incur operational costs in addition to, or that differ from the costs
estimated in the Proposing Release. We did not receive comments
regarding specific costs, although one commenter stated that it did not
believe that the amendments would have a significant impact on the
operations of most money market funds.\1622\ Another commenter stated
that additional time and data costs may be required to determine issuer
affiliations, but also stated that it did not see a significant
increase in costs related to complying with our amended issuer
diversification requirements.\1623\
---------------------------------------------------------------------------

    \1622\ ICI Comment Letter.
    \1623\ State Street Comment Letter.
---------------------------------------------------------------------------

    Based on the activities typically involved in making systems
modifications, and recognizing that money market funds' existing
systems currently have varying degrees of functionality, we estimated
in the Proposing Release, and continue to estimate, that the one-time
systems modifications costs (including modifications to related
procedures and controls) for a money market fund associated with these
amendments would range from approximately

$600,000 to $1,200,000.\1624\ As we stated in the Proposing Release, we
do not expect that money market funds will incur material ongoing costs
to maintain and modify their systems as a result of this amendment
because we expect modifications required by this amendment will be
incremental changes to existing systems that already perform similar
functions (track exposures for purposes of monitoring compliance with
rule 2a-7's 5% issuer diversification limit).
---------------------------------------------------------------------------

    \1624\ Staff estimates that these costs will be attributable to
the following activities: (i) Planning, coding, testing, and
installing system modifications; (ii) drafting, integrating, and
implementing related procedures and controls; and (iii) preparing
training materials and administering training sessions for staff in
affected areas. See also supra section III.A.5.a.
---------------------------------------------------------------------------

    Although we have estimated the costs that a single money market
fund could incur as a result of this amendment, we expect that these
costs will be shared among various money market funds in a complex. As
discussed in the Proposing Release, we do not expect that money market
funds will be required to spend additional time determining
affiliations under our amendments, or if an additional time commitment
is required, we expect that it would be minimal. We estimated in the
Proposing Release that the costs of this minimal additional time
commitment to a money market fund, if it were to occur, will range from
approximately $5,000 to $105,000 annually.\1625\ We did not receive
comments on these particular estimates, although we have updated our
estimates based on more recent data, and now estimate that the costs of
this minimal additional time commitment to a money market fund, if it
were to occur, will range from approximately $6,700 to $109,500
annually.\1626\
---------------------------------------------------------------------------

    \1625\ In arriving at this estimate in the Proposing Release, we
expected that any required additional work generally would be
conducted each time a money market fund determined whether to add a
new issuer to the approved list of issuers in which the fund may
invest. The frequency with which a money market fund makes these
determinations would depend on its size and investment strategy. To
be conservative, and based on Form N-MFP data concerning the number
of securities held in money market funds' portfolios, we estimated
that a money market fund could be required to make such a
determination between 33 and 339 times each year. This was based on
our staff's review of data filed on Form N-MFP as of February 28,
2013, which showed that the 10 smallest money market funds by assets
had an average of 33 investments and the 10 largest money market
funds by assets had an average of 339 investments. The number of a
money market fund's investments should be a rough proxy for the
number of times each year that a money market fund could add an
issuer to its approved list, although this will overstate the
frequency of these determinations (e.g., a fund may have a number of
separate investments in a single issuer). We estimated that the
additional time commitment imposed by our amendments, if any, would
be an additional 1-2 hours of an analyst's time each time the fund
determined whether to add an issuer to its approved list. The
estimated range of costs, therefore, was calculated as follows: (33
Evaluations x 1 hour of a junior business analyst's time at $155 per
hour = $5,115) to (339 evaluations x 2 hours of a junior business
analyst's time at $155 per hour = $105,090). Finally, we recognize
that some money market funds do not use an approved list, but
instead evaluate each investment separately. We believe that the
number of a money market fund's investments also should be a rough
proxy for the number of times such a money market fund would
evaluate each investment. Such funds may be on the higher end of the
range, however, because the extent to which a fund's average number
of investments reflects the number of times such a fund purchases
securities would depend on the rate of the fund's portfolio
turnover. Whether any additional analysis would be required as a
result of our amendments for such a fund also would depend on
whether the fund invested proceeds from maturing securities in
issuers for which a new credit risk analysis was required or in
issuers of securities owned by the fund for which the analysis may
already have been done.
    \1626\ In arriving at this estimate, we expect that any required
additional work generally will be conducted each time a money market
fund determined whether to add a new issuer to the approved list of
issuers in which the fund may invest. The frequency with which a
money market fund will make these determinations would depend on its
size and investment strategy. To be conservative, and based on Form
N-MFP data concerning the number of securities held in money market
funds' portfolios, we estimate that a money market fund could be
required to make such a determination between 42 and 342 times each
year. This is based on our staff's review of data filed on Form N-
MFP as of February 28, 2014, which showed that the 10 smallest money
market funds (not including government or Treasury funds) by assets
had an average of 42 investments and the 10 largest money market
funds (not including government or Treasury funds) by assets had an
average of 342 investments. The number of a money market fund's
investments should be a rough proxy for the number of times each
year that a money market fund could add an issuer to its approved
list, although this will overstate the frequency of these
determinations (e.g., a fund may have a number of separate
investments in a single issuer). We estimate that the additional
time commitment imposed by our amendments, if any, will be an
additional 1-2 hours of an analyst's time each time the fund
determined whether to add an issuer to its approved list. The
estimated range of costs, therefore, is calculated as follows: (42
Evaluations x 1 hour of a junior business analyst's time at $160 per
hour = $6,720) to (342 evaluations x 2 hours of a junior business
analyst's time at $160 per hour = $109,440). Finally, we recognize
that some money market funds do not use an approved list, but
instead evaluate each investment separately. We believe that the
number of a money market fund's investments also should be a rough
proxy for the number of times such a money market fund would
evaluate each investment. Such funds may be on the higher end of the
range, however, because the extent to which a fund's average number
of investments reflects the number of times such a fund purchases
securities would depend on the rate of the fund's portfolio
turnover. Whether any additional analysis would be required as a
result of our amendments for such a fund also would depend on
whether the fund invested proceeds from maturing securities in
issuers for which a new credit risk analysis was required or in
issuers of securities owned by the fund for which the analysis may
already have been done.
---------------------------------------------------------------------------

2. ABS--Sponsors Treated as Guarantors
    We are amending rule 2a-7, as proposed, to require that money
market funds treat the sponsors of ABS as guarantors subject to rule
2a-7's 10% diversification limit applicable to guarantees and demand
features, unless the money market fund's board of directors (or its
delegate) determines that the fund is not relying on the sponsor's
financial strength or its ability or willingness to provide liquidity,
credit or other support to determine the ABS's quality or
liquidity.\1627\ As discussed in the Proposing Release, money market
funds' reliance on and exposure to sponsors of ABCP, a type of ABS,
specifically during 2007, suggests that current rule 2a-7 potentially
permits money market funds to become overexposed to ABCP
sponsors.\1628\ Our amendments today therefore provide that, subject to
an exception, money market funds investing in ABS rely on the sponsor's
financial strength or its ability or willingness to provide liquidity,
credit, or other support to the ABS, and require diversification
against such reliance and exposure to ABS sponsors.\1629\
---------------------------------------------------------------------------

    \1627\ As a result, subject to an exception, a money market fund
cannot invest in ABS, if immediately after the investment it would
have invested more than 10% of its total assets in securities issued
by or subject to demand features or guarantees from the ABS sponsor.
See rule 2a-7(a)(18)(ii) and rule 2a-7(d)(3)(iii). Current rule 2a-7
applies a 10% diversification limitation on demand features and
guarantees to 75% of money market funds' total assets. As discussed
in infra section III.I.3, we are amending rule 2a-7 to apply the 10%
diversification limitation to 85% of a tax-exempt money market
fund's assets and to 100% of a fund's assets for money market funds
other than tax-exempt funds.
    \1628\ See Proposing Release, supra note 25, at section III.J.2.
    \1629\ Under the amended rule, the sponsor of an ABS will be
deemed to guarantee the entire principal amount of those ABS, except
that the sponsor will not be deemed to have provided such a
guarantee for purposes of the following paragraphs of rule 2a-7:
(a)(12)(iii) (Definition of eligible security); (d)(2)(iii) (credit
substitution); (d)(3)(iv)(A) (fractional guarantees); and (e)
(guarantees not relied on). We also are adopting a number of
conforming amendments to other provisions of rule 2a-7 to implement
the treatment of ABS sponsors as guarantors. See rule 2a-
7(f)(4)(iii) (defining defaults for purposes of rule 2a-7(f)(2) and
(3) as applied to guarantees issued by ABS sponsors); rule 2a-
7(g)(7) (requiring periodic re-evaluations of any finding that the
fund is not relying on the sponsor's financial strength or ability
or willingness to provide support in determining the quality or
liquidity of ABS); and rule 2a-7(h)(6) (recordkeeping requirements
for the periodic re-evaluations).
---------------------------------------------------------------------------

    A number of commenters generally supported the requirement to treat
sponsors of ABS as guarantors.\1630\ For

example, one commenter noted that ABS sponsors have provided explicit
as well as implicit credit and liquidity support for the vehicles they
have sponsored and that it is therefore appropriate that such support
be presumed for purposes of applying rule 2a-7 diversification
limitations.\1631\ Several commenters however, generally opposed the
proposed requirement.\1632\ Some of these commenters argued that the
requirement to treat sponsors of ABS as guarantors is not consistent
with the current practice of money market funds.\1633\ For example, one
commenter stated that while money market funds cannot usually review
information about the particular assets underlying ABS,\1634\ money
market funds nevertheless base their credit decisions on a multitude of
factors other than the sponsor's financial strength.\1635\ Some
commenters also argued that money market funds look to the legal
requirement for a sponsor to provide a guarantee rather than relying on
an implicit guarantee by the sponsor,\1636\ and that partial or
incidental reliance on the financial strength of an ABS sponsor should
not require treatment of the sponsor as a 100% guarantor of the
ABS.\1637\ Another commenter argued that the requirement to treat the
sponsor of an SPE issuing ABS as a guarantor of ABS would require money
market funds to expand diversification of ABS sponsors at the same time
many of these sponsors are exiting the market.\1638\ While we recognize
that in many cases a money market fund is not basing its investment
decision solely on the financial strength of the sponsor or on an
implicit guarantee by the sponsor, we understand, as discussed in the
Proposing Release, that money market funds often make investment
decisions based, at least in part, on the presumption that the sponsor
will take steps to prevent the ABS from defaulting.\1639\ However,
money market funds are generally not required to diversify against ABS
sponsors because the support that ABS sponsors provide, implicitly or
explicitly, which money market funds often rely on, typically does not
meet the current rule's definition of ``guarantee'' or ``demand
feature.'' \1640\
---------------------------------------------------------------------------

    \1630\ See, e.g., Goldman Sachs Comment Letter; Schwab Comment
Letter; U.S. Bancorp Comment Letter; Vanguard Comment Letter;
BlackRock II Comment Letter; Wells Fargo Comment Letter.
    \1631\ Goldman Sachs Comment Letter.
    \1632\ See, e.g., SSGA Comment Letter; Federated II Comment
Letter. See also ICI Comment Letter (arguing that the amendment
could result in a reduction of the supply of securities to money
market funds without any increase in investor protection).
    \1633\ See, e.g., Federated VIII Comment Letter; SSGA Comment
Letter; ICI Comment Letter.
    \1634\ See Proposing Release, supra note 25, nn.870-872 and
accompanying text (discussing that an asset-liability mismatch in
ABCP conduits causes ABCP investors to analyze the structure of the
ABCP conduits more so than underlying asset level information).
    \1635\ Federated II Comment Letter (describing information it
reviews, including pool level information about the underlying
assets). See also Federated VIII Comment Letter (discussing its
evaluation of ABCP before investing, noting that only a portion of
their analysis is based on the sponsor, and that significant
emphasis is placed on the qualifying assets); SSGA Comment Letter
(stating that it believes credit analysis with regard to ABS should
not solely rely upon sponsor support).
    \1636\ See, e.g., Federated II Comment Letter; ICI Comment
Letter (arguing that because the proposed requirement would treat a
sponsor as a guarantor of the entire amount of the ABS even when the
sponsor has no legal obligation to support its ABS, the amendment
seems to endorse the practice of relying on an ``implicit''
guarantee when assessing the credit risk of ABS). See also Federated
VIII (arguing that the amendment would encourage investors that are
assessing the credit risk of ABS to rely on an unproven assumption
that a sponsor will voluntarily assume losses on its financial
products, and that because such ``implicit guarantees'' are not
reliable, endorsing this practice would only increase risks to money
market funds that invest in ABS.)
    \1637\ See, e.g., ICI Comment Letter; Federated VIII Comment
Letter.
    \1638\ Invesco Comment Letter.
    \1639\ Comment Letter of the American Securitization Forum (Aug.
2, 2010) (available in File No. S7-08-10) (``ASF August 2010 Comment
Letter''). (``[T]he liquidity and credit support for the vast
majority of ABCP conduits are provided by their financial
institution sponsors.''). But see SFIG Comment Letter (describing
that a subset of ABCP conduits are administered by entities that are
not financial institutions and that credit or liquidity support to
the ABCP conduit is provided by financial institutions that are not
affiliated with the administrator); ICI Comment Letter (suggesting
that there is no reason to require diversification against sponsors
as opposed to other service providers such as servicers and
liquidity providers). Although persons other than the sponsor, such
as servicers and liquidity providers, could support ABS, we
understand that, to the extent ABS have explicit support, it
typically is provided by the sponsor. We also understand that
investors in ABS without explicit support may view the sponsor as
providing implicit support. See, e.g., Goldman Sachs Comment Letter.
    \1640\ See Proposing Release, supra note 25, n.868 and
accompanying text.
---------------------------------------------------------------------------

