68636 Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 

14 15 U.S.C. 78q(d)(1). 

15 17 CFR 240.17d–2. 16 17 CFR 200.30–3(a)(34). 

by § 17(d) of the Act, and Rule 17d–2 

thereunder. 

24. Counterparts. This Agreement 

may be executed in any number of 

counterparts, including facsimile, each 

of which will be deemed an original, but 

all of which taken together shall 

constitute one single agreement among 

the Participating Organizations. 

* * * * * 

EXHIBIT A 

COVERED REGULATION NMS RULES 

SEA Rule 611(a)—Order Protection 

Rule.—Reasonable Policies and 

Procedures. 

SEA Rule 611(b)—Order Protection 

Rule.—Exceptions. 

SEA Rule 612—Minimum Pricing 

Increment. 

III. Date of Effectiveness of the 

Proposed Plan and Timing for 

Commission Action 

Pursuant to Section 17(d)(1) of the 

Act 14 and Rule 17d–2 thereunder,15

after November 29, 2010, the 

Commission may, by written notice, 

declare the proposed Plan, File No. 4– 

618, to be effective if the Commission 

finds that the plan is necessary or 

appropriate in the public interest and 

for the protection of investors, to foster 

cooperation and coordination among 

self-regulatory organizations, or to 

remove impediments to and foster the 

development of the national market 

system and a national system for the 

clearance and settlement of securities 

transactions and in conformity with the 

factors set forth in Section 17(d) of the 

Act. 

IV. Solicitation of Comments 

In order to assist the Commission in 

determining whether to approve the 

proposed 17d–2 Plan and to relieve the 

Participating Organizations of the 

responsibilities which would be 

assigned to FINRA, interested persons 

are invited to submit written data, 

views, and arguments concerning the 

foregoing. Comments may be submitted 

by any of the following methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/other.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number 4–618 on the subject line. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

Station Place, 100 F Street, NE., 

Washington, DC 20549–1090. 

All submissions should refer to File 

Number 4–618. This file number should 

be included on the subject line if e-mail 

is used. To help the Commission 

process and review your comments 

more efficiently, please use only one 

method. The Commission will post all 

comments on the Commission’s Internet 

Web site (http://www.sec.gov/rules/ 

other.shtml). Copies of the submission, 

all subsequent amendments, all written 

statements with respect to the proposed 

plan that are filed with the Commission, 

and all written communications relating 

to the proposed plan between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, on official business 

days between the hours of 10 a.m. and 

3 p.m. Copies of the plan also will be 

available for inspection and copying at 

the principal offices of the Participating 

Organizations. All comments received 

will be posted without change; the 

Commission does not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. All submissions 

should refer to File Number 4–618 and 

should be submitted on or before 

November 29, 2010. 

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.16

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. 2010–28185 Filed 11–5–10; 8:45 am] 

BILLING CODE 8011–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[File No. 500–1] 

8000, Inc.; Order of Suspension of 

Trading 

November 4, 2010. 

It appears to the Securities and 

Exchange Commission that there is a 

lack of current and accurate information 

concerning the securities of 8000, Inc. 

because of questions regarding the 

accuracy of statements made by 8000, 

Inc. in press releases concerning, among 

other things, a cash dividend the 

company announced it would pay 

stockholders and Monk’s Den, an 

investment program and online investor 

network the company disclosed it 

acquired in September 2010. 

The Commission is of the opinion that 

the public interest and the protection of 

investors require a suspension of trading 

in the securities of 8000, Inc. 

Therefore, it is ordered, pursuant to 

Section 12(k) of the Securities Exchange 

Act of 1934, that trading in the 

securities of the above-listed company is 

suspended for the period from 9:30 a.m. 

EDT on November 4, 2010, through 

11:59 p.m. EST on November 17, 2010. 

By the Commission. 

Jill M. Peterson, 

Assistant Secretary. 

[FR Doc. 2010–28241 Filed 11–4–10; 4:15 pm] 

BILLING CODE 8011–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. IC–29497; File No. 4–619] 

President’s Working Group Report on 

Money Market Fund Reform 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Request for comment. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’ or ‘‘SEC’’) is 

seeking comment on the options 

discussed in the report presenting the 

results of the President’s Working Group 

on Financial Markets’ study of possible 

money market fund reforms. Public 

comments on the options discussed in 

this report will help inform 

consideration of reform proposals 

addressing money market funds’ 

susceptibility to runs. 

DATES: Comments should be received on 

or before January 10, 2011. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/other.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number 4–619 on the subject line; or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number 4–619. This file number should 


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1The members of the PWG include the Secretary 

of the Treasury Department (as chairman of the 

PWG), the Chairman of the Board of Governors of 

the Federal Reserve System, the Chairman of the 

SEC, and the Chairman of the Commodity Futures 

Trading Commission. 

2The Report is also available at http://treas.gov/ 

press/releases/docs/ 

10.21%20PWG%20Report%20Final.pdf. 

3 Money Market Fund Reform, Investment 

Company Act Release No. 29132 (Feb. 23, 2010) [75 

FR 10060 (Mar. 4, 2010)] (‘‘SEC Adopting Release’’). 

4The new rules further limit the credit, liquidity, 

and interest rate risks money market funds may 

assume and require fund managers to stress test 

their portfolios against potential economic shocks. 

They also require money market funds to improve 

their disclosure to investors and the Commission 

and provide a means to wind down the operations 

of a fund that ‘‘breaks the buck’’ or suffers a run, 

in an orderly way that is fair to the fund’s investors 

and reduces the risk of market losses that could 

spread to other funds. For a discussion of the 

market stresses experienced by money market funds 

in 2007 and 2008, see Money Market Fund Reform, 

Investment Company Act Release No. 28807 (June 

30, 2009) [74 FR 32688 (July 8, 2009)], at section 

II.D (‘‘SEC Proposing Release’’). 

5See SEC Adopting Release, supra note 3, at 

section I. In proposing the new rules, we had 

requested comment on additional, more 

fundamental regulatory changes, including several 

of those discussed in the Report. See SEC Proposing 

Release, supra note 4, at section III. Following the 

adoption of the new rules, the Commission has 

continued to explore more significant changes in 

light of the comments received on that release and 

through our staff’s work within the PWG. 

6 In particular, the Report notes that reforms may 

be needed to avoid migration of institutional money 

market fund assets into unregulated or less 

regulated money market investment vehicles. 

Without new restrictions on such investment 

vehicles, money market reform may motivate some 

investors to shift assets into money market fund 

substitutes that may pose greater systemic risk than 

registered money market funds. See section 3.h of 

the Report. 

be included on the subject line if e-mail 

is used. To help us process and review 

your comments more efficiently, please 

use only one method. The Commission 

will post all comments on the 

Commission’s Internet Web site (http:// 

www.sec.gov/rules/other.shtml). 

Comments are also available for Web 

site 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 am and 3 pm. 

All comments received will be posted 

without change; we do not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Daniele Marchesani or Sarah ten 

Siethoff 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 

Following the recommendation in the 

U.S. Department of the Treasury’s 2009 

paper on Financial Regulatory Reform: 

A New Foundation, the President’s 

Working Group on Financial Markets 

(‘‘PWG’’) conducted a study of possible 

reforms that might mitigate money 

market funds’ susceptibility to runs.1

The results of this study are included in 

the report issued on October 21, 2010 

and attached to this release as an 

Appendix (the ‘‘Report’’).2

The Report expresses support for the 

new rules regulating money market 

funds that the Commission approved 

last February.3 These new rules seek to 

better protect money market fund 

investors in times of financial market 

turmoil and lessen the possibility that 

money market funds will not be able to 

withstand stresses similar to those 

experienced in 2007 and 2008.4 When 

we adopted these rules, we recognized 

that they were a first step to addressing 

regulatory concerns as the events of 

2007 and 2008 raised the question of 

whether further, more fundamental 

changes to the regulatory structure 

governing money market funds may be 

warranted.5

The Report identifies the features that 

make money market funds susceptible 

to runs as well as the systemic 

implications of the run on prime money 

market funds that occurred in 

September 2008. The Report states that 

the Commission’s new rules alone could 

not be expected to prevent a run of the 

type experienced in September 2008. 

Accordingly, the Report outlines 

possible reforms that could supplement 

the new rules we adopted and, 

individually or in combination, further 

reduce money market funds’ 

susceptibility to runs and the related 

systemic risk. Some of the measures 

discussed in the Report could be 

implemented by the Commission under 

our existing statutory authority; others 

would require new legislation, 

coordination by multiple government 

agencies, or the creation of new private 

entities.6

II. Request for Comment 

The Commission requests comment 

on the Report. Comments received will 

better enable the Commission and the 

newly-established Financial Stability 

Oversight Council (which will be taking 

over the work of the PWG in this area) 

to consider the options discussed in this 

Report to identify those most likely to 

materially reduce money market funds’ 

susceptibility to runs and to pursue 

their implementation. As the Report 

states, we anticipate that following the 

comment period a series of meetings 

will be held in Washington, DC with 

various stakeholders, interested persons, 

experts, and regulators to discuss the 

options in the Report. 

We request comments on the options 

described in the Report both 

individually and in combination. 

Commenters should address the 

effectiveness of the options in mitigating 

systemic risks associated with money 

market funds, as well as their potential 

impact on money market fund investors, 

fund managers, issuers of short-term 

debt and other stakeholders. We also are 

interested in comments on other issues 

commenters believe are relevant to 

further money market fund reform, 

including other approaches for 

lessening systemic risk not identified in 

the Report. We urge commenters to 

submit empirical data and other 

information in support of their 

comments. 

Dated: November 3, 2010. 

By the Commission. 

Elizabeth M. Murphy, 

Secretary. 

BILLING CODE 8011–01–P 


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BILLING CODE 8011–01–C 


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Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 68639 

7The PWG (established by Executive Order 

12631) is comprised of the Secretary of the Treasury 

(who serves as its Chairman), the Chairman of the 

Federal Reserve Board of Governors, the Chairman 

of the Securities and Exchange Commission, and 

the Chairman of the Commodity Futures Trading 

Commission. 

Table of Contents 

Executive Summary 

1. Introduction and Background 

a. Money Market Funds 

b. MMFs’ Susceptibility to Runs 

c. MMFs in the Recent Financial Crisis 

2. The SEC’s Changes to the Regulation of 

MMFs 

a. SEC Regulatory Changes 

b. Need for Further Reform To Reduce 

Susceptibility to Runs 

3. Policy Options for Further Reducing the 

Risks of Runs on MMFs 

a. Floating Net Asset Values 

b. Private Emergency Liquidity Facility for 

MMFs 

c. Mandatory Redemptions in Kind 

d. Insurance for MMFs 

e. A Two-Tier System of MMFs, With 

Enhanced Protections for Stable NAV 

MMFs 

f. A Two-Tier System of MMFs, With 

Stable NAV MMFs Reserved for Retail 

Investors 

g. Regulating Stable NAV MMFs as Special 

Purpose Banks 

h. Enhanced Constraints on Unregulated 

MMF Substitutes 

Executive Summary 

Several key events during the 

financial crisis underscored the 

vulnerability of the financial system to 

systemic risk. One such event was the 

September 2008 run on money market 

funds (MMFs), which began after the 

failure of Lehman Brothers Holdings, 

Inc., caused significant capital losses at 

a large MMF. Amid broad concerns 

about the safety of MMFs and other 

financial institutions, investors rapidly 

redeemed MMF shares, and the cash 

needs of MMFs exacerbated strains in 

short-term funding markets. These 

strains, in turn, threatened the broader 

economy, as firms and institutions 

dependent upon those markets for shortterm financing found credit increasingly 

difficult to obtain. Forceful government 

action was taken to stop the run, restore 

investor confidence, and prevent the 

development of an even more severe 

recession. Even so, short-term funding 

markets remained disrupted for some 

time. 

The Treasury Department proposed in 

its Financial Regulatory Reform: A New 

Foundation (2009), that the President’s 

Working Group on Financial Markets 

(PWG) prepare a report on fundamental 

changes needed to address systemic risk 

and to reduce the susceptibility of 

MMFs to runs. Treasury stated that the 

Securities and Exchange Commission’s 

(SEC) rule amendments to strengthen 

the regulation of MMFs—which were in 

development at the time and which 

subsequently have been adopted— 

should enhance investor protection and 

mitigate the risk of runs. However, 

Treasury also noted that those rule 

changes could not, by themselves, be 

expected to prevent a run on MMFs of 

the scale experienced in September 

2008. While suggesting a number of 

areas for review, Treasury added that 

the PWG should consider ways to 

mitigate possible adverse effects of 

further regulatory changes, such as the 

potential flight of assets from MMFs to 

less regulated or unregulated vehicles. 

This report by the PWG responds to 

Treasury’s call.7 The PWG undertook a 

study of possible further reforms that, 

individually or in combination, might 

mitigate systemic risk by 

complementing the SEC’s changes to 

MMF regulation. The PWG supports the 

SEC’s recent actions and agrees with the 

SEC that more should be done to 

address MMFs’ susceptibility to runs. 

This report details a number of options 

for further reform that the PWG requests 

be examined by the newly established 

Financial Stability Oversight Council 

(FSOC). These options range from 

measures that could be implemented by 

the SEC under current statutory 

authorities to broader changes that 

would require new legislation, 

coordination by multiple government 

agencies, and the creation of new 

private entities. For example, a new 

requirement that MMFs adopt floating 

net asset values (NAVs) or that large 

funds meet redemption requests in kind 

could be accomplished by SEC rule 

amendments. In contrast, the 

introduction of a private emergency 

liquidity facility, insurance for MMFs, 

conversion of MMFs to special purpose 

banks, or a two-tier system of MMFs 

that might combine some of the other 

measures likely would involve a 

coordinated effort by the SEC, bank 

regulators, and financial firms. 

Importantly, this report also 

emphasizes that the efficacy of the 

options presented herein would be 

enhanced considerably by the 

imposition of new constraints on less 

regulated or unregulated MMF 

substitutes, such as offshore MMFs, 

enhanced cash funds, and other stable 

value vehicles. Without new restrictions 

on such investment vehicles, which 

would require legislation, new rules that 

further constrain MMFs may motivate 

some investors to shift assets into MMF 

substitutes that may pose greater 

systemic risk than MMFs. 

The PWG requests that the FSOC 

consider the options discussed in this 

report to identify those most likely to 

materially reduce MMFs’ susceptibility 

to runs and to pursue their 

implementation. To assist the FSOC in 

any analysis, the SEC, as the regulator 

of MMFs, will solicit public comments, 

including the production of empirical 

data and other information in support of 

such comments. A notice and request 

for comment will be published in the 

near future. Following a comment 

period, a series of meetings will be held 

in Washington, DC with various 

stakeholders, interested persons, 

experts, and regulators. 

MMFs Are Susceptible to Runs 

MMFs are mutual funds. They are 

investment vehicles that act as 

intermediaries between shareholders 

who desire liquid investments and 

borrowers who seek term funding. With 

nearly $3 trillion in assets under 

management, MMFs are important 

providers of credit to businesses, 

financial institutions, and governments. 

In addition, these funds are significant 

investors in some short-term funding 

markets. 

