Money Market Fund Reform; Amendments to Form PF

Federal RegisterAug 14, 2014

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270, 274 and 279

[Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13]

RIN 3235-AK61

Money Market Fund Reform; Amendments to Form PF

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to the rules that govern money market mutual funds (or “money market funds”) under the Investment Company Act of 1940 (“Investment Company Act” or “Act”). 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, as much as possible, their benefits. The SEC is removing the valuation exemption that permitted institutional non-government money market funds (whose investors historically have made the heaviest redemptions in times of stress) to maintain a stable net asset value per share (“NAV”), and is requiring 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 (

e.g.,

$1.0000),

i.e.,

transact at a “floating” NAV. The SEC also is adopting amendments that will give the boards of directors of money market funds new tools to stem heavy redemptions by giving them discretion to impose a liquidity fee if a fund's weekly liquidity level falls below the required regulatory threshold, and giving them discretion to suspend redemptions temporarily,

i.e.,

to “gate” funds, under the same circumstances. These amendments will require all non-government money market funds to impose a liquidity fee if the fund's weekly liquidity level falls below a designated threshold, unless the fund's board determines that imposing such a fee is not in the best interests of the fund. In addition, the SEC is adopting amendments designed to make money market funds more resilient by increasing the diversification of their portfolios, enhancing their stress testing, and improving transparency by requiring money market funds to report additional information to the SEC and to investors. Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to the SEC.

DATES:

Effective Date:

October 14, 2014.

Compliance Dates:

The applicable compliance dates are discussed in section III.N. of the Release titled “Compliance Dates.”

FOR FURTHER INFORMATION CONTACT:

Adam Bolter, Senior Counsel; Amanda Hollander Wagner, Senior Counsel; Andrea Ottomanelli Magovern, Senior Counsel; Erin C. Loomis, Senior Counsel; Kay-Mario Vobis, Senior Counsel; Thoreau A. Bartmann, Branch Chief; Sara Cortes, Senior Special Counsel; or Sarah G. ten Siethoff, Assistant Director, Investment Company Rulemaking Office, at (202) 551-6792, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

The Commission is adopting amendments to rules 419 [17 CFR 230.419] and 482 [17 CFR 230.482] under the Securities Act of 1933 [15 U.S.C. 77a-z-3] (“Securities Act”), rules 2a-7 [17 CFR 270.2a-7], 12d3-1 [17 CFR 270.12d3-1], 18f-3 [17 CFR 270.18f-3], 22e-3 [17 CFR 270.22e-3], 30b1-7 [17 CFR 270.30b1-7], 31a-1 [17 CFR 270.31a-1], and new rule 30b1-8 [17 CFR 270.30b1-8] under the Investment Company Act of 1940 [15 U.S.C. 80a], Form N-1A under the Investment Company Act and the Securities Act, Form N-MFP under the Investment Company Act, and section 3 of Form PF under the Investment Advisers Act [15 U.S.C. 80b], and new Form N-CR under the Investment Company Act.

Unless otherwise noted, all references to statutory sections are to the Investment Company Act, and all references to rules under the Investment Company Act, including rule 2a-7, will be to Title 17, Part 270 of the Code of Federal Regulations, 17 CFR Part 270.

