already to identify minimum levels of liquidity they seek to maintain
during stress as part of routine liquidity management, and are required
to test their ability to maintain such liquidity levels under the
baseline liquidity thresholds. Money market funds have also established
written stress testing procedures to comply with existing stress
testing requirements and report the results of the testing to the
board. Thus, such funds may experience costs related to altering
existing stress testing procedures as the proposal would move from
bright line requirements to a principles based approach, as well as
costs related to board reporting and recordkeeping.
    Moreover, to the degree that funds may not always have sufficient
incentives to manage liquidity to meet redemptions, they may choose
insufficiently low minimum levels of liquidity for stress testing,
which may reduce the value of stress testing and corresponding
reporting for board oversight of fund liquidity risk. However, funds
may have significant reputational incentives to manage liquidity
costs--incentives that have, for example, led many funds to voluntarily
provide sponsor support.
4. Swing Pricing
a. Benefits and Costs of Swing Pricing in Money Market Funds in General
    As discussed in the economic baseline, money market fund investors
transacting their shares typically do not incur the costs associated
with their transaction activity. Instead, these liquidity costs may be
borne by shareholders remaining in the fund, which may contribute to a
first-mover advantage and run risk.\351\ Moreover, as discussed above,
liquidity management by money market funds imposes externalities on all
participants investing in the same asset classes. This effect may be
especially acute if there are large-scale net redemptions during times
of market stress.
---------------------------------------------------------------------------

    \351\ As discussed in the economic baseline, dilution costs most
directly impact shareholders in floating NAV funds through changes
to the NAV. In stable NAV funds, dilution costs can make the fund
more likely to breach the $1 share price if dilution costs are
large. It is also important to note that sponsors can choose to
provide sponsor support to manage reputational costs.
---------------------------------------------------------------------------

    The proposed amendments implementing swing pricing would require
institutional prime and institutional tax-exempt money market funds to
implement swing pricing procedures to adjust the fund's floating NAV so
as to charge redeeming shareholders for the liquidity costs they impose
on the fund when a fund experiences net redemptions. The adjusted NAV
would apply to redeemers and subscribers alike. Thus, adjusting the NAV
down when a fund is faced with net redemptions charges redeemers for
the liquidity costs of their redemptions, but also allows subscribers
to buy into the fund at the lower, adjusted NAV.\352\ Under the
proposal, the affected money market fund would recoup the full dilution
costs by charging the redeemers for both the dilution cost of
redemptions as well as the cost of allowing subscribers to buy into the
fund at the lower adjusted NAV.
---------------------------------------------------------------------------

    \352\ Adjusting the NAV captures the liquidity costs that
redeemers impose on the shareholders remaining in the fund. However,
subscribers benefit from the lower NAV as well since subscribers buy
into the fund at a lower NAV. Thus, the benefits of adjusting the
NAV are shared between existing shareholders in the fund and
subscribers.
---------------------------------------------------------------------------

    As discussed in greater detail in the section that follows, the
proposed swing pricing requirement would require funds to estimate
swing factors differently depending on the level of redemptions. If net
redemptions in a particular pricing period are at or below the market
impact threshold (of 4% divided by the number of pricing periods per
day), swing factors would be required to incorporate spread and other
transaction costs. If net redemptions exceed the market impact
threshold, swing factors would be required to reflect spread and other
transaction costs, as well as a good faith estimate of market impact of
net redemptions. Thus, the magnitude of the adjustments to the NAV
during normal market conditions may be small since money market funds
already hold relatively high quality and liquid investments and would
hold even higher levels of liquidity under the proposal, which may
reduce liquidity costs when meeting redemptions.
    One commenter indicated that because NAV adjustments may be small
and investors are unable to observe at the time of placing their orders
whether the fund will adjust its NAV, swing pricing may not have the
intended impacts of swing pricing on investor behavior.\353\ The
proposed swing pricing requirement may increase the variability of
institutional funds' NAV, which can reduce their attractiveness to
investors. However, under the baseline, institutional funds experience
NAV volatility, as demonstrated in Section III.B, and risk averse
investors that prefer NAV stability may have already shifted to
government money market funds or bank accounts around the 2016
implementation of money market fund reforms. Moreover, even if
investors cannot observe whether the NAV will be adjusted on a
particular day, if swing pricing accurately reflects liquidity costs,
investors know that they would not be diluted if they stay in the fund,
reducing their incentives to exit in anticipation of the application of
a swing factor. Moreover, the rule is intended to address the dilution
that can occur when a money market fund experiences net redemptions and
is not intended to result in significant NAV

adjustments unless there is significant net redemption activity leading
to large liquidity costs.
---------------------------------------------------------------------------

    \353\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    The proposed swing pricing requirement may reduce dilution of non-
redeeming shareholders in the face of net redemptions. Thus, swing
pricing may reduce any first mover advantage, fund outflows, and any
dilution resulting from these outflows.\354\ In other jurisdictions
swing pricing is used as a mechanism to protect non-transacting
shareholders from dilution attributable to trading costs, and as an
additional tool to help funds manage liquidity risks.\355\ To the
degree that swing pricing reduces dilution, swing pricing may serve to
protect investors that remain in a fund, for instance, during periods
of high net redemptions. In addition, the proposed elimination of the
ability to impose liquidity fees and gates under rule 2a-7 may increase
the benefit of swing pricing as an important tool for money market
funds to manage the liquidity costs of large-scale redemptions.
---------------------------------------------------------------------------

    \354\ See, e.g., Jin, Dunhong, Marcin Kacperczyk, Buge Kahraman,
and Felix Suntheim. 2021. ``Swing Pricing and Fragility in Open-end
Mutual Funds.'' Review of Financial Studies, forthcoming.
    \355\ However, swing pricing in these other jurisdictions
differs somewhat from our proposed approach. For example, swing
pricing often involves adjusting a fund's NAV in the event of net
redemptions or net subscriptions. Recommendation of the European
Systemic Risk Board (ESRB) on liquidity risk in investment funds,
European Securities and Markets Authority (November 2020); Liquidity
Management in UK Open-Ended Funds, Bank of England and the Financial
Conduct Authority (March 26, 2021); and Jin, et al., Swing Pricing
and Fragility in Open-end Mutual Funds (January 1, 2021) The Review
of Financial Studies, forthcoming, available at SSRN: https://ssrn.com/abstract=3280890 or http://dx.doi.org/10.2139/ssrn.3280890.
---------------------------------------------------------------------------

    The above economic benefits of swing pricing may be reduced by
several factors. First, several commenters have suggested that swing
pricing adjustments would have been too small to affect investor
redemptions and may not have addressed the issues that occurred in
March 2020.\356\ The implementation of swing pricing in the proposal
appears to differ from that in these comment letters in that when net
redemptions exceed the market impact threshold, swing factors would be
required to reflect estimates of market impacts assuming redemptions
are met through the liquidation of a pro-rata share of total portfolio
assets. Thus, when net redemptions are large, swing factors may be
larger than estimated in these comment letters and may capture more of
the dilution costs currently borne by nontransacting shareholders.
---------------------------------------------------------------------------

    \356\ See, e.g., Fidelity Comment Letter; Western Asset Comment
Letter; GARP Risk Institute Comment Letter.
---------------------------------------------------------------------------

    Second, the proposed swing pricing requirement only addresses the
portion of dilution costs related to trading costs, and would not
address other sources of dilution discussed in section III.B.2. Thus,
the proposed requirement may only partly reduce the dilution costs that
redemptions impose on non-transacting investors and the related
liquidity externalities. We do not have granular data about daily money
market fund holdings that would enable us to estimate the amount of
dilution that could have been recaptured under the proposed approach in
March 2020 or the prevalence of other sources of dilution discussed in
Section III.B.2. To the best of our knowledge, such data is not
publicly available, and we solicit any comment or data that could
enable such quantification.
    Third, as discussed in greater detail in Section II, the proposed
swing pricing approach would require affected funds to calculate swing
factors based on, among other things, estimates of market impacts. To
the degree that it may be difficult to value illiquid assets without an
active secondary market, particularly in times of severe liquidity
stress, funds may need to use their discretion in the estimation of
market impact factors. This may give affected funds some discretion in
the calculation of swing factors. To the extent that institutional
investors may be sensitive to NAV adjustments under the proposal, some
funds may use discretion in the calculation of swing factors to reduce
the NAV adjustments. At the same time, funds may use discretion to
apply larger NAV adjustments so as to manipulate and presumably improve
reported fund performance. Importantly, the proposed rule would require
affected funds to use good faith estimates of market impact factors.
Moreover, discretion in the calculation of swing factors may increase
noise in the NAV and may decrease comparability in returns. Investors
may find it more difficult to interpret returns if swing pricing is
applied inconsistently across funds.
    The proposal would require affected funds to implement swing
pricing, rather than make it optional. While money market funds may
have reputational incentives to manage liquidity to meet redemptions,
affected funds also face collective action problems and disincentives
stemming from investor behavior. Specifically, to the degree that
institutional investors may use institutional prime and institutional
tax-exempt funds for cash management and their flows are sensitive to
NAV adjustments, funds may be disincentivized to implement swing
pricing and/or to adjust the NAV frequently. For example, even if all
institutional money market funds recognized the benefits of charging
redeeming investors for the liquidity costs of redemptions, no fund may
be incentivized to be the first to adopt such an approach as a result
of the collective action problem. By making swing pricing mandatory,
rather than optional, the proposal is intended to ensure that funds
adjust the NAV to capture the dilution costs of net redemptions and
that money market fund returns are comparable across funds. Moreover,
it may be suboptimal for an individual money market fund to implement
swing pricing routinely, as the operational costs of doing so are
immediate and certain, while the benefits are largest in relatively
rare times of liquidity stress. The proposed application of swing
pricing by all institutional prime and institutional tax-exempt funds
is intended to ensure that swing pricing is deployed in times of severe
stress by all affected funds, protecting investors from dilution costs
when they are highest, and reducing liquidity externalities that money
market funds may impose on other market participants trading the same
asset classes.
    The proposed swing pricing requirement would impose certain costs,
as analyzed in Section IV. These costs may be passed along in part or
in full to institutional money market fund investors, that are already
earning low and or zero net yields in a low interest rate environment,
in the form of higher expense ratios or fees. In addition, the proposal
would require affected funds to calculate the swing factor based on
net, rather than gross redemptions. As a result, the redeeming
investors would be charged both for the direct liquidity costs of their
redemptions, as well as for the dilution cost that results from
allowing subscribers to buy into the fund at a lower adjusted NAV.
While this would result in the non-transacting shareholders recapturing
more of the dilution costs from redemptions, this aspect of the
proposal would charge redeeming investors for more than the direct
dilution cost of their redemptions, which may disincentivize
redemptions and incentivize subscriptions.
    The proposal may reduce investor demand for institutional prime and
institutional tax-exempt money market funds. If the proposal reduces
investor demand in some funds, it would lead to a decrease in assets
under management of these money market funds, thereby potentially
reducing the wholesale funding liquidity they provide to other

market participants. The implementation of the floating NAV for
institutional money market funds in 2016 resulted in a large scale
reallocation of investor capital into stable NAV money market funds, as
discussed in Section II.A. Thus, investor demand for institutional
money market funds may depend on the low variability of their NAVs. The
proposed swing pricing requirement would increase the volatility of
affected money market fund NAVs, particularly in times of market
stress. Some commenters also suggested that swing pricing would reduce
investor interest in money market funds.\357\ A reduction in the number
of money market funds and/or the amount of money market fund assets
under management as a result of any further money market fund reforms
would have a greater negative impact on money market fund sponsors
whose fund groups consist primarily of money market funds, as opposed
to sponsors that offer a more diversified range of mutual funds or
engage in other financial activities (e.g., brokerage).
---------------------------------------------------------------------------

    \357\ See, e.g., BlackRock Comment Letter; GARP Risk Institute
Comment Letter; mCD IP Comment Letter.
---------------------------------------------------------------------------