Like other mutual funds, MMFs are 

regulated under the Investment 

Company Act of 1940 (ICA). In addition 

to ICA requirements for all mutual 

funds, MMFs must comply with SEC 

rule 2a–7, which permits these funds to 

maintain a stable net asset value (NAV) 

per share, typically $1. However, if the 

mark-to-market per-share value of a 

fund’s assets falls more than one-half of 

1 percent (to below $0.995), the fund 

must reprice its shares, an event 

colloquially known as ‘‘breaking the 

buck.’’ 

The events of September 2008 

demonstrated that MMFs are susceptible 

to runs. In addition, those events proved 

that runs on MMFs not only harm fund 

shareholders, but may also cause severe 

dislocations in short-term funding 

markets that curtail short-term financing 

for companies and financial institutions 

and that ultimately result in a decline in 

economic activity. Thus, reducing the 

susceptibility of MMFs to runs and 

mitigating the effects of possible runs 

are important components of the overall 

policy goals of decreasing and 

containing systemic risks. 

MMFs are vulnerable to runs because 

shareholders have an incentive to 

redeem their shares before others do 

when there is a perception that the fund 

might suffer a loss. Several features of 

MMFs, their sponsors, and their 

investors contribute to this incentive. 

For example, although a stable, rounded 

$1 NAV fosters an expectation of safety, 

MMFs are subject to credit, interest-rate, 

and liquidity risks. Thus, when a fund 


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incurs even a small loss because of 

those risks, the stable, rounded NAV 

may subsidize shareholders who choose 

to redeem at the expense of the 

remaining shareholders. A larger loss 

that causes a fund’s share price to drop 

below $1 per share (and thus break the 

buck) may prompt more substantial 

sudden, destabilizing redemptions. 

Moreover, although the expectations of 

safety fostered by the stable, rounded $1 

NAV suggest parallels to an insured 

demand deposit account, MMFs have no 

formal capital buffers or insurance to 

prevent NAV declines; MMFs instead 

have relied historically on discretionary 

sponsor capital support to maintain 

stable NAVs. Accordingly, uncertainty 

about the availability of such support 

during crises may contribute to runs. 

Finally, because investors have come to 

view MMFs as extremely safe vehicles 

that meet all withdrawal requests on 

demand (and that are, in this sense, 

similar to banks), MMFs have attracted 

highly risk-averse investors who are 

particularly prone to flight when they 

perceive the possibility of a loss. These 

features likely mutually reinforce each 

other in times of crisis. 

The SEC’s New Rules 

In January 2010, the SEC adopted new 

rules for MMFs in order to make these 

funds more resilient and less likely to 

break the buck. The regulatory changes 

that mitigate systemic risks fall into 

three principal categories. First, the new 

rules enhance risk-limiting constraints 

on MMF portfolios by introducing new 

liquidity requirements, imposing 

additional credit-quality standards, and 

reducing the maximum allowable 

weighted average maturity of funds’ 

portfolios. Funds also are required to 

stress test their ability to maintain a 

stable NAV. Second, the SEC’s new 

rules permit a fund that is breaking the 

buck to suspend redemptions promptly 

and liquidate its portfolio in an orderly 

manner to limit contagion effects on 

other funds. Third, the new rules place 

more stringent constraints on 

repurchase agreements that are 

collateralized with private debt 

instruments rather than government 

securities. 

The Need for Further Measures 

The SEC’s new rules make MMFs 

more resilient and less risky and 

therefore reduce the likelihood of runs 

on MMFs, increase the size of runs that 

MMFs can withstand, and mitigate the 

systemic risks they pose. However, the 

SEC’s new rules address only some of 

the features that make MMFs 

susceptible to runs, and more should be 

done to address systemic risk and the 

structural vulnerabilities of MMFs to 

runs. Indeed, the Chairman of the SEC 

characterized the new rules as ‘‘a first 

step’’ in strengthening MMFs, and 

Treasury’s Financial Regulatory Reform: 

A New Foundation (2009) anticipated 

that measures taken by the SEC ‘‘should 

not, by themselves, be expected to 

prevent a run on MMFs of the scale 

experienced in September 2008.’’ 

Mitigating the risk of runs on MMFs 

is especially important because the 

events of September 2008 may have 

created an expectation that, in a future 

crisis, the government may provide 

support for MMFs at minimal cost in 

order to minimize harm to MMF 

investors, short-term funding markets, 

and the economy. Persistent 

expectations of unpriced government 

support distort incentives in the MMF 

industry and pricing in short-term 

funding markets, as well as heighten the 

systemic risk posed by MMFs. It is thus 

essential that MMFs be required to 

internalize fully the costs of liquidity or 

other risks associated with their 

operation. 

In formulating reforms for MMFs, 

policymakers should aim primarily at 

mitigating systemic risk and containing 

the contagious effect that strains at 

individual MMFs can have on other 

MMFs and on the broad financial 

system. Importantly, preventing any 

individual MMF from ever breaking the 

buck is not a practical policy objective— 

though the new SEC rules for MMFs 

should help ensure that such events 

remain rare and thus constitute a 

limited means of containing systemic 

risk. 

Policy Options 

The policy options discussed in this 

report may help further mitigate the 

susceptibility of MMFs to runs. Some of 

these options may be adopted by the 

SEC under its existing authorities. 

Others would require legislation and 

action by multiple government agencies 

and the MMF industry. 

(a) Floating net asset values. A stable 

NAV has been a key element of the 

appeal of MMFs to investors, but a 

stable, rounded NAV also heightens 

funds’ vulnerability to runs. Moving to 

a floating NAV would help remove the 

perception that MMFs are risk-free and 

reduce investors’ incentives to redeem 

shares from distressed funds. However, 

the elimination of the stable NAV for 

MMFs would be a dramatic change for 

a nearly $3 trillion asset-management 

sector that has been built around the 

stable share price. Such a change may 

have several unintended consequences, 

including: (i) Reductions in MMFs’ 

capacity to provide short-term credit 

due to lower investor demand; (ii) a 

shift of assets to less regulated or 

unregulated MMF substitutes such as 

offshore MMFs, enhanced cash funds, 

and other stable value vehicles; and 

(iii) unpredictable investor responses as 

MMF NAVs begin to fluctuate more 

frequently. 

(b) Private emergency liquidity 

facilities for MMFs. The liquidity risk of 

MMFs contributes importantly to their 

vulnerability to runs, and an external 

liquidity backstop to augment the SEC’s 

new liquidity requirements for MMFs 

would help mitigate this risk. Such a 

backstop could buttress MMFs’ ability 

to withstand outflows, internalize much 

of the liquidity protection costs for the 

MMF industry, offer efficiency gains 

from risk pooling, and reduce contagion 

effects. A liquidity facility would 

preserve fund advisers’ incentives for 

not taking excessive risks because it 

would not protect funds from capital 

losses. As such, a liquidity facility alone 

may not prevent broader runs on MMFs 

triggered by concerns about widespread 

credit losses. Importantly, significant 

capacity, structure, pricing, and 

operational hurdles would have to be 

overcome to ensure that such a facility 

would be effective during crises, that it 

would not unduly distort incentives, 

and that it would not favor certain types 

of MMF business models. 

(c) Mandatory redemptions in kind. 

When investors make large redemptions 

from MMFs, they may impose liquidity 

costs on other shareholders in the fund 

by forcing MMFs to sell assets in an 

untimely manner. A requirement that 

MMFs distribute large redemptions in 

kind, rather than in cash, would force 

these redeeming shareholders to bear 

their own liquidity costs and thus 

reduce the incentive to redeem. 

Depending on whether redeeming 

shareholders immediately sell the 

securities received, redemptions in kind 

may still generate market effects. 

Moreover, mandating redemptions in 

kind could present some operational 

and policy challenges. The SEC, for 

example, would have to make key 

judgments regarding when a fund must 

redeem in kind and how funds would 

fairly distribute portfolio securities. 

(d) Insurance for MMFs. Treasury’s 

Temporary Guarantee Program for 

Money Market Funds helped slow the 

run on MMFs in September 2008, and 

some form of insurance for MMF 

shareholders might be helpful in 

mitigating the risk of runs in MMFs. 

Unlike a private liquidity facility, 

insurance would limit credit losses to 

shareholders, so appropriate risk-based 

pricing would be critical in preventing 

insurance from distorting incentives, 


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but such pricing might be difficult to 

achieve in practice. The appropriate 

scope of coverage also presents a 

challenge; unlimited coverage would 

likely cause large shifts of assets from 

the banking sector to MMFs, but limited 

insurance might do little to reduce 

institutional investors’ incentives to run 

from distressed MMFs. The optimal 

form for insurance—whether it would 

be private, public, or a mix of the two— 

is also uncertain, particularly given the 

recent experience with private financial 

guarantees. 

(e) A two-tier system of MMFs with 

enhanced protection for stable NAV 

funds. Reforms aimed at reducing 

MMFs’ susceptibility to runs may be 

particularly effective if they permit 

investors to select the types of MMFs 

that best balance their appetite for risk 

and their preference for yield. 

Policymakers could allow two types of 

MMFs: Stable NAV funds, which would 

be subject to enhanced protections such 

as, for example, required participation 

in a private liquidity facility or 

enhanced regulatory requirements; and 

floating NAV funds, which would have 

to comply with certain, but not all, rule 

2a–7 restrictions (and which would 

presumably offer higher yields). Because 

this two-tier system would permit stable 

NAV funds to continue to be available, 

it would reduce the likelihood of a 

substantial decline in demand for MMFs 

and large-scale shifts of assets toward 

unregulated vehicles. At the same time, 

the forms of protection encompassed by 

such a system would mitigate the risks 

associated with stable NAV funds. It 

would also avoid problems that might 

be encountered in transitioning the 

entire MMF industry to a floating NAV. 

Moreover, during a crisis, a two-tier 

system might prevent large shifts of 

assets out of MMFs—and a reduction in 

credit supplied by the funds—if 

investors simply shift assets from riskier 

floating NAV funds toward safer 

(because of the enhanced protections) 

stable NAV funds. However, 

implementation of such a two-tier 

system would present the same 

challenges as the introduction of any 

individual enhanced protections (such 

as mandated access to a private 

emergency liquidity facility) that would 

be required for stable NAV funds, and 

the effectiveness of a two-tier system 

would depend on investors’ 

understanding the risks associated with 

each type of fund. 

(f) A two-tier system of MMFs with 

stable NAV MMFs reserved for retail 

investors. Another approach to the twotier system already described could 

distinguish funds by investor type: 

Stable NAV MMFs could be made 

available only to retail investors, who 

could choose between stable NAV and 

floating NAV funds, while institutional 

investors would be restricted to floating 

NAV funds. The run on MMFs in 

September 2008 was almost exclusively 

due to redemptions from prime MMFs 

by institutional investors. Such 

investors typically have generated 

greater cash-flow volatility for MMFs 

than retail investors and have been 

much quicker to redeem MMF shares 

from stable NAV funds 

opportunistically. Hence, this approach 

would mitigate risks associated with a 

stable NAV by addressing the investor 

base of stable NAV funds rather than by 

mandating other types of enhanced 

protections for those funds. Such a 

system also would protect the interests 

of retail investors by reducing the 

likelihood that a run might begin in 

institutional MMFs (as it did in 

September 2008) and spread to retail 

funds, while preserving the original 

purpose of MMFs, which was to provide 

retail investors with cost-effective, 

diversified investments in money 

market instruments. This approach 

would require the SEC to define who 

would qualify as retail and institutional 

investors, and distinguishing those 

categories will present challenges. In 

addition, a prohibition on sales of stable 

NAV MMFs shares to institutional 

investors may have several of the same 

unintended consequences as a 

requirement that all MMFs adopt 

floating NAVs (see option (a) in this 

section). 

(g) Regulating stable NAV MMFs as 

special purpose banks. Functional 

similarities between MMF shares and 

bank deposits, as well as the risk of runs 

on both, provide a rationale for 

requiring stable NAV MMFs to 

reorganize as special purpose banks 

(SPBs) subject to banking oversight and 

regulation. As banks, MMFs could have 

access to government insurance and 

lender-of-last-resort facilities. An 

advantage of such a reorganization 

could be that it uses a well-understood 

regulatory framework for the mitigation 

of systemic risk. But while the 

conceptual basis for this option is fairly 

straightforward, its implementation 

might take a broad range of forms and 

would probably require legislation 

together with interagency coordination. 

An important hurdle for successful 

conversion of MMFs to SPBs may be the 

very large amounts of equity necessary 

to capitalize the new banks. In addition, 

to the extent that deposits in the new 

SPBs would be insured, the potential 

government liabilities through deposit 

insurance would be increased 

substantially, and the development of 

an appropriate pricing scheme for such 

insurance would present some of the 

same challenges as the pricing of 

deposit insurance. More broadly, the 

possible interactions between the new 

SPBs and the existing banking system 

would have to be studied carefully by 

policymakers. 

(h) Enhanced constraints on 

unregulated MMF substitutes. New 

measures intended to mitigate MMF 

risks may also reduce the appeal of 

MMFs to many investors. While it is 

likely that some (particularly retail) 

investors may move their assets from 

MMFs to bank deposits if regulation of 

MMFs becomes too burdensome and 

meaningfully reduces MMF returns, 

others may be motivated to shift assets 

to unregulated funds with stable NAVs, 

such as offshore MMFs, enhanced cash 

funds, and other stable value vehicles. 

Such funds, which typically hold assets 

similar to those held by MMFs, are 

vulnerable to runs but are less 

transparent and less constrained than 

MMFs, so their growth would likely 

pose systemic risks. Hence, effective 

mitigation of this risk may require 

policy reforms targeting regulatory 

arbitrage. Reforms of this type generally 

would require legislation and action by 

the SEC and other agencies. 

1. Introduction and Background 

a. Money Market Funds 

MMFs are mutual funds that offer 

individuals, businesses, and 

governments a convenient and costeffective means of pooled investing in 

money market instruments. MMFs 

provide an economically important 

service by acting as intermediaries 

between shareholders who desire liquid 

investments, often for cash 

management, and borrowers who seek 

term funding. 

With nearly $3 trillion in assets under 

management, MMFs are important 

providers of credit to businesses, 

financial institutions, and governments. 

Indeed, these funds play a dominant 

role in some short-term credit markets. 

For example, MMFs own almost 40 

percent of outstanding commercial 

paper, roughly two-thirds of short-term 

state and local government debt, and 

significant portions of outstanding 

short-term Treasury and federal agency 

securities. 

Like other mutual funds, MMFs are 

regulated under the Investment 

Company Act of 1940 (ICA). In addition 

to the requirements applicable to other 

funds under the ICA, MMFs must 

comply with rule 2a–7, which permits 

these funds to maintain a ‘‘stable’’ net 


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8Under the Federal Deposit Insurance 

Corporation’s (FDIC) Temporary Liquidity 

Guarantee Program, coverage limits on noninterestbearing transaction deposits in FDIC-insured 

institutions were temporarily lifted beginning in 

October 2008 and coverage will extend through 

2010. Effective December 31, 2010, pursuant to the 

Dodd-Frank Wall Street Reform and Consumer 

Protection Act, Public Law 111–203, (‘‘Dodd-Frank 

Act’’), all noninterest-bearing transaction deposits 

will have unlimited coverage until January 1, 2013. 

