SEC Proposes Amendments to Money Market Fund Rules

The SEC proposed amendments to the requirements applicable to money market funds pursuant to ICA Rule 2a-7 (“Money Market Funds”) under the Investment Company Act that are generally aimed at preventing a run on money market funds during a time of financial crisis. The amendments were proposed in light of the significant redemptions experienced by money market funds at the start of the COVID-19 pandemic.

Regulatory Changes
The proposed amendments include:

increasing the amount of assets with daily liquidity that a money market fund must hold from 10 percent to 25 percent of its assets; and increasing the amount of assets with weekly liquidity that a money market fund must hold from 30 percent of its assets to 50 percent; funds would be required to institute stress tests to determine their minimum level of desired liquidity; the SEC asks for comment as to what requirements should be imposed on a fund that fails to maintain its required liquidity level;

removing from the existing money market funds rule the authority of funds to impose either gates on redemption or to impose liquidity fees on redeeming investors (the SEC said that such authority was counterproductive encouraging investors to redeem before the gates or fees could be imposed);

requiring institutional prime and institutional tax-exempt money market funds to implement swing pricing, which would permit adjustments to current net asset value per share when the fund has net redemptions (and result in redeeming investors bearing liquidity costs);

modifying certain reporting requirements on Forms N-MFP and N-CR to improve the availability of money market fund information, and making conforming changes to Form N-1A to reflect proposed changes to the regulatory framework for these funds;

adding provisions to address how money market funds with stable net asset values should handle a negative interest rate environment;

adding provisions that specify how funds must calculate weighted average maturity and weighted average life; and

imposing additional reporting requirements on money market funds, including that a fund must file a report when it falls below a specified liquidity threshold.

Comments on the proposal are due within 45 days after its publication in the Federal Register.

Commissioner Statements
SEC Chair Gary Gensler supported the proposal, saying the reforms will help maintain “fair, orderly, and efficient markets.” SEC Commissioner Allison Herren Lee called the proposal a “necessary continuation of our focus on addressing weaknesses of these funds.” She added that, with respect to the public comment period, she would like to better understand the “foreseeable impacts of swing pricing” and how it might impact investor choice. SEC Commissioner Caroline A. Crenshaw stated that both the SEC and investors would be better positioned to “monitor funds’ activities and evaluate the impact of market stress on those funds.”

SEC Commissioner Hester M. Peirce opposed the proposal, saying that, as in the existing rule, there is “too much regulatory prescription and too little room for experimentation by funds.” Ms. Peirce said the proposal could “undermine the objective of making money market funds more resilient” and would “continue the trend of driving more money into government funds.” Ms. Peirce said, such an outcome would leave investors, issuers and markets worse off. Ms. Peirce was supportive of the reform to eliminate the connection between liquidity thresholds and fees and gates.

SEC Commissioner Elad L. Roisman supported some elements of the proposal, including the effort to explore several measures that could reduce run risk for money market funds. However, he dissented and expressed “strong reservations” about the requirement that a “uniform approach to charge fees to redeeming investors” would be applied to all institutional non-government money market funds (emphasis in original). Further, he found the timing of the comment period to be a “major shortcoming,” saying that he did not have confidence that market participants will be able to provide meaningful feedback over a comment period that aligns with several holidays and five other proposed rulemakings.


There may be no area in securities law that is so conceptually difficult to create sound regulation as with respect to money market funds.  The central question is: how does one create a fund that maintains a fixed share value of $1, notwithstanding fluctuation in the value of the fund’s asset, and yet avoid having investors redeem when they believe that the true value of the fund is less than $1?  So far, mission not accomplished.  

Given the difficulty of the problem, Commissioner Peirce’s suggestion that the SEC should be less prescriptive and let different funds approach the problem differently makes sense.  After all, as the SEC concedes, the regulatory imposition of gates did not work.  Perhaps the SEC would do better to let the market experiment with solutions.

Why CFS Divisia Money Matters, Now!

My remarks at the Society for Economic Measurement illustrate how the world may have been different had CFS Divisia money been on the Fed’s dashboard.

Even today, CFS Divisia M4 suggests that growth may be better than expected.

Takeaways for investors and officials from our experience producing monetary aggregates and measuring money in the U.S. since 2012 include: 1) private sector versus state money, 2) deflation and inflation scares, 3) a damaged monetary transmission mechanism, 4) collapse in shadow banking, 5) shortage of financial market liquidity, and 6) ideas for the future.

Whether you are a Keynesian, Monetarist, or simply agnostic, monetary and financial measurement and its integration into policy is essential for the future.

