Over its life span of more than 30 years, Rule 2a-7, which governs the management of U.S.-registered money market funds (MMF), has gone through no fewer than 5 updates. In 2010, as a result of the Reserve Fund’s “breaking of the buck” during the 2008 market crisis set off by the Lehman Brothers default, we saw the most drastic changes to the rule since 1997. In July 2014, after several years of debate and discussion, the most recent changes to the rule, which will come into effect between now and October 2016, were announced.
Institutional prime money market funds are significantly impacted by the changes, however, government, and municipal money market funds will also need to make specific changes in how they operate. Additionally, all MMF will need to decide whether and how to utilize new tools provided to them by the law in order to prevent future runs on their assets by shareholders.
Below is an overview of key changes that are laid out by the rule, followed by recommendations for how to prepare for them.
Liquidity fees & redemption gates
In order to determine whether these new tools, including liquidity fees or redemption gates, should, or can, be imposed on shareholders during a period of market turmoil, all MMFs (excluding government funds, which are exempt from the following unless they decide otherwise) will need to monitor their weekly liquid assets, meaning the percentage of their assets made up of cash, U.S. Treasury securities, and equivalent assets which mature in less than five business days. When the percentage of a fund’s total assets invested in such assets goes below 30%, a fund’s board can begin implementing the liquidity fees and/or redemption gates. If weekly liquid assets fall below 10%, a liquidity fee of 1% must be imposed unless the fund’s board believes that it is not in the best interests of the fund. Liquidity fees are defined as a financial penalty imposed on fund share redemptions during periods of market turmoil, while redemption gates permit funds to temporarily suspend redemptions during similar periods.
In order to promote transparency around the value of institutional prime money market funds, the NAV of such MMF will need to be calculated on a daily basis based on the market value of securities held in the fund, as opposed to being calculated based on the amortized cost of the securities and ensuring that a stable $1 NAV is maintained, as is currently the case. Furthermore, these calculations may need to be made multiple times during the day, as the updated law calls for shareholders to be able to redeem shares intraday.
Compliance Guideline Changes
There are several notable guideline changes which will impact the daily compliance monitoring of MMF.
For example, government MMFs will now need to maintain 99.5% of their assets in securities, cash, or repurchase agreements collateralized completely by US government securities, as opposed to the previous 80% minimum.
From a diversification standpoint, the determination of what an issuer is will also be tightened, as affiliated companies (meaning those having a parent which controls two or more companies) will need to be aggregated for purposes of the 5% issuer test.
An additional change requires the sponsors of asset-backed securities (ABS) to be considered to be the guarantors of the ABS, and to be subject to the 10% of assets in any one guarantor limitation (unless the board of a MMF determines that they are not relying on the credit of the sponsor). It should also be noted, that for non-municipal MMF, the 25% basket in 10% guarantors for guarantees issued by non-controlled parties will be done away with, leaving a strict 10% of assets limit for all guarantors.
Similarly, municipal MMF, will only be able to invest up to 15% of their assets in any one guarantor exceeding 10% of a fund’s assets, as opposed to the current 25% limit.
With that in mind, here are our suggestions for how to best prepare for the latest changes to the rule:
Determine if and how your firm is impacted. Which of the above mentioned changes will impact your firm? Depending on what kind of MMFs are offered, and how they are currently managed, the effect could either be far-reaching, or more tempered.
Assemble a steering committee. As with any regulatory change, all impacted parties will need to be kept abreast of what the change will involve, and should have a seat at the table when deciding how to implement the response to the changes. Open the net as far as possible regarding which areas to include: portfolio management, trading, IT, compliance, etc. Depending on how your firm is structured, it is likely that either the legal or compliance area will be best suited to head up the initiative.
Develop a project plan with deadlines and target dates. The effective date for most requirements is now less than 18 months away, however prior to the changes being announced, some industry experts predicted that it could take up to 3 years to implement all the changes. This implies that the task at hand will be significant, and that there is little time to waste. Accordingly, responses to each change should be prioritized based on expected amount of resources needed to implement, and appropriate work-streams should be created.
Reach out to technology vendors and consultants to understand how to best leverage your systems to meet the new requirements. Instead of starting from ground zero in your initiatives to meet the new requirements, check with your technology and data vendors to see what efforts they may be undertaking in order to assist you with the changes. Will your data vendor be aggregating 2a-7 affiliated issuers? Is your fund accounting system already effective at calculating a floating NAV (for example, can it price a floating-rate fund intraday, and can it price to four decimal places as opposed to the current two)?
Consultants can be valuable resources in helping you to scope out your needs and provide expertise to bring you across the finish line as efficiently as possible. In order to effectively comply with these high profile SEC requirements, an outside resource may play a crucial role in ensuring a smooth, company-wide transition to a new rule 2a-7 landscape.
This article was authored by Roger Binggeli, Senior Compliance Consultant. For more information, please contact Roger at firstname.lastname@example.org or Jane Stabile at email@example.com. Roger can also be reached on 617-314-7415 x118.