The SEC Changes Regulations for Money Market Funds. Here's What It Means for You

The Securities and Exchange Commission (SEC) voted last week to change the regulations governing money market funds. In March 2020, money market funds experienced significant outflows due to the emergence of the COVID-19 pandemic. This led to the U.S. government stepping in to stabilize the situation, similar to 2008. The purpose of the new rules is to discourage these runs and protect the remaining shareholders.

What are money market funds?

Money market funds are a type of mutual fund that invest in low-risk, short-term debt securities, such as government bonds and commercial paper. They are a popular investment option for investors seeking liquidity and safety.

These funds are considered safe because of their low-risk investment strategy. They are primarily used by individuals and institutions, such as corporations and pension plans, to store cash reserves. The share price of a money market fund is generally $1.

Money market funds have experienced significant growth this year, reaching an all-time high of nearly $5.5 trillion. This surge can be attributed to their ability to provide customers with higher interest rates compared to traditional banks.

The recent failures of several banks have further contributed to the popularity of money market funds. According to Crane Data, these funds paid an average interest rate of 4.81% in late June, significantly surpassing the mere 0.42% offered by bank savings accounts.

Why is the SEC making these changes?

The goal for these changes is to balance two things: protecting people with money in investments and making sure money market funds are secure.

The changes aim to prevent future financial crises and protect shareholders from instability and higher costs when there is a high level of redemptions. The act of redeeming a large number of shares can have a significant impact on the expense of a fund and decrease the value of the remaining shareholders' investments.

When the pandemic began to cause instability in the markets, the Federal Reserve had to intervene to save money market funds, marking the second time in 12 years. As a result, there have been demands for the SEC to implement stricter regulations. The goal for these new rules is to prevent similar incidents in the future and ensure the stability of money market funds.

What are the new changes?

The SEC made revisions to its 2021 proposal in light of feedback from lobbyists and lawmakers. The new version eliminates the need for some funds to adopt swing pricing, which is a practice utilized in Europe to protect investors from share dilution during periods of market turmoil.

The revised rule mandates that money market funds designed for institutional investors charge fees if daily net redemptions exceed 5% of the fund's total assets. In simpler terms, if investors pull their money out of a particular fund quickly, the funds will charge extra fees, which should discourage people from taking more of their money out.

The new rule also mandates that funds must now keep a minimum of 25% of their holdings in assets that mature within a day, compared to the previous requirement of 10%, and at least 50% of their holdings must mature within one week, an increase from the previous requirement of 30%.

This is the third change since 2008, when investors panicked after the Reserve Primary Fund lost a lot of money and its share price dropped below $1. The SEC made changes in 2010 and 2014 that required stress testing, allowing money market funds to stop people from taking out their money if there weren't enough liquid assets in the fund. Many in the industry said these changes have backfired, and the new rules will replace some of the 2014 rules.

How will these changes impact investors?

According to SEC Chair Gary Gensler, "Money market funds…have a potential structural liquidity mismatch. As a result, when markets enter times of stress, some investors -- fearing dilution or illiquidity -- may try to escape the bear. This can lead to large amounts of rapid redemptions. Left unchecked, such stress can undermine these critical funds."

While some believe the changes haven't gone far enough and others believe they have gone too far, Gensler believes the changes will increase the stability, liquidity, and transparency of money market funds, helping investors.

The SEC's decision to change the rules governing money market funds seeks to improve their stability and maintain confidence in the financial system. With the new regulations, investors will need to evaluate their investment strategies and risk preferences carefully. At the same time, the increased transparency in the money market fund market benefits investors by providing them with more information about the risks associated with their investments. Before putting any of your money into any investment, it is important to do your research.