Money market reform: What you need to know
We've changed our money market fund lineup to comply with Securities and Exchange Commission (SEC) rules. We don't expect a significant impact on our management of these funds.
What's money market reform?
Money market reform is a set of SEC rule amendments meant to address any potential financial instability that could be caused by money market funds. The amendments took effect on October 14, 2016.
Here are the key elements:
- Establishes 3 categories of money market funds—retail, government, and institutional.
- Restricts who can invest in retail money market funds.
- Continues to seek a stable $1 net asset value (NAV) for retail and government funds, but requires institutional funds to have floating NAVs like other mutual funds.
- Allows certain funds to impose liquidity fees and temporarily suspend withdrawals (known as gates) in certain circumstances.
Money market reform and you
Investors can invest in a federal money market fund, which is a government fund, and/or a tax-exempt municipal money market fund,* which is a retail fund.
- Our government funds (the Cash Reserves Federal Money Market Fund and the Federal Money Market Fund**) seek to maintain a stable $1 NAV. Vanguard Federal Money Market Fund is the only fund that can be used to settle brokerage trades and isn't subject to the liquidity fee or redemption gate requirements.
- Our 3 tax-exempt retail municipal funds* (1 national and 2 state municipal money market funds) seek to maintain a stable $1 NAV.
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A fee (up to 2%) that may be charged by a money market fund when you sell fund shares. The fee is imposed at the discretion of the fund's board if weekly liquid assets drop below 30%. The fee is intended to help the stability of the fund during times of extreme market duress.
A money market fund's ability to temporarily suspend withdrawals during periods of financial instability for up to 10 business days in a 90-day period if weekly liquid assets drop below 30%.
The price of a fund share. It's calculated by dividing the total assets, minus liabilities, allocated to a specific share class by the number of shares outstanding for that class.
The move for money market fund reform grew out of the 2007–2008 financial crisis.
The Reserve Primary Fund, which invested in Lehman Brothers debt, "broke the buck," meaning its net asset value (NAV) dropped below $1 per share.
This event prompted significant redemptions by institutional money market fund investors, putting the funds under severe stress.
Although retail (individual) activity was less volatile, with purchases and redemptions largely offsetting each other, the SEC felt it had to address concerns that money market funds may contribute to financial instability.
The final amendments to money market rules that were made in 2014 aim to protect shareholders from the impacts that a flood of redemptions could have on money market funds. The amendments are also intended to give fund managers time to respond to requests in a more thoughtful, prudent manner.
Liquidity fees and gates are tools to help money market fund managers keep the funds stable during times of extreme market duress. Under the rules:
- A fund may impose a fee of up to 2% on redemptions if a fund's weekly liquid assets fall below 30% of its total assets.
- A fund must impose a 1% fee on redemptions (with the option of imposing a fee of up to 2%) if a fund's weekly liquid assets fall below 10% of its total assets—unless the fund's board determines a fee would not be in the fund's best interest.
- A fund may impose a gate—that is, suspend redemptions—for up to 10 business days in a 90-day period.
The fees and gates rules only apply to retail and institutional funds, although government funds may voluntarily adopt them if the fees and gates are previously disclosed to investors.
The boards of directors of Vanguard's government funds have decided to impose neither fees nor gates.
A mutual fund used to pay for and receive proceeds from trades in your brokerage account.
Amy Chain: Hello, I'm Amy Chain. Welcome to today's discussion on money market funds. We'll discuss the changes in regulations of money market funds and how Vanguard investors are affected.
And with us today are David Glocke and Justin Schwartz of Vanguard's Fixed Income Group, the group responsible for managing Vanguard's money market funds. Gentlemen, thanks for being here today.
Justin Schwartz: Thank you.
David Glocke: Thank you.
Amy Chain: Justin, get us started. Tell us a little bit about some of the changes coming to money market funds.
Justin Schwartz: I think the most important thing to note is that for most of our shareholders, not a lot is going to change, but we are happy to go through a couple of the key changes here today. And the first thing I'd like to get started on is enhanced disclosure.
So our shareholders are going to have some increased transparency into the portfolios, and that's going to take place through the website. So we'll have daily website disclosure on our daily and weekly liquid assets that we hold in the portfolio. In addition, they'll be able to see a market-based value of the portfolio; something different from money market funds. This will be taken out to the fourth decimal place. It's important to note that this is not the share price that investors will be transacting at. We'll strive to maintain a stable $1 NAV in all of our money market funds.
