The Case for Stable NAV Money Market Funds
Money market funds provide a critical source of financing for business and governments.
Consider what the $2.8 trillion invested in money market funds means to our economy.
- Jobs: Money market funds hold more than a third of the commercial paper that businesses issue to finance payrolls and inventories.
- Communities: Money market funds hold nearly two-thirds of the short-term debt that finances state and local governments.
- Ordinary Americans: Money market funds hold significant amounts of the asset-backed commercial paper that finances credit card, home equity, and auto loans.
- Financing the U.S. government: Money market funds hold one dollar out of every eight in short-term paper issued by the Treasury.
Money market funds are valued tools for investors.
- For retail investors, money market funds have long provided the only means to obtain access to higher-yielding money market instruments.
- For institutions of all kinds—businesses, nonprofit organizations, governmental agencies, and financial institutions—money market funds are a preferred vehicle for cash management.
- Money market funds provide investors with a high degree of liquidity, stability in principal value, and a market-based yield.
- Money market funds offer diversification and professional management, while operating under rigorous risk-limiting regulations.
The stable net asset value—typically $1.00 per share—is a fundamental feature of money market funds.
Investors purchase and redeem millions of dollars in money market fund shares every day. Without the ability to operate at a stable net asset value (NAV), money market funds could not provide individuals and institutions the cash-management services that they seek.
Retail and institutional investors vote with their dollars for stable NAV funds.
At the end of September 2010, investors held $2.8 trillion in taxable money market fund shares. By contrast, floating-value short-term bond funds held just $170 billion—despite their higher yields. This 16-to-1 advantage in total assets—at a time when yields on money market funds are razor thin—speaks volumes about the needs and preferences of investors.
Out of more than 120 comment letters filed with the Securities and Exchange Commission during its recent money market fund rulemaking, the ones that favored floating values could be counted on the fingers of one hand. By contrast, scores of letters opposed this idea, from writers as disparate as the American Public Power Association, the city of Brookfield, Wis., the National Association of State Treasurers, AARP, and the Consumer Federation of America—not to mention individual investors strongly opposed to changing the fundamental nature of this product.
The stable NAV provides significant benefits to investors.
For investors, the $1.00 NAV provides convenience and simplicity in terms of tax, accounting, and recordkeeping.
- Tax convenience: If money market funds had a floating NAV, all share sales would become tax-reportable events, potentially multiplying investors’ tax and recordkeeping burdens. A stable $1.00 NAV relieves investors of having to consider the timing of purchases and sales of shares of money market funds, as they must with floating NAV funds, to comply with the so-called “wash sale rule.”
- Accounting simplicity: Stable $1.00 NAV money market funds qualify as “cash equivalents” under accounting standards. Because the NAV is fixed at $1.00 per share, there is no need for investors to recognize gains or losses for financial accounting purposes. With a floating NAV, companies and other organizations would face significant additional burdens of:
- marking to market the value of their money market fund shares;
- tracking the costs of their shares; and
- determining how to match purchases and redemptions for purposes of calculating gains and losses for accounting and tax purposes.
- Operational convenience: For corporations and bank sweep accounts, a stable share price for money market funds simplifies operations because the $1.00 NAV is known in advance. Corporations sometimes have internal guidelines or cash management policies that are easier to adhere to with a stable $1.00 NAV. Without a stable NAV, broker-dealers could not offer their retail investors a range of features including:
- ATM access;
- check writing;
- ACH and fedwire transfers; and
- same-day settlement on shares redeemed via “wire transfers.”
Floating the NAV would undermine money market funds’ convenience and simplicity and confront investors with new accounting, tax, and legal hurdles whose resolution is uncertain.
If money market funds are forced to abandon the stable NAV, many investors will be forced to abandon money market funds.