    These economic costs may be mitigated by three factors. First, the
proposed swing pricing requirement is tailored to the level of net
redemptions. When net redemptions are low (at or below the market
impact factor threshold) and under normal market conditions, the
proposed swing pricing requirement is economically equivalent to
requiring funds strike the NAV at bid prices of securities (since other
transaction costs may also be low under normal conditions). As
discussed in the economic baseline, some fund complexes may already be
striking NAV at bid prices.
    Second, money market funds hold assets that are more liquid and
less risky when compared to other open-end funds. Under normal market
conditions, funds may be able to apply a small swing factor that only
affects the fund's NAV to the fourth decimal place. Affected money
market funds' NAV adjustments would likely be greater during severe
stress, when redeemers impose significant costs on the remaining fund
investors.
    Third, the proposed swing pricing requirement would require
redeeming investors to internalize the costs that their trading imposes
on the investors remaining in the fund, reducing the liquidity
externalities currently present in institutional prime and
institutional tax exempt money market funds. Moreover, to the degree
that some institutional investors may not be aware of the dilution risk
of affected money market funds, the proposed swing pricing requirement
may increase investor awareness of such risks. Importantly, the
proposed swing pricing requirement may enhance allocative efficiency.
As discussed above, the swing pricing requirement could cause some
investors to move their assets to government money market funds to
avoid the possibility of paying liquidity costs of redemptions.
Government money market funds may be a better match for these
investors' preferences, however, in that government money market funds
face lower liquidity costs and these investors may be unwilling to bear
any liquidity costs.
    The proposed swing pricing requirement may impose costs on
investors redeeming shares in response to poor fund management or a
fund complex's emerging reputational risk. Under the proposal, all net
redemptions out of affected funds, regardless of the cause for the
redemption, would result in the NAV being adjusted by the swing factor.
While this may impose costs on efficiency--as redemptions out of poorly
managed funds are efficient and an important part of market discipline
of fund managers--this aspect of the proposal would also capture the
liquidity costs that such redemptions impose on affected funds.
    Two factors may reduce the magnitude of these effects on the
incentives of fund managers. First, money market funds are subject to
requirements of rule 2a-7 and the proposal would increase minimum daily
and weekly liquid asset requirements applicable to money market funds
thereby further restricting fund managers from investing in illiquid
assets. Second, the proposal would require disclosures regarding
historical swing factors, which may make liquidity costs of redemptions
more transparent to investors and lead to affected funds competing on
swing factors they charge investors. In addition, the proposed swing
pricing requirement may pose a number of implementation challenges and
impose related costs on money market funds, third party intermediaries,
and investors.\358\ First, swing pricing would require affected money
market funds to estimate both direct and indirect trading costs on a
daily or more frequent basis, which may be particularly time consuming
and challenging during times of stress. Liquidity costs are not
normally charged separately to money market funds, but are expressed in
less favorable prices or the inability to sell assets under stress.
Moreover, money market fund holdings of many assets, such as municipal
securities, certificates of deposit and commercial paper, are not
exchange traded and many such assets do not have an active secondary
market. As a result, estimating transaction costs and market impact
factors of each component of a money market fund portfolio may be time
consuming and difficult, especially during a liquidity freeze.
Moreover, to the degree that some affected funds may engage in
interfund borrowing to meet redemptions, such costs would not be
captured by the proposed approach.
---------------------------------------------------------------------------

    \358\ See, e.g., SIFMA AMG Comment Letter; JP Morgan Comment
Letter; GARP Risk Institute Comment Letter.
---------------------------------------------------------------------------

    Second, the implementation of swing pricing would require affected
money market funds to receive timely information about order flows.
Some commenters indicated that swing pricing in money market funds is
currently impractical because some intermediaries may report flows with
a delay.\359\ However, as discussed in section III.B.1.a above, many
affected money market funds impose order cut-off times that ensure that
they receive orders prior to striking their NAV. Therefore, many
affected money market funds may already have the necessary information
to determine when the fund has net redemptions and a swing factor needs
to be applied. Affected money market funds that do not already have
cut-off times may introduce cut-off times for order submissions by
intermediaries, such as broker-dealers, retirement fund administrators,
investment advisers, transfer agents, and banks, bearing related costs.
Such funds may face additional operational complexity and costs to
implement a cut-off time or otherwise gather the necessary information
to determine whether it has net redemptions for each pricing period.
---------------------------------------------------------------------------

    \359\ See, e.g., ICI Comment Letter I; PIMCO Comment Letter;
Fidelity Comment Letter; Federated Hermes Comment Letter I.
---------------------------------------------------------------------------

    Third, the proposed swing pricing requirement is likely to reduce
the feasibility and increase the costs of same day settlement and the
ability of affected funds to offer multiple NAV strikes per day.\360\
Specifically, affected money market funds may not have enough time to
accurately estimate flows, make pricing decisions, and strike the NAV
while meeting their existing settlement timeframes. This

may cause affected funds to reduce the number of NAV strikes per day or
move the last NAV strike to an earlier time, which could reduce the
attractiveness of affected money market funds for liquidity-seeking
investors. Some research finds that funds offering multiple intraday
NAVs and redemptions experienced significantly larger outflows during
times of stress when compared with single-strike funds.\361\ While this
research does not distinguish between causal impacts of multiple NAV
strikes a day on run risk and selection effects (with more liquidity
seeking investors being attracted to multiple-strike funds), it
suggests that multiple-strike funds were more prone to large investor
redemptions in March 2020. Thus, the proposed swing pricing requirement
for multiple NAV strikes per day funds may represent a tradeoff between
potential adverse effects on the ability of some affected funds to
offer intraday redemptions and slower settlement on the one hand, and
potential reductions in run risk in money market funds on the other.
---------------------------------------------------------------------------

    \360\ See, e.g., ICI Comment Letter I; SIFMA AMG Comment Letter;
Western Asset Comment Letter; Federated Hermes Comment Letter I; JP
Morgan Comment Letter; Institute of International Finance Comment
Letter; CCMR Comment Letter.
    \361\ See, e.g., Casavecchia, Lorenzo, Georgina Ge, Wei Li, and
Ashish Tiwari. 2021. ``Prime Time for Prime Funds: Floating NAV,
Intraday Redemptions and Liquidity Risk During Crises.'' Working
paper.
---------------------------------------------------------------------------

    Fourth, the proposed swing pricing requirement may increase costs
of tax reporting. Specifically, the swing pricing requirement may
increase tax reporting burdens for investors if the requirement
prevents an investor from using the NAV method of accounting for gain
or loss on shares in a floating NAV money market fund or affects the
availability of the exemption from the wash sale rules for redemptions
of shares in these funds.
b. Benefits and Costs of Specific Aspects of the Proposed
Implementation of Swing Pricing
    The proposed implementation of swing pricing to institutional prime
and tax-exempt funds is characterized by four features. First, the
swing factor must reflect spread and transaction costs, as applicable.
Second, if the institutional fund has net redemptions exceeding 4%
divided by the number of pricing periods per day, the swing factor
would also require the inclusion of estimated market impacts that net
redemption would have on the value of the fund portfolio. Swing pricing
administrators would have flexibility to include market impacts in the
swing factor if net redemptions are at or below the market impact
threshold. Third, the proposal would require funds to calculate the
swing factor under the assumption that the fund would sell all assets
in the fund portfolio proportionally to the amount of net flows to meet
net redemptions (the so-called vertical slice of the fund portfolio),
rather than absorb redemptions out of liquid assets (the so-called
horizontal slice of the fund portfolio). Fourth, the NAV adjustment
would only occur when affected funds have net redemptions and not when
they have net subscriptions. These features of the proposed swing
pricing requirement aim to more fully and in a more tailored manner
address the liquidity externalities that redeemers impose on investors
remaining in the fund and are expected to result in reductions in the
first mover advantage and run risk in institutional money market funds.
i. Benefits
    Under the proposal, when net redemptions are at or below the market
impact threshold of 4% divided by the number of pricing periods per
day, the swing factor would be determined based on the spread costs and
other transaction costs (i.e., brokerage commissions, custody fees, and
any other charges, fees, and taxes associated with portfolio security
sales). As discussed above, such direct transaction costs contribute to
dilution of shareholders remaining in the fund and this aspect of the
proposal may reduce dilution costs of non-transacting investors.
Notably, adjusting the NAV by the spread costs of redemptions is
economically equivalent to striking the NAV at the bid price and, as
discussed above, some money market funds may already do so in the
regular course of business. As a result, the swing pricing requirement
for funds when net redemptions are at or below the market impact
threshold would primarily affect institutional funds that use mid-
market pricing to compute their current NAVs. In addition, when net
redemptions are at or below the market impact threshold, the proposal
would require the NAV adjustment to reflect other transaction costs,
which currently contribute to dilution of non-transacting shareholders.
Based on an analysis of historical daily redemptions out of
institutional prime and institutional tax-exempt money market funds
between December 2016 and October 2021 and discussed in greater detail
in Section III.D.4, approximately 5% of trading days \362\ may involve
such net redemptions. Approximately 3 out of the 53 (5%) institutional
funds as of October 2021 would have outflows exceeding this threshold
on an average trading day. As can be seen from that analysis, net flows
on most days are low, so funds rarely experience large net redemptions
that have significant market impact that would dilute investors.\363\
---------------------------------------------------------------------------

    \362\ This analysis is based on historical daily redemptions.
Since multiple NAV-strike a day funds would apply the threshold
multiple times a day under the proposal, this analysis may under- or
over-estimate how frequently a threshold may be applied.
    \363\ The threshold is based on historical data demonstrating
that the 4% threshold approximately corresponds to the 5th
percentile of daily fund flows.
---------------------------------------------------------------------------

    Under the proposal, if net redemptions exceed the market impact
threshold of 4% divided by the number of pricing periods per day, the
swing factor would be required to include not only the spread costs and
other transaction costs, but also good faith estimates of the market
impact of net redemptions. To the extent funds are able to estimate/
forecast market impact costs accurately, the proposed requirement to
assess the market impact of redemptions when net redemptions exceed the
market impact threshold would result in redeeming investors bearing not
only the direct spread and transaction costs from their redemptions,
but also the impact of their redemptions on the market value of the
fund's holdings. This may allow shareholders remaining in the fund to
capture more of the dilution cost of redemptions, which includes not
only direct transaction costs and near-term price movements, but the
impact of the redemptions on the fund's portfolio as a whole. However,
the magnitude of this benefit may be reduced by the fact that the
proposal would only require market impact factor adjustments if
redemptions exceed the market impact threshold. Based on an analysis of
historical daily redemptions, approximately 5% of trading days may
involve such net redemptions.\364\
---------------------------------------------------------------------------

    \364\ Id.
---------------------------------------------------------------------------

    Importantly, the proposed implementation of swing pricing would
require funds to calculate the swing factor as if the fund were selling
the pro-rata share of all of the fund's holdings, rather than, for
example, assuming the fund would absorb redemptions out of daily liquid
assets. If a fund were to absorb large redemptions out of daily or
weekly liquid assets, the immediate transaction costs imposed on the
funds would be lower. However, the fund would have less remaining daily
and weekly liquidity and transacting shareholders would be diluting
remaining investors in a manner not captured by estimated transaction
costs.

