Charles Schwab becomes the first of the major money fund providers to respond formally to the SEC's recent Money Market Fund Reform proposal, filing a 30-page comment letter. (The manager hosted a call for reporters this morning and sent out their letter to press, but it isn't available online yet.) The comment, written by President Marie Chandoha, says, "Charles Schwab Investment Management ("Schwab") appreciates the opportunity to provide comments on the Securities and Exchange Commission's ("Commission" or "SEC") June 2013 proposal, "Money Market Fund Reform; Amendments to Form PF". Schwab is one of the largest managers of money market fund assets in the United States, with 3 million money market fund accounts and $168 billion in assets under management as of June 30, 2013. The overwhelming majority of Schwab's fund offerings are used by retail investors who use money market funds to manage their cash. Even in the current environment, with historically-low yields on money market funds, our retail clients continue to value the convenience of this product."
She continues, "Approximately 88% of Schwab's money market fund assets are in sweep funds, with the balance in purchased funds. Sweep accounts automatically invest idle cash balances while providing investors with convenience, liquidity and yield. These sweep accounts facilitate trading in brokerage accounts, allowing individuals to seamlessly buy and sell stocks, bonds, and mutual funds. Individuals also can write checks, pay bills electronically and use debit cards on these accounts. In the context of the proposed money market fund reforms, sweep accounts present a number of unique challenges, which we will highlight in this letter."
Chandoha explains, "The proposed rules are the culmination of a multi-year effort by the Commission and the money market fund industry to find a balanced approach to reform. Schwab applauds the Commission for taking the time necessary to build consensus within the agency, for conducting the necessary research to support the proposed rules, and for its willingness to engage in substantive dialogue with Schwab and other industry participants during the process. We also appreciate the Commission's clear signal that one of its goals is, in the words of Chairman Mary Jo White, "to preserve the economic benefits of the product.""
She tells us, "The Commission has, in our view, made a good faith effort to strike an appropriate balance that will increase investor confidence in money market funds while also ensuring that the product retains its critically important role as a valued cash management tool for individual investors, corporations, municipalities, states and non-profit organizations. While we generally support the SEC's proposal, we believe the proposed rule has a number of significant flaws that need resolution before the rule is finalized. We also have concerns that the costs of the proposal, both in terms of the cost of implementation and with regard to the impact on the larger financial system, may outweigh the benefits. We offer the following comments in an attempt to strengthen the proposal and better achieve the desired balance."
The "Executive Summary" states, "Schwab generally supports the SEC's proposed money market fund reforms and recommends that the final rule combine the two alternatives proposed, subject to the recommended changes outlined in this letter, for maximum effectiveness: requiring institutional prime funds to have a floating net asset value (NAV), and allowing a fund's board to impose liquidity fees and gating of all prime, municipal and government money market funds whenever the board believes doing so is in the best interest of the fund. Not surprisingly for a 698-page rule proposal, we have a significant number of concerns about the proposed rule, and we make a number of suggestions for changes that we believe would make the rule less burdensome to implement without compromising the rule's effectiveness."
It continues, "While we detail all of those recommendations in the following pages, we want to highlight those which we believe to be most critical: 1. We recommend that the daily redemption limit for retail investors, which serves as the dividing line between "institutional investors" and "retail investors," be increased from $1 million to $5 million per business day. The $1 million redemption limit could significantly impact retail investors by triggering unexpected violations of the threshold and presenting a host of operational challenges. Those challenges, as well as the likelihood of inadvertent violations of the threshold, decrease markedly at the $5 million level. We also recommend that the Commission create a "Large Trade Order Notification" system that would allow retail investors to redeem more than the maximum daily redemption amount provided they have requested and received approval from the fund for such a transaction at least three days in advance."
Chandoha's letter also says, "2. We recommend that the daily redemption limit be applied on a per-account basis, rather than on a per-shareholder basis. We do not believe there is any realistic way to track a particular shareholder in real time to a total of $1 million (or, as we recommend, $5 million) in redemptions across multiple accounts, particularly if those accounts are of different types (e.g., a retail brokerage account, a 529 college savings account, and a 401(k) employer-sponsored retirement account). While we recognize that this allows investors an opportunity to "game" the system by opening multiple accounts, we share the Commission's view that virtually any distinction between institutional and retail investors could potentially lead to "gaming behavior." We believe that very few investors will want to go through the trouble of opening and managing multiple accounts for that purpose."
It adds, "3. We recommend that municipal (tax-exempt) money market funds be exempted from the floating NAV proposal. Our data illustrates that owners of municipal money market funds are overwhelmingly retail investors and their past behavior in times of market stress indicates there is less risk of a run in these funds. Municipal money market funds are also much more liquid than prime funds, and data shows that even at the height of the 2008 financial crisis, these funds were exceptionally resilient. Moreover, municipal funds are home to only about 10% of the assets under management across all money market funds. We do not believe that municipal funds pose a systemic risk."
Schwab writes, "4. We request that the rule confirm the treatment of registered investment advisers in the context of the definition of "retail" and "institutional" investor. Investment advisers have discretion to trade on behalf of their clients, and most advisers bundle the trades of their underlying clients into a single trade. Investment advisers are neither shareholders of record nor beneficial owners and, therefore, under the proposed rule would not be subject to the proposed redemption limit. However, investment advisers also are not "omnibus account holders," as defined in the proposed rule, and therefore are not expressly exempt from that limit."
Later they say, "6. We recommend that the tax issues identified by the Commission in its proposal be resolved by the appropriate regulator prior to the rule taking effect. We support exempting shareholders of a floating NAV money market fund from being required to report gains and losses unless the gains or losses exceed 50 basis points. 7. While generally supporting the Commission's proposed reforms to money market fund `diversification requirements and the proposed enhancements to disclosure, Schwab has a number of recommendations for changes to these areas of the proposal. We oppose the proposed enhanced stress-testing requirements, because we believe that they will be difficult to comply with and provide little added benefit for understanding the risks in a money market fund."
Chandoha adds, "Finally, it is critically important to observe that Schwab has expended considerable effort attempting to determine the costs of implementing the proposed rule and has concluded that the Commission has vastly underestimated those costs in its analysis. We believe the costs are so significant as to warrant careful consideration by the Commission of whether those costs outweigh the benefits of the proposed rule. The Commission should consider not only the implementation costs that each industry participant will incur to modify its systems and procedures to comply with the rule, but also the larger repercussions the proposed changes to the money market fund industry will have on the broader financial system."
Schwab closes its "Executive Summary" by saying, "The proposed rule, even if the Commission were to adopt every one of Schwab's recommendations for modifications, could still have an enormous impact on individual investors, on money market funds generally, on the stability of the financial system and on the economy as a whole. We urge the Commission to consider and evaluate the unintended consequences before a final rule is issued. We believe, for example, that if investors flee prime funds for government funds during a transition to a new regulatory regime, this could spark the kind of systemically-risky run that the rules themselves are intended to prevent. And we question whether there is adequate capacity in non-prime money market funds and other types of cash-management products to absorb the potential outflows from prime money market funds that will result from the changes contemplated by the Commission in its proposed rule. We also believe that the proposal has the potential to transfer risk to other parts of the financial system by increasing the amount of assets in either less-regulated products or in bank products. The ramifications of what amounts to a fundamental overhaul of a $2.6 trillion industry need to be carefully considered by the Commission before its members vote for final approval of this rule."
