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The SEC Doesn't Seem Particularly Sorry To See Some Money Market Funds Go

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I dunno, you want to get excited about the new proposed money market fund rules? You can if you want. To get a sense of the stakes involved, consider the email I got from a reader today worrying that the SEC may wind up "killing say the market for receivables conduit financing in an attempt to ensure that the precise conditions of September 2008 are never replicated." So: fair, but also, like, farewell receivables conduit financing market, I hardly knew ye. I did not know ye at all, is what I'm trying to say.1

The new rules basically require money market funds to tell you their net asset value, instead of the current rule of not telling you their net asset value, which again is sort of a funny thing to get upset about. In the olden days you could just say your NAV was $1.00 as long as it was at least $0.995; if it fell below that you'd "break the buck" and have to freak out and have massive redemptions and forced sell-offs and so forth. Under the basis-point rounding of the new rules, you'd break the buck at below $0.99995 of NAV and I guess the idea is who has the energy to freak out there, it's like a basis point man, whatever. Binaries create faster death spirals than continuums. The SEC says:

A $1.0000 share price, however, would reflect small fluctuations in value more than a $1.00 price, which may more effectively inform investor expectations. ... “Basis point” rounding should enhance many of the potential advantages of having a floating NAV. It should allow funds to reflect gains and losses more precisely. In addition, it should help reduce incentives for investors to redeem shares ahead of other investors when the shadow price is less than $1.0000 as investors would sell shares at a more precise and equitable price than under the current rules. At the same time, it should help reduce penalties for investors buying shares when shadow prices are less than $1.0000. “Basis point” rounding should therefore help stabilize funds in times of market stress by deterring redemptions from investors that would otherwise seek to take advantage of less precise pricing to redeem at a higher value than a more precise valuation would provide and thus dilute the value of the fund for remaining shareholders.

The rule doesn't apply to (1) government money market funds, because government bonds cannot lose value,2 or (2) retail money market funds, because lying to retail investors about how much their investments are worth is too fundamental a part of our financial system to be stamped out by SEC rules.3 There are also alternative proposals, like liquidity fees and gates, that could be used to reduce the risk of runs instead of or in addition to the floating NAV thing.

If the new rules are ultimately implemented, will they destroy prime (non-government) money market funds? Like, yes, probably. You can tell from the SEC's own discussion:

[W]e anticipate some institutional investors would not or could not invest in a money market fund that does not offer principal stability or that has restrictions on redemptions. ... One survey concluded, among other things, that if the Commission were to require money market funds to use floating NAVs, 79% of the 203 corporate, government, and institutional investors that responded to the survey would decrease their money market fund investments or stop using the funds. Similarly, a 2012 liquidity survey found that up to 77% of the 391 organizations that responded to the survey would be less willing to invest in floating NAV money market funds, and/or would reduce or eliminate their money market fund holdings if the Commission were to require the funds to use floating NAVs. We also understand that some institutional investors currently are prohibited by board-approved guidelines or internal policies from investing certain assets in money market funds that do not have a stable value per share. Other investors, including state and local governments, may be subject to statutory or regulatory requirements that permit them to invest certain assets only in funds that seek to maintain a stable value per share. In these instances, we anticipate monies would flow out of prime money market funds and into government money market funds or alternate investment vehicles. This would result in a contraction in the prime money market fund industry, thereby reducing the type and amount of money market fund investments available to investors and potentially harming the ability of money market funds to compete in several respects affected by our proposal.

