Crown image Columbia Law School

SEC Chair Speaks About Proposed Rules on Money Market Funds, Customer Protection

By by

Today [July 12], the Commission is considering adopting final rules to enhance money market funds’ liquidity and investor protection. I support this adoption because it will enhance these funds’ resiliency and ability to protect against dilution.

Money market funds—nearly $6 trillion in size today—provide millions of Americans with a deposit alternative to traditional bank accounts. Using these funds, shareholders can get market-based returns, fully backed dollar-for-dollar by readily marketable securities.

Money market funds, though, have a potential structural liquidity mismatch. Investors can redeem their money market fund holdings on a daily basis, even if those funds keep some of their holdings in securities with less liquidity.

As a result, when markets enter times of stress, some investors—fearing dilution or illiquidity—may try to escape the bear. This can lead to large amounts of rapid redemptions. We have observed this play out in times of stress, including during the 2008 financial crisis and the “dash for cash” in March 2020. Left unchecked, such stress can undermine these critical funds.

In enacting the 1940 Investment Company and Investment Advisers Acts, Congress understood how important it is for open-end funds to manage effectively liquidity and dilution.[1] In that light, the Commission over the years has adopted rules to address such risks for money market funds. We did so through reforms in 2010 and 2014, in response to the 2008 financial crisis.

Given the market events of March 2020, I think it is important that to take further action to manage these risks. President’s Working Group and Financial Stability Oversight Council reports under different Treasury secretaries and presidents have highlighted these issues as well.

Today’s adoption will enhance money market funds’ liquidity, anti-dilution practices, and transparency in a number of ways.

First, the rules will increase money-market funds’ minimum liquidity requirements. Specifically, the rules will require money market funds to hold greater proportions of their total assets in securities that can be liquidated within one business day as well as within five business days. This will provide a more substantial buffer in the event of rapid redemptions.

Second, the rules will prevent money market funds from temporarily halting redemptions (so-called gates).[2] These gates may have encouraged runs in March 2020 and may be procyclical in times of stress. Removing these gates may remove incentives for preemptive redemptions.

Third, the rules will require institutional prime and institutional tax-exempt money market funds—funds that serve institutional rather than everyday investors—to impose liquidity fees on redeeming investors during times of stress. Such fees will help ensure that during stress times, redeeming investors rather than remaining investors bear the cost of redemptions. These funds, which have faced the largest redemptions in past stress periods, represent currently 11 percent of the broader money market funds space.[3] Under existing rules, these funds are those that use a floating net asset value, whereby their institutional investors at times may redeem at a value other than $1.00 per share.

Based upon public feedback, today’s final rules will require liquidity fees instead of the originally proposed swing pricing requirement. I believe that liquidity fees, compared with swing pricing, offer many of the same benefits and fewer of the operational burdens.

Fourth, the rules will amend certain reporting requirements to improve the transparency of money market funds.

In addition to these reforms, today’s rules will amend Form PF for large liquidity fund advisers to align their reporting requirements with those of money market funds.

Taken together, the rules will make money market funds more resilient, liquid, and transparent, including in times of stress. That benefits investors.

I’d like to thank the members of the SEC staff who worked on these final rules, including:

  • William Birdthistle, Sarah ten Siethoff, Brian M. Johnson, Angela Mokodean, Blair Burnett, Christian Corkery, David Driscoll, Jon Hertzke, Hae-Sung Lee, Isaac Kuznits, Michelle Trillhaase, Susan Zhang, Viktoria Baklanova, Heather Fernandez, and Gregg Jaffray in the Division of Investment Management;
  • Megan Barbero, Meridith Mitchell, Malou Huth, Natalie Shioji, Cathy Ahn, and Joseph Guerra in the Office of the General Counsel;
  • Jessica Wachter, Alex Schiller, Diana Knyazeva, Joe Simmons, Dan Hiltgen, and Robert Girouard in the Division of Economic and Risk Analysis; and
  • Thu Bao Ta, Song Brandon, and Elizabeth Blase in the Division of Examinations.

