Money-Market Funds Get New Regime Aimed at Preventing Runs

Jul 23, 2014 2:49 pm ET

(Updates with Crane comment in seventh paragraph.)

July 23 (Bloomberg) -- The riskiest money-market mutual funds will be required to abandon their stable, $1-share value and allow their prices to float under rules adopted by the U.S. Securities and Exchange Commission.

The rules, approved today on a 3-2 vote, conclude a four- year struggle to toughen regulations after a run at one money fund during the 2008 credit crisis brought the $2.6 trillion industry to near-collapse, halted only by a federal backstop. Many money-fund managers and other business groups opposed the new rules.

The strongest of the measures are reserved for prime money funds, which cater to institutional investors and primarily buy riskier securities, such as commercial paper issued by banks. Instead of a stable price of $1, which means a dollar invested can always be redeemed for $1, prime funds will have to price their shares in a way that will reveal fluctuations. Funds will have two years to comply with the change.

“Today’s reforms will fundamentally change the way that most money-market funds operate,” SEC Chair Mary Jo White said before the vote. “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.”

White and Commissioners Luis A. Aguilar, a Democrat, and Daniel M. Gallagher, a Republican, voted for the rules. Republican Commissioner Michael S. Piwowar and Democratic Commissioner Kara M. Stein opposed them.

Tax Burden

The rules include an agreement with the Treasury Department and Internal Revenue Service to reduce the tax burden from investing in a fund whose share price can change. Investors will only have to account for gains and losses once, at the end of a year, instead of tracking prices at which they buy or sell. The IRS also will waive its “wash-sale” rule, which could have penalized investors who frequently move cash in and out of money funds whose net asset values, or NAV, can float.

“With that change, the floating-NAV went from being a deal-breaker to being a pain in the butt,” said Peter Crane, president of Crane Data LLC, a research firm that tracks the industry.

Retail investors won’t see changes in how their shares are priced. Funds that primarily invest in government and municipal securities are largely exempt from the new requirements.

The rules will be closely examined by money-fund managers such as Federated Investors Inc., which argued that a floating share price wouldn’t prevent investor flight in a crisis.

“It does strike a very good balance between reducing the likelihood of runs in money funds while protecting an important cash-management vehicle for individual investors,” said Marie Chandoha, president and chief executive officer of Charles Schwab Investment Management.

Useful Alternative

The SEC has sought to calibrate the rules so that money funds remain a useful alternative to bank deposits. Gallagher said the final rules averted earlier proposals, backed by the Federal Reserve, to require that funds hold a capital buffer.

“Addressing a three-decade-old error in a nuanced and tailored manner to reinstate market-based pricing should not be seen, as some have argued, as a heavy-handed act of government,” Gallagher said in a statement. “This is especially true when the fix will positively impact investor behavior and eliminate the perception of a federal backstop.”

The Investment Company Institute, which represents companies that sponsor money funds, said in a statement that the rules had preserved “the utility and value of these funds for investors.”

“We will work with the commission and with ICI’s members to ensure a smooth transition to these new rules as they are implemented over the next two years,” ICI Chief Executive Officer Paul Schott Stevens said in a statement.

Manage Cash

The U.S. Chamber of Commerce has complained that the changes will destroy the appeal of prime funds, which corporations use to manage cash. The move to a floating share price also will require corporate investors to pay taxes on gains and losses, making them more complex to use, the Chamber of Commerce said.

Boeing Co. will move its cash out of prime funds because they could lose principal if a fund’s share price declines, said Verett Mims, the company’s assistant treasurer. Boeing has $2 billion to $3 billion invested in money funds, most of that in prime funds, she said.

“The proposals, the way they stand now, are going to push more cash to timed deposits with banks or more non-traditional funds where there is less visibility,” Mims said yesterday in a call with reporters.

Government Securities

Boeing could use money funds that invest in short-term U.S. government securities as an alternative, Mims said. Government funds will be allowed to continue pricing their shares at $1, although the rules include restrictions on assets they can purchase. Government funds will now have to invest 99.5 percent of total assets in cash, government securities or repurchase agreements backed by government debt or cash, according to a fact sheet released by the SEC today.

The SEC, along with the Fed and Treasury Department, has pressed to make money funds safer since the September 2008 collapse of the $62.5 billion Reserve Primary Fund, which triggered a run on other money funds and helped freeze credit markets. The crisis calmed only after the Treasury temporarily guaranteed shareholders against losses and the Fed began buying fund assets at face value to help them meet redemptions.

Federated had threatened to sue to block the changes. A spokeswoman, Meghan McAndrew, declined to say this week whether the Pittsburgh-based company is still considering legal action. Federated oversaw $202 billion in U.S. money market mutual fund assets as of June 30, according to Crane Data LLC.

Preemptively Fleeing

The SEC’s rules also would allow boards of directors of money funds to temporarily suspend withdrawals or impose fees when a fund faces an inability to meet redemptions. Stein said she fears investors will react to the prospect of having to pay fees or losing access to their cash by preemptively fleeing.

“If investors are not able to redeem before the gate comes down, they will be harmed as they are deprived of access to their capital,” Stein said. “Ultimately, this contagion could freeze the wholesale funding markets in much the same way as occurred during the recent financial crisis.”

In a letter made public yesterday, top executives at Goldman Sachs Group Inc.’s asset management arm wrote that they agreed with Stein’s views. A drop in share price won’t stop investors from rushing to the exits if they believe their funds could be frozen, Goldman’s executives wrote.

Piwowar also voted against the rules, saying the design of the floating share price was unnecessarily strict and won’t deter sophisticated investors from redemptions that could lead to losses for other investors. In addition, he said, many companies that use prime funds will no longer find them attractive once they lose their stable value.

“The continued utility of institutional prime and tax- exempt money market funds as a cash-management tool is highly questionable,” Piwowar said in a statement.

--With assistance from Christopher Condon in Boston and Robert Schmidt in Washington.