Proposals from the US Securities and Exchange Commission (SEC) for the reform of regulations affecting money market funds (MMFs) are close to approval and likely to reshape the MMF industry. Now is the time to prepare for the coming changes, writes Calastone’s Ed Lopez
The regulatory circle is turning again for money market funds. In the US, new rules that will change reporting and the way funds manage liquidity are being drawn up. In Europe, early proposals are circulating.
These new regulations include changes that might be positive for market liquidity by raising requirements for the amount of cash a fund must hold – and removing redemption gates that temporarily prevent investors from redeeming funds. The ability to resort to redemption gates has sometimes triggered the very behaviour investment managers want to avoid, as redemption runs have taken place when investors believed a gate imposition was near.
However, other proposed changes are less beneficial. The full SEC regulatory package could also challenge the viability of the short-term fund market as we know it and will certainly change the way funds and treasuries interact. According to Fitch Ratings, at least half of institutional prime MMFs would have to increase their weekly liquidity levels under the proposed new threshold. This will ensure portfolios contain a higher proportion of investments that are easy to sell in any market conditions, such as US treasury bills, but with the likely effect that institutional prime MMF yields will fall.
Overall three areas pose particular challenges to investors, fund managers and their partners and counterparties, and all will require changes in systems and processes in order to address them.
Emerging pressure points
The proposal to introduce swing pricing – passing the transaction cost of buying or selling funds to the party making the transaction – will be challenging for most funds. Money market funds are currently ineligible for swing pricing strategies under the US Investment Company Act, but the SEC proposals will change this. Although swing pricing is usually understood as a protection for longer-term investors against the performance effects of short-term trading, the rationale for the proposed changes in the short-term money market appears to be a regulatory desire to increase the resilience of MMFs at times of market stress. However, swing pricing could create serious challenges for the prime money market fund industry due to the increased operational burden, higher costs and market risks it will create:
- To manage swing pricing, fund providers will be required to closely monitor fund inflows and outflows and to recalculate pricing following each transaction. Fund providers may also face other operational challenges such as setting appropriate redemption threshold policies, and creating appropriate reporting and confirmation processes.
- Fund providers will be faced with added cost due to the increased complexity required to calculate pricing – especially if dealing with legacy systems – leading them to increase fees and offer fewer fund options, which will deter investors. Ultimately, they will lose business to the providers that can drive down compliance cost.
- Corporates’ short-term investment options could be reduced. If the operational difficulty and cost of MMF investing increases, investors may turn away from prime MMFs and into government funds and other asset types which have lower returns but are easier to access. A smaller range of fund options will reduce diversity, drive up risk and make it harder to access invested cash quickly.
The proposal to accelerate the NAV reporting cycle will also pose operating challenges. Instead of just once a day, MMFs may be required to report net asset value (NAV) on a higher frequency cycle, perhaps up to three times a day. The fund and counterparty capability to deliver this is dependent on the systems they have in place – legacy systems make it difficult to manage high-frequency NAV reporting and funds will become more exposed to their counterparties’ reporting capabilities.
- Funds will face acute challenges in reconciling trades through the day with additional valuation windows, and uncertainties over cash available to settle trades could force repeated restatements of NAV.
- High-frequency reporting will prove an operational challenge for fund administrators, transfer agents and depositaries.
The SEC proposals will also introduce new requirements on fund transparency, with MMFs required to report a much higher level of detail on fund composition and ownership.
- Funds will need to establish data processes to deliver the mandated depth of composition and ownership data, with difficulty rising according to the frequency of reporting.
- Funds and counterparties will need to establish the accessibility and accuracy of ownership records in a manageable way.
MMF reforms are a technology call
Rapid price disclosure and more frequent and deeper reporting all call for technology solutions: it is unlikely that funds or counterparties such as transfer agents and custodians with manual or non-integrated processes will be able to manage the costs of compliance with the new MMF regulatory requirements without further automation.
Digital technology can offer the automation and oversight of liquidity needed to ease some of the issues the reforms will create for all parties involved. It will help remove cost and risk and increase transparency. For example, Calastone Money Market Services can enable firms to monitor fund positions in near-real time with cash reported at five-minute intervals, and alerts on fund positions and flows can be provided directly into MMF treasury systems.
Our business insights tools offer funds a rolling capture of subscriptions and redemptions, helping to manage the operational burden posed by swing pricing and high-frequency NAV reporting by automating the delivery of price changes and fund valuations. This allows funds to move from a low-volatility constant pricing model to a variable net-asset-value model where price changes are reported at high frequency.
Technology can also drive fund transparency, providing on-screen real-time access to data on the overall composition and liquidity of funds. Real-time reporting reduces risks and supports rapid decision-making.
The challenge of new money market regulation is one of complexity – and complexity always tends to raise cost. Technology that provides automation is the only way to counter complexity and drive those costs down to a point where the short-term MMF market remains viable. Fund providers, counterparties and investors with the right tools can prepare for new regulation right now.
Find out more about what treasurers think of the forthcoming US and European regulations in our research Global Liquidity Barometer 2022 – Short-Term Investment Trends and Treasury Insights