Testimony of Paul Schott Stevens, President and CEO of the
Investment Company Institute, before the Committee on Banking,
Housing, and Urban Affairs, United States Senate, on ``Perspectives
on Money Market Mutual Fund Reforms,'' June 21, 2012, available at
http://www.ici.org/pdf/12_senate_pss_mmf_written.pdf.
    \1907\ For a discussion of the regulation of STIFs by the Office
of the Comptroller of the Currency (OCC), see Proposing Release,
supra note 25, Table 2, explanatory n.M. The OCC's rule 9.18 governs
STIFs managed by national banks and federal savings associations.
Other types of banks may or may not follow the requirements of OCC
rule 9.18, depending, for example, on state law requirements and
federal tax laws. See Office of the Comptroller of Currency,
Treasury, Short-Term Investment Funds, at n.6 and accompanying text
[77 FR 61229 (Oct. 9, 2012)].
    \1908\ For a discussion of the regulation of European money
market funds, see Proposing Release, supra note 25, Table 2,
explanatory nn.E and H; Common Definition of European Money Market
Funds (Ref. CESR/10-049). See also supra section II.B.3.
    \1909\ See Proposing Release, supra note 25, Table 2,
explanatory n.I.
    \1910\ See Proposing Release, supra note 25, Table 2,
explanatory n.G.
---------------------------------------------------------------------------

    In the Proposing Release and sections III.A and III.B of this
Release, we recognize, and commenters concurred,\1911\ that some
current money market fund investors may have self-imposed restrictions
or fiduciary duties that limit the risks they can assume or that
preclude them from investing in certain alternatives. They may be
prohibited from investing in, for example, enhanced cash funds that are
privately offered to institutions, wealthy clients, and certain types
of trusts due to greater investment risk, limitations on investor base,
or the lack of disclosure and legal protections of the type afforded
them by U.S. securities regulations.\1912\ Likewise, we recognized in
the Proposing Release that money market fund investors that can only
invest in SEC-registered investment vehicles could not invest in LGIPs,
which are not registered with the SEC (as states and local state
agencies are excluded from regulation under the Investment Company
Act). In addition, many unregistered and offshore alternatives to money
market funds--unlike registered money market funds in the United States
today--are not prohibited from imposing gates or redemption fees or
suspending redemptions.\1913\ Other investment alternatives, such as
bank CDs, also impose redemption restrictions.
---------------------------------------------------------------------------

    \1911\ See, e.g., Form Letter Type B [2], Type D [1-2], and Type
F [1]; Federated IV Comment Letter; J.P. Morgan Comment Letter;
Treasury Strategies Comment Letter; American Benefits Council
Comment Letter; Ass'n Fin. Profs. II Comment Letter; Nat'l Ass'n of
College & Univ. Bus. Officers Comment Letter.
    \1912\ According to the 2012 AFP Liquidity Survey, supra note
64, only 21% of respondents stated that enhanced cash funds were
permissible investment vehicles under the organization's short-term
investment policy. In contrast, 44% stated that prime money market
funds were a permissible investment and 56% stated that Treasury
money market funds were a permissible investment.
    \1913\ See, e.g., Proposing Release, supra note 25, Table 2,
explanatory n.F.
---------------------------------------------------------------------------

    The Commission recognizes that not every cash investment
alternative presented here will be available and attractive to each
investor, which may leave investors with fewer investment options than
those enumerated above. Investors, however, have available a range of
investment options, with each choice offering different tradeoffs.
Money market fund investors that are unwilling or unable to invest in
their current option after the reforms will need to analyze the various
tradeoffs associated with each alternative. We anticipate the money
market fund industry may also innovate in various ways to meet
investors' needs. For example, some managers may try to stabilize their
funds' NAVs by choosing low principal-risk portfolio investment
strategies, whereas other funds may seek to offer higher yields within
the restrictions of rule 2a-7.
    We also recognize the reforms adopted today may cause investors to
reallocate assets to investment alternatives that offer different
combinations of yield, risk, and features than those of the funds in
which they are invested today. The fact that investors have bought non-
government funds rather than these other investment alternatives
reveals that they almost certainly prefer these funds to the
alternatives. We, and a number of commenters,\1914\ acknowledge that it
is doubtful that any of the non-money market fund investment
alternatives provide the identical combination of price stability,
transparency, risk, liquidity, yield, and level of regulation provided
by past money market funds. However, with today's adopted amendments,
the Commission addresses certain concerns inherent in the current
structure of non-government money market funds that create incentives
for shareholders to redeem shares ahead of other investors and thus
contribute to the likelihood of heavy share redemptions and shareholder
dilution. Specifically and as pointed out in the DERA study, although
the 2010 reforms made the funds more resilient to both portfolio losses
and investor redemptions, no fund would have been able to withstand the
losses that the Reserve Primary Fund incurred in 2008 without breaking
the buck, and nothing in the 2010 reforms would have prevented the
Reserve Primary Fund's holding of Lehman Brothers debt. We therefore
believe that the relative costs to investors from losing certain
features of some of today's money market funds should be acceptable in
light of the significant benefits stemming from advancing our goals of
reducing money market funds' susceptibility to heavy redemptions,
improving their ability to manage and mitigate potential contagion from
redemptions, and increasing the transparency of their risks.
---------------------------------------------------------------------------

    \1914\ Form Letter Type A [1], Type B [2], Type C [1], Type D
[1], and Type F [1]; Federated II Comment Letter; PFM Asset Mgmt.
Comment Letter; Comment Letter of Square 1 Asset Management (Sept.
17, 2013) (``Square 1 Comment Letter''); Comment Letter of Farmers
Trust Company (July 23, 2013) (Farmers Trust Comment Letter'');
Comment Letter of City of Chicago, Office of the City Treasurer
(Sept. 24, 2013) (``Chicago Treasurer Comment Letter''); Comment
Letter of United States Conference of Mayors (July 18, 2013) (``U.S.
Conference of Mayors Comment Letter'').
---------------------------------------------------------------------------

2. Efficiency, Competition and Capital Formation Effects on the Money
Market Fund Industry
    In this section, we consider certain effects on the money market
fund industry of investors reallocating money away from certain money
market funds as a result of our reforms. As discussed in section III.A,
our primary reforms will not apply to government money market
funds.\1915\ As such, we anticipate current investors in government
funds will likely remain invested in these funds, as they will offer
the price stability, liquidity, and yield to which these investors are
accustomed.\1916\ As discussed further in section III.K.3 below, in
fact we expect some non-government money market fund shareholders will
likely reallocate their investments to government money market funds.
Accordingly, to the extent investors reallocate funds between these two
alternatives, we expect that our primary reforms will affect the short-
term funding market and capital allocation at least in the short-run as
discussed further below. We also expect to have an increase in
allocative efficiency because investors will be making choices best
suited to their investment risk profiles. Furthermore, to the extent
that new government funds will be offered because of an increased
demand for government funds,

competition among government funds will also increase.
---------------------------------------------------------------------------

    \1915\ Government money market funds are permitted to opt in to
the fees and gates reforms if they disclose they are doing so in
advance. Because government funds hold assets with little credit
risk, we believe it is unlikely that these funds will ever choose to
impose fees or gates.
    \1916\ If government funds experience heavy inflows, the yields
on eligible government securities, in which government funds largely
invest, might fall. If the yields on portfolio assets fall, the
yields on the fund will decline as well. We discuss this possibility
and its impact in greater detail below.
---------------------------------------------------------------------------

    Like government funds, money market funds that qualify as retail
funds will also be able to continue transacting at a stable value and
will not be subject to the floating NAV reform. Retail funds will be
required to consider imposing a fee or gate if their liquidity comes
under stress. As such, retail funds will be competing with government
and floating NAV funds based on their structure. Although some
investors may reallocate their investments away from retail money
market funds because they could impose a fee or gate, we expect many
investors will remain in these funds because their investment
experience under normal market conditions is unlikely to change. Some
investors may move into retail money market funds in response to our
reforms, as there are likely some natural persons currently invested in
funds that are categorized as institutional prime or institutional tax-
exempt money market funds that would prefer to stay in a money market
fund that maintains a stable NAV per share and that has a similar
investment risk profile as their current fund. Funds with both retail
and institutional investors also may create new retail-only non-
government funds with the same investment objective. Although we do not
have a basis for estimating the amount of assets that might be
reallocated to retail non-government funds because we do not know what
fraction of the shareholder base of these funds today categorized as
institutional would qualify as natural persons, we anticipate the
number of retail funds and competition among these funds to increase as
they compete to attract new investors and thus increase their
allocative efficiency. The impact on competition likely should, at the
margin, be larger if the increase in the number retail funds stems from
new complexes offering additional retail funds as opposed to current
complexes offering additional retail funds.
    Today's fees and gates amendments are designed to moderate
redemption requests by allocating liquidity costs to those shareholders
who impose such costs on funds through their redemptions and, in
certain cases, stop heavy redemptions in times of market stress by
providing fund boards with additional tools to manage heavy redemptions
and improve risk transparency. As such, the fees and gates amendments
should increase allocational efficiency in the non-government money
market fund industry by making liquidity risk more apparent to
shareholders in these funds through enhanced disclosure and by
allocating the costs of redeeming shares when liquidity is costly to
shareholders that redeem shares.\1917\ If investors make better
informed investment decisions given the liquidity risk inherent in
these money market funds as a result of the fees and gates amendments,
allocational efficiency will be enhanced.
---------------------------------------------------------------------------

    \1917\ Allocational efficiency refers to investors efficiently
allocating their funds to available investments, taking all relevant
factors into account.
---------------------------------------------------------------------------

    In addition to the impacts discussed above, the combination of our
floating NAV and fees and gates reforms may have a number of effects on
efficiency, competition, and capital formation in the institutional
prime money market fund industry. First, by allocating market-based
gains and losses on portfolio securities in institutional prime funds
to each shareholder on a proportionate basis, the floating NAV should
increase allocational efficiency in this industry, as investors are
allocating their investment capital based on true returns.\1918\ Doing
so will further increase the allocative efficiency discussed above in
institutional prime money market funds attributable to the fees and
gates reform and its effect on shareholders' understanding of money
market funds' liquidity risk.
---------------------------------------------------------------------------

    \1918\ Some commenters noted the potential for inequitable
treatment of shareholders under the stable NAV model. See, e.g.,
Better Markets FSOC Comment Letter (stating that ``an investor that
succeeds in redeeming early in a downward spiral may receive more
than they deserve in the sense that they liquidate at $1.00 per
share even though the underlying assets are actually worth less.
Without a sponsor contribution or other rescue, that differential in
share value is paid by the shareholders remaining in the fund, who
receive less not only due to declining asset values but also because
early redeemers received more than their fair share of asset
value.''); Comment Letter of Wisconsin Bankers Association (Feb. 15,
2013) (available in File No. FSOC-2012-0003) (stating that ``[a]
floating NAV has the benefits of . . . reducing the possibilities
for transaction activity that results in non-equitable treatment
across all shareholders''). See also supra section II.B.1.
---------------------------------------------------------------------------

    Our primary reforms also may affect how different kinds of money
market funds compete in the industry, and thus affect efficiency,
competition, and capital formation in the industry. For example, we
anticipate that some institutional investors will continue to demand a
combination of relative price stability, liquidity, and yields that are
higher than the yields offered by government funds. Managers of
floating NAV money market funds may respond to these investors in one
of several ways. Some managers may respond by altering their portfolio
management and preferentially investing portfolio holdings in shorter-
maturity, lower-risk securities than they do today. They would do so to
reduce NAV fluctuations and lessen the probability the fund's weekly
liquid assets decline sufficiently for a fee or gate to be possible.
These portfolio management changes may affect competition within the
institutional prime money market fund industry (or broader money market
fund industry) if these funds more favorably compete with other less
conservatively managed funds. They also could affect capital formation
to the extent they shift portfolio investment away from certain issuers
or certain maturities or lessen the yields passed through to investors
from their money market fund investments. In addition, an increase in
these types of funds could encourage issuers to fund themselves with
shorter term debt.
    Other portfolio managers of institutional prime funds could respond
by using affiliate financial support to minimize principal volatility
or avoid declines in weekly liquid assets that could lead to the
imposition of a fee or gate.\1919\ The emergence of these types of
money market funds also could have competitive effects within the
institutional prime money market fund industry (or broader money market
fund industry), depending on how favorably they compete with money
market funds that are managed differently. These funds could reduce
allocational efficiency to the extent shareholders invest in money
market funds based on the assumption that principal volatility and
liquidity risk will be borne by the fund's sponsor or other affiliate
rather than on the risk-return profile of the fund's portfolio
(although this impact could be tempered to the extent any of these
costs are passed on to investors through higher management fees). They
also could affect capital formation if affiliate sponsor support leads
to higher investment in riskier or longer-term debt securities than
otherwise would occur if investors had to bear the principal volatility
or liquidity risk accompanying those money market fund investments.
---------------------------------------------------------------------------

