The Securities and Exchange Commission last Wednesday adopted several amendments to Rule 2a-7 governing money market funds that aim to reduce risks by increasing credit quality, improving liquidity, shortening maturity limits and requiring the disclosure of a fund’s “shadow” net asset value.
The Commission fell short of requiring a floating NAV, but said it may still consider such a move in the future, as well as eliminating the disclosure delay on holdings and the use of credit ratings agencies.
“Safer” cash will be more appealing to some investors—but less appealing to others. With yields already hovering near zero, the new rules will likely lower yields another 10 basis points, said Peter Crane, president and CEO of the research firm Crane Data LLC, which tracks money fund performance.
“The primary objective of money market funds is to maintain stable value,” said Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management, but “money funds are the exception in the regulatory regime in that they don’t display their actual value. This change doesn’t help inform investors of their true value.”
Currently, most money funds list a stable NAV of $1.00, even if the real number is slightly different. They are able to maintain this by investing in boring, short-term investments like Treasuries and municipal bonds. The “shadow NAV” rule requires the disclosure of the fund’s mark-to-market NAV, which could be different than $1.00, albeit it would be revealed on a two-month delay.
Crane said the requirement of a shadow NAV on a 60-day delayed basis is “a baby step towards more transparency in the actual NAV.”
With approximately $3.24 trillion in assets, the enormous money market fund industry accounts for more than 40% of all mutual fund assets, according to the Investment Company Institute. Institutional investors hold more than two-thirds of all money fund assets, and the mutual fund industry does not want to lose these customers.
Investment experts say money funds grew in popularity due to the way they offer liquidity without all the regulatory hassles and oversight that banks face. Stepped-up oversight could push these assets to less-regulated areas, like short-term municipal bond funds. Experts say assets have already been moving to these areas, noting that money funds lost approximately $550 billion in assets last year as investors sought higher yields and more risk.
Under the new liquidity standards approved last week, money market funds are required to hold enhanced cash reserves in order to meet daily liquidity requirements of 10% of assets in cash or in cash equivalents, and weekly liquidity requirements of 30%. The rules also require funds to have “know-your-customer” procedures that would enable them to hold enough liquid securities to handle large redemption requests.
“These rules will take important initial steps toward making money market funds less vulnerable to runs and seek to limit the contagion effect of any run that may occur,” said SEC Chairman Mary Schapiro.
Repairing the Buck
The day after Lehman Brothers’ Sept. 15, 2008 bankruptcy, The Reserve’s $60 billion Primary Fund “broke the buck,” causing its NAV to fall below $1.00. As a result, panicky institutional investors redeemed $300 billion from other taxable prime money market funds and money funds reduced their holdings of top-rated commercial paper by $200.3 billion, or 29%, said Commissioner Kathleen Casey.
The Primary Fund halted redemptions, and has been winding down assets for the past 17 months, with the sixth and final payment of $3.4 billion made last Friday. The new rules will permit the board of a money market fund to halt redemptions if a fund breaks the buck, and allow the fund to process transactions at prices other than $1.00 in order to allow for an orderly wind-down of assets to investors.
While the SEC’s amendments fell short of separating retail money funds from institutional funds, many industry experts say such a move could greatly improve the transparency and stability of these funds, at the risk of losing assets.
“Retail funds give retail investors access to capital markets,” said Robert Plaze, associate director for regulation at the SEC’s Division of Investment Management. “Institutions already have access to these markets and primarily use money market funds to shift risk away from their corporate treasurers.”
The mutual fund industry is very uninterested in restructuring, Plaze said.
“Ninety percent of the outflows [during September 2008] were from institutional funds,” he said. Retail money market funds, on the other hand, were extremely resilient, he said.
“This space has grown too large for Rule 2a-7,” said Commissioner Casey, who cast the sole dissenting vote. “I think our experience with the Reserve Fund and other funds is a wake-up call that stable-NAV money funds are susceptible to runs, and we must more fundamentally rethink how they are regulated.”
Casey said over-reliance on Nationally Recognized Statistical Ratings Organizations like Moody’s, Standard & Poor’s and Fitch, creates “a false sense of comfort and protection and effectively encourages their use as a substitute for due diligence.”
“I believe the new requirement amounts to a confusing distraction from the real credit analysis that boards (and their designees) are obliged to engage in,” she said. “I believe we are needlessly injecting further regulatory reliance on ratings and, as a result, I fear we are encouraging funds and investors to do the same thing.”
Casey thinks money funds should have dedicated liquidity facilities, similar to the way the Treasury’s Temporary Guarantee Program for Money Market Funds stepped in to provide liquidity in September 2008, in which case the funds should be regulated like banks, or they should move to a floating NAV, she said.
The disclosure of daily or floating NAV would show investors that the value of the underlying holdings may waver and fall below the value of one dollar.
Sticking Point: Floating NAV
Industry leaders are divided on the concept of a floating NAV, and the ICI adamantly opposes such a move.
“We will continue to oppose strongly any move that would directly or indirectly require money market funds to abandon the $1.00 fixed net asset value that has been a defining feature of these funds,” said ICI President and CEO Paul Schott Stevens.
While acknowledging that no one wants to see a flight to unregulated vehicles, Commissioner Luis Aguilar said the amendments represent a trade-off, and that relative disclosure could have more costs than benefits, such as raising the risk of needless runs. “Investments in money market funds are not risk-free,” he said, but “our actions today will make these funds safer. The expectation investors have that $1 in means $1 out needs to be protected.”
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