These funds attempt to maintain a net asset value (NAV) of $1/share, only the yield goes up and down. As a result, these funds have relatively low-risks compared to other mutual funds and pay dividends that generally reflect short-term interest rates. Therefore, MMMFs provide investors with a safe place to invest easily accessible cash-equivalent assets, usually for a year or less. MMMFs are important providers of liquidity to financial intermediaries (an institution that acts as a middleman between investors and those raising funds) and play an important role in our economy.
Money markets are able to stay constant because they do not invest in products that produce capital gains or losses. Should the NAV fall below $1/share, it is said to have “broke the buck.” Prior to September, 2008, investor losses in money markets were almost unheard of. However, that changed when Lehman Brothers Holdings Inc. filed for bankruptcy. On Tuesday, September 16, 2008, Reserve Primary Fund, broke the buck when its shares fell to 97 cents, after writing off debt issued by Lehman. There was concern that investor anxiety triggered by this incident would cause a run on money market funds. In response, the Department of Treasury established the Exchange Stabilization fund. The purpose of the fund is to insure the holdings of covered money market funds, so if they were to break the buck, they will be restored to $1 NAV.
To mitigate the risks to MMMFs, in 2010, the Securities and Exchange Commission (SEC) made significant changes to Rule 2a-7, which among other things, established stricter quality and liquidity requirements, as well as shortened average maturities. The SEC, following Commissioner Schapiro’s speech at the SIFMA Annual Conference, has been exploring further reform initiatives. These include a floating NAV or a combination of capital requirements plus redemption restrictions.
As regulators continue to consider major structural changes to money market mutual fund reform regulation, SIFMA reiterates its perspective that no additional reform is necessary or appropriate at this time.
The 2010 SEC amendments to Rule 2a-7 made MMMFs less susceptible to runs.
The government has already taken significant steps to further regulate MMMFs. These reforms have made the funds more resilient and better able to withstand volatility in the financial markets.
MMMFs are now subject to more stringent constraints on portfolio liquidity, maturity, and credit quality. Furthermore, they are subject to new requirements on disclosure, operations, and governance oversight. MMMFs hold higher levels of liquidity, enabling them to handle large, unexpected redemptions in the rare instances when they do occur. Moreover, MMMF boards now have the power to suspend redemptions in a fund. This gives MMMFs a pre-ordained orderly liquidation plan.
The reforms enabled MMMFs to navigate 2011 market volatility successfully. While the new regulations have been in place for only a short period of time, a significant market test of the regulation occurred in summer 2011. During this period of extreme market volatility, MMMFs were able to satisfy large redemptions, without suffering significant negative impacts to their net asset values (NAVs).
The combination of capital requirements with redemption restrictions is an untenable alternative.
According to Chairman Schapiro in her speech at the SIFMA 2011 Annual Conference, the purpose of further regulation is to sensitize investors that MMMFs are investment products. It seems counterintuitive to impose bank-like capital requirements on MMMFs to achieve this end. A bank-like capital requirement could force many firms to reevaluate this product offering and may shrink the market for this product significantly.
The redemption restrictions piece offers a host of other problems. Simply put, this proposal undermines one of the key features of MMMFs, which is ready liquidity. What’s more, there are significant operational challenges and costs in implementing this proposal.
A Floating NAV would materially alter MMMFs.
Seeking to maintain a stable $1.00 NAV is another key feature of MMMFs. Altering this essential attribute would ultimately shrink the product and have a number of negative consequences. There would be a shortage of short-term financing available which would impact businesses of all sizes. Moreover, these businesses would turn to other more costly and potentially less regulated alternatives, such as off-shore funds. Federal, state and local governments, as well as non-profits, such as hospitals and universities would see dramatic increases in their cost of funding as well. This will increase financial pressures on struggling governments and could result in increased costs for taxpayers.