Following Wednesday's Open Meeting, where Final Money Market Fund Reforms were adopted by a vote of 3-2, the SEC released the text of statements from all five Commissioners. We published Chair Mary Jo White's speech yesterday ("SEC Adopts MMF Reforms; Chair White on Rule's Fundamental Changes"), and today we post excerpts from the two Commissioners who joined her in favor of the rule -- Luis Aguilar and Daniel Gallagher. (For more on the new Reforms, see the SEC's press release here, the SEC's "Speeches" page here, the archived Webcast here, and the full 869-page Final Rule here.) Here's what Aguilar had to say. "It is well known that the journey to arrive at the amendments considered today was a difficult one, and I can confidently say that this has been, at times, perhaps one of the most flawed and controversial rulemaking processes the Commission has undertaken. He added, "The quality of the June 2013 release resulted in the Commission receiving thoughtful input and a considerable amount of data and detailed analysis, which, in turn, has significantly improved today's proposal. In total, the Commission received over 1,400 comment letters from a variety of commenters, including individuals, academics, investment companies, investment advisers, banks, operating companies, professional and trade associations, and government entities. The comment letters commented on all aspects of the June 2013 proposal from a variety of perspectives, including, expressing support, or opposition, to the floating NAV proposal, indicating varying degrees of support, or opposition, for liquidity fees and/or redemption gates (or the combination thereof), and mostly support of the enhanced disclosure requirements in the proposed reforms."
Aguilar continued, "These comments make it clear that many will believe that today's reforms may go too far; while conversely, others will believe that we have not gone far enough. Today's rulemaking, however, is a result of extensive data and in-depth analysis, much of which is the product of work conducted in-house by staff economists in the Division of Economic and Risk Analysis. For example, just to name a few: DERA analyzed the liquidity costs during market stress and non-market stress periods, and its study supports the appropriateness of the 1% default liquidity fee being adopted in today's reforms; DERA analyzed government funds' exposure to non-government securities, and the findings provides support for the significant reduction in the non-government securities basket in today's reforms; DERA measured the extent to which municipal money market funds may be exposed to guarantees or demand features from a single guarantor, and its study supports the staff's recommendation for reducing the 25% basket for guarantees and demand features from a single institution; and (iv) lastly, DERA analyzed the overall availability of domestic and global safe assets, and concluded that, given the size of the global market for safe assets, DERA does not anticipate that the proposed reforms will result in a large impact to the domestic and global markets for safe assets."
He added, "There are several aspects of today's amendments that warrant special mention. First, today the Commission adopts a floating NAV for those money market funds that have tended to exhibit greater volatility. As the release states, for such funds, it is expected that the floating NAV will reduce the chance of unfair investor dilution by weakening the incentive for certain investors to take a "first mover advantage" by redeeming in times of market stress or when there is a price discrepancy between the market-based NAV and the stable share price. Additionally, it will make it even more transparent that money market fund investors bear the risk of loss on their investment, as is always the case. Nevertheless, many have expressed concerns about requiring money market funds to have a floating NAV. In particular, concerns have been raised as to accounting and federal income tax considerations that would make such funds virtually unworkable. However, as today's release discusses, the Treasury Department and the Internal Revenue Service will announce today proposed regulations and a revenue procedure to address these issues. As a result, it is expected that money market funds, even with a floating NAV, will continue to be viable and efficient products. In that regard, I would like to thank the respective staff at the Treasury and the IRS for helping to address the difficult issues raised by the implementation of today's floating NAV amendments."
