HSBC Global Asset Management released a white paper entitled, "Impacts of Money Market Reform: Understanding how change to prime money market funds may affect your cash investment strategies," which reviews the upcoming money market fund reforms and analyzes its key impacts. (Note the paper isn't available on HSBC's website yet, but should be soon.) Author Barry Harbison, North American Head of Liquidity Product, explains in the Executive Summary, "With less than a year to go until the more structural changes are implemented, it is time to address in some detail how these changes will impact institutional investors in prime money market funds. HSBC Global Asset Management (HSBC) believes that the value proposition of prime money market funds persists despite these changes, and that prime funds will continue to be an important cash management option for large corporate and institutional investors. We believe that investors should use the remaining time to fully understand the new regulations and how they will impact their cash investment strategies from October 2016 onwards."
Harbison gives an overview of the rules, writing, "Changes to Rule 2a-7 that will come into effect in April 2016 are largely focused on ensuring money market fund investors have access to relevant information for evaluating a fund's risk levels.... In April, the following data will be disclosed on a daily basis on a money market fund's public website: Daily & weekly liquid assets – The portion of a fund's assets that mature overnight and within the next 5 business days. This is a key metric of a fund's liquidity and ability to meet redemptions. The SEC requires money market funds to maintain daily liquid assets of at least 10% and weekly liquid assets of at least 30%. Daily market-based NAVs – Daily disclosure of the mark to market net asset value (NAV) will now become standard across the money market fund industry.... Net shareholder flows [and] Sponsor support – Money market funds must disclose all instances where the sponsor has provided financial support to the fund over a preceding six month period. Enhanced stress testing of money market funds will also be introduced in April 2016."
He continues, "The amended rules -- with an implementation deadline of October 2016 -- will result in structural changes to how money market funds operate. Prime institutional money market funds will be required to publish and trade on a market-based NAV rounded to the fourth decimal point, otherwise known as a floating NAV." Further, "In stressed market scenarios, money market funds will be able to impose liquidity fees and/or redemption gates to protect existing investors. This will be compulsory for prime money market funds and other money market funds may opt in."
Harbison adds, "A liquidity fee is a fee which can be charged to investors redeeming from a money market fund during a period where that fund is under stress to ensure that the costs of obtaining that liquidity are paid for by the redeeming investor and not by investors who remain within the fund. As remaining investors are protected from the impact of redemptions, they have less incentive to redeem and may choose to remain invested until liquidity fees are no longer imposed by the fund. This reduces the likelihood of a run on a fund and as such reduces the need for a money market fund's board to implement a redemption gate. A redemption gate describes an emergency power where a fund's board may restrict redemptions from a money market fund with the aim of stopping a run on that fund during a period where the fund is under stress."
Furthermore, he says, "The power to impose liquidity fees or redemption gates lies with a fund's independent board of trustees and relies on their determination that imposing such fees or gates is in the best interests of the fund and its shareholders. The fund's board may set a liquidity fee of up to 2% should a fund's weekly liquid assets drop below 30%. If the fund's weekly liquid assets fall below 10%, the board must impose a liquidity fee of 1% unless it determines that the liquidity fee is not in the best interests of the fund's shareholders. The fund's board may set a redemption gate should the fund's weekly liquid assets drop below 30%, if the board believes the gate is in the best interests of a fund and its shareholders."
Harbison comments, "Gates can stay in place for a maximum of 10 consecutive business days, and a maximum of 10 business days in any 90-day period..... With a fund's weekly liquid asset levels becoming the trigger for the fund board to consider imposing liquidity fees and redemption gates, we will likely see increased investor focus on this metric. All money market funds will be required to publicly report overnight and weekly liquid asset levels for the prior 6 months from April 2016 onwards."
He also explains, "A market-based NAV is simply an alternative way to reflect the underlying value of a money market fund's portfolio of securities. It represents the value of each share in a money market fund should the fund sell its underlying assets at that point in time. As the NAV is calculated using a market based price for each underlying asset, any price movement in these assets changes the NAV per share of the fund, which creates the floating NAV.... Given the high credit quality and short average maturity in the underlying investments of money market funds market-based NAVs are generally not expected to fluctuate significantly. However, it is important for investors to understand that selling shares at a different NAV will result in a gain or a loss."
The paper also reviews potential NAV movements, saying, "HSBC has analyzed market data from January 2001 through January 2016 to better understand how often the NAV of four hypothetical prime money market portfolios could potentially decline.... [A] portfolio's recovery time from a decline in the NAV is longer in periods of low interest rates than in periods of higher rates.... [T]here were some movements in the market-based NAVs of a hypothetical prime institutional money market portfolio over the 15 year period.... [But] the magnitude of these movements and the time it took to recover these NAV declines were both reduced, in some cases significantly, by reducing the maximum maturity of the portfolio. The frequency of the NAV declines was also reduced by the length of time an investor held shares in the portfolio."
Harbison concludes, "Money market funds have proven popular with corporate and institutional investors because they aim to provide safety, liquidity and a competitive money market return. While the current changes in regulation may cause investors to think carefully before including money market funds as one of their cash investment solutions, it is important to consider the changes in context. Transacting at a market-based NAV does not make a prime institutional money market fund an outlier in the world of cash investment options. All other short-term securities that investors may consider for their cash management needs, (including commercial paper or Treasuries), have a market-based price that fluctuates over time, assuming the instrument is not held to maturity. After October 2016, bank deposit products, such as time deposits, will be the only cash investment option to have a fixed value. However, in many instances, even here there are costs to 'breaking' a deposit before maturity in the same way that there is a cost to sell a security."
Finally, he adds, "Despite the evolving regulatory landscape, money market funds will continue to play an important role for cash investors seeking a diversified investment product aimed at providing safety, liquidity and a competitive money market return.... We believe that money market fund investors should use the time between now and October 2016 to: Understand the regulatory changes; Consider how the changes impact your current and future cash investment strategy; Update your investment guidelines, where necessary; Communicate the changes within your organization and determine your cash investment strategy from October 2016 onwards. HSBC firmly believes that prime money market funds will continue to be an important cash investment solution despite the changes we have highlighted."