Many institutions face legal constraints or investment policies that allow them to invest their cash balances only in cash pools that do not fluctuate in value. Indentures and other trust documents often include similar restrictions. Many state laws and regulations also authorize municipalities, insurance companies and other state regulated entities to invest in stable NAV funds—but not in floating NAV funds. Thus, if money market funds are required to float their NAV, many corporations, trusts, and state and local governments would no longer be willing or able to use these funds to manage their cash.
Forcing money market funds to float their NAV could deprive state and local governments of much-needed capital.
In the absence of alternative stable NAV investment pools, cash held in money market funds would presumably flow to traditional banks. This would cost municipalities an important source of financing in the short-term markets. Banks cannot pass through tax-exempt income to depositors and thus simply could not replace tax-exempt money market funds.
Forcing money market funds to float their NAV could harm the economy.
If cash held in money market funds flows to traditional banks, corporate America would face a significant reduction in the supply of short-term credit unless banks raised substantial new capital. Even if banks had ready access to the capital to support this expansion, the lending market would be less efficient and the cost of short-term credit would rise.
Forcing money market funds to float their NAV could increase risks to the financial system.
- Institutions that want or require stable value funds for their cash balances would turn to private pools, operated in the U.S. and overseas, that promise to maintain a fixed price.
- These alternatives are not registered with the SEC. Nor are they subject to regulation under the Investment Company Act, including the risk-limiting provisions of Rule 2a-7 governing credit quality, liquidity, maturity, and disclosure.
- Inflows into these alternative investments would create large pools of assets either domestically or offshore that would fall outside the careful regulatory framework in place for money market funds.
- Investors in these pools would be more likely—not less—to withdraw their assets in a future crisis.
Floating the NAV of money market funds is unlikely to reduce systemic risk.
- Hard experience shows that mutual funds that float their NAV are not immune to redemption pressure.
- Floating-value ultra-short bond funds in the U.S., which are similar to money market funds in that they generally invest in fixed-income securities with short maturities, saw substantial outflows during the financial crisis. By the end of 2008, assets in these funds were more than 60 percent below their peak in mid-2007.
- Abroad, French floating NAV dynamic money funds (or trésorerie dynamique funds), lost about 40 percent of their assets over a three-month time span from July 2007 to September 2007.
Policymakers have made great strides toward the goal of making money market funds more resilient—even under extreme market conditions.
The SEC has adopted significant amendments to Rule 2a-7, the regulation governing money market funds, affecting:
- Credit quality: Amendments to Rule 2a-7 raise credit standards.
- Maturity: The amendments reduce interest rate risk and credit spread risk by shortening the maturity of money market funds’ portfolios.
- Disclosure: Under the SEC amendments, money market funds must disclose their holdings more frequently, so regulators and investors will better understand funds’ portfolios.
- Liquidity: The SEC amendments impose for the first time explicit liquidity requirements. Taxable money market funds must maintain daily liquidity of 10 percent of their assets, and all funds must maintain weekly liquidity of 30 percent of their assets. As substantial as they are, those requirements are minimums. Funds also must adopt “know your investor” procedures to help them anticipate the potential for heavy redemptions and adjust their liquidity accordingly.
For more details on the SEC amendments to Rule 2a-7, please see Money Market Fund Reforms: 2010 SEC Amendments.
ICI and its members are participating fully in other efforts to further strengthen money market funds.
The search for ways to weather-proof money market funds has not stopped. For example, we are actively engaged in a task force sponsored by the Federal Reserve Bank of New York to strengthen the underpinnings of a vital portion of the money market—tri-party repurchase agreements. These reforms will be vital for all participants, including money market funds, which provide around one-quarter of the lending in this market.
ICI and its members also have responded to an idea advanced by the Treasury Department’s June 2009 white paper on financial regulatory reform, which called for exploring measures to require money market funds “to obtain access to reliable emergency liquidity facilities from private sources.” ICI is moving forward rapidly to complete a blueprint for such a liquidity facility. This would be a state-chartered bank or trust company, organized and capitalized by the prime money market fund industry and managed and governed in accordance with applicable banking laws.