Could the SEC’s New Regs Kill Prime Money Market Funds?

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Fund-industry giants are pushing against proposed SEC rules to avert a liquidity crisis.

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Andrew Harrer / Businesshala

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For the untrained eye, the Securities and Exchange Commission debate Proposed New Money Market Funds Regulations Nothing can seem like a fight. But it is gathering dust among regulators and fund providers. And it could have big implications for investors.

Money market funds have changed tremendously since the 2008-09 financial crisis, but interest rates have been so low over the years—you’re lucky you’ve got 0.1%—that most investors don’t give these funds much thought. Huh. One of the biggest changes was breaking them into two categories: government and chief. The government money fund has $4.1 trillion in assets; They buy Treasury bills and other short-term government securities. Prime money funds own corporate debt; Today, they are primarily used by institutions and have $831 billion in assets.

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There are also differences in liquidity — how fast they can get investors their money, and preventing the proverbial bank from running out — and whether they can have a stable net asset value, or NAV, of $1 per share. Now, the SEC wants to impose new restrictions on Prime Funds, citing the 2020 economic crisis.

According to the 325-page text of the proposed regulation, prime money funds’ panic sale of short-term commercial paper — loans issued by blue-chip companies with maturities of less than 270 days — exacerbated the financial crisis: “Commercial paper and Certificates of deposit markets in which prime money market funds and other participating investments became ‘frozen’ in March 2020, and liquidity constraints forced federal Reserve Bank To create a facility to backstop funds.

Several major players in the industry-fidelity to truth,
Federated Hermes (ticker: FHI), BlackRock (BLK) and Bank of New York Mellon (BK) have sent letters to regulators saying the new rule will effectively eliminate prime funds.

Ironically, the rush to exit in 2020 could be due to the earlier set of prime fund regs. In 2014, the SEC gave the fund’s board of directors the power to curtail funding for 10 days when liquid assets fell by more than 30%. Prime Fund boards are required to consider imposing an exit fee as high as 2% if the asset declines by more than 10%.

To stabilize money fund flows, those rules prompted institutional investors to flee prime funds in 2020 to exit before any gates closed. The new rules would eliminate gate and exit fees, but would enforce something the industry loves even less – swing pricing.

Swing pricing is widely used in Europe, but not in the US, although it was authorized by the SEC in 2016 for regular mutual funds. Basically, it allows the manager of a fund to reduce its NAV when the outflow of securities exceeds certain limits. The reason they do this is that the first investors to exit a fund do not get a better price because managers tend to sell off their most liquid securities, while the remaining shareholders are stuck with a liquid portfolio that is more likely to fire-sell. Trades at prices.

Pricing and liquidity can be especially problematic with debt investments, which don’t change hands constantly like stocks. “Money markets don’t trade like other markets,” says Peter Crane, CEO of money fund tracker Crane Data. “Almost everything in the money fund space is buy and hold. You don’t find a lot of people selling one-month T-bills because they need the money in two weeks. But when it does, you get these disproportionate price distortions.” See you.”

The new rule would require prime funds to adjust their net asset values ​​by the “swing factor” when reflecting trading costs on the days of the funds’ redemption.

Where things get really tricky is if funds have redemptions of more than 4% of their portfolio value. Then, to calculate the swing value of the NAV, managers need to examine a “vertical slice” of their entire portfolio and estimate how much it would cost to sell each security in that slice, regardless of whether the fund is currently selling those securities. are not selling. Such an estimate requires an analysis of the potential “market impact cost” of selling, such as the cost of selling liquid securities in a troubled market where there are few potential buyers and in which the sale will reduce the price. First-mover sellers will get a swing-adjusted price to discourage them from selling in a panic.

Money fund managers say that such calculations are very difficult. “What makes swing pricing take the place of [money fund redemption] “Fees, but it’s kind of almost impossible operationally,” says Deborah Cunningham, chief investment officer at Federated Hermes, Global Liquidity Markets. “It takes away the ability of money to be able to transact on the same day, because you can’t price [a money fund’s portfolio] unless you clearly know, at the end of the day, what your redemption is.”

The industry’s solution to such liquidity crunch would be to keep fund exit charges, but make them more flexible. “We really like the concept of liquidity fees,” says Jan Heinrich, associate general counsel at the Investment Company Institute, a fund industry trade group. SEC. filed a petition in Swing pricing is not required. “But it would be better if they were at the discretion of the board rather than tied to a specific one” [liquid asset] Number.”

Yet the SEC’s resolution states that the industry has shown no willingness to levy redemption fees when needed: “In March 2020, no money market funds levied liquidity fees, despite the fact that many institutional heads and taxes -Free funds were experiencing significant outflows and were selling off portfolio holdings to meet some redemptions, sometimes at a significant loss due to wide spreads, given the liquidity situation in the market at the time.

Fund boards may have ulterior motives behind not levying exit fees. “Giving discretion to the board on how much and when to levy” [redemption fees] creates a huge conflict of interest,” says Andy Kapirin, co-CIO of RegentAtlantic, a financial advisor with $6 billion in management. “If you charge fees, you’re potentially giving investors your funds. Will stop investing in it again.”

With almost zero returns for prime funds, Kapirin is now on the side of the government—a wise decision with regs still uncertain.

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