When Yields Go Negative: Three Options for U.S. Money Market Funds

Custody - It's Time For an Upgrade

When Yields Go Negative: Three Options for U.S. Money Market Funds

April 2020

By Peter Tenggren

As we saw in 2008, negative yields ripple throughout the financial ecosystem, often in unexpected ways. That is why BNY Mellon Subaccounting and Transfer Agency (TA) Services engaged with a full spectrum of stakeholders to ready our platform for a negative yield environment—including asset managers, service providers, intermediaries, regulators, and industry associations such as ICI, NICSA, and SIFMA. We incorporated their perspectives in developing three alternative approaches for recognizing the impact of negative yields on U.S. money market funds. The first two strategies are ready to implement, while the third requires additional discussions and regulatory approval.

  1. Reverse Stock Splits (RSS) for institutional prime funds. This strategy entails a one-time reverse stock split to $10.000 or $100.0000 per share—that is, a price high enough to keep the new NAV out of “penny stock” territory. A single large split is less complex and risk-prone than repeated daily splits. In a transfer agency environment, the RSS would be processed as a major corporate actions event, presumably run over a weekend to minimize downstream impact on intermediary partners. An RSS may not be available for government or Treasury funds, but may still be a viable option for large prime funds, depending on how market conditions unfold.
  2. Float the Net Asset Value (FNAV) for government and Treasury funds. This approach allows negative yields to be absorbed by the NAV. It requires switching government and Treasury funds from constant NAV (CNAV) to FNAV, as well as calculating NAV out to four decimal places instead of two in order to capture the resulting price movements. Current “hourly” settlement would be delayed until after the FNAV has been struck. This strategy is the smoothest and easiest to implement from both Subaccounting and transfer agency perspectives, since it leverages capabilities already developed for prime funds as part of money market reform. However, it can have a significant downstream impact, especially on intermediaries who use sweep processing to manage their clients’ investible cash. These firms want to retain a dollar share price with two decimal places to follow. In addition, FNAV may not be the most transparent option for affected investors.
  3. Reverse Distribution Mechanism (RDM) to hold a stable $1.00 value. RDM is essentially the mirror image of dividend reinvestment. Instead of using dividends to purchase additional shares, RDM covers negative yields by canceling shares. Each day, fund accounting provides the transfer agent with a negative accrual factor it can use to calculate daily share redemption and process a nightly RDM cycle. There’s no need to settle with Custody, and no impact on the hourly settlement of government/Treasury funds. The key advantage of RDM is that it enables funds to maintain a $1.00 share price, making it the least disruptive option for intermediaries who use money market funds to handle sweeps and redemptions. It’s also the most transparent alternative for investors. However, RDM is no longer available in the EU due to regulatory changes. It also awaits clarification from the SEC, which has asked the industry to estimate the impact of each of these approaches. In addition, the IRS will need to weigh in on tax implications.

Regardless of the method fund managers choose, they will need to manage outflows if yields turn negative. Our technology team recently re-tested our ability to implement gates and fees, confirming that our recordkeeping systems can support these important capabilities.

 

All three strategies are drawn from extensive conversations with our peers and partners—but those conversations are not over yet. The situation remains fluid as all stakeholders await regulatory guidance, market developments, and industry consensus. That’s why BNY Mellon will continue to engage with regulators, industry groups, external accounting partners and especially our clients to ensure a smoother road through a bumpy landscape.


 

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