We go back to the well to review more Comments to the FOSC's "Proposed Recommendations Regarding Money Market Mutual Fund Reform", focusing on two letters from retail money fund managers. Today, we excerpt from USAA's and Waddell & Reed's letters to the Financial Stability Oversight Council. The "Comment from Waddell & Reed Investment Managment Company" says, "As portfolio managers for Waddell & Reed Investment Management Company and Ivy Investment Management Company we are responsible for three prime retail money market funds with assets totaling $1.5 billion. Together, we have a combined industry specific experience of 40 years, including the financial crisis of 2008. We appreciate the opportunity to comment on the issue of proposed money market mutual fund reform and hope to provide more perspective from the standpoint of retail investment managers and our investors, whose interests we believe are underrepresented in the ongoing regulatory process."
Authors Sabrina Saxer & Mira Stevovich explain in "General Comments Regardsing Retail Funds," "The proposed reforms unfairly penalize and disadvantage retail shareholders by failing to differentiate them from institutional investors. Retail funds typically have a broad and granular investor base with average account balances that are much smaller than institutional accounts. Because of the granular investor base, individual investor behavior is highly unlikely to materially influence the value or liquidity of a retail money market fund. Retail investors typically use money market funds as savings vehicles whereas institutional funds use them for working capital management or safe havens. Money market funds provide retail investors access to investments not otherwise affordable or accessible, in particular, instruments issued in high dollar denominations. This provides an opportunity for investment diversification and higher yields than traditional savings accounts."
They continue, "Additional regulation threatens the economic viability of smaller retail funds, potentially causing further industry consolidation and increased deposits of FDIC insured banks. Both of these outcomes seem contrary to the FSOC's objectives, in particular, exposing U.S. taxpayers to more risk of bank failures. Retail funds currently represent $916 billion of industry assets. Under normal market conditions, these assets are a pool of consistent and stable funding for the short term capital markets. In the past four years, over 26% of retail money market fund investors have left the market mostly due to fund closings. Since the beginning of 2008, more than 23% of retail money market funds have closed due to artificially low interest rates and the regulatory environment. Further regulation could continue to chip away at this source of funding. Continuing to disaggregate the retail investor base could cause a permanent contraction in the short term funding market."
Waddell adds, "A floating NAV will modify investor expectations in a negative way and will not eliminate the risk of a run on a fund. Certain surveys such as the 2012 AFP Liquidity Survey and Fidelity's "The Investor's Perspective" indicate that investors will be less willing to invest in money market funds and would reduce or eliminate their holdings. There is no way to completely regulate away market risk. Investors will always have some incentive to redeem out of or sell any financial product, including bank deposits, if they fear losses. A floating NAV did not stop mass exodus from equity funds during the financial crisis of 2008. The implementation of a floating NAV could have unforeseen consequences. Floating money market fund NAVs could cause speculative or irrational investor behavior."
They write, "The money market fund industry has already contracted significantly both in terms of the number of funds and assets. The largest funds have become bigger and hundreds of funds have closed because of the costs associated with regulation and 5 years of artificially low interest rates. Municipal funds are down by over 41%. Government funds are the only class of money market funds that have gained assets since the beginning of January 2008, increasing by almost 21% or $161 billion. Of this increase, only $10 billion was in government retail funds."
Finally, Waddell tells FSOC, "Money market funds are a regulatory success story with only two funds in the history of their existence ever breaking the buck. In both of these instances, only shareholders experienced losses. The credit crisis of 2008 was not caused by the actions of money market funds or their shareholders, however it did expose some areas of weakness that have been addressed through the 2a-7 reforms of 2010. Money market funds are an important source of funding for the global economy, providing efficient and cost effective financing for borrowers and historically higher yields for investors than bank deposit accounts. Changing the fundamental nature of these funds is unnecessary and will negatively impact the financial markets and the economy. While we do not believe additional regulation would be beneficial, we encourage the FSOC to consider retail money market funds separately in their evaluation of systemic risk and to carefully consider the unintentional consequences of disaggregation of the retail investor base."
USAA's letter comments, "USAA believes that any proposed reform targeted at MMFs should be limited to institutional funds. Retail MMFs do not pose the types of risk the Council seeks to address through its recommendations. Tailoring regulations to institutional funds protects both retail investors and the broader financial markets and addresses the potential risks noted in the Proposal.... Certain USAA affiliates sponsor and manage a family of 50 no-load retail mutual funds, including approximately $8 billion in retail MMFs. These retail MMFs are important to USAA's members because they provide a convenient short-term investment vehicle and allow retail investors access to returns from fixed-income capital markets investments that are often not accessible to individuals. At the same time, MMFs provide benefits of liquidity, stability and short term income while allowing retail investors to diversify risk. Without MMFs, investor options for liquid funds would be limited to checking accounts with low (or no) yield and relatively higher transaction costs. Bank savings accounts offer higher yields than checking accounts but limit monthly withdrawals and thus do not offer liquidity comparable to MMFs. It is within this context that we seek regulation that will allow retail MMFs' key attributes to remain available to our members in the shape and form they find most convenient."
They adds, "The first part of this letter describes why we believe that distinguishing between retail and institutional MMFs is appropriate and in the best interest of investors and the broader financial markets. We suggest an approach for defining "retail" and "institutional" MMFs and urge the FSOC to narrowly tailor regulation to institutional MMFs. The second part of this letter addresses the three options for reform proposed by the Council, which we believe would harm retail investors while failing to meet the Council's stated goal of preventing runs."
Finally, USAA concludes, "As the SEC acknowledged in 2009, MMFs are a key component of the U.S. financial system. We strongly believe that the essential characteristics of MMFs, including daily liquidity and a stable NAV, must be preserved in order for the MMF industry to remain viable. These essential characteristics, combined with existing securities laws and rules, have allowed MMFs to remain not only a commercially successful product and vital part of retail investors' portfolios, but also a significant source of financing within the capital markets. As the SEC acknowledged in 2009, "A 'break in the link [between borrowers and money market funds] can lead to reduced business activity and pose risks to economic growth.'" We believe that tailoring MMF reform to institutional MMFs would meet the Council's goal of providing safeguards to prevent MMF runs while protecting retail investors and preserving the MMF industry. In a bifurcated regulatory regime, retail investors could be regulated as they are today, and institutional investors could be regulated according to the additional risks they may pose on the market."
