Given the increasing volumes of Comment Letters on the SEC's "Proposed Rule: Money Market Fund Reform" starting to appear, Crane Data will temporarily increase the frequency of our "News" coverage (normally updated at night for each business day). This weekend we feature money fund nemesis Eric Rosengren, President of the Federal Reserve Bank of Boston who says, "I am writing on behalf of the 12 Federal Reserve Bank Presidents, all of whom are signatories to this comment letter. We appreciate the opportunity to provide comments on the Securities and Exchange Commission's ("SEC") Money Market Fund Reform; Amendments to Form PF release (the "Proposal") issued on June 5, 2013. The SEC took a very important step towards Money Market Mutual Fund ("MMMF") reform by issuing this Proposal, which includes two principal reform alternatives: (i) a floating net asset value per share ("NAV") requirement for prime institutional MMMFs, and (ii) stand-by liquidity fees and temporary redemption gates for non-government MMMFs that breach a pre-determined trigger."
Rosengren continues, "We applaud the SEC Commissioners' and staff's continued efforts in this area. We believe the SEC is well-positioned to implement meaningful reforms that not only better protect investors but also address the risks to financial stability posed by MMMFs. In our previous comment letter to the Financial Stability Oversight Council ("FSOC"), we noted that more than one of the FSOC's proposed alternatives could address these risks. Accordingly, we welcome the inclusion of the floating NAV alternative in the current Proposal. We strongly support this alternative, especially if certain enhancements are undertaken. However, we do not support the stand-by liquidity fees and temporary redemption gates alternative, as these mechanisms do not meaningfully reduce the risks that MMMFs pose to financial stability."
He tells the SEC, "We briefly discuss the risks to financial stability posed by MMMFs, particularly prime MMMFs, in Section I. Section II offers observations on the floating NAV alternative, including several suggestions for increasing its effectiveness. Section III outlines our concerns with the stand-by liquidity fees and temporary redemption gates alternative. Finally, Section IV discusses the proposed enhancements to portfolio disclosure and diversification requirements."
Rosengren explains, "MMMFs serve an important function in the short-term credit markets by acting as intermediaries between investors seeking a highly liquid, diversified fixed income investment, and a variety of corporate and government entities seeking short-term funding. As a result, disruptions in MMMFs' ability to function as credit intermediaries can have a significant negative impact on the broader financial system. On numerous occasions over the past few years, government officials and academics have discussed the risks that MMMFs pose to financial stability. These risks were also highlighted in the FSOC's 2013 annual report. As currently structured, MMMFs permit redemptions and purchases at a constant NAV (generally $1.00), take credit risk, and have no mechanism to absorb losses. Investors therefore have an incentive to "run" from a fund when they perceive its market-based NAV to be less than its transaction (or reported) NAV. The risks associated with this structure were evident in September 2008, when investors fled from prime MMMFs into government MMMFs, exacerbating disruptions in the short-term credit markets."
He says, "The U.S. Government used multiple approaches to restore liquidity to credit markets, some of which targeted MMMFs directly and many of which indirectly helped to restore MMMFs to normal functioning. In 2010, the SEC amended Rule 2a-7, enacting several new or enhanced requirements aimed at strengthening the stability of MMMFs. Despite these important changes, MMMFs remain a significant risk to financial stability. Indeed, a November 2012 study by SEC staff found that the Commission's 2010 reforms were "not sufficient to address the incentive to redeem when credit losses are expected to cause funds' portfolios to lose value or when the short-term financing markets ... come under stress." As such, we strongly urge the SEC to proceed with additional reforms."
The Fed Presidents' letter continues, "We agree with the SEC's position that a floating NAV requirement, if properly implemented, could recalibrate investors' perceptions of the risks inherent in a fund by "making gains and losses a more regularly observable occurrence." Because a constant NAV MMMF generally draws risk-averse investors, it is likely that given an appropriate transition period, the investor base would either change or become more tolerant of NAV fluctuations, lowering the risk of destabilizing runs. Indeed, a floating NAV fund may actually attract investors seeking a higher yield for their cash investment during times of broad financial market stress. Further, the floating NAV alternative reduces investors' incentives to redeem by tempering the "cliff effect" associated with a fund "breaking the buck." The first mover advantage is reduced because redemptions would be processed at a NAV reflective of the market-based value of the fund's underlying securities."
They explain, "While we are supportive of this alternative, we have identified several issues that should be addressed to further enhance its efficacy.... The effectiveness of a floating NAV option depends on funds' ability to properly value money market instruments. To the extent that investors believe that a fund's "true" market-based NAV is below its reported NAV, they will be incented to redeem before other investors. One often-mentioned challenge to valuing non-government related money market instruments is the infrequency of secondary market transactions for such instruments. Even under the current fixed NAV regime, however, funds are able to value such instruments using a combination of matrix pricing and model-based valuation methodologies. As such, MMMFs subject to the floating NAV requirement would also be able to value their portfolio securities on a daily basis for the purposes of computing a transaction NAV. While the resulting prices may serve as a natural starting point for market-based NAV computations required under this alternative, we encourage the SEC to continue its efforts to increase the transparency of fixed income markets to further enhance price discovery."
Rosengren also comments, "On November 19, 2012, the FSOC presented three reform alternatives as part of its Proposed Recommendations Regarding Money Market Mutual Fund Reform. In a comment letter submitted to the FSOC on behalf of the Presidents of the 12 Federal Reserve Banks on February 12, 2013, we noted that all three alternatives had "the potential to increase the resiliency of MMFs and reduce their susceptibility to runs." Of these three presented alternatives, the SEC has chosen to present the floating NAV alternative in their current proposal. Accordingly, we continue to fully support this alternative and urge the SEC to pursue this option and consider ways in which the benefits of a floating NAV could be enhanced, such as continuing to monitor funds' procedures for determining that amortized cost accurately reflects fair value and eliminating the "retail" exemption."
Finally, he adds, "We continue to believe that the liquidity fees and temporary redemption gates alternative does not constitute meaningful reform and that this alternative bears many similarities to the status quo. Investors will still have an incentive to be the first to redeem and the price of those early redemptions (before the trigger is breached) may still be inaccurate and unfair to remaining shareholders if such redemptions occur under a fixed NAV regime. We understand that among the many comment letters the SEC will receive on this Proposal, our position supporting the floating NAV alternative may well be in the minority, as it has been throughout this important debate. Indeed, to the extent that the fees and gates alternative resembles the status quo, it would be an attractive option if the only goal were to minimize the costs of adjustment within the MMMF industry. From a financial stability perspective, however, we believe that the floating NAV is the far better choice. We are grateful for the opportunity to comment on this Proposal and, again, applaud the SEC Commissioners and staff for moving forward with this initiative. We welcome the opportunity to elaborate on or further discuss any aspect of this letter."