For full remarks:

OFR Reports on Bilateral Repo Market

The Office of Financial Research (“OFR”) published quantitative information on bilateral repurchase agreement (“repo”) activities in the U.S. securities financing market. In addition, the OFR identified the three principal challenges involved in collecting this type of market data: (i) the limited scope of pilot data collection, (ii) the lack of data standards and (iii) separate data systems.

The OFR highlighted the following “next steps” to be taken in the U.S. securities financing market:

  • the development of permanent granular data collection of bilateral securities financing trades, which will “build on the lessons learned from this pilot data collection” and utilize consistent reporting definitions, concepts and requirements with collections that cover the triparty repo segment;
  • the implementation of mandatory data standards in order to reduce reporting burdens and improve data quality; and
  • the harmonization of reporting definitions, concepts and requirements by U.S. regulators (such as the Financial Stability Board) and international regulatory bodies.

Lofchie Comment: It would be helpful if the OFR explained how it picks the categories of financial risk that it elects to investigate. While it might be true that the selected securities activities pose a material risk to the economy, they certainly are not the activities that pose the greatest risk. Here are a few examples that might pose greater risk to the economy: the near insolvency of Puerto Rico, as well as the insolvency of a number of cities like Detroit, indicates that municipal bankruptcy is a greater long-term (or even short-term) threat to the economy than those risks that comprise the OFR’s current focus. The current low-interest-rate environment presents significant risk for pension plans that must achieve higher returns in order to meet fixed pension obligations. And threats of widespread bankruptcies in the energy sector remain. Yet despite all that, OFR appears to be focused resolutely on fully collateralized securities lending, seemingly without much regard for the genuine real-world risks that threaten economic stability in the United States.

WSJ features CFS monetary analysis and data…

This morning’s Wall Street Journal features CFS views and data in “Shadow-Credit Rise Is Good Sign” by Michael Casey on page C3.

The article highlights how CFS data on market finance or “shadow banking” can measure the durability of the recovery and help frame the policy debate in a balanced way.

A few highlights include:

“Seven years after the financial crisis, lending in the so-called shadow-banking system finally appears to have bottomed out, a reversal that could presage a long-awaited uptick in U.S. economic growth.”

“Extrapolations from CFS data show that the level of market finance is significantly below where its post-1967 trend would predict. In other words, a great deal of expansion is needed to bring this market back even to a level projected by its prebubble state. Until then, shadow banking will continue to do far less of the heavy lifting in credit creation than it used to.”

For the full article “Shadow-Credit Rise Is Good Sign,” please see page C3 of this morning’s paper or view

FRB Powell on Financial Stability Reform and Credit Markets

Federal Reserve Board (“FRB”) Governor Jerome H. Powell discussed financial stability reforms and cautioned against supervisory interventions that “lean against” the credit cycle. The Governor delivered his remarks at the Stern School of Business of New York University.

According to Mr. Powell, the agenda for financial stability reform that relates to global systemically important banks (“G-SIBs”), financial market infrastructure and money markets is well developed. With regard to G-SIBs, Mr. Powell discussed higher capital requirements, liquidity regulation and stress testing, and noted that regulators have yet to work through resolution procedures and address cross-border issues regarding the failure of G-SIBs. Concerning market infrastructure, Mr. Powell explored possible reforms to the tri-party repo market, including the elimination of reliance on discretionary intraday credit to facilitate settlements, as well as central clearing for standardized derivatives and margin requirements for uncleared derivatives. Mr. Powell noted, however, that regulators have yet to adopt liquidity, margin and other regulations applicable to central counterparty clearinghouses. Finally, with regard to money markets, Mr. Powell cited the Securities and Exchange Commission’s 2014 rule on money market fund reform, and discussed the ongoing development by the Financial Stability Board of global margin rules for securities financing transactions involving nongovernmental securities.

In contrast to the reform agenda for G-SIBs, financial market infrastructure and money markets, the basic agenda for financial stability reform relating to credit markets is less advanced, the Governor stated. He argued that the standard for regulatory intervention in credit markets should be higher than in other areas. In particular, he talked about the leveraged loan market, noting that because such loans generally were not held in investment structures that utilized short-term, confidence-sensitive funding, leveraged loans were not a principal source of runs during the financial crisis.

Mr. Powell argued that supervisors should remain alert to the emergence of run-prone financing structures in credit markets that could lead to fire sales, as well as to conditions that could pose risks to the safety and soundness of G-SIBs. However, Mr. Powell cautioned strongly against using supervisory interventions to “lean against” the credit cycle and expressed his skepticism concerning the ability of supervisors to accurately identify “dangerous” conditions. False positives, he noted, would have the effect of limiting the availability of credit unnecessarily by interfering with market forces.

