By Cyril Tuohy
For retail and institutional advisors who invest in money market mutual funds, a new day has dawned in the world of cash management.
New rules passed by the Securities and Exchange Commission (SEC) are designed to reduce interest rate, credit and liquidity risks to money market funds. In short, the rules are designed to maintain the integrity of money funds.
Money funds aren’t sexy. When’s the last time anyone at the bingo table talked about investing in a hot new money fund?
For advisors with a client roster of retirees, money funds are important. When high-flying sector funds see-saw over the course of a day or a week, investors almost expect it. When money funds change too much in asset values, more people panic.
For insurance carriers investing in big blocks of money market assets, the orderly function of the money market is absolutely critical. Money funds are designed to preserve their $1-a-share net asset values so that investors can always count on the return of principal.
The reforms “will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system,” SEC Chair Mary Jo White said in a news release after the SEC voted 3 to 2 to adopt the reforms.
Reforms to the $3.2 trillion money market fund industry will make the financial system more resilient and transparent, she added.
One of two dissenting SEC commissioners said the reforms could, ironically, create a run on a fund as investors pulled out their money in advance of SEC-imposed delays to withdrawals, or the closure of “redemption gates.”
As the withdrawal window on one fund closes, panicked investors will rush to pull their money out of other money funds in a domino effect.
“More importantly, a run in one fund could incite a systemwide run because investors in other funds likely will fear that they also will impose gates,” White said. Redemption gates, she added, “are the wrong tool to address this risk.”
Paul Schott Stevens, president and chief executive officer of the Investment Company Institute, said the SEC had “proceeded thoughtfully to craft a robust and meaningful final rule” to secure important changes.
The changes are the culmination of more than four years of work during which regulators sought to bolster rules around retail and institutional cash management functions and the needs around short-term financing.
Money market funds don’t sway much with the economic winds. Shares don’t oscillate between $70 a share today, $85 a share tomorrow and $32 a share the day after tomorrow.
Instead, money funds, which invest in short-term government and corporate securities, are designed to retain their net asset values at a relatively constant share price. What you see today is generally what you’re going to get tomorrow and the day after.
Although not guaranteed by the federal government like Federal Deposit Insurance Corp.-insured bank savings accounts, $1 in a money fund today is very likely to be worth $1 tomorrow. Only cash and bank deposits are considered safer.
The reforms are designed to maintain that rock-solid stability.
“With these changes, and the significant safeguards it adopted in 2010, the SEC has issued a strong response to those who believe institutional money market funds pose systemic risk,” said Bill McNabb, chairman and CEO of Vanguard Group.
On Sept. 16, 2008, one money fund in particular posed such a systemic risk: Reserve Primary Fund, the oldest money fund in the U.S.
The New York-based money market giant couldn’t guarantee the net asset values in Reserve Primary after terrified investors yanked their money out of the company in search of safer investment havens. Wall Street experts said that Reserve Funds “broke the buck.”
The value of $1 in the fund fell to 97 cents after the fund wrote off $785 million worth of debt issued by Lehman Brothers, which had filed for bankruptcy protection on Sept. 15, 2008, and Reserve Funds couldn’t prop up Reserve Primary.
Redemptions in the Primary Reserve Fund were suspended for seven days and it was the first time in 14 years that a money fund had fallen under a dollar.
An institutional investor, an insurance carrier with $100 million in Reserve Primary, for example, would have ended Sept. 16, 2008, with $97 million, a loss of cash that was much more damaging in terms of a loss of confidence than in terms of any real economic loss.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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