NAV, such as incentives to purchase in
early pricing periods--when money market funds tend to have more
redemptions--and redeem in a later pricing period, when net
redemptions are less likely); Western Asset Comment Letter; Dechert
Comment Letter (suggesting that swing pricing may have a potentially
unintended dilutive effect of incentivizing investors to buy into a
fund at a lower NAV once the fund swings).
\105\ See IIF Comment Letter.
---------------------------------------------------------------------------
Commenters suggested various alternatives regarding the form and
structure of liquidity fees. Some commenters suggested that fund boards
should have discretion to determine whether to impose liquidity
fees.\106\ Some commenters suggested an approach where liquidity fees
would apply automatically upon certain events, such as upon net
redemptions exceeding an identified threshold or liquidity dropping
below a certain level.\107\
---------------------------------------------------------------------------
\106\ See, e.g., ICI Comment Letter; Schwab Comment Letter;
Federated Hermes Comment Letter I; Federated Hermes Comment Letter
II; Federated Hermes Fund Board Comment Letter; Invesco Comment
Letter; SIFMA AMG Comment Letter.
\107\ See, e.g., Morgan Stanley Comment Letter; Western Asset
Comment Letter; BlackRock Comment Letter; State Street Comment
Letter; SIFMA AMG Comment Letter; ICI Comment Letter; JP Morgan
Comment Letter; IIF Comment Letter; Invesco Comment Letter.
---------------------------------------------------------------------------
After considering these comments, we are adopting a liquidity fee
framework to better allocate liquidity costs to redeeming investors.
The proposed swing pricing requirement was designed to address
potential shareholder dilution and the potential for a first-mover
advantage for institutional funds. While we continue to believe these
goals are important, we are persuaded by commenters that these same
goals are better achieved through a liquidity fee mechanism,
particularly given that current rule 2a-7 includes a liquidity fee
framework that funds are accustomed to and can build upon.
The mandatory liquidity fee framework we are adopting is designed
to address concerns with the prior liquidity fee framework--namely the
incentives for preemptive redemptions associated with predictable
weekly liquid asset triggers. At the same time it continues to seek to
ensure that the costs stemming from redemptions in stressed market
conditions are more fairly allocated to redeeming investors.
Specifically, institutional prime and institutional tax-exempt money
market funds will be subject to a mandatory liquidity fee when net
redemptions exceed 5% of net assets.\108\ Funds will not be required to
impose this fee, however, when liquidity costs are less than one basis
point, which we anticipate will often be the case under normal market
conditions.\109\ As discussed in more detail throughout this section,
the mandatory liquidity fee we are adopting will broadly address the
concerns commenters raised about the swing pricing proposal while still
generally achieving the goals we sought in that proposal. Separately,
similar to the statements in the proposal that money market funds can
impose discretionary liquidity fees under rule 22c-2, amended rule 2a-7
will provide a discretionary liquidity fee tool to all non-government
money market funds, which a fund will use if its board (or the board's
delegate, in accordance with board-approved guidelines) determines that
such fee is in the best interests of the fund.\110\
---------------------------------------------------------------------------
\108\ See amended rule 2a-7(c)(2)(ii).
\109\ See amended rule 2a-7(c)(2)(iii)(D).
\110\ A government money market fund may elect to be subject to
the discretionary liquidity fee requirement.
---------------------------------------------------------------------------
The mandatory liquidity fee approach that we are adopting will
require redeeming investors to pay the cost of depleting a fund's
liquidity, particularly under stressed market conditions and when net
redemptions are sizeable. As discussed in the proposal, trading
activity and other changes in portfolio holdings associated with
meeting redemptions may impose costs, including trading costs and costs
of depleting a fund's daily or weekly liquid assets. These costs, which
currently are borne by the remaining investors in the fund, can dilute
the interests of non-redeeming shareholders and create incentives for
shareholders to redeem quickly to avoid losses, particularly in times
of market stress.\111\ If shareholder redemptions are motivated by this
first-mover advantage, they can lead to increasing outflows, and as the
level of outflows from a fund increases, the incentive for remaining
shareholders to redeem may also increase. Regardless of the motive for
investor redemptions, there can be significant, unfair adverse
consequences to remaining investors in a fund in these circumstances,
including material dilution of remaining investors' interests in the
fund. The mandatory liquidity fee mechanism is designed to reduce the
potential for such dilution.
---------------------------------------------------------------------------
\111\ See infra section IV.B.1.c.
---------------------------------------------------------------------------
Some commenters suggested that an anti-dilution tool is not
necessary for money market funds. Several of these commenters suggested
that money market funds do not experience dilution as a general matter
because they are able to address their liquidity needs without cost and
without selling assets by using daily liquid assets and weekly liquid
assets, which are held to maturity.\112\ Some commenters further
suggested that the Commission did not provide sufficient data analysis
to support its view that money market funds are subject to
dilution.\113\ Some commenters suggested an anti-dilution tool was
unnecessary in light of either the proposed increased daily and weekly
liquid asset requirements, the proposed removal of the tie to weekly
liquid assets, or a combination of those factors because funds would
have additional liquidity to meet redemptions and would be better able
to use that liquidity in future stress periods.\114\
---------------------------------------------------------------------------
\112\ See, e.g., Northern Trust Comment Letter; Fidelity Comment
Letter; SIFMA AMG Comment Letter; IIF Comment Letter; Federated
Hermes Comment Letter II; CCMR Comment Letter; State Street Comment
Letter; ICI Comment Letter; JP Morgan Comment Letter; Comment Letter
of Stephen A. Keen (Apr. 11, 2022) (``Keen Comment Letter'');
Comment Letter of U.S. Bancorp Asset Management (Apr. 14, 2022)
(``Bancorp Comment Letter'').
\113\ See, e.g., Morgan Stanley Comment Letter; Fidelity Comment
Letter (suggesting that the SEC lacked data to demonstrate the
significance or materiality of shareholder dilution); ICI Comment
Letter; SIFMA AMG Comment Letter; CCMR Comment Letter.
\114\ See, e.g., Schwab Comment Letter; Healthy Markets
Association Comment Letter; Allspring Funds Comment Letter; Fidelity
Comment Letter; Invesco Comment Letter; BlackRock Comment Letter;
Federated Hermes Comment Letter II; ICI Comment Letter; SIFMA AMG
Comment Letter; but see Better Markets Comment Letter (suggesting
that increasing the costs of redemptions would reduce potential
first-mover advantages).
---------------------------------------------------------------------------
After considering comments, we continue to believe that in periods
of market stress, when liquidity in underlying short-term funding
markets is scarce and costly, redeeming investors should bear liquidity
costs associated with sizeable redemption activity. While we recognize
that a fund may not incur immediate costs to meet those redemptions if
the fund can satisfy redemptions using daily liquid assets, the fund is
likely to face costs to rebalance the liquidity of its portfolio
[[Page 51414]]
over time.\115\ Moreover, if redemptions are large and ongoing, there
is an increased likelihood that the fund will need to sell less liquid
assets to satisfy redemptions, which involves greater costs. Thus,
there is a timing misalignment between an investor's redemption
activity and when the fund, and its remaining shareholders, incur
liquidity costs. The liquidity fee requirement we are adopting is
designed to protect remaining shareholders from dilution under these
circumstances and to more fairly allocate costs so that redeeming
shareholders bear the costs of removing liquidity from the fund when
liquidity in underlying short-term funding markets is costly.
---------------------------------------------------------------------------
\115\ Theoretically, a money market fund would not incur
rebalancing costs if it were able to perfectly ``ladder'' the
maturity of its portfolio structure, such that investments are
maturing in parallel with investors' redemption activities. However,
as a practical matter, perfect laddering is impossible because funds
do not have advance notice of all investor purchase and redemption
activity.
---------------------------------------------------------------------------
In response to comments suggesting that we conduct a data analysis
on the extent to which money market fund shareholders have experienced
dilution in the past, we do not have fund-specific data on dilution
because funds do not report information about their daily portfolio
holdings and transactions. However, as discussed in the Proposing
Release, in March 2020 institutional prime and institutional tax-exempt
money market funds experienced significant outflows, spreads for
instruments in which these funds invest widened sharply, and these
funds sold significantly more long-term portfolio securities (i.e.,
securities that mature in more than a month) than average.\116\ For
instance, Form N-MFP data suggests that publicly offered institutional
prime funds increased their sales of long-term securities in March 2020
to 15% of total assets, in comparison to a 4% monthly average between
October 2016 and February 2020. In addition, the March 2020 figure,
which is over three times the monthly average as compared to data from
prior years, likely understates the full extent of the selling
activity, as Form N-MFP currently does not provide insight on sales of
portfolio securities that a fund acquired during the relevant
month.\117\ As an example of widening spreads in the markets in which
prime funds invest, bid-ask spreads of highly rated dealer-placed
commercial paper reached between approximately 25 and 55 basis points
at the height of the stress in March and April 2020 depending on
maturity.\118\ Thus, available evidence indicates that money market
funds were incurring liquidity costs to meet redemptions, but these
costs generally were not borne by redeeming investors who received the
NAV at the time of their redemptions.\119\ Moreover, the dilution the
final rule is designed to address is not limited to the costs a fund
incurs in selling portfolio securities to meet redemptions. The final
rule also addresses dilution from the costs of reducing the liquidity
of a fund's portfolio, including associated rebalancing costs, which
would also require granular daily data that funds do not publicly
report.
---------------------------------------------------------------------------
\116\ See Proposing Release, supra note 6, at section I.B.
\117\ As discussed below, we are amending Form N-MFP to require
prime funds to report the value of non-maturing portfolio securities
they sold each month. See infra section II.F.2.a.
\118\ See infra paragraph accompanying note 630.
\119\ To the extent that ultra-short bonds may be somewhat
comparable to the debt instruments that money market funds hold and
the magnitude of NAV discounts that ultra-short bond exchange-traded
funds experienced in March 2020 may proxy for liquidity costs of
money market funds that hold similar assets, this could suggest that
institutional prime money market funds have nontrivial dilution
costs during market stress. See id.
