Regulators' attempts to prevent another run on the $2.7 trillion money-market fund industry is having some unintended consequences.
Some of the largest fund providers, led by Federated Investors Inc. and BlackRock Inc., are considering offering private funds with a fixed $1 dollar share price as an alternative to institutional prime funds that were forced last year to adopt a floating price. Invesco Ltd. is discussing several alternatives with clients, including letting them move money into its existing private pool, said Lu Ann Katz, who heads the firm's global liquidity business.
Abandoning the stable share price was among the key changes the Securities and Exchange Commission introduced last year to make the biggest money funds safer. Opponents unsuccessfully argued that the change could drive large corporations to look for alternatives. If the money managers go ahead with their plans, billions of dollars may end up leaving the regulated funds and move into pools that are largely outside the reach of the SEC.
“If you have a vehicle buying the same things, you are simply rearranging the deck chairs on the Titanic,” said Brandon Semilof, a managing director at StoneCastle Cash Management. “It violates the spirit of all of these regulations.”
Regulators have tried to make money market funds safer since the 2008 collapse of the $62.5 billion Reserve Primary Fund, which caused a widespread run on funds and helped freeze global credit markets. They have argued that a $1 net asset value makes funds vulnerable to large-scale investor withdrawals during times of market dislocation.
The rule forces institutional funds that invest in securities other than those issued or backed by the U.S. government to adopt a floating share price and impose redemption fees and gates in times of market stress.
Money managers are responding with a range of alternatives before the rule goes into effect October 2016. Fidelity Investments plans to convert several of its prime money market funds to ones that buy only securities issued or backed by the U.S. government. The firm's prime fund assets will drop by half to about 30% and government funds will account for more than 50% of all money fund assets, said Nancy Prior, Fidelity's head of fixed income, in a RECENT speech at an industry conference organized by research firm iMoneyNet in Westborough, Mass.
Others, including Vanguard Group and Legg Mason Inc.'s Western Asset Management Co., are offering ultra-short bond funds with fluctuating share prices for investors who want more yield. The funds can buy a broad range of high-quality debt from asset-backed to investment-grade corporate securities with shorter maturities. Vanguard cautions in its product summary that the fund shouldn't be viewed as a substitute for money market funds as it will be subject to principal risk.
BlackRock plans to give clients a choice of different variations of government, prime, municipal and short-duration funds as well as separate accounts, Tom Callahan, co-head of cash management at the firm, said in a statement. The world's largest money manager is also considering private pools for clients, according to a person familiar with the matter, who asked not to be identified because the plans are preliminary.
“We are in active dialogue with our clients, and are learning that different client types have particular sensitivity to different elements of these new regulations,” said Callahan, who didn't elaborate beyond the statement.
Private pools could be an option for investors who find a floating share price and redemption gates unsettling, but who want higher returns from their money funds, said Invesco's Ms. Katz.
Federated, one of the largest providers of money-market mutual funds with more than $258 billion of those assets, is giving investors options including separate accounts, offshore funds and government pools, Chris Donahue, chief executive officer of Pittsburgh-based Federated, said in a fourth-quarter earnings call. It is also proposing to limit some of its funds to securities that mature within 60-days since the SEC allows that debt to be valued at cost.
“We are also working on developing privately placed funds in attempt to mirror existing Federated money market funds to serve the needs of groups of qualified, usually institutional investors unable to use money funds modified by the new rules,” Donahue said.
Meghan McAndrew, a spokeswoman for Federated, declined to comment beyond the public remarks by Mr. Donahue.
Of the $2.7 trillion in assets held by money funds as of March 3, about $1 trillion was held in prime institutional funds, according to data from iMoneynet.
The regulation “becomes a game changer for a majority of those assets,” said StoneCastle's Mr. Semilof.
The SEC and Financial Stability Oversight Council have acknowledged that private funds present risks. In its final rule release, the SEC expressed concern about assets shifting in that direction, which “could increase risk by reducing transparency of the potential purchasers of short-term debt instruments.”
John Nester, a spokesman for the SEC, didn't return a phone call and e-mail seeking comment.
Last year, the regulator enhanced reporting requirements for advisors that manage at least $1 billion in liquidity fund and money market fund assets so it could monitor the flow of money into private liquidity funds. It is requiring quarterly disclosure of details surrounding underlying investments, including information about the issuer, the types of investments and valuation. Robert Plaze, a partner at law firm Stroock & Stroock & Lavan, said the information may be of limited use to the SEC.
“Since these funds fall outside the SEC's jurisdiction, it is unclear what the regulator will be able to do with the information,” said Mr. Plaze.