MIAMI - The Securities and Exchange Commission mandated a series of money market mutual fund reforms in 2010. These included requirements for the funds to hold certain amounts of cash at all times, restrictions on purchasing illiquid securities, shorter maturity times and requirements to invest in higher quality credits.
Then, Mary Schapiro pushed for more reform before she left office in December. Among her proposals, which she dropped in August: Restrictions on redemptions, capital buffers and, most controversially, allowing the net asset value of shares in such funds float from the $1 value that has been its bedrock promise to investors that the value of their capital will be preserved.
Now, the Financial Stability Oversight Council, a new regulator that tries to guard against risks to the nation’s financial economy, has taken up Schapiro’s light sabre. Among its recommendations, for which comments closed on January 18, are different forms of capital buffers as well as a floating net asset value.
"This is like the Star Wars trilogy. With the FSOC proposal, it's like the Empire Strikes Back,’’ says Tim Johnson, partner in the Financial Industry Group at Reed Smith, a fund industry law firm.
But don’t worry, Johnson said at the 2013 NICSA Annual Conference and Expo here.
"We all know the movie ends well. The trilogy ends well,’’ he said. “But there's a lot of blood and gore between the first movie and the happy ending."
Clearly the oversight council, led until recently by U.S. Treasury Secretary Timothy Geithner, is “taking chairman Schapiro's former lead on this subject."
The three options proposed by the FSOC, as summarized by the Harvard Law School include:
• Option One: Floating Net Asset Value. Under the first option, MMFs would be required to float the net asset value (NAV) and use mark-to-market valuation, like other mutual funds.
◦ This option would underscore for investors that MMFs are not guaranteed and that they could lose money. The daily price of MMFs would reflect gains and losses.
◦ In theory, by eliminating the potential of a fund to “break the buck,” the likelihood of a run on an MMF would be reduced.
• Option Two: Stable NAV with NAV Buffer and “Minimum Balance at Risk”. Under the second option, MMFs would keep the constant dollar NAV per share feature, but would tailor a capital buffer of up to one percent of fund assets, adjusted to reflect the fund’s risk characteristics. The capital buffer would absorb day-to-day variations in the fund’s NAV.
◦ The buffer would be paired with a requirement for a minimum balance at risk (“MBR”). The MBR would be three percent of an investor’s highest account value in excess of $100,000 during the previous 30 days. This amount would be held back for 30 days. Investors subject to the MBR requirement would be able to redeem up to 97 percent of their assets in the normal course of business.
◦ The holdback amount would take a so-called “first-loss” position and could be used to provide extra capital to an MMF that suffered losses greater than its capital buffer during that 30-day period.
◦ The capital buffer and its companion loss-absorption feature are designed to counteract the “first-mover advantage” that the regulators believe exacerbate an MMF’s vulnerability to runs.
◦ The MBR requirement would not apply to Treasury MMFs, nor would it apply to investors with account balances below $100,000.
• Option Three: Stable NAV with NAV Buffer and Other Measures. The third option would impose a risk-based NAV capital requirement of three percent, as well as other standards. Such standards would include more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements. The FSOC said that it would be open to a lower capital standard if it can be “adequately demonstrated” that diversification requirements (and possibly other standards) would reduce the vulnerabilities of MMFs.
If these reforms are followed, then a money market fund could become just a “very short duration bond fund,’’ according to Todd Cipperman, principal of compliance firm Cipperman & Company.
There are also questions about who will fund the reforms, since buffers increase cost and lower yield, in a low-interest-rate era with very narrow margins.
More broadly speaking, the question becomes: Is the reform even needed?
"One of the problems with money market reform is whether these are solutions in search of a problem,’’ Cipperman said. “I am not sure there is a problem.'
The push for additional reforms has followed the infamous “breaking of the buck” – the $1 a share promise – by the nation’s oldest money fund, the Reserve Primary Fund, in September 2008.
That led to a run on the funds, with the federal government guaranteeing assets held in the funds and bailing the industry out. Schapiro argued repeatedly that the federal government can’t afford another such bailout.
But "breaking the buck has not really been an industry problem,’’ Cipperman said.
Only one other money fund has ever broken the buck. That occurred in 1994, when the net asset value of a small fund in Denver fell to 96 cents.
The breaking of the buck at the Community Bankers U.S. Government Money Market Fund came when it had to liquidate a series of bad investments in derivative securities.
The breaking of the buck at the Reserve Primary Fund, 14 years later, came when its holdings in Lehman Brothers assets fell precipitously. That happened when the federal governemtn said it would not bail out that investment bank.
"Are these solutions going to hurt the industry more than help?,’’ asked Cipperman.
He suggested that the industry be required to bail itself out, when any run on funds happen in the future. But not to set aside capital before needed.