---------------------------------------------------------------------------
We understand that future stress periods may not look exactly the
same as March 2020, and, as some commenters suggested, in future
periods funds may feel more comfortable drawing on available liquidity
to meet redemptions because we are removing the tie between liquidity
thresholds and fees and gates. Funds also may begin future stressed
periods with higher levels of daily and weekly liquid assets than in
March 2020, although at that time some funds had liquidity above the
minimums we are adopting. However, it is also possible that future
stress periods will be longer or otherwise more severe than March 2020,
that future stress events will have no Federal intervention to
alleviate those stresses, or that a particular fund or group of funds
will come under stress due to factors idiosyncratic to the fund(s). It
is important for funds to be able to manage through various types of
stress events and not to rely solely on liquidity buffers to manage
stress. As discussed below and in the Proposing Release, while
liquidity minimums are an important tool for managing redemptions, our
analysis suggests that some funds would run out of liquidity if faced
with the redemptions rates experienced in March 2020.\120\ Thus, we do
not agree with commenters who suggested that amendments to enhance
money market fund liquidity, and the usability of that liquidity, would
be sufficient on their own, without an available anti-dilution tool.
---------------------------------------------------------------------------
\120\ See infra sections II.C.1 and IV.C.2; Proposing Release,
supra note 6, at sections II.C.1 and III.C.2.
---------------------------------------------------------------------------
Moreover, to the extent that investors currently are incentivized
to redeem quickly during periods of market stress to avoid potential
costs from a fund's future sale of less liquid securities, the
amendments will reduce those first-mover incentives and the associated
run risk. While some academic papers support the premise that liquidity
externalities may create a first-mover advantage that may lead to
cascading anticipatory redemptions, we recognize that investors may
redeem from a fund for a variety of reasons, and these reasons may vary
among investors.\121\ Notably, we are concerned about dilution and fair
allocation of costs when a fund has sizeable net redemptions in a
stressed period regardless of the reasons for investors' redemptions.
In response to comments suggesting that an anti-dilution tool would not
address first-mover issues if an investor does not know if it will
incur liquidity costs at the time the investor submits the redemption
order, we disagree. We believe that an investor's general awareness
that it may incur liquidity costs, particularly in stressed market
conditions and when other investors may also be redeeming, is
sufficient to mitigate the first-mover advantage and reduce its
potential influence on an investor's redemption decisions. We also
disagree with commenters who suggested that an anti-dilution tool with
a net redemption trigger may increase incentives for investors to
redeem ahead of others. Investors generally will not know with
certainty if the fund's flows for any particular day will trigger a
liquidity fee since a fund's net flows are dependent on many investors'
individual investment decisions, which are not knowable in advance and
can be influenced by a multitude of different factors.\122\ While
investors may anticipate that a fund will have net redemptions during a
market stress event, the investors will also know that if they redeem,
the likelihood of incurring fees increases. This dynamic should reduce
investors' incentives to attempt to preemptively redeem to avoid
liquidity fees. We agree with commenters that suggested that a net
redemption threshold would be appropriate to avoid the threshold
effects seen in March 2020.\123\
[[Page 51415]]
Moreover, the 5% net redemption threshold is designed to help mitigate
the risk that a significant amount of redemptions could occur under
stressed market conditions before a fee is triggered, thus
incentivizing investors to redeem ahead of others.
---------------------------------------------------------------------------
\121\ See infra note 550 and accompanying text (discussing these
academic papers).
\122\ See infra section IV.C.4.b.i (further discussing how a
liquidity fee based on a net redemptions trigger may mitigate run
incentives).
\123\ See, e.g., SIFMA AMG Comment Letter; BlackRock Comment
Letter: IIF Comment Letter; Morgan Stanley Comment Letter. As
discussed further below, some of these commenters suggested a
trigger for liquidity fees that paired a net redemption threshold
with a weekly liquid asset threshold.
---------------------------------------------------------------------------
As the Commission has previously recognized, in the absence of an
exemption, imposing liquidity fees could violate 17 CFR 270.22c-1
(``rule 22c-1''), which (together with section 22(c) and other
provisions of the Investment Company Act) requires that each redeeming
shareholder receive his or her pro rata portion of the fund's net
assets.\124\ As a result, we are exercising our authority under section
6(c) of the Act to provide exemptions from these and related provisions
of the Act so that a money market fund can institute liquidity fees,
which can benefit the fund and its shareholders by providing a more
systematic and equitable allocation of liquidity costs, notwithstanding
these restrictions.\125\ We believe that such exemptions do not
implicate the concerns that Congress intended to address in enacting
these provisions, and thus they are necessary and appropriate in the
public interest and consistent with the protection of investors and the
purposes fairly intended by the Act.
---------------------------------------------------------------------------
\124\ See 2014 Adopting Release, supra note 26, at section
III.A.3.
\125\ Section 6(c) of the Investment Company Act. In addition,
like current rule 2a-7, the final rule provides that,
notwithstanding section 27(i) of the Investment Company Act, a
variable insurance contract issued by a registered separate account
funding variable insurance contracts or the sponsoring insurance
company of such separate account may apply a liquidity fee to
contract owners who allocate all or a portion of their contract
value to a subaccount of the separate account that is either a money
market fund or that invests all of its assets in shares of a money
market fund. See 17 CFR 270.2a-7(c)(2)(iv); amended rule 2a-
7(c)(2)(iv). Section 27(i)(2)(A) makes it unlawful for any
registered separate account funding variable insurance contracts or
the sponsoring insurance company of such account to sell a variable
contract that is not a ``redeemable security.''
---------------------------------------------------------------------------
As discussed, we are adopting a mandatory liquidity fee framework
in lieu of the proposed swing pricing requirement. Table 1 below
compares the key elements of the current rule's default liquidity fee,
the proposed swing pricing requirement, and the mandatory liquidity fee
provision we are adopting. In addition, Table 2 below compares the key
elements of the current rule's discretionary liquidity fee, the
redemption fee approach contemplated by the proposal, and the
discretionary liquidity fee provision we are adopting. We discuss these
aspects of the final rule and how they relate to comments on the
proposal in the following sections.
Table 1--Comparison of the Current Rule's Default Liquidity Fee, the Proposed Rule's Swing Pricing Requirement,
and the Final Rule's Mandatory Liquidity Fee
----------------------------------------------------------------------------------------------------------------
Current rule's default Proposed rule's swing Final rule's mandatory
liquidity fee pricing requirement liquidity fee
----------------------------------------------------------------------------------------------------------------
Description of mechanism......... A default fee is charged The fund's NAV is A mandatory fee is
to redeeming investors adjusted downward by a charged to redeeming
when the fund's weekly swing factor when the investors when the fund
liquid assets decline fund has net has net redemptions
below 10%, subject to redemptions. above 5% of net assets.
certain board discretion.
Scope of affected funds.......... Prime and tax-exempt Institutional prime and Institutional prime and
money market funds. institutional tax- institutional tax-
exempt money market exempt money market
funds. funds.
Scope of affected investors...... Redeeming investors are The NAV is adjusted Redeeming investors are
charged a liquidity fee. downward for both charged a liquidity
The liquidity fee does redeemers and fee. The liquidity fee
not affect subscribing subscribers. Redeeming does not affect
investors. investors' redemption subscribing investors.
proceeds are reduced
and subscribing
investors purchase at a
discounted price,
compared to the
unadjusted NAV they
both otherwise would
have received.
Threshold for applying a charge.. If weekly liquid assets At any level of net Fees are triggered when
fall below 10%, then a redemptions for a the fund has total
default fee would apply pricing period, the daily net redemptions
to redeeming investors, swing factor includes that exceed 5% of net
unless the board spreads and certain assets based on flow
determines a fee is not other transaction costs information available
in the best interests of (i.e., brokerage within a reasonable
the fund.\1\ commissions, custody period after the last
fees, and any other computation of the
charges, fees, and fund's net asset value
taxes associated with on that day, or such
portfolio security smaller amount of net
sales). redemptions as the
board determines.
If net redemptions for a
pricing period exceed
4% of net assets
divided by the number
of pricing periods per
day, or such smaller
amount of net
redemptions as the
swing pricing
administrator
determines, the swing
factor also includes
market impact costs.
Duration and application of the The liquidity fee begins The price is adjusted The fund must apply a
charge. to apply on the business for all shareholders liquidity fee to all
day after the fund transacting in the shares that are
crosses the 10% weekly fund's shares during redeemed at a price
liquid asset threshold. the relevant pricing computed on the day the
Once imposed, the fee period. fund has total daily
must be applied to all net redemptions that
shares redeemed and exceed 5% of net
remains in effect until assets.
the fund's board,
including a majority of
directors who are not
interested persons of
the fund, determines
that imposing a fee is
not in the best
interests of the fund.
If the fund has invested
30% or more of its total
assets in weekly liquid
assets as of the end of
a business day, the fund
must cease charging a
fee effective the
beginning of the next
business day.
[[Page 51416]]
Size of the charge............... The default fee is 1%, The swing factor would The size of the fee
unless the fund's board be determined by making generally is determined
of directors, including good faith estimates of by making a good faith
a majority of the the spread, other estimate of the spread,
directors who are not transaction, and market other transaction, and
interested persons of impact costs the fund market impact costs the
the fund, determines would incur, as fund would incur if it
that a higher or lower applicable, if it were were to sell a pro rata
fee level is in the best to sell a pro rata amount of each security
interests of the fund. amount of each security in its portfolio to
in its portfolio to satisfy the amount of
satisfy the amount of net redemptions.
net redemptions.
Affected money market Affected money market
funds could estimate funds can estimate
costs and market impact costs and market
factors for each type impacts for each type
of security with the of security with the
same or substantially same or substantially
similar characteristics similar characteristics
and apply those and apply those
estimates to all estimates to all
securities of that type securities of that type
in the fund's in the fund's
portfolio, rather than portfolio, rather than
analyze each security analyze each security
separately. separately.
If the estimated
liquidity costs are
less than one basis
point (0.01%) of the
value of the shares
redeemed, a fund is not
required to apply a fee
under the de minimis
exception.
If the fund cannot
estimate the costs of
selling a pro rata
amount of each
portfolio security in
good faith and
supported by data, a
default liquidity fee
of 1% of the value of
shares redeemed
applies.
Maximum charge................... The fee cannot exceed 2% The swing factor has no The fee has no upper
of the value of the upper limit. limit.
shares redeemed.
