The SEC’s latest round of money fund (2a-7) reforms was published in July 2023. The reforms were “designed to address concerns about prime and tax-exempt money market funds” following redemptions from prime and tax-exempt funds in March 2020 and to “improve the resilience and transparency of money market funds more generally.”

While the precise impact of the reforms is, as yet, unknown, treasury practitioners should try to understand the potential implications for their organizations.

The proposed reforms include four key measures:

1. The removal of redemption gates. Under previous rules, funds could suspend redemptions in certain circumstances.
2. An increase in portfolio liquidity requirements. The minimum daily liquid asset requirement is increased from 10% to 25%, and the minimum weekly liquid asset requirements from 30% to 50%. These apply to all money market funds with the aim of ensuring funds have access to sufficient cash to meet redemptions without having to resort to the secondary market at a time when the money market is short of liquidity.
3. A liquidity fee requirement. Institutional prime and tax-exempt money market funds may have to impose a liquidity fee if they have daily redemptions of greater than 5% in net assets and if prices have moved more than a “de minimis” amount. This rule does not apply to government or retail funds.
4. Additional provisions to address the effect of potential negative interest rates. There is guidance for any stable NAV fund (i.e., government and retail money market funds) on how to prepare its response if the fund experiences a negative return in future. This could include conversion to a floating NAV fund or the use of a “reverse distribution mechanism.”

So, what do these reforms mean for treasury practitioners?

Redemption gates were introduced in the SEC’s 2016 batch of reforms, and, although they have been available since then, no fund manager has had to impose them. The increased daily and weekly liquidity levels should make prime funds safer and more liquid, albeit by reducing their likely returns.

The most significant potential impact comes from the other two provisions — the emergency liquidity fee regime and the possible conversion of funds from a stable net asset value (NAV) to a floating NAV — as, if imposed, they will both introduce the chance that corporate investors won’t be able to redeem their invested principal in full.

Fund providers may decide to close their prime funds — one has already announced it will translate its institutional prime fund into a government fund. Similarly, some corporate investors may decide to end their use of prime funds in response to liquidity fees (even though they could have been imposed at any time since 2016). If the availability and/or use of prime funds does fall in response to the reforms, it is likely that yield (relative to government funds) will increase, leading some to reconsider their decisions.

The market response remains uncertain, with the industry still working out how liquidity fees will operate in practice. In the meantime, treasurers should talk with their fund providers to understand their response to the reforms. In the case of prime funds, check whether they plan to continue as prime funds and, if so, what their approach to liquidity fees will be. They should also ask what the likelihood is of a fee ever being implemented.

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5/29/2024