The SEC'​s new "​Money Market Fund Reform" Proposals, in addition to laying out likely new quality, maturity, and liquidity restrictions for money funds, invite interested participants to comment on possible future changes to money fund regulations. It says, "The Commission requests comment on the rules and amendments proposed in this release. Commenters are requested to provide empirical data to support their views. The Commission also requests suggestions for additional changes to existing rules or forms, and comments on other matters that might have an effect on the proposals contained in this release."

Following the main body of proposals, the SEC writes, "We recognize that the events of the last two years raise the question of whether further and perhaps more fundamental changes to the regulatory structure governing money market funds may be warranted. Therefore we are exploring other ways in which we could improve the ability of money market funds to weather liquidity crises and other shocks to the short-​term financial markets. We invite interested persons to submit comments on the advisability of pursuing any or all of the following possible reforms, as well as to provide other approaches that we might consider to achieve our goals. We expect to benefit from the comments we receive before deciding whether to propose these changes."

In particular, the Commission seeks comments on the possibility of a "Floating Net Asset Value," which is not among the current proposals recommended by the SEC. They say, "When the Commission adopted rule 2a-​7 in 1983, it facilitated money market funds' maintenance of a stable net asset value by permitting them to use the amortized cost method of valuing their portfolio securities.... [​U]​sing the amortized cost method of valuation is an exception to the general requirement ... that investors in investment companies should pay and receive market value or fair value for their shares. The Commission did not take lightly its decision to permit money market funds to use the amortized cost method of valuation.... [​I]​n exchange for permitting this valuation method, [​the SEC] would impose certain conditions on money-​market funds designed to ensure that these funds invested only in instruments that would tend to promote a stable net asset value per share."

The SEC adds, "The $​1.​00 stable net asset value per share has been one of the trademark features of money market funds. It facilitates the funds' role as a cash management vehicle, provides tax and administrative convenience to both money market funds and their shareholders, and promotes money market funds' role as a low-​risk investment option. Many investors may hold shares in money market funds in large part because of these features. We are mindful that if we were to require a floating net asset value, a substantial number of investors might move their investments from money market funds to other investment vehicles."

But they add, "However, a stable $​1.​00 net asset value per share also creates certain risks for a money market fund and its investors. These risks are a consequence of the amortized cost method of valuation and the resulting insensitivity of the $​1.​00 net asset value per share to market valuation changes. It may create an incentive for investors to redeem their shares when a fund'​s market-​based net asset value per share falls between $​0.​995 and $​1.​00 because they will obtain $​1.​00 in exchange for their right to fund assets worth less than $​1.​00 per share. Regardless of the motivation underlying the redemptions, the unrealized losses attributable to redeeming shareholders are now borne by the remaining money market fund shareholders."

The SEC also requests comment on "requiring money market funds to satisfy redemption requests in excess of a certain size through in-​kind redemptions." Comments should be received by Sept. 8, 2009 and sent to rule-​comments@​sec.​gov (​include File Number S7-​11-​09). Finally, note that we will be adding a panel on "The SEC'​s Money Market Fund Reforms" to the agenda for our upcoming Crane'​s Money Fund Symposium on Sunday afternoon, August 23, in Providence, R.​I.

We'​ve still barely made it half-​way through the SEC'​s new 187-​page proposal on "​Money Market Fund Reforms", but thankfully we have yet to encounter any major surprises or negatives for either investors or fund managers. After reading the document'​s details, the new quality, maturity, liquidity and other mandates are even less onerous than the summary suggests, and the myriad requests for input and comment appear to signal extreme flexibility on the part of regulators. Below, we briefly review the overall proposal and discuss some of the significant recommendations.

The SEC summarizes, "The severe problems experienced by money market funds since the fall of 2007 and culminating in the fall of 2008 have prompted us to review our regulation of money market funds.... [​W]​e today are proposing for public comment a number of significant amendments to rule 2a-​7 under the Investment Company Act.... Commission staff has consulted extensively with other members of the President'​s Working Group on Financial Markets, and in particular the Department of Treasury and the Federal Reserve Board, which provided support to money market funds and the short-​term debt markets last fall, and which continue to administer programs from which money market funds and their shareholders benefit. We have consulted with managers of money market funds and other experts to develop a deeper understanding of the stresses experienced by funds and the impact of our regulations on the readiness of money market funds to cope with market turbulence and satisfy heavy demand for redemptions.... We have also drawn from our experience as a regulator of money market funds under rule 2a-​7 for more than 25 years and particularly since autumn 2007."

They continue, "The proposed rules would reduce the vulnerability of money market funds to breaking the buck by, among other things, improving money market funds' ability to satisfy significant demands for redemptions. If a particular fund does break the buck ... the proposed rules would facilitate the orderly liquidation of the fund in order to protect the interests of all fund shareholders. These changes together should make money market funds (​collectively) less susceptible to a run by diminishing the chance that a money market fund will break a dollar and, if one does, provide a means for the fund to orderly liquidate its assets. Finally, our proposals would improve our ability to oversee money market funds by requiring funds to submit to us current portfolio information. Our proposals represent the first step in addressing issues we believe merit immediate attention.... In addition, we ask comment on some more far-​reaching changes that could transform the business and regulatory model on which money market funds have operated for more than 30 years."

After a comprehensive discussion on the history of money funds, regulation and recent market events, the SEC details its potential new quality, maturity and liquidity changes. It says, "We propose to generally limit money market fund investments to securities rated in the highest NRSRO ratings category. In addition, we are seeking comment on whether to modify provisions of the rule that incorporate minimum ratings by NRSROs.... We propose that rule 2a-​7 be amended to impose a 60-​day weighted average maturity limit.... We propose to add to rule 2a-​7 a new maturity test, which would limit the weighted average life maturity of portfolio securities to 120 days." The SEC also says, "​We propose to prohibit money market funds from acquiring securities unless, at the time they are acquired, they are liquid."

Finally, the proposal, which contains an astounding 300 questions, says, "​We propose to require each taxable retail money market fund to invest at least five percent of its assets in cash, U.​S. Treasury securities, or securities that can provide the fund with daily liquidity.... We propose to limit a taxable institutional fund to acquiring daily liquid assets unless, immediately after acquiring a security, the fund holds at least 10 percent of its total assets in daily liquid assets.... We request comment on whether institutional money market funds should be subject to a higher daily liquidity requirement (​10 percent) than retail funds (​five percent).... Our proposed amendments would require that a money market fund'​s board determine, no less frequently than once each calendar year, whether the fund is an institutional money market fund for purposes of meeting the liquidity requirements."