There'll be a comment period on these proposals and you can imagine people will submit comment letters that are like THIS WILL DESTROY THE MONEY MARKET INDUSTRY but, like, there's your answer, you know? The SEC already knows that these proposals will destroy the money market industry and is really, really cheery about that. Gloating, practically.4

It's sort of a weird complaint, isn't it, that some investors are prohibited from investing in money market funds that mark their assets to market values? Like the reason you should invest in a money market fund5 is something like "it pools a bunch of short-term, slightly risky fixed-income assets, and by aggregating and diversifying reduces the slight risk of loss to a negligible risk." The added benefit of "and by rounding its NAV up it creates the false impression that that risk of loss has become zero" is a thing,6 but it's not a hugely compelling thing to enshrine in your investment policies or statutes or whatever. Those policies really ought to get at your risk, not the number of decimal places on your monthly statement. They should encourage prudence, not blindness. If some investors revise their policies to get at their underlying risk rather than the accounting methodology of their investments, and some others just end up investing more conservatively, you can understand why the SEC would consider that a win.

Money Market Fund Reform [SEC, pdf]
S.E.C. Votes to Take Next Step on Money Market Funds [DealBook]
SEC unveils middle-of-the-road reforms of money market funds [Reuters]

1.Ha, no, kidding, it's "the largest credit market in the US." It'll be funny if the new money market fund rules inadvertently destroy the main market by which companies finance their businesses and plunge the country back into recession and I was all "receivables conduit financing hahahaha." ANYWAY.

2.Nah, I'm just being annoying with that link, you don't have that much rate risk in a government MMMF. I think. I dunno, Fidelity's is like 13% >180 days but still. From the SEC: "The primary risk that these funds bear is interest rate risk; that is, the risk that changes in interest rates result in a change in the market value of portfolio securities. Even the interest rate risk of government money market funds, however, is generally mitigated because they typically hold assets that have short maturities and hold those assets to maturity."

3.OH KIDDING AGAIN, the elegant reason is that the SEC defines a retail fund to be "a money market fund that does not permit a shareholder to redeem more than $1 million in a single business day," so the break-the-buck-and-spark-a-run risk is sort of by definition diminished. I mean though you could all run at once. But the SEC says "Given the tendency of retail investors to continue to hold money market fund shares in times of market stress, it appears to be unnecessary to impose a floating NAV requirement on retail funds to address the risk that a fund would be unable to manage heavy redemptions in times of crisis." Nice of the retail holders not to run on their money.

4.It's a good, bracing read. E.g.:

[T]here are a range ofinvestment alternatives that currently compete with money market funds. If we adopt either of our proposals, investors could choose from among at least the following alternatives: money market funds that are exempt from the proposed reforms; under the liquidity fees and gates proposal, money market funds that invest only in weekly liquid assets; bank deposit accounts; bank certificates of deposit; bank collective trust funds; local government investment pools (“LGIPs”); U.S. private funds; offshore money market funds; short-term investment funds (“STIFs”); separately managed accounts; ultra-short bond funds; short-duration exchange-traded funds; and direct investments in money marketinstruments. Each of these choices involves different tradeoffs, and money market fund investors that are unwilling or unable to invest in a money market fund under either of our proposals would need to analyze the various tradeoffs associated with each alternative.

As opposed to sweeping tradeoffs under the rug as in fixed-NAV prime money market funds, is I suppose the implication.

5.I mean, if you do. I'm not saying you should invest in a money market fund. I don't care.

6.I don't want to understate its thing-ness. Abstractly like half of the financial system is more or less this:

The fight over who gets to be that magic box is fierce and central to our financial system. Banks do because they're regulated for capital, prudence, etc. Money market funds do sort of by historical accident. AAA structured credit products do by ratings agency malfeasance and/or general bamboozlement and/or legitimate math.aEtc.

a.Btw why isn't someone starting a prime MMMF that is like:

  • 80% "senior" shares whose NAV won't fall below $1.0000 unless the fund overall loses 20%, and
  • 20% "junior" shares that are effectively 5x riskier than regular prime MMMFs but still, y'know, basically pretty safe most of the time?

And then have the senior shares pay [Government MMF Rate] < X < [Prime MMF Rate] and the junior shares pay a bit more than standard prime MMF rates? I guess the answer is all money market fund rates are zero now so this is worthless but, like, if they weren't?