Financial advisers foresee an exodus of investors from money market funds if the reforms floated by the Securities and Exchange Commission are implemented.
Last Wednesday, the SEC unanimously approved and released a proposal that offered two alternatives to increase the stability of money funds.
One would require prime institutional funds, which invest in commercial debt and are considered the riskiest, to have net asset values that fluctuated daily with market conditions rather than maintaining the traditional stable $1 share price. Government and retail money funds could continue to use a $1 NAV.
STABLE NAV
The other would maintain a stable NAV for all funds but impose restrictions on redemptions and charge withdrawal fees if fund liquidity fell below a certain threshold.
SEC Chairman Mary Jo White indicated that the two proposals could be combined — with a floating NAV for prime institutional funds and the so-called gate-and-fee mechanism for all other non-government funds.
The proposals, either individually or combined, are likely to cause headaches for advisers and their clients. Advisers commonly use money market funds as a vehicle to store client cash over the short term, capturing returns that, while not huge, beat the minuscule interest rates that bank deposits are paying.
But while a floating NAV would provide greater transparency into the actual value of a client's assets in a money market fund, it also would make them less attractive as a parking spot for cash. And the risk of being locked out of cashing in shares during times of market stress is a non-starter for some advisers.
Indeed, the reforms undermine the stable value and convenient access that make money market funds attractive, according to Samantha Macchia, principal at Summit Financial Strategies Inc.
“People expect that type of vehicle to be safe, liquid and readily available if they want to write a check off of it tomorrow,” she said.
J. Christopher Donahue, president and chief executive of Federated Investors Inc., a major money market firm, said that a floating NAV wouldn't stop heavy redemptions during a crisis but rather would catalyze a shift out of them into large banks and government or private funds.
“If there is a floating NAV on prime institutional money funds ... then those people are going to be out of the money fund,” he said at a Keefe Bruyette & Woods Inc. conference in New York last week.
Prime institutional funds make up 37% of the entire money fund market, according to the SEC, and represent about $1 trillion of the roughly $2.6 trillion in money fund assets.
A floating NAV would make Jason Hochstadt, executive vice president of Jedi Management Inc., hesitate to put money funds in a client's portfolio.
“If there's a chance that I can't get that money out, I would be cautious and re-examine whether I would use them for the cash component,” Mr. Hochstadt said.
Duane Thompson, senior policy analyst for Fi360 Inc., a fiduciary training consultant, added that different rules for prime institutional and retail funds are troublesome.
“A lot of advisers have clients in both kinds of shares,” he said. “It's going to make their analysis of the suitability of money market shares for their clients that much more complex.”
The SEC reforms are designed to increase investor confidence in money funds by preventing a withdrawal stampede such as the one in 2008 that struck the Reserve Primary Fund — the industry's first money fund — when it fell below its $1 NAV, “breaking the buck” in industry parlance. That led to a major disruption in the credit market and contributed to the broader financial crisis.
“The floating-NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds,” said Ms. White, who only two months into her tenure as head of the agency has put forward a money fund proposal.
A similar process collapsed amid SEC dissension last summer under her predecessor, Mary Schapiro.
Unlike bank accounts, money markets don't have a government guarantee. Some advisers are sanguine about a change.
“I suspect the NAV float is the one that makes the most sense because that puts the risk at the front end,” said Leighton Roper, owner of Net Worth Advisory Services.
The SEC defines a government fund as one that holds 80% of its assets in cash, government securities or repurchase agreements collateralized with government debt. A retail fund is one that limits each shareholder's redemption to no more than $1 million daily.
The dual proposal will be open to a 90-day comment period after it is published in the Federal Register. The SEC will review the feedback and possibly make revisions.
Adopting a final rule would require a majority vote of the five-member commission.
Last week's reform proposal comes three years after an initial set of changes that the SEC put in place to reduce interest rate, credit and liquidity risks in money funds. But SEC officials determined that those changes didn't address the risk of funds being struck by a massive run by investors.
In the end, a combination of the two alternatives may prevail. SEC members Daniel Gallagher and Elisse Walter expressed support for such an approach last week.
Money fund reform will require clear client communication, Ms. Macchia said.
“I would have them sign off that they understand the characteristics of that money market fund and that the NAV can change on a daily basis,” she said.
Advisers acknowledge that there is no easy solution.
“As long as interest rates are zero, I don't think there is a good answer,” said Edward Kohlhepp, president of Kohlhepp Investment Advisors Ltd.
