We wrote last Thursday about the SEC's new study, "Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher," which "addresses the questions posed by Commissioners Aguilar, Paredes, and Gallagher in their September 17, 2012 memo to Chairman Schapiro." While the 98-page study has very little new information and many of its conclusions appear predetermined and speculative, there is an interesting section on Investment Alternatives to Money Market Funds. The SEC attempts to answer the question, "If money market funds were to be fundamentally restructured and investors were then to shun such funds, to where would those assets migrate?" They say, "Money market fund investors have many investment options, each offering a different combination of price stability, risk exposure, return, investor protections, and disclosure. This subsection analyzes the characteristics of money market fund alternatives and discusses where current money market fund investors might invest if they find money market funds are no longer a viable investment."
The study explains, "Table 6 [see page 38-39] outlines the principal features of various cash investment alternatives to prime and Treasury money market funds, as currently defined. The features examined include how alternatives are valued, their investment risk relative to a "Benchmark" (defined as a representative prime money market fund), current redemption restrictions, expected yield relative to the Benchmark, whether products are regulated, and whether restrictions exist on investor eligibility. Existing investment alternatives to prime funds include the following: bank deposit accounts, bank collective trust funds, local government investment pools, offshore funds, private funds, separately managed accounts, ultra-short bond funds, short-duration exchange-traded funds, and direct investments in money market instruments. Each of these choices involves different tradeoffs, and none are perfect substitutes for money market funds."
The SEC study continues, "[M]oney market fund investors would have to analyze the various tradeoffs associated with a shift to one of the available cash investment alternatives. These alternatives may create additional operational costs or complexities, and they may impose redemption restrictions or other limitations on liquidity. For example, investors that highly value principal stability would likely consider shifting investments to Treasury money market funds or bank deposits, but would be unlikely to prefer ultra-short bond funds, short-duration ETFs, collective investment funds, or separately managed accounts that do not offer principal stability. If such investors shift their investments to Treasury money market funds, they would sacrifice yield, but they would not generally increase investment risk, principal stability, or liquidity. If they shift to bank CDs, they would not increase investment risk or principal stability, but they would sacrifice liquidity. Most other alternatives would likely involve increased investment risk."
It says, "Thus, the extent to which investors would use the above investment vehicles as substitutes for prime money market fund shares, in part, depends on individual preferences. Some alternatives, such as LGIPs, STIFs, offshore money market funds, separately managed accounts, and direct investments in money market instruments involve significant restrictions on the types of investors that can be accepted, which would render these alternatives unavailable to most current money market fund investors. For example, offshore money market funds can only sell shares in private offerings to U.S. investors, and many prefer to avoid doing so, because it may result in the loss of certain Securities Act exemptions and create adverse tax consequences."
The SEC writes, "Some qualified investors may have additional self-imposed restrictions or fiduciary duties that limit the risk they can assume. Many unregistered or offshore potential money market fund substitutes -- unlike registered money market funds in the United States -- are not prohibited from imposing gates or suspending redemptions. Several other alternative investments also can impose redemption restrictions. Investors placing a high value on liquidity may find the potential imposition of these restrictions unacceptable and thus not view them as viable alternatives. Investors who value the disclosure and protections afforded to them by U.S. securities regulations may not regard private funds and some offshore funds as alternatives to prime money market funds."
It adds, "Money market fund investors that prefer yield over principal stability and low investment risk are likely to shift their investments into floating NAV offshore money market funds, floating value enhanced cash funds, ultra-short bond funds, collective investment funds, short-duration ETFs, or separately managed accounts. One practical constraint is that some investors may not have access to LGIPs, STIFs or offshore money market funds due to the significant restrictions on who is eligible to participate. For example, most existing LGIPs are not registered with the SEC, as states and local state agencies are excluded from regulation under the U.S. federal securities laws. By contrast, STIFs only are offered to accounts for personal trusts, estates, and employee benefit plans that are exempt from taxation under the U.S. Internal Revenue Code, and offshore money funds are investment pools domiciled and authorized outside the United States."
The SEC tells us, "Finally, investors are unlikely to view private funds, such as enhanced cash funds that are privately offered to institutions, wealthy clients, and certain types of trusts, as equivalent investments because of their greater investment risk, limitations on investor base, and lack of legal protections. However, some investors could shift to stable NAV private funds because they provide a closer substitute to money market funds."
They say, "As noted above, some retail investors, particularly those with investment levels that are fully covered by the FDIC insurance limits, may shift their assets to bank deposits. The shift to bank deposits would increase reliance on FDIC deposit insurance and increase the size of the banking sector, which raises additional concerns about the concentration of risk in the economy. However, it is unlikely that many large institutional investors will follow suit. Interest-bearing accounts at depository institutions are insured only through $250,000. Although non-interest bearing transaction accounts at depository institutions are fully insured today, starting in January 2013 they also will only be insured up to $250,000."
Finally, the study adds, "[B]oth individual and business holdings in checkable deposits and currency have significantly increased in recent years relative to their holdings of money market fund shares. The 2012 AFP Liquidity Survey indicates that bank deposits account for 51 percent of the surveyed organizations' short-term investments in 2012, which is up from 25 percent in 2008. Money market funds account for 19 percent of these organizations' short-term investments in 2012 down from 30 percent just a year earlier, and down from almost 40 percent in 2008. This shift has likely been motivated by the availability of unlimited FDIC insurance on non-interest bearing accounts since the end of 2010, and may be likely to reverse if it is eliminated in January 2013."