Party who administers the The board is responsible The board must approve The board is responsible
provision. for administering the swing pricing policies for administering the
liquidity fee and procedures. The liquidity fee
requirement. The board swing pricing requirement, but the
may not delegate administrator is board can delegate this
liquidity fee charged with responsibility to the
determinations. administering the swing fund's investment
pricing requirement. adviser or officers,
The swing pricing subject to written
administrator is the guidelines established
fund's investment and reviewed by the
adviser, officer, or board and ongoing board
officers responsible oversight.\2\
for administering the
fund's swing pricing
policies and
procedures, as
designated by the
fund's board. The
administrator can be an
individual or a group
of persons.
----------------------------------------------------------------------------------------------------------------
Notes:
\1\ The board determinations this Table refers to generally must include a majority of the directors who are not
interested persons of the fund.
\2\ This approach is consistent with the operation of several other provisions of rule 2a-7.
Table 2--Comparison of the Current Rule's Discretionary Liquidity Fee, the Proposed Rule, and the Final Rule's
Discretionary Liquidity Fee
----------------------------------------------------------------------------------------------------------------
Current rule's Final rule's
discretionary liquidity Proposed rule and rule discretionary liquidity
fee 22c-2 fee
----------------------------------------------------------------------------------------------------------------
Description of mechanism......... A discretionary fee may The proposal would have Irrespective of
be charged to redeeming removed the liquidity or redemption
investors when the discretionary liquidity levels, a discretionary
fund's weekly liquid fee provision in rule fee is charged to
assets decline below 30% 2a-7 and stated that redeeming investors
and the board determines money market fund when the board
that a fee is in the boards could rely on determines that the fee
best interests of the existing rule 22c-2 if is in the best
fund.\1\ they determine interests of the fund.
redemption fees are
needed to address
dilution.
Scope of affected funds.......... Prime and tax-exempt Any money market fund Prime and tax-exempt
money market funds. may elect to rely on money market funds.
Government money market rule 22c-2 to impose Government money market
funds may opt in. fees, in which case the funds may opt in.
fund would no longer be
an excepted fund under
that rule.
Scope of affected investors...... Redeeming investors are Redeeming investors are Redeeming investors are
charged a liquidity fee. charged a liquidity charged a liquidity
The liquidity fee does fee. The liquidity fee fee. The liquidity fee
not affect subscribing does not affect does not affect
investors. subscribing investors. subscribing investors.
Threshold for applying a charge.. If weekly liquid assets The fund's board may If the board determines
fall below 30%, then a impose a redemption fee that doing so is in the
fund may institute a fee that in its judgment is best interests of the
if the board determines necessary or fund, the board must
that the fee is in the appropriate to recoup impose a liquidity fee.
best interests of the for the fund the costs
fund. it may incur as a
result of redemptions
or to otherwise
eliminate or reduce so
far as practicable any
dilution of the value
of the outstanding
securities issued by
the fund.
Duration and application of the Once imposed, the Generally subject to Once imposed, the
charge. discretionary fee must board discretion under discretionary fee must
be applied to all shares the rule. be applied to all
redeemed and remain in shares redeemed and
effect until the fund's remain in effect until
board determines that the fund's board
imposing a fee is not in determines that
the best interests of imposing such fee is no
the fund. longer in the best
interests of the fund.
If the fund has invested
30% or more of its total
assets in weekly liquid
assets as of the end of
a business day, the fund
must cease charging a
fee effective the
beginning of the next
business day.
[[Page 51417]]
Size of the charge............... The rule does not The fee must be The rule does not
prescribe the manner or necessary or prescribe the manner or
amount of the fee appropriate, as amount of the fee
calculation. The fee, determined by the calculation. The fee,
however, must be in the board, to recoup for however, must be in the
best interests of the the fund the costs it best interests of the
fund. may incur as a result fund.
of those redemptions or
to otherwise eliminate
or reduce so far as
practicable any
dilution of the value
of the outstanding
securities issued by
the fund.
Maximum charge................... The fee cannot exceed 2% The fee cannot exceed 2% The fee cannot exceed 2%
of the value of the of the value of the of the value of the
shares redeemed. shares redeemed. shares redeemed.
Party who administers the The board is responsible The fund's board........ The board is responsible
provision. for administering the for administering the
liquidity fee liquidity fee
requirement. The board requirement, but the
may not delegate board can delegate this
liquidity fee responsibility to the
determinations. fund's investment
adviser or officers,
subject to written
guidelines established
and reviewed by the
board and ongoing board
oversight.\2\
----------------------------------------------------------------------------------------------------------------
Notes:
\1\ The board determinations this Table refers to generally must include a majority of the directors who are not
interested persons of the fund.
\2\ This approach is consistent with the operation of several other provisions of rule 2a-7.
2. Terms of the New Mandatory Liquidity Fee Requirement
The mandatory liquidity fee we are adopting, like the swing pricing
proposal, is based upon a net redemption threshold and only applies to
institutional prime and institutional tax-exempt funds.\126\ Unlike the
swing pricing proposal, however, the anti-dilution measure triggers
only when net redemptions for the business day exceed 5% of net
assets.\127\ Similar to the proposed swing pricing proposal, the fee
amount would reflect the fund's good faith estimate of liquidity costs,
supported by data, of the costs the fund would incur if it sold a pro
rata amount of each security in its portfolio (i.e., vertical slice) to
satisfy the amount of net redemptions, including: (1) spread costs and
any other charges, fees, and taxes associated with portfolio security
sales; and (2) market impacts for each security.\128\ The final rule
will not require a fund to apply a fee if the estimated costs are de
minimis, meaning that if the fee were applied, the amount of the fee
would be less than 0.01% of the value of the shares redeemed.\129\ In
addition, if a fund cannot make a good faith estimate of liquidity
costs, it will apply a default fee of 1%.\130\ This mandatory liquidity
fee regime substantially accomplishes the same goals as the proposed
swing pricing mechanism and, like swing pricing, it is designed to
ensure that the costs stemming from significant net redemptions in
periods of market stress are fairly allocated and will not give rise to
dilution or a first-mover advantage.
---------------------------------------------------------------------------
\126\ We refer to money market funds that are not government
money market funds or retail money market funds collectively as
``institutional funds'' when discussing the liquidity fee
requirement.
\127\ See amended rule 2a-7(c)(2)(ii) (allowing a fund's board
to determine to use a smaller net redemption threshold than 5%). In
contrast, the proposed swing pricing requirement would have required
an institutional fund to adjust its current NAV per share by a swing
factor reflecting spread and transaction costs, as applicable, if
the fund has net redemptions for the pricing period. If the
institutional fund experienced net redemptions exceeding 4% of the
fund's net asset value (divided by the number of pricing periods the
fund has in a business day, or such smaller amount of net
redemptions as the swing pricing administrator determines), then the
swing factor would also include market impact costs.
\128\ See amended rule 2a-7(c)(2)(iii)(A).
\129\ See amended rule 2a-7(c)(2)(iii)(D).
\130\ See amended rule 2a-7(c)(2)(iii)(C).
---------------------------------------------------------------------------
The new mandatory liquidity fee has some key differences as
compared to the current rule. For example, the mandatory liquidity fee
is triggered by net redemptions as opposed to weekly liquid
assets.\131\ In addition, unlike the current rule, but consistent with
the proposed swing pricing requirement, the amended framework does not
provide discretion to the board with respect to its application.
Rather, the fund will be required to apply a fee if it crosses the net
redemption threshold unless the fee amount is de minimis. Moreover, the
final amendments are more specific in terms of how a fund determines
the amount of the fee than the current rule and, as a result, does not
include a limit on the amount of the fee a fund can charge.\132\
---------------------------------------------------------------------------
\131\ See 17 CFR 270.2a-7(c)(2)(ii) (requiring a non-government
money market fund to impose a default liquidity fee of 1% on all
redemptions if its weekly liquid assets fall below 10% of its total
assets, unless the board of directors of the fund (including a
majority of its independent directors) determines that imposing such
a fee would not be in the best interests of the fund).
\132\ In contrast, under the current rule, a liquidity fee may
not exceed 2% of the value of the shares redeemed. See 17 CFR
270.2a-7(c)(2)(ii)(A).
---------------------------------------------------------------------------
The new mandatory liquidity fee only applies to institutional prime
and institutional tax-exempt funds. This is in contrast to the current
rule's default liquidity fees, which apply to retail funds, but is
consistent with the approach we proposed for swing pricing. We are not
requiring retail or government money market funds to implement
mandatory liquidity fees due to differences in investor behavior and,
in the case of government funds, liquidity costs. As discussed in the
proposal, retail money market funds historically have had smaller
outflows than institutional funds during times of market stress and
appear to be less sensitive to declines in a fund's liquidity.\133\ As
a consequence, we continue to believe retail fund managers may be more
comfortable drawing down available liquidity from the fund's daily
liquid assets and weekly liquid assets to meet redemptions in times of
stress, without engaging in secondary market sales that could result in
significant liquidity costs. In addition, we do not believe that retail
prime and tax-exempt money market funds need special provisions
requiring them to impose liquidity fees given both the anticipated
effect of the daily and weekly liquid asset requirement changes and, as
described below, the availability of the discretionary liquidity fee we
are adopting. As for government money market funds, investors typically
view these funds, in contrast to prime money market funds, as a
relatively safe investment during times of market turmoil, and
government money market funds have seen inflows during periods of
market instability. Government money market funds are also less likely
to incur significant liquidity costs when they purchase or sell
portfolio securities
[[Page 51418]]
due to the generally higher levels of liquidity in the markets in which
they invest.
---------------------------------------------------------------------------
\133\ See Proposing Release, supra note 6, at section II.B.1.
---------------------------------------------------------------------------
Consistent with the swing pricing proposal, the mandatory anti-
dilution mechanism (in this case a liquidity fee) applies to all
institutional funds, irrespective of whether they are offered publicly.
