[Federal Register Volume 86, Number 26 (Wednesday, February 10, 2021)]
[Notices]
[Pages 8938-8952]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-02704]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. IC-34188; File No. S7-01-21]


Request for Comment on Potential Money Market Fund Reform 
Measures in President's Working Group Report

AGENCY: Securities and Exchange Commission.

ACTION: Request for comment.

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SUMMARY: The Securities and Exchange Commission (the ``SEC'' or the 
``Commission'') is seeking comment on potential reform measures for 
money market funds, as highlighted in a recent report of the 
President's Working Group on Financial Markets (``PWG''). Public 
comments on the potential policy measures will help inform 
consideration of reforms to improve the resilience of money market 
funds and broader short-term funding markets.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

    <bullet> Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
    <bullet> Send an email to <a href="/cdn-cgi/l/email-protection#0674736a632b65696b6b636872754675636528616970"><span class="__cf_email__" data-cfemail="9fedeaf3fab2fcf0f2f2faf1ebecdfecfafcb1f8f0e9">[email protected]</span></a>. Please include 
File No. S7-01-21 on the subject line.

Paper Comments

    <bullet> Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-01-21. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method of submission. The Commission will post all 
comments on the Commission's website (http://www.sec.gov). Typically, 
comments are also available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. Due to pandemic conditions, however, access to the Commission's 
public reference room is not permitted at this time. All comments 
received will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make publicly available.
    Studies, memoranda, or other substantive items may be added by the 
Commission or staff to the comment file during this request for 
comment. A notification of the inclusion in the comment file of any 
such materials will be made available on the Commission's website. To 
ensure direct electronic receipt of such notifications, sign up through 
the ``Stay Connected'' option at www.sec.gov to receive notifications 
by email.

DATES: Comments should be received on or before April 12, 2021.

FOR FURTHER INFORMATION CONTACT: Adam Lovell or Elizabeth Miller, 
Senior Counsels; Angela Mokodean, Branch Chief; Thoreau Bartmann, 
Senior Special Counsel; Viktoria Baklanova, Senior Financial Analyst; 
or Brian Johnson, Assistant Director, at (202) 551-6792, Division of 
Investment Management, Securities and Exchange Commission, 100 F Street 
NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

I. The President's Working Group Report

    The PWG has studied the effects of the growing economic concerns 
related to the COVID-19 pandemic in March 2020 on short-term funding 
markets and, in particular, on money market funds.\1\ The results of 
this study are included in the report issued on December 22, 2020 and 
attached to this release as an Appendix (the ``Report'').\2\ The Report 
provides an overview of prior money market fund reforms in 2010 and 
2014, as well as how different types of money market funds have evolved 
since the 2008 financial crisis.\3\ The Report then discusses events in 
certain short-term funding markets in March 2020, focusing on money 
market funds. In reviewing the events of March 2020, the Report 
discusses significant outflows from prime and tax-exempt money market 
funds that occurred and how these funds experienced, and began to 
contribute to, general stress in short-term funding markets before the 
Federal Reserve, with the approval of the Department of the Treasury, 
established facilities to support short-term funding markets, including 
money market funds. The Report observes that these events occurred 
despite prior reform efforts to make money market funds more resilient 
to credit and liquidity stresses and, as a result, less susceptible to 
redemption-driven runs. Accordingly,

[[Page 8939]]

the Report concludes that the events of March 2020 show that more work 
is needed to reduce the risk that structural vulnerabilities in prime 
and tax-exempt money market funds will lead to or exacerbate stresses 
in short-term funding markets. The Report discusses various reform 
measures that policy makers could consider to improve the resilience of 
prime and tax-exempt money market funds and broader short-term funding 
markets. Many of the measures discussed in the Report could be 
implemented by the Commission under our existing statutory authority, 
while others may require coordinated action by multiple agencies or the 
creation of new private entities.\4\ Moreover, relevant money market 
funds could likely implement some of the potential reform measures 
fairly quickly, while other measures would involve longer-term 
structural changes.
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    \1\ The PWG is chaired by the Secretary of the Treasury and 
includes the Chair of the Board of Governors of the Federal Reserve 
System, the Chair of the SEC, and the Chair of the Commodity Futures 
Trading Commission. For a detailed discussion of the structure and 
significance of short-term funding markets and the effects of the 
COVID-19 shock, as well as the effects of monetary and fiscal 
measures, see SEC staff report, ``U.S. Credit Markets 
Interconnectedness and the Effects of COVID-19 Economic Shock,'' 
(October 2020) (``SEC Staff Interconnectedness Report''), available 
at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf. 
The SEC Staff Interconnectedness Report also discusses the effects 
of the March 2020 market stress on money market funds, including 
heavy outflows from prime and tax-exempt money market funds and 
significant inflows for government money market funds.
    \2\ The Report is also available at https://home.treasury.gov/system/files/136/PWG-MMF-report-final-Dec-2020.pdf.
    \3\ See Money Market Fund Reform, Investment Company Act Release 
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (amending 
rule 2a-7 under the Investment Company Act of 1940 (the ``Act'') to, 
among other things, enhance transparency and reduce credit, 
liquidity, and interest rate risks of money market fund portfolios); 
Money Market Fund Reform; Amendments to Form PF, Investment Company 
Act Release No. 31166 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)] 
(amending rule 2a-7 under the Act to address risks stemming from 
investor runs, including a floating NAV requirement for all prime 
and tax-exempt money market funds sold to institutional investors 
and the provision of new gate and fee tools for all prime and tax-
exempt money market funds, including retail funds).
    \4\ For example, certain policy measures discussed in the 
Report, such as requiring prime and tax-exempt money market funds to 
be members of a private liquidity exchange bank, may require 
rulemaking by the Commission as well as regulatory action from the 
Federal Reserve or other banking regulators.
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II. Request for Comment

    The Commission requests comments on the Report. Comments received 
will enable the Commission and other relevant financial regulators to 
consider more comprehensively the potential policy measures the Report 
identifies and help inform possible money market fund reforms.\5\ 
Following the comment period, we anticipate conducting discussions with 
various stakeholders, interested persons, and regulators to discuss the 
options in the Report and the comments we receive.
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    \5\ A Commission staff statement also requested comment on the 
Report. See Staff Statement on the President's Working Group Report 
on Money Market Funds (Dec. 23, 2020), available at https://www.sec.gov/news/public-statement/blass-pwg-mmf-2020-12-23. With the 
issuance of this Commission request for comment, commenters are 
encouraged to submit comments to File No. S7-01-21 by following the 
instructions at the beginning of this release.
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    We request comment on the potential policy measures described in 
the Report both individually and in combination. We also request 
comment on the effectiveness of previously-enacted money market fund 
reforms, and the effectiveness of implementing policy measures 
described in the Report in addition to, or in place of, previously-
enacted reforms. Commenters should address the effectiveness of the 
measures in: (1) Addressing money market funds' structural 
vulnerabilities that can contribute to stress in short-term funding 
markets; (2) improving the resilience and functioning of short-term 
funding markets; and (3) reducing the likelihood that official sector 
interventions will be needed to prevent or halt future money market 
fund runs, or to address stresses in short-term funding markets more 
generally. Commenters also may address the potential impact of the 
measures on money market fund investors, fund managers, issuers of 
short-term debt, and other stakeholders. In addition, we are interested 
in comments on other topics commenters believe are relevant to further 
money market fund reform, including other approaches for improving the 
resilience of money market funds and short-term funding markets 
generally. We encourage commenters to submit empirical data and other 
information in support of their comments.

    By the Commission.

    Dated: February 4, 2021.
Vanessa A. Countryman,
Secretary.

Report of the President's Working Group on Financial Markets

Overview of Recent Events and Potential Reform Options for Money Market 
Funds

December 2020

Table of Contents

 
                                                               Paragraph
                                                                 Nos.
 
I. Overview.................................................         229
II. Background..............................................         231
    A. Money Market Funds--Structure, Asset Types, and               231
     Investor Characteristics...............................
    B. 2010 and 2014 Reforms................................         232
    1C. State of the Money Market Fund Industry Following            234
     the 2008 Financial Crisis..............................
III. Events in March 2020...................................         236
    A. Stresses in Short-Term Funding Markets...............         237
    B. Stresses on Prime and Tax-Exempt Money Market Funds           239
     and Other Money-Market Investment Vehicles.............
    C. Taxpayer-Supported Central Bank Intervention.........         242
IV. Potential Policy Measures to Increase the Resilience of          243
 Prime and Tax-Exempt Money Market Funds....................
    A. Removal of Tie between MMF Liquidity and Fee and Gate         247
     Thresholds.............................................
    1B. Reform of Conditions for Imposing Redemption Gates..         248
    C. Minimum Balance at Risk..............................         249
    D. Money Market Fund Liquidity Management Changes.......         250
    E. Countercyclical Weekly Liquid Asset Requirements.....         251
    F. Floating NAVs for All Prime and Tax-Exempt Money              252
     Market Funds...........................................
    G. Swing Pricing Requirement............................         253
    H. Capital Buffer Requirements..........................         254
    I. Require Liquidity Exchange Bank Membership...........         255
    J. New Requirements Governing Sponsor Support...........         256
 

I. Overview

    In March 2020, short-term funding markets came under sharp stress 
amid growing economic concerns related to the COVID-19 pandemic and an 
overall flight to liquidity and quality among investors. Instruments 
underlying these markets include short-term U.S. Treasury securities, 
short-term agency securities, short-term municipal securities, 
commercial paper (``CP''), and negotiable certificates of deposit 
issued by domestic and foreign banks (``NCDs''). Money market funds 
(``MMFs'') are significant participants in these markets, facilitating 
investment by a broad range of individuals and institutions in the 
relevant short-term instruments. Because these short-term instruments 
tend to have relatively stable values and MMFs offer daily redemptions, 
investors in MMFs often expect to receive immediate liquidity with 
limited price volatility. However, in times of stress, these 
expectations may not match market conditions, causing investors to seek 
to liquidate