    We acknowledge that if sponsor supply were to become limited, it
may be more difficult for money market funds to obtain ABS. However,
after further consideration, we continue to believe it is appropriate
to amend rule 2a-7 to require diversification against such support to
limit a money market fund's concentration in a single sponsor because a
fund could seek to rely on liquidity or capital support from that
sponsor, if necessary. When a money market fund is determining the
ABS's quality or liquidity based, at least in part, on the ABS
sponsor's financial strength or its ability or willingness to provide
liquidity, credit or other support, limiting a money market fund's
concentration in that sponsor mitigates the risk that a money market
fund would face in the case where such ABS sponsor would be unable to
support the value of the fund's investments in times of severe market
stress because it reduces the amount of a money market fund's
investments that would be impacted by the inability of the sponsor to
support the value of those investments.
    As discussed further below, we recognize that in certain cases an
ABS sponsor should not be deemed to guarantee the ABS. An ABS sponsor
therefore will not be deemed to guarantee the ABS if the money market
fund's board of directors (or its delegate) determines that the fund is
not relying on the ABS sponsor's financial strength or its ability or
willingness to provide liquidity, credit, or other support to determine
the ABS's quality or liquidity. We also discuss below that an ABS
sponsor will not be deemed to guarantee the full amount of ABS in cases
of fractional guarantees.
    Commenters noted that under current rule 2a-7, if a company
guarantees or provides a demand feature of a portion of the qualifying
assets, only that portion of the ABS is counted towards the
diversification limit.\1641\ These commenters expressed concern that
amended rule 2a-7 would change this result by treating a company that
sponsors ABS as a guarantor of the entire amount held by a fund, even
if the company's guarantee or demand feature is limited to a smaller
amount.\1642\ As proposed, in cases where a security is subject to a
fractional demand feature or guarantee by the sponsor, as defined in
rule 2a-7, a money market fund may count the fractional demand feature
or guarantee in place of deeming the sponsor as a guarantor of the
entire principal amount of the ABS.\1643\ However, in cases where a
money market fund is partially or incidentally relying on the financial
strength of the ABS sponsor, but such partial or incidental reliance
does not fall under the definition of a fractional guarantee, the money
market fund will be required to treat the sponsor as a guarantor of the
entire principal amount of the ABS. In this case, even though a sponsor
may not be providing a full guarantee, the fund would not be able

to readily determine the actual portion of assets for which the
guarantor is providing structural support. Therefore, except in cases
of fractional guarantees as discussed above, we continue to believe
that, unless the board of directors determines that the fund is not
relying on the financial strength of the sponsor, it is appropriate to
require diversification against such sponsor with respect to all the
qualifying assets in order to mitigate the risk that an ABS sponsor
would be unable to support the value of a money market fund's
investments in times of severe market stress.
---------------------------------------------------------------------------

    \1641\ See, e.g., ICI Comment Letter; Memorandum from the
Division of Investment Management regarding a September 10, 2013
meeting with representatives of the Structured Finance Industry
Group.
    \1642\ Id.
    \1643\ See rule 2a-7(d)(3)(iv)(A) (calculation of fractional
demand features or guarantees) and rule 2a-7(a)(18)(ii) (providing
an exception from the requirement to deem a sponsor of an SPE as
providing a guarantee with respect to the entire principal amount of
ABS in the case of fractional guarantees).
---------------------------------------------------------------------------

    One commenter suggested that explicit support would not always be
dispositive in determining the sponsor's identity and that treating
certain entities as sponsors would not reflect actual economic risks to
the fund.\1644\ This commenter also recommended that we define the term
sponsor in our final amendments, noting that otherwise it may be
difficult for certain money market funds to determine the entity that
is providing the deemed guarantee.\1645\ Although providing a specific
definition of ABS sponsor may exclude certain entities that should
otherwise be treated as a sponsor, and may not allow for future
flexibility with regards to new types of ABS structures, we understand
that determining the ABS sponsor in certain cases may present
difficulties. We recognize that in some cases where the administrator
of an ABCP conduit, which may otherwise be commonly thought of as the
sponsor, is not providing liquidity or credit support, the
administrator would not appropriately be defined as a sponsor for
purposes of our amended diversification requirements. In this case,
requiring diversification against entities that do not, or could not,
provide liquidity, credit or other support to the ABCP conduit would
not reflect the actual risks of a fund's exposure to such an entity.
For ABCP, we believe that the sponsor will typically be the financial
institution that provides explicit liquidity and/or credit support and
also provides administrative services to the ABCP conduit.\1646\ The
amended diversification requirements we are adopting today aim to
diversify against the risks of concentration of exposure to entities
that a fund may be relying on, whether explicitly or implicitly, in
determining the ABS's quality or liquidity. Therefore, if a money
market fund is relying on an entity's financial strength or its ability
or willingness to provide liquidity, credit, or other types of support
to determine the ABS's quality or liquidity, such entity would
appropriately be defined as a sponsor for purposes of our amended
diversification requirements.
---------------------------------------------------------------------------

    \1644\ SFIG Comment Letter (recommending that we define a
provider of credit and liquidity support to an ABCP conduit that
equals or exceeds fifty percent of the outstanding face amount of
the ABCP of such conduit as the sponsor).
    \1645\ Id.
    \1646\ For TOB programs in which the liquidity provider for the
TOB program or its affiliate holds the residual interest in the TOB
trust, we believe the entity that provides both the liquidity
support and holds the residual interest typically will be the
sponsor. For TOB programs in which the liquidity provider or its
affiliate does not also own the residual interest in the TOB trust,
we believe the financial institution that sets up the TOB program,
markets and remarkets the TOBs, transfers the municipal security
into the TOB trust and/or provides liquidity typically will be the
sponsor.
---------------------------------------------------------------------------

    As proposed, our amended rule requires that, unless the board (or
its delegate) determines otherwise, all ABS sponsors are deemed to
guarantee their ABS. We are applying this requirement to all ABS
sponsors because we are concerned that applying the requirement only to
sponsors of certain types of ABS could become obsolete as new forms of
ABS are introduced. Because we recognize that it may not be appropriate
to require money market funds to treat ABS sponsors as guarantors in
all cases, under amended rule 2a-7, an ABS sponsor would not be deemed
to guarantee the ABS if the money market fund's board of directors (or
its delegate) determines that the fund is not relying on the ABS
sponsor's financial strength or its ability or willingness to provide
liquidity, credit, or other support to determine the ABS's quality or
liquidity.\1647\ In determining whether a money market fund is relying
on the ABS sponsor's financial strength or its ability or willingness
to provide liquidity, credit, or other support, the money market fund
board of directors may want to consider, among other things, whether
the fund considers the ABS sponsor's financial strength or its ability
or willingness to provide liquidity, credit, or other support as a
factor when determining the ABS's quality or liquidity.
---------------------------------------------------------------------------

    \1647\ Rule 2a-7(a)(18)(ii). This determination must be
documented and retained by the money market fund. See rule 2a-
7(g)(7) and rule 2a-7(h)(6).
---------------------------------------------------------------------------

    While one commenter specifically supported the exception to the ABS
sponsor designation through money market fund board of directors (or
delegate) action,\1648\ other commenters expressed concern that
overseeing determinations that a money market fund is not relying on
ABS sponsors would impose further burdens on money market fund
directors.\1649\ However, a board can, and likely will, delegate this
responsibility.\1650\ While we recognize that a board will, at a
minimum, need to provide oversight and establish procedures \1651\ if
it delegates its responsibility, we believe that any incremental burden
to make a determination (by the board or its delegate) regarding
reliance on an ABS sponsor should be minimal, as the money market fund
would already have analyzed the security's credit quality and liquidity
when assessing whether the security posed minimal credit risks and
whether the fund could purchase the security consistent with rule 2a-
7's limits on investments in ``illiquid securities.'' \1652\ One
commenter supported a board exception that applied when a money market
fund board (or its delegate) determines that a sponsor's financial
strength or its ability or willingness to provide liquidity, credit or
other support did not play a substantial role in the money market
fund's assessment of the ABS's quality or liquidity.\1653\ On balance
however, we believe that even when a money market fund board of
directors (or its delegate) determines that a sponsor's financial
strength or its ability or willingness to provide liquidity, credit or
other support plays a less than substantial role in the money market
fund's assessment of the ABS's quality or liquidity, it is beneficial
to require diversification against such sponsor because it limits a
money market fund's concentration in a single sponsor on which the fund
could still seek to rely. In addition, requiring diversification
against such sponsor also mitigates the possible effect of an ABS
sponsor being unable to support the value of the ABS because a money
market fund will be required to diversify against its investments in
ABS with such sponsor. We are therefore adopting the board exception as
proposed.
---------------------------------------------------------------------------

    \1648\ Goldman Sachs Comment Letter.
    \1649\ Federated VIII Comment Letter; ICI Comment Letter;
Fidelity Comment Letter.
    \1650\ See rule 2a-7(j) (providing a money market fund's board
of directors the ability to delegate to the fund's adviser or
officers the responsibility to make certain determinations required
to be made by the board of directors under rule 2a-7).
    \1651\ See rule 2a-7(j)(1) and (2).
    \1652\ Rule 2a-7(a)(12) (definition of ``eligible security'')
and rule 2a-7(d)(4) (portfolio liquidity).
    \1653\ Invesco Comment Letter.
---------------------------------------------------------------------------

    Several commenters argued that a board should not have to make a
finding in certain situations where the ABS is fully supported by a
guarantee or demand feature provided by a third party.\1654\ One of
these commenters argued that if an issuance of ABS has a

contractual guarantee of support by a third party, we should require
money market funds to count the third-party guarantor, rather than the
sponsor, for purposes of the diversification limit.\1655\ This
commenter noted that for ABS that carry contractual guarantees of
support by third parties, a fund manager often looks to financial
strength and creditworthiness of the third-party guarantor to evaluate
the creditworthiness or liquidity of the ABS.\1656\ We recognize that
in certain cases, ABS may be fully supported by a guarantee or demand
feature provided by a third party where the board (or its delegate)
would determine that the money market fund is not relying on the ABS
sponsor's financial strength or its ability or willingness to provide
liquidity, credit, or other support to determine the ABS' quality or
liquidity. However, some money market funds may view the third-party
guarantee as a ``layered guarantee'' on top of the sponsor's guarantee,
which today are both subject to a 10% diversification limit under rule
2a-7. We believe it is appropriate to allow for instances of layered
guarantees when a third-party guarantor is present, and therefore
believe that in cases where a money market fund is relying only on the
third-party guarantor the board (or its delegate) can determine that it
is not relying on the sponsor, and in cases where a money market fund
views the third-party guarantor as providing a layered guarantee, the
amended rule will provide that the money market fund treat the
guarantee by the sponsor and the guarantee by the third-party guarantor
as layered guarantees.
---------------------------------------------------------------------------

    \1654\ See, e.g., ICI Comment Letter; Fidelity Comment Letter;
Wells Fargo Comment Letter.
    \1655\ Wells Fargo Comment Letter.
    \1656\ Id.
---------------------------------------------------------------------------