Table of Contents

I. Introduction

II. Background

A. Role of Money Market Funds

B. Certain Economic Features of Money Market Funds

1. Money Market Fund Investors' Desire To Avoid Loss

2. Liquidity Risks

3. Valuation and Pricing Methods

4. Investors' Misunderstanding About the Actual Risk of Investing in Money Market Funds

C. Effects on Other Money Market Funds, Investors, and the Short-Term Financing Markets

D. The Financial Crisis

E. Examination of Money Market Fund Regulation Since the Financial Crisis

1. The 2010 Amendments

2. The Eurozone Debt Crisis and U.S. Debt Ceiling Impasses of 2011 and 2013

3. Continuing Consideration of the Need for Additional Reforms

III. Discussion

A. Liquidity Fees and Redemption Gates

1. Analysis of Certain Effects of Fees and Gates

2. Terms of Fees and Gates

3. Exemptions to Permit Fees and Gates

4. Amendments to Rule 22e-3

5. Operational Considerations Relating to Fees and Gates

6. Tax Implications of Liquidity Fees

7. Accounting Implications

B. Floating Net Asset Value

1. Introduction

2. Summary of the Floating NAV Reform

3. Certain Considerations Relating to the Floating NAV Reform

4. Money Market Fund Pricing

5. Amortized Cost and Penny Rounding for Stable NAV Funds

6. Tax and Accounting Implications of Floating NAV Money Market Funds

7. Rule 10b-10 Confirmations

8. Operational Implications of Floating NAV Money Market Funds

9. Transition

C. Effect on Certain Types of Money Market Funds and Other Entities

1. Government Money Market Funds

2. Retail Money Market Funds

3. Municipal Money Market Funds

4. Implications for Local Government Investment Pools

5. Unregistered Money Market Funds Operating Under Rule 12d1-1

6. Master/Feeder Funds—Fees and Gates Requirements

7. Application of Fees and Gates to Other Types of Funds and Certain Redemptions

D. Guidance on the Amortized Cost Method of Valuation and Other Valuation Concerns

1. Use of Amortized Cost Valuation

2. Other Valuation Matters

E. Amendments to Disclosure Requirements

1. Required Disclosure Statement

2. Disclosure of Tax Consequences and Effect on Fund Operations—Floating NAV

3. Disclosure of Transition to Floating NAV

4. Disclosure of the Effects of Fees and Gates on Redemptions

5. Historical Disclosure of Liquidity Fees and Gates

6. Prospectus Fee Table

7. Historical Disclosure of Affiliate Financial Support

8. Economic Analysis

9. Web site Disclosure

F. Form N-CR

1. Introduction

2. Part B: Defaults and Events of Insolvency

3. Part C: Financial Support

4. Part D: Declines in Shadow Price

5. Parts E, F, and G: Imposition and Lifting of Liquidity Fees and Gates

6. Part H: Optional Disclosure

7. Timing of Form N-CR

8. Economic Analysis

G. Amendments to Form N-MFP Reporting Requirements

1. Amendments Related to Rule 2a-7 Reforms

2. New Reporting Requirements

3. Clarifying Amendments

4. Public Availability of Information

5. Operational Implications of the N-MFP Amendments

H. Amendments to Form PF Reporting Requirements

1. Overview of Proposed Amendments to Form PF

2. Utility of New Information, Including Benefits, Costs, and Economic Implications

I. Diversification

1. Treatment of Certain Affiliates for Purposes of Rule 2a-7's Five Percent Issuer Diversification Requirement

2. ABS—Sponsors Treated as Guarantors

3. The Twenty-Five Percent Basket

J. Amendments to Stress Testing Requirements

1. Overview of Current Stress Testing Requirements and Proposed Amendments

2. Stress Testing Metrics

3. Hypothetical Events Used in Stress Testing

4. Board Reporting Requirements

5. Dodd-Frank Mandated Stress Testing

6. Economic Analysis

K. Certain Macroeconomic Consequences of the New Amendments

1. Effect on Current Investors in Money Market Funds

2. Efficiency, Competition and Capital Formation Effects on the Money Market Fund Industry

3. Effect of Reforms on Investment Alternatives, and the Short-Term Financing Markets

L. Certain Alternatives Considered

1. Liquidity Fees, Gates, and Floating NAV Alternatives

2. Alternatives in the FSOC Proposed Recommendations

3. Alternatives in the PWG Report

M. Clarifying Amendments

1. Definitions of Daily Liquid Assets and Weekly Liquid Assets

2. Definition of Demand Feature

3. Short-Term Floating Rate Securities

4. Second Tier Securities

N. Compliance Dates

1. Compliance Date for Amendments Related to Liquidity Fees and Gates

2. Compliance Date for Amendments Related to Floating NAV

3. Compliance Date for Rule 30b1-8 and Form N-CR

4. Compliance Date for Diversification, Stress Testing, Disclosure, Form PF, Form N-MFP, and Clarifying Amendments

IV. Paperwork Reduction Act

A. Rule 2a-7

1. Asset-Backed Securities

2. Retail and Government Funds

3. Board Determinations—Fees and Gates

4. Notice to the Commission

5. Stress Testing

6. Web Site Disclosure

7. Total Burden for Rule 2a-7

B. Rule 22e-3

C. Rule 30b1-7 and Form N-MFP

1. Discussion of Final Amendments

2. Current Burden

3. Change in Burden

D. Rule 30b1-8 and Form N-CR

1. Discussion of New Reporting Requirements

2. Estimated Burden

E. Rule 34b-1(a)

F. Rule 482

G. Form N-1A

H. Advisers Act Rule 204(b)-1 and Form PF

1. Discussion of Amendments

2. Current Burden

3. Change in Burden

V. Regulatory Flexibility Act Certification

VI. Update to Codification of Financial Reporting Policies

VII. Statutory Authority

Text of Rules and Forms

I. Introduction

Money market funds are a type of mutual fund registered under the Investment Company Act and regulated pursuant to rule 2a-7 under the Act.

Money market funds generally pay dividends that reflect prevailing short-term interest rates, are redeemable on demand, and, unlike other investment companies, seek to maintain a stable NAV, typically $1.00.

This combination of principal stability, liquidity, and payment of short-term yields has made money market funds popular cash management vehicles for both retail and institutional investors. As of February 28, 2014, there were approximately 559 money market funds registered with the Commission, and these funds collectively held over $3.0 trillion of assets.

Money market funds are also sometimes called “money market mutual funds” or “money funds.”

See generally

Valuation of Debt Instruments and Computation of Current Price Per Share by Certain Open-End Investment Companies (Money Market Funds), Investment Company Act Release No. 13380 (July 11, 1983) [48 FR 32555 (July 18, 1983)] (“1983 Adopting Release”). Most money market funds seek to maintain a stable NAV of $1.00, but a few seek to maintain a stable NAV of a different amount,

e.g.,

$10.00. For convenience, throughout this Release, the discussion will simply refer to the stable NAV of $1.00 per share.

Based on Form N-MFP data. SEC regulations require that money market funds report certain portfolio information on a monthly basis to the SEC on Form N-MFP.

See

rule 30b1-7.

Absent an exemption, as required by the Investment Company Act, all registered mutual funds must price and transact in their shares at the current NAV, calculated by valuing portfolio instruments at market value or, if market quotations are not readily available, at fair value as determined in good faith by the fund's board of directors (

i.e.,

use a floating NAV).

In 1983, the Commission codified an exemption to this requirement allowing money market funds to value their portfolio securities using the “amortized cost” method of valuation and to use the “penny-rounding” method of pricing.

Under the amortized cost method, a money market fund's portfolio securities generally are valued at cost plus any amortization of premium or accumulation of discount, rather than at their value based on current market factors.

The penny rounding method of pricing permits a money market fund when pricing its shares to round the fund's NAV to the nearest one percent (

i.e.,

the nearest penny).

Together, these valuation and pricing techniques create a “rounding convention” that permits a money market fund to sell and redeem shares at a stable share price without regard to small variations in the value of the securities in its portfolio.

Other types of mutual funds not regulated by rule 2a-7 generally must calculate their daily NAVs using market-based factors and cannot use penny rounding.

See

section 2(a)(41)(B) of the Act and rules 2a-4 and 22c-1. The Commission, however, has stated that it would not object if a mutual fund board of directors determines, in good faith, that the value of debt securities with remaining maturities of 60 days or less is their amortized cost, unless the particular circumstances warrant otherwise.

See

Accounting Series Release No. 219, Valuation of Debt Instruments by Money Market Funds and Certain Other Open-End Investment Companies, Financial Reporting Codification (CCH) section 404.05.a and .b (May 31, 1977) (“ASR 219”). We further discuss the use of amortized cost valuation by mutual funds in section III.B.5 below.

See

1983 Adopting Release,

supra

note 3. Section 6(c) of the Investment Company Act provides the Commission with broad authority to exempt persons, securities or transactions from any provision of the Investment Company Act, or the regulations thereunder, if, and to the extent that such exemption is in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Investment Company Act.

See

Commission Policy and Guidelines for Filing of Applications for Exemption, SEC Release No. IC-14492 (Apr. 30, 1985).

See

current rule 2a-7(a)(2).

see also

Proposing Release

supra

note 25, at n.72.

See

2013 Association for Financial Professionals Liquidity Survey, at 15,

available at

http://www.afponline.org/liquidity

(subscription required) (“2013 AFP Liquidity Survey”). The size of this allocation to money market funds is down substantially from prior years. For example, prior AFP Liquidity Surveys show higher allocations of organizations' short-term investments to money market funds: almost 40% in the 2008 survey, approximately 25% in the 2009 and 2010 surveys, almost 30% in the 2011 survey, and 16% in the 2012 survey. This shift has largely reflected a re-allocation of cash investments to bank deposits, which rose from representing 25% of organizations' short-term investment allocations in the 2008 Association for Financial Professionals Liquidity Survey,

available at

http://www.afponline.org/pub/pdf/2008_Liquidity_Survey.pdf

(“2008 AFP Liquidity Survey”), to 50% of organizations' short-term investment allocations in the 2013 survey. The 2012 survey noted that some of this shift has been driven by the temporary unlimited FDIC deposit insurance coverage for non-interest bearing bank transaction accounts (which expired at the end of 2012) and in which assets have remained despite the expiration of the insurance.

See

2013 AFP Liquidity Survey. As of February 28, 2014, approximately 67% of money market fund assets were held in money market funds or share classes intended to be sold to institutional investors according to iMoneyNet data. All of the AFP Liquidity Surveys are available at

http://www.afponline.org

Money market funds' size and significance in the short-term markets, together with their features that can create an incentive to redeem as discussed above, have led to concerns that money market funds may contribute to systemic risk. Heavy redemptions from money market funds during periods of financial stress can remove liquidity from the financial system, potentially disrupting other markets. Issuers may have difficulty obtaining capital in the short-term markets during these periods because money market funds are focused on meeting redemption requests through internal liquidity generated either from maturing securities or cash from subscriptions, and thus may be purchasing fewer short-term debt obligations.

