I continue to hear about intermediaries fretting over whether and how to redesign their trading systems to accommodate the possibility of money market fund liquidity fees. This series of blogs will explain why this should be a problem only for the funds’ transfer agents (“TAs”). An intermediary should never need to collect and remit a liquidity fee.
Reforms adopted by the SEC in July 2014 permit the board of directors of a money market fund (including a majority of the independent directors, the “Board”) to:
- suspend redemptions for a period of not more than 10 business days (known as “gating”), or
- impose a fee of not more than 2% on all redemptions (a “liquidity fee”).
A Board may gate or impose a liquidity fee only when the fund’s weekly liquid assets are less than 30% of its total assets. Should weekly liquid assets fall below 10% of total assets, the fund must impose a 1% fee unless the Board determines that a higher (up to 2%) or lower fee (including no fee) would be in the fund’s best interest.
Non-government money market funds may not disclaim the ability to gate or impose a liquidity fee. On the other hand, a Government money market fund must “opt in” to the ability to impose gates and liquidity fees.
So long as the fund’s weekly liquid assets remain below 30%, the Board may switch from a fee to a gate or vice versa, or terminate the fee or gate. After imposing a liquidity fee, the Board may vary the fee, so long as it does not exceed 2%. Once weekly liquid assets exceed 30% at the end of a business day, the fund must terminate the gate or liquidity fee by the following business day.
The Concern—A Welter of Changing Liquidity Fees
The Board’s new ability to set liquidity fees has raised the specter of funds charging different fees and constantly changing their rates. Intermediaries are concerned that they must develop systems that can collect fees for different funds at different rates that may change on a moment’s notice. The likelihood that funds may implement liquidity fees during a market meltdown heightens their concerns.
While I am skeptical that directors would ever tweak fees in this fashion, the prospect of their doing so need not alarm anyone other than the TAs.
The Solution—Collect All Liquidity Fees at the TA
The need for intermediaries to make major systems changes could be avoided if the TA collected all liquidity fees directly from redemption proceeds. Intermediaries’ systems could then prorate the proceeds received from the TA by the dollar or share amount of each client’s redemption.
For example, assume an intermediary has three clients redeeming shares from funds that have imposed liquidity fees. Clients A and B each redeem $1 million from Fund X, and Clients B and C each redeem $1 million from Fund Y. Assume Fund X imposed a 1% fee and Fund Y imposed a 2% fee. This means the intermediary would receive $1,980,000 from Fund X and $1,960,000 from Fund Y. As each client redeemed equal amounts from each fund, the proceeds would be split evenly, with Clients A and B each receiving $990,000 from Fund X and Clients B and C each receiving $980,000 from Fund Y. Proration will produce the correct result, even if the intermediary does not know the percentage fee imposed by each fund.
A proration algorithm could run all the time, insofar as it would allocate the correct amount of proceeds to each client even when the fund was not charging a liquidity fee. So, the intermediary would never need to modify its systems to implement a liquidity fee.
What happens if other clients also purchase shares from the fund? There are at least three ways to address this question, which I will explore in the next two parts.