As we wrote yesterday, Investment Company Institute President & CEO Paul Stevens delivered the opening keynote to the 5th annual Crane's Money Fund Symposium in Baltimore (which runs through Friday). Today, we excerpt more from his speech. Entitled, "Top of the Ninth? The State of Play for Money Market Funds," Stevens says, "From the start, ICI and the fund industry have consistently supported measures designed to make money market funds more resilient, subject to two conditions. First, we must preserve the key features of money market funds that make them so valuable for investors and issuers. Second, we must preserve choice for investors by ensuring a robust and competitive global money market fund industry. The 2010 amendments to Rule 2a-7 met those conditions -- they made money market funds stronger without damaging their core features or undermining competition."
He explains, "[M]oney market funds are plainly much stronger products than they were in 2008. Unfortunately, this evidence was largely dismissed last summer, when the SEC was working on proposals championed by then-Chairman Mary Schapiro. As members of the Commission themselves noted, those 2012 proposals were drafted without a proper economic study on the impact of the 2010 reforms. Instead, as Commissioner Gallagher said, the 2012 proposal was prepared "without the input of the Commissioners and presented to the Commission as an inviolate fait accompli." We all know what happened: A bipartisan majority of the Commission opposed Chairman Schapiro's plan, and she in turn invited the Financial Stability Oversight Council, or FSOC, to intervene in the issue. Or, to quote Commissioner Gallagher again, the SEC "abdicate[d] responsibility for money market fund regulation to the Financial Stability Oversight Council.""
Stevens tells us, "That rush to judgment clearly was a mistake -- for the SEC as an institution and indeed for all concerned. The flawed ideas for capital buffers and redemption holdbacks that the Council put forward clearly reflected FSOC's domination by banking regulators -- with their decades-old antipathy toward money market funds, indifference to the interests of investors, and faith in bank regulatory concepts. Fortunately, the regulatory process took a distinct and encouraging turn for the better last autumn, thanks to the persistent efforts of the SEC. Last November, the agency's Division of Risk, Strategy, and Financial Innovation released an economic study that offered the first official examination of the experience of money market funds in 2008 and the effectiveness of the SEC's 2010 reforms. The Commissioners who insisted on this study recognized that no one -- not the President's Working Group, not FSOC, and not even the SEC under its former leadership -- had attempted such an objective, rigorous analysis."
He explains, "Then-Chairman Elisse Walter launched a collaborative process to bring forward a new proposal, considering the views of all the commissioners as well as the economic analysis that the staff and others have offered. And in first her two months on the job, SEC Chair Mary Jo White has engaged deeply on this issue. Crucially, she has made it clear that she grasps the vital role that money market funds play in our financial system. Indeed, the SEC should be strongly commended for pursuing an appropriate and thoughtful process before bringing the current proposal to a vote."
Stevens continues, "The Commission has unique expertise -- expertise in depth, developed over eight decades of overseeing the U.S. securities markets. The SEC recognizes the crucial role that money market funds play for individuals, businesses, state and local governments, and nonprofits. As the Commission's release states, these funds are not just "popular cash management vehicles for both retail and institutional investors," but also provide "an important source of financing" for the economy. And significantly, the SEC has recognized that different types of money market funds pose different risks and thus should be addressed by different reforms."
He states, "Against this backdrop, it seems clear that the FSOC would have no basis for intervening in this regulatory process again. Fortunately, we've heard recently from regulators in Washington who recognize and support the SEC's role as the industry's primary regulator. For instance, Mary John Miller, the U.S. Treasury Department's Under Secretary for Domestic Finance, recently appeared at ICI's General Membership Meeting. Under Secretary Miller, who coordinates Treasury's capital markets policy, said that the FSOC would "gladly" defer to the SEC as the Commission proceeds with another round of reforms. We think that deference to the SEC is the appropriate and correct approach."
Stevens explains, "That doesn't mean we love everything in the SEC's proposal -- because we do not. But we respect the integrity of the process that Chairs Walter and White have pursued. So let's turn now to substance -- the content and quality of the ideas the Commission has brought forward. As you all know, the 698-page proposal has three central components that can either stand alone or be combined. Reform option number one: requiring Institutional prime and tax-exempt funds to adopt floating net asset values. This proposal exempts funds that invest principally in Treasury and government agency securities, reflecting the SEC's recognition that different types of funds pose different risks. It also attempts to exempt "retail" funds, which the SEC identifies as those that would bar shareholders from redeeming more than $1 million per business day."