Aguilar continued, "However, as is noted in the Commission's release, the floating NAV requirement will not by itself stop runs on money market funds in times of market stress. For that reason, the Commission is also authorizing the use of "fees and gates," as a necessary aid in the reduction of the systemic risks that today's reforms are designed to address. Some observers, including staff at the Federal Reserve Bank of New York, have suggested the possibility that fees and gates may themselves cause pre-emptive runs, by encouraging investors to redeem their shares before fees and gates are imposed. However, as discussed at length in today's release, the Federal Reserve staff's conclusion that fees and gates may cause pre-emptive runs is based on a model whose assumptions and features are different than the reforms we are adopting today. Accordingly, as noted in the release, the Federal Reserve paper's findings regarding the risks of pre-emptive redemptions are not likely to apply. In addition, there are several aspects of today's amendments that are designed to mitigate the risk of pre-emptive runs as the result of "fees and gates," and to reduce the effects of such runs should they occur. These include a maximum time period for the imposition of gates that is shorter than what was proposed and a significantly smaller default liquidity fee than initially proposed."
More on fees and gates: "The use of fees and gates, like other provisions recommended today, has required particularly close and thoughtful deliberation. I struggled with a change that allows fund boards to temporarily prevent investors from redeeming their own cash, even when it is limited to a severe market stress scenario. This amendment is in direct conflict with the foundations of the Investment Company Act of 1940, which require that investors be able to redeem their money. It seems equally concerning to me to support the imposition of a fee on redeeming investors in a time of such high market volatility and investor stress, even when the fee provides additional liquidity to other non-redeeming investors in the same fund. Investors may be required to pay fees when they are least able to do so. I ultimately conclude, however, that the combination of providing investors with full disclosure concerning the possibility that gates and fees will be imposed in certain limited circumstances, and the benefits to investors and the country as a whole of reducing systemic risk and lessening the risk of a future economic collapse, justifies the Commission taking these extraordinary steps."
He concluded, "Today's amendments also address, in part, the possible migration of assets from registered money market funds to private investment funds. In particular, the amendments to Form PF will require large liquidity fund advisers to provide the SEC, on a monthly basis, with basically the same information in respect to their funds' portfolio holdings as is provided by registered money market funds. While Form PF does not cover all unregulated funds or vehicles the additional information will provide important information and transparency to the Commission. I expect the Commission staff to closely monitor these developments and to recommend to the Commission and, if necessary, to Congress, any possible amendments or legislative reforms needed to address the operations of these dark, less regulated markets. More generally, while I support the adoption of today's amendments, I expect the staff to monitor the impact and effects of these amendments and to provide regular and frequent reports to the Commission."
In his comments, Gallagher said, "The process has illustrated that it is incumbent on us as Commissioners to set aside any preconceptions we may have and approach each issue dispassionately and with an open mind. It is our duty to strive to understand the substance of those issues as well as the potential impacts of any regulatory approaches we consider -- and then to make the difficult decisions that often follow. Despite an inauspicious start, this rulemaking process has demonstrated the Commission's ability to make those difficult decisions, and I'm pleased that a majority of the Commission has joined together to successfully conclude our long and arduous path to implement commonsense, reasonable reforms to our rules governing money market mutual funds."
He added, "As for my own path to today's rulemaking, I consistently have been a proponent of requiring money market mutual funds to adopt market-based pricing -- that is, a floating net asset value -- but not at any cost, and only in the context of a reform package that effectively mitigates risks to investors without forcing money funds to masquerade as federally insured bank deposits. I was not able to support an earlier reform proposal that included a proposal for so-called "capital buffer" requirements. That proposal made no economic sense, as proven by `Craig Lewis, and did not fit either the definition of regulatory capital or the structure of money market funds <b:>`_ The paltry so-called "buffer" would have offered only an illusion of protection to investors and the markets."
He explained, "And I would note that the infirmities of the unsuccessful SEC capital buffer proposal of 2012 also feature in pending international proposals, and foreign policymakers should be loath to follow that rabbit down the hole. Like other mutual funds, money market funds should be risk-taking ventures borne of the capital markets, where we want investors, whether retail or institutional, to take risks -- informed risks that they freely choose in pursuit of a return on their investments. Today's reforms squarely address and put investors on notice of this distinction, and I applaud the Commission and staff for resisting outside pressure to apply a bank regulatory paradigm to a product that is so integral to the functioning of the capital markets. Many forget, sometimes all too conveniently, that this agency came very close to imposing a capital buffer on money funds. This was a big-government, bank-regulator preferred proposal that would have crippled the industry. I take great pride in my successful efforts to kill that misguided proposal."
