Though many have moved on to speculating about a possible technical default of Treasury debt in late October, we continue to mine the Comment letters on the SEC's Money Market Fund Reform Proposals. One of the major fund providers' missives that we haven't quoted yet is from F. William McNabb III, Chairman and Chief Executive Officer, Vanguard. (McNabb was also just elected the new Chairman of the Investment Company Institute; see our "People" news.) McNabb writes, "We appreciate the opportunity to provide our comments to the Securities and Exchange Commission (the "Commission" or "SEC") on the thoughtful alternatives for money market mutual fund reform set forth in the Proposal. Vanguard is an SEC-registered investment adviser that has managed money market mutual funds ("MMFs") since 1981. On behalf of our shareholders, who currently invest approximately $205 billion in our MMFs, we welcome the opportunity to work with the Commission to strengthen the money market industry for the benefit and further protection of investors."
He continues, "Over the past five years, Vanguard has been actively involved in researching and evaluating potential MMF reform options. We were strong proponents of the SEC's amendments to Rule 2a-7 that were implemented in 2010. We believe these changes positioned many MMFs to be self-provisioning for liquidity, thereby reducing the likelihood that a future systemic market disruption would impede the ability of the funds to satisfy shareholder redemptions. We believe regulators could do more to strengthen money markets for investors and have previously expressed our support for solutions that were narrowly tailored to the funds most likely to experience destabilizing redemptions. We encouraged regulators to seek a reform solution that would continue to allow investors, particularly retail investors, the discretion to choose MMFs for their cash management needs."
Vanguard tells the SEC, "As the financial crisis of 2008 demonstrated, institutional prime MMFs have an increased risk of experiencing disruptive shareholder redemptions, which can impair a fund's liquidity and its ability to maintain a stable NAV. The primary reason for this increased risk is the composition of an institutional prime MMF's shareholder base. An institutional prime MMF is likely to have a concentrated shareholder base of professional investors who own a significant portion of the fund. When these shareholders redeem their shares at the same time, a fund's liquidity can be severely impaired and its ability to maintain a stable NAV may be compromised."
They explain, "We believe the SEC's Proposal appropriately identifies institutional prime MMFs as the funds most likely to contribute to widespread financial market stress, as these funds have proven to be more susceptible to significant redemptions. The Proposal also acknowledges that retail prime MMFs did not experience disruptive redemptions during the financial crisis of 2008 and, therefore, recommends that such funds retain the stable NAV. This finding is consistent with our experience in managing retail MMFs over the past 32 years -- retail investors do not cause MMFs to experience sudden and disruptive redemptions. For these reasons, Vanguard encourages the Commission to adopt a floating NAV for institutional prime MMFs ("Option I")."
McNabb says, "Part I of this letter provides a summary of our comments. Part II discusses our detailed comments on the proposed structural reforms for MMFs. Part III provides the reasons to exclude municipal (tax-exempt) MMFs from further structural reforms. Part IV discusses our general support for many of the proposed disclosure and diversification reforms for MMFs, but cautions against certain changes that would not be in the best interest of investors."
The letter's "Executive Summary" states, "We have summarized our key points below, each of which is discussed in greater detail in Parts II-IV of this letter: 1. We support Option I to require floating NAVs for institutional prime MMFs and stable NAVs for retail prime MMFs. Option I provides an appropriate balance between targeting the funds that are most likely to experience disruptive redemptions and preserving prime MMFs for the retail investor. In our experience, the stable NAV is a very highly valued feature for those retail investors who continue to invest in retail MMFs to manage their cash, pay their bills, and diversify their portfolios, despite negligible yields."
It continues, "2. We believe that the daily redemption limit for investors in a stable NAV prime MMF should be raised from $1 million to $3 million. If the daily redemption limit is not raised, we believe certain exceptions would be necessary to make the $1 million daily redemption limit less disruptive to ordinary retail shareholder activity. Regardless of the dollar limit on redemptions, however, we believe redemptions in retirement plan accounts and other tax-deferred savings accounts should be deemed "retail" activity."
Vanguard adds, "3. We urge the SEC to treat municipal MMFs like government and Treasury MMFs and exclude such funds from further structural reforms. We believe that the Proposal correctly concludes that government and Treasury MMFs do not require structural reforms. These funds are unlikely to have disruptive redemptions that could contribute to wider financial stress, given the higher credit quality and liquidity of the securities held by these funds. We believe the Proposal mistakenly concludes, however, that municipal MMFs warrant the same reforms as prime MMFs, without any evidence that such funds have a history of destabilizing, widespread redemptions. We believe the Proposal is significantly flawed for its failure to show how shareholder activity in municipal MMFs may result in disruptive redemptions that impair a fund's liquidity, or transmit systemic risk."
They write, "4. We do not support the combination of Option I with the additional structural reforms of liquidity fees and redemption gates ("Option II"), nor do we support having both structural reforms available. We believe combined structural reforms are unnecessary for the SEC to achieve its objective of preventing disruptive redemptions and could serve to make MMFs an unattractive cash management vehicle for investors, particularly those who hold MMFs in a retirement plan or other tax-deferred savings account. We believe having both structural reforms available may be confusing for investors and could promote regulatory arbitrage."
Finally, Vanguard says, "5. We largely support the proposed disclosure and diversification reforms; however, we strongly oppose the proposal to eliminate a fund's ability to hold up to 25% of its assets in securities subject to a guarantee or demand feature from a single institution (the "25% basket"). We support disclosure of a fund's liquidity levels and market-value NAV, which can help investors better understand the liquidity and stability of their MMFs. We also support the proposal to require fund advisors to aggregate exposures to affiliated credit sources, as it is consistent with the spirit of Rule 2a-7's diversification requirements. We oppose, however, eliminating the 25% basket, which can be useful for municipal MMFs as it provides the flexibility to obtain greater exposure to a strong credit source in times when high credit quality may be scarce. Eliminating such flexibility would be an SEC mandate for funds to hold lower-quality securities."
