Managers to shut or convert $220bn of US money market funds before rule change

The $674bn US institutional prime money market funds sector is set to shrink by at least one-third this year, as large investment firms shut down these vehicles rather than pay for upgrades needed to meet new regulations.

Cash managers including Federated Hermes, Capital Group and Vanguard say they are planning to close institutional prime money market funds holding more than $220bn in assets or convert them to another type of fund before Securities and Exchange Commission rules come into effect in early October, imposing 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 predict additional closures and conversions as the deadline draws nearer.

Unlike government debt-focused money market funds, prime funds are able to hold short-dated commercial paper, including bank debt.

Under the new rules, institutional prime funds must impose a fee on departures whenever net redemptions top five per cent of total net assets in a single day.

The new standards are designed to prevent investor stampedes such as those seen at the start of the 2020 pandemic, when large outflows pushed prime funds to sell assets at a discount and inflict losses on those who remained.

But a number of large managers have chosen to shut down prime funds or convert to government debt-focused vehicles, which will not be subject to the rules. They argue that the new criteria constitute an “operationally difficult” and “highly prescriptive” burden that will push up costs and complicate fund structures.

The new requirements are aimed specifically at protecting investors in prime funds, which offer higher returns than so-called “government” money funds.

However some market participants warn that shrinking the ranks of institutional prime funds will reduce the diversification of investors’ portfolios and shrink the pool of buyers for the $1.3tn commercial paper asset class. At the end of January, prime funds held more than $310bn in unsecured and asset-backed paper, or roughly one-quarter of the entire market, according to Federal Reserve data.

“It would be a really uphill struggle to demonstrate that the incremental burden was worth the handful of basis points that we would have preserved by keeping it in its original construct,” said John Croke, head of active fixed income at Vanguard, which is converting an $89bn internal fund that its portfolio managers use for cash management from prime to government securities.

Capital Group is doing the same thing with its $135bn internal fund.

Interest remains strong in retail prime funds, which are not affected by the new SEC liquidity fees. These funds’ net assets were up 48 per cent year on year at $750bn at the end of March, according to Crane Data.

But fund managers worry about reduced institutional demand. Companies that rely on commercial paper will still “be able to get financing, but at what price and at what maturity?” asked Chris Donahue, chief executive of Federated Hermes, which has closed one of its prime funds and merged two others.

The SEC remains committed to the new fees. “As Chair Gensler has said, institutional prime and institutional tax-exempt funds, just 10 per cent of the money market space, have faced the largest redemptions in past stress periods,” said an SEC spokesperson. “The liquidity fees that are part of the final money market fund rules will help manage risk in times of stress to protect investors.”

The industry has also been critical about the way the liquidity fees were imposed. The SEC had initially put forward a different method of dealing with big outflows, known as swing pricing, which would require managers to include the impact of outflows when calculating the net asset value of their funds. After pushback from money managers, the regulator opted for mandatory liquidity fees without providing an additional consultation period.

Many firms are still attempting to “figure out” how to implement the rule, said Eric Pan, chief executive of the Investment Company Institute, noting that there is demand for prime money market funds and a number of providers will “do [their] damnedest to try to meet that demand”.

Still, “the rule should have been reproposed,” Pan said, adding that the “SEC clearly did not understand the complexities and the difficulties in implementing a mandatory liquidity fee.”

Federated’s Donahue said: “They threatened us with death with big swing pricing, and then they only waterboarded us [with liquidity fees]. And when you wake up from waterboarding and you’re not dead, you are supposed to feel happy. That is not a good pattern of regulation.”