    \1919\ Fund affiliates could avoid declines in weekly liquid
assets, for example by purchasing non-weekly liquid assets or
directly purchasing fund shares. Under the reforms we are adopting
today, we are requiring increased disclosure of any affiliate
financial support of money market funds. These reforms, and their
effects on efficiency, competition, and capital formation, are
discussed above in sections III.E and III.F.
---------------------------------------------------------------------------

    Finally, some portfolio managers of institutional prime money
market funds may seek to competitively distinguish their funds post-
reform by altering their portfolio management and investing in
relatively longer-term or riskier securities than they do today. These
funds may seek to appeal to investors that, if investing in a floating
NAV

money market fund that could be subject to fees or gates, now may be
willing to sacrifice liquidity in times of stress or some principal
stability for greater yield. The emergence of these types of money
market funds may enhance competition in the money market fund industry
among different types of institutional prime money market funds along
the risk-return spectrum. It also would affect changes in capital
formation post-reform to the extent that it shifts investment to
issuers of longer-term or riskier securities or increases yields paid
to investors (or increases management fees paid to certain types of
fund complexes). Thus, depending on the magnitude of the primary
reforms' effect on the assets managed by different types of money
market funds, the type and number of institutional prime funds may
contract overall, potentially limiting investors' choices among them,
or may expand, potentially enhancing investors' choices among them.
Accordingly, competition among institutional prime funds may increase
or decrease with an impact that will likely be stronger if the number
of complexes offering institutional prime funds changes.
    Finally, as discussed above, we recognize investors in
institutional prime funds may reallocate assets to investment
alternatives. In addition to the potential effects on investors
described above and the short-term funding markets described below, a
reallocation of assets out of these funds may affect the profitability
of the money market fund industry, and thus have incremental effects on
efficiency, competition, and capital formation. For example, fund
complexes that, on net, experience a decline in managed money market
fund assets as a result of our primary reforms, will likely earn lower
fund advisers' management and other fees than they do today.\1920\ It
is important to note, however, that fees for managing these assets will
still be earned, but by the asset managers to which assets are
reallocated. To the extent investors shift assets within a fund complex
(e.g., to a government fund), at least some of the fees may be retained
by the fund complex. If, however, investors instead reallocate assets
to non-money market fund alternatives, the managers of these other
options will benefit. This shift may have competitive implications
within the money market fund industry as not all fund complexes are
likely to be equally affected by a movement in money market fund assets
as a result of the primary reforms. For example, fund complexes that
primarily advise government money market funds may benefit
competitively as these funds are generally not affected by our primary
reforms and may experience inflows, which would raise these fund
advisers' management fee income. Similarly, fund complexes that manage
mostly retail money market funds may be competitively advantaged post-
reform over those that primarily manage institutional prime funds.
These latter funds will be subject to both our floating NAV and fees
and gates reforms and thus may experience a greater decline in assets
than retail money market funds as a result of our primary reforms. We
thus anticipate our primary reforms may significantly alter the
competitive makeup of the money market fund industry, producing related
effects on efficiency and capital formation. We believe, however, that
these changes are necessary to accomplish our policy goals.
---------------------------------------------------------------------------

    \1920\ See Federated X Comment Letter.
---------------------------------------------------------------------------

3. Effect of Reforms on Investment Alternatives, and the Short-Term
Financing Markets
    In this section, we consider the effects of the reforms on
investment alternatives, issuers, and the short-term financing markets.
We have presented extensive economic analysis relating to our final
policy choices and discussed commenters' views in earlier sections of
the Release. As such, we focus here on the specific macroeconomic
effects of the reforms on investment alternatives, as well as the
short-term financing markets and the impact of the reforms on
efficiency, competition, and capital formation on issuers in the short-
term financing market and the short-term financing market.
    We recognized in the Proposing Release that the amendments we are
adopting today could create incentives for investors to shift assets
out of non-government money market funds, which could lead to changes
in the funding of and other effects on the short-term financing
markets. Many commenters agreed with our views.\1921\ Some commenters,
for example, cautioned that a decrease in investor demand for money
market funds could limit the availability and raise the cost of short-
term funding for businesses, as well as federal, state, and local
governments, and that it is currently unclear whether these entities
would be able to find and use alternative efficient sources of
credit.\1922\ Since government funds are not subject to the fees and
gates and floating NAV requirements, we disagree that today's adopted
amendments have a negative impact on the availability and cost of
short-term funding for the federal government. As discussed in the
Proposing Release and herein, we believe the effects of a shift,
including any effects on efficiency, competition, and capital
formation, will depend on the amount of capital reallocated to specific
investment alternatives and the nature of the alternatives. More
specifically, the extent to which money market fund investors choose to
reallocate their assets to investment alternatives, including other
money market fund types, as a result of these reforms will drive the
effect on the short-term financing markets. We discuss the potential
impact of these shifts in investment below.
---------------------------------------------------------------------------

    \1921\ See, e.g., MFDF Comment Letter; Ariz. Ass'n of County
Treasurers Comment Letter; Utah Treasurer Comment Letter; Northern
Trust Comment Letter; Fidelity Comment Letter.
    \1922\ Form Letter Type E [1] and Type F [1]; Fidelity Comment
Letter; Invesco Comment Letter; iMoneyNet Comment Letter; KeyBank
Comment Letter; Ass'n Fin. Profs. II Comment Letter; Fin. Svcs.
Inst. Comment Letter.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, because non-government money
market funds' investment strategies differ from a number of the
investment alternatives enumerated, a shift by investors from non-
government money market funds to these alternatives could affect the
markets for short-term securities. Commenters warned that movement of
invested assets from prime money market funds to, for example,
government money market funds could skew short-term funding away from
private markets to the public sector.\1923\ The magnitude of the effect
will depend on not only the size of the shift but also the extent to
which there are portfolio investment differences between non-government
money market funds and the chosen investment alternatives. As discussed
in the DERA Study, for example, even a modest shift from prime funds to
other types of money market funds could represent a sizeable increase
in certain investments.\1924\ If instead investors in institutional
prime funds choose to manage their cash directly rather than invest in
alternative cash management products, they may invest in securities
that are similar to those currently held by prime funds, in which the
effects on issuers and the short-term financing markets will likely be
minimal.\1925\
---------------------------------------------------------------------------

    \1923\ Blackrock II Comment Letter; Invesco Comment Letter;
Wells Fargo Comment Letter; U.S. Bancorp Comment Letter; ICI Comment
Letter.
    \1924\ See DERA Study, supra 24, Table 7.
    \1925\ The preference for this alternative, however, may be
tempered by the cost to investors of managing cash on their own.
See, e.g., supra note 580 and accompanying text.

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

    We believe, and a number of commenters agreed,\1926\ that some
capital will be reallocated from non-government funds, especially
institutional prime funds, to government money market funds. If the
magnitude of the flows is large, we anticipate the shift in investment
could affect not only the government securities market, but also
issuers, including companies and municipalities, that previously sold
securities to non-government funds. It is important to note that
although investors may reallocate assets to government funds, it is
also possible and even likely that some will reallocate assets to bank
demand deposits and other investment vehicles, which would mitigate the
negative impact of the reforms on the short-term funding market in
general and bank issuers of short-term papers in particular.\1927\
---------------------------------------------------------------------------

    \1926\ See, e.g., Federated IV Comment Letter; TRACS Financial
Comment Letter; Wells Fargo Comment Letter; Boeing Comment Letter;
American Bankers Ass'n Comment Letter; Def. Contrib. Inst. Inv.
Ass'n Comment Letter. See also Dreyfus DERA Comment Letter,
Federated DERA I Comment Letter, Fidelity DERA Comment Letter,
Invesco DERA Comment Letter, and Wells Fargo DERA Comment Letter.
    \1927\ See supra section III.K.1 of this Release.
---------------------------------------------------------------------------

    Commenters cautioned that there is limited market capacity if
investors reallocate their assets from non-government money market
funds into government money market funds.\1928\ Commenters noted a
specific concern that reallocating assets from non-government funds to
government funds would increase the demand for eligible government
securities,\1929\ which could reduce these securities' yields in what
is already a low-yield environment. Low yields on eligible government
securities would not only affect investors in government funds, but
also those investors who directly purchase government securities.\1930\
Commenters noted heavy flows to government funds during the financial
crisis caused several government funds to close to new investors to
prevent additional net inflows,\1931\ while yields fell close to
zero.\1932\ These problems arose even with large issuances of
government securities during the financial crisis.\1933\ One commenter
specifically stated that negative yields would be problematic for the
competitiveness of government funds and investors, as well as for
parties holding government securities for regulatory capital and
collateral purposes.\1934\
---------------------------------------------------------------------------

    \1928\ See, e.g., Blackrock II Comment Letter; Dreyfus Comment
Letter; Federated II Comment Letter; Invesco Comment Letter;
Northern Trust Comment Letter; Schwab Comment Letter.
    \1929\ See supra section III.C.1.
    \1930\ See, e.g., Federated X Comment Letter; Dreyfus DERA
Comment Letter; Federated DERA I Comment Letter; Invesco DERA
Comment Letter; Wells Fargo DERA Comment Letter.
    \1931\ See Dreyfus DERA Comment Letter; Invesco DERA Comment
Letter. The commenters did not address where the potential new
investors ultimately invested their assets.
    \1932\ See Dreyfus DERA Comment Letter; Federated DERA I Comment
Letter.
    \1933\ See BlackRock DERA Comment Letter; Invesco DERA Comment
Letter; ICI DERA Comment Letter.
    \1934\ See Federated DERA I Comment Letter.
---------------------------------------------------------------------------

    Evidence from the financial crisis also indicates, however, that
government funds absorbed large inflows of assets. Specifically,
approximately $498 billion or 24% of assets flowed out of prime funds,
whereas $409 billion or 44% of assets flowed into government funds
between September 2, 2008 and October 7, 2008,\1935\ and even with
these unprecedented reallocations of assets, Treasury-bill rates
approached or fell below zero for only a relatively short period during
the crisis.\1936\ One commenter also noted the supply of Treasury bills
has declined by more than $250 billion on three separate occasions
between January 31, 2009 and March 31, 2014 without apparent market
dislocation.\1937\ We recognize that any reallocation of assets from
non-government money market funds into government money market funds
may affect yields in the short-run. However, we believe that the two-
year period for funds to implement the fees and gates and floating NAV
reforms that we are adopting may help facilitate the market adjustment
process. For example, fund complexes with non-government funds that
have both institutional and retail investors as well as other fund
complexes will have time to originate retail funds not subject to the
floating NAV requirement to meet the needs of retail clients.
Similarly, retail investors in non-government funds that will be
subject to the floating NAV after the implementation period will have
time to reallocate assets to a retail fund. More generally, investors
will have time to identify investment alternatives and consider trade-
offs for alternatives other than government funds.
---------------------------------------------------------------------------

    \1935\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf. These investors would not be government money
market funds [5].
    \1936\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf. These investors would not be government money
market funds [6-7].
    \1937\ See Fidelity DERA Comment Letter.
---------------------------------------------------------------------------

