U.S. Securities & Exchange Commissioner Luis Aguilar has released a "Statement on Money Market Funds as to Recent Developments," which announces the release of an SEC study on investors behavior, the 2010 2a-7 amendments and the impacts of future reform. Aguilar says, "There have been recent developments related to the Securities and Exchange Commission's consideration of potential reform of money market funds that I would like to highlight. On November 30, 2012, the SEC staff delivered to the Commission its report delving deeper into the causes of investor redemptions in 2008, the efficacy of the Commission's 2010 amendments to strengthen Rule 2a-7 (the principal rule that governs money market funds), and the potential impacts of future reform on issuers and investors. This is a welcome development. As I previously stated (see Aguilar's Aug. 29 comment), I have been requesting this analysis so that it could inform the dialogue as to any further money market fund reform. The staff's report is a response to a request made in mid-September by a majority of the Commission (Commissioners Aguilar, Paredes and Gallagher) that asked the Division of Risk, Strategy, and Financial Innovation to conduct a study to answer a series of questions intended to inform the continuing dialogue. I look forward to the staff's report being made public, so that the Commission can benefit from the public dialogue. (This report was just released.)"

He continues, "There have also been developments in the consideration of the potential impact of assets migrating from existing transparent, regulated money market funds to opaque, unregulated funds (sometimes referred to as Liquidity Funds) as a result of structural changes to money market funds. Given the level of transparency and investor engagement in regulated, transparent money market funds subject to Rule 2a-7 (the principal rule governing money market funds), it remains a concern that assets could flow to unregulated, opaque funds. Many do not realize that due to the 2010 Amendments, money market funds have become one of the most transparent financial instruments for both regulators and investors. The SEC worked very hard to implement new disclosure requirements that now provide a great deal of useful information on individual money market funds, and the industry as a whole. As a result of these new requirements, the SEC receives monthly reports on Form N-MFP that contain a wealth of data, which is also made available to the public on a delayed basis. Moreover, investors and interested parties are able to monitor a fund's portfolio holdings through its website. Additionally, other domestic and foreign regulators have relied on the data to understand money market fund holdings as they affect other regulated entities within the financial system. Accordingly, the transparency of regulated money market funds provides a crucial safeguard in monitoring systemic risk."

Aguilar explains, "The outflow of money fund assets to an unregulated market is a significant systemic risk concern, and can result in harm to our market and investors. As was stated by an SEC spokesperson, this was not a concern shared by the SEC staff. However, the SEC staff's recent report has now identified the issue of migration to unregulated products and is, for the first time, offering a more in-depth analysis. Moreover, the new Director of Investment Management, Norm Champ, who has experience with unregulated funds, has indicated to me that the staff is now actively considering this issue."

He writes, "Additionally, both Secretary Geithner and FSOC have expressly raised the need to address the concern of money fund assets migrating to an opaque, unregulated market as a result of structural changes to money market funds. The serious consideration by the SEC staff and FSOC of the potential migration of money fund assets to opaque, unregulated funds is also a welcome development. These developments are important to address the issues that have been identified regarding money market funds and will serve to inform the nature of any needed reforms. The goal is to act in the best interests of investors and the public interest."

The 98-page SEC study, "Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher," which was prepared by the SEC's staff of Division of Risk, Strategy, and Financial Innovation, says, "This report addresses the questions posed by Commissioners Aguilar, Paredes, and Gallagher in their September 17, 2012 memo to Chairman Schapiro and Director Lewis. The Commissioners' specific questions can be grouped into three categories. The first category addresses the causes of investor redemptions of prime money market fund shares and purchases of Treasury money market fund shares during the 2008 financial crisis. Many potential explanations exist for the money market fund flows during this period. Since the explanations are not mutually exclusive, it is not possible to attribute shareholders' redemptions and purchases to any single explanation. This report provides evidence in support of each of the different explanations such as flights to quality, liquidity, transparency, and performance. The failure of Lehman Brothers and the breaking of the buck by The Reserve Primary Fund occurred contemporaneously with fund flows, perhaps triggering them. Investors, however, did not appear to react to the earlier financial distress of Bear Stearns or the government's support of Fannie Mae and Freddie Mac."

The Executive Summary continues, "The Commissioners asked whether money market funds that break the buck outside a period of financial distress would cause a systemic problem. RSFI documents that a number of funds received or requested sponsor support during non-crisis times, an indication that defaults and rating downgrades have led to significant valuation losses for individual funds. With the exception of The Reserve Primary Fund, however, these funds' distress did not trigger industrywide redemptions. This finding suggests that idiosyncratic portfolio losses may not cause abnormally large redemptions in other money market funds. However, data is limited even on these and other potential events because the instances where sponsor support was provided generally were not publically disclosed to money market fund investors and thus, it is difficult to determine the exact number of funds that might have been affected or the consequences if investors had been aware of sponsor support."

The study says, "The second category of Commissioner questions covers the efficacy of the 2010 money market fund reforms in three general areas: fund characteristics, the events during the summer of 2011 and an analysis of the potential effect of the reforms on money market funds in 2008 had they been in place. First, the report considers the effects of the reforms on fund characteristics, including interest rate risk, liquidity, and credit risk. The report documents that the reduction in maximum weighted average maturity (WAM) from 90 to 60 days did not cause all funds to lower their WAMs. Instead, the largest effect was on funds that had WAMs above 60 days. For example, the 95th percentile decreased from approximately 70 days at the end of 2009 to approximately 55 days at the end of 2010. The range of fund shadow prices contracted after the 2010 reforms."

Finally, the summary adds, "Third, the Commissioners asked how money market funds would likely have performed during the events of September 2008 had the 2010 reforms been in place at the time. The effect of heightened liquidity standards on fund resiliency, given specific levels of capital losses and redemption activity, is examined using money market fund portfolio holdings in September 2008. The findings indicate that funds are more resilient now to both portfolio losses and investor redemptions than they were in 2008. That being said, no fund would have been able to withstand the losses that The Reserve Primary Fund incurred in 2008 without breaking the buck, and nothing in the 2010 reforms would have prevented The Reserve Primary Fund's holding of Lehman Brothers debt. The third set of questions relates to how future reforms might affect the demand for investments in money market fund substitutes and the implications for investors, financial institutions, corporate borrowers, municipalities, and states that sell their debt to money market funds." (Look for more excerpts from the Study tomorrow.)

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