In addition, section 627 of the Dodd-Frank Act 

repeals the prohibition on banks paying interest on 

corporate demand deposit accounts effective July 

21, 2011. 

9Section 1(c) contains more detail on the MMF 

industry’s experience during the recent financial 

crisis. 

asset value (NAV) per share, typically 

$1, through the use of the ‘‘amortized 

cost’’ method of valuation. Under this 

method, securities are valued at 

acquisition cost, with adjustments for 

amortization of premium or accretion of 

discount, instead of at fair market value. 

To prevent substantial deviations 

between the $1 share price and the 

mark-to-market per-share value of the 

fund’s assets (its ‘‘shadow NAV’’), a 

MMF must periodically compare the 

two. If there is a difference of more than 

one-half of 1 percent (or $0.005 per 

share), the fund must re-price its shares, 

an event colloquially known as 

‘‘breaking the buck.’’ 

Historically, the stable NAV has 

played an important role in 

distinguishing MMFs from other mutual 

funds and in facilitating the use of 

MMFs as cash management vehicles. 

Rule 2a–7 also imposes credit-quality, 

maturity, and diversification 

requirements on MMF portfolios 

designed to ensure that the funds’ 

investing remains consistent with the 

objective of maintaining a stable NAV. 

A MMF’s $1 share price is not 

guaranteed through any form of deposit 

or other insurance, or otherwise— 

indeed, MMF prospectuses must state 

that shares can lose value. However, by 

permitting amortized cost valuation, 

rule 2a–7 affords MMFs price stability 

under normal market conditions. 

MMFs pursue a range of investment 

objectives, with corresponding 

differences in portfolio composition. For 

example, tax-exempt MMFs purchase 

short-term municipal securities and 

offer tax-exempt income to fund 

shareholders, while Treasury-only 

MMFs hold only obligations of the U.S. 

Treasury. In contrast, prime MMFs 

invest largely in private debt 

instruments, such as commercial paper 

and certificates of deposit, and, 

commensurate with the greater risks in 

prime MMF portfolios, they generally 

pay higher yields than Treasury-only 

funds. 

MMFs are marketed both to retail 

investors (that is, individuals), for 

whom MMFs are the only means of 

investing in many money market 

instruments, and to institutions, which 

are often attracted by the convenience 

and cost efficiency of MMFs, even 

though many institutional investors 

have the ability to invest directly in the 

instruments held by MMFs. Institutional 

MMFs, which currently account for 

about two-thirds of the assets under 

management in MMFs, have grown 

much faster, on net, in the past two 

decades than retail funds. The rapid 

growth of institutional funds has 

important implications for the MMF 

industry, because institutional funds 

tend to have more volatile flows and 

more yield-sensitive shareholders than 

retail funds. 

MMFs compete with other stablevalue, low-risk investments. Because 

MMFs generally maintain stable NAVs, 

offer redemptions on demand, and often 

provide services that compete with 

those offered to holders of insured 

deposits (such as transactions services), 

many retail customers likely consider 

MMF shares and bank deposits as near 

substitutes, even if the two classes of 

products are fundamentally different 

(most notably because MMF shares are 

not insured and because MMFs and 

banks are subject to very different 

regulatory regimes). Some institutional 

investors may also view bank deposits 

and MMFs as near substitutes, although 

usual limitations on deposit insurance 

coverage and interest payments on 

deposits likely reduce the attractiveness 

of bank deposits for most such 

investors.8 Institutional investors also 

have access to less-regulated MMF 

substitutes (for example, offshore 

MMFs, enhanced cash funds, and other 

stable value vehicles) and may perceive 

them as near substitutes for MMFs, even 

if those vehicles are not subject to the 

protections afforded by rule 2a–7. 

b. MMFs’ Susceptibility to Runs 

In the twenty-seven years since the 

adoption of rule 2a–7, only two MMFs 

have broken the buck. In 1994, a small 

MMF suffered a capital loss because of 

exposures to interest rate derivatives, 

but the event passed without significant 

repercussions. In contrast, as further 

discussed later, when the Reserve 

Primary Fund broke the buck in 

September 2008, it helped ignite a 

massive run on prime MMFs that 

contributed to severe dislocations in 

short-term credit markets and strains on 

the businesses and institutions that 

obtain funding in those markets.9

Although the run on MMFs in 2008 is 

itself unique in the history of the 

industry, the events of 2008 

underscored the susceptibility of MMFs 

to runs. That susceptibility arises 

because, when shareholders perceive a 

risk that a fund will suffer losses, each 

shareholder has an incentive to redeem 

shares before other shareholders. Five 

features of MMFs, their sponsors, and 

their investors principally contribute to 

this incentive: 

(i) Maturity transformation with 

limited liquidity resources. One 

important economic function of MMFs 

is their role as intermediaries between 

shareholders who want liquid 

investments and borrowers who desire 

term funding. As such, MMFs offer 

shares that are payable on demand, but 

they invest both in cash-like 

instruments and in short-term securities 

that are less liquid, including, for 

example, term commercial paper. 

Redemptions in excess of MMFs’ cashlike liquidity may force funds to sell 

less liquid assets. When money markets 

are strained, funds may not be able to 

obtain full value (that is, amortized cost) 

for such assets in secondary markets 

and may incur losses as a consequence. 

Investors thus have an incentive to 

redeem shares before a fund has 

depleted its cash-like instruments 

(which serve as its liquidity buffer). 

(ii) NAVs rounded to $1. Share prices 

of MMFs are rounded to the nearest 

cent, typically resulting in a $1 NAV per 

share. The rounding fosters an 

expectation that MMF share prices will 

not fluctuate, which exacerbates 

investors’ incentive to run when there is 

risk that prices will fluctuate. When a 

MMF that has experienced a small (less 

than one-half of 1 percent) capital loss 

redeems shares at the full $1 NAV, it 

concentrates the loss among the 

remaining shareholders. Thus, 

redemptions from such a fund further 

depress the market value of its assets 

per share outstanding (its shadow NAV), 

and redemptions of sufficient scale may 

cause the fund to break the buck. Early 

redeemers are therefore more likely to 

receive the usual $1 NAV than those 

who wait. 

(iii) Portfolios exposed to credit and 

interest rate risks. MMFs invest in 

securities with credit and interest-rate 

risks. Although these risks are generally 

small given the short maturity of the 

securities and the high degree of 

portfolio diversification, even a small 

capital loss, in combination with other 

features of MMFs, can trigger a 

significant volume of redemptions. The 

events of September 2008—when losses 

on Lehman Brothers Holdings, Inc. 

(Lehman Brothers) debt instruments 

caused just one MMF to break the buck 

and triggered a broad run on MMFs— 

highlight the fact that credit losses at 


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10Souring credits and rapid increases in interest 

rates have adversely affected MMFs on other 

occasions. For example, beginning in the summer 

of 2007, MMF exposures to structured investment 

vehicles and other asset-backed commercial paper 

caused capital losses at many MMFs, and many 

MMF sponsors voluntarily provided capital support 

that prevented some funds from breaking the buck. 

11For example, more than 100 MMFs received 

sponsor capital support in 2007 and 2008 because 

of investments in securities that lost value and 

because of the run on MMFs in September and 

October 2008. See Securities and Exchange 

Commission (2009) ‘‘Money Market Reform: 

Proposed Rule,’’ pp. 13–14, 17, and notes 38 and 54. 

12Even discretionary support for MMFs may lead 

to concerns about the safety and soundness of MMF 

sponsors. Sponsors that foster expectations of such 

support may be granting a form of implicit recourse 

that is not reflected on sponsors’ balance sheets or 

in their regulatory capital ratios, and such implicit 

recourse may contribute to broader systemic risk. 

13Other forms of discretionary financial support, 

such as that provided by dealers for auction rate 

securities, did not fare well during the financial 

crisis. 

even a single fund may have serious 

implications for the whole industry and 

consequently for the entire financial 

system.10

(iv) Discretionary sponsor capital 

support. MMFs invest in assets that may 

lose value, but the funds have no formal 

capital buffers or insurance to maintain 

their $1 share prices in the event of a 

loss on a portfolio asset. 

The MMF industry’s record of 

maintaining a stable NAV reflects, in 

part, substantial discretionary 

intervention by MMF sponsors (that is, 

fund advisers, their affiliates, and their 

parent firms) to support funds that 

otherwise might have broken the 

buck.11 Sponsors do not commit to 

support an MMF in advance, because an 

explicit commitment may require the 

sponsor to consolidate the fund on its 

balance sheet and—if the sponsor is 

subject to regulatory capital 

requirements—hold additional 

regulatory capital against the contingent 

exposure. Nor is there any requirement 

that sponsors support ailing MMFs; 

such a mandate would transform the 

nature of MMF shares by shifting risks 

from investors to sponsors and probably 

would require government supervision 

and monitoring of sponsors’ resources 

and capital adequacy.12 Instead, sponsor 

capital support remains expressly 

voluntary, and not all MMFs have a 

sponsor capable of fully supporting its 

MMFs. Nonetheless, a long history of 

such support probably has contributed 

substantially to the perceived safety of 

MMFs. 

However, the possibility that sponsors 

may become unwilling or unable to 

provide expected support during a crisis 

is itself a source of systemic risk. 

Indeed, sponsor support is probably 

least reliable when systemic risks are 

most salient.13 Moreover, MMFs 

without deep-pocketed sponsors remain 

vulnerable to runs that can affect the 

entire industry. The Reserve Primary 

Fund was not the only MMF that held 

Lehman Brothers debt at the time of the 

Lehman Brothers’ bankruptcy in 

September 2008, but it broke the buck 

because the Reserve Primary Fund, 

unlike some of its competitors, had 

substantial holdings of Lehman Brothers 

debt and Reserve did not have the 

resources to support its fund. Investors 

also recognized the riskiness of sponsor 

support more broadly during the run on 

MMFs in 2008. For example, outflows 

from prime MMFs following the 

Lehman Brothers bankruptcy tended to 

be larger among MMFs with sponsors 

that were themselves under strain (as 

measured by credit default swap 

spreads for parent firms or affiliates), 

indicating that MMF investors quickly 

redeemed shares on concerns about 

sponsors’ potential inabilities to bolster 

ailing funds. 

(v) Investors’ low risk tolerance and 

expectations. Investors have come to 

view MMF shares as extremely safe, in 

part because of the funds’ stable NAVs 

and sponsors’ record of supporting 

funds that might otherwise lose value. 

MMFs’ history of maintaining stable 

value has attracted highly risk-averse 

investors who are prone to withdraw 

assets rapidly when losses appear 

possible. 

MMFs, like other mutual funds, 

commit to redeem shares based on the 

fund’s NAV at the time of redemption. 

MMFs are under no legal or regulatory 

requirement to redeem shares at $1; rule 

2a–7 only requires that MMFs be 

managed to maintain a stable NAV. Yet 

sponsor-supported stable, rounded 

NAVs and the typical $1 MMF share 

price foster investors’ impressions that 

MMFs are extremely safe investments. 

Indeed, the growth of retail MMFs in 

recent decades may have reflected some 

substitution from insured deposits at 

commercial banks, thrifts, and credit 

unions, particularly as MMFs have 

offered transactions services and other 

bank-like functions. Although MMF 

shares, unlike bank deposits, are not 

government insured and are not backed 

by capital to absorb losses, this 

distinction may have become even less 

clear to retail investors following the 

unprecedented government support of 

MMFs in 2008 and 2009. Furthermore, 

that recent support may have left even 

sophisticated institutional investors 

with the mistaken impression that MMF 

safety is enhanced because the 

government stands ready to support the 

industry again with the same tools 

employed at the height of the financial 

crisis. 

The growth of institutional MMFs in 

recent years probably has heightened 

both the risk aversion of the typical 

MMF shareholder and the volatility of 

MMF cash flows. Many institutional 

investors cannot tolerate fluctuations in 

share prices for a variety of reasons. In 

addition, institutional investors are 

typically more sophisticated than retail 

investors in obtaining and analyzing 

information about MMF portfolios and 

risks, have larger amounts at stake, and 

hence are quicker to respond to events 

that may threaten the stable NAV. In 

fact, institutional MMFs have 

historically experienced much more 

volatile flows than retail funds. During 

the run on MMFs in September 2008, 

institutional funds accounted for more 

than 90 percent of the net redemptions 

from prime MMFs. 

The interaction of these five features 

is critical. Taken alone, each of the 

features just listed probably would only 

modestly increase the vulnerability of 

MMFs to runs, but, in combination, the 

features tend to amplify and reinforce 

one another. For example, equity 

mutual funds perform maturity 

transformation and take on capital risks, 

but even after large capital losses, 

outflows from equity funds tend to be 

small relative to assets, most likely 

because equity funds are not marketed 

for their ability to maintain stable 

NAVs, do not attract the risk-averse 

investor base that characterizes MMFs, 

and offer the opportunity for capital 

appreciation. If MMFs with rounded 

NAVs had lacked sponsor support over 

the past few decades, many might have 

broken the buck and diminished the 

expectation of a stable $1 share price. In 

that case, investors who nonetheless 

elected to hold shares in such funds 

might have become more tolerant of risk 

and less inclined to run. If MMFs had 

attracted primarily a retail investor base 

rather than an institutional base, 

investors might be slower to respond to 

strains on a MMF. And even a highly 

risk-averse investor base would not 

necessarily make MMFs susceptible to 

runs—and to contagion arising from 

runs on other MMFs—if funds had a 

credible means to guarantee their $1 

NAVs. Thus, policy responses that 

diminish the reinforcing interactions 

among the features discussed herein 

hold promise for muting overall risks 

posed by MMFs. 

c. MMFs in the Recent Financial Crisis 

The turmoil in financial markets in 

2007 and 2008 caused severe strains 

both among MMFs and in the short-term 

debt markets in which MMFs invest. 

Beginning in mid-2007, dozens of funds 

faced losses from holdings of highly 


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14MMFs that elected to participate in the program 

paid fees of 4 to 6 basis points at an annual rate 

for the guarantee. The Temporary Guarantee 

Program for Money Market Funds expired on 

September 18, 2009. 

15The AMLF expired on February 1, 2010. 

16Several other unprecedented government 

interventions that provided additional support for 

the MMF industry and for short-term funding 

markets were introduced after the run on MMFs 

had largely abated. For example, the Federal 

Reserve in October 2008 established the 

Commercial Paper Funding Facility (CPFF), which 

provided loans for purchases (through a special 

purpose vehicle) of term commercial paper from 

issuers. The CPFF, which expired on February 1, 

2010, helped issuers repay investors—such as 

MMFs—who held maturing paper. Also in October 

2008, the Federal Reserve announced the Money 

Market Investor Funding Facility (MMIFF), which 

was intended to bolster liquidity for MMFs by 

financing (through special purpose vehicles) 

purchases of securities from the funds. The MMIFF 

was never used and expired on October 30, 2009. 

