# Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2023-15124 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** August 3, 2023 - **Citation:** 88 FR 51404 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 270, 274 and 279 [Release Nos. 33-11211; 34-97876; IA-6344; IC-34959; File No. S7-22-21] RIN 3235-AM80 Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A AGENCY: Securities and Exchange Commission. ACTION: Final rule. SUMMARY: The Securities and Exchange Commission (“Commission”) is adopting amendments to certain rules that govern money market funds under the Investment Company Act of 1940. These amendments are designed to improve the resilience and transparency of money market funds. The amendments will revise the primary rule that governs money market funds to remove the ability for a fund board to temporarily suspend redemptions if the fund's liquidity falls below a threshold. In addition, the amendments will remove the tie between liquidity thresholds and the potential imposition of liquidity fees. The amendments will also require certain money market funds to implement a liquidity fee framework that will better allocate the costs of providing liquidity to redeeming investors. In addition, the Commission is increasing the daily liquid asset and weekly liquid asset minimum requirements to 25% and 50%, respectively. The Commission also is amending certain reporting requirements on Form N-MFP and Form N-CR and making certain conforming changes to Form N-1A to reflect amendments to the regulatory framework for money market funds. In addition, the Commission is addressing how money market funds with stable net asset values may handle a negative interest rate environment, including by adopting amendments that will permit these funds to use share cancellation, subject to certain conditions. Further, the Commission is adopting rule amendments to specify how funds must calculate weighted average maturity and weighted average life. In addition, the Commission is adopting amendments to Form PF concerning the information large liquidity fund advisers must report for the liquidity funds they advise. Finally, the Commission is adopting two technical amendments to Form N-CSR and Form N-1A to correct errors from recent Commission rulemakings. DATES: Effective dates: The rule amendments are effective October 2, 2023. The amendments to Forms N-1A and N-CSR are effective October 2, 2023 and the amendments to Forms N-CR, N-MFP, and PF are effective June 11, 2024. Compliance dates: The applicable compliance dates are discussed in section II.H. FOR FURTHER INFORMATION CONTACT: Blair Burnett, Christian Corkery, David Driscoll, or Laura Harper Powell, Senior Counsels; Angela Mokodean, Branch Chief; or Brian M. Johnson, Assistant Director at (202) 551-6792, Investment Company Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549. SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to the following rules and forms: 1 15 U.S.C. 80a-1 et seq. Unless otherwise noted, all references to statutory sections are to the Investment Company Act, and all references to rules under the Investment Company Act are to title 17, part 270 of the Code of Federal Regulations [17 CFR part 270]. 2 15 U.S.C. 77a et seq. 3 15 U.S.C. 78a et seq. Commission reference CFR Citation (17 CFR) Investment Company Act of 1940 (“Act” or “Investment Company Act”) 1 Rule 2a-7 § 270.2a-7. Rule 31a-2 § 270.31a-2. Form N-MFP § 274.201. Form N-CR § 274.222. Securities Act of 1933 (“Securities Act”) 2 and Investment Company Act Form N-1A §§ 239.15A and 274.11A. Securities Exchange Act of 1934 (“Exchange Act”) 3 and Investment Company Act Form N-CSR §§ 249.331 and 274.128. Investment Advisers Act of 1940 (“Advisers Act”) Form PF § 279.9. Table of Contents I. Introduction A. Role of Money Market Funds and Existing Regulatory Framework B. March 2020 Market Events and Need for Reform II. Discussion A. Amendments To Remove the Tie Between the Weekly Liquid Asset Threshold and Redemption Gates and Liquidity Fees 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 B. Liquidity Fee Requirement 1. Determination To Adopt a Liquidity Fee Requirement 2. Terms of the New Mandatory Liquidity Fee Requirement 3. The Continued Availability of Discretionary Liquidity Fees 4. Disclosure 5. Tax and Accounting Implications of Liquidity Fees 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. 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 3. Amendments to Form PF G. Technical Amendments to Form N-CSR and Form N-1A H. Effective and Compliance Dates III. Other Matters IV. Economic Analysis A. Introduction B. Baseline 1. Money Market Funds 2. Large Liquidity Funds and Form PF 3. Other Affected Entities C. Costs and Benefits of the Final 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. Liquidity Fees 5. Amendments Related to Potential Negative Interest Rates 6. Disclosures 7. Calculation of Weighted Average Maturity and Weighted Average Life 8. Form PF Requirements for Large Liquidity Fund Advisers D. Alternatives 1. Alternatives to the Removal of Temporary Redemption Gates 2. Alternatives to the Removal of the Tie Between Weekly Liquid Assets and Discretionary Liquidity Fees 3. Alternatives to the Final Increases in Liquidity Requirements 4. Alternative Stress Testing Requirements 5. Alternative Implementations of Liquidity Fees 6. Swing Pricing 7. Expanding the Scope of the Floating NAV Requirements 8. Countercyclical Weekly Liquid Asset Requirements 9. Amendments Related to Potential Negative Interest Rates 10. Amendments Related to WAL/WAM Calculation 11. Form PF Amendments for Large Liquidity Fund Advisers 12. Disclosures 13. Sponsor Support 14. Capital Buffers 15. Minimum Balance at Risk 16. Liquidity Exchange Bank Membership 17. Alternative Compliance and Filing Periods E. Effects on Efficiency, Competition, and Capital Formation V. Paperwork Reduction Act A. Introduction B. Rule 2a-7 C. Form N-MFP D. Form N-CR E. Form N-1A F. Form PF G. Rule 31a-2 VI. Regulatory Flexibility Act Certification Statutory Authority I. Introduction The Commission is adopting amendments to rule 2a-7 under the Investment Company Act of 1940. Money market funds are a type of mutual fund registered under the Act and regulated pursuant to rule 2a-7. 4 These funds are popular cash management vehicles for both retail and institutional investors because they seek to provide investors with principal stability and access to daily liquidity. In addition, money market funds serve as an important source of short-term financing for businesses, banks, and Federal, state, municipal, and Tribal governments. 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, contributing to stress on short-term funding markets that resulted in government intervention to enhance the liquidity of such markets. 5 Our historical experience with these funds and the events of March 2020 have led us to re-evaluate certain aspects of the regulatory framework applicable to money market funds. Accordingly, the Commission is adopting amendments to rule 2a-7 and certain reporting forms that are designed to improve the resilience of money market funds during times of market stress while preserving the benefits that investors have come to expect from these funds. 4 Money market funds are also sometimes called “money market mutual funds” or “money funds.” 5 See infra section I.B (discussing these events in more detail). In December 2021, the Commission proposed to amend rule 2a-7 to remove the tie between weekly liquid asset thresholds and the potential imposition of liquidity fees and redemption gates, since it appears these provisions contributed to investors' incentives to redeem from certain funds in March 2020 and affected fund managers' willingness to use available liquidity in their portfolios to meet redemptions. 6 For funds that experienced the heaviest outflows in March 2020 and in prior periods of market stress, the proposal also included a new swing pricing requirement that was designed to mitigate the dilution and investor harm that can occur 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. The Commission also proposed to increase the minimum daily and weekly liquid asset requirements to better equip money market funds to manage significant and rapid investor redemptions. In addition, we proposed certain form amendments to improve transparency and facilitate Commission monitoring of money market funds. As part of the proposal, the Commission proposed to amend rule 2a-7 to prohibit a stable net asset value (“NAV”) money market fund from using share cancellation or a reverse distribution mechanism in a negative interest rate environment. 6 Money Market Fund Reforms, Investment Company Act Release No. 34441 (Dec. 15, 2021) [87 FR 7248 (Feb. 8, 2022)] (“Proposing Release”). The Commission received comment letters on the proposal from a variety of commenters, including funds and investment advisers, law firms, other fund service providers, investor advocacy groups, professional and trade associations, and interested individuals. 7 As discussed in greater detail throughout this release, these commenters expressed a diversity of views. Many commenters expressed support for aspects of the proposal, including removing the link between liquidity thresholds and the imposition of redemption gates and liquidity fees; increasing the minimum daily and weekly liquid asset requirements above current minimums; and clarifying the calculation of weighted average portfolio maturity and weighted average life maturity. 8 Many commenters, however, expressed concern about the consequences of the proposed swing pricing requirement, suggesting, among other reasons, that it would be operationally difficult and may not effectively prevent destabilizing runs during periods of stress. 9 Separately, several commenters expressed that the Commission should adopt more modest increases to the daily and weekly liquid asset requirements than proposed. 10 Many commenters also generally opposed the proposed clarification of how stable net asset value money market funds should handle a negative interest rate environment, stating that the proposed prohibition from using share cancellation in certain negative interest environments could be operationally burdensome and costly without clear benefits for investors. 11 Lastly, while some commenters were supportive of the proposed modifications to the fund reporting requirements, others expressed concern about the sensitivity or burdens of reporting certain information regarding money market fund investors or portfolios, as well as significant declines in liquidity. 12 7 The comment letters on the Proposing Release (File No. S7-22-21) are available at https://www.sec.gov/comments/s7-22-21/s72221.htm. 8 See, e.g., Comment Letter of Investment Company Institute (Apr. 11, 2022) (“ICI Comment Letter”); Comment Letter of Americans for Financial Reform Education Fund (Apr. 11, 2022) (“Americans for Financial Reform Comment Letter”). 9 See, e.g., Comment Letter of The Asset Management Group of the Securities Industry and Financial Markets Association (Apr. 11, 2022) (“SIFMA AMG Comment Letter”); Comment Letter of State Street Global Advisors (Apr. 11, 2022) (“State Street Comment Letter”). 10 See, e.g., Comment Letter of Western Asset Management Company, LLC (Apr. 11, 2022) (“Western Asset Comment Letter”); Comment Letter of Healthy Markets Association (Apr. 12, 2022) (“Healthy Markets Association Comment Letter”). 11 See, e.g., Comment Letter of Federated Hermes Inc. (Apr. 11, 2022) (“Federated Hermes Comment Letter I”); Comment Letter of Allspring Funds Management, LLC (Apr. 11, 2022) (“Allspring Funds Comment Letter”); Comment Letter of Fidelity Management Research Company LLC (Apr. 11, 2022) (“Fidelity Comment Letter”). 12 See infra section II.F. After considering the comments on the proposal, we are adopting rule and form amendments to improve the resilience and transparency of money market funds, with certain modifications. 13 As proposed, the final amendments will remove the redemption gate provision from rule 2a-7; increase the minimum daily and weekly liquid asset requirements to 25% and 50%, respectively; specify the weighted average portfolio maturity and weighted average life maturity calculations; and require public reporting of significant declines in liquidity on Form N-CR. However, we are not adopting the proposed swing pricing requirement. Rather, the final amendments will modify the current liquidity fee framework to require institutional prime and institutional tax-exempt money market funds to impose a liquidity fee when the fund experiences net redemptions that exceed 5% of net assets, while also allowing any non-government money market fund to impose a discretionary liquidity fee if the board determines a fee is in the best interest of the fund. Similar to the proposed swing pricing requirement, the liquidity fee framework is designed to better allocate liquidity costs associated with redemptions to the redeeming investors. In addition, in a change from the proposal, the final amendments will permit retail and government money market funds to use a reverse distribution mechanism if negative interest rates occur in the future with certain conditions, including appropriate disclosure to concisely and clearly describe to shareholders the fund's use of a reverse distribution mechanism and its effect on investors. 