The SEC's changes in July to Rule 2a-7 governing money market funds may be simple in concept - but they will require significant changes in fund operations. As speakers from BNY Mellon, Boston Financial Data Services, Deutsche Asset & Wealth Management and EY Global Services explained in a recent NICSA webinar, fund transfer agents and other service providers must significantly reengineer their processes to comply with the new rules between now and 2016, when the most significant changes take effect.
At the same time, how firms handle these challenges will be critical in shaping the money market fund industry of the future. Here's an overview of the key operational challenges of money market reform:
Most observers agree that the most significant change in the revised Rule 2a-7 affects only funds sold to institutional investors that invest in non-U.S. government securities. Beginning in 2016, these "prime" institutional funds - as they are often called - may no longer have a constant, $1 per share net asset value. Instead, these funds must move to a floating NAV that reflects the current market value of portfolio holdings - and that fluctuations in that valuation can't be smoothed through the use of amortized cost accounting.
Prime institutional funds will be required to calculate this NAV out to the fourth decimal place, or 1/100 of a cent, assuming that the fund has base NAV of $1 per share. Right now, funds generally round NAVs off to the second decimal place, which means that reporting systems will need to be modified to accommodate the additional digits.
And while computing the NAV is a demanding task for every mutual fund, it's a particular challenge for institutional money market funds, which normally allow shareholders to purchase and redeem fund shares at various times during the day. That was easy to do when these funds were able to maintain a constant NAV, but under the new regulations, funds that want to offer intraday liquidity must calculate a NAV every time they purchase and redeem shares from investors.
In addition to calculating the NAV at multiple times during the day, funds must have procedures for time stamping purchases and sales to ensure that transactions are recorded at the correct NAV. And funds must have efficient processes for disseminating the updated NAV to intermediaries and shareholders on the website and through other systems.
Despite the challenges, intraday liquidity is such an essential feature of these funds that three of every four prime institutional funds plan to continue to offer it even after the new regulations are in place.
NATURAL PERSON TEST
Retail investors will be much less affected by the new regulations, since they can continue to invest in money market funds with a constant $1 per share NAV.
But if life is simple for retail investors in constant NAV funds, it's much more complicated for the transfer agents keeping track of shareholder accounts in those funds. They must establish procedures to ensure that all investors in a constant NAV fund have provided a Social Security number, which establishes that they are "natural persons" eligible to own shares.
And before the revised regulations take effect in 2016, the transfer agent must migrate any institutional investors in the fund into a floating NAV account - a project that will require new processing routines, software development and lots of communication with the affected shareholders.
REDEMPTION GATES AND FEES
The second major component of the new regulations - which allows funds to impose redemption gates and fees in times of stress - also have significant operational implications.
If a fund's liquidity falls below a specified level, its board of directors can impose a redemption gate, meaning that it can suspend redemptions for a period of time. Alternatively, it can require that redeeming shareholders pay a fee, equal to a percentage of the amount redeemed. In fact, the new rules effectively require that funds charge a redemption fee whenever liquid assets drop below 10% of total assets. (There's an exception for funds investing almost exclusively in U.S. government securities.)
Funds must be prepared for all the complications that could result when a fund imposes gates or fees. Take the case of a prime institutional fund that offers shareholders check-writing privileges. If the board imposes a gate, it can't honor checks presented for payment after the gate is put in place.
On the other hand, if the board establishes a redemption fee, the fund must have a process for deducting the fee as well as the check amount. Also, the fund must be prepared to communicate quickly any imposition of gates and fees.
In a rising interest rate environment, money market funds will be a critical investment vehicle. Funds will need to rise to the operational challenges created by the new regulations so that they can continue to provide an important investment option.
Theresa Hamacher is president of NICSA.