[Federal Register Volume 86, Number 26 (Wednesday, February 10, 2021)]
[Notices]
[Pages 8938-8952]
[FR Doc No: 2021-02704]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. IC-34188; File No. S7-01-21]

Request for Comment on Potential Money Market Fund Reform
Measures in President's Working Group Report

AGENCY: Securities and Exchange Commission.

ACTION: Request for comment.

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SUMMARY: The Securities and Exchange Commission (the ``SEC'' or the
``Commission'') is seeking comment on potential reform measures for
money market funds, as highlighted in a recent report of the
President's Working Group on Financial Markets (``PWG''). Public
comments on the potential policy measures will help inform
consideration of reforms to improve the resilience of money market
funds and broader short-term funding markets.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
     Send an email to<EMAIL_ADDRESS>Please include
File No. S7-01-21 on the subject line.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-01-21. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (http://www.sec.gov). Typically,
comments are also available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Due to pandemic conditions, however, access to the Commission's
public reference room is not permitted at this time. All comments
received will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make publicly available.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this request for
comment. A notification of the inclusion in the comment file of any
such materials will be made available on the Commission's website. To
ensure direct electronic receipt of such notifications, sign up through
the ``Stay Connected'' option at www.sec.gov to receive notifications
by email.

DATES: Comments should be received on or before April 12, 2021.

FOR FURTHER INFORMATION CONTACT: Adam Lovell or Elizabeth Miller,
Senior Counsels; Angela Mokodean, Branch Chief; Thoreau Bartmann,
Senior Special Counsel; Viktoria Baklanova, Senior Financial Analyst;
or Brian Johnson, Assistant Director, at<PHONE_NUMBER>, Division of
Investment Management, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

I. The President's Working Group Report

    The PWG has studied the effects of the growing economic concerns
related to the COVID-19 pandemic in March 2020 on short-term funding
markets and, in particular, on money market funds.\1\ The results of
this study are included in the report issued on December 22, 2020 and
attached to this release as an Appendix (the ``Report'').\2\ The Report
provides an overview of prior money market fund reforms in 2010 and
2014, as well as how different types of money market funds have evolved
since the 2008 financial crisis.\3\ The Report then discusses events in
certain short-term funding markets in March 2020, focusing on money
market funds. In reviewing the events of March 2020, the Report
discusses significant outflows from prime and tax-exempt money market
funds that occurred and how these funds experienced, and began to
contribute to, general stress in short-term funding markets before the
Federal Reserve, with the approval of the Department of the Treasury,
established facilities to support short-term funding markets, including
money market funds. The Report observes that these events occurred
despite prior reform efforts to make money market funds more resilient
to credit and liquidity stresses and, as a result, less susceptible to
redemption-driven runs. Accordingly,

the Report concludes that the events of March 2020 show that more work
is needed to reduce the risk that structural vulnerabilities in prime
and tax-exempt money market funds will lead to or exacerbate stresses
in short-term funding markets. The Report discusses various reform
measures that policy makers could consider to improve the resilience of
prime and tax-exempt money market funds and broader short-term funding
markets. Many of the measures discussed in the Report could be
implemented by the Commission under our existing statutory authority,
while others may require coordinated action by multiple agencies or the
creation of new private entities.\4\ Moreover, relevant money market
funds could likely implement some of the potential reform measures
fairly quickly, while other measures would involve longer-term
structural changes.
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    \1\ The PWG is chaired by the Secretary of the Treasury and
includes the Chair of the Board of Governors of the Federal Reserve
System, the Chair of the SEC, and the Chair of the Commodity Futures
Trading Commission. For a detailed discussion of the structure and
significance of short-term funding markets and the effects of the
COVID-19 shock, as well as the effects of monetary and fiscal
measures, see SEC staff report, ``U.S. Credit Markets
Interconnectedness and the Effects of COVID-19 Economic Shock,''
(October 2020) (``SEC Staff Interconnectedness Report''), available
at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf.
The SEC Staff Interconnectedness Report also discusses the effects
of the March 2020 market stress on money market funds, including
heavy outflows from prime and tax-exempt money market funds and
significant inflows for government money market funds.
    \2\ The Report is also available at https://home.treasury.gov/system/files/136/PWG-MMF-report-final-Dec-2020.pdf.
    \3\ See Money Market Fund Reform, Investment Company Act Release
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (amending
rule 2a-7 under the Investment Company Act of 1940 (the ``Act'') to,
among other things, enhance transparency and reduce credit,
liquidity, and interest rate risks of money market fund portfolios);
Money Market Fund Reform; Amendments to Form PF, Investment Company
Act Release No. 31166 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)]
(amending rule 2a-7 under the Act to address risks stemming from
investor runs, including a floating NAV requirement for all prime
and tax-exempt money market funds sold to institutional investors
and the provision of new gate and fee tools for all prime and tax-
exempt money market funds, including retail funds).
    \4\ For example, certain policy measures discussed in the
Report, such as requiring prime and tax-exempt money market funds to
be members of a private liquidity exchange bank, may require
rulemaking by the Commission as well as regulatory action from the
Federal Reserve or other banking regulators.
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II. Request for Comment

    The Commission requests comments on the Report. Comments received
will enable the Commission and other relevant financial regulators to
consider more comprehensively the potential policy measures the Report
identifies and help inform possible money market fund reforms.\5\
Following the comment period, we anticipate conducting discussions with
various stakeholders, interested persons, and regulators to discuss the
options in the Report and the comments we receive.
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    \5\ A Commission staff statement also requested comment on the
Report. See Staff Statement on the President's Working Group Report
on Money Market Funds (Dec. 23, 2020), available at https://www.sec.gov/news/public-statement/blass-pwg-mmf-2020-12-23. With the
issuance of this Commission request for comment, commenters are
encouraged to submit comments to File No. S7-01-21 by following the
instructions at the beginning of this release.
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    We request comment on the potential policy measures described in
the Report both individually and in combination. We also request
comment on the effectiveness of previously-enacted money market fund
reforms, and the effectiveness of implementing policy measures
described in the Report in addition to, or in place of, previously-
enacted reforms. Commenters should address the effectiveness of the
measures in: (1) Addressing money market funds' structural
vulnerabilities that can contribute to stress in short-term funding
markets; (2) improving the resilience and functioning of short-term
funding markets; and (3) reducing the likelihood that official sector
interventions will be needed to prevent or halt future money market
fund runs, or to address stresses in short-term funding markets more
generally. Commenters also may address the potential impact of the
measures on money market fund investors, fund managers, issuers of
short-term debt, and other stakeholders. In addition, we are interested
in comments on other topics commenters believe are relevant to further
money market fund reform, including other approaches for improving the
resilience of money market funds and short-term funding markets
generally. We encourage commenters to submit empirical data and other
information in support of their comments.

    By the Commission.

    Dated: February 4, 2021.
Vanessa A. Countryman,
Secretary.

Report of the President's Working Group on Financial Markets

Overview of Recent Events and Potential Reform Options for Money Market
Funds

December 2020

Table of Contents

                                                               Paragraph
                                                                 Nos.

I. Overview.................................................         229
II. Background..............................................         231
    A. Money Market Funds--Structure, Asset Types, and               231
     Investor Characteristics...............................
    B. 2010 and 2014 Reforms................................         232
    1C. State of the Money Market Fund Industry Following            234
     the 2008 Financial Crisis..............................
III. Events in March 2020...................................         236
    A. Stresses in Short-Term Funding Markets...............         237
    B. Stresses on Prime and Tax-Exempt Money Market Funds           239
     and Other Money-Market Investment Vehicles.............
    C. Taxpayer-Supported Central Bank Intervention.........         242
IV. Potential Policy Measures to Increase the Resilience of          243
 Prime and Tax-Exempt Money Market Funds....................
    A. Removal of Tie between MMF Liquidity and Fee and Gate         247
     Thresholds.............................................
    1B. Reform of Conditions for Imposing Redemption Gates..         248
    C. Minimum Balance at Risk..............................         249
    D. Money Market Fund Liquidity Management Changes.......         250
    E. Countercyclical Weekly Liquid Asset Requirements.....         251
    F. Floating NAVs for All Prime and Tax-Exempt Money              252
     Market Funds...........................................
    G. Swing Pricing Requirement............................         253
    H. Capital Buffer Requirements..........................         254
    I. Require Liquidity Exchange Bank Membership...........         255
    J. New Requirements Governing Sponsor Support...........         256

I. Overview

    In March 2020, short-term funding markets came under sharp stress
amid growing economic concerns related to the COVID-19 pandemic and an
overall flight to liquidity and quality among investors. Instruments
underlying these markets include short-term U.S. Treasury securities,
short-term agency securities, short-term municipal securities,
commercial paper (``CP''), and negotiable certificates of deposit
issued by domestic and foreign banks (``NCDs''). Money market funds
(``MMFs'') are significant participants in these markets, facilitating
investment by a broad range of individuals and institutions in the
relevant short-term instruments. Because these short-term instruments
tend to have relatively stable values and MMFs offer daily redemptions,
investors in MMFs often expect to receive immediate liquidity with
limited price volatility. However, in times of stress, these
expectations may not match market conditions, causing investors to seek
to liquidate