To the extent that multiple money market funds experience heavy redemptions, the negative effects on the short-term markets can be magnified. Money market funds' experience during the financial crisis illustrates the impact of heavy redemptions, as we discuss in more detail below.

See supra

text preceding and accompanying note 36. Although money market funds also can build liquidity internally by retaining (rather than investing) cash from investors purchasing shares, this is not likely to be a material source of liquidity for a distressed money market fund experiencing heavy redemptions as a stressed fund may be unlikely to be receiving significant investor purchases during such a time.

Heavy redemptions in money market funds may disproportionately affect slow-moving shareholders because, as discussed further below, redemption data from the financial crisis show that some institutional investors are likely to redeem from distressed money market funds far more quickly than other investors and to redeem a greater percentage of their prime fund holdings.

This likely is because some institutional investors generally have more capital at stake, along with sophisticated tools and professional staffs to monitor risk. Because of their proportionally larger investments, just a few institutional investors submitting redemption requests may have a significant effect on a money market fund's liquidity, while it may take many more retail investors, with their typically smaller investments sizes, to cause similar negative consequences. Slower-to-redeem shareholders may be harmed because, as discussed above, redemptions at a money market fund can concentrate existing losses in the fund or create new losses if the fund must sell assets at a discount to obtain liquidity to satisfy redemption requests. In both cases, redemptions leave the fund's portfolio more likely to lose value, to the detriment of slower-to-redeem investors.

Retail investors—who tend to be slower moving—also could be harmed if market stress begins at an institutional money market fund and spreads to other funds, including funds composed solely or primarily of retail investors.

See

Money Market Fund Reform, Investment Company Act Release No. 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)] (“2009 Proposing Release”), at nn.46-48 and 178 and accompanying text.

See, e.g.,

DERA Study,

supra

note 24, at 10 (“Investor redemptions during the financial crisis, particularly after Lehman's failure, were heaviest in institutional share classes of prime money market funds, which typically hold securities that are illiquid relative to government funds. It is possible that sophisticated investors took advantage of the opportunity to redeem shares to avoid losses, leaving less sophisticated investors (if co-mingled) to bear the losses.”).

As discussed further below, retail money market funds experienced a lower level of redemptions in 2008 than institutional money market funds, although the full predictive power of this empirical evidence is tempered by the introduction of the Department of Treasury's (“Treasury Department”) temporary guarantee program for money market funds, which may have prevented heavier shareholder redemptions among generally slower-to-redeem retail investors.

See infra

note 80.

D. The Financial Crisis

The financial crisis in many respects demonstrates the various considerations discussed above in sections B and C, including the potential implications and harm associated with heavy redemption

from money market funds.

On September 16, 2008, the day after Lehman Brothers Holdings Inc. announced its bankruptcy, The Reserve Fund announced that its Primary Fund—which held a $785 million (or 1.2% of the fund's assets) position in Lehman Brothers commercial paper—would “break the buck” and price its securities at $0.97 per share.

At the same time, there was turbulence in the market for financial sector securities as a result of other financial company stresses, including, for example, the near failure of American International Group (“AIG”), whose commercial paper was held by many prime money market funds.

See generally

DERA Study,

supra

note 24, at section 3.

see also infra

section III.A.2.c.

These amendments differ in some respects from the fees and gates that we proposed, which would have required funds to impose a 2% liquidity fee on all redemptions, and would have permitted the imposition of redemption gates for up to 30 days in a 90-day period, after a fund's weekly liquid assets fell below 15% of its total assets. In addition, under our proposal, a fund's board (including a majority of independent directors) could have determined not to impose the liquidity fee or to impose a lower fee. A large number of commenters supported, to varying degrees and with varying caveats, our fees and gates proposal.

104

Many other commenters, on the other hand, expressed their opposition to fees and gates.

105

Comments on the proposal are discussed in more detail below.

104

See, e.g.,

Form Letter Type A; Comment Letter of Fidelity Investments (Sept. 16, 2013) (“Fidelity Comment Letter”); Comment Letter of Federated Investors, Inc. (Re: Alternative 2) (Sept. 16, 2013) (“Federated V Comment Letter”); Comment Letter of Northern Trust Corporation (Sept. 16, 2013) (“Northern Trust Comment Letter”).

105

See, e.g.,

Comment Letter of Capital Advisors Group (Sept. 3, 2013) (“Capital Advisors Comment Letter”); Comment Letter of Americans for Financial Reform (Sept. 17, 2013) (“Americans for Fin. Reform Comment Letter”); Comment Letter of Edward D. Jones and Co., L.P. (Sept. 20, 2013) (“Edward Jones Comment Letter”).

1. Analysis of Certain Effects of Fees and Gates

106

See infra

section III.K (discussing further the economic effects of the fees and gates amendments).

a. Background

As discussed previously, shareholders redeem money market fund shares for a number of reasons.

107

Shareholders may redeem shares because the current rounding convention in money market fund valuation and pricing can create incentives for shareholders to redeem shares ahead of other investors when the market-based NAV per share of a fund is lower than $1.00 per share.

108

Shareholders also may flee to quality, liquidity, or transparency (or combinations thereof) during adverse economic events or financial market conditions.

109

Furthermore, in times of stress, shareholders may simply need or want to withdraw funds for unrelated reasons. In any case, money market funds may have to absorb quickly high levels of redemptions that exceed internal sources of liquidity. In these instances, funds will need to sell portfolio securities, perhaps at a loss either because they incur transitory liquidity costs or they must sell assets at “fire sale” prices.

110

If fund managers deplete their funds' most liquid assets first, this may impose future liquidity costs (that are not reflected in a $1.00 share price based on current amortized cost valuation) on the non-redeeming shareholders because later redemption requests must be met by selling less liquid assets. These effects may be heightened if many funds sell assets at the same time, lowering asset prices. During the financial crisis, for example, securities sales to meet heavy redemptions in money market funds and sales of assets by other investors

created downward price pressure in the market.

111

107

See

Proposing Release,

supra

note 25, at 156-172; DERA Study,

supra

note 24, at 2-4.

108

As discussed in section III.B, the floating NAV amendments help mitigate this incentive for institutional prime funds by causing redeeming shareholders to receive the market value of redeemed shares.

109

See

Proposing Release,

supra

note 25, at n.340.

110

See

Proposing Release,

supra

note 25, at n.341.

111

See supra

section II.D herein (discussing the financial crisis);

see also

Proposing Release,

supra

note 25 at 32-33; DERA Memorandum Regarding Liquidity Cost During Crisis Periods, dated March 17, 2014 (“DERA Liquidity Fee Memo”),

available at

http://www.sec.gov/comments/s7-03-13/s70313-321.pdf

Liquidity fees and redemption gates have been used successfully in the past by certain non-money market fund cash management pools to stem redemptions during times of stress.

112

Liquidity fees provide investors continued access to their liquidity (albeit at a cost) while also reducing the incentives for shareholders to redeem shares. Liquidity fees, however, will not outright stop redemptions. In contrast to fees, redemption gates stop redemptions altogether, but do not offer the flexibility of fees.

113

Because redemption gates prevent investors from accessing their investments for a period of time, a fund may choose to first impose a liquidity fee and then, if needed, impose a redemption gate.

