Money Market Reform Communication Series

leadership series MARKET PERSPECTIVES Money Market Reform Communication Series Money Market Mutual Fund Reform 2014: Key Changes Ahead August 2014 On July 23, 2014, the Securities and Exchange Commission (SEC) the primary regulator of money market mutual funds issued final rules that will further regulate the money market mutual fund industry. The new rules will be implemented within the next two years, and are intended to increase transparency as well as give investors additional protection during rare periods of market stress, when redemptions in some money market mutual funds may increase significantly. Upon implementation, the new rules will create new definitions for government funds and retail funds, and require institutional prime (general purpose) and institutional municipal money market mutual funds to price and transact at a floating net asset value (NAV). During periods of extraordinary market stress, the new rules permit some money market mutual funds to charge shareholders liquidity fees, payable to the fund upon redemption, as well as provide for redemption gates that would halt all withdrawals (see Exhibit 1, below). Government and U.S. Treasury money market mutual funds will not be subject to any of the new structural changes. 1 The new rules are EXHIBIT 1: Overview of Final 2014 SEC Rules Fund Type Net Asset Value (NAV) Liquidity Fee Redemption Gate U.S. Treasury Stable No No Government Stable No No Retail Municipal/Tax-Exempt Stable Yes Yes Retail Prime/General Purpose Stable Yes Yes Institutional Municipal/Tax-Exempt Floating Yes Yes Institutional Prime/General Purpose Floating Yes Yes Money Market Mutual Fund Reform Floating NAV Liquidity Fee Redemption Gate Retail Fund Definition Final Rule Applicable funds will price and transact at a net asset value per share that can change, or float, based on pricing the underlying fund holdings out to four decimal places ($1.0000) If a fund s weekly liquid assets were to fall below 30%, fund s board may impose a 2% fee on redemptions If a fund s weekly liquid assets were to fall below 10%, redemptions will be subject to a 1% fee, unless fund s board determines otherwise If a fund s weekly liquid assets were to fall below 30%, fund s board may suspend redemptions for up to 10 days Retail funds limit shareholders to beneficial ownership by natural persons (individuals) Institutional funds are open to any shareholders, including individuals, small businesses, and large corporations Implementation Date Nancy Prior President, Fixed Income Kevin Meagher Senior Vice President, Deputy General Counsel NEW SEC RULES: Exempt government and U.S. Treasury money market mutual funds from structural reform Create a new distinction between retail and institutional prime (general purpose) and municipal money market mutual funds Require institutional prime and institutional municipal funds to have a floating net asset value (NAV) Permit prime and municipal money market mutual funds to impose liquidity fees and redemption gates in rare periods of unusually heavy redemptions, regardless of whether they are retail or institutional Require the changes listed above to be implemented by Oct. 14, 2016

EXHIBIT 2: The four common types of money market mutual funds under current SEC regulations. Money Market Mutual Fund Type Treasury Typical Instruments Held U.S. Treasury securities and repurchase agreements collateralized by U.S. Treasury securities. The study laid the foundation for a June 2013 proposal for structural reform, as well as the recently announced changes. The SEC received more than 1,400 comment letters in response to the proposal. Ultimately, the recently adopted structural changes incorporated new definitions and tools designed to further enhance the high degree of safety and liquidity in money market mutual funds. Government Municipal/Tax Exempt Prime/General Purpose U.S. Treasury securities, other government securities, and repurchase agreements collateralized by U.S. Treasury or other government securities. Tax-exempt securities issued by state and local governments and nonprofit entities. Any eligible money market instrument as defined by SEC Rule 2a-7, including all types listed above as well as commercial paper, certificates of deposit, corporate notes, and other debt instruments. New definitions Government fund The SEC created a new definition for government money market mutual funds and exempted those funds from structural reform. Government money market mutual funds will be defined as those that invest 99.50% of their total assets in cash, government securities, or repurchase agreements collateralized by government securities. U.S. Treasury and U.S. Treasury Only funds are expected to meet this definition. specific to U.S. money market mutual funds registered with the SEC, and so do not impact UCITS (undertakings for the collective investment in transferable securities, i.e., investment funds regulated within the European Union), 2 offshore accounts, or stable value accounts. The rules are the culmination of several years of deliberation by the SEC. In 2010, the SEC introduced significant changes to the management of money market mutual funds. These included mandated daily and weekly liquidity levels, more stringent credit quality requirements, shorter portfolio maturities, and stress testing. Then, in 2012, the SEC conducted a study that recognized key differences among the four main types of money market mutual funds: U.S. Treasury, government, municipal, and prime (see Exhibit 2, above). Another finding was that retail investors in money market mutual funds behaved differently than institutional investors during periods of market stress. Government and U.S. Treasury money market mutual funds will be eligible to price and transact at a stable $1.00 NAV, and will not be subject to liquidity fees or redemption gates. Retail fund The rules also created a new definition for retail funds, which apply to prime and municipal money market mutual funds. A retail fund will be defined as a money market mutual fund that has policies and procedures reasonably designed to limit beneficial owners to natural persons, meaning individual investors, or human beings. The action was based on the SEC s conclusion that, historically, unlike institutional investors, retail investors have been less likely to make large redemptions from money market mutual funds during times of market stress. The SEC definition differs from how the terms are commonly used in today s marketplace. Currently, fund advisors self-classify funds as either retail or institutional based on varying criteria. EXHIBIT 3: Examples of types of retail and institutional accounts. Examples of Types of Retail Accounts Natural persons represent the beneficial ownership interest of these accounts Examples of Types of Institutional Accounts Natural persons do not represent the beneficial ownership interest of these accounts Individual accounts (brokerage or mutual fund) Retirement accounts, including workplace defined contribution plans College savings plans Health savings plans Accounts with registrations based on a tax identification number with the beneficiary not being a natural person Small business accounts Defined benefit plans Endowments Ordinary trusts Accounts sold through intermediaries with the underlying beneficial ownership being a natural person 2

