In what is starting to seem like an infinite loop, comment letters continue to trickle in regarding the President's Working Group Report on Money Market Fund Reform. Two more postings have appeared on the SEC's website recently -- a critique of the NAV buffer proposal and defense of the Liquidity Facility written by Federated Investors' John McGonigle and a new proposal for a redemption fee plan written by HSBC Global Asset Management's CEO John Flint. No doubt there will be more comments and even more proposals in the coming weeks. (Monday's ICI Money Market Funds Summit should be another interesting affair.)
McGonigle says, "We are writing to address recent industry proposals that seek to further reform money market funds managed in accordance with Rule 2a-7 by adding a net asset value buffer to Money Market Funds, by requiring some other form of capital requirement, or by regulating Money Market Funds as special purpose banks. Although Federated Investors, Inc. previously commented on the proposals made in the President's Working Group Report, we consider it extremely important to highlight, in advance of the May 10, 2011 roundtable discussion, some strong reservations we have on such reforms, and to reiterate our support for the Investment Company Institute's proposed liquidity exchange facility. We believe that the Liquidity Facility is the leading concept to provide enhanced liquidity, resiliency and shareholder protections for Money Market Funds."
The letter continues, "Federated acknowledges that the Buffer Proposal would permit a Money Market Fund to incur small trading losses without having to disclose a shadow NAV significantly below a dollar and that it is possible that small trading losses could help to avoid later and more significant credit losses. Federated also acknowledges that the Buffer Proposal would provide limited protection against credit and liquidity events (except in the event the markets freeze up as in the Fall of 2008) and could be implemented relatively easily (notwithstanding the obvious tax inefficiencies and providing interest rates increase to a level at which it would be possible to retain sufficient income to create the buffer). We believe, however, caution is called for when considering any proposal that so fundamentally alters the character of what has been an important and highly successful part of the capital markets."
McGonigle explains, "In light of the success of the Commission's first round of changes to Money Market Fund regulation, any subsequent round of change should be focused on addressing the core issues that caused the liquidity crisis in the first instance, rather than altering the product so fundamentally. More specifically, while the Buffer Proposal purports to allow Money Market Funds to sell portfolio securities at a loss without "breaking the buck," the crisis in 2008-2009 would not have been alleviated by a Money Market Fund maintaining a 40 basis point buffer. In the days following the Lehman bankruptcy there were no bids available or the spreads were much wider than 40 basis points (as was the case during the crisis). The crisis was alleviated to a large measure by the Boston Fed's AMLF program. This program provided needed liquidity to a system that had ceased to function because of issues wholly unrelated to Reserve Primary Fund's breaking the buck."
Finally, he says, "The Liquidity Facility provides greater protection against systemic risk than the Buffer Proposal. After ten years, the Liquidity Facility is projected to provide nearly $54 billion in available funds to help respond to a liquidity crisis. In contrast, using the same assumptions, a 40 basis point cushion would never provide more than $6.6 billion. The buffer is designed to allow funds to absorb modest losses created by an illiquid market, while the Liquidity Facility is designed to avoid such losses. Importantly, the Liquidity Facility, as proposed, would be a member bank of the Federal Reserve System with access to the Fed discount window. The marginal utility of the Buffer Proposal does not come close to justifying the unintended consequences which would negatively impact shareholders and financial markets."
The HSBC letter comments, "After the recent market events, we continue to affirm our commitment to the money market fund business. We believe MMFs are an important investment product to continue to offer our clients and have an important role to play in the financial system. However, it must be clear that the risks of investing in MMFs reside with the investors. Over the years, due to a number of fund sponsors stepping in to support their MMFs, and the most recent U.S. governmental action in support of MMFs, we believe there continues to be ambiguity about who owns the risk of investing in MMFs. As long as ambiguity about risks continues to exist, we believe there will be an unacceptable mispricing of these risks, and a misallocation of resources. As disclosed to investors in prospectuses, money market funds are an investment product and, as such, investors' capital in MMFs is at risk. We believe that by not addressing this issue at this time that the investment industry will, so to speak, be kicking the can down the road until the next financial crisis."
Flint explains, "We do not believe that there is a single reform that addresses the issue of MMFs susceptibility to runs by investors. As we can never presage future market events, experience shows that MMF investment advisors and Boards need appropriate tools at their disposal to act in the best interest of their shareholders. HSBC Global Asset Management is responding now ... because in addition to the eight possible reforms put forth in the Report, we believe there is another reform worthy of further consideration. We believe the most effective way of mitigating systemic risk is to discourage shareholder runs; and the most effective way of discouraging shareholder runs is to apply a charge on redemption that accurately reflects the cost of raising liquidity to meet redemptions and ... the realisable value of the shares being redeemed."
Finally, HSBC adds, "In summary, we are supportive of the PWG's efforts to enhance the stability of the money market fund industry and we believe now is an opportune time to make the changes necessary to achieve that goal. Any reform enacted must look to remove the ambiguity that exists as to who owns the risk in a money market fund. We believe the use of redemption charges would help achieve both these objectives."
