WASHINGTON The Securities and Exchange Commission's long-awaited proposal to reform the money market mutual fund industry has left observers wondering whether the agency compromised too much in an effort to get a plan out the door.
Former SEC Chairman Mary Schapiro tried and failed to move a proposal forward last year due to objections from other commissioners on the agency's board. Her successor, Mary Jo White, succeeded Wednesday by winning unanimous support for a new plan.
But some observers cast doubt on the effectiveness of the new proposal, arguing it did little to address the underlying fears that money market mutual funds are subject to runs and potential systemic panic.
"It was a good step that will not fundamentally change anything," said Joshua Siegel, managing principal of StoneCastle Partners. "It means better transparency, but as far as I can tell it won't change anything in the risk profile or the systematic liquidity problem. So we've come up with a solution that doesn't solve the problem."
The SEC's proposal, which will allow a 90-day public comment period, noticeably omitted mention of requiring funds to raise more capital to absorb potential losses an option that had been included in the earlier draft plan promoted by Schapiro last year as well as recommendations laid out by the Financial Stability Oversight Council.
Instead, the proposal Wednesday suggested two different alternatives. Under one approach, which had also been suggested by the FSOC, prime institutional money market funds could no longer use stable share prices to value their portfolios but rather would have to use a floating net asset value, according to a fact sheet distributed by the SEC. This step would result in fluctuating share prices to correspond with a changing market-based value of a fund's securities. Government and retail money market funds would be exempted from the requirement.
"It's been a journey to get to this point," SEC Chairman Mary Jo White said at the commission's public meeting. "Commission staff has spent literally years studying different reform alternatives and performing extensive economic analysis in arriving at today's recommendations. These proposals are important in and of themselves and because they advance the public debate that will shape the final rules to address one of the most prominent events arising from the financial crisis."
The second approach could still allow prime institutional funds to set stable share prices. But, instead, funds would be able to charge 2% liquidity fees on redemptions if a fund's liquid assets fell below 15% of its total assets. A fund's board could also, if it chose to, move to temporarily suspend redemptions to prevent runs during times of stress. The suspension known as a "gate" would need to be lifted within 30 days.
Some lauded the focus of the NAV component on institutional prime funds, and not on retail-focused and government funds, as a cautious first step.
"If you think there is a problem with money market mutual funds, it is with the prime institutional funds. This is probably where whatever risks there are in the market reside," said Oliver Ireland, a partner with Morrison Foerster. "It seems to me that that risk is a lot lower with government funds. The default risk is less so the likelihood of runs is a lot less. The likelihood of assets being dumped in the market as the result of retail funds is also a lot less than the likelihood of assets being dumped in the market as a result of the actions of wholesale funds."
But others countered that that targeted approach would overlook a substantial segment of the industry that still poses risks.
Based on the fact sheet, "the stronger 'floating NAV' option creates artificial distinctions between 'prime' and 'government' funds and between 'retail' and 'institutional' funds that leaves a number of money market funds, fund investors and the markets unprotected and at risk for destabilizing runs," said Sheila Bair, former chairman of the Federal Deposit Insurance Corp., who is now senior advisor to The Pew Charitable Trusts. "It also creates real incentives for gaming and arbitrage."
Bair said she was "concerned" that the proposal "falls short of what is necessary to protect taxpayers, mutual fund investors, and the stability of the financial system."
Yet commissioners made clear the proposal was just the start to their deliberations, and retail funds could still be affected by a final regulation. The fact sheet said the agency will consider whether the two proposed options the floating NAV and so-called "fees and gates" will eventually be combined in the regulation adopted by the SEC, or whether the agency chooses just one of the reforms in a final rule. A combined version could require prime institutional funds to use a floating NAV while all non-government money market funds could use the "fees or gates" option under certain scenarios.
"I would caution commenters on assuming that the commission will be deciding between these two reforms," Elisse Walter, one of the commissioners, said at the meeting. "These two options are not mutually exclusive solutions. Each serves a purpose to mitigate systemic risks to financial companies and markets, and to protect investors, and each does so in different ways."
Ultimately, the SEC was forced to act in part because of FSOC's intervention. The regulatory council said last year that it would step in to reform the money market industry if the SEC did not release its own proposal. Its recommendations tracked with what Schapiro had originally proposed.
Commissioners' statements at Wednesday's meeting indicated some lingering tensions over how the process had transpired.
Daniel Gallagher, who sits on the commission, criticized Schapiro for not having sought input from commissioners in trying to advance the previous draft proposal.
"In contrast with today's proposal, last year's proposal, through no fault of the staff's, was drafted without the input of the commissioners and presented to the commissioners as an inviolate fait accompli. Indeed, we were given the proposal only after it had been fully baked and blessed by other agencies," Gallagher said.
Even though it wasn't part of the SEC's new plan, he objected to the earlier proposal's capital buffer, calling it an imprudent step.
"Our economists believe that in order to act as a bulwark against default risk or run risk, a buffer would have to be so large that it would not be economical for MMFs to continue to operate," he said. "And, conversely, if the buffer was small enough to be economical, then it would provide no protection against events like the ones experienced in 2008."
Yet Troy Paredes, who also sits on the commission, said he was not convinced that the floating NAV option was any better.
"I support the staff's recommendation. That said, to be clear, at present I remain unconvinced that floating the NAV is justified on a cost benefit basis," he said. "But floating the NAV is just one of the proposed alternatives. It is particularly important to me that liquidity fees and gates are being proposed as a separate standalone alternative."
But Siegel of StoneCastle Partners said the SEC made a mistake in not proposing a capital buffer, although he acknowledged it was a "controversial" idea because "companies that are the largest sponsors of these don't want to put the capital in."
"The only way really to address the risk is with a first-loss component," he said.
Restrictions on redemptions, meanwhile, will not stop runs, he added.
"Investors will just wait for the redemption date, and then they'll get out," he said. "If people want out, they're going to get out. They'll line up at the door. You're either forcing them to pay a toll to walk out the door, or they just have to twiddle their thumbs for a while until the moment comes. Either way, they're out."
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