F.or for the second time in less than a decade, the SEC is re-examining risks and regulations pertaining to money market funds (money market funds). The reason is simple: Twice in the past decade, the federal government had to withhold losses in order for customers to have access to their funds. Does the federal government have to bail out money market funds again without reforms?
Money market mutual funds, which have been around since 1971, are a common part of any brokerage or other investment account where investors keep their cash balances ready for investment. The problem is that they are neither as secure nor as safe in a bank account and have no state-guaranteed deposit insurance.
Ever since these funds hit the market, investors, like their local bank, have believed in the safety of these cash vehicles. And regulators have given these accounts special treatment, unlike other mutual funds where the investor bears the market risk.
This is generally not the case with retail and government money market funds. Although these money market fund managers take the cash deposits and invest them in other securities like other mutual funds, the investor in these types of money market funds will not incur any loss if these investments decline. The money market fund may hold the value at $ 1 and allow the sponsor to repay the money market fund investor dollar for dollar regardless of whether the underlying investments increase or decrease in value.
The term used for this MMF dynamic is “stable value” or stable net asset value (NAV). The reason why tax laws and securities regulations allow this difference to other investment funds, i.e. no tax effects or reports of MMF profits or losses and no investment risk for the MMF investor, is that the underlying investments are theoretically very “cash-like” are minimal investment or credit risk. MMF has been exempted from its normal treatment of investment results. It all works well in normal markets. But what happens in times of economic downturn when all markets and investments can quickly depreciate, including money market fund investments, and investors want their money? In short, very serious market disruptions can occur.
In just over a decade, the government had to stop money market fund losses twice in order to keep its stocks at $ 1 and allow customers to redeem their money market fund stocks one dollar at a time. By March 2020 at the latest, Covid threatened to shut down economically, and various money market funds had to accept a series of withdrawals that forced the money market fund manager to sell low-risk bonds himself in order to raise the money to redeem investors. The stable value “pledge” was again pushed to its limits and the federal government had to step in and provide liquidity and market support to prevent credit markets from freezing.
While this article does not examine all the complexities and nuances of the money market fund structure, suffice it to say that a taxpayer-funded money market fund bailout was needed to support major capital markets during both the Great Financial Crisis (GFC) and the most recent Covid crisis . The post-GFC reforms and pledges to prevent this from ever happening again through the Dodd Frank Act and subsequent SEC reforms have radically failed.
Now comes a new SEC Please comment – To examine the severity of the economic disruption from COVID, why previous MMF reforms have failed and what to do now. This time around, the SEC is asking if the task of making all money market funds at variable net asset value should end, with the value of the fund and what investors receive when redeeming shares with the value of the underlying investments. In other words, this would do money market funds like any other mutual fund, where the fund’s value fluctuates with the value of the fund’s underlying investments. In this case, investment gains and losses are incurred by investors who return their investment fund units. Investment risk, costs of liquidity events and market disruptions are borne by the fund investor and the money market sponsor, not the Federal Reserve.
This floating NAV structure could be further safeguarded by additional tools such as requiring money market fund sponsors to set up capital buffers or developing rules that prevent investors from withdrawing all their funds immediately, thereby keeping the remaining investors in all losing positions. These measures could be combined to protect MMF investors as much as possible, let the investor and MMF sponsor bear the burden of investment and liquidity risk, and hopefully eliminate federal support in times of market disruption.
The CFA Institute has long supported the valuation of assets such as securities at fair value. The introduction of a variable net asset value for all money market funds would clearly be the right step in this regard, in order to enable fair and transparent pricing for money market fund shares. To the extent that these other liquidity risk management techniques are appropriate and effective, we would leave the decision to the industry and regulators. Ultimately, it is important to fully disclose to investors the investment risks of money market fund products and the potential liquidity and trading risks associated with such vehicles.
We recognize that many in the money market funds industry continue to believe in the light weight approach to regulating money market funds and recognize the critical role these funds play in providing essential liquidity and support to major credit markets, including short term commercial financing. However, the lessons of money market fund marketing are being learned in the same way as those of bank accounts, and the Federal Reserve bailout is still in sight for private sector investment products, and companies are getting old. It is time to correct these shortcomings once and for all.
The views and opinions expressed are those of the author and do not necessarily reflect those of Nasdaq, Inc.