Thus, this aspect of the proposal would make redeeming investors bear
not just the immediate costs of covering redemptions, but also the
costs of rebalancing the fund portfolio to the pre-redemption levels of
liquid asset holdings.
    Finally, the proposal would apply swing pricing to net redemptions,
rather than both net redemptions and net subscriptions. Redemptions,
not subscriptions, pose the greatest run risk. This aspect of the
proposal may reduce the operational costs of implementing swing pricing
by eliminating the need for funds to perform the swing factor analysis
when they are faced with net subscriptions.
ii. Costs
    The proposed implementation of swing pricing may give rise to
burdens on money market funds. As described in the economic baseline,
money market fund holdings exhibit little price volatility outside of
times of severe stress, such as during the 2008 financial crisis and
March 2020 volatility. The proposal would require funds to apply swing
pricing during pricing periods with net redemptions, which would impose
operational burdens on money market funds. However, these burdens may
be mitigated by the fact that the funds scoped into this proposed
requirement already have to perform an analysis to float the NAV \365\
and the fact that some affected money market funds may already be using
bid prices to strike the NAV.
---------------------------------------------------------------------------

    \365\ See 17 CFR 270.2a-7(c)(1)(ii); 17 CFR 270.2a-4.
---------------------------------------------------------------------------

    In addition, the proposed approach would require redeeming
shareholders to bear liquidity costs larger than the direct liquidity
costs they may impose on the fund. Specifically, the proposal would
require institutional funds to calculate the swing factor assuming the
fund would absorb flows by trading the pro-rata share of all of the
fund's holdings, rather than specific asset types. Given the nature of
money market fund holdings (as described in the economic baseline),
money market funds typically absorb redemptions out of daily and weekly
liquid assets. Moreover, their ability to do so may be increased by the
proposed amendments to raise the daily and weekly liquid asset
requirements. At the same time, assets other than daily and weekly
liquid assets--such as municipal securities and commercial paper that
do not mature in the near term--may become illiquid in times of stress
and may need to be held to maturity by the fund. Thus, the realized
transaction costs of most redemptions may be zero as funds absorb them
out of daily liquidity, while the true liquidity costs of redemptions
may consist of the depletion of daily and weekly liquidity during times
of stress (when rebalancing is especially expensive) rather than the
sale of illiquid assets. This aspect of the proposal, therefore, could
impose a large cost on redeemers that does not represent the actual
cost realized from their trading activity, which may reduce the
attractiveness of affected money market funds to investors. Notably,
liquidity costs paid by redeemers under the proposed swing pricing
requirement would flow back to remaining shareholders, disincentivizing
redemptions and reducing the first mover advantage during times of
stress.
    Moreover, market impact factors (which are estimates of the percent
change in the price of an asset per dollar sold) and spread costs may
be difficult to estimate precisely, especially in times of stress and
when many of the assets money market funds hold lack a liquid secondary
market. These difficulties may be attenuated to the degree that funds
may be calculating market impact factors to assess trading costs and
determine optimal trading strategies; however ex ante estimates of
transaction costs and market impact factors may be more difficult than
ex post assessment of trading costs and market impacts. This aspect of
the proposal may lead money market funds to disinvest from some
securities and asset classes with less trade and quotation data for an
accurate estimate of market impact factors. While this may decrease
liquidity risk in institutional funds, this may also reduce the amount
of maturity and liquidity transformation they perform. Moreover, to the
degree that funds' estimation of market impacts and spread costs may be
imprecise, funds may charge redeeming investors an inaccurate fee that
under- or over-estimates the actual liquidity costs funds incurred by
funds after redemptions. The proposal seeks to reduce such costs by
requiring the calculation of market impact factors in swing pricing
only when net redemptions exceed 4% divided by the number of pricing
periods per day.
5. Amendments Related to Potential Negative Interest Rates
    As a baseline matter, negative interest rates have not occurred in
the United States and money market funds are not currently implementing
reverse distribution mechanisms. Moreover, government and retail money
market funds and their transfer agents are already required to be able
to process transactions at a floating NAV. Thus, the proposal would
restrict how money market funds may react to possible future market
conditions resulting in negative fund yields and would effectively
expand existing requirements related to processing orders under
floating NAV conditions to all intermediaries. Government and retail
money market funds would also be required to keep records identifying
intermediaries able to process orders at a floating NAV.
    The proposal is intended to create transparency for investors in
stable NAV funds in the event of negative yields. As discussed in
Section III.D., the reverse distribution mechanism, if implemented by
some funds, may mislead investors about the value of their investments.
Requiring stable NAV funds to implement a floating NAV in a negative
yield environment may better inform investors about the performance of
their investment than allowing such funds to preserve a stable NAV, but
decrease the number of investor shares.\366\ Moreover, the proposed
amendments related to fund intermediaries may facilitate a transition
of stable NAV funds to floating NAV in a negative yield environment.
Notably, these benefits would only be realized in persistently negative
yield environments.
---------------------------------------------------------------------------

    \366\ Jose Joseph Comment Letter.
---------------------------------------------------------------------------

    The proposed amendments may impose significant operational burdens
and costs on investors. For example, requiring retail funds to switch
from a stable NAV to a floating NAV may create accounting and tax
complexities for some retail investors.\367\ In addition, a floating
NAV requirement may be incompatible with popular cash management tools
such as check-writing and wire transfers that are currently offered for
many stable NAV money market fund accounts.\368\
---------------------------------------------------------------------------

    \367\ See, e.g., ICI Comment Letter I; Federated Hermes Comment
Letter I; Madison Grady Comment Letter; Comment Letter of Carter
Ledyard Milburn (Apr. 15, 2021).
    \368\ See, e.g., ICI Comment Letter I; Madison Grady Comment
Letter.
---------------------------------------------------------------------------

    The proposed requirement that government and retail money market
funds determine that their intermediaries have the capacity to process
the transactions at floating NAV and the related recordkeeping
requirements would impose burdens on these funds, as estimated in
Section IV. For example, affected money market funds may have to review
their contracts with intermediaries, and some contracts may need to be
renegotiated. Funds would have flexibility in how they make this
determination for each financial intermediary, which may

reduce these costs for some funds. Moreover, intermediaries that are
currently unable to process transactions in stable NAV funds at a
floating NAV may need to upgrade their processing systems to be able to
continue to transact in government and retail funds. If some
intermediaries are unable or unwilling to do so, the proposed
requirement may adversely impact the size of intermediary distribution
networks of some funds, which can limit access or increase the costs of
investor access to some affected funds. However, there may be economies
of scope in intermediating orders for both stable NAV and floating NAV
funds, especially since some investors may allocate assets in both
stable NAV and floating NAV funds. To the extent that many of the same
intermediaries may process orders for floating and stable NAV money
market funds, such intermediaries may already have processing systems
adequate capable of processing transactions in stable NAV funds at a
floating NAV should such a transition occur. Nevertheless, the use of
stable NAV money market funds as sweep vehicles may present operational
difficulties for intermediaries, and the burdens of the rule may
increase the costs of and reduce the reliance on stable NAV funds for
sweep accounting.
    As with other costs of the proposal, any compliance costs borne by
money market funds may be passed along to investors in the form of
higher fund expense ratios. The proposed amendments are justified
because they serve to protect investors of stable NAV funds and create
price transparency in the event of negative yields.
6. Amendments to Disclosures on Form N-CR, Form N-MFP, and Form N-1A
a. Benefits and Costs of the Proposed Prompt Notice of Liquidity
Threshold Events on Form N-CR and Board Reporting
    The proposed amendments would require money market funds to file a
Form N-CR report whenever a fund has invested less than 25% of its
total assets in weekly liquid assets or less than 12.5% of its total
assets in daily liquid assets. Specifically, in the event of such a
liquidity threshold event, the amendments would require money market
funds to disclose: the date of the initial liquidity threshold event,
the percentage of the fund's total assets invested in both weekly
liquid assets and daily liquid assets on the day of the event, and a
brief description of the facts and circumstances leading to the event.
    As a baseline matter, daily and weekly liquid assets are currently
required to be disclosed on fund websites on a daily basis. Relative to
that baseline, the proposed requirement for funds to report on Form N-
CR may enhance Commission oversight and transparency about money market
fund liquidity during times of stress by providing additional
information about the circumstances of a fund's significantly reduced
liquidity levels. The proposed amendments may also have the effect of
incentivizing funds to maintain daily and weekly liquidity above the
reporting thresholds, including in times of stress.
    Publication of notices surrounding liquidity threshold events may
inform investors about reasons behind the threshold event. To the
degree that some funds' liquidity threshold events may be indicative of
persistent liquidity problems or mismanagement of liquidity risk, and
to the extent that notices may better inform investors about such
causes (relative to baseline website disclosures of liquidity levels),
publication of such notices may trigger investor redemptions out of the
most distressed funds. However, this risk may be reduced because under
the proposed swing pricing approach, redeemers would be charged the
cost of their redemptions and related dilution costs would be
recaptured by the shareholders remaining in the fund.
    The proposal would also require money market funds to notify their
boards when they drop below the 12.5% daily and 25% weekly liquidity
asset thresholds, as discussed in section II.C.2. Since the proposal
would require that liquidity threshold events are reported on Form N-
CR, we preliminarily believe that funds would routinely notify the
board of such events without an explicit board notification
requirement. However, to the degree that some fund boards may not be
notified of some events subject to Form N-CR reporting, the board
notification requirement could enhance the oversight of fund boards
over liquidity management, particularly during periods of stress.
    The proposed amendments to Form N-CR would impose direct compliance
costs by imposing reporting burdens discussed in Section IV. Due to
economies of scale, such costs may be more easily borne by larger fund
families. In addition, the proposed prompt notice requirement may give
rise to two sets of costs. First, the proposed requirement may lead
fund managers to manage their portfolios specifically to try to avoid a
reporting event, rather than in a way that is most efficient for fund
shareholders. Second, the proposed requirement may result in money
market fund managers spending compliance resources on amending Form N-
CR to describe the circumstances of the liquidity threshold event,
which may divert managerial resources away from managing redemptions in
times of stress. Costs borne by money market funds may be passed along
to investors in the form of higher fees and expenses. However, as
discussed above, the promptness of the notice requirement may enhance
Commission oversight and transparency to investors, incentivize funds
to closely monitor their liquidity levels, and ultimately better
protect investors.
b. Benefits and Costs of the Proposed Form N-MFP Amendments
    Proposed amendments to Form N-MFP would require reporting of daily
data points on a monthly basis, of securities that prime funds have
disposed of before maturity, of the composition of institutional money
market funds' shareholders and concentration of money market fund
shareholders, and of additional information about repurchase agreement
transactions (including through the proposed removal of a provision
that allows aggregate information when multiple securities of an issuer
are subject to a repurchase agreement), among other changes.
    Broadly, the proposed amendments to Form N-MFP may make the form
more usable by filers, regulators, and investors, and may increase
transparency around money market fund activities in four ways. First,
the amendments may reduce uncertainty among filers and reduce filing
errors. Second, the proposed requirement that the funds report their
liquid assets, flows, and NAV on a daily basis may reduce costs of
accessing this information relative to the baseline of routinely
accessing and downloading information across many fund websites. Third,
additional information about fund repo activities would enable
investors and the Commission to better assess fund liquidity risks and
oversee the industry. Fourth, information about shareholder
concentration and composition can help the Commission and investors
understand and evaluate potential redemption behavior and related
investor risks.
    In addition, the proposal would add disclosure requirements to Form
N-MFP intended to capture information about the relevant funds' use of
swing pricing, which would include each swing factor applied during the
reporting period, the number of times a

