SEC moves on money market reforms

In a move meant to curb runs on money funds, the Securities and Exchange Commission agreed to a set of reforms. While changes in the industry have been debated since the 2008 financial crisis, they’ve been a while coming.

The Wall Street Journal story offered the most concise and easy to comprehend lead of the stories I read on the topic. Excerpts are below:

The Securities and Exchange Commission voted in favor of overhauling the $2.6 trillion money-market mutual fund industry, targeting the types of funds seen as most prone to investor runs during the financial crisis.

The SEC’s proposal, which is likely to divide the industry, would require “prime” funds catering to large institutional investors to abandon their fixed $1 share price, allowing the funds’ prices to float like those of other mutual funds. Prime funds invest in short-term corporate debt and are considered more risky than funds that buy only government securities.

In targeting prime institutional funds, the SEC s focusing on the roughly 37%, or $1 trillion, portion of the industry considered most likely to lead to trouble. Institutional investors’ concerns about prime funds’ exposure to Lehman Brothers debt caused them to withdraw about $300 billion from the funds in the week after the firm collapsed in September 2008.

As the market works now, all money funds target a stable share price of $1. During the crisis, investors worried that the value of shares in certain prime funds would fall below $1, and rushed to get their money out. Supporters say switching to a floating share price would accustom investors to fluctuating values, making runs less likely.

Reuters offered a good explanation of both parts of the new rule. Here is the second aspect of the proposal:

The SEC said that retail and government funds, which are not considered to be at the same risk for runs, would not be forced to move to a floating net asset value. Retail funds are defined as those that limit shareholder redemptions to $1 million per day.

Crane Data estimates that prime funds account for 55 percent of money market fund assets, with 31 percent institutional and 24 percent retail.

The second alternative in Wednesday’s proposal would allow funds to maintain a stable share price, but they could utilize so-called “liquidity fees and redemption gates” during times of stress. That is an idea that the SEC’s two Republican commissioners last year said they might be able to support.

The SEC said a 2 percent liquidity fee on redemptions could be imposed if a fund’s level of weekly liquid assets fell below 15 percent. Boards could opt, however, not to impose the fee if they felt it was not in the best interest of investors.

The SEC said the redemption fee and gate measures would apply to non-government institutional and retail money market funds, but government funds could voluntarily impose them.

If a fund crossed this threshold, its board of directors would be allowed to impose the gates, or temporarily suspend redemptions.

But what isn’t clear is how this will help consumers. Most of the stories read to me like the reforms are targeted at funds that are primarily held by institutional investors. It took USA Today to offer a good explanation of the outcome for ordinary investors:

If adopted after a 90-day public comment period, investors could theoretically lose principal from their investments in money market investment funds that suffer market losses. But that risk would largely affect institutional rather than mom and pop investors.

This seems like important information to have in every story so people won’t be alarmed if they see principal drop with the market. Apparently CBS News agrees with me, leading its story with this information and then providing this consumer related context high in their story:

Allowing values to float would make some money funds more like bonds, whose principal changes with increases or decreases in interest rates. That’s a fundamental shift because it means investors could lose principal if the value falls below $1.

Proponents say it is necessary change because it would show money funds, while safer than stocks and many other investments, still carry some level of risk. They say more awareness of the risk would reduce the potential for runs on money funds.

The SEC proposal would limit the floating-value requirement to those money market funds known as “prime.”

Prime funds attract mainly big institutional investors, as opposed to retail customers, and are considered more risk prone because they invest in short-term corporate debt. They represent roughly half of the total $2.9 trillion assets held by all money market mutual funds.

Exempt from the floating-value requirement would be money market funds that hold at least 80 percent of their assets in cash or government securities and retail funds limiting an investor’s withdrawals to a maximum of $1 million per business day.

Because many people hold these types of investments, I think it’s important to put the information most relevant to consumers at the top of the story. Some in the business media would be well served to remember the audience when writing these types of stories. While they’re relatively straightforward and routine, it’s important to remember the readers and not just regurgitate facts from the press release.