On Tuesday, the Financial Stability Oversight Council issued a "Proposed Recommendations Regarding Money Market Mutual Fund Reform." The 72-page document says, "Reforms to address the structural vulnerabilities of money market mutual funds ("MMFs" or "funds") are essential to safeguard financial stability. MMFs are mutual funds that offer individuals, businesses, and governments a convenient and cost-effective means of pooled investing in money market instruments. MMFs are a significant source of short-term funding for businesses, financial institutions, and governments. However, the 2007–2008 financial crisis demonstrated that MMFs are susceptible to runs that can have destabilizing implications for financial markets and the economy." (See the FSOC Meeting webinar here.)
It explains, "The Securities and Exchange Commission ("SEC") took important steps in 2010 by adopting regulations to improve the resiliency of MMFs (the "2010 reforms"). But the 2010 reforms did not address the structural vulnerabilities of MMFs that leave them susceptible to destabilizing runs. These vulnerabilities arise from MMFs' maintenance of a stable value per share and other factors as discussed below. MMFs' activities and practices give rise to a structural vulnerability to runs by creating a "first-mover advantage" that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to an MMF's value or liquidity. Because MMFs lack any explicit capacity to absorb losses in their portfolio holdings without depressing the market-based value of their shares, even a small threat to an MMF can start a run. In effect, first movers have a free option to put their investment back to the fund by redeeming shares at the customary stable share price of $1.00, rather than at a price that reflects the reduced market value of the securities held by the MMF."
The FSOC proposal continues, "The broader financial regulatory community has focused substantial attention on MMFs and the risks they pose. Both the President's Working Group on Financial Markets ("PWG") and the Financial Stability Oversight Council ("Council") called for additional reforms to address the structural vulnerabilities in MMFs, through the PWG's 2010 report on Money Market Fund Reform Options and unanimous recommendations in the Council's 2011 and 2012 annual reports, respectively. In October 2010, the SEC issued a formal request for public comment on the reforms initially described in the PWG report, and in May 2011 the SEC hosted a roundtable on MMFs and systemic risk in which several Council members and their representatives participated. However, in August 2012, SEC Chairman Schapiro announced that the SEC would not proceed with a vote to publish a notice of proposed rulemaking to solicit public comment on potential structural reforms of MMFs."
It adds, "Under Section 120 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), if the Council determines that the conduct, scope, nature, size, scale, concentration, or interconnectedness of a financial activity or practice conducted by bank holding companies or nonbank financial companies could create or increase the risk of significant liquidity, credit, or other problems spreading among bank holding companies and nonbank financial companies, the financial markets of the United States, or low-income, minority, or under-served communities, the Council may provide for more stringent regulation of such financial activity or practice by issuing recommendations to a primary financial regulatory agency to apply new or heightened standards or safeguards. The recommended standards and safeguards are required by Section 120 to take costs to long-term economic growth into account, and may include prescribing the conduct of the activity or practice in specific ways, such as applying particular capital or risk-management requirements."
FSOC writes, "The Council is proposing to use this authority to recommend that the SEC proceed with much-needed structural reforms of MMFs. There will be a 60-day public comment period on the proposed recommendations. The Council will then consider the comments and may issue a final recommendation to the SEC, which, pursuant to the Dodd-Frank Act, would be required to impose the recommended standards, or similar standards that the Council deems acceptable, or explain in writing to the Council within 90 days why it has determined not to follow the recommendation."
They say, "Pursuant to Section 120, the Council proposes to determine that MMFs' activities and practices could create or increase the risk of significant liquidity, credit, and other problems spreading among bank holding companies, nonbank financial companies, and U.S. financial markets. This is due to the conduct and nature of the activities and practices of MMFs that leave them susceptible to destabilizing runs; the size, scale, and concentration of MMFs and the important role they play in the financial markets; and the interconnectedness between MMFs, the financial system and the broader economy that can act as a channel for the transmission of risk and contagion and curtail the availability of liquidity and short-term credit."
FSOC explains, "Based on this proposed determination, the Council seeks comment on the proposed recommendations for structural reforms of MMFs that reduce the risk of runs and significant problems spreading through the financial system stemming from the practices and activities described above. The Council is proposing three alternatives for consideration: Alternative One: Floating Net Asset Value. Require MMFs to have a floating net asset value ("NAV") per share by removing the special exemption that currently allows MMFs to utilize amortized cost accounting and/or penny rounding to maintain a stable NAV. The value of MMFs' shares would not be fixed at $1.00 and would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds."
