by Geoffrey Eikmann
Money market funds are designed to be a cash management tool for individuals and institutions, paying distributions based on short-term interest rates while keeping a stable net asset value (NAV; usually $1 per share). In 2008, one money market fund “broke the buck” after having to write down their assets, which contained Lehman Brothers debt. This event triggered a run on the funds as investors tried to liquidate at a $1 NAV out of fear of potential losses. As a result, the U.S. Treasury stepped in and offered funds an opportunity to opt in to a temporary guarantee program to backstop redemption losses if NAV fell below $1 per share.
On Wednesday, July 23rd,the SEC voted 3-2 to adopt new rules aimed at reforming money market funds,which are governed by Rule 2a-7 under the Investment Company Act of 1940. The new regulations, along with the 2010 amendments to the rule, are intended to address the money market fund risks that became apparent during the 2008 financial crisis. The previous amendments required funds to reduce the weighted-average portfolio maturity from 90 to 60 days, imposed a portfolio weighted-average life limit of 120 days, and set additional limits to improve portfolio credit quality and liquidity. The SEC has indicated the new rules provide a two-year transition period for funds and investors to adjust to the changes.
Here are some highlights of the new rules:
- Institutional prime money market and municipal money market funds are required to adopt a floating NAV to allow daily share prices to fluctuate with changes in the market value of assets
- “Prime” refers to funds that primarily invest in corporate debt securities, and “institutional” refers to money market funds with high net minimums marketed to institutions
- Money market funds defined as “retail” would be exempt from this rule and would continue to maintain a constant NAV of $1 per share
- The SEC defines a “retail” fund as one that “has policies and procedures reasonably designed to limit all beneficial owners of the money market fund to natural persons”
- All funds will now have the option to impose redemption fees (up to 2%), and “gate” or temporarily suspend redemptions if liquid assets fall below a certain threshold (weekly liquid assets < 30%)
- Both options are designed to prevent a run on the fund and give management temporary flexibility to address outflows
- Funds that impose a gate would be required to lift it within 10 business days, and would not be able to implement a gate for more than 10 business days in any 90-day period
- Funds would have to promptly disclose the application or removal of any redemption fee or gate
- Funds will be required to disclose levels of daily and weekly liquid assets, net shareholder inflows and outflows, market-based NAVs, and imposition of fees and gates on their website on a daily basis
- U.S. Government money market funds would not be subject to the floating NAV nor the redemption fee/gating provisions, but could voluntarily adopt the fee/gating standards, if disclosed.
These new proposals should have limited impact on clients who hold retail and U.S. Government money market funds. Investors who seek immediate liquidity may be impacted in times of stress if a fund imposes a gate, but the 10-day limit attempts to prevent a long-term lockup of cash. The interpretation of the “retail” fund definition is an important issue currently being analyzed by fund managers and custodians to determine how current funds will be categorized and the potential impact on clients. Following the Eurozone sovereign debt crisis of 2011, we adjusted our money market allocation to use U.S. Government funds. In the current rate environment,there is virtually no yield differential among the many types of money market funds (corporate or government), so it does not seem prudent to take risk without a government guarantee for little to no reward. Overall, the new regulations are intended to provide transparency and reduce the risk of money market funds to investors—particularly in times of short-term distress.