The Securities and Exchange Commission (SEC) today proposed rules that would reduce risk in the money-market mutual fund.

SEC US SecuritiesAndExchange Commission Seal

  The SEC’s two proposals have been voted unanimously 5-0 that would reduce risk of abrupt withdrawals in the $2.6 trillion money market mutual fund industry.

The two proposals from the SEC are alternative in nature that could be adopted alone or in combination.

One of the SEC’s proposals involves requiring a floating net asset value for prime institutional money market funds.

SEC Proposals only for Prime Money Funds

The second proposal from SEC relates to permitting the money market mutual funds the facility of using liquidity fees and redemption gates during times of stress.

Prime money funds are seen as the most vulnerable as they were the source of investor runs during the height of the 2008 financial crisis. Over $300 billion or 15 percent of prime-fund assets fled the mutual funds in the week during September 2008, after the collapse of Lehman Brothers Holdings Inc.

The SEC started evaluating the need for money market fund reform after the Reserve Primary Fund, one of the largest money funds, suffered losses on  Lehman Brothers Holdings Inc. (OTCMKTS:LEHMQ) debt and could not maintain its $1 per share price, popularly called  ‘breaking the buck’ at the height of financial crisis in September 2008.

In recent years, concerns about money funds have increased as regulators started worrying about a sudden jump in interest rates. Such a rise could depress the value of the funds’ asset holdings. The Financial Stability Oversight Council, for a third year running, referred to money funds as a source of systemic risk.

The SEC said that the floating net asset value will not be applicable to retail and government funds, which are considered less risky. Retail funds limit shareholder redemptions to $1 million per day.

The SEC’s second proposal on ‘liquidity fees and redemption gates’ would facilitate funds the power to stop an outflow of investor money.

The fund industry feared a move to a floating net asset value (NAV) could impose potential accounting and tax burdens on the investors. However the SEC officials indicated that they expect Internal Revenue Service would agree to permit investors in funds with a floating NAV to only be required to report once a year.

The SEC’s proposal, however, doesn’t include recommendations made by Financial Stability Oversight Council last year, including requiring money funds to hold capital against potential losses.

Implementation Timeline

Citi in its today’s report titled ‘Short Duration Strategy’ feels the SEC’s proposals are unlikely to be approved before the first quarter of 2014. Besides the final compliance requirement dates are expected to be staggered, with the compliance dates for more stringent options such as floating NAV, could even be early 2015.

The SEC’s proposals would be put out for 90 days for public comment.