    Commenters, using data from July 2013 through March 2014, estimated
there are between $5.2-$6.8 trillion in eligible government
securities.\1938\ However, as noted by several commenters, it is
difficult to estimate the amount of assets that institutional investors
might reallocate from non-government funds to government funds.\1939\
Several commenters cautioned this supply of eligible government
securities would likely be insufficient if today's reforms were
adopted.\1940\ One commenter, however, argued that the supply would be
adequate.\1941\ This commenter estimated 64% or $806 billion could
shift from prime funds to government funds,\1942\ whereas a second
commenter estimated 25% of assets in its institutional prime funds
would transfer permanently into government funds.\1943\ A third
commenter estimated between $500 billion to $1 trillion.\1944\ The
first commenter noted, however, that prime funds invested 19.5% of
their assets on average in eligible government securities as of
February 28, 2014, explaining that prime funds hold eligible government
securities to meet the Daily Liquid Asset and Weekly Liquid Asset
requirements of Rule 2a-7.\1945\ As such, they would likely divest some
of these assets to meet investor redemption requests, thereby freeing
up eligible government securities for government fund purchase.
Applying this 19.5% estimate to prime funds at large and assuming
investors reallocated 64% of prime fund assets to government
funds,\1946\ the commenter then estimated the demand for eligible
government securities would increase

``approximately $806 billion, which is only about 8% of current total
available eligible government securities.'' \1947\ The commenter
concluded, ``the supply of eligible government securities is more than
adequate to meet anticipated demand.'' \1948\ We agree with this
commenter. Applying the 19.5% estimate to institutional prime funds at
large and assuming investors reallocated 25% of prime fund assets to
government funds,\1949\ the demand for eligible government securities
would increase about $239 billion, which is only about 4% of current
total available eligible government securities.\1950\ Therefore, we do
not anticipate the reallocation of fund assets will be large relative
to the market for eligible government securities.
---------------------------------------------------------------------------

    \1938\ See Federated DERA I Comment Letter; Fidelity DERA
Comment Letter; ICI DERA Comment Letter; Wells Fargo DERA Comment
Letter. One commenter (see the Invesco DERA Comment Letter)
estimated eligible government assets were $2 trillion, which is
substantially lower than the other commenters' estimates. It appears
the estimate does not include repurchase agreements collateralized
by U.S. Treasuries or other government securities and may have other
assumptions, so we focus here on the estimates provided in the other
four letters.
    \1939\ See Federated DERA I Comment Letter and Invesco DERA
Comment Letter. See also supra sections III.A-B.
    \1940\ See BlackRock DERA Comment Letter; Dreyfus DERA Comment
Letter; Federated DERA I Comment Letter; Invesco DERA Comment
Letter.
    \1941\ See Fidelity DERA Comment Letter.
    \1942\ Id.
    \1943\ See Dreyfus DERA Comment Letter.
    \1944\ See Federated DERA I Comment Letter. The commenter did
not provide a basis for the estimate in this letter. We note,
however, the commenter presented similar estimates using survey data
in a previous letter. See Federated X Comment Letter. We address
limitations of inferences from the survey in section III.B.
    \1945\ See Fidelity DERA Comment Letter. The Federated DERA I
Comment Letter estimated prime funds invested 27% of assets in
eligible government securities. More specifically, the letter stated
prime money market funds held $95 billion in Treasury securities,
$130 billion in agency securities, and $169 in fully collateralized
repurchase agreements. It cited year-end assets in prime money
market funds of $1.486 trillion.
    \1946\ See Fidelity DERA Comment Letter.
    \1947\ Id.
    \1948\ Id.
    \1949\ See Dreyfus DERA Comment Letter.
    \1950\ See Dreyfus DERA Comment Letter. This estimate assumes
institutions invest about $1.187 trillion in prime funds. To
estimate assets managed by institutional prime funds, we used self-
reported fund data from iMoneyNet as of February 28, 2014 to
estimate the percentage of assets managed by institutional prime
funds. We then multiplied the percentage times the assets managed by
prime funds, as provided by Form N-MFP as of February 28, 2014.
Commenters, using data from July 2013 through March 2014, estimated
there are between $5.2-$6.8 trillion Eligible Government Securities.
See Federated DERA I Comment Letter; Fidelity DERA Comment Letter;
ICI DERA Comment Letter; Wells Fargo DERA Comment Letter.
---------------------------------------------------------------------------

    It is also difficult to estimate the future supply of available
eligible government securities, given market forces and possible
changes in the supply and demand. Commenters, as well as the staff,
noted a number of factors that may affect the supply and demand of
eligible government securities.\1951\ Some factors would affect the net
supply negatively, whereas other factors would affect it positively.
Given the large number of possible factors and the range of possible
effects of each factor on both the supply of eligible government
securities and the economy overall, we cannot estimate the net
macroeconomic effect of the factors overall.\1952\ For this reason, we
discuss these factors qualitatively.
---------------------------------------------------------------------------

    \1951\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf, pp. [4-5].
    \1952\ We note commenters did not provide data to help the
Commission estimate the effects of these factors. See, e.g.,
BlackRock DERA Comment Letter; Dreyfus DERA Comment Letter;
Federated DERA I Comment Letter; Fidelity DERA Comment Letter;
Invesco DERA Comment Letter; Wells Fargo DERA Comment Letter.
---------------------------------------------------------------------------

    Several factors could increase the future demand for and decrease
the future supply of eligible government securities. For example, one
commenter discussed the impact of rising interest rates on the demand
for money market funds generally and the concomitant increase in demand
for eligible government securities.\1953\ This commenter suggested, for
example, the ``eventual resolution of the Federal National Mortgage
Association and Federal Home Loan Mortgage Corporation will reduce the
supply,'' \1954\ as will a reduction in the federal deficit.\1955\ The
same commenter noted several factors have increased the demand of
government securities, including the stockpiling of securities by the
Federal Reserve ``as a result of quantitative easing and other policy
initiatives.'' \1956\ The commenter further notes continued trade
deficits, structural and regulatory changes in the markets for
financial contracts, and regulatory capital and liquidity requirements
have increased and are likely to continue increasing the demand for
U.S. government securities.\1957\ We agree with the commenter that many
of these factors will increase the demand for U.S. government
securities.\1958\
---------------------------------------------------------------------------

    \1953\ See Federated DERA I Comment Letter.
    \1954\ Id.
    \1955\ Id.
    \1956\ See Federated DERA I Comment Letter; Invesco DERA Comment
Letter.
    \1957\ See Federated DERA I Comment Letter; Invesco DERA Comment
Letter; Wells Fargo DERA Comment Letter.
    \1958\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf.
---------------------------------------------------------------------------

    On the other hand, several factors may decrease the future demand
for and increase the future supply of eligible government securities.
For example, one commenter hypothesized companies, seeking better
investment opportunities, may reduce their holdings of cash
equivalents, thereby reducing their holdings of government money market
funds and eligible government securities.\1959\ This commenter further
suggested that central banks might wind down their open market bond
purchases, which could cause investors to sell short-term and purchase
long-term government securities to earn higher yields. In addition, the
commenter suggested that the Federal Reserve Bank of New York through
its Overnight Reverse Repo Program might increase government repurchase
agreements as part of its quantitative easing exit strategy,\1960\ and
the Treasury could increase the supply of Treasury Floating Rate Notes
designed to be attractive to money market funds and their
investors.\1961\ Because we cannot foresee all of the ways markets will
evolve, we cannot predict the macroeconomic effects of these
changes.\1962\ Nevertheless, we acknowledge changes in the market
arising from the reforms may have macroeconomic effects in the future.
---------------------------------------------------------------------------

    \1959\ See Fidelity DERA Comment Letter.
    \1960\ See Fidelity DERA Comment Letter; Federated DERA I
Comment Letter. The Federated DERA I Comment Letter notes, however,
using the Program to counteract ``the unintended consequences of the
Commission's reforms may not be an appropriate use, however, of a
monetary policy tool,'' and it may be an unreliable source of
supply.
    \1961\ See Fidelity DERA Comment Letter.
    \1962\ It is important to also note that arguments supporting
the idea of a shortfall typically ignore the ability of market
participants to adapt to a changing landscape. See SEC Staff
Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf.
---------------------------------------------------------------------------

    In a separate analysis, the staff noted that some investors that
currently own eligible government securities might choose to reallocate
these assets to other global safe assets,\1963\ which could free up
eligible government securities for government fund purchase.\1964\ A
number of commenters argued the Commission should focus solely on the
supply of eligible government securities, given that government funds
are largely restricted to investing in eligible government
securities.\1965\ Several commenters also argued investors other than
government funds may be restricted from holding assets other than
eligible government securities, which would preclude them from buying
other assets.\1966\ One commenter pointed out certain global safe
assets can present risks, such as foreign exchange risk,\1967\ credit
risk (securitized assets and investment grade corporate debt),\1968\
and commodity risk (gold),\1969\ and

suggested investors either may not choose to or cannot hold them.\1970\
Moreover, this commenter suggested that using global safe assets for
regulatory and counterparty purposes may be more expensive than using
eligible government securities.\1971\
---------------------------------------------------------------------------

    \1963\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf. A ``safe asset'' is defined as any debt asset
that promises a fixed amount of money in the future with virtually
no default risk. Safe assets are generally considered to be
information insensitive: Investors' concerns about asymmetric
information or adverse selection are ameliorated when trading
because the asset's creditworthiness is known with near certainty,
reducing the need for investors to collect information. The safety
of a given asset does not depend on the creditworthiness of the
issuer alone but also is determined by the liquidity of the market
in which the asset trades and by guarantees. Any asset can be
rendered safe by an implicit or explicit promise from a central bank
or credit-worthy institution to buy it if its price falls below a
certain level.
    \1964\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf. We note government money market funds are largely
precluded from investing in securities other than government
securities. The market for global safe assets may provide investment
alternatives for current investors in government funds and
institutional investors invested in non-government funds that are
willing to reallocate assets.
    \1965\ See Dreyfus DERA Comment Letter; Federated DERA I Comment
Letter; Fidelity DERA Comment Letter; ICI DERA Comment Letter;
Invesco DERA Comment Letter; Wells Fargo DERA Comment Letter.
    \1966\ See Federated DERA I Comment Letter; Wells Fargo DERA
Comment Letter.
    \1967\ Id.
    \1968\ See Federated DERA I Comment Letter.
    \1969\ Id.
    \1970\ Id.
    \1971\ Id.
---------------------------------------------------------------------------

    We recognize that government funds and certain other investors are
restricted from investing in assets other than eligible government
securities and that other investors may prefer to invest in eligible
government securities. As discussed above, commenters estimated there
are between $5.2-$6.8 trillion of eligible government securities.\1972\
Of these, government money market funds today hold about $959 billion
or 16%, which leaves over $5 trillion or 84% of eligible government
securities in the hands of investors that may be able to reallocate
their investments in eligible government securities to other
assets.\1973\ The staff's analysis, which we credit, suggests any shift
in demand from eligible government securities to global safe assets
more generally would be small relative to the overall supply of global
safe assets, which is estimated to be $74 trillion.\1974\ Consistent
with this argument, a commenter notes that the entire market for
eligible government securities is less than 10% of the market for
global safe assets.\1975\ Based on these comments and the staff's
analysis, we continue to believe that some investors and market
participants may reallocate assets from eligible government securities
to other safe assets, which would free up eligible government
securities for government fund purchase.
---------------------------------------------------------------------------

    \1972\ See Federated DERA I Comment Letter; Fidelity DERA
Comment Letter; ICI DERA Comment Letter; Wells Fargo DERA Comment
Letter. One commenter (see the Invesco DERA Comment Letter)
estimated eligible government assets were $2 trillion, which is
substantially lower than the other commenters' estimates. It appears
the estimate does not include repurchase agreements collateralized
by U.S. Treasuries or other government securities and may have other
assumptions, so we focus here on the estimates provided in the other
four letters.
    \1973\ Based on Form N-MFP data as of February 28, 2014,
government money market funds had approximately $959 billion in
assets under management.
    \1974\ See SEC Staff Analysis http://www.sec.gov/comments/s7-03-13/s70313-324.pdf [3].
    \1975\ See Wells Fargo DERA Comment Letter.
---------------------------------------------------------------------------