fund applies a swing factor during the reporting period, and the end-
of-day NAV per share (as adjusted by a swing factor, as applicable) for
each business day of the reporting period. These amendments are
expected to benefit investors in money market funds by reducing
information asymmetries between institutional funds and investors about
these funds' swing pricing practices. Investors in these funds
experience price fluctuations and, thus, accept price risks inherent in
floating NAVs. However, swing pricing has not yet been implemented by
any U.S. open-end fund, and money market funds are currently not
permitted to use swing pricing. The purpose of the proposed disclosure
requirement is, thus, to inform investors about the manner in which
affected money market funds implement swing pricing. Such transparency
may result in greater allocative efficiency as investors with low
tolerance of liquidity risk and costs may choose to reallocate capital
to money market funds that have lower liquidity risk and costs. In
addition, to the degree that uncertainty about the proposed swing
pricing requirement may reduce the attractiveness of affected money
market funds to investors, transparency about historical swing factors
may reduce those adverse effects.
    The proposed amendments to Form N-MFP would impose initial and
ongoing PRA costs, as discussed in Section IV below. We understand that
money market funds generally already maintain the information they
would be required to report on Form N-MFP pursuant to other regulatory
requirements or in the ordinary course of business. However, funds
would incur some costs in reporting the information. We continue to
note that, due to economies of scale, such costs may be more easily
borne by larger fund families, and that costs borne by money market
funds may be passed along to investors in the form of higher fees and
expenses. In addition, the proposed disclosures of each swing factor,
the number of times a swing factor was applied, and the end-of-day NAV
per share (which would reflect applicable swing pricing adjustments to
that end of day NAV) may create incentives for money market funds to
compete on this dimension. Specifically, institutional investors who
use institutional funds for cash management and prefer lower
variability in the value of their investments may move capital from
money market funds that had high historical swing factors to funds with
lower swing factors. However, while NAV swings penalize redeemers, they
benefit investors remaining in the fund, which may make funds actively
using swing pricing more attractive to longer term institutional
investors.
c. Benefits and Costs of the Proposed Amendments to Form N-1A
    The proposal would require institutional money market funds to
provide swing pricing disclosures to investors, including a risk
disclosure. Specifically, the proposal would require funds required to
implement swing pricing to explain how they use swing pricing and
describe the effects of swing pricing on the fund's average annual
total returns for the applicable period(s). This aspect of the proposed
amendments to Form N-1A is expected to enhance transparency about
institutional fund's swing pricing practices. NAV adjustments under the
proposed swing pricing requirement would be a novel aspect of pricing,
influencing both the dilution risk and the returns of affected funds.
Disclosure about the effects of swing pricing on historical fund
returns is expected to help investors understand the liquidity costs of
redemptions from a particular fund, as well as the degree to which the
fund would recapture dilution of shareholders remaining in the fund.
However, the proposed amendments would impose direct reporting burdens
estimated in Section IV--costs that may be more easily borne by larger
fund complexes due to economies of scale, and costs that may be passed
along in part or in full to end investors.
    The proposed amendments would also remove current disclosures
related to the imposition of liquidity fees and any suspension of
redemptions, the need for which would be obviated by the proposal to
remove fees and gates from rule 2a-7.
d. Benefits and Costs of Proposed Requirements Related to Identifying
Information on Form N-CR and Form N-MFP
    The proposed amendments would also require the registrant name,
series name, related definitions, and LEIs for the registrant and
series on Form N-CR. In addition, the proposal would require money
market funds to report LEIs for the series on Form N-MFP.\369\ The LEI
is used by numerous domestic and international regulatory regimes for
identification purposes.\370\ As such, requiring these additional
disclosures could enable data users such as investors and regulators to
cross-reference the data reported on Forms N-CR with data reported on
Forms N-MFP and with data received from other sources more easily,
thereby expanding the scope of information available to such data users
in their assessments.\371\ All money market funds already have
registrant and series LEI due to baseline Form N-CEN reporting
requirements. The proposed amendments to Form N-MFP would also require
other information to better identify different types of money market
funds, such as amendments to better identify Treasury funds and funds
that are used solely by affiliates and other related parties. These
amendments would help the Commission and market participants to
identify certain categories of money market funds more efficiently.
However, the proposed requirements to improve identifying information
may give rise to direct compliance costs associated with amending
reporting on Forms N-CR and N-MFP, as discussed in Section IV.
---------------------------------------------------------------------------

    \369\ Under the baseline, money market funds are already
currently required to report registrant LEIs on Form N-CEN.
    \370\ Other regulators with LEI requirements include the U.S.
Federal Reserve, E.U.'s MiFid II regime, and Canada's IIROC; the LEI
is also used by private market participants for risk management and
operational efficiency purposes. See https://www.leiroc.org/lei/uses.htm.
    \371\ Fees and restrictions are not imposed for the usage of or
access to LEIs.
---------------------------------------------------------------------------

    In addition to the entity identification information (e.g.,
registrant name, series name, related definitions, and LEIs) discussed
above, the proposed amendments would also expand security
identification information by adding a CUSIP requirement for collateral
securities that money market funds report on Form N-MFP. CUSIP numbers
are proprietary security identifiers and their use (including storage,
assignment, and distribution) entails licensing restrictions and fees
that vary based on factors such as the number of CUSIP numbers
used.\372\ Money market funds are currently required to disclose CUSIP
numbers for each holding they report on Form N-MFP.\373\ As such, the
incremental compliance cost on money market funds associated with the
proposed CUSIP requirement, compared to the baseline, would be limited
to those costs, if any, incurred by money market funds as a result of
storing additional CUSIP numbers (to the extent money market funds do
not already store CUSIP

numbers for their collateral securities).\374\
---------------------------------------------------------------------------

    \372\ The CUSIP system (formally known as CUSIP Global Services)
is owned by the American Bankers Association and managed by Standard
& Poor's Global Market Intelligence. See CGS History, available at
https://www.cusip.com/about/history.html, and License Fees,
available at https://www.cusip.com/services/license-fees.html.
    \373\ See Item C.3 of Form N-MFP.
    \374\ CUSIP license costs vary based upon, among other factors,
the quantity of CUSIP numbers to be used, on a tiered model, with
the lowest tier being up to 500 CUSIP numbers. See CGS License
Structure, available at https://www.cusip.com/services/license-fees.html#/licenseStructure. Based on our understanding of current
CUSIP licenses and usage among money market funds, we do not believe
the proposed CUSIP reporting requirement for collateral securities
is likely to impose incremental compliance costs on money market
funds by moving them into a new CUSIP license pricing tier.
---------------------------------------------------------------------------

e. Benefits and Costs of Proposed Structured Data Requirement for Form
N-CR
    The proposed amendments would require money market funds to submit
reports on Form N-CR using a structured, machine-readable data
language--specifically, in an XML-based language created specifically
for Form N-CR (``N-CR-specific XML'').\375\ Currently, money market
funds submit reports on Form N-CR in HTML or ASCII, neither of which is
a structured data language.\376\ This aspect of the proposed amendments
is expected to benefit investors in money market funds by facilitating
the use and analysis, both by the public and by the Commission, of the
event-related disclosures reported by money market funds on Form N-CR,
as compared to the current baseline. The improved usability of Form N-
CR could enhance market and Commission monitoring and analysis of
reported events, thus providing greater transparency into potential
risks associated with money market funds on an individual level and a
population level.
---------------------------------------------------------------------------

    \375\ This would be consistent with the approach used for other
XML-based structured data languages created by the Commission for
certain specific EDGAR Forms, including Form N-CEN and Form N-MFP.
See Current EDGAR Technical Specifications, available at https://www.sec.gov/edgar/filer-information/current-edgar-technical-specifications.
    \376\ See supra footnote 247.
---------------------------------------------------------------------------

    We anticipate that the incremental costs associated with requiring
money market funds to submit reports on Form N-CR in N-CR-specific XML,
compared to the baseline of submitting Form N-CR in HTML or ASCII,
would be low given that money market funds already utilize XML-based
languages to meet similar requirements in their other reporting, and
can utilize their existing capabilities for preparing and submitting
Form N-CR.\377\ Under the proposed rule, money market funds that choose
to submit Form N-CR directly in N-CR-specific XML (rather than use the
fillable web form) would incur the incremental compliance costs of
updating their existing preparation and submission processes to
incorporate the new technical schema for N-CR-specific XML.\378\
---------------------------------------------------------------------------

    \377\ See supra footnote 331. In addition, money market funds
would be given the option of filing Form N-CR using a fillable web
form that will render into N-CR-specific XML in EDGAR, rather than
filing directly in N-CR-specific XML using the technical
specifications published on the Commission's website.
    \378\ See infra Section IV.E.
---------------------------------------------------------------------------

7. Amendments Related to the Calculation of Weighted Average Maturity
and Weighted Average Life
    The Commission is proposing amendments to rule 2a-7 to specify that
WAM and WAL must be calculated based on percentage of each security's
market value in the portfolio, rather than based on amortized cost of
each portfolio security. These amendments may enhance consistency and
comparability of disclosures by money market funds in data reported to
the Commission and provided on fund websites. A consistent definition
of WAM and WAL across funds can enhance transparency for investors
seeking to assess the risk of various money market funds and may
increase allocative efficiency. Moreover, greater comparability of WAM
and WAL across money market funds may enhance Commission oversight of
risks in money market funds. These amendments are not expected to give
rise to direct compliance costs. Specifically, we understand that all
money market funds currently determine the market values of their
portfolio holdings.\379\ Thus, the costs of these proposed amendments
may be de minimis.
---------------------------------------------------------------------------

    \379\ Money market funds that use a floating NAV use market
values when determining a fund's NAV, while money market funds that
maintain a stable NAV are required to use market values to calculate
their market-based price at least daily.
---------------------------------------------------------------------------

D. Alternatives \380\
---------------------------------------------------------------------------

    \380\ This discussion supplements the discussion of alternatives
in other sections of the release.
---------------------------------------------------------------------------

1. Alternatives to the Removal of the Tie Between the Weekly Liquid
Asset Threshold and Liquidity Fees and Redemption Gates
    The proposal could have replaced the 30% weekly liquid asset
threshold for the imposition of redemption gates or fees with a
different threshold. This alternative would allow money market funds to
impose gates or fees during large redemptions to reduce some of the
dilution costs during large redemptions. However, this alternative
could still trigger runs on money market funds close to the regulatory
threshold in times of liquidity stress. When funds approach any
regulatory threshold that can trigger a redemption gate or fee,
investors are incentivized to redeem ahead of others to avoid a
potential gate or fee and retain access to their capital during
liquidity stress. Thus, the existence of a transparent threshold,
rather than the size of the threshold itself, may make money market
funds vulnerable to runs. Moreover, even under the proposed removal of
redemption fees and gates under rule 2a-7, money market funds are still
able to reduce dilution costs during large redemptions under current
rule 22e-3 where a fund's weekly liquid assets drop below 10%. A fund's
board could also determine to impose redemption fees under Rule 22c-2.
    The proposal could also have reduced or eliminated the transparency
of the trigger for the imposition of redemption gates and liquidity
fees. For example, the proposal could have required fund boards to
impose their own policies and procedures around factors they would take
into account before redemption gates and fees are imposed that are not
transparent to investors. As another alternative, the proposal could
have required fund managers to seek regulatory approval confidentially
before a fund is able to impose a redemption fee or gate. As yet
another alternative, the proposal could have preserved the 30% weekly
liquid asset trigger for the potential imposition of a fee or gate,
while prohibiting the public disclosure of weekly liquid assets.
    These alternatives would increase uncertainty among investors about
how close a given money market fund is to imposing a redemption gate or
fee in times of severe market stress. Because the first mover advantage
is strongest when a fund is on the cusp of imposing a redemption gate
or fee (as many money market fund investors may be risk averse and the
potential imposition of redemption gates could reduce shareholders'
access to liquidity), investor uncertainty about whether a fund is
approaching a redemption gate or fee could prevent runs. The
alternatives making the imposition of redemption gates or fees
discretionary, subject to regulatory approval, or mechanical but
triggered by an unobserved level of weekly liquid assets would also
increase investor uncertainty but could disrupt run dynamics.
    However, these alternatives involve drawbacks. First, while such
alternatives could interrupt runs on the funds closest to the
imposition of the redemption gate or fee, they could also trigger runs
on funds that were less illiquid and less likely to impose redemption
gates or fees. For example, a lack of transparency about which funds
are close to imposing liquidity

fees or gates may lead risk averse investors to redeem from money
market funds in general to preserve access to their capital during
times of liquidity stress, which can lead to runs on more liquid and
less liquid funds alike. Second, requiring money market fund managers
to receive permission from the Commission before a redemption gate or
fee is imposed may create undue delay during market stress events.\381\
Third, these alternatives would not present the same benefits from the
proposed approach, which would both reduce run incentives related to
the potential imposition of redemption gates or fees and, upon net
redemptions, require redeeming shareholders to pay for the dilution
cost they impose on the fund (under the proposed swing pricing approach
discussed below).
---------------------------------------------------------------------------

    \381\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of
James L Setterlund (Apr. 12, 2021) (``James Setterlund Comment
Letter'').
---------------------------------------------------------------------------

