As we noted last week, in addition to containing a series of recommendations designed "to make money market funds more resilient in the face of extreme market conditions," the Investment Company Institute's new Money Market Working Group Report includes a host of additional resources and statistics on money funds. Among these is a comprehensive, 26-page "History of Rule 2a-7" (Appendix E), which details in never-before-seen detail the birth and evolution of the regulations governing money funds. We excerpt from this below.
Appendix E's Introduction says, "Some have suggested that the regulation of money market funds is the single greatest success story in the history of financial services regulation. Money market funds serve as an important source of direct financing for governments, businesses, and financial institutions, and of indirect financing for households. Without these funds, financing for all these institutions and individuals would be more expensive and less efficient. Yet this product would never have achieved its full potential without the flexible and resilient regulatory structure created by the Investment Company Act of 1940."
It continues, "Many fundamental features of today's investment companies--including some of the features essential to the success of money market funds--are prohibited by the Investment Company Act.... [T]he Investment Company Act ... generally require mutual funds to calculate current net asset value (NAV) per share by valuing their portfolio securities ... at market value.... Rule 2a-7 under the Investment Company Act exempts money market funds from these provisions and permits the valuation of their shares at par. As detailed below, the history of Rule 2a-7 could be characterized as a periodic rebalancing of the demand for a liquid, low-fee, stable-value investment against the credit and market risks that could result in a fund breaking a dollar. The trend has been a continual reduction in the risks permitted in the face of an increasing demand for the funds."
The MMWG Report says, "The first money market fund was offered to investors in 1971." It includes a chart citing the "principal reason for the early popularity of money market funds," "From the introduction of money market funds through the mid-1980s, the Federal Reserve's Regulation Q limited the maximum rate that could be paid on passbook savings accounts and prohibited the payment of interest on demand accounts." It adds, "Thus, the first decade following the introduction of money market funds provided almost ideal conditions for their growth. Although banks and thrifts eventually developed higher-yielding products to compete with money market funds, none of their offerings could match the combination of yield, stability, and daily liquidity that these funds offered."
"The growing popularity of money market funds led to an onslaught of exemptive orders seeking to create more funds. The SEC responded in 1982 by proposing an exemptive rule permitting money market funds to use either the amortized cost or penny-rounding method to maintain a stable $1.00 NAV. The SEC adopted the exemptive rule.... Rule 2a-7 largely codified the conditions of the previous exemptive orders with few substantive changes. For example, a money market fund was required to 'maintain a dollar-weighted average portfolio maturity appropriate to its objective of maintaining a stable net asset value per share,' which could not exceed 120 days. The maximum maturity of individual portfolio securities was one year. All portfolio securities were required to be U.S. dollar-denominated and determined by the Board to present minimal credit risks," says the history.
Finally, the Appendix adds, "Just as banks have continued to thrive for centuries notwithstanding periodic failures, so money market funds will continue to survive the failure of any particular funds, no matter how venerable. The resilience of money market funds is in no small measure attributable to Rule 2a-7, under which the SEC imposes more substantive regulations on money market funds than on any other type of investment company."
