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Money Market Funds

Money market funds invest in high quality, short-term debt securities and pay dividends that generally reflect short-term interest rates. Many investors use money market funds to manage their cash and other short-term funding needs. There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate and bank debt securities. Some funds are intended for retail investors, while other funds are intended for institutional investors. The rules governing money market funds and the responsibilities of the directors who oversee them vary based on the type of money market fund.

Money market funds that primarily invest in a variety of taxable short-term corporate and bank debt securities are generally referred to as prime funds. Government money market funds are money market funds that invest 99.5 percent or more of their total assets in very liquid investments, namely, cash, government securities, and/or repurchase agreements that are collateralized fully with government securities. Retail money market funds are money market funds that are limited to investment by natural persons. In response to the 2007-2008 financial crisis, the SEC, in 2010, adopted a series of reforms designed to make money market funds more resilient by reducing the interest rate, credit, and liquidity risks of their portfolios. The SEC adopted more fundamental structural changes to the regulations of money market funds in 2014.

The 2014 SEC rules largely center around two principal reforms. The first reform requires prime institutional and tax-exempt institutional money market funds to price and transact in their shares using “floating” net asset values (NAVs). The rules also require funds to calculate their NAVs to four decimal places. For a fund with a NAV of $1.00, that means calculating the NAV to one-hundredth of a penny—i.e., $1.0000. Government money market funds and retail money market funds may continue to seek to maintain a stable NAV using amortized cost valuation and/or penny rounding.

The second principal reform enables, and in certain cases requires, all nongovernment money market funds (i.e., all prime and tax-exempt funds, whether institutional or retail) to impose barriers on redemptions (so-called liquidity fees and gates) during extraordinary circumstances, subject to determinations by a money market fund’s board of directors.

The SEC also imposes on money market fund boards a number of specific responsibilities relating to oversight of the fund. For example, boards must make an initial determination that the use of the amortized cost method and/or penny rounding is appropriate for a government or retail money market fund and then monitor deviations between the amortized cost price and the market-based price (called the “shadow price”) of fund shares, and take appropriate action if the deviation could result in material dilution or other unfair results to investors. Fund boards also must adopt procedures that provide for periodic stress testing of a money market fund’s ability to maintain certain weekly liquid asset levels and its ability to minimize principal volatility (or, in the case of a government or retail money market fund using the amortized cost or penny-rounding method of pricing, the fund’s ability to maintain a stable NAV) based on certain hypothetical events.