For full remarks:

Representatives Garrett and McHenry Submit Letter to FRB Regarding Reverse Repo Facility

House Financial Services Subcommittee on Oversight and Investigations Chairman Patrick McHenry (R-NC) and Subcommittee on Capital Markets and Government Sponsored Enterprises Chairman Scott Garrett (R-NJ) submitted a letter to Board of Governors of the Federal Reserve System (“FRB”) Chair Janet Yellen, urging the FRB to discontinue its temporary overnight reverse repurchase facility (“RRP”) by the end of the year. 

According to Chairman Garrett and Chairman McHenry (collectively, “Chairmen”), there is concern that the use of the RRP could have a “significant negative impact on the U.S. economy,” a view which they stated is shared by several financial regulators. The Chairmen explained that the overall “lack of transparency” in the establishment of the RRP and the “potential for it to create financial instability if expanded” could inject needless uncertainty and volatility into financial markets. 

The Chairmen applauded the FRB’s recent decision to cap the use of the RRP at $300 billion per day, as well as its commitment to use the program only to the extent necessary. Nevertheless, the Chairmen asked that the FRB respond to their questions regarding the program no later than October 23, 2014. 

See: Chairmen Letter to FRB


SEC Issues Final Money Market Fund Reform Rules (Fed. Reg.)

The SEC adopted amendments to the rules that govern money market mutual funds under the Investment Company Act. According to the SEC, the amendments are designed to address money market funds’ susceptibility to heavy redemptions in times of stress, improve their ability to manage and mitigate potential contagion from such redemptions, and increase the transparency of their risks while preserving their benefits. 

Specifically, the SEC adopted amendments that are intended to:

  • remove the valuation exemption that permitted institutional non-government money market funds to maintain net asset value (“NAV”) per share, and require those funds to sell and redeem shares based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place; i.e., transact a “floating” NAV;
  • provide Boards of Directors of money market funds with new tools to stem heavy redemptions, as well as afford them the discretion to suspend redemptions temporarily;
  • require all nongovernment money market funds to impose a liquidity fee if the fund’s weekly liquidity level falls below a designated threshold;
  • increase the diversification of the portfolios of money market funds, enhance their stress testing, and improve transparency by requiring money market funds to report additional information to the SEC and investors; and
  • require the investment advisers to certain large unregistered liquidity funds to provide additional information about those funds to the SEC.

The effective date of these amendments is October 14, 2014. Other specific compliance dates will occur within the rule release.

Lofchie Comment: It will be interesting to see whether the new money market rules are satisfactory to the banking regulators, acting either through their bank regulatory caps or in the name of FSOC. Notably, in a recent speech, the President and CEO of the Federal Reserve Bank of Boston said this: “While I would have preferred even more protection against financial runs on money market mutual funds, this element of the recent rulemaking does represent a meaningful improvement. Still, I am certainly on record as questioning whether the imposition of withdrawal restrictions (‘gates’) and fees will help to stabilize money market mutual funds in crisis situations” [footnotes omitted].

See: 79 FR 47736.


New York Fed. President Dudley Discusses Short-Term Wholesale Funding Issues

Federal Reserve Bank of New York President William C. Dudley delivered opening remarks at the Workshop on the Risks of Wholesale Funding. The Workshop was held in New York on August 13, 2014 and was sponsored by the Federal Reserve Bank of Boston and the Federal Reserve Bank of New York.

Mr. Dudley’s remarks focused on the role of wholesale financing (such as money-market mutual funds and tri-party repo) in the financial crisis. As Mr. Dudley explained, in the years preceding the crisis, market participants came to rely on short-term funding to finance longer-term assets, creating maturity mismatches. This type of financing, especially when used to finance illiquid and opaque assets such as mortgage-backed securities, is inherently prone to bank runs and self-fulfilling prophecies of financial weakness.

But while these risks have long been recognized in the banking sector, where recurring bank runs were eventually eliminated with a combination of deposit insurance, the Federal Reserve’s role as “lender of last resort” and prudential regulation, they were not as effectively perceived or addressed in the “shadow banking” system. The financial crisis began when losses in the mortgage market forced market participants to sell assets, pushing prices down and spurring lenders to demand more margin. This created a vicious circle that made the weaknesses of the shadow banking system more apparent as the liquidity crisis spread with startling speed and severity.

