On July 24, 2014, the Securities and Exchange Commission released a set of rules that will change how money market mutual funds work. The new rules came about after a detailed study and review of more than 1,400 comments from the public.
This is a major development that will affect most investors.
As Mary Jo White, SEC chairwoman, said: "Today’s reforms fundamentally change the way that money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system. Together, this strong reform package will make our markets more resilient and enhance transparency and fairness of these products for America’s investors."
First, let me give you some background.
Money market mutual fund shares are the only type of mutual funds permitted to use a pricing method (amortized cost or penny rounding) that sets prices at a stable $1 per share.
This method has worked well historically. Only one fund (Reserve Fund’s Primary Fund) "broke the buck." The fund had a 1.2 percent position in Lehman commercial paper when Lehman declared bankruptcy on Sept. 15, 2008.
The fund’s price per share dropped from $1 to $0.97 as a result. Fund shareholders started cashing out their shares, as did the shareholders of other unrelated prime money market funds to the tune of $300 billion, or 14 percent of the assets of such funds. Institutional funds realized the most redemptions.
There are two important types of changes relevant to investors that will be put in place within 60 days as a result of the new rules.
First are pricing changes for shares.
To maintain a stable $1 per share price, "retail" money market funds will continue to use the current amortized-cost or penny-rounding method. What’s a retail fund? One that is owned by natural persons.
"Government funds" also are allowed to continue to use a stable $1 per share pricing method. Government funds invest 99.5 percent (formerly 80 percent) or more of their total assets in cash, government securities or repurchase agreements collateralized by government securities or cash.
However, institutional money market funds will no longer be able to price shares at $1 per share. Share pricing will float with current market values of portfolio holdings. Instead of penny rounding, they will round to the nearest 1/100th of 1 percent.
The second major change is giving the fund (retail or institutional) the authority to impose fees and "gates."
If the fund’s liquidity drops below a regulatory minimum (30 percent of total assets), the board can assess a redemption fee of up to 2 percent to discourage shareholder redemptions if the board determines the fee to be in the best interests of the fund. Liquidity is measured weekly.
If liquidity drops below 10 percent, a 1 percent redemption fee must be charged, unless the board determines "that such a fee is not in the best interests of the fund or that a lower or higher (up to 2 percent) liquidity fee is in the best interests of the fund."
If the fund’s liquidity falls below 30 percent, the board also will have the ability to impose a gate — that is, to temporarily suspend redemptions, but only if doing so is in the fund’s best interests. If the gate is imposed, the fund is required to lift it within 10 business days or earlier. Funds would not be able to impose a gate for more than 10 business days in any 90-day period.
Gates are not new. Under current law, funds are permitted to delay redemptions for up to seven days, or they can suspend redemptions after obtaining an order from the SEC. However, by incorporating gates into this rule, they are now brought front and center to investors’ awareness.
As funds start to comply with these new rules in the next few months, we’ll come back to this topic. If you have questions or comments, email me at email@example.com.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/ comments (firstname.lastname@example.org).
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