13 We have consulted and coordinated with the Consumer Financial Protection Bureau regarding this final rulemaking in accordance with section 1027(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Moreover, while we are adopting the amended reporting requirements for Form N-MFP largely as proposed, we are making modifications to certain aspects of the requirements in response to commenter concerns about the sensitivity of publicly reporting certain investor and portfolio information. We are also adopting, largely as proposed in a January 2022 Proposing Release, amendments to Form PF reporting requirements for large liquidity fund advisers. 14 The final amendments to Form PF generally are designed to align with relevant revisions we are making to Form N-MFP. Finally, we are adopting two technical amendments to Form N-CSR and Form N-1A to correct errors from recent Commission rulemakings. 14 Amendments to Form PF to Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and Large Liquidity Fund Advisers, Investment Advisers Act Release No. 5950 (Jan. 26, 2022) [87 FR 9106 (Feb. 17, 2022)] (“Form PF Proposing Release”). A. Role of Money Market Funds and Existing Regulatory Framework 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—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 retail and institutional investors. Money market funds also serve as an important source of short-term financing for businesses, banks, and governments. 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. 15 “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. 16 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. 17 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. 18 15 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. Staff reports and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person. 16 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.” 17 In this release, we also use the term “non-government money market fund” to refer to prime and tax-exempt money market funds. 18 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. 19 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.” 20 Institutional prime and institutional tax-exempt money market funds, however, are required to use a “floating” NAV per share 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. 21 19 See Proposing Release, supra note 6, at n.10 (discussing amortized cost method and penny rounding cost method); see also 17 CFR 270.2a-7(c)(1)(i) and (g)(1) and (2). 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. 20 These funds must compare their stable share price to the market-based value per share of their portfolios at least daily. 21 See Proposing Release, supra note 6, at n.12. As of March 2023, there were approximately 294 money market funds registered with the Commission, and these funds collectively held over $5.7 trillion of assets. 22 The vast majority of these assets are held by government money market funds ($4.4 trillion), followed by prime money market funds ($1 trillion) and tax-exempt money market funds ($119 billion). 23 Of prime money market funds' assets, approximately 44% are held by retail prime money market funds, with the remaining assets almost evenly split between institutional prime money market funds that are offered to the public and institutional prime money market funds that are not offered to the public. 24 The vast majority of tax-exempt money market fund assets are held by retail funds. 22 Money Market Fund Statistics, Form N-MFP Data, period ending Mar. 2023, available at: https://www.sec.gov/files/mmf-statistics-2023-03.pdf . This data excludes “feeder” funds to avoid double counting assets. 23 Id. 24 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 2010 and 2014, in response to market events that have highlighted money market fund vulnerabilities. 25 Among other things, these past reforms introduced minimum daily and weekly liquid asset requirements, provided for redemption gates and liquidity fees as available tools when a fund's liquidity drops below a threshold, required institutional money market funds to use floating NAVs, and improved transparency through reporting and website posting requirements. 26 25 See Proposing Release, supra note 6, at n.16 and accompanying text (providing more detail related to previous Commission actions and government intervention following the 2008 financial crisis). 26 Money Market Fund Reform, Investment Company Act Release No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (“2010 Adopting Release”); 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”). In addition to reforms for money market funds, in 2014 the Commission introduced new reporting requirements for large advisers of liquidity funds on Form PF to better align reporting obligations of advisers regarding private liquidity funds to those of money market funds, in order to help the Commission have a more complete picture of the broader short-term financing market. 27 Liquidity funds follow similar investment strategies as money market funds, but investment advisers are not required to register liquidity funds as investment companies under the Act. Liquidity funds are a relatively small but important category of private funds due to the role they play along with money market funds as sources, and users, of liquidity in markets for short-term financing. 28 Similar to money market funds, liquidity funds are managed with the goal of maintaining a stable net asset value or minimizing principal volatility for investors. However, liquidity funds are not required to comply with the risk-limiting conditions of rule 2a-7, such as the restrictions on the maturity, diversification, credit quality, and liquidity of investments. Consequently, liquidity funds may take on greater risks and, as a result, may be more sensitive to market stress relative to money market funds. 27 Generally, investment advisers registered (or required to be registered) with the Commission with at least $150 million in private fund assets under management must file Form PF. 28 As of Sept. 2022, there were 79 liquidity funds reported on Form PF with $336 billion in gross assets under management. B. March 2020 Market Events and Need for Reform As discussed in the Proposing Release, 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. 29 Institutional investors, in particular, sought highly liquid investments, including government money market funds. 30 In contrast, institutional prime and institutional tax-exempt money market funds experienced outflows beginning the week of March 9, 2020, which accelerated the following week. 31 Outflows from retail prime and retail tax-exempt funds began the week of March 16, a week after outflows in institutional funds began. 29 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 . 30 More specifically, government money market funds had record inflows of $838 billion in Mar. 2020 and an additional $347 billion of inflows in Apr. 2020. See id. at 25. 31 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. 32 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. 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. 32 See Proposing Release, supra note 6, at n.30. The Proposing Release discussed the potential factors that incentivized investors to redeem from certain money market funds in March 2020. 33 These factors included concerns about the potential imposition of redemption gates or liquidity fees based on observed declines in some funds' weekly liquid assets, general concerns about declining fund liquidity, general uncertainty related to a global health crisis and fears of associated economic downturns, and the need to meet near-term cash needs unrelated to the market stress. The Proposing Release also discussed data regarding the relationship between a fund's weekly liquid asset levels and the amount of outflows it experienced in March 2020. The data showed that funds with lower weekly liquid asset levels were more likely to have significant outflows in March 2020, but some funds with higher levels of liquidity also experienced large outflows. 34 33 Id., at n.42 and accompanying discussion. 34 Id., at n.44. These outflows caused some money market funds to engage in greater than normal selling activity in short-term funding markets which, when combined with similar selling activity from other market participants such as hedge funds and bond mutual funds, both contributed to, and was impacted by, stress in short-term funding markets. 35 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. These markets, in which prime money market funds and other participants invest, essentially became “frozen” in March 2020, making it more difficult to sell these instruments, which have limited secondary trading even in normal market conditions. 36 Similarly, 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. 37 One factor that appears to have contributed to money market funds' sales of long-term portfolio securities is the incentive fund managers had to maintain weekly liquid assets above 30% in an effort to avoid investors' concerns about the possibility of redemption gates or liquidity fees under our current rule. 38 35 See Proposing Release, supra note 6, at n.54 and accompanying discussion. 36 Id. 37 Id. 38 Id., at n.77 and accompanying discussion. 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. 39 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. 40 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. 41 The MMLF ceased providing loans in March 2021. 39 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. 40 See Proposing Release, supra note 6, at n.36. 41 Id., at n.37. Commenters generally agreed that the growing economic concerns related to the impact of the COVID-19 pandemic led investors to seek liquidity in the form of cash and short-term government securities in March 2020, leading to outflows from prime money market funds and significant inflows to government money market funds. 42 Commenters also acknowledged that the markets for private short-term debt instruments, such as commercial paper and certificates of deposit, significantly deteriorated during this period. 43 However, some commenters questioned the nexus between the liquidity crisis in the short-term funding markets and the outflows from prime money market funds, asserting that events in the money market fund market were not a significant cause of the liquidity issues in the short-term funding markets in March 2020. 44 Accordingly, some commenters suggested that any reform exclusive to money market funds by themselves will likely not address the broader liquidity challenges in the short-term funding markets. 45 Going further, a few commenters expressed that the proposed reforms would have negative impacts to the short-term funding markets because they would reduce the demand for prime money market funds, thereby reducing capacity in the short-term funding markets. 46 Some of these commenters encouraged the Commission, and policymakers more generally, to re-examine the short-term funding markets and the various events surrounding the volatility in March 2020, and to consider available tools other than reforms to the money market fund regulatory framework, that would improve resiliency in this segment of our markets. 47 Conversely, other commenters asserted that liquidity issues with money market funds served as a source of significant contagion that imperiled the short-term markets broadly and forced government intervention. 48 Some of these commenters suggested that the Commission should consider more aggressive reforms to solve the unique problems presented by money market funds, mainly that they are hybrid instruments that embody elements of both securities investments and banking products that are treated as cash-like by investors. 49 42 See, e.g., ICI Comment Letter; Comment Letter of The Vanguard Group, Inc. (Apr. 11, 2022) (“Vanguard Comment Letter”); Comment Letter of Professors Samuel G. Hanson, David S. Scharfstein, and Adi Sunderam, Harvard Business School (Apr. 11, 2022) (“Prof. Hanson et al. Comment Letter”); Comment Letter of Blackrock (Apr. 11, 2022) (“BlackRock Comment Letter”); Comment Letter of the CFA Institute (Apr. 11, 2022) (“CFA Comment Letter”). 43 See, e.g., Comment Letter of Invesco Ltd. (Apr. 11, 2022) (“Invesco Comment Letter”); Vanguard Comment Letter; BlackRock Comment Letter (asserting that they struggled to find bids from dealer banks in the secondary market for much of the commercial paper, bank certificates of deposits, or municipal debt they were holding). 44 See, e.g., ICI Comment Letter; Federated Hermes Comment Letter I; Invesco Comment Letter; Vanguard Comment Letter; BlackRock Comment Letter; Healthy Markets Association Comment Letter. 45 See, e.g., ICI Comment Letter; Federated Hermes Comment Letter I; Invesco Comment Letter; Vanguard Comment Letter; BlackRock Comment Letter. 46 See, e.g., SIFMA AMG Comment Letter; Comment Letter of J.P. Morgan Asset Management (Apr. 11, 2022) (“JP Morgan Comment Letter”). 47 See, e.g., JP Morgan Comment Letter; Federated Hermes Comment Letter I; ICI Comment Letter (recommending adjusting bank regulations to enable banks and their dealers to expand their balance sheets to provide market liquidity during periods of market stress without materially reducing the overall resilience of those firms). 48 See, e.g., Comment Letter of Better Markets (Apr. 11, 2022) (“Better Markets Comment Letter”); CFA Comment Letter. 