Ask an Expert: Money Market Fund Reform

After years of deliberation, on July 23, 2014, the Securities and Exchange Commission (SEC) adopted new rules that govern money market mutual funds (MMFs). The reform is largely a response to fallout from the 2008 financial crisis.

The main objectives of the reform are to address MMFs’ susceptibility to heavy redemptions in times of stress, increase MMFs’ risk transparency, and preserve the benefits of investing in MMFs.

The SEC set forth a compliance period of two years. The compliance date for fund diversification, stress testing, Form PF, Form N-MFP, additional disclosures, and clarifying amendments was April 14, 2016. And the compliance date of October 14, 2016 – for the amendments related to the floating net asset value (NAV) and liquidity fees – is rapidly approaching.

What is changing?

These new rules will require a floating NAV for institutional prime MMFs by removing the valuation exception that permitted institutional non-government MMFs (whose investors have historically made the heaviest redemptions in times of market stress) to maintain a stable NAV. Historically, these funds have transacted at a stable NAV price of $1 per share. Now, they will be required to sell and redeem on the NAV of the fund rounded to the fourth decimal place.

Additionally, new tools have been created for boards to prevent heavy redemptions in times of stress, including liquidity fees and gates.

Liquidity fees are fees that can be imposed on investors on all MMF redemptions. Investors will have liquidity, but at an added cost. A liquidity fee of up to 2% on redemptions may be assessed if weekly liquid assets fall below 30% of the fund’s total assets. The fund is required to impose a liquidity fee of 1% (and up to 2%) on all redemptions if its weekly assets fall below 10% of its total assets, unless the fund’s board determines that this is not in the best interest of the fund. The liquidity fee is immediately lifted once the fund’s weekly liquid assets rise above 30%.

A redemption gate is a temporary suspension of redemptions. When imposed, investors will not be able to redeem out of the MMF. A gate of up to ten business days in a ninety-day period may be imposed if the fund’s weekly liquid assets fall below 30% of its total assets, so long as the board determines that imposing such a gate is in the best interest of the fund. Similar to the liquidity fee, the gate is immediately lifted once the fund’s weekly liquid assets rise above 30%.

Now that these MMFs have the ability to impose these fees and gates, both portfolio managers and investors will want to closely monitor the percent of weekly liquid assets in the fund. Weekly liquid assets are defined in the reform as:

• Cash
• Direct obligations of the U.S. Government
• Government issued under supervision/control of the U.S. Government that are issued at a discount and mature within 60 days
• Securities maturing within five business days
• Receivables due within five business days

In an effort to increase transparency, MMFs will be subject to increased diversification requirements and enhanced stress testing. Additional information will need to be submitted to the SEC and to investors, including the fact that investors may report losses and the fund may impose fees and gates.

How Does this Change Impact Insurance Investors?

This new reform has caused investors to reassess the benefits of their investments in institutional prime MMFs. Some have already moved to government MMFs or other non-MMF alternatives, and others have looked at separately managed accounts (SMAs). Conversions from prime MMFs to government funds have accelerated, giving investors more options in the government fund market.

In initial industry feedback, many expressed concerns about the potential accounting and tax reporting implications of these reforms. To ease investors’ tax reporting concerns regarding the new SEC amendments, the IRS and the U.S. Treasury Department released a new regulation permitting investors to use a simplified aggregate method of accounting rather than tracking the timing and price of purchase and sale transactions at a lot level to report capital gains and losses. Under this method, any capital gains and losses would be considered short-term, and any dividends received would be included in income regardless of whether they were reinvested. The IRS and U.S. Treasury Department also released a new regulation that exempts floating NAV MMFs from the wash sale rule.

To date, the Financial Accounting Standards Board (FASB) has been silent on the matter and nothing has changed from a U.S. GAAP perspective. Some commenters wanted the FASB to specifically weigh in on whether or not floating NAV MMFs can be treated as cash equivalents on a balance sheet. However, the SEC stated that this announcement would not be necessary, as the SEC has the plenary authority to confirm that under normal circumstances, a floating NAV MMF meets the definition of a cash equivalent.

From an insurance reporting perspective, this reform primarily impacts reporting of Class 1 funds. These funds were approved by the Securities Valuation Office (SVO) to be placed on Schedule DA as a short-term asset (as opposed to Schedule D – 2.2) as an interest in a fund. The NAIC is holding last-minute discussions to address these issues. At this point, these funds will most likely still be held on Schedule DA, provided they meet certain requirements. However, it will now be up to the insurer to correctly classify MMFs. The SVO has already adopted a proposal to delete the Class 1 list from their Purposes and Procedures Manual, and it seems unlikely that they will add a similar list in time for 2016 year-end reporting.

How is Clearwater Addressing the Change?

Investors and investment management solutions like Clearwater have had two years to prepare for this change. During this preparatory compliance period, Clearwater has been making updates to data, pricing, accounting, and UI, in order to ensure that the solution is ready prior to the October 2016 deadline.

Data Preparations

Clearwater will have multiple provisions in place to ensure that we have proper coverage and data. Clearwater has been working with different data providers that can provide pricing for floating NAV MMFs (to four decimal places) and other data points, such as the percent of daily/weekly liquid assets and a fee and gate indicator.

Accounting Preparations

Clearwater already performs accounting calculations at the lot level and can process MMFs with a price other than $1. Clearwater provides realized and unrealized gains and losses for these assets, just like any other securities that experience price movements.

As mentioned above, the IRS now permits the use of a simplified aggregate method of accounting. This helps provide relief to the floating NAV MMF investors who still take a more manual approach to the calculation of gains and losses. Because the new reform does not place any additional burden on systems already performing lot level calculations, it is not necessary to move to a simplified aggregate method of accounting. Additionally, the Clearwater tax module will not detect or account for wash sales if the security is a floating NAV MMF, as they are now exempt from the wash sale rule.

The overall impact of this reform on the Clearwater interface will be minimal. Clearwater is in the process of updating the way prices are viewed on the website, and will soon update prices to display up to four decimal points, as required by this reform.

As with all regulatory updates, Clearwater experts will continue to proactively monitor MMF reforms, and will continue to inform the insurance investment accounting industry on how such reforms could impact them in the future.