112

A Florida local government investment pool experienced heavy redemptions in 2007 due to its holdings in SIV securities. The pool suspended redemptions and ultimately reopened but only after the pool (and each shareholder's interest) had been split into two separate pools: one holding the more illiquid securities previously held by the pool (“Fund B”) and one holding the remaining securities of the pool (“Fund A”). Fund A reopened, but limited redemptions to up to 15% of an investor's holdings or $2 million without penalty, and imposed a 2% redemption fee on any additional redemptions. Fund B remained closed. When Fund A reopened, it experienced withdrawals, but according to state officials, the withdrawals were manageable.

See

Dealbook, NY Times, Florida Fund Reopens, and $1.1 Billion is Withdrawn; David Evans and Darrell Preston,

Florida Investment Chief Quits; Fund Rescue Approved, Bloomberg

(Dec. 4, 2007); Helen Huntley,

State Wants Fund Audit,

Tampa Bay Times (Dec. 11, 2007);

see also infra

note 114 (discussing the successful use by some European enhanced cash funds of fees or gates during the financial crisis).

113

See

Institutional Money Market Funds Association,

IMMFA Recommendations for Redemption Gates and Liquidity Fees, available at http://www.immfa.org/publications/policy-positions.html

(“Redemption gates and/or a liquidity fee are methods by which a fund manager, if experiencing difficulty due to extreme market circumstances, can control redemptions in order to ensure that all investors are treated fairly and that no `first-mover' advantage exists.”);

cf.

G.W. Schwert & P. J. Seguin,

Securities Transaction Taxes: An Overview of Costs, Benefits and Unresolved Questions,

49 Financial Analysts Journal 27 (1993); K.A. Froot & J. Campbell,

International Experiences with Securities Transaction Taxes,

in The Internationalization of Equity Markets (J. Frankel, ed., 1994), at 277-308.

The fees and gates amendments we are adopting today are designed to address certain issues highlighted by the financial crisis. In particular, the amendments should allow funds to moderate redemption requests by allocating liquidity costs to those shareholders who impose such costs on funds through their redemptions and, in certain cases, stop heavy redemptions in times of market stress by providing fund boards with additional tools to manage heavy redemptions and improve risk transparency. We understand that based on the level of redemption activity that occurred during the financial crisis, many money market funds would have faced liquidity pressures sufficient to cross the liquidity thresholds we are adopting today that would allow the use of fees and gates. Although no one can predict with certainty what would have happened if money market funds had operated with fees and gates during the financial crisis, we believe that money market funds would have been better able to manage the heavy redemptions that occurred and limit contagion, regardless of the reason for the redemptions.

114

See, e.g.,

Comment Letter of Mutual Fund Directors Forum (Sept. 16, 2013) (“MFDF Comment Letter”) (stating, with respect to the proposed fee and gates amendments, “we concur that this approach has the potential to reduce runs during times of stress or crisis”); UBS Comment Letter (“We agree that liquidity fees and gates would help money funds address heavy redemptions in an effective manner and limit the spread of contagion . . .”); Form Letter Type D. We also note that some European enhanced cash funds successfully used fees or gates during the financial crisis to stem redemptions.

See

Elias Bengtsson,

Shadow Banking and Financial Stability: European Money Market Funds in the Global Financial Crisis

(2011) (“Bengtsson”),

available at http:// papers.ssrn.com/sol3/papers.cfm?abstract_id=1772746&download=yes

; Julie Ansidei, et al.,

Money Market Funds in Europe and Financial Stability,

European Systemic Risk Board Occasional Paper No. 1, at 36 (June 2012),

available at http://www.esrb.europa.eu/pub/pdf/occasional/20120622_occasional_paper_1.pdf?465916d4816580065dfafb92059615b6

Fees and gates are just one aspect of the overall package of reforms we are adopting today. We recognize that fees and gates do not address all of the factors that may lead to heavy redemptions in money market funds. For example, fees and gates do not fully eliminate the incentive to redeem ahead of other investors in times of stress

115

or fully prevent investors from redeeming shares (except during the duration of a temporary gate) to invest in securities with higher quality, better liquidity, or increased transparency.

116

Fees and gates also do not address the shareholder dilution that results when a shareholder is able to redeem at a stable NAV that is higher than the market value of the fund's underlying portfolio securities.

117

Nonetheless, for the reasons discussed in this Release, fees and gates provide funds and their boards with additional tools to stem heavy redemptions and avoid the type of contagion that occurred during the financial crisis by allocating liquidity costs to those shareholders who impose such costs on funds and by stopping runs.

115

However, as discussed in section III.B herein, under today's amendments, institutional prime funds will be required to float their NAV. This reform is designed, in part, to address the incentive to redeem ahead of other investors in certain money market funds because of current money market fund valuation and pricing methods.

116

Fees and gates lessen but do not fully eliminate the incentive for investors to redeem quickly in times of stress because redeeming shareholders will retain an economic advantage over shareholders who remain in a fund when liquidity costs are high, but before the fund has imposed fees or gates.

117

In contrast, the floating NAV requirement for institutional prime funds will address this issue.

See infra

section III.B.1.

i. Liquidity Fees

During the financial crisis, some funds experienced heavy redemptions. Shareholders who redeemed shares early bore none of the economic consequences of their redemptions. Shareholders who remained in the funds, however, faced a declining NAV and an increased probability that their funds would “break the buck.” As discussed in the Proposing Release and suggested by commenters, investors may have re-assessed their redemption decisions during the crisis if money market funds had imposed liquidity fees because they would have been required to pay at least some of the costs of their redemptions.

118

It is possible that some investors would have made the economic decision not to redeem because the liquidity fees imposed by the fund and incurred by an investor would have been certain, whereas potential future losses would have been uncertain.

119

118

See, e.g.,

Comment Letter of U.S. Chamber of Commerce, Center for Capital Markets Competitiveness (Sept. 17, 2013) (“Chamber II Comment Letter”) (“[I]f shareholders were to be charged a fee when a MMF's liquidity costs are at a premium, they may be discouraged from redeeming their shares at that time, which would have the effect of slowing redemptions in the MMF.”); Comment Letter of Charles Schwab Investment Management, Inc. (Sept. 12, 2013) (“Schwab Comment Letter”) (“[W]e agree that the proposed liquidity fee of 2% would be a strong disincentive to redeem during a crisis . . .”).

119

See

HSBC Comment Letter;

see also infra

note 152-153 and accompanying text. We acknowledge (as we did in the Proposing Release) that liquidity fees may not always effectively stave off high levels of redemptions in a crisis; however, liquidity fees, once imposed, should help reduce the incentive to redeem shares because investors will pay a fee in connection with their redemptions.

See

Proposing Release,

supra

note 25, at 161.

In addition, liquidity fees would have helped offset the costs of the liquidity provided to redeeming shareholders and potentially protected the funds' NAVs because the cash raised from liquidity

fees would create new liquidity for the funds.

120

Additionally, to the extent that liquidity fees imposed during the crisis could have reduced redemption requests at the margin, they would have allowed funds to generate liquidity internally as assets matured. By imposing liquidity costs on redeeming shareholders, liquidity fees, as noted by commenters, also treat holding and redeeming shareholders more equitably.

