Dramatic Changes for Money Market Funds?

November 29, 2012 | Doug Oest, CAIA, Partner

The challenges facing the money market industry continue to mount, with investors and asset managers growing more frustrated with recent trends. Investors have now experienced several years of near zero returns out of money market funds. The low rate environment has also forced nearly all money market funds to waive part or all of their fees to ensure a positive or flat yield for investors. Revisions to SEC Rule 2a-7 have created money market funds with shorter maturities, higher credit quality and improved liquidity, all of which have added to lower potential returns for money market funds. In addition, the crisis surrounding Lehman Brothers in 2008 which led to the Reserve Primary Fund “breaking the buck” caused large outflows from money market funds into deposit accounts. Not surprisingly, assets in money market funds have dropped dramatically since 2008. As the chart shows, while the decline has stabilized, the downward trend has yet to reverse itself.

Proposed reforms to money market funds seem to further cloud the issue. The Financial Stability Oversight Committee (“FOSC”) recently outlined three possible reform options, while the Financial Stability Board (“FSB”) proposed similar measures. The FOSC proposals are as follows:

• Require money market funds to have a floating net asset value.
• Allow money market funds to continue using a stable net asset value, but require a NAV buffer of up to one percent of assets, and “minimum balance at risk” be made available for redemption on a delayed basis.
• Allow money market funds to continue using a stable net asset value, but require a risk-based NAV buffer of 3 percent, combined with other measures including diversification requirements, increased minimum liquidity levels, and more robust disclosures.

The FSB is endorsing a recommendation that would convert stable NAV funds to floating NAV funds where possible. The money market industry has come out against these proposals, arguing that such moves would undermine the money market product and drive cash to less regulated financial instruments as investment managers come out with new, more profitable cash management strategies.

Investors rely on money market funds for principal protection, and converting to a floating NAV would have a large effect on the cash management industry. Investors would be left to choose between the safety of the underlying assets of a floating NAV money market fund, versus the creditworthiness of a banking institution, were they to allocate assets to a bank in a deposit account above the FDIC limit. If such regulations were made, the market would likely respond as it has done in the past by creating a product that allows investors to invest in a single product that reduces the administrative complexity of allocating assets to multiple bank deposit accounts to ensure FDIC protection.