Money market funds

Despite the wholesale nature of the money markets entailing the transacting of large sums of money - usually £500,000 or $1,000,000 is the minimum transaction size - it is possible for private individuals with funds available for lending in thousands of pounds/euros/dollars rather than hundreds of thousands to participate in the money markets.

Corporations may also deposit money in money market funds to obtain good rates of interest through professional management of the fund. They also value being able to withdraw their money from the fund without the need to deal with the selling of the underlying securities in the secondary markets - in most cases investors in money market funds can gain access to their money within hours: ‘same-day' access. It is also possible to put in place a sweep facility so that money is automatically transferred from a bank account (paying little interest) if it exceeds a stated balance to a money market account (paying more interest) and vice versa - this can be done at the end of each day.

With much of the rest of the financial sector, money markets went through a crisis in 2008. A money market fund, Reserve Primary Fund, had invested a substantial proportion of its funds in Lehman Brothers' short-term debt. When Lehman Brothers went bust the fund was unable to return to investors the amount they had paid into it. This ‘breaking of the buck' is a great sin in the money market world - all money market funds are supposed to be incredibly safe. What made it worse was the subsequent freezing-up of credit markets: investors in funds could not withdraw their money at short notice as per the agreement. The market became illiquid because the money market funds could not find buyers for the securities they held and so could not raise cash at the moment when a high proportion of their investors clamoured to withdraw cash.

A proposal was floating around the corridors of power of the European Commission in 2014 to reform the rules for money market funds. In Europe there is over ˆ450 billion invested in constant net asset value (CNAV) or fixed-value money market funds which promise the return of a euro/dollar put in, while paying out the interest they receive from Treasury bills, etc. to investors. The variable net asset value (VNAV) money market sector is even larger. These funds fluctuate in value each day depending on the market value of the underlying investments; they may go below the initial ˆ1 value. The proposal is to force CNAV funds to hold 3% of their assets in cash as a buffer against ‘runs' by investors, so that those wanting their money returned quickly can have it without too much strain caused by funds having to sell securities in a hurry.

However, there were howls of protest that the loss of interest on 3% of the fund was too much to bear at a time when money market funds were struggling to make even a 0.1% return in a year for investors because interest rates were so low - see Article 1.1. In 2015 the politicians decided to abandon the 3% buffer rule. Instead they insist that most CNAV funds switch to a ‘low-volatility NAV', which means they can only hold money market instruments which mature within 90 days. The other 10% of CNAV are allowed to escape this rule if they are aimed purely at ‘retail' investors or if they invest 99.5% of their assets in government debt. (In the article, ‘AUM' is assets under management - the amount they are investing for others.)

In July 2014 the regulator in the US, the Securities and Exchange Commission (SEC), gained the power to force some CNAV funds to scrap their fixed $1-a-share price structure, permitting the fund to continue even if the under­lying money market investments, e.g. commercial paper, add up to less than $1 per share. This applies to funds invested in corporate debt and municipal (local authority) debt. Those that buy only federal government debt or are sold only to retail investors are exempt, so they stay as CNAV funds.