The beginning of the end of the money market fund industry is in sight. US and European investors who have lodged $4tn for safe keeping in money market funds may soon be forced to reconsider their holdings, as pressure builds on both sides of the Atlantic for structural changes to the way funds operate.
This week the European Systemic Risk Board, a panel of central bank governors and regulators from across the EU, added its voice to the call for reform, recommending to lawmakers that money funds be forced to switch from their fixed $1 or €1 per share to a floating net asset value.
US policy makers, including senior Treasury officials, have also backed the floating NAV among options under consideration as they seek to reduce the systemic risk posed by money funds. The chiefs of all 12 regional US Federal Reserve banks have urged a crackdown on the sector.
Regulators have focused on the floating NAV as a way to make money market funds less prone to a rush of withdrawals, similar to a run on a bank.
Such a run is what regulators say helped spread the effects of panic through the US financial system at the height of the credit crisis.
Most money market fund share prices do not move to reflect fluctuations in the value of their underlying holdings. Regulators say such stable NAVs give investors a false sense of security, as the stable $1 share price creates an impression that it is completely safe, creating panic when it threatens to move.
After Lehman Brothers failed in September 2008
the Reserve Primary fund “broke the buck”: it said that its investors would get back less than $1 for each share in the fund.
The announcement was followed by withdrawals across the industry. Because money market funds are a key source of short-term funding for banks and companies, the withdrawals caused markets to freeze until the Fed and Treasury stepped in to underwrite temporarily the system to restore order.
Since then, policy makers appear to have reached consensus that money funds as currently structured pose a threat to the system.
Yet an end to the stable NAV could send investors in search of alternative homes for their cash, such as bank deposits or short-term government securities.
“Fundamentally it changes the product. There are tax implications, accounting implications – the ability to ensure investors are still interested in this product will hinge on some of these issues,” says Jane Heinrichs, counsel at the Investment Company Institute, a trade group.
Aymeric Poizot, analyst at Fitch, says about half of the funds in Europe, which have around €1tn under management, operate under a fixed NAV framework. A high proportion of treasurers invested in those funds say any move to variable NAV would have a “significant impact”, according to a survey by the agency.
“A move to [a floating NAV] cannot happen overnight, and there are concerns that it could result in significant outflows in the absence of a smooth transition,” says Mr Poizot.
The industry put forward its own set of proposals for improvement in 2009, which became the basis for reforms in 2010 that improved disclosure, restricted money funds to a smaller range of potential investments and required higher standards for the liquidity of underlying investments.
After three years fighting further reform, the industry wants to maintain the status quo. “There is no evidence that a floating NAV is going to help matters. There are no easy solutions,” says Peter Crane of Crane Data, a money-market fund research group.
Fund sponsors argue that no further changes are necessary and are seeking to limit them. Fidelity has called for separate treatment of funds limited to government or US municipal securities, and those used by retail investors.
Michael Lydon, chief executive of Reich & Tang, a money market firm, says retail investors behave differently from the institutional investors who pulled their cash out in a rush.
“Retail investors’ use of money market funds tends to be stable and counter-cyclical. As markets improve, stocks generally rise, and investors reduce cash positions and increase their exposure,” Mr Lydon says.
But money funds have tended to be big and commingled, and their simplicity is part of the attraction. Creating a workable definition of a retail and institutional investor may not be feasible. And Mr Crane says the discussion of regulation has largely occurred between the industry and the authorities; reform ideashave not been put to the underlying users. “Investors will revolt,” he says.