[[Page 8940]]

their positions in MMFs. These investor actions, which are motivated by 
both the expectation-market condition mismatch and the structural 
vulnerabilities of MMFs, can amplify market stress more generally.\6\
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    \6\ For a more detailed discussion of the structure and 
significance of short-term funding markets and the effects of the 
COVID-19 shock, as well as the effects of monetary and fiscal 
measures, see SEC staff report, ``U.S. Credit Markets 
Interconnectedness and the Effects of COVID-19 Economic Shock,'' 
(October 2020) (``SEC Staff Interconnectedness Report''), available 
at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf; 
Board of Governors of the Federal Reserve System, ``Financial 
Stability Report,'' (November 2020) at pp. 13-14, available at 
https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf.
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    The economic and public policy considerations raised by this 
dynamic among investors, MMFs, and short-term funding markets are 
multi-faceted and significant. The orderly functioning of short-term 
funding markets is essential to the performance of broader financial 
markets and our economy more generally. It is the role of financial 
regulators to identify and address market activities that have the 
potential to impair that orderly functioning. Crafters of public policy 
and financial regulation also must recognize that the broad 
availability of short-term funding is critical to short-term funding 
markets and, for many decades, prime and tax-exempt MMFs have been an 
important source of demand in these markets although their market share 
has decreased and assets shifted toward government MMFs in the past 
decade. In addition, the participation of retail investors in MMFs 
raises considerations of fairness and consumer confidence, particularly 
in times of unanticipated stress, that can affect regulatory and public 
policy responses.
    These dynamics and policy considerations were brought into stark 
relief in March 2020. While government MMFs saw significant inflows 
during this time, the prime and tax-exempt MMF sectors faced 
significant outflows and increasingly illiquid markets for the funds' 
assets. As a result, prime and tax-exempt MMFs experienced, and began 
to contribute to, general stress in short-term funding markets in March 
2020. For example, as pressures on prime and tax-exempt MMFs worsened, 
two MMF sponsors intervened to provide support to their funds. It did 
not appear that these funds had idiosyncratic holdings or were 
otherwise distinct from similar funds and, accordingly, it was 
reasonable to conclude that other MMFs could need similar support in 
the near term. These events occurred despite multiple reform efforts 
over the past decade to make MMFs more resilient to credit and 
liquidity stresses and, as a result, less susceptible to redemption-
driven runs. When the Federal Reserve quickly took action in mid-March 
by establishing, with Treasury approval, the Money Market Mutual Fund 
Liquidity Facility (``MMLF'') and other facilities to support short-
term funding markets generally and MMFs specifically, prime and tax-
exempt MMF outflows subsided and short-term funding market conditions 
improved.\7\
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    \7\ The MMLF makes loans available to eligible financial 
institutions secured by high-quality assets the financial 
institution purchased from MMFs. The MMLF also received $10 billion 
in credit protection from the Treasury's Exchange Stabilization 
Fund. Other relevant Federal Reserve facilities include, among 
others: (1) The Commercial Paper Funding Facility (``CPFF''), which 
provides a liquidity backstop to U.S. issuers of commercial paper; 
and (2) the Primary Dealer Credit Facility (``PDCF''), which 
provides funding to primary dealers in exchange for a broad range of 
collateral.
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    Prime and tax-exempt MMFs have been supported by official sector 
intervention twice over the past twelve years. In September 2008, there 
was a run on certain types of MMFs after the failure of Lehman Brothers 
caused a large prime MMF that held Lehman Brothers short-term 
instruments to sustain losses and ``break the buck.'' \8\ During that 
time, prime MMFs experienced significant redemptions that contributed 
to dislocations in short-term funding markets, while government MMFs 
experienced net inflows. Ultimately, the run on prime MMFs abated after 
announcements of a Treasury guarantee program for MMFs and a Federal 
Reserve facility designed to provide liquidity to MMFs.\9\ 
Subsequently, the Securities and Exchange Commission (``SEC'') adopted 
reforms (in 2010 and 2014) that were designed to address the structural 
vulnerabilities that became apparent in 2008.
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    \8\ A number of other funds that suffered losses in 2008 avoided 
breaking the buck because they received sponsor support. See Money 
Market Fund Reform; Amendments to Form PF, Investment Company Act 
Release No. 31166 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)] 
(``SEC 2014 Reforms'') at Section II.B.4, available at https://www.sec.gov/rules/final/2014/33-9616.pdf; See also Steffanie A. 
Brady, Kenechukwu E. Anadu, and Nathaniel R. Cooper, ``The Stability 
of Prime Money Market Mutual Funds: Sponsor Support from 2007 to 
2011,'' Federal Reserve Bank of Boston Supervisory Research and 
Analysis Working Papers (2012), available at https://www.bostonfed.org/publications/risk-and-policy-analysis/2012/the-stability-of-prime-money-market-mutual-funds-sponsor-support-from-2007-to-2011.aspx. For a description of the term ``break the buck,'' 
see Section II.A, below.
    \9\ For a more detailed discussion of the MMF-related events in 
2008, see Report of the President's Working Group on Financial 
Markets, ``Money Market Fund Reform Options,'' (October 2010) 
(``2010 PWG Report''), available at https://www.treasury.gov/press-center/press-releases/Documents/10.21%20PWG%20Report%20Final.pdf.
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    Because prime and tax-exempt MMFs again have shown structural 
vulnerabilities that can create or transmit stress in short-term 
funding markets, it is incumbent upon financial regulators to examine 
the events of March 2020 closely, and in particular the role, 
operation, and regulatory framework for these MMFs, with a view toward 
potential improvements. In addition, absent regulatory reform or other 
action that alters market expectations, these prior official sector 
interventions may have the consequence of solidifying the perception 
among investors, fund sponsors, and other market participants that 
similar support will be provided in future periods of stress.
    With that history and context, this report by the President's 
Working Group on Financial Markets (``PWG'') begins the important 
process of review and assessment.\10\ After providing background on 
MMFs and prior reforms, the report discusses events in certain short-
term funding markets in March 2020, focusing on MMFs. The report then 
discusses various measures that policy makers could consider to improve 
the resilience of MMFs and broader short-term funding markets.\11\ This 
report is meant to facilitate discussion. The PWG is not endorsing any 
given measure at this time.
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    \10\ The PWG is chaired by the Secretary of the Treasury and 
includes the Chair of the Board of Governors of the Federal Reserve 
System, the Chair of the Securities and Exchange Commission, and the 
Chair of the Commodity Futures Trading Commission.
    \11\ Given jurisdictional differences, this report is not 
intended to cover events in other jurisdictions or to suggest a 
uniform international approach to policy changes.
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II. Background

A. Money Market Funds--Structure, Asset Types, and Investor 
Characteristics

    MMFs are a type of mutual fund registered under the Investment 
Company Act of 1940 (the ``Act'') and regulated under rule 2a-7 of the 
Act. MMFs offer a combination of limited principal volatility, 
liquidity, and payment of short-term market returns, which make them a 
popular cash management vehicle for both retail and institutional 
investors. These funds also serve as an important source of short-term 
financing for businesses and financial institutions, as well as 
federal, state, and local governments.
    Overall, MMFs tend to invest in short-term, high-quality debt 
instruments that typically are held to maturity and

[[Page 8941]]

fluctuate very little in value under normal market conditions. However, 
from fund to fund, MMFs vary significantly. They hold different types 
of investments, serve investors of different types (i.e., institutional 
and retail), and pursue different investment objectives. For example, 
tax-exempt MMFs hold short-term state and local government and 
municipal securities, while government MMFs 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 fully by government securities. 
Traditionally, prime MMFs invest mostly in private debt instruments, 
including CP and NCDs. With regard to investor characteristics, there 
are three types of MMFs: (1) Retail MMFs, which are limited to retail 
investors; (2) publicly-offered institutional MMFs, which are held 
primarily by institutional investors and offered broadly to the public; 
and (3) non-publicly-offered institutional MMFs.\12\ Variations in 
portfolio holdings also correspond with investor-specific factors such 
as taxing jurisdictions and, to some extent, risk/return preferences.
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    \12\ For example, funds not offered to the public include 
``central'' funds that asset managers use for internal cash 
management.
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    Another significant difference among different types of MMFs is how 
they price the purchase and redemption of their shares. All government 
MMFs, as well as retail prime and retail tax-exempt MMFs, are permitted 
to price their shares at a stable net asset value (``NAV'') per share 
(typically $1.00) without regard to small variations in the value of 
the assets in their portfolios. These MMFs must periodically compare 
their stable NAV per share to the market-based value per share of their 
portfolios (or ``market-based price''). If the deviation between these 
two values exceeds one-half of one percent (50 basis points), the 
fund's board must consider what action, if any, to take, including 
whether to adjust the fund's share price. If the repricing is below the 
fund's $1.00 share price, the event is commonly called ``breaking the 
buck.'' In light of the importance investors place on a stable $1.00 
share price, such an action can lead to a loss of confidence in the 
fund and, if it is expected to extend beyond one fund, could lead to a 
loss of confidence in all similar funds. As discussed below, following 
the SEC's 2014 reforms, institutional prime and institutional tax-
exempt MMFs are required to price their shares using a floating NAV, 
which reflects the market value of the fund's investments and any 
changes in that value, thus reducing the risk of an adverse signaling 
effect from ``breaking the buck.''
    As investors commonly use MMFs for principal preservation and as a 
cash management tool, many MMF investors may have a low tolerance for 
losses and liquidity limitations. However, MMFs offer shareholder 
redemptions on at least a daily basis (and in some cases at a stable 
NAV), even though a potentially significant portion of portfolio assets 
may not be converted into cash in that timeframe without a reduction in 
value. When the MMF does have to sell portfolio assets at a discount, 
the fund's remaining shareholders generally bear those losses. These 
factors can lead to greater redemptions if investors believe they will 
be better off by redeeming earlier than other investors--a so-called 
``first mover'' advantage--when there is a perception that the fund may 
suffer a loss in value or liquidity. Historically, amid periods of 
stress for MMFs, institutional investors, who may have large holdings 
and the resources to monitor risks carefully, have redeemed shares more 
rapidly and extensively than retail investors.

B. 2010 and 2014 Reforms

    The SEC has implemented a number of reforms over the past decade 
aimed at making MMFs more resilient to credit and liquidity stresses 
and addressing structural vulnerabilities in MMFs that were evident in 
the 2008 financial crisis, particularly the substantial reforms the SEC 
adopted in 2010 and 2014.\13\ The 2010 reforms focused on, among other 
things, enhancing transparency and reducing credit, liquidity, and 
interest rate risks of fund portfolios to make MMFs more resilient and, 
in the case of stable NAV funds, less likely to break the buck. For 
example, the amendments introduced new liquidity requirements: At the 
time an MMF acquires an asset, it must hold at least 10 percent of its 
total assets in daily liquid assets (``DLA'') and at least 30 percent 
of its total assets in weekly liquid assets (``WLA'').\14\ These 
requirements are designed to work in combination and ensure that a MMF 
has the legal right to receive enough cash within one or five business 
days to satisfy redemption requests. To address credit risks, the 
amendments added a new 120-day limit on funds' portfolio weighted 
average life to limit exposure to credit spreads, as well as a 
reduction in the limit on funds' portfolio weighted average maturity 
from 90 days to 60 days to limit interest rate risk.\15\ The 2010 
reforms increased transparency by requiring MMFs to publicly disclose 
portfolio holdings each month. In addition, the amendments addressed 
other important issues such as stress testing, orderly fund 
liquidation, and repurchase agreements.
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    \13\ See Money Market Fund Reform, Investment Company Act 
Release No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] 
(``SEC 2010 Reforms''), available at https://www.sec.gov/rules/final/2010/ic-29132.pdf; SEC 2014 Reforms.
    \14\ All MMFs are subject to these DLA and WLA standards, except 
tax-exempt MMFs are not subject to DLA standards due to the nature 
of the markets for tax-exempt securities and the limited supply of 
securities with daily demand features. If a MMF's portfolio does not 
meet the minimum DLA or WLA standards, it is not in violation of 
rule 2a-7. However, it may not acquire any assets other than DLA or 
WLA until it meets these minimum standards.
     Daily liquid assets are: Cash; direct obligations of the U.S. 
government; certain securities that will mature (or be payable 
through a demand feature) within one business day; or amounts 
unconditionally due within one business day from pending portfolio 
security sales. See rule 2a-7(a)(8).
     Weekly liquid assets are: Cash; direct obligations of the U.S. 
government; agency discount notes with remaining maturities of 60 
days or less; certain securities that will mature (or be payable 
through a demand feature) within five business days; or amounts 
unconditionally due within five business days from pending security 
sales. See rule 2a-7(a)(28).
    \15\ See SEC staff report, ``Response to Questions Posed by 
Commissioners Aguilar, Paredes, and Gallagher,'' (November 2012) at 
pp. 18-30, available at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
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    The SEC's subsequent 2014 reforms focused on the structural 
vulnerabilities that make MMFs susceptible to runs and provided tools 
intended to slow runs should they occur.\16\ These reforms included a 
floating NAV requirement for all prime and tax-exempt MMFs sold to 
institutional investors as a means of mitigating first mover advantages 
for investors who redeem from these funds when the value of their 
assets decline. Under the floating NAV requirement, these MMFs must 
sell and redeem their shares at prices based on the current market-
based value of the assets in their underlying portfolios rounded to the 
fourth decimal place (e.g., $1.0000). Prior to the 2014 reforms, rule 
2a-7