Some commenters suggested that privately offered institutional funds
should not be subject to a mandatory anti-dilution tool.\134\ Asset
managers typically organize privately offered institutional money
market funds to manage cash balances of other affiliated funds and
accounts. These funds operate in almost all respects as a registered
money market fund, except that their securities are privately offered
and thus not registered under the Securities Act.\135\ Some commenters
suggested privately offered institutional funds are not subject to the
same first-mover and run concerns as publicly offered institutional
funds because they serve as tools for funds within the same fund
complex and are used for internal purposes such as cash management and
investing collateral from securities lending transactions.\136\ For
example, one commenter suggested that, because of these
characteristics, such funds are focused more on liquidity than
yield.\137\ Other commenters suggested that such funds have greater
transparency into redemptions than publicly offered institutional
funds.\138\ We decline to provide an exception for these funds from the
mandatory liquidity fee requirement because we do not believe that such
funds are immune to the risks of dilution and potential first-mover
advantages that mandatory liquidity fees are designed to address. For
example, registered funds investing in a privately offered
institutional fund may have an incentive to redeem shares in times of
market stress (e.g., to raise funds to pay their own redemptions, which
may be heightened at that time), increasing the risk of dilution for
remaining registered funds. Potential first-mover incentives may also
exist, particularly if registered funds are investing in a privately
offered institutional fund in another fund complex in which the
registered funds have no greater transparency, creating a potential
incentive to redeem ahead of other investors in times of market
stress.\139\
---------------------------------------------------------------------------
\134\ See, e.g., Fidelity Comment Letter; BlackRock Comment
Letter; Capital Group Comment Letter; ICI Comment Letter; Comment
Letter of Dimensional Fund Advisors LP (Apr. 11, 2022)
(``Dimensional Fund Advisors Comment Letter''); Dechert Comment
Letter.
\135\ See 17 CFR 270.12d1-1 (generally requiring that the
acquiring fund reasonably believes that the money market fund
operates in compliance with rule 2a-7).
\136\ See, e.g., Fidelity Comment Letter; ICI Comment Letter;
BlackRock Comment Letter; Capital Group Comment Letter; ICI Comment
Letter; Dimensional Fund Advisors Comment Letter; Dechert Comment
Letter; but see 2014 Adopting Release, supra note 26, at section
III.C.5 (discussing the Commission's belief that unregistered money
market funds are not immune to the risks posed by money market funds
generally).
\137\ See Capital Group Comment Letter.
\138\ See Capital Group Comment Letter; ICI Comment Letter.
\139\ See 2014 Adopting Release, supra note 26, at section
III.C.5.
---------------------------------------------------------------------------
The final rule provides for mandatory liquidity fees for
institutional funds because institutional investors have a history of
redeeming from these funds quickly in times of stress, increasing the
risk of dilution for remaining shareholders in institutional funds. In
addition, if the liquidity fee regime for these funds were purely
voluntary, institutional funds (or their boards) may require additional
time or information to decide whether to impose fees, depending on the
considerations on which the fee is based. This could result in a delay
that creates timing misalignments between an investor's redemption
activity and the imposition of liquidity costs, thus allowing some
investors to redeem without bearing the associated liquidity costs and
contributing to dilution and a first-mover advantage. Further, some
funds (or their boards) may be reluctant to impose fees to avoid
perceived reputational or competitiveness issues associated with
imposing fees before other institutional funds, which institutional
investors may be more likely to react to than retail investors.\140\ As
a result, a purely voluntary regime may result in institutional funds
not imposing a fee unless a fund is under severe and prolonged stress,
by which point the fee's effectiveness in addressing dilution and
potential first-mover advantages would be significantly reduced.\141\
---------------------------------------------------------------------------
\140\ As discussed above and in the Proposing Release, available
evidence suggests that institutional investors were more sensitive
to the possibility of redemption gates or liquidity fees in Mar.
2020 than retail investors, and institutional prime and
institutional tax-exempt money market funds managed their portfolios
to avoid having less than 30% of their total assets invested in
weekly liquid assets, at which point a board could determine to
institute gates or fees. In addition, the one money market fund to
fall below this threshold in Mar. 2020 did not institute gates or
fees. See supra sections I.B and II.A; Proposing Release, supra note
6, at sections I.B. and II.A. While we believe that institutional
investors are more sensitive to redemption gates than to liquidity
fees, some institutional investors may prefer to avoid the
possibility of liquidity fees as well, if possible.
\141\ One commenter, suggesting that discretionary fees would be
sufficient, indicated that fund boards would have incentives to
impose fees if redemptions reduced the fund's NAV and imposed
material dilution, including due to legal and reputational risk
associated with a failure to act. See Comment Letter of Federated
Hermes, Inc. (July 5, 2023) (``Federated Hermes Comment Letter V'').
Absent persuasive information that redemptions would have these
stated effects, however, there may be contrary incentives to delay
any fee determinations to avoid reputational risk or second-guessing
associated with imposing a fee, particularly if comparable funds are
not imposing fees.
---------------------------------------------------------------------------
a. Threshold for Mandatory Liquidity Fees
We are requiring that institutional funds apply the mandatory
liquidity fee when net redemptions for the business day exceed 5% of
net assets, or such smaller amount of net redemptions as the board (or
its delegate) determines. This 5% threshold is in contrast to the swing
pricing proposal, which would have required funds to charge redeeming
investors spread and certain other transaction costs if the fund had
any net redemptions for the pricing period and to include market
impacts in the charge if net redemptions exceeded 4% of net assets, or
such smaller amount of net redemptions as the swing pricing
administrator determines. In the proposal, application of this 4%
threshold would have required funds to divide the 4% value by the
number of pricing periods (i.e., NAV strikes) the fund has each
day.\142\ In contrast, the 5% net redemption threshold is based on
flows for all pricing periods in a given day. In addition, unlike the
current rule, but consistent with the proposal, application of the
anti-dilution mechanism is not tied to a weekly liquid asset threshold.
Also, unlike the current rule, but consistent with the proposal, the
mechanism applies to redemptions on each business day a fund crosses
the net redemption threshold. This is in contrast to the current rule's
default liquidity fee, which applies to redemptions the business day
after weekly liquid assets fall below the 10% threshold and continues
to apply on subsequent days until the board determines that the
liquidity fee is no longer in the best interests of the fund. Per the
rule we are adopting, an institutional prime or institutional tax-
exempt money market fund must apply a liquidity fee if its total daily
net redemptions exceed 5% of the fund's net asset value based on flow
information available within a reasonable period after the last
computation of the fund's net asset
[[Page 51419]]
value on that day. If this threshold is crossed, the fund must apply a
liquidity fee to all shares that are redeemed at a price computed on
that day.\143\
---------------------------------------------------------------------------
\142\ The proposal defined ``pricing period'' to mean the period
of time in which an order to purchase or sell securities issued by
the fund must be received to be priced at the next computed NAV. For
example, if a fund computes a NAV as of 12 p.m. and 4 p.m., the fund
would determine if it had net redemptions for each pricing period
and, if so, apply swing pricing for the corresponding NAV
calculation.
\143\ See amended rule 2a-7(c)(2)(ii).
---------------------------------------------------------------------------
Many commenters suggested that the proposed 4% market impact
threshold was too low and that a redemption-based threshold for
applying any charge to redeeming investors should be higher than 4%.
Some commenters suggested that money market funds frequently experience
net redemptions greater than 4% in normal market conditions due to
seasonal redemption activity such as investor redemptions to fulfill
payroll or tax obligations.\144\ Some commenters suggested that money
market funds do not incur transaction costs or dilution at such low
levels of net redemptions due to the structure of these funds,
including liquidity requirements that insulate funds from transaction
costs, which allows funds to pay redemptions through maturing assets
instead of secondary market activity even during periods with high
redemption levels.\145\ Some commenters suggested that if a fund has
multiple NAV strikes per day, then the 4% threshold would be
particularly problematic because the proposal divided the 4% figure by
the number of pricing periods per day, resulting in a lower
threshold.\146\ One commenter suggested that swing pricing should be
triggered by portfolio security sales that are needed to fund
shareholder redemptions.\147\ The same commenter stated that funds
should have discretion in setting their own swing thresholds.
---------------------------------------------------------------------------
\144\ See, e.g., Morgan Stanley Comment Letter; Bancorp Comment
Letter; Federated Hermes Comment Letter I; IIF Comment Letter; SIFMA
AMG Comment Letter; BlackRock Comment Letter; Federated Hermes
Comment Letter II.
\145\ See, e.g., Allspring Funds Comment Letter; Fidelity
Comment Letter; T. Rowe Comment Letter; US Chamber of Commerce
Comment Letter; Vanguard Comment Letter; Western Asset Comment
Letter; SIFMA AMG Comment Letter; Federated Hermes Comment Letter
II.
\146\ See, e.g., Bancorp Comment Letter; ICI Comment Letter.
\147\ See Capital Group Comment Letter.
---------------------------------------------------------------------------
Many commenters suggested limiting the application of liquidity
fees to periods of market stress. Several commenters suggested that
fund boards should have discretion to determine when fees should apply,
which would effectively limit fees to times of stress.\148\ Several
commenters expressed support for requiring a fund to apply a liquidity
fee if it has net redemptions of more than 10%. These commenters
generally suggested that the rule should pair a net redemption
threshold with a weekly liquid asset threshold to ensure that the fee
would apply only when the fund is under stress.\149\ Some of these
commenters suggested that a liquidity threshold is needed because a
fund could meet net redemptions of more than 10% without dilution if it
has sufficient liquidity and because redemptions exceeding more than
10% can occur under normal market conditions, although they are rarer
than net redemptions exceeding 4% of net assets.\150\ Some commenters
suggested that pairing a weekly liquid asset threshold with a net
redemption threshold would reduce the predictability of the liquidity
fee trigger and reduce the likelihood of preemptive redemptions in
comparison to the current rule, especially considering the effect of
removing redemption gates from the rule, which commenters suggested
were more likely to incentivize investor redemptions than liquidity
fees.\151\ Some commenters suggested a tiered approach with multiple
thresholds and fee amounts, beginning with the dual threshold of 10%
net redemptions and 30% weekly liquid assets and then using weekly
liquid asset-based thresholds to determine when to increase the fee
amount.\152\ Two commenters discussed using a tiered approach with
solely weekly liquid asset thresholds.\153\ Commenters supporting a
tiered approach generally suggested that beginning with relatively
small fee amounts may reduce investor incentives to preemptively redeem
in response to declines in liquidity in an effort to avoid a fee.\154\
Separately, some commenters suggested thresholds based on the amount of
net redemptions over multiple days to identify circumstances in which a
fund is under stress.\155\
---------------------------------------------------------------------------
\148\ See, e.g., ICI Comment Letter (suggesting that the rule
require fund boards to consider certain enumerated factors when
deciding whether to implement a liquidity fee, subject to a
determination that implementing fees is in the best interests of the
fund and its shareholders and is necessary to prevent material
dilution or other unfair results); JP Morgan Comment Letter;
Federated Hermes Comment Letter II; Invesco Comment Letter; SIFMA
AMG Comment Letter.