their positions in MMFs. These investor actions, which are motivated by
both the expectation-market condition mismatch and the structural
vulnerabilities of MMFs, can amplify market stress more generally.\6\
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    \6\ For a more detailed discussion of the structure and
significance of short-term funding markets and the effects of the
COVID-19 shock, as well as the effects of monetary and fiscal
measures, see SEC staff report, ``U.S. Credit Markets
Interconnectedness and the Effects of COVID-19 Economic Shock,''
(October 2020) (``SEC Staff Interconnectedness Report''), available
at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf;
Board of Governors of the Federal Reserve System, ``Financial
Stability Report,'' (November 2020) at pp. 13-14, available at
https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf.
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    The economic and public policy considerations raised by this
dynamic among investors, MMFs, and short-term funding markets are
multi-faceted and significant. The orderly functioning of short-term
funding markets is essential to the performance of broader financial
markets and our economy more generally. It is the role of financial
regulators to identify and address market activities that have the
potential to impair that orderly functioning. Crafters of public policy
and financial regulation also must recognize that the broad
availability of short-term funding is critical to short-term funding
markets and, for many decades, prime and tax-exempt MMFs have been an
important source of demand in these markets although their market share
has decreased and assets shifted toward government MMFs in the past
decade. In addition, the participation of retail investors in MMFs
raises considerations of fairness and consumer confidence, particularly
in times of unanticipated stress, that can affect regulatory and public
policy responses.
    These dynamics and policy considerations were brought into stark
relief in March 2020. While government MMFs saw significant inflows
during this time, the prime and tax-exempt MMF sectors faced
significant outflows and increasingly illiquid markets for the funds'
assets. As a result, prime and tax-exempt MMFs experienced, and began
to contribute to, general stress in short-term funding markets in March
2020. For example, as pressures on prime and tax-exempt MMFs worsened,
two MMF sponsors intervened to provide support to their funds. It did
not appear that these funds had idiosyncratic holdings or were
otherwise distinct from similar funds and, accordingly, it was
reasonable to conclude that other MMFs could need similar support in
the near term. These events occurred despite multiple reform efforts
over the past decade to make MMFs more resilient to credit and
liquidity stresses and, as a result, less susceptible to redemption-
driven runs. When the Federal Reserve quickly took action in mid-March
by establishing, with Treasury approval, the Money Market Mutual Fund
Liquidity Facility (``MMLF'') and other facilities to support short-
term funding markets generally and MMFs specifically, prime and tax-
exempt MMF outflows subsided and short-term funding market conditions
improved.\7\
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    \7\ The MMLF makes loans available to eligible financial
institutions secured by high-quality assets the financial
institution purchased from MMFs. The MMLF also received $10 billion
in credit protection from the Treasury's Exchange Stabilization
Fund. Other relevant Federal Reserve facilities include, among
others: (1) The Commercial Paper Funding Facility (``CPFF''), which
provides a liquidity backstop to U.S. issuers of commercial paper;
and (2) the Primary Dealer Credit Facility (``PDCF''), which
provides funding to primary dealers in exchange for a broad range of
collateral.
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    Prime and tax-exempt MMFs have been supported by official sector
intervention twice over the past twelve years. In September 2008, there
was a run on certain types of MMFs after the failure of Lehman Brothers
caused a large prime MMF that held Lehman Brothers short-term
instruments to sustain losses and ``break the buck.'' \8\ During that
time, prime MMFs experienced significant redemptions that contributed
to dislocations in short-term funding markets, while government MMFs
experienced net inflows. Ultimately, the run on prime MMFs abated after
announcements of a Treasury guarantee program for MMFs and a Federal
Reserve facility designed to provide liquidity to MMFs.\9\
Subsequently, the Securities and Exchange Commission (``SEC'') adopted
reforms (in 2010 and 2014) that were designed to address the structural
vulnerabilities that became apparent in 2008.
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    \8\ A number of other funds that suffered losses in 2008 avoided
breaking the buck because they received sponsor support. See Money
Market Fund Reform; Amendments to Form PF, Investment Company Act
Release No. 31166 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)]
(``SEC 2014 Reforms'') at Section II.B.4, available at https://www.sec.gov/rules/final/2014/33-9616.pdf; See also Steffanie A.
Brady, Kenechukwu E. Anadu, and Nathaniel R. Cooper, ``The Stability
of Prime Money Market Mutual Funds: Sponsor Support from 2007 to
2011,'' Federal Reserve Bank of Boston Supervisory Research and
Analysis Working Papers (2012), available at https://www.bostonfed.org/publications/risk-and-policy-analysis/2012/the-stability-of-prime-money-market-mutual-funds-sponsor-support-from-2007-to-2011.aspx. For a description of the term ``break the buck,''
see Section II.A, below.
    \9\ For a more detailed discussion of the MMF-related events in
2008, see Report of the President's Working Group on Financial
Markets, ``Money Market Fund Reform Options,'' (October 2010)
(``2010 PWG Report''), available at https://www.treasury.gov/press-center/press-releases/Documents/10.21%20PWG%20Report%20Final.pdf.
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    Because prime and tax-exempt MMFs again have shown structural
vulnerabilities that can create or transmit stress in short-term
funding markets, it is incumbent upon financial regulators to examine
the events of March 2020 closely, and in particular the role,
operation, and regulatory framework for these MMFs, with a view toward
potential improvements. In addition, absent regulatory reform or other
action that alters market expectations, these prior official sector
interventions may have the consequence of solidifying the perception
among investors, fund sponsors, and other market participants that
similar support will be provided in future periods of stress.
    With that history and context, this report by the President's
Working Group on Financial Markets (``PWG'') begins the important
process of review and assessment.\10\ After providing background on
MMFs and prior reforms, the report discusses events in certain short-
term funding markets in March 2020, focusing on MMFs. The report then
discusses various measures that policy makers could consider to improve
the resilience of MMFs and broader short-term funding markets.\11\ This
report is meant to facilitate discussion. The PWG is not endorsing any
given measure at this time.
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    \10\ The PWG is chaired by the Secretary of the Treasury and
includes the Chair of the Board of Governors of the Federal Reserve
System, the Chair of the Securities and Exchange Commission, and the
Chair of the Commodity Futures Trading Commission.
    \11\ Given jurisdictional differences, this report is not
intended to cover events in other jurisdictions or to suggest a
uniform international approach to policy changes.
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II. Background

A. Money Market Funds--Structure, Asset Types, and Investor
Characteristics

    MMFs are a type of mutual fund registered under the Investment
Company Act of 1940 (the ``Act'') and regulated under rule 2a-7 of the
Act. MMFs offer a combination of limited principal volatility,
liquidity, and payment of short-term market returns, which make them a
popular cash management vehicle for both retail and institutional
investors. These funds also serve as an important source of short-term
financing for businesses and financial institutions, as well as
federal, state, and local governments.
    Overall, MMFs tend to invest in short-term, high-quality debt
instruments that typically are held to maturity and

fluctuate very little in value under normal market conditions. However,
from fund to fund, MMFs vary significantly. They hold different types
of investments, serve investors of different types (i.e., institutional
and retail), and pursue different investment objectives. For example,
tax-exempt MMFs hold short-term state and local government and
municipal securities, while government MMFs almost exclusively hold
obligations of the U.S. government, including obligations of the U.S.
Treasury and federal agencies and instrumentalities, as well as
repurchase agreements collateralized fully by government securities.
Traditionally, prime MMFs invest mostly in private debt instruments,
including CP and NCDs. With regard to investor characteristics, there
are three types of MMFs: (1) Retail MMFs, which are limited to retail
investors; (2) publicly-offered institutional MMFs, which are held
primarily by institutional investors and offered broadly to the public;
and (3) non-publicly-offered institutional MMFs.\12\ Variations in
portfolio holdings also correspond with investor-specific factors such
as taxing jurisdictions and, to some extent, risk/return preferences.
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    \12\ For example, funds not offered to the public include
``central'' funds that asset managers use for internal cash
management.
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    Another significant difference among different types of MMFs is how
they price the purchase and redemption of their shares. All government
MMFs, as well as retail prime and retail tax-exempt MMFs, are permitted
to price their shares at a stable net asset value (``NAV'') per share
(typically $1.00) without regard to small variations in the value of
the assets in their portfolios. These MMFs must periodically compare
their stable NAV per share to the market-based value per share of their
portfolios (or ``market-based price''). If the deviation between these
two values exceeds one-half of one percent (50 basis points), the
fund's board must consider what action, if any, to take, including
whether to adjust the fund's share price. If the repricing is below the
fund's $1.00 share price, the event is commonly called ``breaking the
buck.'' In light of the importance investors place on a stable $1.00
share price, such an action can lead to a loss of confidence in the
fund and, if it is expected to extend beyond one fund, could lead to a
loss of confidence in all similar funds. As discussed below, following
the SEC's 2014 reforms, institutional prime and institutional tax-
exempt MMFs are required to price their shares using a floating NAV,
which reflects the market value of the fund's investments and any
changes in that value, thus reducing the risk of an adverse signaling
effect from ``breaking the buck.''
    As investors commonly use MMFs for principal preservation and as a
cash management tool, many MMF investors may have a low tolerance for
losses and liquidity limitations. However, MMFs offer shareholder
redemptions on at least a daily basis (and in some cases at a stable
NAV), even though a potentially significant portion of portfolio assets
may not be converted into cash in that timeframe without a reduction in
value. When the MMF does have to sell portfolio assets at a discount,
the fund's remaining shareholders generally bear those losses. These
factors can lead to greater redemptions if investors believe they will
be better off by redeeming earlier than other investors--a so-called
``first mover'' advantage--when there is a perception that the fund may
suffer a loss in value or liquidity. Historically, amid periods of
stress for MMFs, institutional investors, who may have large holdings
and the resources to monitor risks carefully, have redeemed shares more
rapidly and extensively than retail investors.

B. 2010 and 2014 Reforms

    The SEC has implemented a number of reforms over the past decade
aimed at making MMFs more resilient to credit and liquidity stresses
and addressing structural vulnerabilities in MMFs that were evident in
the 2008 financial crisis, particularly the substantial reforms the SEC
adopted in 2010 and 2014.\13\ The 2010 reforms focused on, among other
things, enhancing transparency and reducing credit, liquidity, and
interest rate risks of fund portfolios to make MMFs more resilient and,
in the case of stable NAV funds, less likely to break the buck. For
example, the amendments introduced new liquidity requirements: At the
time an MMF acquires an asset, it must hold at least 10 percent of its
total assets in daily liquid assets (``DLA'') and at least 30 percent
of its total assets in weekly liquid assets (``WLA'').\14\ These
requirements are designed to work in combination and ensure that a MMF
has the legal right to receive enough cash within one or five business
days to satisfy redemption requests. To address credit risks, the
amendments added a new 120-day limit on funds' portfolio weighted
average life to limit exposure to credit spreads, as well as a
reduction in the limit on funds' portfolio weighted average maturity
from 90 days to 60 days to limit interest rate risk.\15\ The 2010
reforms increased transparency by requiring MMFs to publicly disclose
portfolio holdings each month. In addition, the amendments addressed
other important issues such as stress testing, orderly fund
liquidation, and repurchase agreements.
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    \13\ See Money Market Fund Reform, Investment Company Act
Release No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)]
(``SEC 2010 Reforms''), available at https://www.sec.gov/rules/final/2010/ic-29132.pdf; SEC 2014 Reforms.
    \14\ All MMFs are subject to these DLA and WLA standards, except
tax-exempt MMFs are not subject to DLA standards due to the nature
of the markets for tax-exempt securities and the limited supply of
securities with daily demand features. If a MMF's portfolio does not
meet the minimum DLA or WLA standards, it is not in violation of
rule 2a-7. However, it may not acquire any assets other than DLA or
WLA until it meets these minimum standards.
     Daily liquid assets are: Cash; direct obligations of the U.S.
government; certain securities that will mature (or be payable
through a demand feature) within one business day; or amounts
unconditionally due within one business day from pending portfolio
security sales. See rule 2a-7(a)(8).
     Weekly liquid assets are: Cash; direct obligations of the U.S.
government; agency discount notes with remaining maturities of 60
days or less; certain securities that will mature (or be payable
through a demand feature) within five business days; or amounts
unconditionally due within five business days from pending security
sales. See rule 2a-7(a)(28).
    \15\ See SEC staff report, ``Response to Questions Posed by
Commissioners Aguilar, Paredes, and Gallagher,'' (November 2012) at
pp. 18-30, available at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
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    The SEC's subsequent 2014 reforms focused on the structural
vulnerabilities that make MMFs susceptible to runs and provided tools
intended to slow runs should they occur.\16\ These reforms included a
floating NAV requirement for all prime and tax-exempt MMFs sold to
institutional investors as a means of mitigating first mover advantages
for investors who redeem from these funds when the value of their
assets decline. Under the floating NAV requirement, these MMFs must
sell and redeem their shares at prices based on the current market-
based value of the assets in their underlying portfolios rounded to the
fourth decimal place (e.g., $1.0000). Prior to the 2014 reforms, rule
2a-7

