Rule 2a-7 Money Market Amendments

Transcription

1 Rule 2a-7 Money Market Amendments January 2010 None of the information contained in this document should be interpreted, construed, or relied upon as regulatory, legal, compliance or other professional advice and is offered on a blind basis without knowledge of your particular facts and circumstances. Readers are encouraged to seek the advice of their own legal counsel with the respect to the effect on their business Beacon Hill Fund Services, Inc

2 Introduction Money market funds are open-end management investment companies, registered under the Investment Company Act of 1940 (the 1940 Act ) that invest in high-quality, short-term debt instruments such as commercial paper, Treasury bills and repurchase agreements. Money market funds pay dividends that reflect prevailing short-term interest rates and, unlike other investment companies, maintain a stable net asset value, generally $1.00 per share. All money market funds are subject to Rule 2a-7 which, among other things, facilitates money market funds ability to maintain a stable net asset value per share by permitting them to use the amortized cost method of valuation. 1 To reduce the likelihood of a material deviation occurring between the amortized cost value of a portfolio and its market-based value, the rule contains several conditions that limit the fund s exposure to certain risks, such as credit quality and interest rate risks. During , money market funds were exposed to substantial losses, first as a result of debt securities issued by structured investment vehicles, and then by the default of debt securities issued by Lehman Brothers Holdings Inc. All but one of the funds that were exposed to losses from SIV and Lehman Brothers securities obtained support of some type from their advisers or other affiliate. The cumulative effect of these events and the general turbulence in the financial markets, led to a run on taxable prime money market funds, which contributed to severe dislocations in short-term credit markets. On September 19, 2008, the Treasury Department and the Federal Reserve Board announced an unprecedented intervention in the short-term markets. The Treasury Department announced the Temporary Guarantee Program, which temporarily guaranteed certain investments in money market funds that decided to participate in the program. The Federal Reserve Board announced the creation of its Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, through which it extended credit to U.S. banks and bank holding companies to finance their purchases of high-quality asset backed commercial paper from money market funds. These programs were effective in containing the run on money market funds and providing the necessary additional liquidity. The Investment Committee Institute s Money Market Working Group ( ICI Working Group ), established in November 2008, conducted a wide ranging study of the money market industry and submitted a series of recommendations designed to make money market funds more resilient in the face of extreme market conditions such as those encountered in September Under the amortized cost method, portfolio securities generally are valued at cost plus any amortization of premium or accumulation of discount. The basic premise underlying money market funds use of the amortized cost method of valuation is that high-quality, short-term debt securities held until maturity will eventually return to their amortized cost value, regardless of any current disparity between the amortized cost value and market value, and would not ordinarily be expected to fluctuate significantly in value. 1

3 On January 27, 2010, the SEC adopted new rules and rule amendments governing the operation of money market funds, many based on the recommendations of the ICI Working Group. Those rule changes are intended to: ~ limit the risks money market funds may assume by; requiring them to increase the credit quality of fund portfolios and to reduce the maximum weighted average maturity of their portfolios, requiring money market funds to maintain liquidity buffers that will help them withstand sudden demands for redemptions; and requiring fund managers to stress test their portfolios against potential economic shocks such as sudden increases in interest rates, heavy redemptions, and potential defaults ~ provide investors with more timely, relevant information about fund portfolios to hold fund managers more accountable for the risks they take and improve the SEC s ability to oversee money market funds; and ~ provide an orderly way for a fund that has broken the buck or suffered a run to wind down its operations in a manner that is fair to the fund s investors and reduces the risk of market losses that could spread to other funds. The following chart summarizes the content and the applicable compliance dates of the amendments. 2

4 I. Portfolio Quality The amendments to rule 2a-7 reduce the amount of credit risk a money market fund may assume by limiting the securities in which money market funds may invest and bringing greater definition to the way that NRSRO ratings are used in the rule. A. Second Tier Securities The amended rule places tighter limits on a money market fund's ability to acquire lower quality securities by: ~ Restricting a fund from investing more than 3 percent of its assets in Second Tier securities. 2 ~ Restricting a fund s investment in Second Tier securities issued by any single issuer to ½ of 1 percent of its total assets. ~ Restricting a fund from buying Second Tier securities that mature in more than 45 days. The old rule restricts a money market fund from: ~ Investing more than 5 percent of its assets in Second Tier securities. ~ Investing more than 1 percent or $1 million of its assets in Second Tier securities issued by any single issuer. ~ Investing in Second Tier securities that mature in more than 397 days. Amended Rule 2a-7(c)(3)(ii) Amended Rule 2a-7(c)(4)(i)(C) Definitions: eligible security: Amended Rule 2a-7(a)(12) second tier security: Amended Rule 2a-7(a)(24) total assets: Amended Rule 2a-7(a)(27) 2 The amendments apply the new limit on second tier securities holdings to all money market funds, including tax-exempt funds. Current rule 2a-7 limits taxexempt funds holdings of second tier securities only with respect to conduit securities. 3