In November 2008, Treasury agreed to become a 

buyer of last resort for certain securities held by the 

Reserve U.S. Government Fund (a MMF), in order 

to facilitate an orderly and timely liquidation of the 

fund. Under the agreement, Treasury would 

purchase certain securities issued by government 

sponsored enterprises at amortized cost (not mark 

to market), and $3.6 billion of such purchases were 

completed in January 2009. 

rated asset-backed commercial paper 

(ABCP) issued by structured investment 

vehicles (SIVs), some of which had 

exposures to the subprime mortgage 

market. Fear of such losses at one MMF 

caused that fund to experience a 

substantial run in August 2007, which 

was brought under control when the 

fund’s sponsor purchased more than 

$5 billion of illiquid securities from the 

fund. Indeed, financial support from 

MMF sponsors in recent years probably 

prevented a number of funds from 

breaking the buck because of losses on 

SIV paper. 

The crisis for MMFs worsened 

considerably in September 2008 with 

the bankruptcy of Lehman Brothers on 

September 15 and mounting concerns 

about other issuers of commercial paper, 

particularly financial firms. The Reserve 

Primary Fund, a $62 billion MMF, held 

$785 million in Lehman Brothers debt 

on the day of Lehman Brothers’ 

bankruptcy and immediately began 

experiencing a run—shareholders 

requested redemptions of approximately 

$40 billion in just two days. In order to 

meet the redemptions, the Reserve 

Primary Fund depleted its cash reserves 

and began seeking to sell its portfolio 

securities, which further depressed their 

valuations. Unlike other MMFs that 

held distressed securities, the Reserve 

Primary Fund had no affiliate with 

sufficient resources to support its $1 

NAV, and Reserve announced on 

September 16 that its Primary Fund 

would break the buck and re-price its 

shares at $0.97. On September 22, the 

SEC issued an order permitting the 

suspension of redemptions in certain 

Reserve MMFs to permit their orderly 

liquidation. 

The run quickly spread to other prime 

MMFs, which held sizable amounts of 

financial sector debt that investors 

feared might decline rapidly in value. 

During the week of September 15, 2008, 

investors withdrew approximately $310 

billion (15 percent of assets) from prime 

MMFs, with the heaviest redemptions 

coming from institutional funds. To 

meet these redemption requests, MMFs 

depleted their cash positions and sought 

to sell portfolio securities into already 

illiquid markets. These efforts caused 

further declines in the prices of shortterm instruments and put pressure on 

per-share values of fund portfolios, 

threatening MMFs’ stable NAVs. 

Nonetheless, only one MMF—the 

Reserve Primary Fund—broke the buck, 

because many MMF sponsors provided 

substantial financial support to prevent 

capital losses in their funds. 

Fearing further redemptions, many 

MMF advisers limited new portfolio 

investments to cash, U.S. Treasury 

securities, and overnight instruments, 

and avoided term commercial paper, 

certificates of deposit, and other shortterm credit instruments. During 

September 2008, MMFs reduced their 

holdings of commercial paper by about 

$170 billion (25 percent). As market 

participants hoarded cash and refused 

to lend to one another on more than an 

overnight basis, interest rates spiked 

and short-term credit markets froze. 

Commercial paper issuers were required 

to make significant draws on their 

backup lines of credit, placing 

additional pressure on the balance 

sheets of commercial banks. 

On September 19, 2008, Treasury and 

the Board of Governors of the Federal 

Reserve System (Federal Reserve) 

announced two unprecedented market 

interventions to stabilize MMFs and to 

provide liquidity to short-term funding 

markets. Treasury’s Temporary 

Guarantee Program for Money Market 

Funds temporarily provided guarantees 

for shareholders in MMFs that elected to 

participate in the program.14 The 

Federal Reserve’s Asset-Backed 

Commercial Paper Money Market 

Mutual Fund Liquidity Facility (AMLF) 

extended credit to U.S. banks and bank 

holding companies to finance their 

purchases of high-quality ABCP from 

MMFs.15

The announcements of these 

government programs substantially 

slowed the run on prime MMFs. 

Outflows from prime MMFs diminished 

to about $65 billion in the week after the 

announcements and, by mid-October, 

these MMFs began attracting net 

inflows. Moreover, in the weeks 

following the government interventions, 

markets for commercial paper and other 

short-term debt instruments stabilized 

considerably.16

2. The SEC’s Changes to the Regulation 

of MMFs 

The effects of the financial turmoil in 

2007 and 2008 on MMFs—and, in 

particular, the run on these funds in 

September 2008 and its consequences— 

have highlighted the need for reforms to 

mitigate the systemic risks posed by 

MMFs. Appropriate reforms include 

changes to MMF regulations as well as 

broader policy actions. This section first 

examines rule changes that have been 

adopted by the SEC to improve the 

safety and resilience of MMFs and then 

discusses some limitations in these 

measures’ mitigation of systemic risk 

and the need for further reforms. 

Notwithstanding the need for reform, 

the significance of MMFs in the U.S. 

financial system suggests that changes 

must be considered carefully. Tighter 

restrictions on MMFs might, for 

example, lead to a reduction in the 

supply of short-term credit, a shift in 

assets to substitute investment vehicles 

that are subject to less regulation than 

MMFs, and significant impairment of an 

important cash-management tool for 

investors. Moreover, the economic 

importance of risk-taking by MMFs—as 

lenders in private debt markets and as 

investments that appeal to shareholders’ 

preferences for risk and return— 

suggests that the appropriate objective 

for reform should not be to eliminate all 

risks posed by MMFs. Attempting to 

prevent any fund from ever breaking the 

buck would be an impractical goal that 

might lead, for example, to draconian 

and—from a broad economic 

perspective—counterproductive 

measures, such as outright prohibitions 

on purchases of private debt 

instruments and securities with 

maturities of more than one day. 

Instead, policymakers should balance 

the benefits of allowing individual 

MMFs to take some risks and facilitating 

private and public borrowers’ access to 

term financing in money markets with 

the broader objective of mitigating 

systemic risks—in particular, the risk 

that one fund’s problems may cause 

serious harm to other MMFs, their 

shareholders, short-term funding 

markets, the financial system, and the 

economy. 

a. SEC Regulatory Changes 

In January 2010, the SEC adopted new 

rules regulating MMFs in order to make 

these funds more resilient to market 


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17Tax-exempt money market funds are exempt 

from daily minimum liquidity requirements but not 

the weekly minimum liquidity requirements, 

because most tax-exempt fund portfolios consist of 

longer-term floating- and variable-rate securities 

with seven-day ‘‘put’’ options that effectively give 

the funds weekly liquidity. Tax-exempt funds are 

unlikely to have investment alternatives that would 

permit them to meet a daily liquidity requirement. 

18Under SEC rule 2a–7, for short-term debt 

securities to qualify as second-tier securities, they 

generally must have received the second highest 

short-term debt rating from the credit rating 

agencies or be of comparable quality. Section 939A 

of the Dodd-Frank Act requires that government 

agencies remove references to credit ratings in their 

rules and replace them with other credit standards 

that the agency determines appropriate. As a result, 

the SEC will be reconsidering this rule and its 

provisions relating to second-tier securities to 

comply with this statutory mandate. 

19For purposes of computing WAM, a floatingrate security’s ‘‘maturity’’ can be its next interestrate reset date. In computing WAL, the life of a 

security is determined solely by its final maturity 

date. Hence, WAL should be more useful than 

WAM in reflecting the risks of widening spreads on 

longer-term floating-rate securities. 

disruptions and thus less likely to break 

the buck. The new rules also might help 

reduce the likelihood of runs on MMFs 

by facilitating the orderly liquidation of 

funds that have broken the buck. The 

SEC designed the new rules primarily to 

meet its statutory obligations under the 

ICA to protect investors and promote 

capital formation. Nonetheless, the rules 

should mitigate (although not eliminate) 

systemic risks by reducing the 

susceptibility of MMFs to runs, both by 

lessening the likelihood that an 

individual fund will break the buck and 

by containing the damage should one 

break the buck. The rule changes fall 

into three principal categories. 

(i) Enhanced Risk-Limiting 

Constraints on Money Market Fund 

Portfolios. Each of the changes that 

follow further constrains risk-taking by 

MMFs. 

Liquidity Risk. One of the most 

important SEC rule changes aimed at 

reducing systemic risk associated with 

MMFs is a requirement that each fund 

maintain a substantial liquidity cushion. 

Augmented liquidity should position 

MMFs to better withstand heavy 

redemptions without selling portfolio 

securities into potentially distressed 

markets at discounted prices. Forced 

‘‘fire sales’’ to meet heavy redemptions 

may cause losses not only for the fund 

that must sell the securities, but also for 

other MMFs that hold the same or 

similar securities. Thus, a substantial 

liquidity cushion should help reduce 

the risk that strains on one MMF will be 

transmitted to other funds and to shortterm credit markets. 

Specifically, the SEC’s new rules 

require that MMFs maintain minimum 

daily and weekly liquidity positions. 

Daily liquidity, which must be at least 

10 percent of a MMF’s assets, includes 

cash, U.S. Treasury obligations, and 

securities (including repurchase 

agreements) that mature or for which 

the fund has a contractual right to 

obtain cash within a day. Weekly 

liquidity, which must be at least 30 

percent of each MMF’s assets, includes 

cash, securities that mature or can be 

converted to cash within a week, U.S. 

Treasury obligations, and securities 

issued by federal government agencies 

and government-sponsored enterprises 

with remaining maturities of 60 days or 

less.17 Furthermore, the new rules 

require MMF advisers to maintain larger 

liquidity buffers as necessary to meet 

reasonably foreseeable redemptions. 

Credit Risk. The new rules reduce 

MMFs’ maximum allowable holdings of 

‘‘second-tier’’ securities, which carry 

more credit risk than first-tier securities, 

to no more than 3 percent of each fund’s 

assets.18 In addition, a MMF’s exposure 

to a single second-tier issuer is now 

limited to one-half of 1 percent of the 

fund’s assets, and funds can only 

purchase second-tier securities with 

maturities of 45 days or less. These new 

constraints reduce the likelihood that 

individual funds will be exposed to a 

credit event that could cause the funds 

to break the buck. Also, since secondtier securities often trade in thinner 

markets, these changes should improve 

the ability of individual MMFs to 

maintain a stable NAV during periods of 

market volatility. 

Interest Rate Risk. By reducing the 

maximum allowable weighted average 

maturity (WAM) of fund portfolios from 

90 days to 60 days, the new rules are 

intended to diminish funds’ exposure to 

interest rate risk and increase the 

liquidity of fund portfolios. The SEC 

also introduced a new weighted average 

life (WAL) measure for MMFs—and set 

a ceiling for WAL at 120 days—in order 

to lower funds’ exposure to interest-rate, 

credit, and liquidity risks associated 

with the floating-rate obligations that 

MMFs commonly hold.19

Stress Testing. Finally, the SEC’s new 

rules require fund advisers to 

periodically stress test their funds’ 

ability to maintain a stable NAV per 

share based on certain hypothetical 

events, including a change in short-term 

interest rates, an increase in shareholder 

redemptions, a downgrade or default of 

a portfolio security, and a change in 

interest rate spreads. Regular and 

methodical monitoring of these risks 

and their potential effects should help 

funds weather stress without incident. 

(ii) Facilitating Orderly Fund 

Liquidations. The new SEC rules should 

reduce the systemic risk posed by 

MMFs by permitting a fund that is 

breaking the buck to promptly suspend 

redemptions and liquidate its portfolio 

in an orderly manner. This new rule 

should help prevent a capital loss at one 

fund from forcing a disorderly sale of 

portfolio securities that might disrupt 

short-term markets and diminish share 

values of other MMFs. Moreover, the 

ability of a fund to suspend redemptions 

should help prevent investors who 

redeem shares from benefiting at the 

expense of those who remain invested 

in a fund. 

(iii) Repurchase Agreements. The 

SEC’s new rules place more stringent 

constraints on repurchase agreements 

that are collateralized with private debt 

instruments rather than cash 

equivalents or government securities. 

MMFs are among the largest purchasers 

of repurchase agreements, which they 

use to invest cash, typically on an 

overnight basis. Because the collateral 

usually consists of long-term debt 

securities, a MMF cannot hold the 

securities underlying this collateral 

without violating SEC rules that limit 

MMF holdings to short-term obligations. 

Accordingly, if a significant 

counterparty fails to repurchase 

securities as stipulated in a repurchase 

agreement, its MMF counterparties can 

be expected to direct custodians to sell 

the collateral immediately, and sales of 

private debt instruments could be 

sizable and disruptive to financial 

markets. To address this risk, the SEC’s 

new rule places additional constraints 

on MMFs’ exposure to counterparties 

through repurchase agreement 

transactions that are collateralized by 

securities other than cash equivalents or 

government securities. 

b. Need for Further Reform To Reduce 

Susceptibility to Runs 

The new SEC rules make MMFs more 

resilient and less risky and therefore 

reduce the likelihood of runs on funds, 

increase the size of runs that they could 

withstand, and mitigate the systemic 

risks they pose. However, more can be 

done to address the structural 

vulnerabilities of MMFs to runs. Indeed, 

the Chairman of the SEC characterized 

its new rules as ‘‘a first step’’ in 

strengthening MMFs and noted that a 

number of additional possible reforms 

(many of which are presented in section 

3 of this report) are under discussion. 

Likewise, Treasury’s Financial 

Regulatory Reform: A New Foundation 

(2009) anticipated that measures taken 

by the SEC ‘‘should not, by themselves, 

be expected to prevent a run on MMFs 

of the scale experienced in September 

2008.’’ 


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20At the time of its bankruptcy, Lehman Brothers’ 

short-term debt was still a first-tier security, so 

MMFs were able to hold up to 5 percent of their 

assets in Lehman Brothers’ debt. The SEC’s new 

rules do not affect this limit. 

Of the five features that make MMFs 

vulnerable to runs (see section 1(b)), the 

two most directly addressed in the new 

SEC rules are liquidity risks associated 

with maturity transformation and MMF 

portfolios’ exposures to credit and 

interest-rate risks. The SEC’s new rules 

should substantially reduce these risks, 

but systemic risks arising from the other 

features of MMFs and their investors— 

the stable, rounded NAV, a system of 

discretionary sponsor support, and a 

highly risk-averse investor base—still 

remain, as do many of the amplifying 

interaction effects. Some mitigation of 

the destabilizing effects that one or a 

few MMFs can impose on the rest of the 

industry through contagion might be 

achievable through further 

modifications to rule 2a–7 and other 

SEC rules. Importantly, however, other 

reforms that could more substantially 

reduce the risk of contagion and that, as 

such, merit further consideration, would 

require action beyond what the SEC 

could achieve under its current 

authority. 

Mitigating the risk of runs before 

another liquidity crisis materializes is 

especially important because the events 

of September 2008 may have induced 

expectations of government assistance at 

minimal cost in case of severe financial 

strains. Market participants know, and 

recent events have confirmed, that when 

runs on MMFs occur, the government 

will face substantial pressure to 

intervene in some manner to minimize 

the propagation of financial strains to 

short-term funding markets and to the 

real economy. Importantly, such 

interventions would be intended not 

only to reduce harm to MMF investors 

but also to prevent disruptions of 

markets for commercial paper and other 

short-term financing instruments, which 

are critical for the functioning of the 

economy. Therefore, if further measures 

to insulate the industry from systemic 

risk are not taken before the next 

liquidity crisis, market participants will 

likely expect that the government would 

provide emergency support at minimal 

cost for MMFs during the next crisis. 