Gallagher continued, "The Commission does not have oversight authority over banks or bank products, and we do not have access to the tools available to the prudential regulators who do. There should be no confusion about that, now or ever, and the agency learned no tougher lesson from the events of 2008. The Commission is an appropriated independent agency without a Treasury line of credit or a balance sheet. We cannot bail out any firm or product, and that is the proper order of things. Our oversight should be focused on market-based valuations and strict capital standards employing those valuations, and in the case of failure, we should be expert in the wind-down process. As I have said so many times recently, we should be the morticians, not the ER doctors."
He added, "The tailored floating NAV requirement we are adopting today directly addresses concerns that arose during the financial crisis. Most notably, as has been discussed, it eliminates the first-mover "put" advantage that favors sophisticated institutional investors at the expense of retail investors, leaving the latter holding the proverbial bag. Just as importantly, in my view, today's floating NAV reforms clarify for investors the risks associated with investing in money market mutual funds while making it clear to the markets and to policymakers that these financial instruments are not bank products to be overseen by prudential regulators, but rather investment products properly regulated by the SEC. However, as I have consistently stated, requiring money market funds to float their net asset values should help stem a run, but does not fully solve the problem of run risk."
He told the Open Meeting, "Unlike in the banking sector, there is no federal insurance program, and no taxpayer dollars, to help stop runs. Accordingly, it is critical for fund boards to have discretionary tools at their disposal to limit or suspend redemptions temporarily in appropriate circumstances. The fees and gates allowed in today's rule give fund boards a mechanism to stem the tidal wave of redemptions that can materialize in the midst of a market crisis -- and that cannot be stopped by floating the NAV alone. And the gating component of today's rule is actually just a codification of the status quo with mandated disclosure so investors can better understand the potential of a liquidity event. Neither reform on its own would have meaningfully achieved all of the objectives we set out to accomplish. But together, as demonstrated by DERA's comprehensive analysis, today's floating NAV and fees and gates reforms are a targeted and measured regulatory response and the best path forward for our regulatory oversight of money market mutual funds in the future."
Gallagher went on, "All that said, I have consistently, loudly, and publicly stated that my vote for a floating NAV was contingent on the resolution of the tax and accounting-related issues arising from the move away from a constant NAV. As we make abundantly clear in today's release, the accounting issues have been completely addressed: money funds are cash equivalents. And, as Chair White noted, concurrently with today's rulemaking, the Department of the Treasury and the IRS have issued a revenue procedure, that is, an official IRS statement of procedure that may be relied on by taxpayers under the Internal Revenue Code, and a proposed rulemaking that squarely addresses each of the principal concerns that were raised by commenters, and that may be relied upon by taxpayers beginning on the same date that today's rule becomes effective."
He said, "First, Treasury and the IRS have issued a proposed rulemaking that allows taxpayers to use the simplified aggregate accounting method for funds subject to a floating NAV. Under this method, investors will not be required to track and report the cost or tax basis and redemption price of all shares they purchase and redeem. Rather, they will calculate their taxable gain or loss on an aggregate basis at the end of the tax year, based on information already provided in their year-end statements. Second, Treasury and the IRS have issued a revenue procedure that exempts taxpayers invested in funds subject to a floating NAV from the "wash sale" rules, which prohibit taxpayers from recognizing a loss on the sale of a security if the investor buys a substantially identical security within 30 days -- a common occurrence with short term cash management securities such as money market funds. This revenue procedure will become effective on the same day as our amendments, providing full and immediate relief to taxpayers who otherwise would have had to track the timing of individual purchases and redemptions for compliance with the wash sale rules."
In conclusion, Gallagher said, "I have also insisted that we provide a long compliance period to give the industry and investors the time needed to implement and understand the intricacies of today's rule, and so I am pleased that there will be a two-year compliance period. Today's amendments introduce substantial changes to the regulatory framework governing money market funds, and it is imperative that we afford money funds and their investors ample time to make business and investment decisions."
