In the latest issue of our flagship Money Fund Intelligence, we profile J.P. Morgan Asset Management's John Donohue, the newly-appointed CEO of Investment Management Americas and Global Head of Liquidity, and Andrew Linton, Global Head of Liquidity Product Development. Below, we reprint part of the Q&A, in which they discuss the implementation of the SEC's recently adopted money fund reforms, particularly issues involving the "gates and fees" provisions. (Look for more of the interview in coming days, or see Crane Data's January Money Fund Intelligence.)
MFI: How big a concern are gates and fees? Are they a bigger issue than the floating NAV? Donohue: Clients are telling us that fees and gates are potentially more problematic than a floating NAV. That's simply because they are aware that if and when a gate actually happens it will be during a stressed market, which is precisely when they would most want access to their liquidity. Many investors use money market funds for liquidity, so to the extent that they think that a gate is potentially going to be utilized, there is a risk that they will look to move earlier than they otherwise may have to get money out of funds. So, at least initially, I think there is some risk of unintended consequences in the form of large outflows.
Linton: Clients are certainly wary of both the fee and gate, and the floating NAV, and a fee potentially creates some complicated issues for money market funds. Saying that you're going to impose a maximum 2% fee, from a processing standpoint, sounds simple. But if you have a transfer agent that has 10 different clients and each one of those clients comes in at a different time of the day and implements a fee that might be at different levels, and then starts changing it every day.... Well, an extreme number of permutations would have to be put in place. This could turn into an incredibly tangled web. In addition, new regulations require money fund boards to take on significant new responsibilities. I know they are thinking carefully about what those responsibilities entail. We have heard they will want more clarity about what exactly they are responsible for and where they might run into trouble.
MFI: How do these issues differ from the current rules? Linton: Ordinarily, U.S. open-end funds may not suspend the right of redemption, and may not postpone the payment of redemption proceeds for more than seven days following receipt of a redemption request. However, under the 2010 money market fund reforms, Rule 22e-3 permits money market funds to suspend redemptions and postpone payment of redemption proceeds in an orderly liquidation of the fund if, subject to other requirements, the fund's board determines that the deviation between the fund's amortized cost per share and its current net asset value per share may result in material dilution or other unfair results to investors or existing shareholders. Basically, under Rule 22e-3 you have to move to liquidate the fund. Under the new rule, you can suspend redemptions for up to 10 business days in a 90 day period. Also, you don't have to move to liquidation.
We should point out, while we just went through the reasons why maybe there are some hidden dangers in the use of a gate, at the end of the day, the gates themselves can be a shareholder friendly protection. If a gate does come down, if used appropriately, it may help to ensure that shareholders are treated fairly.
Donohue: If we had gates back in 2008 and Reserve had put one in place, would that have prevented the contagion that ensued? Would Reserve have been able to survive? We'll never know the answer to this question. But we do know that it probably couldn't have been any worse. Linton: If Reserve could have imposed a gate for 10 business days, then it might have been possible for them to go through an orderly liquidation of the fund instead of what we saw happen.
MFI: What would it take to trigger gates? Donohue: I think it's important to note, new disclosure requirements should encourage clients NOT to rush for the fund exits. But if weekly liquidity falls below 30%, a fund may impose a gate. Before the most recent reforms, when the gate goes down under Rule 22e-3, that's an event of liquidation -- and that's the difference. Now, if, at any time, a money fund has invested less than 30% of its total assets in weekly liquid assets, then its board may implement a gate. I think the SEC wanted to give flexibility on the trigger in the weekly liquid assets. However, 30% is a lot of liquidity, and today there are times when money market funds go below that 30% threshold. But just because you go below 30% doesn't mean you are having a liquidity issue in your fund. You may have large redemptions; you may go down to 29% but have 4-5% maturing over the next two weeks.
I think it’s going to force people to actually hold more than 30% in weekly liquid assets. Responsible fund managers are likely going to manage these funds differently than they do today to try to ensure that they remain above the applicable threshold. I would almost equate it to a "breaking the buck" scenario today. Fund managers will likely do everything they possibly can to make sure the fund doesn't "break the buck." They are going to manage to that level of liquidity to seek to ensure that they never have to put down a gate or a fee.
At 30%, the board has the ability to opt into a fee or a gate. You are giving a lot of discretion to the board. Do I think that any reasonable board in "business as usual" activity is going to throw down a gate if a fund drops below the 30% threshold? I don't. But that doesn't mean they can't. I think the number where it would make sense to approve the implementation of a gate would typically be well below 30%. What is that number where boards implement fees and gates? Every scenario is different. That is why I think that client outreach and education about liquidity in funds is going to become much more important. But again, fund managers will likely hold more liquidity than they do today to try to make sure they don't breach that 30% threshold and, of course, it's going to have an effect on the yield of the fund. The more liquidity you hold, the lower your yield will likely be.
