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Changing Complexities

New regulations and a shifting rate environment offer opportunities to liquidity investors

CONTRIBUTORS ANDREW LINTON

IN BRIEF

The new SEC rules governing money market funds are designed to provide greater protection to investors and do not change the function or eliminate the utility of MMFs. Money market funds have previously calculated and disclosed their market-based NAVs, but now institutional prime and municipal MMFs will be transacting at these values. A thorough understanding of the new rules will help liquidity investors to make the most-knowledgeable decisions.

This understanding will be especially helpful as investors look to segment their cash, distinguishing among operating cash (requiring same-day liquidity), reserve cash (with an investment horizon of six to nine months or longer) and strategic cash (with an investment horizon of one year or longer). Cash segmentation coupled with a complete grasp of the new SEC rules will enable investors to create the most-effective liquidity strategies for their own particular risk tolerances and return objectives.

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In July 2014, the Securities and Exchange Commission (SEC) approved substantial changes to the rules governing Money Market Funds (MMF). Several take effect in October 2016. As investors adapt to the new regulatory environment, they are re-evaluating their liquidity strategies and considering their investment options.

Regulatory changes will unfold in a market environment in which interest rates, industry flows and portfolio security supply/demand dynamics may be very much in flux. As the Federal Reserve (Fed) resumes monetary policy normalization, it will likely change the yields of, and the spreads between, prime and government MMFs. And apart from the SEC's MMF reform, other global financial regulations, most notably Basel III, will impact the relative attractiveness of MMFs as compared with bank deposits.

"As liquidity investors contemplate these sometimes countervailing forces, they should know that MMF reforms…have made the industry stronger and more transparent."

As liquidity investors contemplate these sometimes countervailing forces, they should know that MMF reforms, beginning with those adopted in 2010 (amendments to Rule 2a-7 under the Investment Company Act of 1940), have made the industry stronger and more transparent. Two key changes approved in July 2014 will take effect in October 2016, following a two-year transition period:

  • Institutional prime and municipal MMFs must float their market-based net asset values (NAV) by executing sales and redemptions based on the current market values of the securities in their portfolios, rounded to the fourth decimal place. (Institutional funds are defined as non-retail funds; retail funds must limit their beneficial owners to "natural persons.")
  • The board of trustees of an MMF may impose a liquidity fee or gate if the fund's weekly liquidity assets fall below 30% of total assets. Government MMFs are not required to be subject to the fee and gate provisions.

In the PDF, we discuss the substance of the SEC’s reforms, explain how they help to protect investors and strengthen stability in short-term fixed income markets, and explore how liquidity investors can craft the most-effective strategies for their own particular risk tolerances and return objectives.


Key questions to ask before investing in a money market fund
Sponsor
  • Have you evaluated the strength of the MMF sponsor?
  • What is the scope of your overall relationship with the MMF sponsor?
  • Does the MMF business reside in a diversified fixed income and asset management business?
  • Has the fund sponsor garnered assets during times of market instability?
Credit/investment process
  • Have adequate resources been allocated: size of team, tenure (industry and firm), global location, sector experience, monitoring systems?
  • What is the level of access to portfolio managers and credit analysts?
  • Has the fund had to step in to buy out any securities or provide liquidity to a fund?
  • What is the underlying investment diversification?
Liquidity
  • What are the key service features: late cutoff times, Internet capability, ease of use?
  • How diverse is the client base of the fund sponsor?
  • Have you evaluated the liquidity profile of the fund?
  • Has the fund ever restricted withdrawals?

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Andrew Linton, Head of Product Development, discusses the substances of the SEC reforms

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