So it is coming down to this: a capital buffer or a floating net asset value.
Those are the two options that chairman Mary Schapiro said last week that the Securities and Exchange Commission is considering for its next, and most fundamental, reform of how money market funds operate.
"Notwithstanding their generally strong record, there is a lingering concern about how money market funds will stand up in a significant financial crisis or whether a particular money market fund holding unexpectedly could default, making matters worse,'' Schapiro told professionals gathered in New York for the annual meeting of the Securities Industry and Financial Markets Association. "There still is concern that a money market fund portfolio manager simply could make a mistake'' that could cause a run.
And leave the industry without a means for avoiding another calamity such as occurred in September 2008, when the Reserve Primary Fund-the nation's oldest money market fund-famously "broke the buck."
Having invested heavily in Lehman Brothers assets, the fund found that it could not maintain a stable $1 value on the shares in its fund.
That promise is the bedrock of money market funds-the feature that makes it appear to investors to be more like a cash savings or checking account, than an investment.
SEC rules permit money market funds to use amortized cost accounting in order to maintain that stable net asset value.
And the idea that these were the same as "liquid cash accounts,'' as Schapiro put it, led investors to put $4 trillion into them.
But when the Reserve Primary Fund "broke the buck,"' there was a run on funds. More than $300 billion was pulled out. Some funds lost a third of their assets, in one week.
Temporary federal measures guaranteed balances at their state on September 19. The SEC subsequently tightened credit quality standards, shortened weighted average maturities and for the first time imposed a liquidity requirement on money market funds.
But that was just the start. Now comes the decision, or at least the proposal, on how to "fix" money market funds, long-term. To prevent a recurrence of the Reserve collapse, where the U.S. government actually stepped in and provided reserve funds to Reserve shareholders, the Investment Company Institute in January proposed the creation of an industry-funded Liquidity Facility, for a future emergency.
But exchange-traded fund giant BlackRock and mutual fund paragon Fidelity Investments want funds to stand on their own.
BlackRock proposed that fund managers be set up as "special purpose entities" and regulated in a way that ensures they set aside funds that prevent runs. Fidelity recommended that every fund be required to retain a portion of its income to build a reserve against potential losses.
The ICI's Liquidity Facility, which was to be funded by fees coming out of plan sponsors' pockets, appears to have been moved to a back burner.
"Any reforms must preserve the utility of money market funds for investors and avoid imposing costs that would make large numbers of advisers unwilling or unable to continue to sponsor these funds,'' said ICI President and Chief Executive Paul Schott Stevens.
The institute, he said, "remains open to ideas to strengthen money market funds further.''
A floating net asset value is a non-starter in the view of many large financial firms, including BlackRock, best known for its exchange-traded funds.
"A floating NAV is not acceptable to investors, and the demise of money market funds as we now know them is likely to cause unintended consequences,'' BlackRock contends. "Institutional and retail investors strongly prefer a stable NAV. If a stable NAV is not available in money market funds, investors are likely to look elsewhere for a comparable vehicle, in either bank deposits or non-registered investment vehicles.''
One alternative BlackRock suggests is an "NAV buffer" that would siphon "a small amount of income from the portfolio to be set aside" as a cushion.
The assumption, the global investment management firm said, is that a uniform "fee" would be set by regulators. The buffer capital would be regarded as an asset of the portfolio and, as such, calculated into the net asset value.
The siphon would be turned on and off depending on the size of the buffer relative to a pre-determined minimum capital requirement.
That would mean the portfolio would stop retaining income when the target buffer is reached. Shareholders of the fund would "own" the buffer. The plan sponsor would have no "skin in the game."
Alternately, the kind of "special purpose entity" that BlackRock has proposed would provide a guarantee to the fund that the fund sponsor would "top up" the net asset value to $1 whenever the fund's fair value drops below 99.5 cents.
The capital for this could come from the fund sponsor, (a fee imposed on the portfolio, third parties or some combination of these).
Fidelity believes that a floating net asset value would create, rather than reduce, risk in the short-term markets.
The mutual fund giant says its experience "with enhanced cash and other short-term bond funds" indicates that a fluctuating value does not prevent large shareholder redemptions. In fact, the firm says it believes " that a floating NAV mandate will lead to significant redemptions in money market mutual funds. This would destabilize a key part of the financial markets."
Fidelity has proposed a "mandatory reserve" that would be funded by a holdback of a portion of a fund's income. The holdback would be disclosed in the money market fund's prospectus, as either a shareholder "charge" or "fee.''
Each fund's reserve would be used to protect shareholders of the fund in the event of an unrealized or realized loss in that fund.
Fidelity said its modeling has shown that a fund with such a buffer could withstand significant redemptions and market losses and still maintain a net asset value above $1.00.
"Forcing money market funds to float their NAVs is draconian-and would end money market funds as we know them,'' Schapiro acknowledged. "They would look like any other mutual fund, although with very short-term, high-quality portfolio holdings.''
Plus, while "floating NAVs would reinforce what money market funds are-an investment-and what they are not-a guaranteed product,'' Schapiro said it would be hard to steer the industry and its investors from stable NAVs to floating NAVs.