    Commenters also argued that the board should not have to make the
required findings for certain types of ABS, such as TOBs. Commenters
argued that diversification from TOB sponsors is unnecessary because
TOBs have dedicated liquidity providers and frequently have credit
enhancement, and the TOB sponsor may not necessarily be the provider of
either.\1657\ Commenters also stated that tax-exempt money market funds
in particular would suffer if TOBs were not excluded because the
amended diversification requirements would further restrict a money
market fund's ability to hold TOBs.\1658\ One commenter recommended
excluding sponsors of all types of ABS (other than ABCP) from the
proposed ABS sponsor rule, noting that sponsors of non-ABCP ABS do not
typically provide explicit credit or liquidity support.\1659\ We
recognize that in some cases diversification from non-ABCP ABS
sponsors, including TOB sponsors may be unnecessary if the fund is not
relying on the sponsor's financial strength or its ability or
willingness to provide liquidity, credit or other support to determine
the ABS's quality or liquidity.
---------------------------------------------------------------------------

    \1657\ See, e.g., Vanguard Comment Letter. See also SIFMA
Comment Letter.
    \1658\ See, e.g., Fidelity Comment Letter; SIFMA Comment Letter
(noting that TOBs already have a limited number of sponsors).
    \1659\ SFIG Comment Letter.
---------------------------------------------------------------------------

    Although commenters suggested providing an exclusion from the
amended rule, we believe that non-ABCP ABS, including TOBs, are more
appropriately addressed through the board exception to the
diversification requirement. Because at least in some instances a fund
may be looking to the sponsor's financial strength or its ability or
willingness to provide liquidity, credit or other support to determine
the ABS's quality or liquidity, we have decided to retain the
presumption for ABS generally. In addition, we believe that it would be
inefficient to attempt to anticipate every type of ABS sponsor that
should be excluded now or in the future, and designating particular
exclusions in the amended rule may not provide for innovation of new
types of ABS over time. The rebuttable presumption we are adopting
today however, does allow for flexibility in instances where the fund
is not looking to the sponsor, irrespective of the actual type of ABS,
where the board of directors determines that the fund is not relying on
the sponsor to make determinations about quality or liquidity.
3. The Twenty-Five Percent Basket
    We proposed amending rule 2a-7 to eliminate the ``twenty-five
percent basket,'' under which as much as 25% of the value of securities
held in a money market fund's portfolio may be subject to guarantees or
demand features from a single institution.\1660\ After further
consideration, and in light of the comments received, our final
amendments (i) remove the twenty-five percent basket for money market
funds other than tax-exempt money market funds, and (ii) reduce to 15%,
rather than eliminate, the twenty-five percent basket for tax-exempt
money market funds, including single state money market funds.\1661\
---------------------------------------------------------------------------

    \1660\ Current rule 2a-7 applies a 10% diversification limit on
guarantees and demand features only to 75% of a money market fund's
total assets. See current rule 2a-7(c)(4)(iii)(A). A money market
fund, however, may only use the twenty-five percent basket to invest
in demand features or guarantees that are first tier securities
issued by non-controlled persons. See rules 2a-7(c)(4)(iii)(B) and
(C). Although we proposed to delete current rule 2a-7(a)(10)
(definition of demand feature issued by a non-controlled person)
because the term is used only in connection with the twenty-five
percent basket, we are retaining the definition because our
amendments provide a fifteen percent basket for tax-exempt money
market funds. See rule 2a-7(a)(10). We also are adopting certain
amendments to clarify that a fund must comply with this 10%
diversification limit immediately after it acquires a security
directly issued by, or subject to guarantees or demand features
provided by, the institution that issued the security or provided
the demand feature or guarantee. See rules 2a-7(d)(3)(i) and (iii).
We believe this amendment reflects funds' current practices and is
consistent with rule 2a-7's current requirements.
    \1661\ We note that Investment Company Act rule 12d3-1 also
refers to a twenty-five percent basket. See rule 12d3-1(d)(7)(v).
That rule generally permits investment companies to purchase certain
securities issued by companies engaged in securities-related
activities notwithstanding section 12(d)(3)'s limitations on these
kinds of transactions. Among other things, rule 12d3-1 provides that
the acquisition of a demand feature or guarantee as defined in rule
2a-7 will not be deemed to be an acquisition of the securities of a
securities-related business provided that ``immediately after the
acquisition of any Demand Feature or Guarantee, the company will
not, with respect to 75 percent of the total value of its assets,
have invested more than 10 percent of the total value of its assets
in securities underlying Demand Features or Guarantees from the same
institution.'' We requested comment as to whether we should revise
rule 12d3-1 to apply this diversification requirement with respect
to all of an investment company's total assets, rather than just 75%
of assets, for consistency with the proposed elimination of the
twenty-five percent basket in rule 2a-7. We received no comments
regarding rule 12d3-1. At this time we are not amending rule 12d3-1
to reflect our amendments to rule 2a-7's diversification provisions
because although rule 12d3-1 provides a twenty-five percent basket
for purposes of section 12(d)(3) limitations, this twenty-five
percent basket is not directly associated with the twenty-five
percent basket in rule 2a-7.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, a number of recent events
have highlighted the risks to money market funds caused by their
substantial exposure to providers of demand features and
guarantees.\1662\ For example, during the financial crisis, many funds
were heavily exposed to bond insurers and a few major financial
institutions that served as liquidity providers. This concentration led
to considerable stress in the municipal markets when some of these bond
insurers and financial institutions came under pressure during the
financial crisis. We continue to believe that tightening
diversification requirements with respect to a money market fund's
exposure to securities subject to guarantees or demand features from a
single guarantor or demand feature provider will reduce this risk.
However, we are concerned that removing the twenty-five percent basket
entirely for tax-exempt money market funds would inhibit the ability of
these funds to be

fully invested in securities subject to guarantees or demand features
or may force them to invest in securities that have weaker credit than
the securities they might otherwise purchase, due to the more limited
availability of guarantors and demand feature providers for tax-exempt
money market funds as compared to non-tax-exempt money market
funds.\1663\ Accordingly, under our amendments, as much as 15% of the
value of securities held in a tax-exempt money market fund's portfolio
may be subject to guarantees or demand features from a single
institution.\1664\
---------------------------------------------------------------------------

    \1662\ See Proposing Release, supra note 25, at section III.J.3.
    \1663\ As discussed in more detail below, this concern primarily
applies to tax-exempt funds, the largest users of the basket, as
they face a significantly more constrained supply of investable
securities than other types of money market funds.
    \1664\ See rule 2a-7(d)(3)(iii)(B) and rule 2a-7(a)(28). See
also supra note 1583.
---------------------------------------------------------------------------

a. Use of Twenty-Five Percent Basket by Money Market Funds
i. Non-Tax-Exempt Money Market Funds
    To help us evaluate the possible effects of removing the twenty-
five percent basket on non-tax-exempt money market funds, DERA staff
analyzed the exposure that money market funds have to guarantors, as
described in detail in the DERA Guarantor Diversification Memo.\1665\
As demonstrated below, DERA staff found that the majority of money
market funds do not use the twenty-five percent basket.
---------------------------------------------------------------------------

    \1665\ See Municipal Money Market Funds Exposure to Parents of
Guarantors (``DERA Guarantor Diversification Memo'') (March 17,
2014), available at http://www.sec.gov/comments/s7-03-13/s70313-323.pdf. In the DERA Guarantor Diversification Memo, the term
``guarantors'' is used to refer both to the ultimate parent of
issuers of guarantees and issuers of demand feature, and the term
``guarantees'' is used to refer both to guarantees and demand
features.
---------------------------------------------------------------------------

    As presented in the figure below, DERA staff examined the number of
money market funds for which guarantors compose more than 10%, 15% and
20% of their portfolios, respectively.\1666\
---------------------------------------------------------------------------

    \1666\ Id. The DERA Guarantor Diversification Memo also provides
information regarding tax-exempt money market funds, which we
discuss below.
[GRAPHIC] [TIFF OMITTED] TR14AU14.001

    As shown in the figure below, DERA staff also examined the percent
of all money market funds for which guarantors compose more than 10%,
15%, and 20% of their portfolios, respectively.\1667\
---------------------------------------------------------------------------

    \1667\ Id.

---------------------------------------------------------------------------

[GRAPHIC] [TIFF OMITTED] TR14AU14.002

    In addition, as illustrated in the figure below, DERA staff
examined the amount of excess exposure that money market funds have
above the 10%, 15%, and 20% thresholds, respectively.\1668\
---------------------------------------------------------------------------

    \1668\ Id.
    [GRAPHIC] [TIFF OMITTED] TR14AU14.003

    DERA staff also found, as illustrated below, that only a small
percentage of the entire money market fund industry assets are exposed
to guarantors in excess of the 10%, 15%, and 20% thresholds.\1669\
---------------------------------------------------------------------------

    \1669\ Id.

---------------------------------------------------------------------------

[GRAPHIC] [TIFF OMITTED] TR14AU14.004

    In addition to showing that the majority of money market funds do
not use the basket, the data analyzed in the DERA Guarantor
Diversification Memo also shows that money market funds that do use the
twenty-five percent basket use the basket to a limited extent for
purposes of gaining a high level of exposure to any one particular
guarantor or demand feature provider.\1670\ In fact, commenters noted
that although a money market fund may use the full twenty-five percent
basket to gain exposure to one guarantor or demand feature, money
market funds will often use the twenty-five percent basket to gain a
smaller amount of exposure to two guarantors or demand feature
providers above the 10% diversification limit, for a total of up to
twenty-five percent.\1671\
---------------------------------------------------------------------------

    \1670\ Id. The DERA Guarantor Diversification Memo shows that
money market funds' exposure in excess of the 15% diversification
threshold is relatively small, amounting to 0.03% of the assets in
the entire money market fund industry as of November 2012.
    \1671\ See, e.g., Wells Fargo DERA Comment Letter; Comment
Letter of Federated Investors, Inc. (Municipal Money Market Funds)
(Apr. 23, 2014) (``Federated DERA III Comment Letter''); SIFMA DERA
Comment Letter. For example, money market funds may use the twenty-
five percent basket to obtain exposure for two demand feature
providers or guarantors above the 10% diversification limit, in
which case the exposure to any one demand feature provider or
guarantor would have to be less than 15%, and the average exposure
to any one demand feature provider or guarantor could not exceed
12.5%. See Federated DERA III Comment Letter.
---------------------------------------------------------------------------

    As noted by commenters, currently, a money market fund can use the
twenty-five percent basket in two ways. First, a money market fund can
apply the basket to one guarantor where the guarantor can account for
as much as 25% of the portfolio's guarantees. The figures above show
that $260 million or 0.01% of the industry dollars are above the 20%
threshold as of November 2012 and $740 million or 0.03% of the industry
dollars are above the 15% threshold as of November 2012, suggesting
that few funds are using the basket this way. Second, a money market
fund can apply the basket to two guarantors where each guarantor has
between 10% and 15% of the portfolio guarantees and the sum equals 25%
or less. The difference between the 15% and the 10% threshold amounts
in the above illustrations represents the usage under this scenario. As
of November 2012, $6.02 billion or 0.2% of the industry dollars are
used this way, suggesting that most funds use the twenty-five percent
basket divided up among two guarantors with exposures up to 15%.\1672\
If we assume an even split of 12.5% between two guarantors, then
instead of having to reduce exposure from 25% to 10% for one guarantor,
most money market funds will be required to reduce exposure from 12.5%
to 10% for two guarantors. Thus, because most money market funds are
not today using the twenty-five percent basket to gain high levels of
exposure to any one particular guarantor or demand feature provider, we
believe that any negative effects for these money market funds that
would be associated with reducing exposure to guarantors would
generally be minimal.
---------------------------------------------------------------------------

    \1672\ As discussed below, the DERA analysis further shows that
the usage of the twenty-five percent basket is predominantly used by
tax-exempt money market funds.
---------------------------------------------------------------------------

    One commenter suggested that the figures we provided in the
Proposing Release (which were derived from monthly Form N-MFP filings)
only captured the funds that used the twenty-five percent basket on one
particular day, but that the basket is regularly relied upon during the
course of the fund's operations.\1673\ The DERA Guarantor
Diversification Memo addresses the commenter's concern by reviewing the
use of the twenty-five percent basket over a period of two years.\1674\
After further review, our staff found that the data we provided in the
Proposing Release is comparable with the use of the twenty-five percent
basket when we analyze money market funds' use over two years.\1675\
Therefore, although commenters suggest that the use of the twenty-five
percent basket may vary considerably during the course of operation,
and commenters did not provide any specific data suggesting otherwise,
our staff found that the use of the twenty-five percent basket over a
longer period was in fact relatively constant.
---------------------------------------------------------------------------