\149\ See, e.g., Invesco Comment Letter; IIF Comment Letter;
SIFMA AMG Comment Letter (explaining that the 10% net redemption
threshold was selected because it represents half of the commenter's
preferred 20% daily liquid asset threshold and is less likely to be
triggered by routine, expected flow activity, particularly if paired
with a liquidity threshold); ICI Comment Letter.
\150\ See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter.
\151\ See, e.g., IIF Comment Letter; JP Morgan Comment Letter;
BlackRock Comment Letter.
\152\ See, e.g., BlackRock Comment Letter; JP Morgan Comment
Letter; IIF Comment Letter.
\153\ See Western Asset Comment Letter (suggesting a mandatory
approach to tiered fees that would first trigger when weekly liquid
assets are below 30%); ICI Comment Letter.
\154\ See, e.g., ICI Comment Letter; Western Asset Comment
Letter; JP Morgan Comment Letter.
\155\ See, e.g., Morgan Stanley Comment Letter (suggesting a
framework in which fees would apply when net redemptions are more
than 15% over two consecutive trading days); State Street Comment
Letter (suggesting that fees should trigger if net redemptions
exceed 5% for three consecutive days and the fund has experienced an
event that requires reporting on Form N-CR).
---------------------------------------------------------------------------
After considering comments, we are adopting a 5% net redemption
threshold for mandatory liquidity fees. We recognize that some funds
would trigger the proposed 4% net redemption threshold with some
frequency under normal market conditions, particularly if the fund had
multiple NAV strikes per day and therefore used a smaller threshold for
each pricing period under the proposal. Based on historical flow data,
we estimate that an average of 4.4% of institutional prime and
institutional tax-exempt money market funds would cross a 4% net
redemption threshold on a given day.\156\ To reduce the burdens of the
liquidity fee requirement and to reduce the frequency at which the
requirement may trigger under normal market conditions, when liquidity
costs and the benefits to remaining shareholders of imposing liquidity
fees are likely small, we are increasing the threshold to 5%. We
estimate that an average of 3.2% of institutional funds would cross a
5% net redemption threshold on a given day. While funds may still cross
the 5% threshold under normal market conditions, we anticipate that a
fund's liquidity costs generally will be de minimis under those
circumstances, and the final rule will not require a fund to apply a
fee when estimated costs are de minimis.\157\ We are also making other
changes to the final rule that we believe will reduce the burdens of
determining the amount of the fee, as discussed below.
---------------------------------------------------------------------------
\156\ See infra section IV.C.4.b.i (analyzing historical daily
redemptions out of institutional prime and institutional tax-exempt
money market funds between Dec. 2016 and Oct. 2021).
\157\ See amended rule 2a-7(c)(2)(iii)(D).
---------------------------------------------------------------------------
Consistent with the swing pricing proposal, the final rule permits
a fund to use a lower net redemption threshold than is required.\158\
Allowing a fund's board (or delegate) to use a net redemption threshold
below 5% for purposes of applying mandatory fees is designed to
recognize that there may be circumstances in which a smaller threshold
would be appropriate to mitigate dilution of fund shareholders. For
example, this may be the case when
[[Page 51420]]
a fund holds a larger amount of less liquid investments or in times of
stress.
---------------------------------------------------------------------------
\158\ See amended rule 2a-7(c)(2)(ii); proposed rule 2a-
7(c)(2)(vi)(B).
---------------------------------------------------------------------------
We are not adopting an even higher net redemption threshold, or a
net redemption threshold paired with a liquidity threshold, as some
commenters suggested. While a higher net redemption threshold, such as
10%, would reduce the likelihood of a fund crossing the threshold under
normal market conditions when liquidity costs are low, it likewise
would reduce the likelihood of a liquidity fee applying in the
beginning wave of redemptions in a crisis period. For example, of the
outflows from institutional prime and tax-exempt money market funds
during the week of March 20, 2020, approximately 31% of fund days were
above the 5% threshold, but only 11% of fund days were above the 10%
threshold.\159\ If investors can redeem during the beginning stages of
a crisis with a very low likelihood of incurring a fee, that may
incentivize investors to redeem early, contributing to a first-mover
advantage. In addition, we considered the effect of different net
redemption thresholds during periods of prolonged stress, which might
have occurred in March 2020 absent government intervention, by modeling
fund portfolios and liquidity levels.\160\
---------------------------------------------------------------------------
\159\ See infra section IV.C.4.b.i (discussing this analysis and
other analyses regarding net redemption thresholds for mandatory
liquidity fees). ``Fund days'' refers to observations of daily
redemptions using a sample set of funds during a particular period
of time. Here, the fund days relate to a measure of daily outflows
during the week of Mar. 20, 2020. To illustrate the analysis, we
observed 43 institutional prime and institutional tax-exempt money
market funds over the 5 days that week. This results in 215 (= 43 x
5) fund day observations. Using a net redemption threshold of 5%, we
observed that during the week of Mar. 20 funds would have exceeded
that threshold on 31% of fund days. This means that net outflows
exceeded the 5% threshold on 67 (= 0.31 x 215) fund days during the
week of Mar. 20.
\160\ See id.
---------------------------------------------------------------------------
If we were to pair a 10% net redemption threshold with a weekly
liquid asset threshold, that would further reduce the likelihood of a
liquidity fee applying to the first wave of redemptions in a stress
period. Moreover, adding a weekly liquid asset threshold to a net
redemption threshold, or using a weekly liquid asset threshold on its
own, would allow investors to better predict when a liquidity fee may
apply, which may contribute to preemptive redemptions. Incorporating a
fund's weekly liquid assets into the liquidity fee trigger also may
incentivize fund managers to maintain weekly liquid assets above the
relevant threshold, creating a disincentive for using available
liquidity to meet redemptions and potentially contributing to dilution
of remaining shareholders through the sale of longer-term portfolio
securities in a stress period. In March 2020, we observed both of these
unintended results from the tie between liquidity fees and weekly
liquid assets in the current rule. As for a tiered approach, we
understand some commenters' views that using a weekly liquid asset
threshold to trigger a very small fee amount may be less likely to
trigger preemptive runs at the outset. However, a tiered approach that
increases the fee amount according to a specific schedule as liquidity
declines below predictable thresholds has the risk of ``cliff
effects.'' Specifically, a tiered approach may incentivize investors to
redeem before a fund crosses a lower, predictable weekly liquid asset
threshold to avoid a nonlinear jump in the fee size.
We also are not adopting other liquidity fee approaches that some
commenters suggested. A net redemption threshold based on net
redemptions over multiple trading days may lead to a threshold that is
more predictable than same day net redemptions, as funds provide
information about the prior day's net flows on their websites.\161\ In
addition, a multi-day threshold would contribute to operational
complexity if the fee applied to redemptions that trigger the fee, as a
fund would need to apply a fee to redemptions that occurred on a prior
day. Alternatively, if the fee applied to redemptions occurring after
the threshold is triggered, this approach would contribute to a first-
mover advantage, as investors redeeming at the onset of market stress
would be significantly less likely to incur a fee.
---------------------------------------------------------------------------
\161\ See 17 CFR 270.2a-7(h)(10)(ii)(C).
---------------------------------------------------------------------------
We also are not adopting an approach that allows funds to establish
their own criteria for triggering liquidity fees or that relies on
board considerations of certain criteria. If institutional funds were
permitted to establish their own criteria for triggering liquidity
fees, we believe they may use criteria that are unlikely to trigger
liquidity fees, particularly if they perceive the potential for
reputational harm from imposing fees. With respect to board
determinations, as discussed in the Proposing Release, we do not
believe an approach that relies on board determinations would result in
timely decisions to impose liquidity fees on days when the fund has net
redemptions that, due to associated costs to meet those redemptions,
will dilute the value of the fund for remaining shareholders.\162\ For
instance, it may take time for a fund board to convene and determine
whether to apply a liquidity fee with respect to any particular stress
event. We do not believe that these discretionary approaches would
provide an effective tool for addressing institutional shareholder
dilution and potential institutional investor incentives to redeem
quickly in times of liquidity stress to avoid further losses. Finally,
we are not adopting a threshold based on when a fund must sell
portfolio securities to satisfy redemptions because, as discussed
above, we believe such an approach overlooks the costs redeeming
investors impose by removing liquidity from the fund, including
subsequent rebalancing costs, and by increasing the likelihood that the
fund will need to sell less liquid assets to satisfy future
redemptions.
---------------------------------------------------------------------------
\162\ See Proposing Release, supra note 6, at n.95 and
accompanying text.
---------------------------------------------------------------------------
When a fund crosses the 5% net redemption threshold, it must apply
a liquidity fee to all shares that are redeemed at a price computed on
that day. As a result, when the 5% net redemption threshold is crossed,
the fee must be applied to all shares redeemed that day, including
redemptions that are eligible to receive a NAV computed on that day
even if received by the fund after the last pricing period of the day.
This approach will require redeeming investors who cause the fund to
exceed the threshold to bear the costs of their redemption activity,
irrespective of when they redeem during the day. This approach is
different from the current rule, which provides that default liquidity
fees begin to apply on the day after the fund has crossed the 10%
weekly liquid asset threshold. Compared to the current rule, the
approach we are adopting is designed to better align the application of
liquidity fees to those investors whose redemptions result in liquidity
costs for the fund and to reduce potential first-mover advantages. We
recognize, however, that funds and intermediaries may need to update
their systems to apply fees to redemptions on the day the net
redemption threshold is crossed.\163\
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\163\ Under the current rule, the determination to apply
discretionary liquidity fees could occur at any time during the day,
meaning that funds and intermediaries would need to begin to apply
fees to redemptions on that day. See 2014 Adopting Release, supra
note 26, at n.383 and accompanying text. It is our general
understanding, in light of the current rule, that there has been an
industry expectation that a fund board would determine to impose
discretionary fees after the end of a trading day, such that
discretionary fees would begin to apply on the next morning.
