On Friday, BlackRock published a "ViewPoints" paper entitled, "Money Market Funds: The Debate Continues, Exploring Redemption Restrictions, Revisiting the Floating NAV. The 7-page comment says, "Money market funds (MMFs) have been a topic of discussion -- and often vehement disagreement -- among regulators and market participants since the 2008 financial crisis and historic "breaking of the buck" by the Reserve Primary Fund. This single event cast scrutiny upon an industry that for the prior 40 years had successfully provided liquidity to the financial markets -- and market yields to investors -- without requiring government intervention. The result is the implementation of reforms that tightened standards and enhanced protections for MMF investors." (See also Bloomberg's "BlackRock Says Money Funds Would Survive Floating NAV".)
The paper explains, "Many in the industry believe that these reforms are sufficient. Regulators disagree and continue to explore ways to further strengthen the regulatory structure of MMFs. As an active participant in this dialogue, BlackRock has worked with others to formulate one or more capital solutions for MMFs. These are described in detail in a separate ViewPoint paper titled "Money Market Funds: Potential Capital Solutions," published in August 2011. To date, industry consensus on capital proposals has been elusive. This paper will focus on a model for MMF reform recently highlighted by the Securities and Exchange Commission (SEC) and currently under consideration. The SEC proposed model would give money fund providers a choice of a stable-value MMF that incorporates capital buffers plus redemption restrictions or a MMF with a floating net asset value (NAV). Given that this plan is likely to be proposed by the SEC in the near future, it is important to fully evaluate its likely impact on MMFs and for market participants to identify features that may mitigate the potential negative impacts of these proposals."
On "Where Are We Now?," BlackRock writes, "Fund sponsors, issuers and regulators agree on one key point: MMFs are essential as a source of short-term financing for businesses, institutions and governments and, as such, are critical to the financial system and the broader economy. Regulators' interest in fortifying the industry is derived from a constructive place and, indeed, the regulatory response in the wake of the 2008 financial crisis was both swift and effective. That said, many fund sponsors argue that additional regulation would bring costs in excess of incremental benefits and believe that the 2010 reforms are sufficient. They contend that the measures imposed to date have met the goal of shielding MMFs and their investors from both idiosyncratic (fund-specific) and most systemic (industry-wide) shocks. They fear that further reform could do more harm than good. They point out that even in the case of the Reserve Primary Fund, institutional investors lost only 1%, and the government intervention that followed cost taxpayers nothing (in fact, taxpayers made a profit on the money market-related programs)."
It continues, "Regulators, however, point out that the improvised steps taken to stem the run on the money markets in 20081 are no longer permitted under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). As a result, they believe further steps are needed to protect the industry and the broader economy from a potential run on money market funds. SEC Chairman Mary Schapiro is prepared to move quickly on MMF reform and is seeking to issue a notice of proposed rulemaking (NPR) in the first quarter of 2012, with the goal of having a final rule in place this year. The final position of the SEC remains uncertain given mixed public comments from various commissioners. Opposition to the SEC's proposals from the industry and other market participants has also been strong and vocal. Some industry participants have indicated a willingness to pursue legal action if the Commission moves forward with plans that fundamentally alter the structure of MMFs."
BlackRock adds, "In seeking reform, the stated goals of regulators are: i) to reduce the risk of a run on MMFs and ii) to provide a cushion against losses, with a focus on the first issue. Over the past three years, many ideas have been proposed and discussed at great length; none has met with consensus. Various capital solutions have merit in their potential to meet regulators' stated objectives. However, different firms' legal structures make it impossible to find a single solution that works for everyone. At this juncture, given regulators' stated intention to move forward with structural reform, it is important to identify a proposal that preserves MMFs and is acceptable to as many industry participants as possible. The model expected to be put forth by the SEC provides the option of either: i) a stable-NAV MMF with capital buffers plus redemption restrictions or ii) a floating-NAV MMF. The latter is not a new proposal, but one that continues to resurface as a potential option. In the following pages, we consider the merits and implications of these ideas. We also consider the case for whether regulators have already done enough."