    \1673\ BlackRock II Comment Letter. See also Federated II
Comment Letter (stating that tax-exempt money market funds regularly
rely on the twenty-five percent basket during the course of their
operations and that three quarters of its tax-exempt money market
funds and all but two of its 14 single state funds currently hold
securities in their twenty-five percent basket).
    \1674\ See DERA Guarantor Diversification Memo, supra note 1665.
    \1675\ Id.
---------------------------------------------------------------------------

    The data and figures provided above, which show that most funds
that are using the basket are using the basket between the 15% and 10%
thresholds, suggest that eliminating the basket for all money market
funds (other than tax-exempt money market funds), as opposed to
providing a fifteen percent basket, most effectively addresses our
concerns about a money market fund's exposure to a single guarantor or
demand feature provider because eliminating the basket provides a
significant mitigation of the risks to money market funds caused by
their substantial exposure to these providers. After further
consideration, we continue to believe that removing the twenty-five
percent basket for money market funds (other than tax-exempt money
market funds) instead of providing a fifteen percent basket (or other
size basket),

more appropriately addresses the risk that a fund faces when it is
heavily exposed to a single guarantor or demand feature provider.
ii. Tax-Exempt Money Market Funds
    As discussed in greater detail in the DERA Guarantor
Diversification Memo, and as discussed further below, DERA staff also
analyzed data and figures regarding the use of the twenty-five percent
basket by tax-exempt money market funds. DERA staff found that tax-
exempt money market funds in general, and single state money market
funds in particular, use the twenty-five percent basket to a higher
degree than money market funds as a whole. As set forth below, DERA
staff examined the number of other tax-exempt funds and single state
funds for which guarantors compose more than 10%, 15%, and 20% of their
portfolios, respectively.\1676\
---------------------------------------------------------------------------

    \1676\ Id. The DERA Guarantor Diversification Memo divides
municipal money market funds into two categories, consistent with
the two types of municipal money market funds on Form N-MFP (Item
10), ``single state funds'' and ``other tax-exempt funds.''
[GRAPHIC] [TIFF OMITTED] TR14AU14.005

    As illustrated below, DERA staff also examined the percent of other
tax-exempt funds and single state funds for which guarantors compose
more than 10%, 15%, and 20% of their portfolios, respectively.\1677\
---------------------------------------------------------------------------

    \1677\ Id.
    [GRAPHIC] [TIFF OMITTED] TR14AU14.006

    In addition, DERA staff examined the amount of excess exposure that
other tax-exempt funds and single state funds have in assets above the
10%, 15%, and 20% thresholds, respectively.\1678\
---------------------------------------------------------------------------

    \1678\ Id.
    [GRAPHIC] [TIFF OMITTED] TR14AU14.007

    Lastly, as illustrated below, DERA staff found that only a small
percentage of the entire other tax-exempt fund and single state fund
industry assets are exposed to guarantors in excess of the 10%, 15%,
and 20% thresholds.\1679\
---------------------------------------------------------------------------

    \1679\ Id.
    [GRAPHIC] [TIFF OMITTED] TR14AU14.008

    DERA staff analyzed, among other things: (i) The percentage of tax-
exempt money market fund assets exposed to guarantors above the 10%
threshold, which shows the percentage of assets that would need to be
reinvested if we eliminated the twenty-five percent basket, as
proposed; and (ii) the percentage of tax-exempt money market fund
assets exposed to guarantors above the 15% threshold, which shows the
percentage of assets that will need to be reinvested as a result of the
fifteen percent basket that we are adopting today for tax-exempt money
market funds. We believe that our staff's analysis of the percentage of
assets invested in securities subject to demand features or guarantees
in excess of the 10% and 15% guarantor diversification limits,
respectively, provides an accurate reflection of the potential impact
that elimination or reduction of the twenty-five percent basket would
have on other tax-exempt funds and single state funds. We also believe
that looking to the percentage of assets, as

opposed to the number of funds or excess amount of assets in dollars
(which only show absolute numbers), most accurately shows the
corresponding level of assets that will need to be reinvested.
    The above data shows that the percentage of other tax-exempt funds
and single state fund assets exposed to guarantors above the 10% and
15% guarantor diversification limits are relatively small when compared
to other municipal money market funds and the money market fund
industry as a whole, although the data also shows that other tax-exempt
funds and single state funds use the basket to a greater extent than
money market funds generally. In addition to acknowledging that the
proposed elimination of the basket would have a greater effect on tax-
exempt money market funds because of their higher use of the basket, we
have also taken into account commenters' concerns, as discussed below,
regarding the limited availability of guarantor and demand feature
providers for tax-exempt money market funds as opposed to non-tax-
exempt money market funds.
b. Additional Considerations
i. Non-Tax-Exempt Money Market Funds
    Several commenters generally supported the removal of the twenty-
five percent basket.\1680\ For example, one commenter argued that
eliminating the twenty-five percent basket for all money market funds
would be an appropriate step to further reducing concentration risk in
money market funds.\1681\ Other commenters, however, opposed the
removal of the twenty-five percent basket.\1682\ Commenters argued that
the elimination of the twenty-five percent basket would increase money
market funds' reliance on lower quality investments with higher credit
risk, particularly due to the limited number of providers of guarantees
and demand features.\1683\ One commenter argued that since the
financial crisis, fewer issuers have been providing guarantees and
other credit support for securities to be purchased by money market
funds, and that removing the twenty-five percent basket could force
managers to purchase paper of lower quality issuers that are unable or
unwilling to obtain third-party demand features.\1684\ Another
commenter stated that consolidation in the banking industry has
substantially reduced the pool of high-quality demand feature and
guarantee providers, and increased regulatory capital requirements will
likely further reduce the number of available providers in coming
years.\1685\
---------------------------------------------------------------------------

    \1680\ See, e.g., Barnard Comment Letter; CFA Institute Comment
Letter. See also U.S. Bancorp Comment Letter (supporting the removal
of the twenty-five percent basket for all money market funds); Wells
Fargo Comment Letter (supporting the removal of the twenty-five
percent basket only for taxable money market funds); Schwab Comment
Letter (supporting the removal of the twenty-five percent basket,
but recommending that state-specific municipal money market funds be
allowed to continue using the basket to some extent).
    \1681\ U.S. Bancorp Comment Letter.
    \1682\ See, e.g., SSGA Comment Letter; ICI Comment Letter; Legg
Mason & Western Asset Comment Letter. Most of the commenters that
opposed the removal of the twenty-five percent basket focused
specifically on the consequences for tax-exempt money market funds.
We address their particular concerns regarding tax-exempt money
market funds below.
    \1683\ Goldman Sachs Comment Letter; SIFMA Comment Letter; J.P.
Morgan Comment Letter; ICI Comment Letter; Legg Mason & Western
Asset Comment Letter; Vanguard Comment Letter.
    \1684\ Legg Mason & Western Asset Comment Letter. See also ICI
Comment Letter (expressing concern that eliminating the twenty-five
percent basket would increase rather than decrease risk by
increasing a fund's reliance on less creditworthy credit support
providers, noting that the universe of institutions issuing or
providing guarantees or liquidity for eligible money market fund
securities has become limited).
    \1685\ J.P. Morgan Comment Letter.
---------------------------------------------------------------------------

    As discussed below, we do not believe that the removal of the
twenty-five percent basket for non-tax-exempt money market funds will
cause money market funds to use lower credit quality guarantors and
demand feature providers or potentially reduce liquidity and
flexibility for money market funds, and if any such impact were to
occur, we expect that it would be limited. As noted above, the data
analyzed in the DERA Guarantor Diversification Memo shows, among other
things, that most funds, especially non-tax-exempt money market funds,
do not use the twenty-five percent basket, and thus we believe that
most money market funds will likely not be forced to use lower credit
quality guarantors and demand feature providers.\1686\ Under today's
amendments, non-tax-exempt money market funds will not be required to
include more than 10 guarantors or demand feature providers in their
portfolios if each one maximized the 10% diversification limit. DERA
staff evaluated the exposure to guarantors and found that the top five
guarantor parents accounted for a combined total of 43% of the exposure
across all money market funds. DERA staff measured the credit risk for
each guarantor by credit default swap (CDS) spreads and composite
credit ratings (NRSROs) and found that the credit quality of guarantors
among the top twenty guarantors is similar to that of the top five
guarantors.\1687\ Thus, we believe that, if today's amendments cause
non-tax-exempt money market funds to include additional guarantors or
demand feature providers in the funds' portfolios, there exists a
supply of guarantors and demand feature providers that have similar
credit quality as the top five guarantors used by funds. As such, we
believe that, for non-tax-exempt money market funds that are currently
using the twenty-five percent basket, it is likely that these money
market funds would be able to use these additional guarantors and
demand feature providers and will not be forced to resort to low credit
quality guarantors or demand feature providers because of the amended
rule.
---------------------------------------------------------------------------

    \1686\ See DERA Guarantor Diversification Memo, supra note 1665
and accompanying text.
    \1687\ Id.
---------------------------------------------------------------------------

    A few commenters argued that composite credit ratings from NRSROs
are not a reliable standalone metric to assess credit quality.\1688\ We
agree. This is why the DERA memo also assessed credit risk through CDS
spreads, which are the market's current assessment of a guarantor's
future financial capacity to provide the necessary support. A few
commenters also argued that money market funds analyze the credit
quality of guarantors using a variety of factors other than CDS spreads
and composite credit ratings.\1689\ While we recognize that money
market funds' internal analysis of the credit quality of guarantors and
demand feature providers might be different, we believe that using a
combination of the objective factors, CDS spreads and composite credit
ratings, for the purpose of our staff's analysis is an acceptable
alternative to conducting an individual credit risk analysis of
guarantors and closely approximates the credit risk of such guarantors
and demand feature providers. Thus, after further review, we believe
our staff's findings support the conclusion that, to the limited extent
a money market fund may need to engage new institutions as providers of
guarantees and demand features, there will be a sufficient supply of
first tier guarantors in the market. We therefore believe that, even
with a 10% guarantor limit for non-tax-exempt money market funds, any
increase in guarantor diversification should not lead to deterioration
in credit quality.
---------------------------------------------------------------------------

    \1688\ See, e.g., Wells Fargo DERA Comment Letter.
    \1689\ See, e.g., Wells Fargo DERA Comment Letter; Dreyfus DERA
Comment Letter.
---------------------------------------------------------------------------

ii. Tax-Exempt Money Market Funds
    Although a number of commenters opposed the removal of the twenty-
five percent basket generally, many

commenters specifically opposed the removal of the twenty-five percent
basket for tax-exempt money market funds, and single state money market
funds in particular.\1690\ Some commenters argued that the twenty-five
percent basket has not been the reason tax-exempt money market funds
have experienced credit events in the past.\1691\ For example, one
commenter argued that the twenty-five percent basket did not have an
adverse impact on tax-exempt money market funds and their shareholders
and that significant disruptions should not justify removal of the
twenty-five percent basket for tax-exempt money market funds.\1692\
However, as we discussed in the Proposing Release, in 2008, the
concentration of tax-exempt money market funds in guarantee and demand
feature providers led to considerable stress in the municipal
markets.\1693\ During this time municipal issuers had to quickly find
substitutes for demand features on which they relied to shorten their
securities' maturities.\1694\ In addition, at least one provider of
demand features and guarantees for many municipal securities held by
money market funds avoided bankruptcy in part due to substantial
support received from various entities.\1695\ We believe the risk that
a money market fund faces in cases where the guarantor or demand
feature provider comes under significant strain is substantial and that
possible external support is unreliable in cases when guarantors or
demand feature providers may become stressed. We therefore continue to
believe that it is appropriate to amend rule 2a-7 to enhance the
diversification requirements by reducing the twenty-five percent basket
to a fifteen percent basket, in order to limit a tax-exempt money
market fund's exposure to any one guarantor or demand feature provider,
thereby mitigating the risk the fund faces when it heavily relies on a
single guarantor or demand feature provider.
---------------------------------------------------------------------------

    \1690\ See, e.g., Federated II Comment Letter; Dreyfus Comment
Letter; Wells Fargo Comment Letter; Schwab Comment Letter; Vanguard
Comment Letter; BlackRock II Comment Letter.
    \1691\ See, e.g., Vanguard Comment Letter; Federated II Comment
Letter.
    \1692\ Federated II Comment Letter. See also Federated VII
Comment Letter (arguing that tax-exempt money market funds weathered
problems by relying on the credit of the underlying obligor or
working with the obligor to substitute another guarantor).
    \1693\ See Proposing Release, supra note 25, section III.J.3.
    \1694\ Id.
    \1695\ Id.
---------------------------------------------------------------------------