permitted these funds to maintain a stable NAV per share like all other
MMFs.
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    \16\ Prior to the 2014 reforms, the Financial Stability
Oversight Council (``FSOC'') proposed recommendations regarding MMF
reforms to address structural vulnerabilities of MMFs that the SEC's
2010 reforms did not address. These proposed recommendations, which
FSOC made pursuant to Section 120 of the Dodd-Frank Act, included
alternatives on a floating NAV, a risk-based NAV buffer of 3 percent
to provide explicit loss-absorption capacity, and a minimum balance
at risk. See Financial Stability Oversight Council, ``Proposed
Recommendations Regarding Money Market Mutual Fund Reform,''
(November 2012) (``FSOC Proposed Recommendations''), available at
https://www.treasury.gov/initiatives/fsoc/Documents/Proposed%20Recommendations%20Regarding%20Money%20Market%20Mutual%20Fund%20Reform%20-%20November%2013,%202012.pdf.
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    In addition, to provide tools to slow an investor run should it
occur, the 2014 reforms provided new fee and gate tools for all prime
and tax-exempt MMFs, including retail funds.\17\ Under the fee and gate
provisions, boards of these MMFs are permitted to impose liquidity
(redemption) fees of up to 2 percent or to temporarily suspend
redemptions if the fund's WLA falls below the 30 percent minimum
required. In addition, funds must impose a 1 percent liquidity fee if
WLA falls below 10 percent of total assets, unless the fund's board
determines that imposing the fee is not in the best interests of the
fund. Liquidity fees provide investors continued access to cash
redemptions but may reduce the incentive to redeem. Gates, on the other
hand, stop redemptions altogether for up to ten business days but may
cause investors to seek a first mover advantage and redeem in advance
of the imposition of gates.
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    \17\ Government MMFs are permitted (but not required) to adopt
fee and gate provisions.
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    Further, the 2014 amendments enhanced transparency for MMF
investors and provided information about important MMF events more
uniformly and efficiently. For instance, the amendments required MMFs
to promptly report certain significant events in filings with the SEC,
including the imposition or removal of fees or gates, portfolio
security defaults, the use of sponsor support, and a fall in a retail
or government MMF's market-based price per share below $0.9975. The
2014 reforms also generally required website disclosure of these
events, as well as daily website disclosure of a fund's DLA, WLA,
market-based NAV, and net flows. In addition, the reforms addressed MMF
diversification and valuation practices.

C. State of the Money Market Fund Industry Following the 2008 Financial
Crisis

    Since 2008, the composition of the MMF sector has changed
substantially, and the industry continued to evolve through 2020. Chart
1 provides information about changes in net assets by type of MMF,
while Chart 2 provides more detail about subcategories of prime and
tax-exempt MMFs (i.e., retail and institutional funds). As of September
30, 2020, total industry net assets were $4.9 trillion, down slightly
from an all-time high of $5.2 trillion in May 2020 (see Chart 1).
BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TN10FE21.001

[GRAPHIC] [TIFF OMITTED] TN10FE21.002

BILLING CODE 8011-01-C
    The assets of government MMFs (the blue line in Chart 1), which
were under $1 trillion in August 2008, have grown considerably since
then. Much of the growth occurred in 2016, when government MMF assets
increased more than $1 trillion as investors shifted money from prime
and tax-exempt MMFs, which were required, starting in October 2016, to
implement the more significant aspects of the 2014 reforms.\19\ In
March 2020, government MMF assets increased by $840 billion to $3.6
trillion, and their assets reached nearly $4.0 trillion at the end of
April. As of September 2020, government MMFs accounted for 77 percent
of industry net assets.
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    \18\ The 2014 amendments introduced a regulatory definition of a
retail MMF (and implemented it in 2016). Because data on
institutional and retail MMFs prior to October 2016 may not be
entirely comparable with current statistics, Chart 2 does not
include data on retail and institutional MMFs prior to October 2016.
     The drop in prime retail MMF assets in September 2020 is the
result of a large prime retail MMF converting to a government MMF.
    \19\ The compliance date for the floating NAV requirement for
institutional prime and institutional tax-exempt MMFs and for the
fee and gate provisions for all prime and tax-exempt funds was
October 14, 2016.
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    The net assets of prime MMFs (the red line in Chart 1) contracted
substantially in the year leading up to the October 2016 deadline for
implementing the 2014 MMF reforms and were $550 billion in December
2016. By February 2020, these funds' assets had recovered to $1.1
trillion, but their assets fell $125 billion on net in March. As of
September 2020, prime MMFs accounted for around 20 percent of industry
net assets.
    Net assets in tax-exempt MMFs (the dashed green line in Chart 1)
have also declined since 2008, when these funds had net assets
exceeding $500 billion. Tax-exempt funds' assets fell $120 billion in
the year before October 2016 and were about $135 billion at the end of
2016. By February 2020, tax-exempt fund assets were about $140 billion,
and they declined $9 billion in March 2020. The vast majority of tax-
exempt MMF net assets are in retail funds (see Chart 2). Tax-exempt
MMFs represent under three percent of total industry net assets as of
September 2020.

III. Events in March 2020

    Amid escalating concerns about the economic impact of the COVID-19
pandemic in March 2020, market participants sought to rapidly shift
their holdings toward cash and short-term government securities. This
rapid shift in asset allocation preferences placed stress on various
components of short-term funding markets, including prime and tax-
exempt MMFs, the repo markets, the CP market, and short-term municipal
securities markets (including the market for variable-rate demand notes
(``VRDNs'')). As discussed in more detail below, pressures on prime and
tax-exempt MMFs again revealed structural vulnerabilities in MMFs that
led to increased redemptions and, in turn, began to contribute to and
increase the general stress in short-term funding markets.

A. Stresses in Short-Term Funding Markets

    Private short-term debt markets. In markets for private short-term
debt instruments, such as CP and NCDs, conditions began to deteriorate
rapidly in the second week of March. Spreads for instruments held by
MMFs began widening sharply (see Chart 3). Specifically, spreads to
overnight indexed swaps (``OIS'') for AA-rated nonfinancial CP reached
new historical highs, while spreads for AA-rated financial CP and A2/
P2-rated nonfinancial CP widened to the highest levels seen since the
2008 financial crisis. Along with widening spreads, new issuance of CP
and NCDs declined markedly and shifted to short tenors. For instance,
the share of CP issuance with overnight maturity climbed steadily to
nearly 90 percent on March 23.
    Pricing and liquidity concerns at MMFs were driven by, and began to
contribute to, these market stresses. Widening spreads in short-term
funding markets put downward pressure on the prices of assets in prime
MMFs' portfolios, and redemptions from MMFs likely contributed to
stress in these markets, as prime funds reduced their CP holdings
disproportionately compared to other holders. At the end of February,
prime MMFs offered to the public owned about 19 percent of outstanding
CP.\20\ From March 10 to

March 24, these funds cut their CP holdings by $35 billion. This
reduction accounted for 74 percent of the $48 billion overall decline
in outstanding CP over those two weeks.\21\ In addition, MMFs with WLAs
close to 30 percent were likely reluctant to purchase assets with
maturities of more than 7 days that would not qualify as WLA to avoid
going below the regulatory requirements.\22\ Beyond MMFs, there were
also other factors contributing to stress in CP markets, including
outflows from other investment vehicles that invest in these markets
(see below).
---------------------------------------------------------------------------

    \20\ Total CP outstanding at the end of February 2020 was $1.1
trillion (source: Federal Reserve). Holdings of publicly-offered
prime funds are based on data from iMoneyNet. Total prime MMF
holdings of CP, including internal funds that are not offered to the
public, were 29 percent of outstanding CP at the end of February
2020 (source: SEC Form N-MFP).
    \21\ About $6 billion of the reduction in MMF holdings of CP
during this time was pledged as collateral to the MMLF.
    \22\ Funds with WLAs below the 30 percent minimum threshold are
prohibited from purchasing assets that are not WLAs, including CP
and NCDs with maturities exceeding 7 days. On March 17 and 18, one
prime MMF offered to institutional investors reported WLAs below 30
percent.
---------------------------------------------------------------------------

    Some market participants have suggested that another contributing
factor to stress in CP markets was that dealers in CP markets (as well
as issuing dealers and banks) were experiencing their own liquidity
pressures and limits on their willingness to intermediate in money
markets.\23\ Historically, however, because the vast majority of CP
typically is held to maturity, dealers have not had a substantial role
in making secondary markets in CP. This is also the case for other
private short-term debt instruments that prime MMFs hold. Thus, there
was no reason to expect dealers to take a materially increased
intermediation role in these assets in March. There are also a large
number of individual issues (i.e., CUSIPs) in the private short-term
debt markets, which adds complexity to intermediation.\24\ In contrast
to the private short-term debt markets, Treasury and agency securities
markets have fewer CUSIPs, large daily trading volumes, and more liquid
secondary markets, with primary dealers and others playing a large
daily intermediation role in these markets.
---------------------------------------------------------------------------

    \23\ For example, large customer sales increased dealers'
inventories of Treasuries and mortgage-backed securities. Facing
balance sheet constraints and internal risk limits amid the elevated
volatility, dealers cut back on intermediation more generally.
    \24\ According to DTCC's Money Market Kinetics report as of
March 31, 2020 (available at https://www.dtcc.com/money-markets),
the 12-month average of daily settlements for fixed and floating
rate CP was approximately $80 billion, although only a small share
of this volume appears to have been secondary market transactions,
and further analysis of secondary market activity is needed. As
previously noted, there was approximately $1.1 trillion of total CP
outstanding at the end of February 2020.
[GRAPHIC] [TIFF OMITTED] TN10FE21.003

    Short-term municipal debt markets. Conditions in short-term
municipal debt markets also worsened rapidly in mid-March. Similar to
the relationship between the CP market and prime MMFs discussed above,
stresses in short-term municipal markets contributed to pricing
pressures and outflows for tax-exempt MMFs which, in turn, contributed
to increased stress in municipal markets. Beginning on March 12, tax-
exempt MMFs experienced unusually large redemptions, with outflows
accelerating over the next week. In response, tax-exempt funds reduced
their holdings of VRDNs by about 16 percent ($15 billion) in the two
weeks from March 9 to March 23, with primary dealer VRDN inventories
nearly tripling in the week ending March 18. VRDNs have a demand or
tender feature that allows tax-exempt MMFs to require the tender agent
to repurchase the security at par plus accrued interest. When a tax-
exempt MMF tenders a VRDN, a remarketing agent typically remarkets the
VRDN to other investors at a higher yield (and thus a lower price).
    The redemption stresses on tax-exempt MMFs likely contributed to
worsening conditions in short-term municipal debt markets. The SIFMA 7-
day municipal swap index yield, a benchmark weekly rate in these
markets, shot up 392 basis points on

March 18, as remarketing agents offered VRDNs at higher yields in
response to tax-exempt MMFs putting back their notes to tender agents.
The spike in the SIFMA index yield caused a drop in market-based NAVs
of tax-exempt MMFs (which mostly have stable, rounded NAVs).

