WASHINGTON -- The SEC approved a long-awaited set of rules on Wednesday aimed at shoring up money-market mutual funds, opting for a dual approach that seeks to align trading prices with underlying market values and guard against destabilizing runs.
In a 3-to-2 vote, the commission pushed forward a rule that will require institutional prime funds to allow net asset value to float to its market value, rather than holding pat at $1. In addition to the floating NAV, the commission adopted a so-called fees and gates proposal, authorizing fund boards to impose fees on investors seeking to redeem their shares in times of stress, and then the ability to temporarily close off sales to prevent a run.
The SEC's work on money-market funds comes in response to the upheaval of the financial crisis, specifically the run in September 2008 that saw the Reserve Primary Fund break the buck, triggering a ripple effect that froze up short-term credit markets and ultimately prompted the Treasury Department to intervene to stabilize the market.
"The recommendation before us today creates a very strong reform package that significantly mitigates the risk of a run in money-market funds and that will limit further contagion should a run occur," SEC Chairwoman Mary Jo White said at Wednesday's meeting. "Together, this strong reform package will make our financial system more
resilient, and enhance the transparency and fairness of these products for America's investors."
The move to require institutional prime funds to float the NAV is intended to guard against what the SEC describes as the first mover advantage, the concern that sophisticated investors who anticipate that a fund's shadow value is moving below the stable $1 price could sell off shares in anticipation of the fund breaking the buck. With the floating NAV proposal, the SEC is seeking to bring prime institutional funds more in line with conventional mutual funds.
In drafting the floating NAV rule, the SEC singled out institutional prime funds, while exempting retail and government funds. The commission noted that the exemption comes amid a recognition that those classes of funds weathered the financial crisis very differently and that, amid the mass selloffs in institutional prime funds, retail and government funds proved far sounder, obviating the need for the floating NAV requirements.
"Institutional prime money-market funds experienced the precipitous run during the financial crisis, and our analysis has shown that they continue to be the most susceptible to runs," White says. "Retail and government money-market funds have not to date faced significant runs even in the worst of times. In fact, investors ran to government money-market funds in 2008 and the value of their portfolios appreciated.
CASH MANAGEMENT VEHICLE
Of note for financial advisors, White acknowledges the value of money-market funds as a cash-management vehicle for retail investors, and says the reforms approved Wednesday were drafted with care to preserve the value of those funds as an investment vehicle.
"Retail investors in particular have come to rely on the liquidity and stability of money-market funds, and they lack investment substitutes with similar characteristics, including those that may be available to institutional investors," she says. "Reform must be tailored to preserve benefits like these for retail investors when the risks do not dictate otherwise."
Funds will have two years to comply with the new rules.
The SEC's work on money-market funds reform has drawn keen interest and considerable opposition from various corners of the industry. The rules were developed with feedback drawn from hundreds of meetings and around 1,400 comments from investment advisors, trade groups, academics and other stakeholders.
One aspect of the floating NAV proposal that groups such as the Financial Services Roundtable found particularly troubling involved the accounting and tax requirements of tracking the gains and losses associated with a fund with a market valuation in constant flux.
In response to those concerns, shortly after the SEC's vote, the Treasury Department and the IRS issued a new proposal that would provide a simplified method of tax accounting for sales of floating NAV fund shares that allows transactions to be reported on an aggregated basis annually.
The SEC bills the fees and gates proposal as an important investor protection intended to curtail the risk of a run on a fund, and to establish a firewall that could prevent one troubled fund from sparking a broader selloff, similar to 2008.
The fees and gates rule applies to both institutional prime and retail funds, while exempting government funds.
The money-market fund rulemaking was not without dissent within the SEC. Commissioners Kara Stein, a Democrat, and Republican Michael Piwowar voted against the proposal. Stein, who called for a broader response to fund instabilities that would include other regulators, particularly objected to the gate proposal, which she warns could actually invite the runs on a fund it aims to prevent. In anticipation that a redemption gate could close, jittery investors could rush to sell, while slower-moving, less-sophisticated asset holders could see their investment frozen behind the temporary wall, Stein cautions.
Piwowar, for his part, takes issue with the move to couple the floating NAV rule with the fees and gates provisions. Piwowar says he favors fees and gates, but blasted the floating NAV rule, which he says invites a preemptive run on a fund as trouble signs emerge through the greater pricing transparency.
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