# Money Market Fund Reforms > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2021-27532 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** February 8, 2022 - **Citation:** 87 FR 7248 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 270 and 274 [Release No. IC-34441; File No. S7-22-21] RIN 3235-AM80 Money Market Fund Reforms AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Securities and Exchange Commission (“Commission”) is proposing amendments to certain rules that govern money market funds under the Investment Company Act of 1940. The proposed amendments are designed to improve the resilience and transparency of money market funds. The proposal would remove the liquidity fee and redemption gate provisions in the existing rule, which would eliminate an incentive for preemptive redemptions from certain money market funds and could encourage funds to more effectively use their existing liquidity buffers in times of stress. The proposal would also require institutional prime and institutional tax-exempt money market funds to implement swing pricing policies and procedures to require redeeming investors to bear the liquidity costs of their decisions to redeem. The Commission is also proposing to increase the daily liquid asset and weekly liquid asset minimum liquidity requirements, to 25% and 50% respectively, to provide a more substantial buffer in the event of rapid redemptions. The proposal would amend certain reporting requirements on Forms N-MFP and N-CR to improve the availability of information about money market funds, as well as make certain conforming changes to Form N-1A to reflect our proposed changes to the regulatory framework for these funds. In addition, the Commission is proposing rule amendments to address how money market funds with stable net asset values should handle a negative interest rate environment. Finally, the Commission is proposing rule amendments to specify how funds must calculate weighted average maturity and weighted average life. DATES: Comments should be received on or before April 11, 2022. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's internet comment form ( https://www.sec.gov/rules/submitcomments.htm ). Paper Comments • Send paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-22-21. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's website ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Operating conditions may limit access to the Commission's public reference room. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: Blair Burnett, David Driscoll, Adam Lovell, or James Maclean, Senior Counsels; Angela Mokodean, Branch Chief; or Brian Johnson, Assistant Director at (202) 551-6792, Investment Company Regulation Office; Keri Riemer, Senior Counsel; Penelope Saltzman, Senior Special Counsel; or Thoreau Bartmann, Assistant Director, Chief Counsel's Office, (202) 551-6825; Viktoria Baklanova, Analytics Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549. SUPPLEMENTARY INFORMATION: The Commission is proposing for public comment amendments to 17 CFR 270.2a-7 (rule 2a-7) and 17 CFR 270.31a-2 (rule 31a-2) under the Investment Company Act of 1940, 1 Form N-1A under the Investment Company Act and the Securities Act, 2 and Forms N-MFP and N-CR under the Investment Company Act. 1 15 U.S.C. 80a et seq. 2 15 U.S.C. 77a et seq. Table of Contents I. Introduction A. Types of Money Market Funds and Existing Regulatory Framework B. March 2020 Market Events II. Discussion A. Amendments To Remove Liquidity Fee and Redemption Gate Provisions 1. Unintended Effects of the Tie Between the Weekly Liquid Asset Threshold and Liquidity Fees and Redemption Gates 2. Removal of Redemption Gates From Rule 2a-7 3. Removal of Liquidity Fees From Rule 2a-7 B. Proposed Swing Pricing Requirement 1. Purpose and Terms of the Proposed Requirement 2. Operational Considerations 3. Tax and Accounting Implications 4. Disclosure C. Amendments to Portfolio Liquidity Requirements 1. Increase of the Minimum Daily and Weekly Liquidity Requirements 2. Consequences for Falling Below Minimum Daily and Weekly Liquidity Requirements 3. Proposed Amendments to Liquidity Metrics in Stress Testing D. Amendments Related to Potential Negative Interest Rates E. Amendments To Specify the Calculation of Weighted Average Maturity and Weighted Average Life F. Amendments to Reporting Requirements 1. Amendments to Form N-CR 2. Amendments to Form N-MFP G. Compliance Date III. Economic Analysis A. Introduction B. Economic Baseline 1. Affected Entities 2. Certain Economic Features of Money Market Funds 3. Money Market Fund Activities and Price Volatility C. Costs and Benefits of the Proposed Amendments 1. Removal of the Tie Between the Weekly Liquid Asset Threshold and Liquidity Fees and Redemption Gates 2. Raised Liquidity Requirements 3. Stress Testing Requirements 4. Swing Pricing 5. Amendments Related to Potential Negative Interest Rates 6. Amendments to Disclosures on Form N-CR, Form N-MFP, and Form N-1A 7. Amendments Related to the Calculation of Weighted Average Maturity and Weighted Average Life D. Alternatives 1. Alternatives to the Removal of the Tie Between the Weekly Liquid Asset Threshold and Liquidity Fees and Redemption Gates 2. Alternatives to the Proposed Increases in Liquidity Requirements 3. Alternative Stress Testing Requirements 4. Alternative Implementations of Swing Pricing 5. Liquidity Fees 6. Expanding the Scope of the Floating NAV Requirements 7. Countercyclical Weekly Liquid Asset Requirement 8. Alternatives to the Amendments Related to Potential Negative Interest Rates 9. Alternatives to the Amendments Related to Processing Orders Under Floating NAV Conditions for All Intermediaries 10. Alternatives to the Amendments Related to WAL/WAM Calculation 11. Sponsor Support 12. Disclosures 13. Capital Buffers 14. Minimum Balance at Risk 15. Liquidity Exchange Bank Membership E. Effects on Efficiency, Competition, and Capital Formation F. Request for Comment IV. Paperwork Reduction Act A. Introduction B. Rule 2a-7 C. Rule 31a-2 D. Form N-MFP E. Form N-CR F. Form N-1A V. Initial Regulatory Flexibility Analysis VI. Consideration of Impact on the Economy VII. Statutory Authority I. Introduction Money market funds are a type of mutual fund registered under the Investment Company Act of 1940 (“Act”) and regulated pursuant to rule 2a-7 under the Act. 3 Money market funds are managed with the goal of providing principal stability by investing in high-quality, short-term debt securities, such as Treasury bills, repurchase agreements, or commercial paper, and whose value does not fluctuate significantly in normal market conditions. Money market fund investors receive dividends that reflect prevailing short-term interest rates and have access to daily liquidity, as money market fund shares are redeemable on demand. The combination of limited principal volatility, diversification of portfolio securities, payment of short-term yields, and liquidity has made money market funds popular cash management vehicles for both retail and institutional investors. Money market funds also provide an important source of short-term financing for businesses, banks, and Federal, state, municipal, and Tribal governments. 3 Money market funds are also sometimes called “money market mutual funds” or “money funds.” In March 2020, in connection with an economic shock from the onset of the COVID-19 pandemic, certain types of money market funds had significant outflows as investors sought to preserve liquidity. 4 We are proposing to amend rule 2a-7 to remove provisions in the rule that appear to have contributed to investors' incentives to redeem from certain funds during this period. For the category of funds that experienced the heaviest outflows in March 2020 and in prior periods of market stress, we are proposing a new swing pricing requirement that is designed to mitigate the dilution and investor harm that can occur today when other investors redeem—and remove liquidity—from these funds, particularly when certain markets in which the funds invest are under stress and effectively illiquid. We are also proposing to increase liquidity requirements to better equip money market funds to manage significant and rapid investor redemptions. In addition to these reforms, we are proposing changes to improve transparency and facilitate Commission monitoring of money market funds. We also propose to clarify how certain money market funds would operate if interest rates became negative. Finally, we propose to specify how funds must calculate weighted average maturity and weighted average life. 5 4 See infra Section I.B (discussing these events in more detail). 5 We have consulted and coordinated with the Consumer Financial Protection Bureau regarding this proposed rulemaking in accordance with section 1027(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. A. Types of Money Market Funds and Existing Regulatory Framework Different types of money market funds exist to meet differing investor needs. “Prime money market funds” hold a variety of taxable short-term obligations issued by corporations and banks, as well as repurchase agreements and asset-backed commercial paper. 6 “Government money market funds,” which are currently the largest category of money market fund, almost exclusively hold obligations of the U.S. Government, including obligations of the U.S. Treasury and Federal agencies and instrumentalities, as well as repurchase agreements collateralized by government securities. 7 Compared to prime funds, government money market funds generally offer greater safety of principal but historically have paid lower yields. “Tax-exempt money market funds” (or “municipal money market funds”) primarily hold obligations of state and local governments and their instrumentalities, and pay interest that is generally exempt from Federal income tax for individual taxpayers. 8 Within the prime and tax-exempt money market fund categories, some funds are “retail” funds and others are “institutional” funds. Retail money market funds are held only by natural persons, and institutional funds can be held by a wider range of investors, such as corporations, small businesses, and retirement plans. 9 6 Commission staff regularly publish comprehensive data regarding money market funds on the Commission's website, available at https://www.sec.gov/divisions/investment/mmf-statistics.shtml . This data includes information about the monthly holdings of prime money market funds by type of security. 7 Some government money market funds generally invest at least 80% of their assets in U.S. Treasury obligations or repurchase agreements collateralized by U.S. Treasury securities and are called “Treasury money market funds.” 8 In this release, we also use the term “non-government money market fund” to refer to prime and tax-exempt money market funds. 9 A retail money market fund is defined as a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons. See 17 CFR 270.2a-7(a)(21) (rule 2a-7(a)(21)). To some extent, different types of money market funds are subject to different requirements under rule 2a-7. One primary example is a fund's approach to valuation and pricing. Government and retail money market funds can rely on valuation and pricing techniques that generally allow them to sell and redeem shares at a stable share price, typically $1.00, without regard to small variations in the value of the securities in their portfolios. 10 If the fund's stable share price and market-based value per share deviate by more than one-half of 1%, the fund's board may determine to adjust the fund's share price below $1.00, which is also colloquially referred to as “breaking the buck.” 11 Institutional prime and institutional tax-exempt money market funds, however, are required to use a “floating” net asset value per share (“NAV”) to sell and redeem their 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). These institutional funds are required to use a floating NAV because their investors have historically made the heaviest redemptions in times of market stress and are more likely to act on the incentive to redeem if a fund's stable price per share is higher than its market-based value. 12 10 Under the amortized cost method, a government or retail 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 such a money market fund when pricing its shares to round the fund's NAV to the nearest 1% ( i.e., the nearest penny). Together, these valuation and pricing techniques create a “rounding convention” that permits these money market funds to sell and redeem shares at a stable share price without regard to small variations in the value of portfolio securities. See 17 CFR 270.2a-7(c)(i), (g)(1), and (g)(2). 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”). Throughout this release, we generally use the term “stable share price” or “stable NAV” to refer to the stable share price that these money market funds seek to maintain and compute for purposes of distribution, redemption, and repurchases of fund shares. 11 These funds must compare their stable share price to the market-based value per share of their portfolios at least daily. 12 See Money Market Fund Reform; Amendments to Form PF, Investment Company Act Release No. 31166 (July 23, 2014) [79 FR 47735 (Aug. 14, 2014)] (“2014 Adopting Release”). As stated in the 2014 Adopting Release, this incentive exists largely in prime money market funds because these funds exhibit higher credit risk that makes declines in value more likely (compared to government money market funds). As of July 2021, there were approximately 318 money market funds registered with the Commission, and these funds collectively held over $5.0 trillion of assets. 13 The vast majority of these assets are held by government money market funds ($4.0 trillion), followed by prime money market funds ($875 billion) and tax-exempt money market funds ($101 billion). 14 Slightly less than half of prime money market funds' assets are held by publicly offered institutional funds, with the remaining assets almost evenly split between retail prime money market funds and institutional prime money market funds that are not offered to the public. 15 The vast majority of tax-exempt money market fund assets are held by retail funds. 13 Money Market Fund Statistics, Form N-MFP Data, period ending July 2021, available at: https://www.sec.gov/files/mmf-statistics-2021-07.pdf. This data excludes “feeder” funds to avoid double counting assets. 