B. Stresses on Prime and Tax-Exempt Money Market Funds and Other Money-
Market Investment Vehicles

    As part of the general deterioration in short-term funding market
conditions, prime and tax-exempt MMFs experienced heavy redemptions
beginning in the second week of March 2020. Outflows increased quickly,
peaking on March 17 for prime funds (the day the Federal Reserve
announced the CPFF) and on March 23 for tax-exempt funds (one business
day after the Federal Reserve's MMLF was expanded to include tax-exempt
securities).\25\
---------------------------------------------------------------------------

    \25\ The following discussion provides data on the size of the
largest outflows from different types of MMFs during a given two-
week (10 business day) period in March. These two-week periods do
not necessarily coincide. For example, the two-week period for
institutional prime funds begins two days before that for retail
prime funds, in part because institutional prime funds experienced
heavy redemptions earlier than retail prime funds. Using data for
one-week periods provides qualitatively similar results. For
comparison purposes, we also provide data on outflows for a standard
two-week period from March 9 to March 20 for all types of MMFs,
based on SEC Form N-MFP weekly data.
---------------------------------------------------------------------------

    Institutional prime fund outflows. Among institutional prime MMFs
offered to the public, outflows as a percentage of fund size exceeded
those in the September 2008 crisis. However, the dollar amount of
outflows from these funds was much smaller in March 2020, in part
because their assets on the eve of the pandemic were less than one-
quarter of their size on the eve of the 2008 crisis. Over the two-week
period from March 11 to 24, net redemptions from publicly-offered
institutional prime funds totaled 30 percent (about $100 billion) of
the funds' assets, and these funds' outflows exceeded 5 percent of
their assets on three consecutive days beginning on March 17. For
comparison, in September 2008, the highest outflows from these funds
over a two-week period were about 26 percent (about $350 billion) of
assets.\26\
---------------------------------------------------------------------------

    \26\ Data on daily MMF flows are from iMoneyNet. SEC Form N-MFP
provides an official source of weekly flows data (for weeks ending
on Fridays). For the two weeks from March 9 to 20, outflows from
institutional prime funds that are offered to the public (as proxied
by their presence in commercial databases) totaled $90 billion (27
percent of assets). Form N-MFP weekly flows data are not available
for the September 2008 crisis.
---------------------------------------------------------------------------

    A sizable portion of the institutional prime fund sector's assets
are in funds that are not offered to the public.\27\ These non-public
funds had smaller outflows than their publicly-offered counterparts,
indicating that, on average, the former do not demonstrate the same
vulnerabilities as funds that are offered publicly to a broad range of
unaffiliated institutional investors. This difference may be
attributable to investor characteristics as much as or more than the
nonpublic nature of the offering. Outflows from non-public
institutional prime funds totaled 6 percent ($17 billion) of assets
from March 9 to March 20.\28\
---------------------------------------------------------------------------

    \27\ See footnote 12 and accompanying text for an explanation of
publicly-offered funds versus non-public funds.
    \28\ Source: SEC Form N-MFP.
---------------------------------------------------------------------------

    Retail prime fund outflows. Although outflows from retail prime
MMFs as a share of assets in March exceeded retail prime MMF outflows
during the 2008 crisis, the March outflows from retail prime MMFs were
smaller than outflows from institutional prime MMFs. The redemptions
from retail prime MMFs in March began a couple of days after those for
institutional funds. Net redemptions totaled 9 percent (just over $40
billion) of assets over the two weeks from March 13 to 26.\29\ In
September 2008, the heaviest retail outflows over a two-week period
totaled 5 percent of assets. Retail prime funds had about 60 percent
more assets in 2008 than in February 2020, so outflows were similar in
dollar terms in both crises.\30\ Some retail prime MMFs experienced
declining market-based prices in March, but none of these funds
reported a market-based price below $0.9975. Moreover, retail prime MMF
flows in March 2020 appear to have been unrelated to market-based
prices, as funds with lower market-based prices did not experience
larger outflows than other retail prime MMFs.
---------------------------------------------------------------------------

    \29\ Source: iMoneyNet daily data. Similarly, data from SEC Form
N-MFP show retail prime fund outflows of 7 percent of assets ($33
billion) over the two week period from March 9 to 20.
    \30\ See footnote 18 (explaining that data on institutional and
retail MMFs prior to 2016 may not be entirely comparable with
current statistics).
---------------------------------------------------------------------------

    Tax-exempt fund outflows and declining market-based prices.
Outflows from tax-exempt MMFs, which are largely retail funds, were 8
percent ($11 billion) of assets during the two weeks from March 12 to
25.\31\ In 2008, when tax-exempt MMF assets were more than four times
larger than in February 2020, such funds had outflows of 7 percent
(almost $40 billion) of assets in one two-week period. In March, some
retail tax-exempt MMFs also had declining market-based prices. Although
none of these funds broke the buck, one fund reported a market-based
price below $0.9975. As with retail prime MMFs, there does not appear
to have been a relationship between a decline in a particular retail
tax-exempt MMF's market-based price and the size of its outflows.
---------------------------------------------------------------------------

    \31\ Source: iMoneyNet daily data. Similarly, data from SEC form
N-MFP show tax-exempt fund outflows of 8 percent of assets ($11
billion) over the two weeks from March 9 to 20.
---------------------------------------------------------------------------

    Declining WLAs and relation to fees and gates. As prime funds
experienced heavy redemptions, their WLAs declined, and some funds'
WLAs (which must be disclosed publicly each day) approached or fell
below the 30 percent minimum threshold that SEC rules require. Investor
redemptions, which may have been further exacerbated by declining WLAs,
can put additional pressure on fund liquidity during times of stress.
As previously noted, when a fund's WLA falls below 30 percent, the fund
can impose fees or gates on redemptions. Market participants reported
concerns that the imposition of a fee or gate by one fund, as well as
the perception that a fee or gate would be imposed by one fund, could
spark widespread redemptions from other funds, leading to further
stresses in the underlying markets. Although one institutional prime
fund (with assets that declined from $3.8 billion at the end of
February to $1.5 billion at the end of March) had WLAs below the 30
percent minimum, it did not impose a fee or gate in March.
    Preliminary research indicates that prime fund outflows accelerated
as WLAs declined, suggesting that the potential imposition of a fee or
gate when a fund's WLA drops below 30 percent encouraged institutional
investors to redeem before that threshold was crossed.\32\
Additionally, some market participants and observers have suggested
that investors' potential motivation to redeem as a MMF moves toward
the 30 percent threshold is primarily driven by concerns about gates,
rather than liquidity fees, because MMF investors have a low tolerance
for being unable to access cash on demand.
---------------------------------------------------------------------------

    \32\ See Lei Li, Yi Li, Marco Macchiavelli, and Xing (Alex)
Zhou, ``Runs and Interventions in the Time of COVID-19: Evidence
from Money Funds,'' working paper (2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3607593.
---------------------------------------------------------------------------

    Sponsor support. As strains on prime and tax-exempt MMFs worsened,
two fund sponsors provided support for their funds. They did so by
purchasing securities from three prime institutional MMFs and making a
capital contribution to one tax-exempt fund.
    Other investment vehicles that invest in securities and other
instruments

similar to MMFs. Other investment vehicles that invest in instruments
held by MMFs also experienced outflows and stress in March. Short-term
investment funds (``STIFs'') operated by banks, which have assets of
about $300 billion, had outflows in March and experienced related
stress.\33\ Ultra-short corporate bond mutual funds, which had assets
of $200 billion in February 2020, had outflows of $33 billion (16
percent of assets) in March.\34\ In addition, in the two weeks from
March 12 to 25, outflows from European dollar-denominated MMFs
investing in assets similar to U.S. prime MMFs (so-called offshore
MMFs, which are largely domiciled in Ireland and Luxembourg), totaled
25 percent (about $95 billion) of assets.\35\
---------------------------------------------------------------------------

    \33\ The Office of the Comptroller of the Currency (``OCC''),
which oversees national banks operating STIFs, issued an interim
final rule and an administrative order allowing STIFs to extend
their dollar-weighted average portfolio maturity and dollar-weighted
average portfolio life maturity to alleviate pressure on STIF
management's ability to comply with these maturity limits in light
of stressed market conditions. See Short-Term Investment Funds, 85
FR 16888 (Mar. 25, 2020), available at https://www.occ.gov/news-issuances/federal-register/2020/85fr16888.pdf.
    \34\ Source: Morningstar data.
    \35\ Source: iMoneyNet data.
---------------------------------------------------------------------------

    Prime and tax-exempt MMFs' role in short-term funding markets'
stress. Short-term funding markets are interconnected with other market
segments, and stress in one market can lead to stress in others. Prime
and tax-exempt MMFs were not the sole contributors to the pressures in
short-term funding markets.\36\ However, it appears that MMF actions
were particularly significant relative to market size. For example, as
noted above, prime funds reduced their CP holdings disproportionately
compared to other holders.\37\
---------------------------------------------------------------------------

    \36\ For example, leveraged non-bank entities, such as hedge
funds using Treasury collateral and real estate investment trusts
using agency mortgage-backed security collateral, may have also
contributed to pressure in short-term funding markets. See, e.g.,
FSOC Annual Report 2020 at p. 5, available at https://home.treasury.gov/system/files/261/FSOC2020AnnualReport.pdf.
    \37\ See paragraph accompanying footnote 20.
---------------------------------------------------------------------------