5 B. Ratings Organizations The amended rule requires funds to designate in the registration statement each year at least four rating agencies whose ratings the fund's board considers to be reliable and eliminates the requirement that funds invest only in asset backed securities that have been rated by a rating agency. The amended rule continues to limit a money market fund's investment in rated securities to those securities rated in the top two rating categories (or unrated securities of comparable quality) and also continues to require funds to perform an independent credit analysis of every security purchased. The old rule limits a money market fund to investing in securities rated in the top two rating categories (or unrated securities of comparable quality) and require funds to perform an independent credit analysis of every security purchased. Amended Rule 2a-7(c)(11) Amended Rule 2a-7(c)(23) Amended Rule 2a-7(c)(3) Definitions: NRSRO: Securities Exchange Act of (a)(62) eligible security: Amended Rule 2a-7(a)(12) first tier security: Amended Rule 2a-7(a)(14) second tier security: Amended Rule 2a-7(a)(24) 4

6 II. Portfolio Maturity The SEC has amended rule 2a-7 to further restrict the maturity limitations on a money market fund s portfolio to reduce the exposure of investors to certain risks, including interest rate risk, spread risk, and liquidity risk. The amended rule shortens the average maturity limits for money market funds by: ~ Restricting the maximum weighted average maturity ( WAM ) of a fund's portfolio to 60 days. ~ Restricting the maximum weighted average life ( WAL ) maturity of a fund's portfolio to 120 days. 3 The old rule requires a money market fund to maintain a dollarweighted average portfolio maturity of 90 days or less and did not include a "weighted average life" maturity limitation. Amended Rule 2a-7(c)(2) 3 The term "weighted average life" is not actually used in the rule amendments, although it is used in the Adopting Release. A definition derived from the rule would be: a dollar weighted average portfolio maturity determined without reference to the exceptions in Rule 2a-7(d) regarding interest rate readjustments. See: Rule 2a-7(c)(2)(iii). 5

7 III. Portfolio Liquidity The SEC has amended rule 2a-7 to require money market funds to evaluate their need for, and to maintain sufficient liquidity to meet redemption requests. A. General Liquidity Requirements The amended rule requires funds to develop procedures to evaluate the volatility of its cash flows and to maintain sufficient liquidity to meet reasonably foreseeable redemptions. There is no current requirement that is analogous to this. Amended Rule 2a-7(c)(5) B. Illiquid Securities The amended rule restricts the ability of money market funds to invest in illiquid securities by: ~ Restricting money market funds from purchasing illiquid securities if, after the purchase, more than 5 percent of the fund's portfolio will be illiquid securities. ~ Redefining as "illiquid" any security that cannot be sold or disposed of within seven days at carrying value. The old rule restricts money market funds from purchasing illiquid securities if, after the purchase, more than 10 percent of the fund's portfolio will be illiquid securities. Amended Rule 2a-7(c)(5)(i) Definitions: illiquid security: Amended Rule 2a-7(a)(19) 6

8 C. Minimum Liquidity Requirements The amended rule requires money market funds to have a minimum percentage of their assets in liquid securities: ~ Daily Requirement: For all taxable money market funds, at least 10 percent of assets must be in daily liquid assets - (i) cash; (ii) Treasury securities; and (iii) securities that will mature or are subject to a demand feature that is exercisable and payable within one business day. ~ Weekly Requirement: For all money market funds, at least 30 percent of assets must be in weekly liquid assets - (i) cash; (ii) Treasury securities; and (iii) securities that will mature or are subject to a demand feature that is exercisable and payable within five business days. There are no current liquidity requirements analogous to those in the amended rule. Amended Rule 2a-7(c)(5)(ii) and (iii) Definitions: daily liquidity requirement: Amended Rule 2a-7(a)(8) weekly liquidity requirement: Amended Rule 2a-7(a)(32) 7

