As Comments on the FSOC's "Proposed Recommendations Regarding Money Market Mutual Fund Reform" continue to roll in (the deadline was Friday), we continue our posting of the more substantial letters. Today, we excerpt from Invesco's response, written by Head of Global Liquidity Lu Ann Katz. It says, "In summary, our views are as follows: Before undertaking reform, regulators must give adequate consideration to whether additional reform is necessary. In particular, further changes to Treasury, government and municipal MMFs appear unnecessary. We disagree with proposals to impose an artificial distinction between "retail" and "institutional" investors or MMFs. Capital buffer proposals are not feasible because there would be no practical way to fund the buffer. Furthermore, we do not believe that capital buffers prevent MMF runs. The MBR could jeopardize the continued existence of MMFs by changing their fundamental nature and undermining their utility to investors, in addition to imposing onerous administrative burdens on MMF sponsors and investors. We do not believe that a floating NAV would serve as an effective deterrent to runs on MMFs and, in any event, we have serious concerns about the feasibility of this proposal. If regulators determine that additional MMF reform is necessary, we urge consideration of a redemption gate that a MMF board could activate, with a minimum trigger of a decline in weekly liquid assets to 7.5% or less, coupled with a liquidity fee."
Invesco explains, "It is imperative that FSOC and the Securities and Exchange Commission ("SEC"), as the primary regulator for MMFs, first demonstrate clearly that further reform to MMFs -- beyond the comprehensive changes to Rule 2a-7 promulgated in 2010 (the "2010 Reforms") -- is necessary in order to further the goal of reducing systemic risk to financial markets. Given the central importance of MMFs to the stable and efficient functioning of global capital markets -- MMFs represented over $2.7 trillion in assets under management as of December 31, 2012 -- drastic changes to MMFs could have a significant adverse effect on the stability of global markets generally, a result that would be contrary to FSOC's mandate to guard against activities that "could create or increase the risk of significant liquidity, credit or other problems spreading among ... U.S. financial markets." If it is determined that further reforms are, in fact, necessary then thorough consideration must be given to the full direct and indirect impact of the proposed alternatives since there is great potential for unintended harmful consequences."
They tell us, "It is also important to recognize the significant beneficial effects of increased MMF transparency brought about by the 2010 Reforms and additional voluntary steps that have been taken within the industry. MMF investors now have access to more -- and more timely -- information than ever before regarding the funds in which they are invested. For example, Invesco and many other MMF providers are now voluntarily disclosing market value NAVs for the majority of prime MMF assets on a daily basis; this information was previously disclosed monthly with a 60-day lag. Greater access to information substantially reduces the likelihood of investors engaging in preemptive runs based on a fear of the unknown. It is also significant that market value NAVs of MMFs have experienced only de minimis fluctuations since implementation of the 2010 Reforms."
Invesco's letter continues, "In the event that regulators determine that further reforms to MMFs are necessary, any such reforms must be carefully tailored to address clearly identified risks. We strongly believe that there is no need for further changes to the rules applicable to government and Treasury MMFs.... Municipal MMFs likewise have been relatively unaffected by investor runs during periods of market turmoil.... We note that some commentators have proposed that any additional reforms be targeted solely at "institutional" rather than "retail" prime MMFs. While we acknowledge that the disruptions experienced by MMFs during the 2008 financial crisis were largely attributable to prime MMF redemptions by large investors, we believe that efforts to characterize MMFs or their investors as either "institutional" or "retail" are misplaced and impractical due to the difficulty of establishing a litmus test that can be used consistently to identify those investors most likely to trigger a MMF run."
They state, "While it may be possible to establish metrics to distinguish between "retail" and "institutional" investors, many investors could easily be characterized as either. For example, the investment behavior of the corporate treasurer for a small- or mid-sized business may arguably resemble more closely the behavior of an individual (or "retail") investor than that of a larger corporation whose investments are guided by professional investment advice. Retirement plan and bank sweep accounts may also be difficult to classify, given that a single decision maker acts on behalf of many underlying shareholders. Separating "retail" and "institutional" funds would also be extremely difficult given that many fund complexes have a large number of investors who access their MMFs through unaffiliated intermediary omnibus accounts."