14 Id. 15 Some asset managers establish privately offered money market funds to manage cash balances of other affiliated funds and accounts. The Commission adopted rule 2a-7 in 1983 and has amended the rule several times over the years, including in response to market events that have highlighted money market fund vulnerabilities. 16 For example, during 2007-2008, some prime money market funds were exposed to substantial losses from certain of their holdings. 17 At that time, one money market fund “broke the buck” and suspended redemptions, and many fund sponsors provided financial support to their funds. 18 These events, along with general turbulence in the financial markets, led to a run primarily on institutional prime money market funds and contributed to severe dislocations in short-term credit markets. The U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System subsequently announced intervention in the short-term markets that was effective in containing the run on prime money market funds and providing additional liquidity to money market funds. 19 16 See 1983 Adopting Release, supra footnote 10; see also infra footnote 20. 17 For a more detailed account of these events, see Money Market Fund Reform, Investment Company Act Release No. 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)], at section I.D. 18 See id. at paragraphs accompanying nn.41 and 44. At this time, all money market funds generally were permitted to maintain stable prices per share. 19 The Treasury Department's Temporary Guarantee Program for Money Market Funds temporarily guaranteed certain investments in money market funds that participated in the program. The Federal Reserve Board's Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility 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. See Press Release, Treasury Department, Treasury Announces Guaranty Program for Money Market Funds (Sept. 19, 2008), available at https://www.treasury.gov/press-center/press-releases/Pages/hp1161.aspx ; Press Release, Federal Reserve Board, Federal Reserve Board Announces Two Enhancements to its Programs to Provide Liquidity to Markets (Sept. 19, 2008), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20080919a.htm . After the events of the 2008 financial crisis, the SEC adopted a number of amendments to its money market fund regulations in 2010 and 2014. 20 In 2010, the Commission adopted amendments to rule 2a-7 that, among other things, for the first time required that money market funds maintain liquidity buffers in the form of specified levels of daily and weekly liquid assets. 21 The amendments required that taxable money market funds have at least 10% of their assets in cash, U.S. Treasury securities, or securities that convert into cash ( e.g., mature) within one day (“daily liquid assets”), and that all money market funds have at least 30% of assets in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, or securities that convert into cash within one week (“weekly liquid assets”). 22 These liquidity buffers provide a source of internal liquidity and are intended to help funds withstand high redemptions during times of market illiquidity. The 2010 amendments also increased transparency about a money market fund's holdings by introducing monthly Form N-MFP reporting requirements and website posting requirements. In addition, the Commission further limited the maturity of a fund's portfolio, including by shortening the permitted weighted average portfolio maturity and introducing a separate weighted average life to limit the portion of a fund's portfolio held in longer-term adjustable rate securities. 20 Money Market Fund Reform, Investment Company Act Release No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (“2010 Adopting Release”); 2014 Adopting Release, supra footnote 12. 21 2010 Adopting Release, supra footnote 20. See rule 17 CFR 270.2a-7(c)(5)(ii) and (iii). 22 See 17 CFR 270.2a-7(a)(8) (rule 2a-7(a)(8)) (defining “daily liquid assets”) and 17 CFR 270.2a-7(a)(28) (rule 2a-7(a)(28)) (defining “weekly liquid assets”). In 2014, the Commission further amended the rules that govern money market funds. In these amendments the Commission provided the boards of directors of non-government money market funds with new tools to stem heavy redemptions by giving them discretion to impose a liquidity fee or temporary suspension of redemptions ( i.e., a gate) if a fund's weekly liquid assets fall below 30%. These amendments also require all non-government money market funds to impose a liquidity fee if the fund's weekly liquid assets fall below 10%, unless the fund's board determines that imposing such a fee is not in the best interests of the fund. Additionally, in 2014 the Commission removed the valuation exemption that permitted institutional non-government money market funds to maintain a stable NAV, and required those funds to transact at a floating NAV. The amendments provided guidance related to amortized cost valuation, as well as introduced requirements for strengthened diversification of money market funds' portfolios and enhanced stress testing. The Commission also introduced a requirement that money market funds report certain significant events on Form N-CR and made other amendments to improve transparency, including additional website posting requirements and amendments to Form N-MFP. Following the 2014 amendments, government money market funds grew substantially, while prime money market funds diminished in size, as shown in the chart below. 23 23 While the Commission adopted the amendments in 2014, the compliance date for the floating NAV requirement for institutional prime and institutional tax-exempt funds and for the fee and gate provisions for all prime and tax-exempt funds was October 14, 2016. BILLING CODE 8011-01-P EP08FE22.002 The chart below depicts the distribution between retail and institutional net assets in both prime and tax-exempt funds beginning in October 2016. 24 24 The 2014 amendments introduced a regulatory definition of a retail money market fund and implemented it in October 2016. Data on institutional and retail prime and tax-exempt money market funds prior to this time may not be fully comparable with current data and, thus, Chart 2 covers a period beginning in October 2016. EP08FE22.003 Finally, Table 1 below depicts the key requirements currently applicable to each type of money market fund. EP08FE22.004 BILLING CODE 8011-01-C B. March 2020 Market Events In March 2020, growing economic concerns about the impact of the COVID-19 pandemic led investors to reallocate their assets into cash and short-term government securities. 25 These heavy asset flows placed stress on short-term funding markets. 26 For instance, commercial paper and certificates of deposit markets in which prime money market funds and other participants invest became “frozen” in March 2020, making it more difficult to sell these instruments, which have limited secondary trading even in normal times. 27 Institutional investors, in particular, sought highly liquid investments, including government money market funds. 28 In contrast, institutional prime and tax-exempt money market funds experienced outflows beginning the week of March 9, 2020, which accelerated the following week. 29 Outflows from retail prime and tax-exempt funds began the week of March 16, a week after outflows in institutional funds began. Outflows from some publicly offered institutional prime funds as a percentage of fund size exceeded those in the September 2008 crisis, although the outflows in dollar amounts were much smaller in March 2020, due in part to the significant reductions in the size of prime money market funds that occurred between September 2008 and March 2020. 25 See SEC Staff Report on U.S. Credit Markets Interconnectedness and the Effects of the COVID-19 Economic Shock (Oct. 2020) (“SEC Staff Interconnectedness Report”) at 2, available at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf . 26 Notably, this market stress in March 2020, including its impact on money market funds, was more of a liquidity event than in 2008. In 2008 there were heightened concerns regarding the credit quality of some money market funds' underlying holdings. 27 See SEC Staff Interconnectedness Report, supra footnote 25, at 23. 28 More specifically, government money market funds had record inflows of $838 billion in March 2020 and an additional $347 billion of inflows in April 2020. See id. at 25. 29 Id. During the two-week period of March 11 to 24, publicly offered institutional prime funds had a 30% redemption rate (about $100 billion), which included outflows of approximately 20% of assets during the week of March 20 alone. 30 The largest weekly redemption rate from a single publicly offered institutional prime fund during this period was around 55%, and the largest daily outflow was about 26%. In contrast, privately offered institutional prime funds had redemptions of 3% of assets during the week of March 20, and lost approximately 6% of their total assets ($17 billion) from March 9 through 20. 30 This discussion of the size of outflows in March 2020 is based on the Report of the President's Working Group on Financial Markets, Overview of Recent Events and Potential Reform Options for Money Market Funds, infra footnote 39, and our additional analysis. Retail money market funds had lower levels of outflows than publicly offered institutional funds. Retail prime funds had outflows of approximately 11% of their total assets ($48 billion) in the last three weeks of March 2020. Outflows from tax-exempt money market funds, which are mostly retail funds, were approximately 8% of their total assets ($12 billion) from March 12 through 25. As prime money market funds experienced heavy redemptions, their holdings of weekly liquid assets generally declined. However, these declines were not commensurate with the level of redemptions. Available data suggests that managers were actively managing their portfolios to avoid having weekly liquid assets below 30% of their total assets by, in some cases, selling other portfolio securities to meet redemptions. Available evidence, supported by many comment letters in response to the Commission's request for comment discussed below, suggested that funds' incentives to maintain weekly liquid assets above the 30% threshold were directly tied to investors' concerns about the possibility of redemption gates and liquidity fees under our rules if a fund drops below that threshold. 31 Based on Form N-MFP data providing the size of each fund's weekly liquid assets as of the end of each week, between March 13 and March 20, the weekly liquid assets of most money market funds changed by less than 5%. In particular, institutional prime money market funds that were closer to the 30% weekly liquid asset threshold tended to increase their weekly liquid assets, while those with higher weekly liquid assets tended to decrease their weekly liquid assets. 32 One institutional prime fund's weekly liquid assets fell below the 30% minimum threshold set forth in rule 2a-7. 33 To support liquidity of fund portfolios, two fund sponsors provided support to three institutional prime funds by purchasing commercial paper and certificates of deposit the funds held. 34 31 See, e.g., Comment Letter of State Street Global Advisors (Apr. 12, 2021) (“State Street Comment Letter”); Comment Letter of Schwab Asset Management Solutions (Apr. 12, 2021) (“Schwab Comment Letter”); Comment Letter of the Investment Company Institute (Apr. 12, 2021) (“ICI Comment Letter I”); Comment Letter of Wells Fargo Funds Management, LLC (Apr. 12, 2021) (“Wells Fargo Comment Letter”); Comment Letter of J.P. Morgan Asset Management (Apr. 12, 2021) (“JP Morgan Comment Letter”). See also, e.g., Li, Lei, Yi Li, Marco Machiavelli, and Alex Xing Zhou, “Runs and Interventions in the Time of COVID-19: Evidence from Money Funds,” working paper (2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3607593 (“Li et al.” ). 32 Based on our analysis, two-thirds of retail prime money market funds and about half of institutional prime money market funds increased their weekly liquid assets slightly during this period. 33 The one money market fund that fell below the 30% threshold did not impose a gate or fees. 34 As reported by these money market funds in their filings on Form N-CR. On March 18, 2020, the Federal Reserve, with the approval of the Department of the Treasury, broadened its program of support for the flow of credit to households and businesses by taking steps to enhance the liquidity and functioning of money markets with the establishment of the Money Market Mutual Fund Liquidity Facility (“MMLF”). The MMLF provided loans to financial institutions on advantageous terms to purchase securities from money market funds that were raising liquidity, thereby helping enhance overall market functioning and credit provisions to the broader economy. 35 MMLF utilization reached a peak of just over $50 billion in early April 2020, or about 5% of net assets in prime and tax-exempt money market funds at the time. 36 Along with other Federal Reserve actions and programs to support the short-term funding markets, the MMLF had the effect of significantly slowing outflows from prime and tax-exempt money market funds. 37 The MMLF ceased providing loans in March 2021. 38 35 Information about the MMLF is available on the Federal Reserve's website at https://www.federalreserve.gov/monetarypolicy/mmlf.htm . The Federal Reserve Bank of Boston operated the MMLF. 36 See PWG Report, infra footnote 39, at 17. Institutional and retail prime and tax-exempt money market funds were eligible to participate in the MMLF. See also Federal Reserve Bank of New York Staff Reports, no. 980, The Money Market Mutual Fund Liquidity Facility (Sept. 2021) at text accompanying nn. 19 and 22, available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr980.pdf (providing an analysis of prime funds' participation in the MMLF and stating that through its life, the MMLF extended loans to nine banks, which purchased securities from 30 institutional prime funds and 17 retail prime funds). 37 See, e.g., “Federal Reserve Issues FOMC Statement” (Mar. 15, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm ; “Federal Reserve Actions to Support the Flow of Credit to Households and Businesses” (Mar. 15, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm ; “Federal Reserve Board Announces Establishment of a Commercial Paper Funding Facility (CPFF) to Support the Flow of Credit to Households and Businesses” (Mar. 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317a.htm ; “Federal Reserve Board Announces Establishment of a Primary Dealer Credit Facility (PDCF) to Support the Credit Needs of Households and Businesses” (Mar. 