    If significant capital flows from institutional prime funds to
demand deposits, issuers and the short-term capital markets may be
affected. If banks invest the additional capital in the short-term
financing markets, we do not anticipate a large impact on issuers or
the short-term capital markets. But if they do not, less capital will
be available to issuers, which could negatively impact capital
formation in the short-term financing market and perhaps increase the
cost of short-term financing. In this scenario, however, banks, which
tend to fund longer-term lending and capital investments, will have
additional monies to invest in the long-term financing market, which
could lower the cost of capital for long-term financing and aid capital
formation in that market.
    Several commenters noted that shifts in assets from institutional
prime funds to banks, although reducing systemic risk in money market
funds, might increase systemic risk in the banking system.\1976\ Some
commenters, for example, noted that a shift of assets from money market
funds to bank deposits would increase the size of the banking sector
and investors' reliance on FDIC-deposit insurance, possibly increasing
the concentration of risk in banks.\1977\ Several commenters also
observed that banks in this scenario would likely need to raise capital
to meet capital adequacy standards.\1978\ Several commenters discussed
the effects of evolving regulations (and related regulatory
uncertainty) on banks' willingness to accept large inflows. For
example, they noted that pending proposals to increase banks' leverage
ratios could limit banks' willingness to accept large cash deposits on
their balance sheets, because banks will need to raise large amounts of
new capital to reflect the growth in bank assets.\1979\ Finally,
commenters explained that state and municipal entities might not be
able to find banks willing to accept their large deposits due to the
high cost of collateralizing public bank deposits, a common requirement
among municipalities.\1980\
---------------------------------------------------------------------------

    \1976\ See, e.g., Federated X DERA Comment Letter; Fidelity DERA
Comment Letter; Invesco DERA Comment Letter; PFM Asset Mgmt. DERA
Comment Letter; Reich & Tang DERA Comment Letter; UBS DERA Comment
Letter.
    \1977\ See, e.g., Comment Letter of James Angel (Feb. 6, 2013)
(available in File No. FSOC-2012-0003) (``Angel FSOC Comment
Letter'') (stating that ``[m]any of the proposed reforms would
seriously reduce the attractiveness of money market funds,'' which
``could increase, not decrease, systemic risk as assets move to too-
big-to-fail banks.''); Comment Letter of Jonathan Macey (Nov. 27,
2012) (available in File No. FSOC-2012-0003) (stating that a
``reduced money market fund industry may lead to the flow of large
amounts of cash into [the banking system], especially through the
largest banks, and increase pressure on the FDIC.''); See, e.g.,
Comment Letter of Federated Investors, Inc. (Jan. 25, 2013)
(available in File No. FSOC-2012-0003) (``A floating NAV would
accelerate the flow of assets to ``Too Big to Fail'' banks, further
concentrating risk in that sector.'').
    \1978\ See, e.g., Federated X Comment Letter; Angel Comment
Letter.
    \1979\ See, e.g., Federated X Comment Letter; State Street
Comment Letter; American Bankers Ass'n Comment Letter.
    \1980\ See, e.g., Ga. Treasurer Comment Letter; WV Bd. of Treas.
Invs. Comment Letter; Chicago Treasurer Comment Letter. The
commenters explained that many state and local governments have laws
that require their bank deposits to be collateralized by marketable
securities at a higher amount than the current $250,000 FDIC deposit
insurance limit (often over 100 percent of the deposits after the
deduction of the amount of deposit insurance).
---------------------------------------------------------------------------

    As discussed above, although we are not able to estimate the flows
of capital from institutional prime funds, we do expect some outflow
when investors in institutional prime funds weigh the costs and
benefits of each investment alternative against the prime fund
investment and find an investment alternative a superior allocation.
Given the heterogeneity of investors' preferences and investment
objectives and constraints, we do not expect that all investors will
allocate assets to the same alternative. We expect, for example, that
some investors will allocate assets to government funds, some to demand
deposits, and others to various other alternatives. If, however,
significant capital flows from prime money market funds to demand
deposits, the size of the banking sector will increase. It is uncertain
to what extent an increase in the size of the banking sector is a
concern. First, banks are highly regulated and attuned to managing and
diversifying risks. Second, because the size of the remaining
institutional prime funds' portfolios will, in aggregate, be smaller,
these portfolios could contain a higher percentage of high-quality
prime assets, with improved diversification, and likely could be less
susceptible to heavy redemptions. Taken together, it is not clear what
the net effect on the resilience of the short-term funding markets will
be due to a shift of assets from institutional prime funds to the
banking sector.
    Historically, money market funds have been a significant source of
financing for issuers of commercial paper, especially financial
commercial paper, and for issuers of short-term municipal debt.\1981\
Analysis of Form

N-MFP data from November 2010 through March 2014 indicates that
financial company commercial paper and asset-backed commercial paper
comprise most of money market funds' commercial paper holdings.\1982\
Thus, we acknowledge that a shift by investors from non-government
money market funds to other investment alternatives could cause a
decline in demand for commercial paper and municipal debt, reducing
these firms and municipalities' access to capital from money market
funds and potentially creating a decline in short-term financing for
them.\1983\ If, however, money market fund investors shift capital to
investment alternatives that demand the same assets as prime money
market funds, the net effect on the short-term financing markets should
be small.
---------------------------------------------------------------------------

    \1981\ Based on Form N-MFP data, non-financial company
commercial paper, which includes corporate and non-financial
business commercial paper, is a small fraction of overall money
market holdings. In addition, commercial paper financing by non-
financial businesses is a small portion (one percent) of their
overall credit market instruments. According to Federal Reserve
Board flow of funds data, as of December 31, 2012 non-financial
company commercial paper totaled $130.5 billion compared with
$12,694.2 billion of total credit market instruments outstanding for
these entities. As such, we do not anticipate a significant effect
on the market for non-financial corporate fund raising. Federal
Reserve Board flow of funds data is available at http://www.federalreserve.gov/releases/z1/Current/z1.pdf.
    \1982\ In addition, according to the DERA Study, supra note 24,
``as of March 31, 2012, money market funds held $1.4 trillion in
Treasury debt, Treasury repo, Government agency debt, and Government
agency repo as its largest sector exposure, followed by $659 billion
in financial company commercial paper and CDs, its next largest
sector exposure.''
    \1983\ See, e.g., Comment Letter of Associated Oregon Industries
(Jan. 18, 2013) (available in File No. FSOC-2012-0003) (stating that
if the proposed reforms ``drive investors out of money market funds,
the flow of short-term capital to businesses will be significantly
disrupted.''); U.S. Chamber FSOC Comment Letter (stating that ``any
changes [that make money market funds] a less attractive investment
will impact the overall costs for issuers in the commercial paper
market resulting from a reduced demand in commercial paper.'');
Comment Letter of N.J. Municipal League (Jan. 23, 2013) (available
in File No. FSOC-2012-0003) (stating that ``money market funds hold
more than half of the short-term debt that finances state and
municipal governments for public projects,'' which could force local
governments to ``limit projects and staffing, spend more on
financing . . . or increase taxes'' if such financing was no longer
available.); Comment Letter of Government Finance Officers
Association, et al. (Feb. 13, 2013) (available in File No. FSOC-
2012-0003) (stating that with respect to FSOC's floating NAV
proposal, ``changing the fundamental feature of money market funds .
. . would dampen investor demand for municipal securities and
therefore could deprive state and local governments and other
borrowers of much-needed capital.'').
---------------------------------------------------------------------------

    As discussed in the DERA Study, the 2008-2012 increase in bank
deposits coupled with the contraction of money market funds provides
data to examine how capital formation can be affected by a reallocation
of capital among different funding sources. According to Federal
Reserve Board flow-of-funds data, money market funds' investments in
commercial paper declined by 45%, or $277.7 billion, from the end of
2008 to the end of 2012. Contemporaneously, funding corporations
reduced their holdings of commercial paper by 99% or $357.7
billion.\1984\ The end result was a contraction of more than 40% or
$647.5 billion in the amount of commercial paper outstanding.
---------------------------------------------------------------------------

    \1984\ The Federal Reserve flow of funds data defines funding
corporations as ``funding subsidiaries, custodial accounts for
reinvested collateral of securities lending operations, Federal
Reserve lending facilities, and funds associated with the Public-
Private Investment Program (PPIP).''
---------------------------------------------------------------------------

    Although the decline in funds' commercial paper holdings was large,
it is important to place commercial paper borrowing by financial
institutions into perspective by considering its size compared with
other funding sources. As with non-financial businesses, financial
company commercial paper is a small fraction (3.2%) of all credit
market instruments.\1985\ We have also witnessed the ability of
issuers, especially financial institutions, to adjust to changes in
markets. Financial institutions, for example, dramatically reduced
their use of commercial paper from $1.1 trillion at the end of 2008 to
$449.2 billion at the end of 2012.\1986\ As such, we continue to
believe that financial institutions, as well as other firms, will be
able to identify alternate short-term financing sources if the amount
of capital available to purchase financial commercial paper declines in
response to our money market fund rule changes.
---------------------------------------------------------------------------

    \1985\ According to the Federal Reserve Flow of Funds data as of
December 31, 2012, commercial paper outstanding was $449.2 billion
compared with $13,852.2 billion of total credit market instruments
outstanding for financial institutions.
    \1986\ The statistics in this paragraph are based on the Federal
Reserve Board's Flow of Funds data. See also 2012 FSOC Annual
Report, available at http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf, at 55-56, 66 (showing
substantial declines in domestic banking firm's reliance on short-
term wholesale funding compared with deposit funding). The Basel III
liquidity framework also proposes requirements aimed at limiting
banks' reliance on short-term wholesale funding. See 2011 FSOC
Annual Report, available at http://www.treasury.gov/initiatives/fsoc/Documents/FSOCAR2011.pdf, at 90 (describing Basel III's
proposed liquidity coverage ratio and the net stable funding ratio);
Basel Committee on Banking Supervision: Basel III: The Liquidity
Coverage Ratio and liquidity risk monitoring tools (Jan. 2013),
available at http://www.bis.org/publ/bcbs238.pdf (describing
revisions to the liquidity coverage ratio).
---------------------------------------------------------------------------

    We recognize, however, that as part of this shift there is the
potential that commercial paper issuers may have to offer higher yields
to attract alternate investors, which would increase issuers' short-
term cost of capital.\1987\ Any increase in yield would likely increase
demand for these investments which in turn could to some extent
mitigate the potential adverse capital formation effects on the
commercial paper market. Issuers, facing higher short-term financing
costs, might consider the trade-offs of shifting into longer-term
sources of financing. To the extent issuers' funding costs rise,
whether short or long term, issuers will be less likely to raise
capital and invest in projects, possibly affecting capital formation
negatively. However, we also note that to the extent that fees and
gates slow capital from leaving money market funds during times of
stress, the fees and gates amendments adopted today should benefit the
short-term funding market. This is because money from maturing
portfolio assets may need to be reinvested in the short-term funding
market, which may help prevent that market from completely locking up
during times of stress as we have experienced during the financial
crisis. To that extent, fees and gates may allow issuers to continue
accessing the short-term capital market served by money market funds
while they identify alternate sources of short-term capital.
---------------------------------------------------------------------------

    \1987\ See, e.g., Federated X Comment Letter.
---------------------------------------------------------------------------

    Municipalities also could be affected if the new amendments cause
the size or number of municipal money market funds to contract.
Commenters expressed concern about a loss of funding or other adverse
impacts on state and local governments.\1988\ As discussed in detail in
section III.B, however, we anticipate the impact will likely be
relatively small. As of the last quarter of 2013, municipal funds held
approximately 7% of the municipal debt outstanding.\1989\ Of that 7%,
retail investors owned approximately 71% of the assets under
management. Even though municipal funds will be subject to our fees and
gates reforms, we do not anticipate that retail investors in
significant numbers will divest their assets in municipal funds because
these funds should continue to offer price stability,\1990\ yield, and
liquidity in all

but exceptional circumstances. We therefore anticipate that many retail
investors will continue to find municipal funds to be an attractive
cash management tool compared to other alternatives.
---------------------------------------------------------------------------

    \1988\ A number of commenters argued that applying our floating
NAV reform to municipal funds would reduce demand for municipal
securities and raise the costs of financing. See, e.g., Fidelity
Comment Letter (noting that tax-exempt funds purchase approximately
65% of short-term municipal securities and that fewer institutional
investors in tax-exempt funds will lead to less purchasing of short-
term municipal securities by tax-exempt funds and a corresponding
higher yield paid by municipal issuers to attract new investors);
BlackRock II Comment Letter; Federated VII Comment Letter; ICI
Comment Letter; U.S. Mayors Comment Letter.
    \1989\ Based on data from Form N-MFP and the Federal Reserve
Board ``Flow of Funds Accounts of the United States'' (Z.1), which
details the flows and levels of municipal securities and loans, to
estimate outstanding municipal debt, (March 6th, 2014), available at
http://www.federalreserve.gov/releases/z1/current/z1.pdf. This
estimate is consistent with a previous estimate presented in U.S.
Securities and Exchange Commission. 2012 Report on the Municipal
Securities Market. The estimate in the 2012 report was based on data
from Mergent's Municipal Bond Securities Database.
    \1990\ Retail municipal funds are exempt from the floating NAV
requirement adopted today.
---------------------------------------------------------------------------