2. Alternatives to the Proposed Increases in Liquidity Requirements
a. Alternative Thresholds
    The proposal could have included a variety of alternative daily and
weekly liquid asset thresholds. To quantify the potential effect of
various liquidity thresholds on the probability that money market funds
would confront liquidity stress, we modeled stress in publicly offered
institutional prime fund portfolios using the distribution of
redemptions from 42 institutional prime funds observed during the week
of March 16 to 20, 2020 (``stressed week'') at various starting levels
of daily and weekly liquid assets. The possible new thresholds
determined by stress in publicly offered institutional prime fund
portfolios were then applied to all money market funds except for the
daily liquid asset threshold for tax-free money market funds. We also
calculated from the distribution of daily and weekly liquidity asset
values what percentage of retail and institutional prime funds combined
would be impacted by the various liquidity thresholds. The analysis
below estimates the probability that a publicly offered institutional
prime fund with a given level of daily and weekly liquid assets would
deplete daily liquid assets to meet redemptions (and have to liquidate
assets under stressed market conditions) on a given day during the
stressed week.\382\ Specifically, Figure 14 below plots the probability
that a fund will run out of daily liquid assets on a given day of the
stressed week. For the proposed thresholds of weekly liquid assets at
50% and daily liquid assets at 25%, Figure 14 shows that less than 10%
of funds would deplete daily liquid assets and be unable to absorb
redemptions out of daily liquid assets on at least one of the five
stressed days. By contrast, a threshold of 15% daily liquid assets and
40% weekly liquid assets would approximately double the estimate of
funds that would deplete daily liquidity to meet redemptions on at
least one of the days of a stressed week (to approximately 20%). As
referenced above, the largest weekly and daily redemption during the
week of March 16 to 20, 2020, was approximately 55% and 25%
respectively. Thus, an approach aimed at eliminating the risk of funds
having insufficient liquid assets to absorb redemptions (using
redemption data from March 16 to20, 2020) would require funds to hold
more than 55% of weekly and at least 25% of daily liquid assets. Lower
thresholds increase the probability that some funds may deplete their
liquid assets to meet redemptions, but also reduce the adverse impacts
described above.
---------------------------------------------------------------------------

    \382\ See supra footnote 206.
    [GRAPHIC] [TIFF OMITTED] TP08FE22.020

    Table 5 quantifies the daily probability that a publicly offered
institutional prime fund depletes daily liquid assets to meet
redemptions under four scenarios: The current baseline daily and weekly
liquid asset thresholds, thresholds based on the largest daily and
weekly redemption during the week of March 16, 2020; pre-COVID weighted
mean daily and weekly liquid assets; and post-COVID weighted mean daily
and weekly liquid assets. The baseline scenario would require no change
for money market funds; the ``biggest redemptions'' alternative would
require approximately 10% of all prime funds (including both
institutional and retail prime funds) to increase their daily liquid
assets and approximately 75% of all prime funds to increase their
weekly liquid assets. The alternative of imposing thresholds at the
``pre-COVID'' mean would require approximately 25% of all prime funds
to increase their daily and 50% of all prime funds to increase their
weekly liquid assets. Finally, the alternative

that would impose ``post-COVID'' average liquidity metrics on the
industry would require approximately 50% of all prime funds to increase
daily and 75% of all prime funds to increase weekly liquid assets.
[GRAPHIC] [TIFF OMITTED] TP08FE22.021

    This analysis includes a number of modeling assumptions. First,
institutional prime fund redemptions were historically higher than
redemptions out of retail funds, which may bias the analysis to
overestimate the probability a retail or private institutional prime
fund runs out of liquidity on a given day. Second, the analysis assumes
that assets maturing on a given business day will be available at the
end of that day. Third, the analysis assumes no assets are sold into a
distressed market and redemptions are absorbed fully into a fund's
liquid assets. Fourth, the models do not include government agency
securities with a maturity in excess of seven days, and assume Treasury
securities have daily liquidity regardless of maturity and can be sold
without any loss. Fifth, the analysis assumes that funds would go below
the 30% weekly liquid asset threshold, continuing to meet redemptions
out of liquid assets, rather than hold on to the weekly liquid assets.
As discussed above, the removal of the trigger for the potential
imposition of redemption gates may increase the willingness of money
market funds to meet redemptions with daily and weekly liquid assets.
Sixth, these estimates are based on redemption patterns in March 2020
and the distribution of future redemptions may differ, in part, as a
result of the proposed amendments.
    Therefore, the above estimates show that alternatives imposing
higher minimum daily and weekly liquidity thresholds relative to the
proposal would require funds to hold more liquid assets, reducing the
risk of fund liquidations or selloffs that may necessitate future
government backstops. However, higher minimum liquidity thresholds
would require a larger number of money market funds to reallocate their
portfolios towards lower yielding investments. In addition, higher
liquidity thresholds may lead funds to increase the risk in the
remainder of their portfolios to attract investor flows or to keep fund
yields from sliding below zero and ensure the viability of the asset
class (the latter risk may be more pronounced in very low interest rate
environments). Moreover, higher liquidity requirements may increase the
availability of funding liquidity through repos to leveraged market
participants, resulting in a higher levels of risk taking in less
transparent and less regulated sectors of the financial system. As
discussed in more detail in Section III.C.2.a, an analysis of
redemptions during market stress of March 2020 shows that, under the
proposed liquidity thresholds, the probability that a fund depletes
available weekly liquidity on at least one day during the stressed week
was only approximately 9%. Thus, the proposed liquidity thresholds may
be sufficient to meet redemptions during periods of liquidity stress.
    Similarly, lower thresholds relative to the proposal would allow
funds to hold less liquid assets, increasing fund liquidity risks.
However, lower thresholds would decrease the number of money market
funds having to shift portfolios; would reduce the incentives of funds
to take larger risks in the less liquid portion of their portfolios;
and would reduce the concentration of liquidity in repos that are used
by leveraged market participants for funding liquidity. The proposed
thresholds reasonably balance these economic costs and benefits.
b. Caps on Fund Holdings of Certain Assets
    As an alternative to increasing the minimum daily and weekly liquid
asset requirements, the Commission considered proposing caps on money
market fund holdings of certain assets, such as commercial paper and
certificates of deposit. Commercial paper and certificates of deposit
lack an actively traded secondary market and are difficult to value or
sell during times of liquidity stress. Limiting money market fund
holdings of such instruments may reduce run risk to the degree that the
illiquidity of all or a portion of a fund's portfolio may create
externalities from redeeming investors borne by investors remaining in
the fund, which may incentivize early redemptions.
    However, this alternative relies on the assumption that commercial
paper and certificates of deposit homogeneously reduce the liquidity of
a fund's portfolio by more than other money market fund holdings across
maturities. These assumptions may not always hold for different money
market funds and over different time horizons. Moreover, to the degree
that investors prefer funds that deliver higher returns and money
market funds benefit from investor expectations of implicit government
backstops during times of liquidity stress, money market funds may
react to this alternative by changing the maturity structure of their
portfolio and reallocating into other securities with potentially
higher liquidity risk. For example, money market funds may substitute
short-term commercial paper and certificates of deposit that are
classified as daily or weekly liquid assets with longer term commercial
paper and certificates of deposit that

would not be classified as daily or weekly liquid assets. Finally,
because this alternative would involve defining the types of
instruments subject to the cap, issuers may be able to create new
financial instruments that are similar, and perhaps synthetically
identical, to commercial paper and certificates of deposit along risk
and return dimensions, but that would not be subject to the caps. The
proposed approach, which would increase minimum daily and weekly liquid
asset requirements, may reduce liquidity and run risk in money market
funds without such potential drawbacks, while ensuring funds have
minimum liquidity to meet large redemptions.
    As another alternative, the proposal could have replaced the
minimum daily and weekly liquid asset thresholds with asset
restrictions, such as imposing a minimum threshold for holdings of
government securities \383\ and repos backed by government securities.
Under the baseline, such assets are generally categorized as daily
liquid assets. Thus, such an approach would have the effect of
replacing minimum daily and weekly liquid asset thresholds with a
single daily liquid asset threshold, and restricting the types of
assets that would qualify as daily liquid assets. This alternative
would reduce the liquidity risk of liquid assets held by money market
funds, which may help them meet redemptions without transaction costs.
However, waves of redemptions as experienced in 2008 and 2020 occur
over multiple days, suggesting that money market funds need to have
both daily and weekly liquidity to meet redemptions. Moreover, asset
restrictions imposing large minimum thresholds for holdings of
government securities would decrease not only the risk, but also the
yield of money market funds and their attractiveness to investors,
reducing the viability of the asset class in low interest rate
environments. This approach would also further concentrate money market
fund holdings in specific types of assets, which may increase the
likelihood of funds selling the same assets to meet redemptions in
times of stress.
---------------------------------------------------------------------------

    \383\ See, e.g., CCMR Comment Letter.
---------------------------------------------------------------------------

    Finally, under the baseline, funds falling below minimum liquid
asset thresholds may not acquire any assets other than daily or weekly
liquid assets, respectively, until funds meet those minimum thresholds.
The proposal would retain this baseline approach, while increasing the
absolute daily and weekly liquid asset thresholds. As an alternative,
the proposal could have imposed penalties on funds or fund sponsors
upon dropping below the required minimum liquidity threshold.
Similarly, the proposal could have imposed a minimum liquidity
maintenance requirement, which would require that a money market fund
maintain the minimum daily liquid asset and weekly liquid asset
thresholds at all times instead of the current requirement to maintain
the minimums immediately after the acquisition of an asset. During the
market stress in 2020, funds experiencing large redemptions were
reluctant to draw down on weekly liquid assets due to the existence of
the threshold for the potential imposition of redemption fees and
gates. Such alternatives may have a similar effect of penalizing money
market funds for using liquidity when liquidity is most scare, which
may make money market funds reluctant to use daily and weekly liquid
assets to meet large redemptions during market stress. As a result,
money market funds would be incentivized to sell less liquid assets,
such as longer maturity commercial paper, into distressed markets,
rather than risk penalties and dropping below minimum liquidity
maintenance requirements. This may increase transaction costs borne by
redeeming investors and may result in money market fund redemptions
magnifying liquidity stress in underlying securities markets.
3. Alternative Stress Testing Requirements
    As an alternative to the proposed amendments to stress testing
requirements, the proposal could have modified weekly liquidity
thresholds that funds must use for stress testing. For example, the
proposal could have required money market funds to perform stress
testing using 15%, 20%, or 30% minimum weekly liquid asset thresholds.
As another example, the proposal could have required money market funds
to use specific minimum daily and weekly liquid asset thresholds. These
alternatives would reduce the discretion of fund managers to identify
their own optimal liquid asset thresholds for purposes of stress
testing. However, as discussed above, optimum levels of liquidity will
vary depending on the type of money market fund, investor
concentration, investor composition, and historical distribution of
redemption activity under stress, among other factors. The alternatives
establishing bright line thresholds for stress testing could reduce the
ability of funds to stress test against the most optimal liquid asset
thresholds, which may reduce usability of stress testing results for
board and Commission oversight.
4. Alternative Implementations of Swing Pricing
a. Alternative Thresholds for the Application of Market Impact Factors
    As described in Section II.B above, the proposal would require
funds to apply different swing factor calculations depending on the
size of net redemptions. Specifically, if net redemptions are at or
below 4% of the fund's NAV divided by the number of pricing periods per
day, the swing factor would reflect spread and transaction costs of
redemptions. If net redemptions exceed 4% of the fund's NAV divided by
the number of pricing periods per day, the swing factor would include
not only spread and transaction costs, but also a good faith estimation
of market impacts of net redemptions. The proposal could have used a
different net redemption threshold for the application of market impact
factors. For example, the proposal could have required funds to
estimate market impacts if net redemptions exceed 2% or 0.5% divided by
the number of pricing periods per day. Based on an analysis in Table 6
below, these alternatives would require funds to estimate market impact
factors on 10% or 25% of trading days.\384\ Since net flows of these
funds are zero at the median, and because there are only 53
institutional funds in our sample, a 10%-ile or 25%-ile alternative
threshold would correspond to approximately 5 and 13 funds respectively
having outflows greater than the threshold on an average trading day,
relative to approximately 3 funds under the proposal. Alternatively,
the proposal could have used different redemption thresholds for the
swing factor calculation for institutional prime or institutional tax-
exempt funds.
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    \384\ This analysis is based on historical daily redemptions,
but multiple NAV-strike a day funds would apply the threshold
multiple times a day under the proposal. Thus, this analysis may
under- or over-estimate how frequently a threshold may be applied.

