Last week, the SEC issued its Final "Financial Responsibility Rules for Broker-Dealers," which includes several sections (rules 15c3-3 and 15c3-1) that impact money market mutual funds negatively. The SEC's release says, "The Securities and Exchange Commission today announced the adoption of amendments to the net capital, customer protection, books and records, and notification rules for broker-dealers. The amendments to the broker-dealer financial responsibility rules are designed to better protect a broker-dealer's customers and enhance the SEC's ability to monitor and prevent unsound business practices. The rule amendments were approved by a unanimous Commission vote." Mary Jo White, Chair of the SEC, comments, "Investors need to feel confident that their money is safe when it's being held by their broker-dealers. These measures will significantly bolster the protections that our rules already offer."
Stradley Ronon's Joan Swirsky tells us, "The SEC has issued a rule dealing with broker-dealer obligations to maintain reserve accounts and to maintain capital. In the final rule, the SEC declined to enact provisions that were proposed in early 2007 (prior to the financial crisis) that would have eased application of these provisions with respect to money market funds. The SEC explained that the decision to defer these provisions was made in light of the separate reform proposals which are pending for money market funds, to provide the SEC the opportunity to assess the impact of those reforms under these broker-dealer rules."
The SEC's final rule summary explains, "The Securities and Exchange Commission is adopting amendments to the net capital, customer protection, books and records, and notification rules for broker-dealers promulgated under the Securities Exchange Act of 1934. These amendments are designed to address several areas of concern regarding the financial responsibility requirements for broker-dealers. The amendments also update certain financial responsibility requirements and make certain technical amendments."
Of the portions impacting money market funds, Swirsky explains, "Rule 15c3-3 under the Securities Exchange Act of 1934 limits a broker-dealer to depositing cash or "qualified securities" into a bank account it maintains to meet its customer reserve deposit requirements ("special reserve account"). Prior to the amendments, the rule defined the term "qualified security" to include investments in securities issued or guaranteed as to principal and interest by the United States ("U.S. Treasury securities"). To address operational difficulties associated with directly holding and managing a portfolio of U.S. Treasury securities, the 2007 proposal would have expanded the definition to include money market funds that invest solely in securities meeting the definition of "qualified security" in Rule 15c3-3. In a comment letter posted at the SEC website on June 18, 2007, the ICI had suggested that the SEC expand the proposal to include money market funds beyond those that invest solely in U.S. Treasury securities."
She adds, "Rule 15c3-1 seeks to ensure that broker-dealers maintain sufficient liquid capital to protect the assets of customers and to meet their responsibilities to other broker-dealers. When calculating the value of their assets for purposes of establishing their net capital under the rule, broker-dealers must reduce the market value of the securities and commodities they own by certain percentages. The reductions are called "haircuts".... The 2007 proposal would have reduced the "haircut" under Exchange Act Rule 15c3-1 that broker-dealers are required to apply to proprietary positions in money market funds that are registered under the Investment Company Act and subject to Rule 2a-7 from two percent to one percent. The ICI had filed a comment letter stating that the ICI strongly supported reducing the haircut for money market funds. In the final rule, however, the SEC declined to take action with respect to reduce the haircut on money market fund shares, given the pending amendments to Rule 2a-7."
The SEC's rule explains under "Expansion of the Definition of "Qualified Securities" to Include Certain Money Market Funds," "A broker-dealer is limited to depositing cash or qualified securities into the bank account it maintains to meet its customer (and now PAB account) reserve deposit requirements under Rule 15c3-3. Paragraph (a)(6) of Rule 15c3-3 defines qualified securities to mean securities issued by the United States or guaranteed by the United States with respect to principal and interest. This strictly limits the types of assets that can be used to fund a broker-dealer's customer or PAB reserve account. The strict limitation is designed to further the purpose of Rule 15c3-3; namely, that customer assets be segregated and held in a manner that makes them readily available to be returned to the customer. As the Commission noted when first proposing Rule 15c3-3: The operative procedures of the Special [Reserve] Account are designed to protect the integrity of customer-generated funds by insulating them against inroads from the broker-dealer's firm activities, whether they be underwriting, market making, other trading, investing, or mere speculation in securities, meeting overhead or any other nature whatever. The Special [Reserve] Account should achieve a virtual 100% protection to customers with respect to the carrying and use of customers' deposits or credit balances which is mandated by Section 7(d) of the SIPC Act."
