Sweeping money market fund reforms adopted by SEC

John McColley, Portfolio Manager, Liquidity Strategies | July 28, 2014

  • In a split vote, the SEC adopted sweeping reforms to Rule 2a-7 which governs the operation of money market funds.
  • Many funds that were previously considered retail due to their lower investment minimums will now be called institutional and fall under the new regulations.
  • No immediate changes need to occur and we will proceed with careful anticipation and as always capital preservation remains our number one goal.

On July 23, the SEC voted 3-2 to adopt sweeping reforms to Rule 2a-7 which governs the operation of money market funds. These changes cap nearly six years of debate over the future of the money fund industry. Speaking on the changes, Chairperson Mary Jo White said that these new provisions will “fundamentally change the way that most money market funds operate, and provide important new tools to protect investors and the financial system in a crisis.” The split vote by the commission echoes the concerns voiced by investors, issuers and fund operators over the last several years and the resulting compromise action will leave much work to be done before final implementation of the most revolutionary provisions nearly two years forward. One thing is certain, Columbia Management shares regulators’ desire to further protect shareholders and any steps we take will be taken with an eye to offering shareholders a product which will generate current income consistent with liquidity and stability of principal.

An important part of determining which regulations apply to each money market fund is how the SEC defined the differences between an institutional prime and a retail fund. High investment minimums have historically defined institutional money market funds while lower investment minimums and higher average expense ratios were previously considered retail. Under the new definition, retail funds are now defined as funds that have policies and procedures reasonably designed to limit all beneficial owners of the money market fund to natural persons. Therefore, many funds that were previously considered retail due to their lower investment minimums, such as Columbia Money Market Fund, will now be called institutional and fall under the new regulations.

The action taken by the commission includes additional diversification and enhanced reporting in an effort to improve liquidity and transparency. However, the headline changes include the following two sweeping changes:

1. Institutional prime money funds will be required to transact at and report daily a floating NAV. That is, they will no longer be able to value their portfolio’s securities using the amortized cost accounting method. Government* and retail funds will continue to utilize a stable $1 NAV when valuing shares of the fund.

2. Discretionary liquidity fees and gates may be imposed by a fund’s administrators when the fund’s weekly liquidity falls below certain minimum thresholds. These fees and gates are designed to allow the fund’s board to temporarily halt redemptions in an effort to protect all shareholders in the fund from loss due to “first movers” in the event of a run on the fund.

The key feature which historically has made money funds attractive to shareholders as a daily sweep vehicle has been the ability to transact at a stable $1 NAV. As part of this reform, Treasury and the IRS have provided new tax guidance which will provide some relief to investors in institutional prime funds where the fund’s price will float daily. First, investors may use a simplified aggregate gain/loss accounting method which will release them from having to do a transaction-by-transaction calculation for purposes of filing their taxes. Second, the 30 day “wash sale” rule will not apply to dispositions of money market fund shares.

It is important to remember that this action will have no immediate impact on money market funds. All of the changes approved by the SEC will be phased in over time, with the floating NAV provision more than two years away. This will give everyone additional time to plan for the transition as investors will need to identify their cash management requirements, and fund operators begin to implement new policies, procedures and technology to insure compliance with the new rules.

Again there are no immediate changes that need to occur and time for a thoughtful assessment has begun. We will proceed with careful anticipation and as always capital preservation remains our number one goal.

*Government funds are defined as funds that invest at least 99.5% in government securities.

 

John McColley

Portfolio Manager, Liquidity Strategies
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