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317b.htm ; “Federal Reserve Board Broadens Program of Support for the Flow of Credit to Households and Businesses by Establishing a Money Market Mutual Fund Liquidity Facility (MMLF)” (Mar. 18, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm . 38 See supra footnote 35. Report of the President's Working Group on Financial Markets and the Commission's Request for Comment The President's Working Group on Financial Markets (“PWG”) issued a report discussing these events and several potential money market fund reform options in December 2020 (the “PWG Report”). 39 The Commission issued a request for comment (the “Request for Comment”) on the various reform options discussed in the PWG Report, and the comment period closed in April 2021. 40 We received numerous comments in response to the Request for Comment, which are discussed throughout this release. Several of the reforms we are proposing in this release were included as potential reform options in the PWG Report. 41 39 See Report of the President's Working Group on Financial Markets, Overview of Recent Events and Potential Reform Options for Money Market Funds (Dec. 2020), available at https://home.treasury.gov/system/files/136/PWG-MMF-report-final-Dec-2020.pdf . 40 Request for Comment on Potential Money Market Fund Reform Measures in President's Working Group Report, Investment Company Act Release No. 34188 (Feb. 4, 2021) [86 FR 8938 (Feb. 10, 2021)]. Comment letters received in response to the Request for Comment are available at: https://www.sec.gov/comments/s7-01-21/s70121.htm . 41 After considering comments on the Commission's request for comment, we are not proposing other reform options discussed in the PWG Report. These other reform options included: (i) Reform of the conditions for imposing redemption gates; (ii) minimum balance at risk; (iii) countercyclical weekly liquid asset requirements; (iv) floating NAVs for all prime and tax-exempt money market funds; (v) capital buffer requirements; (vi) requiring liquidity exchange bank (“LEB”) membership; and (vii) new requirements governing sponsor support. The Commission has considered several of these reform options in the past, including minimum balance at risk, floating NAVs for a broader range of funds, capital buffers, and LEB membership. See 2014 Adopting Release, supra footnote 12, at section III.L. After considering comments, we believe the package of reforms we are proposing is appropriately tailored to achieve our regulatory goals. See infra Section III.D (discussing the reform alternatives in the PWG Report that we are not proposing). Reasons for Investors' Redemption Behavior We considered several factors that may have driven investors' redemptions during this period of market stress, including the potential for the imposition of fees and gates as funds neared the 30% weekly liquid asset threshold, declining NAVs, risk reduction, and general concerns about the economic impact of the COVID-19 pandemic. Evidence suggests that concerns about the potential for fees or gates contributed to some investors' redemption decisions. For example, one research paper indicated that institutional prime money market fund outflows accelerated as funds' weekly liquid assets went closer to the 30% threshold. 42 Another paper found that smaller institutional investors redeemed more intensely from prime money market funds with lower liquidity levels, whereas large institutional investors redeemed heavily from prime money market funds regardless of fund liquidity level. 43 Weekly Form N-MFP data analyzed in Table 2 shows that most of the largest asset outflows from institutional prime funds in the third week of March 2020 were from those funds with weekly liquid assets below 41%. The five institutional prime money market funds with the lowest weekly liquid assets accounted for roughly 40% of the dollar change in assets among all such money market funds. Although Table 2 shows that money market funds with weekly liquid assets closer to the 30% threshold had a higher percent of outflows during the week ending March 20, 2020, some prime funds with higher levels of weekly liquid assets also experienced large outflows. 44 While Table 2 is based on weekly data provided on Form N-MFP, a research report found that 42 See Li et al., supra footnote 31. 43 See BIS Quarterly Review: International banking and financial market developments, Bank for International Settlements (Mar. 2021), available at https://www.bis.org/publ/qtrpdf/r_qt2103.pdf . 44 For example, two institutional prime money market funds with outflows greater than 40% had weekly liquid assets of 46% and 48%. weekly liquid assets dropped during the third week of March 2020, but started to recover by the end of the week. 45 45 For example, on March 16 there were two institutional prime money market funds with weekly liquid assets less than 35%, six on March 18, and three on March 20. See ICI Report, Experiences of US Money Market Funds During the Covid-19 Crisis (Nov. 2020) (“ICI MMF Report”), available at https://www.ici.org/pdf/20_rpt_covid3.pdf . Beyond concerns about the potential imposition of fees or gates, general declines in liquidity levels may have been a concern for investors because the declines can signify that a fund may be less equipped to handle redemptions in the near-term. While declining liquidity on its own likely contributed to some investors' redemption decisions, a few commenters provided information from investor surveys suggesting that the potential for gates, and to a somewhat lesser extent the potential of liquidity fees, was a more common concern among investors. 46 46 See infra footnote 73 (discussing these surveys). EP08FE22.005 We also considered the possibility that declining market-based prices for retail and institutional non-government funds contributed to investors' redemptions in March 2020. For retail funds that maintain a stable NAV, declining market-based prices can contribute to investor concerns that these funds may “break the buck” ( i.e., have market-based prices below $0.9950) and re-price their shares below $1.00. Most retail prime and tax-exempt money market funds experienced declining market-based prices in March 2020. However, only one retail tax-exempt fund reported a market-based price below $0.9975, and that fund subsequently received sponsor support in the form of a capital contribution to reduce the deviation between the fund's market-based price and its stable price per share. 47 Moreover, retail prime and tax-exempt money market funds with lower market-based prices did not experience larger outflows than other retail prime and tax-exempt money market funds, so these funds' flows in March 2020 appear to have been unrelated to market-based prices. Like retail funds, most institutional prime and tax-exempt money market funds experienced declines in their market-based prices in March 2020. However, none of the market-based prices dropped below $0.9975. Staff analysis and an external study did not find a correlation between market prices and institutional prime fund redemptions during this time. 48 47 PWG Report, supra footnote 39, at 15. 48 See Baklanova, Kuznits, and Tatum, “Prime MMFs at the Onset of the Pandemic: Asset Flows, Liquidity Buffers, and NAVs,” SEC Staff Analysis (Apr. 15, 2021) (“Prime MMFs at the Onset of the Pandemic Report”) at 5, available at https://www.sec.gov/files/prime-mmfs-at-onset-of-pandemic.pdf . Any statements therein represent the views of the staff of the Division of Investment Management. These statements are not a rule, regulation, or statement of the U.S. Securities and Exchange Commission. The Commission has neither approved nor disapproved their content. Such statements, like all staff statements, have no legal force or effect: They do not alter or amend applicable law, and they create no new or additional obligations for any person. See also Li et al., supra footnote 31. We also considered the potential relationship between a money market fund's portfolio holdings and investors' redemption behavior. Investor redemption behavior differed based on the overall nature of a money market fund's portfolio, given that government money market funds had significant inflows and prime money market funds had large outflows. However, unlike the events of 2008, redemptions from prime money market funds did not appear to be correlated to a fund's particular holdings. For instance, prime money market funds with the largest holdings of commercial paper and certificates of deposit did not experience greater redemptions than other prime funds, even though the commercial paper and certificates of deposit markets were experiencing greater strains in March 2020 than other markets in which money market funds invest. 49 49 The five institutional prime money market funds with the highest concentration of commercial paper and certificates of deposit accounted for roughly 3% of the dollar change in assets among all institutional prime money market funds. These five funds each held between 71% and 83% of their assets in commercial paper and certificates of deposit. In aggregate, these five funds held $31 billion in assets on March 13, 2020, and experienced a combined outflow of $3 billion, or roughly 10% of their total assets, during the week of March 20, 2020. Beyond factors that relate to the regulatory framework for money market funds, there are other factors that may have had a relationship to investors' redemption incentives in March 2020. As some commenters suggested, general uncertainty of a global health crisis and fears of possible business disruptions and economic downturns in the real economy as people stayed at home resulted in investors becoming increasingly risk averse and seeking to preserve or increase liquidity. 50 Some commenters also asserted that some institutional investor redemptions were ordinary course redemptions that otherwise would have occurred, irrespective of the pandemic and market stress, to meet near-term cash needs, including for operating cash, to make quarterly corporate tax payments, or to meet payroll expenses. 51 50 See, e.g., ICI Comment Letter I; JP Morgan Comment Letter; Comment Letter of the Vanguard Group, Inc. (Apr. 12, 2021) (“Vanguard Comment Letter”); Comment Letter of Federated Hermes, Inc. (Apr. 12, 2021) (“Federated Hermes Comment Letter I”). 51 See, e.g., Comment Letter of Invesco (Apr. 12, 2021) (“Invesco Comment Letter”) (stating that prime money market funds experienced increased redemptions leading up to the quarterly corporate tax deadline); Federated Hermes Comment Letter I (citing a Carfang Group survey in which 50% of surveyed corporate treasurers who redeemed from institutional prime funds in March 2020 stated that they were doing so to meet operating cash needs); Comment Letter of the Securities Industry and Financial Markets Association Asset Management Group (Apr. 12, 2021) (“SIFMA AMG Comment Letter”) (stating that tax return filings for partnerships and S-corporations were due on March 16, 2020, and many businesses had biweekly or semimonthly payroll expenses around the same time). In addition, our staff identified some relationships between the size of outflows and the type of adviser to the fund or the size of the fund. This revealed that publicly offered prime institutional money market funds managed by bank-affiliated advisers had the most outflows in March 2020. 52 Money market funds complexes with lower assets under management in publicly offered prime institutional money market funds also generally had larger outflows during this time. 53 52 See Prime MMFs at the Onset of the Pandemic Report, supra footnote 48, at 3. The analysis in this report concluded that the largest outflows in mid-March 2020 were from the publicly offered prime institutional money market funds with advisers owned by banking firms. The funds with advisers owned by the largest U.S. banks designated as global systemically important banks (“G-SIBs”) accounted for 56% of the outflows in the third week of March, even though these funds managed only around 28% of net assets in publicly offered prime institutional money market funds. 53 Id at 3. Connection Between Money Market Fund Outflows and Stress in Short-Term Funding Markets In markets for private short-term debt instruments, such as commercial paper and certificates of deposit, conditions significantly deteriorated in the second week of March 2020. Spreads for commercial paper and certificates of deposits began widening sharply, and new issuances declined and shifted to shorter tenors. 54 While there is limited secondary activity in these markets even in normal times, several industry commenters discussed particular difficulties selling commercial paper in March 2020. 55 Moreover, where money market funds were able to sell commercial paper during this period, increased selling activity from institutional prime funds may have contributed to stress in these markets as discussed below. 54 PWG Report, supra footnote 39, at 11. 55 See infra footnote 202 and accompanying paragraph. Using Form N-MFP data, we observed that retail prime and privately offered institutional prime funds did not sell significantly more long-term portfolio securities ( i.e., securities that mature in more than a month) in March 2020 relative to their typical averages. Publicly offered institutional prime funds, however, increased their sales of long-term securities in March 2020 to 15% of total assets during this time period, which includes assets sold to the MMLF and sponsors, compared to a 4% monthly average during the period from October 2016 through February 2020. In March 2020, these funds sold around $52 billion in certificates of deposit and commercial paper with maturities greater than one month. 56 Of this amount, approximately $4 billion was sold to fund sponsors, as reported on Form N-CR. Combining this data with data provided by an industry group's member survey and Federal Reserve data on the balance of the MMLF, prime money market funds sold an estimated $80 billion in commercial paper and certificates of deposit in March 2020, with approximately 5% ($4 billion) of that total sold to sponsors, 66% ($53 billion) pledged to the MMLF, and 29% ($23 billion) sold in the secondary market. 