The Securities and Exchange Commission’s proposed regulations for the money fund industry would entail significant changes for prime funds that target institutional investors, changes that could discourage treasurers from using such funds. If the regulations are adopted, many treasuries are expected to shift cash out of prime funds to government or treasury money market funds, or to alternatives like bank accounts.
The SEC put forward two alternatives last week. One would require prime funds—those that invest in short-term corporate debt—for institutional investors to adopt a variable net asset value (NAV), instead of the constant, $1-a-share NAV that’s now standard for money market funds. The requirement wouldn’t apply to government money funds or funds for retail investors, which are defined as those that limit shareholder redemptions to $1 million a day.
The second proposal would require money funds to impose a 2% liquidity fee on redemptions if their minimum liquidity went below 15%; it would also allow the boards of funds to temporarily suspend investor redemptions in that situation.
Institutional investors have about $929 billion in institutional prime funds, said Brandon Semilof, a managing director at StoneCastle Partners, which invests in community banks.
“If these proposals go through as is, then there’s a good chance that a lot of assets will be leaving prime institutional funds for other vehicles,” said Semilof, adding that corporate treasurers are likely to move to Treasury and government money funds and to bank deposits.
Of course, the proposed requirement that prime funds move to a floating NAV was a step back from an SEC draft proposal last year that would have required a floating NAV for all money market funds.
And even when it comes to last week’s SEC proposal, “things may not be as onerous as the headlines appear,” said Lance Pan, director of investment research and strategy at Capital Advisors Group. For example, Pan noted, if a fund’s securities have final maturities less than 60 days, they can still be priced at amortized cost. That provision might give institutional prime funds a way to maintain a NAV of $1 by keeping their maturity at 60 days.
Pan agreed that institutional investors would prefer a fixed NAV. If the floating NAV is required, absent some workaround involving shorter maturities, “I would imagine a third or even half of the people will want to go that fixed-NAV route through Treasury and government funds,” he said
Floating NAV also poses issues for corporate treasurers in terms of the accounting and tax treatment of their money funds. “Putting your money in and pulling it out with a floating NAV, you have either capital appreciation or capital depreciation over time,” said Ian Rasmussen, senior director in the fund and asset management ratings group at Fitch Ratings. “Even minute changes would have to be reported.”
But that problem may also have solutions. According to Reuters, SEC officials say they hope the IRS will let investors in money funds with floating NAVs report on those positions just once a year. And SEC Commissioner Daniel Gallagher said when the proposal was released that from an accounting standpoint, investors in funds with floating NAVs might still be able to treat those investments as cash equivalents because the fluctuations in the NAVs would be so small.
Rasmussen also expects some assets to shift from prime institutional funds to government funds if the floating NAV requirement goes into effect, and said that could pose a challenge for the fund industry because government funds are already dealing with a tight supply of government securities. “I don’t believe the government funds could take all of the institutional investors looking to move into government funds,” he said.
Semilof sees “significant headwinds” for companies moving money into either government money market funds or bank accounts. Given the limited supply of government securities, “there’s probably going to be a period when Treasury and government funds will no longer accept new deposits,” he said. And to the extent that corporate treasurers buy Treasury or government agency securities directly, rather than investing via money funds, they contribute to the supply shortfall, he said.
Nor are banks eager for more deposits. “The appetite for deposits is sitting at historical lows,” Semilof said. “We’re hearing rates are de minimis. If you are getting an earnings credit rate, banks are lowering your earnings credit rate.”
Fitch Ratings’ Rasmussen sees the possibility that over time, treasurers may become more comfortable with floating NAV. “A lot of the funds are disclosing their shadow NAV for the prime funds on a daily basis now,” Rasmussen noted. “Those shadow NAVs are very stable over time; they don’t change much.”
Longer term, as treasurers became more familiar with floating NAV, they may also feel more comfortable about using some of their cash to go a little farther out the curve to pick up yield, Rasmussen said. “We’ve already seen managers start to anticipate that kind of market,” he said, noting that a couple of investment managers have set up ultra short-term bond funds.
BlackRock began offering the Ultra-Short Obligations Fund late last year, and Legg Mason’s Western Asset Management unit filed to offer the Western Asset Ultra Short Obligations Fund. The ultra short-term bond funds will not have a stable NAV, but they will offer somewhat higher yields than money funds, Rasmussen said.
Semilof also expects treasurers to divide cash into buckets and consider short-term investments other than money funds for cash they won’t need to use for some time. “Seven years ago, five years ago, it wasn’t unusual to see a corporation keep a majority of their cash in a money market fund,” he said. “People realize now that the cost of utilizing a vehicle that offers daily liquidity is pretty high, and it’s not necessary to keep 100% of their cash in a money market fund.”
Investors will have plenty of time to figure out what to do. The SEC has set a 90-day comment period, which will be followed by reviews and then the writing of rules. Observers said the proposal could change considerably during that period.
“It’s going to be a very long process,” said Capital Advisors Group’s Pan, citing a two-year implementation period for the floating NAV proposal if it is approved, which would push implementation back to late 2015 or early 2016.