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Bond markets: Shutting the liquidity gate

The increasing investment by short-term funds in longer-term assets is a liquidity mismatch that is attracting growing regulatory attention. This comes as little surprise given the damage wreaked by just such strategies at the beginning of the financial crisis in 2007.

Under the new SEC rules for money market funds that were passed in July, funds have the power to impose liquidity fees on redemptions and temporarily suspend, or gate, redemptions under periods of stress. The gates can last for up to 10 days and exit fees can be up to 2% of redeemed balances. Funds have two years to implement the new regulations.

Fraser Lundie, co-head of credit at Hermes Investment Management
 The threat of gating is enough to trigger a stampede early

Fraser Lundie

The new rules are targeted at the one third of the US money market industry that invests outside the government bond markets – a total of $890 billion in size.

The SEC also launched an investigation into alternative mutual funds in August, concerned about the growing popularity of liquid alternative funds, which have seen inflows of more than $17 billion so far this year.

Andrew Bowden, director of the SEC’s office of compliance inspections and examinations, raised concerns over the liquidity implications of these funds in March, stating: “The use of hard to value and/or illiquid securities in an open ended mutual fund, which requires daily valuation and offers daily liquidity, is fraught with risk.”

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