57 Thus, we find that prime money market funds, particularly institutional funds, were engaging in greater than normal selling activity in these markets which, when combined with similar selling from other market participants such as hedge funds and bond mutual funds, both contributed to, and were impacted by, stress in short-term funding markets. 58 56 This analysis is based on longer-term holdings that these funds reported on Form N-MFP in February 2020 but that they did not report holding in March 2020. The estimate includes $24.3 billion in certificates of deposit and $28.1 billion in commercial paper. 57 Our analysis of available data suggests that of the $80 billion in commercial paper and certificates of deposit sold in March 2020, about $70 billion had maturities greater than a month and about $10 billion had maturities less than a month. As of April 1, 2020, the MMLF balance was close to $53 billion according to the Federal Reserve's weekly data, available at https://www.federalreserve.gov/releases/h41/20200402/. See ICI Comment Letter I (providing information about money market fund selling activity in March 2020 based on a member survey). 58 See, e.g., SEC Staff Interconnectedness Report, supra footnote 25, at 4. At the end of February 2020, prime money market funds offered to the public owned about 19% of commercial paper outstanding. See PWG Report, supra footnote 39, at 11. Conditions in short-term municipal debt markets also worsened rapidly in March 2020. Stresses in short-term municipal markets contributed to pricing pressures and outflows for tax-exempt money market funds which, in turn, contributed to increased stress in municipal markets. 59 Table 2 shows that as tax-exempt money market funds experienced heightened redemptions in the third week of March 2020 of 9.2%, they reduced their holdings ( e.g., tender option bonds and variable rate demand notes) by $12.9 billion that week. 59 See PWG Report, supra footnote 39, at 12. See also SEC Staff Interconnectedness Report, supra footnote 25, at 27. One commenter suggested that the overall issue in the municipal securities market in March 2020 was selling pressure from many market participants, and not selling pressure from tax-exempt money market funds, which make up only a small portion of the overall market. 60 This commenter suggested that other market participants were raising cash by selling short-term municipal securities, which caused meaningful discounts on the market value of those securities and consequently placed downward pressure on market-based NAVs of tax-exempt money market funds. The commenter also stated that longer-term municipal money market securities, and not variable rate demand notes, bore the brunt of the market stress in March 2020. Another commenter suggested that tax-exempt money market funds sold longer-term holdings in March 2020 to maintain an average weighted maturity of not more than 60 days, rather than to maintain weekly liquid assets above 30% (given that these funds typically hold much higher levels of weekly liquid assets). 61 Our analysis found that tax-exempt money market funds sold a larger amount of portfolio securities with maturities of more than a month in March 2020 than they typically do. Retail tax-exempt money market funds sold 16% of total assets of such holdings during this period, compared to a monthly average of 3% during the period from October 2016 through February 2020. Institutional tax-exempt money market funds increased their sales of longer-term securities from 5% of total assets during the period from October 2016 through February 2020 to 24% in March 2020. Similar to what we observed with prime money market funds, tax-exempt funds engaged in greater than normal selling activity. 62 60 Vanguard Comment Letter. 61 Comment Letter of Stephen Keen (Apr. 28, 2021). This commenter also disagreed with a statement in the PWG Report that a spike in the SIFMA index yield caused a drop in market-based NAVs of tax-exempt money market funds. The commenter suggested that it is more likely that the fund reporting a market-based NAV below $0.9775 had already realized losses from earlier portfolio sales and sold longer-term holdings in response to redemptions in March, with the March redemptions increasing the significance of the realized losses. 62 Although the tax-exempt money market funds held only $127 billion in assets in the third week of March 2020, they, like other larger market participants, found it difficult to sell assets during this period of market stress. II. Discussion A. Amendments To Remove Liquidity Fee and Redemption Gate Provisions 1. Unintended Effects of the Tie Between the Weekly Liquid Asset Threshold and Liquidity Fees and Redemption Gates Under current rule 2a-7, a money market fund has the ability to impose liquidity fees or redemption gates (generally referred to as “fees and gates”) after crossing a specified liquidity threshold. 63 A money market fund may impose a liquidity fee of up to 2%, or temporarily suspend redemptions for up to 10 business days in a 90-day period, if the fund's weekly liquid assets fall below 30% of its total assets and the fund's board of directors determines that imposing a fee or gate is in the fund's best interests. 64 Additionally, a non-government money market fund is required to impose a liquidity fee of 1% on all redemptions if its weekly liquid assets fall below 10% of its total assets, unless the board of directors of the fund determines that imposing such a fee would not be in the best interests of the fund. 65 Separately, a money market fund is required to provide daily disclosure of the percentage of its total assets invested in weekly liquid assets (as well as daily liquid assets) on its website to provide transparency to investors and increase market discipline. 66 63 Government funds are permitted, but not required, to impose fees and gates, as discussed below. 64 If, at the end of a business day, a fund has invested 30% or more of its total assets in weekly liquid assets, the fund must cease charging the liquidity fee (up to 2%) or imposing the redemption gate, effective as of the beginning of the next business day. See 17 CFR 270.2a-7(c)(2)(i)(A) and (B), and (ii)(B). 65 The board also may determine that a lower or higher fee would be in the best interests of the fund. See 17 CFR 270.2a-7(c)(2)(ii)(A). 66 17 CFR 270.2a-7(h)(10)(ii); 2014 Adopting Release, supra footnote 12, at section III.E.9.a. Fees and gates were intended to serve as redemption restrictions that would provide a “cooling off” period to temper the effects of a short-term investor panic and preserve liquidity levels in times of market stress, as well as better allocate the costs of providing liquidity to redeeming investors. 67 However, these provisions did not achieve these objectives during the period of market stress in March 2020. Based on available evidence, even though no money market fund imposed a fee or gate, the possibility of the imposition of a fee or gate appears to have contributed to incentives for investors to redeem and for money market fund managers to maintain weekly liquid asset levels above the threshold, rather than use those assets to meet redemptions. 68 These tools therefore appear to have potentially increased the risks of investor runs without providing benefits to money market funds as intended. As a result, and after considering comments, we are proposing to remove the tie between liquidity thresholds and fee and gate provisions and, moreover, to remove fee and gate provisions from rule 2a-7 entirely. 69 67 See 2014 Adopting Release, supra footnote 12, at section III.L.1.a. 68 See supra Section I.B. 69 We also propose to remove related disclosure and reporting provisions that require funds to disclose certain information about the possibility of fees and gates in their prospectuses and to report any imposition of fees or gates on Form N-CR, on the fund's website, and in its statement of additional information. See Items 4(b)(1)(ii) and 16(g)(1) of current Form N-1A; Parts E, F, and G of current Form N-CR; 17 CFR 270.2a-7(h)(10)(v). Commenters broadly supported removal of the tie between weekly liquid asset thresholds and the potential imposition of fees and gates. 70 Many commenters stated that this tie contributed to investors' incentives to redeem in March 2020 as funds' weekly liquid assets declined. 71 Commenters suggested that, although the rule allows but does not require a fund's board to impose redemption gates or liquidity fees when the fund drops below the 30% weekly liquid asset threshold, investors viewed the 30% threshold as a bright line prompting redemptions. 72 Some commenters also provided information suggesting that concerns about the potential imposition of fees or gates contributed to institutional investors' decisions to redeem. 73 One commenter stated that these concerns, combined with investors' ability to track weekly liquid asset levels on a daily basis, drove investors' redemption behavior. 74 A few commenters suggested that investors were more concerned about the potential for temporary suspensions of redemptions than the potential for liquidity fees. 75 In addition, a few commenters stated that retail investors were less sensitive to concerns about potential fees or gates than institutional investors. 76 70 See e.g., ICI Comment Letter I; SIFMA AMG Comment Letter; Comment Letter of Fidelity Management & Research Company LLC (Apr. 12, 2021) (“Fidelity Comment Letter”); Comment Letter of Northern Trust Asset Management (Apr. 12, 2021) (“Northern Trust Comment Letter”); Schwab Comment Letter; Comment Letter of Professors of Finance, Stanford Graduate School of Business, and The University of Chicago Booth School of Business (Apr. 9, 2021) (“Prof. Admati et al. Comment Letter”); Comment Letter of Healthy Markets Association (Apr. 19, 2021) (“Healthy Markets Comment Letter”). 71 See, e.g., ICI Comment Letter I; Vanguard Comment Letter; Fidelity Comment Letter; Prof. Admati et al. Comment Letter; Comment Letter of U.S. Chamber of Commerce Center for Capital Markets Competitiveness (Apr. 12, 2021) (“CCMC Comment Letter”). 72 See Schwab Letter; ICI Comment Letter I; Comment Letter of the Investment Company Institute (May 12, 2021) (“ICI Comment Letter II”); JP Morgan Comment Letter; Wells Fargo Comment Letter. 73 See, e.g., JP Morgan Comment Letter (discussing an informal survey of institutional investor clients in which respondents, on average, identified the potential for gates as the most important factor affecting their decisions to redeem among several possible factors the survey identified); Federated Hermes Comment Letter I (citing a survey of 39 treasury managers in which 49% of the treasurers decreased their holdings of prime money market funds in March 2020 and, of those treasurers, 87% mentioned the potential of “redemption hurdles” as a factor in their decision to redeem). 74 ICI Comment Letter I. 75 See Invesco Comment Letter (stating that investors were less concerned about the price of their shares and more concerned about not having access to their shares, particularly for investors who were bolstering their liquidity positions ahead of what was an unknown situation in March 2020); ICI Comment Letter I (stating that investors view access to their money as paramount in stress periods and are less concerned with “losing a few pennies” through, for example, a fee); ICI Comment Letter II. 76 See, e.g., ICI Comment Letter I (stating that retail prime money market funds did not exhibit the same pattern of increasing redemptions as a fund neared the 30% threshold, despite the fact that retail prime funds are subject to the same fee and gate provisions as institutional prime funds); Fidelity Comment Letter. Several commenters also discussed the effect of the connection between liquidity thresholds and fees and gates on money market fund managers' behavior in March 2020. These commenters stated that, rather than use weekly liquid assets, some managers sold longer-dated securities to meet redemptions to avoid falling below the 30% threshold. 77 Commenters asserted that these sales led to losses for funds and their remaining investors, and contributed to downward pricing pressure on the underlying securities. 78 A few commenters also suggested that the pressure for money market funds to maintain liquidity buffers well above the 30% threshold exacerbated market stress in March 2020 as most money market funds were seeking liquidity at the same time to maintain or build their buffers in the face of redemptions. 79 Commenters also recognized that, in a few instances, fund sponsors provided financial support by purchasing securities from affiliated institutional prime money market funds to prevent these funds from dropping below the 30% weekly liquid asset threshold. 80 One commenter stated that, prior to the 2014 reforms that created the connection between liquidity thresholds and fees and gates, money market funds regularly used their liquidity buffers and had weekly liquid assets below the 30% threshold without adverse consequences. 81 77 See, e.g., State Street Comment Letter; ICI Comment Letter I; JP Morgan Comment Letter. 78 See, e.g., JP Morgan Comment Letter. 79 See Schwab Comment Letter; State Street Comment Letter (stating that the commenter observed that institutional prime money market funds held, on average, weekly liquid assets of approximately 45% during March 2020). 80 See, e.g., ICI Comment Letter I; Wells Fargo Comment Letter. 81 ICI Comment Letter I (stating that for the more than 6 years the 30% weekly liquid asset threshold was in effect but not connected to fee and gate provisions, 68% of prime money market funds and 10% of tax-exempt money market funds dropped below the 30% threshold at least once, and at least one prime money market fund was below this threshold in nearly each week during this period). We recognize that the current fee and gate provisions did not have their intended effect in March 2020 and, instead, appear to have contributed to some of the stress that some money market funds and short-term funding markets faced during that period. Some investors may have feared that if they were not the first to exit their fund, there was a risk that they could be subject to gates or fees, and this anticipatory, risk-mitigating perspective potentially further accelerated redemptions. As discussed above, our analysis and external research are consistent with commenters' views on investor behavior and found that prime and tax-exempt money market funds whose weekly liquid assets approached the 30% threshold had, on average, larger outflows in percentage terms than other prime and tax-exempt money market funds. 