9 D. Stress Testing Requirement The amended rule requires fund managers to examine the fund's ability to maintain a stable net asset value per share in the event of shocks - such as interest rate changes, higher redemptions, and changes in credit quality of the portfolio. Previously, there were no stress test requirements. There is no current requirement that is analogous to this. Amended Rule 2a-7(c)(10)(v) 8

10 IV. Repurchase Agreements The SEC has adopted two amendments to rule 2a-7 that affect fund investments in repurchase agreements for purposes of rule 2a-7 s diversification provisions. The amended rule strengthens the requirements for allowing a money market fund to "look through" the repurchase issuer to the underlying collateral securities for diversification purposes by requiring that: ~ Collateral must be cash items or government securities. ~ The fund must evaluate the creditworthiness of the repurchase counterparty. The old rule allows a money market fund to "look through" the repurchase issuer to the underlying collateral securities for diversification purposes Amended Rule 2a-7(c)(4)(ii)(A) See also: Rule 5b-3 Definitions: Collateralized fully: Amended Rule 2a-7(a)(5) 9

11 V. Disclosure Requirements The SEC has adopted amendments that require money market funds to disclose information about their portfolio holdings each month on their websites and to make a monthly filing with the SEC of more detailed portfolio holdings information. Monthly Web Site Posting: The amended rule requires money market funds to post their WAM, WAL and monthly portfolio holdings on their web site for a period of not less than six months, beginning no later than the fifth business day after each month end. Monthly Reporting: A new rule requires money market funds to file Form N-MFP with the SEC no later than five business days after the end of each month. Form N-MFP will provide detailed portfolio schedules in a format that can be used to create an interactive database, including a money market fund's "shadow" NAV, or the mark-to-market value of the fund's net assets, rather than the stable $1.00 NAV at which shareholder transactions occur. The filing will be made available to the public sixty days after the end of the month to which the information pertains. There is no current requirement that a money market fund post information on a web site. SEC Interim Final Rule 30b1-6T requires the reporting of basic securities portfolio information to the SEC. Amended Rule 2a-7(c)(12) Rule 30b1-7 Form N-MFP 10

12 VI. New Operational Requirements The SEC has amended rule 2a-7 to require funds to have the capacity to redeem shares at the fund s current net asset value per share; to allow the suspension of redemptions and to allow affiliates to purchase distressed assets. Processing of Transactions: The amended rule requires money market funds and their administrators to be able to process purchases and redemptions electronically at a price other than $1.00 per share. This requirement facilitates share redemptions if a fund were to break the buck. Suspension of Redemptions: A new rule permits a money market fund's board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund. In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule. Purchases by Affiliates: Amendments to Rule 17a-9 expand the ability of affiliates of money market funds to purchase distressed assets from funds in order to protect a fund from losses. Amendments to Rule 2a-7 require reporting to SEC with respect to these transactions. There are no current requirements that are analogous to these. Amended Rule 2a-7(c)(13) Rule 22e-3 Rule 17a-9 Amended Rule 2a-7(c)(7)(iii) 11

13 VII. Compliance Dates The amendments to rules 2a-7 and 17a-9, and new rules 22e-3 and 30b1-7, and new Form N-MFP become effective May 5, Amended Rule 2a-7 Amendments to Rule 2a-7 that relate to: ~ Portfolio Quality; ~ Portfolio Maturity; and ~ Portfolio Liquidity Compliance Date May 28, 2010 Funds are not required to dispose of portfolio securities owned, or terminate repurchase agreements entered into, as of the time of adoption of the amendments to comply with the requirements of the rule as amended. June 30, 2010 Fund portfolios must meet the new maximum Weighted Average Maturity and Weighted Average Life limitations. Website Disclosure October 7, 2010 The compliance date for public website disclosure. Rule 30b1-7 Filing December 7, 2010 All money market funds must begin filing information on Form N-MFP pursuant to rule 30b1-7. Designation of NRSRO December 31, 2010 Each fund must disclose the designated NRSROs in its Statement of Additional Information. Transaction Processing Requirements October 31, 2011 Funds must comply with the new requirement to be able to process transactions at prices other than a stable net asset value. 12