Is the SEC about to deliver a kill shot to money market funds with its next round of proposed regulations, now widely expected by March? Or will the SEC decide to leave well enough alone, at least for the time being, given its extensive — and relatively new — set of existing reforms?
The firestorm started in November, when SEC chairman Mary Schapiro floated a trial balloon at the Securities Industry and Financial Markets Association’s annual meeting in New York City. In a lengthy speech, she said she believed “additional steps should be taken to address the structural features that make money market funds vulnerable to runs,” as a follow-on to the original reforms adopted by the SEC in February 2010. Those reforms had already “tightened credit quality standards, shortened weighted-average maturities, and for the first time imposed a liquidity requirement,” she noted. But she described the stable $1.00 net asset value (NAV) used by money market funds as “brittle,” and said that out of the “numerous reform options on the table,” the options that looked to have “the greatest viability” were “floating NAVs and capital buffers, possibly combined with redemption restrictions.”
Under an SEC rule, money market funds are the only mutual funds that are allowed to sell and redeem shares at a fixed price of $1.00 per share, but that has always been conditional. The day-to-day value of the funds’ assets cannot deviate from that $1.00 per share mark by more than a very slim margin, or they risk being marked down to less than a dollar. That risk became real when Lehman Brothers went into bankruptcy, and the Reserve Primary Fund ‘broke the buck’ because it was holding $785 million of Lehman’s short-term paper, equal to 1.2 percent of its assets. That set off a panicked run of redemption requests throughout the industry, threatening a meltdown, and the SEC and the Federal Reserve have been trying to come up with solutions ever since.
Peter Crane, the co-founder of Crane Data, the Westport, Massachusetts–based publisher of Money Fund Intelligence and other money fund products and publications, believes “[adopting] the floating NAV has always been a long shot and a last resort.” In analyzing Schapiro’s full speech, he believes the SEC has “issues with it as well,” and notes that in that speech, Schapiro “emphasizes that the SEC is spending most of its time looking at a capital buffer or a set-aside that would help cushion any future loss in a money market fund.” A floating NAV “won’t fix the problem of preventing a run, and it may cause a lot of collateral damage,” he says.
What everyone in the mutual fund industry seems to be focusing on now is a proposal put forward last August by professor Jeffrey Gordon of Columbia University in a comment letter he filed with the SEC. He suggested a two-tier system, with Class A and Class B shares — the first with a fixed NAV, and the second, “whose value will float to cover outright defaults or depreciation in [the] market value of portfolio securities.” Under his proposal, the Class B shares would represent five percent of an investor’s investment in a money fund, and would be subject to a seven-day hold, redeemable “at the then-NAV of those shares,” he said. That means that if there was a problem, investors could lose some of their money, but their losses would be limited.
“Notice what this proposal accomplishes,” he said, in his comment letter. “It requires the users of institutional money market funds to supply the capital necessary for their stability, and it creates disincentives for such investors to run.”
The idea that is now being “batted back and forth” between the regulators and the industry, says Mike McNamee, the senior director of public communications for the Investment Company Institute, the trade organization for the mutual fund industry, is to tweak the professor’s idea by lowering the percentage that would be subject to a hold to three percent, but in exchange, the holding period would be longer at 30 days. “The buzz in the industry is that it will be three and 30,” he says.
It’s not clear that the SEC will indeed do anything further. Back in November, Schapiro ended her speech by stating, “And I look forward to sharing a reform proposal with you very soon.”
But John Hawke, Jr., a lawyer with the Washington, D.C., law firm of Arnold & Porter, who has filed several hefty comment letters on behalf of Federated Investors, says that “it appears to me that there’s a division within the Commission about whether anything more needs to be done.”
The most visible sign of that is a speech made on December 14 in Washington, D.C., before the U.S. Chamber of Commerce, by new SEC commissioner Daniel Gallagher. While emphasizing that he was speaking strictly for himself, he noted that “a move to a floating NAV would work a profound change in the money market industry as we know it today,” and that perhaps further study was in order. He suggested that “it would be important to understand the effect of such a change on the commercial paper market and bank deposits,” and also suggested that “if the Commission moves forward with a proposal, the option of doing nothing until we have seriously analyzed the impact of last year’s reforms must be given serious consideration.”
A SEC spokeswoman said she could not comment on when the SEC expected to act.
But, if it does act in March — as widely expected among those in the industry who have been involved in the discussions with the regulators — it is not even clear whether the SEC will put out what is known as an NPR, or Notice of Proposed Rulemaking, which is more general and conceptual, or a proposed rule that would also be seeking comments, Hawke says.
“A lot of trial balloons are being put up and getting shot down,” Hawke says. “The staff people at the SEC and the Fed seem to come up with new ideas every week.”
At the moment, the Crane 100 Money Fund Index is showing an annualized 7-day current yield of a mere five basis points, notes Crane, which means that a three percent capital cushion would translate into an even lower yield of two basis points. But even with a five basis point yield, there is “still $2.7 trillion sitting there” in money funds, he says. “I think investors have clearly shown that yield is secondary to convenience and safety,” he says.
Some people believe the regulators’ zeal is misplaced. As noted by Anthony Carfang, a partner and director at consulting firm Treasury Securities, compared to the banks “it’s the money market funds that haven’t had a single dollar of federal aid injected into them.”
