Here's what financial advisers need to tell clients about new money-market rules

The key changes will require institutional prime money funds to move from a fixed $1 net asset value to a floating NAV, and adopt potential liquidity fees and redemption gates

Oct 10, 2016 @ 11:01 am

By John Waggoner

Here's what you need to tell your clients about the new money-market rules that take effect Oct. 14: Relax. But be aware of the changes, and be able to explain them to your clients.

Start with the basics. Money funds are mutual funds that invest in short-term money-market securities, such as Treasury bills and commercial paper. Historically, money funds have kept their share prices at a constant $1, giving the illusion that they can't lose value. But money funds aren't guaranteed by the government or anyone else.

In money fund parlance, “prime” funds are those that invest in array of money-market instruments, including bankers' acceptances and Eurodollar deposits, among others. Government money funds invest solely in U.S. government instruments, and Treasury-only funds invest, not surprisingly, only in Treasuries.

The new rules make sharp distinctions between money funds sold to institutions and retail investors, defined as “natural persons.”

By and large, those would be your clients. Institutions that invest in prime funds will see their funds' prices start to float, just as any mutual fund's price does. The share prices will be calculated out to four decimal places. The funds now publish a “shadow” share price, subject to a 60-day delay, so you can see what kind of fluctuations they have without the $1-a-share amortized accounting convention.

It's unlikely you or your clients will have to worry about this. “The money-market funds they use will price and transact with a $1 NAV,” said Bob Litle, head of Intermediary Sales at Fidelity Institutional Asset Management. That's true for either prime or government money funds.

Those who choose to invest in prime funds, which typically yield a bit more than government funds, will have to decide whether they want the restrictions that all prime funds will have after Oct. 14. In times of extraordinary stress, such as the collapse of Lehman Brothers, prime funds will be able to limit the effect of big redemptions in two ways. First, they can impose an exit fee of up to 2% for a limited time. Secondly, they can suspend redemptions for up to 10 business days. These rules apply to tax-free money funds as well.

The choice for investors is fairly clear. “Clients must decide if they value more the slightly higher yield in prime funds or if they put their primary focus on liquidity,” Mr. Litle said. Currently, the average retail prime money fund yields 0.17%, versus 0.03% for the average retail government money fund, according to iMoneyNet, which tracks the funds.

Money funds have already shored up their liquidity by decreasing their average maturities and increasing the amount they have on hand to pay departing investor thanks to recent changes in Rule 2a-7, which governs money funds. Taxable funds must hold at least 10% of their assets in investments that can be converted into cash within one day. At least 30% of assets must be in investments that can be converted into cash within five business days.

Why are regulators so concerned about money funds? The new rules for money-market funds are a long-delayed repercussion of the financial crisis. When the Reserve Primary Fund, the nation's first money-market fund, announced on Sept. 16, 2008 that it could no longer keep its share price at a stable $1, the financial markets went into a freefall. But it wasn't just Reserve that got into trouble: 155 money-fund sponsors got permission to bail out their funds between 2007 and 2008, according to the Securities and Exchange Commission.

With the collapse of Reserve, however, the money market essentially froze, and it took action from the Federal Reserve, in the form of money-fund guarantees and liquidity facilities, to unfreeze it. The commercial paper market fell from $2.2 trillion before the financial crisis to about $9.4 billion today. Without those steps by the Federal Reserve, however, companies from banks to manufacturers could have defaulted on their own short-term loans, missed payrolls, or been unable to conduct business.

“You can't separate the shadow banking system from the actual banking system,” said Peter Crane, editor of Money Fund Intelligence . “It's not a big stretch to say the whole financial system was in danger.”

Commercial Paper Outstanding
Source: Board of Governors of the Federal Reserve System (US)

So far, the transition to the new rules has gone smoothly: About $1 trillion has moved from prime money funds to government money funds, Mr. Crane said. One of the biggest movers was the $133 billion Fidelity Cash Reserves (FDRXX), once a prime fund, has changed its name and objective to Fidelity Government Cash Reserves. Mr. Crane expects similar moves by other funds will reduce their expense ratios, but will also be cheaper to run. “Still, it sure beats assets leaving,” he said.


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