Any prime or municipal money market mutual fund that does not meet the retail fund definition will be considered an institutional fund. Natural persons will, however, be able to purchase institutional funds. Examples of both retail and institutional accounts are listed in Exhibit 3 (see page 2). As noted in Exhibit 3, funds may look through to the end investor to determine whether beneficial ownership is limited to natural persons. As long as each end investor is an individual, the fund will meet the retail definition. This means that many omnibus accounts will be eligible to invest in retail funds. The same is true for ordinary trusts, although trusts will need to be reviewed on a case-by-case basis. Structural changes Stable versus floating net asset values While retail prime and retail municipal money market mutual funds will be eligible to use amortized cost accounting, and to price and transact at a stable $1.00 NAV, the SEC s new rules require all institutional prime and institutional municipal money market mutual funds to have a floating NAV. Floating NAV money market mutual funds will not be able to use amortized cost accounting, except to the extent it is available to all mutual funds. Instead, institutional funds will price and transact their shares to four decimal places, a practice known as basis point rounding. Basis point rounding may cause a shareholder to experience a gain or loss if the per-share value of the fund changes by 1/100th of a penny. For example, if a shareholder owned 10,000 shares priced at $1.0000, a 1 basis point change in a floating NAV fund would result in a gain or loss of $1.00. Floating NAV tax, accounting, and disclosure matters Concerns were raised during the SEC s public comment period regarding the tax, accounting, and same-day settlement issues the new rules would create. For example, under existing tax law, any gains or losses in a floating NAV fund could create taxable events for shareholders. The U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) provided guidance that floating NAV shareholders will be able to report a single net number for the gains and losses over the course of a year, rather than reporting individual transactions. This will significantly reduce tax recordkeeping for shareholders. Additionally, the Treasury and the IRS made it clear that sales of floating NAV money market mutual funds will not be subject to the wash-sale rule. 3 As for accounting and settlement, the SEC stated that floating NAV money market mutual funds will be considered a cash equivalent, and also could be eligible for same-day settlement by pricing fund shares multiple times within a single day. The new SEC rules will require money market mutual funds to provide additional disclosure. By July 2015, each fund must disclose daily on its website: the fund s daily market NAV, reported out to four decimal places ($1.0000); daily and weekly liquid assets as a percentage of the fund s total assets; and the fund s net flows from the previous day. New redemption restrictions Liquidity fees and redemption gates The new rules enable prime and municipal funds both retail and institutional to impose liquidity fees and/or redemption gates in rare periods of unusually heavy fund redemptions. Government and U.S. Treasury money market mutual funds will not be subject to liquidity fees or redemption gates. The trigger for the potential imposition of liquidity fees or redemption gates is the level of weekly liquid assets, a term defined under current money market fund regulation. SEC rules require money market mutual funds to hold at least 10% of total assets in securities that are convertible into cash within one business day, whether through maturity or exercise of a demand feature 4 in one business day ( daily liquid assets ) and 30% of total assets in securities that are convertible into cash within five business days ( weekly liquid assets ), as detailed in Exhibit 4. The liquidity fee is designed 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. All fees are payable to the fund. In particular, if a prime or municipal fund s weekly liquid assets were to fall below 30%, the fund s board of directors may either charge a liquidity fee of up to 2% on shareholder redemptions or impose a halt on all shareholder redemptions (known as a gate ) for no longer than 10 days. If weekly liquid assets were to fall below 10%, a prime or municipal fund must impose a liquidity fee of 1%, unless the fund s board determines that such a fee is not in EXHIBIT 4: Types of money market mutual fund assets that satisfy SEC requirements for daily and weekly liquid assets. Cash 5 Daily Liquid Assets Weekly Liquid Assets Daily liquid assets (see column to left) Direct obligations of the U. S. government 6 Government agency discount notes with remaining maturities of 60 days or less Securities that will mature or are subject to a demand feature that is exercisable and payable within one business day Receivables scheduled to be paid within one business day Securities that will mature or are subject to a demand feature that is exercisable and payable within five business days Receivables scheduled to be paid within five business days 3

