Wringing the Risks Out of Money Funds

On June 24, 2009, the Securities and Exchange Commission (SEC) announced the long-anticipated proposed amendments to the 2a-7 rule that regulates money market mutual funds. The proposed changes were prompted by the extraordinary events in the money fund industry that took place after the Reserve Primary Fund’s net asset value (NAV) dropped below a constant dollar ($1.00) per share last fall.
We do agree that the proposed changes will make money funds marginally safer. However, we feel this proposal did not address the fundamental issue of preventing a run on the funds. As institutional cash investors, we also fear that, by allowing funds to halt redemptions without advanced notice, the usefulness of the funds as cash management vehicles may be significantly diminished. As part of the ongoing dialogue of making the funds safer, we have several of our own proposals below that we think will be beneficial to institutional money fund investors.

Comments on the SEC Rule Amendments

Improved Liquidity: The proposed rule requires that institutional money funds keep at least 10% of assets in cash or securities readily convertible to cash (e.g U.S Treasuries) within a day, and at least 30% within a week. Retail funds, which tend to experience less fund flow fluctuations, must keep at least 5% in daily liquidity and 15% within a week. The current rule does not have such requirements.
Our Take: We view these new liquidity requirements as minimum maintenance levels, since most large “prime” funds (those that can invest in corporate securities) are already managed to these levels after the Reserve Fund event. We see two potential drawbacks of this change: 1) If a run on a fund begins to develop, the 10% and 30% liquidity buffers would still seem inadequate; 2) by requiring 30% of a portfolio to mature within a week, the rule may encourage funds to invest disproportionately more in securities with longer maturities in a so-called “barbell” structure. Over time, this barbell structure may present higher interest rate and liquidity risks.
Shortened Maturity Limits: The proposal would restrict the maximum weighted average maturity (WAM) of a fund to 60 days from the current limit of 90 days. It also introduces a new concept of maximum “weighted average life” maturity (WALM) of 120 days. This WALM (sometimes called “Spread WAM”) looks to the legal final maturities of individual securities with floating rates, extendible or reset features. Compared to the reset dates of one or three months as allowed by the current rule, the legal final dates may be as long as 13 months for corporate securities and two years for government securities. This rule change is intended to reduce long-term floating rate securities in a fund.
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