Views on improving the integrity of global capital markets
23 July 2014

SEC Toughens Money-Market Fund Rules: Floating NAV Addresses Systemic Risks

Posted In: Systemic Risk, US SEC

New rules approved by the Securities and Exchange Commission (SEC) today on whether net asset values (NAVs) for money market funds must float or remain fixed closely track what CFA Institute suggested to the SEC in its letter from September 2013.

Under the new rules, NAVs for institutional prime money-market mutual funds will now have to allow their share prices to float, reflecting the changing value of portfolio securities. By comparison, money-market funds for retail investors and funds investing in government securities can continue to use so-called “fixed” NAVs. In its letter to the SEC, CFA Institute expressed ultimate support for floating NAVS as being consistent with the principles of fair value accounting (see our issue brief for more). It also urged the SEC to exempt retail and government securities funds from the floating NAV requirement due to the significantly lower potential for such funds to experience investor runs that might lead to systemic failure.

The new rules will come into effect over a two-year transition period and are intended to address perceived systemic risks posed by money-market funds in times of stress, especially to the extent that customer sell orders lead to a spiral of portfolio liquidations that potentially freeze the wholesale funding markets. The SEC also announced that the US Treasury Department and Internal Revenue Service would soon propose new rules to simplify tax accounting treatment for investors in variable net asset value (VNAV) money-market funds, which opponents to reform had cited as a significant burden.

The SEC rules also would allow boards of directors for institutional and retail money market funds — government securities funds would be exempt — to impose redemption gates and/or liquidity fees at a lower threshold of the proportion of funds’ liquid assets than previously proposed. The intent is to slow the potential for runs, but not to precipitate runs by those who predict imposition of gates. The element of discretion on the part of fund boards will create some dilemmas for directors who must consider their fiduciary duty to their funds’ shareholders as well as the systemic implications of their actions. On balance, it is hard to be optimistic that introducing more uncertainty in times of stress would ultimately be useful.

European policymakers have expressed keen interest in the SEC’s new money-market fund rules as the European Parliament will reexamine its own money-market fund reforms after this past May’s elections. The European approach thus far has been to propose that funds either maintain capital buffers or switch to floating net asset values, so there is potential for different regulatory approaches across the Atlantic.


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Photo credit: ©iStockphoto.com/Miesna

About the Author(s)
Bob Dannhauser, CFA

Bob Dannhauser, CFA, is head of global private wealth management at CFA Institute.

5 thoughts on “SEC Toughens Money-Market Fund Rules: Floating NAV Addresses Systemic Risks”

  1. Sean Thomson says:

    Hi Bob,

    Thanks for the article,

    Out of curiosity, why did/do MM funds currently price at a fixed NAV?

    Was there some regulatory exemption that they had capability of utilizing that they could not as a floating NAV fund, and if so, what would this exemption be? And what of European regulations?

    It seems to make complete sense to adopt a floating NAV in line with all other fund pricing principles for the sake of consistency.

    With the US adopting a floating NAV, do they still enjoy same day settlement functionality?

    Thanks for the article,
    Sean

  2. Bob Dannhauser, CFA says:

    Sean,

    Money market funds in the US are able to maintain a constant net asset value per provisions of rule 2a-7 of the Investment Compant Act of 1940, which allows use of amortized cost or the penny-rounding method of striking a net asset value for shares of a fund, subject to some conditions and procedures. Allowing for a constant net asset value made these vehicles far more attractive as an alternative to bank deposits for corporate cash and retail investors alike, and indeed, one of the arguments against reform is that these investors would abandon the product if the share price floated, creating follow-on effects in the short term corporate finance markets. The decision by the IRS to simplify tax accounting for floating NAV money market funds (rather than requiring calculation of individual tax lots) should help alleviate some concern over movement away from constant NAV vehicles. Same-day settlement would still be a feature of variable NAV money market funds, just like other open-end mutual funds that settle the day’s transactions at the NAV calculated at the end of the trading day.

    The regulatory approach in Europe was heading in a different direction (featuring requirements for maintenance of capital buffers for constant NAV funds) but since the European parliamentary elections last year, there is some sentiment now for reconsidering the way forward. There are likely to be some similarities between the European and US approaches, for example featuring liquidity fees and redemption gates imposed in times of stress.

    Thanks for your interest!

    1. Sean Thomson says:

      Thanks for the clarity Bob,

      So there will be no other changes to regulations regarding the move to floating NAV? Was the primary concern the flight of investors once the a perceived guarantee on their capital is lost, and not any loss of regulatory benefit or increased regulatory requirements?

      How will the IRS simplify the tax treatment? Will it be a requirement that capital appreciation/loss and that of income accrual be split out somehow? i.e does the floating NAV exclude the income accrual?

      When is the cut-off for same day settlement in the US? 17:30?

  3. Bob Dannhauser, CFA says:

    The primary motivation in seeking reform was to deal with the systemic risk implications of redemptions from money market funds during times of stress, recognizing the procyclical effects of forced sales to meet redemptions. The SEC has an excellent overview of the new US rules here: http://www.sec.gov/spotlight/money-market.shtml. And the IRS proposed rules are described here: http://www.irs.gov/irb/2014-33_IRB/ar13.html. Funds set their policies for when trade orders for fund shares must be received, typically 4pm eastern time at market close.

  4. Sean says:

    Perfect, thanks Bob

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