The biggest reform since the financial crisis is about to hit the ground running, and the U.S. stock market is waiting anxiously
“I don’t know if the outcome (of the upcoming reform package) will have us celebrating with popcorn and champagne in a conference room, or will we cry collectively,” said Federated Hermes, head of global liquidity. Debbie Cunningham, the market’s chief investment officer, said so.
What makes him so disturbed is that the money fund market is about to undergo its third reform since the 2008 financial crisis, and it will also be the largest reform in many years. The U.S. Securities and Exchange Commission (SEC) will vote on reshaping the money market industry rules at 10 a.m. Eastern Time on Wednesday (12th). Like Canning, fund managers were still unsure of what to reveal on Wednesday despite numerous meetings with SEC commissioners and staff.
Biggest reforms since the financial crisis
In 2008, the US subprime mortgage crisis broke out, and on September 15, Lehman Brothers filed for bankruptcy. At the time, the Reserve Primary Fund, one of the oldest and largest money funds in U.S. history, had $785 million in Lehman Brothers bonds among its $62 billion in assets. Although these bonds accounted for only a little more than 1% of the fund’s overall assets, it caused investors to panic. In just two days on September 15 and 16, there were about 40 billion US dollars of redemption applications, equivalent to the amount of money in the money fund. 65% of the assets. For this reason, on September 16, 2008, the reserve fund company had to announce the implementation of the “breaking the buck” operation, depreciating the fixed net value of US$1 to US$0.9667. On September 17, the reserve fund company announced the suspension of redemption. On the 22nd, the SEC announced an emergency order, allowing the fund to suspend and postpone redemption in order to give the fund time to pay off its assets. But this still cannot block the redemption and capital outflow of other products of the reserve fund company. Soon, the Reserve Fund Corporation ran out of cash. For this reason, on September 19, 2008, the Federal Reserve and the U.S. Treasury Department had to announce for the first time in history that they would provide credit enhancement for the money base facing a run on through market tools.
The crisis has exposed major problems with money market funds that are supposed to be ultra-safe havens for individual and corporate investors to park their cash. Regulators then spent years implementing reforms aimed at slowing redemptions during times of stress. But panicked investors withdrew billions of dollars from money-based markets in less than two months, starting in March 2020, in the wake of the coronavirus outbreak, underscoring the last round of reforms that began in 2016. Failed to achieve expected results. In desperation, the Federal Reserve bailed out the money market for the second time in 12 years.
This has triggered a new round of reflection on how to stabilize the industry, and the SEC has also been called to strengthen supervision of the industry. To this end, the SEC said earlier that the long-awaited reform has been included in its agenda, and more restrictive measures may be introduced as soon as October this year. But last week, the SEC suddenly announced that it will vote on the new reform plan on Wednesday, which caught the market by surprise.
Industry insiders said that the best case scenario is that the SEC only makes some simplistic adjustments, such as simply removing the link between consumption rates and liquidity levels, but promises to continue to study more complex reform policies. It’s similar to what happened after the financial crisis, when regulators set daily and weekly liquidity rules for money funds in 2010 and mandated better credit quality and shorter maturity limits, but waited until 2014 for more significant measures . What the industry is even more unwilling to see is that the SEC announces the implementation of more pressureful reform measures in one go, such as requiring investors to pay a certain fee to withdraw funds.
It is worth mentioning that the market size affected by this reform is larger than before, because after the banking crisis this year and the Fed’s continuous interest rate hikes to raise short-term interest rates, the attractiveness of money funds to investors has continued to rise this year. According to data from Bank of America, as of the week of July 5, the annual inflows of US money market funds were US$750 billion, and the total assets under management reached US$7.8 billion.
“We’re all waiting with bated breath to see where the reforms go,” said Jon Luc Dupuy, a partner at K&L Gates LLP. “I’m not usually a gambler, so I can’t bet on it.”
Or will cancel the “swing pricing” mechanism
Although the reform plan to be disclosed is generally in a state of “blind box drawing”, but as the results are getting closer and closer, foreign media quoted people familiar with the matter on Tuesday as saying that the SEC may cancel “swing pricing” in Wednesday’s vote. “(swing pricing) mechanism to prevent the rapid outflow of funds from the cargo base during the period of financial stress in the market. The person familiar with the matter also revealed that the SEC still intends to impose other fees.
The swing pricing mechanism is a mechanism for protecting long-term fund investors. Generally speaking, the fund will retain a certain amount of cash to deal with redemption, but the amount should not be too large, otherwise it will drag down the performance of the fund. However, when the fund has a large net outflow or inflow of funds, that is, investors in the market suddenly subscribe or redeem a large number of purchases simultaneously, at this time, if the fund swing pricing mechanism is used, the relevant transaction costs will be adjusted from the purchase on the same day by adjusting the net value. Or redemption investors, this method can avoid the impact of long-term investors’ rights and interests, also known as “anti-dilution mechanism”.
Previously, in December 2021, the SEC had proposed a plan, which included: increasing the percentage of total assets that the fund must maintain in cash or other quickly convertible assets – overnight liquidity increased to 25%, weekly liquidity Removal of funds’ ability to charge redemption fees or temporarily capping redemption fees if liquid assets fall below a certain threshold; Requiring institutional prime money funds to use swing pricing, which would force redeemers to bear the cost of withdrawals; If the federal funds rate goes negative, government funds are required to float to net asset value. However, once the plan was proposed, it was opposed by the industry.