WASHINGTON — The Securities and Exchange Commission voted 3-2 on Wednesday to require institutional money market mutual funds to adopt a floating net asset value.
The SEC also imposed liquidity fees and redemption gates, changes that muni market groups have said will hurt the market as well as state and local governments.
The final rule allows funds investing in federal government securities, as well as "retail" funds that have policies and procedures in place designed to limit investors to "natural persons," to use a stable NAV. Natural persons means human beings, rather than business entities. The SEC also adopted discretionary redemption gates and liquidity fees of up to 2% if a MMF's level of weekly liquid assets falls below 30% of its total assets. A fund's controlling board could impose a fee or restrict redemptions in times of stress, giving the board time to figure out a way to meet those redemptions.
The changes, first proposed last year, are designed to prevent investors from causing a "run" on MMFs by pulling out of them in a scenario similar to one that occurred during the financial crisis in 2008.
"Today's reforms will fundamentally change the way most money market funds operate," SEC chairman Mary Jo White said prior to the vote. The commission could have chosen to adopt only the floating NAV or only the redemption gates and fees, but White said adopting one of the proposed reforms without the other would leave the commission's work "incomplete." There will be a two-year "transitional period" to allow money market funds to adjust to the changes.
Lawmakers and muni market participants have argued that these changes will make MMFs, which often purchase high-quality muni debt, less attractive to investors and deprive state and local governments of important financing tools. Federal lawmakers have joined in lobbying the SEC for a specific exemption for municipal funds. SEC staff said Wednesday that the commission believes such funds are likely to qualify as retail funds.
Groups such as the National Association of State Treasurers and Government Finance Officers Association have said that municipalities use MMFs as vehicles for short-term cash-flow management, which wouldn't be feasible under a floating NAV.
The groups have also said that local government investment pools will be damaged by the reforms. LGIPs operate in several states to help municipalities invest public funds safely and efficiently. They are designed to provide short-term investments for funds that are needed by governmental entities on a short-term basis. They operate like money market funds, but their clients are local governments. They are indirectly regulated by the SEC because the Governmental Accounting Standards Board mandates that money market-like funds be governed by money market fund rules.
Responding to concerns over how investors will calculate their tax obligations under a floating NAV, the Internal Revenue Service is expected to release guidance soon.
Commissioner Daniel Gallagher said the move to require institutional MMFs to adopt market-based pricing is a "common sense" change that shouldn't be viewed as heavy-handed government regulation. Commissioner Kara Stein, one of two "no" votes, opposed the idea of redemption gates because she worried that one fund's use of a gate could frighten investors in other funds and end up hurting the market. Commissioner Micheal Piwowar, the other dissenter, said the combination of a floating NAV with fees and gates is too heavy-handed and fails to preserve many of the desirable characteristics of money market funds. A better approach would be to allow investors to choose between funds that float the NAV and those that can impose fees and gates, Piwowar said.
The commission also voted to propose removing from the MMF rules the "objective" credit rating standard for determining which debt is of high enough quality for the fund, leaving the decision up to the board. That change was mandated by the Dodd-Frank Act.