82 82 See supra Section I.B (discussing our analysis and external papers). 2. Removal of Redemption Gates From Rule 2a-7 We are proposing to remove the ability of a money market fund to impose redemption gates under rule 2a-7, as suggested by some commenters. 83 For example, a few commenters suggested that gates be eliminated from rule 2a-7 entirely, or that funds be permitted to suspend redemptions only under extraordinary circumstances, such as in anticipation of a fund liquidation in accordance with rule 22e-3. 84 One of these commenters suggested that, given the strong investor aversion to gates and the likelihood that liquidation would be a consequence of any board determination to impose a gate, the current gate provisions contemplated for fund liquidations in existing rule 22e-3 may be sufficient. 85 Based on the experience in March 2020, we are concerned that redemption gates may not be an effective tool for money market funds to stem heavy redemptions in times of stress due to money market fund investors'—who typically invest in money market funds for cash management purposes—general sensitivity to being unable to access their investments for a period of time and tendency to redeem from such funds preemptively if they fear a gate may be imposed. Under the proposal, a money market fund would continue to be able to suspend redemptions to facilitate an orderly liquidation of the fund under rule 22e-3. Rule 22e-3 generally allows a money market fund to suspend redemptions if, among other conditions, (1) the fund, at the end of a business day, has invested less than 10% of its total assets in weekly liquid assets or, in the case of a government or retail money market fund, the fund's price per share has deviated from its stable price ( i.e., it has “broken the buck”) or the fund's board determines that such a deviation is likely to occur, and (2) the fund's board has approved the fund's liquidation. We continue to believe that the ability to suspend redemptions in these circumstances can help address the significant run risk and potential harm to shareholders. 83 See Vanguard Comment Letter; Comment Letter of Western Asset Management Company, LLC (Apr. 12, 2021) (“Western Asset Comment Letter”); see also JP Morgan Comment Letter; ICI Comment Letter I. 84 See Vanguard Comment Letter (noting the negative potential consequences if gates remain in the rule text); Western Asset Comment Letter (recommending that gates be permitted only under extraordinary circumstances, such as when a fund is in severe difficulties or in anticipation of liquidation); JP Morgan Comment Letter (suggesting either that the gate provision be removed from the rule or that rule 2a-7 grant boards the discretion to impose gates at any time if they deem it to be in the best interest of the fund). 85 See JP Morgan Comment Letter. Some commenters suggested other ways of removing the tie between the weekly liquid asset threshold and a fund's ability to impose a gate. For example, some suggested that fund boards should have discretion to impose gates at any time they determine doing so is in the best interests of the fund. 86 One commenter stated that some institutional investors may still redeem preemptively when a fund's weekly liquid assets approach the 30% threshold out of fear of a gate, but asserted that granting the board discretion without a liquidity threshold tie would reduce the incentive for a large percentage of shareholders to preemptively redeem. The commenter also suggested this approach could materially improve the functioning of money market funds in any future liquidity events and could be easily implemented within the existing regulatory framework. 87 A few other commenters recommended that any reform should maintain a regulatory link between the weekly liquid asset threshold and the imposition of gates, but that the weekly liquid asset threshold should be lowered to 10% or 15%. 88 These commenters expressed concern that without clear regulatory protocol on when money market funds could implement gates, boards might face too much pressure in making this decision and investors may have additional uncertainty, which could negatively affect investor redemption decisions. 86 See e.g., Wells Fargo Comment Letter; Federated Hermes Comment Letter I; Comment Letter of the Institute of International Finance (Apr. 12, 2021) (“Institute of International Finance Comment Letter”); Comment Letter of the American Bankers Association (Apr. 12, 2021) (“ABA Comment Letter”); JP Morgan Comment Letter; ICI Comment Letter I; Comment Letter of Federated Hermes, Inc. (Sept. 13, 2021) (“Federated Hermes Comment Letter III”) (suggesting the rule identify certain types of information that a fund's board could consider requesting from the adviser to inform this decision). 87 Wells Fargo Comment Letter. 88 Comment Letter of Dreyfus Cash Investment Strategies (Apr. 12, 2021) (“Dreyfus Comment Letter”); Comment Letter of T. Rowe Price (Apr. 12, 2021) (“T. Rowe Price Comment Letter”); Comment Letter of BlackRock, Inc. (Apr. 12, 2021) (“BlackRock Comment Letter”). We are not proposing a gate provision, either with or without an associated liquidity threshold, to limit the potential for investor uncertainty and de-stabilizing preemptive investor redemption behavior regarding the potential use of gates during stress events. Based on investor behavior in March 2020, we are concerned that voluntary gates may not be imposed, and if imposed, could lead to the closure of the fund in question. Rule 22e-3 under the Act provides a mechanism for a fund to suspend redemptions to facilitate an orderly liquidation, so we believe that this provision provides adequate flexibility for liquidating funds without incentivizing de-stabilizing investor redemption behavior during stress events. In addition, without a specific regulatory threshold or other specific guidelines to govern the imposition of gates, it may be difficult for a fund's board to determine whether it is in the fund's best interests to impose a voluntary gate. We are concerned that the discretionary ability of the board to impose gates could add uncertainty in times of market stress, and investors may decide to redeem at this time simply to avoid the potential imposition of a gate. Such preemptive redemptions could increase pressure on fund liquidity during periods of market stress. We request comment on our proposal to remove from rule 2a-7 the ability of money market funds to impose redemption gates and to retain the availability of a suspension under the terms set forth in rule 22e-3, including the following: 1. Should we, as proposed, no longer allow money market funds to impose redemption gates under rule 2a-7? Are there circumstances, beyond those covered by rule 22e-3, in which the ability of a money market fund to impose a gate or suspend redemptions would provide benefits to money market funds and short-term funding markets? 2. Instead of removing the ability to impose gates from rule 2a-7, should we retain gates as an available tool for money market funds? If so, should we modify the current provision to remove the tie between gate determinations and liquidity thresholds? Should a fund board be able to impose a gate any time it determines that doing so is in the best interests of the fund? If so, should a fund have to opt in ex ante to having gates as a potential tool? In what circumstances would it likely be in the fund's best interests to impose a gate? Would a board impose a gate in practice and, if so, what are the practical consequences of any such decision? Would it be effective to require a fund to adopt board-approved policies and procedures that identify the circumstances in which the fund would impose a gate? If so, what factors should those policies and procedures consider for purposes of when to impose a gate? How would this approach affect investor and fund behavior? For example, would investors be likely to redeem preemptively in times of stress out of concern that a fund may impose a gate, or would investors view a redemption gate as unlikely under this approach? 3. If we retain the connection between redemption gates and liquidity thresholds, what liquidity threshold should we use to permit a board to impose a redemption gate? For example, should the liquidity threshold remain at 30% weekly liquid assets, increase to 50% weekly liquid asset in connection with our proposal to increase liquidity requirements, or be lower than the current 30% threshold ( e.g., 10% or 15% weekly liquid assets)? Should the board's ability to impose a redemption gate instead be tied to a daily liquid asset threshold, such as the current 10% threshold, the proposed 25% threshold discussed below, or a lower threshold, such as 5%? How would these changes affect investor and fund behavior? Are there other ways we should modify provisions related to redemption gates to make them less likely to incentivize preemptive redemptions in times of stress? 4. Should we allow certain types of money market funds to impose redemption gates, but not others? For example, are retail investors less sensitive to the potential imposition of gates, such that allowing retail funds to impose gates is less likely to contribute to incentives to redeem preemptively? Alternatively, should we only allow institutional funds to impose gates given that these funds historically have experienced higher levels of redemptions in times of stress? 5. If we retain a redemption gate provision in rule 2a-7, would the board's ability to impose a redemption gate reduce the need for, or otherwise affect, other regulatory provisions we are proposing ( e.g., the swing pricing requirement for institutional prime and institutional tax-exempt money market funds, increased liquidity requirements for all money market funds)? 3. Removal of Liquidity Fees From Rule 2a-7 We also are proposing to remove from rule 2a-7 the provisions allowing or requiring money market funds to impose liquidity fees once the fund crosses certain liquidity thresholds. As a general matter, we believe investors are less sensitive to the possibility of bearing liquidity costs than they are to the possibility of redemption gates. 89 We also continue to believe it is important for institutional prime and institutional tax-exempt money market funds to have a tool to cause redeeming investors to bear the costs of liquidity if they redeem during a period of stress. However, we do not believe the current liquidity fee provisions in rule 2a-7 achieve this goal. In March 2020, no money market funds imposed liquidity fees, despite the fact that many institutional prime and tax-exempt funds were experiencing significant outflows and some were selling portfolio holdings to meet redemptions, sometimes at a significant loss due to wider spreads given liquidity conditions in the market at that time. 90 In part, this is due to the design of the current rule, given that only one institutional prime fund had weekly liquid assets below the 30% threshold and could have therefore imposed a liquidity fee. 89 See supra footnote 75 (discussing comment letters that expressed the view that the possibility of redemption gates was a greater concern for investors in March 2020 than the possibility of liquidity fees). 90 See, e.g., JP Morgan Comment Letter. Some commenters recommended that we allow a fund's board to impose liquidity fees whenever the board determines that doing so is in the best interests of shareholders, without reference to a specific liquidity threshold. 91 A few other commenters suggested allowing fund boards to impose liquidity fees when the fund's weekly liquid assets reach a set level that is lower than the existing 30% threshold. 92 Some commenters suggested that we require money market funds to have policies and procedures that provide a fund's board with direction on when to impose fees and how to calculate them. 93 Another commenter recommended that the rule identify certain types of information that the board could request from the fund's adviser to inform its decision of whether to impose liquidity fees and require the board to summarize the basis of its decision to impose liquidity fees in a report to the Commission. 94 We are not proposing any of these approaches because we do not believe they would result in timely decisions to impose liquidity fees on days when the fund has net outflows that, due to associated costs to meet those redemptions, will dilute the value of the fund for remaining shareholders. 95 Moreover, while one commenter suggested removing the ability to impose fees from rule 2a-7, the commenter did not support any alternative tools for imposing liquidity costs on redeeming investors. 96 91 See, e.g., Federated Hermes Comment Letter I; Comment Letter of Federated Hermes, Inc. (June 1, 2021); Wells Fargo Comment Letter. 92 See, e.g., BlackRock Comment Letter (suggesting 10%); Dreyfus Comment Letter (suggesting 15%). 93 JP Morgan Comment Letter; ICI Comment Letter I; Western Asset Comment Letter. 94 Federated Hermes Comment Letter III. 95 In contrast, the proposed swing pricing requirement discussed below would not require board action to impose costs on redeeming investors on a particular day and instead would connect the liquidity costs to the amount of net redemptions for that period, thus reducing the potential for a first-mover advantage or other timing misalignment between an investor's redemption activity and the imposition of liquidity costs. 96 Vanguard Comment Letter. For institutional prime and tax-exempt money market funds, we are concerned that the current rule—and the alternatives commenters suggested—would not protect remaining investors in a fund from dilution resulting from sizeable outflows in future periods of stress. While we are proposing to remove liquidity fee provisions from the rule, we believe it is important for these funds to have an effective tool to address shareholder dilution and potential institutional investor incentives to redeem quickly in times of liquidity stress to avoid further losses. As a result, we are proposing to require institutional prime and tax-exempt money market funds to implement swing pricing, as discussed in more detail below. For retail prime and tax-exempt funds, these funds historically have experienced lower, more gradual levels of redemptions in stress periods than institutional funds. This was also true in March 2020, when retail prime funds had outflows of approximately 11% over a three-week period in comparison to institutional prime fund outflows of approximately 30% over a two-week period. As discussed below, we are proposing to increase liquidity requirements for all money market funds, including retail funds. When the Commission originally determined to apply the fee and gate provisions to retail funds, it expressed concern that retail investors may be motivated to redeem heavily in flights to quality, liquidity, and transparency (even if they may do so somewhat more slowly than institutional investors) and stated that it could not rule out the potential for heavy redemptions in retail funds in the future. 