    Of that 7% of municipal debt outstanding that municipal funds held,
institutional investors, who might divest their municipal fund assets
if they do not want to invest in a floating NAV fund, held
approximately 30% of assets.\1991\ Because we estimate that
institutional municipal funds held approximately 2% of the total
municipal debt outstanding, we believe at most approximately 2% is at
risk of leaving the municipal debt market.\1992\ Of this 2% of the
municipal debt market that institutions hold, we anticipate many
investors that currently invest in institutional municipal funds likely
value the tax benefits of the funds and should choose to continue
investing in municipal funds to take advantage of the tax benefits. In
addition, we anticipate that some investors who qualify as natural
persons and currently are invested in institutional prime funds may
reallocate their assets to retail municipal funds, thereby increasing
investment in retail municipal funds.
---------------------------------------------------------------------------

    \1991\ See Dreyfus II Comment Letter indicated that based on
data from iMoneyNet institutional tax-exempt funds represent
``approximately $80 billion in assets,'' which ``constitute
approximately 30% of the current Municipal MMF industry.''
Commission staff estimates based on data from Form N-MFP and
iMoneyNet as of February 28, 2014 confirm these statistics. To
estimate the assets managed by the retail and institutional segments
of municipal funds, we used self-reported fund data from iMoneyNet
as of February 28, 2014 to estimate percentages. We then multiplied
the percentages times the total assets managed by municipal funds,
as provided by Form N-MFP as of February 28, 2014. We note the
retail designation is self-reported and omnibus accounts in these
funds may include both individual and institutional beneficial
owners. For these reasons, our estimates may underestimate the
number of funds with retail investors. In the Proposing Release, we
estimated that retail investors own close to all municipal fund
assets. We now recognize retail investors own approximately 71% of
municipal fund assets.
    \1992\ This estimate is calculated as follows: Municipal funds
hold 7.5% of municipal debt outstanding x 29% of municipal assets
held by institutional investors = 2.2% of total municipal debt held
by institutions.
---------------------------------------------------------------------------

    Even if municipal funds were to reduce their purchasing of
municipal securities, we expect that other investors may fill the gap.
Between the end of 2008 and the end of 2012, for example, money market
funds decreased their holdings of municipal debt by 34% or $172.8
billion.\1993\ Despite this reduction in holdings by money market
funds, municipal issuers increased aggregate borrowings by over 4%
between the end of 2008 and the end of 2012. Municipalities were able
to fill the gap by attracting other investor types. Other types of
mutual funds, for example, increased their municipal securities
holdings by 61% or $238.6 billion. Depository institutions have also
increased their funding of municipal issuers during this time period by
$141.2 billion as investors have shifted their assets away from money
market funds into bank deposit accounts. Life insurance companies
almost tripled their municipal securities holdings from $47.1 billion
at the end of 2008 to $121 billion at the end of 2012. Because
historically other types of investors have increased their investment
in municipal debt when money market funds have decreased their
investment, the Commission expects that other investors may again
increase their investment in municipal debt if money market funds
reduce their funding of the municipal debt market in the future, though
we note that yields on municipal securities could rise. For these
reasons, we do not anticipate the amendments adopted today will
substantially affect capital formation in the municipal debt market.
---------------------------------------------------------------------------

    \1993\ The statistics in this paragraph are based on the Federal
Reserve Board's Flow of Funds data.
---------------------------------------------------------------------------

    The amendments we are adopting today, including the floating NAV
requirement and enhanced disclosure requirements should improve
informational efficiency in the capital markets by increasing
investors' ability to knowledgably allocate capital. We recognize,
however, that a fund's imposition of a liquidity fee increases the cost
of reallocating their assets while it is in place, whereas a gate
prevents investors from doing so. The additional costs of liquidity and
inability of investors to redeem shares may impede the efficient
allocation of capital and hence capital formation during periods of
market stress because investors will not be able to reallocate capital
as freely. We have tried to mitigate the magnitude of this effect by
reducing the time that gates are in place to at most 10 business days
in any 90-day period (down from the proposed 30 calendar days) and by
adopting a 1% default liquidity fee (down from the proposed 2% fee). We
also expect that funds will impose fees and gates infrequently.\1994\
---------------------------------------------------------------------------

    \1994\ As discussed in section III.E, the DERA study found that
2.7% of the funds had their monthly weekly liquid assets percentages
fall below 30% and 0.02% of the funds had their monthly weekly
liquid assets percentages fall below 10%.
---------------------------------------------------------------------------

    Although we recognize that the reallocation of assets by money
market fund investors may affect efficiency, competition, and capital
formation within the short-term financing markets, the final amendments
reflect our efforts to moderate the amount of assets that may be
potentially redistributed by limiting our fees and gates requirement to
non-government funds and our floating NAV requirement to institutional
prime funds. If shareholders either remain in non-government money
market funds or move to alternatives that invest in similar underlying
assets, the competitive effects are likely to be small. If, however,
investors reallocate (whether directly or through intermediaries)
investments into substantively different assets, the effects may be
larger. In that case, issuers may have to access different investor
bases and perhaps offer higher yields to attract capital, whether from
the smaller money market fund industry or from other investors. Either
way, we recognize that issuers that are unable to offer the required
higher yield may have difficulties raising capital, at least in the
short-term financing markets. However, as discussed in detail earlier
in this section, we can neither precisely estimate the amount of
capital that will be reallocated nor its destination.
    The Commission anticipates other competitive consequences and
effects on capital formation as well. For example, we expect managers
of non-government money market funds will have incentives to closely
manage weekly liquid assets and principal risk so as to avoid crossing
the threshold for triggering fees and gates or having a volatile
NAV.\1995\ To manage these risks, fund managers will have incentives to
hold short-maturity, low-risk securities, and as a result the overall
short-term financing markets may tilt toward these issuances. If so,
the prices of these securities are likely to rise and yields may fall.
We anticipate issuers that are able and willing to issue securities
that meet these criteria may gain a competitive advantage over other
issuers in the market. Alternatively, the new amendments may create a
competitive advantage for issuers of higher yielding and riskier assets
that are rule 2a-7-eligible securities if non-government funds pursue
more aggressive investment strategies within the confines of rule 2a-7
or if relatively less risk-averse investors avoid government funds and
instead invest in non-government funds. If so, issuers of higher-
yielding 2a-7-eligible assets may gain a competitive advantage.
---------------------------------------------------------------------------

    \1995\ See, e.g., SIFMA Comment Letter; BlackRock II Comment
Letter; Wells Fargo Comment Letter; Peirce & Greene Comment Letter;
Dreyfus Comment Letter; Goldman Sachs Comment Letter.
---------------------------------------------------------------------------

    The DERA study pointed out that although the 2010 reforms made
money

market funds more resilient to both portfolio losses and investor
redemptions, no fund would have been able to withstand the losses that
the Reserve Primary Fund incurred in 2008 without breaking the buck,
and nothing in the 2010 reforms would have prevented the Reserve
Primary Fund's holding of Lehman Brothers debt. We therefore believe
that the costs to participants in the short-term funding market are
acceptable relative to the benefits stemming from advancing our goals
of reducing money market funds' susceptibility to heavy redemptions,
improving their ability to manage and mitigate potential contagion from
redemptions, and increasing the transparency of their risks.

L. Certain Alternatives Considered

    In this section, we discuss certain reasonable alternatives that we
considered as potential other methods for achieving our primary reform
goals, as well as a number of other alternatives suggested by
commenters, and discuss their benefits as well as their
limitations.\1996\ The goals of today's reforms include reducing money
market funds' susceptibility to heavy redemptions, improving their
ability to manage and mitigate potential contagion from such
redemptions, and increasing the transparency of their risks, while
preserving, as much as possible, the benefits of money market funds.
Having considered carefully the trade-offs of the alternatives
discussed below, we believe, based on our experience, observations, and
analysis, as well as careful consideration of comments received on the
adopted reforms and alternatives, that the amendments we are adopting
today best effectuate our policy goals.
---------------------------------------------------------------------------

    \1996\ This section discusses reasonable alternatives to the
primary fees and gates and floating NAV reforms discussed above. We
also discuss reasonable alternatives to other rule amendments, as
well as more specific or distinct issues, throughout other parts of
the Release. For example, see supra section III.B.5 for a discussion
of alternatives related to decimal place rounding.
---------------------------------------------------------------------------

1. Liquidity Fees, Gates, and Floating NAV Alternatives
    In the Proposing Release, we presented a number of reform options.
Among them were standalone floating NAV, standalone fees and gates, and
a combination of fees, gates, and a floating NAV requirement. Today we
are adopting an approach that includes fees and gates for all non-
government money market funds, as well as an additional targeted reform
of a floating NAV for the funds with investors most susceptible to
heavy redemptions, institutional prime funds.\1997\ We are adopting
this approach based on our evaluation, discussed both in other sections
of this Release and below, of our policy goals, experience,
observations, and analysis, as well as careful consideration of
comments received on the following reasonable alternatives.
---------------------------------------------------------------------------

    \1997\ We did not propose to apply either the fees and gate or
floating NAV reforms to government money market funds, and
accordingly the final amendments do not apply to government funds,
for the policy reasons discussed in section III.C.1. The analysis of
reasonable alternatives below therefore does not focus on the
potential effects of these alternatives as applied to government
funds.
---------------------------------------------------------------------------

a. Standalone Liquidity Fees and Redemption Gates
    One option outlined in the Proposing Release was for non-government
fund boards to be given discretion to impose liquidity fees and permit
imposition of redemption gates under certain conditions, but without
also requiring a floating NAV for institutional prime money market
funds.\1998\ We believe a standalone fee option would reduce money
market funds' susceptibility to heavy redemptions when liquidity costs
are high and fund liquidity is stressed and would allocate liquidity
costs to redeeming shareholders, making them pay for the liquidity that
they receive, rather than transferring such liquidity costs to
remaining shareholders. Gates, in addition to liquidity fees, would
help improve the ability of fund managers and boards to manage and
mitigate potential contagion from high levels of shareholder
redemptions.\1999\ A standalone fees and gates requirement would
eliminate some of the benefits of money market funds as they exist
today for investors, but retain others. Investors would face the
possibility of costly redemptions or the elimination of redemptions
temporarily when fund liquidity is stressed. On the other hand, fees
and gates, as discussed in section III.A and below, would retain the
advantages of a stable-price product, avoiding certain issues
associated with floating NAV funds. A large number of commenters
supported, to varying degrees and with varying caveats, our fees and
gates proposal.\2000\ Many other commenters, however, expressed their
opposition to fees and gates.\2001\ We discuss specific comments on
fees and gates in detail in section III.A.\2002\
---------------------------------------------------------------------------

    \1998\ See Proposing Release, supra note 25, at section III.B.
We note that we have adopted this alternative for a certain subset
of funds-namely retail funds that limit their investors to natural
persons. We discuss the reasons why we adopted this alternative for
retail funds, and the tradeoffs involved, in section III.C.2.
    \1999\ See section III.A for a detailed discussion of
commenters' responses.
    \2000\ See, e.g., Form Letter Type A, Fidelity Comment Letter;
Federated V Comment Letter; Northern Trust Comment Letter.
    \2001\ See, e.g., Capital Advisors Comment Letter; Boston
Federal Reserve Comment Letter; Americans for Fin. Reform Comment
Letter; Edward Jones Comment Letter.
    \2002\ We discuss the trade-offs of standalone fees versus
standalone gates in section III.L.1.a below.
---------------------------------------------------------------------------

    As discussed here and in the Proposing Release, liquidity fees are
designed to preserve the current benefits of principal stability,
liquidity, and a market yield, but reduce the likelihood that ``when
markets are dislocated, costs that ought to be attributed to a
redeeming shareholder are externalized on remaining shareholders and on
the wider market.'' \2003\ Even if a liquidity fee is imposed, fund
investors will continue to be able to access liquidity, although at a
cost. The ability of fund boards to impose liquidity fees when
liquidity costs are high would have many benefits, including reducing
the incentives for shareholders to redeem shares when the fees are in
effect. Liquidity fees will require redeeming shareholders to bear the
liquidity costs associated with their redemptions, rather than
transferring those costs to remaining shareholders. Likewise, fees
would help reduce investors' incentives to redeem shares ahead of other
investors, especially if fund managers deplete their funds' most liquid
assets first to meet redemptions, leaving later redemption requests to
be met by selling less liquid assets. Liquidity fees would protect fund
liquidity by requiring redeeming shareholders to repay funds for the
liquidity costs incurred. For these reasons, we believe liquidity fees
would reduce money market funds' susceptibility to heavy redemptions
when liquidity fees are high and would improve fund managers and
boards' ability to manage and mitigate potential contagion from such
redemptions.
---------------------------------------------------------------------------

    \2003\ See Proposing Release, supra note 25, n.343.
---------------------------------------------------------------------------

    We also recognize that the possibility of fees and gates being
imposed when a fund is under stress may make the risk of investing in
money market funds more salient and transparent to some investors,
which could sensitize them to the risks of investing in the funds. The
disclosure amendments we are adopting today will require funds to
provide disclosure to investors regarding the possibility of fees and
gates being imposed if a fund's liquidity is significantly stressed.
Funds' disclosures that shareholders may face liquidity fees and
redemption gates may help inform and could perhaps sensitize some of
those investors to some of the risks of investing in money market
funds.