49 See, e.g., Better Markets Comment Letter; Prof. Hanson et al. Comment Letter. We understand that money market funds are not the totality of the short-term funding markets and that the reforms discussed in this adopting release may not solve all future issues connected to the short-term funding markets. However, we believe the events of March 2020 evidence that money market funds need better functioning tools for managing through stress while mitigating harm to shareholders. Specifically, in addition to requiring higher liquidity minimums to prepare for significant and rapid investor redemptions, funds need to be able to use that liquidity when such redemptions occur. In addition, to prevent redeeming shareholders from diluting the interests of remaining shareholders by removing liquidity from the fund in times of market stress, when liquidity in underlying short-term funding markets is scarce and costly, funds need tools to ensure that liquidity costs are fairly allocated to redeeming investors. Moreover, while the period of market stress in March 2020 was relatively brief, it is important to consider that future stressed periods—whether specific to certain money market funds or the short-term funding markets more generally—may be more protracted or more severe than in March 2020, particularly absent Federal Reserve action. We believe that these needs for better functioning tools to manage through stress while mitigating harm to shareholders can be met while preserving the benefits that investors have come to expect from money market funds. Accordingly, we are adopting amendments to rule 2a-7 and related reporting and registration forms that are designed to achieve these key objectives and to reflect our experience with the rule since it was initially adopted in 1983. 50 50 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)]. II. Discussion A. Amendments To Remove the Tie Between the Weekly Liquid Asset Threshold and Redemption Gates and Liquidity Fees 1. Unintended Effects of the Tie Between the Weekly Liquid Asset Threshold and Liquidity Fees and Redemption Gates Following amendments to rule 2a-7 in 2014, 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. 51 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. 52 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. 53 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. 54 51 Government funds are permitted, but not required, to impose fees and gates, as discussed below. See 17 CFR 270.2a-7(c)(2); 2014 Adopting Release, supra note 26. 52 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). 53 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). 54 17 CFR 270.2a-7(h)(10)(ii); 2014 Adopting Release, supra note 26, at section III.E.9.a. Money market fund fees and gates below these thresholds 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. 55 However, these provisions did not achieve these objectives during the period of market stress in March 2020. As discussed in the Proposing Release, evidence suggests that in March 2020, even though no money market fund imposed a liquidity fee or gate, the possibility of their imposition after crossing the publicly disclosed 30% weekly liquid asset threshold appears to have contributed to investors' incentives to redeem from prime money market funds. 56 The presence of this threshold appears to have increased investor redemption activity as prime and tax-exempt money market funds approached the 30% weekly liquid asset level. 57 Further, this liquidity threshold also appeared to affect money market fund managers' behavior in March 2020 and contributed to incentives for money market fund managers to maintain weekly liquid asset levels above a 30% weekly liquid asset threshold, rather than use those assets to meet redemptions. 58 Thus, contrary to its intended benefit, this threshold appeared to heighten prime and tax-exempt money market funds' susceptibility to heavy redemptions as funds' publicly disclosed weekly liquid assets approached it and increased the lack of liquidity in underlying short-term funding markets in March 2020. 55 See 2014 Adopting Release, supra note 26, at section III.A. 56 See Proposing Release, supra note 6, at section I.B. 57 See id. 58 See id. See also ICI Comment Letter; SIFMA AMG Comment Letter. In addition, as discussed in the Proposing Release, it appears that money market fund investors are more sensitive to the possibility of redemption gates than the possibility of liquidity fees. 59 While liquidity fees impose a cost for an investor to redeem, gates outright stop redemptions for the duration of the gate. Money market fund investors—who typically invest in money market funds for cash management purposes—are generally sensitive to being unable to access their investments for a period of time and have a tendency to redeem from such funds preemptively if they fear a gate may be imposed. 59 See Proposing Release, supra note 5, at nn. 75-76 and accompanying text (discussing comment letters that expressed views that the possibility of redemption gates was a greater concern for investors, particularly institutional investors, in Mar. 2020 than the possibility of liquidity fees and that retail investors appeared less sensitive to fees and gates than institutional investors). Many commenters agreed with the Commission's assessment that the regulatory link between a known liquidity threshold and the imposition of fees and gates contributed to investors' incentives to redeem from money market funds in March 2020. 60 Many commenters also agreed with the Commission's assessment that the weekly liquid asset threshold also contributed to incentives for managers to avoid falling below this threshold. 61 One commenter suggested that removing the regulatory link between weekly liquid assets and redemption gates (and liquidity fees) would free up an additional 30% of liquidity that funds could use in a crisis similar to March 2020. 62 60 See, e.g., Comment Letter of Morgan Stanley Investment Management Inc. (Apr. 8, 2022) (“Morgan Stanley Comment Letter”); ICI Comment Letter; Comment Letter of Northern Trust Asset Management (Mar. 24, 2022) (“Northern Trust Comment Letter”); Fidelity Comment Letter; see also Proposing Release, supra note 6, at section II.A.1 (“Available evidence, supported by many comment letters in response to the Commission's request for comment [ ] 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.”). 61 See, e.g., ICI Comment Letter, Comment Letter of T. Rowe Price (Apr. 11, 2022) (“T. Rowe Comment Letter”); JP Morgan Comment Letter. 62 See Federated Hermes Comment Letter I. Several commenters stated that the potential imposition of redemption gates in particular, as opposed to liquidity fees, drove instability and redemptions in March 2020. 63 For example, one commenter suggested that the mere possibility that fund boards may impose gates was a key factor that contributed significantly to the stresses experienced by publicly offered institutional prime funds in March 2020. 64 Another commenter stated that, based on a survey of institutional investor clients, investors were particularly concerned about gates and perceived the 30% weekly liquid asset threshold as a “bright line” not to be crossed. 65 An additional commenter stated that, based on data and discussions with its member funds, the possibility of a gate especially caused investors in March 2020 to redeem heavily. 66 63 See, e.g., Fidelity Comment Letter; Northern Trust Comment Letter; Comment Letter of the Institute of International Finance (Apr. 11, 2022) (“IIF Comment Letter”); ICI Comment Letter. 64 See Fidelity Comment Letter. 65 See JP Morgan Comment Letter. 66 See ICI Comment Letter. Thus, based on available evidence and as suggested by many commenters, the weekly liquid asset threshold for consideration of fees and gates appear to have potentially increased the risks of investor runs without providing benefits to money market funds as intended by the Commission. In addition, money market fund investors have demonstrated particular sensitivity to the possibility of gates and the corresponding lack of access to their investments, and these concerns appear to have incentivized redemptions in March 2020 more so than any concerns about the possibility of fees. Accordingly, after considering the comments received, we are adopting amendments to the fee and gate provisions in rule 2a-7 to remove the regulatory link between weekly liquid assets and fees and gates. As discussed below, we are amending rule 2a-7 to remove gate provisions altogether and amending the liquidity fee structure to remove weekly liquid asset-linked thresholds and implement a modified liquidity fee framework that will provide for both mandatory and discretionary liquidity fees. We believe these changes will provide more effective tools for money market funds to use to mitigate 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. 2. Removal of Redemption Gates From Rule 2a-7 We are adopting, as proposed, the removal of money market funds' ability through rule 2a-7 to temporarily suspend redemptions ( i.e., impose a “gate”). 67 In the Proposing Release, we discussed our concern that 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' general sensitivity to being unable to access their investments for a period of time and tendency to redeem from funds preemptively if they fear a gate may be imposed. We believe that removing gate provisions altogether from rule 2a-7 will reduce the risk of investor runs on money market funds during periods of market stress. Money market funds will continue to be able to impose permanent gates to facilitate an orderly liquidation of a fund pursuant to 17 CFR 270.22e-3 (“rule 22e-3”), and we are not adopting any changes to that rule. 68 67 See Proposing Release, supra note 6, at section II.A.2. 68 See 17 CFR 270.22e-3. Rule 22e-3 under the Act permits money market funds to suspend redemptions and postpone the payment of proceeds in connection with a liquidation upon certain declines in liquidity or deviations between market-based and stable prices, board approval of liquidation, and notice to the Commission. Many commenters generally supported the proposal to remove redemption gates in rule 2a-7. 69 Several of these commenters stated that use of rule 22e-3 to suspend redemptions in connection with a fund liquidation would be sufficient to address scenarios in which a fund may need to suspend redemptions. 70 One such commenter suggested that any money market fund that needed to impose a gate would likely need to fully liquidate, making rule 22e-3 sufficient for these purposes. 71 69 See, e.g., Western Asset Comment Letter; Morgan Stanley Comment Letter; Vanguard Comment Letter; CFA Comment Letter; SIFMA AMG Comment Letter; Comment Letter of the Committee on Capital Markets Regulation (Apr. 11, 2022) (“CCMR Comment Letter”); T. Rowe Comment Letter. 70 See Allspring Funds Comment Letter; CFA Comment Letter; IIF Comment Letter; Northern Trust Comment Letter; SIFMA AMG Comment Letter. 71 See Invesco Comment Letter. Some commenters supported removing the tie between the weekly liquid asset threshold and a fund's ability to impose a gate but suggested that gates could still be a useful tool outside of a fund liquidation. These commenters suggested that fund boards should have broader discretion to impose gates without linkage to a weekly liquid asset threshold. 72 Some commenters suggested that the rule should permit fund boards to impose a gate if the board determines a gate is in the best interests of the fund and its shareholders, subject to certain policies and procedures, disclosure, and reporting requirements. 73 Another commenter suggested that fund boards should have complete discretion with respect to imposing gates but that the SEC should require relevant disclosures. 74 72 See Federated Hermes Comment Letter I; Comment Letter of Federated Hermes Funds Board of Trustees (Apr. 11, 2022) (“Federated Hermes Fund Board Comment Letter”); Comment Letter of the Cato Inst. (Feb. 10, 2022) (“Cato Inst. Comment Letter”). 73 See Federated Hermes Comment Letter I (stating that funds should be required to report the basis for imposing temporary gates to the Commission); Federated Hermes Fund Board Comment Letter. 74 See Cato Inst. Comment Letter. After considering these comments, we continue to believe that the removal of money market funds' ability to impose gates through rule 2a-7 is appropriate. 75 By removing the gate provision, either with or without an associated liquidity threshold, we seek to limit the potential for investor uncertainty and de-stabilizing preemptive investor redemption behavior related to the potential use of gates during stress events as well as to better encourage funds to more effectively use their existing liquidity buffers in times of stress. As discussed above, rather than providing an effective tool for money market funds to manage redemption pressures during a period of stress, the potential availability of gates under prescribed parameters exacerbated the redemption pressures experienced by some funds during March 2020. 