    As discussed above and in the Proposing Release, when evaluating
money market funds in the aggregate, most money market funds do not use
the twenty-five percent basket and those funds that do use the twenty-
five percent basket do not make significant use of it.\1696\
Commenters, however, argued that tax-exempt money market funds in
particular do regularly rely on the twenty-five percent basket.\1697\
For example, one commenter stated that as of June 30, 2013, 75% of
municipal money market funds made use of the twenty-five percent
basket.\1698\ Another commenter noted that nine of the top 10 largest
tax-exempt money market funds, which represent approximately 40% of the
tax-exempt money market fund assets, use the twenty-five percent
basket.\1699\ As previously discussed, commenters noted that besides
using a single guarantor in the twenty-five percent basket, money
market funds may also use two guarantors to fill the twenty-five
percent basket by having, for example, a 13% exposure to one guarantor
and a 12% exposure to another.\1700\ The DERA Guarantor Diversification
Memo found, as shown above, that 10.8% and 2.6% of ``single state
funds'' and ``other tax-exempt funds'' had at least one guarantor above
the 20% threshold as of November 2012, respectively.\1701\ The DERA
Guarantor Diversification Memo also found that 30.6% and 7.7% of single
state funds and other tax-exempt funds had at least one guarantor above
the 15% threshold as of November 2012, respectively. In addition, the
memo shows that 80.2% and 50.0% of single state and other tax-exempt
funds had at least one guarantor above the 10% threshold as of November
2012, respectively.\1702\ DERA staff's findings are consistent with the
data provided by the commenters above, which suggest that tax-exempt
money market funds use the twenty-five percent basket to a greater
extent than non-tax-exempt money market funds.
---------------------------------------------------------------------------

    \1696\ See Proposing Release, supra note 25, nn.892-893 and
accompanying text.
    \1697\ See, e.g., SIFMA Comment Letter; Fidelity Comment Letter.
    \1698\ SIFMA Comment Letter.
    \1699\ Fidelity Comment Letter (noting that only one of those
nine funds was over 15% and recommending a fifteen percent basket
for all money market funds).
    \1700\ See, e.g., Comment Letter of Investment Company Institute
DERA (Apr. 22, 2014) (``ICI DERA Comment Letter'').
    \1701\ See DERA Guarantor Diversification Memo, supra note 1665.
    \1702\ Id.
---------------------------------------------------------------------------

    One commenter argued that although the DERA staff analysis
demonstrates that most tax-exempt money market funds use the twenty-
five percent basket, the sample period (2010-2012) is not appropriate
because there were no events during this time period that caused stress
on money market funds.\1703\ We note, however, that another commenter
stated that it was beneficial for money market funds to have the
flexibility of the twenty-five percent basket during the Eurozone
concerns in 2011,\1704\ which occurred during our sample time period.
As discussed above, the data analyzed in the DERA Guarantor
Diversification Memo shows that over the course of two years, the use
of the twenty-five percent basket remained steady and there was minimal
variability in the use of the basket over time, even when certain
events during this time period caused stress on money market
funds.\1705\
---------------------------------------------------------------------------

    \1703\ See Wells Fargo DERA Comment Letter.
    \1704\ See Fidelity DERA Comment Letter.
    \1705\ See DERA Guarantor Diversification Memo, supra note 1665.
---------------------------------------------------------------------------

    Many commenters expressed concern regarding the impact of the
proposed removal of the twenty-five percent basket for tax-exempt money
market funds, and single state money market funds in particular, due to
the limited availability of demand feature providers and guarantors for
these types of funds. Commenters argued that the elimination of the
twenty-five percent basket would limit a tax-exempt money market fund's
flexibility to obtain greater exposure to strong credit sources in
times when high credit quality may be scarce.\1706\ A number of
commenters also argued that the removal of the twenty-five percent
basket will make it difficult for tax-exempt money market funds to
acquire sufficient liquid assets.\1707\ Commenters argued that there is
a relatively narrow group of banks and other financial institutions
that provide much of the liquidity in the short-term municipal and TOB
markets,\1708\ and that single state funds in particular have even
fewer issuers available to them.\1709\
---------------------------------------------------------------------------

    \1706\ Vanguard Comment Letter; Invesco Comment Letter;
BlackRock II Comment Letter. See also Dreyfus Comment Letter; ICI
Comment Letter; Legg Mason & Western Asset Comment Letter; Federated
VII Comment Letter; Federated II Comment Letter.
    \1707\ Wells Fargo Comment Letter; Invesco Comment Letter;
BlackRock II Comment Letter; SIFMA Comment Letter; Goldman Sachs
Comment Letter; Federated II Comment Letter. See also Fidelity
Comment Letter.
    \1708\ Id.
    \1709\ See, e.g., BlackRock II Comment Letter.
---------------------------------------------------------------------------

    One commenter stated that with a constrained supply of securities
with diverse guarantors, a twenty-five percent basket may actually
allow a manager to reduce risk by avoiding or reducing exposure to the
relatively weakest guarantors.\1710\ Some commenters also argued that
the twenty-five percent basket is an important tool

that money market funds may use to accommodate the variability and
unpredictability of supply and demand in the municipal market.\1711\ We
recognize commenters' concerns regarding the proposed removal of the
twenty-five percent basket for tax-exempt money market funds, and
single state money market funds in particular, due to the limited
availability of demand feature providers and guarantors for these types
of funds. As noted above, we believe that requiring tax-exempt money
market funds to limit exposure to any one guarantor or demand feature
provider while still providing tax-exempt money market funds with a
fifteen percent basket, will address many of the commenters' concerns
regarding the limited supply of demand feature providers and guarantors
for tax-exempt money market funds.
---------------------------------------------------------------------------

    \1710\ Wells Fargo Comment Letter.
    \1711\ See, e.g., Dreyfus Comment Letter; BlackRock II Comment
Letter. See also Wells Fargo DERA Comment Letter (noting that the
basket provides a means for money market funds to limit portfolio
credit risk by concentrating exposure in the highest quality
guarantor).
---------------------------------------------------------------------------

    Several commenters suggested we reduce the twenty-five percent
basket to a fifteen percent basket for tax-exempt money market
funds.\1712\ One commenter stated that, although the twenty-five
percent basket may not have been heavily used recently by money market
funds, the availability of a basket would provide useful flexibility to
money market funds on occasion.\1713\ A second commenter argued that a
fifteen percent basket would achieve the objective of balancing
diversification and flexibility, while reducing the potential for
unintended consequences.\1714\ After further consideration, and in
light of the data for tax-exempt money market funds and commenters'
concerns and recommendations regarding the removal of the basket for
tax-exempt money market funds, we have decided to allow tax-exempt
money market funds, including single state funds, to rely on a fifteen
percent basket, under which as much as 15% of the value of securities
held in a tax-exempt money market fund's portfolio may be subject to
guarantees or demand features from a single institution. Although
eliminating the basket for tax-exempt money market funds would reduce
concentration risk by requiring tax-exempt money market funds to lessen
their exposure to a single guarantor or demand feature provider, we are
concerned that eliminating the basket entirely could cause these funds
to invest in weaker credits. We believe that a reduction of the twenty-
five percent basket to a fifteen percent basket for tax-exempt money
market funds, which the DERA Guarantor Diversification Memo shows use
the basket more than non-tax-exempt money market funds, appropriately
addresses the concerns related to heavy concentration in a single
guarantor or demand feature provider as well as the concerns that
eliminating the twenty-five percent basket for tax-exempt money market
funds could lead to an overall deterioration of credit quality or
liquidity because tax-exempt funds may have to obtain guarantees or
demand features from less creditworthy institutions due to a limited
supply of guarantees and demand features.
---------------------------------------------------------------------------

    \1712\ See, e.g., Goldman Sachs Comment Letter; Fidelity DERA
Comment Letter. See also Schwab Comment Letter (recommending that
single state money market funds be allowed to continue using the
twenty-five percent basket except that within the basket no single
guarantor or demand feature provider could represent more than 15%
of the fund's assets). Some commenters suggested we reduce the
twenty-five percent basket to a fifteen percent basket for all money
market funds (both tax-exempt funds and non-tax-exempt funds). See
Goldman Sachs Comment Letter; SIFMA Comment Letter; Fidelity Comment
Letter. See also J.P. Morgan Comment Letter (recommending that
instead of eliminating the basket, we mandate a maximum guarantee
and/or demand feature exposure that can be held within the basket in
any one entity, such as at a 15% cap).
    \1713\ Goldman Sachs Comment Letter (suggesting that our data is
limited to a short period of time and arguing that it supports the
conclusion that a smaller basket would satisfy portfolio managers of
most funds).
    \1714\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    We believe for several reasons that reducing the twenty-five
percent basket to a fifteen percent basket should not significantly
restrict the ability of guarantors to fill the needed capacity as the
guarantors become more diversified. First, the data analyzed in the
DERA Guarantor Diversification Memo shows 0.5% and 0.2% of the
guarantor's dollars are excess dollars above the 15% threshold when
single state funds and other tax-exempt funds, respectively, are
considered separately in November 2012, meaning little if any
additional capacity has to be developed.\1715\ Second, it is reasonable
to expect that a reduction by one money market fund (because its
exposure to a particular guarantor is too high) could become a
purchasing opportunity for another money market fund whose exposure to
a particular guarantor is below the 15% threshold. Third, should any of
the top guarantors listed in the DERA Guarantor Diversification Memo
choose to increase their capacity, this could become a purchasing
opportunity for a money market fund since the amount of excess dollars
above the 15% threshold is smaller than the amount needed for the
remaining funds to reach the 10% or 15% threshold for the same
guarantor. Lastly, it is also reasonable to expect that if a reduction
by any of the top guarantors does occur, this could become an
opportunity for another guarantor to step in. We therefore believe
that, although other tax-exempt funds and single state funds may
currently use the twenty-five percent basket to a higher degree than
money market funds generally and may face greater supply constraints
than non-tax-exempt funds, because these funds will be permitted to use
a fifteen percent basket, any increase in guarantor diversification
should not lead to deterioration in credit quality and any negative
effects for tax-exempt money market funds that currently use the
twenty-five percent basket will be minimal.\1716\
---------------------------------------------------------------------------

    \1715\ See DERA Guarantor Diversification Memo, supra note 1665.
    \1716\ See supra note 1665 and accompanying text (discussing
level of assets and supply of providers).
---------------------------------------------------------------------------

    A couple of commenters argued that VRDNs provide a significant
source of liquidity for money market funds and that the proposed
removal of the twenty-five percent basket would therefore have a
negative impact on a fund's ability to access liquidity through
VRDNs.\1717\ In addition, one of these commenters argued that the
combination of regulatory requirements and the diminishing number of
financial guaranty companies and highly rated banks has significantly
reduced the number of entities offering credit support for VRDNs,\1718\
noting that in late 2012, tax-exempt money market funds had an average
of 83% of total assets invested in VRDNs.\1719\ As

discussed in the Proposing Release, and as discussed further below,
concerns about the creditworthiness of guarantors and demand feature
providers have reduced the amount of VRDNs outstanding since
2010.\1720\ We expect that reducing the twenty-five percent basket to a
fifteen percent basket instead of eliminating the basket will alleviate
commenters' concerns regarding the availability of VRDNs. In addition,
because the amount of outstanding VRDNs and other short-term municipal
debt has decreased 47% between 2008 and 2013, the top guarantors will
have some additional capacity built in should the overall demand for
such securities continue to decrease into the future.\1721\ Rule 2a-7
restricts money market funds to short-term maturities, which in turn
limits the municipal debt in money market funds to VRDNs and other
short-term municipal debt.\1722\ In addition, analyzing money market
fund municipal debt holdings and the availability of acceptable money
market fund municipal securities (VRDNs and other short-term municipal
debt) from 2002 to 2013 suggests that the municipal debt market is able
to adjust to both increasing and decreasing demand for such
securities.\1723\
---------------------------------------------------------------------------