    Redemption gates would stop heavy redemptions in times of market or
fund stress.\2004\ Like liquidity fees, gates would preserve the
current benefits of money market funds under most market conditions.
Funds, however, would be able to use gates to respond to runs by
halting redemptions. Gates would provide a ``cooling off'' period,
which might temper the effects of short-term investor panic, possibly
reducing investors' incentives to redeem shares. In addition, gates
would allow funds to generate additional internal liquidity as assets
mature and would reduce or eliminate the likelihood that funds sell
otherwise desirable assets and engage in ``fire sales.'' They would
also provide time for funds to identify solutions in crises and
communicate the nature of any stresses to shareholders.
---------------------------------------------------------------------------

    \2004\ See supra section III.A. We note, however, gates could
prompt pre-emptive runs if investors anticipate them. We believe,
however, that several aspects of today's amendments mitigate this
risk, and the effects of such pre-emptive runs should they occur.
For example, board discretion in imposing gates mitigates this risk.
We have also tried to mitigate the magnitude of this effect by
reducing the time that gates are in place to at most 10 business
days in any 90-day period (down from the proposed 30 days) and
adopted a 1% default liquidity fee (down from a 2% fee).
---------------------------------------------------------------------------

    Standalone liquidity fees and gates would preserve many of the
current benefits of money market funds under normal market conditions.
As discussed in the Proposing Release, the ability of funds to impose
liquidity fees and redemption gates, had it been available during the
financial crisis, might have helped some funds manage the heavy
redemptions that occurred and may have helped limit the contagion
effects of such redemptions, though it is impossible to know what
exactly would have happened if money market funds had operated with
fees and gates at that time. Unlike a floating NAV, which affects day-
to-day fund pricing, fund boards would impose liquidity fees and gates
only when liquidity costs are high and fund liquidity is stressed. In
addition, a standalone liquidity fee and redemption gate structure
would preserve many of the benefits of stable price money market funds,
avoiding many of the costs associated with floating NAV funds.\2005\
---------------------------------------------------------------------------

    \2005\ As discussed previously, the Commission acknowledges, for
example, some investors may reallocate assets from floating NAV
prime funds to either government money market fund or other stable-
price alternatives, which may impose costs on investors, funds, and
the short-term capital markets. We discuss these effects in more
detail in section III.K.
---------------------------------------------------------------------------

    The Commission recognizes, however, that liquidity fees and
redemption gates address some of the risks associated with money market
funds, but cannot address all of the factors that might lead to heavy
redemptions in certain money market funds. As discussed previously, we
have found that certain money market funds (i.e., institutional prime
funds) pose particularly significant risks that fees and gate alone do
not fully address.\2006\ Specifically, fees and gates are intended to
enhance money market funds' ability to manage and mitigate potential
contagion from high levels of redemptions and make investors pay their
share of the costs of the liquidity that they receive. They do not,
however, eliminate the incremental incentive for certain investors to
redeem shares ahead of other shareholders when their money market
fund's shadow price falls below $1.00--a risk to which institutional
prime funds are particularly susceptible, and the potential resultant
dilution of remaining shareholders interests. Thus, we believe a
liquidity fee combined with a redemption gate--without a floating NAV--
will not adequately address this risk of heavy redemptions for
institutional prime funds. However, balanced with the competing goal of
retaining the benefits of money market funds for investors to the
extent possible, as discussed above, we believe that a standalone fees
and gates approach does meet our policy goals when applied to retail
funds.\2007\
---------------------------------------------------------------------------

    \2006\ See supra section III.B.
    \2007\ The tradeoffs of just a fee or gate (without a floating
NAV) are discussed in section III.A. We note that one commenter
suggested a ``penny rounding'' alternative that, if combined with
fees and gates, is very similar to the fees and gates alternative we
proposed (which included a requirement for penny-rounded pricing).
We discuss this alternative at notes 512-515 and accompanying text.
We are not adopting this suggested ``penny rounding'' alternative
combined with fees and gates for the reasons described in this
section III.L.1.a.
---------------------------------------------------------------------------

b. Standalone Floating NAV
    Another option outlined in the Proposing Release was for
institutional prime funds to transact at a floating NAV with no
liquidity fees or gates.\2008\ Most commenters opposed requiring a
standalone floating NAV.\2009\ As we discuss in detail in section
III.B, we believe a floating NAV requirement reduces certain money
market funds' susceptibility to heavy redemptions and improves the
allocation of gains, losses, and costs among shareholders. It does not,
however, fully address the ability of fund managers and boards to
manage and mitigate potential contagion from high levels of shareholder
redemptions. A standalone floating NAV requirement would eliminate some
of the benefits of a stable-price fund for institutional investors,
while retaining other benefits that investors currently experience with
money market funds.
---------------------------------------------------------------------------

    \2008\ See Proposing Release, supra note 25, at section III.A.
    \2009\ See supra section III.B for a detailed discussion of
comments we received on this issue.
---------------------------------------------------------------------------

    First and foremost, we believe a standalone floating NAV would help
reduce institutional prime money market funds' susceptibility to heavy
redemptions by reducing the incremental incentive for shareholders in
these funds to redeem shares ahead of other investors when a fund's
shadow NAV falls below $1.00.\2010\ As discussed in Section III.B, a
floating NAV requirement mandating that institutional prime money
market funds transact at share prices that reflect current market-based
factors (not amortized cost or penny rounding, as currently is
permitted) would lessen investors' incentives to redeem early to take
advantage of transacting at a stable value. As a result, the floating
NAV requirement by itself without an accompanying liquidity fee and/or
redemption gate would help mutualize potential losses and costs among
all investors, including redeeming shareholders.\2011\
---------------------------------------------------------------------------

    \2010\ Although most commenters opposed requiring a floating
NAV, a number of commenters did agree that a floating NAV would
address this incremental incentive to redeem. See, e.g., Thrivent
Comment Letter; TIAA-CREF Comment Letter; Fin. Svcs. Roundtable
Comment Letter; SIFMA Comment Letter; Systemic Risk Council Comment
Letter. But see, e.g., BlackRock II Comment Letter; Dreyfus Comment
Letter; Federated IV Comment Letter; Ropes & Gray Comment Letter;
ICI Comment Letter; Chamber II Comment Letter.
    \2011\ See, e.g., Deutsche Comment Letter; TIAA-CREF Comment
Letter; Systemic Risk Council Comment Letter.
---------------------------------------------------------------------------

    A standalone floating NAV, which many observers perceive to be more
equitable than a stable NAV,\2012\ may also minimize investor dilution.
A standalone floating NAV should result in redeeming investors
receiving only their fair share of the fund when there are embedded
losses in the portfolio, thereby avoiding dilution of remaining
shareholders. A standalone floating NAV requirement would also preserve
certain current benefits of money market funds, because investors would
continue to be able to redeem shares during times of market stress
without paying a liquidity fee or waiting for a redemption gate to be
lifted. A standalone floating NAV would also avoid certain costs
associated with liquidity fees and redemption gates.
---------------------------------------------------------------------------

    \2012\ See supra section III.B; see also TIAA-CREF Comment
Letter.
---------------------------------------------------------------------------

    We anticipate a standalone floating NAV would contribute to the
allocation of money market fund risks in the same ways that a floating
NAV does in a combination approach. As discussed in the Proposing
Release and in section

III.B, a floating NAV requirement is designed to increase the
allocation of the risks present in money market funds by causing
shareholders to experience gains and losses when a fund's value
fluctuates. Some money market fund investors, accustomed to a stable
NAV, may not appreciate the risks associated with money market funds
whose prices may remain stable, but whose underlying values may
fluctuate in times of market stress. As we have discussed previously,
transacting at prices based on current market values will help ensure
that institutional investors who invest in floating NAV funds do so
only if they are willing to tolerate small fluctuations in share price
in return for potentially higher yield.\2013\ And for those investors
who are unwilling to tolerate the risk that the price fluctuations
reflect, we anticipate they may reallocate their investments to other,
more appropriate alternatives, which may help reduce any redemption
pressure that these investors could have caused in times of stress had
they remained in the funds.\2014\
---------------------------------------------------------------------------

    \2013\ See, e.g. Vanguard Comment Letter.
    \2014\ See supra section III.B.
---------------------------------------------------------------------------

    A standalone floating NAV would not necessarily eliminate, however,
shareholders' incentives to redeem shares from institutional prime
money market funds ahead of other investors when liquidity costs are
high. In times of severe market stress when the secondary markets for
funds' assets become illiquid and liquidity costs are high, investors
may still have an incentive to rapidly redeem shares before their
fund's liquidity dries up. A floating NAV may also not alter
institutional prime money market fund shareholders' incentives to
redeem shares in times of market stress when investors want to shift
from money market funds into securities with greater quality,
liquidity, and transparency. As such, when the situation develops, a
standalone floating NAV would not necessarily prevent heavy shareholder
redemptions in institutional prime money market funds and the related
effects on the short-term capital markets or help fund managers and
boards manage redemptions.\2015\ Thus, a standalone floating NAV would
likely be insufficient to satisfy these important policy goals of the
money market fund reform.
---------------------------------------------------------------------------

    \2015\ We have discussed the particular risks posed by
institutional prime funds throughout this Release and especially in
section III.B.
---------------------------------------------------------------------------

    We have therefore determined to adopt a floating NAV as a targeted
reform that is intended to supplement the broader liquidity fees and
gates reforms discussed above (as well as other reforms discussed in
sections III.E, III.I, and III.J) by addressing the incremental
incentive for institutional investors to redeem from prime funds. We
believe that an approach that includes both fees and gates for all non-
government money market funds as well as a floating NAV for a subset of
those funds (i.e., institutional prime money market funds) provides
fund managers and boards with targeted and additional tools to manage
heavy redemptions and help limit contagion.
c. Fund Choice of Standalone Floating NAV or Standalone Liquidity Fees
and Redemption Gates
    We also considered providing institutional prime money market funds
a choice of either transacting with a floating NAV or being able to
impose liquidity fees and gates in times of stress--in other words,
each institutional prime money market fund would choose to apply either
the floating NAV alternative or the liquidity fees and gates
alternative.\2016\ In the Proposing Release, we discussed how providing
such a choice might allow each money market fund to select the reform
alternative that is most efficient, cost-effective, and preferable to
its shareholders. We suggested such a choice might enhance the
efficiency of our reforms and minimize costs and competitive impacts.
---------------------------------------------------------------------------

    \2016\ We note that we did not propose to require retail or
government funds to adopt a floating NAV, and accordingly this
discussion focuses on the tradeoffs between allowing such a choice
for institutional prime funds. We discuss the reasons why we are not
mandating either a floating NAV or fees and gates for government
money market funds, but allowing them to opt in to fees and gates if
they choose in section III.C.1 and discuss why we believe that a
floating NAV is not necessary for retail funds in section III.C.2.
---------------------------------------------------------------------------

