The U.S. Securities and Exchange Commission (SEC) is currentlyconsidering a proposal that would require institutional investors toaccount for their holdings in prime money-market funds—those thatinvest in short-term corporate debt—using a variable net assetvalue (NAV), rather than the stable NAV that is currently theindustry standard. The proposal was announced in June, and thedeadline for comments is September 17.

Thegoal would be to increase transparency, in order to avoid a runon money funds in future financial crises like the run thatoccurred in September 2008 when the Reserve Primary Fund “broke thebuck,” repricing shares below $1 to devalue investors' holdings.Critics of constant NAV money funds argue that their constant $1 price masks movement in the marketand that if they're going to promise liquidity on par with bankaccounts, they should be regulated like banks. The problem is thatwhat may seem like a fairly minor accounting change could have amajor impact on corporate usage of money funds.

Consulting firm Treasury Strategies conducted a study for the U.S. Chamber of Commerce that pins a dollarfigure on the impact to institutional investors of a move to afloating NAV for money-market funds: between $1.8 billion and $2billion up front, then another $270 million to $280 million peryear. Treasury Strategies came to these numbers by analyzing theeffects of the change on investors in an array of differentcategories, including corporations of all sizes and publicinstitutions such as municipalities and universities. “We applied alot of different cost components and then generated a veryconservative estimate,” says Steve Wiley, a manager with TreasuryStrategies.

The study identified seven areas in which corporate investorswould incur significant costs if they continued using prime moneyfunds under the new proposal:

Investment policy development. Manycompanies' current investment policies include language that wouldprohibit investment in a floating NAV money-market fund. Althoughmoney funds' prices might hover around $1 per share, the SECproposal envisions rounding to four decimal places, so prices mightswing frequently. To continue using money funds, organizationsmight have to rewrite their investment policies to take intoaccount mark-to-market valuations in calculating parameters for NAVfluctuations and acceptable levels of counterparty risk in moneyfund investments, as well as to ensure that their money fundaccounting meets GAAP requirements.

“You'll need to establish acceptable net asset value parameterswithin investment policies, or else say that a prime money-marketfund is no longer acceptable,” Wiley says. “You'll have to gothrough the process of having the board and senior executivesreview and approve that policy. Then there's another dynamic. Aninstitutional investor's counterparty risk policy specifies thetotal amount of exposure across all financial instruments—creditfacilities, bank balances, investments, derivatives—that you'rewilling to accept with a particular counterparty. That will have tochange a little bit as well, to factor in the mark-to-marketposition for the company's money-market funds.”

Investment process reengineering.Today, processes for initiating and redeeming holdings inmoney-market funds are usually as simple as transferring fundsbetween accounts. Treasury Strategies anticipates that if moneyfunds moved to a floating NAV, companies would have to take theextra step, before every initiation, of verifying that theinvestment instrument is acceptable at its current net asset value.This step would need to be taken during automatic sweeping of fundsinto money-market accounts, which would obviously complicate thatprocess, possibly requiring automatic sweeps to involve a greatdeal more manual intervention.

“Companies will have to put in place a confirmation process,”predicts Paul LaRock, a Treasury Strategies principal. “Right now,when you buy or sell a money-market share, you know the price: It'sa dollar. With the floating NAV, the price will vary slightly upand down around a dollar. Buyers and sellers will have to confirmwith each other the exact purchase price, out four digits right ofthe decimal, just like when they trade ultrashort bond funds orequities. That will require a formal confirmation process to be putin place. To the extent that a buyer and a seller have slightlydifferent prices on a trade, there will have to be an exceptionresolution process to mitigate those problems, and that willrequire staffing. When they don't match, people will have to get onthe phone and fix it.”

Intraday liquidity management. Evenmore problematic, financial institutions may no longer be able toaccommodate intraday settlements if money funds move to a floatingNAV. “The companies we interviewed had a lot of concerns aroundintraday liquidity management,” Wiley says. “It's unclear right nowhow frequently the net asset value would be published, butcorporates may have to redeem funds from money-market investmentson a prior-day basis for next-day value. That would eliminatemoney-market funds as a practical cash-equivalent liquidityinstrument. If they lose that key utility, that's going to drivecorporates into other instruments that can meet the intradayliquidity management provision.” In other words, companies wouldhave to decide between riskier investments or non-interest-bearingaccounts for parking cash.