[[Page 8942]]

permitted these funds to maintain a stable NAV per share like all other 
MMFs.
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    \16\ Prior to the 2014 reforms, the Financial Stability 
Oversight Council (``FSOC'') proposed recommendations regarding MMF 
reforms to address structural vulnerabilities of MMFs that the SEC's 
2010 reforms did not address. These proposed recommendations, which 
FSOC made pursuant to Section 120 of the Dodd-Frank Act, included 
alternatives on a floating NAV, a risk-based NAV buffer of 3 percent 
to provide explicit loss-absorption capacity, and a minimum balance 
at risk. See Financial Stability Oversight Council, ``Proposed 
Recommendations Regarding Money Market Mutual Fund Reform,'' 
(November 2012) (``FSOC Proposed Recommendations''), available at 
https://www.treasury.gov/initiatives/fsoc/Documents/Proposed%20Recommendations%20Regarding%20Money%20Market%20Mutual%20Fund%20Reform%20-%20November%2013,%202012.pdf.
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    In addition, to provide tools to slow an investor run should it 
occur, the 2014 reforms provided new fee and gate tools for all prime 
and tax-exempt MMFs, including retail funds.\17\ Under the fee and gate 
provisions, boards of these MMFs are permitted to impose liquidity 
(redemption) fees of up to 2 percent or to temporarily suspend 
redemptions if the fund's WLA falls below the 30 percent minimum 
required. In addition, funds must impose a 1 percent liquidity fee if 
WLA falls below 10 percent of total assets, unless the fund's board 
determines that imposing the fee is not in the best interests of the 
fund. Liquidity fees provide investors continued access to cash 
redemptions but may reduce the incentive to redeem. Gates, on the other 
hand, stop redemptions altogether for up to ten business days but may 
cause investors to seek a first mover advantage and redeem in advance 
of the imposition of gates.
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    \17\ Government MMFs are permitted (but not required) to adopt 
fee and gate provisions.
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    Further, the 2014 amendments enhanced transparency for MMF 
investors and provided information about important MMF events more 
uniformly and efficiently. For instance, the amendments required MMFs 
to promptly report certain significant events in filings with the SEC, 
including the imposition or removal of fees or gates, portfolio 
security defaults, the use of sponsor support, and a fall in a retail 
or government MMF's market-based price per share below $0.9975. The 
2014 reforms also generally required website disclosure of these 
events, as well as daily website disclosure of a fund's DLA, WLA, 
market-based NAV, and net flows. In addition, the reforms addressed MMF 
diversification and valuation practices.

C. State of the Money Market Fund Industry Following the 2008 Financial 
Crisis

    Since 2008, the composition of the MMF sector has changed 
substantially, and the industry continued to evolve through 2020. Chart 
1 provides information about changes in net assets by type of MMF, 
while Chart 2 provides more detail about subcategories of prime and 
tax-exempt MMFs (i.e., retail and institutional funds). As of September 
30, 2020, total industry net assets were $4.9 trillion, down slightly 
from an all-time high of $5.2 trillion in May 2020 (see Chart 1).
BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TN10FE21.001


[[Page 8943]]


[GRAPHIC] [TIFF OMITTED] TN10FE21.002

BILLING CODE 8011-01-C
    The assets of government MMFs (the blue line in Chart 1), which 
were under $1 trillion in August 2008, have grown considerably since 
then. Much of the growth occurred in 2016, when government MMF assets 
increased more than $1 trillion as investors shifted money from prime 
and tax-exempt MMFs, which were required, starting in October 2016, to 
implement the more significant aspects of the 2014 reforms.\19\ In 
March 2020, government MMF assets increased by $840 billion to $3.6 
trillion, and their assets reached nearly $4.0 trillion at the end of 
April. As of September 2020, government MMFs accounted for 77 percent 
of industry net assets.
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    \18\ The 2014 amendments introduced a regulatory definition of a 
retail MMF (and implemented it in 2016). Because data on 
institutional and retail MMFs prior to October 2016 may not be 
entirely comparable with current statistics, Chart 2 does not 
include data on retail and institutional MMFs prior to October 2016.
     The drop in prime retail MMF assets in September 2020 is the 
result of a large prime retail MMF converting to a government MMF.
    \19\ The compliance date for the floating NAV requirement for 
institutional prime and institutional tax-exempt MMFs and for the 
fee and gate provisions for all prime and tax-exempt funds was 
October 14, 2016.
---------------------------------------------------------------------------

    The net assets of prime MMFs (the red line in Chart 1) contracted 
substantially in the year leading up to the October 2016 deadline for 
implementing the 2014 MMF reforms and were $550 billion in December 
2016. By February 2020, these funds' assets had recovered to $1.1 
trillion, but their assets fell $125 billion on net in March. As of 
September 2020, prime MMFs accounted for around 20 percent of industry 
net assets.
    Net assets in tax-exempt MMFs (the dashed green line in Chart 1) 
have also declined since 2008, when these funds had net assets 
exceeding $500 billion. Tax-exempt funds' assets fell $120 billion in 
the year before October 2016 and were about $135 billion at the end of 
2016. By February 2020, tax-exempt fund assets were about $140 billion, 
and they declined $9 billion in March 2020. The vast majority of tax-
exempt MMF net assets are in retail funds (see Chart 2). Tax-exempt 
MMFs represent under three percent of total industry net assets as of 
September 2020.

III. Events in March 2020

    Amid escalating concerns about the economic impact of the COVID-19 
pandemic in March 2020, market participants sought to rapidly shift 
their holdings toward cash and short-term government securities. This 
rapid shift in asset allocation preferences placed stress on various 
components of short-term funding markets, including prime and tax-
exempt MMFs, the repo markets, the CP market, and short-term municipal 
securities markets (including the market for variable-rate demand notes 
(``VRDNs'')). As discussed in more detail below, pressures on prime and 
tax-exempt MMFs again revealed structural vulnerabilities in MMFs that 
led to increased redemptions and, in turn, began to contribute to and 
increase the general stress in short-term funding markets.

A. Stresses in Short-Term Funding Markets

    Private short-term debt markets. In markets for private short-term 
debt instruments, such as CP and NCDs, conditions began to deteriorate 
rapidly in the second week of March. Spreads for instruments held by 
MMFs began widening sharply (see Chart 3). Specifically, spreads to 
overnight indexed swaps (``OIS'') for AA-rated nonfinancial CP reached 
new historical highs, while spreads for AA-rated financial CP and A2/
P2-rated nonfinancial CP widened to the highest levels seen since the 
2008 financial crisis. Along with widening spreads, new issuance of CP 
and NCDs declined markedly and shifted to short tenors. For instance, 
the share of CP issuance with overnight maturity climbed steadily to 
nearly 90 percent on March 23.
    Pricing and liquidity concerns at MMFs were driven by, and began to 
contribute to, these market stresses. Widening spreads in short-term 
funding markets put downward pressure on the prices of assets in prime 
MMFs' portfolios, and redemptions from MMFs likely contributed to 
stress in these markets, as prime funds reduced their CP holdings 
disproportionately compared to other holders. At the end of February, 
prime MMFs offered to the public owned about 19 percent of outstanding 
CP.\20\ From March 10 to

[[Page 8944]]

March 24, these funds cut their CP holdings by $35 billion. This 
reduction accounted for 74 percent of the $48 billion overall decline 
in outstanding CP over those two weeks.\21\ In addition, MMFs with WLAs 
close to 30 percent were likely reluctant to purchase assets with 
maturities of more than 7 days that would not qualify as WLA to avoid 
going below the regulatory requirements.\22\ Beyond MMFs, there were 
also other factors contributing to stress in CP markets, including 
outflows from other investment vehicles that invest in these markets 
(see below).
---------------------------------------------------------------------------

    \20\ Total CP outstanding at the end of February 2020 was $1.1 
trillion (source: Federal Reserve). Holdings of publicly-offered 
prime funds are based on data from iMoneyNet. Total prime MMF 
holdings of CP, including internal funds that are not offered to the 
public, were 29 percent of outstanding CP at the end of February 
2020 (source: SEC Form N-MFP).
    \21\ About $6 billion of the reduction in MMF holdings of CP 
during this time was pledged as collateral to the MMLF.
    \22\ Funds with WLAs below the 30 percent minimum threshold are 
prohibited from purchasing assets that are not WLAs, including CP 
and NCDs with maturities exceeding 7 days. On March 17 and 18, one 
prime MMF offered to institutional investors reported WLAs below 30 
percent.
---------------------------------------------------------------------------

    Some market participants have suggested that another contributing 
factor to stress in CP markets was that dealers in CP markets (as well 
as issuing dealers and banks) were experiencing their own liquidity 
pressures and limits on their willingness to intermediate in money 
markets.\23\ Historically, however, because the vast majority of CP 
typically is held to maturity, dealers have not had a substantial role 
in making secondary markets in CP. This is also the case for other 
private short-term debt instruments that prime MMFs hold. Thus, there 
was no reason to expect dealers to take a materially increased 
intermediation role in these assets in March. There are also a large 
number of individual issues (i.e., CUSIPs) in the private short-term 
debt markets, which adds complexity to intermediation.\24\ In contrast 
to the private short-term debt markets, Treasury and agency securities 
markets have fewer CUSIPs, large daily trading volumes, and more liquid 
secondary markets, with primary dealers and others playing a large 
daily intermediation role in these markets.
---------------------------------------------------------------------------

    \23\ For example, large customer sales increased dealers' 
inventories of Treasuries and mortgage-backed securities. Facing 
balance sheet constraints and internal risk limits amid the elevated 
volatility, dealers cut back on intermediation more generally.
    \24\ According to DTCC's Money Market Kinetics report as of 
March 31, 2020 (available at https://www.dtcc.com/money-markets), 
the 12-month average of daily settlements for fixed and floating 
rate CP was approximately $80 billion, although only a small share 
of this volume appears to have been secondary market transactions, 
and further analysis of secondary market activity is needed. As 
previously noted, there was approximately $1.1 trillion of total CP 
outstanding at the end of February 2020.
[GRAPHIC] [TIFF OMITTED] TN10FE21.003

    Short-term municipal debt markets. Conditions in short-term 
municipal debt markets also worsened rapidly in mid-March. Similar to 
the relationship between the CP market and prime MMFs discussed above, 
stresses in short-term municipal markets contributed to pricing 
pressures and outflows for tax-exempt MMFs which, in turn, contributed 
to increased stress in municipal markets. Beginning on March 12, tax-
exempt MMFs experienced unusually large redemptions, with outflows 
accelerating over the next week. In response, tax-exempt funds reduced 
their holdings of VRDNs by about 16 percent ($15 billion) in the two 
weeks from March 9 to March 23, with primary dealer VRDN inventories 
nearly tripling in the week ending March 18. VRDNs have a demand or 
tender feature that allows tax-exempt MMFs to require the tender agent 
to repurchase the security at par plus accrued interest. When a tax-
exempt MMF tenders a VRDN, a remarketing agent typically remarkets the 
VRDN to other investors at a higher yield (and thus a lower price).
    The redemption stresses on tax-exempt MMFs likely contributed to 
worsening conditions in short-term municipal debt markets. The SIFMA 7-
day municipal swap index yield, a benchmark weekly rate in these 
markets, shot up 392 basis points on

[[Page 8945]]

March 18, as remarketing agents offered VRDNs at higher yields in 
response to tax-exempt MMFs putting back their notes to tender agents. 
The spike in the SIFMA index yield caused a drop in market-based NAVs 
of tax-exempt MMFs (which mostly have stable, rounded NAVs).

