A private liquidity facility to provide emergency relief in a crisis to prime money market funds. Permission to float net asset values, instead of fixing them at $1 a share. A two-tier system of floating rate and stable net asset values. Mandatory redemption of shares in "in-kind" distributions of shares, rather than cash. Regulating money market funds as special-purpose banks.
These are just some of the changes that could be in store for money market funds, as the $2.8 trillion industry revamps operations in the wake of the global credit crisis and the Dodd-Frank Wall Street Reform Act. And implementing them won't be easy.
These options were contained in a paper issued this month by the Investment Company Institute, the trade association representing mutual funds. The viewpoints of the ICI, and many of its members, were presented to the Securities and Exchange Commission, which has to carry out facets of the reform act. Comments on the President's Working Group Report on Money Market Fund Reform were due by Jan. 10.
The recommendations of the working group, which consists of the heads of the SEC, Treasury Department, Federal Reserve and the Commodity Futures Trading Commission, are designed to prevent a repeat of the 2008 crisis when, in industry terms, the buck got broken. That's not supposed to happen in the safest of investments, akin to savings accounts.
On Sept. 17, 2008, a record $140 billion was pulled out of money-market accounts and the Reserve Primary Fund saw its value fall below $1 a share because of its investments in Lehman Brothers short-term debt. The Treasury Department responded with a guarantee program to ensure that certain losses incurred by fund shareholders would be covered. The Federal Reserve also rolled out two programs to buy commercial paper to provide liquidity but the Dodd-Frank legislation has made it more difficult for the Fed to make similar bailouts.
Of all the ideas on the table, implementing the private liquidity facility for prime money-market funds appears to be the most favored by money market fund operators in large part because it's the least operationally challenging; it's supported by JP Morgan Chase; Federated Investors and Vanguard Group, three of the six largest money fund providers.
Under ICI's plan, all prime money market funds-those that invest in high-quality, short-term money market instruments, including commercial paper-would be legally required to participate in the liquidity facility which would step in and buy high-quality, short-term holdings from the funds so they could cash out investors.
The liquidity facility would be structured as a state-chartered bank or trust company regulated by state banking authorities and the Federal Reserve. The facility would start off with $350 million in assets and grow to about $24 billion in 10 years.
In its letter to the SEC, the ICI said the liquidity facility would need to hire a "custodian or issuance agent" to safe keep the facility's assets, and manage cash movements involved in settling trades between the fund and its participants. The liquidity fund would likely need to receive information from the money market fund in question and buy the necessary assets on the same day. That means standardizing data formats and creating electronic links between the liquidity fund and each participating money market fund or creating some type of messaging hub, say money market fund experts.
Those experts believe that adopting a daily floating rate NAV and mandatory in-kind redemptions-giving securities instead of cash payment, when liquidating funds-will be either operationally challenging because of changes needed to back-office systems or downright impossible to achieve.
For instance, money market funds wouldn't be able to transfer ownership of some securities in the fund to investors and other types of financial instruments-such as commercial paper-cannot be divided among many investors. Even securities which can be divided would require shareholders to establish brokerage or custody accounts in advance and pay ongoing fees for those accounts.
The latest proposals from the President's Working Group represent the second phase of money market reform. Money market funds will be required in October 2011 to comply with amendments to SEC's Rule 2a7 that require funds to be able to process a floating rate net asset value. But that requirement only applies if a fund breaks a buck. What the President's Working Group has suggested-and the money market funds industry opposes-is requiring funds to always use a floating net asset value.
"Money market funds have so far been calculating their net asset values at amortized cost-a type of accounting methodology designed to facilitate maintaining a stable $1 NAV," said Timothy Levin, a partner with Morgan Lewis & Bockius in Philadelphia.
Changing to a floating NAV means that money market fund operators will have to switch to value assets daily, with new mark-to-market assessments. "A floating rate NAV would require fund managers or third-party service providers to make coding changes to their portfolio accounting and transfer agency systems, which are pegged to a fixed $1 NAV," said Joseph Rezabek, managing director for North American mutual fund administration at Citigroup. He noted that Citi can provide its money market fund clients with a floating rate NAV because it has integrated its portfolio accounting, custody and transfer agency platforms to allow for the correct valuation to be synchronized among systems.
A recommendation made only by the ICI-and endorsed by many money market funds-to require broker-dealers and banks to cough up information about investors in money market funds could also prove operationally challenging for both fund managers and the financial intermediaries. Because institutional clients often buy money market funds through electronic portals and omnibus accounts, the money market fund operator doesn't know the identity of the ultimate investor.
Jack Murphy, a partner at the law firm of Dechert LLP, in Washington DC, said broker-dealers might be able to divulge certain key characteristics, such as the size of the investors' accounts, their cash flows and redemption activity without needing to identify particular clients.
"Broker-dealers will have to keep track of the information and update it on a periodic basis while fund managers would need to store the data," he explained. "Both sides would also have to agree on a standardized data formats for providing the information."