C. Taxpayer-Supported Central Bank Intervention

    On March 18, 2020, the Federal Reserve, with the approval of the
Secretary of the Treasury, authorized the MMLF, which began to operate
on March 23.\38\ The MMLF provides non-recourse loans to U.S.
depository institutions and bank holding companies to finance their
purchases of specified eligible assets from MMFs under certain
conditions. The non-recourse nature of the loan protects the borrower
from any losses on the asset pledged to secure the MMLF loan. The
Federal Reserve, along with the OCC and Federal Deposit Insurance
Corporation (``FDIC''), also took steps to neutralize the effects of
purchasing assets through the MMLF on risk-based and leveraged capital
ratios and liquidity coverage ratio requirements of financial
institutions to facilitate participation in the facility.\39\ The MMLF
program, in combination with other programs, was intended to stabilize
the U.S. financial system by allowing MMFs to raise cash to meet
redemptions and to foster liquidity in the markets for the assets held
by MMFs, including the markets for CP, NCDs, and short-term municipal
securities.\40\ The Department of the Treasury provided $10 billion of
credit protection to the Federal Reserve in connection with the MMLF
from the Treasury's Exchange Stabilization Fund.\41\ MMLF utilization
ramped up quickly to a peak of just over $50 billion in early April, or
about 5 percent of net assets in prime and tax-exempt MMFs at the time.
---------------------------------------------------------------------------

    \38\ Information about the MMLF is available on the Federal
Reserve's website at https://www.federalreserve.gov/monetarypolicy/mmlf.htm. The Federal Reserve Bank of Boston operates the MMLF.
    \39\ See Regulatory Capital Rule: Money Market Mutual Fund
Liquidity Facility, 85 FR 16232 (March 23, 2020), available at
https://www.federalregister.gov/documents/2020/03/23/2020-06156/regulatory-capital-rule-money-market-mutual-fund-liquidity-facility;
Liquidity Coverage Ratio Rule: Treatment of Certain Emergency
Facilities, 85 FR 26835 (May 6, 2020), available at https://www.federalregister.gov/documents/2020/05/06/2020-09716/liquidity-coverage-ratio-rule-treatment-of-certain-emergency-facilities.
    \40\ The MMLF would not have worked in isolation, and other
programs and monetary policy responses would not have worked as well
without the MMLF. See SEC Staff Interconnectedness Report; Marco
Cipriani et al., ``Municipal Debt Markets and the COVID-19
Pandemic,'' (June 29, 2020), available at https://libertystreeteconomics.newyorkfed.org/2020/06/municipal-debt-markets-and-the-covid-19-pandemic.html.
    \41\ The CARES Act also temporarily removed restrictions on
Treasury's authority to use the Exchange Stabilization Fund to
guarantee money market funds. See section 4015 of the CARES Act.
This authority has not been used.
---------------------------------------------------------------------------

    Outflows from prime MMFs abated fairly quickly after the Federal
Reserve's announcement of programs and other actions to support short-
term funding markets and the flow of credit to households and
businesses more generally, including its initial announcement of the
MMLF on March 18.\42\ Overall market conditions also began to improve.
For example, in the CP market, the share of CP issuance with overnight
maturity began to fall on March 24 and spreads to OIS for most types of
term CP started narrowing a few days later. After the expansion of the
MMLF to include municipal securities on March 20 (and VRDNs on March
23), tax-exempt MMF outflows eased and conditions in short-term
municipal debt markets improved. Beyond the MMLF, several other Federal
Reserve actions and announcements in March likely contributed to these
improved conditions. For example, the Federal Open Market Committee
lowered the target range for the federal funds rates twice in March by
a total of 150 basis points. A large increase in open market purchases
of Treasury securities and agency mortgage-backed securities was
announced on March 15, and establishments of the PDCF and the CPFF were
announced on March 17.
---------------------------------------------------------------------------

    \42\ See, e.g., ``Federal Reserve Issues FOMC Statement'' (March
15, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm; ``Federal Reserve Actions to
Support the Flow of Credit to Households and Businesses'' (March 15,
2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm; ``Federal Reserve Board
Announces Establishment of a Commercial Paper Funding Facility
(CPFF) to Support the Flow of Credit to Households and Businesses''
(March 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317a.htm; ``Federal Reserve
Board Announces Establishment of a Primary Dealer Credit Facility
(PDCF) to Support the Credit Needs of Households and Businesses''
(March 17, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200317b.htm; ``Federal Reserve
Board Broadens Program of Support for the Flow of Credit to
Households and Businesses by Establishing a Money Market Mutual Fund
Liquidity Facility (MMLF)'' (March 18, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm.
---------------------------------------------------------------------------

    While stress affected a variety of money market instruments and
investment vehicles, the broad policy responses from the Federal
Reserve, including the availability of secondary market liquidity for
MMFs through the MMLF, appeared to have had the intended broad calming
effect on short-term funding markets. For instance, although European
dollar-denominated MMFs are not eligible to participate in the MMLF,
outflows from these funds abated shortly after the MMLF began
operations. The resulting stability in short-term funding markets,
along with the fiscal stimulus provided by the CARES Act and the
expectation of continued accommodative monetary policy, facilitated
stability in the capital markets more generally.

IV. Potential Policy Measures To Increase the Resilience of Prime and
Tax-Exempt Money Market Funds

    While many of the post-2008 MMF reforms added stability to MMFs,
the events of March 2020 show that more work is needed to reduce the
risk that

structural vulnerabilities in prime and tax-exempt MMFs will lead to or
exacerbate stresses in short-term funding markets. The following
discussion sets forth potential policy measures that could address the
risks prime and tax-exempt MMFs pose to short-term funding markets.
This report is meant to facilitate discussion. The PWG is not endorsing
any given measure at this time.
    These potential policy measures differ in terms of the scope and
breadth of regulatory changes they would require. For example, many of
the potential reforms would apply only to prime and tax-exempt MMFs,
while reforms such as swing pricing could apply to mutual funds more
generally. Moreover, some potential reforms would involve targeted
amendments to SEC rules, which relevant MMFs could likely implement
fairly quickly, while others would involve longer-term structural
changes or may require coordinated action by multiple agencies. The
different measures are not necessarily mutually exclusive, nor are they
equally effective at mitigating the vulnerabilities of prime and tax-
exempt MMFs. Policy makers could combine certain measures within a
single set of reforms. Some policy measures listed below have been
raised for consideration previously, including in the PWG's October
2010 report on MMF reform options and the FSOC's 2012 proposed
recommendations on MMF reform, and warrant renewed consideration in
light of recent MMF stresses.
    This report focuses on reform measures for MMFs only. It is
important to recognize MMFs' role in the market events in March 2020
and to examine measures that would address concerns and structural
vulnerabilities specific to MMFs. Although they are beyond the scope of
this report, and as discussed generally above, there were other
stresses in short-term funding markets in March 2020 that may have
contributed to the pressure on MMFs.
    As discussed in more detail below, the potential policy measures
for prime and tax-exempt MMFs explored in this report are:
     Removal of Tie between MMF Liquidity and Fee and Gate
Thresholds;
     Reform of Conditions for Imposing Redemption Gates;
     Minimum Balance at Risk (``MBR'');
     Money Market Fund Liquidity Management Changes;
     Countercyclical Weekly Liquid Asset Requirements;
     Floating NAVs for All Prime and Tax-Exempt Money Market
Funds;
     Swing Pricing Requirement;
     Capital Buffer Requirements;
     Require Liquidity Exchange Bank (``LEB'') Membership; and
     New Requirements Governing Sponsor Support.
    Overarching goals for MMF reform. As a threshold matter, it should
be recognized that the various policy reforms, individually and in
combination, should be evaluated in terms of their ability to
effectively advance the overarching goals of reform. That is:
     First, would they effectively address the MMF structural
vulnerabilities that contributed to stress in short-term funding
markets?
     Second, would they improve the resilience and functioning
of short-term funding markets?
     Third, would they reduce the likelihood that official
sector interventions and taxpayer support will be needed to halt future
MMF runs or address stresses in short-term funding markets more
generally?
    Assessment of the MMF reform options. An assessment of the
effectiveness of reform options in achieving these goals should take
into account: (a) How each option would address MMF structural
vulnerabilities and contribute to the overarching goals; (b) the effect
of each option on short-term funding markets and the MMF sector more
broadly, including through its effects on the resilience, functioning,
and stability of short-term funding markets, as well as whether the
reform option would trigger the growth of existing investment
strategies and products, or the development of new strategies and
products, that could either exacerbate or mitigate market
vulnerabilities; and (c) potential drawbacks, limitations, or
challenges specific to each reform option. The reform options
considered in this report seek to achieve the goals in different ways.
For example, some are intended to address the liquidity-related
stresses that were evident in March 2020, while others also touch on
potential credit-related concerns. This menu of options reflects the
possibility that future financial stress events may affect the
liquidity of short-term investments, their credit quality, or both.
    (a) How the reform options would seek to achieve the goals.
    (1) Internalize liquidity costs of investors' redemptions,
particularly in stress periods. Some options would impose a cost on
redeeming investors that rises as liquidity stress increases to reflect
the costs of redemptions for the fund. These options, particularly
swing pricing and the MBR, could reduce or eliminate first-mover
advantages for redeeming investors and protect investors who do not
redeem.
    (2) Decouple regulatory thresholds from consequences such as gates,
fees, or a sudden drop in NAV. Some options, such as those that revise
fee and gate thresholds or introduce the floating NAV for retail prime
and tax-exempt MMFs, could eliminate or diminish the importance of
thresholds (such as 30 percent WLA or an NAV of $0.995) that may spur
investor redemptions. By diminishing the importance of thresholds,
these options could also give MMFs greater flexibility, for example, to
tap their own liquid assets to meet redemptions.
    (3) Improve MMFs' ability to use available liquidity in times of
stress. In March 2020, some prime and tax-exempt MMFs may have avoided
using their liquid assets to meet redemptions. Options such as
countercyclical WLA requirements or revisions to fee and gate
thresholds could make MMFs more comfortable in deploying their liquid
assets in times of stress.
    (4) Commit private resources ex ante to enable MMFs to withstand
liquidity stress or a credit crisis. When prime and tax-exempt MMFs
have encountered serious strains, official sector interventions have
followed quickly. Options such as capital buffers, explicit sponsor
support, and the LEB could provide committed private resources to
supply liquidity or absorb losses and thus reduce the likelihood that
official sector support would be needed to calm markets.
    (5) Further improve liquidity and portfolio risk management.
Changes to liquidity management requirements could include raising
required liquid-asset buffers. Other options could motivate more
conservative risk management by explicitly making fund sponsors or
others responsible for absorbing any heightened liquidity needs or
losses in their MMFs.
    (6) Clarify that MMF investors, rather than taxpayers, bear market
risks. Government support has repeatedly provided emergency liquidity
to prime and tax-exempt funds and also has obscured the risks of
liquidity and credit shocks for MMFs. Some options, such as the
floating NAV for retail prime and tax-exempt MMFs, swing pricing, and
the MBR could make risks to investors more apparent.
    (b) Effects on short-term funding markets. The reform options are
intended to reduce the structural vulnerabilities of MMFs, which could
make them a more stable source of short-term funding for financial
institutions, businesses, and state and local governments. This would
improve