B. Stresses on Prime and Tax-Exempt Money Market Funds and Other Money-
Market Investment Vehicles

    As part of the general deterioration in short-term funding market 
conditions, prime and tax-exempt MMFs experienced heavy redemptions 
beginning in the second week of March 2020. Outflows increased quickly, 
peaking on March 17 for prime funds (the day the Federal Reserve 
announced the CPFF) and on March 23 for tax-exempt funds (one business 
day after the Federal Reserve's MMLF was expanded to include tax-exempt 
securities).\25\
---------------------------------------------------------------------------

    \25\ The following discussion provides data on the size of the 
largest outflows from different types of MMFs during a given two-
week (10 business day) period in March. These two-week periods do 
not necessarily coincide. For example, the two-week period for 
institutional prime funds begins two days before that for retail 
prime funds, in part because institutional prime funds experienced 
heavy redemptions earlier than retail prime funds. Using data for 
one-week periods provides qualitatively similar results. For 
comparison purposes, we also provide data on outflows for a standard 
two-week period from March 9 to March 20 for all types of MMFs, 
based on SEC Form N-MFP weekly data.
---------------------------------------------------------------------------

    Institutional prime fund outflows. Among institutional prime MMFs 
offered to the public, outflows as a percentage of fund size exceeded 
those in the September 2008 crisis. However, the dollar amount of 
outflows from these funds was much smaller in March 2020, in part 
because their assets on the eve of the pandemic were less than one-
quarter of their size on the eve of the 2008 crisis. Over the two-week 
period from March 11 to 24, net redemptions from publicly-offered 
institutional prime funds totaled 30 percent (about $100 billion) of 
the funds' assets, and these funds' outflows exceeded 5 percent of 
their assets on three consecutive days beginning on March 17. For 
comparison, in September 2008, the highest outflows from these funds 
over a two-week period were about 26 percent (about $350 billion) of 
assets.\26\
---------------------------------------------------------------------------

    \26\ Data on daily MMF flows are from iMoneyNet. SEC Form N-MFP 
provides an official source of weekly flows data (for weeks ending 
on Fridays). For the two weeks from March 9 to 20, outflows from 
institutional prime funds that are offered to the public (as proxied 
by their presence in commercial databases) totaled $90 billion (27 
percent of assets). Form N-MFP weekly flows data are not available 
for the September 2008 crisis.
---------------------------------------------------------------------------

    A sizable portion of the institutional prime fund sector's assets 
are in funds that are not offered to the public.\27\ These non-public 
funds had smaller outflows than their publicly-offered counterparts, 
indicating that, on average, the former do not demonstrate the same 
vulnerabilities as funds that are offered publicly to a broad range of 
unaffiliated institutional investors. This difference may be 
attributable to investor characteristics as much as or more than the 
nonpublic nature of the offering. Outflows from non-public 
institutional prime funds totaled 6 percent ($17 billion) of assets 
from March 9 to March 20.\28\
---------------------------------------------------------------------------

    \27\ See footnote 12 and accompanying text for an explanation of 
publicly-offered funds versus non-public funds.
    \28\ Source: SEC Form N-MFP.
---------------------------------------------------------------------------

    Retail prime fund outflows. Although outflows from retail prime 
MMFs as a share of assets in March exceeded retail prime MMF outflows 
during the 2008 crisis, the March outflows from retail prime MMFs were 
smaller than outflows from institutional prime MMFs. The redemptions 
from retail prime MMFs in March began a couple of days after those for 
institutional funds. Net redemptions totaled 9 percent (just over $40 
billion) of assets over the two weeks from March 13 to 26.\29\ In 
September 2008, the heaviest retail outflows over a two-week period 
totaled 5 percent of assets. Retail prime funds had about 60 percent 
more assets in 2008 than in February 2020, so outflows were similar in 
dollar terms in both crises.\30\ Some retail prime MMFs experienced 
declining market-based prices in March, but none of these funds 
reported a market-based price below $0.9975. Moreover, retail prime MMF 
flows in March 2020 appear to have been unrelated to market-based 
prices, as funds with lower market-based prices did not experience 
larger outflows than other retail prime MMFs.
---------------------------------------------------------------------------

    \29\ Source: iMoneyNet daily data. Similarly, data from SEC Form 
N-MFP show retail prime fund outflows of 7 percent of assets ($33 
billion) over the two week period from March 9 to 20.
    \30\ See footnote 18 (explaining that data on institutional and 
retail MMFs prior to 2016 may not be entirely comparable with 
current statistics).
---------------------------------------------------------------------------

    Tax-exempt fund outflows and declining market-based prices. 
Outflows from tax-exempt MMFs, which are largely retail funds, were 8 
percent ($11 billion) of assets during the two weeks from March 12 to 
25.\31\ In 2008, when tax-exempt MMF assets were more than four times 
larger than in February 2020, such funds had outflows of 7 percent 
(almost $40 billion) of assets in one two-week period. In March, some 
retail tax-exempt MMFs also had declining market-based prices. Although 
none of these funds broke the buck, one fund reported a market-based 
price below $0.9975. As with retail prime MMFs, there does not appear 
to have been a relationship between a decline in a particular retail 
tax-exempt MMF's market-based price and the size of its outflows.
---------------------------------------------------------------------------

    \31\ Source: iMoneyNet daily data. Similarly, data from SEC form 
N-MFP show tax-exempt fund outflows of 8 percent of assets ($11 
billion) over the two weeks from March 9 to 20.
---------------------------------------------------------------------------

    Declining WLAs and relation to fees and gates. As prime funds 
experienced heavy redemptions, their WLAs declined, and some funds' 
WLAs (which must be disclosed publicly each day) approached or fell 
below the 30 percent minimum threshold that SEC rules require. Investor 
redemptions, which may have been further exacerbated by declining WLAs, 
can put additional pressure on fund liquidity during times of stress. 
As previously noted, when a fund's WLA falls below 30 percent, the fund 
can impose fees or gates on redemptions. Market participants reported 
concerns that the imposition of a fee or gate by one fund, as well as 
the perception that a fee or gate would be imposed by one fund, could 
spark widespread redemptions from other funds, leading to further 
stresses in the underlying markets. Although one institutional prime 
fund (with assets that declined from $3.8 billion at the end of 
February to $1.5 billion at the end of March) had WLAs below the 30 
percent minimum, it did not impose a fee or gate in March.
    Preliminary research indicates that prime fund outflows accelerated 
as WLAs declined, suggesting that the potential imposition of a fee or 
gate when a fund's WLA drops below 30 percent encouraged institutional 
investors to redeem before that threshold was crossed.\32\ 
Additionally, some market participants and observers have suggested 
that investors' potential motivation to redeem as a MMF moves toward 
the 30 percent threshold is primarily driven by concerns about gates, 
rather than liquidity fees, because MMF investors have a low tolerance 
for being unable to access cash on demand.
---------------------------------------------------------------------------

    \32\ See Lei Li, Yi Li, Marco Macchiavelli, and Xing (Alex) 
Zhou, ``Runs and Interventions in the Time of COVID-19: Evidence 
from Money Funds,'' working paper (2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3607593.
---------------------------------------------------------------------------

    Sponsor support. As strains on prime and tax-exempt MMFs worsened, 
two fund sponsors provided support for their funds. They did so by 
purchasing securities from three prime institutional MMFs and making a 
capital contribution to one tax-exempt fund.
    Other investment vehicles that invest in securities and other 
instruments

[[Page 8946]]

similar to MMFs. Other investment vehicles that invest in instruments 
held by MMFs also experienced outflows and stress in March. Short-term 
investment funds (``STIFs'') operated by banks, which have assets of 
about $300 billion, had outflows in March and experienced related 
stress.\33\ Ultra-short corporate bond mutual funds, which had assets 
of $200 billion in February 2020, had outflows of $33 billion (16 
percent of assets) in March.\34\ In addition, in the two weeks from 
March 12 to 25, outflows from European dollar-denominated MMFs 
investing in assets similar to U.S. prime MMFs (so-called offshore 
MMFs, which are largely domiciled in Ireland and Luxembourg), totaled 
25 percent (about $95 billion) of assets.\35\
---------------------------------------------------------------------------

    \33\ The Office of the Comptroller of the Currency (``OCC''), 
which oversees national banks operating STIFs, issued an interim 
final rule and an administrative order allowing STIFs to extend 
their dollar-weighted average portfolio maturity and dollar-weighted 
average portfolio life maturity to alleviate pressure on STIF 
management's ability to comply with these maturity limits in light 
of stressed market conditions. See Short-Term Investment Funds, 85 
FR 16888 (Mar. 25, 2020), available at https://www.occ.gov/news-issuances/federal-register/2020/85fr16888.pdf.
    \34\ Source: Morningstar data.
    \35\ Source: iMoneyNet data.
---------------------------------------------------------------------------

    Prime and tax-exempt MMFs' role in short-term funding markets' 
stress. Short-term funding markets are interconnected with other market 
segments, and stress in one market can lead to stress in others. Prime 
and tax-exempt MMFs were not the sole contributors to the pressures in 
short-term funding markets.\36\ However, it appears that MMF actions 
were particularly significant relative to market size. For example, as 
noted above, prime funds reduced their CP holdings disproportionately 
compared to other holders.\37\
---------------------------------------------------------------------------

    \36\ For example, leveraged non-bank entities, such as hedge 
funds using Treasury collateral and real estate investment trusts 
using agency mortgage-backed security collateral, may have also 
contributed to pressure in short-term funding markets. See, e.g., 
FSOC Annual Report 2020 at p. 5, available at https://home.treasury.gov/system/files/261/FSOC2020AnnualReport.pdf.
    \37\ See paragraph accompanying footnote 20.
---------------------------------------------------------------------------

