Federated Investors appears to have beaten Schwab (see yesterday's "News") as the first major fund complex to weigh in on the SEC's "Comments on Proposed Rule: Money Market Fund Reform; Amendments to Form PF" web page. (There is normally a one-day lag for the SEC to post the letters, so we should see Schwab's full letter today.) The first of what will likely be a number of weighty treatises, is labelled, "John D. Hawke, Jr., Arnold and Porter, LLP on behalf of Federated Investors. It says, "We are writing on behalf of our client, Federated Investors, Inc. and its subsidiaries ("Federated"), to provide initial comments in response to the Securities and Exchange Commission's (the "Commission's") proposed rules on money market fund ("MMF") reform (the "Release"). We appreciate the Commission's work in re-claiming jurisdiction over MMF reform efforts from the Financial Stability Oversight Council ("FSOC"), which has attempted to usurp the Commission's jurisdiction through its legally questionable initiation of the Dodd-Frank Section 120 process. We also appreciate the efforts of the Commissioners and staff in developing a Release that explains the Commission's goals and that acknowledges what the Commission knows and does not know about the impact of the alternatives proposed. This is an initial letter on behalf of Federated, intended to inform the Commission of our overall analysis while we and others continue to develop more detailed comments responsive to specific issues raised by the Release. Federated will be filing additional comment letters during the next few days."
The letter explains, "We note that the Release is 698 pages long and includes well over 1000 questions and requests for data. In view of the very large number of questions posed in the Release and the amount and complexity of the cost data and other information requested, we renew our previously filed request that the Commission extend the comment period so that Federated and others may complete efforts to assemble data to respond more fully to the questions and information requests in the Release. Federated has almost 40 years of experience in the business of managing MMFs and, during that period, has participated actively in the money market as it has developed over the years. Through its MMFs and related services, Federated has served the cash management and investment needs of millions of individual and institutional investors of all sizes, including thousands of intermediaries who, through omnibus accounts, provide Federated-sponsored MMFs to millions of their individual and institutional investors."
Hawke writes, "Federated believes MMFs do not require dramatic regulatory change that would restructure the product and undermine its utility for investors. The 2010 amendments to Rule 2a-7, augmented by industry practices, have made MMFs substantially more resilient and transparent. We believe any further MMF reform should be designed to preserve the utility of MMFs for investors and be targeted to address very narrow circumstances, such as the type of once-in-a generation scenario experienced in 2008, or where one or more individual MMFs experiences a large credit event or other event likely to cause an unusual rush to redeem. Based upon the Commission's own statements, these types of circumstances, which have the potential to result in material dilution or unfair treatment of shareholders or a risk of contagion for the broader financial markets, appear to be the Commission's concerns as well. However, as discussed briefly below and as will be discussed in more detail in forthcoming comments:"
He continues, "1) Imposing a floating NAV requirement on a large subset of MMFs, as proposed in "Alternative One," would destroy key operational features that make MMFs useful to investors and would be enormously costly to investors and the economy, without furthering the Commission's goal of preventing or reducing the risk of large shareholder redemptions in a crisis. Indeed, it appears that the primary purpose of the floating NAV proposal is to increase awareness among sophisticated institutional investors in prime MMFs of trivial fluctuations in estimated "market-based" valuations of the MMFs' portfolios by forcing them to transact in prime MMF shares at these minutely fluctuating valuations. The resulting operational, accounting, tax, legal and other burdens associated with a floating NAV, which have not been addressed in the current proposal, will drive away users and lead to a dramatic shrinkage of MMFs. The delays in transactions resulting from the requirement for "market-based" pricing will further undermine the utility of MMFs and introduce new risks. These issues would need to be completely resolved and the resolutions implemented -- not merely discussed -- before a floating NAV could be imposed, unless the regulatory goal is to eliminate, or dramatically shrink investors' use of, MMFs."
Federated's letter tells us, "2) The proposed exemptions in Alternative One do not alleviate the disruptive effects of the proposal. For example, the proposed "retail" exemption from the floating NAV requirement for MMFs that limits redemptions to no more than $1 million per day, which is included in Alternative One to narrow its application and thereby lessen its impact, creates its own set of complex operational and compliance problems that would make the exemption difficult or impossible to implement. The exemption for government MMFs, intended to provide investors with a stable value option, also is problematic, as further discussed below. Thus, Alternative One, if adopted, will have an even broader practical impact than may have been intended by the Commission. Meeting the requirements of the exemptions would impose restrictions and burdens upon a MMF and its shareholders every day, rather than only in times of economic uncertainty. These restrictions would limit MMF shareholders' access to their liquid assets and disrupt their normal use of MMFs on a daily basis."