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[[Page 51421]]
Consistent with the final rule, the proposed swing pricing
requirement would have applied a charge to redeeming investors who
caused the fund to have net redemptions. However, the design of the net
redemption threshold in the final rule is somewhat different from the
proposal, which would have applied a charge to redeeming investors
based on net redemption activity for each pricing period if a fund had
multiple NAV strikes per day. Some commenters expressed concern about
separately analyzing flows for each pricing period under the proposal.
For example, some commenters stated that institutional money market
fund investors tend to redeem in the morning and move remaining cash
back into the fund toward the end of the day, making it more likely
that funds would need to apply swing pricing in the morning even if
investor activity for the day, on net, would not cross a
threshold.\164\ Some commenters expressed concern about potentially
needing to calculate liquidity costs and apply a charge multiple times
a day.\165\ In addition, some commenters suggested that it would be
particularly difficult to calculate liquidity costs under a tightly
compressed timeline, which is especially a concern for funds that offer
same-day settlement since the swing pricing adjustment had to occur
before a fund published its NAV.\166\
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\164\ See, e.g., Invesco Comment Letter; Western Asset Comment
Letter; SIFMA AMG Comment Letter; BlackRock Comment Letter.
\165\ See, e.g., Northern Trust Comment Letter; U.S. Chamber of
Commerce Comment Letter; Invesco Comment Letter; ABA Comment Letter
I; IIF Comment Letter; Mutual Fund Directors Forum Comment Letter.
\166\ See, e.g., SIFMA AMG Comment Letter; BlackRock Comment
Letter; Capital Group Comment Letter.
---------------------------------------------------------------------------
The final rule will not distinguish between flows for different
pricing periods during the day and, instead, will apply a fee to all
investors who redeemed on that day if the threshold is crossed. This
addresses commenters' concerns about applying a threshold to individual
pricing periods during the day and reduces burdens by requiring no more
than one liquidity fee determination per day. We recognize, however,
that the requirement to apply a liquidity fee to all shares redeemed on
the day the 5% threshold is crossed will likely require some
adjustments for funds that offer multiple NAV strikes per day.\167\
Specifically, we recognize that an investor may redeem at a pricing
period in the morning or early afternoon, before the fund knows that it
has crossed the 5% threshold for the day. Under these circumstances,
the final rule will necessitate a fund that offers multiple NAV strikes
to develop a method for applying the fee to shares redeemed in an
earlier pricing period on that day. Funds might take different
approaches to address this issue. For instance, among other potential
approaches, the fund might apply the liquidity fee charge to the
remaining balance in an investor's account if the investor did not
redeem the full amount of its shares in the fund. Another approach
would be to hold back a portion of the redemption proceeds until the
end of the day when the liquidity fee determination is made.\168\
Alternatively, a fund might develop a mechanism for taking back a
portion of redemption proceeds that the investor has already received.
Further, while not required, some funds might choose to reduce the
number of NAV strikes they offer or no longer offer multiple NAV
strikes for operational ease.\169\ Funds and intermediaries may also
develop other approaches to address this issue. Depending on a given
fund's approach, a redeeming investor may experience a reduction in its
access to liquidity relative to current practices. In addition,
different approaches may have differing effects on investors or raise
tax or other considerations. Overall, we believe it is unlikely that
the mandatory liquidity fee would result in a redeeming investor being
unable to access same-day liquidity.\170\
---------------------------------------------------------------------------
\167\ See infra section IV.C.4.b.ii.
\168\ See BlackRock Comment Letter (stating that, under its
preferred liquidity fee framework, it would plan for its multi-
strike NAV funds to pay out a portion of redemption proceeds after
each intraday NAV is struck, with the remaining redemption proceeds
paid out after the close if no fee is required or reduced by the fee
if a fee is required).
\169\ See infra section IV.C.4.b.ii.
\170\ See id.
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Some commenters questioned the fairness of applying a charge to
certain types of investors who redeem on a given day. For instance,
some commenters suggested that it would be unfair to apply a charge to
investors who redeem and later purchase an identically sized investment
on the same day, because these investors would incur costs despite
having no net effect on liquidity.\171\ One commenter suggested that it
would be unfair for a shareholder redeeming a relatively small number
of shares to be charged a liquidity fee because another shareholder
redeemed a large number of shares and triggered the threshold.\172\
---------------------------------------------------------------------------
\171\ See, e.g., Federated Hermes Comment Letter I; Allspring
Funds Comment Letter; Americans for Tax Reform Comment Letter.
\172\ See Dechert Comment Letter.
---------------------------------------------------------------------------
With respect to the application of a fee to an investor who has
both redeemed and purchased the fund's shares on the relevant day, the
final rule would permit funds to apply liquidity fees based on an
investor's net transaction activity for that day. The current rule
likewise provides this flexibility.\173\ When the Commission adopted
the liquidity fee framework in the current rule, however, several
commenters suggested that it may be too operationally difficult and
costly for funds to apply liquidity fees to shareholders based on their
net activity for the day. As a result, while we are permitting a fund
to apply fees based on a shareholder's net activity, this approach is
not required, and a fund could instead apply liquidity fees to each
redemption separately. As for the application of a liquidity fee to
small redemptions, the final rule will require application of liquidity
fees regardless of the size of the redemption. Consistent with the
Commission's views in 2014 with respect to the current rule's liquidity
fee framework, an exception from the mandatory liquidity fee for small
redemptions would increase the cost and complexity of the amendments
and could facilitate gaming on the part of investors because investors
could attempt to fit their redemptions within the scope of an
exception.\174\
---------------------------------------------------------------------------
\173\ See 2014 Adopting Release, supra note 26, at paragraph
accompanying n. 380.
\174\ See id. at section III.C.7.a (stating that such an
exception for small redemptions would add cost and complexity both
as an operational matter--for example, fund groups would need to be
able to separately track which shares are subject to a fee and which
are not, and create the system and policies to do so--and in terms
of ease of shareholder understanding).
---------------------------------------------------------------------------
Under the final rule, to determine whether a fund has crossed the
5% threshold, the fund will use information about its net flows for the
day that are available within a reasonable period of time after the
last pricing time of that day.\175\ For example, if the fund's last NAV
strike is as of 3 p.m., it would calculate its net flows within a
reasonable time period thereafter such that the fund can calculate and
apply any fee as of that day. The fund's approach to determining when
to calculate net flows should be in its board-approved guidelines on
the application of liquidity fees.\176\ In determining when to
calculate its net flows, a fund should consider historical data on when
it typically receives flow
[[Page 51422]]
information and may also consider the period of time needed to
calculate and apply fees. For example, if a fund generally receives
substantially all of its flows by 5 p.m. and the process for
determining the fee amount will take up to one hour, the rule would not
require the fund to wait until 6 p.m. to calculate its net flows if, by
6 p.m., the fund typically has an even larger percentage of its flows.
Using the same example, it would not be reasonable for this fund to
calculate its net flows at 3:30 p.m., when it generally has less than a
majority of its net flows by this time, given that the fund can
reasonably expect, based on historical data, to have more net flow
information by 5 p.m. and still be able to calculate and apply any fee
as of that later time. This approach is designed to provide a fund with
flexibility to calculate daily flows using the best information
available to the fund while still being able to offer same-day
settlement. Consistent with the proposal and with 17 CFR 270.18f-3
(``rule 18f-3''), an institutional fund with multiple share classes
must include net flow activity across all share classes in the
aggregate when determining if the fund has crossed the 5% threshold,
rather than applying the threshold on a class by class basis.\177\
---------------------------------------------------------------------------
\175\ See amended rule 2a-7(c)(2)(ii).
\176\ See infra section II.B.2.b (discussing liquidity fee
guidelines that the fund's board must approve if it delegates its
responsibility for liquidity fee determinations to the fund's
investment adviser or officers).
\177\ See Proposing Release, supra note 6, at n. 112 and
accompanying text.
---------------------------------------------------------------------------
Some commenters stated that it may be difficult for funds to
receive sufficient flow information to implement swing pricing.\178\ A
few commenters suggested that using estimates of flows for swing
pricing would raise potential NAV error and liability concerns.\179\ A
few commenters suggested that funds may need to establish earlier cut-
off times for receiving investor orders.\180\ As discussed below, the
amended rule requires that funds calculate net redemptions based on
actual flow data for the day, as opposed to estimates of flows. In
addition, in a change from the proposal, we are not requiring funds to
separately examine flows for each pricing period of the day or reflect
the charge in the form of a NAV adjustment. We believe these changes
help mitigate commenters' concerns about sufficiency of flow
information, as well as liability and other risks.
---------------------------------------------------------------------------
\178\ See, e.g., ICI Comment Letter; Fidelity Comment Letter;
Capital Group Comment Letter; Invesco Comment Letter.
\179\ See, e.g., Invesco Comment Letter; ICI Comment Letter;
SIFMA AMG Comment Letter; ICI Comment Letter; see also Western Asset
Comment Letter (expressing concern about erroneous application of
market impacts if an investor or its intermediary partner notifies
the fund of large outflows and then cancels the instructions late in
the trading day).
\180\ See, e.g., Invesco Comment Letter; State Street Comment
Letter; Dechert Comment Letter; IDC Comment Letter; JP Morgan
Comment Letter; Federated Hermes Comment Letter I; Fidelity Comment
Letter.
---------------------------------------------------------------------------
As discussed in the Proposing Release, institutional money market
funds often impose order cut-off times to be able to offer same-day
settlement, which requires that funds complete Fedwire instructions
before the Federal Reserve's 6:45 p.m. Eastern Time (ET) Fedwire cut-
off time.\181\ Therefore, we believe many institutional funds would
have a sizeable portion of their daily flows by the last pricing time
of the day or within a reasonable period of time thereafter. We
understand there will be circumstances in which the flow information a
fund uses to determine whether it has crossed the net redemption
threshold does not reflect the fund's full flows for that day. For
example, a fund may receive subsequent cancellations or corrections to
correct intermediary or investor errors, which modify the flows. In
addition, the fund, or a share class of the fund, may settle some
transactions on T+1 and receive flow information for those trades from
intermediaries later, although they are eligible to receive the NAV as
of the last pricing time.\182\ To the extent that a fund received
additional flow information after determining that it crossed the 5%
threshold, but before applying a liquidity fee, the fund could take the
additional flow information into account when determining the amount of
the liquidity fee. While using the fund's net flows available within a
reasonable period after the last pricing time to determine whether the
fund has crossed the 5% threshold may result in false positives and
false negatives under certain circumstances, we believe the associated
risk is relatively low because we anticipate that funds typically will
not impose liquidity fees under normal market conditions under the de
minimis exception, and institutional money market funds often have net
redemptions in periods of stress. Moreover, this risk is justified by
the benefits of a framework that is easier for funds to operationalize
and likely less prone to error than a framework based on estimated
flows. In addition, to the extent that a fund did not have net
redemptions of more than 5% within a reasonable period after the last
pricing period but subsequently received additional net redemptions
that would cause it to cross the threshold, the fund should consider
imposing a liquidity fee under the discretionary fee provision
discussed below.
