Recent proposed changes by the SEC could have a strong negative impact on money market funds, likely resulting in industrywide resistance.
Worried about systemic risk, the SEC has proposed some big changes that would dramatically diminish the appeal of money market funds. And that may well be the goal of the SEC in proposing these changes. It's an open question as to whether this cure will make things better or worse.
Morningstar's Greggory Warren says that the actual rules the SEC adopts will likely be much less dramatic. Having believed we would see some additional proposals aimed at reforming money market funds from the SEC as early as March of this year, it was no surprise to see news leak out that regulators were pushing forward with a package of reforms that included a call for floating net asset values, or NAVs, for money market funds, as well as capital reserves for firms running cash management operations. The fact that the SEC continues to focus on money market reforms, even though many in the industry believe that the reforms enacted in the aftermath of the financial crisis have already done a good job of stabilizing the business, means there will continue to be a fair amount of uncertainty for firms like Federated Investors FII, which garners more than three fourths of its assets under management, or AUM, from its cash management operations, and Legg Mason LM, which has around one fifth of its managed assets tied up in money market funds.
Although the details of the proposals have yet to be unveiled, it is believed to include calls for: (1) firms to set aside capital reserves (by injecting cash from their own coffers, issuing additional equity or debt, or collecting capital from fund shareholders); (2) use of a floating NAV for money market funds (which would allow the daily value of a money market fund to fluctuate with the value of the holdings in the fund rather than peg it at $1); and, (3) a 30-day holdback feature (where investors selling all of their holdings in a money market fund would only receive 95% of their capital up front, having to wait 30 days to receive the remainder). We believe the first proposal has a much greater degree of success than the latter two, given that most of the industry believes the use of floating NAVs and the installation of a 30-day holdback feature would kill the two primary attractions of money market funds--stability and liquidity--for both institutional and retail investors.
Even though Federated's CEO has vowed to sue the SEC if the new regulations interfere with the firm's ability to do business, we don't believe it will actually go that far (at least not yet). SEC chairwoman Mary Schapiro recently acknowledged that three out of five commissioners have expressed reluctance to support new money fund reforms, and she would need three out of five commissioners to approve of the proposed reforms before the SEC could submit them for public comment, making it likely that some (if not all) of the proposals might not even make it to the public comment period.
Should the proposals see the light of day, we expect the industry to fight vehemently to halt several of them--most particularly, the call for floating NAVs and the installation of a 30-day holdback feature for money market funds. In the meantime, we expect the shares of Federated, and to a lesser extent Legg Mason, to be pressured by the negative headlines associated with the more recent moves by the SEC.
Morningstar analysts Gregg Warren and Russel Kinnel contributed to this article.