121

120

Fees paid by investors that redeem shares should help prevent a fund's NAV from becoming impaired based on liquidity costs, as long as the liquidity fee imposed reflects the liquidity cost of redeeming shares. Fees should also generate additional liquidity to help funds meet redemption requests.

121

See, e.g.,

Invesco Comment Letter (“Liquidity fees would provide an appropriate and effective means to ensure that the extra costs associated with raising liquidity to meet fund redemptions during times of market stress are borne by those responsible for them.”); Comment Letter of J.P. Morgan Asset Management (Sept. 17, 2013) (“J.P. Morgan Comment Letter”); UBS Comment Letter;

but see, e.g.,

Comment Letter of U.S. Bancorp Asset Management, Inc. (Sept. 16, 2013) (“U.S. Bancorp Comment Letter”) (suggesting that liquidity fees harm those that redeem after the fees are imposed and that gates harm those that remain in the fund after the gate is in place).

Liquidity fees, which we believe would rarely be imposed under normal market conditions, are designed to preserve the current benefits of principal stability, liquidity, and a market yield, but reduce the likelihood that, in times of market stress, costs that ought to be attributed to a redeeming shareholder are externalized on remaining shareholders and on the wider market.

122

Even if a liquidity fee is imposed, fund investors continue to have the flexibility to access liquidity (albeit at a cost). The Commission believes, and commenters suggested, that if funds could have imposed liquidity fees during the crisis, they would likely have been better able to manage redemptions, thereby ameliorating their impact and reducing contagion effects.

123

122

See

Proposing Release,

supra

note 25, at n.343.

123

See

Proposing Release,

supra

note 25, at 155;

see also

Comment Letter of Wells Fargo Funds Management, LLC (Jan. 17, 2013) (available in File No. FSOC-2012-0003) (“Wells Fargo FSOC Comment Letter”) (stating that a liquidity fee would “provide an affirmative reason for investors to avoid redeeming from a distressed fund” and “those who choose to redeem in spite of the liquidity fee will help to support the fund's market-based NAV and thus reduce or eliminate the potential harm associated with the timing of their redemptions to other remaining investors”).

Several commenters noted that liquidity fees could “re-mutualize” risk-taking among investors and provide a way to recover costs of liquidity in times of stress.

138

This is because liquidity fees allocate at least some of the costs of providing liquidity to redeeming rather than non-redeeming shareholders and protect fund liquidity by requiring redeeming shareholders to repay funds for liquidity costs incurred.

139

To the extent liquidity fees exceed such costs, they also can help increase the fund's net asset value for remaining shareholders which would have a restorative effect if the fund has suffered a loss. As one commenter has said, a liquidity fee can “provide a strong disincentive for investors to make further redemptions by causing them to choose between paying a premium for current liquidity or delaying liquidity and benefitting from the fees paid by redeeming investors.”

140

This explicit pricing of liquidity costs in money market funds should offer significant benefits to funds and the broader short-term financing market in times of potential stress because it should lessen both the frequency and effect of shareholder redemptions, which might otherwise result in the sale of fund securities at “fire sale” prices.

141

138

See, e.g.,

HSBC Comment Letter; Invesco Comment Letter; IDC Comment Letter.

139

We note that investors owning securities directly—as opposed to through a money market fund—naturally bear liquidity costs. They bear these costs both because they bear any losses if they have to sell a security at a discount to obtain their needed liquidity and because they directly bear the risk of a less liquid investment portfolio if they sell their most liquid holdings first to obtain needed liquidity.

140

See

Proposing Release,

supra

note 25, at 160 n.352 (citing ICI Jan. 24 FSOC Comment Letter).

141

See

Chamber II Comment Letter (“[I]f shareholders were to be charged a fee when an MMF's liquidity costs are at a premium, they may be discouraged from redeeming their shares at that time, which would have the effect of slowing redemptions in the MMF.”).

In contrast, redemption gates will provide fund boards with a direct and immediate tool for stopping heavy redemptions in times of stress.

142

Unlike liquidity fees, gates are designed to directly stop a run by delaying redemptions long enough to allow (1) fund managers time to assess the condition of the fund and determine the appropriate strategy to meet redemptions, (2) liquidity buffers to grow organically as securities in the portfolio (many of which are very short-term) mature and produce cash, and (3) shareholders to assess the liquidity and value of portfolio holdings in the fund and for any shareholder or market panic to subside.

143

As contemplated by today's amendments, gates definitively stop runs for funds that impose them by blocking all redemptions for their duration.

142

See, e.g.,

Chamber II Comment Letter (“[A] redemption gate would stop a `run' in [its] tracks, because shareholders would be prohibited from redeeming their shares while the gate is in place.”)

143

See

Proposing Release,

supra

note 25, at n.348.

We recognize that redemption gates, if they are ever imposed, will inhibit the full, unfettered redeemability of money market fund shares, a principle embodied in section 22(e) of the Investment Company Act.

144

However, as discussed in section III.A.3 below, section 22(e) of the Investment Company Act is aimed at preventing funds and their advisers from interfering with shareholders' redemption rights for improper purposes, such as preservation of management fees. Consistent with that aim, redemption gates under today's amendments are designed to benefit the fund and its shareholders and may be imposed only when a fund's board determines that doing so is in the best interests of the fund.

145

We also note that, in response to commenter concerns regarding investor access to their investments and the proposed duration of redemption gates, under today's amendments, gates will be limited to up to 10 business days in any 90-day period (rather than 30 days in a 90-day period as proposed).

146

As such, the extent to which today's amendments inhibit the redeemability of money market fund shares is limited.

144

See

section 22(e).

145

See

rule 2a-7(c)(2)(i).

146

See

rule 2a-7(c)(2)(i)(B);

see also

HSBC Comment Letter; Schwab Comment Letter (“A liquidity fee would force early redeemers to pay for the costs of their redemption, without knowing whether the fund was actually going to experience losses or not. This is a powerful disincentive.”);

but see

Comment Letter of Melanie L. Fein Law Offices (Sept. 10, 2013) (“Fein Comment Letter”) (suggesting liquidity fees are unlikely to “prevent institutional [money market fund] investors from reallocating their assets in a crisis”).

153

See, e.g.,

Proposing Release,

supra

note 25, at n.355 (citing Daniel Kahneman, Thinking, Fast and Slow (2011), at 278-288);

see also

HSBC Comment Letter; Schwab Comment Letter.

It is possible, however, that liquidity fees might not be fully effective during a market-wide crisis because, for example, shareholders might redeem shares irrespective of the level of their fund's true liquidity costs and the imposition of a liquidity fee.

154

In those cases, gates will be able to function as circuit breakers, creating time for funds to rebuild their own internal liquidity and shareholders to reconsider whether redemptions are still desired or warranted.

155

154

See

DERA Study,

supra

note 24, at 7-14 (discussing different possible explanations for why shareholders may redeem from money market funds in times of stress).