He says, "Reform option number two would allow all money market funds to offer a stable NAV, coupled with the new ability to impose liquidity fees and redemption gates when a fund's liquidity is constrained. Government funds would not be required to offer fees and gates, although they could opt in. Under this alternative, if a money market fund's level of weekly liquid assets dipped below 15 percent of its total assets, the fund would impose a liquidity fee of up to 2 percent on all redemptions, unless its board determines the fee is not in the fund's best interests. As for gates, the proposal sets forth that once a money market fund crosses the 15 percent threshold, its board of directors may temporarily suspend redemptions altogether."
Stevens adds, "The third core component of the proposal provides a set of enhanced standards on disclosure, reporting, and diversification. Those are the broad outlines. Please understand that we have had just two weeks to study the 698 pages of detail fleshing out the proposal. There is a lot to chew over. With that in mind, what do we make of it so far? Let's work backwards, starting with the third component that I mentioned: enhanced disclosure and diversification. We're still examining the particulars, but we see potential for positive changes. Some of these items bring the rules up to speed with practices already taking place in the industry. For example, many fund complexes are already disclosing their funds' mark-to-market value on a daily basis. We need more time, however, to assess the costs of providing the other disclosures, and how the information would affect investors."
He tells the Baltimore crowd of 450, "Next, alternative two: liquidity fees and redemption gates. To us, this is the best alternative. Liquidity fees and gates precisely address the core problem that regulators express greatest concern about: heavy redemption pressure in periods of market turmoil. A liquidity-based trigger introduces immediate redemption frictions and exacts a substantial cost for liquidity when liquidity in a particular fund is at a premium. Liquidity fees, if deemed appropriate by a fund's board, still allow investors access to their cash. But the fees compensate both the fund and its remaining shareholders for the potential cost to the fund of withdrawing liquidity. Thus, the fees both help slow redemptions and protect investors when they most need that protection."
Stevens continues, "As for temporary gates, they provide breathing room for a fund under intense pressure. They give the fund's board time to assess whether it can restore liquidity or should move to an orderly liquidation. Fees and gates also can relieve other funds and the markets if they too are facing tight liquidity pressures. A number of European funds -- and a few U.S. funds -- were able to suspend redemptions during the financial crisis in 2008, and thus successfully protected their investors. Some critics claim that liquidity fees and gates will induce "preemptive runs" -- that investors will flee a fund when its weekly liquidity is approaching the trigger. We don't buy that. As Commissioner Paredes pointed out, under the SEC's proposal, fees and gates are imposed at the discretion of the board -- so investors "may find it difficult to redeem preemptively with any confidence that their timing is correct.""
He says, "It's also important to note that these gates and fees are triggered on a fund-by-fund basis. So even if investors redeem preemptively at one fund, any systemic effect -- in other words, spillover to other funds -- is unlikely.... Finally, I'll mention what is perhaps the foremost advantage to liquidity fees and redemption gates: the approach would in no way limit investors' access to their shares when their fund has adequate liquidity. That clearly distinguishes it from the FSOC's proposed minimum balance at risk suggestion, which would penalize investors and impose heavy costs on funds and intermediaries even when liquidity is plentiful. Thus, gates and fees would not radically change the characteristics of money market funds -- or their value to investors and the economy."
Stevens also says, "That brings me at last to the SEC's alternative number one: forcing institutional prime and tax-exempt funds to float their share prices. This option is a nonstarter, in our view. Yes, our opposition to floating NAVs remains as firm as ever. And this opposition springs in large part from the same notion that -- on the flip side -- makes liquidity fees and gates a more compelling alternative. Simply put, forcing funds to float their NAVs doesn't address the problem that most preoccupies many regulators -- how to avert heavy redemptions out of money market funds. As Commissioner Paredes quite succinctly said: "If a run does start, a floating NAV is unable to stop it.""
Finally, he adds, "Regulators also argue that floating NAVs will make investors more aware that the assets held by money market funds may fluctuate in value. The trouble with that argument is that there's no evidence that investors are operating under any illusions on that score now. And if they are, enhanced disclosure can educate them just as well -- without destroying the value of money market funds for shareholders or the markets. Failing to address the central problem that regulators want to solve -- that would seem to be one big strike against floating NAVs. Here's strike two: Floating NAVs will eliminate important benefits to investors."
