SEC Finalizes New MMF Liquidity Rules to Start in 2024

The Securities and Exchange Commission adopted rule updates during a hearing on Wednesday which amend liquidity management requirements for money market funds governed by the Investment Company Act of 1940.

The new rule requires MMFs to keep 25% of their assets in daily liquid assets, up from 10%, and at least 50% in weekly liquid assets, up from 30%.

Jamie Gershkow, a partner in Stradley Ronon, explains that MMFs which fall below these limits cannot acquire new assets until they satisfy these requirements.

A new liquidity fee will also be imposed on certain redemptions from institutional prime and tax-exempt MMFs. If daily net outflows exceed 5% of the fund’s value, then the fund must impose a liquidity fee on new redemptions. Gershkow explains that this fee must be a good faith estimate of the costs associated with continuing to satisfy redemptions. Imposing the fee is mandatory and intended to mitigate panic sales that could dilute a fund’s value for the remaining investors.

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Gershkow explains that the SEC is targeting prime and tax-exempt MMFs because these funds were especially strained by outflows at the beginning of the pandemic.

The rule was motivated primarily by large outflows from MMFs in early 2020 during the beginning of the pandemic. William Birdthistle, the director of the SEC’s Division of Investment Management, explained that investors moved from MMFs to cash and Treasurys and the Federal Reserve had to establish an emergency liquidity program whereby it loaned money to MMFs at favorable rates so they could meet their redemptions.

The amendments also remove some elements of a 2014 rule which was also designed to improve MMF liquidity management. Under the 2014 rule, when a fund’s daily or weekly liquid assets fell below the regulatory thresholds, those funds were enabled to impose fees or “gates,” meaning a pause in redemptions. The new rules disconnected fees and gates from a specific liquidity threshold.

Jessica Wachter, the director of the SEC’s division of economic and risk analysis, explained during Wednesday’s hearing that the older rules had created perverse incentives: When investors anticipated a gate or fee being triggered, they actually began to sell more aggressively to ensure their access to cash. The 2014 rule therefore aggravated panic selling when it was intended to mitigate it.

The new final rule, which passed by a 3-2 vote, dropped a controversial swing pricing mechanism from the original 2021 proposal. The MMF swing pricing proposal is distinct from the proposal to implement swing pricing on mutual funds with a floating NAV, which is still pending.

Gershkow says mutual funds and MMFs are different products, so the SEC’s decision to abandon swing pricing for MMFs does not automatically mean it will be discarded from the mutual fund liquidity management proposal.

The Investment Company Institute gave mixed feedback in a statement: “The SEC has missed the mark by forcing money market funds to adopt an expensive and complex mandatory fee on investors. There is no precedent for such a fee framework.”

The statement continued, “The removal of the tie between minimum liquidity thresholds and fees and gates is a positive step—one we have long supported. We also supported a reasonable increase in daily and weekly liquid asset requirements, although the Commission has adopted an excessive threshold. We do applaud the Commission’s recognition that swing pricing is not an appropriate regulatory tool.”

The rule updates will take effect one year after its entry into the federal register, estimated to be August 2024.

Tags: liquidity risk, money market funds, SEC, swing pricing

While major index rebalancings might seem seismic in scope, they often fail to change things very much. The evidence lies in past revamps, and projections for the current one that look like more of the same.

The just-announced change in the weightings of the tech-oriented Nasdaq 100 (the largest valued stocks in the Nasdaq Composite) are designed to remedy the outsized influence of Big Tech—namely the so-called Magnificent Seven, headed by Apple. As of June 30, the seven stocks constituted almost half of the index’s $15.4 trillion market cap. Impelled by federal rules that forbid any group of stocks to command that much, parent Nasdaq intends to whittle the seven’s portion back to 40%.

“This won’t have a huge impact,” says Burns McKinney, senior portfolio manager at NFJ Investments, of the overhaul. “The tech giants have surged so much and have massive amounts of liquidity.”

In other words, the seven will continue to have a sizable sway over the index, and their prices won’t be harmed. The Nasdaq 100 is ahead 39.2% this year, as compared with 15.6% for the broad-market S&P 500.

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The announcement on Monday took a very temporary toll on the seven mega-cap stocks. All but one fell Monday: Microsoft suffered the most, losing 5.4%, and Apple the least, dipping 2.1%. The exception was Facebook parent Meta Platforms, which gained 3.6%, likely due to the popularity of its new social media entry, Threads.

By Tuesday, that downdraft had passed like a bad dream. Six of the tech titans were back in the black, ranging from Amazon’s 1.3% jump to Tesla’s 0.07% increase. The only loser was Apple, slipping a scant 0.3%.

They all have enjoyed enormous gains in recent years, with the party continuing in 2023. Typical is the trajectory of computer chipmaker Nvidia, up 196% year to date. Of the seven, the laggard is Alphabet, owner of Google, ahead 28%. Note that the larger S&P 500, in which the tech gargantuans also have an outsized presence, was positive both Monday and Tuesday.

The pending Nasdaq 100 weight decreases—Nasdaq will release the details Friday, to take effect on July 24—will be minor, according to estimates by Wells Fargo analysts. The largest trim will be to Microsoft, losing 1.8%, followed closely by Apple’s 1.7%, the bank contended.

In the last Nasdaq 100 rebalancing, in April 2011, the downsizing mostly focused on Apple, which then commanded 20% of the index (its weight lately is 12.9%). After the weight reduction a dozen years ago, Apple’s price inched down by just four cents. By year-end 2011, it had soared 19.5%.

This year’s very public two-week run-up to the reordering of the index’s components is meant to allow investors and funds that track the Nasdaq 100 ample time to make adjustments in an orderly fashion—which would not be the case if the new weighting were suddenly announced after the fact. “Our aim is to provide transparency,” says Cameron Lilja, global head of index product and operations at Nasdaq.

Certainly, index funds and institutional investors that craft their own in-house replicas will be busy over the next several weeks to realign their holdings. The Nasdaq 100 is rebalanced four times per year, at the end of every quarter. But this time its corporate parent chose to do a special reweighting because the Magnificent Seven were getting dangerously near the federally mandated cap of 50% for any stock grouping.

The alteration for the seven is hardly unexpected to NFJ’s McKinney, who observes, “It’s indicative of their overvaluation.”