75 As proposed, in addition to removing the gate provisions from rule 2a-7, we are also removing associated disclosure and reporting requirements about a fund's potential or actual imposition of gates. See Items 4(b)(1)(ii) and 16(g) of current Form N-1A; Parts F and G of current Form N-CR. Retaining a gate provision under rule 2a-7 without an associated liquidity threshold, as suggested by some commenters, could result in continuing investor uncertainty and may contribute to preemptive investor redemption behavior during stress events. In normal and stressed markets, shareholders may need or want to access their funds for various reasons, including to meet near-term cash needs. When in place, a gate fully inhibits the redeemability of the money market fund shares for the duration of the gate, thereby blocking shareholders' access to their shares. We believe this complete halt to redemptions, even if temporary, has the potential to significantly incentivize preemptive redemptions. As discussed above, several commenters stated that fear of gates in particular contributed to redemptions in March 2020. Removing the link to a publicly disclosed liquidity threshold seemingly would expand the current gate provisions under rule 2a-7, potentially increasing investor uncertainty regarding when a fund may impose a gate. Even if such action by a money market fund board is unlikely to occur, as suggested by some commenters, 76 the mere possibility of a gate would persist and thus investor uncertainty and fear may remain, particularly when there are signs that a fund or short-term funding markets are under stress. Accordingly, we are removing the gate provision from rule 2a-7 to avoid this unintended outcome. 76 See, e.g., Comment Letter of Mutual Fund Directors Forum (Apr. 11, 2022) (“Mutual Fund Directors Forum Comment Letter”). In light of the proposed removal of gates under rule 2a-7, some commenters suggested additional amendments to rule 22e-3. This rule generally allows a money market fund to suspend redemptions if, among other conditions, (1) the fund 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 market-based price per share has deviated or is likely to deviate from its stable price, and (2) the fund's board has approved the fund's liquidation. Some commenters suggested that the SEC remove the weekly liquid asset threshold enumerated in rule 22e-3 and give fund boards more flexibility to approve liquidations. 77 One of these commenters suggested that the weekly liquid asset threshold in rule 22e-3 would not remain meaningful because of the Commission's proposal to remove the liquidity fee provisions from rule 2a-7, including the default liquidity fee provision for non-government money market funds with weekly liquid assets that fall below 10%. 78 77 See Allspring Funds Comment Letter; Comment Letter of Dechert LLP (Apr. 11, 2022) (“Dechert Comment Letter”). 78 See Dechert Comment Letter. We do not agree that expanding the availability of rule 22e-3 is appropriate. Rule 22e-3 provides a mechanism for a money market fund to permanently suspend redemptions when the fund is under significant stress to facilitate an orderly liquidation. While the amendments in this release include the removal of a default liquidity fee provision for non-government money market funds linked to a 10% weekly liquid asset threshold, we do not agree with the contention that the significance of the 10% weekly liquid asset threshold is thereby meaningfully reduced with respect to rule 22e-3. Due to the absolute and significant nature of a permanent suspension of redemptions and liquidation, the conditions in rule 22e-3, including the 10% weekly liquid asset threshold, limit the fund's ability to permanently suspend redemptions to circumstances that present a significant risk of a run on the fund and potential harm to shareholders. 79 We continue to believe that where a fund's weekly liquid assets fall below 10%, the fund is reasonably understood to be experiencing significant stress and circumstances may present a significant risk of a run on the fund and potential harm to shareholders. In these circumstances, the ability of the board of directors of such fund to suspend redemptions in light of a decision to liquidate can help address the significant run risk and reduce potential harm to shareholders. Where a money market fund is unable to avail itself of a permanent suspension of redemptions under rule 22e-3, the fund may suspend redemptions after obtaining an exemptive order from the Commission. 80 Accordingly, we are not adopting amendments to rule 22e-3. 79 See 2010 Adopting Release, supra note 26, at section II.H. 80 15 U.S.C. 80a-22(e). B. Liquidity Fee Requirement 1. Determination To Adopt a Liquidity Fee Requirement After considering comments, we are adopting a mandatory liquidity fee framework for institutional prime and institutional tax-exempt funds instead of the proposed swing pricing requirement. We believe the mandatory liquidity fee will reduce operational burdens associated with swing pricing while still achieving many of the benefits we were seeking with swing pricing by allocating liquidity costs to redeeming investors in stressed periods. In addition, we are adopting a discretionary liquidity fee for all non-government money market funds so that liquidity fees are an available tool for such funds to manage redemption pressures when the mandatory fee does not apply. Whether the fee is mandatory or discretionary, we are, as proposed, removing from rule 2a-7 the tie between liquidity fees and a fund's weekly liquid asset levels to avoid predictable triggers that may incentivize investors to preemptively redeem to avoid incurring fees. 81 This liquidity fee framework, independent of a predictable threshold for its application, achieves the intended benefits of the current liquidity fee regime by allocating liquidity costs to redeeming shareholders in times of stress while, in contrast to the current rule, avoiding incentives for preemptive redemptions associated with weekly liquid asset triggers. An approach solely based on liquidity fees, as opposed to gates, does not present the same concerns about incentivizing redemptions that exist under current rule 2a-7. As discussed, money market fund investors seemingly have been more concerned about the possibility of redemption gates than the possibility of liquidity fees. 82 This change is designed to increase the resilience of money market funds. 81 By “predictable,” we mean that an investor can use available information to predict whether a fee will apply on a given day or on future days. In the case of weekly liquid assets, an investor can observe the weekly liquid asset level disclosed for the prior day and use that information to predict whether the fund will cross the weekly liquid asset threshold in the near term. In the case of the net redemption threshold we are adopting for mandatory liquidity fees, while an investor can observe net flows for the prior day, that flow information does not necessarily predict the fund's flows for that day or future days, as net flows depend on independent investment decisions made by a large number of investors with differing needs and considerations. See infra section IV.C.4.a.i. 82 See supra section II.A.1. The Commission proposed a swing pricing requirement under which an institutional prime or institutional tax-exempt fund would downwardly adjust its current NAV per share by a swing factor when a fund has net redemptions. The swing factor adjustment would reflect spread and transaction costs and, if net redemptions exceeded 4% of the fund's net assets, then the swing factor would also include market impact costs. The Commission also proposed to remove the liquidity fee provision in rule 2a-7, which conditions the use of liquidity fees upon declines in fund liquidity below identified, predictable thresholds, and to specify that money market funds could instead impose liquidity fees under 17 CFR 270.22c-2 (“rule 22c-2”) at their discretion. 83 83 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). Many commenters expressed broad concerns about the swing pricing proposal and its potential effect on institutional money market funds and investors. Several commenters stated that the proposed swing pricing requirement was incompatible with how money market funds operate and manage liquidity, which may limit the utility of these funds as cash management vehicles. 84 For instance, commenters expressed concern that swing pricing may inhibit a fund's ability to offer features such as same-day settlement and multiple NAV strikes per day due to concerns that swing pricing would delay a fund's ability to determine its NAV. 85 Some commenters suggested that swing pricing may assume a greater degree of liquidity costs than funds incur to meet redemptions because money market funds generally satisfy redemptions through maturing assets, rather than secondary market selling activity, and are equipped to handle relatively large redemptions with available liquidity. 86 Some commenters stated that swing pricing would introduce greater volatility in fund share prices and performance, which they asserted would reduce investor demand for institutional money market funds. 87 In addition, some commenters indicated that the operational costs of the proposed swing pricing requirement could cause some sponsors to eliminate their institutional prime and institutional tax-exempt money market funds, particularly smaller funds, and reduce money market fund assets. 88 In light of these considerations, some commenters suggested that swing pricing is not an appropriate tool for money market funds and stated that a liquidity fee framework would be better suited to the structure and characteristics of money market funds, if the Commission determines that an anti-dilution tool is necessary for these funds. 89 84 See, e.g., Comment Letter of Independent Directors Council (Apr. 11, 2022) (“IDC Comment Letter”); Mutual Fund Directors Forum Comment Letter; Comment Letter of The Bank of New York Mellon (Apr. 11, 2022) (“BNY Mellon Comment Letter”); Fidelity Comment Letter; Comment Letter of State Street Global Advisors (Apr. 11, 2022) (“State Street Comment Letter”); Comment Letter of Federated Hermes, Inc. (Apr. 11, 2022) (“Federated Hermes Comment Letter II”) (letter primarily focused on the proposed swing pricing requirement). 85 See, e.g., Comment Letter of Capital Group Companies, Inc. (Apr. 11, 2022) (“Capital Group Comment Letter”); State Street Comment Letter; ICI Comment Letter; Federated Hermes Comment Letter II; SIFMA AMG Comment Letter; BNY Mellon Comment Letter. 86 See, e.g., SIFMA AMG Comment Letter; Comment Letter of American Bankers Association (Apr. 11, 2022) (“ABA Comment Letter I”); Invesco Comment Letter; Fidelity Comment Letter; Allspring Funds Comment Letter. 87 See SIFMA AMG Comment Letter; Western Asset Comment Letter; see also Northern Trust Comment Letter; Federated Hermes Comment Letter II. 88 See, e.g., JP Morgan Comment Letter; BlackRock Comment Letter; IDC Comment Letter; Comment Letter of U.S. Chamber of Commerce, Center for Capital Markets Competitiveness (Apr. 11, 2022) (“US Chamber of Commerce Comment Letter”); CCMR Comment Letter; Comment Letter of Americans for Tax Reform (Apr. 9, 2022) (“Americans for Tax Reform Comment Letter”); Northern Trust Comment Letter. 89 See, e.g., ICI Comment Letter (suggesting that, if data and analysis show that an anti-dilution mechanism is necessary for public institutional prime and tax-exempt funds, modifying and leveraging the existing fee framework would be less problematic than swing pricing and could serve the Commission's goals in a way that avoids imposing unnecessary operational costs); Invesco Comment Letter; SIFMA AMG Comment Letter (suggesting that, to the extent the Commission continues to believe, based on data driven findings and analysis, that an additional anti-dilution tool is necessary, the Commission consider liquidity fees instead of swing pricing); Federated Hermes Comment Letter I; Federated Hermes Comment Letter II; Invesco Comment Letter; Comment Letter of The Charles Schwab Corporation (Apr. 11, 2022) (“Schwab Comment Letter”); Morgan Stanley Comment Letter; JP Morgan Comment Letter; BlackRock Comment Letter; State Street Comment Letter; Western Asset Comment Letter; IIF Comment Letter; Allspring Funds Comment Letter. Some of the comments received with respect to the swing pricing proposal are also relevant to issues implicated by the liquidity fee mechanism that we are adopting. We primarily discuss those comments below in the relevant sections addressing the amended liquidity fee framework. Commenters expressed different views on whether the proposed swing pricing requirement would achieve the Commission's goal of ensuring that the costs stemming from net redemptions are fairly allocated and do not give rise to dilution or a potential first-mover advantage, particularly in times of stress. A few commenters were supportive of swing pricing and suggested that it would enhance the resilience of money market funds. 90 Many commenters, however, expressed concern that swing pricing would not achieve the Commission's goals of allocating liquidity costs and reducing dilution and potential first-mover advantages. Some commenters suggested that redemptions are not motivated by a first-mover advantage and that liquidity, rather than avoiding dilution from other shareholders' redemptions, was the motivation for redemptions in March 2020. 91 Some commenters suggested that swing pricing would not address first-mover issues because investors would not know at the time they submitted redemptions orders if a swing factor would apply for that pricing period. 