SEC Proposes Amendments To Rules Governing Money Market Funds
The performance of money market funds (MMFs), which typically invest in short-term, highly liquid assets, have historically provided a window into market funding conditions, with periods of money market stress usually reflecting conditions across the wider capital markets. The economic and financial impact of the COVID-19 pandemic that began to affect financial markets in first-quarter 2020 manifested into a period of significant market volatility and liquidity stress. MMFs, which are typically a barometer for market liquidity, were not immune to this volatility.
Rule 2a-7, which falls under the investment company act of 1940, provides governance for taxable and tax-exempt MMFs--both institutional and retail. On Dec. 15, 2021, the Securities and Exchange Commission (SEC) proposed for public comment amendments to Rule 2a-7. According to the proposal, the amendments are designed to improve the resiliency and transparency of MMFs following the liquidity stresses experienced in March 2020 in connection with the pandemic and the associated stresses in short-term credit markets.
We are limiting our discussion in this FAQ to the key proposals that we have determined to be the most relevant to registered MMFs rated under our principal stability fund rating (PSFR) criteria. First, a material rule change under the proposed amendments includes the elimination of mandatory liquidity fee and redemption gate provisions, and decoupling these requirements from minimum liquidity thresholds. This proposed rule change stems from the belief that these provisions accelerated investor redemptions out of MMFs during the March 2020 liquidity crisis and, in turn, placed unintended market stresses within the short-term markets.
Other proposed changes to Rule 2a-7 include the requirement for institutional prime and institutional tax-exempt MMFs to implement swing pricing policies and procedures. All MMFs would be required to clarify their use of reverse distribution mechanisms under a potential negative interest rate environment, increase their daily liquid asset (DLA) and weekly liquid asset (WLA) minimum requirements to 25% and 50% from 10% DLA and 30% WLA, respectively, and calculate WAM and WAL based on the percentage of each security's market value in the portfolio. Finally, technical changes to stress testing would decouple stress testing from liquidity fees.
A PSFR, commonly referred to as a money market fund rating, is forward-looking opinion about a fixed-income fund's ability to maintain principal value (i.e., net asset value [NAV]). PSFRs are typically assigned to funds that seek to maintain stable or, as is prevalent in non-U.S. funds, accumulating NAVs. The quantitative aspect of our PSFR analysis focuses primarily on the creditworthiness of the fund's investments and counterparties, and also assesses its investments' maturity structure and management's ability and policies to maintain the fund's stable NAV. Below, we answer questions on how we view these proposals under our current PSFR methodology.
Frequently Asked Questions
What impact would the removal of liquidity fees and redemption gates associated with minimum liquidity thresholds have on funds rated under S&P Global Ratings' PSFR criteria?
We would likely view the elimination of the regulatory linkage between the gates and fees to the minimum liquidity thresholds as a positive for MMF principal stability providing the removal reduces the risk of large redemption requests in anticipation of a gate or fee imposition. We think this proposal would support NAV stability--the focus of our MMF ratings and a key feature for investors. However, we recognize the removal of automatic linkages may not entirely eliminate the possibility for a fund sponsor to utilize gates and fees during a fund liquidation stressed event. In our view, the removal of automatic linkages will not, in practice, decouple investors' redemption decisions from their view of MMFs' liquidity positions, but it may reduce the likelihood of correlated shareholder redemption requests. We, therefore, consider this aspect of the proposed reform maybe more successful if implemented along with other reforms, such as measures to strengthen the price transparency, market depth, and liquidity of the underlying portfolios.
Would the proposed increased portfolio liquidity requirements strengthen S&P Global Ratings' view of a fund's ability to maintain stable principal?
We would likely view the regulatory establishment of a minimum liquidity for MMFs as supportive of principal stability in concept. But the exact design of any metrics and stress tests could still lead to some potential distortions and are unlikely to reflect future stress conditions. We also anticipate investors would redeem their shares if they see a narrowing in the liquidity buffer over even a conservative minimum liquidity threshold. Continued raising of the minimum regulatory threshold may also bring forward the point at which investors would redeem, unless the proposals were complemented by considerations of contingency planning and risk management procedures by MMFs.
Why doesn't S&P Global Ratings have minimum overnight and weekly liquidity requirements as part of its PSFR criteria?
We have assigned PSFRs since December 1983; as of Feb. 28, 2022, we rated about 260 funds globally totaling more than US$4 trillion. Quite often, no two MMFs have the same characteristics, particularly when viewing investor composition and each investor's unique liquidity requirements. We have opted not to establish minimum daily and weekly liquidity metrics as part of our PSFR criteria because we assess funds management's approach to maintaining adequate liquidity given their unique shareholder needs. Our qualitative review of fund management assesses a fund manager's strategy for maintaining sufficient liquidity based on specific shareholder needs and expectations. In our view, criteria regarding specific liquidity buffers may not be sufficient for some funds given their shareholder base or highly volatile cash flows (see "How Liquidity Risk Factors Into Money Market Fund Ratings," published June 21, 2016, for more insight into our assessment of liquidity risk in PSFR).
