On Wednesday, the SEC voted 3 to 2 to finalize rules aimed at increasing the resilience of the US money-market fund industry.

The SEC says in its press release about the reforms that the amendments will increase minimum liquidity requirements for money-market funds with the goal of providing a more substantial liquidity buffer in the event of rapid redemptions.

The amendments will also remove provisions in the current rule that permit a money market fund to suspend redemptions temporarily through a gate and allow money-market funds to impose liquidity fees if their weekly liquid assets fall below a certain threshold.

Reducing investor run risk

The changes are designed to reduce the risk of investor runs on money-market funds during periods of market stress.

These amendments represent the third time in 15 years the SEC has tweaked the rules pertaining to money-market funds in the hope of preventing further bailouts in times of turmoil.

Specifically, the new liquidity fee requires money market funds to impose mandatory fees when a fund experiences daily net redemptions that exceed 5% of net assets, unless the fund’s liquidity costs are negligible. It also gives a fund’s board the discretion to impose a fee, if necessary.

In 2008, a run on money-market funds threatened to freeze global markets and spurred the government to backstop the sector.

Money market funds saw massive outflows in March 2020 at the onset of the Covid-19 pandemic, prompting the US government to intervene to stabilize them. In the heart of the financial crisis of 2008, a run on money-market funds threatened to freeze global markets and again spurred the government to backstop the sector.

And when markets enter times of stress, some investors – fearing dilution or illiquidity – often try to escape. This can lead to large amounts of rapid redemptions and quite possibly undermine these critical funds.

The amendments will require institutional prime and institutional tax-exempt money-market funds to impose liquidity fees when a fund experiences daily net redemptions that exceed 5% of net assets, unless the fund’s liquidity costs are de minimis.

Discretionary liquidity fee

In addition, the amendments will require any non-government money-market fund to impose a discretionary liquidity fee if the board determines that a fee is in the best interest of the fund.

The agency also adopted amendments to Form PF concerning the information large liquidity fund advisers must report for the liquidity funds they advise.

The reforms are designed to protect remaining shareholders from dilution and to more fairly allocate costs so redeeming shareholders bear the costs of redeeming from the fund when liquidity in underlying short-term funding markets is costly.

Dissenting commissioners

Commissioner Hester Peirce said mandating redemption fees without allowing fund boards the freedom to opt out of implementing them is unwise.

She said it’s not clear the benefits to investors of the rule outweigh the costs to investors, and pointed out that the dilution problem may not be material in money-market funds, which are flush with short-term liquidity that can be used to meet redemptions without diluting remaining shareholders.

Peirce and dissenting Commissioner Mark Ayeda also lamented the fact that the agency was not making a serious effort to hear from commentators on mandatory liquidity fees.

BD Customer Protection Rules

Also on Wednesday, the SEC proposed amendments to Rule 15c3-3 (the Customer Protection Rule) to require certain broker-dealers to increase the frequency with which they perform computations of the net cash they owe to customers and other broker-dealers (known as PAB account holders) from weekly to daily.

Net cash owed to customers and PAB account holders must now be held in a special reserve bank account.

In this way, broker-dealers must not only segregate customers’ cash and securities from a broker-dealer’s own account – those that are carrying large credit balances must make daily reserve account calculations and deposits.

“I am pleased to support this proposal because, if adopted, it would help protect customers in the event that a broker-dealer fails.”

Gary Gensler, Chair, SEC

As discussed in the SEC’s press release about the amendments, 11 of the largest broker-dealers already make these calculations on a daily basis. “Today’s proposal would standardize this practice for broker-dealers carrying total credit balances that averaged at least $250m for the previous 12 months,” Chairman Gary Gensler said in a statement.

“I am pleased to support this proposal because, if adopted, it would help protect customers in the event that a broker-dealer fails,” he added.

All of the commissioners agreed to move the proposal along to the comment phase. “Today’s amendments are narrowly tailored to address the risk that a mismatch may develop and persist between the net cash large broker-dealers owe to their customers and the amount on deposit in a bank account established to hold these funds,” Commissioner Peirce said.

Commissioner Ayeda observed that “the data and observations of current broker-dealer practices are sufficiently robust so as to persuade me that the proposal is appropriate for public comment”.