Changing Rule 2a-7 and the Risk Profiles of Money Market Mutual Funds
15 Pages Posted: 1 Jul 2016
Date Written: 2015
Rule 2a-7 defines the quality, maturity and diversity of investments allowed in money market fund (MMF) portfolios. Following the financial crisis, the Securities and Exchange Commission (SEC) modified this rule to improve the liquidity and the credit quality (valuation) of MMFs. We analyze the portfolio compositions of 295 taxable MMFs to determine if liquidity and credit quality (valuation) were problems during the crisis and whether the changes to the earlier rule address the issues. We find that the problems in the MMF industry during the crisis stem principally from valuation issues and argue that the modifications to Rule 2a-7 are only a partial solution towards making MMFs more resilient to market disruptions. We propose a two-tier system based on asset classes, where Tier One would comprise traditional informationally-insensitive and transparent money market securities and Tier Two would allow less transparent, more risky qualifying securities.
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