Barclays Abate on Swing Pricing
Barclays Joseph Abate writes on "Swinging NAVs" in his latest "Interest Rate Research." He tells us, "Last month, the SEC released a series of money fund reform proposals. The most significant was a swing price requirement for institutional prime funds. We review the proposal, its complications, and consider its effects on funding markets.... Money fund reform returned to regulators' policy agendas in the aftermath of the surge in prime fund redemptions in March 2020 that caused the CP market to freeze up. Over a 1m period, institutional balances in prime funds fell by nearly $130bn or more than 20%. Although they had different causes, the rush to redeem early was similar to that which followed the Lehman bankruptcy in September 2008.... This is despite two intervening rounds of reforms meant to prevent investor runs by shifting institutional prime funds to floating NAVs and imposing minimum overnight and weekly liquidity buffer requirements." The piece continues, "These reform proposals all share similar features, which reflects the fact that many of these ideas are modifications of past reforms or retreads of earlier, rejected approaches. There does not seem to be a strong consensus among the SEC commissioners about all of these reforms -- two of the five commissioners noted their opposition to swing pricing last month. But one of these opponents is resigning at the end of this month. Thus, although we think there is a strong chance that the next round of money fund reforms will include measures to reduce investors' propensity to run, it is not clear if this will take the form of swing pricing. The SEC laid out an expected timeline for its proposals. Once the rule becomes effective (perhaps by next summer), some of the rule changes will take immediate effect. Others, such as the minimum liquidity buffers and swing pricing, will be adopted after a transition period of 6m and 12m, respectively." Abate adds, "But while swing pricing would change investor behavior and reduce the propensity for investors to run, the mechanism depends critically on expert judgment made under difficult circumstances in which there is no (or very little) data. As proposed, swing pricing relies on liquid secondary market prices in order to calculate the market impact factor. Under normal conditions the assets that prime funds buy are typically purchased at a discount and held to maturity (at par). As a result, there is little secondary market liquidity for CP and wholesale time deposits. Secondary liquidity dries up in periods of market stress. This is compounded by the fact that the amounts the money funds hold and could wish to sell in a stress event far outstrip the balance sheet capacity of intermediating banks and dealers. As became apparent in March 2020, there may not be any bid for these assets. So how would a 'good faith estimate' of the market impact factor be determined, and could it be defended from angry investors seeking to redeem and faced with very steep NAV haircuts? The SEC acknowledges the difficulty involved in accurately determining market impact factors for swing pricing. As an alternative, it is also asking about using a dynamic liquidity fee framework. The liquidity fee would be similar to the swing price. Funds would be required to impose a fee on redemptions when they exceeded a pre-determined trigger threshold (such as 4% during a pricing period)."
