The widely anticipated reforms for money market funds are due for implementation in October 2016, drastically changing the way investors and the affected fund providers view them as an alternative for short-term cash investing. Many investors, especially institutions, face increased risks or lower yields on their short-term money, while fund providers must reconsider the worth of their offerings. With more than $2.7 trillion invested in money market funds, investors and providers alike have a lot at stake in the changes and how funds must be managed going forward. The changes will be nominal for most individual or retail investors, but for institutional investors and the fund providers, the changes will require significant rethinking on the value of money market funds.

The Reason Behind Money Market Fund Reform

At the peak of the 2008 financial crisis, the Reserve Primary Fund, a large New York-based fund manager, was forced to reduce the net asset value (NAV) of its money market fund below $1 due to massive losses generated by failed short-term loans issued by Lehman Brothers. It was the first time a major money market fund had to break the $1 NAV, which caused a panic among institutional investors, who began mass redemptions. The fund lost two-thirds of its assets in 24 hours, and eventually had to suspend operations and commence liquidation.

Six years later in 2014, the Securities and Exchange Commission (SEC) issued new rules for the management of money market funds to enhance the stability and resilience of all money market funds. Generally, the new rules place tighter restrictions on portfolio holdings while enhancing liquidity and quality requirements. The most fundamental change is the requirement for money market funds to move from a fixed $1 share price to a floating NAV, which introduces the risk of principal where it had never existed.

In addition, the rules require fund providers to institute liquidity fees and suspension gates as a means of preventing a run on the fund. The requirements include asset level triggers for imposing a liquidity fee of 1 or 2%. If weekly liquid assets fall below 10% of total assets, it triggers a 1% fee. Below 30%, the fee is increased to 2%. Funds may also suspend redemptions for up to 10 business days in a 90-day period. While those are the fundamental rule changes, there are several factors investors should know about the reform and how it may affect them upon implementation.

Retail Investors Not Completely Affected

The most significant rule change, the floating NAV, is not likely to affect investors who invest in retail money market funds. These funds may still maintain the $1 NAV. However, they may still be required to institute the redemption triggers for charging a liquidity fee or suspending redemptions. Many of the larger fund groups are taking actions to either limit the possibility of a redemption trigger or avoid it altogether by converting their funds into a government money market fund, which has no requirement.

The same cannot be said for people who invest in prime money market funds inside their 401(k) plans, because these are typically institutional funds subject to all of the new rules. Plan sponsors will have to change out their fund options, offering a government money market fund or some other alternative.

Institutional Investors Have a Dilemma

Because institutional investors are the target of the new rules, they will be the most affected. For them, it will come down to a choice of securing a higher yield or higher risk. They can still invest in U.S. government money markets, which are not subject to the floating NAV or redemption triggers. However, they will have to accept a lower yield. Institutional investors seeking higher yields may have to consider other options, such as bank certificates of deposit (CDs), alternative prime funds that invest primarily in very short maturity assets to limit interest rate and credit risk, or ultra-short duration funds that offer higher yields, but also have more volatility.

Fund Groups Must Adapt or Get Out of Money Market Funds

Most of the major fund groups, such as Fidelity Investments, Federated Investors Inc. (NYSE: FII) and Vanguard Group, already plan to offer viable alternatives to their investors. Fidelity is converting its largest prime fund into a U.S. government fund. Federated is taking steps to shorten the maturities of its prime funds to make it easier to maintain a $1 NAV. Vanguard is assuring its investors that its prime funds have more than enough liquidity to avoid triggering a liquidity fee or redemption suspension. However, many fund groups are still assessing whether the cost of compliance with the new regulations is worth keeping their funds. In anticipation of the new rules, Bank of America Corp. (NYSE: BAC) sold its money market business to BlackRock Inc. (NYSE: BLK) in 2015. Regardless of the approach any particular fund group takes, investors can expect a flurry of communications explaining any changes and their options.

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