In addition to that, we'll be posting daily shareholder cash flows on the web page so shareholders will have a better insight into what's going on to the fund day in and day out.
In addition to that, we do currently report holdings, detailed portfolio holdings to the SEC at the end of every month. Those are currently available on a 60-day lag and after April 14, our shareholders will be able to access those through the SEC's website. And, actually, there's a link on our website as well immediately after posting.
David Glocke: In addition to that, a couple of things that investors are probably going to start hearing about is the SEC allowed the money market funds to not just offer the stable net asset value portfolios, which clients have gotten used to for the last 40 years, but to also go ahead and offer floating-rate net asset value type portfolios. And we've decided at Vanguard that's not really where we want to go. We just want to offer the stable NAV traditional-type money market funds that clients are used to. So those are the products that we'll offer.
Also they'll hear something about fees and gates. So the SEC is going ahead and allowing boards of directors of portfolios to implement fees and gates, which we would expect would be implemented in times of extreme stress. The trigger mechanism for that is something that's going to be displayed on our website through the enhanced disclosure, which represents the amount of weekly liquidity in the fund.
As long as the portfolio has at least 30% weekly liquidity in the portfolio, the board of directors won't have to consider whether they need to implement fees and gates. So what we've done is we've enhanced the amount of liquidity in our funds to around 40% in total assets. And we think that's going to give us enough of a buffer to go ahead and avoid the times where we might have to turn around and implement that.
And in addition to the government funds that we offer, won't have fees and gates apply to them at all. The SEC allowed the board of directors to go ahead and opt out of that for government funds and Vanguard's board chose to do that.
Amy Chain: How about from the perspective of managing our money market funds, do these regulatory changes bring any changes to the way we manage money?
David Glocke: Really, I mean, on the taxable side, there's not a lot of changes other than enhancing the amount of liquidity. During the financial crisis, in particular during the Lehman period when things were really volatile, we lost less than 2% of our assets over the course of a week.* So having that additional buffer from 30 to 40% I think gives us a lot of comfort knowing that we can go ahead and deal with anything that comes up day to day.
And certainly, as we did during the financial crisis, if we saw conditions eroding in the markets, we would turn around and enhance that to go ahead and make sure that we had an even larger buffer, again, similar to the way we managed the cash back in that time period.
Amy Chain: Pause for a minute and tell me a little bit about why liquidity is important in a money market fund.
David Glocke: Well, it's interesting. I mean, a money market fund allows investors to go ahead and transact in their portfolios all the time. We don't have any restrictions. And so, like a bank, we would have to have certain assets on hand to go ahead and meet redemptions, and we do that through maturities, assets that are coming due on a daily basis. And, also, our bank would go ahead and invest more long-term. Money market funds invest short-term. So we have average maturity that's determined by the SEC, which has to be 60 days or less.
Amy Chain: So all of the securities within the money market portfolios have maturities of 60 days or less, or a large majority of them.
David Glocke: Not necessarily. They'll have maturities that can go out a bit further but the average maturity of the overall portfolio has to be 60 days or less. So it's common for us to go out and buy six-month bank CDs and put that in the portfolio, but we'll have a large weight of short-term assets which offset that.
And so there's always a constant flow of maturities coming due in the portfolio to meet redemptions. So on top of that, the SEC wants us to have more liquidity. And so for us in Prime Money Market, I go out and I buy U.S. Treasury securities or I might go out and buy an agency security, which are very highly liquid and also qualify as weekly liquidity for the SEC rules.
Justin Schwartz: And on the municipal side, I'd say very little has changed in terms of how we manage the portfolios. The securities that are available for money market funds in the municipal market are actually structured such that they qualify for daily or weekly liquid assets. So traditionally, even dating back before the financial crisis, municipal money market funds ran about 70 to 80% in what today qualifies as weekly liquid assets.**
Amy Chain: Certainly, we have many, many investors who are investors in our money market funds. Many of them through our brokerage accounts. Talk to me about how these policy changes impact our investors.
Justin Schwartz: That's probably one of the biggest areas of change that our shareholders will see. So, as a result of the reform, Vanguard has decided to only offer the Vanguard Federal Money Market Fund as a settlement option and a brokerage account.