92 Similarly, another commenter suggested that small adjustments to a fund's NAV would be unlikely to affect a shareholder's decision to redeem, even with a market impact factor. 93 Some other commenters suggested that uncertainty regarding the application of swing pricing may in fact increase incentives for investors to redeem ahead of others. 94 90 See, e.g., Americans for Financial Reform Comment Letter; CFA Comment Letter; Comment Letter of Systemic Risk Council (Apr. 15, 2022) (“Systemic Risk Council Comment Letter”); Better Markets Comment Letter; Comment Letter of Chris Barnard (Oct. 19, 2022) (“Chris Barnard Comment Letter”). 91 See, e.g., Fidelity Comment Letter; Capital Group Comment Letter; BlackRock Comment Letter; Americans for Tax Reform Comment Letter; see also Federated Hermes Comment Letter I (suggesting that the 2014 amendments that imposed a floating NAV on institutional funds sufficiently addressed first-mover issues). 92 See, e.g., Capital Group Comment Letter; Dechert Comment Letter; Schwab Comment Letter; Allspring Funds Comment Letter; Federated Hermes Comment Letter II; JP Morgan Comment Letter; BlackRock Comment Letter; ICI Comment Letter; SIFMA AMG Comment Letter; see also US Chamber of Commerce Comment Letter. 93 See Fidelity Comment Letter. 94 See, e.g., CCMR Comment Letter (suggesting that swing pricing could incentivize runs as investors seek to redeem before a market impact factor is applied); Comment Letter of Institutional Cash Distributors (Apr. 11, 2022) (“ICD Comment Letter”); Prof. Hanson et al. Comment Letter; State Street Comment Letter. As discussed in the Proposing Release, swing pricing and liquidity fees can be economically equivalent in terms of charging redeeming investors for the liquidity costs they impose on a fund. 95 Both approaches allow funds to recapture the liquidity costs of redemptions to make non-redeeming investors whole. The Commission considered both approaches in the Proposing Release and, after acknowledging that each approach has certain advantages and disadvantages over the other, the Commission expressed the view that swing pricing appeared to have operational benefits relative to liquidity fees. For example, as discussed in the proposal, the Commission believed swing pricing would require less involvement by intermediaries in applying a charge to redeeming investors than liquidity fees. 96 95 See Proposing Release, supra note 6, at sections II.B.1 and III.D.5. 96 See id. at paragraph accompanying n.149 and section III.D.5. Many commenters stated that liquidity fees were preferable to swing pricing. 97 Many of these commenters stated that liquidity fees would be easier for money market funds to implement. 98 For instance, some commenters suggested that funds would be able to build on their existing experience with liquidity fees under current rules. 99 Similarly, some commenters raised the concern that swing pricing is ill-suited for money market funds given the general lack of experience with swing pricing in the money market fund industry. 100 97 See, e.g., Invesco Comment Letter; SIFMA AMG Comment Letter (stating that liquidity fees offer many advantages as compared to swing pricing); Federated Hermes Comment Letter I (suggesting that a discretionary liquidity fee would be less onerous than swing pricing); Federated Hermes Commenter Letter II; Invesco Comment Letter; Schwab Comment Letter; Morgan Stanley Comment Letter; JP Morgan Comment Letter; BlackRock Comment Letter; State Street Comment Letter; Western Asset Comment Letter; IIF Comment Letter; Allspring Funds Comment Letter; see also Dechert Comment Letter; CFA Comment Letter. 98 See, e.g., Federated Hermes Comment Letter II; Invesco Comment Letter; SIFMA AMG Comment Letter; Schwab Comment Letter; IIF Comment Letter; BlackRock Comment Letter. 99 See, e.g., Federated Hermes Comment Letter II; Invesco Comment Letter; SIFMA AMG Comment Letter; Schwab Comment Letter; IIF Comment Letter. 100 See Morgan Stanley Comment Letter; SIFMA AMG Comment Letter; IIF Comment Letter; Federated Hermes Comment Letter I; Federated Hermes Comment Letter II; Comment Letter of Senator Pat Toomey (Apr. 12, 2022) (“Senator Toomey Comment Letter”); Mutual Fund Directors Forum Comment Letter; see also Comment Letter of Professor Stephen G. Cecchetti, Brandeis International Business School, and Professor Kermit L. Schoenholtz, Leonard N. Stern School of Business, New York University (Feb. 1, 2022) (“Profs. Ceccheti and Schoenholtz Comment Letter”). Several commenters stated that a liquidity fee framework would provide benefits to investors relative to swing pricing. 101 Some of these commenters suggested that a liquidity fee would be less confusing and more transparent with respect to the liquidity costs redeeming investors incur because investors are more familiar with the concept of liquidity fees (which exist in the current rule) and because the size of the swing factor is not readily observable in the fund's share price. 102 Some commenters suggested that a liquidity fee would be a more direct way to pass along liquidity costs and, unlike swing pricing, would do so without providing a discount to subscribing investors or adding volatility to the fund's NAV. 103 Some commenters suggested that the changes in a fund's NAV caused by application of the swing factor may cause investors to time their purchases of money market shares to attain a pricing advantage during predictable seasonal redemption activity such as tax payment dates or month-end. 104 Further, one commenter indicated that a liquidity fee framework could better preserve same-day liquidity for investors than swing pricing because liquidity fees are already operationally feasible for many money market funds and present fewer implementation challenges. 105 101 See, e.g., ICI Comment Letter; Invesco Comment Letter; SIFMA AMG Comment Letter; Federated Hermes Comment Letter I; Federated Hermes Commenter Letter II; Invesco Comment Letter; Schwab Comment Letter; Morgan Stanley Comment Letter; JP Morgan Comment Letter; BlackRock Comment Letter; State Street Comment Letter; Western Asset Comment Letter; IIF Comment Letter; Allspring Funds Comment Letter; see also Dechert Comment Letter; CFA Comment Letter. 102 See, e.g., Morgan Stanley Comment Letter (expressing the belief that investors understand and are more comfortable with a fee-based regime, as compared to swing pricing, because of previous efforts of money market fund sponsors to educate fund investors on liquidity fees, as well as investors' experiences with redemption fees under rule 22c-2 and sales charges and deferred sales charges); SIFMA AMG Comment Letter; Federated Hermes Comment Letter II. 103 See, e.g., ICI Comment Letter; Federated Hermes Comment Letter II (“Shareholders who subscribe on days when price is swung down will receive a windfall profit.”); JP Morgan Comment Letter (“[R]emaining investors will not experience additional NAV volatility as with swing pricing.”). 104 See Federated Hermes Comment Letter I; Federated Hermes Comment Letter II (expressing concern about other scenarios in which swing pricing may incentivize trading to take advantage of fluctuations in the fund's NAV, such as incentives to purchase in early pricing periods—when money market funds tend to have more redemptions—and redeem in a later pricing period, when net redemptions are less likely); Western Asset Comment Letter; Dechert Comment Letter (suggesting that swing pricing may have a potentially unintended dilutive effect of incentivizing investors to buy into a fund at a lower NAV once the fund swings). 105 See IIF Comment Letter. Commenters suggested various alternatives regarding the form and structure of liquidity fees. Some commenters suggested that fund boards should have discretion to determine whether to impose liquidity fees. 106 Some commenters suggested an approach where liquidity fees would apply automatically upon certain events, such as upon net redemptions exceeding an identified threshold or liquidity dropping below a certain level. 107 106 See, e.g., ICI Comment Letter; Schwab Comment Letter; Federated Hermes Comment Letter I; Federated Hermes Comment Letter II; Federated Hermes Fund Board Comment Letter; Invesco Comment Letter; SIFMA AMG Comment Letter. 107 See, e.g., Morgan Stanley Comment Letter; Western Asset Comment Letter; BlackRock Comment Letter; State Street Comment Letter; SIFMA AMG Comment Letter; ICI Comment Letter; JP Morgan Comment Letter; IIF Comment Letter; Invesco Comment Letter. After considering these comments, we are adopting a liquidity fee framework to better allocate liquidity costs to redeeming investors. The proposed swing pricing requirement was designed to address potential shareholder dilution and the potential for a first-mover advantage for institutional funds. While we continue to believe these goals are important, we are persuaded by commenters that these same goals are better achieved through a liquidity fee mechanism, particularly given that current rule 2a-7 includes a liquidity fee framework that funds are accustomed to and can build upon. The mandatory liquidity fee framework we are adopting is designed to address concerns with the prior liquidity fee framework—namely the incentives for preemptive redemptions associated with predictable weekly liquid asset triggers. At the same time it continues to seek to ensure that the costs stemming from redemptions in stressed market conditions are more fairly allocated to redeeming investors. Specifically, institutional prime and institutional tax-exempt money market funds will be subject to a mandatory liquidity fee when net redemptions exceed 5% of net assets. 108 Funds will not be required to impose this fee, however, when liquidity costs are less than one basis point, which we anticipate will often be the case under normal market conditions. 109 As discussed in more detail throughout this section, the mandatory liquidity fee we are adopting will broadly address the concerns commenters raised about the swing pricing proposal while still generally achieving the goals we sought in that proposal. Separately, similar to the statements in the proposal that money market funds can impose discretionary liquidity fees under rule 22c-2, amended rule 2a-7 will provide a discretionary liquidity fee tool to all non-government money market funds, which a fund will use if its board (or the board's delegate, in accordance with board-approved guidelines) determines that such fee is in the best interests of the fund. 110 108 See amended rule 2a-7(c)(2)(ii). 109 See amended rule 2a-7(c)(2)(iii)(D). 110 A government money market fund may elect to be subject to the discretionary liquidity fee requirement. The mandatory liquidity fee approach that we are adopting will require redeeming investors to pay the cost of depleting a fund's liquidity, particularly under stressed market conditions and when net redemptions are sizeable. As discussed in the proposal, 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 and create incentives for shareholders to redeem quickly to avoid losses, particularly in times of market stress. 111 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 the motive for investor redemptions, 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. The mandatory liquidity fee mechanism is designed to reduce the potential for such dilution. 111 See infra section IV.B.1.c. Some commenters suggested that an anti-dilution tool is not necessary for money market funds. Several of these commenters suggested that money market funds do not experience dilution as a general matter because they are able to address their liquidity needs without cost and without selling assets by using daily liquid assets and weekly liquid assets, which are held to maturity. 112 Some commenters further suggested that the Commission did not provide sufficient data analysis to support its view that money market funds are subject to dilution. 113 Some commenters suggested an anti-dilution tool was unnecessary in light of either the proposed increased daily and weekly liquid asset requirements, the proposed removal of the tie to weekly liquid assets, or a combination of those factors because funds would have additional liquidity to meet redemptions and would be better able to use that liquidity in future stress periods. 114 112 See, e.g., Northern Trust Comment Letter; Fidelity Comment Letter; SIFMA AMG Comment Letter; IIF Comment Letter; Federated Hermes Comment Letter II; CCMR Comment Letter; State Street Comment Letter; ICI Comment Letter; JP Morgan Comment Letter; Comment Letter of Stephen A. Keen (Apr. 11, 2022) (“Keen Comment Letter”); Comment Letter of U.S. Bancorp Asset Management (Apr. 14, 2022) (“Bancorp Comment Letter”). 113 See, e.g., Morgan Stanley Comment Letter; Fidelity Comment Letter (suggesting that the SEC lacked data to demonstrate the significance or materiality of shareholder dilution); ICI Comment Letter; SIFMA AMG Comment Letter; CCMR Comment Letter. 