We've gotten a number of requests for a basic recap and the current status of the latest round of money market fund reforms, so we wanted to produce a quick summary of the latest regulatory and fund changes. The following brief answers a number of frequently asked questions (FAQs) on the reforms and provides an overview of the major issues. As many of you know, the Securities & Exchange Commission, which regulates mutual funds, amended "Rule 2a-7" and approved new rules for money market funds in July 2014, which are still in the process of being implemented. The massive (893-page) "Money Market Fund Reform" document explains, "The amendments are designed to address money market funds' susceptibility to heavy redemptions in times of stress, improve their ability to manage and mitigate potential contagion from such redemptions, and increase the transparency of their risks, while preserving, as much as possible, their benefits."
The SEC's press release explains, "The amendments make structural and operational reforms to address risks of investor runs in money market funds, while preserving the benefits of the funds. Today's rules build upon the reforms adopted by the Commission in March 2010 that were designed to reduce the interest rate, credit and liquidity risks of money market fund portfolios.... The new rules require a floating net asset value (NAV) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets and provide non-government money market fund boards new tools -- liquidity fees and redemption gates -- to address runs."
The most critical changes -- the "Floating NAV" and "Fees and Gates" -- go into effect Oct. 14, 2016, others "go live" on April 14, 2016, and some of the minor changes have already been implemented. We briefly review the key features of the SEC's reforms below, then we discuss moves fund companies (and investors) have made in reaction to these changes. In particular, a number of funds have chosen to "go Government" and become Government money market funds, which will still be allowed to keep a stable $1.00 share price (and use "amortized cost" to value securities). Most investors have stayed put to date, though, waiting to see how the new regulations might impact them.
Q: What kinds of money funds are there? While in the past categorization of money funds – retail, institutional, prime, Treasury, government -- has been done by various rankings agencies, like Crane Data, and by language in funds' prospectuses, the SEC's latest amendments outline new classifications of money market funds. They will define "Government," "Retail," and "Institutional," and investment managers are in the process of altering their funds to meet these pending definitions. Government funds must invest at least 99.5% of assets in cash, government securities, and/or government securities-backed repurchase agreements. Government MMFs may impose a liquidity fee or redemption gate, but they are not required to. (Almost all government funds have chosen not to have gates and fees.) Further, Government MMFs can use amortized cost accounting and have a Stable NAV.
Retail MMFs must limit investors to people and have "policies and procedures designed to reasonable limit all beneficial owners of the fund to natural persons." Like Government funds, Prime Retail money market funds can use amortized cost accounting and maintain a Stable NAV. However, unlike Government funds, fees and gates will apply to all Prime Retail money market funds. Prime (or Tax Exempt) funds that do not qualify as Government funds or Retail funds will have to adapt a Floating NAV. Prime Institutional will not be able to use the amortized cost or penny rounding methods to maintain a stable value; they must use "mark-to-market" pricing. Further, Prime Institutional funds will also be subject to fees and gates.
What is the Floating NAV? Will it float? Effective Oct. 14, 2016, Prime and Tax-Exempt Institutional funds will be required to round and transact going out to 4 decimal places (i.e., $1.0000) and to "value their portfolio securities using market-based factors and will sell and redeem shares based on a floating NAV." The SEC rules explain, "When a money market fund's shadow price is less than the fund's $1.00 share price, shareholders have an economic incentive to redeem shares ahead of other investors." Funds have always been required to "shadow" price underneath and monitor any deviations. Going forward these miniscule deviations (except in the case of a financial crisis) should cause these funds to move on occasion. Money funds will continue to invest in safe and stable securities, and any variations should be infrequent and minor.
A critical piece of the SEC's money market reform rules is a proposal by the U.S. Department Treasury and IRS to allow floating NAV money market fund investors to use a simplified tax accounting method to track gains and losses and provide relief from the "wash sale" rules. The Treasury release explains, "An MMF that uses market factors to value its securities and uses basis point rounding to price its shares ... has a share price that is expected to change regularly, or "float." Floating-NAV MMFs therefore resemble in some respects other mutual funds that are not MMFs, but they remain subject to the risk-limiting conditions in Rule 2a–7 and are expected to continue to fulfill MMFs' unique role. In the absence of the simplified method of accounting ... current law would require shareholders to compute gain or loss on every redemption of shares in a floating-NAV MMF." In response to these concerns, "the Treasury and IRS approved a simplified method which aggregates all transactions in a period and on aggregate fair market values."
What are Liquidity Fees and Redemption Gates? "Emergency" fees and gates also go into effect Oct. 14, 2016 for all non-Government funds. The fees and gates, which a board may implement in an emergency situation, are designed to work in concert with the floating NAV rule to stem heavy redemptions and avoid the type of contagion that occurred in the 2008 Financial Crisis. The rules explain, "The amendments will allow a money market fund to impose a liquidity fee of up to 2%, or temporarily suspend redemptions (also known as "gate") for up to 10 business days in a 90-day period, if the fund's weekly liquid assets fall below 30% of its total assets and the fund's board of directors (including a majority of its independent directors) determines that imposing a fee or gate is in the fund's best interests. Additionally ... a money market fund will be required to impose a liquidity fee of 1% on all redemptions if its weekly liquid assets fall below 10% of its total assets, unless the board of directors of the fund (including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund." This will allow funds to moderate redemption requests and, in certain cases, stop heavy redemptions in times of market stress.
Are there any other major changes? The SEC's Money Fund Reforms include a number of additional minor tweaks, including: a new Form N-CR, which will disclose certain specified events, such as fund "bailouts" (Form N-CR rule went into effect July 14, 2015); and, a revised Form N-MPF, which includes disclosure of monthly portfolio holdings. This latter mandate, with a number of additional website disclosures (4-digit NAV per share, daily and weekly liquid assets, shareholder flows), goes into effect April 14, 2016. The final rules also enhance "stress testing" requirements adopted by the SEC in 2010 and they remove references to credit ratings agencies.
How are these changes impacting fund managers and investors? The complexity and costs of the new rules have caused a number of funds to convert into Government-only money funds or to exit the business entirely. We've seen dozens of funds representing almost $265 billion declare their intent to "go Government," and we've seen over $190 billion of this total already switch. We'll no doubt see more funds switch going forward, since Government funds will see the least amount of change under the new regulations. For investors, the safety and simplicity of Government money funds will meet many of their cash management needs, so it's expected that Government funds will see additional inflows from investors beyond these fund changes.
But additional yield and spreads between Prime and Government funds will matter too. So fund companies and investors are looking to keep their options open, and many have launched or offer short-term bond funds or separately managed accounts. With yields rising for the first time in almost 10 years, the playing field for money funds and cash investors is indeed changing. The coming year figures to be an exciting one, but everyone in the money markets will have to adjust and prepare for the new world of cash in 2016.
