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January 28, 2013

ICI Issues Report on Money Market Funds Since SEC Reforms

By Matthew Garza, J.D.

The Investment Company Institute has concluded in a report that U.S. money market funds have faced significant turmoil since the 2008 financial crisis, including the political fight over the U.S. federal debt ceiling and deteriorating conditions in European debt markets, and money market funds have "passed these tests." The ICI is a national association that represents the interests of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds, and unit investment trusts. The report gave credit to reforms undertaken by the SEC, saying "[b]olstered by the 2010 reforms, money market funds easily met the heightened 2011 redemptions triggered by market difficulties." The ICI said it did not specifically consider further proposals to reform money market funds in the report, but said "some of these proposals would come at the cost of eliminating money market funds and the substantial benefits they provide to investors and issuers who obtain financing from money market funds."

Breaking the buck. In February 2010, the SEC adopted amendments designed to make money market funds more resilient to certain short-term market risks by increasing the quality of their portfolios and providing greater protections for investors in a fund that is unable to maintain a stable net asset value per share (Release No. IC- 29132). This circumstance arose on September 16, 2008, when the Reserve Primary Fund, which held $785 million in debt from doomed Lehman Brothers, found itself without sufficient support from a sponsor and re-priced its securities at $0.97 per share, an event referred to as "breaking the buck." The fund suspended redemptions the next day. The SEC thereafter passed amendments to Rule 270.2a-7 that required funds to maintain a portion of their portfolios in instruments that can be readily converted to cash. The reforms also required money market funds to report their portfolio holdings monthly to the SEC and allowed a fund that has broken the buck, or is at risk of doing so, to suspend redemptions to allow for an orderly liquidation of assets.

Effectiveness of reforms. The research paper sought to examine the 2010 reforms in order to assess their effectiveness. It examined the history of Rule 2a-7, which restricted the portfolio holdings of money market funds as originally adopted in 1983, and became more restrictive through amendments made in the 1990s and in 2010. "The new liquidity requirements have had a transformative effect on money market funds," the report stated.

As of June 2012, funds exceeded the minimum daily and weekly liquidity requirements by a considerable margin, said the ICI. Money market funds held in total $1.38 trillion in weekly liquid assets, of which $629 billion was held by prime money market funds. In the week Lehman Brothers failed, prime money market funds experienced estimated outflows of $310 billion. Thus, in June 2012, the report concluded, prime money market funds held liquid assets more than twice the level of outflows that were experienced in the worst week in money market fund history. The report went on to examine money market funds' response to pressures put on them by the U.S. debt ceiling and Eurozone crises and found that fund managers' successfully mitigated the risks posed by those events.

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