The Association for Financial Professionals recently published a guide entitled, "Money Fund Reform: The Broader Implications," which was underwritten by Allspring Global Investments and covers the ongoing discussions around money market reforms. It begins, "Late last year, the SEC proposed a number of reforms designed to improve the resilience of money market funds during times of market stress. These amendments, along with rising interest rates and general market volatility, could potentially alter demand for institutional money funds which is, not surprisingly, causing uncertainty for practitioners heading into 2023. With these potential changes likely imminent, treasurers have been left wondering what can be done now to prepare. In this guide, we take a look at the implications of the proposed changes, as well as provide treasurers with practical next steps and questions to consider in advance of these changes. A good first step, if not taken already, is to review the investment policy and procedures to ensure they remain fit for purpose in uncertain times." (Reminder: For those attending our Money Fund University, Dec. 15-16 in Boston, Mass, at the Hyatt Regency, please make your hotel reservations ASAP if you haven't done so. Our discounted room rate expires on Nov. 22. Clients and friends are also welcome to stop by the cocktail party on 12/15 from 5-7pm!)
The paper's Introduction explains, "Money funds play an important role in the economy by acting as an intermediary between borrowers and lenders, via their investment in high-quality securities, and therefore providing important liquidity to the money markets. For corporate treasurers, money funds play a dual role: they are a popular vehicle for investing corporate cash and, by actively investing in short-dated securities, they provide a market for corporate issuers of commercial paper."
It continues, "Money funds provide corporate treasurers with an alternative to banks as a location for placing short-term surplus cash. This role has become more important as banks have been required to manage their own balance sheets and sources of deposits more carefully, in order to meet stricter capital adequacy requirements."
The AFP writes, "As a direct result of liquidity pressures the SEC identified in the market in the spring of 2020, in December 2021, it proposed a package of reforms aimed at improving the resilience of money funds during times of market stress. These reforms have the potential to alter the demand for institutional money funds, particularly prime funds, as an investment vehicle for corporate short-term cash. This guide identifies the likely effects of the various SEC proposals to help treasurers prepare for possible change. It also discusses wider market issues, such as rising interest rates and general market volatility, and suggests a review of investment strategies and policies as we head into 2023."
A section titled "Overview of SEC Reforms" states, "Regulators have been concerned about the resilience of money market funds for some time, primarily due to the risk that a 'run' on one money market fund might result in liquidity problems in the money markets and, by extension, the wider economy. Following the Global Financial Crisis, regulators in the United States and abroad enacted new money market regulations to try to mitigate such liquidity problems in future. The adoption of the post-crisis reforms in the U.S. resulted in money fund investors shifting several hundreds of billions of dollars from prime money funds (which can be invested in a range of securities including commercial paper) to government funds (which have to hold the overwhelming majority of their assets under management in government securities, such as T-bills)."
It tells us, "In March 2020, during the initial stages of the coronavirus pandemic, many institutional investors redeemed their investments from prime funds, preferring to hold surplus cash either with banks or in government securities, including in government money funds. For many investors, the primary objective was to focus on ensuring access to sufficient liquidity to cover the uncertainty during the early stages of the pandemic. The Federal Reserve took a range of actions to try to preserve liquidity in the money markets, notably by establishing the Money Market Mutual Fund Liquidity Facility, which operated from March 2020 to March 2021."
The guide comments, "Following an analysis of investor behavior in March 2020, the SEC identified pressures on the money markets generally, and on institutional prime money market funds in particular. In response, it has proposed a series of reforms to try to reduce the risk that a future market event will result in a similar outcome. The proposed reforms include four key measures: 1. The removal of redemption gates and liquidity fees. 2. An increase in portfolio liquidity requirements. 3. A requirement for swing pricing for institutional prime and municipal funds. 4. Additional provisions to address the effect of potential negative interest rates. Each measure has potentially significant implications for users of money market funds. In each case, we will outline the current proposal and then identify how it could affect corporate users of money market funds."
The paper discusses the reform proposals briefly, then says, "The nature of the SEC's proposals gives an indication of the regulator's residual concerns over the central position of money market funds within the economy. Fundamentally, the SEC is concerned that a run on a particular fund has the potential to disrupt the flow of liquidity in the money markets, which in turn could undermine fundamental business activity in the economy as a whole. Critics might argue that the SEC is merely responding to the latest observable problems, so these proposed reforms are backward-looking and fail to prepare the industry for the next crisis."
It explains, "In comparison, the European Securities and Markets Authority (ESMA) adopted reforms post-financial crisis that are similar to those adopted by the SEC. Part of the regulation imposed a review of the reforms after a five-year period, such that reforms are due for review in 2022. ESMA made suggestions for reform following the events of spring 2020, with the outcome of its consultation due by the end of the year."
AFP adds, "Any time new money market fund regulations are under consideration, treasury practitioners want to know how the reforms will affect the availability and risk profile of money market funds. In practice, while some specific elements of reform will affect treasury departments directly, wider changes in the economy may also influence the use of money market funds over the coming months."
Finally, the guide quotes our Peter Crane, "Over the last twenty years, money fund investors have learned to adjust to regulation. No matter what the SEC decides, big investors will adapt this time too. Yield has not been a factor over this period, but that's also changing now."