The letter adds, "Imposing capital requirements on MMFs by requiring NAV buffers would be neither feasible nor effective. Furthermore, requiring MMFs to establish and maintain capital buffers to protect against investment losses would be fundamentally misguided because it would apply to investment funds a safeguard that was designed for banks. If such a change were mandated, it would drastically reduce the size and diversity of the MMF industry, which would have a destabilizing effect on short-term funding markets generally."
Invesco explains, "Fundamental obstacles would confront the implementation of capital buffers for MMFs. First, there is no practical way to fund such buffers. As a result of the ongoing ultra-low interest rate environment, MMF yields remain at historic lows and are not expected to increase significantly during the foreseeable future. A requirement to divert a portion of a MMF's earnings in order to build a NAV buffer would result in prime MMF yields essentially equaling those of Treasury MMFs.... Nor are MMF sponsors a realistic source for funding NAV buffers. To mitigate the impact on investors of low MMF yields, the vast majority of MMF sponsors are already waiving advisory fees and reimbursing fund expenses, substantially diminishing the profitability for sponsors. If saddled with an additional requirement to allocate capital to MMFs, even on a contingent basis, many of these sponsors would choose to exit the business."
They continue, "Arguably the most concerning element contained in the Proposal is the proposed requirement for MMFs to impose a MBR on investors. We believe that instituting such a "holdback" provision would fundamentally alter the nature, utility and attractiveness of MMFs as an investment product and seriously threaten the viability of the MMF industry. A principal weakness of the MBR proposal that it would remain in effect at all times, even when there is sufficient liquidity available in a MMF portfolio to fund redemptions. Full daily liquidity has been a fundamental and defining feature of MMFs since their inception and restricting access to liquidity unnecessarily -- even if an investor may not require full liquidity -- significantly alters the usefulness of the product. Our clients have clearly communicated to us their strong objections to the MBR and their disposition to eliminate or significantly reduce their use of MMFs if a MBR were introduced."
Invesco comments, "The MBR proposal also would encounter significant operational and administrative hurdles. The extensive and highly complex industry infrastructure that supports the efficient processing of MMF transactions cannot be modified easily.... Even if there were a way to implement the MBR proposal equitably, we question its effectiveness as a deterrent to investor runs in the event of a large-scale financial crisis such as was experienced in 2008. In such cases, investors may simply view the holdback as a cost of doing business and nevertheless choose to redeem in full."
They add, "History demonstrates that a floating NAV does not necessarily reduce investors' incentive to redeem during times of market stress. For example, ultra-short bond funds in the United States saw substantial outflows during 2007-8, and by the end of 2008 assets in these funds had declined more than 60% from their mid-2007 peak. A similar experience occurred with respect to French floating NAV dynamic money funds ("tresorerie dynamique" funds), which saw assets decline approximately 40% over the three months from July to September 2007; by year-end 2008, assets in these funds had fallen an additional 20 percentage points."
Invesco's comment also says, "In contrast to the alternatives suggested in the Proposal, redemption "gates" -- temporary, across-the-board suspensions of investors' ability to redeem -- have proven to be an effective method of stopping or significantly impeding investor runs. We agree with view expressed by SEC Commissioners Paredes and Gallagher that "[d]iscretionary gating directly responds, we believe, to run risk, both as to individual fund and across multiple funds, as well as to potential disparate treatment between retail and institutional investors." We also agree with these Commissioners that any such gating should be implemented at the discretion of the board of directors and that this would be "a change that would build on the 2010 reforms.""
Finally, they conclude, "The principal reform options set forth in the Proposal would threaten the continued viability of MMFs, alter their fundamental characteristics and undermine their attractiveness and usefulness to investors. Regulators should consider carefully the need for additional MMF reforms before mandating changes that have been roundly criticized by MMF investors, sponsors and many academics. Furthermore, the need for additional MMFs reforms must be determined taking into account the risks posed by the manner in which MMFs -- and financial markets generally -- operate today, rather than as they did in the past. MMFs have served a critical function in the operation of global short-term markets role for over 40 years. During that span they have enjoyed a nearly flawless record of safety and liquidity while providing shareholders with competitive investment returns. And, as acknowledged by the SEC, the 2010 Reforms have ensured that MMFs are more resilient and transparent than ever. We believe that it is important to give due weight to these facts, as well as the substantial burdens and challenges posed by potential further changes, when considering the need for any additional reforms."
