Advisors: Prepare Now for the Coming Money Market Reform

In the financial world, money market funds have become synonymous with cash. They are the industry standard for short-term, liquid investing. InvestorsGuidelines have viewed them as being almost as safe as a mattress, but with a better yield (although in this environment, not much better!). Financial advisors like money market funds because they have a history of maintaining principal and provide daily liquidity.

However, money market funds are not FDIC insured and can lose money. We saw this happen during the financial crisis of 2008, when the Reserve Primary Fund, the oldest money market fund, broke the buck, dropping from the traditional $1.00 per share price to $0.97, after debt issued by Lehman Brothers plummeted in value when the firm declared bankruptcy.* This incident redefined money markets in the eyes of the industry, individual investors and, most importantly, the Securities and Exchange Commission (SEC).

In an effort to help protect the broader financial system, on July 23, 2014, the SEC adopted amendments to the rules that govern money market mutual funds by protecting them from destabilizing runs during crisis events like 2008. The changes outlined in the amendments forever change how money markets operate; most notably, imposing the use of floating rate net asset values (NAVs) on “institutional” non-government money market funds, and providing for liquidity fees and redemption gates in certain circumstances on all money market funds. These developments are quite dramatic for the financial services industry and for retail investors. The story, as is often the case, can only be understood through a close look at the details.

Institutional vs. retail funds

To be a retail fund, the fund shareholders may only be “natural persons.” If even one investor in the fund does not meet that definition, then the fund will be classified as an institutional money market fund.

Government funds

A fund is a government money market fund if it invests at least 99.5% of its assets in government securities or repurchase agreements on government securities.

Floating rate net asset value

The NAV of non-government money market funds deemed “institutional” will change daily, based on the underlying securities held within the fund out to four decimal places ($1.0000).

Redemption gates and liquidity fees

For all money market funds, if the fund’s weekly liquid assets fall below 30%, the board may suspend redemptions for a period of no more than 10 days within any 90 day period, and may impose a redemption fee of up to 2%. If the fund’s weekly liquid assets fall below 10%, non-government money market funds are required to impose a 1% redemption fee unless the board determines it is not in the fund’s best interests to do so.

The table below illustrates how the adopted amendments impact various money market funds available to clients:

Fund Type Net Asset Value Liquidity Fees Redemption Gate
U.S. Treasury Stable Optional Optional
Government Stable Optional Optional
Retail municipal/Tax-exempt Stable Yes Yes
Retail prime/General purpose Stable Yes Yes
Institutional municipal/Tax-exempt Floating Yes Yes
Institutional prime/General purpose Floating Yes Yes

 

 

The SEC recognizes that the amendments impact how financial services firms transact and operationalize money market funds, so they have provided a window for compliance that expires on October 14, 2016. Financial services firms know how the rules apply to their funds with no changes, so 2015 is the year we expect financial services firms to determine what changes they will make to their money market offering, in light of the rules becoming effective, to align with the institutional, retail and government segments outlined by the SEC. Here are a few things you can do as an advisor to prepare your clients for the new money market environment:

  1. Review the money market funds currently being used in your client accounts.
  2. If you don’t use government or treasury money markets, consider how they might fit into your business.
  3. Keep an eye out for prospectus updates indicating changes to the money market fund structure.
  4. Talk to your clients about the impending change and explain to them how they could be impacted.

My objective is to keep you informed about the upcoming money market reform, so that advisors can educate and set appropriate expectations with clients. From our preliminary review, there are three compliance deadlines, with the earliest falling at the end of 2015. Some changes may happen this year and changes will ramp up fairly quickly in 2016. In that spirit, I will post a follow up blog on money market reform as the industry begins shaking out the details.

Happy New Year and welcome to 2015!

 

After the final distribution was paid in December 2014, the Reserve shareholders who held it when it broke the buck ultimately received $0.991 per share.

 

Image Courtesy of Freedigitalphotos.com

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John Frownfelter

John Frownfelter

John Frownfelter is the investments contributor for Practically Speaking and the managing director of investment solutions within the SEI Advisor Network.

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