Such market expectations of 

(hypothetical) future non-priced or 

subsidized government support would 

distort incentives for MMFs and prices 

in short-term funding markets and 

would potentially increase the systemic 

risk posed by MMFs. To forestall these 

perverse effects, it is thus imperative 

that MMFs be required to internalize 

fully the costs of liquidity or other risks 

associated with their operation. 

MMF regulatory reform in light of the 

run on MMFs in September and October 

2008. The run on MMFs in 2008 

provides some important lessons for 

evaluating potential reforms for 

mitigating systemic risk. For example, 

the triggering events of the run and the 

magnitude of the outflows that followed 

underscore the difficulty of designing 

reforms that might prevent runs and the 

associated damage to the financial 

system. 

Making each individual MMF robust 

enough to survive a crisis of the size of 

that experienced in 2008 may not be an 

appropriate policy objective because it 

would unduly limit risk taking. Indeed, 

although the SEC’s tightening of 

restrictions on the liquidity, interestrate, and credit risks borne by 

individual MMFs will be helpful in 

making MMFs more resilient to future 

strains, there are practical limits to the 

degree of systemic risk mitigation that 

can be achieved through further 

restrictions of this type. For example, an 

objective of preventing any MMF from 

breaking the buck probably would not 

be feasible for funds that invest in 

private debt markets. Changes that 

would prevent funds from breaking the 

buck due to a single Lehman Brotherslike exposure would have to be severe: 

Only limiting funds’ exposures to each 

issuer to less than one-half of 1 percent 

of assets would prevent a precipitous 

drop in the value of any single issuer’s 

debt from causing a MMF to break the 

buck.20 But even such a limit on 

exposure to a single issuer would not 

address the risk that MMFs may 

accumulate exposures to distinct but 

highly correlated issuers, and that funds 

would remain vulnerable to events that 

cause the debt of multiple issuers to lose 

value. 

Beyond diversification limits, new 

rules to protect MMFs from material 

credit losses would be difficult to craft 

unless regulators take the extreme step 

of eliminating funds’ ability to hold any 

risky assets. But that approach would be 

clearly undesirable, as it would 

adversely affect many firms that obtain 

short-term financing through 

commercial paper and similar 

instruments. In addition, such an 

extreme approach would deny many 

retail investors any opportunity to 

obtain exposure to private money 

market instruments and most likely 

would motivate some institutional 

investors to shift assets from MMFs to 

less regulated vehicles. 

Similarly, liquidity requirements 

sufficient to cover all redemption 

scenarios for MMFs probably would be 

impractical and inefficient. The SEC’s 

new liquidity requirements help 

mitigate liquidity risks borne by the 

funds, and if MMFs had held enough 

liquid assets in September 2008 to meet 

the new liquidity requirements, each 

MMF would have had adequate daily 

liquidity to meet redemption requests 

on most individual days during the run. 

Even so, the cumulative effect of severe 

outflows on consecutive days would 

have exceeded many funds’ liquidity 

buffers. Moreover, without external 

support in 2008—specifically, the 

introduction of the Treasury’s 

Temporary Guarantee Program for 

Money Market Funds and the Federal 

Reserve’s AMLF—outflows likely would 

have continued and been much larger, 

and they would have forced substantial 

sales of assets to meet redemptions. 

Such asset sales would have contributed 

to severe strains in short-term markets, 

depressed asset prices, caused capital 

losses for MMFs, and prompted further 

shareholder flight. Hence, MMFs’ 

experience during the run in 2008 

indicates that the new SEC liquidity 

requirements make individual MMFs 

more resilient to shocks but still leave 

them susceptible to runs of substantial 

scale. 

Raising the liquidity requirements 

enough so that each MMF would hold 

adequate daily liquidity to withstand a 

large-scale run would be a severe 

constraint and would fail to take 

advantage of risk-pooling opportunities 

that might be exploited by external 

sources of liquidity. During the run in 

2008, individual MMFs experienced 

large variations in the timing and 

magnitude of their redemptions. 

Liquidity requirements stringent enough 

to ensure that every individual MMF 

could have met redemptions without 

selling assets would have left most of 

the industry with far too much liquidity, 

even during the run, and would have 

created additional liquidity risks for 

issuers of short-term securities, since 

these issuers would have had to roll 

over paper more frequently. Some of the 

approaches discussed in section 3 are 

aimed at buttressing the SEC’s new 

minimum liquidity requirements 

without simply increasing their 

magnitude. 

Finally, the run on MMFs in 2008 

demonstrated the systemic threat that 

such runs may represent. Without 

additional reforms to more fully 

mitigate the risk of a run spreading 

among MMFs, the actions to support the 

MMF industry that the U.S. government 

took beginning in 2008 may create an 

expectation for similar government 

support during future financial crises, 

and the resulting moral hazard may 

make crises in the MMF industry more 


jlentini on DSKJ8SOYB1PROD with NOTICES
Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 68647 

frequent than the historical record 

would suggest. Accordingly, despite the 

risk reduction that should be achieved 

by the initial set of new SEC rules, 

policymakers should explore the 

advantages and disadvantages of 

implementing further reforms before 

another crisis materializes. 

3. Policy Options for Further Reducing 

the Risks of Runs on MMFs 

This section discusses a range of 

options for further mitigation of the 

systemic risks posed by MMFs. The SEC 

requested comment on some of these 

options, such as requiring that MMFs 

maintain a floating NAV or requiring in 

kind redemptions in certain 

circumstances. In addition, the SEC 

received comments proposing a two-tier 

system of MMFs in which some funds 

maintain a stable NAV and others a 

floating NAV. Other options discussed 

in this section go beyond what the SEC 

could implement under existing 

authorities and would require 

legislation or coordinated action by 

multiple government agencies and the 

MMF industry. While the measures 

presented here, either individually or in 

combination, would help diminish 

systemic risk, new restrictions imposed 

solely on MMFs may reduce their 

appeal to some investors and might 

cause some—primarily institutional— 

investors to move assets to less 

regulated cash management substitutes. 

Many such funds, like MMFs, seek to 

maintain a stable NAV and have other 

features that make them vulnerable to 

runs, so such funds likely also would 

pose systemic risks. Therefore, effective 

mitigation of MMFs’ susceptibility to 

runs may require policy reforms beyond 

those directed at registered MMFs to 

address risks posed by funds that 

compete with MMFs. Such reforms, 

which generally would require 

legislation, are discussed in section 3(h). 

a. Floating Net Asset Values 

Historically, the $1 stable NAV that 

MMFs maintain under rule 2a–7 has 

been a key element of their appeal to a 

broad range of investors, and the stable 

NAV has contributed to a dramatic 

expansion in MMFs’ assets over the past 

two decades. At the same time, as noted 

in section 1(b), the stable, rounded NAV 

is one of the features that heighten the 

vulnerability of MMFs to runs. The 

significance of MMFs in financial 

markets and the central role of the 

stable, rounded NAV in making MMFs 

appealing to investors and, at the same 

time, vulnerable to runs, make careful 

discussion of the potential benefits and 

risks of moving MMFs away from a 

stable NAV essential to a discussion of 

MMF reform. 

The stable, rounded NAVs of MMFs 

contribute to their vulnerability to runs 

for several reasons. 

• First, the stable, rounded NAV, 

coupled with MMF sponsors’ 

longstanding practice of supporting the 

stable NAV when funds have 

encountered difficulties, has fostered 

investors’ expectations that MMF shares 

are risk-free cash equivalents. When the 

Reserve Primary Fund failed to maintain 

those expectations in September 2008, 

the sudden loss of investor confidence 

helped precipitate a generalized run on 

MMFs. By making gains and losses a 

regular occurrence, as they are in other 

mutual funds, a floating NAV could 

alter investor expectations and make 

clear that MMFs are not risk-free 

vehicles. Thus, investors might become 

more accustomed to and tolerant of 

NAV fluctuations and less prone to 

sudden, destabilizing reactions in the 

face of even modest losses. However, 

the substantial changes in investor 

expectations that could result from a 

floating NAV also might motivate 

investors to shift assets away from 

MMFs to banks or to unregulated cashmanagement vehicles, and the effects of 

potentially large movements of assets on 

the financial system should be 

considered carefully. These issues are 

discussed in more detail later. 

• Second, a rounded NAV may 

accelerate runs by amplifying investors’ 

incentives to redeem shares quickly if a 

fund is at risk of a capital loss. When 

a MMF experiences a loss of less than 

one-half of 1 percent and continues to 

redeem shares at a rounded NAV of $1, 

it offers redeeming shareholders an 

arbitrage opportunity by paying more 

for the shares than the shares are worth. 

Simultaneously, the fund drives down 

the expected future value of the shares 

because redemptions at $1 per share 

further erode the fund’s market-based 

per-share value—and increase the 

likelihood that the fund will break the 

buck—as losses on portfolio assets are 

spread over a shrinking asset base. 

These dynamics are inherently unstable. 

Thus, even an investor who otherwise 

might not choose to redeem may do so 

in recognition of other shareholders’ 

incentives to redeem and the effects of 

such redemptions on a fund’s expected 

NAV. The growth of institutional 

investment in MMFs has exacerbated 

this instability because institutional 

investors are better positioned than 

retail investors to identify potential 

problems in a MMF’s portfolio and 

rapidly withdraw significant amounts of 

assets from the fund. 

In contrast, a floating NAV eliminates 

some of the incentives to redeem when 

a MMF has experienced a loss. Because 

MMFs must redeem shares at NAVs set 

after redemption requests are received, 

losses incurred by a fund with a floating 

NAV are borne on a pro rata basis by all 

shareholders, whether they redeem or 

not. Redemptions from such a fund do 

not concentrate already incurred losses 

over a smaller asset base and do not 

create clear arbitrage opportunities for 

investors. However, as discussed below, 

a floating NAV does not eliminate the 

incentive to redeem shares from a 

distressed MMF. 

• Third, the SEC rules that permit 

funds to maintain a stable, rounded 

NAV also force an abrupt decrease in 

price once the difference between a 

fund’s market-based shadow NAV and 

its $1 stable NAV exceeds one-half of 1 

percent. So, although NAV fluctuations 

are rare in MMFs, when prices do 

decline, the change appears as a sudden 

drop. This discontinuity heightens 

investors’ incentives to redeem shares 

before a loss is incurred, produces dire 

headlines, and probably raises the 

chance of a panic. 

These considerations suggest that 

moving to a floating NAV would reduce 

the systemic risk posed by MMFs to 

some extent. Under a required floating 

NAV, MMFs would have to value their 

portfolio assets just like any other 

mutual fund. That is, MMFs would not 

be able to round their NAVs to $1 or use 

the accounting methods (for example, 

amortized cost for portfolio securities 

with a maturity of greater than 60 days) 

currently allowed under rule 2a–7. 

To be sure, a floating NAV itself 

would not eliminate entirely MMFs’ 

susceptibility to runs. Rational investors 

still would have an incentive to redeem 

as fast as possible the shares of any 

MMF that is at risk of depleting its 

liquidity buffer before that buffer is 

exhausted, because subsequent 

redemptions may force the fund to 

dispose of less-liquid assets and incur 

losses. However, investors would have 

less of an incentive to run from MMFs 

with floating NAVs than from those 

with stable, rounded NAVs. 

Notwithstanding the advantages of a 

floating NAV, elimination of the stable 

NAV for MMFs would be a dramatic 

change for a nearly $3 trillion assetmanagement sector that has been built 

around the stable $1 share price. Indeed, 

a switch to floating NAVs for MMFs 

raises several concerns. 

• First, such a change might reduce 

investor demand for MMFs and thus 

diminish their capacity to supply credit 

to businesses, financial institutions, 

state and local governments, and other 


jlentini on DSKJ8SOYB1PROD with NOTICES
68648 Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 

21Even a contraction in the credit extended by 

MMFs might be an efficient outcome if such credit 

has been over-supplied because markets have not 

priced liquidity and systemic risks appropriately. 22A stable NAV relieves shareholders of the 

administrative task of tracking the timing and price 

of purchase and sale transactions for tax and 

accounting purposes. For investors using MMFs for 

cash management, floating NAV funds (under 

current rules) would present more record-keeping 

requirements than stable NAV funds, although 

certain tax changes beginning in 2011 will require 

mutual funds, including MMFs, to report the tax 

basis (presumably using an average basis method) 

to shareholders and thereby help reduce any 

associated accounting burden from a floating NAV. 

23Outflows from prime MMFs totaled about $200 

billion in the two days prior to the Treasury and 

Federal Reserve announcements on Friday, 

September 19, 2008. However, in the two business 

days following the announcements (Monday and 

Tuesday, September 22 and 23), outflows were just 

$22 billion. 

borrowers who obtain financing in 

short-term debt markets. MMFs are the 

dominant providers of some types of 

credit, such as commercial paper and 

short-term municipal debt, so a 

significant contraction of MMFs might 

cause particular difficulties for 

borrowers who rely on these 

instruments for financing. If the 

contraction were abrupt, redemptions 

might cause severe disruptions for 

MMFs, the markets for the instruments 

the funds hold, and borrowers who tap 

those markets. While there is no direct 

evidence on the likely effect of a floating 

NAV on the demand for MMFs, the risk 

of a substantial shift of assets away from 

MMFs and into other vehicles should be 

weighed carefully. Assets under 

management in MMFs dwarf those of 

their nearest substitutes, such as, for 

example, ultra-short bond funds, most 

likely because ultra-short bond funds 

are not viewed as cash substitutes. To 

the extent that demand for stable NAV 

funds is boosted by investors who hold 

MMFs because they perceive them to be 

risk-free, a reduction in demand for 

these funds might be desirable.21

However, some investors face functional 

obstacles to placing certain assets in 

floating NAV funds. For example, 

internal investment guidelines may 

prevent corporate cash managers from 

investing in floating NAV funds, some 

state laws allow municipalities to invest 

only in stable-value funds, and fiduciary 

obligations may prevent institutional 

investors from investing client money in 

floating NAV funds. In addition, some 

investors may not tolerate the loss of 

accounting convenience and tax 

efficiencies that would result from a 

shift to a floating NAV, although these 

problems might be mitigated somewhat 

through regulatory or legislative 

actions.22

• Second, a related concern is that 

elimination of MMFs’ stable NAVs may 

cause investors to shift assets to stable 

NAV substitutes that are vulnerable to 

runs but subject to less regulation than 

MMFs. In particular, many institutional 

investors might move assets to less 

regulated or unregulated cash 

management vehicles, such as offshore 

MMFs, enhanced cash funds, and other 

stable value vehicles that hold portfolios 

similar to those of MMFs but are not 

subject to the ICA’s restrictions on 

MMFs. These unregistered funds can 

take on more risks than MMFs, but such 

risks are not necessarily transparent to 

investors. Accordingly, unregistered 

funds may pose even greater systemic 

risks than MMFs, particularly if new 

restrictions on MMFs prompt 

substantial growth in unregistered 

funds. Thus, changes to MMF rules 

might displace or even increase 

systemic risks, rather than mitigate 

them, and make such risks more 

difficult to monitor and control. 