Accounting practices. It's unclearwhether money-market funds would change from cash-equivalentinstruments, which don't require reporting on daily changes invalue of the portfolio, to available-for-sale securities as definedby U.S. GAAP. If the funds' GAAP status changed, companies wouldhave to monitor their mark-to-market value and account for gains orlosses on the balance sheet.

“On the balance sheet, there are going to be unrealized gains orlosses,” LaRock says. “But when you buy and sell the shares, you'regenerating realized gains or losses. Companies will have to adopteither a LIFO [last in, first out] or FIFO [first in, first out]valuation approach so that when they liquidate they know whichshares they're selling. They're going to have to develop thatprotocol and then calculate the realized gains or losses on thoseshares, just as they would with equities.”

Tax reporting. If money-market fundsadopted a floating NAV, all sales of money fund shares would becometax-reportable events. Corporate tax and treasury functions wouldneed to capture each trade's share identifier/name, acquisitioncost, and holding period. They would also have to recognize whethera security sale meets the IRS's “wash rule,” which prohibits acompany from recognizing a loss on the sale of a security when itpurchases a replacement security within 30 days.

Treasury Strategies predicts that moving money funds to afloating NAV would require between one-half and one additionalfull-time equivalent (FTE) employee for the typical company. Muchof Treasury Strategies' estimated increase in annual operatingcosts, a total of $270 million to $280 million across the U.S.,derives from that extra staffing. “The ongoing costs would mostlybe around additional resources they'd need across treasury,accounting, and tax,” Wiley says. “This is a real pain point forthe corporate treasury folks we talked to. We talked to oneuniversity that said they'd have to hire an additional person todevelop and manage the new procedures—and they were worried theskill set would be hard to find because it would be in highdemand.”

Systemreengineering. The complexities that a floating NAVwould introduce in accounting, tax reporting, and initiation andredemption of money-market funds would likely require a company toupgrade, if not replace, software systems. “As a rule of thumb, themore complex the system and the greater reliance on automatedprocedures within the systems to transact with money-market funds,the more expensive and elongated the compliance period will be,”Wiley says. “Corporations use a number of different systems tomanage investment activity. For companies that manage money-marketfund activity within a treasury management system, an ERP, oranother specialized software package, the move to floating NAV willbe very expensive because they are going to be dependent on thesystem providers for upgrades. And after the upgrades areavailable, they're going to rely on system vendor consultants orimplementation resources to configure those systems.

“One larger corporate we talked to likened this to an ERPupgrade,” Wiley adds. “They quoted a low-seven-figure number. Itwill be very expensive.”

Debt issuance. Treasury Strategiesanticipates that a move to a floating NAV would make money-marketfunds less attractive to corporations. “They would probably not becomfortable using the institutional prime funds because of theinvestment in time and money required to administer those funds ifthis proposal were to go through,” LaRock says. Ultimately, thismight shrink the market for commercial paper and drive up borrowingcosts.

Treasury Strategies has developed a costcalculator to help companies determine how much it would costthem to continue using money-market funds if the SEC proposal wereadopted. The calculator divides costs into five high-levelcategories and then subdivides each of those into more specificexpenses. The firm strongly recommends that money fund usersperform these calculations, then contact the SEC with the results.

“The SEC is sincere in wanting input from institutionalinvestors,” LaRock says. “They don't know everybody's internalcosts, and they sincerely want to have a deeper understanding sothey make a good decision. This is not a topic that people shouldbe passive on. To the degree that they can estimate costs, thestaff at the SEC would love to see that. Corporate treasurersshould take up the SEC on its request for input before the SECmakes a decision.”

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MegWaters is the editor in chief of Treasury &Risk. She is the former editor in chief of BPMMagazine and the former managing editor of BusinessFinance.