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Money Market Funds — What’S Next?

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Money Market Funds — What’S Next? Vol. 18, No. 6 • June 2011 Money Market Funds — What’s Next? by Jack W. Murphy, Stephen T. Cohen and Sumeera Younis ven after significant regulatory reform, money market funds remain a potential target for additional oversight and regulation. This article briefly reviews the key steps taken by lawmakers and regulators since E the events of September 2008. It then discusses further changes that may be proposed and offers alternative approaches in an effort to resolve the question of “What’s next?” Introduction funds struggling to meet heavy redemptions. On September 15, 2008, Lehman Brothers In the wake of those events, the Securities Holdings Inc. filed for Chapter 11 bankrupt- and Exchange Commission (SEC) proposed cy protection, causing the Reserve Primary and adopted extensive amendments to Rule Fund to become the second money market 2a-7 under the Investment Company Act of fund in history to break the dollar share price 1940, as amended (the 1940 Act), which were and triggering a widespread “flight to qual- designed to address many of the issues with ity” which left many prime money market which money market funds grappled during the weeks following the Lehman bankruptcy. Mr. Murphy is a partner, and Mr. Cohen and Ms. Notwithstanding those amendments, how- Younis are associates, in the Financial Services ever, lawmakers, regulators and industry Group of Dechert LLP. From 1994 to 1997, Mr. leaders have continued to engage in a discus- Murphy served as Associate Director and Chief sion about whether additional regulatory Counsel of the SEC’s Division of Investment changes are necessary to address perceived Management. issues relating to the money market fund industry and, if so, what form those changes The 2010 Rule 2a-7 Amendments should take. In February 2010, the SEC adopted amend- The public debate about the future of the ments to Rule 2a-7 and other rules governing money market fund industry has taken place money market funds (the Amendments).1 K e y against the backdrop of the Dodd-Frank Wall provisions of the Amendments require money Street Reform and Consumer Protection Act market funds to: of 2010 (Dodd-Frank). While not directed specifically at money market funds, Dodd- • Comply with enhanced portfolio quality Frank created the Financial Stability Oversight and maturity requirements; Council (FSOC), which is tasked with the responsibility for identifying and designating • Comply with stringent portfolio liquid- as systemically significant nonbank financial ity requirements; companies (Significant Nonbanks) and sub- jecting those entities to prudential regulation • Periodically “stress test” the fund’s abil- by the Board of Governors of the Federal ity to maintain a stable $1.00 net asset Reserve System (FRB). Money market funds value (NAV) per share upon the occur- and their sponsors are among the non-bank rence of certain hypothetical events; financial companies that have been suggested as possible targets of FSOC consideration. • Disclose fund portfolio and other infor- Adding fuel to the fire of the debate is the mation in public Web site postings on a report of the President’s Working Group on monthly basis; Financial Markets (PWG) on “Money Market Fund Reform Options” (the PWG Report). • Electronically report portfolio and The PWG Report, which was subsequently other information to the SEC on Form published by the SEC for public comment, N-MFP; and identified several perceived issues raised (or at least not addressed) by the manner in which • Be able to process transactions at prices money market funds currently are operated other than a stable $1.00 NAV no later and regulated. Most recently, on May 10, 2011, than October 31, 2011. the SEC hosted a roundtable discussion on money market funds and systemic risk where The Amendments also adopted Rule 22e-3, industry participants and regulators, including which permits a money market fund to sus- members of the FSOC, came together to dis- pend redemptions of its shares in anticipation cuss the future of money market funds. of the liquidation of the fund. The SEC also Clearly, therefore, money market funds broadened the relief provided by Rule 17a-9, remain in the spotlight and additional regula- which now permits fund affiliates to purchase tory measures (whether from the FSOC, the portfolio securities from money market funds, FRB and/or the SEC) may be forthcoming. subject to a “claw-back” requirement that This article will briefly review the key steps that any profit realized from a subsequent sale of have been taken since the events of September a purchased security (other than a security 2008. It will then discuss some of the regulatory that is in default or is no longer an Eligible and structural changes that have been proposed Security under Rule 2a-7) must be returned by industry participants and others to further to the fund. strengthen the ability of money market funds Although the Amendments were compre- to operate in the face of future crises. The pur- hensive in scope, at the time they were adopted pose of the article is not to suggest that there is SEC Chairman Mary Schapiro characterized a “silver bullet” that can cure all of the real and them as “an important first step in our efforts imagined ills surrounding the money market to strengthen the money market regime.” 