They continue, "Alternative Two: Stable NAV with NAV Buffer and "Minimum Balance at Risk." Require MMFs to have an NAV buffer with a tailored amount of assets of up to 1 percent to absorb day-to-day fluctuations in the value of the funds' portfolio securities and allow the funds to maintain a stable NAV. The NAV buffer would have an appropriate transition period and could be raised through various methods. The NAV buffer would be paired with a requirement that 3 percent of a shareholder's highest account value in excess of $100,000 during the previous 30 days -- a minimum balance at risk (MBR) -- be made available for redemption on a delayed basis. Most redemptions would be unaffected by this requirement, but redemptions of an investor's MBR itself would be delayed for 30 days. In the event that an MMF suffers losses that exceed its NAV buffer, the losses would be borne first by the MBRs of shareholders who have recently redeemed, creating a disincentive to redeem and providing protection for shareholders who remain in the fund. These requirements would not apply to Treasury MMFs, and the MBR requirement would not apply to investors with account balances below $100,000."
They continue, "Alternative Three: Stable NAV with NAV Buffer and Other Measures. Require MMFs to have a risk-based NAV buffer of 3 percent to provide explicit loss-absorption capacity that could be combined with other measures to enhance the effectiveness of the buffer and potentially increase the resiliency of MMFs. Other measures could include more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements. The NAV buffer would have an appropriate transition period and could be raised through various methods. To the extent that it can be adequately demonstrated that more stringent investment diversification requirements, alone or in combination with other measures, complement the NAV buffer and further reduce the vulnerabilities of MMFs, the Council could include these measures in its final recommendation and would reduce the size of the NAV buffer required under this alternative accordingly."
FSOC explains, "These proposed recommendations are not necessarily mutually exclusive but could be implemented in combination to address the structural vulnerabilities that result in MMFs' susceptibility to runs. For example, MMFs could be permitted to use floating NAVs or, if they preferred to maintain a stable value, to implement the measures contemplated in Alternatives Two or Three. Other reforms, not described above, may be able to achieve similar outcomes. Accordingly, the Council seeks public comment on the proposed recommendations and other potential reforms of MMFs. Comments on other reforms should consider the objectives of addressing the structural vulnerabilities inherent in MMFs and mitigating the risk of runs. For example, some stakeholders have suggested features that only would be implemented during times of market stress to reduce MMFs’ vulnerability to runs, such as standby liquidity fees or gates. Commenters on such proposals should address concerns that such features might increase the potential for industry-wide runs in times of stress."
Finally, FSOC adds, "The Council recognizes that regulated and unregulated or less-regulated cash management products (such as unregistered private liquidity funds) other than MMFs may pose risks that are similar to those posed by MMFs, and that further MMF reforms could increase demand for non-MMF cash management products. The Council seeks comment on other possible reforms that would address risks that might arise from a migration to non-MMF cash management products. Further, the Council is not considering MMF reform in isolation. The Council and its members intend to use their authorities, where appropriate and within their jurisdictions, to address any risks to financial stability that may arise from various products within the cash management industry in a consistent manner. Such consistency would be designed to reduce or eliminate any regulatory gaps that could result in risks to financial stability if cash management products with similar risks are subject to dissimilar standards. In accordance with Section 120 of the Dodd-Frank Act, the Council has consulted with the SEC staff. In addition, the standards and safeguards proposed by the Council take costs to long-term economic growth into account."
The announcement also says, "Interested persons are invited to submit comments on all aspects of Proposed Recommendations Regarding Money Market Mutual Fund Reform according to the instructions below. All submissions must refer to docket number FSOC-2012-0003. Electronic Submission of Comments. Interested persons may submit comments electronically through the Federal eRulemaking Portal at http://www.regulations.gov. Electronic submission of comments allows the commenter maximum time to prepare and submit a comment, ensures timely receipt, and enables the Council to make them available to the public. Comments submitted electronically through http://www.regulations.gov can be viewed by other commenters and interested members of the public. Commenters should follow the instructions provided on that site to submit comments electronically."