155

See, e.g.,

Comment Letter of Department of the Treasury, Commonwealth of Virginia (Sept. 17, 2013) (“Va. Treasury Comment Letter”); Chamber II Comment Letter; Dreyfus Comment Letter.

ii. Management-Related Advantages

We are also mindful that permitting fund boards to impose fees and/or gates after a fund has fallen below a particular threshold, and requiring funds to impose liquidity fees at a lower designated threshold (absent a board finding that the fee is not in the best interests of the fund), may offer certain benefits to funds with respect to management of liquidity and redemption activity. Some commenters suggested that, even during non-stress periods, fees and gates could provide fund managers with an incentive to carefully monitor shareholder concentration and shareholder flow to lessen the chance that the fund might have to impose fees or gates (because larger redemptions are more likely to cause the fund to breach the threshold).

156

The fees and gates amendments also may have the additional effect of encouraging portfolio managers to more closely monitor fund liquidity and hold more liquid securities to increase the level of daily and weekly liquid assets in the fund, as it would tend to lessen the likelihood of a fee or gate being imposed.

157

Such an approach could also lead to greater investor participation in money market funds to the extent investors seek to invest in a product with low liquidity risk, thereby increasing the supply of capital available to invest in commercial paper. We recognize, however, that such an approach could perhaps shrink the market for riskier or longer-term commercial paper, or have a negative effect on yield.

158

156

See, e.g.,

Comment Letter of Securities Industry and Financial Markets Association (Sept. 17, 2013) (“SIFMA Comment Letter”) (stating that some members “believe the existence of the liquidity trigger for the fee and gate will motivate fund managers to maintain fund liquidity well in excess of the trigger level, to avoid triggering the fee or gate. That is to say, the mere existence of the potential for the fee or gate will result in enhanced liquidity in money market funds.”); BlackRock II Comment Letter; Comment Letter of Hester Peirce and Robert Greene (Sept. 17, 2013) (“Peirce & Greene Comment Letter”);

see also

HSBC Global Asset Management,

Liquidity Fees; a proposal to reform money market funds

(Nov. 3, 2011) (“HSBC 2011 Liquidity Fees Letter”) (a liquidity fee “will result in more effective pricing of risk (in this case, liquidity risk) . . . [and] act as a market-based mechanism for improving the robustness and fairness” of money market funds); Comment Letter of BlackRock, Inc. (Dec. 13, 2012) (available in File No. FSOC-2012-0003) (“BlackRock FSOC Comment Letter”) (“A fund manager will focus on managing both assets and liabilities to avoid triggering a gate. On the liability side, a fund manager will be incented to know the underlying clients and model their behavior to anticipate cash flow needs under various scenarios. In the event a fund manager sees increased redemption behavior or sees reduced liquidity in the markets, the fund manager will be incented to address potential problems as early as possible.”).

157

See, e.g.,

Proposing Release,

supra

note 25, at n.365.

158

See infra

section III.K.

We also note that funds may take alternate approaches to managing liquidity and imposing fees and gates,

which may differentially affect the short-term funding markets. For example, a fund that imposes a fee or gate may decide to immediately build liquidity by investing all maturing securities in highly liquid assets, particularly if the fund wants to remove the fee or gate as soon as possible. Another fund may plan to impose a fee or gate for a set period of time, in which case, there would be no reason to stop investing in less liquid short-term commercial paper provided it matured while the fee or gate was in place. The first strategy would likely have the capital formation effect of lowering participation in short-term funding markets, whereas the second strategy may defer the impact until a later time, possibly after market conditions have improved.

iii. Transparency

We recognize, and certain commenters noted,

159

that the prospect of fees and gates being implemented when a fund is under stress should help make the risk of investing in money market funds more salient and transparent to investors, which may help sensitize them to the risks of investing in money market funds. On the other hand, we note that other commenters argued that fees and gates would not improve transparency of risk for investors.

160

Having considered these comments, however, we believe that there will be an appreciable increase in transparency as a result of our fees and gates amendments. The disclosure amendments we are adopting today will require funds to provide disclosure to investors regarding the possibility of fees and gates being imposed if a fund's liquidity is impaired. We believe such disclosure will benefit investors by informing them further of the risks associated with money market funds, particularly that money market funds' liquidity may, at times, be impaired.

161

In addition, as noted above, fees and gates also could encourage shareholders to monitor funds' liquidity levels and exert market discipline over the fund to reduce the likelihood that the imposition of fees or gates will become necessary in that fund.

162

159

See, e.g.,

ICI Comment Letter; Comment Letter of Myra Page (July 19, 2013) (“Page Comment Letter”).

160

See, e.g.,

Comment Letter of Thrivent Financial for Lutherans (Sept. 17, 2013) (“Thrivent Comment Letter) (“The imposition of a liquidity fee or gate will always be a surprise to the investors that do not redeem quickly enough to avoid it. The need to impose such a fee or gate will not be transparent to the investor unless redemption activity is disclosed in a timely manner providing sufficient time for investors to react.”); Capital Advisors Comment Letter. Two commenters also expressed concern that the ability to impose fees and gates would perpetuate shareholder reliance on sponsor support.

See

Capital Advisors Comment Letter; Thrivent Comment Letter. As discussed herein, we believe fees and gates and the disclosure associated with fees and gates will provide investors certain benefits, including informing investors further of the risks associated with money market funds. We further believe that the disclosure requirements adopted today regarding sponsor support should help ameliorate concerns regarding shareholder reliance on sponsor support.

See infra

sections III.E.7, III.E.9.g and III.F.3.

161

We recognize that the level of board discretion in the fees and gates amendments may make it more difficult for investors to predict when fees and/or gates will imposed; however, we are adopting certain thresholds and maximums that we believe will provide investors with notice as to the possible imposition of fees and gates. Additionally, today we are adopting a requirement that funds disclose their percentage of weekly liquid assets on a daily basis on their Web sites and, thus, shareholders should be aware when a fund is approaching these thresholds.

See

rule 2a-7(h)(10)(ii)(B).

162

See

Proposing Release,

supra

note 25, at n.366. The disclosure of fees and gates also could advantage larger funds and fund groups if the ability to provide financial support reduces or eliminates the need to impose fees and/or gates (whose imposition may be perceived to be a competitive detriment).

c. Concerns Regarding Fees and Gates

i. Pre-Emptive Runs and Broader Market Concerns

We acknowledge the possibility that, in market stress scenarios, shareholders might pre-emptively redeem shares if they fear the imminent imposition of fees or gates (either because of the fund's situation or because other money market funds have imposed redemption restrictions).

163

A number of commenters suggested investors would do so.

164

Some commenters also suggested that sophisticated investors in particular might be able to predict that fees and gates may be imposed and may redeem shares before this occurs.

165

163

See, e.g.,

Proposing Release,

supra

note 25, at 163-167, n.361.

164

See, e.g.,

Comment Letter of Novelis (July, 16, 2013) (“Novelis Comment Letter”); Comment Letter of State Investment Commission, Commonwealth of Kentucky (Sept. 9, 2013) (“Ky. Inv. Comm'n Comment Letter”); Boston Federal Reserve Comment Letter; Comment Letter of Hester Peirce and Robert Greene, Working Paper: Opening the Gate to Money Market Fund Reform (Apr. 8, 2014) (“Peirce & Greene II Comment Letter”). Some commenters were concerned that news of one money market fund imposing a redemption restriction could trigger a system-wide run by investors in other money market funds.

See, e.g.,

Samuel Hanson, David Scharfstein, and Adi Sunderam (Sept. 16, 2013) (“Hanson

et al.