C. Taxpayer-Supported Central Bank Intervention

    On March 18, 2020, the Federal Reserve, with the approval of the 
Secretary of the Treasury, authorized the MMLF, which began to operate 
on March 23.\38\ The MMLF provides non-recourse loans to U.S. 
depository institutions and bank holding companies to finance their 
purchases of specified eligible assets from MMFs under certain 
conditions. The non-recourse nature of the loan protects the borrower 
from any losses on the asset pledged to secure the MMLF loan. The 
Federal Reserve, along with the OCC and Federal Deposit Insurance 
Corporation (``FDIC''), also took steps to neutralize the effects of 
purchasing assets through the MMLF on risk-based and leveraged capital 
ratios and liquidity coverage ratio requirements of financial 
institutions to facilitate participation in the facility.\39\ The MMLF 
program, in combination with other programs, was intended to stabilize 
the U.S. financial system by allowing MMFs to raise cash to meet 
redemptions and to foster liquidity in the markets for the assets held 
by MMFs, including the markets for CP, NCDs, and short-term municipal 
securities.\40\ The Department of the Treasury provided $10 billion of 
credit protection to the Federal Reserve in connection with the MMLF 
from the Treasury's Exchange Stabilization Fund.\41\ MMLF utilization 
ramped up quickly to a peak of just over $50 billion in early April, or 
about 5 percent of net assets in prime and tax-exempt MMFs at the time.
---------------------------------------------------------------------------

    \38\ 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 operates the MMLF.
    \39\ See Regulatory Capital Rule: Money Market Mutual Fund 
Liquidity Facility, 85 FR 16232 (March 23, 2020), available at 
https://www.federalregister.gov/documents/2020/03/23/2020-06156/regulatory-capital-rule-money-market-mutual-fund-liquidity-facility; 
Liquidity Coverage Ratio Rule: Treatment of Certain Emergency 
Facilities, 85 FR 26835 (May 6, 2020), available at https://www.federalregister.gov/documents/2020/05/06/2020-09716/liquidity-coverage-ratio-rule-treatment-of-certain-emergency-facilities.
    \40\ The MMLF would not have worked in isolation, and other 
programs and monetary policy responses would not have worked as well 
without the MMLF. See SEC Staff Interconnectedness Report; Marco 
Cipriani et al., ``Municipal Debt Markets and the COVID-19 
Pandemic,'' (June 29, 2020), available at https://libertystreeteconomics.newyorkfed.org/2020/06/municipal-debt-markets-and-the-covid-19-pandemic.html.
    \41\ The CARES Act also temporarily removed restrictions on 
Treasury's authority to use the Exchange Stabilization Fund to 
guarantee money market funds. See section 4015 of the CARES Act. 
This authority has not been used.
---------------------------------------------------------------------------

    Outflows from prime MMFs abated fairly quickly after the Federal 
Reserve's announcement of programs and other actions to support short-
term funding markets and the flow of credit to households and 
businesses more generally, including its initial announcement of the 
MMLF on March 18.\42\ Overall market conditions also began to improve. 
For example, in the CP market, the share of CP issuance with overnight 
maturity began to fall on March 24 and spreads to OIS for most types of 
term CP started narrowing a few days later. After the expansion of the 
MMLF to include municipal securities on March 20 (and VRDNs on March 
23), tax-exempt MMF outflows eased and conditions in short-term 
municipal debt markets improved. Beyond the MMLF, several other Federal 
Reserve actions and announcements in March likely contributed to these 
improved conditions. For example, the Federal Open Market Committee 
lowered the target range for the federal funds rates twice in March by 
a total of 150 basis points. A large increase in open market purchases 
of Treasury securities and agency mortgage-backed securities was 
announced on March 15, and establishments of the PDCF and the CPFF were 
announced on March 17.
---------------------------------------------------------------------------

    \42\ See, e.g., ``Federal Reserve Issues FOMC Statement'' (March 
15, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm; ``Federal Reserve Actions to 
Support the Flow of Credit to Households and Businesses'' (March 15, 
2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm; ``Federal Reserve Board 
Announces Establishment of a Commercial Paper Funding Facility 
(CPFF) to Support the Flow of Credit to Households and Businesses'' 
(March 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317a.htm; ``Federal Reserve 
Board Announces Establishment of a Primary Dealer Credit Facility 
(PDCF) to Support the Credit Needs of Households and Businesses'' 
(March 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317b.htm; ``Federal Reserve 
Board Broadens Program of Support for the Flow of Credit to 
Households and Businesses by Establishing a Money Market Mutual Fund 
Liquidity Facility (MMLF)'' (March 18, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm.
---------------------------------------------------------------------------

    While stress affected a variety of money market instruments and 
investment vehicles, the broad policy responses from the Federal 
Reserve, including the availability of secondary market liquidity for 
MMFs through the MMLF, appeared to have had the intended broad calming 
effect on short-term funding markets. For instance, although European 
dollar-denominated MMFs are not eligible to participate in the MMLF, 
outflows from these funds abated shortly after the MMLF began 
operations. The resulting stability in short-term funding markets, 
along with the fiscal stimulus provided by the CARES Act and the 
expectation of continued accommodative monetary policy, facilitated 
stability in the capital markets more generally.

IV. Potential Policy Measures To Increase the Resilience of Prime and 
Tax-Exempt Money Market Funds

    While many of the post-2008 MMF reforms added stability to MMFs, 
the events of March 2020 show that more work is needed to reduce the 
risk that

[[Page 8947]]

structural vulnerabilities in prime and tax-exempt MMFs will lead to or 
exacerbate stresses in short-term funding markets. The following 
discussion sets forth potential policy measures that could address the 
risks prime and tax-exempt MMFs pose to short-term funding markets. 
This report is meant to facilitate discussion. The PWG is not endorsing 
any given measure at this time.
    These potential policy measures differ in terms of the scope and 
breadth of regulatory changes they would require. For example, many of 
the potential reforms would apply only to prime and tax-exempt MMFs, 
while reforms such as swing pricing could apply to mutual funds more 
generally. Moreover, some potential reforms would involve targeted 
amendments to SEC rules, which relevant MMFs could likely implement 
fairly quickly, while others would involve longer-term structural 
changes or may require coordinated action by multiple agencies. The 
different measures are not necessarily mutually exclusive, nor are they 
equally effective at mitigating the vulnerabilities of prime and tax-
exempt MMFs. Policy makers could combine certain measures within a 
single set of reforms. Some policy measures listed below have been 
raised for consideration previously, including in the PWG's October 
2010 report on MMF reform options and the FSOC's 2012 proposed 
recommendations on MMF reform, and warrant renewed consideration in 
light of recent MMF stresses.
    This report focuses on reform measures for MMFs only. It is 
important to recognize MMFs' role in the market events in March 2020 
and to examine measures that would address concerns and structural 
vulnerabilities specific to MMFs. Although they are beyond the scope of 
this report, and as discussed generally above, there were other 
stresses in short-term funding markets in March 2020 that may have 
contributed to the pressure on MMFs.
    As discussed in more detail below, the potential policy measures 
for prime and tax-exempt MMFs explored in this report are:
    <bullet> Removal of Tie between MMF Liquidity and Fee and Gate 
Thresholds;
    <bullet> Reform of Conditions for Imposing Redemption Gates;
    <bullet> Minimum Balance at Risk (``MBR'');
    <bullet> Money Market Fund Liquidity Management Changes;
    <bullet> Countercyclical Weekly Liquid Asset Requirements;
    <bullet> Floating NAVs for All Prime and Tax-Exempt Money Market 
Funds;
    <bullet> Swing Pricing Requirement;
    <bullet> Capital Buffer Requirements;
    <bullet> Require Liquidity Exchange Bank (``LEB'') Membership; and
    <bullet> New Requirements Governing Sponsor Support.
    Overarching goals for MMF reform. As a threshold matter, it should 
be recognized that the various policy reforms, individually and in 
combination, should be evaluated in terms of their ability to 
effectively advance the overarching goals of reform. That is:
    <bullet> First, would they effectively address the MMF structural 
vulnerabilities that contributed to stress in short-term funding 
markets?
    <bullet> Second, would they improve the resilience and functioning 
of short-term funding markets?
    <bullet> Third, would they reduce the likelihood that official 
sector interventions and taxpayer support will be needed to halt future 
MMF runs or address stresses in short-term funding markets more 
generally?
    Assessment of the MMF reform options. An assessment of the 
effectiveness of reform options in achieving these goals should take 
into account: (a) How each option would address MMF structural 
vulnerabilities and contribute to the overarching goals; (b) the effect 
of each option on short-term funding markets and the MMF sector more 
broadly, including through its effects on the resilience, functioning, 
and stability of short-term funding markets, as well as whether the 
reform option would trigger the growth of existing investment 
strategies and products, or the development of new strategies and 
products, that could either exacerbate or mitigate market 
vulnerabilities; and (c) potential drawbacks, limitations, or 
challenges specific to each reform option. The reform options 
considered in this report seek to achieve the goals in different ways. 
For example, some are intended to address the liquidity-related 
stresses that were evident in March 2020, while others also touch on 
potential credit-related concerns. This menu of options reflects the 
possibility that future financial stress events may affect the 
liquidity of short-term investments, their credit quality, or both.
    (a) How the reform options would seek to achieve the goals.
    (1) Internalize liquidity costs of investors' redemptions, 
particularly in stress periods. Some options would impose a cost on 
redeeming investors that rises as liquidity stress increases to reflect 
the costs of redemptions for the fund. These options, particularly 
swing pricing and the MBR, could reduce or eliminate first-mover 
advantages for redeeming investors and protect investors who do not 
redeem.
    (2) Decouple regulatory thresholds from consequences such as gates, 
fees, or a sudden drop in NAV. Some options, such as those that revise 
fee and gate thresholds or introduce the floating NAV for retail prime 
and tax-exempt MMFs, could eliminate or diminish the importance of 
thresholds (such as 30 percent WLA or an NAV of $0.995) that may spur 
investor redemptions. By diminishing the importance of thresholds, 
these options could also give MMFs greater flexibility, for example, to 
tap their own liquid assets to meet redemptions.
    (3) Improve MMFs' ability to use available liquidity in times of 
stress. In March 2020, some prime and tax-exempt MMFs may have avoided 
using their liquid assets to meet redemptions. Options such as 
countercyclical WLA requirements or revisions to fee and gate 
thresholds could make MMFs more comfortable in deploying their liquid 
assets in times of stress.
    (4) Commit private resources ex ante to enable MMFs to withstand 
liquidity stress or a credit crisis. When prime and tax-exempt MMFs 
have encountered serious strains, official sector interventions have 
followed quickly. Options such as capital buffers, explicit sponsor 
support, and the LEB could provide committed private resources to 
supply liquidity or absorb losses and thus reduce the likelihood that 
official sector support would be needed to calm markets.
    (5) Further improve liquidity and portfolio risk management. 
Changes to liquidity management requirements could include raising 
required liquid-asset buffers. Other options could motivate more 
conservative risk management by explicitly making fund sponsors or 
others responsible for absorbing any heightened liquidity needs or 
losses in their MMFs.
    (6) Clarify that MMF investors, rather than taxpayers, bear market 
risks. Government support has repeatedly provided emergency liquidity 
to prime and tax-exempt funds and also has obscured the risks of 
liquidity and credit shocks for MMFs. Some options, such as the 
floating NAV for retail prime and tax-exempt MMFs, swing pricing, and 
the MBR could make risks to investors more apparent.
    (b) Effects on short-term funding markets. The reform options are 
intended to reduce the structural vulnerabilities of MMFs, which could 
make them a more stable source of short-term funding for financial 
institutions, businesses, and state and local governments. This would 
improve

