Regulators are searching for ways to make money market funds stronger without inadvertently crippling the $3.7 trillion industry, but reaching that delicate balance will require compromises from both sides.
"We are seeking to strike a proper balance and find changes that make sense in times of stormy weather and calm waters," said Andrew "Buddy" Donohue, director of the Securities and Exchange Commission's division of investment management. "A ship incased in armor might survive a collision, but it could sink under its own weight."
At an open meeting last Wednesday, the SEC proposed several amendments to Rule 2a-7 governing money market funds, the most controversial of which would eliminate the stable $1 net asset value (NAV), something the industry says is the funds' most attractive feature.
"The stable NAV is a crucial feature of money market funds, and a fluctuating NAV could destroy the value of the product," said Paul Schott Stevens, president and CEO of the Investment Company Institute. "Such a change would be so unpopular with investors that it would likely push them into riskier, less-regulated products."
Money market mutual funds contain nearly 40% of the total $9.7 trillion in mutual fund assets, according to the ICI, and eliminating the stable NAV feature could trigger a major and devastating dislocation of assets from mutual funds to other areas like banks and certificates of deposit. Such a sudden and massive transfer of assets could also have unseen consequences on global market stability.
"If money funds had a floating NAV, would investors turn to other investments?" asked Commissioner Troy Paredes. "What are the incentives for investors when they see a market-based NAV start to creep down?"
"If investors want a fixed NAV, and they cannot get it from funds operated under Rule 2a-7, they will look elsewhere for alternatives," Stevens said. "And there are many alternatives that do or could offer a fixed NAV. If regulators mandate a floating NAV, they may drive trillions of dollars to be managed elsewhere, in some cases with less regulation and oversight."
A Broken Promise
Money funds were nearly flawless for 30 years until last September, when one money fund did the worst thing possible. The Reserve Primary Fund "broke the buck," its implied promise to maintain a stable $1 NAV no matter what.
This broken promise during an already panicky period triggered an avalanche of redemptions from other money funds, $120 billion worth in one week alone, forcing the Federal Reserve and Treasury Department to step in and help.
Money funds have returned to investing in safe and low-yielding areas like government bonds, but regulators are looking to make substantial and permanent changes that will hopefully prevent future runs on money funds, and that will help funds deal with any future runs in an orderly manner.
After last year's debacle, the ICI created a Money Market Working Group to examine money funds and look for ways to fix problematic areas. The group, headed by Vanguard Chairman John Brennan, came up with a list of voluntary changes that would increase credit quality standards, tighten portfolio maturity limits and set daily and weekly minimum liquidity requirements for the funds. The Working Group's report is strongly opposed to eliminating the stable NAV.
SEC Chairman Mary Schapiro called the Working Group's recommendations a good start, but indicated the Commission seeks to make them requirements rather than voluntary changes, in part because some authorities are skeptical the funds may return to their risky ways again when greed eventually replaces fear.
Schapiro said she knows the stable NAV is a very touchy issue, but said the Treasury's latest whitepaper on financial regulatory reform expressly mentioned eliminating the stable NAV as a possibility to be considered by the President's Working Group, which includes the SEC.
"I will be very interested in commenter views on whether a so-called floating NAV would better protect investors from runs on money market funds and other abuses, or whether the efficiency of the $1 NAV is more beneficial to investors," Schapiro said.
In addition to changing the NAV, other proposed amendments include requiring funds to maintain minimum percentages of assets in cash or securities that can be easy converted to cash (5% for retail funds and 10% for institutional funds), shorten the weighted average maturity limits for fund portfolio from 90 to 60 days, limit investment to the highest quality securities, require periodic stress tests and require money funds to report portfolio holdings to the SEC and investors every month.
Money funds are already voluntarily following many of the proposed amendments, so presumably it should be easy for them to adapt to the changes if they are approved. Stevens said the ICI is supportive of most of these changes.
Money funds were never designed to hold such a large portion of total industry assets, but for the past few months, investors have been gradually moving money out of the safety of money funds and back into equities, helping to restore equilibrium to the system.
In light of the continuing problems with dissolving the Reserve Fund, the Commission is seeking to set up an orderly process for fund liquidation in the event that another fund should break the buck.
"These proposals are intended to avoid the types of problems investors experienced from the disorderly fallout that resulted from the liquidation of the Reserve Primary Fund," Schapiro said.
Some of the recommendations would allow a fund's board of directors to temporarily halt redemptions if a run happened and give boards more flexibility to refund investors their money in a timely manner.
"The hallmark of money market mutual funds is their redeemability," said Robert Plaze, assistant director of the SEC's division of investment management. "If a fund breaks a dollar, they need to get assets back to investors as soon as possible, even if this means they may have to redeem at less than a dollar per share."
A requirement to increase the minimum amount of cash and easily redeemable securities money funds keep on hand will help the funds handle a moderate increase in redemptions, but large redemption requests by institutional investors could wipe out any stockpiles. In these cases, large requests could be paid through in-kind redemptions, such as securities, rather than cash, Plaze said.
The public has 60 days to comment on the new proposals.
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