As expected, the Securities & Exchange Commission unanimously approved a proposal on "Reforming Money Market Funds" (see yesterday's "News"). The SEC's press release says, "The Securities and Exchange Commission today voted unanimously to propose rules that would reform the way that money market funds operate in order to make them less susceptible to runs that could harm investors. The SEC's proposal includes two principal alternative reforms that could be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for prime institutional money market funds. The other alternative would allow the use of liquidity fees and redemption gates in times of stress. The proposal also includes additional diversification and disclosure measures that would apply under either alternative. The SEC began evaluating the need for money market fund reform after the Reserve Primary Fund "broke the buck" at the height of the financial crisis in September 2008." "Our goal is to implement effective reform that decreases the susceptibility of money market funds to runs and prevents events like what occurred in 2008 from repeating themselves," said Mary Jo White, Chair of the SEC. The public comment period for the proposal will last for 90 days after its publication in the Federal Register." (Note: The SEC has also now released the full 698-page text of its "Money Market Fund Reform" Proposal.)
While we await the release of the actual 500+-page document to see specifics, we excerpt from some of the Commissioner's speeches. Chairman White's "Opening Statement at the SEC Open Meeting" says, "It has been a journey to get to this point. Commission staff has spent literally years studying different reform alternatives and performing extensive economic analysis in arriving at these recommendations. These proposals are important in and of themselves and because they advance the public debate that will shape the final rules to address one of the most prominent events arising from the financial crisis. Today's proposal contains two alternative reforms that could be adopted separately or combined into a single reform package to address run risk in money market funds."
She explains, "The first proposed alternative would require that all institutional prime money market funds operate with a floating net asset value (NAV). That is, they could no longer value their entire portfolio at amortized cost and they could not round their share prices to the nearest penny. The set "dollar" would be replaced by a share price that actually fluctuates, reflecting the changing values in these money market funds. This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds. Retail and government money market funds - which have not historically faced runs in even the worst of times - would be exempt from the proposed floating NAV requirement."
White comments, "This approach would thus preserve the stable value fund product for those retail investors who have found it to be convenient and beneficial. It also would allow municipal and corporate investors to have access to government money market funds - a stable value product - if they need it, although it would be a product that holds federal government securities as opposed to the higher-yielding investments of a prime fund. We are soliciting commenters' views regarding the impact of targeting the floating NAV reform to institutional prime funds and whether government and retail money market funds also should operate with a floating NAV, as well as commenters' views regarding whether today's proposal would effectively differentiate retail funds from institutional funds by imposing a $1 million redemption limit. These and other important questions are specifically posed in the proposal."
She adds, "I believe the floating NAV reform proposal is important for a number of reasons: First, by eliminating the ability of early redeemers to receive $1.00 - even when the fund has experienced a loss and its shares are worth somewhat less - this proposal should reduce incentives for shareholders to redeem from institutional prime money market funds in times of stress. Second, the proposal increases transparency and highlights investment risk because shareholders would experience price changes as an institutional prime money market fund's value fluctuates. And, third, the proposal is targeted, by focusing reform on the segment of the market that experienced the run in the financial crisis."
White also says on "Fees & Gates," "The second proposed alternative seeks to directly counter potentially harmful redemption behavior during times of stress. Under this alternative, non-government money market funds would be required to impose a 2 percent liquidity fee if the fund's level of weekly liquid assets fell below 15 percent of its total assets, unless the fund's board determined that it was not in the best interest of the fund. That determination would be subject to the board's fiduciary duty, and we believe it would be a high hurdle. After falling below the 15 percent weekly liquid assets threshold, the fund's board would also be able to temporarily suspend redemptions in the fund for up to 30 days - or "gate" the fund."
She explains, "This "fees and gates" alternative potentially could enhance our regulation in several ways: First, it could more equitably allocate liquidity risk by assigning liquidity costs in times of stress (when liquidity is expensive) to redeeming shareholders - the ones who create the liquidity costs and disruption. Second, this alternative would provide new tools to allow funds to better manage redemptions in times of stress, and thereby potentially prevent harmful contagion effects on investors, other funds, and the broader markets. If the beginning of a run or significantly heightened redemptions occur, they would no longer continue unchecked, potentially spiraling into a crisis. The imposition of liquidity fees or gates would be an available tool to directly counteract a run. And, third, this approach also is targeted, focusing the potential limitations on a money market fund investor's experience to times of stress when unfettered liquidity can have real costs."
White tells us, "The two alternative approaches in today's proposal target the common goal of reducing the incentive to redeem in times of stress, albeit in different ways. Accordingly, the proposal requests comment on whether a better reform approach would be to combine the two alternatives into a single reform package - requiring that prime institutional funds have a floating NAV and be able to impose fees and gates in times of stress, and that retail funds be able to impose fees and gates. We specifically solicit and I am interested in commenters' views on this combined approach."
She explains the "Greater Diversification, Disclosure and Reporting portion," "Importantly, the staff's recommendations also contain a number of other significant reform proposals - tightening diversification requirements, enhancing disclosure requirements, strengthening stress testing and improving reporting on both money market funds and unregistered liquidity funds that could serve as alternatives to money market funds for some investors. These proposed reforms should further enhance the resiliency and transparency of this important product and are significant complements to the other proposals."
White says, "Today's proposal is the product of very hard work by all those who have sought to meaningfully reform this investment product that is such a critical piece of the nation's financial fabric. There have been important and thoughtful comments throughout this process, including suggestions and recommendations from investors, the industry, and fellow regulators. We have given them all very careful consideration and they have proven invaluable to us formulating the important proposals we are voting on today. In this regard I especially would like to thank all of my fellow Commissioners for their contributions and the spirit of cooperation in which we worked leading up to today's meeting."
Finally, she adds, "I want to reiterate that our goal is to implement an effective reform that decreases the susceptibility of money market funds to run risk and prevents money market fund events similar to those that occurred in 2008 from repeating themselves. With this goal in mind, I very much look forward to the comments and am very pleased that, with my fellow Commissioners, we are moving this reform process forward."