    \1717\ Legg Mason & Western Asset Comment Letter; Invesco
Comment Letter. The interest rates on VRDNs are typically reset
either daily or every seven days. VRDNs include a demand feature
that provides the investor with the option to put the issue back to
the trustee at a price of par value plus accrued interest. This
demand feature is supported by a liquidity facility such as letters
of credit, lines of credit, or standby purchase agreements provided
by financial institutions. The interest-rate reset and demand
features shorten the duration of the security and allow it to
qualify as an eligible security under Rule 2a-7. See Handbook of
Fixed Income Securities 237 (Frank J. Fabozzi & Steven V. Mann eds.,
8th ed. 2012) nn.735-36.
    \1718\ Invesco Comment Letter (stating that, while total
municipal market debt outstanding has held stable for the past five
years at about $3.7 trillion, VRDNs outstanding have declined
steadily from $444.9 billion in December 2008 to only $246.8 billion
in June 2013).
    \1719\ Id. (noting that there has been a marked decline in the
issuance of credit enhanced securities and that the contraction in
the availability of these securities hinders the level of
diversification that managers can achieve in tax-exempt money market
fund portfolios; also providing data that securities issued with a
letter of credit, standby purchase agreement or guarantee comprised
25.6% of total municipal market issuance in 2008 and that in 2012
these securities made up 9.5% of total issuance).
    \1720\ See Proposing Release, supra note 25, at section III.E.
    \1721\ See infra note 1723.
    \1722\ Our staff's review of portfolio holdings of single state
funds and other tax-exempt funds from Form N-MFP filings, using
aggregate amortized values from November 2010 to December 2013,
found that these funds held approximately 71% in VRDNs and 18% in
other municipal debt.
    \1723\ The Federal Reserve Board's Flow of Funds of the United
States provides the amount of municipal securities held by money
market funds and the overall market. It ranged from about $270
billion in 2002 to a maximum of $520 billion in 2008 only to decline
to approximately $305 billion by 2013. The decrease shows that $215
billion ($520-$305) or 39% exited the money market fund industry
since the financial crisis. One can closely approximate these money
market fund holdings by summing the amount of outstanding VRDNs
(Source: Securities Market and Financial Markets Association Web
site) with the amount of outstanding short term municipal debt
(Source: Federal Reserve Board's Flow of Funds of the United
States), suggesting that money market funds hold nearly all the
VRDNs and short-term municipal debt. This sum has nearly halved from
a high of $500 billion in 2008 to $265 billion in 2013. This
corresponds to a decrease of $235 billion, or 47%, of short term
municipal debt and VRDNs money market funds holdings. We note, as
well, that the overall municipal debt market has absorbed these
large money market fund outflows, and, in fact, the overall
municipal debt market has grown approximately $200 billion during
this same time period. See Federal Reserve Board, Flow of Funds of
the United States, available at http://www.federalreserve.gov/releases/z1 and Securities Market and Financial Market Association
Reports, available at http://www.sifma.org/research/reports.aspx.
---------------------------------------------------------------------------

c. Additional Economic Analysis
    Our diversification amendments, including (i) the amendment to
require that money market funds treat the sponsors of ABS as guarantors
subject to rule 2a-7's 10% diversification limit applicable to
guarantees and demand features, unless the money market fund's board of
directors (or its delegate) determines that the fund is not relying on
the sponsor's financial strength or its ability or willingness to
provide liquidity, credit or other support to determine the ABS's
quality or liquidity (``ABS amendment'') and (ii) the amendment to
remove the twenty-five percent basket for money market funds other than
tax-exempt money market funds and to reduce to fifteen percent, rather
than eliminate, the twenty-five percent basket for tax-exempt money
market funds, including single state money market funds (``twenty-five
percent basket amendment''),\1724\ are designed to provide a number of
benefits, as discussed in more detail below. DERA staff's review of
data suggests that our ABS amendment and twenty-five percent basket
amendment (treating only ABCP sponsors as guarantors for purposes of
this analysis) \1725\ would have little impact on the majority of money
market funds, which do not make use of the twenty-five percent basket,
and would likely have a minimal impact on those funds that do. Because
tax-exempt money market funds make greater use of the basket than non-
tax-exempt money market funds and may face greater constraints
regarding the availability of demand feature providers and guarantors,
we have provided tax-exempt money market funds with the ability to use
a fifteen percent basket. DERA staff's review of data suggests that the
effect of our twenty-five percent basket amendment on tax-exempt money
market funds would thus also have little impact on the majority of tax-
exempt money market funds.
---------------------------------------------------------------------------

    \1724\ See infra note 1660.
    \1725\ Our staff assumed when reviewing the Form N-MFP data that
any fully or partially supported ABCP owned by a fund would result
in the sponsor guaranteeing the ABCP. For this purpose, our staff
considered an ABCP conduit to be fully supported when the program's
investors are protected against asset performance deterioration and
primarily rely on the ABCP sponsor to provide credit, liquidity, or
some other form of support to ensure full and timely repayment of
ABCP, and considered an ABCP conduit to be partially supported when
the ABCP sponsor, although not fully supporting the program,
provided some form of credit, liquidity, or other form of support.
See also infra note 1726.
---------------------------------------------------------------------------

    Based on the data analyzed in the DERA Guarantor Diversification
Memo, our staff found that approximately 131 funds, or 21.9% of all
funds submitting Form N-MFP for November 2012, reported that they made
use of the twenty-five percent basket for guarantees and demand
features, even when we treat sponsors of ABCP as guarantors (and thus
subject to a 10% diversification limitation). Thus, although a minority
does use the twenty-five percent basket, the majority of money market
funds do not. Furthermore, money market funds as of February 28, 2014,
had invested 16.5% of their assets in ABS and securities subject to
demand features or guarantees, suggesting that issuers have a ready
supply of money market fund investors eligible to purchase their
securities. The 131 funds that used the twenty-five percent basket had,
on average, $31.4 billion of their assets invested in excess of the 10%
diversification limitation we are adopting today (i.e., in the twenty-
five percent basket) as of November 2012.\1726\ Furthermore, data as of
November 2012, shows that 98.9% of total money market fund assets are
not in funds' twenty-five percent baskets. Thus, because most money
market funds are not using the twenty-five percent basket to gain high
levels of exposure to any one particular guarantor or demand feature
provider and because a very high percentage of money market fund assets
are not in a twenty-five percent basket, we believe any negative
effects for these non-tax-exempt money market funds will generally be
minimal.

In addition, we believe that, if today's amendments cause non-tax-
exempt money market funds to include additional guarantors or demand
feature providers in the funds' portfolios, there exists a sufficient
supply of guarantors and demand feature providers.
---------------------------------------------------------------------------

    \1726\ This estimate likely overstates the number of funds and
the amount of money market funds' assets that could be affected by
our ABS amendments for three reasons. First, it assumes that any
fully or partially supported ABCP owned by a fund would result in
the sponsor guaranteeing the ABCP. Under our amendments, however, an
ABCP (or other ABS) sponsor would not be deemed to guarantee the
ABCP if the board (or its delegate) determines the fund is not
relying on the sponsor's financial strength or its ability or
willingness to provide support to determine the ABCP's quality or
liquidity. We did not assume sponsors of other types of ABS
guaranteed those ABS because we understand that other forms of ABS
offered to money market funds either do not typically have sponsor
support or, if they are supported, the support typically is in the
form of a guarantee or demand feature, which would already be
included in our calculation of exposure to providers of demand
features and guarantees. Second, Form N-MFP data does not
differentiate between funds that would have had exposure in excess
of 10% upon the acquisition of a demand feature or guarantee (which
will not be permitted under our amendments) and those funds that
were under that level of exposure at the time of acquisition but the
fund later decreased in size, increasing the fund's exposure above
the 10% limit (which will be permitted under our amendments). Third,
where a fund owned securities issued by or subject to demand
features or guarantees from affiliated institutions, we treated the
separate affiliated institutions as single institutions for purposes
of these estimates.
---------------------------------------------------------------------------

    As discussed above, and as addressed by certain commenters, we
recognize that tax-exempt money market funds, and in particular, single
state tax-exempt money market funds, use the twenty-five percent basket
to a greater degree than other types of money market funds. DERA staff
found that approximately 128 tax-exempt funds, or 67.7% of all tax-
exempt funds submitting Form N-MFP for November 2012, made use of the
twenty-five percent basket. For single state funds, our staff found
that approximately 89 single state funds, or 80.2% of single state
funds submitting Form N-MFP for November 2012 made use of the twenty-
five percent basket. However, tax-exempt money market funds, including
single state funds, that do use the twenty-five percent basket
generally do not make significant use of it. The 128 tax-exempt money
market funds that used the twenty-five percent basket had, on average,
2.4% of their assets invested in excess of the 10% diversification
limitation we are adopting today (i.e., in the twenty-five percent
basket), and the 89 single state money market funds that used the
twenty-five percent basket had, on average, 0.5% of their assets
invested in access of the 15% diversification limitation as of November
2012.\1727\ In addition, the 128 tax-exempt money market funds that
used the twenty-five percent basket had, on average, 0.3% of their
assets invested in excess of the 15% diversification limitation we are
adopting today, and the 89 single state money market funds that used
the twenty-five percent basket had, on average, 0.5% of their assets
invested in excess of the 15% diversification limitation as of November
2012.\1728\
---------------------------------------------------------------------------

    \1727\ Id.
    \1728\ Id.
---------------------------------------------------------------------------

    Although we understand that non-tax-exempt money market funds, and
tax-exempt money market funds in particular, may have made greater use
of the twenty-five percent basket in the past (and might do so in the
future if we fully retained the twenty-five percent basket), we are
concerned that funds were previously exposed to concentrated risks
inconsistent with the purposes of rule 2a-7's diversification
requirements as discussed above. We continue to believe that amending
rule 2a-7 to tighten diversification limits for securities subject to
guarantees or demand features from a single institution for both non-
tax-exempt money market funds and tax-exempt money market funds will
mitigate some of the risk that a money market fund faces by limiting a
fund's exposure to any one guarantor or demand feature provider.
    The principal effect of the ABS amendment and twenty-five percent
basket amendment we are adopting today may be to restrain some managers
of money market funds from being heavily exposed to an individual ABS
sponsor and from making use of the twenty-five percent basket in the
future, under perhaps different market conditions.\1729\ Our
diversification amendments may deny fund managers some flexibility in
managing fund portfolios and could decrease fund yields. To assess our
amendment's effect on yield, our staff examined whether the 7-day gross
yields of funds that use the twenty-five percent basket were higher
than the 7-day gross yields for those funds that do not.\1730\ Our
staff found: (i) For other tax-exempt funds, the average yield for
funds using the twenty-five percent basket was 0.0893% as compared to
the average yield for other tax-exempt funds that did not use the
twenty-five percent basket of 0.0987% and the average yield for funds
using the twenty-five percent basket above the 15% threshold was
0.0736% as compared to the average yield for other tax-exempt funds
that either did not use the twenty-five percent basket or used the
twenty-five percent basket below the 15% threshold of 0.0951%; (ii) for
single state funds, the average yield for funds using the twenty-five
percent basket was 0.0886% as compared to the average yield for single
state funds that did not use the twenty-five percent basket of 0.0754%
and the average yield for single state funds using the twenty-five
percent basket above the 15% threshold was 0.1075% as compared to the
average yield for singe state funds that either did not use the twenty-
five percent basket or used the twenty-five percent basket below the
15% threshold of 0.0790%; and (iii) for prime money market funds, the
average yield for funds using the twenty-five percent basket was
0.1740% as compared to the average yield for prime money market funds
that did not use the twenty-five percent basket of 0.1875%.\1731\ The
prime money market fund yield differences may not, of course, be caused
by the use of the twenty-five percent basket, but may instead reflect
the overall risk tolerance of fund managers that take advantage of the
twenty-five percent basket. In addition, we acknowledge that the
current low interest-rate environment may cause the yield spread in
each comparison above to be less than if we were measuring the yield
spreads in a higher interest rate environment.
---------------------------------------------------------------------------

    \1729\ One commenter suggested that compliance with our
amendments would require it to reallocate or sell its money market
fund portfolio securities. See Fidelity Comment Letter (also
suggesting that we extend our nine-month implementation period for
modifying the twenty-five percent basket due to the need for
additional time for transactions). However, funds with investments
in excess of those permitted under the revised rule are not required
to sell the excess investments to come into compliance. The
amendments require a fund to calculate its exposure to issuers of
demand features and guarantees as of the time the fund acquires a
demand feature or guarantee or a security directly issued by the
issuer of the demand feature or guarantee. See rules 2a-7(d)(3)(i)
and (iii).
    \1730\ We assumed that any fully or partially supported ABCP
owned by a fund would result in the sponsor guaranteeing the ABCP.
See supra note 1726.
    \1731\ These averages are derived from Form N-MFP data as of
February 28, 2014, weighted by money market funds' assets under
management.
---------------------------------------------------------------------------

