Wednesday, January 27, 2010

SEC's New Rules for Money Market Funds

should make Treasury and the Federal Reserve happy.

While the financial press is more focused these on the banking industry regulations and the re-confirmation of the Fed chairman, the Security and Exchange Commission has just adopted a new set of rules to regulate $3.3 trillion (and rapidly declining) money market funds industry, which will affect the public much more than the re-confirmation of Ben Bernanke.

There are 3 areas that SEC focuses on to regulate the industry:

1. Further Restricting Risks by Money Market Funds
2. Enhancing Disclosure of Portfolio Securities
3. Improving Money Market Fund Operations

Of these, the first is the most detailed. It includes:

Minimum liquidity requirement (currently there is no such requirement):

Daily Requirement: For all taxable money market funds, at least 10 percent of assets must be in cash, U.S. Treasury securities, or securities that convert into cash (e.g., mature) within one day.
Weekly Requirement: For all money market funds, at least 30 percent of assets must be in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, or securities that convert into cash within one week
Shorter maturity requirement:

Restricting the maximum "weighted average life" maturity of a fund's portfolio to 120 days. Currently, there is no such limit. The effect of the restriction is to limit the ability of the fund to invest in long-term floating rate securities.
It seems like SEC has found a ready (unwilling, maybe) buyer of Treasury debts and agency bonds and MBS backed by Fannie, Freddie, Ginnie and FHA (as long as these bonds mature in 60 days). Now the Federal Reserve has a big enough counterparty to do the reverse repo agreement! Bernanke can finally implement one of his "exit strategies". (If he is re-confirmed as chairman, that is.)

Under the third, there is this clause:

Suspension of Redemptions: The new rules permit a money market fund's board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule.

SEC says that the "new rules are intended to increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds by tightening the maturity and credit quality standards and imposing new liquidity requirements". What's ironic about it is that the Reserve Primary Fund broke the buck in September 2008 because of the government regulators' capricious decision to let Lehman Brothers go bankrupt. The run on the Reserve Primary Fund triggered a far bigger run on money market funds that could have collapsed the entire world economy.

SEC also says the new rules are being adopted to "better protect investors". Now, do you feel secure, knowing you may not able to get your money back in a crisis?

The rules will be effective 60 days after their publication in the Federal Register.

60 days, folks.


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