I was looking for something else on the Division of Investment Management’s (Division) website the other day and ran across a study of Prime MMFs’ Asset Composition and Asset Sales (the Study) released by its Analytics Office in June. Nothing indicates why the Study was prepared, but I hope it reflects an effort by the Division to better understand how prime institutional money market funds operate and the potential consequences of the proposal to require these funds to employ “swing pricing” whenever they have net redemptions. The Study supports my conclusion that this proposal would dilute redeeming shareholders rather than preventing dilution to remaining shareholders.

The Swing Pricing Proposal

In a nutshell, the U.S. Securities and Exchange Commission (SEC) has proposed amendments to Rule 2a-7 that would require an institutional money fund to implement a “swing price” whenever it calculates its share price for a period in which it had net redemptions (i.e., the number of shares redeemed exceeded the number issued for the period). The swing price must reduce the net asset value per share by the estimated costs the fund would incur if it sold a percentage of every portfolio security equal to the percentage of net redemptions. For example, if net redemptions were 1% of the outstanding shares, the net asset value would be reduced by the estimated cost of selling 1% of every portfolio security. If net redemptions exceed 4% divided by the number of times the fund prices its shares each day, then the swing price must also be reduced by the estimated market impact (if any) of selling the portfolio securities.

This post, and the subsequent series, has a more detailed explanation.

Study Confirms Funds Rarely Sell

The Study mostly concerns reestimating the extent of sales by prime institutional funds during the financial (and regulators’) panic in March 2020. I could not find a bottom line, but I think they conclude that sales to the Federal Reserve’s Money Market Mutual Fund Liquidity Facility were $49 billion rather than $53 billion. Also, the Investment Company Institute’s comment letter on the proposed amendments included an estimated $23 billion in sales from March 2 through March 18, which are apparently in addition to the sales included in the SEC’s earlier estimates.

More significantly, the Study reiterates that prime institutional funds disposed of investments before maturity at “a 4% monthly average during the period from October 2016 through February 2020.” The Study cites the proposing release as the source of this estimate, but the release does not explain how it was derived.

What makes this significant is that the SEC estimates that the swing pricing proposal would require, on average, three institutional funds to assume that they will dispose of 4% or more of their portfolio on each trading day, whereas their study estimates that prime institutional funds would typically dispose of 4% of their portfolios over the course of a month. As there are between 19 and 22 trading days in a month, the swing pricing proposal will regularly overestimate the costs of net redemptions by a factor of 20 or more.

Conclusion

“A swing price that ‘passes on’ estimated costs a fund never incurs will dilute shareholders redeeming at the swing price.” The Study appears to demonstrate that this will be the result of swing pricing by institutional money market funds if adopted as proposed.

I am reluctant to make work for our clients, but the SEC need not guess about the level of sales by prime institutional funds. All mutual funds must maintain records of their portfolio sales and the SEC can request these records for examination. A sweep request would provide actual data for the Division to examine and evaluate the swing pricing proposal, and may be less work than providing “better, more granular data about assets sales” in monthly Form N-MFP filings.