---------------------------------------------------------------------------
\181\ See Proposing Release, supra note 6, at section II.B.2.
Based on a 2021 analysis of information from CraneData, a majority
of the prime institutional money market funds that impose an order
cut-off time impose a 3 p.m. ET deadline for same-day processing of
shareholder transaction requests. See id.; see also Fidelity Comment
Letter (stating that its prior publicly offered institutional prime
fund that offered same-day settlement used the same order cut-off
and NAV strike times to allow the fund to calculate its NAV and wire
redemption proceeds as quickly as possible to meet shareholder
expectations and cash needs).
\182\ See Federated Hermes Comment Letter II (stating that over
a 3-month representative period, its institutional prime fund
received 35.7% of trade notices after 3 p.m. and that generally
settled on T+1).
---------------------------------------------------------------------------
We recognize that institutional money market funds that are used as
cash management vehicles for other funds may have particular difficulty
obtaining flow information by the last pricing time of the day.\183\ As
with other institutional funds that may cross the 5% threshold after
the last pricing time of the day, these funds should consider imposing
liquidity fees under the discretionary fee provision if they
subsequently cross the 5% threshold under market conditions where
estimated liquidity costs are not de minimis.
---------------------------------------------------------------------------
\183\ See Capital Group Comment Letter.
---------------------------------------------------------------------------
In general, the proposed swing pricing requirement would have
required institutional money market funds to apply charges to reflect
spread and certain other transaction costs for any level of net
redemptions. We are not requiring institutional funds to apply a
liquidity fee when net redemptions are below the 5% net redemption
threshold. After considering comments, we do not believe that the
benefits of the proposed approach justify the costs at this time
because the structure of money market funds, including minimum
liquidity requirements, helps mitigate dilution risk when the fund has
low levels of net redemptions. In addition, the vast majority of money
market funds already price portfolio securities at the bid price when
striking their NAVs.\184\ This market practice effectively passes
spread costs on to redeeming investors, which means that the proposed
application of swing pricing when a fund has low levels of net
redemptions would have had limited effect.\185\
---------------------------------------------------------------------------
\184\ See ICI Comment Letter; JP Morgan Comment Letter; see also
Allspring Funds Comment Letter.
\185\ See Financial Accounting Standards Board Accounting
Standards Codification (``FASB ASC'') 820-10-35-36C. Generally
accepted accounting principles (``GAAP'') provide that if an asset
measured at fair value has a bid price and an ask price (for
example, an input from a dealer market), the price within the bid-
ask spread that is most representative of fair value in the
circumstances shall be used to measure fair value, and that the use
of bid prices for asset positions is permitted but not required for
these purposes. Id; see also FASB ASC 820-10-35-36D (stating that
use of mid-market pricing as a practical expedient for fair value
measurements within a bid-ask spread is not precluded). Very
generally, mid-market pricing values a security at the average of
its bid price and ask price. Since a seller generally asks for a
higher price for a security than a buyer bids for that security, the
mid-market price is incrementally higher than the bid price for a
security, but lower than its ask price.
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[[Page 51423]]
b. Administration of Mandatory Liquidity Fees
Under the final rule, an institutional fund's board will be
responsible for administering the mandatory liquidity fee, but the
board can delegate this responsibility to the fund's investment adviser
or officers, subject to written guidelines established and reviewed by
the board and ongoing board oversight.\186\ The current rule, in
contrast, does not permit a board to delegate its responsibility for
liquidity fee determinations.\187\ Boards will be able to delegate
liquidity fee determinations under the final rule, unlike under the
current rule, to facilitate timely application of liquidity fees on
days when the fund has net redemptions that, due to associated costs to
meet those redemptions, will dilute the value of the fund for remaining
shareholders. This change will better allow funds to address liquidity
fee determinations in periods of market stress when it may not be
practical to assemble a quorum of the necessary directors in advance of
the required application of a fee, particularly because the final rule
requires application of fees to redemptions on the same day the 5% net
redemption threshold is crossed. Because money market funds already
have experience with liquidity fee requirements, it is appropriate to
allow for the delegation of liquidity fee determinations. This approach
is consistent with other delegable routine board functions under rule
2a-7.
---------------------------------------------------------------------------
\186\ See amended rule 2a-7(j). Consistent with rule 2a-7, the
fund must maintain and preserve for six years a written copy of
these guidelines. The fund also must maintain and preserve for six
years a written record of the board's considerations and actions
taken in connection with discharging its responsibilities, to be
included in the board's minutes. See 17 CFR 270.2a-7(h)(1) and (2).
\187\ See 17 CFR 270.2a-7(j) (stating that a board may not
delegate determinations related to liquidity fees and temporary
gates).
---------------------------------------------------------------------------
Allowing a board to delegate the responsibilities for making
liquidity fee determinations is similar to the proposed requirement for
a board-designated swing pricing administrator. Also consistent with
the proposal, the board will be responsible for oversight of the anti-
dilution mechanism. Specifically, the board will be required to review
its written guidelines and the delegate's liquidity fee determinations
periodically. This approach is similar to the proposed board oversight
of the swing pricing administrator.
Under the final rule's delegation provision, a board will need to
adopt and periodically review written guidelines (including guidelines
for determining the application and size of liquidity fees) and
procedures under which a delegate makes liquidity fee determinations.
Such written guidelines generally should specify the manner in which
the delegate is to act with respect to any discretionary aspect of the
liquidity fee mechanism (e.g., whether the fund will apply a fee to a
shareholder based on the shareholder's gross or net redemption activity
for the relevant day, the fund's approach to determining the reasonable
period after the last pricing period of the day when the delegate will
measure the fund's flows for purposes of the 5% net redemption
threshold). The board will also need to periodically review the
delegate's liquidity fee determinations. This approach is consistent
with rule 2a-7's approach to the delegation of board responsibilities
generally and provides a framework for a board effectively to oversee
liquidity fees imposed by the fund.
c. Calculation and Size of Mandatory Liquidity Fees
The mandatory liquidity fee provision we are adopting generally
will require an institutional fund to determine the amount to charge
redeeming investors by making a good faith estimate, supported by data,
of the costs the fund would incur if it sold a pro rata amount of each
security in its portfolio (i.e., ``vertical slice'') to satisfy the
amount of net redemptions, including spread costs, such that the fund
is valuing each security at its bid price and any other charges, fees,
and taxes associated with portfolio security sales (``transaction
costs'') and market impacts.\188\ This is a change from the current
rule, which establishes a default fee of 1% and provides for board
discretion to adjust that amount down or up (subject to a 2% limit),
but does not prescribe how the board determines the liquidity fee
amount. The final rule's approach, however, is similar to the
proposal's swing pricing requirement and its inclusion of transaction
costs and good faith estimates of market impacts in the swing factor
when net redemptions exceed a specified level. In a change from the
proposal, we are modifying the requirements for the liquidity fee
calculation in response to comments, as well as providing additional
guidance on how a fund may arrive at good faith estimates of the costs.
For instance, the final rule will provide that if an institutional fund
makes a good faith estimate that liquidity costs are de minimis, then
the fund is not required to charge a liquidity fee.\189\ In addition,
if a fund cannot estimate in good faith the costs of selling a pro rata
amount of each portfolio security, then the fund will apply a default
fee of 1% of the value of the shares redeemed.\190\
---------------------------------------------------------------------------
\188\ Amended rule 2a-7(c)(2)(iii)(A); see Proposing Release,
supra note 6, at section II.B.1; see also amended rule 31a-2(a)(2)
(requiring funds to preserve for the prescribed periods all
schedules evidencing and supporting each computation of a liquidity
fee by the fund).
\189\ Amended rule 2a-7(c)(2)(iii)(D).
\190\ Amended rule 2a-7(c)(2)(iii)(C).
---------------------------------------------------------------------------
As discussed in the proposal, the vertical slice approach may help
prevent remaining shareholders from bearing the costs associated with
fund redemptions and may help discourage investors from redeeming
quickly during periods of market stress. Several commenters expressed
concern about the proposed vertical slice assumption for estimating the
costs imposed by redeeming investors. These commenters generally argued
that because money market funds generally meet redemptions with
available liquidity from maturing assets, rather than through the sale
of a vertical slice of the fund's portfolio, the vertical slice
assumption may impose costs on redeeming investors that the fund does
not actually incur.\191\ We understand that a money market fund does
not typically sell a vertical slice of its portfolio to meet
redemptions. However, the vertical slice approach is designed to
account for the costs of leaving remaining investors with a less liquid
portfolio and potential rebalancing costs. For example, if investor
redemptions are met through daily or weekly liquid assets, the
redemptions leave the fund with less liquidity, which increases the
likelihood that further redemptions could require the fund to sell less
liquid assets or incur costs in rebalancing the portfolio, particularly
in periods of market stress when redemptions may be elevated. If we
instead required funds to determine the amount of a liquidity fee based
on the direct transaction costs incurred to meet redemptions, a fund
would not charge a liquidity fee to redeeming investors until after
other investors' redemptions had already extracted much of the
[[Page 51424]]
fund's liquidity. Such a framework could incentivize preemptive
redemptions to avoid liquidity fees in periods of stress and would not
account for the full costs of removing liquidity from the fund in these
periods.
---------------------------------------------------------------------------
\191\ See, e.g., SIFMA AMG Comment Letter; BlackRock Comment
Letter; State Street Comment Letter; ICI Comment Letter; Federated
Hermes Comment Letter II; Bancorp Comment Letter; ABA Comment Letter
I; Invesco Comment Letter; Fidelity Comment Letter; Allspring Funds
Comment Letter; Keen Comment Letter; Western Asset Comment Letter.
