SEC Open Meeting
U.S. Securities and Exchange Commission
Open Meeting
Wednesday, July 12, 2023
Topline
- Both items were approved by the Commission. Item 1 was approved by a vote of 3-2, with Commissioners Peirce and Uyeda opposing. Item 2 was approved unanimously.
ITEM 1: Money Market Fund Reform; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N-CSR and Form N-1A
The Commission will consider whether to adopt amendments to certain rules that govern money market funds and related form amendments. The Commission will also consider whether to adopt amendments to Form PF to revise reporting requirements for large liquidity fund advisers and certain technical amendments to other forms.
Staff Discussion
William Birdthistle, Division of Investment Management
Birdthistle said that the staff is recommending the Commission adopt amendments to SEC regulations designed to enhance the resilience and transparency of money market funds. He explained that money market funds are popular cash management vehicles for retail and institutional investors that provide an important source of short-term financing for businesses, banks, and governments. The COVID-19 pandemic, however, led investors to shift investments to cash and short-term government securities, which resulted in tax exempt money market funds experiencing large outflows and government money market funds experiencing significant inflows. Redemption pressures subsided following Federal Reserve maneuvers to support short-term funding markets.
Birdthistle stated that under current rules, a prime or tax-exempt money market fund may impose a liquidity fee or temporarily suspend redemptions if its level of certain liquid assets falls below 30% of total assets. He stated that recent data shows that assets designed to provide liquidity to a money market in times of stress did not fully serve their purpose in March 2020. This data, along with comment letters on the Commission’s proposal, helped create and tailor the amendments for money market funds and their investors, while still achieving the goals of greater resilience and transparency.
David Driscoll, Division of Investment Management
Driscoll discussed the specific components of the final amendments. First, the amendments would remove from current Rule 2a-7 the provisions that create the regulatory weekly asset link that currently exists. Second, the amendments would require institutional prime and institutional tax-exempt money market funds to comply with a mandatory requirement that would apply when net redemptions for the business day exceed 5% of a fund’s net assets. It would largely retain the discretionary liquidity fee that would apply to all non-government money market funds. Third, as proposed, they would increase minimum liquidity requirements for money market funds and raise their daily liquid asset threshold from 10% to 25% and the weekly threshold from 30% to 50%. Fourth, the amendments would modify monthly and current reporting requirements to include information about shareholders, prime fund sales of investments, and imposition of liquidity fees. There would also be prompt reporting following a significant drop in liquidity. Fifth, the staff recommends amendments to Form PF to require additional information about private liquidity funds and provide a more complete picture of short-term financing markets. Finally, the amendments address how money market funds should handle a stable interest environment.
Jessica Wachter, Division of Economic and Risk Analysis
Wachter said that they expect the final rule to reduce the incentives for early redemptions, and thus the runs that harm investors. She noted that the amendments would require a greater minimum amount of liquidity, eliminate the ability of money market funds to reduce redemption gates, and require that institutional prime and tax-exempt funds charge a liquidity fee should redemptions on any given day exceed 5% of daily assets. Finally, Wachter noted that the rule will impose costs on money market funds, as well as other intermediaries, and may reduce attractiveness of institutional prime and tax-exempt funds from investors.
Commissioner Questions and Comments
Commissioner Hester Peirce
Peirce began by stating that today’s adoption contains the same flaw that tanked the 2014 money market rulemaking, and thus she will be voting no. She said the final rule eliminates broad discretion to impose liquidity fees and gates if weekly liquid assets drop below 30% of fund assets. She noted that eliminating the link between the liquidity threshold is good, but the Commission is grasping for more by imposing mandatory fees for institutional primes and tax-exempt funds. Peirce also said the Commission has a habit of lurching from one side to another when it comes to regulating money market funds, and in this instance is convinced it has found a solution to first movers and share dilution. In reality, however, Peirce said the Commission has yet to identify the problem it is trying to solve.
Overall, Peirce said that if the Commission is determined to move forward with a liquidity fee mandate, it should go back out to commenters to get wisdom on how to design it. She added that the mandatory element of the liquidity fee is symptomatic of the Commission’s one size fits all approach to money market regulation. Finally, she said that the final rule has some good features, including eliminating swing pricing and allowing share cancelation in negative interest rate environments.
