Money Market Funds currently comprise approximately $2.7 trillion in assets and are one of the most highly regulated forms of investment companies. Now the SEC is proposing reforms aimed at diminishing the perceived risk of investing in Money Market Funds. But these reforms may disrupt the business of investment advisors – both those advising Money Market Funds and those investing their assets in Money Market Funds.

Since inception, there have only been two scenarios where a Money Market Fund has traded at anything but $1, and those were in extreme scenarios. It seems to us that the regulators are throwing more rules on an already highly regulated investment tool that has served its investors well through some very difficult times.

This regulatory reform, which is expected to be implemented in March, is aimed at protecting investors from the risk of investing in Money Market Funds and is focused on two areas:

Capital buffer requirements would require Money Market Funds to have cash set aside in order to be able to satisfy redemptions. While the requirements have not been settled, it appears there are a number of options that will enable the creation of a buffer.

• Investors in the Money Market Fund would have up to 5% of their redemption held for 30 days. This would serve to chase away investors in Money Market Funds as they are currently used for flexibility and easy access. To the extent that investors are not able to redeem all their cash, they will turn to other options.
• 10% of Money Market Fund holdings would be required to be liquid immediately, and 30% of holdings would be required to be liquid within 5 days. This would serve to require the investment advisor of the Money Market Fund to effectively hold cash on the side for potential redemption runs. This has a direct effect on the operations and investment strategy of the advisor. In addition to chasing investors away from these Funds, this change likely will serve to eliminate a number of currently operating Money Market Funds.

Floating Net Asset Value (NAV) would be implemented. Currently, Money Market Funds maintain a fixed NAV (usually of $1.00), offering clients a place to sweep their cash and make interest with little risk to the principal value and the flexibility of having the cash at their fingertips.

While it is not clear how changing the NAV from a static NAV to a floating NAV could aid in capital requirements, it could affect the perception of risk of these investments, which is probably where the SEC is aiming. We would make the argument that the average investor in a Money Market Fund is using this tool as part of a trading concept or as a tool to hold cash temporarily and is intelligent enough to know that Money Market Funds are not cash and therefore do have some, albeit very limited, risk.

Currently, Money Market Funds are regulated by Rule 2a-7 of the Investment Company Act of 1940. Rule 2a-7 regulates portfolio maturity (the dollar weighted average of the portfolio can’t exceed 60 days), portfolio quality (there are credit quality requirements on the holdings of the Fund), portfolio diversification (no more than 5% of the portfolio can be held by one issuer), and liquidity restrictions (no more than 5% of the portfolio in illiquid securities).

We are closely monitoring this news and will provide any relevant updates as announced.