Comment Letter”); Deutsche Comment Letter; Boston Federal Reserve Comment Letter (suggesting further that “because of the relative homogeneity in many [money market funds' holdings], the imposition of a liquidity fee or redemption gate on one fund may incite runs on other funds which are not subject to such measures”) (citation omitted). In addition, one commenter, drawing an analogy to banks prior to the adoption of federally insured deposits, noted that although withdrawal suspensions were commonly used by banks in response to fleeing depositors, the specter of suspensions themselves were often the cause of such investor flight.

See, e.g.,

Comment Letter of Committee on Capital Markets Regulation (Sept. 17, 2013) (“Comm. Cap. Mkt. Reg. Comment Letter”).

165

See, e.g.,

MFDF Comment Letter; Va. Treasury Comment Letter; Goldman Sachs Comment Letter.

While we recognize that there is risk of pre-emptive redemptions, the benefits of having effective tools in place to address runs and contagion risk leads us to adopt the proposed fees and gates reforms, with some modifications. We believe several of the changes we are making in our final reforms will mitigate this risk and dampen the effects on other money market funds and the broader markets if pre-emptive redemptions do occur.

As discussed below, the shorter maximum time period for the imposition of gates and the smaller size of the default liquidity fee that we are adopting in these final amendments, as compared to what we proposed, are expected to lessen further the risk of pre-emptive runs.

166

We understand that the potential for a longer gate or higher liquidity fee before a restriction is in place may increase the incentive for investors to redeem at the first sign of any potential stress at a fund or in the markets.

167

We believe that by limiting the maximum time period that gates may be imposed to 10 business days in any 90-day period (down from the proposed 30 days), investor concerns regarding an extended loss of access to cash from their investment should be mitigated. Indeed, some money market funds today retain the right to delay payment on redemption requests for up to seven days, as all registered investment companies are permitted to do under the Investment Company Act, and we are not aware that this possibility has led to any pre-emptive runs historically.

168

In addition, we note that under section 22(e), the Commission also has the authority to, by order, suspend the right of redemption or allow the postponement of payment of redemption requests for more than seven days. The Commission used this authority, for example, with

respect to the Reserve Primary Fund. To our knowledge, this authority also has not historically led to pre-emptive redemptions. We believe that the gating allowed by today's amendments extends and formalizes this existing gating framework, clarifying for investors when a money market fund potentially may use a gate as a tool to manage heavy redemptions and thus prevents any investor confusion on when gating may apply.

166

See

Comment Letter of Federated Investors, Inc. (Apr. 25. 2014) (“Federated XI Comment Letter”).

167

See

J.P. Morgan Comment Letter (“The potential of total loss of access to liquidity for up to thirty (30) days will be a concern for investors, and could exacerbate a pre-emptive run.”); Federated V Comment Letter (“Shareholders will find it increasingly difficult to compensate for their loss of liquidity the longer the suspension of redemptions continues. It is therefore important for Alternative 2 to limit the suspension of redemptions to a period in which the potential benefits to shareholders of delaying redemptions outweigh the potential disruptions caused by the delay.”).

168

See

section 22(e).

We believe that the maximum 10 business day gating period we are adopting today is a similarly short enough period of time (as compared to the seven days a fund may delay payment on redemption requests) that many investors may not be unduly burdened by such a temporary loss of liquidity.

169

Thus, these investors may have less incentive to redeem their investments pre-emptively before the imposition of a gate. For similar reasons, the reduction in the default liquidity fee to 1% (down from the proposed 2%), discussed further below, may also lessen shareholders' incentives to redeem pre-emptively as fewer investors may consider it likely that a liquidity fee will result in an unacceptable loss on their investment.

170

169

See, e.g.,

Federated V Comment Letter (stating that 10 calendar days “would be a significantly shorter period than proposed by the Commission, while still allowing prime [money market funds] more than a week to address whatever problem led to the suspension of redemptions. This would also be consistent with the comments of some of the investors who indicated to Federated that they probably could not go more than two weeks without access to the cash held in their [money market fund].”);

see also infra

section III.A.2.d (discussing the maximum duration of temporary redemption gates under today's amendments).

170

We note that under our final amendments, the 1% default liquidity may be raised by a fund's board (up to 2%) if it is in the best interests of the fund.

See

rule 2a-7(c)(2)(ii)(A). However, given the empirical information regarding liquidity costs in money market fund eligible securities in the financial crisis, as discussed in the DERA Liquidity Fee Memo, which supported the reduction in the size of the default liquidity fee to 1%, money market fund shareholders may estimate that a fee as high as 2% will be unlikely and that depending on the circumstances, a fee of less than 1% could be appropriately determined by the board of directors.

See

DERA Liquidity Fee Memo,

supra

note 111.

In addition, we expect that the additional discretion we are granting fund boards to impose a fee or gate at any time after a fund's weekly liquid assets have fallen below the 30% required minimum, a much higher level of remaining weekly liquid assets than proposed, should mitigate the risk of pre-emptive redemptions. This board discretion should reduce the incentive of shareholders from trying to pre-emptively redeem because they will be able to less accurately predict specifically when, and under what circumstances, fees and gates will be imposed.

171

Board discretion also should allow boards to act decisively if they become concerned liquidity may become impaired and to react to expected, as well as actual, declines in liquidity levels, given their funds' investor base and other characteristics.

171

See

Wells Fargo Comment Letter (“The ability for fund investors to frequently and aggressively `game' and avoid the potential imposition of Fees or Gates is undermined by the element of uncertainty inherent in a fund board's discretion to impose a Fee or a Gate.”);

see also

Proposing Release,

supra

note 25, at n.362. Additionally, we believe that requiring investors in institutional prime funds to redeem their shares at floating NAV should lower the incentive to run pre-emptively when investors anticipate that a gate will be imposed as a result of a credit event.

See infra

section III.B for a discussion of the floating NAV requirement.

Likewise, increased board discretion should lessen the likelihood that sophisticated investors can preferentially predict when a fee or gate is going to be imposed because sophisticated investors, like any other investor, will not know what specific circumstances a fund board will deem appropriate for the imposition of fees or gates.

172

We recognize that sophisticated investors may monitor the weekly liquid assets of funds and seek to redeem before a fund drops below the 30% weekly liquid asset threshold. We believe, however, that a sophisticated investor may be dissuaded from redeeming in these circumstances because the fund still has a substantial amount of internal liquidity. In addition, redemptions when the fund still has this much internal liquidity would not lead to fire sales or other such adverse effects.

172

Although funds' Web site disclosure will indicate when a fund is approaching the weekly liquid asset thresholds for imposing a fee or gate, investors will not know the circumstances under which a board will deem such a restriction to be in the best interests of the fund.

See

rule 2a-7(h)(10)(ii)(B).

We also believe that increased board flexibility will reduce the occurrence of pre-emptive redemptions by shareholders who seek to redeem because

another

money market fund has imposed a fee or gate. Increased board flexibility will likely result in different funds imposing different redemption restrictions at different times, particularly considering that after crossing the 30% threshold each fund's board will be required to make a best interests determination with respect to the imposition of a fee or gate.