Reforms designed to reduce risks in less 

regulated or unregulated MMF 

substitutes are discussed in more detail 

in section 3(h). 

Elimination of MMFs’ stable NAVs 

may also prompt some investors— 

particularly retail investors—to shift 

assets from MMFs to banks. Such asset 

shifts would have potential benefits and 

drawbacks, which are discussed in some 

detail in section 3(g). 

• Third, MMFs’ transition from stable 

to floating NAVs might itself be 

systemically risky. For example, if 

shareholders perceive a risk that a fund 

that is maintaining a $1 NAV under 

current rules has a market-based 

shadow NAV of less than $1, these 

investors may redeem shares 

preemptively to avoid potential losses 

when MMFs switch to floating NAVs. 

Shareholders who cannot tolerate 

floating NAVs probably also would 

redeem in advance. If large enough, 

redemptions could force some funds to 

sell assets and make concerns about 

losses self-fulfilling. Hence, successful 

implementation of a switch to floating 

NAVs would depend on careful design 

of the conversion process to guard 

against destabilizing transition 

dynamics. 

• Fourth, risk management practices 

in a floating NAV MMF industry might 

deteriorate without the discipline 

required to maintain a $1 share price. 

MMFs comply with rule 2a–7 because 

doing so gives them the ability to use 

amortized-cost accounting to maintain a 

stable NAV. Without this reward, the 

incentive to follow 2a–7 restrictions is 

less clear. Moreover, the stable, rounded 

NAV creates a bright line for fund 

advisers: Losses in excess of 1⁄2 of 1 

percent would be catastrophic because 

they would cause a fund to break the 

buck. With a floating NAV, funds would 

not have as clear a tipping point, so 

fund advisers might face reduced 

incentives for prudent risk management. 

• The fifth and final concern is that 

a floating NAV that accomplishes its 

proponents’ objectives of reducing 

systemic risks may be difficult to 

implement. Under normal market 

conditions, even a floating NAV would 

likely move very little because of the 

nature of MMF assets. For example, 

although a requirement that MMFs 

move to a $10 NAV and round to the 

nearest cent would force funds to 

reprice shares for as little as a 5 basis 

point change in portfolio value, NAV 

fluctuations might still remain relatively 

rare. Enhanced precision for NAVs (for 

example, NAVs with five significant 

figures) could bring more regular, 

incremental fluctuations, but precise 

pricing of many money market 

securities is challenging given the 

absence of active secondary markets. In 

addition, if fund sponsors decided to 

provide support to offset any small 

deviations from the usual NAV, 

deviations from that NAV might remain 

rare. 

Thus, a floating NAV may not 

substantially improve investors’ 

understanding of the riskiness of MMFs 

or reduce the stigma and systemic risks 

associated with breaking the buck. 

Investors’ perceptions that MMFs are 

virtually riskless may change slowly 

and unpredictably if NAV fluctuations 

remain small and rare. MMFs with 

floating NAVs, at least temporarily, 

might even be more prone to runs if 

investors who continue to see shares as 

essentially risk-free react to small or 

temporary changes in the value of their 

shares. 

To summarize, requiring the entire 

MMF industry to move to a floating 

NAV would have some potential 

benefits, but those benefits would have 

to be weighed carefully against the risks 

that such a change would entail. 

b. Private Emergency Liquidity 

Facilities for MMFs 

As discussed in section 1(b), the 

liquidity risk of MMFs contributes 

importantly to MMFs’ vulnerability to 

runs. The programs introduced at the 

height of the run on MMFs in 

September 2008—Treasury’s Temporary 

Guarantee Program for Money Market 

Funds and the liquidity backstop 

provided by the AMLF—were effective 

in stopping the run on MMFs.23 More 

generally, policymakers have long 

recognized the utility of liquidity 


jlentini on DSKJ8SOYB1PROD with NOTICES
Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 68649 

24For example, as noted in the text, even if MMFs 

in September 2008 had held liquid assets in the 

proportions that the SEC has recently mandated, the 

net redemptions experienced by the funds 

following the Lehman Brothers bankruptcy would 

have forced MMFs to sell considerable amounts of 

securities into illiquid markets in the absence of the 

substantial government interventions. But a 

liquidity facility with the capacity to provide an 

additional 10 percent overnight liquidity to each 

fund would double the effective overnight liquid 

resources available to MMFs. If MMFs in September 

2008 had already been in compliance with the new 

liquidity requirements, a facility with this capacity 

would have considerably reduced funds’ need to 

raise liquidity (for example, through asset sales) 

during the run. In addition, the very existence of 

the facility might have reduced redemption requests 

in the first place. 

25A private liquidity facility could also result in 

retail fund investors bearing some of the costs of 

meeting the likely higher liquidity needs of 

institutional funds. Consideration should be given 

as to whether and how to prevent such an outcome. 

backstops for institutions engaged in 

maturity transformation: Banks, for 

example, have had access to the 

discount window since its inception, 

and backstop lending facilities also have 

been created more recently for other 

types of institutions. Thus, enhanced 

liquidity protection should be 

considered as part of any regulatory 

reform effort aimed at preventing runs 

on MMFs. At the same time, such 

enhanced liquidity protection does not 

have to be provided necessarily by the 

government: A private facility, 

adequately capitalized and financed by 

the MMF industry, could be set up to 

supply liquidity to funds that most need 

it at times of market stress. Depending 

on its structure, such a private facility 

itself might have access to broader 

liquidity backstops. 

A private emergency liquidity facility 

could be beneficial on several levels. 

First, a private liquidity facility, in 

combination with the SEC’s new 

liquidity requirements, might 

substantially buttress MMFs’ ability to 

withstand outflows without selling 

assets in potentially illiquid markets.24

Second, a private emergency facility 

might offer important efficiency gains 

from risk pooling. Even during the 

systemic liquidity crisis in 2008, 

individual MMFs experienced large 

variations in the timing and magnitude 

of redemptions. An emergency facility 

could provide liquidity to the MMFs 

that need it; in contrast, liquidity 

requirements for individual MMFs 

would likely leave some funds with too 

much liquidity and others with too 

little. Third, a private liquidity facility 

might provide funds with flexibility in 

managing liquidity risks if, for example, 

regulators allowed MMFs some relief in 

liquidity requirements in return for the 

funds’ purchase of greater access to the 

liquidity facility’s capacity. 

Importantly, a properly designed and 

well-managed private liquidity facility 

would internalize the cost of liquidity 

protection for the MMF industry and 

provide appropriate incentives for 

MMFs and their investors.25 Such a 

facility would not help funds that take 

on excessive capital risks or face runs 

because of isolated credit losses (a welldesigned private liquidity facility would 

not have helped the Reserve Primary 

Fund or its shareholders avoid losses in 

September 2008 due to holdings of 

Lehman Brothers debt). Moreover, a 

liquidity facility alone may not prevent 

runs on MMFs triggered by concerns 

about more widespread credit losses at 

MMFs. However, a liquidity facility 

could substantially reduce the damage 

that a run on a single distressed fund 

might cause to the rest of the industry. 

While a private emergency liquidity 

facility would be appealing in several 

respects, setting up an effective facility 

would present a number of challenges. 

The structure and operations of a 

private liquidity facility would have to 

be considered carefully to ensure that it 

would be effective during crises and 

that it would not unduly distort 

incentives, while, at the same time, that 

it would be in compliance with all 

applicable regulations and that it would 

not favor certain market participants or 

business models. For example: 

• On the one hand, if MMFs were 

required to participate in a private 

facility, regulators would assume some 

responsibility for ensuring that the 

facility was operated equitably and 

efficiently, that it managed risks 

prudently, and that it was able to 

provide liquidity effectively during a 

crisis. On the other hand, if 

participation were voluntary, some 

MMFs would likely choose not to 

participate to avoid sharing in the costs 

associated with the facility. Nonparticipating MMFs might present 

greater risks than their competitors but 

would free-ride on the stability the 

liquidity facility would provide. In a 

voluntary participation framework, one 

means of balancing risks between MMFs 

that do and do not participate in a 

liquidity facility would be to require 

nonparticipants to adhere to more 

stringent risk-limiting constraints or to 

require such funds to switch to a 

floating NAV. Such an approach (in 

which some MMFs have stable NAVs 

and others floating NAVs) is considered 

in section 3(e). 

• Ensuring that the facility has 

adequate capacity to meet MMFs’ 

liquidity needs during a crisis would be 

critical to the effectiveness of the facility 

in mitigating systemic risk. Inadequate 

capacity might, for example, create an 

incentive for MMF advisers to tap the 

facility before others do and thus make 

the facility itself vulnerable to runs. 

News of a depleted liquidity facility 

might amplify investor concerns and 

trigger or expand a run on MMFs. 

However, raising enough capital to 

build adequate liquidity capacity 

without undue leverage would be a 

challenge for the asset management 

industry. Accordingly, meaningful 

mitigation of systemic risk may require 

that the facility itself have access to 

alternative sources of liquidity. 

• A private facility may face conflicts 

of interest during a crisis when liquidity 

is in short supply. Responsibility to the 

facility’s shareholders would mandate 

prudence in providing liquidity to 

MMFs. For example, facility managers 

would want to be selective in providing 

liquidity against term commercial paper 

out of concern about losses on such 

paper. However, excessive prudence 

would be at odds with the facility 

serving as an effective liquidity 

backstop. In addition, a private facility 

may face conflicts among different types 

of shareholders and participants who 

may have different interests, and a 

strong governance structure would be 

needed to address these conflicts as well 

as prevent the domination of the facility 

by the advisers of larger funds. 

• Rules governing access to the 

facility would have to be crafted 

carefully to minimize the moral hazard 

problems among fund advisers, who 

could face diminished incentives to 

maintain liquidity in their MMFs. 

However, excessive constraints on 

access would limit the facility’s 

effectiveness. An appropriate balancing 

of access rules might be difficult to 

achieve. 

Notwithstanding these concerns, a 

private emergency liquidity facility 

could play an important role in 

supplementing the SEC’s new liquidity 

requirements for MMFs. The potential 

advantages and disadvantages of such a 

facility, as well as its optimal structure 

and modes of operation, should be the 

subjects of further analysis and 

discussion. 

c. Mandatory Redemptions in Kind 

When investors make large 

redemptions from MMFs, they impose 

liquidity costs on other shareholders in 

the fund. For example, redemptions 

may force a fund to sell its most liquid 

assets to raise cash. Remaining 

shareholders are left with claims on a 

less liquid portfolio, so redemptions are 

particularly costly for other 


jlentini on DSKJ8SOYB1PROD with NOTICES
68650 Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 

26The problem is exacerbated by a rounded NAV, 

because a fund that has already incurred a capital 

loss but that continues to redeem each share at $1 

also transfers capital losses from redeeming 

shareholders to those who remain in the fund. 

27Such a requirement also would force redeeming 

shareholders to bear their share of any losses that 

a MMF has already incurred—even if the fund 

maintains a stable, rounded NAV and has not yet 

broken the buck—rather than concentrating those 

losses entirely in the MMF and thus on remaining 

MMF shareholders. 

28 If the investor sells securities at a loss, 

however, and the MMF also holds the same or 

similar securities, the fund may be forced to reprice the securities and lower its mark-to-market, 

shadow NAV. So, remaining investors in the fund 

may be affected indirectly by the redeeming 

investor, even if that investor receives redemptions 

in kind. 

29All publicly offered stable NAV MMFs were 

eligible to participate in the program. If a MMF 

elected to participate, the program guaranteed that 

each shareholder in that MMF would receive the 

stable share price (typically $1) for each share held 

in the fund, up to the number of shares held as of 

the close of business on September 19, 2008. In the 

event that a participating MMF broke the buck, the 

fund was required to suspend redemptions and 

commence liquidation, and the fund was eligible to 

collect payment from Treasury to enable payment 

of the stable share price to each covered investor. 

Treasury neither received any claims for payment 

nor incurred any losses under the program. 

30The degree of insurance coverage provided by 

Treasury’s Temporary Guarantee Program for 

Money Market Funds was unprecedented. Private 

insurance with considerably narrower coverage has 

been available to MMFs in the past: ICI Mutual 

Insurance Company, an industry association captive 

insurer, offered very limited insurance to MMFs 

from 1999 to 2003. This insurance covered losses 

on MMF portfolio assets due to defaults and 

insolvencies but not losses due to events such as 

a security downgrade or a rise in interest rates. 

Coverage was limited to $50 million per fund, with 

a deductible of the first 10 to 40 basis points of any 

loss. Premiums ranged from 1 to 3 basis points. ICI 

Mutual reportedly discontinued offering the 

insurance in 2003 because coverage restrictions and 

other factors limited demand to the point that the 

insurance was not providing enough risk pooling to 

remain viable. Of course, MMFs continue to have 

access to other market-based mechanisms for 

transferring risks, such as credit default swaps, 

although holdings of such derivative securities by 

MMFs are tightly regulated by rule 2a–7. 

shareholders during a crisis, when 

liquidity is most valued.26

A requirement that MMFs distribute 

large redemptions by institutional 

investors in kind, rather than in cash, 

would force these redeeming 

shareholders to bear their own liquidity 

costs and reduce their incentive to 

redeem.27 If liquidity pressures are 

causing money market instruments to 

trade at discounts, a MMF that 

distributes a large redemption in cash 

may have to sell securities at a discount 

to raise the cash. All shareholders in the 

fund would share in the loss on a pro 

rata basis. However, if the fund 

distributes securities to the investor in 

proportion to the claim on the fund 

represented by the redeemed shares, the 

liquidity risk would be borne most 

directly by the redeeming investor. If 

the fund elects to dispose of the 

securities in a dislocated market and 

incurs a loss, other shareholders are not 

directly affected.28

Requiring large redemptions to be 

made in kind would reduce, but not 

eliminate the systemic risk associated 

with large, widespread redemptions. 

Shareholders with immediate liquidity 

needs who receive securities from 

MMFs would have to sell those assets, 

and the consequences for short-term 

markets of such sales would be similar 

to the effects if the money market fund 

itself had sold the securities. Smaller 

shareholders would still receive cash 

redemptions, and larger investors might 

structure their MMF investments and 

redemptions to remain under the inkind threshold. 

An in-kind redemption requirement 

would present some operational and 

policy challenges. Portfolio holdings of 

MMFs sometimes are not freely 

transferable or are only transferable in 

large blocks of shares, so delivery of an 

exact pro rata portion of each portfolio 

holding to a redeeming shareholder may 

be impracticable. Thus, a fund may have 

to deliver different securities to different 

investors but would need to do so in an 

equitable manner. Funds should not, for 

example, be able to distribute only their 

most liquid assets to redeeming 

shareholders, since doing so would 

undermine the purpose of an in-kind 

redemptions requirement. Thus, the 

SEC would have to make key judgments 

on the circumstances under which a 

fund must redeem in kind, as well as 

the criteria that funds would use for 

determining which portfolio securities 

must be distributed and how they 

would be valued. 

d. Insurance for MMFs 

As noted in section 1(b), the absence 

of formal capital buffers or insurance for 

MMFs, as well as their historical 

reliance on discretionary sponsor 

support in place of such mechanisms, 

further contributes to their vulnerability 

to runs. Treasury’s Temporary 

Guarantee Program for Money Market 

Funds, announced on September 19, 

2008, was a key component of the 

government intervention that slowed 

the run on MMFs. The program 

provided guarantees for shares in MMFs 

as of the announcement date. These 

guarantees were somewhat akin to 

deposit insurance, which for many 

decades has played a central role in 

mitigating the risk of runs on banks.29

Therefore, some form of insurance for 

MMF shareholders might be helpful in 

mitigating systemic risks posed by 

MMFs, although insurance also may 

create new risks by distorting incentives 

of fund advisers and shareholders. 

