The U.S. Securities & Exchange Commission's Division of Economic and Risk Analysis (DERA) published a study titled, "Influences on Money Market Fund Price Variations During the March 2020 Market Dislocation," which states in its Abstract, "This white paper examines weekly fluctuations in money market fund ('MMF') market prices surrounding the March 2020 market dislocation, which resulted from the economic disruptions caused by the COVID 19 pandemic.... The analysis in this white paper identifies key factors influencing these price variations, including interest rates, redemptions, portfolio construction, and liquidity. This white paper aims to inform the Commission, investors, and other interested parties with insights into broader trends within the money market fund industry."
The paper explains, "There are three main categories of MMFs: i) government MMFs, which hold a mix of Treasury and government agency instruments (i.e., debt and repurchase agreements ('repos')); ii) prime MMFs, which mainly hold repos, Treasury debt, government agency debt, commercial paper ('CP') and certificates of deposit ('CDs'); and iii) tax-exempt MMFs, which primarily hold municipal debt. As of December 31, 2024, of $7.2 trillion in total MMF net assets, 82% was invested in government MMFs, 16% in prime MMFs, and 2% in tax-exempt MMFs."
It tells us, "By disrupting economic activity, the Covid-19 pandemic adversely affected U.S. funding markets, exacerbating financial stress that culminated in March 2020. MMFs, which previously acted as a conduit for contagion during the Great Recession in 2008, were similarly impacted during this period. Some MMFs experienced volatility in their net asset value per share ('NAV') and faced substantial redemptions as institutional investors shifted capital from institutional prime and institutional tax-exempt MMFs into government MMFs, despite regulatory reform in 2010 and 2014 aimed at enhancing their resiliency."
The SEC writes, "The 2010 reforms required funds to hold more liquid assets, shortened the weighted average maturity of their portfolios, and enhanced stress testing and disclosure requirements. The 2014 reforms, introduced floating NAV for institutional prime and institutional tax-exempt MMFs to mitigate first mover advantage and gave MMF boards for prime and tax-exempt MMFs the ability to implement fees and gates should MMF weekly liquid assets ('WLA') drop below 30%, with the goal of reducing the risk of investor runs. Another reason for the reforms was that market price volatilities for prime and tax-exempt MMFs were much larger than for government funds."
They comment, "Commission staff and other stakeholders studied the impact of the Covid-19 pandemic and the resulting March 2020 market dislocation. The President's Working Group on Financial Markets ('PWG'), for instance, published a report detailing key events -- such as large institutional prime MMF redemptions -- and outlined several policy reform options. The Commission then issued a request for comment ('RFC') on potential policy measures as described by the PWG report and any other topics relevant to any potential reforms. Several of the comment letters received as a result are referenced below. The Commission then adopted reforms in 2023, which included a modified liquidity fee framework, increased liquidity thresholds, and the removal of the gate provision established in the 2014 reforms."
The DERA study states, "The 2021 proposing release for the 2023 reforms described several empirical trends, including fluctuations in prime MMF market prices prior to and around March 2020. Analyses conducted by Commission staff and academics, as discussed in the 2021 proposing release, found no statistically significant correlation between institutional prime MMF redemptions and market prices amid the March 2020 market dislocation. This paper builds on the analyses presented in the 2021 proposing release to examine the key determinants of price variability during this period. Specifically, the report looks at the impact of the Covid-19 pandemic on market price fluctuations, identifying the factors that most significantly influenced market prices. These factors include interest rates, redemptions, portfolio construction, and liquidity."
It explains, "Currently, MMFs can be broadly categorized into those with stable NAVs and those with floating NAVs. Stable NAV MMFs, such as government and retail MMFs, have two distinct prices: the stable NAV (net amortized cost divided by the number of outstanding shares) and the market price (i.e., mark-to-market NAV or shadow price). If the market price remained within $0.0050 of $1, the MMF could price their portfolio using their stable NAV. In contrast, floating NAV MMFs -- typically institutional prime or institutional tax-free MMFs -- must value their shares to four decimal points, reflecting real-time market fluctuations in their underlying assets."
The paper continues, "It was long assumed that the low-risk nature of institutional prime and institutional tax-free MMF assets would limit the potential to cause a deviation in market value from $1 and ultimately material dilution or other unfair results to investors. However, this assumption had not proven to be correct; for example, the market stress of 2008, which resulted in the Reserve Primary Fund 'breaking the buck' and significant numbers of institutional investors running from prime MMFs, triggered regulatory reform, resulting in institutional prime and institutional tax-free MMFs floating their NAV. In addition, it showed the importance of sponsor support in preventing significant deviations in MMF market prices."
It adds, "To reduce volatility in their market prices, MMFs invest in very short-term, high-credit-quality, well diversified debt securities following the guidelines set forth in rule 2a-7. Although these guidelines attempt to control risks a MMF may face, they do not eliminate those risks. Risks that remain may cause the fund's market price to deviate from $1. Changes in interest rates or a security's credit rating, for example, could put temporary downward pressure on an asset's price before it matures at par. In addition, if redemptions lead to fire sales or securities matured at less than the amortized cost, then the fund's market price could decrease below $1."
The SEC also says, "Various other factors (e.g., portfolio construction and liquidity) may also influence market price fluctuation of MMF shares. For example, MMFs may construct their portfolios with a small number of second-tier securities, to the extent the board can determine that those securities present minimal credit risk to the fund. During the March 2020 market dislocation, for instance, second-tier non-financial CP experienced a higher yield increase (higher price decrease) than first-tier securities. In response to the PWG's December 2020 report, one commenter noted that fund managers had difficulty selling their longer maturity assets, while some experienced losses when selling securities. Finally, an issuer may default on payments of principal or interest, generating losses for funds holding the issuer's securities. If the loss is big enough, a stable NAV fund could break the buck while a floating NAV fund could see a decline in its share price."
Finally, they add, "During the March 2020 market dislocation, MMFs faced the added complexity of liquidity constraints, as some managers had to contend with the possibility of implementing fees and gates when WLA amounts approached the 30% threshold following a wave of redemptions. The way MMF managers responded to redemption pressures -- whether by selling assets or strategically managing their liquidity -- had a direct impact on MMF market prices. This paper looks for patterns within this complex environment to better understand the factors driving MMF price movements. The rest of the paper is organized as follows: Section II. describes the data and methodology, Section III. examines the distribution and standard deviation of MMF prices, and Section IV. documents the empirical findings."