ENDNOTES

 [1] As SEC Commissioner Robert E. Healy put it in his testimony on behalf of the ’40 Acts: “Due to the right of the stockholder to come in and demand a redemption, the [open-end fund] has to keep itself in a very liquid position. That is, it has to be able to turn its securities into money on very short notice.” See Investment Trusts and Investment Companies: Hearings on H.R. 10065 before a Subcommittee of the House Committee on Interstate and Foreign Commerce, 76th Cong., 3d Sess. 112 (1940), at 57 (Statement of Robert E. Healy). The SEC said in a report in 1942: “Open-end investment companies, because of their security holders’ right to compel redemption of their shares by the company at any time, are compelled to invest their funds predominantly in readily marketable securities.” See Investment Trusts and Investment Companies: Report of the Securities and Exchange Commission (1942), at 76.

[2] Rule 22e-3 would still permit gates in the event of a liquidation.

[3] Based on Form N-MFP data for June 2023. The release reflects money market fund data through March 2023, at which point affected institutional funds represented about 12 percent of total money market fund assets.

Statement on Customer Protection Rule

Today [July 12], the Commission is considering proposing amendments that would require broker-dealers carrying large customer balances to calculate and deposit on a daily basis the net cash they owe their customers and other broker-dealers. I am pleased to support this proposal because, if adopted, it would help protect customers in the event that a broker-dealer fails.

A key tenet of our securities laws is the segregation of customers’ cash and securities from a broker-dealer’s own account. Congress gave us authority to adopt this key protection as part of the Securities Investor Protection Act of 1970 (SIPA). The Commission in 1972 adopted Rule 15c3-3, requiring broker-dealers that custody customers’ cash and securities to maintain a special reserve bank account that contains the net cash a broker owes to its customers. The rule requires broker-dealers to calculate and deposit the appropriate balance for that account on a weekly basis.

SIPA also is known for setting up the Securities Investor Protection Corporation (SIPC) and establishing the SIPC Fund, which together help protect customers in the event a broker not only fails financially but also cannot repay its customers. Taken together, Rule 15c3-3 and SIPA are designed to ensure that if a broker-dealer fails, its customers will be made whole.

Our markets have evolved dramatically in the 51 years since Rule 15c3-3 was adopted. It was the same year that Atari released the first mass-produced arcade game, Pong. Though the game was revolutionary for its time, you now are more likely to find Pong at the Smithsonian Institution than at an arcade.[1]

Given the speed, scale, and volume of today’s market activity—much faster than a game of Pong—I believe customers would benefit if broker-dealers carrying large credit balances made daily reserve account calculations and deposits. This frequency would better align with the inflows, swings, and balances that broker-dealers experience in today’s markets.

As discussed in the release, currently 11 of the largest broker-dealers already make these calculations on a daily basis. Today’s proposal would standardize this practice for broker-dealers carrying total credit balances that averaged at least $250 million for the previous 12 months.[2]

This would reduce the likelihood and duration of a mismatch between the size of the reserve bank account and the amount of net cash currently owed to customers and other broker-dealers. Further, it would better help to protect the SIPC Fund, particularly from the risk that when a broker-dealer fails, it has a midweek shortfall in its reserve account.

Accordingly, this proposal, if adopted, would help protect customers as well as the SIPC Fund. That enhances trust in the markets.

I’d like to thank the members of the SEC staff who worked on this proposal, including:

  • Haoxiang Zhu, Sheila Swartz, Abraham Jacob, Randall Roy, Mike Macchiaroli, Tom McGowan, Ray Lombardo, Tim Fox, David Saltiel, Andrea Orr, Yue Ding, John Prochilo, and Roni Bergoffen in the Division of Trading and Markets;
  • Jessica Wachter, Juan Echeverri, Dasha Safonova, Ryan Brady, Caroline Schulte, Oliver Richard, Jill Henderson, Lauren Moore, and Charles Woodworth in the Division of Economic and Risk Analysis; and
  • Megan Barbero, Robert Teply, Donna Chambers, Cynthia Ginsberg, Marie-Louise Huth, and Meridith Mitchell in the Office of the General Counsel.

ENDNOTES

[1] See The Week, “Pong at 50: the video game that ‘changed the world’” (Nov. 29, 2022), available at https://www.theweek.co.uk/news/technology/958675/pong-at-50-the-video-game-that-changed-the-world.

[2] The proposal would define “average total credits” to mean the arithmetic mean of the sum of total credits in the customer and PAB reserve computations reported in a carrying broker-dealer’s 12 most recently filed month-end FOCUS Reports. This means the average total credits would be a 12-month rolling average.

These statements were issued on July 12, 2023, by Gary Gensler, chair of the U.S. Securities and Exchange Commission.