As we await the crush of last-minute SEC MMF Reform Proposal Comment Letters (they're due by the end of Tuesday), we excerpt from another of the recent substantial postings, this one from Barbara Novick, Vice Chairman, and Richard Hoerner, CFA, Managing Director, Head of Global Cash Management, BlackRock. The 23-page comment says, "BlackRock, Inc. ("BlackRock") is pleased to have the opportunity to provide comments to the Securities and Exchange Commission the "Commission") on the proposals for Money Market Fund Reform (the "Proposed Rule"). We commend the Commission for issuing a thoughtful set of proposals that address many of the concerns raised by us and other market participants in the money market fund ("MMF") reform debate. As outlined in the Proposed Rule, several other critical issues need to be considered and addressed prior to adoption of any final rules. Our letter identifies some of the challenges associated with the proposed structural changes and recommends potential solutions."
The letter explains, "BlackRock and its predecessor companies have been involved in the management of MMFs since 1973, and today, BlackRock manages approximately $192.6 billion (as of June 30, 2013) in Rule 2a-7 MMF assets regulated by the Commission. BlackRock also manages substantial cash management assets in bank collective funds regulated by the Office of the Comptroller of the Currency and in Undertakings for Collective Investment in Transferable Securities products regulated by the European Securities and Markets Authority. Our success in building this business came not because we always offer the highest yield; we have grown because we have earned our clients' trust through multiple interest rate cycles and a wide variety of market events. We believe cash management is a distinct investment category, different from other fixed income strategies. We understand the importance of putting safety and liquidity first, not as a marketing message, but as the foundation of our investment philosophy."
Novick and Hoerner continue, "The Commission and the industry have struggled to find the best way to strengthen the regulatory structure of MMFs since the financial crisis of 2008 and the historic "breaking of the buck" by the Reserve Primary Fund. We and our clients remain immensely grateful for the work of the Commission and various other Government agencies during and following the financial crisis in 2008. The swift, decisive and collective actions taken by multiple agencies were essential in restoring confidence and order to the markets. After the 2008 crisis, we and others in the industry worked collaboratively with the Commission to modify Rule 2a-7 under the Investment Company Act of 1940, as amended (the "Investment Company Act"), to enhance the liquidity and safety of MMFs; the result was the implementation of reforms in 2010 (referred to herein as the "2010 MMF Reforms") that imposed tighter restrictions on MMFs' portfolio maturity, credit quality and liquidity guidelines, expanded portfolio disclosure requirements and increased transparency to investors. Furthermore, we recognize the benefits of protecting MMF investors and the broader financial system."
They continue, "One of the many challenges in the dialogue around MMF reform subsequent to the 2010 MMF Reforms has been identifying which issues could and should be solved through regulatory reform. We commend the Commission for acknowledging in the Proposed Rule that the key issue to be solved by further MMF reform is "stopping the run" while preserving, as much as possible, the benefits of MMFs. MMFs play a unique role in the economy by providing short-term funding to commercial and municipal borrowers through purchases of commercial paper and other short-term debt while providing short-term investments and liquidity to a broad array of institutional and retail investors. Adopting regulatory reform that focuses on the specific issues of "run risk" while narrowing the scope to the most susceptible funds and preserving the benefits of MMFs is critical."
BlackRock tells us, "From the outset, we endorsed the idea of attempting to solve for systemic risk issues when considering additional reform proposals. In particular, we have focused on the "run risk" and have engaged in this dialogue with regulators, clients and issuers in a serious and constructive manner for several years. In a number of papers and comment letters, we have indicated that any additional reforms that are adopted for MMFs should provide a mechanism for halting mass client redemptions while preserving the benefits of MMFs as both a liquidity management tool for investors and as a critical source of short term funding in the capital markets. In our letter to the Financial Stability Oversight Council dated December 13, 2012, we explicitly explored both floating net asset value ("NAV") and standby liquidity fees and gates, each of which present challenges but warrant serious consideration."
