As investment companies face the stress of major market unrest, the U.S. Federal Reserve (Fed) and the Securities and Exchange Commission (SEC) are working to ease the burden on money market funds. Last week, the Fed and the SEC took various actions to support open-end investment companies regulated as money market funds under Rule 2a-7 under the Investment Company Act of 1940 (1940 Act). The regulators took these steps in light of the short-term dislocations in the market for money market securities and ensuing liquidity problems for those securities, resulting from the COVID-19 (commonly referred to as coronavirus) outbreak. In addition, there have been large amounts of redemptions from “prime” money market funds, which invest in short-term commercial paper, among other securities, and flow into government and treasury money market funds. These market issues, in particular, have stressed some prime funds and impacted their ability to maintain the minimum weekly liquid assets required under Rule 2a-7. Below are some of the regulatory actions that have occurred in the last week.
Commercial Paper Funding Facility
On March 17, 2020, the Fed announced a Commercial Paper Funding Facility (CPFF). This facility will buy commercial paper directly from companies that issue it, and it is intended to support the primary issuance of commercial paper. Prime money market funds are purchasers of significant amounts of commercial paper.
Fed Exemption for Purchase of Affiliated Money Market Fund Assets
On March 17, 2020, the Board of Governors of the Federal Reserve System issued no-action letters to certain banks regulated under the Federal Reserve Act, exempting purchases of securities from affiliated money market funds from the limits in Section 23A of the Federal Reserve Act for “covered transactions.” This Fed exemption is subject to certain conditions, including that the purchase be at a fair market price determined by a reliable third-party source.
Money Market Mutual Fund Liquidity Facility
On March 18, 2020, the Fed launched the Money Market Mutual Fund Liquidity Facility (MMLF). The MMLF, operated by the Federal Reserve Bank of Boston, extends loans to financial institutions, which are collateralized by various types of high quality money market securities purchased by the financial institutions from prime or tax exempt money market funds, including short-term commercial paper, variable rate demand notes and bank certificates of deposit. The MMLF is intended to provide liquidity to the markets for money market securities and help prime money market funds, which need to sell portfolio securities to raise cash to meet redemptions from shareholders.
SEC No-Action Relief for Affiliated Purchases Under Rule 17a-9
On March 19, 2020, The staff of the SEC’s Division of Investment Management issued a no-action letter (No-Action Letter) to permit affiliated persons (or affiliated persons of such persons) of money market funds, which are subject to Sections 23A and 23B of the Federal Reserve Act, to purchase distressed and non-distressed securities from affiliated money market funds in reliance on Rule 17a-9 under the 1940 Act without complying with all aspects of the Rule. Rule 17a-9, among other conditions, requires that any purchase be paid in cash and at a price equal to the greater of the amortized cost of the security or its market price.
The SEC staff responded to concerns raised by the Investment Company Institute that certain affiliated purchasers may wish to purchase securities from money market funds to enhance the funds’ liquidity or stability, but are unable to do so in reliance on Rule 17a-9 due to conflicting banking regulations (such as the Fed exemption discussed above). Thus, the No-Action Letter permits these affiliated transactions without compliance with all aspects of Rule 17a-9, as long as the following conditions are satisfied:
- the purchase is at a fair market value as determined by a reliable third-party pricing service.
- the purchase satisfies the conditions of Rule 17a-9 under the 1940 Act except to the extent that the terms of the purchase would otherwise conflict with (i) applicable banking regulations or (ii) the Fed exemption (discussed above) defining “covered transactions” for purposes of section 23A of the Federal Reserve Act to not include the purchase of assets from an affiliated fund.
- the fund timely files Form N-CR with the SEC and reports such transaction under Part C of the Form (and in Part H of the Form discloses that the purchase was conducted in reliance on the No-Action Letter). These reports are publicly available upon filing on EDGAR.
The No-Action Letter is temporary in response to the COVID-19 outbreak and will cease to be in effect upon notice from the SEC staff.
The regulatory actions described above were designed to alleviate stresses to prime money market funds. Fund advisers should continue to monitor regulatory and other developments that may impact these and other types of funds. Among other things, they should also consider reviewing the assumptions underlying money market funds’ stress tests required under Rule 2a-7, as well as the frequency and reporting of those tests to the funds’ board of trustees. In addition, money market funds are required to report certain material events on Form N-CR filed with the SEC, including purchases by affiliates pursuant to Rule 17a-9.
As the number of cases around the world grows, Faegre Drinker’s Coronavirus Resource Center is available to help you understand and assess the legal, regulatory and commercial implications of COVID-19.