Floating NAVs: SEC money market fund compliance risk looms on the horizon

July 7, 2016

With the deadline for new valuation rules on certain money market funds only months away, compliance and risk professionals at fund management firms need to confirm they have taken the necessary steps to ensure that their systems are ready, as well as having communicated how such changes will impact their clients.

The Securities and Exchange Commission adopted amendments to rules that govern money market mutual funds in 2014, introducing structural and operational reforms to address risks of investor runs in money market funds. The effective compliance date for the new changes is October 2016.

Specifically, the SEC set out three major reforms:

Floating Net Asset Value (NAV)

Certain money market funds – specifically institutional prime and municipal funds – will need to maintain a floating net asset value (NAV) for sales and redemptions based on the current market value of the securities in their portfolios rounded to the fourth decimal place (e.g., $1.0000). The requirement will result in the daily share prices of the money market funds fluctuating along with changes in the market-based value of the funds’ investments. While many mutual funds have long had such a requirement, the reform represents a significant change for such money market funds.

Fees and Gates

Fund managers will need to provide new tools to money market fund boards of directors to directly address a run on a fund. The new tools – fees and gates – would give fund boards the ability to impose liquidity fees or to suspend redemptions temporarily, also known as “gate,” if a fund’s level of weekly liquid assets falls below a certain threshold.
Portfolio Diversification, Disclosure and Stress Testing

There are also enhanced diversification, disclosure and stress testing requirements as well as updated reporting rules by money market funds and private funds that operate like money market funds.

Floating NAV seen having biggest impact

Industry participants say that the SEC’s changes have led firms to invest and test heavily their numerous front-office and operational systems, including risk and compliance monitoring. Of all the changes put forward, perhaps the most difficult will be the transition to floating NAV for client sales and redemptions.

“The main crux of the new reforms . . . from a prime and municipal perspective in the institutional funds is that those funds have to float their NAVs,” Tracy Hopkins, executive vice president at BNY Mellon Fixed Income, told a recent Thomson Reuters webinar on the SEC’s impending rules.

Part of the challenge for funds in calculating and posting up-to-date NAVs for their funds is the timing and frequency of intraday updates, or so-called “snaps.” According to Hopkins, an industry consensus seems to be forming around three updates: 9 a.m., 12 noon, and 3 p.m., but some funds are considering an 8 a.m., 12 noon and 2 p.m. schedule.

“The reasoning behind this is to support the varying needs of institutional investors,” said Hopkins. “Because institutional prime and muni funds will go to floating NAVs, the only way to accommodate that activity is to actually price the fund multiple times” during the day.

Some market participants have voiced concern over the future ability for investors to redeem their holdings due to the perceived limited number of intraday updates. In a recent industry blog post , two Goldman Sachs executives said: “Under the old money market rules, investors generally could access money in prime funds on an hourly basis. In multiple-NAV prime funds, however, a need for precise timing of trade execution arises.”

The executives argued that redemption requests made at 8:05 a.m., for example, might not be processed until the next NAV update at noon.

“Three hours may not seem like a lot in some others contexts. For some corporate treasurers with immediate liquidity needs or certain types of liquidity investors who access cash throughout the day, however, we think this may be a game changer,” they added.

Challenges emerge when markets become volatile

Echoing the concerns raised by the Goldman executives, others say that the real challenge will come when markets enter a period of sustained volatility. During such periods funds will have to rely not only on their internal valuation models, but also from those supplied by external vendors. If the recent market volatility seen after Britain’s referendum to exit the European Union is any guide, funds might face considerable challenges in obtaining values that represent so-called “fair value.”

Sam Mulliner, a partner at Deloitte, and who also participated in the Thomson Reuters webinar, asked: “How much thought has gone into instances of where the markets have gone under duress, and where you have high volatility? What is going to be the process or levers that you can pull to get through a full NAV within that three-hour window?”

Mulliner cited research by Deloitte that showed money market fund managers seeing volumes during the Brexit market turmoil that were “three, four, five times what they would see on a normal day.”

 

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on July. 6. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry at henry.engler@thomsonreuters.com)

 

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