[[Page 8948]]

the stability and resilience of short-term funding markets.
    At the same time, some of the reform options would likely diminish 
the size of prime and tax-exempt MMFs, which would also affect the 
functioning of short-term funding markets. A shrinkage of MMFs could 
reduce the supply of short-term funding for financial institutions, 
businesses, and state and local governments. Making prime and tax-
exempt MMFs less desirable as cash-management vehicles also could cause 
investors to move to less regulated and less transparent mutualized 
cash-management vehicles that are also susceptible to runs that cause 
stress in short-term funding markets.
    A reduction in the size of prime and tax-exempt MMFs may not 
necessarily be inappropriate if, for example, the growth of these funds 
has reflected in part the effects of implicit taxpayer subsidies and 
other externalities (that is, broader economic costs of runs that are 
not borne by investors or the funds). In addition, if these MMFs remain 
run prone, a reduction in the size of the industry could mitigate the 
effects of future runs from these funds on short-term funding markets.
    The aftermath of the 2014 MMF reforms provides a precedent for the 
consequences of a substantial reduction in the size of prime and tax-
exempt funds, although a future experience could differ. In the year 
before the October 2016 implementation deadline for those reforms, 
aggregate prime MMF assets shrank by $1.2 trillion (69 percent) and 
tax-exempt MMF assets declined about $120 billion (47 percent). 
Nonetheless, to the extent that spreads for instruments held by these 
MMFs were affected, they generally widened only temporarily, and 
investor migration to other mutualized cash-management vehicles was 
largely limited to shifts to government MMFs. (Over the next three 
years, prime MMFs regained about half of the 2015-2016 decline.)
    These considerations are important, because some of the reform 
options could reduce the size of the prime and tax-exempt fund sectors 
by:
    <bullet> Reducing attractiveness of prime and tax-exempt MMFs for 
investors. The costs associated with some options, such as capital 
buffers and LEB membership, may reduce the funds' yields. The MBR would 
limit the liquidity of their shares in some circumstances. The floating 
NAV requirement and swing pricing would make NAVs more volatile and MMF 
shares less cash-like. And investors may view some policies, such as 
swing pricing and the MBR, as unfamiliar, restrictive, and complicated.
    <bullet> Increasing costs associated with MMF sponsorship. Some 
options, such as the introduction of capital buffers, required LEB 
membership, and explicit sponsor support, could raise operating costs 
for sponsors. Other options, such as swing pricing and MBR, may also 
have sizable implementation costs. Increased costs and operational 
complexity could lead to increased concentration and a reduction in the 
overall size of the MMF industry.
    (c) Potential drawbacks, limitations, and challenges specific to 
each option. Evaluation of the reform options also should take into 
account potential drawbacks, limitations, and challenges of each 
option, such as implementation challenges or limits on an option's 
ability to achieve the desired goals. The report discusses these 
considerations for each option below.
    Several specific policy options are described below, along with a 
high-level analysis of the potential benefits and drawbacks of each 
option.

A. Removal of Tie Between MMF Liquidity and Fee and Gate Thresholds

    Liquidity fees and redemption gates are intended to give MMF boards 
tools to stem heavy redemptions by imposing a fee to reduce 
shareholders' incentives to redeem or by stopping redemptions 
altogether for a period of time. Currently, MMF boards have discretion 
to impose fees or gates when WLAs fall below 30 percent of total assets 
and generally must impose a fee of 1 percent if WLAs fall below 10 
percent, unless the board determines that such a fee would not be in 
the best interest of the fund or that a lower or higher (up to 2 
percent) liquidity fee is in the best interests of the fund.
    Definitive thresholds for permissible imposition of liquidity fees 
and redemption gates may have the unintended effect of triggering 
preemptive investor redemptions as funds approach the relevant 
thresholds. Some preliminary research suggests that redemptions 
accelerated in March 2020 from funds with declining WLAs.\43\ Removing 
the tie between the 30 percent and 10 percent WLA thresholds and the 
imposition of fees and gates is one possible reform. Fund boards could 
be permitted to impose fees or gates when doing so is in the best 
interest of the fund, without reference to any specific level of 
liquidity.
---------------------------------------------------------------------------

    \43\ See footnote 32, above.
---------------------------------------------------------------------------

    Potential benefits:
    <bullet> Removing the tie between the WLA thresholds and funds' 
ability to impose gates and fees would reduce the salience of these 
thresholds and could diminish the incentive for preemptive runs.
    <bullet> This may improve the usability of WLA buffers by making 
MMFs more comfortable in deploying their liquid assets in times of 
stress.
    Potential drawbacks, limitations, and challenges:
    <bullet> While this option would remove a focal point that may 
trigger runs, it would do little otherwise to mitigate run incentives.
    <bullet> If MMFs maintain fewer liquid assets (by holding WLA 
levels closer to 30 percent) as a result of this change, the funds may 
be less equipped to manage significant redemptions without engaging in 
fire sales.
    <bullet> Permitting funds to impose fees or gates without reference 
to a specific threshold may cause broader contagion if investors fear 
the imposition of fees or gates in other funds that otherwise would 
have been seen as safe.

B. Reform of Conditions for Imposing Redemption Gates

    Reforming rules regarding redemption gates to reduce the likelihood 
that gates may be imposed could diminish investors' incentives to 
engage in preemptive runs. For example, funds could be required to 
obtain permission from the SEC or notify the SEC prior to imposing 
gates. Alternatively, fund boards could be required to consider 
liquidity fees before gates, making it less likely that gates would be 
imposed. Another option could be to lower the WLA threshold at which 
gates could be imposed to, for example, 10 percent.
    Gate rules also could be reformed to make gates ``soft'' or 
``partial.'' With soft gates, for example, if redemptions on a 
particular day exceed a certain amount, a fund could reduce each 
investor's redemption pro rata to bring total redemptions below that 
amount, with remaining redemption amounts deferred to the next business 
day (and continuing daily deferrals until all redemption requests are 
satisfied). This affords investors at least some liquidity, in contrast 
to the complete curtailment of liquidity when a fund suspends all 
redemptions.
    Potential benefits:
    <bullet> Reforming the rules around gates might reduce concerns 
that gates will be imposed immediately upon a breach of the 30 percent 
WLA requirement and reduce the salience of that threshold, particularly 
if investors are more concerned about gates than fees.
    <bullet> Gates could still be imposed, but only in very dire 
conditions when runs on funds are likely anyway.

[[Page 8949]]

    <bullet> This may improve the usability of WLA buffers by making 
MMFs more comfortable in deploying their liquid assets in times of 
stress.
    <bullet> A ``soft'' or ``partial'' gate could reduce disruptions 
caused by the imposition of a gate by allowing shareholders to redeem a 
portion of shares as normal, with a portion held for a limited time to 
help the fund slow the rate of redemptions during stress periods 
without engaging in fire sales.
    Potential drawbacks, limitations, and challenges:
    <bullet> If thresholds remain, they could still be focal points for 
runs on MMFs.
    <bullet> While this option could reduce the salience of a threshold 
that may trigger runs, it would do little otherwise to mitigate run 
incentives.
    <bullet> Reducing the likelihood that a gate may be imposed could 
reduce the potential utility of gates as a tool to slow investor 
redemptions.
    <bullet> Providing the SEC a role in granting permission for 
imposition of gates may result in less timely action than the current 
framework involving the MMF's board, particularly if multiple MMFs seek 
SEC permission in a short period of time, which could allow runs to 
continue or accelerate. Absent a threshold, it could be challenging to 
develop objective criteria in advance for quickly approving or denying 
such requests in a consistent and appropriate manner amid a fast-moving 
crisis.
    <bullet> If MMFs maintain fewer liquid assets (by holding WLA 
levels closer to 30 percent) as a result of this change, the funds may 
be less equipped to manage significant redemptions without engaging in 
fire sales.
    <bullet> Like other gates, a ``soft'' (or ``partial'') gate may 
spur preemptive runs, but a soft gate may be less effective at slowing 
runs than a full gate, as investors can continue to redeem even after a 
soft gate has been imposed.
    <bullet> ``Soft'' or ``partial'' gates could introduce accounting 
and administrative complexities.

C. Minimum Balance at Risk

    An MBR is a portion of each shareholder's recent balances in a MMF 
that would be available for redemption only with a time delay to ensure 
that redeeming investors still remain partially invested in the fund 
over a certain time period. As such, even if the investor redeems all 
of her available shares, she would still share in any losses incurred 
by the fund during that timeframe. A ``strong form'' of MBR would also 
put a portion of redeeming investors' MBRs first in line to absorb any 
losses, which creates a disincentive to redeem. The size of the MBR 
would be a specified fraction of the shareholder's maximum recent 
balance (less an exempted amount). An MBR mechanism could be used in a 
floating NAV fund to allocate losses only under certain rare 
circumstances, such as when the fund suffers a large drop in NAV or is 
closed.
    Potential benefits:
    <bullet> A properly calibrated ``strong'' MBR could reduce the 
vulnerability of MMFs to runs.
    <bullet> A strong MBR can internalize the liquidity costs of 
investors' redemptions and thus reduce or eliminate the first-mover 
advantage for redeeming investors. It would do so by subordinating a 
portion of their shares to put them at greater risk if the fund suffers 
a loss. This can weigh against incentives to redeem in a stress event, 
so it can be particularly helpful as liquidity costs rise.\44\
---------------------------------------------------------------------------

    \44\ See, for example, FSOC Proposed Recommendations; Patrick E. 
McCabe, Marco Cipriani, Michael Holscher, and Antoine Martin, ``The 
Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks 
Posed by Money Market Funds,'' Brookings Papers on Economic Activity 
(Spring 2013), available at https://www.brookings.edu/wp-content/uploads/2016/07/2013a_mccabe.pdf.
---------------------------------------------------------------------------

    <bullet> The disincentive to redeem created by an MBR strengthens 
mechanically as stresses increase and put subordinated shares at 
greater risk. Hence, the MBR does not create a threshold effect that 
might spur redemptions.
    <bullet> Under a strong form of MBR, the subordinated shares of 
redeeming investors provide extra loss absorption to protect the 
investments of non-redeeming investors.
    <bullet> An MBR could provide more transparency to shareholders 
regarding their risk, as shareholders' account information could 
include their balances and the size of their MBRs.
    Potential drawbacks, limitations, and challenges:
    <bullet> The MBR could present implementation and administration 
challenges. For example, MMFs, intermediaries, and service providers 
would need to update systems to: (1) Compute the MBR on an ongoing 
basis for each shareholder account and update the allocation of 
unrestricted, holdback, or subordinated holdback shares for each 
account to reflect any additional subscriptions or redemptions and the 
passage of time; and (2) prevent a shareholder from redeeming holdback 
or subordinated holdback shares in transaction processing systems.\45\ 
In addition, a ``strong form'' of MBR may create the need to convert 
existing MMF shares or issue new subordinated shares to comply with 
typical state law limitations on allocating losses to a subset of 
shares in a single share class.
---------------------------------------------------------------------------

    \45\ Many MMF investors hold their shares through intermediaries 
(such as broker-dealers, banks, trust companies, and retirement plan 
administrators) that establish omnibus accounts with the fund. An 
intermediary's omnibus account aggregates shares held on behalf of 
its underlying clients or beneficiaries, and the fund does not have 
access to information about these underlying clients or 
beneficiaries. As a result, intermediaries would be involved in 
implementing MBR reforms.
---------------------------------------------------------------------------

    <bullet> An MBR mechanism may have different and unequal effects on 
investors in stable NAV and floating NAV MMFs. During the holdback 
period, investors in a stable NAV MMF would only experience losses if 
the fund breaks the buck, but investors in a floating NAV MMF are 
always exposed to changes in the fund's NAV and would continue to be 
exposed to such risk for any shares held back.
    <bullet> The MBR is an unfamiliar concept in the fund industry that 
may result in investor discomfort or confusion, particularly when it is 
first introduced.
    <bullet> Calibrating the appropriate size for an MBR could be a 
challenge; an MBR that is too small may not create sufficient 
disincentives to redeem in stress events, but one that is too large 
would unnecessarily reduce the liquidity of the fund's shares.