How would S&P Global Ratings view the implementation of swing pricing, if adopted?
As stated under the proposal, institutional prime or tax-exempt MMFs would be required to adjust their current NAV per share by a swing factor if the fund has net redemptions for the pricing period, reflecting spread and transaction costs, as applicable.
We view swing pricing, which reduces redemption proceeds if made during a period of high shareholder redemption demand, as likely not supportive of principal stability. Although swing pricing can help reduce liquidity demands on funds, it also means investors may find the value of their investments being reduced. Consequently, such pricing may serve as a factor to shift potential liquidity pressures to other parts of the financial markets. A decision to use a liquidity management tool, such as swing pricing, could lead to a rating change due to a fund's inability to maintain NAV stability or to meet redemption requests on a full and timely basis, which could result in the investor getting less than the value of their investment back.
How does S&P Global Ratings view the usage of reverse distribution mechanisms in a negative interest rate environment or similar share reduction tools under its PSFR methodology?
PSFRs, or MMF ratings, are identified by the 'm' suffix (for example, 'AAAm') to distinguish a PSFR from an S&P Global Ratings "traditional" issue or issuer credit rating (ICR). Principal stability fund ratings are neither commentaries on yield levels paid by the fund, nor commentaries on loss of principal due to negative yields.
Negative yields due to market rates are excluded from the calculations to determine NAV stability, as described in table 1 (PSFR Quantitative Metrics), table 10, and paragraph 104-105. The disclosure to investors indicates that they have affirmatively voted for or invested with full knowledge of the fund's ability to lose principal but maintain stable NAV by reducing the number of shares owned by investors or similar action (e.g., a declining NAV for accumulating NAV funds). We do not lower our PSFR when the permitted loss is due to negative yield that results from investment in low credit risk, short-duration securities. These strategies are consistent with the risk mitigants expressed in our criteria. NAV declines due to management fees greater than the fund's return result in a loss of principal to investors and can result in lowering a PSFR.
Market losses arising from negative yields as a consequence of investment in low credit risk, short-duration securities with negative coupon would not solely result in lowering a PSFR when the fund's operating documents permit loss of principal reflected in variable NAV or stable NAV funds with share class reductions or similar mechanisms. These strategies are consistent with the risk mitigants addressed in our analysis of and tolerance for credit and duration risk at each PSFR rating level.
How does the proposed modification to WAM/WAL affect S&P Global fund ratings?
Currently under rule 2a-7, MMFs are limited to 60 days for the WAM and 120 days for the WAL. The proposal does not change the WAM/WAL limitations, rather provides clarification that calculations of these metrics should be based on the market value of underlying investments and not on amortized cost. We would view this proposed change as neutral to the rating.
How does S&P Global Ratings view the proposed technical change to stress testing MMFs?
Our PSFR criteria includes the review of a fund's internal controls. Generally, the rating on a fund could be lowered by one category for an area where it lacks adequate internal controls. One of the key factors is stress testing the portfolio. We maintain our view that stress testing is an important management tool in tracking the sensitivity of a fund's marked-to-market NAV to various factors. We view stress testing on a monthly, or more frequent, basis as supportive of principal stability.
The SEC proposes technical changes to the stress testing requirements for MMFs. The changes would decouple stress testing from liquidity fees. MMFs would be required to determine an individual minimum level of liquidity they seek to maintain during stress periods and then test whether they are able to maintain sufficient minimum liquidity under the specified hypothetical events. In our view, this proposed change is neutral to the rating.
Related Criteria
- Principal Stability Fund Rating Methodology, June 23, 2016
Related Research
- S&P Global Ratings Comments On Proposed Money Market Reforms, July 7, 2021
- How Money Market Funds Are A Barometer For Gauging Market Liquidity, April 20, 2020
- So Far, Funds Are Maintaining Stable Net Asset Values Amid Increased Redemptions And Liquidity Pressures, March 25, 2020
- How Liquidity Risk Factors Into Money Market Fund Ratings, June 21, 2016
- Will SEC Rule Changes Affect Our Ratings On Money Market Funds, June 21, 2016
- Identifying The Shifting Sands For Money Market Funds In 2016, Dec. 3, 2015
- EC Regulation For Money Market Funds May Have Unintended Consequences, Nov. 29, 2013
This report does not constitute a rating action.
| Primary Credit Analyst: | Joseph Zimbalist, New York; joseph.zimbalist@spglobal.com |
| Secondary Contacts: | Marissa Zuccaro, Centennial + 1 (303) 721 4762; marissa.zuccaro@spglobal.com |
| Michael Masih, New York + 1 (212) 438 1642; michael.masih@spglobal.com |
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