the stability and resilience of short-term funding markets.
    At the same time, some of the reform options would likely diminish
the size of prime and tax-exempt MMFs, which would also affect the
functioning of short-term funding markets. A shrinkage of MMFs could
reduce the supply of short-term funding for financial institutions,
businesses, and state and local governments. Making prime and tax-
exempt MMFs less desirable as cash-management vehicles also could cause
investors to move to less regulated and less transparent mutualized
cash-management vehicles that are also susceptible to runs that cause
stress in short-term funding markets.
    A reduction in the size of prime and tax-exempt MMFs may not
necessarily be inappropriate if, for example, the growth of these funds
has reflected in part the effects of implicit taxpayer subsidies and
other externalities (that is, broader economic costs of runs that are
not borne by investors or the funds). In addition, if these MMFs remain
run prone, a reduction in the size of the industry could mitigate the
effects of future runs from these funds on short-term funding markets.
    The aftermath of the 2014 MMF reforms provides a precedent for the
consequences of a substantial reduction in the size of prime and tax-
exempt funds, although a future experience could differ. In the year
before the October 2016 implementation deadline for those reforms,
aggregate prime MMF assets shrank by $1.2 trillion (69 percent) and
tax-exempt MMF assets declined about $120 billion (47 percent).
Nonetheless, to the extent that spreads for instruments held by these
MMFs were affected, they generally widened only temporarily, and
investor migration to other mutualized cash-management vehicles was
largely limited to shifts to government MMFs. (Over the next three
years, prime MMFs regained about half of the 2015-2016 decline.)
    These considerations are important, because some of the reform
options could reduce the size of the prime and tax-exempt fund sectors
by:
     Reducing attractiveness of prime and tax-exempt MMFs for
investors. The costs associated with some options, such as capital
buffers and LEB membership, may reduce the funds' yields. The MBR would
limit the liquidity of their shares in some circumstances. The floating
NAV requirement and swing pricing would make NAVs more volatile and MMF
shares less cash-like. And investors may view some policies, such as
swing pricing and the MBR, as unfamiliar, restrictive, and complicated.
     Increasing costs associated with MMF sponsorship. Some
options, such as the introduction of capital buffers, required LEB
membership, and explicit sponsor support, could raise operating costs
for sponsors. Other options, such as swing pricing and MBR, may also
have sizable implementation costs. Increased costs and operational
complexity could lead to increased concentration and a reduction in the
overall size of the MMF industry.
    (c) Potential drawbacks, limitations, and challenges specific to
each option. Evaluation of the reform options also should take into
account potential drawbacks, limitations, and challenges of each
option, such as implementation challenges or limits on an option's
ability to achieve the desired goals. The report discusses these
considerations for each option below.
    Several specific policy options are described below, along with a
high-level analysis of the potential benefits and drawbacks of each
option.

A. Removal of Tie Between MMF Liquidity and Fee and Gate Thresholds

    Liquidity fees and redemption gates are intended to give MMF boards
tools to stem heavy redemptions by imposing a fee to reduce
shareholders' incentives to redeem or by stopping redemptions
altogether for a period of time. Currently, MMF boards have discretion
to impose fees or gates when WLAs fall below 30 percent of total assets
and generally must impose a fee of 1 percent if WLAs fall below 10
percent, unless the board determines that such a fee would not be in
the best interest of the fund or that a lower or higher (up to 2
percent) liquidity fee is in the best interests of the fund.
    Definitive thresholds for permissible imposition of liquidity fees
and redemption gates may have the unintended effect of triggering
preemptive investor redemptions as funds approach the relevant
thresholds. Some preliminary research suggests that redemptions
accelerated in March 2020 from funds with declining WLAs.\43\ Removing
the tie between the 30 percent and 10 percent WLA thresholds and the
imposition of fees and gates is one possible reform. Fund boards could
be permitted to impose fees or gates when doing so is in the best
interest of the fund, without reference to any specific level of
liquidity.
---------------------------------------------------------------------------

    \43\ See footnote 32, above.
---------------------------------------------------------------------------

    Potential benefits:
     Removing the tie between the WLA thresholds and funds'
ability to impose gates and fees would reduce the salience of these
thresholds and could diminish the incentive for preemptive runs.
     This may improve the usability of WLA buffers by making
MMFs more comfortable in deploying their liquid assets in times of
stress.
    Potential drawbacks, limitations, and challenges:
     While this option would remove a focal point that may
trigger runs, it would do little otherwise to mitigate run incentives.
     If MMFs maintain fewer liquid assets (by holding WLA
levels closer to 30 percent) as a result of this change, the funds may
be less equipped to manage significant redemptions without engaging in
fire sales.
     Permitting funds to impose fees or gates without reference
to a specific threshold may cause broader contagion if investors fear
the imposition of fees or gates in other funds that otherwise would
have been seen as safe.

B. Reform of Conditions for Imposing Redemption Gates

    Reforming rules regarding redemption gates to reduce the likelihood
that gates may be imposed could diminish investors' incentives to
engage in preemptive runs. For example, funds could be required to
obtain permission from the SEC or notify the SEC prior to imposing
gates. Alternatively, fund boards could be required to consider
liquidity fees before gates, making it less likely that gates would be
imposed. Another option could be to lower the WLA threshold at which
gates could be imposed to, for example, 10 percent.
    Gate rules also could be reformed to make gates ``soft'' or
``partial.'' With soft gates, for example, if redemptions on a
particular day exceed a certain amount, a fund could reduce each
investor's redemption pro rata to bring total redemptions below that
amount, with remaining redemption amounts deferred to the next business
day (and continuing daily deferrals until all redemption requests are
satisfied). This affords investors at least some liquidity, in contrast
to the complete curtailment of liquidity when a fund suspends all
redemptions.
    Potential benefits:
     Reforming the rules around gates might reduce concerns
that gates will be imposed immediately upon a breach of the 30 percent
WLA requirement and reduce the salience of that threshold, particularly
if investors are more concerned about gates than fees.
     Gates could still be imposed, but only in very dire
conditions when runs on funds are likely anyway.

     This may improve the usability of WLA buffers by making
MMFs more comfortable in deploying their liquid assets in times of
stress.
     A ``soft'' or ``partial'' gate could reduce disruptions
caused by the imposition of a gate by allowing shareholders to redeem a
portion of shares as normal, with a portion held for a limited time to
help the fund slow the rate of redemptions during stress periods
without engaging in fire sales.
    Potential drawbacks, limitations, and challenges:
     If thresholds remain, they could still be focal points for
runs on MMFs.
     While this option could reduce the salience of a threshold
that may trigger runs, it would do little otherwise to mitigate run
incentives.
     Reducing the likelihood that a gate may be imposed could
reduce the potential utility of gates as a tool to slow investor
redemptions.
     Providing the SEC a role in granting permission for
imposition of gates may result in less timely action than the current
framework involving the MMF's board, particularly if multiple MMFs seek
SEC permission in a short period of time, which could allow runs to
continue or accelerate. Absent a threshold, it could be challenging to
develop objective criteria in advance for quickly approving or denying
such requests in a consistent and appropriate manner amid a fast-moving
crisis.
     If MMFs maintain fewer liquid assets (by holding WLA
levels closer to 30 percent) as a result of this change, the funds may
be less equipped to manage significant redemptions without engaging in
fire sales.
     Like other gates, a ``soft'' (or ``partial'') gate may
spur preemptive runs, but a soft gate may be less effective at slowing
runs than a full gate, as investors can continue to redeem even after a
soft gate has been imposed.
     ``Soft'' or ``partial'' gates could introduce accounting
and administrative complexities.

C. Minimum Balance at Risk

    An MBR is a portion of each shareholder's recent balances in a MMF
that would be available for redemption only with a time delay to ensure
that redeeming investors still remain partially invested in the fund
over a certain time period. As such, even if the investor redeems all
of her available shares, she would still share in any losses incurred
by the fund during that timeframe. A ``strong form'' of MBR would also
put a portion of redeeming investors' MBRs first in line to absorb any
losses, which creates a disincentive to redeem. The size of the MBR
would be a specified fraction of the shareholder's maximum recent
balance (less an exempted amount). An MBR mechanism could be used in a
floating NAV fund to allocate losses only under certain rare
circumstances, such as when the fund suffers a large drop in NAV or is
closed.
    Potential benefits:
     A properly calibrated ``strong'' MBR could reduce the
vulnerability of MMFs to runs.
     A strong MBR can internalize the liquidity costs of
investors' redemptions and thus reduce or eliminate the first-mover
advantage for redeeming investors. It would do so by subordinating a
portion of their shares to put them at greater risk if the fund suffers
a loss. This can weigh against incentives to redeem in a stress event,
so it can be particularly helpful as liquidity costs rise.\44\
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    \44\ See, for example, FSOC Proposed Recommendations; Patrick E.
McCabe, Marco Cipriani, Michael Holscher, and Antoine Martin, ``The
Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks
Posed by Money Market Funds,'' Brookings Papers on Economic Activity
(Spring 2013), available at https://www.brookings.edu/wp-content/uploads/2016/07/2013a_mccabe.pdf.
---------------------------------------------------------------------------

     The disincentive to redeem created by an MBR strengthens
mechanically as stresses increase and put subordinated shares at
greater risk. Hence, the MBR does not create a threshold effect that
might spur redemptions.
     Under a strong form of MBR, the subordinated shares of
redeeming investors provide extra loss absorption to protect the
investments of non-redeeming investors.
     An MBR could provide more transparency to shareholders
regarding their risk, as shareholders' account information could
include their balances and the size of their MBRs.
    Potential drawbacks, limitations, and challenges:
     The MBR could present implementation and administration
challenges. For example, MMFs, intermediaries, and service providers
would need to update systems to: (1) Compute the MBR on an ongoing
basis for each shareholder account and update the allocation of
unrestricted, holdback, or subordinated holdback shares for each
account to reflect any additional subscriptions or redemptions and the
passage of time; and (2) prevent a shareholder from redeeming holdback
or subordinated holdback shares in transaction processing systems.\45\
In addition, a ``strong form'' of MBR may create the need to convert
existing MMF shares or issue new subordinated shares to comply with
typical state law limitations on allocating losses to a subset of
shares in a single share class.
---------------------------------------------------------------------------

    \45\ Many MMF investors hold their shares through intermediaries
(such as broker-dealers, banks, trust companies, and retirement plan
administrators) that establish omnibus accounts with the fund. An
intermediary's omnibus account aggregates shares held on behalf of
its underlying clients or beneficiaries, and the fund does not have
access to information about these underlying clients or
beneficiaries. As a result, intermediaries would be involved in
implementing MBR reforms.
---------------------------------------------------------------------------

     An MBR mechanism may have different and unequal effects on
investors in stable NAV and floating NAV MMFs. During the holdback
period, investors in a stable NAV MMF would only experience losses if
the fund breaks the buck, but investors in a floating NAV MMF are
always exposed to changes in the fund's NAV and would continue to be
exposed to such risk for any shares held back.
     The MBR is an unfamiliar concept in the fund industry that
may result in investor discomfort or confusion, particularly when it is
first introduced.
     Calibrating the appropriate size for an MBR could be a
challenge; an MBR that is too small may not create sufficient
disincentives to redeem in stress events, but one that is too large
would unnecessarily reduce the liquidity of the fund's shares.

