Here’s what new money-market rules mean
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After two years of preparations, new rules aimed at preventing a 2008-style stampedeout of money-market funds took effect Friday after sending ripples through financial markets and forcing businesses to adjust their money management techniques.
For the most part, analysts don’t expect to see lasting disruptions. But there are some implications investors should remain aware of.
What’s changed?
Under the new rules, funds that invest in private-sector debt, such as commercial paper or certificates of deposit, must let their share prices float. That is a forced break from the prevailing practice of fixing share prices at $1.
The Securities and Exchange Commission contends the increased transparency will prompt investors to adjust holdings in response to changing asset values. The ultimate aim is to avoid a repeat of the mass exit from such money-market funds should they suddenly find out their shares are worth less than a buck. Only one fund “broke the buck” in the mayhem that followed the collapse of Lehman Brothers in 2008, but the subsequent panic deprives the money market of liquidity and amplified the crisis.
The new rules also require such funds to adopt gates and fees that would slow redemptions during rough patches.
Libor
As a result, investors have pulled money out of such funds and plowed them back into funds focused on government and government agency debt, which don’t have the same restrictions. Bloomberg estimated that around $1 trillion worth of assets have been shifted from prime money-market funds into government money-market funds.
Since the affected prime money-market funds are big buyers of short-term commercial debt, the outflows have led to higher funding costs for interbank loans and municipal-debt markets.
Libor—the London interbank offered rate, a measure of the cost for banks to borrow from each other in dollars that also serves as a benchmark reference rate for trillions of dollars in private-sector debt—rose sharply as money managers prepared for the rule change, hitting levels unseen since the 2008-09 financial crisis.
Since the rise has more to do with the new rules than with a reluctance by banks to lend to each other, investors haven’t been freaking out about it. But it has, nevertheless, served to tighten financial conditions in the U.S., as well as for banks abroad when it comes to dollar funding. Indeed, some observers have argued that the tighter conditions give the Federal Reserve another excuse to hold off raising rates.
Bank profitability
The pinch, overall, hasn’t been all that painful. Ratings firm Standard & Poor’s this week said rising dollar-funding costs might put more strains on net-interest margins for banks in some countries as they struggle with low or even negative interest rates in their domestic markets.
But S&P sees little scope for a shortage in dollar funding for banks in the U.S., Europe, Japan and Australia because their exposure to U.S. money-market funds have shrunk over the past few years. The impact is also mitigated by the fact banks are less reliant on short-term wholesale funding thanks to tighter regulations on liquidity requirements. Growing reliance on alternative funding sources and a global flood of liquidity from major central banks are also helping to cushion the blow, S&P said.
What next
It might take a while for outflows to fully calm down, “but the bulk of the adjustment appears to be behind us,” wrote analysts at Commerzbank in a Friday note. They observed that the spread between Libor and the overnight interest swap, a closely watched gauge of interbank-lending conditions, has “already stabilized on levels which we consider reasonable,” given widespread expectations for a Fed rate rise in December (see chart above).
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