Measuring money... faster, cheaper, cleaner

As next Friday's deadline approaches for feedback on the Financial Stability Oversight Council's Money Market Fund Reform Proposals, a number of Comment Letters are being posted, and some even have substance and familiarity with the issues at hand. One of the more educated recent postings is a Comment from The Independent Trustees of the Fidelity Fixed-Income and Asset Allocation Funds. Chairman Albert Gamper writes, "Frankly, we are increasingly dismayed at the imbalance of contextual perspective represented by the Proposed Recommendations and the poverty of the economic and financial analysis on which they rest. We think that singling out MMFs as the first financial product to be subject to FSOC recommendations under Section 120 represents a perverse mis-prioritization in light of more pressing financial and economic issues, disregards the very substantial benefits that MMFs have brought to MMF shareholders, short-term credit markets generally both in terms of pricing and liquidity, and to borrowers in those markets, including the United States Treasury itself, state and municipal governments and public and privately-held enterprises, and ignores the effects of both the 2010 Rule 2a-7 amendments and MMF industry participants' efforts to enhance the resiliency of MMFs to credit market uncertainty and turmoil."

The letter continues, "We view differently than the FSOC the events that led to and the aftermath of the Lehman default, and do not agree with its proposed determination that the pricing methodology of MMF shares is a source of systemic risk. Indeed, it seems to us that the attribution of general market illiquidity to MMFs in the fall 2008 disproportionately burdens a financial sector entirely not responsible for the opaque financial institution balance sheets and the regulatory environment in which such institutions existed at that time, and dramatically underweights the behavior of many other market participants during the period. We object to the characterization of MMFs as "shadow" banking because MMF balance sheets and assets are a beacon of light compared to the opacity of the balance sheet and off-balance sheet liabilities of so many regulated and nonregulated financial institutions at that time and now. Moreover, the proposed determination that the activities of MMFs are the first non-bank financial activities under Section 120 to pose systemic risk represents a perverse policy choice with substantial risk that the consequences intended to be avoided will in fact be precipitated or accelerated, including the probable migration to unregulated investment pools or increased deposits in still weak banking institutions."

Gamper's letter explains, "We believe that neither the SEC nor the FSOC have made sufficient study and analysis of the possible effects of changes to MMF regulation on the nation's short-term credit markets generally, and the discussion in FSOC's Proposed Recommendations is speculative and unpersuasive. As a result, we think the Proposed Recommendations are at best premature."

The letter says of FSOC's Alternative 1, "We have been attentive to the debates since prior to the proposal of amendments to Rule 2a-7 in 2009 concerning changing MMFs' pricing from amortized cost valuation to market valuation. We are unpersuaded that the purported benefits of reducing systemic risk through Alternative 1 outweigh the detriments to shareholders. Indeed, it seems self-evident to us that first-mover advantage, and thus possible contagion risk, cannot be eliminated through either constant or variable net asset valuations. Enhanced and more frequent and current portfolio and mark-to-market valuation disclosure, as required by the 2010 amendments, has greater potential in our view to engender caution in credit determinations than net asset valuation pricing, and without the destabilizing effect of the anticipated massive redemptions by shareholders which can or will not use variable net asset value liquidity vehicles. In addition, net asset value pricing in declining credit conditions creates no impediment to redemptions and could, indeed, generate undesirable volatility in short-term credit markets."

The Independent Directors comment, "Alternative 2 will, in our view, make MMFs so unattractive to shareholders that well before the end of any "transition period" there will be few assets left. MMF shareholders, including ours, whether retail or institutional, have been encouraged over several decades to value the convenience, flexibility and current yield of MMFs by their banks, their broker-dealers, their benefit plan advisors and sponsors and their investment advisers. To say nothing of the nearly impossible task of funding the capital buffer from fund income in the current interest rate environment, the minimum balance requirement deferring a portion of full redemptions of holdings greater than $100,000 (the "MBR") is simply an unacceptable burden on shareholders. The MBR is not in their interests and we believe they will not accept it as a regular feature of their source of daily liquidity. We are mindful that Reserve Primary Fund was unable to maintain a constant $1.00 net asset value, and that other MMFs received actual or committed sponsor support from time to time, and particularly in the financial crisis of 2008-2009. Nevertheless, we believe that there is no demonstrable need for the MBR based on more than three decades of experience. Instead, we believe that, rather than attempting to solve for some economists' theoretical view of perfect protection against credit events in an MMF portfolio with the likely consequence that a valuable financial product which has almost invariably met shareholder expectations would be destroyed, shareholders should continue to benefit from MMFs in their current form and with the enhanced disclosures of possible risk of loss that may be required by further amendments to Rule 2a-7."

Finally, they add, "Alternative 3 is a hollow recommendation because in establishing in our view an utterly impossible hurdle for an MMF to leap over, it betrays either a profound cynicism intended to gather support for the other proposals or a design to eliminate MMFs entirely. We appreciate that some sponsors may be able to establish up to 3% capital buffers, but we think no MMF will be able to do so in the transition period -- at all, or even during a transition period with a more favorable interest rate environment. Moreover, we think the capital buffer (as contemplated by both Alternative 2 and Alternative 3) is ill-conceived and based on a bank-centric model that is inapposite to the MMF model. Banks are required to have depositary insurance and capital buffers to protect depositors at the expense of bank shareholders who otherwise benefit from the returns earned on deposits. MMF shareholders earn a return, or not, on the MMF's assets, and neither look to, nor expect that either there is, a U.S. Government guarantee or fund sponsor support to avoid loss in principal. We have been advised, and it has been widely reported, that Fidelity's shareholder surveys clearly demonstrate an understanding of an MMF's key financial attributes, including the absence of a guarantee from anyone against loss."

See also, Reuters' "Fidelity trustees call money market reform 'perverse'", which says, "Independent trustees of the money market funds at Fidelity Investments called proposed industry reforms a "perverse mis-prioritization," according to a letter released on Thursday. The trustees, including former CIT Group Inc Chairman Albert Gamper Jr., told the Financial Stability Oversight Council that there are more pressing financial and economic issues than reforming money market funds."

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