The Securities and Exchange Commission last month approved new rules for money market funds, attempting to address one of the major unresolved issues of the financial crisis.
Passed in a 3-2 vote, the rules require institutional “prime” money funds and municipal funds to have a floating net asset value, or NAV. The rules will not take effect for two years.
Changes have been inevitable since 2008, when the collapse of Lehman Brothers caused liquidity in the credit markets to seize up. The Reserve Primary Fund, a money market fund that held Lehman short-term debt, suffered losses that caused the per-share value of the fund to fall below $1, an event referred to as “breaking the buck.”
Initial reforms to improve liquidity and transparency in money funds passed in 2010. Then in 2012, the SEC proposed floating rate net asset values for all money market funds. In other words, the value of a money market fund share would fluctuate around the $1 level, based on the underlying value of the fund’s investments.
The big money fund operators pushed back. Industry players such as Federated Investors, Fidelity, Schwab and Vanguard felt this would damage the attractiveness of money funds to investors if their cash holdings were to fluctuate in value daily.
The firms now appear somewhat relieved that the 2014 rules will apply only to “prime” and municipal institutional money market funds. Prime funds invest in short-term corporate debt. Money market funds that invest exclusively in short-term Treasury securities and debt issued by government agencies are excluded.
Currently, an aggregate $2.5 trillion is invested in money market funds, of which $900 billion is in retail funds (unaffected by the rules) and $1.6 trillion in institutional funds. Within the institutional category, $884 billion was in prime funds and $72 billion in municipal funds, which would have to convert to floating rates.
Even though the original proposal on floating rates for all funds was watered down, not everyone is on board. Statements by Vanguard and Schwab appeared supportive of the rules, namely because money market funds catering to individual investors were spared. However, Federated said it was “disappointed” that the SEC voted to adopt floating rates on institutional funds, and that the change would cause “significant and costly” burdens on money market fund operators.
More controversial within the new rules is a provision allowing the use of a redemption “gate” or liquidity fee. In times of financial market stress, money funds at their discretion could temporarily restrict investor withdrawals of cash or charge a fee to investors redeeming shares.
Kara Stein, one of the two SEC commissioners who voted against the new rules, fears the redemption restrictions will incite investor withdrawals in a crisis, rather than curb them. All 12 Federal Reserve Bank presidents share that concern.
The Investment Company Institute astutely points out that these restrictions might deny investors ready access to all of their funds when cash needs or new investing opportunities arise.
As a result, it would not be surprising to see investors seeking places other than money market funds to store their cash in the future.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or [email protected]