---------------------------------------------------------------------------
Consistent with the proposal, the fee has two components: (1)
transaction costs; and (2) market impact costs. The transaction costs
category includes spread costs, such that the fund is valuing each
security at its bid price, and any other charges, fees, and taxes
associated with portfolio security sales.\192\ Several commenters
suggested that money market funds would not need to include spread
costs in a charge to redeeming investors because most money market
funds already value their portfolio securities at bid prices when
striking their NAVs.\193\ In light of this general market practice, we
recognize that most funds will not have to include spread costs in
their charged liquidity fee because they already use bid pricing. Per
the rule, however, the few funds that do not currently use bid pricing
will need to include spread costs in the fee.
---------------------------------------------------------------------------
\192\ The proposal included within this category of costs
specific references to both brokerage and custody fees. A few
commenters suggested that brokerage fees would not be applicable to
money market funds and custody fees would not increase when a fund
has net redemptions. See Allspring Funds Comment Letter; see also
Capital Group Comment Letter. In a change from the proposal, we have
removed from the final rule those references, but we expect the
transaction costs category to include, as applicable, any charges
the fund would incur if it sold a pro rata amount of each security
in its portfolio to satisfy the amount of net redemptions, whether
in the form of brokerage, custody, or other fees.
\193\ See Americans for Tax Reform Comment Letter; Allspring
Funds Comment Letter; ICI Comment Letter; JP Morgan Comment Letter;
see also Federated Hermes Comment Letter I.
---------------------------------------------------------------------------
The second component of the mandatory liquidity fee calculation
requires that funds make a good faith estimate of the market impact of
selling a vertical slice of a fund's portfolio to satisfy the amount of
net redemptions.\194\ The required market impact calculation is
designed to provide a good faith estimate of the full liquidity costs
of selling a vertical slice of a money market fund's portfolio because,
for a money market fund's less liquid investments, market impacts may
impose significant costs on a fund that should be borne by redeeming
investors as opposed to remaining investors. This concern may be
particularly acute when net redemptions are large or in times of stress
and when a fund must sell less liquid investments. In terms of the
mechanics, a fund would first establish a market impact factor for each
security, which is a good faith estimate of the percentage change in
the value of the security if it were sold, per dollar of the amount of
the security that would be sold, if the fund sold a pro rata amount of
each security in its portfolio to satisfy the amount of net
redemptions, under current market conditions. A fund would then
multiply the market impact factor by the dollar amount of the security
that would be sold.\195\
---------------------------------------------------------------------------
\194\ See amended rule 2a-7(c)(2)(iii)(A).
\195\ See amended rule 2a-7(c)(2)(iii)(A)(2).
---------------------------------------------------------------------------
Some commenters stated that it would be challenging to make a good
faith estimate of the market impact of selling a vertical slice of a
money market fund's portfolio because of the limited nature of the
secondary market for funds' portfolio securities.\196\ Some commenters
expressed particular concern about funds' abilities to make good faith
estimates of market impacts in stress events such as March 2020, when
some underlying markets are prone to freezing and few transactions
occur.\197\ Some commenters suggested that the market impact
calculations will require estimates in periods of market stress and
will result in either errors or incorrect estimates.\198\ One commenter
suggested that estimating market impact costs a priori is challenging
and requires judgments for which it may be difficult to have a high
degree of confidence.\199\ Some commenters suggested that it would take
time to undertake the market impact calculation, which may create
operational burdens that result in the need for earlier order cut-off
times or a reduction of features like multiple NAV strikes per day or
same-day settlement.\200\ Some commenters suggested that funds need
additional guidance to make the good faith estimates of market impacts
that the rule will require.\201\ One commenter suggested that if funds
have too much discretion in making good faith estimates, then it could
lead to artificial manipulation.\202\
---------------------------------------------------------------------------
\196\ See, e.g., ICI Comment Letter; BlackRock Comment Letter.
\197\ See, e.g., Federated Hermes Comment Letter II; ICI Comment
Letter; BlackRock Comment Letter; SIFMA AMG Comment Letter.
\198\ See Federated Hermes Comment Letter I; Federated Hermes
Comment Letter II; CCMR Comment Letter; BlackRock Comment Letter;
see also Western Asset Comment Letter (suggesting that application
of calculation is likely to vary across the industry and lead to
inconsistencies).
\199\ See ICI Comment Letter.
\200\ See, e.g., State Street Comment Letter; IIF Comment
Letter; see also Capital Group Comment Letter; Northern Trust
Comment Letter.
\201\ See, e.g., BlackRock Comment Letter; ICI Comment Letter
(suggesting particular challenges exist for securities that do not
trade frequently); Federated Hermes Comment Letter II; Capital Group
Comment Letter.
\202\ See Morgan Stanley Comment Letter.
---------------------------------------------------------------------------
We recognize that market impact costs of a transaction cannot be
determined with certainty before the transaction occurs. As a result,
the rule requires good faith estimates of these costs, given that a
fund generally is not selling a vertical slice of its portfolio to meet
net redemptions.\203\ While the calculated liquidity fee will be based
on good faith estimates and thus will not precisely reflect the
liquidity costs of redemptions, this result is preferable to an overly
low liquidity fee that does not attempt to include market impact costs,
which can be a significant source of liquidity costs. We also recognize
the challenges in assessing the amount of a liquidity fee to charge in
times of market stress when underlying markets are frozen or
transactions are rare. To reduce these challenges, we are providing
guidance on one method funds could use to make a good faith estimate of
the costs of selling a vertical slice of the fund's portfolio to meet
net redemptions. In addition, like the proposal, the final rule permits
a fund to make a good faith estimate of costs for each type of security
with the same or substantially similar characteristics and apply those
good faith estimates to all securities of that type in the fund's
portfolio, rather than analyze each security separately.\204\ Some
commenters suggested that the Commission should provide additional
guidance on how to determine which securities share substantially
similar characteristics.\205\ As discussed in the proposal, a fund
could determine that the liquidity, trading, and pricing
characteristics of a subset of securities justifies the application of
the same costs and market impact factor to all securities of that type
within its portfolio. Further examples of the kinds of criteria that
fund might consider when determining how to group securities could
include: issuance size, credit worthiness, number of other investors in
the same issuance, maturity, industry, and geographic region. Also
consistent with the proposal, and as reflected in the amended rule, we
continue to believe it would be reasonable to assume a market impact of
zero for the fund's daily and weekly liquid assets, since a fund could
reasonably expect such assets to convert
[[Page 51425]]
to cash without a market impact to fulfill redemptions (e.g., because
the assets are maturing shortly).\206\ In addition, in a change from
the proposal, we are requiring funds to apply a default fee of 1% of
the value of shares redeemed if they are unable to make good faith
estimates of these costs. This change is intended to reduce the burden
on funds if good faith estimates are not feasible. The default fee
provision applies if costs cannot be estimated in good faith and
supported by data.
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\203\ If a fund were to manipulate its estimates of market
impact costs in an effort to increase or decrease the calculated fee
amount, without regard to a reasonable assessment of costs under
current market conditions, the manipulated estimates would not be
``good faith'' estimates.
\204\ See amended rule 2a-7(c)(2)(iii)(B).
\205\ See Capital Group Comment Letter; Fidelity Comment Letter;
see also Federated Hermes Comment Letter II.
\206\ See amended rule 2a-7(c)(2)(iii)(A)(2); Proposing Release,
supra note 6, at section II.B.1.
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To develop good faith estimates of market impact costs supported by
data, funds may consider using historical data to model the reasonably
expected price concessions a fund may need to make to sell different
amounts of a security under different market conditions. Specifically,
among other potential methods for establishing a good faith estimate of
the market impact of selling a vertical slice of the fund's portfolio
to meet net redemptions, a fund could estimate and document in pricing
grids the effect of selling different amounts of the security on a
security's price for each group of securities in its portfolio with the
same or substantially similar characteristics under different market
conditions. Under a grid-based approach, a fund would develop separate
grids for different market conditions, such as normal market conditions
or periods with credit stress, liquidity stress, or interest rate
stress (or a combination of such stresses).\207\ Because market impact
varies depending on the amount a fund sells, the grids would assess
market impact of selling different amounts of a security. For example,
a grid might estimate the market impact of selling various percentage-
or value-based ranges of a security or group of securities. Thus, on a
day a fund has net redemptions of more than 5%, it could calculate
market impact by referring to the appropriate grid that reasonably
approximates current market conditions and identifying the market
impact estimate for the assumed amount to be sold under the required
vertical slice analysis. If a fund uses grids to implement its market
impact calculations, it generally should review the grids periodically
and update them to account for recent market data. Under the rule, if a
fund encountered unforeseen market conditions not contemplated in
advance and the fund was not able to otherwise make a good faith
estimate of its liquidity costs, then the fund would rely on the 1%
default liquidity fee provision of the amended rule.\208\
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\207\ Funds may be able to leverage existing processes and
historical data from existing sources, including stress testing, to
develop and maintain such grids.
\208\ See Federated Hermes Comment Letter II (suggesting that
funds could develop schedules of estimated market impact costs
stratified by the size of trade for different classes of securities,
which would require periodic updating over time as market conditions
evolve, but that these schedules may not be able to reflect good
faith estimates in stressed conditions).
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After estimating the transaction costs and market impact costs of
selling a vertical slice of the fund's portfolio to meet net
redemptions, the fund will need to determine the liquidity fee amount,
as a percentage of the value of the shares redeemed, to fairly allocate
these costs across all redemptions. To do so, a fund will need
information about gross redemptions from each intermediary for that
day.\209\ We recognize that some intermediaries may currently provide
only net flow information to funds. In those circumstances, funds may
need to update their arrangements with intermediaries to obtain the
gross amount of redemptions in a timely manner.\210\ We also recognize,
as discussed above, that a fund may not have complete flow information
at the time it determines to apply a fee. The fund's board-approved
guidelines for implementing mandatory liquidity fees may want to
specify the time by which the fund will review its flow information for
purposes of calculating the liquidity fee amount. We recognize that
this time may differ among funds. For example, some funds (e.g., those
that typically settle the vast majority of shareholder purchase and
redemption activity on T+0) may use the same flow information they use
to determine if the fund has crossed the 5% net redemption threshold.
Other funds may determine to wait until a later point, particularly if
they have developed a method for applying a fee after a trade is
executed. As discussed above, some funds may develop such methods in
connection with applying liquidity fees
[…truncated; see source link]Indexed from Federal Register on August 3, 2023.
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