As expected, comment letters on the "President's Working Group Report on Money Market Fund Reform" almost unanimously oppose the possibility of a floating rate NAV for money market mutual funds. Today, we excerpt from one of the most eloquent critiques of the radical change concept. J. Charles Cardona, President, The Dreyfus Corporation writes, "We commend the PWG's fair and balanced consideration of the potential for each Policy Option to reduce money market funds' susceptibility to runs. We were particularly pleased that the PWG was guided by a concern for mitigating possible adverse consequences of further regulatory change, such as the potential flight of assets from money market funds to less regulated or unregulated vehicles, and that the PWG recognized potentially effective Policy Options for reducing systemic risk without requiring the extreme act of transitioning to a floating net asset value for money market funds."
Dreyfus explains, "We believe first and foremost that it is unnecessary to obsolete Rule 2a-7, stable NAV money market funds in order to reduce systemic risk. Accordingly, we do not support the Policy Option of adopting a floating NAV for money market funds, which we believe would be problematic to implement, and which poses other significant negative consequences."
The letter says, "We believe the Report has accurately identified the reasons why transitioning from a stable NAV to a floating NAV for money market funds may not mitigate systemic risk. First, we agree that this Policy Option could not be implemented without causing systemic stress to the financial markets and to the economy. There is no one, practical solution for implementing this change that would not be systemically disruptive to the markets and the economy. Secondly, we believe a floating NAV would reduce systemic risk only nominally, because floating NAV investments that would continue to be used for ready liquidity would still be subject to runs as those investors seek to 'get out first' in order to minimize losses. Thirdly, we believe that if the Commission were to mandate a floating NAV it would eliminate the liquidity vehicle of choice for millions of retail and institutional investors while only shifting systemic risk to those liquidity vehicles that would replace the stable NAV money market fund."
Cardona comments, "We strongly agree with the statement in the Report that the transition from a stable NAV to a floating NAV itself would be systemically risky, because we believe that implementing this Policy Option would precipitate the movement of at least hundreds of billions of dollars to alternative (regulated or unregulated) liquidity sources. Conversely, we strongly disagree with the following statements in the Report which are offered as a justification for moving to a floating NAV: '... making gains and losses a regular occurrence, as they are in other mutual funds ... could alter investor expectations and [make them] more accustomed to and tolerant of NAV fluctuations and less prone to sudden, destabilizing reactions' [and] 'investors would have less of an incentive to run from money market funds with floating NAVs than from those with stable, rounded NAVs.'"
He explains, "Liquidity investing, by its very nature, is loss-averse. Moving to a floating NAV will not change the nature of liquidity investing -- it will only relocate it to different vehicles, where the same intolerance for loss will be evidenced during periods of unusual market stress that threaten the stability of liquidity balances broadly. In an environment where floating NAV funds have replaced stable NAV funds, we believe floating NAV funds also would be likely to experience 'sudden, destabiliting reattions' during periods of unusual market stress. While the 'investor left behind' in a stable NAV fund likely faces a loss of about 1% (before the fund liquidates and winds up its affairs), a floating NAV fund also can have 'investors left behind' who can be subject to deeper downside market value risk with a small likelihood that those losses could be recovered through capital gains. Faced with that risk, substantial net redemption activity during periods of unusual market stress would be foreseeable in floating NAV funds."
Dreyfus adds, "In part, our opinions are based on feedback from our fund shareholders. For example, as noted in our comment letter to the Commission in September 2009 on the proposed amendments to Rule 2a-7, we surveyed 37 of the largest Dreyfus institutional money market fund shareholders (with over $60 billion invested) and asked them, inter alia, whether their respective businesses could continue to utilize a money market fund for short-term liquidity needs if a floating NAV was introduced. We reported that two-thirds of these shareholders said they would seek an alternative liquidity investment. Of these respondents, 50% said they could not tolerate the principal risk associated with a floating NAV, 16% cited systems support obstacles (mainly, cash sweep accounts), and 8% cited relevant investment guidelines that would prohibit that transaction."
The letter continues, "We believe these results support the view that floating NAV money market funds would not serve the liquidity needs of investors, and that moving to a floating NAV would precipitate the prompt transfer billions of dollars from stable NAV money market funds to other liquidity vehicles that do not have the protections afforded by Rule 2a-7, which itself would have significant systemic implications. Further, we refer to the statement in the Report that 'there is no direct evidence on the likely effect of a floating NAV on the demand for money market funds' and suggest that our survey offer[s] relevant 'direct evidence' that the demand for money market funds would be substantially lower if a floating NAV replaced the stable NAV."
Finally, Dreyfus writes, "We also disagree with the suggestion in the Report that moving to a floating NAV is advisable in order to dispel investor expectations that money market funds are 'risk-free cash equivalents' and make them less systemically vulnerable. We do not believe that investors, particularly institutional investors, believe that money market funds are risk-free investments. To the contrary, institutional investors have increased their demand for due diligence meetings and have demonstrated greater vigilance about portfolio holdings and strategies (among other aspects of money fund investing). We believe this behavior evidences a strong appreciation for the risk of loss inherent in stable NAV money market fund investments and, like investors past net redemption activity during periods of unusual market stress, is inconsistent with the belief that their investment is 'risk-free.'"