D. Money Market Fund Liquidity Management Changes

    MMFs currently are subject to daily and weekly liquid asset
requirements and must disclose the amount of daily and weekly liquid
assets each day on the fund's website. Changes to liquidity management
requirements could include a new category of liquidity requirements.
For example, instead of focusing solely on daily and weekly liquid
assets, creating an additional category for assets with slightly longer
maturities (e.g., biweekly liquid assets) could strengthen funds' near-
term portfolio liquidity when short-term funding markets become
stressed.
    As another alternative, an additional threshold, such as a WLA
threshold of 40 percent, could be set to augment current liquidity
buffers. If a fund's WLAs fell below this threshold, penalties such as
requiring the escrow of fund management fees until the level of WLA is
restored could be imposed on fund managers, rather than investors. This
effectively would require funds to maintain a larger amount of WLAs
than currently required.
    Potential benefits:
     An additional tier of liquidity may make MMFs more
resilient to significant redemptions by ensuring they maintain assets
that will soon become WLAs. Additional liquidity requirements also

could limit ``barbell'' strategies (where a fund offsets its short-term
assets with riskier longer-term assets that enhance returns but
increase the riskiness of the fund's portfolio).
     Rules to penalize fund managers first for having
inadequate portfolio liquidity have the potential to diminish the
salience of WLA thresholds to investors by ensuring that initial
consequences for crossing the thresholds are not imposed directly on
investors.
    Potential drawbacks, limitations, and challenges:
     Requiring funds to purchase additional near-term liquid
assets or maintain larger WLAs to avoid penalties might encourage funds
to take greater risks in the less liquid parts of their portfolios,
particularly in a low interest rate environment, absent other measures
to constrain this behavior.
     Imposing the escrow of fees or other penalties on fund
managers if WLAs do not meet a new higher minimum requirement could
further diminish the usability of WLA buffers by making MMFs less
comfortable in deploying their liquid assets in times of stress.
     Further increases in liquid asset requirements may provide
funds only a little extra time during a run, as institutional prime
fund outflows exceeded 5 percent of assets per day at the height of the
run in March 2020.
     Additional liquid asset requirements for MMFs could
heighten roll-over risks for issuers of short-term debt that may see
more demand for issuance in shorter tenors. In addition, to the extent
that new investors would replace MMFs in the tenors outside the near-
term liquidity requirements, transparency regarding the nature of these
investors may be lower.
     It is not clear whether the required escrow of fees or
other penalties could be imposed on fund managers in a way that would
not also affect MMF investors (e.g., fund managers may respond by
reducing the amount of fees they waive).
    Additional considerations:
     Funds that purchase additional near-term liquid assets or
maintain larger WLAs to avoid penalties may generate lower yield
compared to similar investment products, which may reduce investor
demand for such funds. As noted above, a reduction in the size of the
prime and tax-exempt MMF sectors could affect the resilience and
functioning of short-term funding markets in a variety of ways.

E. Countercyclical Weekly Liquid Asset Requirements

    During the market stress in March 2020, prime and tax-exempt MMFs
that were close to the 30 percent WLA threshold may have avoided using
their liquid assets to meet redemptions. MMFs' incentives to maintain
WLAs well above the 30 percent minimum, even in the face of significant
outflows, may include the desires to avoid: (1) Prohibitions on
purchasing assets that are not WLAs; (2) raising investor concerns
about the potential imposition of fees or gates; and (3) potential
scrutiny resulting from public disclosure of low WLA amounts. A
countercyclical WLA requirement could reduce some or all of these
concerns. Under this approach, minimum WLA requirements could
automatically decline in certain circumstances, such as when net
redemptions are large or when the SEC provides temporary relief from
WLA requirements. Any thresholds linked to a fund's minimum WLA
requirements (e.g., fee or gate thresholds) would also move with the
minimum.
    Potential benefits:
     A countercyclical WLA requirement could reduce the
salience of the 30 percent WLA threshold and may lessen redemption
pressures when a fund is near that threshold.
     This may improve the usability of WLA buffers by making
MMFs more comfortable in deploying their liquid assets in times of
stress.
    Potential drawbacks, limitations, and challenges:
     Funds that reduce WLAs in stress events would be less
equipped to manage additional redemptions without engaging in fire
sales.
     Even if the WLA threshold is reduced, threshold effects
may still motivate investors to redeem. In addition, investors may
still prefer to redeem from funds that are approaching or breaching the
standard 30 percent threshold, and reduced WLA minimums may in fact
call attention to potential stress and prompt greater investor
outflows.
     The benefits of this change for funds' use of liquid
assets may be modest, as current rules do not preclude funds from using
WLAs to meet redemptions or prohibit funds from allowing their WLAs to
fall below 30 percent.
     Appropriately calibrating a countercyclical WLA
requirement, including determining whether it would be an automatic
mechanism or one that the SEC has to adjust in a crisis, could be
challenging.

F. Floating NAVs for All Prime and Tax-Exempt Money Market Funds

    Retail prime MMFs and retail tax-exempt MMFs currently can use a
rounded NAV and value portfolio assets at their amortized cost, which
permits the funds to sell and redeem shares at a stable share price
(e.g., $1.00) without regard to small variations in the value of the
securities in their portfolios. A floating NAV requirement would ensure
that these MMFs instead sell and redeem their shares at a price that
reflects the market value of a fund's portfolio and any changes in that
value. This would be consistent with floating NAV requirements that
currently apply to institutional prime and institutional tax-exempt
MMFs. Although this option would only affect retail MMFs, those funds
had large outflows in March 2020, and outflows likely would have
continued or worsened without official sector intervention.\46\
---------------------------------------------------------------------------

    \46\ Retail prime MMFs and tax-exempt MMFs were under stress
during March 2020, with one tax-exempt MMF receiving sponsor
support, although stress among retail funds was less severe than
that for institutional prime MMFs. See Section III.B, above
(explaining that outflows from retail prime funds totaled 9 percent
(or just over $40 billion) of assets during the two weeks from March
13 to 26, and outflows from tax-exempt MMFs--which are largely
retail funds--were 8 percent ($11 billion) of assets during the two
weeks from March 12 to 25).
---------------------------------------------------------------------------

    Potential benefits:
     The floating NAV eliminates the salience of a MMF's NAV
dropping more than 0.5 percent ($0.995). Unlike stable NAV funds, MMFs
with floating NAVs cannot ``break the buck.''
     Stable NAVs can create an incentive to redeem when MMF
portfolios assets lose value because redeeming investors can receive
more for their shares than they are worth, while losses are
concentrated among non-redeeming investors. In contrast, a floating NAV
mitigates that incentive to redeem as losses are spread across all
shareholders on a pro rata basis whether they redeem or not. Thus, a
floating NAV requirement may decrease retail prime and tax-exempt MMFs'
vulnerabilities to runs by mitigating the first mover advantage for
redeeming investors.
     Floating NAVs make portfolio risks more transparent by
making fluctuations in share values readily observable, which could
better align investors' expectations with the risks of portfolio
holdings.
    Potential drawbacks, limitations, and challenges:
     A floating NAV requirement would not affect institutional
MMFs, which have historically been the most vulnerable to runs but
already have floating NAVs.

     Institutional prime MMFs with floating NAVs still
experienced runs in March; floating NAVs do not prevent runs.
    Additional considerations:
     Floating NAVs could result in a reduction in the size of
retail prime and retail tax-exempt MMF sectors by making retail MMF
shares less cash-like, which could reduce investor demand. As noted
above, a reduction in the size of the prime and tax-exempt MMF sectors
could affect the resilience and functioning of short-term funding
markets in a variety of ways.

G. Swing Pricing Requirement

    Under current rules, MMF investors redeeming their shares in a
prime or tax-exempt fund typically do not incur the costs associated
with this redemption activity. Instead, these costs are largely borne
by other investors in the fund, and this contributes to a first-mover
advantage for those who redeem quickly in a crisis. Swing pricing
effectively allows a fund to impose the costs stemming from redemptions
directly on redeeming investors by adjusting the fund's NAV downward
when net redemptions exceed a threshold.\47\ That is, when the NAV
``swings'' down, redeeming investors receive less for their shares. A
swing pricing requirement could help ensure that redeeming shareholders
bear liquidity costs throughout market cycles (i.e., not only in times
of market stress). In the United States, an optional swing pricing
framework is permissible for certain mutual funds, but not for MMFs.
Although swing pricing is largely untested for MMFs, it has been
helpful for other types of non-U.S. mutual funds.\48\
---------------------------------------------------------------------------

    \47\ If a fund has net inflows above the swing threshold, swing
pricing would instead adjust the fund's NAV upward.
    \48\ See, for example, Jin, Dunhong, Marcin Kacperczyk, Bige
Kahraman, an Felix Suntheim, ``Swing Pricing and Fragility in Open-
end Mutual Funds,'' IMF Working Paper WP/19/227 (2019); Association
of the Luxembourg Fund Industry, Swing Pricing Updae 2015 (Dec.
2015) (``ALFI Survey 2015'') at 21, available at http://www.alfi.lu/sites/alfi.lu/files/ALFI-Swing-Pricing-Survey-2015-FINAL.pdf.
---------------------------------------------------------------------------

    Potential benefits:
     A properly calibrated swing pricing mechanism could reduce
the vulnerability of MMFs to runs.
     Swing pricing can internalize the liquidity costs of
investors' redemptions and thus reduce or eliminate the first-mover
advantage for redeeming investors. By making redemptions costly, swing
pricing can weigh against incentives to redeem in a stress event, so it
can be particularly helpful as liquidity costs rise. Swing pricing also
benefits investors who do not redeem by reducing dilution to the value
of a fund's shares and insulating these investors from the effects of
others' redemption activity.
     Swing pricing can improve long-run fund performance by
reducing dilution.
     If swing pricing is available (and used occasionally) in
``normal'' times, its use can help investors understand that they bear
liquidity risks in a MMF. Moreover, regular deployment of swing pricing
would make its use in stress events less unsettling for investors.
    Potential drawbacks, limitations, and challenges:
     Eligible U.S. mutual funds have yet to implement swing
pricing, largely because implementation would require substantial
reconfiguration of current distribution and order-processing practices.
MMFs could face similar challenges.
     Unlike other mutual funds, some MMFs strike their NAVs
more than once per day and allow intraday purchases and redemptions for
any orders received prior to a given NAV strike. The potential
management of swing pricing considerations multiple times per day could
be particularly challenging in times of market stress.
     It may be challenging to design and calibrate a swing
pricing mechanism that can effectively internalize liquidity costs for
redeeming investors, especially during stress events.

