Risk Management

Money-Market Funds Meet Their Waterloo

New SEC rules provide money-market funds with more shock-absorption. But they will cause treasurers to think twice before investing in them.
Vincent RyanJune 26, 2013

This is the second of four stories exploring short-term cash investing strategies in a climate of near-zero interest rates. The other three are Better Than Nothing, which profiles companies earning meaningful yield on their cash; Beyond Money Funds: Other Places to Park Cash, which looks at alternative cash investment products like ETFs; and Avoiding the Pendulum Portfolio, which explains how to put an end to “risk-on, risk-off” investing behavior.


Money-market funds once seemed the perfect short-term investing vehicles, offering stability of principal, diversification, daily liquidity and tax benefits. Treasurers can kiss some of those virtues goodbye, though, if the Securities and Exchange Commission pushes through its new round of reforms.

On June 6, the SEC dropped the other shoe on money-market fund sponsors. It proposed a long-debated set of additional post-financial crisis reforms. They are designed to mitigate the funds’ susceptibility to investor runs and increase the transparency of the risk to which they expose investors.

The SEC proposed two major reforms (one or both could be enacted) and additional changes to fund reporting practices. Under the first major reform — which may rankle treasurers and money-fund sponsors alike — “prime” institutional money-market funds would be required to have daily, floating share prices, or “net asset values,” instead of their stable $1 per share NAV. That means a fund’s share price would fluctuate as the market-based value of the fund’s portfolio’s securities fluctuate.

The floating NAV would apply only to prime funds — funds that offer relatively high yields and hold riskier assets. Government money-market funds – those that hold at least 80 percent of their assets in cash, government securities or certain repurchase agreements — would be exempt from the floating NAV. Retail funds, which already limit shareholder redemptions to $1 million per business day, would also be exempt, says the SEC.

“The animating purpose behind floating the NAV is to address the incentive to redeem that the stable $1 share price can create,” said SEC Commissioner Troy A. Paredes at the open meeting in June at which the proposal was introduced. “Simply put, an investor may be motivated to exit a fund if the investor can get out at $1 when the fund’s shadow price is less than $1.”

But Parades is skeptical of what the floating NAV will accomplish. He pointed out that when investors see signs of stress, “they will have an incentive to redeem sooner rather than later before the NAV floats downward.”

The alternative to the floating NAV would give money funds the power to impose liquidity fees and redemption “gates” on investors to stop them from fleeing a fund “in times of stress.” Those allowable emergency measures would kick in when a fund’s weekly liquid assets fall below 15 percent of the total. At that point, the money fund would have to impose a 2 percent liquidity fee on redemptions, subject to board discretion. Once the fund fell below the 15 percent threshold, the board would also be able to temporarily suspend redemptions for 30 days — the so-called “gate.”

“Floating the NAV should better inform investors about the risks associated with investing in MMFs and will enhance the transparency of these products, thus reducing the incentive to run,” said SEC Commissioner Dan Gallagher at the June meeting. “But the only way to ensure that a run is stopped in its tracks is to permit gating.”

If a fund sponsor used the liquidity fee or gating option, it would have to disclose that publicly, and reveal the content of the board’s discussion around whether to impose a liquidity fee or redemption gate.

Both major reforms come with other beefed-up disclosure requirements. These include website disclosures of floating NAV values; event-related disclosures, like the imposition of a liquidity fee; and reporting of any instances, past and present, when the fund’s sponsor had to step in and provide capital to shore up the money market fund. The new regs would also subject funds to enhanced internal stress testing.

But despite all the government regulation, money funds still appeal to some CFOs. Well after regulators had begun to propose the idea of a floating NAV, Scott Scheirman, CFO of Western Union, said he continued to like MMFs. “We focus on the ones that are triple-A rated,” he told CFO. “The yields aren’t particularly high, but it’s important for our money to be safe, secure and liquid.”

On average companies had 10 percent of their short-term cash in diversified MMFs and 6 percent in Treasury MMFs in the first quarter, down only slightly from 2012, according to the 2013 Liquidity Survey by the Association for Financial Professionals.

But finance chiefs and treasurers might have to reconsider the use of these cash investing vehicles once the SEC enacts the new regs. Goran Jankovic, treasurer of WellCare Health Plans, is closely watching the evolution of money-market regulation.

WellCare typically keeps a “couple of hundred million dollars” of its $1.6 billion in cash in money market funds, and won’t necessarily discontinue investing in MMFs, he says. But Jankovic believes he may have to scale back. The credit quality or viability of MMFs doesn’t concern him as much as the accounting impact of a variable NAV. “I really wouldn’t consider [MMFs] equivalent to cash [anymore],” Jankovic says. “If I had a cash call and the NAV had decreased we would lose money,” he says. If the current SEC proposals passed, “I would still invest in [MMFs] but it might be with my second-tier cash — not the cash for daily or weekly needs, but something I can hold a little longer.”

According to a May paper from Moody’s Investors Service, a flight from money funds might depend on whether accounting authorities treat variable NAV funds as cash equivalents and whether the funds still receive favorable tax treatment. (See chart below.) In the reform proposal, the SEC said, “a floating NAV alone would not preclude shareholders from classifying their investments in money market funds as cash equivalent because fluctuations in the amount of cash received upon redemption would likely be insignificant and would be consistent with the [GAAP] concept of a ‘known’ amount of cash.”

Tax treatment could be even more critical. Since constant NAV shares are bought and sold at $1, at redemption there is no capital gain or loss, so all the returns are taxed as interest income, notes Moody’s. If rulings on the cash equivalent issue or the tax treatment are unfavorable, “investors would reassess their options” and move money elsewhere, including to government money market funds with lower yields, says Moody’s.

Those potential side effects don’t even take into account investors’ distaste for liquidity fees and redemption gates. Redemption gates in times of stress would lower the attractiveness of MMFs, because they would “alter the very nature of MMFs as a same-day liquidity instrument,” says Moody’s.

Indeed, the new SEC regulations would change the investment case for money-market funds entirely, giving CFOs plenty to think about.


This is the second of four stories exploring short-term cash investing strategies in a climate of near-zero interest rates. The other three are Better Than Nothing, which profiles companies earning meaningful yield on their cash; Beyond Money Funds: Other Places to Park Cash, which looks at alternative cash investment products like ETFs; and Avoiding the Pendulum Portfolio, which explains how to put an end to “risk-on, risk-off” investing behavior.