The Federal Reserve (“Fed”) and the U.S. Treasury Department (“Treasury”) stepped in with a number of programs designed to inject liquidity into the system and stabilize the markets. The Fed intervened in the tri-party repo markets, money-market mutual funds, and even directly in the market for commercial paper, among other places. Although these stopgap measures were effective at that time, Mr. Dudley argued, they were not a sufficient response to the weaknesses of the shadow banking system, especially since Dodd-Frank imposed more stringent conditions on the Fed’s authority to engage in emergency lending in the future. The Workshop on the Risks of Wholesale Funding was organized as part of the Fed’s ongoing efforts to increase the stability of the U.S. financial system. Below is a link to a PDF of the agenda for the workshop that, in turn, contains links to several papers that were presented. One of the topics discussed was whether the Bankruptcy Code’s safe harbor for repurchase transactions should be reconsidered and potentially limited to liquid securities (and not, for instance, to mortgage-backed securities).

See: President and CEO of the New York Federal Reserve Bank William C. Dudley’s Remarks at the Workshop on the Risks of Wholesale Funding.
Related news: The President of the Federal Reserve Bank of Boston’s Remarks on Broker-Dealer Capital (August 13, 2014).


SEC Adopts Money Market Fund Reform Rules

The SEC adopted amendments to the rules that govern money market mutual funds. According to the SEC, these amendments build on the reforms adopted in March 2010, and make structural and operational reforms to address mitigating the risks of investor runs on money market funds while preserving the benefits of the funds.

Specifically, the new rules require a floating net asset value (“NAV”) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets. The rules also provide non-government money market fund boards new tools, such as liquidity fees and redemption gates, to address runs. 

With a floating NAV, institutional prime money market funds are required to value their portfolio securities using market prices. These funds can sell and redeem shares based on a floating NAV. These funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.00. With liquidity fees and redemption gates, money market fund boards have the ability to impose fees and gates during periods of stress. The final rules also include enhanced diversification, disclosure and stress testing requirements, as well as updated reporting by money market funds and private funds that operate like money market funds.

The final rules provide a two-year transition period to enable funds and investors time to fully adjust their systems. 

According to SEC Chair White, the reforms “fundamentally change the way that money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system.”

The SEC also issued a notice proposing exemptions from certain confirmation requirements for transactions effected in shares of floating NAV money market funds. Additionally, the SEC re-proposed amendments to the SEC’s money market fund rules and Form N-MFP to address provisions that reference credit ratings, which is consistent with the Dodd-Frank requirements that the SEC review and replace rules that use credit ratings as an assessment of creditworthiness.

Lofchie Comment: The statements from the various SEC Commissioners make for interesting reading in that they all reflect some degree of uncertainty or skepticism as to the new rules (leaving aside the statement from Chair White, from whom such a comment would arguably have been less appropriate). That uncertainty seems to be a prudent reaction to rule changes that are likely to be significant to the money market globally.

The Commissioners’ comments also seemed to reflect ongoing dialog, and perhaps tensions, with the banking regulators and with FSOC. See, for example, the statement by Commissioner Piwowar in which he noted that if banking regulators are concerned at the over-reliance by banks on the use of money market funds, that over reliance should be addressed by the bank regulators oversight of banks. On the other hand, Commissioner Stein seemed to suggest in her statement that the SEC should generally defer to the Financial Stability Oversight Council, which, according to Commissioner Stein “must continue to play a leading role” and is “uniquely positioned to tap the expertise of each regulator.” For its part, FSOC released a brief statement that it “looks forward to more fully examining the SEC’s rule and its potential impact on [money market funds] and financial stability,” which seems to be less than a full endorsement.

See: Text of Money Market Fund Reform Final Rules and Amendments to Form PF; Text of Re-Proposed Rule to Remove Credit Ratings References in Money Market Fund Rule; Money Market Proposed Permanent Exemption; SEC Press Release.
See also: Chair White’s Statement; Video of Chair White’s Statement; Commissioner Gallagher’s Statement; Commissioner Piwowar’s Statement; Commissioner Aguilar’s Statement; Commissioner Stein’s Statement; FSOC Statement on Rules; SIFMA Statement on Rules.


Commissioner Stein Discusses FSOC and Capital Regulations for Broker-Dealers

In a speech before the Peterson Institute of International Economics, SEC Commissioner Kara M. Stein discussed several key areas where the SEC must play a critical role in addressing systemic risks. 

Commissioner Stein acknowledged the seriousness of the fact that many substantive Dodd-Frank reforms have yet to be implemented, and that advancements on the systemic risk front have been generally mixed at best so far.  However, she went on to point out what she saw as some successes: the FSOC is meeting regularly, the OFR is operational and has over 200 staffers monitoring and assessing threats to financial stability, the Volcker Rule is finalized, and the largest banks are submitting resolution plans.

