4.4 Money Market Funds
Money market funds (MMFs) are investment funds that maintain a constant per-share net asset value (NAV) by adjusting the periodic interest rates paid to investors. The NAV is usually set at $1 per share. Generally, investors can make withdrawals from MMFs on short notice without incurring a penalty. However, as a result of the most recent credit crisis, certain money market mutual funds incurred losses on their investments, causing some of the funds to “break the buck” when the NAV fell below the constant per-share amount. As the fair values of MMFs declined as a result of deterioration in the creditworthiness of their assets and general illiquidity conditions, redemptions by investors increased. Accordingly, some funds were forced to impose limits on redemptions, liquidate their assets, or obtain support from related entities.
In July 2014, the SEC issued a final
rule that amends the rules governing MMFs under the Investment
Company Act of 1940. The final rule requires certain MMFs to “sell and redeem shares
based on the current market-based value of the securities in their underlying
portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a
’floating’ NAV.”1 In addition, the final rule gives the boards of directors of MMFs the
“discretion to impose a liquidity fee [or] suspend redemptions temporarily” (i.e.,
gate) if a fund’s weekly liquidity falls below the required regulatory threshold.
Further, the rules require nongovernmental MMFs to impose a liquidity fee or gate if
a fund’s weekly liquidity deteriorates below a designated threshold.
The definition of “cash equivalents” in the ASC master glossary indicates that
MMFs are often included within its scope. Under normal circumstances, an investment
in an MMF that has the ability to impose a fee or gate does not prevent the MMF from
being classified as a cash equivalent. Further, the requirement for certain MMFs to
transact at a floating NAV does not prevent an investment from being classified as a
cash equivalent. However, if events occur that give rise to credit and liquidity
issues for an investment and result in the imposition of redemption restrictions
(e.g., liquidity fees or gates) or a planned liquidation, it would generally not be
appropriate to continue to classify the investment as a cash equivalent.
Example 4-5
An MMF imposes a restriction on redemption before the balance sheet date to prevent an investor from converting its investment into cash as of the balance sheet date. It would not be appropriate to classify the fund as a cash equivalent since it is no longer “[r]eadily convertible to known amounts of cash” in accordance with the definition of “cash equivalents” in ASC 230.
Implicit in the definition of a cash equivalent is the assertion that an MMF is, in substance, cash or near cash. Therefore, a restriction on an MMF would contradict the definition of cash and therefore the intent of classification as a cash equivalent. Further, when an MMF has imposed redemption restrictions or is liquidating its investments over a period and is distributing the proceeds, an investor should not record any portion of its investment as a cash equivalent unless the entire investment is considered a cash equivalent in accordance with ASC 230. It would not be appropriate to look through the investment to the underlying securities and classify a portion of the investment as a cash equivalent.
Example 4-6
An MMF imposes an “insignificant” penalty on redemption, and an investor concludes that the imposition of this penalty causes the fund’s fair value to fall below the investor’s cost/par. Therefore, the MMF no longer qualifies as a cash equivalent.
Example 4-7
A redemption restriction is imposed on an MMF on or before the balance sheet date but is lifted after the balance sheet date and before the financial statements are issued or available to be issued. As a result, an investor is able to withdraw funds from the MMF without prior notice or penalty. The subsequent change to lift the redemption restriction should be accounted for as a nonrecognized subsequent event.
If a redemption restriction is imposed on January 15 for a calendar-year-end entity, we would expect the entity to reconsider the classification of the MMF and evaluate whether credit and liquidity issues existed as of the balance sheet date. Even if the redemption restriction is not imposed until after the balance sheet date, it may be appropriate to reclassify the MMF in the prior period depending on whether such conditions existed as of the balance sheet date.
Footnotes
1
The requirement to transact at a floating NAV applies to
institutional prime MMFs but not to government or retail MMFs.