This SEC Move Won't Kill Your Money Market Fund

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Millions of investors use money market funds as a savings-account alternative, relying on their shares to hold their value and produce at least modest income. But ever since the financial crisis, the Securities and Exchange Commission has looked at money market funds as a potential systemic risk, and yesterday, the SEC finally took action that it hopes will shore up their stability.

Although many commentators believe that the stricter regulations on money market funds will make them useless, the particular focus those regulations took should limit their impact for most retail investors. Let's take a closer look at exactly how the SEC decided to handle the risks involved in the money market fund industry.

What the SEC did
Yesterday's ruling approved two proposals that can either stand alone or work in concert. One rule would end the long-standing tradition of having money market fund net asset values fixed at $1 per share, instead allowing the share price to float up or down the same way that stock and bond mutual fund prices do. The other proposal would allow funds to charge exit fees or temporarily stop investors from selling their shares for up to 30 days during times of market stress that affect the liquidity of fund assets.

The key to the proposals, however, is that they don't affect all money market funds. In particular, the floating-share-price proposal wouldn't apply to "retail" money market funds, defined as funds that limit daily shareholder redemptions to $1 million or less. In addition, even institutional funds designed for big institutional investors with large liquidity needs would be exempt if they concentrated on government securities rather than commercial paper and other less financially secure debt. Similarly, the proposal on exit fees and temporary sales restrictions wouldn't apply to government-focused funds, although the SEC didn't include a retail-fund exclusion.

Did the SEC just make money market funds useless?
Both of these proposals have been in the works for years, and they've drawn considerable debate in past iterations. The retail-investor exemption to floating share prices directly addressed concerns that fund giant Fidelity expressed last year that if money market fund prices were allowed to float, more than half of its customers would move some or all of their assets.

Yet as much as the SEC has focused on the funds that average investors use, retail money market funds have been out of favor for years, because of the Federal Reserve's low interest rate policy. Fidelity, Charles Schwab (NYSE: SCHW  ) , and Vanguard have had to subsidize their money market funds, accepting fee reductions in order to keep their net income from going negative. Moreover, Schwab, TD AMERITRADE  (NASDAQ: AMTD  ) , and E*TRADE Financial (NASDAQ: ETFC  ) have all established brokerage sweep-account options that tie to FDIC-insured bank accounts at their banking subsidiaries, essentially urging their customers to avoid money market funds entirely and helping them avoid some of the hit to their earnings that subsidizing those funds would entail.

Most important, institutional investors don't have the alternatives that retail investors have with their cash. For years, high-yield savings accounts have offered average investors much higher rates on their savings, with accounts still available that pay as much as 1% while offering full FDIC protection. For Barclays (NYSE: BCS  ) , General Electric's (NYSE: GE  ) GE Capital division, and other banks offering high-yield accounts, paying an above-market rate for savings gives them access to capital that they otherwise wouldn't be able to attract. Moreover, by running their high-yield banking operations largely over the Internet, these institutions are able to make use of the banking infrastructure they already have in place while benefiting from the lower costs of Internet banking.

But with FDIC maximums and other restrictions, those accounts aren't generally available to institutional investors, who have to settle for the much lower yields on Treasuries and commercial paper. As a result, imposing restrictions on institutionally focused funds likely won't dissuade institutions from using them, if only because their other options are limited.

Much ado about nothing
In the end, individual investors shouldn't be too concerned about whether money market funds survive in their current form, because they haven't been a competitive savings option for years. By limiting the impact of its floating-price proposal to big institutions, the SEC has implicitly recognized the need to allow money market funds to keep their most attractive feature for retail investors in order to give them a chance to continue to exist. In the meantime, investors and fund companies alike can only wait and hope that rising short-term interest rates will eventually make money market funds a meaningful investment again.

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