The Securities and Exchange Commission (“SEC”) issued a press release yesterday announcing that it would propose new rules to reform the way money market funds operate. In a unanimous vote, the SEC put forth the following two alternative rule proposals:
1) to require shares of money-market funds to report a dynamic value rather than staying fixed at $1.00 per share; or
2) to allow the use of fees and redemption controls during times of value fluctuation.
Each of these alternatives is focused on preventing a recurrence of the 2008 run on mutual funds by institutional investors resulting from the Reserve Primary Fund (a money market fund) re-pricing its shares below $1.00 during the financial crisis.
By way of further explanation, the SEC released a Fact Sheet, portions of which have been reproduced here:
The History of Money Market Funds — Money market funds are a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts. They have since grown significantly and currently hold more than $2.9 trillion in assets, the majority of which is in institutional funds.
Under Investment Company Act Rule 2a-7, these funds must limit their portfolio investments to high-quality, short-term debt securities. Unlike other mutual funds, money market funds seek to maintain a stable share price (typically $1.00) through the use of certain valuation and pricing methods permitted under Rule 2a-7. The typical experience for a money market fund investor is that when they invest a dollar, they are able to get back a dollar on demand (plus the yield that was earned during the course of the investment). As a result, money market funds have become popular cash management vehicles for retail and institutional investors.
When a money market fund’s market-based value deviates more than 0.5 percent ($0.005) from its stable $1.00 share price, a money market fund generally re-prices at its market value. At these times, investors will no longer get back their full dollar — a phenomenon known as “breaking the buck.”
There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate debt securities. Money market funds that primarily invest in corporate debt securities are referred to as prime funds.
Funds are often structured to cater to different types of investors. Some funds are marketed to individuals and intended for retail investors, while other funds that typically require very high minimum investments are intended for institutional investors.
The Financial Crisis — At the height of the financial crisis in September 2008, a money market fund named the Reserve Primary Fund “broke the buck” and re-priced its shares below its $1.00 stable share price, leading many investors to pull their money out of the fund. That same week, prime institutional money market funds experienced rapid heavy redemptions, with investors withdrawing approximately $300 billion (14 percent of their assets). These redemptions, which halted after the U.S. Treasury provided a government guarantee, prompted the SEC to evaluate the need for money market fund reform.
The 2010 Amendments — In March 2010, the Commission adopted a series of amendments to its rules on money market funds. The amendments were designed to make money market funds more resilient by reducing the interest rate, credit, and liquidity risks of their portfolios. Although these reforms improved money market fund resiliency, the Commission said at the time that it would continue to consider whether further, more fundamental changes to money market fund regulation might be warranted.
Study by the Division of Risk, Strategy, and Financial Innovation — In December 2012, staff from the SEC’s Division of Risk, Strategy, and Financial Innovation published a study relating to money market funds. The study contained, among other things, a detailed analysis of the possible causes of investor redemptions in prime money market funds during the 2008 financial crisis, certain characteristics of money market funds before and after the Commission’s 2010 reforms, and how future reforms of money market fund regulation might affect investor demand for money market funds and alternative investments.
The study indicated that government money market funds generally are not susceptible to heavy redemptions or runs due to the nature of their portfolio assets. Retail investors have historically been less likely to redeem heavily from such funds in times of financial stress. The study informed the Commission’s consideration of the risks that may be posed by money market funds and provided a foundation for this proposal.”
For further information related to the new rule proposals, please visit the SEC’s website, here.