This is the fourth in my series of posts analyzing the SEC’s recent proposal to require money market funds with floating share prices (“institutional money funds”) to implement “swing pricing” for pricing periods in which the fund has net redemptions. This post continues the example from the previous post to illustrate how the proposal would address net redemptions exceeding the market impact threshold.
The previous post assumed an institutional money fund with net assets of $600 million and 600 million shares outstanding. The fund prices its shares three times each business day, so it has three pricing periods. The market impact threshold for each pricing period would be 1 and ⅓% of the fund’s net assets.
One of the fund’s holdings is a 2.125% Treasury Note maturing December 31, 2022, with a face amount of $30 million. The current bid price for this note is $101.070 and the asked price is $101.074. (Prices are quoted per $100 face amount.) The fund uses the “mid” price ($101.072) to value the note.
Results of the First Pricing Period
During the first pricing period the fund paid redemptions of $9 million and received subscriptions of $3 million. This reduced the fund’s net assets from $600 to $594 million.
The net redemptions required the fund to calculate a swing price for this pricing period. I assumed the estimated costs of selling a $6 million vertical slice of the portfolio would be $301, which resulted in a swing price that rounded down to $0.9999. As explained in the prior post, this price would be used for both subscriptions and redemptions, so the fund issued 3,000,300.03 shares to subscribing shareholders and redeemed 9,000,900.09 shares from redeeming shareholders. This reduced the outstanding shares to 593,999,399.94 shares.
Hence, the fund begins its second pricing period (from 9 a.m. to noon) with slightly more net assets than shares outstanding. The swing price in the first pricing period has increased the fund’s net asset value per share (“NAV”) slightly, although the NAV is still $1.0000 when rounded to the fourth digit.
Second Pricing Period
The decrease in the fund’s net assets also produces a decrease in the market impact threshold for the second pricing period, from $8,000,000 to roughly $7,920,000. To illustrate the application of market impact factors, assume that at the end of the second pricing period there are redemptions of $10 million and subscriptions of $1 million. The resulting net redemptions of $9 million exceed the market impact threshold, so the fund must—
Apply [a] swing factor that includes spread costs (if the fund uses midmarket pricing), other transaction costs, and market impact factor of selling a vertical slice of the fund’s portfolio.”
The vertical slice for the second pricing period would be $9 million, rather than $6 million for the first pricing period. For simplicity’s sake, assume that the spread costs and other transaction costs increase proportionately, from $301 to $451.
A market impact factor is an estimate of the reduction (if any) in the bid price for a security that may result from selling the vertical slice under current market conditions. The fund must establish a market impact factor for each security, although it may use the same market impact factor “for each type of security with the same or substantially similar characteristics.”
Market Impact Factor for the Treasury Note
The proposing release states that:
it would be reasonable to apply a market impact factor of zero to the fund’s daily and weekly liquid assets … (e.g., because the assets are maturing shortly).”
The Treasury Note would be a daily liquid asset even though it would not mature for a year. Would zero still be a reasonable market impact factor for this note? The release requests comments on this question.
Zero might be a reasonable market impact factor in any case, given that the fund would be selling a face amount of $450,000 into a market (for Treasury coupon notes with less than two years to maturity) with a monthly trading volume in excess of $50 billion.
Estimating Market Impact Factors
To continue the illustration, I need other securities in the vertical slice to have market impact factors. While preparing these posts I noted that, when yields increased rapidly in mid-January, the spread on the Treasury Note increased from 0.4 to 0.6 basis points, a 50% increase. This might be an example of a “market impact,” so I will assume that the market impact factors increase the estimated cost of selling the vertical slice by 50%, from $451 to (using a round number) $675.
Plugging $675 into the swing factor formula produces a swing factor of:
$675 ÷ ($675 + $9,000,000) = $675 ÷ $9,000,675 = 0.00749944%.
Applying this swing factor to the $1.000 NAV produces a swing price of $0.999925, which rounds down to $0.9999.
Results of the Second Pricing Period
Given a swing price of $0.9999, the following table shows the impact on shares issued and redeemed during the second pricing period.
|Dollar Amount||Shares @ NAV||Shares @ Swing Price||Impact of Swing Price|
My next post will bring the fund’s day to a close and consider the overall impact of these swing prices.