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Money markets are undergoing huge changes. Here's why it matters

The rules allow funds to block investors from pulling cash during times of high volatility.

A large portion of the financial markets, and one that played a pivotal role during the financial crisis, is about to undergo substantial changes.

At the core of the rules is an effort to stabilize the $2.7 trillion industry, which provides a generally safe climate where both retail and institutional investors can park funds and earn modest returns with the bonus that they will never lose money.

For a brief moment in time, that compact was broken.

In 2008, as the financial world crumbled under the weight of the financial crisis that took down Wall Street and threatened to crush the global economy, one fund did the unthinkable: It "broke the buck." That means its share price fell below $1 due to heavy losses it experienced from the collapse of Lehman Brothers. The move by the Reserve Primary Fund set off a wave of panic over possible redemptions and the implosion of a sector that at the time boasted nearly $3.5 trillion in assets.

The new rules seek to prevent a similar occurrence in the future. They allow all funds to block investors — using what are known as "gates" — from withdrawing cash during times of market volatility, a move that coincides with a mandate that retail and government funds maintain a $1 share price. The rules allow prime institutional funds to move to a floating value, meaning they have the possibility both for greater return and greater risk.

"Essentially, the rules are intended to make sure that we don't have a run out of the funds, to protect investors," said Blaine Aikin, executive chairman at fi360, which provides information and training to financial services providers.

Electronic display financial prices
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The new rules come from the Securities and Exchange Commission, which adopted them in 2014 and gave money market fund managers until Oct. 14 this year to implement.

One immediate effect they are having is driving more investor money to government funds, which provide more stability but less opportunity for return given that their asset value is anchored. Fidelity, which manages $2.1 trillion, has transitioned three of its biggest money market funds to government funds, and other big managers have done the same.

Vanguard, which manages $3.6 trillion, also is preparing its clients for the new rules.

"We believe that these changes, along with the safeguards implemented in 2010, constitute a strong response to concerns that institutional money market funds may pose a risk to the financial system," Vanguard said in a statement.

Government fund assets passed institutional funds in May for the first time ever, one of the more significant shifts as the industry prepares for a new frontier. The institutional side has lost more than 25 percent of its total assets since mid-April. (Fund assets overall have stayed relatively steady over the past four years or so after peaking near $4 trillion during the crisis.)

"The SEC gave the industry two years, and it's going to take two years to get through this," said Jane Heinrichs, associate general counsel at the Investment Company Institute, an industry service provider whose members manage $17.9 trillion. "The transition has been smooth, but not without difficulties and not without costs. But we're going to get there."

Aikin is telling financial advisor clients at fi360 to follow a four-point plan: Do your homework about the plans; perform due diligence to consider and compare the plans; document whatever funds are used and why; and monitor fund performance on an ongoing basis.

"There has been some complacency associated with the long time period where these things have been percolating," Aikin said. "These rules do have some fairly profound ramifications for fiduciaries."