D. Money Market Fund Liquidity Management Changes

    MMFs currently are subject to daily and weekly liquid asset 
requirements and must disclose the amount of daily and weekly liquid 
assets each day on the fund's website. Changes to liquidity management 
requirements could include a new category of liquidity requirements. 
For example, instead of focusing solely on daily and weekly liquid 
assets, creating an additional category for assets with slightly longer 
maturities (e.g., biweekly liquid assets) could strengthen funds' near-
term portfolio liquidity when short-term funding markets become 
stressed.
    As another alternative, an additional threshold, such as a WLA 
threshold of 40 percent, could be set to augment current liquidity 
buffers. If a fund's WLAs fell below this threshold, penalties such as 
requiring the escrow of fund management fees until the level of WLA is 
restored could be imposed on fund managers, rather than investors. This 
effectively would require funds to maintain a larger amount of WLAs 
than currently required.
    Potential benefits:
    <bullet> An additional tier of liquidity may make MMFs more 
resilient to significant redemptions by ensuring they maintain assets 
that will soon become WLAs. Additional liquidity requirements also

[[Page 8950]]

could limit ``barbell'' strategies (where a fund offsets its short-term 
assets with riskier longer-term assets that enhance returns but 
increase the riskiness of the fund's portfolio).
    <bullet> Rules to penalize fund managers first for having 
inadequate portfolio liquidity have the potential to diminish the 
salience of WLA thresholds to investors by ensuring that initial 
consequences for crossing the thresholds are not imposed directly on 
investors.
    Potential drawbacks, limitations, and challenges:
    <bullet> Requiring funds to purchase additional near-term liquid 
assets or maintain larger WLAs to avoid penalties might encourage funds 
to take greater risks in the less liquid parts of their portfolios, 
particularly in a low interest rate environment, absent other measures 
to constrain this behavior.
    <bullet> Imposing the escrow of fees or other penalties on fund 
managers if WLAs do not meet a new higher minimum requirement could 
further diminish the usability of WLA buffers by making MMFs less 
comfortable in deploying their liquid assets in times of stress.
    <bullet> Further increases in liquid asset requirements may provide 
funds only a little extra time during a run, as institutional prime 
fund outflows exceeded 5 percent of assets per day at the height of the 
run in March 2020.
    <bullet> Additional liquid asset requirements for MMFs could 
heighten roll-over risks for issuers of short-term debt that may see 
more demand for issuance in shorter tenors. In addition, to the extent 
that new investors would replace MMFs in the tenors outside the near-
term liquidity requirements, transparency regarding the nature of these 
investors may be lower.
    <bullet> It is not clear whether the required escrow of fees or 
other penalties could be imposed on fund managers in a way that would 
not also affect MMF investors (e.g., fund managers may respond by 
reducing the amount of fees they waive).
    Additional considerations:
    <bullet> Funds that purchase additional near-term liquid assets or 
maintain larger WLAs to avoid penalties may generate lower yield 
compared to similar investment products, which may reduce investor 
demand for such funds. As noted above, a reduction in the size of the 
prime and tax-exempt MMF sectors could affect the resilience and 
functioning of short-term funding markets in a variety of ways.

E. Countercyclical Weekly Liquid Asset Requirements

    During the market stress in March 2020, prime and tax-exempt MMFs 
that were close to the 30 percent WLA threshold may have avoided using 
their liquid assets to meet redemptions. MMFs' incentives to maintain 
WLAs well above the 30 percent minimum, even in the face of significant 
outflows, may include the desires to avoid: (1) Prohibitions on 
purchasing assets that are not WLAs; (2) raising investor concerns 
about the potential imposition of fees or gates; and (3) potential 
scrutiny resulting from public disclosure of low WLA amounts. A 
countercyclical WLA requirement could reduce some or all of these 
concerns. Under this approach, minimum WLA requirements could 
automatically decline in certain circumstances, such as when net 
redemptions are large or when the SEC provides temporary relief from 
WLA requirements. Any thresholds linked to a fund's minimum WLA 
requirements (e.g., fee or gate thresholds) would also move with the 
minimum.
    Potential benefits:
    <bullet> A countercyclical WLA requirement could reduce the 
salience of the 30 percent WLA threshold and may lessen redemption 
pressures when a fund is near that threshold.
    <bullet> This may improve the usability of WLA buffers by making 
MMFs more comfortable in deploying their liquid assets in times of 
stress.
    Potential drawbacks, limitations, and challenges:
    <bullet> Funds that reduce WLAs in stress events would be less 
equipped to manage additional redemptions without engaging in fire 
sales.
    <bullet> Even if the WLA threshold is reduced, threshold effects 
may still motivate investors to redeem. In addition, investors may 
still prefer to redeem from funds that are approaching or breaching the 
standard 30 percent threshold, and reduced WLA minimums may in fact 
call attention to potential stress and prompt greater investor 
outflows.
    <bullet> The benefits of this change for funds' use of liquid 
assets may be modest, as current rules do not preclude funds from using 
WLAs to meet redemptions or prohibit funds from allowing their WLAs to 
fall below 30 percent.
    <bullet> Appropriately calibrating a countercyclical WLA 
requirement, including determining whether it would be an automatic 
mechanism or one that the SEC has to adjust in a crisis, could be 
challenging.

F. Floating NAVs for All Prime and Tax-Exempt Money Market Funds

    Retail prime MMFs and retail tax-exempt MMFs currently can use a 
rounded NAV and value portfolio assets at their amortized cost, which 
permits the funds to sell and redeem shares at a stable share price 
(e.g., $1.00) without regard to small variations in the value of the 
securities in their portfolios. A floating NAV requirement would ensure 
that these MMFs instead sell and redeem their shares at a price that 
reflects the market value of a fund's portfolio and any changes in that 
value. This would be consistent with floating NAV requirements that 
currently apply to institutional prime and institutional tax-exempt 
MMFs. Although this option would only affect retail MMFs, those funds 
had large outflows in March 2020, and outflows likely would have 
continued or worsened without official sector intervention.\46\
---------------------------------------------------------------------------

    \46\ Retail prime MMFs and tax-exempt MMFs were under stress 
during March 2020, with one tax-exempt MMF receiving sponsor 
support, although stress among retail funds was less severe than 
that for institutional prime MMFs. See Section III.B, above 
(explaining that outflows from retail prime funds totaled 9 percent 
(or just over $40 billion) of assets during the two weeks from March 
13 to 26, and outflows from tax-exempt MMFs--which are largely 
retail funds--were 8 percent ($11 billion) of assets during the two 
weeks from March 12 to 25).
---------------------------------------------------------------------------

    Potential benefits:
    <bullet> The floating NAV eliminates the salience of a MMF's NAV 
dropping more than 0.5 percent ($0.995). Unlike stable NAV funds, MMFs 
with floating NAVs cannot ``break the buck.''
    <bullet> Stable NAVs can create an incentive to redeem when MMF 
portfolios assets lose value because redeeming investors can receive 
more for their shares than they are worth, while losses are 
concentrated among non-redeeming investors. In contrast, a floating NAV 
mitigates that incentive to redeem as losses are spread across all 
shareholders on a pro rata basis whether they redeem or not. Thus, a 
floating NAV requirement may decrease retail prime and tax-exempt MMFs' 
vulnerabilities to runs by mitigating the first mover advantage for 
redeeming investors.
    <bullet> Floating NAVs make portfolio risks more transparent by 
making fluctuations in share values readily observable, which could 
better align investors' expectations with the risks of portfolio 
holdings.
    Potential drawbacks, limitations, and challenges:
    <bullet> A floating NAV requirement would not affect institutional 
MMFs, which have historically been the most vulnerable to runs but 
already have floating NAVs.

[[Page 8951]]

    <bullet> Institutional prime MMFs with floating NAVs still 
experienced runs in March; floating NAVs do not prevent runs.
    Additional considerations:
    <bullet> Floating NAVs could result in a reduction in the size of 
retail prime and retail tax-exempt MMF sectors by making retail MMF 
shares less cash-like, which could reduce investor demand. As noted 
above, a reduction in the size of the prime and tax-exempt MMF sectors 
could affect the resilience and functioning of short-term funding 
markets in a variety of ways.

G. Swing Pricing Requirement

    Under current rules, MMF investors redeeming their shares in a 
prime or tax-exempt fund typically do not incur the costs associated 
with this redemption activity. Instead, these costs are largely borne 
by other investors in the fund, and this contributes to a first-mover 
advantage for those who redeem quickly in a crisis. Swing pricing 
effectively allows a fund to impose the costs stemming from redemptions 
directly on redeeming investors by adjusting the fund's NAV downward 
when net redemptions exceed a threshold.\47\ That is, when the NAV 
``swings'' down, redeeming investors receive less for their shares. A 
swing pricing requirement could help ensure that redeeming shareholders 
bear liquidity costs throughout market cycles (i.e., not only in times 
of market stress). In the United States, an optional swing pricing 
framework is permissible for certain mutual funds, but not for MMFs. 
Although swing pricing is largely untested for MMFs, it has been 
helpful for other types of non-U.S. mutual funds.\48\
---------------------------------------------------------------------------

    \47\ If a fund has net inflows above the swing threshold, swing 
pricing would instead adjust the fund's NAV upward.
    \48\ See, for example, Jin, Dunhong, Marcin Kacperczyk, Bige 
Kahraman, an Felix Suntheim, ``Swing Pricing and Fragility in Open-
end Mutual Funds,'' IMF Working Paper WP/19/227 (2019); Association 
of the Luxembourg Fund Industry, Swing Pricing Updae 2015 (Dec. 
2015) (``ALFI Survey 2015'') at 21, available at http://www.alfi.lu/sites/alfi.lu/files/ALFI-Swing-Pricing-Survey-2015-FINAL.pdf.
---------------------------------------------------------------------------

    Potential benefits:
    <bullet> A properly calibrated swing pricing mechanism could reduce 
the vulnerability of MMFs to runs.
    <bullet> Swing pricing can internalize the liquidity costs of 
investors' redemptions and thus reduce or eliminate the first-mover 
advantage for redeeming investors. By making redemptions costly, swing 
pricing can weigh against incentives to redeem in a stress event, so it 
can be particularly helpful as liquidity costs rise. Swing pricing also 
benefits investors who do not redeem by reducing dilution to the value 
of a fund's shares and insulating these investors from the effects of 
others' redemption activity.
    <bullet> Swing pricing can improve long-run fund performance by 
reducing dilution.
    <bullet> If swing pricing is available (and used occasionally) in 
``normal'' times, its use can help investors understand that they bear 
liquidity risks in a MMF. Moreover, regular deployment of swing pricing 
would make its use in stress events less unsettling for investors.
    Potential drawbacks, limitations, and challenges:
    <bullet> Eligible U.S. mutual funds have yet to implement swing 
pricing, largely because implementation would require substantial 
reconfiguration of current distribution and order-processing practices. 
MMFs could face similar challenges.
    <bullet> Unlike other mutual funds, some MMFs strike their NAVs 
more than once per day and allow intraday purchases and redemptions for 
any orders received prior to a given NAV strike. The potential 
management of swing pricing considerations multiple times per day could 
be particularly challenging in times of market stress.
    <bullet> It may be challenging to design and calibrate a swing 
pricing mechanism that can effectively internalize liquidity costs for 
redeeming investors, especially during stress events.