2 fund industry. Rather, the purpose is to encour- This statement and other statements made by age those engaged in the debate to give serious the SEC and its Staff indicate that addition- consideration to the proposals described as al modifications to the SEC’s regulation of they determine the next steps to be taken. money market funds may yet be forthcoming. THE INVESTMENT LAWYER 2 Implications of the Implementation non-delegable and must be made by a vote of of Dodd-Frank for Money no less than two-thirds of the FSOC’s voting Market Funds members then serving, including an affirma- tive vote by the Chairperson. Designation as a On July 21, 2010, President Obama signed Significant Nonbank would cause a financial into law Dodd-Frank, 3 which made sweeping company to become subject to a set of pru- changes to the supervisory and regulatory dential standards and requirements, including regime governing the US financial markets. heightened capital and liquidity requirements, Among the most significant aspects of the new to be developed and implemented by the FRB, law for money market funds are: (i) the estab- either on its own initiative or pursuant to rec- lishment of the FSOC; and (ii) a requirement ommendations of the FSOC under Sections to remove references to Nationally Recognized 165 and 166 of Dodd-Frank. Statistical Rating Organizations (NRSROs) Section 113(a)(2) of Dodd-Frank sets forth from SEC rules, including Rule 2a-7. ten specific factors for the FSOC to con- sider when determining whether to make a Establishment of the FSOC Significant Nonbank designation: Title I of Dodd-Frank established the (1) Leverage . The extent to which the com- FSOC, a new body charged with monitor- pany’s assets are or may be leveraged; ing systemic risks to the US financial sys- (2) Off-balance-sheet exposures . The extent tem. Chaired by the Secretary of the US and nature of any off-balance-sheet expo- Department of the Treasury (Treasury), the sures of the company; FSOC is comprised of representatives from (3) Significant Transactions and Relationships . each of the major financial regulatory agen- The extent and nature of the transac- cies and has ten voting members and five tions and relationships of the company nonvoting members. 4 Under Section 113 of with other significant nonbank financial Dodd-Frank, the FSOC is given broad author- companies and significant bank holding ity to designate Significant Nonbanks and to companies; subject those companies to prudential regula- (4) Credit for Businesses and Governments . tion by the FRB. In addition, Section 120 of The importance of the company as a Dodd-Frank gives the FSOC the authority to source of credit for households, business- recommend that a primary financial agency, es, and state and local governments and as such as the SEC, apply new or heightened a source of liquidity for the US financial standards and safeguards to significant finan- system; cial activities (Significant Financial Activities) (5) Credit for Underserved Populations . The conducted by entities under its jurisdiction. importance of the company as a source of credit for low-income, minority, or under- Authority to Designate served communities, and the impact that Signifi cant Non-Banks the failure of such company would have on the availability of credit in such com- Section 113 of Dodd-Frank empowers the munities; FSOC to determine that a “nonbank financial (6) Assets Under Management . The extent company” shall be supervised by the FRB and to which assets are managed rather than be subject to prudential standards. To make owned by the company and the extent to this determination, the FSOC must conclude which ownership of assets under manage- that material financial distress at the US non- ment is diffuse; bank financial company, or the nature, scope, (7) Size, Complexity, and Interconnected ness, size, scale, concentration, interconnectedness, etc . The nature, scope, size, scale, concen- or mix of its activities, could pose a threat to tration, interconnectedness and mix of the the financial stability of the United States. The activities of the company; FSOC’s determination to designate a nonbank (8) Existing Regulation . The degree to which financial company as a Significant Nonbank is the company is already regulated by one 3 Vol. 18, No. 6 • June 2011 or more primary financial regulatory prudential standards specified for Significant agencies; Nonbanks are either already addressed more (9) Financial Assets . The amount and nature comprehensively in current money market of the financial assets of the company; fund regulations or would be an inappropriate and fit for money market funds.9 (10) Liabilities .
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