Money Market Fund Reforms to Reduce Systemic Risk Take Effect in October

Starting 14 October, money market funds that are registered with the US SEC will have to abide by a new set of rules that were adopted to reduce the systemic risk potential of these funds. It has been nearly 27 months since the rules were adopted on 23 July 2014.

The main change deals with a fund’s net asset value (NAV). Money market funds have traditionally operated with a stable NAV and under a special pricing and valuation (amortized cost valuation) that allowed them to maintain a constant $1.00/share price. But following the 2007–08 financial crisis, policymakers started to reconsider this pricing structure, especially after the Reserve Fund’s Primary Fund “broke the buck.” Since then, the SEC has been reviewing perceived vulnerabilities in the money market fund structure, adopting changes to Rule 2a-7 in 2010 to restrict further the ability of funds to invest in “second tier” securities.

The changes adopted in 2014 are an attempt to bolster the stability of money market funds. The following are some of the sweeping reforms included in the new rules:

• Floating NAV — Institutional prime money market funds (including institutional municipal money market funds) will be required to price their shares using a floating NAV and will no longer be able to use the amortized cost method to maintain a stable $1.00/share price. Instead, these funds will have to daily value their portfolio securities rounded to the fourth decimal place (e.g., $1.0000).
• Liquidity Fees and Redemption Gates — Retail and government money market funds will continue to use a stable NAV pricing mechanism. But retail money market funds will now be allowed to impose liquidity fees and “gates” on redemptions in times of extreme stress in order to discourage runs on the fund. They will also have to reduce the “first mover advantage,” which is the ability of early movers to get all of their money out of the funds because they sell more marketable instruments and leave lower-quality assets available to fund the redemptions of slower movers, potentially at less than 100% of their original NAV. Actions to impose either gates or fees will require a finding by the board of directors that such action would be in the best interest of that fund. If the level of a fund’s weekly liquid assets falls below 10%, it can impose liquidity fees on redemption of up to 1%; if the level falls below 30%, liquidity fees can go up to 2%. Funds can suspend (or “gate”) redemptions for up to 10 business days in cases when the fund’s level of weekly liquid assets falls below 30%.
• Diversification and Stress Testing — Money market funds will now be subject to stricter diversification requirements, including aggregating affiliates, changing the fund’s diversification limit for guarantors and demand feature providers, and requiring sponsors of asset-backed securities to be counted as guarantors. Funds will also have to meet more stringent stress testing requirements and reporting to fund boards.

Although adopted two years ago, the SEC used this implementation phase to allow “both funds and investors time to fully adjust their systems, operations and investing practices.” That implementation stage has seen recent changes to the money market arena in terms of shrinking investments in commercial paper and other moves toward liquidity in anticipation of the reforms, with some noting the market turmoil as a result of the pending changes.

The Standards and Advocacy team at CFA Institute has closely monitored these changes and has weighed in over the years on several of the SEC’s proposed changes to money market funds. We released an Issue Brief in October 2013 highlighting positions we took based on feedback from members of CFA Insitute.

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