Money-market reform has been in the works since September 2008 when the Reserve Primary money-market fund “broke the buck” due to the collapse of Lehman Brothers. After eight years of deliberation by the SEC, the second round of regulations governing money market funds go into effect on October 14 that include:
Money-market funds will be required to increase the transparency of fund operations and risks. Funds will need to disclose their levels of daily and weekly liquid assets on their websites on a weekly basis in addition to net inflows/outflows, NAVs, fees, and sponsor support. Money market funds will also be required to report portfolio holdings within five business days after month-end and improve private liquidity fund reporting.
Prior to the reform, all money market funds attempted to maintain a stable price of $1.00 per share. The new SEC rules require all institutional prime and institutional municipal money market funds to change their pricing to a floating or fluctuating NAV. Government money market funds, which invest 99.50% of assets in cash, government securities and/or repurchase agreements collateralized by government securities, along with retail municipal and retail prime funds can continue to transact at the stable $1.00 share price.
Diversification requirements for money market funds will also be changing and they will be required to periodically test the ability to maintain weekly liquid assets of at least 10%.
Retail prime, retail municipal, institutional prime, and institutional municipal money market funds will be required to impose redemptions fees and gates during periods of heavy fund redemptions. The directors of money market funds that fail to meet certain liquidity minimums will have the ability to impose fees and redemptions gates to halt or slow potential runs on the fund. Government money market funds are not required to impose such fees or redemptions gates.
With the assistance of iMoneyNet’s Managing Editor, Mike Krasner, we take a look at how these rule changes affect investors and investment management firms.
Due to the heightened restrictions on institutional funds, 52 institutional prime funds have either closed, merged or have been reconstituted as government or retail funds in order to maintain a stable-NAV structure and the net assets have decreased by over 45%. While institutional prime funds have decreased in volume and size, government institutional funds have added 15 new funds and assets have increased by 42% through September 8. iMoneyNet projects the total money market funds available to drop from 1,300 at the end of 2015 to around 1,100 by mid-October.
This trend of assets flowing out of institutional prime funds and into government funds may persist as investors wait to see how the floating NAV plays out. One factor that may reverse the flow of assets is an increase in the yield spread between prime funds and government funds. Prime money funds typically carry a positive yield spread versus government funds and this is likely to continue. As of September 8, the 7-day yield spread was 13 basis points (bps). It is unknown if a yield spread of 25 bps or 50 bps will be attractive enough to change the direction of the flows. Only time will tell.
A combination of low interest rates, increased costs to maintain positive yields, and higher costs associated with the SEC-mandated changes including some that took effect in 2010 have hindered the money market fund industry. However, an increase in interest rates will provide support for the money market providers and allow them to provide increased yields to their shareholders.
Investors of money market funds will now have near real-time access to portfolio holdings along with additional food for thought to be used when questioning the fund managers. Retail investors may not notice a change other than the fund name on their financial statements, while institutional investors will experience greater change and have decisions ahead of them.