the fund s best interest. The board also will have the authority to impose a lower fee or even no fee at all if, in its opinion, that is in the best interests of the fund. The fee would be lifted when weekly liquid assets return to 30% or when the fund s board determines that a liquidity fee is no longer in the best interests of the fund. In addition to imposing a liquidity fee, the new SEC rules permit the fund s board to impose a temporary suspension of all redemptions if weekly liquid assets were to fall below 30%. The gate would be lifted when weekly liquid assets return to 30% or when the fund s board determines a gate is no longer in the best interests of the fund. Redemptions could be suspended for 10 consecutive days or 10 days in total over the course of a 90-day period. The new rules promote transparency, requiring that investors have ready access to information regarding liquidity fees and redemption gates. Once the new rules are implemented, a money market mutual fund will have to disclose daily on its website the daily and weekly liquid assets as a percentage of the fund s total assets. A fund also must disclose promptly and publicly whether a redemption gate has been imposed or removed, as well as a discussion of the board s analysis in determining whether or not to impose or remove a gate. Shared goals and communication 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. Throughout the debate on money market fund reform, Fidelity has been engaged with regulators, policymakers, and business leaders, advocating on behalf of our fund shareholders as the discussion developed. Fidelity ultimately shares the same goal as regulators and policymakers: to ensure the strength and stability of money market mutual funds and our financial system while preserving the benefits that these funds provide investors, issuers, and our economy. Money market mutual funds are an integral part of Fidelity s business. We continue to be vigilant in keeping our money market mutual funds safe and liquid, and in protecting the $1.00 NAV, which has always been our number-one objective in managing these funds. Currently, we are reviewing and assessing the effect of the new rules. At this time, there are no changes in the way money market mutual funds are managed or the way they operate, as the rules have a lengthy implementation period. Fidelity will continue to communicate with our customers, keeping them well informed by providing information, updates, and perspective. For more information about the SEC s final rules, please read the Fidelity Investments Money Market Reform Communication Series to include: Key Money Market Mutual Fund Regulations 2014: Overview of Final SEC Rules Glossary of Key Terms for Money Market Mutual Fund Regulation Understanding Government and U.S. Treasury Money Market Mutual Funds Comparing Retail and Institutional Money Market Mutual Funds Comparing Stable and Floating Net Asset Value Money Market Mutual Funds Redemption Restrictions in Money Market Mutual Funds: Liquidity Fees and Redemption Gates Government Money Market Mutual Funds: An Attractive Option for Institutional Cash Management Understanding Liquidity in Money Market Mutual Funds Authors Nancy Prior President, Fixed Income Nancy Prior is president of Fidelity s Fixed Income division, where she has strategic oversight of Fidelity s Global Bond and Money Market groups. Kevin Meagher Senior Vice President, Deputy General Counsel Kevin Meagher is senior vice president, deputy general counsel for Fidelity Investments, where he is responsible for leading the Fixed Income Legal Team. 4 Fidelity Thought Leadership Vice President and Senior Investment Writer Maggie Stenman provided editorial direction.

Before investing, consider the funds investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Past performance is no guarantee of future results. Endnotes 1 The final rules are clear that liquidity fees and/or redemption gates do not apply to U.S. Treasury or government money market mutual funds. The SEC is allowing U.S. Treasury or government money market mutual funds to add liquidity fees and/or redemption gates to a fund, but only after shareholders receive 60 days written advance notice. 2 UCITS are investment funds that are regulated at the European Union level. They represent a significant share of collective investments by small investors in Europe. 3 A wash sale occurs when a security is sold at a loss and within 30 days prior to or after that, a substantially identical stock or security, or a contract or option is purchased by the same individual, the individual s spouse, or a company controlled by the individual. 4 A demand feature is an embedded attribute of a security that entitles the holder to redeem the security at a price that approximates its amortized cost plus any accrued interest at the time of exercise. Most securities with a demand feature in the money market universe have an exercise price of 100% of face value (plus accrued interest), and tend to trade at or near par. 5 In the money market mutual fund industry, cash is broadly understood to take the form of demand deposits at banks. 6 U.S. Treasury bills, notes, and bonds. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. If receiving this piece through your relationship with Fidelity Financial Advisor Solutions (FFAS), this publication is provided to investment professionals, plan sponsors, institutional investors, and individual investors by Fidelity Investments Institutional Services Company, Inc. If receiving this piece through your relationship with Fidelity Personal & Workplace Investing (PWI), Fidelity Family Office Services (FFOS), or Fidelity Institutional Wealth Services (IWS), this publication is provided through Fidelity Brokerage Services LLC, Member NYSE, SIPC. If receiving this piece through your relationship with National Financial or Fidelity Capital Markets, this publication is FOR INSTITUTIONAL INVESTOR USE ONLY. Clearing and custody services are provided through National Financial Services LLC, Member NYSE, SIPC. 5