It states, "3) The elimination of the amortized cost method of accounting to price shares of stable value MMFs, and its replacement with the "penny rounding" method, would be very costly to implement and would cause severe operational problems for MMFs, create settlement bottlenecks and delays for investors and intermediaries, introduce new risks from potential technology breakdowns and systems failures at pricing vendors, and potentially impose systemic risks on payment systems and markets. For retail and government MMFs, these costs would be incurred to show minute, irrelevant fluctuations in "market-based" estimates of MMF share NAVs that are rounded to the nearest penny, thus adding immense costs to get to a result that is identical to the current calculation -- $1.00. Disclosure of an amortized cost method MMF's shadow price would inform shareholders of the same minute fluctuations in the estimated value of its portfolio as disclosure of the unrounded penny rounding price, for a fraction of the cost and less risk and inconvenience for shareholders."
Hawke adds, "4) While Federated does not believe that further structural MMF reforms are necessary, Alternative Two is the only current alternative that would address the policy concerns identified by the Commission, while preserving the utility of MMFs for investors and the short-term financing provided to corporate and governmental issuers. It provides tools MMF directors may use if necessary to protect investors from material dilution and prevent "fire sales" of MMF portfolio holdings if a MMF comes under extraordinary redemption pressure."
He writes, "The Commission needs to make critical modifications to Alternative Two, however, in order for these additional tools to operate effectively and to minimize their potential impact on shareholders. Specifically, Alternative Two should be modified to (a) permit directors to implement a liquidity fee or suspend redemptions temporarily before the end of the business day, so the board can respond whenever the directors find that unimpeded redemptions could result in material dilution or other unfair results to investors and shareholders, (b) reduce the maximum period that redemptions may be suspended to ten calendar days, and subject liquidity fees to the same limitation, and (c) include tax exempt funds in the exemption proposed in paragraph (c)(2)(iii). Federated also urges the Commission to make it clear that the purpose of the provision is to protect, and not to penalize, shareholders and that it therefore is to be used only in extreme circumstances that could result in unfair results for shareholders."
Federated's letter continues, "5) The direct and indirect costs of implementing the proposals -- particularly the floating NAV imposed under Alternative One and the elimination of the amortized cost method of valuing shares contained in both Alternatives -- on investors, on corporate, state and local government issuers, on financial institutions, and on the economy, will be staggering, with no offsetting benefits. A final rule containing these elements cannot meet the cost/benefit and statutory considerations required for a Commission rulemaking, particularly when there are alternatives that meet the Commission's goals with far less disruption and costs. A targeted provision authorizing temporary suspension of redemptions, under the circumstances described above, would fulfill the Commission's statutory obligations."
They also say, "6) The disclosure and reporting proposals in the Release contain many useful elements, but also other elements that would be excessively costly and burdensome without a corresponding benefit to investors or systemic stability. The Commission's definition of sponsor financial support is overly broad and would capture many routine transactions that are not indicative of stress. Daily disclosure of current weekly liquid assets and flows in conjunction with Alternative Two has the potential to be destabilizing, because it could result in reactionary redemptions that are not based on the MMF's true liquidity levels. The lot level reporting contemplated under Form N-MFP would be a wasteful, inefficient and inequitable means of evaluating pricing in the money markets, and could be used by other market participants to trade to their advantage and the MMF's disadvantage. These proposals must be more carefully tailored before any final rules are adopted."
Federated continues, "7) While aggregating parents and subsidiaries for purposes of diversification reflects a practice already followed by Federated and many other MMF managers, the other proposed changes to the diversification requirements would seriously impair the operations of MMFs or create arbitrary restrictions without contributing to the goal of investor protection. Although clarification of the current stress testing requirements would be helpful to MMFs and their directors, the proposed wholesale expansion of stress testing would be a waste of resources and of the directors' limited time."
They add, "8) Regardless of what reforms the Commission decides to impose on prime MMFs, tax exempt funds should (a) be excluded from both Alternative One and Alternative Two, because tax exempt funds resemble government MMFs more closely than prime MMFs, (b) retain the ability to rely on the so-called "25% basket" when diversifying guarantees and demand features, which is essential to their operations, and (c) remain exempt from the 10% daily liquid asset requirement."
Finally, the Federated letter comments, "9) The proposed amendments, if adopted, will not directly affect LGIPs that operate within the governmental fund exclusion in Section 2(b) of the Investment Company Act. Adoption of the proposals as currently drafted (particularly Alternative One) would, however, impose a large burden on state and local governments and the Government Accounting Standards Board ("GASB") to address and resolve the relationship between the amendments and the use of the amortized cost method of accounting by external pools that operate as "2a7-like" LGIPs. We do not anticipate that the end result would be a transformation of LGIPs to floating NAV funds."
