Like it or not, the SEC is pushing ahead with yet another reform of the $2.6 trillion money market mutual fund industry. Although no one truly likes or wants more regulation, financial advisers should view this latest effort as an opportunity to educate clients about how money funds work and the risks involved in using them.
The Securities and Exchange Commission last Wednesday proposed a plan that would require prime institutional funds, which make up about 37% of the money fund market, to maintain net asset values that fluctuated daily with market conditions, rather than have a stable $1 share price or NAV. Government and retail money market funds could continue to use a $1 NAV.
The SEC also proposed allowing funds to temporarily prevent investors from withdrawing their money in times of financial market stress. If the fund's weekly liquid assets fell below 15% of its total assets, the fund would be required to impose a 2% redemption fee unless the fund's board determined that such a fee would be harmful to the fund.
The board also could set the fee at a lower rate. In addition, once a fund's assets fell below the liquidity threshold, its board could temporarily suspend redemptions for up to 30 days.
The proposal, which was unanimously approved by SEC Chairman Mary Jo White and her four fellow commissioners, marks a significant step in the SEC's continuing efforts to strengthen the financial underpinnings of money funds. It also marks an all-too-rare showing of unity among the SEC commissioners, which is a welcome sign.
Nevertheless, the SEC should move carefully and deliberately in imposing new rules and regulations on the money fund industry. The last thing that regulators should do is impose changes that would make it more expensive for investors to buy money market funds, thereby reducing their already paltry yields and perhaps forcing many of them out of the business.
That said, the proposal put forth last week is a step in the right direction and certainly is worthy of serious consideration.
Although the proposal has the potential to create even more confusion surrounding money funds, it is an intriguing notion to limit the floating NAV to prime institutional funds, which tend to be riskier and used by more-sophisticated investors — those who presumably already are aware that money funds don't come with a guarantee against a loss of principal. Therefore, a limited rollout of free-floating NAVs makes more sense than requiring all funds to abandon stable-value NAVs, which was the idea previously floated by the SEC.
Although requiring all funds to float their NAV might reduce the chances of a run by making it clear to investors that money funds aren't bank accounts, it also probably would lead to a severe contraction of the industry.
In terms of last week's proposal, the plan to impose a 2% redemption fee on investors looking to withdraw their money if a fund's weekly liquid assets fall below 15% of its total assets invites skepticism. It is doubtful that a 2% redemption fee would be enough to curtail a spate of panic-driven withdrawals, therefore rendering that aspect of the plan essentially useless.
The SEC has been pushing for reform since 2008 when the Reserve Primary Fund, the industry's first money fund, fell below its $1-per-share NAV when its investments in debt of Lehman Brothers Holdings Inc. dropped sharply in value. In the span of two days, investors redeemed $40 billion from the Reserve Fund, or about two-thirds of its total assets.
And in just one week, investors yanked $310 billion in total from prime money market funds, a figure that represented 14% of the funds' total assets at the time.
In 2010, the SEC made dramatic changes to how all money funds operated. Those changes involved increasing the cash that such funds are required to keep on hand to meet redemptions and boosting the credit standards for the kinds of securities in which they invest.
Money market funds are one of the greatest financial product innovations of our time. Their safety and usefulness should be enhanced, not diminished, by regulation.
Advisers should participate in the process of regulating money market funds by taking the time to review the SEC's proposal and providing input during the 90-day comment period.
Moreover, now is a good time for advisers to help educate clients about money market funds.
Clients should know, for example, that money market funds aim to keep their NAV at a constant $1 per share, while the yield changes over time. They should also know that NAVs do, in fact, fluctuate and that during periods of extremely low short-term interest rates, like today, it is possible that fees charged will exceed income earned, therefore leading to a loss of principal.
Investor education will go a long way toward making money market funds even safer than they already are.