Regulation of Money Market Funds
Money market funds (MMFs), which are sometimes called money funds, are a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts. Money market funds invest in high quality, short-term debt securities and pay dividends that generally reflect short-term interest rates. Many investors use money market funds to manage their cash and other short term funding needs. These funds currently hold some $3 trillion in assets. The aggregate size of MMFs, combined with the demand nature of their short-term assets, creates a significant potential for liquidity challenges in the sector, which can have negative implications for corporate commercial paper funding, banks’ short-term funding, and U.S. Treasury offerings.
The run by institutional investors after the Reserve Primary Fund “broke the buck” in 2008 resulted in significant MMF redemptions and a run on institutional prime MMFs that caused a domino effect on global short-term credit markets. (Breaking of the buck is when the NAV of an MMF falls below $1. Breaking the buck can happen when the MMF's investment income does not cover operating expenses or investment losses.)
This effect culminated with the US government intervening to offer to insure any MMF, giving rise to the expectation that it would do so again if another such calamity were to occur. The extraordinary measures taken by the US government in 2008, and the effect felt by the short-term credit markets globally, ignited a debate about whether the MMF structure posed a systemic risk.
In 2014, the SEC adopted new rules to permit MMFs directed at retail investors and funds that invest solely in government securities to continue to offer a stable NAV. Institutional prime MMFs (including institutional municipal MMFs) are required to maintain a floating NAV.
The new rules allowed funds to use liquidity fees and to impose “gates” (temporary suspension of redemptions) in times of stress. These funds also are subject to enhanced diversification, disclosure, and testing requirements.
The European Commission has published proposed reforms for European MMFs, but instituting regulations across all 28 member countries is a laborious process; reforms likely will not become effective until late 2018 or early 2019.
CFA Institute Viewpoint
In a September 2013 comment letter to the SEC, CFA Institute reiterated its concerns about the potential systemic risk implications of MMFs that maintain stable NAVs, as well as additional concerns that investors perceive investments in these instruments to be risk free. The letter also reiterated a longstanding position in favor of fair-value reporting.
CFA Institute has long advocated for fair-value reporting for financial reporting and with regard to financial instruments. We believe it provides investors with a more accurate picture of an entity’s financial condition. We thus agree with requiring institutional MMFs (as defined in the regulation) to use a variable NAV. Although the first alternative allows retail and government funds (as defined) to continue using a stable NAV, we encourage further regulatory or industry-driven action ultimately to move all MMFs, including retail and government funds, to a variable NAV pricing method.
We believe in providing investors with options by allowing sponsors to offer MMFs with different structures wherever practicable and provided they (1) are required to provide investors with meaningful disclosures that fully address the investment risks, and (2) do not put the financial system at risk of collapse.
Although we recognize the current confusion surrounding investing in MMFs with a stable NAV, we believe the proposed disclosure requirements go a long way toward mitigating this confusion. As noted, we hope that over time, investors will appreciate the benefits and value of investing in variable NAV funds and that the industry will move, of its own accord, in that direction without the need for regulatory intervention.
CFA Institute supports mark-to-market valuation methodologies. At the same time, we recognize that investors, including investment managers, use MMFs for a variety of purposes and understand that not all of the investment instruments used by MMFs have active trading markets that use mark-to-market valuations.
Improved Regulation for Stable NAV Funds
In particular, we recommend (1) that sponsors who provide capital guarantees be required to maintain capital reserves, (2) the adoption of enhanced liquidity structures, and (3) better disclosures aimed at informing investors that MMFs are not “riskless.” We also support imposing capital buffers on stable NAV MMFs that would be financed by fund sponsors.
Although we support enhanced liquidity mechanisms, CFA Institute members do not support imposing a liquidity fee on investors that redeem first to prevent runs on the fund. Instead, members have expressed support for the use of redemption restrictions that include holding back a small minimum balance. Restrictions of this sort should be used only in times of extreme market stress and periods of heavy redemptions.