Friday, June 7, 2013

SEC Commissioners Vote Unanimously on Money-Market Reform Measures

By Tim Dulaney, PhD and Tim Husson, PhD

The SEC voted on Wednesday on changes to rules governing money market funds (MMFs).  As we discussed on Tuesday, MMFs are considered low risk, low return investments similar to bank accounts, but experienced 'runs' during the financial collapse of 2008 that helped freeze financial markets.  The SEC's new rules hope to prevent such runs by changing how MMFs report their assets.

As widely suspected, the changes target MMFs favored by large institutional investors (dubbed 'prime funds').  While many small retail investors have some allocation to MMFs, the large institutional investors are thought to be most likely to cause a run because only a relatively small number of them need to withdraw at once to lead to unsustainable outflows.  Prime funds invest primarily in short-term corporate debt, rather than cash or government securities, and so are riskier than other MMFs.  Prime funds also do not limit investor outflows to $1 million per day, as retail MMFs do.  Prime funds account for about 35% of the MMF industry.

Prime funds, like other MMFs, typically keep their net asset value (NAV) at $1.  This means that buying or selling a MMF never incurs a taxable event, as there is no capital appreciation or loss to report.  However, it also means that losses on the fund's assets are in some sense hidden from investors, which is thought to have contributed to the runs experienced in 2008.  The SEC's proposed rules require prime funds to 'float' their NAV, effectively letting it deviate from $1 if the value of its assets rises or falls, much like other mutual funds.

In addition, the SEC proposed a 2% fee on withdrawals from MMFs whose liquid assets fall below a certain level, as well as allowing MMFs to suspend redemptions for up to 30 days. As noted by Commissioner Daniel M. Gallagher, this 'gating' provision is a more stringent control than simply floating NAVs:
Floating the NAV should better inform investors about the risks associated with investing in MMFs and will enhance the transparency of these products, thus reducing the incentive to run. But the only way to ensure that a run is stopped in its tracks is to permit gating.
Also included in the proposed reforms are increased disclosure requirements.  For example, MMFs would now be required to disclosure "historic instances of sponsor support".  In addition, the reforms would remove the 60-day delay of public disclosure of form N-MFP filings that disclose monthly portfolio holdings.

For the next 90 days, the SEC will hear public comments about the proposed changes before they go into effect.  Reactions to the rules has been mixed, and the proposed changes are less extensive than those proposed last fall by the Financial Stability Oversight Council.  But the need for money market reform has been noted by both industry and investor advocates, and may now be close to reality.

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