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[GRAPHIC] [TIFF OMITTED] TP08FE22.046

    Higher (lower) net redemption thresholds for the calculation of
market impact factors would reduce (increase) the number of pricing
periods for which affected money market funds must calculate market
impact factors for portfolio securities, reducing (increasing) related
costs and operational challenges. However, higher (lower) net
redemption thresholds would also reduce (increase) the amount of
dilution from redemptions that is recaptured by money market funds and
accrue to non-transacting shareholders.
---------------------------------------------------------------------------

    \385\ This table reports the results of an analysis of daily
flows reported in CraneData on 1,228 days between December 2016 and
October 2021. As of September 2021, CraneData covered 87% of the
funds and 96% of total assets under management. Flows at the class
level were aggregated to the fund level. Flows of feeder funds were
aggregated for an approximation of flows for the corresponding
master fund.
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    As can be seen from Table 6, the proposed 4% market impact
threshold would represent approximately the 5th percentile of daily
redemptions. We note that 1st and 5th percent correspond to standard
confidence levels in statistical testing, and such confidence levels
have been used in other Commission rules.\386\ Importantly, when daily
net redemptions reach 4%, most funds may experience significant market
impact if they were to sell a pro-rata share of their portfolio
holdings to meet redemptions. Thus, the proposed market impact
threshold may appropriately tailor the market impact factor requirement
to relatively rare pricing periods of extreme stress.
---------------------------------------------------------------------------

    \386\ For example, rule 18f-4 requires that an open end fund's
value at risk model use a 99% confidence level. The Commission also
considered requiring a different confidence level for the value at
risk test, such as the 95% or 99% confidence levels. See, e.g., Use
of Derivatives by Registered Investment Companies and Business
Development Companies, Investment Company Act Release No. 34084
(Nov. 2, 2020) [85 FR 83162 (Dec. 21, 2020)], at 83250.
---------------------------------------------------------------------------

    As another alternative, the proposal could have defined the market
impact threshold on a fund-by-fund basis, with reference to a fund's
historical flows.\387\ For example, each fund could have been required
to determine the trading days for which it had its highest flows over a
set time period, and set its market impact threshold based on the 5% of
trading days with the highest redemptions.\388\ While this alternative
could allow funds to customize their market impact thresholds to their
historical redemption flows, it may reduce the comparability of money
market fund returns for investors because swing factors, including the
associated market impact factor, influence reported fund returns.
Finally, such an alternative may create strategic incentives for fund
complexes to open and close funds depending on historical redemption
activity. For example, to the degree that the estimation of market
impact factors may be burdensome, fund families may choose to close
funds that experienced high redemptions to avoid the application of
market impact factors.
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    \387\ As another possibility, the proposal we could have allowed
funds discretion over which historical period could be chosen.
However, because money market funds may not internalize the
externalities that their liquidity management imposes on investors
in the same asset class, they may not be incentivized to use such
discretion in a way that mitigates those externalities. For example,
some affected funds may choose a historical time period that results
in market impact thresholds that are too high, so that market impact
factors are rarely applied. Moreover, because market impact
thresholds would influence NAV adjustments and reported returns, the
alternative may reduce the comparability of money market fund
returns for investors.
    \388\ As another alternative, the rule could have required
policies and procedures regarding the choice of a threshold percent
level based on historical data.
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b. Other Alternative Approaches to Market Impact Factors
    The proposal could have required institutional funds to apply swing
pricing as proposed, but without any requirement to estimate market
impact factors. As a related alternative, the proposal could have made
the use of market impact factors in swing factor calculations less
prescriptive and more principled-based or optional in their entirety.
These alternatives would reduce the likelihood and frequency with which
affected money market funds would estimate market impacts, which may
reduce costs and operational challenges of doing so. However, this may
reduce the frequency and size of NAV adjustments and the benefits of
swing pricing for non-transacting shareholders.
    Increased discretion may allow funds to tailor the calculation of
market impact factors to individual portfolio and asset characteristics
and prevailing market conditions. This may make swing factors a more
precise measure of liquidity costs assessed to redeeming investors.
However, because swing factor adjustments influence reported fund
returns, greater discretion over the calculation of swing factors may
reduce the comparability of money market fund returns for investors.
Moreover, because money market funds may not internalize the
externalities that their liquidity management practices may impose on
investors in the same asset class, they may not be incentivized to use
such discretion in a way that mitigates those externalities.
c. Other Alternative Implementations of Swing Pricing
    Under the proposal, all institutional prime and institutional tax
exempt money-market funds would be required to apply swing pricing
during pricing periods with net redemptions. As an alternative, the
proposal could have required a fund to adopt policies and procedures
that specify how the fund would determine swing pricing thresholds and
swing factors based on a principles based approach, instead of
specifying swing factor calculations and thresholds in the rule. As
another alternative, the proposal could have made the application of
swing pricing optional. The operational costs of implementing swing
pricing are immediate and certain, while the benefits are largest in
relatively rare times of liquidity stress. Moreover, while money market
funds may have reputational incentives to manage liquidity to meet
redemptions--and fund sponsors may have chosen to provide sponsor
support in the past--institutional money market funds also face
disincentives from investor behavior and collective action problems.
Specifically, to the degree that institutional investors may use
institutional prime and institutional tax-

exempt funds for cash management and are sensitive to NAV adjustments,
funds may be disincentivized to swing the NAV and recapture the
dilution costs for shareholders remaining in the fund.
    These alternatives may allow funds not to implement swing pricing
or to implement a swing pricing approach with higher swing thresholds
and different swing factors (for example, without estimating market
impacts). Relative to the proposal, these alternatives may allow funds
to better tailor their liquidity management and swing pricing design to
investor composition, portfolio and asset characteristics, and
prevailing market conditions. This alternative may also avoid
operational costs and challenges of swing pricing for some funds. To
the degree that the implementation of swing pricing may increase the
variability of fund NAVs which reduces the attractiveness of affected
funds to investors, these alternatives may reduce potential adverse
impacts of swing pricing on the size of the institutional money market
fund sector, the number of institutional money market funds available
to investors, and the availability of wholesale funding liquidity in
the financial system. However, affected funds may not internalize the
externalities that they impose on investors in the same asset classes
or the externalities that redeeming investors impose on investors
remaining in the fund. In addition, as a result of the collective
action problem and disincentives from investor flows, no fund may be
incentivized to be the first to implement swing pricing, even if all
institutional money market funds recognize the value of charging
redeeming investors for the liquidity costs of redemptions. Thus, these
alternatives could reduce the likelihood that funds adjust the NAV to
capture the dilution costs of net redemptions relative to the proposal
because affected funds may not internalize the externalities that they
impose on investors in the same asset class. This may reduce or
eliminate important benefits of the proposed swing pricing requirement,
including protecting non-transacting investors from dilution, reducing
first-mover advantage and run risk, and reducing liquidity
externalities money market funds may impose on market participants
transacting in the same asset classes. In addition, relative to the
proposal, these alternatives would increase fund manager discretion
over the choice of swing threshold, swing factors, and the application
of swing pricing in general. As a result, because the application of
swing pricing in general and swing factor adjustments in particular
influence reported fund returns, greater discretion over the
application of swing pricing may reduce the comparability of money
market fund returns for investors.
    The proposal could have required institutional funds to adjust the
NAV only when net flows exceed a certain swing threshold (either
regulatory threshold or threshold selected by each institutional fund),
allowing funds to not adjust the NAV at all when redemptions are low.
As described in the economic baseline, money market funds generally
hold highly liquid assets, and the proposal would require money market
funds to hold even higher levels of daily and weekly liquid assets. As
a result, unless both net redemptions and price uncertainty are large,
institutional funds may be able to absorb redemptions of transacting
investors without imposing large liquidity costs on the remaining
investors. Thus, the alternative may allow institutional funds to avoid
the costs and operational burdens of calculating spread and transaction
costs when net redemptions are low.
    However, alternatives that allow funds not to apply swing pricing
when net redemptions are below a swing threshold selected by the fund
may reduce the expected economic benefits of swing pricing. First, if
money market funds are able to select their own swing thresholds, they
may choose to set high swing thresholds, reducing the probability that
funds would swing the NAV under normal conditions. To the degree that
money market fund investors use institutional funds as a very low risk
or cash-like investment vehicle and are averse to any fluctuations in
the value of their money market fund holdings, these funds may seek to
only swing the NAV when redemptions are large enough that they would
have required fund liquidation. Second, in 2020 institutional money
market fund investors appeared to be highly sensitive to the
possibility that a redemption gate or fee would be imposed. To the
extent money market investors are able or attempt to forecast when
swing pricing would apply or attempt to do so, the existence of a swing
threshold may incent these investors to redeem before the swing.
Importantly, formulating a swing threshold based on redemptions in a
particular pricing period, rather than based on historical redemptions,
is likely to interrupt self-fulfilling run dynamics and eliminate
incentives for strategic redemptions around swing thresholds.
    The proposal could have allowed funds to calculate the swing factor
under the assumption that the fund would absorb redemptions out of
liquid assets (the so-called horizontal slice of the fund portfolio) or
otherwise provide funds with flexibility to determine the costs based
on how they would satisfy redemptions on a given day. Money market
funds may manage their liquidity so as to be able to absorb redemptions
out of daily and weekly liquid assets, rather than having to sell a
pro-rata share of their portfolio holdings. Moreover, the proposal
would require money market funds to hold higher levels of daily and
weekly liquid assets. Assets that are not daily and weekly liquid
assets can be illiquid and generally may need to be held to maturity by
the fund. Thus, the alternative would allow funds to avoid swinging the
NAV if they are able to, for example, by absorbing redemptions out of
more liquid assets. This may reduce uncertainty for investors about the
magnitude of the potential NAV adjustment, especially when liquidity is
not scarce. However, this alternative would result in redeeming
investors not being charged for the true liquidity costs of
redemptions, which consist not only of the immediate costs of
liquidating fund assets, but also of the cost of leaving the fund more
depleted of liquidity and thus more vulnerable to future redemptions.
    As another alternative, the proposal could have required that
affected money market funds calculate the swing factor based on the
fund's best estimate of the liquidity costs of redemptions. Under this
alternative, swing factors may more accurately capture the costs of
redemptions as funds would be able to tailor swing factors to their
liquidity management strategies (whether that is, for example,
liquidating pro-rata shares of portfolio holdings, absorbing
redemptions out of daily or weekly liquidity, some combination of the
two, or borrowing). However, this alternative would increase fund
discretion in the calculation of swing factors, and fund manager
incentives may not be aligned with incentives to accurately estimate
liquidity costs of redemptions. For example, larger swing factors
applied to redemptions benefit the fund and can improve reported fund
performance. At the same time, disclosures about historical swing
factors can incentivize fund managers to apply excessively low swing
factors to attract investors.
    The proposal could have required institutional funds to allocate
the aggregate dollar cost of trading to gross (as opposed to net)
redemptions. Under the alternative, redeeming investors

would bear the dilution cost of the redemptions, but not the dilution
cost that comes from subscribers being able to buy into the fund at the
lower adjusted NAV.\389\ This approach could result in redeeming
investors paying only the liquidity costs of their orders. However,
this alternative may not fully compensate shareholders remaining in the
fund for the full dilution cost associated with redemptions.
---------------------------------------------------------------------------

    \389\ Some regulatory authorities in other countries allow fund
managers to choose one of two allocation rules: A rule under which
costs are fully borne by subscribing and redeeming investors and a
rule under which costs are borne on a pro-rata basis by transacting
investors. See, e.g., ``Code of Conduct for Asset Managers Using
Swing Pricing and Variable Anti-Dilution Levies,'' 2016, available
at https://www.afg.asso.fr.
---------------------------------------------------------------------------

