We are going to make a prediction: if new US money market fund reforms go through on variable NAVs, investor gates and capital reserves, then the 2a–7 money market fund structure that we know is dead for institutional investors.
In recent conversations and listening in to conference calls of 2a-7 fund managers, we are hearing a repeat of the same themes: BBB is the new AA; 2a-7 offers no yield; short-term repo supply is difficult to access; and there is too much cash chasing too few assets that meet the strict definitions of the 2a-7 fund structure.
We also hear more money fund managers talking with their clients about moving out of the 2a-7 legal structure to provide more flexibility. This isn’t proposing leaving 2a-7-like guidelines altogether, but allowing for example 10% of the portfolio to stretch beyond the 13 month limit or allowing a portion of assets to be in lower rated securities to garner some yield.
These conversations have led us to the conclusion that 2a-7 funds will be effectively dead for institutional investors if new reforms are put in place by the US SEC. With very low yields already, money managers suggesting alternatives, and genuinely unpleasant restrictions forecast for the future, there is no real reason why a corporate treasurer, pension plan or anyone else with a choice would keep their investments in a 2a-7 fund.
In securities lending with cash collateral, we think that a newly reformed 2a-7 structures will be pretty much untenable. Investors will not care to have gates on their withdrawals if they want to liquidate a securities lending portfolio on short notice. Variable NAV funds will cause some consternation but may be doable, especially if the US President’s Working Group on Financial Markets recommendation from 2010 is adopted that variable NAV funds can have $1 accounting. Yes, this is an oxymoron, but it is also a legal workaround. But given the trend towards separately managed accounts, we see no argument for why a beneficial owner would want the restrictions of a legal 2a-7 fund when it could move into a separate account that follows mostly 2a-7 rules without the bigger obstacles.
As to whether a demise of the 2a-7 structure for institutions is a good or bad idea, we can see it both ways. However, there doesn’t appear to be a middle ground option on the table. Regulators want to reduce any potential for systematic risk, but in doing so they are pushing money out of the regulated system into separately managed accounts that will take on the same types of investments. Regulators could hypothetically force all investors to use 2a-7 funds thereby constraining the market further (and this has been discussed for securities lending cash collateral), but that would be an extreme step. We don’t see it happening quite yet.
For our part, we won’t miss 2a-7 funds. We think that the last round of US money market reforms reduced yields, opportunities and investment choices sufficiently that their reputations have suffered along with their returns. Separately managed accounts with 2a-7-like guidelines offer the right degrees of flexibility and, where risk-managed appropriately, a better opportunity for some yield.