John Hunt, partner in the Investment Management Group of Sullivan & Worcester, explains the changes to US Money Market Fund regulation and their impact on the industry
What are the reasons behind the reform and what are regulators looking to achieve?
The impetus for reform – that is, the 2010, 2014 and 2015 amendments to the U.S. money fund rules – was the difficulty that some money market funds had in responding to the 2008 financial crisis.
What the SEC has said it is trying to achieve through these amendments is to make money market funds more resilient to heavy withdrawals, especially during times of market volatility. According to the SEC, making money market funds more resilient to heavy withdrawals should reduce the risk of runs in money market funds and, more generally, protect investors and the financial system.
What are the key changes?
The 2014 and 2015 amendments, which require full compliance by October 14, 2016, are intended to complement the 2010 money market fund amendments. In 2010, the focus of those amendments was on Rule 2a-7’s risk-limiting conditions, that is, requirements relating to minimum levels of quality, maturity, diversification, and liquidity. The 2014 amendments focused on structural and operational reforms. The 2015 amendments were adopted primarily to conform money fund rules with new requirements imposed by Dodd-Frank.
The 2014 amendments are likely to have the greatest impact on money market funds. The two most significant changes are:
- Institutional prime money market funds will no longer be able to purchase or sell their shares using a stable net asset value, or value individual securities using the amortized cost method, or value the fund’s portfolio using the penny rounding method
- All money market funds may, and in certain cases all money market funds other than U.S. government money market funds, must impose redemptions fees and liquidity gates when the percentage of the fund’s liquid assets fall below certain amounts.
What have been the biggest challenges for the industry?
In my experience, the biggest challenge for the industry has been to determine what will happen to the remaining investments in institutional prime money market funds. Professional investors have by and large not tipped their hands as to whether those investments will remain in the fund after it begins to use a floating share price, or move to a non-registered money fund that may use pre-amendment Rule 2a-7 as an investment guideline, or move to a separately managed account or some other product.
What impact have the rules had on the industry?
The most significant impact of the rule amendments on the industry has been to increase the costs of operating a registered money market fund. Largely because of those increased costs, a number of smaller registered money market funds have either liquidated or been acquired by larger funds. It will be interesting to see if former money market fund managers come back in with new funds or new competitive products once the 2014 amendments are fully digested.
Do you think there could be further Money Market reform?
I do not think that the SEC will further amend Rule 2a-7 in the short term. The Commission has either adopted or expressly rejected every significant reform that has been proposed in connection with the 2008 financial crisis short of a prohibition of all money market funds. Moreover, there does not seem to be the political pressure on the SEC – especially from the U.S. Treasury and the Boston Fed – to amend money fund regulations as there has been over the past few years.
Over the medium- and long-terms, however, I fully expect there to be further amendments to the money fund rule. SEC rules, especially those rules as complex as Rule 2a-7, are rarely static. Those amendments are likely to be influenced by changes in the money markets, and we could see Rule 2a-7 applied to certain non-registered money funds or modifications to the rule to clarify how Rule 2a-7 applies to new types of money market instruments. Future amendment also may reflect attempts by the SEC to codify certain “best practices” adopted by the money market fund industry in response to the recent amendments, especially with respect to reporting, fund governance, and disaster planning that extends beyond stress testing. Finally, the next market meltdown will likely reveal weaknesses in money market fund rules, operations, and governance that today are not apparent, and the SEC will likely propose amendments to address those weaknesses.
What’s the best book you’ve read this year?
Citizens, by Simon Schama. It had been sitting on my library shelf for several years, since I bought it in a used bookstore for $4. I grabbed it without much thought as I was leaving for summer vacation, and I enjoyed all 850 pages.
John Hunt is a partner in the Investment Management Group of Sullivan & Worcester’s Boston office. His practice is focused on representing asset managers and their affiliates on regulatory, compliance and transactional matters. Mr. Hunt represents U.S. and non-U.S. investment advisors as well as mutual funds, hedge funds, bank-managed collective investment funds, private equity funds and venture capital funds. He also represents the independent directors to mutual funds. He regularly interfaces with U.S. regulators on a broad range of matters, including exemptive order applications, no-action letters, registration statements and examination inquiries.
Mr. Hunt has significant experience with onshore and offshore money market funds and other types of cash management products. He negotiates on behalf of his clients’ derivatives (ISDA), securities lending and repurchase agreement documentation, as well as custody and distribution arrangements. He also assists asset managers and fund sponsors in organizing and operating U.S. and non-U.S. collective investment vehicles, including registered/publicly offered mutual funds, commodity pools and hedge funds organized in the Luxembourg, Ireland, Australia, the Cayman Islands, Bermuda, the British Virgin Islands, and many other offshore jurisdictions. Over his career, Mr. Hunt has interacted extensively with non-U.S. regulators.
Mr. Hunt has practiced corporate law with other national firms in Boston and San Francisco. Prior to that he was the general counsel and chief compliance officer of IXIS Asset Management Global Associates (now Natixis Global Associates) and was responsible for all legal and compliance matters of that firm’s investment advisers, investment funds and distribution companies organized in Luxembourg, Ireland and Australia, as well as its subsidiaries and branches located in Europe, Asia and the Middle East.
The views expressed in this material are those of the author as of September 30, 2016 and may or may not be consistent with the views of Brown Brothers Harriman & Co. and its subsidiaries and affiliates (“BBH”), and are intended for informational purposes only.
Neither, Brown Brothers Harriman, its affiliates, nor its financial professionals, render tax or legal advice. Please consult with attorney, accountant, and/or tax advisor for advice concerning you particular circumstances.
BBH is not affiliated with Mr. Hunt or Sullivan & Worcester.