173

As such, it will be less likely that investors can predict whether any particular fund will impose a fee or gate, even if another fund has done so, and thus perhaps less likely they will redeem assuming that one fund imposing such a restriction means other funds may soon do so.

173

Boards will also be required to make a best interests determination if they determine to change the level of the default liquidity fee or to not impose the default fee.

See

rule 2a-7(c)(2)(ii).

Moreover, we believe that funds' ability to impose fees and gates once weekly liquid assets drop below 30% will substantially mitigate the broader effects of pre-emptive runs, should they occur. A money market fund that imposes a fee or gate with substantial remaining internal liquidity is in a better position to bear those redemptions without a broader market impact because it can satisfy those redemption requests through existing or internally generated cash and not through asset sales (other than perhaps sales of government securities that tend to increase in value and liquidity in times of stress). Thus, pre-emptive runs, if they were to occur, under these circumstances are less likely to generate adverse contagion effects on other money market funds or the short-term financing markets.

We note some commenters suggested that concerns about pre-emptive run risks from fees and gates are likely overstated.

174

One commenter noted that the “element of uncertainty inherent in a board's discretion to impose a fee or gate” would diminish any possible gaming by investors.

175

Another commenter further noted that “appropriate portfolio construction and daily transparency” would reduce the likelihood of anticipatory redemptions.

176

For example, as discussed below, our amendments require that each money market fund disclose daily on its Web site its level of weekly liquid assets. This means that if one money market fund imposes a fee or gate, investors in other money market funds will have the benefit of full transparency on whether the money market fund in which they are invested is similarly experiencing liquidity stress and thus is likely to impose a fee or gate. Pre-emptive redemptions and contagion effects due to a lack of transparency

(which may have occurred in the crisis) may therefore be reduced. Some commenters also have previously indicated that a liquidity fee or gate should not accelerate a run, stating that such redemptions would likely trigger the fee or gate and that, once triggered, the fee or gate would then lessen or halt redemptions.

177

174

See, e.g.,

SIFMA Comment Letter; Wells Fargo Comment Letter; Dreyfus Comment Letter;

see also

Chamber II Comment Letter (stating that “unlike with the current conditions of [r]ule 22e-3 under the [Investment Company Act], a redemption gate would allow the MMF to remain in operation after the gate is lifted. This, in turn, will provide MMF investors with comfort regarding the ultimate redemption of their investment and make any large-scale redemptions less likely.”); Comment Letter of Artie Green (Aug. 29, 2013) (“Green Comment Letter”) (“Fund shareholders would be less likely to panic if they know they will have access to their assets when the fund reopens after a short suspension of redemptions.”).

175

See

Wells Fargo Comment Letter.

176

See

Dreyfus Comment Letter.

177

See, e.g.,

Proposing Release,

supra

note 25, at n.364.

Additionally, we note that while many European money market funds are able to suspend redemptions and/or impose fees on redemptions, we are not aware that their ability to do so has historically led to pre-emptive runs. Most European money market funds are subject to legislation governing Undertakings for Collective Investment in Transferable Securities (“UCITS”), which also covers other collective investments, and which permits them to suspend temporarily redemptions of units.

178

For example, in Ireland, UCITS are permitted to temporarily suspend redemptions “in exceptional cases where circumstances so require and suspension is justified having regard to the interest of the unit-holders.”

179

Similarly, many money market funds in Europe are also permitted to impose fees on redemptions.

180

178

See, e.g.,

UCITS IV Directive, Article 84 (permitting a UCITS to, in accordance with applicable national law and its instruments of incorporation, temporarily suspend redemption of its units); Articles L. 214-19 and L. 214-30 of the French Monetary and Financial Code (providing that under exceptional circumstances and if the interests of the UCITS units holders so demand, UCITs may temporarily suspend redemptions);

see also

Coll. 7.2R United Kingdom Financial Conduct Authority Handbook (allowing the temporary suspension of redemptions “where due to exceptional circumstances it is in the interest of all the unitholders in the authorized fund”).

179

See

Regulation 104(2)(a) of S.I. No. 352 of 2011.

180

See, e.g.,

HSBC Comment Letter (“We are in the process of rolling out the ability for the Board of Directors to impose trigger based liquidity fees in our [money market funds] where current regulation allows. At this time we are working on implementation in our flagship “Global Liquidity Fund” range domiciled in Dublin.”).

We also note that a commenter discussed a paper by the staff of the Federal Reserve Bank of New York (“FRBNY”) entitled “Gates, Fees, and Preemptive Runs.”

181

The FRBNY staff paper constructs a theoretical model of fees or gates used by a financial intermediary and finds “that rather than being part of the solution, redemption fees and gates can be part of the problem.”

182

This commenter argued that this paper fails to consider numerous restrictions in bank products similar to fees and gates that do not appear to have triggered pre-emptive runs on banks.

183

In particular, the commenter noted that all banks are required “to retain contractual authority as to most deposits to postpone withdrawals (gating) or impose early redemption fees and to reserve the right to impose restrictions—either gates or fees or both—on redemptions of all bank deposits other than demand deposit accounts. . . .”

184

181

See

Federated XI Comment Letter.

182

See

Gates, Fees and Preemptive Runs, Federal Reserve Bank of New York Staff Report No. 670 (Apr. 2014),

available at http://www.newyorkfed.org/research/staff_reports/sr670.pdf

183

See

Federated XI Comment Letter.

184

See id.

(citations omitted). The commenter states that, other than with respect to demand deposit accounts, “banks (1) are required . . . to reserve the right to require seven days' advance notice of a withdrawal from [money market deposit accounts], NOW accounts and other savings accounts; (2) are not required to allow early withdrawal from [certificates of deposit] and other time deposits; and (3) are allowed to impose early withdrawal fees on time deposits if they choose to permit an early withdrawal from a time deposit.”

We note that the model of fees or gates in the FRBNY staff paper has a number of features and assumptions different than the reforms we are adopting today. For example, the paper's model assumes the fees or gates are imposed only when liquid assets are fully depleted. In contrast, under our reforms fees or gates may be imposed while the fund still has substantial liquid assets and, as discussed above, we believe investors may be dissuaded from pre-emptively redeeming from funds with substantial internal liquidity because the fund is more likely to be able to readily satisfy redemptions without adversely impacting the fund's pricing.

185

Moreover, under our reforms (unlike the model), a fund board has discretion in the decision of when to impose fees or gates, which as discussed above should reduce the incentive for investors to run, because they will be able to less accurately predict specifically when, and under what circumstances, fees or gates will be imposed.

186

Another significant difference is that our reforms include a floating NAV for institutional prime money market funds, which constitute a sizeable portion of all money market funds, but the model assumes a stable NAV. As discussed below, we believe the floating NAV requirement may encourage those investors who are least able to bear risk of loss to redirect their investments to other investment opportunities (

e.g.,

government money market funds), and this may have the secondary effect of removing from the funds those investors most prone to redeem should a liquidity event occur for which fees or gates could be imposed. Furthermore, the paper also assumes that no investor could foresee the possibility of a shock to a money market fund that reduces the fund's value or liquidity despite the events of 2008 that should have informed investors that fund NAVs can change over time and that liquidity levels may fluctuate. In addition, under our floating

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