114 See, e.g., Schwab Comment Letter; Healthy Markets Association Comment Letter; Allspring Funds Comment Letter; Fidelity Comment Letter; Invesco Comment Letter; BlackRock Comment Letter; Federated Hermes Comment Letter II; ICI Comment Letter; SIFMA AMG Comment Letter; but see Better Markets Comment Letter (suggesting that increasing the costs of redemptions would reduce potential first-mover advantages). After considering comments, we continue to believe that in periods of market stress, when liquidity in underlying short-term funding markets is scarce and costly, redeeming investors should bear liquidity costs associated with sizeable redemption activity. While we recognize that a fund may not incur immediate costs to meet those redemptions if the fund can satisfy redemptions using daily liquid assets, the fund is likely to face costs to rebalance the liquidity of its portfolio over time. 115 Moreover, if redemptions are large and ongoing, there is an increased likelihood that the fund will need to sell less liquid assets to satisfy redemptions, which involves greater costs. Thus, there is a timing misalignment between an investor's redemption activity and when the fund, and its remaining shareholders, incur liquidity costs. The liquidity fee requirement we are adopting is designed to protect remaining shareholders from dilution under these circumstances and to more fairly allocate costs so that redeeming shareholders bear the costs of removing liquidity from the fund when liquidity in underlying short-term funding markets is costly. 115 Theoretically, a money market fund would not incur rebalancing costs if it were able to perfectly “ladder” the maturity of its portfolio structure, such that investments are maturing in parallel with investors' redemption activities. However, as a practical matter, perfect laddering is impossible because funds do not have advance notice of all investor purchase and redemption activity. In response to comments suggesting that we conduct a data analysis on the extent to which money market fund shareholders have experienced dilution in the past, we do not have fund-specific data on dilution because funds do not report information about their daily portfolio holdings and transactions. However, as discussed in the Proposing Release, in March 2020 institutional prime and institutional tax-exempt money market funds experienced significant outflows, spreads for instruments in which these funds invest widened sharply, and these funds sold significantly more long-term portfolio securities ( i.e., securities that mature in more than a month) than average. 116 For instance, Form N-MFP data suggests that publicly offered institutional prime funds increased their sales of long-term securities in March 2020 to 15% of total assets, in comparison to a 4% monthly average between October 2016 and February 2020. In addition, the March 2020 figure, which is over three times the monthly average as compared to data from prior years, likely understates the full extent of the selling activity, as Form N-MFP currently does not provide insight on sales of portfolio securities that a fund acquired during the relevant month. 117 As an example of widening spreads in the markets in which prime funds invest, bid-ask spreads of highly rated dealer-placed commercial paper reached between approximately 25 and 55 basis points at the height of the stress in March and April 2020 depending on maturity. 118 Thus, available evidence indicates that money market funds were incurring liquidity costs to meet redemptions, but these costs generally were not borne by redeeming investors who received the NAV at the time of their redemptions. 119 Moreover, the dilution the final rule is designed to address is not limited to the costs a fund incurs in selling portfolio securities to meet redemptions. The final rule also addresses dilution from the costs of reducing the liquidity of a fund's portfolio, including associated rebalancing costs, which would also require granular daily data that funds do not publicly report. 116 See Proposing Release, supra note 6, at section I.B. 117 As discussed below, we are amending Form N-MFP to require prime funds to report the value of non-maturing portfolio securities they sold each month. See infra section II.F.2.a. 118 See infra paragraph accompanying note 630. 119 To the extent that ultra-short bonds may be somewhat comparable to the debt instruments that money market funds hold and the magnitude of NAV discounts that ultra-short bond exchange-traded funds experienced in March 2020 may proxy for liquidity costs of money market funds that hold similar assets, this could suggest that institutional prime money market funds have nontrivial dilution costs during market stress. See id. We understand that future stress periods may not look exactly the same as March 2020, and, as some commenters suggested, in future periods funds may feel more comfortable drawing on available liquidity to meet redemptions because we are removing the tie between liquidity thresholds and fees and gates. Funds also may begin future stressed periods with higher levels of daily and weekly liquid assets than in March 2020, although at that time some funds had liquidity above the minimums we are adopting. However, it is also possible that future stress periods will be longer or otherwise more severe than March 2020, that future stress events will have no Federal intervention to alleviate those stresses, or that a particular fund or group of funds will come under stress due to factors idiosyncratic to the fund(s). It is important for funds to be able to manage through various types of stress events and not to rely solely on liquidity buffers to manage stress. As discussed below and in the Proposing Release, while liquidity minimums are an important tool for managing redemptions, our analysis suggests that some funds would run out of liquidity if faced with the redemptions rates experienced in March 2020. 120 Thus, we do not agree with commenters who suggested that amendments to enhance money market fund liquidity, and the usability of that liquidity, would be sufficient on their own, without an available anti-dilution tool. 120 See infra sections II.C.1 and IV.C.2; Proposing Release, supra note 6, at sections II.C.1 and III.C.2. Moreover, to the extent that investors currently are incentivized to redeem quickly during periods of market stress to avoid potential costs from a fund's future sale of less liquid securities, the amendments will reduce those first-mover incentives and the associated run risk. While some academic papers support the premise that liquidity externalities may create a first-mover advantage that may lead to cascading anticipatory redemptions, we recognize that investors may redeem from a fund for a variety of reasons, and these reasons may vary among investors. 121 Notably, we are concerned about dilution and fair allocation of costs when a fund has sizeable net redemptions in a stressed period regardless of the reasons for investors' redemptions. In response to comments suggesting that an anti-dilution tool would not address first-mover issues if an investor does not know if it will incur liquidity costs at the time the investor submits the redemption order, we disagree. We believe that an investor's general awareness that it may incur liquidity costs, particularly in stressed market conditions and when other investors may also be redeeming, is sufficient to mitigate the first-mover advantage and reduce its potential influence on an investor's redemption decisions. We also disagree with commenters who suggested that an anti-dilution tool with a net redemption trigger may increase incentives for investors to redeem ahead of others. Investors generally will not know with certainty if the fund's flows for any particular day will trigger a liquidity fee since a fund's net flows are dependent on many investors' individual investment decisions, which are not knowable in advance and can be influenced by a multitude of different factors. 122 While investors may anticipate that a fund will have net redemptions during a market stress event, the investors will also know that if they redeem, the likelihood of incurring fees increases. This dynamic should reduce investors' incentives to attempt to preemptively redeem to avoid liquidity fees. We agree with commenters that suggested that a net redemption threshold would be appropriate to avoid the threshold effects seen in March 2020. 123 Moreover, the 5% net redemption threshold is designed to help mitigate the risk that a significant amount of redemptions could occur under stressed market conditions before a fee is triggered, thus incentivizing investors to redeem ahead of others. 121 See infra note 550 and accompanying text (discussing these academic papers). 122 See infra section IV.C.4.b.i (further discussing how a liquidity fee based on a net redemptions trigger may mitigate run incentives). 123 See, e.g., SIFMA AMG Comment Letter; BlackRock Comment Letter: IIF Comment Letter; Morgan Stanley Comment Letter. As discussed further below, some of these commenters suggested a trigger for liquidity fees that paired a net redemption threshold with a weekly liquid asset threshold. As the Commission has previously recognized, in the absence of an exemption, imposing liquidity fees could violate 17 CFR 270.22c-1 (“rule 22c-1”), which (together with section 22(c) and other provisions of the Investment Company Act) requires that each redeeming shareholder receive his or her pro rata portion of the fund's net assets. 124 As a result, we are exercising our authority under section 6(c) of the Act to provide exemptions from these and related provisions of the Act so that a money market fund can institute liquidity fees, which can benefit the fund and its shareholders by providing a more systematic and equitable allocation of liquidity costs, notwithstanding these restrictions. 125 We believe that such exemptions do not implicate the concerns that Congress intended to address in enacting these provisions, and thus they are necessary and appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the Act. 124 See 2014 Adopting Release, supra note 26, at section III.A.3. 125 Section 6(c) of the Investment Company Act. In addition, like current rule 2a-7, the final rule provides that, notwithstanding section 27(i) of the Investment Company Act, a variable insurance contract issued by a registered separate account funding variable insurance contracts or the sponsoring insurance company of such separate account may apply a liquidity fee to contract owners who allocate all or a portion of their contract value to a subaccount of the separate account that is either a money market fund or that invests all of its assets in shares of a money market fund. See 17 CFR 270.2a-7(c)(2)(iv); amended rule 2a-7(c)(2)(iv). Section 27(i)(2)(A) makes it unlawful for any registered separate account funding variable insurance contracts or the sponsoring insurance company of such account to sell a variable contract that is not a “redeemable security.” As discussed, we are adopting a mandatory liquidity fee framework in lieu of the proposed swing pricing requirement. Table 1 below compares the key elements of the current rule's default liquidity fee, the proposed swing pricing requirement, and the mandatory liquidity fee provision we are adopting. In addition, Table 2 below compares the key elements of the current rule's discretionary liquidity fee, the redemption fee approach contemplated by the proposal, and the discretionary liquidity fee provision we are adopting. We discuss these aspects of the final rule and how they relate to comments on the proposal in the following sections. Table 1—Comparison of the Current Rule's Default Liquidity Fee, the Proposed Rule's Swing Pricing Requirement, and the Final Rule's Mandatory Liquidity Fee Current rule's default liquidity fee Proposed rule's swing pricing requirement Final rule's mandatory liquidity fee Description of mechanism A default fee is charged to redeeming investors when the fund's weekly liquid assets decline below 10%, subject to certain board discretion The fund's NAV is adjusted downward by a swing factor when the fund has net redemptions A mandatory fee is charged to redeeming investors when the fund has net redemptions above 5% of net assets. Scope of affected funds Prime and tax-exempt money market funds Institutional prime and institutional tax-exempt money market funds Institutional prime and institutional tax-exempt money market funds. Scope of affected investors Redeeming investors are charged a liquidity fee. The liquidity fee does not affect subscribing investors The NAV is adjusted downward for both redeemers and subscribers. Redeeming investors' redemption proceeds are reduced and subscribing investors purchase at a discounted price, compared to the unadjusted NAV they both otherwise would have received Redeeming investors are charged a liquidity fee. The liquidity fee does not affect subscribing investors. Threshold for applying a charge If weekly liquid assets fall below 10%, then a default fee would apply to redeeming investors, unless the board determines a fee is not in the best interests of the fund. 1 At any level of net redemptions for a pricing period, the swing factor includes spreads and certain other transaction costs ( i.e., brokerage commissions, custody fees, and any other charges, fees, and taxes associated with portfolio security sales) Fees are triggered when the fund has total daily net redemptions that exceed 5% of net assets based on flow information available within a reasonable period after the last computation of the fund's net asset value on that day, or such smaller amount of net redemptions as the board determines. If net redemptions for a pricing period exceed 4% of net assets divided by the