Download To the Point: New rules may affect how entities classify and

No. 2016-46
13 October 2016
To the Point
New rules may affect how entities
classify and account for investments
in certain money market funds
Market conditions
may affect an
entity’s ability to
classify certain
investments in
money market
funds as cash
equivalents.
What you need to know
•
Entities will need to consider whether changes in the way money market funds now
operate under SEC rules will affect their periodic assessment of whether they can
continue to classify investments in certain funds as cash equivalents.
•
Institutional prime money market funds are required to have floating net asset
values, and all money market funds are allowed to impose liquidity fees on
redemptions or temporarily suspend redemptions in certain situations. These rules
are effective tomorrow.
•
While these changes in how money market funds operate aren’t expected to affect
the classification of investments in the funds under normal circumstances, entities
will need to develop processes and controls to identify fund investments that could be
affected and to monitor developments that could cause a change in classification.
•
Entities with investments in institutional prime money market funds will need to
determine how to record unrealized gains and losses resulting from changes in a
fund’s net asset value.
Overview
Entities will need to consider whether changes in the way money market funds now operate
will affect their periodic assessment of whether they can continue to classify investments in
certain money market funds as cash equivalents.
EY AccountingLink | ey.com/us/accountinglink
The Securities and Exchange Commission (SEC) adopted amendments 1 to its money market
fund rules in 2014 in response to significant redemptions that these funds experienced in
2008 after the Reserve Primary Fund announced that its net asset value (NAV) per share had
fallen below $1.00. The floating NAV and redemption amendments, which are effective
tomorrow, were the key elements in a package of changes the SEC made to how registered
money market funds are regulated under Rule 2a-7 of the Investment Company Act of 1940.
Background
Institutional prime money market funds,2 including institutional municipal money market funds,
are now required to base their NAV on the market value of the securities in their portfolios,
rounded to the fourth decimal place (e.g., $1.0001). These funds, which are required to make
high-quality, short-term investments, are no longer permitted to maintain stable prices by using
the amortized cost valuation method (i.e., value their portfolios at their acquisition cost adjusted
for amortization of premium or accretion of discount) or penny-rounding. Floating NAVs are
intended to reduce or eliminate the advantage shareholders previously had if they were
among the first to redeem their shares in times of economic turmoil.
Under normal
circumstances, the
adoption of a
floating NAV alone
will not preclude
entities from
classifying their
investments in
money market
funds as cash
equivalents.
In addition, the board of a non-government money market fund is now required to impose a
1% liquidity fee on redemptions if the fund’s weekly liquid assets (as defined in the amendments)
fall below 10% of its total assets, unless the board determines that imposing such a fee would
not be in the fund’s best interest. The board of such a fund is also allowed to impose a liquidity
fee of up to 2% on redemptions or impose a gate by temporarily suspending redemptions for
up to 10 business days in a 90-day period, if the fund’s weekly liquid assets fall below 30% of
its total assets. Government funds are permitted but not required to impose liquidity fees and
gates. The changes are intended to give funds tools to manage redemption requests. While
fees don’t stop redemptions, they reduce incentives for investors to flee and compensate
funds for the cost of liquidating assets to meet redemption requests.
Key considerations
If a fund’s NAV changes by more than an insignificant amount or a fund imposes a liquidity fee
or temporarily suspends redemptions, an investment in that fund may no longer meet the
definition of a cash equivalent. US GAAP defines cash equivalents as short-term, highly liquid
investments that are both (1) readily convertible to known amounts of cash and (2) so near
their maturity that they present insignificant risk of changes in value because of changes in
interest rates.
The SEC has said that, under normal circumstances, the adoption of a floating NAV alone will
not preclude entities from classifying their investments in money market funds as cash
equivalents because fluctuations in the amount of cash received upon redemption would likely
be small3 and would be consistent with the concept of a “known” amount of cash. The SEC
has also said that, under normal circumstances, an investment in a money market fund that
has the ability to impose redemption gates or liquidity fees would qualify as a cash equivalent.
To appropriately account for investments in money market funds, entities will need to develop
processes and controls to: (1) identify investments that are subject to floating NAVs and the
imposition of liquidity fees and redemption gates and (2) monitor events that may indicate
that an investment in a money market fund no longer qualifies for cash equivalent
classification. Specifically, entities will need to establish a NAV fluctuation threshold to
determine changes that are inconsistent with the “known amounts of cash” criterion.
Determining this threshold will be a matter of judgment. In addition, at each reporting date,
entities will need to determine whether it’s likely that the money market fund’s board will
impose redemption gates and/or liquidity fees (which may also be inconsistent with the notion
of a cash equivalent investment).
2 | To the Point New rules may affect how entities classify and account for investments in certain money market funds 13 October 2016
EY AccountingLink | ey.com/us/accountinglink
An investment in a money market fund that no longer meets the definition of a cash equivalent
will have to be reclassified and presented as either trading securities or available-for-sale
(AFS) securities on the balance sheet. The classification change should be made prospectively
without revising prior-period balances because the assessment of whether an investment
qualifies for cash equivalent classification is based on conditions existing as of the end of each
reporting period.
Accounting Standards Codification (ASC) 230 4 allows entities to establish a policy concerning
which short-term highly liquid investments that satisfy the definition of cash equivalents are
treated as cash equivalents. If an investment in a money market fund is reclassified because it
no longer qualifies as a cash equivalent under the entity’s policy, it would instead be treated
as an investment for purposes of the statement of cash flows.
While the SEC expects fluctuations in the prices of floating NAV money market funds to be
small under normal circumstances, entities will now need to determine how they will record
unrealized gains and losses resulting from changes in NAV. ASC 305 5 does not provide initial
and subsequent measurement guidance for items that qualify as cash equivalents. As a result,
entities should refer to other accounting topics for applicable guidance.
Investments in Rule 2a-7 money market funds are equity securities that are in the scope of
ASC 320-10 6 and are subject to all of the accounting and disclosure requirements of that
guidance, even if they are classified as cash equivalents. Accordingly, entities will record changes
in unrealized gains or losses related to cash equivalents either through earnings (for those held
as trading securities) or through other comprehensive income (for those held as AFS securities).
How we see it
We generally expect entities to record in earnings any changes in unrealized gains and
losses related to investments in floating NAV money market funds (consistent with the
accounting for trading securities). That’s because changes in NAV are expected to be
small, and immediately recording them in earnings avoids the additional accounting and
reporting complexities associated with investments classified as AFS (e.g., determining
whether declines in NAV are other than temporary).
Endnotes:
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3
4
5
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Refer to SEC Release No. 33-9616, Money Market Fund Reform; Amendments to Form PF, issued on July 23, 2014.
These money market funds are held by institutional investors (i.e., not retail investors) and generally invest in a
variety of taxable short-term obligations issued by corporations and banks, as well as repurchase agreements and
asset-backed commercial paper. They do not include government money market funds, which principally hold
obligations of the US government, including obligations of the US Treasury and federal agencies and
instrumentalities, as well as repurchase agreements collateralized by government securities.
In its adopting release, the SEC said the staff analyzed money market fund pricing data between November 2010 and
November 2013 and found that that the prices would have fluctuated for fewer than 5% of funds if the NAV had been
rounded to the third decimal place and for 53% of funds if the NAV had been rounded to the fourth decimal place.
ASC 230, Statement of Cash Flows
ASC 305, Cash and Cash Equivalents.
ASC 320-10, Investments — Debt and Equity Securities — Overall.
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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.
3 | To the Point New rules may affect how entities classify and account for investments in certain money market funds 13 October 2016