This is the third 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 illustrates how the proposal would operate when market impact factors are not required. Readers should refer to the first post for an explanation of the proposed swing pricing process and the second post for an explanation of how a swing price should be calculated.
The Institutional Fund
For purposes of illustration, assume an institutional money fund with net assets of $600 million and 600 million shares outstanding, which results in a net asset value per share (“NAV”) of exactly $1.0000. The fund prices its shares at 9 a.m., noon and 3 p.m., so it has three pricing periods. This results in a market impact threshold for each pricing period of 1 and ⅓% of the fund’s net assets, which is $8 million.
First Pricing Period
At 9 a.m., the fund has redemptions of $9 million and subscriptions of $3 million, producing net redemptions of $6 million. Under the proposal, this would require the fund to—
Apply [a] swing factor that includes spread costs (if the fund uses midmarket pricing) and other transaction costs of selling a vertical slice of the fund’s portfolio.”
The vertical slice must have a value equal to the amount of the net redemptions. No market impact factor is required because the net redemptions are less than the market impact threshold of $8 million.
The Swing Factor Formula
As explained in my second post, the swing factor is a percentage by which the NAV is reduced to determine the swing price. This can be expressed as:
Swing Price = NAV x (1 ‒ Swing Factor).
The swing factor is based on the estimated spread and other transaction costs of selling the vertical slice of the portfolio. The swing factor should be calculated using the following formula:
Swing Factor = Estimated Costs ÷ (Net Redemptions + Estimated Costs).
The blog editor doesn’t do equations, so, for the mathematically inclined, here is a link to the derivation of the swing factor formula.
To illustrate spread cost, assume that one of the fund’s holdings is a 2.125% Treasury Note maturing December 31, 2022, in the face amount of $30 million. According to the Wall Street Journal, the current bid price for this note is $101.070 and the asked price is $101.074. (Prices are quoted per $100 face amount of the note.) The fund values the note at its “mid” price of $101.072.
The net redemptions are 1% of the fund’s net assets, so the vertical slice would be 1% of every portfolio investment. One percent of the Treasury Note would have a face amount of $300,000. At the mid price, this face amount would have a market value of $300,213.86. If the fund sold this face amount at the bid price, it would receive $300,207.92, which is $5.94 less. This $5.94 represents the spread cost.
Calculation of the Swing Price
If the spread cost of this Treasury Note, which is just under 0.2 basis points, was representative of the spread cost for the rest of the vertical slice, then the swing price would remain $1.000 when rounded to the fourth digit. The estimated costs would have to exceed $300 before the swing factor would exceed half a basis point, which would cause the NAV to round down to $0.9999.
Therefore, assume that the estimated costs of selling the vertical slice are $301. The resulting swing factor would be:
$301 ÷ ($6,000,000 + $301) = $301 ÷ $6,000,301 = 0.00501642%.
Reducing the $1.0000 NAV by this percentage results in a swing price of $0.99994, which rounds down to $0.9999.
One Price per Pricing Period
One critical aspect of the swing pricing proposal is that the swing price—
would apply to redeemers and subscribers alike. Thus, adjusting the NAV down when a fund is faced with net redemptions charges redeemers for the liquidity costs of their redemptions, but also allows subscribers to buy into the fund at the lower, adjusted NAV.
We will discuss the implications of this in another post.
Given that the swing price would be used for both subscriptions and redemptions, the following table shows what the subscriptions and redemptions would be at the NAV and at the swing price. The differences represent the impact of the swing price.
|Dollar Amount||Shares @ NAV||Shares @ Swing Price||Impact of Swing Price on Shares|
My next post will discuss the effect of this swing price on the next pricing period.