Like an external liquidity facility, 

insurance would reduce the risk of runs 

on MMFs, but the consequences of 

insurance and a liquidity facility would 

otherwise be different. A liquidity 

facility would do little or nothing to 

help a fund that had already 

experienced a capital loss, but such a 

facility might be very helpful in 

mitigating the destabilizing effects that 

one fund’s capital loss might impose on 

the rest of the industry. Insurance, in 

contrast, would substantially reduce or 

eliminate any losses borne by the 

shareholders of the MMF that 

experienced the capital loss and damp 

their incentives to redeem shares in that 

fund. Although either option might 

reduce the incentives for asset managers 

and shareholders to minimize risks, a 

liquidity facility without an insurance 

scheme would leave intact shareholders’ 

incentive to monitor funds for the credit 

and interest rate risks that may trigger 

a run. However, in a crisis that triggers 

concerns about widespread credit 

losses, liquidity protection without 

some form of insurance may still leave 

MMFs vulnerable to runs. 

In addition to these general 

considerations, the design and 

implementation of an insurance 

program for MMFs would require 

resolution of a number of difficult 

issues. For example: 

• Insurance could, in principle, be 

provided by the private sector, the 

government, or a combination of the 

two, but all three options have potential 

drawbacks. Private insurers have had 

considerable difficulties in fairly pricing 

and successfully guaranteeing rare but 

high-cost financial events, as 

demonstrated, for example, by the 

recent difficulties experienced by 

financial guarantors. That no private 

market for insurance has developed is 

some evidence that such insurance for 

MMFs may be a challenging business 

model, particularly if funds are not 

required to obtain insurance.30 Making 

insurance for MMFs mandatory could 

attract private insurance providers, but 

the pricing and scope of coverage that 

these providers could offer would need 

to be the subject of careful 

consideration. In any case, insurers 

would need to maintain capital and 

carry reinsurance as necessary to cover 

losses during extraordinary events. 

Public insurance would necessitate new 

government oversight and 

administration functions and, 

particularly in the absence of private 

insurance, would require a mechanism 


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31 If stable NAV MMFs carried mandatory 

insurance, some limitations on insurance coverage 

(for example, stipulating that individual shares in 

such funds could be insured only after a given 

number of days) might reduce the magnitude of 

flows between different types of MMFs and reduce 

implicit subsidies for investors who purchase 

shares in stable NAV funds only during crises. 

However, such rules might diminish the value of 

insurance in preventing runs. 

for setting appropriate risk-based 

premiums (either pre- or post-event). A 

hybrid insurance scheme—for example, 

with MMFs or their sponsors retaining 

the first level of losses up to a threshold, 

private insurers or risk pools handling 

losses up to a certain higher threshold, 

and a government insurance program 

serving as a backstop (perhaps with 

post-event recoupment)—might offer 

some advantages, but it would be 

subject to the risks of private insurance 

and the challenges of public insurance. 

• On the one hand, mandatory 

participation in an insurance system 

likely would be necessary to instill 

investor confidence in the MMF 

industry, to ensure an adequate pooling 

of risk, to prevent riskier funds from 

opting out yet free-riding on the stability 

afforded by insured funds, and to create 

a sufficient premium base. On the other 

hand, an insurance requirement would 

create new government responsibilities, 

and the regulatory and economic 

implications of such a requirement 

would have to be evaluated carefully. 

• Insurance increases moral hazard 

and would shift incentives for prudent 

risk management by MMFs from fund 

advisers, who are better positioned to 

monitor risks, to public or private 

insurers. In addition, insurance removes 

investors’ incentives to monitor risk 

management by fund advisers. Broadly 

speaking, insurance fundamentally 

changes the nature of MMF shares, from 

pooled pass-through investments in 

risky assets to insured products with 

relatively low yields and limited or no 

risk. 

• Appropriate pricing would be 

critical to the success of a MMF 

insurance program, as pricing would 

affect the financial position of the 

guarantor, the incentives of MMF 

advisers, and the relative attractiveness 

of different types of MMFs and their 

competitors (for example, bank 

deposits). Insurance pricing that is not 

responsive to the riskiness of individual 

MMF portfolios, for example, would 

heighten moral hazard problems that 

undermine incentives for prudent MMF 

risk management. Underpriced 

insurance might cause disruptive 

outflows from bank deposits to MMFs 

and would be a subsidy for sponsors of 

and investors in MMFs. Still, insurance 

for MMFs might be easier to price fairly 

than deposit insurance for banks, as 

MMF portfolios are highly restricted, 

relatively homogeneous in comparison 

with bank portfolios, transparent, and 

priced on a daily basis. 

• Limits on insurance coverage 

(perhaps similar to those for deposit 

insurance) would be needed to avoid 

giving MMFs an advantage over banks 

and to preserve incentives for large 

investors to monitor the risk 

management practices at MMFs. 

However, such limits would leave most 

institutional investors’ shares only 

marginally covered by insurance and do 

little to reduce their incentive to run 

should MMF risks become salient. 

e. A Two-Tier System of MMFs, With 

Enhanced Protections for Stable NAV 

MMFs 

Reforms intended to reduce the 

systemic risks posed by MMFs might be 

particularly effective if they allow 

investors some flexibility in choosing 

the MMFs that best match their riskreturn preferences. Policymakers might 

accommodate a range of preferences by 

allowing two types of MMFs to be 

regulated under rule 2a–7: 

(i) Stable NAV MMFs. These funds 

would continue to maintain stable, 

rounded NAVs, but they would be 

subject to enhanced protections, which 

might include some combination of 

tighter regulation (such as higher 

liquidity standards) and required access 

to an external liquidity backstop. Other 

options to provide enhanced protection 

for stable NAV funds might include 

mandatory distribution of large 

redemptions in kind and insurance. 

(Policymakers may also consider 

limiting the risk arising from investors 

in stable NAV funds by restricting sales 

of such funds’ shares to retail investors, 

as discussed in section 3(f).) 

(ii) Floating NAV funds. Although 

these MMFs would still have to comply 

with many of the current restrictions of 

rule 2a–7, these restrictions might be 

somewhat less stringent than those for 

stable NAV funds. So, floating NAV 

funds could bear somewhat greater 

credit and liquidity risks than stable 

NAV funds, might not be required to 

obtain access to external sources of 

liquidity or insurance, and most likely 

would pay higher yields than their 

stable NAV counterparts. Regulatory 

relief—for example, allowing simplified 

tax treatment for small NAV changes in 

funds that adhere to rule 2a–7—might 

help preserve the attractiveness of such 

funds for many investors. 

A two-tier system could mitigate the 

systemic risks that arise from a stable, 

rounded NAV, by requiring funds that 

maintain a stable NAV to have 

additional protections that directly 

address some of the features that 

contribute to their vulnerability to runs. 

At the same time, by preserving stable 

NAV funds, such a system would 

mitigate the risks of a wholesale shift to 

floating NAV funds. For example, a twotier system would diminish the 

likelihood of a large-scale exodus from 

the MMF industry by investors who 

might find a floating NAV MMF 

unacceptable. 

Floating NAV MMFs would face a 

lower risk of runs for the reasons 

outlined in section 3(a): Frequent 

changes in these funds’ NAVs would 

help align investor perceptions and 

actual fund risks, and investors would 

have reduced incentives to redeem early 

in a crisis without a rounded NAV. In 

addition, investor sorting might 

ameliorate the risk of runs: Under such 

a two-tier system, investors who choose 

floating NAV funds presumably would 

be less risk-averse and more tolerant of 

NAV changes than the shareholders of 

stable NAV funds. 

During a crisis, investors would likely 

shift at least some assets from riskier 

floating NAV MMFs to stable NAV 

MMFs, which would presumably be 

safer because of their enhanced 

protections. Such flows might be 

similar, in some respects, to the asset 

flows seen during the September 2008 

crisis from prime MMFs to government 

MMFs, but a shift between tiers of prime 

funds could be less disruptive to shortterm funding markets and the aggregate 

supply of credit to private firms than a 

flight from prime to government MMFs. 

Effective design of a two-tier system 

would have to incorporate measures to 

ensure that large-scale shifts of assets 

among MMFs in crises would not be 

disruptive.31

For a two-tier system to be effective 

and materially mitigate the risk of runs, 

investors would have to fully 

understand the difference between the 

two types of funds and their associated 

risks. Investors who do not make this 

distinction might flee indiscriminately 

from floating NAV and stable NAV 

funds alike; in this case, a two-tier 

system would not be effective in 

mitigating the risk of runs. 

The relative ease or difficulty of 

implementing a two-tier system would 

depend on the nature of the stable NAV 

and floating NAV MMFs that comprise 

it. For example, if the stable NAV funds 

simply were required to satisfy more 

stringent SEC rules governing portfolio 

safety, creation of a two-tier system 

would be fairly straightforward. A 

requirement that stable NAV funds 

obtain access to an emergency liquidity 

facility would likely make stable NAV 


jlentini on DSKJ8SOYB1PROD with NOTICES
68652 Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 

32For example, after Federal Open Market 

Committee (FOMC) actions that lower the FOMC’s 

target for the federal funds rate, MMF shadow 

NAVs rise and institutional MMFs often experience 

large net inflows. 

33Such an approach to MMF reform was 

advocated by the Group of Thirty. See Group of 

Thirty, Financial Reform: A Framework for 

Financial Stability, released on January 15, 2009. 34There may be a question as to whether floating 

NAV MMFs—if such funds are offered—should or 

should not be required to reorganize as SPBs. Other 

mutual funds with floating NAVs, such as ultrashort bond funds, presumably would not be affected 

by a mandate that MMFs reorganize as SPBs. The 

principal distinction between other (non-MMF) 

mutual funds and floating NAV MMFs would be 

that the latter are constrained by rule 2a–7 and thus 

have less risky portfolios, so the advantages and 

disadvantages of mandating these funds to 

reorganize as banks would have to be carefully 

evaluated. However, policymakers could consider 

prohibiting floating NAV MMFs from offering banklike services that attract risk-averse investors, such 

as the ability to provide transactions services. 

funds less prone to runs and would 

reduce the likelihood that investors flee 

indiscriminately from both types of 

funds in the event of severe market 

strains. However, this approach also 

would face the challenges associated 

with the creation of an effective 

liquidity facility (discussed in more 

detail in section 3(b)). 

f. A Two-Tier System of MMFs, With 

Stable NAV MMFs Reserved for Retail 

Investors 

Another approach to the two-tier 

system described in section 3(e) could 

distinguish stable NAV and floating 

NAV funds by investor type. Stable 

NAV MMFs could be made available 

only to retail investors, while 

institutional investors would be 

restricted to floating NAV funds. 

This approach would bring enhanced 

protections to stable NAV MMFs by 

mitigating the risk arising from the 

behavior of their investors, because 

institutional investors have historically 

generated greater risks of runs for MMFs 

than retail investors. As noted 

previously, the run from MMFs in 

September 2008 was primarily a flight 

by institutional investors. More than 90 

percent of the net outflows from prime 

MMFs in the week following the 

Lehman Brothers bankruptcy came from 

institutional funds, and institutional 

investors withdrew substantial sums 

from prime MMFs even before the 

Reserve Primary Fund broke the buck. 

Moreover, evidence suggests that the 

additional risks posed by institutional 

investors during the run on MMFs in 

September 2008 were not unique to that 

episode. Relative to retail investors, 

institutional investors have greater 

resources to monitor MMF portfolios 

and risks and have larger amounts at 

stake, and are therefore quicker to 

redeem shares on concerns about MMF 

risks. Institutional MMFs typically have 

greater cash flow volatility than retail 

funds. Net flows to institutional MMFs 

have also exhibited patterns indicating 

that institutional investors regularly 

arbitrage small discrepancies between 

MMFs’ shadow NAVs and their $1 share 

prices.32 These observations suggest that 

many institutional investors are aware 

of such discrepancies—which are likely 

to widen during financial crises—and 

are able to exploit them. 

A two-tier system based on investor 

type would protect the interests of retail 

investors by reducing the likelihood that 

a run might begin in institutional MMFs 

(as it did in September 2008) and spread 

to retail funds. Moreover, such a system 

would preserve the original purpose of 

MMFs, which was to provide retail 

investors with cost-effective access to 

diversified investments in money 

market instruments. Retail investors 

have few alternative opportunities to 

obtain such exposures. In contrast, 

institutional investors, which can meet 

minimum investment thresholds for 

direct investments in money market 

instruments, would be able to continue 

doing so. 

One advantage of this alternative is 

that it could be accomplished by SEC 

rulemaking under existing authorities 

without establishing additional market 

structures. A prohibition on 

institutional investors’ use of stable 

NAV MMFs would have some practical 

hurdles, however. Successful 

enforcement of the rule would require 

the SEC to define who would qualify as 

retail and institutional investors. In 

practice, such distinctions may be 

difficult, although not impossible, to 

make. For example, retail investors who 

own MMF shares because of their 

participation in defined contribution 

plans (such as 401(k) plans) may be 

invested in institutional MMFs through 

omnibus accounts that are overseen by 

institutional investors (plan 

administrators). Simple rules that might 

be used to identify institutional 

investors, such as defining as 

institutional any investor whose 

account size exceeds a certain 

threshold, would be imperfect and 

could motivate the use of workarounds 

(such as brokered accounts) by 

institutional investors. The SEC, as part 

of its rulemaking, would need to take 

steps to prevent such workarounds. 

Because many institutional investors 

may be particularly unwilling to switch 

to floating NAV MMFs, a prohibition on 

sales of stable NAV MMFs shares to 

such investors may have many of the 

same unintended consequences as a 

requirement that all MMFs adopt 

floating NAVs (see section 3(a)). In 

particular, prohibiting institutional 

investors from holding stable NAV 

funds might cause large shifts in assets 

to unregulated MMF substitutes. This 

concern is of particular importance 

given that institutional MMFs currently 

account for almost two-thirds of the 

assets under management in MMFs. 