Peirce also asked multiple questions of the staff. First, she asked about the plan for seeing how this rule affects the money market landscape. Birdthistle said that staff maintains a robust conversation with the industry and trade associations. Wachter added that they have lots of data in the money market funds space, and she is confident that they will continue to look at this space going forward. Peirce also asked why they do not impose a 40% threshold on retail funds. Birdthistle replied that in the absence of liquidity fees, that level is the primary blacktop so that is why they recommended it. She also asked how the costs associated with mandated liquidity fees compare with the diluted costs they are aimed at preventing. Wachter noted that liquidity fees do go back to the investor, so this is primarily about the operational cost to the fund. She said the liquidity fee design is meant to have the costs not be substantial, and there are various approaches that funds could take.
Commissioner Caroline Crenshaw
Crenshaw opened by stating recent history has shown how certain money market funds are vulnerable to runs in times of stress. She said that these products, which are often taken for granted as synonymous with stability, can present systemic market concerns. She continued by noting that today’s rule removes the link between fees and redemption and increases minimum daily liquid assets from 10% to 25% and weekly from 30% to 50%. This will ensure that funds can meet the redemption needs of investors, even in times of stress. Crenshaw said that she proceeds today with cautious optimism, and that she wants to be a steadfast observer of this space, watching to ensure the protections are the right ones.
Commissioner Mark Uyeda
Uyeda opened by stating that this is the third round of money market reforms since 2010. He said that today’s reforms include removal of redemption gate, increase in minimum weekly asset requirements, removal of the regulatory ties, and a new mandatory liquidity fee for institutional prime and tax-exempt funds. He said that it also adds a previously undisclosed mandatory liquidity fee that replaces the proposed swing price but was not disclosed to the public.
Uyeda also argued that the Commission could have taken an incremental approach by evaluating the impact of the supported amendments before going further. He added that key questions remain unanswered, and the Commission cannot quantify the problem it claims to fix or the benefits of its new mandatory liquidity fee. He said that it is not hard to identify the potential pitfalls that warrant the benefit of public feedback on the imposition of a mandatory liquidity fee, and it is confounding that the Commission would choose to wander into this unknown territory since the other elements of the rule are widely supported. Finally, Uyeda said that they need to be careful about staging compliance dates so that they do not hit like a tidal wave.
Commissioner Jaime Lizarraga
Lizarraga stated that the Commission is adopting reforms to strengthen the resilience of money market funds, which should help reduce their susceptibility to runs. He said that money market funds carry their own unique vulnerabilities, and that these reforms follow previous ones in 2010 and 2013. Lizarraga stated that the experience of March 2020 revealed that these reforms did not do enough. He also noted that increasing liquidity requirements may reduce transaction costs of redemptions, and that improvements to the liquidity fee framework protect investors from dilution. Finally, he said that these changes are the product of a thorough and extensive public comment process.
Chair Gary Gensler
Gensler said that he also supports the recommendation, which will enhance these funds’ resiliency and ability to protect against dilution. He said that money market funds have a potential structural problem from liquidity mismatches. He continued by stating that as a market enters times of stress, investors may try to escape the bear market, which can lead to challenges during times of stress. Additionally, in both 2008 and 2020, the federal government stepped in with extraordinary means to support these markets. Gensler stated that the adoption addresses the structural issues of dilution, liquidity, and rapid redemptions in stress times. The rule does require a portion of the market to impose liquidity fees on redeeming investors during times of stress, but he said that these fees will help ensure that during stress time, redeeming investors bear the cost of redemption. He also noted that these fees would only be imposed on 11% of the money market space. Gensler concluded saying that he is voting yes, and voting for fewer bailouts in the future.
Vote
Chairman Gensler called the role. The item was approved 3-2. Peirce and Uyeda voted no.
ITEM 2: Daily Computation of Customer and Broker-Dealer Reserve Requirements under the Broker-Dealer Customer Protection Rule
The Commission will consider whether to propose amendments to the broker-dealer customer protection rule to require certain broker-dealers to compute their customer and broker-dealer reserve deposit requirements daily rather than weekly.
