It's been just over a month since the SEC adopted its voluminous 893-page Money Market Fund Reforms, which we've been digesting and excerpting since its release July 23. Following the rule's publication, there were a host of summaries and articles on the rules, but these have dried up lately. However, we came across a couple of new pieces yesterday that do a nice job of recapping the rules. One was published by Fidelity Investments in its August "Insight & Outlook" newsletter. Entitled, "Money Market Mutual Fund Reform 2014: Key Changes Ahead," it says, "On July 23, 2014, the Securities and Exchange Commission (SEC) issued final rules that would further regulate the money market mutual fund industry. The new rules will be implemented within the next two years, and will exempt government and U.S. Treasury money market mutual funds from structural reform. Upon implementation, the new rules will create a new definition for "government fund" and "retail fund" and will require institutional prime (general purpose) and institutional municipal money market mutual funds to price and transact at a "floating" net asset value (NAV)."
"Additionally, for prime and municipal funds -- regardless of whether they are retail or institutional -- the rules will establish liquidity fees that would be charged to shareholders upon redemption, as well as provide for redemption gates that would halt all withdrawals during periods of extraordinary market stress. Institutional investors will face some changes under the new SEC rules; however, some of the uneasiness associated with the uncertainty of the adjustments may be partially offset by knowing that the implementation period is lengthy, that guidance has been provided on several major concerns raised during the comment period, and that government and U.S. Treasury money market mutual funds are exempt from structural reform," writes Fidelity.
So what are the impacts? There will be a new distinction between "retail" and "institutional" prime and municipal money market mutual funds. Implementation date: October 14, 2016. Retail funds will be limited to "natural persons," that is, individuals or human beings. There is no specific definition of "institutional fund;" however, the term will apply to all prime and municipal funds that do not qualify as being retail. Examples of types of institutional accounts include accounts with registrations based on a tax identification number with the beneficiary not being a natural person, small business accounts, defined benefit plans, and endowments. However, institutional funds will also be available to natural persons for purchase."
Also, "Institutional funds will be required to have a floating NAV. Implementation date: October 14, 2016. Funds deemed to be institutional will be required to price and transact using a floating NAV, pricing their shares out to four digits ($1.0000), a process known as "basis-point rounding." At this degree of precision, shareholders would experience a gain (or loss) if the NAV moves up (or down) by one basis point, potentially creating a taxable event. Concerns were raised during the comment period related to tax and accounting issues, as well as on same-day settlement."
The Fidelity piece explains the concerns and how they were addressed by the Treasury, SEC, and IRS. Tax Reporting: The Treasury and the IRS issued guidance that shareholders will be able to report a single net number for the gains and losses experienced over the course of a year, rather than reporting individual transactions. This will significantly reduce the expected tax reporting burden, and is in effect immediately, without waiting for any further guidance from the Treasury. Wash-sale rule: The Treasury and IRS also provided guidance that sales of money market mutual funds will not be subject to the wash-sale rule. Cash equivalent: The SEC stated its position that floating NAV money market mutual funds will be considered a “cash equivalent. Same day settlement: The SEC provided clarity that a floating NAV money market mutual fund could be eligible for same-day settlement by pricing fund shares multiple times within a single day."
Institutional funds will also have new disclosure requirements. "Beginning in April 2016, each floating NAV fund will disclose daily on its website the fund's: Daily market NAV, reported out to four decimal places; Daily and weekly liquid assets as a percentage of the fund's total assets; [and] Net flows from the previous day."
Retail and institutional prime and municipal money market mutual funds can impose liquidity fees or redemption gates. "Implementation date: October 14, 2016. The intent of a liquidity fee is to transfer the costs of liquidating fund securities from the shareholders who remain in the fund to those who leave the fund during periods when liquidity is scarce, to remove a "first mover advantage." ... The gate could be in place for no longer than 10 consecutive days or for 10 days in total over the course of a 90-day period. However, a prime or municipal fund must impose a liquidity fee of 1% if weekly liquid assets were to fall below 10%, unless the fund's board determines that such a fee is not in the fund's best interests. The board will have the authority to impose a lower fee or perhaps no fee at all if, in its opinion, that is in the best interests of the fund."
The piece concludes, "Fidelity Investments is well prepared for the new rules and we are ready to make any changes to our product offerings and fund operations that may be needed to comply with them. As we have done throughout the money market mutual fund reform debate, we will keep our customers well informed by providing information, updates, and perspective."
The law firm Grant Thornton also issued an informative recap of the Treasury/IRS tax accounting changes. They write: "By requiring floating MMFs to issue and redeem shares at a price that changes regularly, shareholders will typically recognize gain or loss on redemptions of floating MMFs, unlike before, when prices were constant. The SEC received comments that expressed concern that the frequent purchases and redemption of floating MMF shares combined with relatively small changes in share values could result in tax compliance burdens disproportionate to the amounts of gain or loss."
Under the proposed regulations, taxpayers may use the "NAV method" to determine gain or loss for a taxable year related to shares of a floating MMF.... The NAV method computes net gain or loss for each "computational period" equal to the ending value of shares of a particular floating MMF minus the starting basis of the floating MMF shares, minus "net investment" in the floating MMF during the computational period. The computational period may be the taxable year or a shorter period -- for example, a month or a week. A taxpayer's gain or loss related to floating MMF shares under the NAV method is capital if the underlying floating MMF shares would otherwise give rise to capital gain or loss. Similarly, a taxpayer's gain or loss related to floating MMF shares under the NAV method is ordinary if the underlying floating MMF shares would otherwise give rise to ordinary gain or loss."
The rule provides procedures for when the Section 1091 wash-sale rule will not apply to the redemption of shares of an MMF. "The wash-sale rule disallows a loss realized by a taxpayer on a sale or disposition of stock or securities if the taxpayer acquires, or enters into a contract to acquire, substantially identical stock or securities, and the acquisition or contract is entered into within a period beginning 30 days before and ending 30 days after the date of the sale or disposition. Because investors may purchase and redeem MMF shares frequently, Section 1091 could apply to disallow a loss realized by a redeeming investor. Because the NAV method provides for no gain or loss for any particular redemption during a computational period, the NAV method would not implicate the wash-sale rule. However, a shareholder of a floating MMF that doesn't use the NAV method may typically experience frequent wash sales.... The IRS won't treat a redemption of an MMF as part of a wash sale if the MMF constituted a floating MMF at the time of the redemption."
