In a speech Monday morning at the Investment Company Institute's Mutual Funds and Investment Management Conference in Phoenix, Arizona entitled, "Weathering the Worst: Making Money Market Funds Even Stronger," ICI President & CEO Paul Schott Stevens strongly defended the money market mutual fund industry and its $1.00 NAV standard, and revealed that the ICI is pursuing the challenge of a "stronger liquidity backstop" for the industry."
Steven's says, "Today, I'd like to discuss that process of reform with regard to one specific product -- money market funds. As you all know, a string of failures in major financial institutions drove investors and liquidity out of the money markets beginning in the summer of 2007.... This sequence of events battered virtually every part of the financial system, including all issuers, investors, and intermediaries in the money markets.... Many forms of government intervention ultimately stemmed the crisis. The Treasury Guarantee Program for Money Market Funds helped calm the waters. Facilities established by the Federal Reserve helped restore liquidity to the markets for commercial paper and asset-backed securities. One measure of the success of these facilities is that the Treasury collected $1.2 billion in guarantee fees from money market funds, but paid out no claims. Money market funds and other market participants clearly benefited from these interventions."
Stevens says, "As markets began to recover, our industry understood the need to address a concern that was by no means apparent during the long and successful run money market funds have enjoyed as a stable, secure tool for cash management and investment. In short: how can we make money market funds more resilient under extreme market conditions -- able to withstand another deep and widespread loss of liquidity in the money markets? The Institute and our members have devoted countless hours to working on this problem. There are three points that I'd like to discuss with you today."
"First, the fund industry and the Securities and Exchange Commission (SEC) already have made significant and important progress toward making money market funds more secure.... The significance of the SEC's new rules for money market funds should not be underestimated. Second, the search for ways to make money market funds even more secure under the most adverse market conditions has not stopped. The Institute and its members remain active on a number of fronts, as I will describe shortly. My third point is that the fund industry remains open to a wide range of ideas on reform of money market funds -- with one exception. We strongly oppose the notion of forcing money market funds to abandon their objective of maintaining a stable per-share value. The steady net asset value (NAV) -- typically $1.00 per share -- is a fundamental feature of money market funds," he says.
Stevens explains, "Make no mistake: forcing these funds to 'float' their NAV will destroy money market funds as we know them. It will penalize individual investors and exact a high price in the American economy. But it will not -- repeat, not -- reduce risks to the financial system. By any measure, it is a bad idea.... The heavy redemption pressure on money market funds clearly revealed vulnerabilities that needed to be addressed -- not just to sustain money market funds, but to protect the financial markets and the economy. We have taken those problems very seriously, and continue to do so."
He continues, "Some observers believe there is a simple solution to these challenges: force money market funds to float their per-share value. By their account, the amortized cost accounting that allows a money market fund to seek to maintain a stable net asset value makes these funds more vulnerable to runs. They argue that investors are prone to sell stable-value shares when there are small drops in the value of the funds' underlying securities below the fixed $1.00 -- but wouldn't sell if the shares' value floated routinely. Proponents of this idea, and other measures that would have the same effect, are motivated by sincere concerns about reducing systemic risk. But their prescription in many cases reveals a bank-centered view of the world and a nostalgia for the 1970s that investors simply don't share."
"Repeatedly, these critics say that money market funds are part of a 'shadow banking system' that operates with 'no supervision.' Of course, as you all know, money market funds hardly operate in the shadows. The public disclosure regime to which they are subject exceeds anything known to the banking sector. And they operate under a strict regulatory regime -- one that embraces all the regulations applicable to mutual funds generally, as well as highly detailed standards for management of their portfolios. For my part, I'll take the record of money market fund regulation over the last 30-plus years any day. Even so, we have looked at this proposition in detail, in the light of market data and investor behavior. And we have concluded that the notion of forcing money market funds to float their value would wreak havoc on our markets -- without any offsetting benefits."
Stevens adds, "Clearly, this is a bad idea -- and we should reject it. What do we suggest instead? First, let's recognize that the SEC and the fund industry have already made major strides toward the goal of making money market funds more resilient even under extreme conditions.... But even with this great progress, our search for ways to weather-proof money market funds has not stopped. ICI and our industry are not resting. For example, we are actively engaged in a task force sponsored by the Federal Reserve Bank of New York to strengthen the underpinnings of a vital portion of the money market -- tri-party repurchase agreements.... ICI has also pursued the challenge of providing a stronger backstop for money market funds in a time of crisis. After it issued its report last March, ICI's Money Market Working Group began to explore additional ideas for providing liquidity for money market funds to meet redemptions when liquidity has dried up in the markets."
He says, "Today, I'm pleased to tell you that we are moving forward rapidly to complete a blueprint for such a liquidity facility. This would be a state-chartered bank or trust company, organized and capitalized by the prime money market fund industry and managed and governed in accordance with applicable banking laws. It would be dedicated to providing additional liquidity to prime money market funds in the event of severe market conditions."
"We have discussed this facility with regulators and other policymakers, and recognize that there are significant hurdles we must clear to create such an institution. I can't give you an exact timetable on when -- or even if -- this liquidity facility might be launched. I can tell you that ICI's Executive Committee supports establishing such a facility if industry participants and regulators can agree on a workable model. While we have committed to pursuing this liquidity facility proposal, we are not shutting the door to other ideas that would meet the goal of making money market funds even more resilient in the face of another deep and pervasive freeze in markets."
Finally, Stevens says, "What I've described for you is a multi-layered approach to enhancing the resilience of money market funds. The foundation is the sound risk-limiting regulations that have been in place under Rule 2a-7 since 1982, reinforced by new credit, maturity, and disclosure standards. These have been enhanced by the SEC's new liquidity requirements, including the 'know your investor' rules to increase awareness among both fund advisers and fund boards of the potential for sudden redemptions. Add to that the authority provided a money market fund board to halt a run in the fund and implement a fair and orderly liquidation. New reforms of the tri-party repurchase agreement market will ensure that money market funds will have greater confidence in their collateral and enhanced security in those agreements. And finally, we are working on a facility that can provide a mutual pool of liquidity available in times of market stress. Taken together, these measures would provide a wholly new level of protection for money market funds, their investors, and the markets."
