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Federal Register / Vol. 86, No. 26 / Wednesday, February 10, 2021 / Notices
framework could partially internalize the costs of liquidity protection for the MMF industry and reduce distortions that can arise from an expectation of official sector support in times of stress.
Chartered banks generally have access to Federal Reserve liquidity through the discount window, although the duration and extent of access is not guaranteed. To the extent that the LEB
has access to the discount window, that access may further mitigate liquidity pressures on MMFs and reduce the likelihood of fire sales.
Pooling liquidity resources for MMFs may offer efficiency gains. An LEB would provide liquidity to MMFs that need it, rather than requiring each MMF to hold liquidity separately.
Potential drawbacks, limitations, and challenges:
Access to the LEB backstop during times of market stress, without further consideration of risk management measures, could have moral hazard effects that motivate some funds to take greater risks in the less-liquid parts of their portfolios.
The LEB, which would not provide traditional banking services, is not intended to operate as a commercial bank, and commercial banks are not organized to buy assets from entities facing financial difficulties. As such, it is unclear whether such an entity would be able to obtain a banking charter.
Access to the discount window by the LEB is not guaranteed, particularly in the size and term that may be needed to provide material liquidity support to MMFs under stress.
To the extent that liquidity provided by the Federal Reserve exceeds what is provided to a typical commercial bank, the LEB would not be significantly different from other types of historical official sector support.
As a bank, the LEB would be subject to supervision and regulation, including restrictions on transactions with affiliate funds.50 In addition, investors in the LEB may themselves become bank holding companies. If an investor became a bank holding company, it would be subject to consolidated supervision and regulation, and would be required to serve as a source of strength to the LEB.51
The LEB would need significant capital to both be in a position to provide meaningful liquidity for MMFs in stress events and be seen as a credible liquidity backstop. Building adequate capacity from MMF income could take several years, particularly in a low 50 12
51 12

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interest rate environment. Moreover, the need to comply with applicable leverage-based capital requirements on a continuous basiseven during periods of peak usage under stresscould render the LEBs lending capacity insufficiently robust in extremis.
News that an LEB is running out of capacity could accelerate runs.
Requiring fund sponsors to provide initial capital for an LEB would likely favor large and bank-affiliated sponsors and could cause some others to exit the industry, thus increasing industry concentration.
Administering an LEB may raise complex governance and fairness concerns, particularly in times of stress.
Additional considerations:
Requiring membership in an LEB
likely would impose a cost on sponsors and reduce yields for investors, both of which could result in a reduction in the size of the prime and tax-exempt MMF
sectors. As noted above, a reduction in the size of these MMFs could affect the resilience and functioning of short-term funding markets in a variety of ways.
J. New Requirements Governing Sponsor Support In times of market stress, sponsor support has been a tool for stabilizing MMF share prices and providing liquidity. Support of funds was relatively common during the 2008
financial crisis as a number of MMF
sponsors purchased large amounts of portfolio securities from their MMFs or provided capital support to their MMFs.52 However, the discretionary nature of sponsor support contributes to uncertainty about who will bear risks in periods of stress, including when there is a run on a MMF. Moreover, the inability of one sponsor to provide support for a distressed fund accelerated the run on MMFs in September 2008.
Currently, sponsors may provide support to MMFs under certain conditions established by rule 17a9
under the Act, and must make public disclosure of any financial support to increase transparency about sponsor involvement.53 However, bank sponsors are subject to limits on transactions with affiliates under section 23A of the Federal Reserve Act. In March, the Federal Reserve, in conjunction with the 52 See SEC 2014 Reforms, at paragraph accompanying footnote 53; 2010 PWG Report. A
sponsor may also provide support when the fund is not under stress. As one example, a sponsor may provide support in a form of capital contribution to maintain a funds stable NAV when liquidating a fund that experienced small losses as assets matured.
53 See Investment Company Act rule 17a9 17
CFR 270.17a9; SEC Form NCR, Part C; and SEC
Form NMFP, Item C.18.

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FDIC and OCC, provided temporary relief from these restrictions.54 The SEC
staff also issued a temporary no-action letter in March to permit the purchase of certain MMF securities by an affiliate where reliance on rule 17a9 could conflict with sections 23A and 23B of the Federal Reserve Act.55
A regulatory framework governing sponsor support could clarify who bears MMF risks by establishing when a sponsor would be required to provide support.56
Potential benefits:
Explicit sponsor support, similar to a capital buffer, would commit private resources ex ante to absorb losses, mitigate risks to MMF shareholders, and reduce their incentives to redeem in a stress event.
Similar to a capital buffer financed by MMF sponsors, explicit sponsor support could strengthen sponsors incentives to reduce portfolio risks.
Potential drawbacks, limitations, and challenges:
Making sponsor support for MMFs explicit would favor bank-sponsored funds and would likely increase MMF
industry concentration.
Making support explicit would require new official sector oversight to ensure that sponsors have resources to provide support.
Additional considerations:
Formalizing sponsor support would impose an expected cost on sponsors and likely would cause them to charge higher fees to investors, which could lead to a reduction in the size of the prime and tax-exempt MMF sectors. At the same time, explicit support could boost demand for these funds by making them less risky. As noted above, changes in the size of these MMFs could affect the resilience and functioning of short-term funding markets in a variety of ways.
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54 See Letters dated March 17, 2020, available at https www.federalreserve.gov/supervisionreg/
legalinterpretations/fedreserseactint20200317.pdf.
55 See Letter to Susan Olson, Investment Company Institute March 19, 2020, available at https www.sec.gov/investment/investmentcompany-institute-031920-17a.
56 This reform could also include changes to obviate the need for future SEC staff no-action letters relating to the interaction of rule 17a9 and certain banking law provisions, which may provide more certainty with respect to sponsor support.

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