number of pricing periods per day, or such smaller amount of net redemptions as the swing pricing administrator determines, the swing factor also includes market impact costs Duration and application of the charge The liquidity fee begins to apply on the business day after the fund crosses the 10% weekly liquid asset threshold. Once imposed, the fee must be applied to all shares redeemed and remains in effect until the fund's board, including a majority of directors who are not interested persons of the fund, determines that imposing a fee is not in the best interests of the fund The price is adjusted for all shareholders transacting in the fund's shares during the relevant pricing period The fund must apply a liquidity fee to all shares that are redeemed at a price computed on the day the fund has total daily net redemptions that exceed 5% of net assets. If the fund has invested 30% or more of its total assets in weekly liquid assets as of the end of a business day, the fund must cease charging a fee effective the beginning of the next business day Size of the charge The default fee is 1%, unless the fund's board of directors, including a majority of the directors who are not interested persons of the fund, determines that a higher or lower fee level is in the best interests of the fund The swing factor would be determined by making good faith estimates of the spread, other transaction, and market impact costs the fund would incur, as applicable, if it were to sell a pro rata amount of each security in its portfolio to satisfy the amount of net redemptions The size of the fee generally is determined by making a good faith estimate of the spread, other transaction, and market impact costs the fund would incur if it were to sell a pro rata amount of each security in its portfolio to satisfy the amount of net redemptions. Affected money market funds could 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 in the fund's portfolio, rather than analyze each security separately Affected money market funds can estimate costs and market impacts 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. If the estimated liquidity costs are less than one basis point (0.01%) of the value of the shares redeemed, a fund is not required to apply a fee under the de minimis exception. If the fund cannot estimate the costs of selling a pro rata amount of each portfolio security in good faith and supported by data, a default liquidity fee of 1% of the value of shares redeemed applies. Maximum charge The fee cannot exceed 2% of the value of the shares redeemed The swing factor has no upper limit The fee has no upper limit. Party who administers the provision The board is responsible for administering the liquidity fee requirement. The board may not delegate liquidity fee determinations The board must approve swing pricing policies and procedures. The swing pricing administrator is charged with administering the swing pricing requirement. The swing pricing administrator is the fund's investment adviser, officer, or officers responsible for administering the fund's swing pricing policies and procedures, as designated by the fund's board. The administrator can be an individual or a group of persons The board is responsible for administering the liquidity fee requirement, but the board can delegate this responsibility to the fund's investment adviser or officers, subject to written guidelines established and reviewed by the board and ongoing board oversight. 2 Notes: 1 The board determinations this Table refers to generally must include a majority of the directors who are not interested persons of the fund. 2 This approach is consistent with the operation of several other provisions of rule 2a-7. Table 2—Comparison of the Current Rule's Discretionary Liquidity Fee, the Proposed Rule, and the Final Rule's Discretionary Liquidity Fee Current rule's discretionary liquidity fee Proposed rule and rule 22c-2 Final rule's discretionary liquidity fee Description of mechanism A discretionary fee may be charged to redeeming investors when the fund's weekly liquid assets decline below 30% and the board determines that a fee is in the best interests of the fund. 1 The proposal would have removed the discretionary liquidity fee provision in rule 2a-7 and stated that money market fund boards could rely on existing rule 22c-2 if they determine redemption fees are needed to address dilution Irrespective of liquidity or redemption levels, a discretionary fee is charged to redeeming investors when the board determines that the fee is in the best interests of the fund. Scope of affected funds Prime and tax-exempt money market funds. Government money market funds may opt in Any money market fund may elect to rely on rule 22c-2 to impose fees, in which case the fund would no longer be an excepted fund under that rule Prime and tax-exempt money market funds. Government money market funds may opt in. Scope of affected investors Redeeming investors are charged a liquidity fee. The liquidity fee does not affect subscribing investors Redeeming investors are charged a liquidity fee. The liquidity fee does not affect subscribing investors Redeeming investors are charged a liquidity fee. The liquidity fee does not affect subscribing investors. Threshold for applying a charge If weekly liquid assets fall below 30%, then a fund may institute a fee if the board determines that the fee is in the best interests of the fund The fund's board may impose a redemption fee that in its judgment is necessary or appropriate to recoup for the fund the costs it may incur as a result of redemptions or to otherwise eliminate or reduce so far as practicable any dilution of the value of the outstanding securities issued by the fund If the board determines that doing so is in the best interests of the fund, the board must impose a liquidity fee. Duration and application of the charge Once imposed, the discretionary fee must be applied to all shares redeemed and remain in effect until the fund's board determines that imposing a fee is not in the best interests of the fund Generally subject to board discretion under the rule Once imposed, the discretionary fee must be applied to all shares redeemed and remain in effect until the fund's board determines that imposing such fee is no longer in the best interests of the fund. If the fund has invested 30% or more of its total assets in weekly liquid assets as of the end of a business day, the fund must cease charging a fee effective the beginning of the next business day Size of the charge The rule does not prescribe the manner or amount of the fee calculation. The fee, however, must be in the best interests of the fund The fee must be necessary or appropriate, as determined by the board, 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 The rule does not prescribe the manner or amount of the fee calculation. The fee, however, must be in the best interests of the fund. Maximum charge The fee cannot exceed 2% of the value of the shares redeemed The fee cannot exceed 2% of the value of the shares redeemed The fee cannot exceed 2% of the value of the shares redeemed. Party who administers the provision The board is responsible for administering the liquidity fee requirement. The board may not delegate liquidity fee determinations The fund's board The board is responsible for administering the liquidity fee requirement, but the board can delegate this responsibility to the fund's investment adviser or officers, subject to written guidelines established and reviewed by the board and ongoing board oversight. 2 Notes: 1 The board determinations this Table refers to generally must include a majority of the directors who are not interested persons of the fund. 2 This approach is consistent with the operation of several other provisions of rule 2a-7. 2. Terms of the New Mandatory Liquidity Fee Requirement The mandatory liquidity fee we are adopting, like the swing pricing proposal, is based upon a net redemption threshold and only applies to institutional prime and institutional tax-exempt funds. 126 Unlike the swing pricing proposal, however, the anti-dilution measure triggers only when net redemptions for the business day exceed 5% of net assets. 127 Similar to the proposed swing pricing proposal, the fee amount would reflect the fund's good faith estimate of liquidity costs, supported by data, of the costs the fund would incur if it sold a pro rata amount of each security in its portfolio ( i.e., vertical slice) to satisfy the amount of net redemptions, including: (1) spread costs and any other charges, fees, and taxes associated with portfolio security sales; and (2) market impacts for each security. 128 The final rule will not require a fund to apply a fee if the estimated costs are de minimis, meaning that if the fee were applied, the amount of the fee would be less than 0.01% of the value of the shares redeemed. 129 In addition, if a fund cannot make a good faith estimate of liquidity costs, it will apply a default fee of 1%. 130 This mandatory liquidity fee regime substantially accomplishes the same goals as the proposed swing pricing mechanism and, like swing pricing, it is designed to ensure that the costs stemming from significant net redemptions in periods of market stress are fairly allocated and will not give rise to dilution or a first-mover advantage. 126 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 liquidity fee requirement. 127 See amended rule 2a-7(c)(2)(ii) (allowing a fund's board to determine to use a smaller net redemption threshold than 5%). In contrast, the proposed swing pricing requirement would have required an institutional fund 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. If the institutional fund experienced net redemptions exceeding 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), then the swing factor would also include market impact costs. 128 See amended rule 2a-7(c)(2)(iii)(A). 129 See amended rule 2a-7(c)(2)(iii)(D). 130 See amended rule 2a-7(c)(2)(iii)(C). The new mandatory liquidity fee has some key differences as compared to the current rule. For example, the mandatory liquidity fee is triggered by net redemptions as opposed to weekly liquid assets. 131 In addition, unlike the current rule, but consistent with the proposed swing pricing requirement, the amended framework does not provide discretion to the board with respect to its application. Rather, the fund will be required to apply a fee if it crosses the net redemption threshold unless the fee amount is de minimis. Moreover, the final amendments are more specific in terms of how a fund determines the amount of the fee than the current rule and, as a result, does not include a limit on the amount of the fee a fund can charge. 132 131 See 17 CFR 270.2a-7(c)(2)(ii) (requiring a non-government money market fund to impose a default 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 (including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund). 132 In contrast, under the current rule, a liquidity fee may not exceed 2% of the value of the shares redeemed. See 17 CFR 270.2a-7(c)(2)(ii)(A). The new mandatory liquidity fee only applies to institutional prime and institutional tax-exempt funds. This is in contrast to the current rule's default liquidity fees, which apply to retail funds, but is consistent with the approach we proposed for swing pricing. We are not requiring retail or government money market funds to implement mandatory liquidity fees due to differences in investor behavior and, in the case of government funds, liquidity costs. As discussed in the proposal, retail money market funds historically have had smaller outflows than institutional funds during times of market stress and appear to be less sensitive to declines in a fund's liquidity. 133 As a consequence, we continue to believe retail fund managers may be more comfortable drawing down available liquidity from the fund's daily liquid assets and weekly liquid assets to meet redemptions in times of stress, without engaging in secondary market sales that could result in significant liquidity costs. In addition, we do not believe that retail prime and tax-exempt money market funds need special provisions requiring them to impose liquidity fees given both the anticipated effect of the daily and weekly liquid asset requirement changes and, as described below, the availability of the discretionary liquidity fee we are adopting. As for government money market funds, investors typically view these funds, in contrast to prime money market funds, as a relatively safe investment during times of market turmoil, and government money market funds have seen inflows during periods of market instability. Government money market funds are also less likely to incur significant liquidity costs when they purchase or sell portfolio securities due to the generally higher levels of liquidity in the markets in which they invest. 