SEC Changes Liquidity Fee, Gate Structure for MMFs

The Securities and Exchange Commission adopted rule updates during a hearing on Wednesday which amend liquidity management requirements for money market funds governed by the Investment Company Act of 1940.

The new rule requires MMFs to keep 25% of their assets in daily liquid assets, up from 10%, and at least 50% in weekly liquid assets, up from 30%.

Jamie Gershkow, a partner in Stradley Ronon, explains that MMFs which fall below these limits cannot acquire new assets until they satisfy these requirements.

A new liquidity fee will also be imposed on certain redemptions from institutional prime and tax-exempt MMFs. If daily net outflows exceed 5% of the fund’s value, then the fund must impose a liquidity fee on new redemptions. Gershkow explains that this fee must be a good faith estimate of the costs associated with continuing to satisfy redemptions. Imposing the fee is mandatory and intended to mitigate panic sales that could dilute a fund’s value for the remaining investors.

Gershkow explains that the SEC is targeting prime and tax-exempt MMFs because these funds were especially strained by outflows at the beginning of the pandemic.

The rule was motivated primarily by large outflows from MMFs in early 2020 during the beginning of the pandemic. William Birdthistle, the director of the SEC’s Division of Investment Management, explained that investors moved from MMFs to cash and Treasurys and the Federal Reserve had to establish an emergency liquidity program whereby it loaned money to MMFs at favorable rates so they could meet their redemptions.

The amendments also remove some elements of a 2014 rule which was also designed to improve MMF liquidity management. Under the 2014 rule, when a fund’s daily or weekly liquid assets fell below the regulatory thresholds, those funds were enabled to impose fees or “gates,” meaning a pause in redemptions. The new rules disconnected fees and gates from a specific liquidity threshold.

Jessica Wachter, the director of the SEC’s division of economic and risk analysis, explained during Wednesday’s hearing that the older rules had created perverse incentives: When investors anticipated a gate or fee being triggered, they actually began to sell more aggressively to ensure their access to cash. The 2014 rule therefore aggravated panic selling when it was intended to mitigate it.

The new final rule, which passed by a 3-2 vote, dropped a controversial swing pricing mechanism from the original 2021 proposal. The MMF swing pricing proposal is distinct from the proposal to implement swing pricing on mutual funds with a floating NAV, which is still pending.

Gershkow says mutual funds and MMFs are different products, so the SEC’s decision to abandon swing pricing for MMFs does not automatically mean it will be discarded from the mutual fund liquidity management proposal.

The Investment Company Institute gave mixed feedback in a statement: “The SEC has missed the mark by forcing money market funds to adopt an expensive and complex mandatory fee on investors. There is no precedent for such a fee framework.”

The statement continued, “The removal of the tie between minimum liquidity thresholds and fees and gates is a positive step—one we have long supported. We also supported a reasonable increase in daily and weekly liquid asset requirements, although the Commission has adopted an excessive threshold. We do applaud the Commission’s recognition that swing pricing is not an appropriate regulatory tool.”

The rule updates will take effect one year after its entry into the federal register, estimated to be August 2024.