97 Although retail funds did not have particularly heavy redemptions during the liquidity stress of March 2020, some retail prime funds participated in the MMLF, and it is impossible to know whether outflows would have continued absent official sector intervention that helped stabilize short-term funding markets. 98 We believe, however, that the significant increases to daily and weekly liquid asset thresholds we are proposing—which would have the largest effect on retail prime funds based on their average historical liquidity levels—should result in these funds being able to manage much heavier redemptions than they have experienced during any previous stress period. 99 As a result of the expected effect of the liquidity requirement changes, we do not believe that retail prime and tax-exempt money market funds need special provisions allowing them to impose liquidity fees or other analogous tools under rule 2a-7. 97 See 2014 Adopting Release, supra footnote 13, at section III.C.2.a. 98 See supra footnote 36 (noting that 17 retail prime funds participated in the MMLF). 99 See infra paragraph accompanying footnote 209 (explaining that while the proposal would require retail prime funds to maintain higher levels of liquidity than they have historically maintained on average, the resulting larger liquidity buffers would increase the likelihood that these funds can meet redemptions without significant dilution). While the proposal would remove the liquidity fee provision in rule 2a-7, a money market fund's board of directors may nonetheless approve the fund's use of redemption fees (up to but not exceeding 2% of the value of shares redeemed) to eliminate or reduce as practicable dilution of the value of the fund's outstanding securities under rule 22c-2 under the Act. 100 As the Commission has previously recognized, rule 22c-2 is not limited to recouping costs associated with short-term trading strategies, such as market timing, and can be used to mitigate dilution arising from shareholder transaction activity generally, including indirect costs such as liquidity costs. 101 Although rule 22c-2 generally classifies money market funds as excepted funds that are not subject to the rule's requirements, the rule does not treat money market funds as excepted funds if they elect to impose redemption fees under the rule. 102 Thus, to the extent a money market fund's board determines that the ability to impose fees may be necessary to protect its investors, the board could establish a redemption fee approach to meet the needs of the fund, provided the fund otherwise complies with rule 22c-2 ( e.g., by entering into shareholder information agreements with intermediaries) and discloses information about the redemption fee in its prospectus in compliance with Form N-1A. If a money market fund elects to impose redemption fees under rule 22c-2, its process for determining when to apply a fee and in what amount generally should be designed to result in timely application of a fee to address dilution. 100 See 17 CFR 270.22c-2 (rule 22c-2 under the Investment Company Act) (providing that an open-end fund may impose a redemption fee, not to exceed 2% of the value of the shares redeemed, upon the determination by the fund's board of directors that such fee is “necessary or appropriate to recoup for the fund the costs it may incur as a result of those redemptions or to otherwise eliminate or reduce so far as practicable any dilution of the value of the outstanding securities issued by the fund”). We anticipate that retail prime and tax-exempt money market funds would be more likely to rely on rule 22c-2 to impose redemption fees than institutional prime and tax-exempt funds, as the institutional funds would be subject to a proposed swing pricing requirement to address dilution. 101 See Mutual Fund Redemption Fees, Investment Company Act Release No. 26782 (Mar. 11, 2005) [70 FR 13328 (Mar. 18, 2005)]; Investment Company Swing Pricing, Investment Company Release No. 32316 (Oct. 13, 2016) [81 FR 82084 (Nov. 18, 2016)] (“Swing Pricing Adopting Release”), at paragraph accompanying n.26. 102 See 17 CFR 270.22c-2(b). We request comment on our proposal to no longer permit or require money market funds to impose liquidity fees under rule 2a-7, including on the following: 6. Should we remove the liquidity fee provisions from rule 2a-7, as proposed? To what extent did the possibility of liquidity fees motivate investors' redemption decisions in March 2020? If liquidity fees are less of a concern for investors than redemption gates, would liquidity fee provisions, on their own, be less likely to contribute to preemptive redemptions in future stress periods? If so, are there advantages to retaining the current liquidity fee provisions and their connection to weekly liquid asset thresholds? If we retain the connection between liquidity fees and liquidity thresholds, what liquidity threshold should we use to permit a board to impose a liquidity fee ( e.g., the current 30% weekly liquid asset threshold or 10% daily liquid asset threshold, the 50% weekly liquid asset threshold or 25% daily liquid asset threshold we propose to use for purposes of funds' minimum liquidity requirements, or a lower threshold, such as 10% or 15% weekly liquid assets or 5% daily liquid assets)? How would changes to the liquidity threshold that allows a fund board to consider liquidity fees affect investor and fund behavior? 7. Rather than remove the current liquidity fee provisions, should we modify the circumstances in which a money market fund may impose liquidity fees? Should we permit a fund's board to impose liquidity fees when it determines that fees are in the best interests of the fund? Would a board use this tool in practice? What would be the impediments (if any) of the board making this determination? Would the board be able to act quickly enough to impose a fee so that redeeming investors bear the costs associated with their redemptions and do not have a first-mover advantage? Are there other ways we could achieve these goals through a liquidity fee framework? For example, would it be effective to require a fund to adopt board-approved policies and procedures that identify the circumstances in which the fund would impose a liquidity fee and how the fund would calculate the amount of the fee, without requiring in-the-moment board decisions or action? If so, what factors should those policies and procedures consider for purposes of when to impose a liquidity fee ( e.g., size of redemptions, liquidity of the fund's portfolio, market conditions, and transaction costs)? As another alternative, should we require a fund to adopt board-approved policies and procedures that result in a fund determining its liquidity costs each day it has net redemptions and applying those costs through a fee? Under either of these approaches, how should funds calculate the amount of a liquidity fee? Should this calculation method be the same as or similar to the calculation of a swing factor for purposes of our proposed swing pricing requirement or the Commission's current swing pricing rule applicable to other mutual funds? 103 Should the calculation account for factors that boards may consider in determining the level of a liquidity fee under the current rule, such as changes in spreads for portfolio securities (whether based on actual sales, dealer quotes, pricing vendor mark-to-model or matrix pricing, or otherwise); the maturity of the fund's portfolio securities; or changes in the liquidity profile of the fund in response to redemptions and expectations regarding that profile in the immediate future? 104 Should the liquidity fee take into account the market impact of selling the fund's securities to meet redemptions? 105 Should the liquidity fee be based on an assumption that the fund meets redemptions with its most liquid securities, a pro rata amount of each security in its portfolio, or only the securities the fund intends to use to meet redemptions? Should the liquidity fee be a set amount, such as 0.5%, 1%, or 2% of the value of the shares redeemed? Instead of a uniform fee amount, should the rule establish a default fee that funds could adjust upward or downward, as appropriate? 103 See infra Section II.B.1 (discussing calculation of a swing factor under our proposal); 17 CFR 270.22c-1(a)(3)(i)(C) (describing calculation of a swing factor under the Commission's current swing pricing rule applicable to non-money market funds). 104 See 2014 Adopting Release, supra footnote 12, at paragraph accompanying n.303. 105 Market impact costs are costs incurred when the price of a security changes as a result of the effort to purchase or sell the security. Market impact costs reflect price concessions (amounts added to the purchase price or subtracted from the selling price) that are required to find the opposite side of the trade and complete the transaction. 8. If we maintain a liquidity fee provision in the rule, should it apply only to institutional prime and tax-exempt funds, or should retail or government funds also be subject to the provision? What are the key distinguishing characteristics of the funds that would lead to differing approaches? 9. If we allowed or required funds to impose liquidity fees, are there other changes we should make to the current framework? For example, should we continue to limit the size of the liquidity fee to no more than 2% of the value of the shares redeemed? Are there circumstances in which the liquidity costs associated with meeting redemptions may exceed 2% of the value of the shares redeemed, such that increasing or removing the limit would better mitigate dilution? 10. If we adopted a modified liquidity fee framework that required funds to apply liquidity fees more frequently than is contemplated by the current rule, are there operational issues we would need to consider? For example, are intermediaries able to apply liquidity fees on a dynamic basis ( e.g., where liquidity fees vary in size and may apply more frequently than during periods of stress)? 11. Should we require money market funds to implement practices to mitigate investor dilution but permit money market funds to choose between imposing liquidity fees or imposing the proposed swing pricing approach as the method for doing so? Should we allow money market funds to choose other unspecified options for mitigating investor dilution? What are the advantages and disadvantages of these approaches? What factors would influence a fund's decision of whether to implement swing pricing, a liquidity fee framework, or another method of mitigating dilution? 12. Do money market funds view rule 22c-2 as a viable way to implement liquidity fees, if the board approves the use of such fees? Should we modify any of the requirements of rule 22c-2 or Form N-1A that relate to redemption fees for these funds? For example, should we specify that, like a liquidity fee under rule 2a-7, a money market fund redemption fee under rule 22c-2 does not need to be disclosed in the prospectus fee table? Would retail prime or retail tax-exempt funds opt to rely on rule 22c-2? Would institutional prime or institutional tax-exempt funds ever use rule 22c-2 in addition to the proposed swing pricing requirement and, if so, why? B. Proposed Swing Pricing Requirement 1. Purpose and Terms of the Proposed Requirement We are proposing a swing pricing requirement specifically for institutional prime and institutional tax-exempt money market funds that would apply when the fund experiences net redemptions. 106 This requirement is designed to ensure that the costs stemming from net redemptions are fairly allocated and do not give rise to a first-mover advantage or dilution under either normal or stressed market conditions. 107 The swing pricing requirement would complement our proposal to require funds to hold additional liquidity by requiring redeeming investors to pay the cost of depleting a fund's liquidity. Requiring swing pricing also would address a fund's potential reluctance to impose a voluntary liquidity fee even when doing so might be beneficial to the fund. 106 We refer to money market funds that are not government money market funds or retail money market funds collectively as “institutional funds” when discussing the proposed swing pricing requirement. 107 The proposed swing pricing requirement differs in certain respects from the swing pricing provision in rule 22c-1, which does not apply to money market funds. We are proposing a swing pricing requirement specifically for institutional funds in rule 2a-7, rather than proposing amendments to rule 22c-1, because we are focused on money market fund reform in this release. The Fall 2021 Unified Agenda notes that the Division of Investment Management is considering recommending changes to regulatory requirements relating to open-end funds' liquidity and dilution management. See Securities and Exchange Commission, Fall 2021 Unified Agenda, available at www.reginfo.gov . Swing pricing is a process of adjusting a fund's current NAV such that the transaction price effectively passes on costs stemming from shareholder transaction flows out of the fund to shareholders associated with that activity. 108 Trading activity and other changes in portfolio holdings associated with meeting redemptions may impose costs, including trading costs and costs of depleting a fund's daily or weekly liquid assets. These costs, which currently are borne by the remaining investors in the fund, can dilute the interests of non-redeeming shareholders. This can create incentives for shareholders to redeem quickly to avoid losses, particularly in times of market stress. If shareholder redemptions are motivated by this first-mover advantage, they can lead to increasing outflows, and as the level of outflows from a fund increases, the incentive for remaining shareholders to redeem may also increase. Regardless of whether investor redemptions are motivated by a first-mover advantage or other factors, there can be significant, unfair adverse consequences to remaining investors in a fund in these circumstances, including material dilution of remaining investors' interests in the fund. Swing pricing can reduce the potential for dilution of investors who choose to remain in the fund. 108 While the term swing pricing typically refers to a process of adjusting a fund's NAV for either net redemptions or net subscriptions, the proposed swing pricing framework for money market funds would only apply when a fund has net redemptions. The proposed swing pricing requirement is designed to address these concerns. Under the proposal, an institutional fund would be required to adjust its current NAV per share by a swing factor reflecting spread and transaction costs, as applicable, if the fund has net redemptions for the pricing period. 