J.P. Morgan Securities published a "Short-Term Market Research Note: Money fund reform FAQ" yesterday, which says, "Over the past several months, SEC Chairman Mary Schapiro and other financial regulators have been building a very public case for a substantive restructuring of money market mutual funds (MMF), which they argue currently pose an unacceptable level of systemic risk. Regulators' arguments have proven controversial, drawing resistance from investors, fund sponsors and others. In spite of the controversy, Schapiro is pushing SEC commissioners to hold a vote in the coming weeks to release draft proposals and related questions for public comment." (Note that contrary to some reports, the SEC has not released an agenda for next Wednesday's Open Meeting yet.)

The piece, written by Alex Roever, Teresa Ho and Chong Sin, explains, "Pushing for this vote now is politically risky as Schapiro may not have the support she needs. The vote could pass or it could fail. A failure could mark the moment reform efforts hit a political wall. Alternatively, the failure might serve as a rallying point for further attempts at reform either by the SEC or the FSOC. While it is not clear whether the majority of SEC commissioners will support the MMF release, the process has definitely generated many questions from market participants. What follows are some of the more common questions we have received along with our answers."

JPM's Q&A asks, "Why are additional money fund regulations being considered now? <b:>`_" They answer, "Four years after the Reserve Primary Fund broke the buck in the midst of the most volatile financial crisis in US history, US regulators may be on the verge of proposing fundamental changes to how MMFs operate. We believe the prospective regulations would force some MMFs to choose between converting to a floating NAV business model and having to hold capital and requiring shareholders to have a fraction of their shares subject to temporary holdbacks at liquidation. Although no MMF has broken the buck since the Reserve suffered a run following Lehman Brothers' bankruptcy in September 2008, the memory of that run both haunts and motivates fund shareholders, fund sponsors and regulators."

It continues, "Proponents of regulation, including the SEC chairman and the presidents of the New York and Boston Federal Reserve Banks, argue that MMFs remain systemically risky, and that their constant NAV makes them particularly vulnerable to runs. They say that although the Fed and Treasury were able to provide emergency support to the money funds following the run on the Reserve, the Dodd-Frank Act (DFA) would prohibit similar moves in the future. Because of the DFA, they argue that systemic costs of a broken buck have increased. Recently, both the SEC and the Fed have conducted studies that conclude that there would have been more MMFs breaking the buck absent liquidity injections into funds via various methods. While the SEC claims sponsors have provided support to funds over 300 times since the 1970's (over 100 of these were in September 2008), a more detailed Boston Fed working paper concluded 21 funds would have broken the buck from 2007-11, absent sponsor support."

Roever writes, "Opponents of further regulation argue that much has changed since the Reserve. The deleveraging resulting from the financial crisis forced the riskiest issuers and securities out of the money markets, eliminating the proximate market risks that fostered the crisis. In addition, opponents argue that new rules governing MMFs introduced by the SEC in 2010 have reduced risk, increased liquidity, transparency and fund stability."

The JPM piece also comments, "Press reports suggest that the five SEC commissioners are split on the need for further MMF rules at this time. Chairman Mary Schapiro (I) and Commissioner Elise B. Walter (D) are in favor of additional reforms, while the two Republican commissioners, Troy A. Parades and Daniel M. Gallager are opposed. Commissioner Luis A. Aguilar (D) is viewed as the swing vote, but he has not embraced the need for additional reforms, and is thought to be against the SEC proposing new MMF rules at this time."

It adds, "Reportedly, the SEC staff has drafted a 337-page document containing proposals and questions for public comment that so far has been circulated only to the commissioners and their staffs. For the proposal to be officially released to the public, 3 of the 5 commissioners would have to vote to approve a release. Schapiro is said to be targeting a public vote of the commissioners for this purpose as soon as August 29, although that date might drift if she cannot lock down a majority until then."

Finally, the piece says, "Proceeding with a vote to release a proposal without a majority is politically risky. On the one hand, a vote would put all of the commissioners on record for or against reform, perhaps allowing for more direct political pressure to be applied on the opponents. Even if there were a 3-2 vote against releasing the current proposals, it may be possible to revisit the reforms in the future if the commissioners' views, or the commissioners themselves, change. On the other hand, the SEC is busy with many issues besides MMFs. With the Dodd-Frank rule writing woefully behind schedule, pursuing these same proposals after a negative vote borders on quixotic, and may draw unwelcome political pressure from Congress and others."

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