The Investment Company Institute published a three-part series on money market mutual funds ahead of the October 14 Money Fund Reform deadline. We reviewed the first piece, "For Money Market Funds, Massive Preparation Has Paid Off in Smooth Transition," in yesterday's "Link of the Day," and we review Parts II and III below. The second "Viewpoints" post, "As Money Market Fund Investors Adjust, Funds Have Managed Flows," and the third, "Money Market Fund Reforms Combine with Bank Regulations to Boost Interest Rates," were written by ICI's Sean Collins and discuss the massive shift of Prime MMF assets to Government MMFs and its implications.

ICI's "Second in a series on money market funds" says, "The Securities and Exchange Commission's new rules for money market funds, which must be fully implemented by October 14, largely center around two key reforms: Prime and tax-exempt money market funds that are sold to institutional investors must price their shares and transact using a "floating" net asset value (NAV), rather than the stable $1.00 NAV that such funds have long maintained; All nongovernment money market funds (i.e., prime and tax-exempt funds, whether retail or institutional) can impose delays ("gates") or redemption fees on redeeming shareholders under limited situations. A fund is required to impose redemption fees if the fund's weekly liquid assets fall below 10 percent of its total assets, unless the fund's board decides a redemption fee is not in the fund's best interests."

It explains, "These changes are pushing investors toward government money market funds -- those that invest principally in securities issued by the US Treasury or government agencies (or repurchase agreements backed by government securities). Institutional investors who prefer money market funds with stable $1.00 NAVs, and retail investors who want to avoid even the remote chance of redemption fees or gates, will have no choice but to invest in a government money market fund."

ICI adds, "According to weekly data, from January 7, 2015, to September 21, 2016, assets in prime institutional money market funds dropped $547 billion. Over the same period, assets in government institutional money market funds rose by a nearly identical amount, $544 billion. A similar, though more muted, shift occurred in retail share classes of money market funds. From January 7, 2015, to September 21, 2016, assets in prime retail money market funds dropped $235 billion. In addition, over the same period, assets in tax-exempt money market funds—the vast majority of which are held by retail investors -- fell $128 billion. Over the same period, assets of government retail money market funds rose by $328 billion."

They write, "Though we can't track the actual dollars moving from one fund to another, it seems likely that most of the $910 billion in assets that have moved out of prime and tax-exempt money market funds in response to the SEC's rule has ended up in government funds.... Many large money market fund sponsors have announced the dates on which they will implement floating NAVs, ranging from October 1 to October 14. So a natural question arises: How much more money could shift from prime to government funds by October 14?"

The Viewpoint answers, "Ballpark estimates by industry participants suggest the flow could total anywhere between $200 billion and $400 billion. Estimates at the upper end of this range are not implausible.... Thus far, the massive shift in assets has proceeded smoothly -- and all indications are that it will continue to do so. Prime money market funds have prepared for the October 14 deadline by making their portfolios extremely liquid."

Finally, it tells us, "In sum, although vast amounts of assets have left prime money market funds for government money market funds, and although even more will leave by October 14, the transition has been orderly -- and all indications are that it will continue to be orderly. In no small part, this reflects the time and effort funds have put into transition planning and execution since the SEC adopted its new rule in 2014."

ICI's Part III piece <i:https://www.ici.org/viewpoints/view_16_mmf_transition_3>_ explains, "`As detailed in the previous ICI Viewpoints in this series, the new Securities and Exchange Commission (SEC) rules for money market funds induced a drop in the assets of prime and tax-exempt money market funds of $910 billion since January 2015 and a roughly comparable $872 billion rise in the assets of government money market funds. This Viewpoints discusses some of the effects of that shift in money market fund assets—combined with Federal Reserve policy and changes in banking rules -- on the market for short-term borrowing and lending (i.e., the money market)."

It comments, "One effect is that with the steep drop in their assets, prime money market funds have had to reduce their holdings of money market instruments. For example, from April 2016 to August 2016, prime money market funds' holdings of large time deposits at banks (bank certificates of deposit and non-negotiable time deposits) declined $163 billion, while their holdings of commercial paper fell $149 billion.... Since last October, interest rates on money market instruments have jumped."

ICI's Collins writes, "Market participants note, however, that part of the rise in short-term interest rates probably reflects regulatory changes for both money market funds and banks: In advance of the October 14 deadline, prime funds have sought to lend dollars at the very short end of the yield curve, limiting their lending almost entirely to 30 days or less. Banks, in contrast, have been less willing to borrow at the very short end of the yield curve, because bank regulators have pushed them to limit their use of overnight or very short-term borrowing in funding their longer-term assets. This mismatch -- between prime money market funds seeking to lend short and banks seeking to borrow longer -- may help explain why the yield on three-month commercial paper has risen more rapidly than the yield on one-month commercial paper since June 2016."

He tells us, "So far, the effects of the new money market fund rules have been largely predictable: Institutional investors have reacted to the floating NAV and the prospect of fees and gates by reducing their holdings of prime money market funds. Retail investors and their intermediaries have reacted (perhaps more strongly than expected) to the prospect of fees and gates by reducing their holdings of prime and tax exempt money market funds. Government funds, which are exempt from the two main changes under the rules, have gained substantial new assets."

Finally, ICI adds, "Throughout all these shifts since January 2015, total money market fund assets have remained at a consistent level around $2.7 trillion. Money market interest rates have responded to the reforms and related flows, particularly as combined with the effects of bank regulatory changes and Federal Reserve policy. Extensive preparation by money market fund sponsors has helped funds, investors, and markets make a smooth transition. ICI will continue to monitor developments in the money markets as the October 14 implementation date approaches, and beyond."

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