109 If the institutional fund has net redemptions for a pricing period that exceed the “market impact threshold,” which would be defined as 4% of the fund's net asset value divided by the number of pricing periods the fund has in a business day, or such smaller amount of net redemptions as the swing pricing administrator determines, the swing factor would also include market impacts, as described below. 110 The “pricing period” would be defined, in substance, to mean the period of time in which an order to purchase or sell securities issued by the fund must be received to be priced at the next computed NAV. This is designed to address money market funds that compute their NAVs multiple times per day. For example, if a fund computes a NAV as of 12:00 p.m. and 4:00 p.m., the fund would determine if it had net redemptions for each pricing period and, if so, apply swing pricing for the corresponding NAV calculation. 111 Consistent with the approach taken by the Commission with respect to the swing pricing provision in rule 22c-1, an institutional fund with multiple share classes must determine whether it experienced net redemption activity across all share classes in the aggregate, rather than determining net redemption activity on a class by class basis. 112 109 See proposed rule 2a-7(c)(2)(ii)(A). The proposal would implement the swing pricing requirement by requiring an affected money market fund to adopt swing pricing policies and procedures, approved by the fund's board and administered by a “swing pricing administrator,” as discussed in more detail below. In addition, and consistent with the Commission's current swing pricing rule (rule 22c-1), with respect to master-feeder funds, only the master fund can apply swing pricing under our proposed rule. See proposed rule 2a-7(c)(2)(v). 110 See proposed rule 2a-7(c)(2)(iii)(B) and proposed rule 2a-7(c)(2)(vi)(B). See infra Section III.D.4 for a more detailed analysis of the proposed market impact threshold and potential alternative approaches. 111 Under the proposal a fund may estimate shareholder flow information to determine whether the fund has net redemptions for a pricing period and to determine the amount of net redemptions, provided the swing pricing administrator receives sufficient investor flow information to make a reasonable estimate. Although institutional funds generally have more timely flow information than other kinds of open-end funds, we believe reasonable estimates are appropriate in the absence of complete flow information. 112 See Swing Pricing Adopting Release, supra footnote 102, at paragraph accompanying n.175. If a fund were to only include the transaction activity of a single share class, and were to swing one share class and not another, one share class would pay expenses incurred in the management of the fund's portfolio as a whole, which would generally be inconsistent with rule 18f-3. A mandatory swing pricing regime for net redemptions is intended to address funds' (or fund boards') likely reluctance to impose a voluntary swing pricing regime or voluntary liquidity fee. For example, while money market funds were permitted to impose liquidity fees on redeeming investors under rule 2a-7 if a fund had less than 30% of its assets invested in weekly liquid assets no money market fund imposed such fees during the March 2020 market turmoil. Moreover, even if all institutional money market funds recognized the benefits of charging redeeming investors for liquidity costs, we believe there is a collective action problem in which no fund would want to be the first to adopt such an approach. We believe past experience with the existing liquidity fee regime supports a mandatory approach to dilution mitigation for institutional funds. The proposed swing pricing requirement would not apply to net subscriptions because, for money market funds, we believe net redemptions are more likely to contribute to dilution and other liquidity costs than net subscriptions. Institutional funds have come under significant stress twice in the last 13 years in the face of high levels of redemptions—significant subscriptions into these funds have not had similar effects. Beyond these considerations, we also recognize that applying our proposed swing pricing requirements to institutional fund subscriptions would require these funds to make certain assumptions about how they invest cash from new subscriptions that would be inconsistent with the requirements in rule 2a-7. 113 113 For example, an institutional fund with weekly liquid assets below the regulatory threshold must invest only in weekly liquid assets and could not purchase a pro rata amount of each security in its portfolio, but our proposed swing pricing framework would require such a fund to assume the purchase of a pro rata amount of each portfolio holding if the framework extended to net subscriptions. Our proposed money market fund swing pricing framework specifies how an institutional fund would determine its swing factor, which would differ based on the amount of net redemptions (see Figure 1, below). The swing factor would be determined by calculating identified types of costs the fund would incur, as applicable, by selling a pro rata amount of each security in its portfolio to satisfy the amount of net redemptions for the pricing period. 114 114 See proposed rule 2a-7(c)(2)(iii). The swing factor is the amount, expressed as a percentage of the fund's net asset value, by which the fund adjusts its net asset value per share. The requirement that a money market fund calculate costs to sell a pro rata amount of each security in its portfolio—a “vertical slice” of the portfolio—is designed to ensure that a fund's adjusted NAV incorporate the costs of selling its less liquid holdings, which may protect remaining shareholders from dilution and may discourage investors from redeeming quickly during periods of market stress to seek to avoid potential costs from a fund's future sale of less liquid securities. 115 For example, when investors redeem, if those redemptions are met through daily or weekly liquid assets, the redemptions leave the fund with less liquidity. This increases the likelihood that further redemptions could require the fund to sell less liquid assets or incur costs in rebalancing the portfolio. Although further redemptions may be more likely to require the fund to sell less liquid assets in times of market stress when redemptions may be elevated, redeeming investors depleting a fund's daily and weekly liquid assets can impose liquidity costs on the remaining shareholders as well as the fund generally, even during non-stressed periods. This depletion of a money market fund's liquidity can dilute the interests of remaining investors and also can create a first-mover advantage for investors who redeem in an attempt to avoid bearing the costs created by other investors' redemptions. 115 As described in more detail below, a fund's swing pricing administrator may estimate costs and market impact factors for each type of security with the same or substantially similar characteristics and apply those estimates to all securities of that type rather than analyze each security separately. The factors a fund must take into account when calculating the swing factor vary depending on the size of net redemptions for the pricing period (see Figure 1, below). If the fund has net redemptions that do not exceed the market impact threshold, the swing factor reflects the spread costs and other transaction costs ( i.e., brokerage commissions, custody fees, and any other charges, fees, and taxes associated with portfolio security sales), as applicable, from selling a vertical slice of the portfolio to meet those net redemptions. 116 Including the spread cost in the swing factor calculation effectively requires a fund to value a security in its portfolio at the bid price when the fund has net redemptions. We understand that money market funds may already price portfolio securities at the bid price when striking their NAVs. 117 As a result, the requirement to adjust the fund's current NAV by a swing factor when it has net redemptions that do not exceed the market impact threshold would generally affect institutional funds that use mid-market pricing to compute their current NAVs. 118 Spread costs and other transaction costs associated with portfolio security sales also are included in the Commission's current swing pricing rule for non-money market funds. Those transaction-related costs can create dilution for money market funds just as they can for other kinds of funds, and we are including them in this proposal for the same reasons the Commission included them in the current swing pricing rule. 119 116 See proposed rule 2a-7(c)(2)(iii)(A). Put another way, the fund must take into account these factors if it has net redemptions in any amount. If a fund has net redemptions that exceed its market impact threshold, it must also apply a market impact factor. 117 See FASB ASC 820-10-35-36C. Generally accepted accounting principles (“GAAP”) provide that if an asset measured at fair value has a bid price and an ask price (for example, an input from a dealer market), the price within the bid-ask spread that is most representative of fair value in the circumstances shall be used to measure fair value, and that the use of bid prices for asset positions is permitted but not required for these purposes. 118 See FASB ASC 820-10-35-36D (stating that use of mid-market pricing as a practical expedient for fair value measurements within a bid-ask spread is not precluded). Very generally, mid-market pricing values a security at the average of its bid price and ask price. Since a seller generally asks for a higher price for a security than a buyer bids for that security, the mid-market price is incrementally higher than the bid price for a security, but lower than its ask price. 119 Our proposed rule requires a money market fund to estimate the costs that would result from selling a vertical slice of its portfolio on a given day. Accordingly, our proposed rule does not incorporate the separate reference to near-term costs that is included in the general swing pricing rule. See 17 CFR 270.22c-1(a)(3)(i)(C). If net redemptions exceed the market impact threshold, a fund's swing factor would also be required to include good faith estimates of the market impact of selling a vertical slice of a fund's portfolio to satisfy the amount of net redemptions for the pricing period. The fund would estimate market impacts for each security in its portfolio by first estimating the market impact factor. This factor is the percentage decline in the value of the security if it were sold, per dollar of the amount of the security that would be sold, under current market conditions. Then, the fund would multiply the market impact factor by the dollar amount of the security that would be sold if the fund sold a pro rata amount of each security in its portfolio to meet the net redemptions for the pricing period. 120 120 See proposed rule 2a-7(c)(2)(iii)(B). We understand that it may be difficult to produce timely, good faith estimates of the market impact of selling a pro rata portion of each instrument the fund holds. Recognizing these difficulties, and because many securities held by institutional funds have similar characteristics and would likely incur similar costs if sold, the proposed rule would permit a fund to estimate costs and the market impact factor for each type of security with the same or substantially similar characteristics and apply those estimates to all securities of that type in the fund's portfolio, rather than analyze each security separately. 121 As part of this process, we believe it would be reasonable to apply a market impact factor of zero to the fund's daily and weekly liquid assets, since a fund could reasonably expect such assets to convert to cash without a market impact to fulfill redemptions ( e.g., because the assets are maturing shortly). 121 See proposed rule 2a-7(c)(2)(iii)(C). A fund could, for example, determine the liquidity, trading, and pricing characteristics of a subset of securities justifies the application of the same costs and market impact factor to all securities of that type within its portfolio. EP08FE22.000 We recognize that the market impact of selling a vertical slice of the fund's portfolio is likely to be negligible when net redemptions are small, and estimating the market impact of selling a security can be challenging. As a result, we are proposing to require funds to include market impact in their swing factors only when net redemptions exceed the market impact threshold. To establish the amount of net redemptions that should trigger application of the market impact factor, we reviewed historical flow information for institutional money market funds over a nearly five-year period. 122 During this time, institutional funds had daily outflows greater than 4% on approximately 5% of trading days. 123 At these heightened levels of outflows, market impacts are designed to estimate the full liquidity costs of selling a vertical slice of a money market fund's portfolio because, for a money market fund's less liquid investments, market impacts may impose significant costs on a fund, particularly when net redemptions are large or in times of stress. We also propose to allow the swing pricing administrator to apply a market impact factor at a lower amount of net redemptions. This flexibility is designed to recognize that there may be circumstances in which a smaller market impact threshold would be appropriate to mitigate dilution of fund shareholders, such as when a fund holds a larger amount of less liquid investments or in times of stress. 