H. Capital Buffer Requirements

    Capital (or ``NAV'') buffers, which could be structured in a
variety of ways, can provide dedicated resources within or alongside a
fund to absorb losses and can serve to absorb fluctuations in the value
of a fund's portfolio, reducing the cost to taxpayers in case of a
run.\49\ For a floating NAV fund, capital buffers could be reserved to
absorb the fund's losses only under certain rare circumstances, such as
when it suffers a large drop in NAV or is closed.
---------------------------------------------------------------------------

    \49\ See, for example, Craig M. Lewis, ``Money Market Fund
Capital Buffers,'' (April 6, 2015), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2687687; Samuel G.
Hanson, David S. Scharfstein, and Adi Sunderam, ``An Evaluation of
Money Market Fund Reform Proposals,'' (May 2014), available at
https://www.imf.org/external/np/seminars/eng/2013/mmi/pdf/Scharfstein-Hanson-Sunderam.pdf.
---------------------------------------------------------------------------

    Potential benefits:
     A capital buffer adds ex ante loss-absorption capacity to
a MMF that would mitigate MMF shareholders' risk of losses and their
incentives to redeem in a stress event.
     A buffer would mitigate the MMF industry's reliance on
discretionary, ex post sponsor support by assuring that MMFs already
have resources in place to absorb losses.
     Owners of capital will have incentives to mitigate risk-
taking by the fund. For example, if capital is provided by the fund's
sponsor, the sponsor will have an explicit incentive to manage
portfolio risks to preserve the capital.
    Potential drawbacks, limitations, and challenges:
     A capital buffer financed from unaffiliated investors
could be complex to administer.
     Sizable capital buffers are costly to finance, and
building adequate capital buffers from MMF income could take
substantial time, particularly in a low interest rate environment, and
could disadvantage current MMF investors for the benefit of future MMF
investors.
     Calibrating the appropriate size for a capital buffer
could be a challenge; MMFs would continue to be vulnerable if the
buffer is too small, but one that is too large would be unnecessarily
costly.
     A capital requirement could increase MMF industry
concentration because provision of initial capital would be a
substantial burden for some asset managers and could cause them to exit
the industry. In addition, such a requirement may favor bank-sponsored
funds.
    Additional considerations:
     The costs of financing a capital buffer would be borne by
MMF sponsors and investors, and these costs could result in a reduction
in the size of the prime and tax-exempt MMF sectors. As noted above, a
reduction in the size of these MMFs could affect the resilience and
functioning of short-term funding markets in a variety of ways.

I. Require Liquidity Exchange Bank Membership

    To provide a liquidity backstop during periods of market stress,
prime and tax-exempt MMFs could be required to be members of a private
liquidity exchange bank. The LEB would be a chartered bank. Under one
LEB proposal, MMF members and their sponsors would capitalize the LEB
through initial contributions and ongoing commitment fees. During times
of market stress, the LEB would purchase eligible assets from MMFs that
need cash, up to a maximum amount per fund. The LEB would not be
intended to provide credit support.
    Potential benefits:
     The existence of a liquidity backstop provided by an LEB
could diminish investors' incentives to run.
     An LEB would commit private resources, including bank
capital, ex ante to provide liquidity to MMFs. This

framework could partially internalize the costs of liquidity protection
for the MMF industry and reduce distortions that can arise from an
expectation of official sector support in times of stress.
     Chartered banks generally have access to Federal Reserve
liquidity through the discount window, although the duration and extent
of access is not guaranteed. To the extent that the LEB has access to
the discount window, that access may further mitigate liquidity
pressures on MMFs and reduce the likelihood of fire sales.
     Pooling liquidity resources for MMFs may offer efficiency
gains. An LEB would provide liquidity to MMFs that need it, rather than
requiring each MMF to hold liquidity separately.
    Potential drawbacks, limitations, and challenges:
     Access to the LEB backstop during times of market stress,
without further consideration of risk management measures, could have
moral hazard effects that motivate some funds to take greater risks in
the less-liquid parts of their portfolios.
     The LEB, which would not provide traditional banking
services, is not intended to operate as a commercial bank, and
commercial banks are not organized to buy assets from entities facing
financial difficulties. As such, it is unclear whether such an entity
would be able to obtain a banking charter.
     Access to the discount window by the LEB is not
guaranteed, particularly in the size and term that may be needed to
provide material liquidity support to MMFs under stress.
     To the extent that liquidity provided by the Federal
Reserve exceeds what is provided to a typical commercial bank, the LEB
would not be significantly different from other types of historical
official sector support.
     As a bank, the LEB would be subject to supervision and
regulation, including restrictions on transactions with affiliate
funds.\50\ In addition, investors in the LEB may themselves become bank
holding companies. If an investor became a bank holding company, it
would be subject to consolidated supervision and regulation, and would
be required to serve as a source of strength to the LEB.\51\
---------------------------------------------------------------------------

    \50\ 12 U.S.C. 371c; 12 CFR 223.
    \51\ 12 U.S.C. 1841 et seq.
---------------------------------------------------------------------------

     The LEB would need significant capital to both be in a
position to provide meaningful liquidity for MMFs in stress events and
be seen as a credible liquidity backstop. Building adequate capacity
from MMF income could take several years, particularly in a low
interest rate environment. Moreover, the need to comply with applicable
leverage-based capital requirements on a continuous basis--even during
periods of peak usage under stress--could render the LEB's lending
capacity insufficiently robust in extremis.
     News that an LEB is running out of capacity could
accelerate runs.
     Requiring fund sponsors to provide initial capital for an
LEB would likely favor large and bank-affiliated sponsors and could
cause some others to exit the industry, thus increasing industry
concentration.
     Administering an LEB may raise complex governance and
fairness concerns, particularly in times of stress.
    Additional considerations:
     Requiring membership in an LEB likely would impose a cost
on sponsors and reduce yields for investors, both of which could result
in a reduction in the size of the prime and tax-exempt MMF sectors. As
noted above, a reduction in the size of these MMFs could affect the
resilience and functioning of short-term funding markets in a variety
of ways.

J. New Requirements Governing Sponsor Support

    In times of market stress, sponsor support has been a tool for
stabilizing MMF share prices and providing liquidity. Support of funds
was relatively common during the 2008 financial crisis as a number of
MMF sponsors purchased large amounts of portfolio securities from their
MMFs or provided capital support to their MMFs.\52\ However, the
discretionary nature of sponsor support contributes to uncertainty
about who will bear risks in periods of stress, including when there is
a run on a MMF. Moreover, the inability of one sponsor to provide
support for a distressed fund accelerated the run on MMFs in September
2008. Currently, sponsors may provide support to MMFs under certain
conditions established by rule 17a-9 under the Act, and must make
public disclosure of any ``financial support'' to increase transparency
about sponsor involvement.\53\ However, bank sponsors are subject to
limits on transactions with affiliates under section 23A of the Federal
Reserve Act. In March, the Federal Reserve, in conjunction with the
FDIC and OCC, provided temporary relief from these restrictions.\54\
The SEC staff also issued a temporary no-action letter in March to
permit the purchase of certain MMF securities by an affiliate where
reliance on rule 17a-9 could conflict with sections 23A and 23B of the
Federal Reserve Act.\55\
---------------------------------------------------------------------------

    \52\ See SEC 2014 Reforms, at paragraph accompanying footnote
53; 2010 PWG Report. A sponsor may also provide support when the
fund is not under stress. As one example, a sponsor may provide
support in a form of capital contribution to maintain a fund's
stable NAV when liquidating a fund that experienced small losses as
assets matured.
    \53\ See Investment Company Act rule 17a-9 [17 CFR 270.17a-9];
SEC Form N-CR, Part C; and SEC Form N-MFP, Item C.18.
    \54\ See Letters dated March 17, 2020, available at https://www.federalreserve.gov/supervisionreg/legalinterpretations/fedreserseactint20200317.pdf.
    \55\ See Letter to Susan Olson, Investment Company Institute
(March 19, 2020), available at https://www.sec.gov/investment/investment-company-institute-031920-17a.
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    A regulatory framework governing sponsor support could clarify who
bears MMF risks by establishing when a sponsor would be required to
provide support.\56\
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    \56\ This reform could also include changes to obviate the need
for future SEC staff no-action letters relating to the interaction
of rule 17a-9 and certain banking law provisions, which may provide
more certainty with respect to sponsor support.
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    Potential benefits:
     Explicit sponsor support, similar to a capital buffer,
would commit private resources ex ante to absorb losses, mitigate risks
to MMF shareholders, and reduce their incentives to redeem in a stress
event.
     Similar to a capital buffer financed by MMF sponsors,
explicit sponsor support could strengthen sponsors' incentives to
reduce portfolio risks.
    Potential drawbacks, limitations, and challenges:
     Making sponsor support for MMFs explicit would favor bank-
sponsored funds and would likely increase MMF industry concentration.
     Making support explicit would require new official sector
oversight to ensure that sponsors have resources to provide support.
    Additional considerations:
     Formalizing sponsor support would impose an expected cost
on sponsors and likely would cause them to charge higher fees to
investors, which could lead to a reduction in the size of the prime and
tax-exempt MMF sectors. At the same time, explicit support could boost
demand for these funds by making them less risky. As noted above,
changes in the size of these MMFs could affect the resilience and
functioning of short-term funding markets in a variety of ways.

[FR Doc. 2021-02704 Filed 2-9-21; 8:45 am]
BILLING CODE 8011-01-P