Money market funds asked to keep more liquidity by SEC

The SEC (Securities and Exchange Commission) has on Wednesday tightened the regulations for money market funds in order to prevent financial meltdowns in future.  Money funds are more like the checking accounts as they are interest-bearing but they are essentially mutual funds which invest in short-term and high-quality IOU’s that are issued by the US (state and local) governments and corporations.  But the share prices of money funds are kept at $1 unlike other funds and hence investors don’t end up losing money.  However, these funds are not federally insured and hence any significant problem in the holdings could result in the share price falling below $1.

During September 2008, there were huge redemptions which resulted in some investors losing heavily on investments and this was the first time that something like this had happened in a money fund that was open to the public.

The bigger investors pulled out their money from the Reserve as they got worried about the holdings especially securities that were issued by Lehman Bros that had failed in September 2008.  There were more of large redemptions especially by institutional investors, much more than it could handle and thereby forcing the share price to 97 cents.

As per the new rules laid out by the SEC this year, funds will have to retain enough liquidity to meet huge redemptions in future.

–          The money funds are required to have at least 10% of their asset value in cash or some form of investment which could easily be liquidated within a day if the need arose.  The other 30% must be in investments that could be liquidated within a week.  So theoretically speaking if there is more liquidity available the departing investors could be paid off and the funds will not get swamped due to redemptions as the Reserve did.

–          While the maturity time on the funds average portfolios are 90 days at present it would change to 60 days or less which would mean lower yields.  Whereas long-term investments do offer high yields there is more volatility when the rates increase.

–          Now the funds can put only 3% instead of 5% of the assets into investments that are not high quality.

The fund industry has offered support with regard to the new rules by the SEC’s where the money market funds would become more resilient in the face of adversity like the 2008 scenario.