    We requested comment as to whether there would be a significant
impact on fund yield, and if so, how significant. Although commenters
did not address the specific impact on fund yield, one commenter stated
that our staff's analysis assumed that funds could replace securities
guaranteed or subject to a demand feature in a twenty-five percent
basket with the same securities that were held by the funds that do not
use the twenty-five percent basket, and suggested that the elimination
of the basket might therefore decrease both yield and liquidity of tax-
exempt funds.\1732\ We recognize that it is possible that one money
market fund may not be able to obtain the exact securities of another
money market fund that is not currently relying on the basket. However,
as discussed above, our staff's analysis shows that there exists a
sufficient supply of first tier guarantors in the market for funds to
invest. Therefore, after further consideration, we believe that the
effect on yield, given the 7-day gross yields of funds that use the
twenty-five percent basket versus the 7-day gross yields for those
funds that do not, will be minimal.
---------------------------------------------------------------------------

    \1732\ Federated VII Comment Letter.
---------------------------------------------------------------------------

    Our twenty-five percent basket amendment requires non-tax-exempt
money market funds that use the twenty-five percent basket, and tax-
exempt money market funds that use the twenty-five percent basket at
levels above the fifteen percent threshold, or that would use it in the
future, to either not acquire certain demand features or guarantees (if
the fund could not assume

additional exposure to the provider of the demand feature or guarantee)
or to acquire them from different institutions. Funds that choose the
latter course could thereby increase demand for providers of demand
features and guarantees and increase competition among their providers.
If new entrants do not enter the market for demand features and
guarantees in response to this increased demand, reducing the twenty-
five percent basket to a fifteen percent basket for tax-exempt money
market funds, and removing the twenty-five percent basket for all other
money market funds, could result in money market funds acquiring
guarantees and demand features from lower quality providers than those
the funds use today, although, as discussed above, we expect such
potential effect to be mitigated due to the available supply of first-
tier guarantors and demand feature providers that have similar credit
quality as the top guarantors that are used by funds. If new entrants
do enter the market (or if current participants increase their
participation), the effect on money market funds would depend on
whether these new entrants (or current participants) are of high or low
credit quality as compared to the providers money market funds would
use absent our amendments.
    Our ABS amendment and twenty-five percent basket amendment also may
increase the costs of monitoring the credit risk of funds' portfolios
or make that monitoring less efficient, to the extent they are more
diversified under our amendments and money market fund advisers must
expend additional effort to monitor the credit risks posed by a greater
number of guarantors and demand feature providers. Although we cannot
provide a point estimate of these costs, and commenters did not provide
us with any data that would assist us with a point estimate, we expect
that these costs would be included in our broader cost estimates as
discussed above in section III.I.1. A money market fund that could not
acquire a particular guarantee or demand feature under our amendments
could, for example, be able to acquire a guarantee or demand feature
from another institution in which the fund already was invested, at no
additional monitoring costs to the fund.
    Issuers also could incur costs if they were required to engage
different providers of demand features or guarantees under our
amendments, which could negatively affect capital formation. This could
occur because an issuer might otherwise have sought a guarantee or
demand feature from a particular bank, but might choose not to use that
bank because the money market funds to which the issuer hoped to market
its securities could not assume additional exposure to the bank. If
issuers were unable to receive demand features or guarantees from banks
(or other institutions) to which they would have turned absent our
amendments, they would have to engage different banks, which could make
the offering process less efficient and result in higher costs if the
different banks charged higher rates. Issuers of securities with
guarantees or demand features (e.g., issuers of longer-term securities
that can be sold to money market funds only with a demand feature) also
could be required to broaden their investor base or seek out different
providers of guarantees or demand features under our amendments, which
could make their offering process less efficient or more costly.
    As discussed above, some commenters argued that single state funds
in particular would be negatively affected by the removal of the
twenty-five percent basket.\1733\ We believe that providing single
state funds a fifteen percent basket retains much of the flexibility
for single state funds to invest in securities subject to guarantees or
demand features while also limiting the extent to which a single state
fund can become exposed to any one guarantor or demand feature
provider. Although our amendments reduce the twenty-five percent basket
for all single state funds, we are not changing the application of rule
2a-7's 5% issuer limit to single state funds, which today applies only
to 75% of a single state fund's total assets.\1734\ We historically
have applied the issuer diversification limitation differently to
single state funds, recognizing that ``single state funds face a
limited choice of very high quality issuers in which to invest'' and,
therefore, that there is a risk that ``too stringent a diversification
standard could result in a net reduction in safety for certain single
state funds.'' \1735\ The market for demand features and guarantees, in
contrast, is national for most single state funds and therefore may not
be subject to the same supply constraints as is the market for issuers
in which single state funds may directly invest. However, the market
for demand features and guarantees for some single state funds is not
national. For example, the state of California through the California
State Teachers Retirement System is a guarantor for securities held in
California municipal money market fund portfolios as reported on Form
N-MFP. Additional analysis of the data in the DERA Guarantor
Diversification Memo shows that 74% of the single state fund's excess
guarantees above the 15% threshold on average come from California
municipal money market funds (39%), New York municipal money market
funds (24%), and Massachusetts municipal money market funds (11%). All
other state municipal money market funds account for 5% or less of the
excess guarantees dollars above the 15% threshold. As such, we would
expect that in terms of the amount of assets, California, New York, and
Massachusetts may be affected more than other states. However, as we
discussed earlier, we expect the impact to be minimal since the amount
of excess guarantee dollars above the 15% threshold is less than 0.5%
of the single state guarantee dollars.\1736\ This may be reduced
further if other single state funds with guarantees below the 10% and
15% threshold choose to increase their percent exposures to those
guarantors with excess exposure in other funds.
---------------------------------------------------------------------------

    \1733\ See, e.g. BlackRock II Comment Letter; Schwab Comment
Letter; Federated VII Comment Letter; Dreyfus Comment Letter.
    \1734\ See current rule 2a-7(c)(4)(i)(B) and rule 2a-
7(d)(3)(i)(B).
    \1735\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 21837 (Mar. 21, 1996) [61 FR
13956 (Mar. 28, 1996)] (``1996 Adopting Release''), at text
following n.38.
    \1736\ See DERA Guarantor Diversification Memo, supra note 1665.
---------------------------------------------------------------------------

    We do not expect that our ABS and twenty-five percent basket
diversification amendments will result in operational costs for funds.
We understand that money market funds generally have systems to monitor
their exposures to guarantors (among other things) and to monitor the
funds' compliance with rule 2a-7's current 10% demand feature and
guarantee diversification limit. We expect that money market funds
could use those systems to track exposures to ABS sponsors under our
amendments and could continue to track the funds' compliance with a 10%
demand feature and guarantee diversification limit. To the extent a
money market fund did have to modify its systems as a result of our ABS
and twenty-five percent basket diversification amendments, we expect
that the money market fund would make those modifications when
modifying its systems in response to our amendments to require money
market funds to aggregate exposure to affiliated issuers for purposes
of rule 2a-7's 5% diversification limit, for which we provide cost
estimates above.\1737\

Because the costs estimated above are those associated with activities
typically involved in making systems modifications, we expect they also
would cover any systems modifications associated with our ABS and
twenty-five percent basket diversification amendments.
---------------------------------------------------------------------------

    \1737\ See supra note 1625 and accompanying text.
---------------------------------------------------------------------------

    In the Paperwork Reduction Act analysis in section IV.A.1 below, we
identified certain initial and ongoing hour burdens and associated time
costs related to our diversification amendments. Specifically, our ABS
amendment requires that the board of directors adopt written procedures
requiring periodic evaluation of any determinations made regarding
instances in which the fund is not relying on the ABS sponsor's
financial strength or its ability or willingness to provide quality or
liquidity. Furthermore, for a period of not less than three years from
the date when the evaluation was most recently made, the fund must
preserve and maintain in an easily accessible place a written record of
the evaluation. These requirements are a collection of information
under the Paperwork Reduction Act, and are designed to help ensure that
the objectives of the diversification limitations are achieved. We
estimate the one-time burden to prepare and adopt these procedures will
be 1,368 hours at $1,130,880 in total time costs for all money market
funds and we estimate that the annual burden would be approximately 608
burden hours and $842,080 in total time costs for all money market
funds. We also note that a board can delegate its responsibility to
determine whether the fund is relying on the ABS sponsor's financial
strength or its ability or willingness to provide quality or liquidity
pursuant to rule 2a-7.\1738\ To the extent that a board delegates this
responsibility, it may incur additional costs related to its oversight
of such a delegate, although we expect that any such additional costs
would be minimal.
---------------------------------------------------------------------------

    \1738\ See rule 2a-7(j).
---------------------------------------------------------------------------

J. Amendments to Stress Testing Requirements

    We are adopting amendments to the stress testing requirements under
rule 2a-7, with modifications from the proposal in response to
comments. Specifically, we are adopting reforms to the current stress
testing provisions that will require funds periodically to test their
ability to maintain weekly liquid assets of at least 10% and to
minimize principal volatility \1739\ in response to specified
hypothetical events that include (i) increases in the level of short-
term interest rates, (ii) the downgrade or default of particular
portfolio security positions, each representing various exposures in a
fund's portfolio, and (iii) the widening of spreads in various sectors
to which the fund's portfolio is exposed, each in combination with
various increases in shareholder redemptions.\1740\ The fund adviser
must report the results of such stress testing to the board, including
such information as may be reasonably necessary for the board of
directors to evaluate the stress testing results.\1741\ We discuss
these requirements and the modifications from the proposal in further
detail below.
---------------------------------------------------------------------------

    \1739\ Stable NAV funds will continue to be required to test
their ability to maintain a stable NAV. See rule 2a-7(g)(8)(i).
Additionally, as discussed below, we recognize that fund advisers
and boards are more likely to be concerned with, and the
hypothetical events are focused on, downside volatility.
    \1740\ Id.
    \1741\ See rule 2a-7(g)(8)(ii).
---------------------------------------------------------------------------

1. Overview of Current Stress Testing Requirements and Proposed
Amendments
    The current stress testing requirements, adopted in 2010, require
that the fund adopt procedures providing for periodic testing of the
fund's ability to maintain a stable price per share based on (but not
limited to) certain hypothetical events. These hypothetical events
include a change in short-term interest rates, an increase in
shareholder redemptions, a downgrade of or default on portfolio
securities, and the widening or narrowing of spreads between yields on
an appropriate benchmark selected by the fund for overnight interest
rates and commercial paper and other types of securities held by the
fund. As we discussed in the Proposing Release, we have monitored the
stress testing requirement and how different fund groups have
approached its implementation in the marketplace. Through our staff's
examinations of money market fund stress testing procedures, we have
observed disparities in the quality and comprehensiveness of stress
tests, the types of hypothetical circumstances tested, and the
effectiveness of materials produced by fund managers to explain the
stress testing results to boards. For example, some funds test for
combinations of events, as well as for correlations between events and
between portfolio holdings, whereas others do not. As discussed in the
proposal, we believe that an evaluation of combinations of events and
correlations among portfolio holdings is an important part of a fund's
stress testing.\1742\
---------------------------------------------------------------------------

    \1742\ See Proposing Release, supra note 25, at section III.L.
---------------------------------------------------------------------------

    We also noted in the proposal that we have had several
opportunities to assess the effectiveness of the stress testing
requirements during periods of market stress, including the 2011
Eurozone debt crisis and the 2011 U.S. debt ceiling impasses. We
further assessed the role of stress testing in fund boards' assessment
of fund risks during the 2013 U.S. debt ceiling impasse. Our staff has
observed that funds that had strong stress testing procedures were able
to use the results of those tests to better manage their portfolios and
better understand and minimize the risks associated with these
events.\1743\
---------------------------------------------------------------------------

    \1743\ Id.
---------------------------------------------------------------------------

    Finally, we also noted that, both with stable NAV and floating NAV
funds, we believe that stress testing the liquidity of money market
funds could enhance a fund board's understanding of the risks to the
fund related to periods of heavy shareholder redemptions and could help
the fund manage those risks. We also noted that from the staff's review
of stress testing by funds, some funds already incorporate an analysis
of their ability to maintain liquidity in their stress tests.\1744\
---------------------------------------------------------------------------

    \1744\ Id.
---------------------------------------------------------------------------

