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Bank of America Pulls Out Of Money Market With New SEC Regulations

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As the second largest bank in the United States, Bank of America plans to simplify their investment options as increased regulation looms on the horizon–– and other investment groups seem to be planning on doing the same. After the financial hardships of 2008, The Security Exchange Commission (SEC) passed new regulations aimed at reducing risks for money market funds. These new regulations are set to go into action in October of this year, and will dramatically change investing practices.

Why is this happening?

In many cases, money market accounts can be extremely volatile. During the financial crisis of 2008, failed money market funds left shareholders in treacherous waters, which led to the subsequent invocation of increased regulation from the government.

In a notable case, one fund in particular had share value drop below one dollar. The Reserve Fund had to liquidate all assets after a run on the fund from worried shareholders. The fund held $64.8 billion in assets, and of those assets, $785 million were allocated to short-term loans issued by Lehman Brothers.

These “commercial paper” loans became worthless when Lehman Brothers filed bankruptcy.

Although the commercial paper made up only 1.5 percent of the total money market fund, fear among shareholders grew as the news broke about the Lehman Brothers collapse. Within 24 hours, two-thirds of investors pulled their money out of the Reserve Fund. As tumult struck, the net asset value (NAV) fell below $1 per share to 97 cents—marking one of the first times in history the NAV of any money market fund fell that low.

The increased volume of redemption requests from investors caused the fund to put a seven-day freeze on redemptions. Attempts to save the fund were unsuccessful–– eventually, the Reserve Fund had no choice but to suspend all operation and commence liquidation. News of the event shocked the investing community and acted as a wake-up call about the reality of credit markets like the Reserve Fund.

Six years after the meltdown of this major money market fund, the federal government began working to increase regulation aimed at preventing these kinds of faults.

What does the regulation actually look like?

In 2014, the SEC released the new guidelines that are set to take effect in October of this year. The guidelines place higher restrictions on portfolio holdings and increase liquidity. Additionally, the addition of a “floating NAV” further increases the stability for shareholders, while increasing risk for fund managers. No longer allowed to manipulate stock value through special pricing models, the NAV of money market funds must now remain constant at $1.

To prevent a run on the fund (as was the case with the Reserve Fund), the SEC also mandates fund managers implement liquidity fees and suspension gates. If the weekly liquid assets of a fund fall below 10 percent of the total assets, a 1 percent liquidity fee is activated. If liquid assets fall below 30 percent, the fee is raised to 2 percent. Furthermore, funds may now suspend redemptions up to 10 business days. Between the fees and redemption suspensions, the SEC hopes to eliminate runs on the fund, as they often create chaos within the industry.

In a press release and fact sheet released by the SEC, Mary Jo White, Chair of the SEC, said that the new regulations will, “fundamentally change the way that money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system.”

How will this affect investors?

Retail investors, institutional investors, and fund groups all will experience varied levels of impact, but overall, this is a major win for stockholder stability.

Retail Investors will feel minimal effects from the new regulation. Although the $1 floating NAV is not likely to affect these kinds of investors, liquidity fees and redemption suspensions will. In order to be considered a retail fund, the fund must have policies and procedures that will benefit “natural persons”–– that is, not corporations or other organizations. Certain funds such as retirement plans with forfeiture accounts, pooled investments holding money market funds and donor advised funds, are in a grey area. Their retail eligibility is still unclear.

Unlike retail investors, the new rules directly target institutional investors. Compromise is the name of the game moving forward for institutional investor: higher yield or higher risk? Pick one. Choosing to invest in government money markets offers security but lower yields. Investors seeking higher yields can explore other investment options, like bank certificates of deposit and ultra-short duration funds. However, neither of these options stands out as great because either returns are low or volatility is high.

In many cases, fund groups need to consider their future in money market investments. For some, meeting compliance regulations outweighs the benefit of managing the fund. In the case of Bank of America, the group no longer saw money market investments as lucrative or worthwhile, so they sold out.

Moving forward, investors should understand the importance of this change to money market investments. Although just one type of investment, consider an investment portfolio from a holistic standpoint and continue to remain aware of the changing financial regulations in the US.

In tandem with the Department of Labor’s new Fiduciary Rule set for enforcement in the spring of next year, the financial industry of this country continues to morph, so keep heads up and ears open.

Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.

Securities offered through TFS Securities, Inc., Member FINRA / SIPC, a full service broker dealer. Investment Advisory Services offered through TFS Advisory Services, a division of TFS Securities.