133 See Proposing Release, supra note 6, at section II.B.1. Consistent with the swing pricing proposal, the mandatory anti-dilution mechanism (in this case a liquidity fee) applies to all institutional funds, irrespective of whether they are offered publicly. Some commenters suggested that privately offered institutional funds should not be subject to a mandatory anti-dilution tool. 134 Asset managers typically organize privately offered institutional money market funds to manage cash balances of other affiliated funds and accounts. These funds operate in almost all respects as a registered money market fund, except that their securities are privately offered and thus not registered under the Securities Act. 135 Some commenters suggested privately offered institutional funds are not subject to the same first-mover and run concerns as publicly offered institutional funds because they serve as tools for funds within the same fund complex and are used for internal purposes such as cash management and investing collateral from securities lending transactions. 136 For example, one commenter suggested that, because of these characteristics, such funds are focused more on liquidity than yield. 137 Other commenters suggested that such funds have greater transparency into redemptions than publicly offered institutional funds. 138 We decline to provide an exception for these funds from the mandatory liquidity fee requirement because we do not believe that such funds are immune to the risks of dilution and potential first-mover advantages that mandatory liquidity fees are designed to address. For example, registered funds investing in a privately offered institutional fund may have an incentive to redeem shares in times of market stress ( e.g., to raise funds to pay their own redemptions, which may be heightened at that time), increasing the risk of dilution for remaining registered funds. Potential first-mover incentives may also exist, particularly if registered funds are investing in a privately offered institutional fund in another fund complex in which the registered funds have no greater transparency, creating a potential incentive to redeem ahead of other investors in times of market stress. 139 134 See, e.g., Fidelity Comment Letter; BlackRock Comment Letter; Capital Group Comment Letter; ICI Comment Letter; Comment Letter of Dimensional Fund Advisors LP (Apr. 11, 2022) (“Dimensional Fund Advisors Comment Letter”); Dechert Comment Letter. 135 See 17 CFR 270.12d1-1 (generally requiring that the acquiring fund reasonably believes that the money market fund operates in compliance with rule 2a-7). 136 See, e.g., Fidelity Comment Letter; ICI Comment Letter; BlackRock Comment Letter; Capital Group Comment Letter; ICI Comment Letter; Dimensional Fund Advisors Comment Letter; Dechert Comment Letter; but see 2014 Adopting Release, supra note 26, at section III.C.5 (discussing the Commission's belief that unregistered money market funds are not immune to the risks posed by money market funds generally). 137 See Capital Group Comment Letter. 138 See Capital Group Comment Letter; ICI Comment Letter. 139 See 2014 Adopting Release, supra note 26, at section III.C.5. The final rule provides for mandatory liquidity fees for institutional funds because institutional investors have a history of redeeming from these funds quickly in times of stress, increasing the risk of dilution for remaining shareholders in institutional funds. In addition, if the liquidity fee regime for these funds were purely voluntary, institutional funds (or their boards) may require additional time or information to decide whether to impose fees, depending on the considerations on which the fee is based. This could result in a delay that creates timing misalignments between an investor's redemption activity and the imposition of liquidity costs, thus allowing some investors to redeem without bearing the associated liquidity costs and contributing to dilution and a first-mover advantage. Further, some funds (or their boards) may be reluctant to impose fees to avoid perceived reputational or competitiveness issues associated with imposing fees before other institutional funds, which institutional investors may be more likely to react to than retail investors. 140 As a result, a purely voluntary regime may result in institutional funds not imposing a fee unless a fund is under severe and prolonged stress, by which point the fee's effectiveness in addressing dilution and potential first-mover advantages would be significantly reduced. 141 140 As discussed above and in the Proposing Release, available evidence suggests that institutional investors were more sensitive to the possibility of redemption gates or liquidity fees in Mar. 2020 than retail investors, and institutional prime and institutional tax-exempt money market funds managed their portfolios to avoid having less than 30% of their total assets invested in weekly liquid assets, at which point a board could determine to institute gates or fees. In addition, the one money market fund to fall below this threshold in Mar. 2020 did not institute gates or fees. See supra sections I.B and II.A; Proposing Release, supra note 6, at sections I.B. and II.A. While we believe that institutional investors are more sensitive to redemption gates than to liquidity fees, some institutional investors may prefer to avoid the possibility of liquidity fees as well, if possible. 141 One commenter, suggesting that discretionary fees would be sufficient, indicated that fund boards would have incentives to impose fees if redemptions reduced the fund's NAV and imposed material dilution, including due to legal and reputational risk associated with a failure to act. See Comment Letter of Federated Hermes, Inc. (July 5, 2023) (“Federated Hermes Comment Letter V”). Absent persuasive information that redemptions would have these stated effects, however, there may be contrary incentives to delay any fee determinations to avoid reputational risk or second-guessing associated with imposing a fee, particularly if comparable funds are not imposing fees. a. Threshold for Mandatory Liquidity Fees We are requiring that institutional funds apply the mandatory liquidity fee when net redemptions for the business day exceed 5% of net assets, or such smaller amount of net redemptions as the board (or its delegate) determines. This 5% threshold is in contrast to the swing pricing proposal, which would have required funds to charge redeeming investors spread and certain other transaction costs if the fund had any net redemptions for the pricing period and to include market impacts in the charge if net redemptions exceeded 4% of net assets, or such smaller amount of net redemptions as the swing pricing administrator determines. In the proposal, application of this 4% threshold would have required funds to divide the 4% value by the number of pricing periods ( i.e., NAV strikes) the fund has each day. 142 In contrast, the 5% net redemption threshold is based on flows for all pricing periods in a given day. In addition, unlike the current rule, but consistent with the proposal, application of the anti-dilution mechanism is not tied to a weekly liquid asset threshold. Also, unlike the current rule, but consistent with the proposal, the mechanism applies to redemptions on each business day a fund crosses the net redemption threshold. This is in contrast to the current rule's default liquidity fee, which applies to redemptions the business day after weekly liquid assets fall below the 10% threshold and continues to apply on subsequent days until the board determines that the liquidity fee is no longer in the best interests of the fund. Per the rule we are adopting, an institutional prime or institutional tax-exempt money market fund must apply a liquidity fee if its total daily net redemptions exceed 5% of the fund's net asset value based on flow information available within a reasonable period after the last computation of the fund's net asset value on that day. If this threshold is crossed, the fund must apply a liquidity fee to all shares that are redeemed at a price computed on that day. 143 142 The proposal defined “pricing period” 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. For example, if a fund computes a NAV as of 12 p.m. and 4 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. 143 See amended rule 2a-7(c)(2)(ii). Many commenters suggested that the proposed 4% market impact threshold was too low and that a redemption-based threshold for applying any charge to redeeming investors should be higher than 4%. Some commenters suggested that money market funds frequently experience net redemptions greater than 4% in normal market conditions due to seasonal redemption activity such as investor redemptions to fulfill payroll or tax obligations. 144 Some commenters suggested that money market funds do not incur transaction costs or dilution at such low levels of net redemptions due to the structure of these funds, including liquidity requirements that insulate funds from transaction costs, which allows funds to pay redemptions through maturing assets instead of secondary market activity even during periods with high redemption levels. 145 Some commenters suggested that if a fund has multiple NAV strikes per day, then the 4% threshold would be particularly problematic because the proposal divided the 4% figure by the number of pricing periods per day, resulting in a lower threshold. 146 One commenter suggested that swing pricing should be triggered by portfolio security sales that are needed to fund shareholder redemptions. 147 The same commenter stated that funds should have discretion in setting their own swing thresholds. 144 See, e.g., Morgan Stanley Comment Letter; Bancorp Comment Letter; Federated Hermes Comment Letter I; IIF Comment Letter; SIFMA AMG Comment Letter; BlackRock Comment Letter; Federated Hermes Comment Letter II. 145 See, e.g., Allspring Funds Comment Letter; Fidelity Comment Letter; T. Rowe Comment Letter; US Chamber of Commerce Comment Letter; Vanguard Comment Letter; Western Asset Comment Letter; SIFMA AMG Comment Letter; Federated Hermes Comment Letter II. 146 See, e.g., Bancorp Comment Letter; ICI Comment Letter. 147 See Capital Group Comment Letter. Many commenters suggested limiting the application of liquidity fees to periods of market stress. Several commenters suggested that fund boards should have discretion to determine when fees should apply, which would effectively limit fees to times of stress. 148 Several commenters expressed support for requiring a fund to apply a liquidity fee if it has net redemptions of more than 10%. These commenters generally suggested that the rule should pair a net redemption threshold with a weekly liquid asset threshold to ensure that the fee would apply only when the fund is under stress. 149 Some of these commenters suggested that a liquidity threshold is needed because a fund could meet net redemptions of more than 10% without dilution if it has sufficient liquidity and because redemptions exceeding more than 10% can occur under normal market conditions, although they are rarer than net redemptions exceeding 4% of net assets. 150 Some commenters suggested that pairing a weekly liquid asset threshold with a net redemption threshold would reduce the predictability of the liquidity fee trigger and reduce the likelihood of preemptive redemptions in comparison to the current rule, especially considering the effect of removing redemption gates from the rule, which commenters suggested were more likely to incentivize investor redemptions than liquidity fees. 151 Some commenters suggested a tiered approach with multiple thresholds and fee amounts, beginning with the dual threshold of 10% net redemptions and 30% weekly liquid assets and then using weekly liquid asset-based thresholds to determine when to increase the fee amount. 152 Two commenters discussed using a tiered approach with solely weekly liquid asset thresholds. 153 Commenters supporting a tiered approach generally suggested that beginning with relatively small fee amounts may reduce investor incentives to preemptively redeem in response to declines in liquidity in an effort to avoid a fee. 154 Separately, some commenters suggested thresholds based on the amount of net redemptions over multiple days to identify circumstances in which a fund is under stress. 155 148 See, e.g., ICI Comment Letter (suggesting that the rule require fund boards to consider certain enumerated factors when deciding whether to implement a liquidity fee, subject to a determination that implementing fees is in the best interests of the fund and its shareholders and is necessary to prevent material dilution or other unfair results); JP Morgan Comment Letter; Federated Hermes Comment Letter II; Invesco Comment Letter; SIFMA AMG Comment Letter. 149 See, e.g., Invesco Comment Letter; IIF Comment Letter; SIFMA AMG Comment Letter (explaining that the 10% net redemption threshold was selected because it represents half of the commenter's preferred 20% daily liquid asset threshold and is less likely to be triggered by routine, expected flow activity, particularly if paired with a liquidity threshold); ICI Comment Letter. 150 See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter. 151 See, e.g., IIF Comment Letter; JP Morgan Comment Letter; BlackRock Comment Letter. 152 See, e.g., BlackRock Comment Letter; JP Morgan Comment Letter; IIF Comment Letter. 153 See Western Asset Comment Letter (suggesting a mandatory approach to tiered fees that would first trigger when weekly liquid assets are below 30%); ICI Comment Letter. 154 See, e.g., ICI Comment Letter; Western Asset Comment Letter; JP Morgan Comment Letter. 155 See, e.g., Morgan Stanley Comment Letter (suggesting a framework in which fees would apply when net re [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%3A2023-15124. Public record. Not legal advice.