In addition, a two-tier system based 

on investor type would preclude some 

of the advantages of allowing 

institutional investors to choose 

between stable NAV MMFs and floating 

NAV MMFs (as the option described in 

section 3(e) would permit). For 

example, under the two-tier system 

described in section 3(e), investor 

sorting would provide some protection 

for the floating NAV funds, because 

institutional investors holding floating 

NAV MMFs likely would be less riskaverse than those who held stable NAV 

funds. With institutional investors 

prohibited from holding shares in stable 

NAV MMFs, such sorting among these 

investors would not occur. During a 

crisis, under the system described in 

section 3(e), institutional investors 

might be expected to shift assets from 

floating NAV MMFs to stable NAV 

funds, but a ban on institutional 

holdings of stable NAV MMF shares 

would prevent such shifts. 

g. Regulating Stable NAV MMFs as 

Special Purpose Banks 

Functional similarities between MMF 

shares and deposits, as well as the risk 

of runs on both types of instruments, 

provide a rationale for introducing 

bank-like regulation for MMFs. For 

example, mandating that stable NAV 

MMFs be reorganized as SPBs might 

subject these MMFs to banking 

oversight and regulation, including 

requirements for reserves and capital 

buffers, and provide MMFs with access 

to a liquidity backstop and insurance 

coverage within a regulatory framework 

specifically designed for mitigation of 

systemic risk.33 If each MMF were 

offered the option of implementing a 

floating NAV as an alternative to 

reorganizing as a bank, the 

reorganization requirement for stable 

NAV MMFs might be viewed as part of 

a two-tier system for MMFs.34

Although the conceptual basis for 

converting stable NAV MMFs to SPBs is 

seemingly straightforward, in practice 

this option spans a broad range of 

possible implementations, most of 

which would require legislative changes 

and complex interagency regulatory 

coordination. The advantages and 

disadvantages of this reform option 

depend on how exactly the conversion 

to SPBs would be implemented and 


jlentini on DSKJ8SOYB1PROD with NOTICES
Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 68653 

35 In contrast, institutional investors could 

continue to obtain such exposures either by 

investing directly in money market instruments or 

by holding shares in offshore MMFs, enhanced cash 

funds, and other stable value vehicles. Hence, 

absorption of MMFs by banks might have the 

unintended effect of reducing investment 

opportunities for retail investors, who generally did 

not participate in the run on MMFs in 2008, while 

leaving money market investment options for 

institutional investors largely intact. 

36Currently, MMFs are essentially 100 percent 

capital—their liabilities are the equity shares held 

by investors—so the meaning of ‘‘capital 

requirements’’ for such funds is not clear. However, 

if MMFs were reorganized as SPBs, their capital 

structure would become more complex. MMF 

shares would likely be converted to deposit 

liabilities, and MMFs would have to hold 

additional capital (equity) buffers to absorb first 

losses. Capital requirements would regulate the size 

of such buffers. 

37The magnitude of the capital required might be 

reduced if floating NAV MMFs were not required 

to reorganize as SPBs and if a substantial number 

of funds elected to float their NAVs rather than 

reorganize as banks. In addition, the capital 

required might be reduced somewhat if regulators 

determined that the nature of the assets held by 

MMFs justifies capital requirements that are lower 

than those imposed on commercial banks and 

thrifts. 

38Section 627 of the Dodd-Frank Act repeals the 

prohibition on banks paying interest on corporate 

demand deposit accounts effective July 21, 2011. 

how the new banks would be 

structured. A thorough discussion of the 

full range of possibilities—including 

their feasibility, probable effect on the 

MMF industry, broader implications for 

the banking system, and likely efficacy 

in mitigating systemic risk—would be 

quite complex and is beyond the scope 

of this report. 

As an example of the issues that this 

option involves, one possible approach 

to its implementation would be to 

preserve stable NAV MMFs as 

standalone entities but to treat their 

shares as deposits for the purposes of 

banking law. These shares, unlike other 

deposits, might be claims specifically 

(and only) on MMF assets, which could 

continue to be subject to strict risklimiting regulations such as those 

provided by rule 2a–7 or similar rules. 

The introduction of such hybrid 

investment vehicles would preserve 

investors’ opportunity to benefit from 

mutualized investments in private 

money market instruments, but, being a 

novel combination of features of banks 

and mutual funds, such vehicles would 

also present complex regulatory and 

operational challenges. In contrast, 

other approaches to converting MMFs to 

SPBs, such as absorbing or transforming 

stable NAV MMFs into financial 

institutions that offer traditional 

deposits, might be simpler to 

accomplish in practice, but nonetheless 

subject to different sets of challenges. In 

particular, if the deposits offered by the 

new SPBs were only of the types 

currently offered by other banks, 

investors—and particularly retail 

investors, who have few alternative 

opportunities to obtain diversified 

exposures to money market 

instruments—would lose access to 

important investment options.35 In 

addition, to the extent that banks have 

different preferences for portfolio assets 

than MMFs, a simple transformation of 

MMFs into depository institutions 

might lead to a decline in the 

availability of short-term financing for 

firms and state and local governments 

that currently rely on money markets to 

satisfy their funding needs. 

Considerable further study would thus 

be needed in pursuing this option. 

Leaving aside the details of how 

exactly this option could be 

implemented, in general terms, a 

principal advantage of reorganizing 

MMFs as SPBs is that such a change 

would provide MMFs with a broad 

regulatory framework similar to existing 

regulatory systems that are designed for 

mitigation of systemic risk. Investments 

in MMFs and insured deposits—which 

already serve some similar functions, 

particularly for retail investors—could 

be regulated similarly. MMFs and their 

investors might benefit from access to 

government insurance and emergency 

liquidity facilities at a price similar to 

that currently paid by depository 

institutions. Importantly, such access 

would not require any extraordinary 

government actions (such as the 

establishment in September 2008 of 

Treasury’s Temporary Guarantee 

Program for Money Market Funds or the 

creation of the Federal Reserve’s 

AMLF); instead, the terms of such 

access would be codified and wellunderstood in advance. 

Moreover, by providing explicit 

capital buffers, access to a liquidity 

backstop, and deposit insurance, a 

conversion of stable NAV MMFs to 

SPBs might substantially reduce the 

uncertainties and systemic risks 

associated with MMF sponsors’ current 

practice of discretionary capital support. 

Clear rules for how the buffers, 

backstop, and insurance would be used 

would improve the transparency of the 

allocation of risks among market 

participants. 

However, the capital needed to 

reorganize MMFs as SPBs may be a 

significant hurdle to successful 

implementation of this option. Access to 

the Federal Reserve discount window 

and deposit insurance coverage most 

likely would require that the new SPBs 

hold reservable deposits and meet 

specific capitalization standards.36

Given the scale of assets under 

management in the MMF industry, 

MMF sponsors (or banks) that wish to 

keep funds operating would have to 

raise substantial equity—probably at 

least tens of billions of dollars—to meet 

regulatory capital requirements.37

Raising such sums would be a 

considerable challenge. The asset 

management business typically is not 

capital intensive, so many asset 

managers—and several of the largest 

sponsors of MMFs—are lightly 

capitalized and probably could not 

provide such amounts of capital. If asset 

managers or other firms were unwilling 

or unable to raise the capital needed to 

operate the new SPBs, a sharp reduction 

in assets in stable NAV MMFs might 

diminish their capacity to supply shortterm credit, curtail the availability of an 

attractive investment option 

(particularly for retail investors), and 

motivate institutional investors to shift 

assets to unregulated vehicles. 

An additional hurdle to converting 

MMFs to SPBs would be the substantial 

increase in explicit government 

guarantees that would result from the 

creation of new insured deposits. The 

potential liability to the government 

probably would far exceed any 

premiums that could be collected for 

some time. 

Uncertainties about the reaction of 

institutional investors to MMFs 

reorganized as SPBs raise some 

important concerns about whether such 

reorganizations would provide a 

substantial degree of systemic-risk 

mitigation. Coverage limits on deposit 

insurance would leave many large 

investors unprotected in case of a 

significant capital loss. Thus, even with 

the protections afforded to banks, MMFs 

would still be vulnerable to runs by 

institutional investors, unless much 

higher deposit insurance limits were 

allowed for the newly created SPBs. 

Moreover, even in the absence of runs, 

institutional MMFs often experience 

volatile cash flows, and the potential 

effects of large and high-frequency flows 

into and out of the banking system (if 

MMFs become SPBs) would need to be 

analyzed carefully. 

The reaction of institutional investors 

to the altered set of investment 

opportunities may also have unintended 

consequences. For example, SPBs that 

pay positive net yields to investors 

(depositors) would be very attractive for 

institutional investors who currently 

cannot receive interest on traditional 

bank deposits.38 Thus, on the one hand, 

the new SPBs might prompt shifts of 

assets by institutional investors from the 

traditional banking system. On the other 

hand, a substantial mandatory capital 


jlentini on DSKJ8SOYB1PROD with NOTICES
68654 Federal Register / Vol. 75, No. 215 / Monday, November 8, 2010 / Notices 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

3 17 CFR 240.19b–4(f)(6). 

4See Securities Exchange Act Release No. 61566 

(February 22, 2010), 75 FR 9262 (March 1, 2010) 

(Order Approving File No. SR–FINRA–2009–065) 

(hereinafter, ‘‘SEC Order Approving TRACE 

Expansion—Asset-Backed Securities’’). 

5See Securities Exchange Act Release No. 60860 

(October 21, 2009), 74 FR 55600 (October 28, 2009) 

(Notice of Filing of File No. SR–FINRA–2009–065). 

6See Letter from Sharon Zackula, Associate Vice 

President and Associate General Counsel, FINRA, to 

Elizabeth M. Murphy, Secretary, SEC, dated 

December 22, 2009. 

7The TRACE ABS filing included amendments 

to: (a) Rule 6710 to amend the defined terms, 

‘‘Asset-Backed Security’’ and ‘‘TRACE-Eligible 

Security’’ to include Asset-Backed Securities as 

TRACE-Eligible Securities, to amend several other 

defined terms, and to add several new defined 

terms, most of which relate to Asset-Backed 

Securities; (b) Rule 6730 to require the reporting of 

Asset-Backed Securities transactions, to establish a 

six-month pilot period for reporting such 

transactions no later than T + 1 during TRACE 

System hours, and to amend certain requirements 

in connection with the reporting of commissions, 

factors, transaction size and settlement terms in 

buffer for MMFs would reduce their net 

yields and possibly motivate 

institutional investors to move assets 

from MMFs to unregulated alternatives 

(particularly if regulatory reform does 

not include new constraints on such 

vehicles). The effect of these competing 

incentives on institutional investors’ 

cash management practices is uncertain, 

but it is at least plausible that a 

reorganization of MMFs as SPBs may 

lead to a net shift of assets to 

unregulated investment vehicles. 

h. Enhanced Constraints on Unregulated 

MMF Substitutes 

New rules intended to reduce the 

susceptibility of MMFs to runs generally 

also will reduce the appeal of the funds 

to many investors. For example, several 

of the reforms recently adopted by the 

SEC probably will reduce the net yields 

that the funds pay to shareholders, and 

a switch to floating NAVs would 

eliminate a feature that some MMF 

shareholders see as essential. 

Reforms that reduce the appeal of 

MMFs may motivate some institutional 

investors to move assets to alternative 

cash management vehicles with stable 

NAVs, such as offshore MMFs, 

enhanced cash funds, and other stable 

value vehicles. These vehicles typically 

invest in the same types of short-term 

instruments that MMFs hold and share 

many of the features that make MMFs 

vulnerable to runs, so growth of 

unregulated MMF substitutes would 

likely increase systemic risks. However, 

such funds need not comply with rule 

2a–7 or other ICA protections and in 

general are subject to little or no 

regulatory oversight. In addition, the 

risks posed by MMF substitutes are 

difficult to monitor, since they provide 

far less market transparency than 

MMFs. 

Thus, effective mitigation of systemic 

risks may require policy reforms 

targeted outside the MMF industry to 

address risks posed by funds that 

compete with MMFs and to combat 

regulatory arbitrage that might offset 

intended reductions in MMF risks. Such 

reforms most likely would require 

legislation and action by the SEC and 

other agencies. For example, 

consideration should be given to 

prohibiting unregistered investment 

vehicles from maintaining stable NAVs, 

perhaps by amending sections 3(c)(1) 

and 3(c)(7) of the ICA to specify that 

exemptions from the requirement to 

register as an investment company do 

not apply to funds that seek a stable 

NAV. Banking and state insurance 

regulators might consider additional 

restrictions to mitigate systemic risk for 

bank common and collective funds and 

other investment pools that seek a stable 

NAV but that are exempt from 

registration under sections 3(c)(3) and 

3(c)(11) of the ICA. 

[FR Doc. 2010–28177 Filed 11–5–10; 8:45 am] 

BILLING CODE 8011–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–63223; File No. SR–FINRA– 

2010–054] 

Self-Regulatory Organizations; 

Financial Industry Regulatory 

Authority, Inc.; Notice of Filing and 

Immediate Effectiveness of Proposed 

Rule Change To Extend the 

Operational Date of SR–FINRA–2009– 

065 

November 1, 2010. 

Pursuant to Section 19(b)(1) of the 

Securities Exchange Act of 1934 

(‘‘Act’’) 1 and Rule 19b-4 thereunder,2

notice is hereby given that on October 

27, 2010, the Financial Industry 

Regulatory Authority, Inc. (‘‘FINRA’’) 

filed with the Securities and Exchange 

Commission (‘‘SEC’’ or ‘‘Commission’’) 

the proposed rule change as described 

in Items I and II, which Items have been 

prepared by FINRA. FINRA has 

designated the proposed rule change as 

constituting a ‘‘non-controversial’’ rule 

change under paragraph (f)(6) of Rule 

19b-4 under the Act,3 which renders the 

proposal effective upon receipt of this 

filing by the Commission. The 

Commission is publishing this notice to 

solicit comments on the proposed rule 

change from interested persons. 

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

FINRA is proposing to extend the 

period during which FINRA may make 

the rule changes set forth in SR–FINRA– 

2009–065 and approved by the SEC on 

February 22, 2010, effective to no later 

than June 1, 2011.4

The proposed rule change would not 

make any new changes to the text of 

FINRA rules. 

II. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

In its filing with the Commission, 

FINRA included statements concerning 

the purpose of and basis for the 

proposed rule change and discussed any 

comments it received on the proposed 

rule change. The text of these statements 

may be examined at the places specified 

in Item IV below. FINRA has prepared 

summaries, set forth in sections A, B, 

and C below, of the most significant 

aspects of such statements. 

A. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

1. Purpose 

On October 1, 2009, FINRA filed SR– 

FINRA–2009–065, a proposed rule 

change to expand the Trade Reporting 

and Compliance Engine (‘‘TRACE’’) to 

designate asset-backed securities, 

mortgage-backed securities and other 

similar securities (collectively, ‘‘AssetBacked Securities’’) as eligible for 

TRACE, and to establish reporting, fee 

and other requirements for such 

securities. In SR–FINRA–2009–065, 

FINRA stated that it would announce 

the effective date of the proposed rule 

change in a Regulatory Notice to be 

published ‘‘no later than 60 days 

following Commission approval’’ and 

the effective date would be ‘‘no later 

than 270 days following publication’’ of 

the Regulatory Notice announcing the 

Commission’s approval. 

The proposed rule change was 

published for notice and comment.5

FINRA filed its response to comments 

on December 22, 2009,6 and 

Amendment No. 1 to SR–FINRA–2009– 

065 on January 19, 2010 (hereinafter, 

SR–FINRA–2009–065 and Amendment 

No. 1 thereto are, together, the ‘‘TRACE 

ABS filing’’).7 The Commission 


jlentini on DSKJ8SOYB1PROD with NOTICES