They comment, "In July 2010, we published a ViewPoint titled "Money Market Mutual Funds: The Case Against Floating the Net Asset Value." We continue to believe that a floating NAV will not eliminate the risk of runs in money market funds and will substantially contract the industry. However, given the choice between a floating NAV and the redemption restrictions described above, we believe many of our clients will choose the floating NAV. As a result, more thought should be given to how a floating NAV might be structured to meet the needs of investors, regulators and fund sponsors. The discussion that follows is meant to start this dialogue."
BlackRock explains, "We recommend that the following be included in a floating-NAV proposal: Prime and municipal funds must use the 2a-7 portfolio rules to use the name "money market fund." This requirement would maintain a level playing field and would mandate conservative portfolios. Assets with less than 60 days to maturity should be allowed to use amortized cost accounting. A policy package should include an IRS de minimis rule for gains and losses given very small fluctuations in the NAV historically. This would be revenue neutral and would simplify administrative concerns of investors. The goal should be to eliminate the need for tax-lot accounting of money market shares. The transition strategy and timeframe are critical and must be carefully considered in terms of client education, mapping of assets and operational challenges. Government funds should remain constant-NAV products. These funds do not present the same credit issues as prime funds. For investors who must have constant NAV, we believe this would be a reasonable (albeit lower-yielding) investment option."
They also write, "No discussion of MMF reform would be complete without consideration of the question: Have we done enough already? Some in the industry have argued that sufficient action has been taken and that the $2.66 trillion MMF industry is in a place of strength and stability today. On February 7, 2012, Paul Schott Stevens, President and CEO of the ICI, wrote that the SEC proposals that remain on the table today, "are not necessary, particularly in light of the SEC's own success in reforming money market funds." Federated Investors has been outspoken in its view that enough has been done and recently published a paper titled "Leave Money Market Funds Alone!" in which it described the "bashing" to which MMFs have been subject since 2008 and the SEC's "conscientious and effective job" of overseeing the industry. The paper contrasts the SEC's ability to regulate MMFs with the Fed's oversight of banks."
BlackRock tells us, "In addition to the changes to MMF standards under Rule 2a-7 (outlined on page 2), numerous efforts have been undertaken worldwide to strengthen the broader financial system. In the US, these include the establishment of the Financial Stability Oversight Council (FSOC), which has the ability to provide proactive and more comprehensive monitoring of the financial markets, including money market instruments; and the implementation of the Dodd-Frank Act, which further bolsters the safety of MMFs by reducing risk in the instruments issued by financial institutions and held by MMFs. A frequently overlooked point is that in addition to changes to MMFs themselves, regulators have substantially limited the ability of financial institutions to rely on short-term funding in their capital structures.... We believe the reduced reliance on short-term funding by financial institutions reduces the systemic importance of the money fund industry. It appears that, in aggregate, these measures have been effective. MMFs have been functioning efficiently, with no systemic or idiosyncratic events recorded since the September 2008 breaking of the buck."
It adds, "Despite the success of the 2010 reforms and the resilience of MMFs during periods of market stress over the past several months, Chairman Schapiro confirmed her intention to take action soon in remarks to the Practicing Law Institute on February 24, 2012. She stated that, "investors have been given a false sense of security by money fund sponsor support and a one-time Treasury guarantee" and "funds remain vulnerable to the reality that a single money market fund breaking the buck could trigger a broad and destabilizing run." Chairman Schapiro further noted that, "we need to move forward with some concrete ideas to address these structural risks.""
Finally, the paper states, "BlackRock, as one of the world's largest cash management providers, fully supports the goal of strengthening the MMF industry while reducing systemic risk. Throughout the 2008 financial crisis and its aftermath, the swift, decisive and concerted actions taken by regulators were essential in restoring confidence and order to the markets in a time of uncertainty. Many would contend that the new protections have met their goals. However, it appears that more change is imminent for the MMF industry. Faced with this very real possibility, it is important that all interested parties -- policymakers, fund sponsors, industry organizations and corporate and municipal issuers of commercial paper -- are part of the discussions to ensure the best outcome for investors, the MMF industry, the broader financial system and our economy. Ultimately, when contemplating additional change, it is critical to ensure that the reforms, both those implemented and those currently proposed, achieve the objective of protecting MMFs and the shareholders who invest in them without inadvertently destabilizing financial markets or increasing systemic risk."
