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The $674 billion U.S. prime institutional money market funds sector is expected to shrink by at least a third this year, with large investment firms shutting down such vehicles rather than paying for upgrades needed to meet new regulations.
Money managers, including Federated Hermes, Capital Group and Vanguard, say they plan to close major institutional money market funds with more than $220 billion in assets or convert them to another type of fund before SEC rules take effect in early October. This imposes a mandatory fee on large redemptions.
Other managers say they are still deciding what to do, but analysts at Bank of America and industry executives expect additional closings and transfers as the deadline approaches.
Unlike government money market funds that focus on government debt, prime funds are able to hold short-term commercial paper, including bank debt.
Under the new rules, major institutional funds must charge fees for departures when net redemptions exceed 5 percent of total net assets in a single day.
The new standards are designed to prevent investor stampedes like those seen at the start of the 2020 pandemic, when large outflows prompted major funds to sell assets at a discount and inflict losses on those who remained.
But a number of senior managers have chosen to close major funds or switch to vehicles focused on government debt, which would not be subject to the rules. They claim that the new standards create an “operationally difficult” and “highly prescriptive” burden that will lead to higher costs and complexity of fund structures.
The new requirements are specifically aimed at protecting investors in prime funds, which offer higher returns than so-called “government” funds.
However, some market participants warn that shrinking the ranks of major institutional funds will reduce the diversification of investors' portfolios and shrink the pool of buyers for the $1.3 trillion commercial paper asset class. At the end of January, major funds held more than $310 billion of unsecured and asset-backed securities, or nearly a quarter of the entire market, according to Federal Reserve data.
“It will be really difficult to prove that the enormous incremental pricing costs that will be placed not only on fund providers but also on custodians and asset service providers are really worth the additional benefits,” said John Crook, head of active fixed income at the firm. Vanguard, which is shifting an $89 billion internal fund used by its portfolio managers to manage cash from senior securities to government securities.
Capital Group is doing the same with its $135 billion internal fund.
Interest remains strong in underlying retail funds, which are not affected by the new liquidity fees imposed by the Securities and Exchange Commission. The net assets of these funds rose by 48 percent year-on-year to reach $750 billion at the end of March, according to Crane Data.
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But fund managers are concerned about declining institutional demand. Companies that rely on commercial paper will still “be able to obtain financing, but at what price and at what maturity?” asked Chris Donahue, CEO of Federated Hermes, which closed one of its flagship funds and merged two others.
The SEC remains committed to the new fees. “As Chairman Gensler said, prime institutional funds and tax-exempt institutional funds, which represent just 10 percent of the money market space, have faced the largest redemptions in past stress periods,” an SEC spokesperson said. “The liquidity fees that are part of the final rules for money market funds will help manage risk in times of stress to protect investors.”
The industry has also criticized the way liquidity fees were charged. The SEC had initially introduced a different method for dealing with large outflows, known as swing pricing, which requires managers to include the impact of outflows when calculating the net asset value of their funds. Following opposition from money managers, the regulator chose to impose mandatory liquidity fees without providing an additional consultation period.
Many firms are still “trying to figure out” how to implement the rule, said Eric Bahn, CEO of the Investment Company Institute, noting that there is demand for prime money market funds and that a number of providers “will do so.” [their] “It is worse to try to meet this demand.”
However, “the rule should have been re-proposed,” Pan said, adding that “the SEC did not clearly understand the complexities and difficulties of implementing mandatory liquidity fees.”
“They threatened to kill us with big swing prices, and then they just waterboarded us,” the union's Donahue said. [with liquidity fees]. And when you wake up from waterboarding and you're not dead, you're supposed to feel happy. “This is not a good way to organize.”