The release continues, "In response to a petition for rulemaking, the Commission proposed a limited expansion of the definition of qualified security to include shares of an unaffiliated money market fund that: (1) is described in Rule 2a-7 under the Investment Company Act of 1940; (2) invests solely in securities issued by the United States or guaranteed by the United States as to interest and principal; (3) agrees to redeem fund shares in cash no later than the business day following a redemption request by a shareholder; and (4) has net assets equal to at least 10 times the value of the shares deposited by the broker-dealer in its customer reserve account. Twenty commenters addressed the proposed amendment. A majority of commenters supported the proposal and generally argued that the definition of qualified security should be expanded further to include more types of instruments. One commenter noted that permitting the use of certain money market funds to make up the required reserve account deposit would introduce "an intermediary (namely, the holding company or money market fund) at which problems might arise." The commenter also noted that a number of SIPA liquidations have involved the mishandling of money market or mutual fund shares or the confirmations of purchases of nonexistent "money market funds.""
They add, "The Commission recently has proposed substantial amendments to its rules on money market funds. In light of these proposed amendments, the Commission is deferring consideration of any further expansion of the definition of qualified security in Rule 15c3-3 at this time. This will allow the Commission to assess the potential impact of any money market fund reforms it may adopt and whether any such impact would have consequences for the customer protection objective of the reserve account requirement in Rule 15c3-3."
Later in the Rule, they write, "The Commission is adopting an amendment to paragraph (c)(2)(vi)(D)(1) of Rule 15c3-1 to clarify that a money market fund, for the purposes of paragraph (c)(2)(vi)(D)(1), is a fund described in Rule 2a-7 under the Investment Company Act of 1940 ("Rule 2a-7"). The Commission did not receive any comments on this proposal and is adopting it, as proposed."
Under "Proposed Haircut Reduction from 2% to 1%," the SEC states, "The Commission proposed an amendment to reduce the "haircut" that broker-dealers apply under Rule 15c3-1 for money market funds. In 1982, the Commission adopted a 2% haircut requirement for redeemable securities of money market funds. In 1991, the Commission adopted certain amendments to Rule 2a-7 that strengthened the risk-limiting investment restrictions for money market funds. Based on the enhancements to Rule 2a-7, the Commission proposed to amend paragraph (c)(2)(vi)(D)(1) of Rule 15c3-1 to reduce the haircut on such funds from 2% to 1% in order to better align the net capital charge with the risk associated with holding shares of a money market fund. In addition to the general request for comments in the proposing release, the Commission also specifically requested comments regarding whether the haircut for certain types of money market funds should be reduced to 0% as suggested in a petition for rulemaking submitted to the Commission."
They continue, "The Commission received a total of 14 responses from 12 different commenters regarding this proposed amendment. All of the commenters supported a reduction in the haircut for money market funds and urged that the haircut be reduced below the proposed 1%, with the majority proposing a haircut of 0% for "top-rated" money market funds (i.e., those with the highest ratings). Commenters cited the safety record of money market funds, in particular AAA-rated money market funds, in support of imposing lower haircuts. Several commenters argued that top-rated money market funds were more liquid and posed less credit and interest rate risk than other instruments and suggested haircuts of 1/8 of 1% or even 0%."
Finally, the SEC comments, "As discussed above in section II.E.6.ii. of this release, the Commission recently proposed substantial amendments to its money market fund rules. In light of these proposed amendments, the Commission is deferring consideration of a reduction of the haircut for money market funds in Rule 15c3-1 at this time. Therefore, the haircut that broker-dealers apply for money market funds will remain at 2% under paragraph (c)(2)(vi)(D)(1) of Rule 15c3-1. Deferring action will allow the Commission to assess the potential impact of any money market fund reforms it may adopt and whether any such impact would have consequences for the net liquid asset standard of Rule 15c3-1."