Commissioner Stein remarked that the SEC must do better to identify and mitigate the buildup and transmission of risks that can “take down our entire financial system,” and offered the following suggestions for the SEC:

  1. think broadly and cooperatively with fellow regulators, both domestic and international;
  2. focus on improving the stability and resiliency of the short-term funding markets, including securities lending and repo agreements; and
  3. re-examine how the SEC evaluates capital, leverage, and liquidity within the financial institutions and funds it regulates.

As to her first recommendation, Commissioner Stein stated that the FSOC should be a starting point. She noted that the point of the FSOC was for regulators with expertise in particular areas to identify potential risks, and then enlist the help of the entire council to address them.  The common purpose is to “make sure the foundation of our financial markets is strong so it can support a strong and thriving economy.”  Commissioner Stein remarked that she fears the FSOC’s individual members are become bogged down in regulatory turf wars.

Regarding short-term funding markets, Commissioner Stein noted that the SEC is working hard on rules to prevent runs on money market funds, and that there have been a lot of discussions about capital, insurance, floating net asset values, redemption fees, gates, and restricting sponsor support.  Commissioner Stein mentioned the SEC’s efforts to soon finish a money market fund rule, but cautioned the rule would only address part of the issues and some of the lenders. She further suggested that in order to create stability the regulators need to address the borrowers and the intermediaries. 

On the subject of capital, leverage, and liquidity, Commissioner Stein urged the SEC to revisit and enhance some of its rules. The SEC, she noted, has historically had broad powers to regulate the financial responsibility of broker-dealers, but it has always viewed the regulation from the standpoint of investor or customer protection, not systemic risk. She further remarked that the goal of the SEC’s capital regime generally has been “somewhat agnostic as to the failure of the firm itself, focusing instead on ensuring the return of assets to the firm’s customers.”  Given the systemic risks posed by some of the firms regulated by the SEC, Commissioner Stein urged the agency to revise its reasoning for imposing capital requirements to reflect not only its historical objective to protect a firm’s customers, but also reduce the risk to the entire financial system of a large broker-dealer’s collapse. She further encouraged the SEC to (i) reconsider what constitutes capital, (ii) require some meaningful minimum haircuts for all types of securities lending and repos, and (iii) recognize the importance of liquidity, among other things.

Commissioner Stein concluded by stating that all of these efforts “should not attempt to wring risk out of the capital markets, but [should] instead be focused on strengthening the fabric of our entire financial system.” 

Lofchie Comment:  In this speech, Commissioner Stein establishes a position as the most vocal proponent of Dodd-Frank and, thereby, of imposing further substantial regulatory burdens on broker-dealers.

Commissioner Stein comes to the defense of the Financial Stability Oversight Council (“FSOC”), an agency that has been roundly criticized by Commissioners of both parties for overstepping its expertise.  Commissioner Stein lends significant support to the notion that the FSOC might mandate capital regulation of private investment funds, saying:  “We must also keep a close eye on other market participants that can cause . . . systemic shocks.  In particular, we should closely monitor investment funds, such as large hedge funds, that may be highly levered and interconnected to other players in our financial markets.” 

As to broker-dealers, Commissioner Stein expresses conservative views as to the way in which regulatory capital should be computed. She challenges the notion that “subordinated debt” should be considered “good” capital for regulatory purposes, describing it as “supposedly ‘sticky’ funding”.  She also criticizes the SEC’s 2004 net capital rule changes that reduced capital haircuts for certain positions held by broker-dealers, and then goes on to say that these reduced “regulatory costs [were] ultimately accomplished at great cost to broker-dealers, investors, our economy, and American taxpayers.”  This is an interesting conclusion, as there is no obvious link between the 2004 rule changes and the financial crisis, and the Commissioner does not draw one.  If the goal of regulators is to force securities derivatives out of banks, then the 2004 capital changes (and more like them) are absolutely essential. Without them, it would be impossible to book derivatives into broker-dealers as well as into banks (essentially forcing U.S. financial institutions out of the business of being dealers). Lastly, Commissioner Stein advocates higher capital charges on broker-dealer financing businesses, such as margin lending, repurchase agreements, and securities lending. 

The types of changes advocated by Commissioner Stein would significantly impede the ability of U.S. broker-dealers to act as intermediaries in credit and financing transactions, or would at least materially raise the costs imposed on broker-dealers engaged in such transactions. 

If the Commissioner’s comments reflect the direction of future SEC regulation, financial market customers will face an altered landscape.  Financial market customers, looking to the long term, will be forced to consider whether the securities financing markets can even continue in their current form or whether some substitution will be necessary, perhaps in the form of customer-to-customer financing or accessing overseas credit markets.

See: Commissioner Stein’s Remarks.