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Can’t break a buck if there’s no buck

By Sheyna Steiner · Bankrate.com
Thursday, April 11, 2013
Posted: 9 am ET

Remember last year when former head of the Securities and Exchange Commission Mary Schapiro pushed for further regulation of money market funds? The most controversial aspect of the proposed regulations was changing the fixed $1 per share net asset value, or NAV, to a floating NAV that would reflect the actual value of the fund.

As you probably know, the fixed NAV is one of the defining features of money market funds.

That plan stalled last summer, but the push for further regulation from the Securities and Exchange Commission, or SEC, didn't end. In the interim, many money market fund sponsors have voluntarily moved toward more daily transparency on money market funds -- showing the actual net asset value while maintaining the fixed $1 per share NAV. Huge financial firms such as Goldman Sachs, Fidelity Investments, JPMorgan and BlackRock all began voluntarily disclosing the daily fluctuations in share price earlier this year, according to a January story on CFO.com, "Money-fund disclosure could aid Treasurers."

Money funds were hit with regulations following the financial crisis, but many felt they didn't go far enough to protect investors in case of a run or to prevent the possibility of a run.  Now, a new proposal to strengthen money market funds could be coming very soon, according to a Bloomberg story that appeared Wednesday, "SEC money-market fund proposal two months away, Gallagher says."

From the story:

The money-fund industry has said a floating-share price would ruin the funds' appeal. Allowing the share price to vary also would create new tax liabilities for investors, who would have to account for small gains and losses. The SEC has discussed the tax issues with the Internal Revenue Service.

No one wants to face the possibility of losing money in what has always been billed as a stable, liquid account but that's what a fluctuating price could mean. While that sounds alarming, the fluctuations are typically less than 1 cent, according to the Investment Company Institute, the mutual fund industry's trade association.

From the 2011 paper, "Money market funds' 'shadow prices' fluctuate regularly; historical data show limited movement":

The report finds that events large enough to move per-share market values by $0.0050 are extremely rare. The report's economic analysis shows that four factors likely to change a fund's market value are falling or rising interest rates, a portfolio's dollar-weighted average maturity, investors selling or purchasing shares, and a credit event, such as a ratings upgrade or downgrade or a default, affecting a security in the fund's portfolio.

For many large entities such as endowments, corporations or institutions that use money market funds for daily short-term cash needs, the difference between $1 and half-way to $0.99 can be substantial.

"If you make a withdrawal a day later and get back $0.999999, that makes it difficult to many entities who have obligations on their investment parameters," says Tim Cameron, managing director of the Securities Industry and Financial Markets Association's, or SIFMA's, Asset Management Group.

For instance, endowments, municipalities and insurance companies may have restrictions on investing in funds with floating NAV.

So they take their money elsewhere?

Money market funds are important because they not only give small investors higher returns in relative safety, they provide liquidity for businesses through the market for commercial paper. Not only do investors need protection, but global credit markets are at risk from disturbances as well. As in, for instance, the series of events in 2008 when credit markets froze.

"Because we transact in a more global way, the interconnectedness between different funding vehicles makes things more complicated," says Cameron.  "If you have a Lehman Brothers going down, if you held Lehman paper in a money market fund like the Reserve Primary Fund did, how do you resolve that without the rest of the market pulling back and freezing up?"

SIFMA and others in the industry proposed instituting short-term redemption restrictions, or gates, and temporary liquidation fees in case of market disturbances.

"In theory, the gating option would be very temporary so that you don't lead to further panic in the marketplace. You would have gates come down for an hour or two hours for the fund to institute a liquidation fee. The liquidation fee would go back into the fund so that people who are left in don't get left holding the bag," says Cameron.

The theory behind instituting a floating net asset value is that if investors are accustomed to seeing the fluctuations, they won't freak out and clamor to get their money all at once. Of course, it's all conjecture at this point -- we'll see what the SEC has to say soon enough.

What do you think? My question is, how does a floating NAV prevent runs? If you have the answer, put it in the comments.

Follow me on Twitter: @SheynaSteiner.

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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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