H. Capital Buffer Requirements

    Capital (or ``NAV'') buffers, which could be structured in a 
variety of ways, can provide dedicated resources within or alongside a 
fund to absorb losses and can serve to absorb fluctuations in the value 
of a fund's portfolio, reducing the cost to taxpayers in case of a 
run.\49\ For a floating NAV fund, capital buffers could be reserved to 
absorb the fund's losses only under certain rare circumstances, such as 
when it suffers a large drop in NAV or is closed.
---------------------------------------------------------------------------

    \49\ See, for example, Craig M. Lewis, ``Money Market Fund 
Capital Buffers,'' (April 6, 2015), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2687687; Samuel G. 
Hanson, David S. Scharfstein, and Adi Sunderam, ``An Evaluation of 
Money Market Fund Reform Proposals,'' (May 2014), available at 
https://www.imf.org/external/np/seminars/eng/2013/mmi/pdf/Scharfstein-Hanson-Sunderam.pdf.
---------------------------------------------------------------------------

    Potential benefits:
    <bullet> A capital buffer adds ex ante loss-absorption capacity to 
a MMF that would mitigate MMF shareholders' risk of losses and their 
incentives to redeem in a stress event.
    <bullet> A buffer would mitigate the MMF industry's reliance on 
discretionary, ex post sponsor support by assuring that MMFs already 
have resources in place to absorb losses.
    <bullet> Owners of capital will have incentives to mitigate risk-
taking by the fund. For example, if capital is provided by the fund's 
sponsor, the sponsor will have an explicit incentive to manage 
portfolio risks to preserve the capital.
    Potential drawbacks, limitations, and challenges:
    <bullet> A capital buffer financed from unaffiliated investors 
could be complex to administer.
    <bullet> Sizable capital buffers are costly to finance, and 
building adequate capital buffers from MMF income could take 
substantial time, particularly in a low interest rate environment, and 
could disadvantage current MMF investors for the benefit of future MMF 
investors.
    <bullet> Calibrating the appropriate size for a capital buffer 
could be a challenge; MMFs would continue to be vulnerable if the 
buffer is too small, but one that is too large would be unnecessarily 
costly.
    <bullet> A capital requirement could increase MMF industry 
concentration because provision of initial capital would be a 
substantial burden for some asset managers and could cause them to exit 
the industry. In addition, such a requirement may favor bank-sponsored 
funds.
    Additional considerations:
    <bullet> The costs of financing a capital buffer would be borne by 
MMF sponsors and investors, and these costs could result in a reduction 
in the size of the prime and tax-exempt MMF sectors. As noted above, a 
reduction in the size of these MMFs could affect the resilience and 
functioning of short-term funding markets in a variety of ways.

I. Require Liquidity Exchange Bank Membership

    To provide a liquidity backstop during periods of market stress, 
prime and tax-exempt MMFs could be required to be members of a private 
liquidity exchange bank. The LEB would be a chartered bank. Under one 
LEB proposal, MMF members and their sponsors would capitalize the LEB 
through initial contributions and ongoing commitment fees. During times 
of market stress, the LEB would purchase eligible assets from MMFs that 
need cash, up to a maximum amount per fund. The LEB would not be 
intended to provide credit support.
    Potential benefits:
    <bullet> The existence of a liquidity backstop provided by an LEB 
could diminish investors' incentives to run.
    <bullet> An LEB would commit private resources, including bank 
capital, ex ante to provide liquidity to MMFs. This

[[Page 8952]]

framework could partially internalize the costs of liquidity protection 
for the MMF industry and reduce distortions that can arise from an 
expectation of official sector support in times of stress.
    <bullet> Chartered banks generally have access to Federal Reserve 
liquidity through the discount window, although the duration and extent 
of access is not guaranteed. To the extent that the LEB has access to 
the discount window, that access may further mitigate liquidity 
pressures on MMFs and reduce the likelihood of fire sales.
    <bullet> Pooling liquidity resources for MMFs may offer efficiency 
gains. An LEB would provide liquidity to MMFs that need it, rather than 
requiring each MMF to hold liquidity separately.
    Potential drawbacks, limitations, and challenges:
    <bullet> Access to the LEB backstop during times of market stress, 
without further consideration of risk management measures, could have 
moral hazard effects that motivate some funds to take greater risks in 
the less-liquid parts of their portfolios.
    <bullet> The LEB, which would not provide traditional banking 
services, is not intended to operate as a commercial bank, and 
commercial banks are not organized to buy assets from entities facing 
financial difficulties. As such, it is unclear whether such an entity 
would be able to obtain a banking charter.
    <bullet> Access to the discount window by the LEB is not 
guaranteed, particularly in the size and term that may be needed to 
provide material liquidity support to MMFs under stress.
    <bullet> To the extent that liquidity provided by the Federal 
Reserve exceeds what is provided to a typical commercial bank, the LEB 
would not be significantly different from other types of historical 
official sector support.
    <bullet> As a bank, the LEB would be subject to supervision and 
regulation, including restrictions on transactions with affiliate 
funds.\50\ In addition, investors in the LEB may themselves become bank 
holding companies. If an investor became a bank holding company, it 
would be subject to consolidated supervision and regulation, and would 
be required to serve as a source of strength to the LEB.\51\
---------------------------------------------------------------------------

    \50\ 12 U.S.C. 371c; 12 CFR 223.
    \51\ 12 U.S.C. 1841 et seq.
---------------------------------------------------------------------------

    <bullet> The LEB would need significant capital to both be in a 
position to provide meaningful liquidity for MMFs in stress events and 
be seen as a credible liquidity backstop. Building adequate capacity 
from MMF income could take several years, particularly in a low 
interest rate environment. Moreover, the need to comply with applicable 
leverage-based capital requirements on a continuous basis--even during 
periods of peak usage under stress--could render the LEB's lending 
capacity insufficiently robust in extremis.
    <bullet> News that an LEB is running out of capacity could 
accelerate runs.
    <bullet> Requiring fund sponsors to provide initial capital for an 
LEB would likely favor large and bank-affiliated sponsors and could 
cause some others to exit the industry, thus increasing industry 
concentration.
    <bullet> Administering an LEB may raise complex governance and 
fairness concerns, particularly in times of stress.
    Additional considerations:
    <bullet> Requiring membership in an LEB likely would impose a cost 
on sponsors and reduce yields for investors, both of which could result 
in a reduction in the size of the prime and tax-exempt MMF sectors. As 
noted above, a reduction in the size of these MMFs could affect the 
resilience and functioning of short-term funding markets in a variety 
of ways.

J. New Requirements Governing Sponsor Support

    In times of market stress, sponsor support has been a tool for 
stabilizing MMF share prices and providing liquidity. Support of funds 
was relatively common during the 2008 financial crisis as a number of 
MMF sponsors purchased large amounts of portfolio securities from their 
MMFs or provided capital support to their MMFs.\52\ However, the 
discretionary nature of sponsor support contributes to uncertainty 
about who will bear risks in periods of stress, including when there is 
a run on a MMF. Moreover, the inability of one sponsor to provide 
support for a distressed fund accelerated the run on MMFs in September 
2008. Currently, sponsors may provide support to MMFs under certain 
conditions established by rule 17a-9 under the Act, and must make 
public disclosure of any ``financial support'' to increase transparency 
about sponsor involvement.\53\ However, bank sponsors are subject to 
limits on transactions with affiliates under section 23A of the Federal 
Reserve Act. In March, the Federal Reserve, in conjunction with the 
FDIC and OCC, provided temporary relief from these restrictions.\54\ 
The SEC staff also issued a temporary no-action letter in March to 
permit the purchase of certain MMF securities by an affiliate where 
reliance on rule 17a-9 could conflict with sections 23A and 23B of the 
Federal Reserve Act.\55\
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    \52\ See SEC 2014 Reforms, at paragraph accompanying footnote 
53; 2010 PWG Report. A sponsor may also provide support when the 
fund is not under stress. As one example, a sponsor may provide 
support in a form of capital contribution to maintain a fund's 
stable NAV when liquidating a fund that experienced small losses as 
assets matured.
    \53\ See Investment Company Act rule 17a-9 [17 CFR 270.17a-9]; 
SEC Form N-CR, Part C; and SEC Form N-MFP, Item C.18.
    \54\ See Letters dated March 17, 2020, available at https://www.federalreserve.gov/supervisionreg/legalinterpretations/fedreserseactint20200317.pdf.
    \55\ See Letter to Susan Olson, Investment Company Institute 
(March 19, 2020), available at https://www.sec.gov/investment/investment-company-institute-031920-17a.
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    A regulatory framework governing sponsor support could clarify who 
bears MMF risks by establishing when a sponsor would be required to 
provide support.\56\
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    \56\ This reform could also include changes to obviate the need 
for future SEC staff no-action letters relating to the interaction 
of rule 17a-9 and certain banking law provisions, which may provide 
more certainty with respect to sponsor support.
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    Potential benefits:
    <bullet> Explicit sponsor support, similar to a capital buffer, 
would commit private resources ex ante to absorb losses, mitigate risks 
to MMF shareholders, and reduce their incentives to redeem in a stress 
event.
    <bullet> Similar to a capital buffer financed by MMF sponsors, 
explicit sponsor support could strengthen sponsors' incentives to 
reduce portfolio risks.
    Potential drawbacks, limitations, and challenges:
    <bullet> Making sponsor support for MMFs explicit would favor bank-
sponsored funds and would likely increase MMF industry concentration.
    <bullet> Making support explicit would require new official sector 
oversight to ensure that sponsors have resources to provide support.
    Additional considerations:
    <bullet> Formalizing sponsor support would impose an expected cost 
on sponsors and likely would cause them to charge higher fees to 
investors, which could lead to a reduction in the size of the prime and 
tax-exempt MMF sectors. At the same time, explicit support could boost 
demand for these funds by making them less risky. As noted above, 
changes in the size of these MMFs could affect the resilience and 
functioning of short-term funding markets in a variety of ways.

[FR Doc. 2021-02704 Filed 2-9-21; 8:45 am]
BILLING CODE 8011-01-P


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