    The proposal also could have required that institutional funds
apply swing pricing to both net redemptions and net subscriptions.
Relative to the proposal, this alternative would involve greater
benefits to non-transacting investors by not only capturing the
dilution costs of redemptions, but also the dilution costs arising out
of the need to invest net subscriptions. At the same time, waves of
subscriptions may be less likely to destabilize the money market fund
sector in a way that leads to government support. Moreover, the
alternative would increase the ongoing operational costs of swing
pricing--costs that are expected to be passed along to fund investors
that are already earning low or zero net yields in a low interest rate
environment. Finally, as discussed in Section II above, applying the
proposed swing pricing requirements to fund subscriptions would require
these funds to make certain assumptions about how they invest cash from
new subscriptions and, in some cases, these assumptions would be
inconsistent with requirements in rule 2a-7.
5. Liquidity Fees
    As an alternative to the proposed swing pricing requirement, the
proposal could have required that institutional prime and institutional
tax exempt money market funds establish board-approved procedures to
impose liquidity fees that capture liquidity externalities of
redemptions. As a related alternative, the proposal could have required
institutional prime and tax-exempt money market funds to establish a
dynamic liquidity fee framework that uses the same, or similar,
parameters as swing pricing for determining when to impose a fee and
how to calculate the fee. For instance, the liquidity fee framework
could apply a fee any time the fund has net redemptions, and calculate
the amount of the fee in the same or similar way as the swing factor
under our proposed approach. Alternatively, the liquidity fee framework
could be modified in the same or similar manner as one of the swing
pricing alternatives discussed above (e.g., the fee could apply only
when net redemptions exceed a certain threshold, or the fee calculation
method could be based on how the fund expects to satisfy redemptions
instead of assuming sale of a vertical slice of the fund's portfolio).
    While the PWG Report largely analyzed liquidity fees in the context
of the removal of the ties between weekly liquid asset thresholds and
the potential imposition of fees and gates, several commenters
discussed the above related liquidity fee alternatives (collectively,
the ``alternative liquidity fee approach''). For example, some
commenters recommended allowing the board to impose liquidity fees when
it determines that doing so is in the best interest of shareholders,
without reference to a specific weekly liquid asset threshold.\390\
Some commenters suggested a modified fee framework whereby money market
funds would be required to have policies and procedures that provide
the fund's board with direction on when to impose fees and how to
calculate them, in order to impose fees that reflect the cost of
liquidity.\391\ Two such commenters suggested that the Commission could
identify non-binding factors to consider (e.g., net redemptions;
portfolio specific characteristics like liquid assets, investor
concentration, and diversity of holdings; and market-based
metrics).\392\ Under these commenters' suggested approach, funds would
be required to disclose the possibility of liquidity fees to investors
but could avoid providing information that would allow investors to
preemptively redeem before fees apply.
---------------------------------------------------------------------------

    \390\ See, e.g., JP Morgan Comment Letter; Federated Hermes I
Comment Letter; Federated Hermes II Comment Letter; Wells Fargo
Comment Letter; ICI I Comment Letter; Western Asset Comment Letter.
    \391\ See, e.g., JP Morgan Comment Letter; ICI I Comment Letter;
Western Asset Comment Letter.
    \392\ See, e.g., JP Morgan Comment Letter; ICI I Comment Letter.
---------------------------------------------------------------------------

    Like the proposed swing pricing approach, the liquidity fee
alternative would require funds to recapture the liquidity costs of
redemptions to make non-redeeming investors whole. Thus, many of the
economic costs and benefits of the proposed swing pricing approach are
also expected with the liquidity fee alternative.
    Specifically, like the proposed swing pricing requirement, the
liquidity fee alternative may reduce dilution of non-redeeming
shareholders in the face of net redemptions. Liquidity fees may reduce
the first mover advantage, fund outflows during market stress, and
dilution. To the degree that liquidity fees may reduce dilution, they
may protect investors that remain in the fund, for instance, during
periods of high net redemptions.
    Similar to the proposal, the magnitude of liquidity fees applied by
affected funds may be quite small since money market funds hold
relatively high quality and liquid investments, which may reduce
liquidity costs when meeting redemptions. The fact that the alternative
may result in relatively small liquidity fees as well as the inability
of investors to observe at the time of placing their orders whether the
liquidity fee will be applied may interrupt self-fulfilling run
dynamics and reduce the likelihood of strategic behavior around
liquidity fees. The alternative would address the dilution that can
occur when a money market experiences net redemptions and would not
result in large liquidity fees unless there is significant net
redemption activity leading to large liquidity costs.
    Some of the direct and indirect costs of the liquidity fee
alternative may be similar to those of the proposed swing pricing
requirement. First, a liquidity fee framework in which funds are more
likely to apply liquidity fees relative to the baseline may reduce
investor demand for institutional prime and institutional tax-exempt
money market funds. Reduced investor demand may lead to a decrease in
assets under management of affected money market funds, thereby
potentially reducing the wholesale funding liquidity they provide to
other market participants. If some institutional money market fund
investors are concerned about preserving their invested capital and to
the degree that the liquidity fee alternative would require redeeming
investors to bear the liquidity risk of their redemptions (a risk they
do not currently internalize), the alternative may reduce investor
demand for institutional money market funds.
    Second, the liquidity fee alternative could impose costs on
investors redeeming shares in response to poor fund management or a
fund complex's emerging reputational risk. The alternative would assess
liquidity fees based on the liquidity costs of effecting redemptions
and regardless of the cause for the redemptions. Similar to the
proposed swing pricing approach, this could reduce the strength of
market discipline of poor fund management.

    Third, liquidity fees would require affected funds to pass along
liquidity costs of redemptions onto investors. This may decrease the
need of funds to provide and investor expectation of sponsor support to
cover liquidity costs of redemptions. As a result, like the proposed
swing pricing approach, the liquidity fee alternative could magnify the
incentives of affected funds to invest in more illiquid assets, may
reduce their incentives to manage downside liquidity risk, and may
reduce fund incentives to find the cheapest way to source liquidity to
meet redemptions. In addition, fund managers may be incentivized to
apply liquidity fees frequently and to use their discretion to apply
larger liquidity fees because they improve a fund's reported returns
and benefit the fund. These factors may be partly mitigated by
reputational incentives of fund managers, to the degree that the large
and frequent application of liquidity fees may discourage liquidity
seeking investors from allocating to such funds. Fourth, the
implementation of the alternative liquidity fee approach would pose
some operational challenges and impose related costs on money market
funds, third party intermediaries, as well as investors. Similar to the
proposed swing pricing approach, the calculation of liquidity fees
would require affected money market funds to estimate spread and other
costs on days with net redemptions, which may be particularly time
consuming and challenging during times of stress. As discussed above,
many assets that money market funds hold are not exchange traded and do
not have an active secondary market. As a result, estimating spread
costs and market impact factors of each component of a money market
fund portfolio may be time consuming and difficult, especially during a
liquidity freeze.
    The liquidity fee alternative also has several important
differences from the proposed swing pricing approach, and these
differences give rise to different economic benefits, costs, and
operational challenges. Specifically, the proposed swing pricing
approach would recapture dilution costs of redemptions by adjusting the
NAV of the fund as a whole depending on the volume of net redemptions,
spread and other costs, and estimates of market impacts. The liquidity
fee alternative would, instead, require funds to assess liquidity fees
on redeeming investors depending on the same or similar considerations.
    As a result, the alternative liquidity fee approach may have
several benefits relative to the proposed swing pricing approach.
First, liquidity fees could be more transparent than a swing factor
adjustment to the fund's NAV, as redeeming investors would more clearly
see application of a separate fee. However, while redeeming investors
would enjoy greater transparency regarding liquidity fees, other
investors would not observe when a liquidity fee is charged. Second,
similar to the proposed swing pricing approach, liquidity fees would
mitigate dilution. However, under the proposed swing pricing approach
redeemers compensate the fund for the dilution of redemptions as well
as the dilution from subscriptions. Thus, redeemers would subsidize
subscribers in the fund--an incentive effect that may be particularly
important when liquidity is scarce and a fund is facing a wave of
redemptions. By contrast, the alternative liquidity fee approach could
charge redeeming investors fees that compensate the fund for dilution
from redemptions only. While the liquidity fee alternative would not
create a positive incentive for subscriptions, it would avoid charging
subscribers for more than the liquidity cost of their redemptions.
Third, if liquidity fees are to be assessed after the NAV is struck, it
could reduce the operational challenges and time pressures of swing
pricing and allow affected money market funds to charge the ex post
trading costs to redeeming investors. The alternative liquidity fee
approach could avoid the potentially adverse impacts of swing pricing
on settlement cycles and may be less likely to affect the number of NAV
strikes some funds currently offer each day.
    Importantly, the alternative liquidity fee approach could give rise
to several sets of operational concerns and related costs. In contrast
with the proposed swing pricing approach, which is implemented through
affected funds adjusting the NAV, the alternative liquidity fee
approach would require intermediaries to assess fees to investors. As a
result, the alternative liquidity fee approach would require greater
involvement by intermediaries in applying the fees and submitting the
proceeds to the fund. While intermediaries to non-government money
market funds and other service providers should be equipped to impose
liquidity fees under the current rule, the alternative liquidity fee
approach would likely result in more frequent and varying application
of fees than the current rule contemplates. Requiring intermediaries to
apply a fee more frequently, with the potential to change in amount
from pricing period-to-pricing period, could introduce additional
operational complexity and cost. By consequence, intermediaries may
need to develop or modify policies, procedures, and systems designed to
apply fees to individual investors and submit liquidity fee proceeds to
the fund. In addition, liquidity fees may require more coordination
with a fund's service providers than swing pricing, since fees need to
be imposed on an investor-by-investor basis by each intermediary, which
may be particularly difficult with respect to omnibus accounts.
Moreover, funds may not have insight into whether an intermediary is
appropriately and fairly applying the liquidity fee to redeeming
investors and affected funds may need to develop or modify policies and
procedures reasonably designed to ensure intermediaries are
appropriately and fairly applying the fees. Finally, due to the costs
that the alternative may impose on intermediaries and distribution
networks of affected funds, the alternative liquidity fee approach may
require money market funds to alter their intermediary distribution
contracts, networks, and flow aggregation practices. We lack data to
quantify such burdens and costs and solicit comment and data that would
inform this analysis.
6. Expanding the Scope of the Floating NAV Requirements
    The proposal could have expanded the floating NAV requirements to a
broader scope of money market funds. For example, the proposal could
have imposed floating NAV requirements on all prime money market funds,
but not on tax-exempt funds.\393\ As another alternative, the proposal
could have imposed floating NAV requirements on all prime and tax-
exempt money market funds.\394\ Finally, the proposal could have
required that all money market funds float their NAVs.\395\
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    \393\ See, e.g., PIMCO Comment Letter; Vanguard Comment Letter.
    \394\ See, e.g., Schwab Comment Letter; Northern Trust Comment
Letter.
    \395\ See, e.g., Comment Letter of the CFA Institute (Apr. 14,
2021) (``CFA Comment Letter''); Comment Letter of Better Markets,
Inc. (Apr. 12, 2021) (``Better Markets Comment Letter''); Systemic
Risk Council Comment Letter; Comment Letter of Professor David
Zaring, The Wharton School (Apr. 2, 2021) (``Prof. Zaring Comment
Letter'').
---------------------------------------------------------------------------

    Expanding the scope of the floating NAV requirements beyond
institutional prime and institutional tax-exempt funds would involve
several main benefits. First, a floating NAV may increase transparency
about the risk of money market fund investments. Portfolios of money
market funds give rise to liquidity, interest rate, and credit risks--
risks that are relatively low under normal market conditions, but may
be

magnified during market stress. To the degree that investors in stable
NAV funds are currently treating them as if they were holding U.S.
dollars due to a lack of transparency about risks of such funds,
expanding the scope of the floating NAV requirements may enhance
investor protections and enable investors to make more informed
investment decisions. Some commenters stated that expanding a floating
NAV requirement could enhance transparency about the underlying
performance of credit-sensitive assets within prime money market
funds.\396\ Another commenter indicated that a floating NAV provides
investors with more accurate information about the fund's financial
condition, enhances transparency about the risks of the fund's
portfolio holdings, and is consistent with the valuation of investment
funds generally.\397\ Yet another commenter suggested that a floating
NAV can provide more flexibility and resilience than a stable NAV, but
tax-exempt money market funds could continue to support a stable NAV as
long as the Commission tightened portfolio restrictions on such
funds.\398\
---------------------------------------------------------------------------

    \396\ See, e.g., PIMCO Comment Letter.
    \397\ See, e.g., CFA Comment Letter.
    \398\ Id. (noting that tax-exempt money market funds invest in
entities that often have the taxing power to support their debt, may
not be able to discharge their debt obligations through bankruptcy,
and issue notes that offer contractual liquidity).
---------------------------------------------------------------------------

