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Federal Register / Vol. 86, No. 26 / Wednesday, February 10, 2021 / Notices
the stability and resilience of short-term funding markets.
At the same time, some of the reform options would likely diminish the size of prime and tax-exempt MMFs, which would also affect the functioning of short-term funding markets. A shrinkage of MMFs could reduce the supply of short-term funding for financial institutions, businesses, and state and local governments. Making prime and tax-exempt MMFs less desirable as cashmanagement vehicles also could cause investors to move to less regulated and less transparent mutualized cashmanagement vehicles that are also susceptible to runs that cause stress in short-term funding markets.
A reduction in the size of prime and tax-exempt MMFs may not necessarily be inappropriate if, for example, the growth of these funds has reflected in part the effects of implicit taxpayer subsidies and other externalities that is, broader economic costs of runs that are not borne by investors or the funds. In addition, if these MMFs remain run prone, a reduction in the size of the industry could mitigate the effects of future runs from these funds on shortterm funding markets.
The aftermath of the 2014 MMF
reforms provides a precedent for the consequences of a substantial reduction in the size of prime and tax-exempt funds, although a future experience could differ. In the year before the October 2016 implementation deadline for those reforms, aggregate prime MMF
assets shrank by $1.2 trillion 69
percent and tax-exempt MMF assets declined about $120 billion 47
percent. Nonetheless, to the extent that spreads for instruments held by these MMFs were affected, they generally widened only temporarily, and investor migration to other mutualized cashmanagement vehicles was largely limited to shifts to government MMFs.
Over the next three years, prime MMFs regained about half of the 20152016
decline.
These considerations are important, because some of the reform options could reduce the size of the prime and tax-exempt fund sectors by:
Reducing attractiveness of prime and tax-exempt MMFs for investors. The costs associated with some options, such as capital buffers and LEB
membership, may reduce the funds yields. The MBR would limit the liquidity of their shares in some circumstances. The floating NAV
requirement and swing pricing would make NAVs more volatile and MMF
shares less cash-like. And investors may view some policies, such as swing
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pricing and the MBR, as unfamiliar, restrictive, and complicated.
Increasing costs associated with MMF sponsorship. Some options, such as the introduction of capital buffers, required LEB membership, and explicit sponsor support, could raise operating costs for sponsors. Other options, such as swing pricing and MBR, may also have sizable implementation costs.
Increased costs and operational complexity could lead to increased concentration and a reduction in the overall size of the MMF industry.
c Potential drawbacks, limitations, and challenges specific to each option.
Evaluation of the reform options also should take into account potential drawbacks, limitations, and challenges of each option, such as implementation challenges or limits on an options ability to achieve the desired goals. The report discusses these considerations for each option below.
Several specific policy options are described below, along with a high-level analysis of the potential benefits and drawbacks of each option.

gates and fees would reduce the salience of these thresholds and could diminish the incentive for preemptive runs.
This may improve the usability of WLA buffers by making MMFs more comfortable in deploying their liquid assets in times of stress.
Potential drawbacks, limitations, and challenges:
While this option would remove a focal point that may trigger runs, it would do little otherwise to mitigate run incentives.
If MMFs maintain fewer liquid assets by holding WLA levels closer to 30 percent as a result of this change, the funds may be less equipped to manage significant redemptions without engaging in fire sales.
Permitting funds to impose fees or gates without reference to a specific threshold may cause broader contagion if investors fear the imposition of fees or gates in other funds that otherwise would have been seen as safe.

A. Removal of Tie Between MMF
Liquidity and Fee and Gate Thresholds Liquidity fees and redemption gates are intended to give MMF boards tools to stem heavy redemptions by imposing a fee to reduce shareholders incentives to redeem or by stopping redemptions altogether for a period of time.
Currently, MMF boards have discretion to impose fees or gates when WLAs fall below 30 percent of total assets and generally must impose a fee of 1 percent if WLAs fall below 10 percent, unless the board determines that such a fee would not be in the best interest of the fund or that a lower or higher up to 2
percent liquidity fee is in the best interests of the fund.
Definitive thresholds for permissible imposition of liquidity fees and redemption gates may have the unintended effect of triggering preemptive investor redemptions as funds approach the relevant thresholds.
Some preliminary research suggests that redemptions accelerated in March 2020
from funds with declining WLAs.43
Removing the tie between the 30
percent and 10 percent WLA thresholds and the imposition of fees and gates is one possible reform. Fund boards could be permitted to impose fees or gates when doing so is in the best interest of the fund, without reference to any specific level of liquidity.
Potential benefits:
Removing the tie between the WLA
thresholds and funds ability to impose
Reforming rules regarding redemption gates to reduce the likelihood that gates may be imposed could diminish investors incentives to engage in preemptive runs. For example, funds could be required to obtain permission from the SEC or notify the SEC prior to imposing gates. Alternatively, fund boards could be required to consider liquidity fees before gates, making it less likely that gates would be imposed.
Another option could be to lower the WLA threshold at which gates could be imposed to, for example, 10 percent.
Gate rules also could be reformed to make gates soft or partial. With soft gates, for example, if redemptions on a particular day exceed a certain amount, a fund could reduce each investors redemption pro rata to bring total redemptions below that amount, with remaining redemption amounts deferred to the next business day and continuing daily deferrals until all redemption requests are satisfied. This affords investors at least some liquidity, in contrast to the complete curtailment of liquidity when a fund suspends all redemptions.
Potential benefits:
Reforming the rules around gates might reduce concerns that gates will be imposed immediately upon a breach of the 30 percent WLA requirement and reduce the salience of that threshold, particularly if investors are more concerned about gates than fees.
Gates could still be imposed, but only in very dire conditions when runs on funds are likely anyway.

43 See
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footnote 32, above.

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B. Reform of Conditions for Imposing Redemption Gates
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