BlackRock released a comment letter Thursday which argues that the FSOC's three primary proposals "do not achieve the objective of protecting against a systemic run and negatively impact the core benefits of MMFs," and they revise and expand upon their proposal for a "Constant Net Asset Value with Standby Liquidity Fees". [We prefer the moniker ELF, for emergency liquidity fees, instead of "SLF", given The Hobbit's arrival today.] The letter says, "BlackRock appreciates the opportunity to respond to the proposed recommendations regarding money market mutual fund ("MMF") reform (the "Proposals") issued by the Financial Stability Oversight Council (the "Council"). In addition to reviewing the Proposals, our letter discusses several other reform proposals, including one, a constant net asset value fund ("CNAV"), coupled with standby liquidity fees ("SLFs"), that we believe achieves the stated objective of reform: to provide a mechanism for halting mass client redemptions (or "runs") while preserving the benefits of MMFs as both a liquidity management tool for investors and as a critical source of short term funding in the capital markets."
They explain, "We appreciate the extensive discussions and work that the Council has done in preparing these Proposals. We and our clients remain immensely grateful for the work of the various Government agencies throughout the financial crisis in 2008. The swift and decisive actions taken by multiple agencies in concert were essential in restoring confidence and order to the markets. After the 2008 crisis, we and others in the industry worked collaboratively with the SEC in 2009 to modify Rule 2a-7 under the Investment Company Act of 1940, as amended (the "Act"), to enhance the liquidity and safety of money market funds; these proposals were adopted by the SEC in 2010 and are referred to herein as the "2010 MMF Reforms". Even with the 2010 MMF Reforms, we are in agreement that further measures should be taken to protect MMF investors and the broader financial system."
BlackRock writes, "Increasingly, there are references to MMFs as "shadow banks". We would like to address this issue directly. First, the name "shadow bank" has a negative connotation, when, in fact MMFs play a critical role in what we call "market finance". Second, the term "shadow bank" implies that while banks are regulated, MMFs are not regulated. While it is true that banks are subject to capital requirements and other banking regulations, it is also true that MMFs are subject to a host of mutual fund and MMF-specific regulations."
They tell us, "While some bank deposits are guaranteed by the Federal Deposit Insurance Corporation ("FDIC"), MMFs clearly disclose that shares are not insured by the FDIC, the Federal Reserve Board or any other agency and are subject to investment risks, including the possible loss of principal amount invested. While many cite an "implied guarantee" for MMFs, in the case of The Reserve Fund, investors did not recoup $1.00 upon liquidation of the Reserve Fund; the final recovery for investors was approximately $0.99. Clearly, MMFs are not guaranteed and investors understand that they bear the risk of investment results." Banks and MMFs also differ in terms of both transparency and liquidity."
BlackRock explains, "One of the primary concerns expressed about MMFs is the potential for a "run". Sometimes this issue is linked to the accounting conventions used in MMFs which allow the net asset value to be rounded to $1.00; these funds are called stable NAV or CNAV funds. An assumption is made that investors will run when the market value of the portfolio (also known as the mark-to-market or shadow NAV) is less than the "official" NAV of $1.00. In reality, the adoption and continued use of MMFs by investors are driven fundamentally by three things: the quality of the assets in the MMFs, the limited duration of those assets and the amount of available liquidity held in the MMFs."
They continue, "Economists speculate about the potential first mover advantage in a CNAV fund; however, in our experience, clients decide to leave a MMF based on their assessment of the quality of assets, duration of assets and liquidity levels and their assessment of whether those are deteriorating in an unusually dramatic way. Moreover, we and academics who have studied this believe that in FNAV MMFs, the potential for a first mover advantage is still present. Because MMFs will sell their most liquid assets first to support redemptions, the remaining investors will be left with a riskier, less liquid portfolio. Consequently, the first mover advantage still exists whether the NAV of a fund is floating or constant. In observing actual investor behavior, the primary reason for a run is a crisis of confidence. In 2008, liquidity had already seized in the capital markets well before The Reserve Fund broke the buck. This incident was simply the final straw which shattered what little remained of investor confidence and led to panic behavior. Investors were fearful about the creditworthiness of the underlying assets given the seeming meltdown of the global financial system, and they made the decision that they could not take any risk given the overall environment; they therefore liquidated their holdings in Prime MMFs."
The BlackRock letter says, "Agreeing on the objectives and scope of additional reforms is critical to defining potential solutions. Many commenters, including the Chairman of the SEC, have cited protecting against systemic runs (and protecting taxpayers) as the key objective of MMF reforms. Others have noted the need to be able to support an individual fund which is experiencing a credit impairment. Yet others want to be assured that investors recognize the risk of MMFs and even want investors to explicitly pay for the CNAV feature. And, finally, investors and borrowers have expressed concern that MMFs remain a viable product given the important role of MMFs in the broader economy. As discussed in the prior section, investors have demonstrated that they understand the risks of investing in MMFs. We believe that any further MMF regulation must satisfy a two-part test: a. Preserve the benefits of the product as a liquidity management tool for investors and preserve the functioning of the short-term funding markets; and b. Provide a mechanism for managing mass client redemptions, or "runs" and minimize the risk of a run on a single fund triggering a systemic run."
They add, "The Council further suggests that there may be a solution involving liquidity gates and/or redemption fees. In a subsequent section, we present our CNAV with SLFs proposal, and we present an evaluation of each of the Council's Proposals. As detailed further in the discussion of each Proposal, we are concerned that the three primary Proposals do not achieve the objective of protecting against a systemic run and negatively impact the core benefits of MMFs, whereas the CNAV with SLFs Proposal is specifically designed to address these issues."
BlackRock tells us, "Several additional topics have been raised in discussions of MMF reform. We have included a special section addressing a range of topics that examine the potential structural reforms of MMFs. These topics include (i) the scope of the new rule in terms of which types of money market funds will be covered; (ii) the benefits of single versus multiple types of Prime MMFs; (iii) sponsor support; (iv) the importance of a transition period for any new rules; (v) the need for and the approach to harmonizing rules on cash products regulated outside of Rule 2a-7; (vi) the value of transparency into data on underlying clients in managing MMFs; and (vii) the challenges of differentiating between retail and institutional clients."
The description of "BlackRock's Constant Net Asset Value with Standby Liquidity Fees Proposal," says, "The Council's Proposals considered alternative ideas for structural reform, and Section V. D of their recommendations describes a potential solution using liquidity fees and/or gates. This section also raised the question of whether this structure would increase the likelihood of preemptive runs along with a number of other important questions. Below, we describe a structure that uses a CNAV Fund with SLFs to stop a run, and we also respond to the questions raised by the Council."
They explain, "The basic features of a CNAV fund with SLFs would include: 1. Objective triggers. The SLFs would not be active during times of normal market functioning. We recommend that SLFs be triggered when a fund has fallen to one half of the required weekly liquidity levels under Rule 2a-7.... 2. Enhanced transparency. This proposal would include a requirement of a weekly public disclosure with a 5-business day delay of the mark-to-market NAV and daily disclosure of Weekly Liquid Asset Levels based on the prior day's close. 3. Gates.... 4. Standby Liquidity Fee. We recommend that a fee of 1% be imposed on withdrawals occurring after the gate has been put in place.... With SLFs in place, the NAV of a fund would improve as investors who leave are charged a fee, which would create a natural brake on a run, and investors remaining in the fund would be protected from the behavior of those who redeemed. 5. Removal of SLF and Special Distribution. Any SLFs gathered by the fund would be retained in the fund to restore the NAV. Once the NAV reached $1.00, the SLF would be removed and the fund would return to functioning normally."