Staff Discussion
Haoxiang Zhu, Division of Trading and Markets
Zhu explained that the staff is recommending that the Commission propose amendments to require certain broker-dealers to increase the frequency with which they perform computations of the net cash they owe to customers and other broker-dealers (known as PAB account holders) from weekly to daily. He said that currently, most broker dealers are required to make these computations weekly, but large mismatches pose a risk to the carrying broker dealer’s customers. Today’s proposal would speed up the computations from weekly to daily to reduce this mismatch risk.
Sheila Swartz, Division of Trading and Markets
Swartz noted that a carrying broker dealer is required to have a bank account with cash or qualified securities determined by the computation of net cash owed to customers or PAB account holders. She said that carrying broker dealers can elect to perform the computation more frequently than weekly. By shortening the time frame between computation, she said the proposal will assist carrying broker dealers in dynamically matching the amount of cash owed to customers, which will reduce risk that a carrying broker dealer will fail financially and not return all the securities and cash owed to its customers and PAB account holders. She reiterated that the proposal would require carrying broker dealers with large amounts of total credits to increase the frequency of their customer and PAB reserve computations to daily. By requiring daily rather than weekly, Swartz said the proposal would more accurately match the net amount of cash owed to customers and PAB holders, lessening the potential for large mismatches.
Jessica Wachter, Division of Economic and Risk Analysis
Wachter stated that the proposal would require broker dealers with average credits of about $250 million to tally these funds daily. She said that this lowers the risk of a mismatch between what the broker dealer owes the customer versus what is in the customer bank account. Wachter noted that with many failures, even the Securities Investor Protection Corporation (SIPC) may not be able to cover the difference. Finally, she said that large mismatch is a collective action problem, and that broker dealers would experience operational costs in making this switch.
Commissioner Questions and Comments
Commissioner Hester Peirce
Peirce stated that she supports the proposal to amend the rule to decrease the likelihood of customer loss in the event of a bad failure. She said that if the rule functions properly, it protects customers and the SIPC fund. She also added that the amendments are narrowly tailored to address the risk that mismatches may develop and persist, and that the data presented in the recommendation suggests that requiring large firms to make the computations and deposits daily will reduce the risk of mismatch.
Finally, Peirce said that she hopes commenters will help the Commission determine whether the threshold for firms needing to do these daily are correct. She added that it would be helpful to hear from firms that may be impacted about whether it will reduce the frequency and size of mismatches. Finally, she hopes commenters will alert the Commission to any unexpected interactions between proposed amendments and last year’s proposal regarding Treasury clearing.
Commissioner Caroline Crenshaw
Crenshaw said that the amendments would strengthen customer protection rules by requiring broker dealers to maintain sufficient funds to reimburse their customers. She noted that the mismatch discussed in the economic analysis can equal hundreds of millions or even billions of dollars and can result in substantial losses. She also said that while many large broker dealers already do this on a voluntary basis, a significant number do not. Finally, Crenshaw said she hopes commenters provide feedback, particularly in response to the scope of the proposal. Specifically, she asked if the threshold/time periods for eligibility for daily computations make sense.
Commissioner Mark Uyeda
Uyeda stated that carrying broker dealers currently need a special reserve account at a bank that holds qualified security/cash of an amount determined by weekly computation. He reiterated that the amendment would require certain broker dealers to make such computations daily. He said that this is a good starting point for a conversation on this topic, and that he will look to the public for comments/feedback to inform future actions.
Commissioner Jaime Lizarraga
Lizarraga said that today’s proposal to update the customer protection rule for carrying broker dealers will improve the daily functioning of capital markets and increase investor confidence. He also noted that the amount of potential shortfalls is not trivial, and recent failures in the banking sector brought into view the need to review vulnerabilities. He added that the proposal is designed to strengthen protections for customer access.
Chair Gary Gensler
Gensler said that he is pleased to support this proposal, as it would help protect customers if a broker dealer fails. He added that Congress gave the agency the authority to adopt security measures in the 1970 Security Investor Protection Act, and customers would benefit if brokers made daily reserve calculations, rather than weekly. Finally, Gensler said that 11 of the largest broker-dealers make the calculations daily, and today’s proposal would standardize this practice.
Vote
Chairman Gensler called the role. The item was approved unanimously.
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