124 We believe a fund's swing pricing administrator, responsible for the day-to-day administration of the fund's swing pricing program and therefore familiar with the fund's redemption patterns and the operational requirements of the swing pricing program, would be well positioned to determine whether a smaller market impact threshold could be beneficial for the fund's investors to help mitigate dilution. To address the concerns the Commission expressed in 2016 that subjective estimates of market impact costs could grant excessive discretion in the determination of a swing factor, we also are providing additional parameters for estimating market impact to make the calculation more objective as discussed above. 125 These requirements should help to limit subjectivity that could be abused, and proposed recordkeeping rules would require funds to document their market impact factors, facilitating our staff's review and oversight of money market fund swing pricing. 126 122 See infra Section III.D.4 for a more detailed analysis of the proposed market impact threshold and potential alternative approaches. The analysis is based on daily flows of institutional prime and institutional tax-exempt funds reported in CraneData on 1,228 days between December 2016 and October 2021. As of September 2021, CraneData covered 87% of the funds and 96% of total assets under management, resulting in a count of 37 institutional prime funds and 10 institutional tax-exempt funds. 123 The proposed definition of market impact threshold would require a fund to divide 4% of the fund's net asset value by the number of pricing periods to arrive at the amount of net redemptions that would trigger the threshold. In recognition that some institutional funds have multiple pricing periods per day, and the number of pricing periods may vary among funds, this aspect of the definition is designed to provide a threshold that would apply more consistently to funds with different numbers of pricing periods, as opposed to a static figure applicable to all funds. 124 For example, investors that invest in funds with less liquid portfolios may accept the risk of larger swings because they believe that the fund's less liquid portfolio could generate higher returns. 125 See Swing Pricing Adopting Release, supra footnote 101, at paragraphs accompanying nn. 143 and 148. Specifically, a fund's market impact factor calculation for a security would reflect the percentage decline in the value of the security if it were sold, per dollar of the amount of the security that would be sold, under current market conditions, multiplied by the dollar amount of the security that would be sold if the fund sold a pro rata amount of each security in its portfolio to meet the net redemptions for the pricing period. 126 See proposed rule 31a-2(a)(2). With respect to application of a swing factor, a fund with multiple share classes must use the same swing factor for each share class. Because the economic activity causing dilution occurs at the fund level, it would not be appropriate to employ swing pricing at the share class level to target such dilution. 127 In addition, when an institutional fund applies the swing factor to its net asset value, it must round the adjusted current net asset value per share to a minimum of the fourth decimal place in the case of a fund with a $1.0000 share price or an equivalent or more precise level of accuracy for money market funds with a different share price ( e.g., $10.000 per share, or $100.00 per share). 128 127 See Swing Pricing Adopting Release, supra footnote 101, at paragraph accompanying n.178. 128 See proposed rule 2a-7(c)(1)(ii). This provision is designed to provide the same level of pricing precision that an institutional fund must calculate with respect to its floating NAV. We are not proposing an upper limit on a fund's swing factor. The Commission included a 2% upper limit in the current swing pricing rule in light of concerns that, without an upper limit, a fund's application of swing pricing could operate as a “de facto gate” or place an undue restriction on investors' ability to redeem. 129 We believe the more specific parameters in this proposal for determining a fund's swing factor sufficiently mitigate these concerns. Further, if a fund were to experience such high costs, we believe it would be appropriate for redeeming investors to bear the costs their redemptions create for the benefit of remaining investors. Given our experience with investor behavior in March 2020, we also believe that requiring redeeming investors to internalize the liquidity costs of their redemptions would make investors consider potential redemption requests more carefully, particularly during periods of market stress, and would prevent remaining investors from bearing costs imposed on the fund by redeeming investors. 129 Swing Pricing Adopting Release, supra footnote 102, at paragraph accompanying n.254. Finally, we are proposing several requirements related to the administration of the proposed swing pricing requirement. Specifically, a money market fund's swing pricing policies and procedures must be implemented by a board-designated administrator (the “swing pricing administrator”), and the administration of the swing pricing program must be reasonably segregated from portfolio management of the fund and may not include portfolio managers. 130 The Commission's current swing pricing rule also requires the board to designate a swing pricing administrator and the administration of a swing pricing program that is reasonably segregated from portfolio management of the fund and may not include portfolio managers. We are proposing the requirement here for the same reasons the Commission adopted it in that rule: Requiring segregation of functions with respect to the administration of swing pricing will provide better clarity of roles and reduce the possibility of conflicts of interest in the administration of swing pricing. 131 130 See proposed rule 2a-7(c)(2)(iv)(B) and proposed rule 2a-7(c)(2)(vi)(E). Consistent with the Swing Pricing Adopting Release, we believe that portfolio managers may have conflicts of interest with respect to setting the swing factor, and therefore we do not believe that they should be involved in setting the swing factor. See Swing Pricing Adopting Release, supra footnote 102, at paragraph accompanying n.293. 131 Swing Pricing Adopting Release, supra footnote 102, at paragraph accompanying n.293. We also are proposing requirements to facilitate board oversight of swing pricing. A fund's board, including a majority of directors who are not interested persons of the fund, would be required to (1) approve the fund's swing pricing policies and procedures; (2) designate the swing pricing administrator; and (3) review, no less frequently than annually, a written report prepared by the swing pricing administrator describing the adequacy and effectiveness of the program. 132 We propose to amend rule 2a-7 to provide that a money market fund's board may not delegate its responsibilities to make the determinations that the proposed swing pricing provisions would require of the board. 133 The swing pricing administrator's report to the board would be required to describe (1) the administrator's review of the adequacy of the fund's swing pricing policies and procedures and the effectiveness of their implementation; (2) any material changes to the fund's swing pricing policies and procedures since the date of the last report; and (3) the administrator's review and assessment of the fund's swing factors and market impact threshold, including the information and data supporting the determination of the swing factors and the swing pricing administrator's determination to use a smaller market impact threshold, if applicable. 134 The proposal, like the Commission's current swing pricing rule, generally contemplates a board role in compliance oversight, rather than board involvement in the day-to-day administration of a fund's swing pricing program. Moreover, money market fund boards in particular have significant responsibilities regarding valuation- and pricing-related matters and should be well-positioned to provide effective oversight of the proposed swing pricing program. Accordingly, board approval of the swing pricing policies and procedures, and targeted review of the implementation of the fund's swing pricing program, will help ensure that swing pricing operates in the best interests of the fund's shareholders. 132 See proposed rule 2a-7(c)(2)(iv)(A) through (C). 133 See proposed rule 2a-7(j). Rule 2a-7(j) permits a money market fund's board of directors to delegate to the fund's investment adviser or officers the responsibility to make the determinations required to be made by the board of directors under the rule, except for certain specified provisions. 134 See proposed rule 2a-7(c)(2)(iv)(C)( 1 ) through ( 3 ). The report to the board, which must be delivered no less frequently than annually, must include a description of the impact of the swing pricing program on eliminating or reducing liquidity costs associated with satisfying shareholder redemptions. The report must include the information and data that support the administrator's determination of the fund's swing factor each day. We are proposing recordkeeping requirements that are consistent with the requirements in our existing swing pricing rule. Specifically, a fund must maintain a written copy of the reports provided by the swing pricing administrator to the board for six years, the first two in an easily accessible place. 135 Similarly, existing recordkeeping requirements applicable to all money market fund procedures would require a fund to maintain its swing pricing policies and procedures for six years, the first two in an easily accessible place. 136 135 See proposed rule 2a-7(h)(8). 136 See 17 CFR 270.2a-7(h)(1). Our proposed money market fund swing pricing framework considers and addresses the comments we received on the swing pricing option included in the PWG Report. Two of those comments supported a swing pricing requirement for money market funds. 137 One of these commenters suggested that swing pricing would directly address investor incentives for rapid redemptions from money market funds by ensuring that all investors who redeem are at risk for any losses created by a run, reducing or eliminating the incentive for early redemptions. 138 However, most commenters opposed a swing pricing requirement. 139 Several commenters suggested that swing pricing may not slow investor redemptions and would not have addressed the issues that occurred in March 2020. 140 One of these commenters suggested that imposing an additional cost through swing pricing would not materially affect investor behavior, particularly because an investor does not know at the time of placing its order whether the fund will adjust its NAV. 141 One commenter suggested that swing pricing may encourage investors to accelerate redemptions and seek a first-mover advantage. 142 Certain commenters also expressed concern that swing pricing would reduce investor interest in money market funds. 143 137 Comment Letter of Robert Rutkowski (Apr. 13, 2021); Comment Letter of the Americans for Financial Reform Education Fund (Apr. 12, 2021) (“Americans for Financial Reform Comment Letter”). 138 Americans for Financial Reform Comment Letter. 139 See, e.g., Fidelity Comment Letter; Western Asset Comment Letter; Comment Letter of the GARP Risk Institute (Mar. 16, 2021) (“GARP Risk Institute Comment Letter”); Healthy Markets Comment Letter; Comment Letter of PIMCO (Apr. 19, 2021) (“PIMCO Comment Letter”); SIFMA AMG Comment Letter; ICI Comment Letter I; Federated Hermes Comment Letter I; JP Morgan Comment Letter; BlackRock Comment Letter; Institute of International Finance Comment Letter; State Street Comment Letter; CCMC Comment Letter; T Rowe Price Comment Letter; Comment Letter of the Investment Company Institute (June 3, 2021) (“ICI Comment Letter III”). 140 See, e.g., Fidelity Comment Letter; Western Asset Comment Letter; GARP Risk Institute Comment Letter. 141 Fidelity Comment Letter. 142 Western Asset Comment Letter. 143 BlackRock Comment Letter; GARP Risk Institute Comment Letter; Comment Letter of mCD IP Corporation (Apr. 12, 2021) (“mCD IP Comment Letter”). We recognize that investors would not know at the time of order submission whether a fund would have net redemptions for that pricing period and swing the fund's price accordingly. However, we believe the implementation of a swing pricing regime for institutional funds may cause some investors in those funds to choose not to redeem, including in times of market stress, because those investors view the potential swing factor and price adjustment as more tangible than the uncertain possibility of potential future losses during times of reduced liquidity. We do not agree that, as some commenters suggested, a swing pricing requirement would encourage investors to preemptively redeem and seek a first-mover advantage. 144 Investors do not necessarily know whether the fund's flows during any given pricing period will trigger swing pricing or, if so, the size of the swing factor for that period. In addition, redeeming investors would bear the cost of liquidity under the proposed rule even when net redemptions are small, meaning that there would not be a clear advantage to redeeming earlier versus later. Rather than encourage preemptive redemptions, we believe the proposed swing pricing requirement would discourage excessive redemptions, particularly in times of stress, by requiring redeeming investors to bear liquidity costs. For example, investors may determine not to redeem during stress periods, or to redeem smaller amounts over a longer period of time, which could help reduce concentrated redemptions and associated liquidity pressures that institutional funds can face in times of stress. The swing pricing requirement also could cause some investors to move their assets to government money market funds, as certain commenters stated, to avoid the possibility of paying liquidity costs. Government money market funds may be a better match for investors unwilling to bear liquidity costs, however, in that government money market funds face lower liquidity costs. Even if for some investors the prospect of swing pricing does not alter redemption behavior on a particular day, we believe swing pricing results in fairer, non-dilutive pricing, particularly when there are heavy redemptions (even if the prospect of swing pricing does not materially change the level of those redemptions [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2021-27532. Public record. Not legal advice.