    Second, these alternatives could reduce run risk in affected stable
NAV funds. Specifically, floating the NAV may reduce the first mover
advantage in redemptions, partly mitigating investor incentives to run.
Some commenters supported the benefits of a floating NAV requirement in
discouraging herd redemption behavior across all prime money market
funds,\399\ and suggested that a floating NAV may reduce the advantages
of sophisticated investors that redeem quickly under stressed
conditions.\400\ We are also aware of research that examined fund
outflows outside the U.S. and found reduced outflows in floating NAV
funds.\401\
---------------------------------------------------------------------------

    \399\ See, e.g., PIMCO Comment Letter.
    \400\ See, e.g., Better Markets Comment Letter.
    \401\ See, e.g., Witmer, Jonathan. 2016. ``Does the Buck Stop
Here? A Comparison of Withdrawals from Money Market Mutual Funds
with Floating and Constant Share Prices.'' Journal of Banking and
Finance 66: 126-142.
---------------------------------------------------------------------------

    As a caveat, to the degree that heavy redemptions in floating NAV
funds reduce available liquidity and credit quality of remaining fund
holdings, investors may still be incentivized to redeem early, albeit
at a NAV below $1. In this sense, floating the NAV may reduce, but not
eliminate incentives for early redemptions during market selloffs that
are present in securities markets and open-end funds more generally.
Some commenters stated that floating the NAV of stable NAV funds would
do little to reduce redemption activity during periods of market
stress, particularly given that institutional prime funds experienced
heavy redemptions in March 2020 despite having a floating NAV.\402\
Another commenter opposed a floating NAV requirement, suggesting that
it likely would not address run risk but may give the appearance of
discouraging runs.\403\ Some academic research \404\ shows that
floating the NAV in the US has not eliminated run risk in the
redemption decisions of investors in institutional funds. However, that
research does not distinguish between causal impacts of a floating NAV
requirement and investor selection effects. Specifically, the paper
does not rule out the possibility that investors that need liquidity
the most invest in floating NAV and multi-strike funds and that such
investors are also most likely to redeem in times of liquidity stress.
Yet another paper models the problem theoretically and finds that a
stable NAV can reduce risk taking by money market funds in low interest
rate environments because it can create default risk and the need to
have a buffer of safe assets, reducing risky investment when risk-free
rates fall.\405\
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    \402\ SIFMA AMG Comment Letter; ICI Comment Letter I; Western
Asset Comment Letter; Fidelity Comment Letter; Federated Hermes
Comment Letter I; JP Morgan Comment Letter; BlackRock Comment
Letter; Americans for Financial Reform Comment Letter; Comment
Letter of Madison E. Grady (Apr. 14, 2021) (``Madison Grady Comment
Letter'').
    \403\ Comment Letter of Professor Jeffrey N. Gordon, Columbia
Law School (Feb. 26, 2021) (noting that money market funds should
not be treated similarly to other mutual funds because MMF investors
typically redeem en masse during periods of liquidity stress and
money market fund investments tend to be concentrated in the credit
issuances of financial firms).
    \404\ See, Casavecchia, Lorenzo, Georgina Ge, Wei Li, and Ashish
Tiwari. 2021. ``Prime Time for Prime Funds: Floating NAV, Intraday
Redemptions and Liquidity Risk During Crises.'' Working paper.
    \405\ See La Spada, Gabriele. 2018. ``Competition, Reach for
Yield, and Money Market Funds.'' Journal of Financial Economics
129(1): 87-110.
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    Third, floating the NAV of a broader range of money market funds
could more accurately capture their role in asset transformation and
corresponding risks. As quantified in Section III.B.3.a, retail prime
and retail tax exempt funds have some risky portfolio holdings.
Specifically, some of the underlying holdings of retail money market
funds are similar to those of institutional prime funds, which
experienced significant stress in 2020. One commenter \406\ supported
floating the NAV for government money market funds, citing redemption
pressure and run risks associated with U.S. debt ceiling negotiations
and potential credit rating downgrades of U.S. Government securities
and suggesting that all money market fund investors should be aware
that all such funds can, and do, fluctuate in value. Expanding the
floating NAV requirements to all money market funds would result in a
consistent regulatory treatment of money market funds. Moreover, it may
enhance the allocative efficiency in the money market fund industry and
may enhance competition between floating NAV and stable NAV funds. For
example, some commenters indicated that the disparate treatment of
floating NAV and stable NAV funds led to a significant migration of
institutional investments from prime and tax-exempt money market funds
to government money market funds.\407\ An alternative that would expand
the scope of the floating NAV requirement to all money market funds may
lead to outflows from government money market funds back into prime and
tax-exempt sectors.
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    \406\ See, e.g., Better Markets Comment Letter.
    \407\ See, e.g., CFA Comment Letter.
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    Floating NAV alternatives would give rise to three groups of costs.
First, such alternatives may reduce the attractiveness of affected
money market funds to investors and may result in significant
reductions in the size of the money market fund sector.\408\ The
Commission understands that retail investors use money market funds as
a safe, cash-like product. To that extent, floating the NAV of some or
all stable NAV funds may lead investors of stable NAV funds to
reallocate capital into cash accounts subject to deposit
insurance.\409\ In a somewhat parallel setting, in the aftermath of the
2016 implementation of the floating NAV requirement for institutional
prime and institutional tax-exempt funds, approximately $1 trillion
left newly floating NAV funds and flowed into government money market
funds, matched by corresponding outflows from floating NAV products.
About 90% of these outflows came from the larger institutional prime
funds, while the remaining 10% came from the smaller institutional tax-
exempt funds. Thus, many investors may flee to safety in times of
stress and may be unlikely to

remain invested in money market funds affected by the floating NAV
alternative. Some commenters stated that a floating NAV requirement
would, indeed, diminish the appeal of money market funds relative to
other cash management vehicles.\410\ Importantly, such reallocation
effects are not necessarily suboptimal per se, if it is a result of
greater investor awareness of the risks of money market fund
investments.
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    \408\ See, e.g., SIFMA AMG Comment Letter; Western Asset Comment
Letter; Federated Hermes Comment Letter I (noting that some
investors may choose to move assets to banks or to less regulated
and less transparent products such as private funds).
    \409\ See, e.g., Schwab Comment Letter.
    \410\ See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter I;
Federated Hermes Comment Letter I; JP Morgan Comment Letter; Comment
Letter of the National Association of State Treasurers and
Government Finance Officers Association (Apr. 12, 2021) (``NAST and
GFOA Comment Letter''); Comment Letter of the State Financial
Officers Foundation and Ron Crane (Apr. 26, 2021) (``SFOF and Crane
Comment Letter''); Madison Grady Comment Letter.
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    Second, if the floating NAV alternatives resulted in a decrease in
the size of the money market fund industry, they would adversely impact
the availability of wholesale funding liquidity and access to capital
for issuers. Prior research suggests that increasingly constrained
balance sheets of regulated financial institutions after the financial
crisis reduced both their involvement in arbitrage activities and their
willingness to provide leverage to other arbitrageurs, leading to
growing mispricings across markets.\411\ Given this baseline, a
reduction of wholesale funding liquidity available to arbitrageurs may
magnify mispricings across securities markets. However, under the
alternative, wholesale funding costs would more accurately reflect true
costs of funding liquidity, since the alternative would reduce the
distortions arising out of implicit government guarantees of money
market funds. Similarly, a reduction in the size of affected money
market funds or the money market fund industry as a whole would
increase the costs of or decrease access to capital for issuers in
short-term funding markets.\412\ However, the current reliance of some
issuers on short-term financing from money market funds that is
susceptible to refinancing and run risks may be sustainable, in part,
due to perceived government backstops of money market funds and lack of
transparency to investors about the risks inherent in money market fund
investments. While the alternative would impose potentially significant
costs on issuers, it would do so by reducing cross-subsidization of
money market funds and increasing transparency about risks of money
market fund investments.
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    \411\ See, e.g., Boyarchenko, Nina, Thomas Eisenbach, Pooja
Gupta, Or Shachar, and Peter Van Tassel. 2020. ``Bank-Intermediated
Arbitrage.'' Federal Reserve Bank of New York Staff Report No. 854.
    \412\ SIFMA AMG Comment Letter; ICI I; Federated Hermes Comment
Letter I; JP Morgan Comment Letter; NAST and GFOA Comment Letter
(describing increased borrowing costs for municipalities upon the
implementation of floating NAVs for institutional funds); SFOF and
Crane Comment Letter; Madison Grady Comment Letter.
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    Third, the floating NAV alternative would involve significant
operational, accounting, and tax challenges. Specifically, the
Commission is concerned that switching retail funds from stable NAV to
floating NAV may create accounting and tax complexities for some retail
investors.\413\ A floating NAV requirement may be incompatible with
popular cash management tools such as check-writing and wire transfers
that are currently offered for many stable NAV money market fund
accounts.\414\ In addition, a floating NAV alternative would involve
many of the same implementation burdens on broker-dealers, retirement
plan administrators, and other intermediaries \415\ as the proposed
amendment requiring that stable NAV funds determine that their
intermediaries are capable of transacting at non-stable prices.
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    \413\ See, e.g., ICI Comment Letter I; Federated Hermes Comment
Letter I; Madison Grady Comment Letter; Comment Letter of Carter
Ledyard Milburn (Apr. 15, 2021).
    \414\ See, e.g., ICI Comment Letter I; Madison Grady Comment
Letter.
    \415\ See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter I;
Federated Hermes Comment Letter I; Western Asset Comment Letter; JP
Morgan Comment Letter; Dreyfus Comment Letter; BlackRock Comment
Letter.
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    Importantly, the floating NAV alternative would not address three
key market failures in money market funds. First, floating the NAV may
reduce, but does not eliminate, the first mover advantage and
corresponding run incentives during selloffs. As discussed above,
floating NAV funds experienced a significant amount of redemptions in
2020. During past episodes of stress in money market funds (in 2008 and
2020), retail investor redemptions were far more limited than
redemptions out of institutional prime money market funds. Moreover, as
referenced above, in 2020 capital flowed into government money market
funds as investors fled to safety. Future redemption dynamics in stable
NAV funds may evolve as a function of investor type, risk tolerance,
investment horizons, liquidity needs, and sophistication, among others.
However, modest historical redemptions out of stable NAV funds may
suggest that they are currently less susceptible to run risk, reducing
the value of floating NAV alternatives for such funds.
    Second, floating NAV alternatives would not alter economic
incentives of stable NAV fund managers to reduce risk taking. For
example, floating the NAV would not incentivize stable NAV fund
managers to hold enough liquid assets and to have low enough credit
risk to meet redemptions in times of stress; nor would it constrain
portfolio composition. Insofar as investor flows remain sensitive to
fund performance, and fund managers are compensated for performance,
money market funds may have incentives to take greater risks to deliver
higher returns. The proposed liquidity requirement amendments, while
not altering incentives of fund managers, may meaningfully constrain
money market fund portfolio composition and risk taking.
    Third, floating NAV alternatives may not influence the liquidity
risk of affected money market funds as directly as the proposal. At
their core, money market funds transform capital subject to daily
redemptions into short-term debt instruments that carry liquidity and
credit risk. Some research suggests that floating the NAV would not
reduce, and may even increase risk taking incentives.\416\ However, as
can be seen from Section III.B.3.b, the distribution of market NAV
fluctuations among prime money market funds decreased around the
compliance date with the 2014 amendments. In contrast, the proposed
increases to daily and weekly liquidity requirements may directly
reduce the amount of liquidity risk in money market fund portfolios.
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    \416\ See, e.g., La Spada, Gabriele. 2018. ``Competition, Reach
for Yield, and Money Market Funds.'' Journal of Financial Economics
129(1): 87-110.
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7. Countercyclical Weekly Liquid Asset Requirement
    The PWG Report raised an alternative countercyclical weekly liquid
asset requirement approach. For instance, during periods of market
stress, the minimum weekly liquid asset threshold could decrease, for
example, by 50%. The proposal could have specified the definitions of
market stress that would trigger a change in weekly liquid asset