Wednesday, July 23, 2014

New Money Market Rules: Finally

New Money Market Rules: Finally

Today the Securities and Exchange Commission is expected to issue long-awaited rules on money market funds.  It’s been about five years since the SEC started to air proposals and receive comments.  The rules are born from the instability during the credit crisis of the Reserve Fund, an institutional money market fund that threatened to break its $1.00 NAV.   In previous posts I have noted the vigorous attack by the mutual fund industry on every attempt by the SEC to institute reform. (see, “Planting the Seeds for the Next Financial Crisis: Gutting Money Market Reform [September  23, 2013]” and “Killing Fundamental Reform: Money Market Funds [October 31, 2012]”)  The attacks have successfully delayed and whittled down the SEC’s reform efforts. 

The new rule will only require institutional prime funds to float their net asset value.  This means that corporations and not-for-profits that put their extra cash in money market funds that invest in short-term corporate paper will no longer be able to count on the fund returning the precise amount they invested in the fund.  In other words, this type of fund’s price will experience small fluctuations every day.  In a credit crisis, the fund might experience sizable declines.  The idea is to make clear that the risk of prime funds is borne by the investor and not the Federal Reserve or taxpayers.   Retail money market funds and money market funds that invest in government securities will not be subject to the new rule.

The rule will also authorize mutual fund boards to temporarily close any money market fund to withdrawals during a financial crisis.  I remain concerned about this aspect of the proposal because it may actually stoke panic among retail investors if they can’t get access to their cash.

Despite the narrow focus of the rule, segments of the money management industry are still opposed to the rule.  Tim Pawlenty, President of the Financial Services Round Table and former US Senator, continues to attack the rule.  Because the NAV will fluctuate, corporate investors will have to account for the capital gains and losses generated by prime funds.  Since these types of funds have to trade frequently and corporate treasurers continually adjust their cash positions, the tax records could be extensive.  The former senator bemoans the cost to the mutual fund industry of adjusting their accounting systems as well as the burden on their corporate clients.  The mutual fund industry already has sophisticated systems to account for the tax consequences of all sorts of mutual funds, so it’s hard to believe that they won’t be able to adjust and provide clients with the appropriate information. 

Opponents are really concerned about themselves.  This rule will place risk where it belongs.  If institutional investors want the additional yield derived from short-term corporate paper, they should bear the risk.  As a result, many of these investors may opt for other forms of investing for their cash.  They may not want to do the due diligence or tax accounting involved in prime funds.  While this may hurt certain segments of the mutual fund industry, it’s the proper result. 

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