    A number of commenters offered support for this ``choice'' reform
approach,\2017\ and one commenter specifically opposed it.\2018\ The
commenters who supported allowing funds to choose which reform
alternative to implement argued that this approach would allow the
market to decide which reform was most suitable rather than imposing a
top-down solution. They noted that each alternative offers a varying
set of benefits and drawbacks and that allowing funds to choose which
reform to implement would allow them to offer different kinds of funds
to clients who may have divergent priorities for either liquidity or a
stable NAV.\2019\ These commenters also suggested that letting each
fund choose would allow them to select the approach that they can
implement at lowest cost and with least disruption. The commenters who
supported allowing fund choice between the principal reforms we are
adopting today also emphasized they did not support imposing both
reforms in combination, only alternatively.\2020\ One commenter that
supported fund choice nonetheless suggested intermediaries may be
unwilling to accommodate funds that have two options as they would have
to bear the costs of dealing with both sets of reforms for different
funds.\2021\ The commenter that opposed allowing a choice of structural
reforms stated that having both primary structural reforms available
could be confusing for investors and may promote regulatory
arbitrage.\2022\ They argued that the Commission should adopt a
standardized structure that is simple for investors to
understand.\2023\
---------------------------------------------------------------------------

    \2017\ Dreyfus Comment Letter; Legg Mason Comment Letter; ICI
Comment Letter; MFDF Comment Letter.
    \2018\ Vanguard Comment Letter.
    \2019\ See, e.g., ICI Comment Letter; MFDF Comment Letter; SPARK
Comment Letter.
    \2020\ See, e.g., ICI Comment Letter; Dreyfus Comment Letter;
Goldman Sachs Comment Letter.
    \2021\ See ICI Comment Letter.
    \2022\ See Vanguard Comment Letter.
    \2023\ Id.
---------------------------------------------------------------------------

    We have carefully considered these comments. However, for the same
reasons that we believe a standalone approach with either fees and
gates or floating NAV would not fully address the risks inherent in
money market funds, we believe, based on our consideration of relevant
risks and policy objectives, allowing institutional prime money market
funds to choose between them also would not address the risks posed by
money market funds. As discussed above, the floating NAV alternative by
itself would not necessarily eliminate shareholders' incentives to
redeem shares from money market funds ahead of other investors when
liquidity costs are high. In times of severe market stress when the
secondary markets for funds' assets become illiquid and liquidity costs
are high, investors may still have an incentive to redeem shares before
their fund's liquidity dries up. A floating NAV also may not alter
money market fund shareholders' incentives to redeem shares in times of
market stress when investors want to shift from money market funds into
securities with greater quality, liquidity, and transparency. As such,
a floating NAV alternative by itself would not necessarily prevent
heavy shareholder redemptions and the related effects on the short-term
capital markets

or help fund managers and boards manage the rapid heavy redemptions to
which institutional prime funds can be susceptible. These funds would
lack the additional tools of fees and gates to help manage heavy
redemptions and limit contagion. Thus, providing institutional prime
funds an alternative and having some funds adopt a floating NAV would
prevent us from satisfying certain important policy goals of the money
market fund reform for those funds.
    Some funds might instead choose to adopt the liquidity fees and
gates option. However, as discussed above, these funds, while having
certain tools to manage heavy redemptions, would have a diminished
ability to address an important factor that can lead to redemptions in
money market funds. Specifically, fees and gates would not eliminate
the incentive for institutional investors to redeem shares ahead of
other shareholders to avoid market-based losses embedded in their
fund's portfolio or mitigate shareholder dilution. Liquidity fees and
gates would not allocate day-to-day gains, losses, and costs to
investors on a proportionate basis, a risk that is particularly
relevant to institutional prime funds.
    In addition, we note that today neither funds nor their investors
may necessarily internalize the full likely effects of their own
decisions on other funds and investors and the short-term financing
markets, and thus capital formation.\2024\ The approach that we are
adopting today, which subjects all non-government funds to the fees and
gates reform and only institutional prime funds to the additional
floating NAV requirement, is designed to address these externalities by
reducing money market funds' susceptibility to heavy redemptions and
improving their ability to manage and mitigate potential contagion from
such redemptions. Because allowing institutional prime funds to choose
between either a floating NAV or fees and gates would effectively
negate the combined effects of the reforms that we have found to be
necessary to address their risks, we believe that this is not the most
appropriate alternative, for the reasons discussed above. For these
reasons, we now believe neither liquidity fees and redemption gates nor
floating NAV, alone, addresses all of the factors that might lead to
heavy redemptions in institutional prime money market funds, and
thereby to allow them such a choice would not effectively mitigate all
of the risks that our reforms are designed to address.
---------------------------------------------------------------------------

    \2024\ See generally MFDF Comment Letter (discussing, in the
context of fees and gates, that boards need not put significant
emphasis on the broader systemic effects of their decisions).
---------------------------------------------------------------------------

d. Standalone Fees or Standalone Gates
    The amendments we are adopting today will allow funds to impose
liquidity fees and redemption gates.\2025\ Some commenters on the
proposal, however, expressed a preference for either just fees or just
gates. For example, some commenters noted a preference for fees over
gates.\2026\ One commenter argued that liquidity fees could slow runs,
as the price for liquidity would be factored into investors' redemption
decisions, whereas a gate could exacerbate the risk of pre-emptive runs
if investors expect gates to be imposed.\2027\ Another commenter stated
that although a liquidity fee might be acceptable to shareholders if it
reflected the cost of liquidity, gates that prevented investors from
accessing their cash would be the least attractive alternative for
institutional investors that use money market funds for cash management
purposes.\2028\
---------------------------------------------------------------------------

    \2025\ As discussed in section III.C.1, government funds are not
required to impose fees or gates, but may opt to do so if they
choose. We believe that if a government fund were to choose to opt
into a fee and gate regime, for the same reasons discussed below,
such a fund should have the flexibility to use both tools, rather
than be limited to just one or the other. We further note that
gating is always entirely discretionary (once a fund goes below 30%
weekly liquid assets), and that if a board finds that a fee is not
in the best interests of the fund need not impose it, and thus a
government fund that opted into fees and gates could apply
effectively only a fee or only a gate if the boards finds that using
only one such tools is in the best interests of the fund.
    \2026\ See, e.g., Deutsche Comment Letter; Capital Advisors
Comment Letter.
    \2027\ See Deutsche Comment Letter.
    \2028\ See Capital Advisors Comment Letter.
---------------------------------------------------------------------------

    Conversely, other commenters expressed a preference for gates over
fees.\2029\ One commenter noted liquidity fees are unlikely to prevent
institutional investors from redeeming shares in a crisis, but that
gates would be more likely to achieve the Commission's goals.\2030\
Similarly, another commenter described gates as the ``most effective
option in addressing run risk,'' but was skeptical as to whether fees
``would deter shareholders from redeeming their shares in a time of
extreme market stress.'' \2031\ Finally, a commenter suggested
implementing only fully discretionary gates but no fees, noting in part
that, ``establishing appropriate triggers and setting properly sized
fees in advance are difficult and likely futile tasks.'' \2032\
---------------------------------------------------------------------------

    \2029\ See, e.g., Fein Comment Letter; Peirce & Greene Comment
Letter.
    \2030\ See Fein Comment Letter.
    \2031\ See U.S. Bancorp Comment Letter.
    \2032\ See Peirce & Greene Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that funds and their boards should be
permitted to choose between fees and gates but be capable of utilizing
both when determining the best way to address heavy redemptions. As
discussed in section III.1 above, fees and gates can accomplish similar
policy goals, but one may be better suited to one set of circumstances
or funds than the other.\2033\ The flexibility in today's amendments
should address many of the commenters' concerns in favoring one
approach over the other,\2034\ because it gives boards the option to
impose fees, gates, neither or both. The flexibility provided in
today's amendments will allow funds to tailor the redemption
restrictions they employ to market conditions, as well as the
preferences and behavior of their particular shareholder base and to
adapt restrictions over time as they and the industry gain experience
employing such restrictions. Of course, consideration of any such
factors would have to be made in the context of the fund's best
interests.\2035\ The flexibility provided by today's amendments also
allows funds to alter their approach as events unfold. For example, if
a board determines initially that a liquidity fee is in the best
interests of the fund, but the fee turns out to be ineffective in
reducing heavy redemptions, the board

may then choose to impose a redemption gate. Accordingly, we believe
that providing funds and their boards with the flexibility to choose on
an ongoing basis between fees and gates best meets our policy goals of
reducing money market funds' susceptibility to heavy redemptions and
helping funds manage and mitigate potential contagion from such
redemptions.
---------------------------------------------------------------------------

    \2033\ As discussed in the Proposing Release, shareholders
valuing principal preservation may prefer a redemption gate over a
liquidity fee, particularly if the fund expects to rebuild liquidity
through maturing assets. In contrast, shareholders preferring
liquidity over principal preservation may prefer a liquidity fee
because it allows access to that investor's money market fund
shareholdings--it just imposes a greater cost for that liquidity if
the fund is under stress. See, e.g., Comment Letter of BlackRock,
Inc. on the IOSCO Consultation Report on Money Market Fund Systemic
Risk Analysis and Reform Options (May 28, 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf (stating their
preference for liquidity fees over gates ``because clients with an
extreme need for liquidity can choose to pay for that liquidity in a
crisis''); Comment Letter of BNP Paribas on the IOSCO Consultation
Report on Money Market Fund Systemic Risk Analysis and Reform
Options (May 25, 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf (stating that it ``would not make sense
to restrict the redeemer willing to pay the price of liquidity'');
see also Capital Advisors Comment Letter.
    \2034\ See supra section III.A.1.c.i addressing pre-emptive run
concerns and section III.A.2 addressing concerns with default
thresholds and fees. We also note that, to the extent an investor is
seeking to invest in a money market fund for cash management
purposes and views a fund with the ability to impose a fee or gate
as incompatible with cash management, it may alternatively invest in
a government money market fund that does not impose fees and gates.
    \2035\ See rule 2a-7(c)(i) and (ii).
---------------------------------------------------------------------------

e. Partial Gates
    We are adopting amendments to rule 2a-7 that, like the proposal,
will allow a fund board to impose a gate on all redemptions, but that
will not allow for partial redemption gates.\2036\ A number of
commenters advocated allowing the board greater discretion to impose
partial gates.\2037\ For example, some commenters noted partial gates
would provide investors with some immediate liquidity, but allow funds
time to regenerate liquidity or service redemptions under improved
market conditions.\2038\ In addition, a commenter stated that partial
gates would, ``make it easier for a board to determine that a gate is
in the best interests of the fund because a partial gate would impose a
lesser hardship on investors.'' \2039\
---------------------------------------------------------------------------

    \2036\ See rule 2a-7(c)(2)(i)(B).
    \2037\ See, e.g., Wilmington Trustees Comment Letter; UBS
Comment Letter; Chamber II Comment Letter; ABA Business Law Section
Comment Letter; see also Comment Letter of HSBC Global Asset
Management on the European Commission's Green Paper on Shadow
Banking (May 28, 2012) (stating that a money market fund should be
able to limit the total number of shares that the fund is required
to redeem on any trading day to 10% of the shares in issue, that any
such gate be applied pro rata to redemption requests, and that any
redemption requests not met be carried over to the next business day
and so forth until all redemption requests have been met).
    \2038\ See, e.g., Wilmington Trustee Comment Letter; ABA
Business Law Section Comment Letter; Deutsche Comment Letter.
    \2039\ See ABA Business Law Section Comment Letter.
---------------------------------------------------------------------------

    Commenters suggested a variety of approaches for imposing partial
gates. For example, a commenter proposed allowing shareholders to
redeem ``at least 50% of their remaining balance at the then basis-
point rounded NAV plus a 1% fee.'' \2040\ Others proposed imposing
partial gates with greater restrictions on shareholders making larger
redemptions and lower or no restrictions on shareholders making smaller
redemptions.\2041\ Another commenter suggested limiting redemptions to
10% of outstanding shares per day and applying this limitation pro rata
among all redeeming shareholders that day, with the balance of
unredeemed shares carried to the next day until all redemption requests
have been met.\2042\ In contrast, other commenters were opposed to the
idea of partial redemption gates, citing significant operational
challenges and costs,\2043\ as well as the potential for arbitrary and
inconsistent application among funds and inequitable treatment among
shareholders.\2044\
---------------------------------------------------------------------------