They add, "This letter focuses on four key aspects of the Proposed Rule: The benefits and challenges of the structural approaches in the Proposed Rule; An exemption for all Municipal MMFs; Defining retail and institutional clients; and A series of technical operational issues. Our discussion and analysis addresses each of these aspects while keeping in mind the primary goal of preserving the benefits of MMFs and the functioning of the short term funding markets while providing a mechanism for managing potential mass redemptions in a MMF. BlackRock supports a number of the proposals in the Proposed Rule including: Focusing on Prime MMFs for the Floating Net Asset Value ("FNAV") proposal, while exempting Government MMFs; Proposing standby liquidity fees and gates as a standalone proposal for consideration; Increasing transparency to investors through MMF portfolio information disclosures; and Increasing stress testing for funds.
The letter says, "We continue to believe, however, that the following challenges remain with the Proposed Rule: The combined structural proposal, requiring FNAV and standby liquidity fees and gates, is not workable for investors; The focus of any final rule (FNAV or standby liquidity fees and gates) should be only on Prime MMFs; All Municipal MMFs should be exempted like Government MMFs; Ten basis point rounding should be used by FNAV MMFs; and The definition of "retail" funds as proposed is not adequate and needs to be redefined. In each section, we provide recommendations to address these challenges that we believe will make the proposals in the Proposed Rule more palatable to investors, thus better preserving the benefits of the funds for both investors and borrowers."
BlackRock also comments on the floating NAV, "We don't believe that an FNAV MMF would decrease the incentive for investors to redeem shares in times of stress, nor do we believe that the additional transparency, if any, that a floating NAV would provide, would limit runs. In our experience, clients decide to redeem from a MMF in times of crisis based on their assessment of the quality of assets, duration of assets and liquidity levels and their assessment of whether those are deteriorating in an unusually dramatic way."
On the combination of floating NAV and fees/gates, they write, "If one of the stated objectives of the further reforms is to preserve the benefits of MMFs and have a viable product for investors to use, this proposal is not workable. A rational investor would not purchase a MMF, with the strict portfolio requirements of Rule 2a-7, that has both a floating NAV and has the prospect of a liquidity fee and gate. As we have already noted in this letter, certain investors require a stable NAV in a MMF product. Other investors need continuous access to their funds and cannot use a MMF that has gates and fees. As a result, if both of these proposals are combined and required in a single fund, the number of investors that would be eliminated from using the product is too great—leaving only a small number who would find this product viable."
BlackRock also adds, "If the Commission exempts "retail" funds from certain of the proposals, we believe that "retail" should be defined by the type of investor investing the funds. Retail MMFs should be limited to investors with a social security number, and participant-directed retirement plans. This definition creates a front-end qualifying test that is operationally easier to implement as the test is only performed once when an investor opens an account or is given access to a fund. The current proposed definition creates ongoing operational testing and additional, unnecessary costs for monitoring.... Defining retail money market funds by limits on redemptions is operationally difficult and could lead to a two-tiered approach to MMFs that may lead to gaming behavior by investors. If the simpler front-end approach is adopted, this potential gaming behavior would be eliminated."
Finally, they add, "In conclusion, we are supportive of further MMF reform that seeks to mitigate "run risk" and continues to preserve the benefits of the product for both investors and issuers. To that end, we make the following recommendations to the Commission: Choose one of the proposed structural reforms in the Proposed Rule: either FNAV or the liquidity fees and gates; Resolve cross-agency issues and provide clear guidance simultaneous to finalizing a new 2a-7 rule; Focus only on Prime MMFs and clearly exempt Government and Municipal MMFs from further structural reforms; Retail MMFs should be limited to investors with a social security number, and participant-directed retirement plans; Mandate increased disclosure to investors; Allow for amortization cost accounting for funds that are exempt from FNAV provided the MMF each day calculates its mark-to-market share price using basis point rounding and publicly discloses it; and, Allow for sufficient time to finalize guidance, address operational issues and educate end investors."
