In Profile

A Conversation With Sue Ann Cormack

Prime Numbers

by PE Kelley

Mr. Kelley is managing editor of Advisor Magazine. Connect with him by e-mail:

As the SEC implemented new changes to money market fund rule 2a-7, the National Association of Insurance Companies was required to take action as to how those funds would be treated by insurers related to their capital charges.
With time, the funds were deemed by the NAIC to be treated the same way as originally designated (before MMF Reform).Sue Ann Cormack, Executive Vice President and Director of Sales, BNY Mellon Fixed Income, sat down with us to discuss some of the key issues surrounding these changes, including how the funds are treated following MMF reform and why prime funds are still a beneficial investment option for operating cash.

AdvMag: What was the genesis of the new changes to Rule 2a-7?
SAC:The new 2a-7 changes were an outgrowth of the 2008 liquidity crisis which, among other things, caused one money market fund to experience such heavy redemptions that it ‘broke the buck,’ as discussed below. In order to guard against the potential that a similar situation occurs in the future,

The Securities and Exchange Commission (SEC) adopted amendments to the rules that govern money market funds which went into effect October 2016. The rules are intended to strengthen the resiliency of money market funds during periods of severe market stress while maintaining the many benefits that money market funds provide to shareholders. The revised rules are designed to:

  • Increase transparency by making more information available on websites
  • Provide fund boards additional tools to manage redemptions during periods of extraordinary market stress.
  • Preserve the benefits of money market funds for investors such as principal stability, liquidity, and short-term yields.

AdvMag: On the heels of the 2008 crisis, what was the deemed ‘systemic risk’ that may have triggered a need for reform?
SAC: We do not believe any defined ‘systemic risk’ drove the need for reform; rather the changes appear to have been the outgrowth of the SEC’s judgment that it should further protect shareholders during periods of severe market stress.

AdvMag: How will a floating Net Asset Value impact the use of prime funds by insurance companies?
SAC: The initial response from the NAIC required them to remove the NAIC Class I rating for prime funds. That change automatically reclassified prime funds as a Class VI rating which created a punitive capital treatment for the product. After further discussion and detailed review, the NAIC notified the insurance constituents that the Risk Based Capital (RBC) charge would revert to the prior treatment (pre-MMF Reform) and be carried as a short-term investment.

On the reporting front, there are current discussions with the NAIC to move all MMF’s to a cash equivalent category, treating prime and government or treasury funds the same from an RBC perspective.

Separately, the floating NAV on prime funds is only part of what investors are reviewing as they go forward. In addition to the floating NAV, investors that elect to use prime funds must also get comfortable with the potential implementation of liquidity fees and redemption gates. As yield spreads widen and prime funds offer a higher return, insurers are taking a closer look to rationalize their investment choices.

Excessive liquidations in the Reserve Primary Fund because of the fund’s Lehman Brothers holdings caused its shadow NAV to vary so widely from $1.00 that it was no longer able to trade at that price

Fund transparency and reporting make it easier to see any movement in NAV and with time, investors are likely to employ a broader strategy that may include all types of MMF’s based upon their respective liquidity needs, comfort with each product, and the benefits of each. This may be supplemented with other short term investment solutions that are being reintroduced to the investors.

AdvMag: What is the effect of 2a-7 on both investors, seeking cash-management vehicles, and institutions (NAIC included), seeking short-term investment vehicles?
SAC: I believe the question is the effect of 2a-7 reform?  If so:
Since the liquidity crisis, institutional investors have put their cash to work in a prolonged low interest rate environment. With some treasury funds paying as little as .00 or .01% on cash, investors placed record amounts in these funds for the simple reason of conservatism and minimizing their exposure to risk.

As expected, alternate solutions surfaced, including the use of bank balance sheets, higher ECR (earnings credit paid by banks), and other short term securities, short term bond funds, and recently the reintroduction of private funds.

As reform went into effect in October, 2016 accompanied by the evolving bank regulatory landscape that tightened the availability of bank balance sheets, there was also an increase in rates from the Fed in December. The confluence of these events entices investors to engage in deeper dialogue about short term cash solutions, taking a closer look at the concept of tiering their cash (what must be liquid and what may be put to work for a slightly higher level of risk and potential return), and revisiting how the MMFs perform under the new regulatory framework.

The NAIC appears to be actively involved in understanding the breadth of these changes and spending additional time on ensuring their treatment of short term investments reflects that changing landscape.

AdvMag : We’ve read where the Reserve Fund ‘Broke the Buck’, and dipped below the $1 /share NAV? What does this mean and will a variable rate impact the use of prime funds going forward?
SAC: Pursuant to an SEC exemption, money market funds historically were able to value portfolio securities using the amortized cost method of valuation and the penny-rounding method of pricing. These tools allowed money market funds to strive to maintain a stable $1.00 per share even though, absent the exemption, the NAV  – sometimes referred to as the ‘shadow NAV’ – might have calculated to a number that was fractionally more or less than exactly $1.00. But the ability to maintain the stable $1.00 per share was only permissible so long as the fluctuation in the shadow NAV was minimal.

Excessive liquidations in the Reserve Primary Fund because of the fund’s Lehman Brothers holdings caused its shadow NAV to vary so widely from $1.00 that it was no longer able to trade at that price. Therefore, according to then-existing regulations, it was required to stop accepting trades and ultimately liquidates all its shares to shareholders at the shadow NAV, which – according to the SEC – was greater than 98 cents per share but less than the full dollar.

One of the 2a-7 changes the SEC enacted was a revocation of its exemption for prime money market funds, so they must now trade at their actual NAV, calculated to the fourth decimal. This means that between the required market valuation and the inability to use amortized cost methodology for calculating the fund’s NAV, investors have to ensure a thorough and current understanding of the value and opportunity cost of using prime MMFs. ◊