    Considering this information and experience, the Commission
proposed certain modifications, enhancements, and clarifications to the
current stress testing requirements in rule 2a-7 to strengthen the
stress testing requirements. First, we added a proposed requirement for
each fund to stress test its ability to avoid having its weekly liquid
assets fall below 15% of all fund assets. Under the floating NAV
alternative, we also proposed removing the requirement that floating
NAV funds test their ability to maintain a stable share price.
Additionally, we proposed certain enhancements and clarifications to
the list of hypothetical events that funds were required to include in
their stress testing. Finally, we proposed to modify the requirements
to report results to the board, proposing an additional requirement
that the fund adviser include such information as may be reasonably
necessary for the board of directors to evaluate the stress
testing.\1745\
---------------------------------------------------------------------------

    \1745\ Id.
---------------------------------------------------------------------------

    Comments on the proposed changes to the stress testing requirement
were mixed. Some commenters supported the proposed reforms to varying
degrees.\1746\

Others opposed them.\1747\ Commenters who supported the reforms
suggested that they will enable better management of money market fund
risk and help address run incentives by heightening board awareness of
how events can affect liquidity and share price.\1748\ Commenters who
opposed the reforms indicated that they believed the current stress
testing requirements were sufficient, and that the reforms might be
costly, difficult to implement, and provide unnecessary information to
boards.\1749\ Two commenters believed that stress testing should not be
required for floating NAV funds.\1750\ Other commenters believed that
stress testing requirements should continue to apply to floating NAV
funds.\1751\ These comments are discussed in more detail below.
---------------------------------------------------------------------------

    \1746\ See, e.g., TIAA-CREF Comment Letter; BlackRock II Comment
Letter; MFDF Comment Letter; Comment Letter of Treasurer, State of
Connecticut (Sept. 17, 2013) (``Conn. Treasurer Comment Letter'');
Barnard Comment Letter; Santoro Comment Letter.
    \1747\ See, e.g., Federated VIII Comment Letter; ICI Comment
Letter; Schwab Comment Letter; Legg Mason & Western Asset Comment
Letter; Dreyfus Comment Letter.
    \1748\ See, e.g., BlackRock II Comment Letter (noting that
stress testing plays a critical role in a board's understanding of
money market fund risks).
    \1749\ See, e.g., ICI Comment Letter (noting that there are
limitations to stress testing and of fund directors' capacity to
review and interpret stress tests, which could lead to diminishing
returns as the number and complexity of stress tests increase).
    \1750\ See Deutsche Comment Letter; Legg Mason & Western Asset
Comment Letter.
    \1751\ See, e.g., BlackRock II Comment Letter; Fidelity Comment
Letter; MSCI Comment Letter.
---------------------------------------------------------------------------

2. Stress Testing Metrics
a. Liquidity
    As proposed, we are requiring money market funds to test their
liquidity, but have modified the threshold to require funds to test
their ability to maintain 10% weekly liquid assets from the 15%
proposed.\1752\ This change is consistent with the modification from
the proposal regarding the threshold of weekly liquid assets that will
trigger a default liquidity fee.\1753\ Several commenters generally
supported the proposed requirement that funds test their
liquidity.\1754\ One commenter supported the proposal that funds test
against the 15% threshold, and added that the commenter already tests
against multiple liquidity thresholds and will continue to do so.\1755\
Another commenter argued that funds should be required to test against
a more conservative threshold, such as 20%, to allow funds to manage
liquidity with ``an eye toward a significant buffer'' against the
liquidity threshold that would trigger fees and gates.\1756\ Finally,
one commenter, although generally supportive of testing liquidity,
suggested that rather than requiring funds to test against a specific
liquidity threshold, funds should analyze the impact of specific
hypothetical event scenarios on weekly liquidity and the fund's NAV,
even if such events fall short of triggering a specific liquidity
threshold.\1757\
---------------------------------------------------------------------------

    \1752\ See rule 2a-7(g)(8)(i).
    \1753\ See rule 2a-7(c)(2(ii).
    \1754\ See, e.g., BlackRock II Comment Letter; Fidelity Comment
Letter; MSCI Comment Letter; Dreyfus Comment Letter (but expressing
objection to the stress tests as proposed as vague, qualitative, and
onerous).
    \1755\ See BlackRock II Comment Letter.
    \1756\ See MSCI Comment Letter.
    \1757\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    Several commenters, however, opposed the proposed requirement to
have funds stress test their liquidity.\1758\ One commenter noted that
it believed that testing liquidity would not be particularly meaningful
for funds, as it is not possible to predict what assets a fund would
sell to meet redemptions.\1759\ This commenter also believed that
testing liquidity in floating NAV funds would serve no useful purpose
because any losses on sales of securities to meet redemptions would be
reflected in the fund's NAV.\1760\ Several commenters believed that it
was not feasible for a fund to test ``the magnitude of each
hypothetical event that would cause'' the fund to cross the liquidity
threshold,\1761\ as the proposed rule would have required for reporting
to the board.\1762\ These commenters noted that, unlike stable share
price, there was not a direct relationship between a fund's liquidity
levels and the hypothetical events listed in the proposed rule, other
than shareholder redemptions.\1763\ They believed that conducting such
stress tests would therefore require funds to make complex assumptions
about how hypothetical events, such as an interest rate increase, would
affect the level of shareholder redemptions or a portfolio manager's
decision to sell securities.\1764\ As an alternative, commenters
suggested that funds could calculate the level of shareholder
redemptions that, if satisfied using only weekly liquid assets, would
reduce the fund's weekly liquid assets to 15%.\1765\ Additionally, one
commenter, although not objecting to having funds stress test for
liquidity maintenance generally, believed that the stress tests as
proposed were vague and qualitative in nature.\1766\
---------------------------------------------------------------------------

    \1758\ See ICI Comment Letter; Federated II Comment Letter;
Federated VIII Comment Letter; Legg Mason & Western Asset Comment
Letter; Invesco Comment Letter; IDC Comment Letter.
    \1759\ See Legg Mason & Western Asset Comment Letter.
    \1760\ Id.
    \1761\ See ICI Comment Letter; Federated VIII Comment Letter.
See also IDC Comment Letter (noting that testing when a hypothetical
event may impact a fund's ability to maintain weekly liquid assets
of 15% may not be feasible).
    \1762\ See proposed rule 2a-7(g)(7)(ii) (Floating NAV
Alternative or Fees and Gates Alternative).
    \1763\ See ICI Comment Letter (arguing that there is no
practical means of testing when a hypothetical event, other than
redemptions, would cause a money market fund to cross the 15%
liquidity threshold); Federated II Comment Letter (same); Federated
VIII Comment Letter (same). See also Invesco Comment Letter
(objecting to the testing of scenarios in which a fund falls below
the 15% liquidity threshold because the only reasonable scenario in
which this would occur is shareholder redemptions).
    \1764\ See ICI Comment Letter (noting that funds do not have a
basis for determining the amount of redemptions might indirectly
result from significant changes in interest rates, spreads or a
downgrade or default on portfolio securities); Federated VIII
Comment Letter (arguing that the proposed test on liquidity levels
would have to be based on a behavioral relationship between changes
in interest rates and decisions by the fund's portfolio manager to
sell portfolio securities); Schwab Comment Letter (noting that
testing liquidity requires estimation of data that is not directly
observable, such as redemption contagion and security level price
correlations).
    \1765\ Id.
    \1766\ See Dreyfus Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that funds should assess their liquidity as
part of the stress testing process. As one commenter noted, investors
are likely to monitor their funds' liquidity levels, and the
deterioration of liquidity could spark redemptions.\1767\ We agree. We
also believe that the benefits to testing liquidity will apply to
floating NAV funds as well as stable NAV funds. We believe that
floating NAV funds need to understand what can place stress on
liquidity, regardless of the fact that losses from the sales of
securities are reflected in a market-based NAV, particularly in light
of the potential for triggering a fee or gate.\1768\ It is important
for boards to understand and be aware of what could cause a fund's
liquidity to deteriorate below certain thresholds (or below a
regulatory threshold) as this renders the fund less able to satisfy
redemptions through internal liquidity and thus increases the
likelihood that satisfying future redemptions will generate liquidity
costs.
---------------------------------------------------------------------------

    \1767\ See MSCI Comment Letter.
    \1768\ See Legg Mason & Western Asset Comment Letter.
---------------------------------------------------------------------------

    We disagree with the commenter that indicated that testing
liquidity would not be meaningful because it is not possible to predict
what assets would be sold to meet redemptions.\1769\ As discussed
below, we have made several modifications to the proposed rule in
response to comments to reduce the number and complexity of assumptions
that funds will need to make. We

recognize that funds still need to make certain assumptions in their
stress testing. In particular, when testing the effect of an increase
in shareholder redemptions, funds will have to make assumptions
regarding which assets are sold to meet such redemptions. We believe,
however, that the stress testing requirements that we are adopting
today will still be helpful to a board's understanding of a fund's
liquidity and the events that can make it deteriorate, even when it
includes some assumptions. In support of this belief that such testing
can be useful to funds, we note that some commenters indicated that
they already stress test liquidity, even though it is not currently
required.\1770\ Additionally, as we discuss below, we believe that a
disclosure and discussion of the assumptions that fund managers made
when developing stress testing can increase the board's understanding
of the stress testing results, and how the results might differ if
different assumptions are used.
---------------------------------------------------------------------------

    \1769\ Id.
    \1770\ See BlackRock II Comment Letter; Dreyfus Comment Letter.
---------------------------------------------------------------------------

    Regarding the commenters that noted that there was not a direct
relationship between a fund's liquidity levels and the hypothetical
events listed in the rule, we recognize that many of the hypothetical
events in the rule do not have a direct effect on liquidity. We did not
intend to require funds to make complex assumptions regarding how the
hypothetical events listed in the proposed rule would affect redemption
levels and therefore liquidity. In response to the concerns that these
commenters raised, and as discussed further below, we have modified the
stress testing requirements so that each hypothetical event listed in
the amendments is tested assuming varying levels of shareholder
redemptions. We are not requiring the fund to test, for example, how a
change in interest rates or credit spreads by itself affects a fund's
level of weekly liquid assets, but rather how increases in redemptions
combined with the effect of specific hypothetical events, like a change
in interest rates or credit spreads, may affect fund liquidity. It
should also simplify the implementation of the requirement by not
requiring the fund to make potentially complex or speculative
assumptions about how an increase in interest rates or deterioration in
portfolio credit quality will affect shareholder redemptions, and
thereby affect liquidity, a concern that was raised by
commenters.\1771\ We believe this measure, in addition to modifications
to the proposed hypothetical events discussed below, addresses the
concern of the commenter that did not object to testing liquidity in
principle but believed that the proposed hypothetical events made the
stress testing requirements vague and qualitative in nature. Finally,
as discussed further below, we are eliminating the proposed requirement
that funds report the ``magnitude of each hypothetical event'' that
would cause the fund to fall below the liquidity threshold. This change
from the proposal responds to commenters' concerns that making such a
determination is not feasible.\1772\
---------------------------------------------------------------------------

    \1771\ See Federated VIII Comment Letter; ICI Comment Letter.
    \1772\ Id.
---------------------------------------------------------------------------

    As noted above, we are requiring funds to test against a 10% weekly
liquid assets threshold. We have chosen the 10% weekly liquid assets
threshold because it is the same threshold that will trigger a default
liquidity fee absent board action under the final amendments. Much like
the inability to maintain a stable price, the triggering of a default
fee absent board action under our fees and gates reform may result in
consequences for a fund and its shareholders. Requiring funds to stress
test their ability to avoid falling below this threshold should help
inform boards and fund managers of the circumstances that could cause a
fund to trigger a default liquidity fee and provide them a tool to help
avoid doing so. We considered setting the required threshold at a more
conservative level, in particular 30%, because this threshold is the
level of weekly liquid assets that funds are required to maintain and
the level below which fund directors will be permitted to impose a
discretionary fee or gate. We believe, however, that fund directors
would benefit most from understanding the events that could place such
stress on a fund's liquidity that it would trigger a liquidity fee,
absent board action. Although we believe funds would also benefit from
testing the ability to maintain higher liquidity thresholds,\1773\ we
are sensitive to the potential costs of requiring funds to stress test
against multiple liquidity thresholds, and have therefore chosen to set
the liquidity threshold for required testing at the lower 10%
threshold. Nonetheless, we encourage funds to consider testing multiple
liquidity thresholds, particularly up to and including the 30%
threshold, and to consider more generally the effects of hypothetical
events and combinations of those events on liquidity.
---------------------------------------------------------------------------

    \1773\ See BlackRock II Comment Letter (noting that it stress
tests against other weekly thresholds it deems appropriate);
Fidelity Comment Letter (noting that testing the effects of events
on liquidity and share price can be useful to boards even if the