As David mentioned before, government funds are not subject to fees and gates and they're open to all investors. So with Vanguard Brokerage thought that would be the best option for clients. It is important to note that they can continue to use all the Vanguard money market funds as they do today with the exception of settling brokerage trades.
Amy Chain: So your settlement fund and your brokerage account has to be the Federal Money Market Fund; otherwise, any impacts to investors?
David Glocke: Yes. I could go ahead and have a Federal Money Market account to handle any stock trades that I might want to do, but I can still have my cash in another account whether it's a tax-exempt money market fund or Prime Money Market. So I can continue to maintain that same investment profile, but then just transfer the money over as I need it to deal with brokerage trades.
Justin Schwartz: It's a good opportunity for investors to think about what they value in their money market fund, whether it's tax-exempt income or, in the case of a prime fund, maybe a slightly higher yield than a government portfolio. So those are decisions and things that the clients may want to consider.
Amy Chain: Are there any strategies that investors should be considering to minimize the impact of these changes?
David Glocke: The strategies that we're hearing about and seeing people execute on, we know that Vanguard introduced an ultra-short bond fund recently. So it's positioned right between a money market fund and a short-term bond fund. It's a variable NAV fund very similar to a bond fund, but it buys shorter-duration assets. So that's where its maturity profile would be right between the two.
And we've seen a lot of interest in that product, investors considering that, mostly though from investors who have money maybe in money market funds that recognize at this point that maybe it's time to take some of that cash that has traditionally been long-term cash in the money market fund and move it into something that offers a better opportunity for returns.
Justin Schwartz: And we have a municipal product, Short-Term Tax-Exempt Fund, that has a similar maturity and duration profile to the ultra-short-term taxable fund that is available for clients as well who desire the tax-exempt income.
David Glocke: In this low-yield environment that we finally are starting to move out of very slowly, a lot of clients were looking for a way to go ahead and get a higher return but yet not necessarily to go into the more traditional-type bond funds. So these products give investors who have that risk profile an opportunity to do something a bit different.
Amy Chain: We've talked a little bit about N-A-V or NAV today. Can you define that for us? What does that mean and what do shareholders need to know about it?
David Glocke: Really, I guess the net asset value of the portfolio is the level, the price of the fund that you're transacting in. So when you think of net asset value in the money market fund, it's traditionally been the dollar, a buck. And that's how a lot of times how we'll turn around and refer to it. Whereas the floating NAV or floating net asset value portfolios really price more like bond funds. On the money market side, they would be shorter-duration in nature and so they wouldn't have as much volatility, obviously, as a bond fund.
But I think a lot of clients really prefer to go ahead and know that when they're transacting, it's $1 in, $1 out. It's never a guarantee. We can say that over and over and it's in all the prospectus. We have a long tradition of very conservative investment management and we feel very comfortable that our investment-style approach that Vanguard has will go ahead and keep us where we should be.
Amy Chain: David, you also talked a little bit about fees and gates today. Can you define them for us?
David Glocke: Sure. So the fees and gates are associated, again, with when you go ahead and drop below 30%. The board of directors at that point has the opportunity to decide if they want to go ahead and present a fee, a redemption fee, or gate, where they control the flow above the cash they go ahead and leave.
Amy Chain: The idea would be if there is volatility in the market such that we're afraid there would be mass redemptions from a money market fund, these fees or gates would slow down the outflow to protect shareholders of the fund.
Amy Chain: Let's sum up some of what we've talked about today. Any final thoughts to share?
David Glocke: I think, really, for most Vanguard clients, there aren't a lot of changes that are going to impact the way that they use their money market funds today.
Justin Schwartz: And as we talked a little bit about before for brokerage clients, the settlement fund change will happen. And when it does, they'll just need to make sure that when they do a brokerage transaction that they're funding that account to settle the trade. Other than that, they can continue to maintain their position in their prime or tax-exempt money market funds that they have today.
Amy Chain: Gentlemen, thank you so much for sharing with us today. We covered a lot of information. For a deeper dive on some of the topics, terms, and concepts that we talked about, I encourage you to visit our money market reform overview page on vanguard.com.
So from all of us here at Vanguard, we'd like to say thank you for joining us and we'll see you next time.
footnote*For the period 9/15/08 to 9/22/08, Vanguard Prime Money Market lost 1.47% of assets. For the week of the Lehman period, 9/15/08 to 9/19/08, Vanguard Prime Money Market lost 1.19% of assets. Source: Vanguard.
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