    \2040\ See Capital Advisors Comment Letter.
    \2041\ See UBS Comment Letter; Chamber II Comment Letter.
    \2042\ See HSBC Comment Letter.
    \2043\ See Fidelity Comment Letter; Fin. Info. Forum Comment
Letter; Federated V Comment Letter.
    \2044\ See Fidelity Comment Letter.
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    We have determined not to permit partial redemption gates under
amended rule 2a-7. An important policy goal of this reform is to
improve funds' ability to manage and mitigate potential contagion from
such redemptions. Partial gates do not fully stop runs, because
shareholders can continue to redeem shares. Although board discretion
to impose partial gates may be effective for individual funds, it may
not address our larger concerns about contagion resulting from rapid
heavy redemptions. There may exist times when full gates are required
to limit the contagion effects of heavy redemptions on remaining
investors and the short-term financing markets, but individual firms
may choose instead to impose partial gates. We also note that a number
of commenters opposed partial gates, noting significant operational
challenges and costs, which are not associated with full gates.\2045\
We also believe the benefits of allowing partial gating is further
diminished now that we are adopting only a 10 business day maximum gate
period, because 10 business days (rather than the 30-day gate under the
proposal) may be a more reasonably manageable period of time during
which investors may not need the safety valve that a partial gate might
afford.
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    \2045\ See, e.g., Fidelity Comment Letter; Fin. Info. Forum
Comment Letter; Federated V Comment Letter.
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    There are several additional potential issues with partial gates.
First, we understand it may be difficult for funds to achieve desired
outcomes with partial gates, and partial gates may create unintended
consequences. For example, when a Florida LGIP suspended redemptions in
2007 in response to a run, it re-opened with a combined partial gate
and liquidity fee--local governments could take out the greater of 15%
of their holdings or $2 million without penalty, and the remainder of
any redemptions was subject to a 2% redemption fee.\2046\ We understand
that investors redeemed most of what was allowed under the partial gate
without triggering the redemption fee, which meant the partial gate not
only did not stop the run, but may have triggered redemptions up to
that limit.\2047\
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    \2046\ See David Evans and Darrell Preston, Florida Investment
Chief Quits; Fund Rescue Approved, Bloomberg (Dec. 4, 2007).
    \2047\ See, e.g., Neil Weinberg, Florida Fund Meltdown: Bad to
Worse, Forbes (Dec. 6, 2007) (noting that investors withdrew $1.2
billion from the $14 billion pool after it re-opened, while
depositing only $7 million, but that only 3 out of about 1,700
participants in the pool withdrew assets subject to the redemption
fee).
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    Second, partial gates based on the size of redemptions may also be
easily manipulated unless appropriate, but costly and complex,
procedures are put in place to prevent such gaming. For example, a
partial gate that allowed small redemptions could result in investors
redeeming small amounts over a number of days, essentially achieving
large redemptions through multiple smaller redemption
transactions.\2048\ Funds could prevent this sort of gaming by limiting
each shareholder's redemptions to a certain amount, but this type of
restriction would only serve to increase the costs and complexity of
such a gate. Third, a partial gate based on the size of redemptions
could effectively exempt certain types of funds and their shareholders
(e.g., retail funds and their shareholders) from a gating requirement.
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    \2048\ See supra section III.A.1.c herein discussing gaming of
redemption restrictions.
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    Fourth, we also believe partial gates would complicate the fees and
gates requirements as an operational matter. If partial gates were
assessed on a redemption-by-redemption basis (e.g., the size of a
shareholder's redemption), we believe, as one commenter stated, ``[t]he
systems enhancements necessary to track holdings for purposes of
determining each shareholder's redemption limit would be more
complicated, cumbersome, and costly than the changes required to
implement the full gate.'' \2049\ Similarly, complexity would be
compounded by the existence of omnibus accounts, as funds would need to
track all redemptions made by a single investor through multiple
accounts over the course of a day to prevent investors from making
redemptions in excess of the limit imposed by a partial gate in a
single day by spreading them over multiple omnibus accounts.
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    \2049\ See Fidelity Comment Letter.
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f. In-Kind Redemptions
    As discussed in the Proposing Release, we requested comment in 2009

on a potential amendment that would require funds to satisfy redemption
requests in excess of a certain size through in-kind redemptions.\2050\
We also requested comment on this type of redemption restriction when
we requested comment on the PWG Report.\2051\ Almost all commenters on
the PWG alternative opposed it.\2052\ Most commenters believed that
requiring in-kind redemptions would be technically unworkable due to
the complex valuation and operational issues that would be imposed on
both the fund and on investors receiving portfolio securities.\2053\
Several commenters stated that investors would dislike the prospect of
receiving redemptions in-kind and would structure their holdings to
avoid the requirement, but would nevertheless still collectively engage
in redemptions if the money market funds were to come under stress with
similar adverse consequences for the funds and the short-term financing
markets.\2054\
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    \2050\ See 2009 Proposing Release, supra note 66, at section
III.B; PWG Report, supra note 506, at section 3.c. An in-kind
redemption occurs when a shareholder's redemption request to a fund
is satisfied by distributing to that shareholder portfolio assets of
that fund instead of cash. In-kind redemptions might lessen the
effect of large redemptions on remaining money market fund
shareholders, and they would ensure that the redeeming investors
bear part of the cost of their liquidity needs. During the financial
crisis, one money market fund stated that it would honor certain
large redemptions in-kind in an attempt to decrease the level of
redemptions in that fund. See 2009 Proposing Release, supra note 66,
at n.30.
    \2051\ See PWG Report, supra note 506, at section 3.c
(discussing requiring that money market funds satisfy certain
redemptions in-kind).
    \2052\ But see Proposing Release, supra note 25 at n.472.
    \2053\ See Proposing Release, supra note 25 at 233-34 n.473.
They also asserted that required in-kind redemptions could result in
disrupting, rather than stabilizing, markets if redeeming
shareholders needing liquidity were forced to sell into declining
markets. See Proposing Release, supra note 25, at n.474.
    \2054\ See Proposing Release, supra note 25 at n.475.
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    In connection with the current reforms, we again asked for comment
regarding possible in-kind redemption restrictions. Two commenters
noted the complexity of implementing this mechanism.\2055\ One of these
commenters suggested that the Commission permit, but not require, money
market funds to meet redemptions by returning a pro rata share of the
fund's assets rather than cash to investors.\2056\ In light of these
comments and comments we previously received, we continue to believe
requiring in-kind redemptions could create operational difficulties
that might prevent funds from treating investors fairly in practice. In
contrast, we anticipate reforms such as liquidity fees and gates would
fulfill many of our policy goals in a manner that is operationally
simpler and potentially fairer to investors than in-kind redemptions.
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    \2055\ See State Street Comment Letter (``State Street agrees
with commenters that requiring in[hyphen]kind redemptions would be
unworkable due to the complex valuation and operational issues that
would be imposed on both the fund and on investors receiving
portfolio securities.''); HSBC Comment Letter.
    \2056\ See HSBC Comment Letter.
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    We also note requiring in-kind redemptions would not necessarily
stop runs and the related adverse effects on the short-term financing
markets and capital formation. Rather, we believe the liquidity fees
and gates approach described in section III.A would better achieve our
policy goals, including improving money market funds' ability to manage
and mitigate potential contagion from high levels of redemptions and
helping to preserve the benefits of money market funds for investors
and the short-term financing markets for issuers. We note that money
market funds are already permitted to satisfy redemptions in kind if
they disclose such a possibility in the fund's prospectus.\2057\
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    \2057\ See section 2(a)(32) (defining a redeemable security as a
security where the holder is entitled . . . to receive approximately
his proportionate share of the issuer's current net assets, or the
cash equivalent thereof (italics added)). See also rule 18f-1, which
provides an exemption from certain prohibitions of section 18(f)(1)
of the Act with regard to redemptions in kind and in cash.
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g. Standalone Floating NAV Combined With Only Liquidity Fees or
Redemption Gates
    The Commission also considered combining a floating NAV with either
a liquidity fee or a redemption gate; that is, we considered an
alternative where money market funds would be required to maintain a
floating NAV combined with a liquidity fee but not a redemption gate
and an alternative where money market funds would be required to
maintain a floating NAV combined with a redemption gate but not a
liquidity fee. Combining a floating NAV with just a liquidity fee or
just a redemption gate would simplify the operational implementation of
the rule and perhaps make money market funds more attractive to
investors.
    These more limited combinations, however, would likely fail to
achieve the policy goals of the money market fund reform to the same
extent as the full set of reforms that we are adopting today. Without
liquidity fees, there would be heightened incentives for shareholders
to redeem in times of market stress before fund managers deplete their
funds' liquidity to meet redemptions. The costs of providing liquidity
to redeeming shareholders would fall on non-redeeming shareholders,
creating a financial inequity between shareholder types.
    Similarly, without the possibility of imposing gates, funds would
lose an important tool to manage redemptions during periods of stress.
They would not be able to fully halt redemptions, which could affect
funds' ability to generate internal liquidity as assets mature, perhaps
undermining capital formation. Losing the time necessary to generate
internal liquidity would increase the likelihood funds would have to
sell desirable assets, perhaps at ``fire sale'' prices. Funds would not
have as much time to identify solutions and communicate with investors
as they would with gates. They would also lose the ability to create a
``cooling off'' period, which might temper the effects of short-term
investor panic, possibly reducing investors' incentives to redeem
shares.
    Precommiting to either a combination of a floating NAV and fees or
a combination of a floating NAV and gates would reduce funds' ability
to manage heavy redemptions relative to having a floating NAV and both
fees and gates. In addition, it would limit boards' ongoing discretion
to address potential problems. A fund's optimal response to managing
heavy redemptions would likely depend on its particular circumstance,
market conditions, and the appropriateness of imposing a fee or gate.
As discussed in section III.A above, we believe funds are likely to
first impose fees in times of market stress and then to impose gates,
but only if fees fail to control redemptions. That said, the managers
of a fund that experiences a credit event in an otherwise healthy
economy might instead choose to gate their fund to staunch redemptions,
forgoing a liquidity fee because liquidity costs are low. By forcing
funds to precommit to fees or gates (along with a floating NAV), this
alternative limits funds' ability to manage and mitigate potential
contagion from such redemptions.
2. Alternatives in the FSOC Proposed Recommendations
    As discussed in the Proposing Release, we considered a number of
alternatives for regulatory reform, including the reforms proposed by
FSOC. We received comment on several of these alternatives. After
considering the comments that FSOC received on their proposed reforms
(the ``FSOC Proposed Recommendations''), as well as the comments we
received on the

Proposing Release and the economic analysis set forth in this Release,
we have concluded that these alternatives generally would not achieve
our regulatory goals as well as the reforms we are adopting today. We
are, however, today adopting a floating NAV for institutional funds,
which was one proposed reform included in the FSOC Proposed
Recommendations. We discuss below these options, and our principal
reasons for not adopting them (other than the floating NAV for
institutional prime money market funds).
    In November 2012, the FSOC proposed to recommend that we undertake
structural reforms of money market funds. FSOC proposed three
alternatives for consideration, which, it stated, could be implemented
individually or in combination. The first option \2058\--requiring that
money market funds use a floating NAV--is one of the reforms we are
adopting today for institutional prime money market funds. We discuss
this option in section III.B below. The other two options in the FSOC
Proposed Recommendations each would require that money market funds
maintain a NAV buffer, or a specified amount of additional assets
available to absorb daily fluctuations in the value of the fund's
portfolio securities. One option would require that most money market
funds have a risk-based NAV buffer of up to 1% to absorb day-to-day
fluctuations in the value of the funds' portfolio securities and allow
the funds to maintain a stable NAV and that this NAV buffer be combined
with a ``minimum balance at risk.'' \2059\ The required minimum size of
a fund's NAV buffer would be determined based on the composition of the
money market fund's portfolio according to the following formula:
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    \2058\ See FSOC Proposed Recommendations, supra note 1562, at
section V.A.
    \2059\ Under the FSOC Proposed Recommendations, Treasury money
market funds would not be subject to a NAV buffer or a minimum
balance at risk. See FSOC Proposed Recommendations, supra note 1562,